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Inter-Corporate Loans, Investments, Guarantees and Security, Related Party Transactions An Overview
The Companies Act, 2013 has brought in plentiful changes in the area of Inter-Corporate Loans, Investments, Guarantees, and Security dealt under Section 186 and Related Party Transactions dealt under Section 188. To understand its applicability and significant coverage that the new legislation has enabled, we might have to touch upon the provisions and old provisions as and when to differentiate the intent and extended scope.
Under the Companies Act, 1956, Section 372A deals with Inter-Corporate Loans and Investments. Inter Corporate Loans and Investment plays a vital role in the growth of industries as it recognizes and formulates the flow of funds for the group or associate companies or other companies who are in the need of those funds. Every company must make a plan so that they can invest in such a way that should turn out to be productive and within the legal framework.
The present law is no more a provision covering only inter-corporate loans, investments, and guarantees, it has now extended its scope to all loans and investments made by a company to any other person also. The most significant change to be noted is the new Act provides that inter-corporate investments not to be made through more than two layers of investment companies. As per the provisions:
A Company shall make investments through not more than two layers of investment companies. However, this shall affect:
a. A company from acquiring any other company incorporated in a country outside India if such other company has investment subsidiaries beyond two layers as pert the law of such country
b. A subsidiary company from having any investment subsidiary for the purposed of meeting the requirements under any law or rules or regulation framed under any law for the time being in force.
For the purpose of this section, an “Investment Company” means a company whose principal business is the acquisition of shares, debentures, and other securities.
In simple words, companies can make investments only through two layers of investment companies subject to exceptions which include companies incorporated outside India. Whereas giving of loan, providing of guarantee or security is not restricted. Therefore a company can give loans, provide security, or guarantee beyond two layers.
The applicability of this section is extended to all companies. the exemption available from the provisions of section 372A of the 1956 Act to private companies as well as loans or investment given or made by a holding company to its subsidiary company are no longer available under the 2013 Act.
The following transactions cover the loan given and investments made by the company either directly or indirectly:
a. Loan to any person or a body corporate
b. The guarantee is given or security provided in connection with a loan to a body corporate or a person
c. Acquiring by way of subscription, purchase or otherwise the securities of any other body corporate
Limits & Approvals
The Board of directors of the company can sanction making of investments, giving of loan, providing of guarantee or security no exceeding:
i. 60% of its paid-up share capital, free reserves and securities premium account or
ii. 100% of its free reserves and securities premium account, whichever is more.
Moreover, the manner of sanction is the important element where the resolution at the meeting of the Board must be passed with consent of all the directors, i.e. unanimous approval.
Any investments, loans, guarantee, or security exceeding the above limits requires
i. Prior approval by way of a special resolution passed by the shareholders at a general meeting of the company.
ii. Prior approval of public financial institution (PFI)
Exception: prior approval of PFI shall not be required if the aggregate of investments, loans, guarantee or security does not exceed the limit and the company should not have committed default in repayment of loan installments or payment of interest according to the terms and conditions of such loan to the PFI
iii. However, a company registered under section 12 of SEBI Act, 1992 and other class of companies as may be prescribed shall not take inter-corporate loans or deposits exceeding the prescribed limits. The company shall furnish the details of the loans and deposits in its financial statements.
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i. A company shall not give a loan under this section at a rate of interest lower than the prevailing yield of one year, three years, five years or ten years Government Security closest to the tenor of the loan.
ii. A company which is in default in the repayment of any deposits or insert on it, shall not give any loan, guarantee or provide any security or make an acquisition till such default is subsisting.
i. The company shall disclose to the members in the financial statement the full particulars of the loans given, the investment made or guarantee given or security provided, and the purpose for which the loan or guarantee or security is proposed to be utilized by the recipient of the loan or guarantee or security.
Recording of the particulars are dealt with in detail under Rule 12 of the Companies (Meeting of Board and its Powers Rule, 2014)
i. Every company giving a loan or giving a guarantee or providing security or making an acquisition under this section shall maintain a register in Form MBP 2 and enter the particulars of the loans and guarantees given security provided and acquisition made
ii. The entries to the register shall be made chronologically in respect of each such transaction within seven days
iii. The register can be maintained electronically or manually
iv. The entries in the register shall be authenticated by the Company Secretary or any other person authorized by the Board for this purpose.
v. The register shall be kept at the registered office of the company, preserved permanently, and shall be kept in the custody of the Company Secretary or any other person authorized by the Board for this purpose.
vi. The extract from the register may be furnished to any member of the company on payment of such fee as prescribed in the articles of the company. However, it shall no exceed ten rupees per page.
The exception to 186 but Not
The act has provided an exemption for a few companies and transactions, wherein the whole section 186 shall not apply to it. The keynote here is as far as subsection (1) which deals with two-layer restriction shall apply to these companies also. This exception is in place and the same time not. The provision of section 186 apart from subsection (1) shall not apply to:
a. A loan made, guarantee given or security provided by a banking company or an insurance company or a housing financing company in the ordinary course of business or the company engaged in the business of financing of companies or of providing infrastructural facilities (Schedule VI contain the list of facilities referred in here).
b. to any acquisition:
i. made by a non-banking financial company registered under Chapter IIIB of the RBI Act, 1934 and whose principal business is the acquisition of securities subject to its investing and lending activities to be considered as a non-banking financial company
ii. made by a company whose principal business is the acquisition of securities
iii. of shares allotted in pursuance of Section 62(1) dealing with the further issue of capital
iv. made by a banking company or an insurance company or a housing financing company making the acquisition of securities in the ordinary course of its business.
