LOANS AND INVESTMENT BY THE COMPANY

SECTION 186: LOANS AND INVESTMENT BY COMPANY

Section 186 of the Act, applicable to both public and private companies, deals with the provisions relating to ‘Loan and Investment’ by a company. In addition, Rules 11, 12 and 13 also contain provisions governing the making of loans and investments, giving of guarantees and providing of securities by a company. These provisions are discussed as under:

(i) Investment permitted through two layers of Investment Companies [Section 186(1)]: A company, unless otherwise prescribed, is not permitted to make investment through more than two layers of investment companies. Placing of such a restriction helps in preventing diversion of funds. It is a common experience that the funds can be more flagrantly diverted if a company invests through a number of step-down subsidiaries.

Note: It is clarified by way of clause (a) of Explanation that the expression “investment company” means a company whose principal business is the acquisition of shares, debentures or other securities. Further, a company will be deemed to be principally engaged in the business of acquisition of shares, debentures or other securities, if its assets in the form of investment in shares, debentures or other securities constitute not less than fifty per cent of its total assets, or if its income derived from investment business constitutes not
less than fifty per cent as a proportion of its gross income.

Exception to the rule of two layers: In the following cases, the provisions of Section 186(1) shall not apply i.e. rule of ‘two layers’ shall not be applicable:

(a)  Acquisition of a company incorporated outside India: If a company acquires any other company incorporated in a country outside India and if such other company has investment subsidiaries beyond two layers as per the laws of such country, the rule of ‘two layers’ shall not prevent this kind of acquisition.

(b)  Subsidiary from having an investment subsidiary: Again, the rule of ‘two layers’ shall not prevent a subsidiary company from having any investment subsidiary for the purposes of meeting the requirements under any law or under any rule or regulation framed under any law for the time being in force.


(ii) Imposition of limit on the quantum of loan and investment made by a company: According to Section 186 (2), following types of transactions (both direct and indirect) shall be subject to the specified limit as depicted in the diagram:

(a) giving of loan to any person or other body corporate;

(b) giving of guarantee or provision of security in connection with a loan to any other body corporate or person;

(c) acquiring by way of subscription, purchase or otherwise the securities of any other body corporate.

Explanation: For the purposes of Section 186 (2), the word "person" does not include any individual who is in the employment of the company.
 

The MCA has clarified that loans and/or advances made by the companies to their employees, other than the managing or whole-time directors (which is governed by Section 185) are not governed by the requirements of Section 186.

This clarification will, however, be applicable if such loans/advances to employees are in accordance with the conditions of service applicable to employees and are also in accordance with the remuneration policy, in cases where such policy is required to be formulated.

[General Circular No. 04/2015, dated 10/3/2015.]

In other words, a company is permitted to enter into transactions of giving loan or guarantee or providing security or acquiring of securities (i.e. shares, debentures, etc.), in the aggregate, upto 60% of its paid-up share capital (both equity and preference), free reserves and securities premium or 100% of its free reserves and securities premium, whichever is more.

(iii) Prior approval by a special resolution for exceeding limit [Section 186(3)]: Where the aggregate of the loans and investment so far made, the amount for which guarantee or security so far provided to or in all other bodies corporate along with the investment, loan, guarantee or security proposed to be made or given by the Board, exceed the limits specified under Section 186 (2), no investment or loan shall be made or guarantee shall be given or security shall be provided unless previously authorized by a special resolution passed in a
general meeting.

Note 1: In case the provisions of Section 110 of the Act apply to the company which is considering giving of loans or extending guarantee or providing security in excess of the limit specified under Section 186 (3), it shall pass the special resolution containing such item of business by means of voting through postal ballot.
Note 2: A One Person Company and other companies having members up to two hundred are not required to transact any business through postal ballot.

Disclosure of total amount in resolution in respect of loan or guarantee or security or acquisition: As per the Rule 13 of the Companies (Meetings of Board and its Powers) Rules, 2014,a resolution passed at a general meeting in terms of Section 186 (3) to give any loan or guarantee or investment or providing any security or the acquisition under Section 186 (2) shall specify the total amount up to which the Board of Directors are authorized to give such loan or guarantee, to provide such security or make such acquisition.

Exemption from special resolution [First Proviso to Section 186 (3) and Rule 11 (1)]: However, where a loan or guarantee is given or where a security has been provided by a company to its wholly owned subsidiary company or a joint venture company, or acquisition is made by a holding company, by way of subscription, purchase or otherwise of, the securities of its wholly owned subsidiary company, the requirement of passing a special resolution as required by Section 186 (3) shall not apply.

Disclosure in financial statement [Second Proviso to Section 186 (3) and Proviso to Rule 11 (1)]: In case of exemption from special resolution, the company shall disclose the details of such loans or guarantee or security or acquisition in the financial statement as provided under Section 186 (4).

