Loan to Directors and the Provisions of the Companies Act

Loan to Directors and the Provisions of the Companies Act Loans to the direcotors of the company given by the company are governed by section 295 of the companies act, 1956. Section 295 put restrictions on a public company or a private company being a subsidiary of a public company intending to make any type of transaction with a director of the company or partner or relative of a director, etc. whether, directly or indirectly to make any loan, or to give any guarantee, or to provide any security in connection with a loan made by any other person to, or to any other person by, and it calls for obtaining the previous approval of the Central Government. This section is applicable to a public company or a private company, which is a subsidiary of a public company. Exemption (a) Private Company which is not a subsidiary of public company; (b) Banking Company; (c) Government Company' (d) Loan made by holding company to its subsidiary company; (e) Guarantee given or security provided by holding company in respect of any loan made to its subsidiary company Persons covered under section 295 (a) Any director of the lending company; (b) Any director of the holding company; (c) Any partner of any such director; (d) Any relative of any such director; (e) Any firm in which any such director is a partner; (f) Any firm in which a relative of such a director is a partner; (g) Any private company of which any such director is a director; (h) Any private company of which any such director is a member; (i) any body corporate of which not less than 25% of the total voting power may be exercised or controlled t a general meeting by any director or by two or more directors together; and

(ii) 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 . Non-applicability of the provisions of section 295

any loan made to an employee of the company, who is not a relative of any director; any loan or advance made to a trust in which directors are trustees; any quasi-loan; any advance or deposit made in connection with leasing/hire-purchase transaction; any advance payment of salary given to an employee who is a relative of a director as per the rules of the company; any investment made in acquiring residential accommodation for director(s) (whether by way of purchase or entering into a lease agreement); house building loan given to a director subject to the guidelines issued for that purpose by the Central Government; any loan made to a Registered Co-operative Society; any loan given by a holding company to any director of its subsidiary company; advance given for services to be rendered or goods to be supplied provided it is reasonable and commensurate with the services to be rendered or goods to be supplied; section 295(1) does not apply to a government company provided that such company has obtained the approval of the Ministry or Department of the Central Government, which is administratively in charge of the company, or as the case may be or the State Government.

Meaning of Loan: The word Loan is not defined in the Act. Hence we can take the general meaning. According to Blacks Law Dictionary loan means a lending; delivery by one party to and receipt by another party of a sum of money upon agreement, express or implied, to repay it with or without interest. Hence essential requirements of a loan is the advance of money upon the understanding that it shall be returned, and it may or may not carry interest.

This section also applies to any transactions represented by Book debt which was from its inception in the nature of a loan or an advance vide section 296. Penalty for contravention of provisions of Section 295

Section 295 (4) provides that every person who is knowingly a party to any contravention of sub-section (1), including in particular any person to whom the loan is made or who has taken the loan in respect of which the guarantee is given or the security is provided, shall be punishable either with fine which may extend to Rs. 5000/- or with a simple imprisonment for a term which may extend to 6 months; provided that where any such loan, or any loan in connection with which any such guarantee or security has been given or provided by the lending company, has been repaid in full, no punishment by way of imprisonment shall be imposed under subsection (4); and where the loan has been repaid in part, the maximum punishment which may be imposed by way of imprisonment shall be proportionately reduced.

Further, according to sub-section (5), all persons who are knowingly parties to any contravention of this section shall be liable, jointly or severally, to the lending company for the repayment of the loan or for making good the sum which the lending company may have been called upon to pay in virtue of the guarantee given or the security provided by such company

Applicability of Section 295 under certain situations:

1.

Applicability of Section 292 Any loan falling within the purview of section 295 would attract the provisions of section 292 i.e. exercise of the powers only by means of resolutions passed at the Board meeting. Hence this power is to be exercised ny means of Board resolution not otherwise. However Board can delegate the power to any committee of directors, managing director, manager or any other principal officer of the company, in accordance with the provisions of the Act.

2.