Penal Provision on Contravention
If a company contravenes the provisions of section 186 –
a. company shall be punishable with fine, not less than twenty-five thousand which may extend to five lakhs and
b. every officer-in-default shall be punishable with imprisonment for a term which may extend to two years and with fine not less than twenty-five thousand which may extend to one lakh rupees.
Related Party Transactions – Section 188
The provisions dealing with Related Party Transactions (RPT) has evolved significantly from its coverage in 1956 Act and 2013 Act. The Companies Act, 2013 has upgraded the concept and provision relating to RPT to a greater extent. It has succeeded in combining section 297 (dealing with contracts in which directors are interested) and section 314 (of dealing with office or place of profit).
Further, it also brought in the scope of Arm’s Length transaction which was not in the earlier Act, this could be seen as a meticulous effort that was made to align it with the definition under Income Tax Act, 1961. Lets’ try to learn this complex topic in a simple way. This section deals with the transactions of the company with its related parties, fair conduct of transaction,s and compliance with the law with adequate approvals.
Definition of Related Party – Section 2(76)
“Related Party” with reference to a company means:
i. a director or his relative
ii. key managerial personnel or his relative
iii. a firm, in which a director, manager or relative is a partner
iv. a private company in which a director or manager or his relative is a member or director
v. a public company in which a director or manager is a director and holds along with his relatives, more than two percent of its paid-up share capital.
vi. Anybody corporate whose Board of Directors, managing director, or manager is accustomed to act in accordance with the advice, directors, or instructions of a director or manager
vii. Any person on whose advice, directors, or instructions of a director or manager is accustomed to act
viii. Any company which is
ix. A holding, subsidiary, or an associate company of such company or
x. A subsidiary of a holding company to which it is also a subsidiary ( in simple words subsidiaries having a common holding company)
xi. A director other than an independent director or key managerial personnel of the holding company or his relative with reference to a company shall be deemed to be a related party.
Exception: Advice, directions, and instructions referred to in points (f) and (g) shall not apply if they are given in a professional capacity.
Nature of Transactions
The transaction may be any contract or arrangement with a related party with respect to-
i. Sale, purchase, or supply of any goods or materials
ii. Selling or otherwise disposing of or buying, the property of any kind
iii. Leasing of property of any kind
iv. Availing or rendering of any services
v. Appointment of any agents for the purchase of sale of goods, materials, services, or property
vi. Such related party’s appointment to any office or place of profit in the company it’s subsidiary company or associate company
vii. Underwriting the subscription of any securities or derivatives of the company
Approval of Transaction
i. Board of Directors: The company shall not enter into a related party transaction without the consent of the Board of the company by the way a resolution passed at the meeting of the Board, subject to the other conditions.
ii. Shareholders: in case of a company having a paid-up share capital of exceeding ten crores shall not enter into any contract or arrangement with the related party without obtaining prior approval of the shareholder by way of a resolution.
However few conditions and exception are vested with this prior approval of the shareholders, such as:
i. A member shall not vote on such resolution to approve any contract or arrangement
i. The requirement of prior approval shall not apply for transactions entered into by the company in its ordinary course of business other than transactions which are not on an arm’s length basis
ii. The requirement of prior approval shall not apply to transactions entered into between a holding company and its wholly owned subsidiary whose accounts are consolidated with the holding company and placed before the shareholders at the general meeting for approval.
References to Terms
i. The expression “office or place of profit” shall mean any office or place –
a . In relation to a director – if her receives anything by way of remuneration over and above the remuneration to which he is entitled as a director (namely, salary, fee, commission, perquisite, any rent free accommodation or otherwise.)
b. In relation to an individual other than director or Firm, private company or other body corporates – if they received from the company anything by way of remuneration (namely, salary, fee, commission, perquisite, any rent-free accommodation or otherwise.)
ii. The expression “arm’s length transaction” shall mean a transaction between two related parties that is conducted as if they were unrelated so that there is no conflict of interest.
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Every contract or arrangement entered under this section shall be referred in the Board’s report to the shareholders. It shall also contain the justification for entering into such contract or arrangement.
Status of Unapproved Transaction and Consequences
i. In case of a contract or arrangement entered into by a director or any other employee without obtaining the consent of the Board or Shareholders, as the case may be, it must be ratified by the shareholders at a meeting within three months from the date of the contract or arrangement. Failing which, the contract or arrangement is not ratified shall be voidable at the option of the Board
ii. If the contract or arrangement is with a related party to any director or is authorized by any other director, the concerned directors shall indemnify the Company against any loss incurred by it.
iii. Moreover being subjected to ratification or not, it shall be open to a company to proceed against a director or other employee, who entered into a contract or arrangement contravening the provisions for the recovery of any loss sustained by it as a result of the contract or arrangement.
Penal Provision on Contravention
A director or other employee of the company who had entered into or authorize the contract or arrangement violating the above provisions shall be liable for penalty:
i. In case of a listed company: punishable with imprisonment extending to one year or fine not less than twenty-five thousand extending to five lakhs or with both
ii. In case of other company: punishable with fine, not less than twenty-five thousand extending to five lakhs
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