"A private company can lend to its director freely": what Sections 185 and 186 actually say

Ask ten promoters of small private limited companies whether the company can lend money to its own director, and eight will say yes — "it's my company, it's my money." The remaining two will say the 2017 amendment "removed the restriction for private companies." Both answers are wrong, and the second one is dangerous because it sounds informed.

Section 185 of the Companies Act, 2013 was never repealed. It was restructured in 2017. What changed is how a loan to a director becomes permissible — not whether it is restricted. And Section 186, which governs inter-corporate loans and investments, quietly catches far more transactions than most founders realise, including the routine act of parking surplus cash in another group entity.

What the law actually says

Section 185 — loans to directors and connected persons

Section 185(1) is an absolute prohibition. A company shall not, directly or indirectly, advance any loan (including a loan represented by a book debt), give any guarantee, or provide any security in connection with a loan taken by:

• 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 resolution that cures a Section 185(1) breach. It is flat.

Section 185(2) is the conditional gateway, and this is where the 2017 amendment (Companies (Amendment) Act, 2017, effective 7 May 2018) did its work. A company may advance a loan, guarantee or security to any person in whom any director is interested — a much wider category that includes private companies where a director is a director or member, and bodies corporate where directors control 25% or more of voting power — provided two conditions are met together:

• A special resolution is passed in general meeting, and the explanatory statement discloses full particulars of the loan, its purpose, and the source of funding; and
• The borrowing company uses the loan for its principal business activities — not to re-lend, not to park, not to fund an unrelated venture.

Section 185(3) carves out genuine exceptions: a loan to a managing or whole-time director as part of a service condition extended to all employees, or under a scheme approved by special resolution; a company whose ordinary business is lending money, at a rate not below the prevailing yield of a one-, three-, five- or ten-year Government security closest to the tenor of the loan; and a holding company giving a loan or guarantee to its wholly-owned subsidiary, or guaranteeing a bank loan to its subsidiary, where the funds are used for the subsidiary's principal business.

The penalty under Section 185(4) is the part that gets skipped in WhatsApp forwards. The company is liable to a fine of not less than Rs.5,00,000 which may extend to Rs.25,00,000. Every officer in default faces imprisonment up to six months or a fine between Rs.5,00,000 and Rs.25,00,000. The director or other person to whom the loan was advanced is liable to imprisonment up to six months, or a fine between Rs.5,00,000 and Rs.25,00,000, or both. Note the asymmetry: the recipient is personally exposed, and unlike most Companies Act defaults, this one is not a mere monetary compounding matter.

Section 186 — loans and investments by a company

Section 186 operates on a different axis. It restricts the quantum of what a company may lend, guarantee or invest, regardless of whether a director is interested.

Section 186(1) limits investment through more than two layers of investment companies, with exceptions for acquisition of a foreign company where that company has investment subsidiaries beyond two layers as per the law of that country, and for a subsidiary making investment to comply with any law in force.

Section 186(2) is the ceiling. No company shall directly or indirectly give a loan to any person or other body corporate, give a guarantee or provide security in connection with a loan to any other body corporate or person, or acquire the securities of any other body corporate, exceeding the higher of:

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

Cross the ceiling and Section 186(3) requires prior authorisation by special resolution in general meeting.

Section 186(5) requires that every such loan, guarantee, security or investment — even within the limits — be approved by a resolution passed at a Board meeting with the consent of all directors present, and where a term loan from a public financial institution is subsisting, prior approval of that institution is also needed unless the company is within the 186(2) limits and has no default in repayment.

Section 186(7) sets a floor on pricing: no loan shall be given at a rate of interest lower than the prevailing yield of one-year, three-year, five-year or ten-year Government security closest to the tenor of the loan. Interest-free loans to group companies are, quite simply, not permitted under Section 186(7).

Section 186(4) mandates disclosure in the financial statements of the full particulars of every loan, investment, guarantee and security, and the purpose for which the recipient proposes to use it. Section 186(9) and (10) require a register in Form MBP-2 to be maintained at the registered office, kept open for inspection by members.

The penalty under Section 186(13): the company is fined between Rs.25,000 and Rs.5,00,000, and every officer in default faces imprisonment up to two years and a fine between Rs.25,000 and Rs.1,00,000.

Where Section 186 does not apply. Sub-section (11) exempts loans, guarantees, securities and investments made by a banking company, insurance company, housing finance company in the ordinary course of business, or a company engaged in the business of financing companies or providing infrastructural facilities. It also exempts acquisition of shares under a rights issue under Section 62(1)(a), and — importantly — the 60%/100% ceiling in 186(2) does not apply to a loan or guarantee given by a holding company to its wholly-owned subsidiary, or to acquisition by a holding company of securities of its wholly-owned subsidiary. But the Board resolution and disclosure obligations still run.

