New Cos Act May Hit Flow of Credit to Subsidiaries

The ministry of corporate affairs recently notified the commencement of various provisions of the new Companies Act, 2013. Sections 185 and 186 relating to grant of loans, giving guarantees and providing securities by a company to any of its directors or any other company or persons, have become effective. Section 185 prohibits sanction of loans or giving guarantee or providing security for any loan, by any company to any of its directors or any other person in whom the director is interested. The only exception is the loan to directors as part of conditions of service of whole-time directors. The object of this provision is to ensure directors of companies do not abuse their position for personal gain either directly as a director of the company or through any other person or subsidiary company in which the director is interested. The section corresponds to Section 295 of the Companies Act, 1956. The old provisions excluded loans given by banks, or loans by private companies, or loans by holding companies to their subsidiaries, from the purview of restrictions on lending to directors. But Section 185 in the new Act has no such exemption and, hence, loans by private companies or holding companies to their directors are not permissible. Under Section 186, it is permissible for a company to give a loan or guarantee any loan or provide security for any loan to any other company not exceeding 60% of its paid capital and free reserves or 100% of its free reserves, whichever is more. The old law exempted loans, guarantees or securities provided by banks or by holding com panies to wholly owned subsidiaries. The exemptions in section 186(11) of the new Act do not cover loans given, or guarantees or securities provided by holding companies to subsidiaries. Withdrawal of such exemptions will make lending to subsidiaries more complex and difficult requiring shareholders' approval for facilities exceed ing the ceilings pre ing the ceilings prescribed by Section 186. The effect of the new provisions is that loans obtained by subsidiaries from banks and other lenders for which the holding company provides guarantee or security over its assets, will also be in sets, will also be included in its ceilings of 60% of paidup capital plus free reserves or 100% of free reserves, thereby restricting the extent of borrowing by subsidiaries. Section 186(11) also exempts “a loan made guarantee given or security provided by a banking company“, but when a bank gives a loan to a subsidiary company , it obtains guarantee for due repayment of the loan from the holding company or obtains security over any assets belonging to the holding company . While the new provisions exempt bank loans from applicability of section 186, there is no exemption for guarantee or security given by a holding company for loans given by a bank to a subsidiary . The exemption should have been unambiguous as contained in section 372A(8) of the old law. The defective wording of the exemption will result in bringing guarantees given and securities provided by the holding companies for loans given by banks to its subsidiaries within the purview of restrictions contained in section 186. Non-compliance with the provisions of Section 186 is an offence punishable with fine up to `5 lakh on the company and imprisonment for officers in default. The banks and other lenders will have to ensure that holding companies providing guarantees or securities comply with the re quirements of Section 186. This will become a hurdle to the smooth flow of credit to subsidiary companies. The absence of clear exemptions as contained in the old law, also raises the issue of continuance of existing loans, guarantees given and securities provided, which are not in compliance with provisions contained in Sections 185 and 186 of the new law. There is no transitory provision made in the Companies Act, 2013 for credit facilities already being availed of by private companies or subsidiary companies either from their holding companies or banks. The only solution to the problem is to issue a “removal of difficulty order“ under section 470 of the Companies Act, 2013, to restore following exemptions and clarify that provisions of Sections 185 and 186 shall not apply to loans given by banks to subsidiaries with guarantee of the holding company or security over assets of the holding company; and provisions of Sections 185 and 186 will have prospective effect.

Economic Times, New Delhi, 21-05-2014