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Loans, security and guarantees
The Companies Act 2013 has introduced some changes to provisions governing loans and financial assistance to related parties.
Under the 1956 Act, public companies and their subsidiaries are subject to numerous restrictions in relation to loans or other financial assistance provided to directors. These restrictions were not applicable to private companies.
Introduction of limits on the amount of investments, loans and financial assistance

The Companies Act 2013 has introduced restrictions on the quantum and manner of loans and investments that can be made by companies – these are applicable to private companies as well. They are discussed below:
  1. Loans or guarantees to any other person or body corporate, or investments in shares by a company cannot exceed the higher of the following:  
  • Aggregate of securities premium and free reserves
  • 60 percent of its capital (calculated by aggregating the paid-up share capital, securities premium and free reserves – free reserves are nothing but accumulated profits that have not been distributed as dividend)  
  1. Any loans must be given at the interest rate which is at least equal to the yield provided by a government security of a corresponding duration.
 Similar limits as mentioned in points (1) and (2) existed under the 1956 Act, but they were not applicable to private companies.
  1. Ordinarily, investments cannot be made through more than 2 layers of investment companies (unless a specific law in India or offshore requires the company to have an investment subsidiary) – this can prevent undue layering – a strategy which is often used to hide the real nature of a transaction.
The only exception is with respect to companies involved in the business of making investments or in the financial sector (banking, housing finance, insurance or infrastructure).

What should be done in respect of pre-existing loans or investments made by private companies prior to the act?

Note that these restrictions were inapplicable to private companies under the old act, and it is possible that private companies had extended such loans, to which the new Companies Act of 2013 has now become applicable. In such cases, where a loan or guarantee exceeding the thresholds was provided prior to the new act without obtaining a special resolution, the company must obtain the resolution within one year from the notification of the section.
The company is also liable to disclose in the financial statement of the company the full details of such transactions and the purpose for which such loan or guarantee or security is proposed to be utilised by the recipient.

Compliance requirements and punishment for non-compliance

Maintenance of Registers
It is mandatory for every company giving loan/guarantee/security or making an acquisition to maintain a register in Form MBP 2, which shall contain particulars and details of the transaction. Moreover, the companies are required to maintain a separate register in Form MBP 3, which will record all the investments which are beneficially held by the company but which are not in the name of the company. The entries made in such register must be authenticated by the company secretary of the company or any other person who is authorized by the company. The register must be kept at the registered office of the company and shall be open to inspection by the members of the company.

Punishment for non-compliance
The companies which make any transaction in contravention of the provisions related to investment, inter-corporate loans shall be punishable with fine between INR 25,000 to INR 5 lakh. Every officer of the company who is in default shall be punishable with imprisonment for upto two years and with fine between INR 25,000 to INR 1 lakh.

Loans and financial assistance to restricted entities
The 2013 Act imposes restrictions on loans and financial assistance provided by companies to specified entities. As per the 1956 Act, a company (Lending Company) could not without prior approval of the Central Government directly or indirectly make any loan, give any guarantee or provide any security in connection with a loan made by any other person to specific bodies listed below (Restricted Entities), or to any other person by the Restricted Entities.


This provision was applicable to public companies (and their private subsidiaries) only. There was an exception for private companies and holding / subsidiary companies. 
Now, however, there is no exception for private companies under the 2013 Act. 
Secondly, the requirement of Central Government approval has been removed under the 2013 Act – such financial assistance can be provided pursuant to a scheme that is approved by a special resolution of the shareholders. 
Thirdly, the 2013 Act makes an exception for loans made to a managing or whole-time director as part of the conditions of service, which are extended to all the employees of the company has also been added. 

There is an exception for companies which provide loans or give guarantees / securities in the ordinary course of business for loans obtained at an interest rate greater than the bank rate prescribed by the RBI.
Restricted Entities are listed below:

(a) a director of the Lending Company, or of a company which is its holding company or any partner or relative of any such director;

(b) a firm in which any such director or relative is a partner;

(c) a private company of which any such director is a director or member;

(d) a body corporate,

(i) if in the general meeting the body corporate not less than twenty-five per cent of the total voting power is exercised or controlled by any such director, or by two or more such directors together or

(ii) if its Board, managing director or manager are accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company.
Related party transactions by listed companies are also governed by the Listing Agreement of the Stock Exchanges.
This requires a policy decision with respect to issuing loans, guarantee etc and if possible, incorporation of the same is articles or shareholders’ agreement of the company.
Earlier, none of the restrictions under the head Loans, security and guarantees to related parties were applicable to private companies – hence, we had recommended that the founders of a startup structured as a private limited company could consider introducing appropriate provisions in the articles of association.
The situation will be different under the Companies Act 2013 as it does not exclude private companies from its application. Some of its provisions enable the Central Government to pass rules for its enforcement – it is unclear whether by making such rules the government can exclude the application of these provisions of the Companies Act 2013 to private companies.
Investors often include such restrictions in the shareholders agreement (which are also mirrored in the amended articles of the company post the investment) – any financial assistance to promoters typically requires the approval of the investors. 

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