A point regularly confused: loans and advances to employees who are not managing or whole-time directors are outside Section 186 altogether — they sit outside the ceiling and outside the MBP-2 register.

Practical implications

Scenario 1 — The founder's "temporary" withdrawal. A director of a private limited company with Rs.1 crore in the current account withdraws Rs.15 lakh and books it as "loan to director," intending to repay in four months. This is a direct Section 185(1) breach. No resolution fixes it, no repayment cures it. The company faces a minimum Rs.5,00,000 fine and the director faces personal liability up to Rs.25,00,000 or imprisonment. The correct instruments are a declared dividend, remuneration approved under Section 197, or reimbursement of documented business expenses.

Scenario 2 — Lending to a company where the director is also a director. Company A lends Rs.40 lakh to Company B; the same person is a director in both. This is not 185(1) — it is 185(2), so it is permissible, but only if a special resolution is passed with the explanatory statement disclosing purpose and source, and Company B uses the Rs.40 lakh for its own principal business. If Company B on-lends it to a third party, the exemption collapses.

Scenario 3 — Group cash pooling. Company A has paid-up capital of Rs.10 lakh, free reserves of Rs.90 lakh and no securities premium. Its Section 186(2) ceiling is the higher of 60% of Rs.1 crore (Rs.60 lakh) or 100% of Rs.90 lakh (Rs.90 lakh) — so Rs.90 lakh. Lend Rs.1.2 crore to a sister concern and you have crossed it: a special resolution under 186(3) is mandatory, and the loan must carry interest at or above the closest-tenor G-Sec yield under 186(7).

Scenario 4 — Wholly-owned subsidiary. Company A holds 100% of Company B and guarantees B's Rs.5 crore working capital facility. Section 185(3)(c) protects the guarantee, and Section 186(11) lifts the quantum ceiling. But the all-directors-present Board resolution under 186(5), the MBP-2 register entry, and the 186(4) financial statement disclosure all still apply — and the funds must go to B's principal business.

Step-by-step: what to do

• Classify the counterparty before you move money. Is it a director, a relative of a director, a partnership firm with a director or relative as partner? If yes, stop — Section 185(1) applies and nothing cures it.
• If it is a "person in whom a director is interested," run the 185(2) route. Convene a general meeting, pass a special resolution, and draft the explanatory statement to state the exact amount, the purpose, and the source of funds. Obtain a written undertaking from the borrower that the funds will be applied to its principal business activity.
• Compute your Section 186(2) headroom before every transaction. Take audited paid-up capital, free reserves and securities premium as at the last audited balance sheet date. Calculate both 60% and 100% figures. Use the higher. Add all existing loans, guarantees, securities and investments outstanding — the limit is cumulative, not per-transaction.
• Pass the Board resolution with all directors present consenting. Not a majority — the unanimous consent of directors present at the meeting is the statutory requirement under Section 186(5). Circular resolutions do not satisfy this.
• Price the loan at or above the G-Sec benchmark. Identify the tenor of your loan, pick the closest of the one/three/five/ten-year G-Sec, take the prevailing yield, and document the source of that yield in the Board minutes.
• Maintain Form MBP-2 within seven days. Enter the name of the body corporate or person, amount, purpose, terms and date. Keep it at the registered office, open to member inspection.
• Disclose in the financial statements. Section 186(4) particulars, plus AOC-2 disclosure if the transaction is also a related-party transaction under Section 188, plus the auditor's CARO 2020 clause 3(iii) reporting on loans and advances.
• File the special resolution in Form MGT-14 within 30 days of passing it, where a special resolution was required.

FAQ

Can a private limited company give an interest-free loan to its subsidiary?
No. Section 186(7) requires the rate to be at or above the yield of the closest-tenor Government security. This applies even to wholly-owned subsidiaries — Section 186(11) lifts the quantum ceiling, not the interest floor.

Does Section 185 apply if the director repays the loan before the financial year ends?
Yes. The offence is complete at the moment the loan is advanced. Repayment does not undo the contravention, and it does not remove the company's or the director's exposure under Section 185(4).

Is a director's current account overdrawn balance a "loan" under Section 185?
Yes, if it represents money advanced by the company to the director. Section 185(1) expressly covers a loan "represented by a book debt." Labelling it an imprest, advance, or current account balance does not change its character.

We are a small private company with two directors. Do we still need a general meeting for the special resolution?
Yes. There is no exemption from the special resolution requirement based on company size. A two-member general meeting is perfectly valid — call it, minute it, pass it, and file MGT-14 within 30 days.

---

For your specific situation, book a consultation at harunraaj.com

Need help with this?

Our team handles the paperwork. You focus on your business.