The Ministry of Corporate Affairs (“MCA”) has notified Rules for Chapter XII (among other Chapters) of the Companies Act, 2013 (the “Act”) on 27th March 2014.

The Rules have brought about much needed clarity on the exceptions to restrictions placed by Section 185 of the Act which was notified by the MCA on 12th September 2013 for implementation.

In terms of Section 185 of the Act, an Indian company has been prohibited from either advancing any loan to, or giving any guarantee or security in relation to any loan taken by, its director or any other person in whom a director is interested. In terms of the Explanation to Section 185 of the Act, the expression ‘any other person in whom a director is interested’ includes a company having common directorship with the company providing the loan/security/guarantee. Such restrictions are not applicable if advancing loans, giving guarantee or providing security is done in the ordinary course of business of the lending company.

However, this provision, when notified, caused difficulties for corporates and financial institutions alike as most financings availed by companies would typically be backed by some form of security or guarantee from an associate or holding company. Since associate/parent companies usually have directors common with their subsidiaries (and in any event the wording of Section 185 was quite broad), in light of the restrictions under Section 185, providing such loans or security would not have been possible anymore.

It is pertinent to note that such restrictions had also been imposed under Section 295 of the Companies Act, 1956 (“1956 Act”), but Section 295 also provided certain exclusions, including situations where security is provided by a holding company for a loan being availed by its subsidiary. Unfortunately, although the language of Section 185 of the Act indicated that the restrictions imposed by it would be applicable subject to exceptions provided elsewhere in the Act, not many other sections of the Act, including the likely savior in Section 186, had been notified.

After receiving several representations with respect to Section 185 of the Act, the Ministry of Corporate Affairs issued clarificatory circulars in November 2013 and subsequently in February 2014, stating that till such time as Section 186 of the Act is notified, the corresponding provision in Section 372A of the 1956 Act will continue to apply. While the aforesaid circulars were probably intended to provide for exceptions to Section 185 of the Act, unfortunately they lacked clarity and only added complexity to the legal framework.

Now, the new Rules that have been notified right on the heels of more provisions of the Act including Section 186, have clarified the situation beyond doubt for now by allowing the following exceptions to Section 185 of the Act:

1. Loans made by a holding company to its wholly owned subsidiary for its principal business activities;
2. Guarantees given or security provided by a holding company in respect of any loan made to its wholly owned subsidiary for its principal business activities; and
3. Guarantees given or security provided by a holding company in respect of loan made by any bank or financial institution to its subsidiary for its principal business activities.

The financing sector of the economy would surely be relieved with the notification of this exemption. However, with a host of other provisions having been notified alongside, what lies ahead still remains to be seen. In any event, shareholder loans from Indian parents or associate companies (except wholly owned subsidiaries) will still fall within the prohibition under Section 185.

Neha Vijayvargiya
neha.vijayvargiya@pxvlaw.com