(iv) Disclosure to members [Section 186(4) and Proviso to Rule 13]: The company shall make full disclosure to the members as depicted in the following diagram:

(v) Unanimous resolution of the Board [Section 186(5)]:

• Any investment shall be made or loan or guarantee or security given by the company only after when the resolution sanctioning it is passed at a meeting of the Board with the consent of all the directors present at the meeting.
• The prior approval of the public financial institution concerned where any term loan is subsisting shall also be obtained.
  
  Circumstances when no prior approval of public financial institution (PFI) is required [Proviso to Section 186 (5)]: Prior approval of a public financial institution (PFl)shall not be required where the aggregate of the loans and investments so far made, the amount for which guarantee or security so far provided to or in all other bodies corporate, along with the investments, loans, guarantee or security proposed to be made or given:

The prior approval of the public financial institution concerned where any term loan is subsisting shall also be obtained.

Circumstances when no prior approval of public financial institution (PFI) is required [Proviso to Section 186 (5)}: Prior approval of a public financial institution (PFl)shall not be required where the aggregate of the loans and investments so far made, the amount for which guarantee or security so far provided to or in all other bodies corporate, along with the investments, loans, guarantee or security proposed to be made or given:

(vi) Rate of interest on loan [Section 186 (7)]: A loan under this section shall be given at a rate of interest which is not lower than the prevailing yield of one year, 3 year, 5 year or 10 year Government Security closest to the tenor of the loan.

1. Clarification in respect of Section 186 (7) - Rate of Interest

The MCA has clarified that in cases where effective yield (effective rate of return) on tax free bonds is greater than the prevailing yield of one year, three year, five year or ten year Government Security closest to the tenor of the loan, there is no violation of sub-section (7) of Section 186 of the Companies Act, 2013.[General Circular No. 06/2015, dated 9th April, 2015]

2. Modification in Section 186 (7) in respect of Section 8 Companies

In respect of Section 8 Companies which have not committed a default in filing their financial statements under Section 137 or Annual Return under Section 92 with the Registrar, following proviso shall be inserted in Section 186(7):

‘Provided that nothing contained in this sub-section shall apply to a company in which twenty- six per cent or more of the paid-up share capital is held by the Central Government or one or more State Governments or both, in respect of loans provided by such company for funding Industrial Research and Development projects in furtherance of its objects as stated in its memorandum of association’. [Notification No. GSR 466(E), dated 5-6-2015 as amended by Notification No. GSR 584(E), dated 13-6-2017.]

(vii) No giving of loan, etc., till default in respect of deposits is subsisting [Section 186 (8): A company which is in default in the repayment of any deposits accepted before or after the commencement of the Companies Act, 2013 or in payment of interest thereon, shall not give any loan or give any guarantee or provide any security or make an acquisition till such default is subsisting.

(viii) Non-applicability of Section 186 except sub-section (1) to certain transactions [Section 186 (11)]: Section 186, (except Section 186 (1), shall not apply:

(a) to any loan made, any guarantee given or any security provided or any investment:

« made by a banking company, or an insurance company, or a housing finance company in the ordinary course of its business; or

« made by a company established with the object of and engaged in the business of financing industrial enterprises, or of providing infrastructural facilities;

(b) to any investment—

(i) made by an investment company;

‘Note: The expression “investment company” means a company whose principal business is the acquisition of shares, debentures or other securities and a company will be deemed to be principally engaged in the business of acquisition of shares, debentures or other securities, if its assets in the form of investment in shares, debentures or other securities constitute not less than fifty per cent. of its total assets, or if its income derived from investment business constitutes not less than fifty per cent. as a proportion of its gross income

(ii) made in shares allotted in pursuance of Section 62 (1) (a)[i.e. right shares] or in shares allotted in pursuance of rights issues made by a body corporate;

(iii) made, in respect of investment or lending activities, by a non-banking financial company registered under Chapter III-B of the Reserve Bank of India Act, 1934 and whose principal business is acquisition of securities.

(ix) Restriction on the inter-corporate loans/deposits to be taken by companies registered under Section 12 of SEBI [Section 186 (6) and Rule 11 (3)]: A company registered under Section 12 of the Securities and Exchange Board of India Act, 1992 and covered under such class or classes of companies which may be notified by the Central Government in consultation with the Securities and Exchange Board, shall not take inter-corporate loan or deposits in excess of the limits specified under the regulations applicable to this kind of company, pursuant to which it has obtained certificate of registration from the Securities and Exchange Board of India.

Further, such company shall furnish in its financial statement the details of the loan or deposits.

Note: Section 12 of the SEBI Act, 1992 requires stock broker, sub-broker, share transfer agent, banker to an issue, registrar to an issue, merchant banker, underwriter, portfolio manager, etc. to get registered with SEBI and obtain certificate of registration. There are regulations framed by SEBI which regulate such entities.

(x) Punishment for contravention [Section 186 (13)]: In case of contravention of any of the provisions of Section 186, the punishment shall be as under:

• Company: punishable with minimum fine of 25,000 and maximum of 5 lakhs
• Every defaulting officer: punishable with imprisonment maximum up to two years and with fine minimum of 25,000 and maximum of 1,00,000.

For the purposes of section 186, the expression “infrastructure facilities” means the facilities specified in Schedule VI.