Applicability of Section 372A Following provisions of Section 295 will also apply to section 372A. Hence compliance of both sections besides section 292 is required for any loan made to, or any guarantee given or security provided in connection with a loan made by any other person to, or to any other person by, -

i) ii)

Any private company of which director of lending company is a director or member; Any body corporate at a general meeting of which not less than 25% or more of the total voting power is exercised or controlled by one or more directors of the lending company;

iii)

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.

3.

Applicability on Debt A loan contracted creates a debt, but there may be a debt contracted without contracting a loan. Therefore every debt is not a loan. In order to attract section 295 there has to be the making of loan. For example: In case of sale/supply of goods on credit, the outstanding amount on such sale on credit is debt but it was not of the nature created by Loan. The Bombay high court held that the deferred amount payable by a director a consideration for sale of flat by the Company to the Director is a Debt but not in the nature of loan.

4.

Applicability on Advances Section 295 is not applicable for all types of advances. Section 295 would not be attracted if the person taking advance against his salary is an employee. Suppose an advance against salary given to the wife of director who was employed by the company on a monthly salary, the provisions of section 295 would not applicable provided such advance facility should be available to all employees of the Company. However if advance is given on the her capacity as Wife of Director, then Section 295 will be applicable.

5.

Housing loans to managing and whole-time directors The Central Government has permitted the Companies granting of loans to their managing and whole-time directors for the purpose of housing without the approval of the Central Government subject to certain conditions i.e. the provisions of section 295 is not applicable if housing loan was given the managing/ whole-time directors under the housing loan scheme of the Company for its employees and for the purpose said loan, the managing director shall be treated in all respects like other employee in a particular grade and loan is granted on the terms and conditions as applicable to the other employees in the identical category.

6.

Loans to directors of Government Companies The Government Companies have been exempted by notification no. SO 729 dated 27.05.1978, provided that such company shall obtain the approval of the Ministry or Department of the Central Government which is administratively in-charge of the Company, or as the case may be, the State Government.

7.

No retrospective effect

On the question whether the approval of the Central Government under sub-section (1) will be required to be obtained after any exempted loans (under sub-section (2)) ceases to be such or after the exempted company ceases to be eligible to enjoy the exemption, such as conversion of private company to public. The Department has advised that the provisions of section 295 would not be applicable to loans already made by the exempted companies even though they ceased to be so and compliance of section 295 would not be required.

Criteria followed by the Government in considering the applications under Section 295 In considering the applications under section 295, the following important aspects will scrutinized by the Central Government i) ii) iii) iv) v) vi) Purpose of loan; Financial position of lender and borrower; Whether lending company possesses surplus fund to lend; Whether loan is secured, if yes whether security is adequate; Whether the rate of interest offered is reasonable; Whether loan is for a definite period;

vii) Whether the borrower is fully solvent; viii) If the borrower is a company, whether it has a good profit record etc.

Exempted loans, guarantees and securities According Sub-section (2), following transactions are exempted from the restrictions of sub-section (1) i) ii) iii) Any loan made, guarantee given or security provided by a private company which is not a subsidiary of a public company, Any loan made by a holding company to its subsidiary, Any guarantee given or security provided by a holding company in respect of a loan made to its subsidiary.

