Can Your Company Lend You Money? Section 185 Director Loans Explained for Founders
Section 185 of the Companies Act 2013 bars loans, guarantees and security to directors and their circle. What is allowed, what is exempt, and the penalties.
CA Harun Raaj
makeitlegit.in
A company with spare cash and a founder who needs money: the loan looks like the easy fix. Section 185 of the Companies Act, 2013 stops it. The section bans loans, guarantees and security to directors and their close circle, allows a narrow route for companies in which a director is interested, and fines the company, its officers and the borrower for a breach. The company can still pay you through routes that sit under other sections.
Legal basis: Companies Act, 2013, s.185, as it stands after the 2018 substitution (substituted by Act 1 of 2018, with effect from 7 May 2018).
What to do now
- Next step: list every amount your company has advanced to you, your relatives or any firm you or they are partners in: loans, "book debts" (amounts the company's books show you owe) owed by you, guarantees and security. Treat each as caught by s.185(1) until a CA tells you otherwise.
- Deadline: s.185 gives no grace period or cure period in its text. The offence is the advance, guarantee or security itself, "advanced... or utilised in contravention" (s.185(4), Companies Act 2013). Act before the next audit or filing, not after.
- Consequence: the company faces a fine of ₹5 lakh to ₹25 lakh. Every officer in default faces up to six months' imprisonment or the same fine. You, as the borrower, face the same punishment as the officers (s.185(4)(i)-(iii), Companies Act 2013).
Have a CA review your facts before you act or file.
The ban in s.185(1)
The section opens: "No company shall, directly or indirectly, advance any loan, including any loan represented by a book debt to, or give any guarantee or provide any security in connection with any loan taken by" any of these (s.185(1), Companies Act 2013):
- (a) any director of the company, or of its holding company (the company that controls it), or any partner or relative of such a director; or
- (b) any firm in which such a director or relative is a partner.
Four points matter for a founder.
- Loans, guarantees and security are all covered. The company cannot guarantee your personal bank loan or pledge its assets for it. That counts the same as lending you cash.
- "Book debt" (an amount the books show as owed to the company) is covered. A loan "represented by a book debt" is a loan. If you leave personal spending on the company's account and it sits as a receivable from you, it can be a loan under this section even if no one signed a loan agreement.
- "Directly or indirectly" is wide. Sending the money through a third entity does not take it out of the section.
- The circle is wide. It covers you, directors of your holding company, the partners and relatives of each, and any firm where such a person is a partner.
The permitted route in s.185(2)
The ban in s.185(1) covers the director and the director's relatives and firms. A different category is treated more softly: a company "in whom any of the director of the company is interested". The company may lend to, or give a guarantee or security for, such a person, but only on these conditions (s.185(2), Companies Act 2013):
- (a) A special resolution (a higher-vote member approval) is passed by the company in general meeting. The explanatory statement to the notice of that meeting must disclose "the full particulars of the loans given, or guarantee given or security provided and the purpose for which the loan or guarantee or security is proposed to be utilised by the recipient of the loan or guarantee or security and any other relevant fact".
- (b) Principal-business use. The loans must be "utilised by the borrowing company for its principal business activities".
The Explanation to s.185(2) defines "any person in whom any of the director of the company is interested" as:
- (a) any private company of which any such director is a director or member;
- (b) 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; or
- (c) any body corporate whose Board, managing director or manager is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company.
(Explanation to s.185(2), Companies Act 2013.)
Two practical consequences follow. First, a founder's side company in which she holds a quarter or more of the votes can qualify under limb (b), and any private company where she is a director or a member can qualify under limb (a). Second, the principal-business condition runs past the vote. If the borrower diverts the money away from its own principal business, the loan is "utilised in contravention" of the section even though a valid special resolution stands behind it (s.185(4), Companies Act 2013).
This route is not open to you personally. Section 185(2) speaks of a person in whom a director is interested, not of the director. A loan to the director, to a relative or to a partnership firm of the kind in s.185(1) stays barred.
Exemptions in s.185(3)
Nothing in sub-sections (1) and (2) applies to the following (s.185(3), Companies Act 2013):
| Exemption | What the section says |
|---|---|
| (a)(i) | A loan to a managing or whole-time director as part of the conditions of service extended by the company to all its employees |
| (a)(ii) | A loan to a managing or whole-time director under a scheme approved by the members by a special resolution |
| (b) | A company that in the ordinary course of its business provides loans or gives guarantees or securities for repayment of any loan, where interest is charged at a rate not less than the prevailing yield of the one year, three year, five year or ten year Government security closest to the tenor of the loan |
| (c) | A loan by a holding company to its wholly owned subsidiary, or a guarantee or security by a holding company for a loan to its wholly owned subsidiary |
| (d) | A guarantee or security by a holding company for a loan made by a bank or financial institution to its subsidiary |
For clauses (c) and (d), the proviso adds that the loans must be "utilised by the subsidiary company for its principal business activities".
Notice what these exemptions cover. Clause (a) reaches only a managing or whole-time director, and (a)(i) requires the same terms to be available to all employees. A founder who is a non-executive director does not fit either (a) limb. Clause (b) is for companies whose ordinary business is lending. A start-up that is not a lender cannot use it. Clauses (c) and (d) are group-funding provisions that run from a holding company down to its subsidiary. They do not run to a director.
