Thursday, September 4, 2014

Guest Post: Guarantee Against Loan from Banks and Financial Institutions

[The following post is contributed by Abhishek Bansal and Stuti Bansal, Corporate Professionals, Advisors & Advocates. The authors can be reached at and respectively]

Recently, India saw the enactment of the Companies Act, 2013 (“Act”), replacing the Companies Act, 1956, which governed the incorporation, functioning, transactions and other activities of the companies in India. Witnessing uproar from corporate India, much discussion was seen in the arena of loans and guarantees, e-commerce business, and corporate social responsibility amongst others. This post, while examining the provisions of section 185 of the new Act, throws light specifically on guarantees against loans from banks and financial institutions.

Some background

The provisions of section 185 of the Act, as earlier notified, for the most part, barred granting of any loans, giving of guarantee or providing of any security to the directors or any other person in whom the director is interested; otherwise than for given exemptions. In contrast to the counterpart provisions under the Act of 1956, the section withdrew exemptions with respect to such transactions among private limited companies and transactions between holding and subsidiary companies and also the provision for obtaining approval of the Central Government.

Many corporates filed representations before the Ministry of Corporate Affairs (“Ministry”) requiring clarification on the intent of Section 185 and for making the provisions industry friendly, although the Ministry seemed clear on its intent, citing that it had taken stringent view having regard to the flow of funds from the company to its directors or other person in whom the director is interested. The Companies (Meetings of Board and its Powers) Rules, 2014, legislated under the section, provide for the following exemptions:

- Transactions amongst holding and wholly owned subsidiary company with regard to:

- Any loan made by a holding company to its wholly owned subsidiary company; or

- Any guarantee given or security provided by a holding company in respect of any loan made to its wholly owned subsidiary company and

- Transactions amongst holding and subsidiary company

- Any guarantee given or security provided by a holding company in respect of loan made by any bank or financial institution to its subsidiary Company; wherein such loans are utilized by the subsidiary Company for its principal business activities.

Section 185: A brief discussion

The provisions of Section 185 of Chapter XII of the Act of 2013, which corresponds to Section 295 of the Companies Act, 1956 provides that:

- No company shall, directly or indirectly, advance any loanincluding any loan represented by a book debt, to any of its directors or to any other person in whom the director is interested or give any guarantee or provide any security in connection with any loan taken by him or such other person.

- Exemptions under the section relate to:-

- the giving of any loan to a managing or whole-time director if it is given as a part of the conditions of service extended by the company to all its employees; or pursuant to any scheme approved by the members by a special resolution; or

- a company which in the ordinary course of its business provides loans or gives guarantees or securities for the due repayment of any loan and in respect of such loans an interest is charged at a rate not less than the bank rate declared by the Reserve Bank of India.

- Here, the expression “to any other person in whom director is interested” means—

            - any director of the lending company, or of a company which is its holding company or any partner or relative of any such director;

            - any firm in which any such director or relative is a partner;

            - any private company of which any such director is a director or member;

            - any body corporate at a general meeting of which not less than twenty five per cent of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together; and

            - any body corporate, the Board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company.

It may be said in terms of Section 185 of the Act that even a promoter company cannot give loan or guarantee against the loan taken by such company, where the directors of such company and its promoter company are common or if there is any other person in such company in whom the director(s) of the promoter company is/are interested. The only exception is given in favour of the holding company which can give guarantee in respect of the loan made by any Bank or Financial Institution only and not from any other entity and the loan amount is utilized by the subsidiary for its business activities. In other words, the said exemption would be available if any only if the loan is made by a bank of financial institution and not by any other body corporate or individual. Thus, understanding the meaning of a ‘bank and financial institution’ becomes crucial here.

Meaning of “Bank”

A “Banking Company” is defined under the Companies Act, 2013, as a Banking Company as defined in clause (c) of Section 5 of Banking Regulation Act 1949.

Section 5(c) of Banking Regulation Act, 1949 defines ‘Banking Company’ as any company which transacts the business of banking in India.

Further, in terms of Section 7(1) of the Banking Regulation Act, 1949, no company other than a banking company shall use a part of its name or in connection with its business any of the words "bank", "banker" or "banking" and no company shall carry on the business of banking in India unless it uses a part of its name at least one of such words.

Meaning of “Financial Institution”

As per the Companies Act, 2013, “financial institution” includes a scheduled bank and any other financial institution defined or notified under the RBI Act, 1934 (2 of 1934). A list of scheduled banks has been provided under Schedule II of the RBI Act, 1934.

Further, “Financial Institution” has been defined under section 45I (c) of RBI Act, 1934 as any non- banking institution. “Non-Banking Institution” means a company, corporation or cooperative society under section 45I(e) of RBI Act, 1934. “Corporation” under Section 45I(b) of RBI Act means, a corporation incorporated by an Act of any legislature.

Thus, it may be said that where the promoter company of a company is not a holding company of such company, it cannot give guarantee for the loan taken by such company. However, if the promoter company of a company is a holding company of such company, it may give guarantee for the loan taken from a bank and even a foreign bank provided such foreign bank falls under schedule II of the RBI Act, 1934. However, this must not be the intention of law, since the loan from any of the foreign banks is coming through the regulated channel. For such cases, representations may be filed before the Ministry of Corporate Affairs seeking clarification.

It is interesting to note that, and also worthwhile to keep a note that, in the event of default/ non-compliance, not only the provider of guarantee but also such company (borrower) who is taking loan is liable for penal provisions under sub-section (2) of Section 185 of the Act.

- Abhishek Bansal & Stuti Bansal

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