DCA guidelines for loans to directors add some more confusion

The Companies Act, 1956 is perhaps the bulkiest enactment we have in this country and inspite of exercises from time to time to simplify the law, the fact is that every attempt at simplification has invariably resulted in more complication. Hence, it comes as no surprise that the recent guidelines (also termed as "check list") issued by the DCA, Ministry of Law, Justice and Company Affairs, relating to making of loans, etc, to directors (section 295 of the Companies Act), have created avoidable confusion. As it is, the professionals were still recovering from the after effects of poor drafting of the postal ballot rules, then the department came out with changes in schedule XIII, ostensibly liberalising the provisions relating to managerial remuneration. While the professionals are still trying to figure out its exact implications, they are now faced with one more set of guidelines to add to their woes. Section 295 of the Companies Act regulates grant of loans by a public company (and its subsidiaries), barring exempted categories, to its directors, their relatives and the firms and companies in which they are interested, as mentioned in the said section. Therefore, the section provides that a company cannot make a loan, give guarantee or provide security in connection with such a loan without obtaining the previous approval of the central government. There is no doubt that to protect the interests of all the shareholders of a public company, it is necessary that there are effective controls so as to ensure that the companys funds are not misused by the directors. Accordingly, the government has been issuing guidelines from time to time stipulating the procedural and other requirements to be fulfilled by such a company intending to make loans, etc, to directors and other specified persons. In that context, the government has once again, through the DCA, come out with a set of guidelines called "check list". The very purpose of any such guidelines is to simplify the task of those persons who intend to approach the government for seeking its approval. The new check list comprising of 21 points, though a welcome step, has unwittingly generated some confusion where none existed. Confusion has basically arisen due to the reference to section 372A, in the checklist, in a manner not envisaged by the section itself. It needs to be noted that section 372A has replaced the earlier sections 370 and 372 with effect from October 31, 1998. Under the said two old sections there was a provision that for giving any loan or making any investment beyond the prescribed limits, the concerned company was required to obtain prior approval of the central government. However, the Companies (Amendment) Act, 1999, liberalised this provision by giving the shareholders the ultimate power. In other words, according to the provisions of section 372A, when the loans, investments and guarantees exceed the prescribed limits then the company is required to obtain the consent of its shareholders by a special resolution. As a result, the earlier stipulation of obtaining approval of the central government in such cases is no more applicable. However, so far as section 295 is concerned, the provision relating to approval of the government continues to be on the statute. The confusion arises due to the fact that it seems that the draftsman has presumed that government approval is necessary under section 372A.

The heading of the check list itself refers to submission of application under section 372A. Similarly, point no 10 of the check list requires the applicant company to give shareholding details of the applicant and the borrower companies and specifically refers to applications under section 372A. Although even point 15 of the check list refers to section 372A, but there is no confusion in that regard as in some cases both sections ie 295 and 372A may be attracted and so compliance therein has to be made. There is no form of application specified by the check list, but it has stipulated the information that the concerned company is required to submit. An application fees, ranging from Rs 500 to Rs 2000, depending upon the authorised capital of the company, is payable to the government. Any such loan has to carry a minimum interest of four percent above the prevailing bank rate. The company will have to submit a declaration to the effect that the company has not defaulted in making repayments to the investors of the amounts that have fallen due. Similarly, the company also has to submit a certificate from a practising company secretary or the statutory auditors of the company, wherein it has to be mentioned that the proposal is in conformity with the provisions of section 372A. Interestingly, not every application under section 295 would attract the provisions of section 372A, in that case what should the practicing company secretary or the auditor mention in the certificate? Perhaps, the answer would be that the said section is not applicable to the concerned case. The other issues to be covered by the said certificate are, that the company has not defaulted in repayment deposits and interest thereon, dividend, redemption of debenture and interest thereon, redemption of preference shares. Lastly, it has also to be certified that the company is regular in filing all forms and returns as required to be filed under the Companies Act. Another requirement is that a NOC/ prior approval of public financial institutions/ banks has to be obtained in cases where any term loan is subsisting. It should be noted that such a clearance is required even when there is neither default nor any overdue term loan amount. Perhaps the intention of this stipulation is to ensure that the term loan amount is not misused by such a company by giving loans to its directors and so it requires clearance from the concerned financial institution/ bank. Conclusion It is a fact that several companies after raising funds from the market, obtaining deposits from small investors and after taking term loans have grossly misused the same. Hence the government has now prescribed several conditions with a view to better regulate the granting of loans, providing of guarantee or security in connection with such loans to directors of a public company and its subsidiaries. At the same time, it is advisable that the glitches that have crept into the guidelines/ check list are removed so as to avoid needless confusion.