If you think an exemption fits, have a CA confirm it before the money moves. Whether a private company can rely on any separate exemption notified under the Act is a point to check with your CA. This article does not rely on one.
What happens on a breach: s.185(4)
"If any loan is advanced or a guarantee or security is given or provided or utilised in contravention of the provisions of this section", three consequences follow (s.185(4), Companies Act 2013):
| Who | Consequence |
|---|---|
| The company | Fine of not less than ₹5 lakh, extending to ₹25 lakh |
| Every officer of the company who is in default | Imprisonment up to six months, or fine of not less than ₹5 lakh extending to ₹25 lakh |
| The director or other person to whom the loan, guarantee or security was given | Imprisonment up to six months, or fine of not less than ₹5 lakh extending to ₹25 lakh, "or with both" |
Read the table closely. For the company, the text is a fine only. For officers, the text says imprisonment "or with fine". For the borrower, the text adds "or with both". Imprisonment is therefore a possibility, not an automatic add-on. The point founders tend to miss is that liability does not stop at the company. The person who received the money is named in the section.
How s.185 fits with s.186
Section 185 asks who can receive company money. Section 186 asks how much and how. Both apply to the same transaction, so a lawful connected-party loan has to pass both.
Section 186(2) says that no company shall directly or indirectly give any loan, give any guarantee or provide security, or acquire securities of another body corporate, "exceeding sixty per cent. of its paid-up share capital, free reserves and securities premium account or one hundred per cent. of its free reserves and securities premium account, whichever is more" (s.186(2), Companies Act 2013). Where the total would go past that limit, s.186(3) requires prior authorisation by a special resolution in general meeting. That sub-section carves out loans, guarantees or security given to a wholly owned subsidiary or joint venture company, subject to disclosure of the details in the financial statement.
Other s.186 conditions that commonly apply to a loan:
- The board resolution must be passed at a meeting "with the consent of all the directors present at the meeting" (s.186(5), Companies Act 2013).
- No loan may carry interest lower than the prevailing yield of the one year, three year, five year or ten year Government security closest to the tenor of the loan (s.186(7), Companies Act 2013).
- A company giving a loan, guarantee or security must keep a register with the prescribed particulars (s.186(9), Companies Act 2013).
Section 186(11) says that, except for sub-section (1), s.186 does not apply to certain loans made by banking, insurance or housing finance companies in the ordinary course of business, and some other categories. If your company is not one of those, assume s.186 applies.
Ways a founder can legitimately take money out
Where the aim is simply to get money to the founder, the section points away from borrowing and toward routes that need no s.185 exemption:
- Remuneration for work done as a director or employee, approved through the board and, where the law requires, the members. The limits on director pay are in separate provisions of the Act that this article does not cover.
- Dividend out of eligible profits, declared under the dividend provisions of the Act, which are also outside this article.
- A loan made to the company by the founder, not the other way around. Section 185 restricts what the company lends, not what it borrows from a director. The rules on a company accepting money from directors sit elsewhere in the Act.
- A structured loan to a qualifying connected company under s.185(2), with a special resolution, full disclosure and principal-business use, where there is a real business purpose.
- A genuine employee-terms loan if you are a managing or whole-time director and the same terms are extended to all employees (s.185(3)(a)(i), Companies Act 2013).
Mistakes worth checking for in your own books
- The rolling "temporary advance". Company funds paid to a director and carried month after month. The section captures a loan "represented by a book debt", so the ledger label does not decide the question.
- The guarantee given as a favour. A board minute recording a guarantee for a director's personal loan, as if it were routine business. Guarantee and security are caught exactly like cash.
- The side-company loan with a thin explanatory statement. The special resolution route requires "full particulars" and the purpose of use. A statement that gives only the amount does not meet the proviso to s.185(2)(a).
- Diversion after approval. Money lent to a connected company for its business and then used for the founder's personal needs. The section penalises loans "utilised in contravention", so the breach can arise after the vote.
- Forgetting relatives. A loan to a spouse, parent or sibling of a director is within s.185(1)(a) because "relative" of a director is expressly named.
Common questions
Can the company lend directly to me as a director?
No, unless one of the s.185(3) exemptions applies. Section 185(1) bars loans, guarantees and security to directors, to directors of the holding company, to their partners and relatives, and to firms in which they are partners, "directly or indirectly".
Can it lend to my other company?
Possibly. If that company is one "in whom any of the director of the company is interested" within the Explanation to s.185(2), the company may lend by special resolution with the full explanatory statement, and the borrower must use the money for its principal business activities.
Does a special resolution fix a loan made without one?
Section 185 does not provide for approval after the event. The section speaks of a special resolution being passed as a condition of making the advance. Ask a CA how to handle an advance already made.
Who is punished for an unlawful loan?
The company, every officer in default, and the director or other person who received the loan, guarantee or security (s.185(4), Companies Act 2013). The amounts are stated in the table above.
Does s.185 apply to a one-person company or a small private company?
The text of s.185 draws no distinction by size. It speaks of "no company". Whether any separate exemption applies to your company is a matter for your CA to confirm from the current notifications.
Where does s.186 come in?
It sets the ceiling, the sanction, the interest floor and the register for loans and investments. A loan can pass s.185 and still fail s.186.
Have a CA review your facts before you act or file.
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