Sections 185 and 186: Lending to Your Own Directors and Group Companies

Groups built organically tend to move money where it is needed: the profitable entity funds the one that is building, the holding company bridges a subsidiary's payroll, the director's current account takes up the slack. Commercially this is unremarkable. Under the Companies Act, 2013 it engages two separate provisions with different machinery, and getting them wrong is expensive — Section 185 was a criminal provision until the 2017 and 2020 amendments reworked it, and it still carries a substantial monetary penalty on the company, on the officers in default, and on the recipient.

Section 185: who you cannot lend to

Section 185 restricts a company from advancing a loan, including any loan represented by a book debt, or giving any guarantee or providing any security in connection with a loan.

The prohibition operates in two tiers, which is the structure to hold on to.

Tier one — an absolute prohibition

A company may not, directly or indirectly, advance a loan to or give a guarantee or security for:

• any director of the company;
• any director of its holding company;
• any partner or relative of such a director;
• any firm in which such a director or relative is a partner.

There is no shareholder approval that opens this door. A loan to your own director is simply not available.

Tier two — permitted by special resolution

A company may advance a loan to, or give a guarantee or security for a loan to, any person in whom any of its directors is interested, provided:

• a special resolution is passed in general meeting, and the explanatory statement discloses the full particulars of the loan, its purpose, and the source of funding; and
• the borrowing company uses the loan for its principal business activities.

"Any person in whom a director is interested" is defined, and the limbs that matter in practice are:

• a private company of which any such director is a director or member;
• a body corporate at whose general meeting 25% or more of the total voting power may be exercised or controlled by any such director, or by two or more such directors together;
• a body corporate whose board, managing director or manager acts in accordance with the directions of the board or of any director of the lending company.

The second and third limbs catch most group structures. Common directorship or common control is the usual route in.

The exemptions

Section 185 does not apply to:

• a loan to a managing or whole-time director as part of a scheme available to all employees, or approved by special resolution;
• a company whose ordinary course of business is giving loans or providing guarantees, where interest is charged at a rate not less than the prescribed benchmark rate;
• loans by a holding company to its wholly owned subsidiary, and guarantees or securities given by a holding company for a loan to its wholly owned subsidiary;
• guarantees or securities given by a holding company for a loan from a bank or financial institution to its subsidiary.

Note how specific the third and fourth exemptions are. A holding to wholly owned subsidiary loan is exempt. A loan from one sister company to another, both owned by the same individuals, is not — that is the most common structure and the most commonly missed.

Section 186: how much, and the approvals

Section 185 asks whether you may lend at all. Section 186 asks how much, and applies to inter-corporate loans and investments generally.

A company may not, directly or indirectly, give any loan to any person or other body corporate, give any guarantee or provide security in connection with a loan, or acquire the securities of any other body corporate, exceeding the higher of:

• 60% of its paid-up share capital, free reserves and securities premium account; or
• 100% of its free reserves and securities premium account,

without the prior authority of a special resolution passed in general meeting.

Other requirements under the section:

• the resolution of the board must be passed at a meeting with the consent of all the directors present, and the board cannot delegate this;
• where a term loan from a public financial institution is subsisting, prior approval of that institution is also required unless the limits are not exceeded and there is no default in repayment;
• the rate of interest charged may not be lower than the prevailing yield of a government security of comparable tenor;
• a company in default on repayment of deposits or interest on them may not give a loan or guarantee until the default is made good;
• a register in Form MBP-2 must be maintained, with the particulars of every loan, guarantee, security and investment;
• there is a restriction on investing through more than two layers of investment companies, subject to the carve-outs.

A loan to a wholly owned subsidiary and a guarantee for it fall outside the special resolution requirement where the rest of the section is complied with, but the loan is still disclosed.

Putting the two together

For any proposed transfer, in order:

1. Who is the recipient? A director, a relative, or a firm in which they are a partner — stop, tier one, no route.
2. Is the recipient a person in whom a director is interested? If so, Section 185 applies: special resolution, full disclosure in the explanatory statement, and the money must go into the borrower's principal business.
3. Is it holding to wholly owned subsidiary? Then the Section 185 exemption applies.
4. Does the aggregate exceed the 60%/100% test? If so, Section 186 needs its own special resolution — and where both sections apply you need the Section 185 approval and the Section 186 approval. One special resolution carefully drafted can cover both, but the explanatory statement has to satisfy each.
5. Interest rate. Not below the comparable government security yield.
6. Board meeting with unanimous consent of the directors present, at a meeting rather than by circulation.
7. File MGT-14 for the special resolution, within thirty days.
8. Record it in MBP-2, and disclose it in the board's report and in the notes to the accounts.

The consequences, and the other statutes watching

Under Section 185, contravention attracts a penalty on the company, on every officer in default, and on the director or other person to whom the loan was advanced — the only one of these three groups that is frequently forgotten is the third. Check the current figures against the amended section; the structure is a substantial minimum with a higher maximum.

Two other provisions are usually in the room at the same time:

• Section 2(22)(e) of the Income-tax Act. A loan or advance by a company in which the public are not substantially interested, to a shareholder holding not less than 10% of voting power, or to a concern in which such a shareholder has a substantial interest, is deemed dividend to the extent of accumulated profits — taxable in the recipient's hands. A director's loan can therefore be both a Companies Act contravention and a taxable dividend.
• Section 188, on related party transactions, where the arrangement is a transaction with a related party rather than a loan.

What we usually find

• Sister-company loans treated as exempt. The wholly owned subsidiary exemption is read as a group exemption. It is not.
• The director's current account. Running debit balances built up over years with no resolution, no interest and no documentation, which an auditor eventually has to report.
• No special resolution for Section 186, because nobody computed the 60%/100% limit against the latest audited figures.
• Interest below the benchmark, or no interest at all, which breaches Section 186 and invites a transfer pricing or Section 2(22)(e) question too.
• MGT-14 not filed, so the special resolution exists in the minute book and nowhere on the record.
• MBP-2 never opened. It is a statutory register and its absence is a separate default.

None of this makes intra-group funding impossible. It makes it a documented transaction with a resolution, a rate and a register behind it — which is a few hours of work before the transfer, and a great deal more after it.