Section 295 and 372A of the Companies Act 1956

Sec 295 of the Companies Act 1956 does not allow Public Limited Company to give any guarantee to any person , but my question is that our CS says that there is a specific section which states that a Public Limited Company can be a guarantor if the loan is certain % of company's paid up capital. Sec 372A says that Intercorporate guarantees are permitted under this section, but please clarify Can a Public Limited Company give a guarantee to loans availed by its employees from a Cooperative Bank, if yes under what section of the Companies Act and what are the conditions to be satisfied. Waiting for reply as our employees have taken Loan/OD facility from a cooperative and the Company is willing to be a Guarantor for the same.

Loan to Public Limited Companies under Section 295 of the Companies Act, 1956 Clarification regarding
General Circular No. 24/2011, Dated: 12th May, 2011 F. No. Government Ministry of Corporate Affairs Subject:- Loan to Public Limited Companies under Section 295 of the Companies Act, 1956 Clarification regarding. It has come to the notice of the Ministry that some companies are making applications for getting prior approval of Central Government when they propose to make any loan to, or give any guarantee or provide any security inconnection with a loan made by any other person to a Public Limited Company of which any such Director is a Director or a member even when the proposal does not fall under Section 295(d) and Section 295(e) of the Companies Act, 1956. 2. Companies are requested to note that when the beneficiary of the loan/guarantee/security is a Public Limited Company, approval of Central Government should only be sought if the provisions of sub-Section (d) or (e) of Section 295 of the Companies Act, 1956 are attracted. The application should also clearly bring out the facts in this regard. Yours faithfully, Dr. T. V. Somnathan) Joint Secretary of 14/13/2011-CL-VII India

Loan to Director, relative, partner.

The Companies Act, 1956 does not restrict Private Companies and Banking Companies to give loans or guarantee or security to its directors. The same view is taken towards the loans or guarantee or security made by a holding Company to its subsidiary Company. According to Section 295 of the Companies Act, 1956, a Public Limited Company or its subsidiary should obtain prior approval of the Central Government for: Lending; Giving guarantee; or Providing security to

1.

2.

3. 4.

5. 6.

7. 8.

Any Director of the Company; Any Director of its holding Company; Any partner or relative of a Director; Any firm-in which the Director/relative is a partner; Any Private Company- in which such Director is a Director/ member; Any Body Corporate- in which any (such) Director (or two or more directors together) controls 25% of voting power. vii. Any Body Corporate- The Board of Directors, Managing Director or Manager of that body Corporate is accustomed to act on the directions of the Board/any Director of the lending Company. Important points: Section 295(1) is not applicable to a Government Company provided such Company has obtained prior approval of the administrative ministry/Department of the concerned State Government. Application for giving loan, providing security or guarantee connection with a loan shall be made to the Central Government in Form 24AB.(Companies (Central Governments) General Rules and Forms, 1956) As the offence under Section 295 is punishable with fine or imprisonment, it is compoundable but with the permission of the Court [Section 621A(2)] Giving loan by a Company attracts the provisions of section 292. Therefore, Approval of Board by means of a resolution is essential for the loans/guarantee/security given under Section 295. Applicability of Section 372A is accompanying with Section 295 for the loans given to the persons viz. v, vi, and vii of the above given list. The Central Government has permitted the Companies granting housing loans to their Managing Director and whole-time directors without the approval of the Central Government, provided there is an existing house loan scheme for employees. This Section is not applicable for loans given to members and employees of the Company. Contravention to Section 295 leads to the vacation of the office of the Director under Section 283. Case study There is no prohibition against a banking Company lending money to concerns of which a Director of the bank is also a Director Re. Bank of Commerce Limited(1947) A Company selling one of its flat to one of its directors on receiving half the price in cash and agreeing to accept the balance in installments does not amount to giving loan to the Director. Fridie Ardeshir Mehta v. Union of India (1991)

i. ii. iii. iv. v. vi.