Corporate Guarantee Under Amended Company Law

New Companies Act makes it difficult for subsidiaries firms to raise money

A new Section prohibits banks to lend money to smaller subsidiaries companies despite Corporate Guarantee from the parent.

This Article make the crucial scrutiny of Section 185 of New Companies Act 2013 which relates to giving of Corporate Guarantee by larger/bigger companies (often a known flagship or holding or parent company) for providing loans to its smaller or its subsidiary companies who may not be well known or have developed a relationship with the banks/lenders.

The wrongful interpretations of Section 185 resulted de facto prohibition by banks from taking Corporate Guarantee as a security for sanctioning loans to its subsidiary.

Corporate Guarantee is a written affirmation payment made by a known flagship or holding company, on behalf of its other business entity who would be normally smaller company.

Since Section 185 of the New Companies Act 2013 became operative effective September 2013, there is all around ambiguity in banking sector whether the bank can stipulate Corporate Guarantee as one of security or not.

Section 185 is in fact replacement of old section 295 of the Companies Act, 1956, which provides for loans to directors.

As per the objective of the legislation, there is a control for loans to directors etc. and to any other person in whom the director is interested, which was earlier allowable under Section 295 of the Companies Act, 1956.

But true spirit of every economic legislation/statutory enactment should ever facilitate and improve the efficacy of the economic structure of a nation in line with the changing and dynamic requirements of a vibrant Indian economy.

Proviso of new Companies Act should never put speed-breakers or bottlenecks for the growth of trade & commerce.

Because when the Corporate Guarantees are provided to any Bank, the Bank lend monies in the economic system of the country and that funds are usually used in the ordinary course of business for productive purposes in the overall growth the economy of the country.

The eventual purpose of Section 185 of the New Companies Act, 2013 is to put additional restrictions on loan to directors only and not on giving of Corporate Guarantee by the holding company to its subsidiary company.

This new proviso of Section 185 unintentionally hampered the acceptance of Corporate Guarantees as one of security by banks. Even under the (old) Section 295 of the Companies Act, 1956, a Corporate Guarantee by the holding company to its subsidiary company is permissible.

Section 372A of the Companies Act, about inter-corporate loans and investments, including giving of Corporate Guarantee 1956 which is still in operation, specifically deals with inter-corporate loans, giving of any guarantee including Corporate Guarantee or providing any security to the Banks.

In view of all these related proviso of Section 372A of the Companies Act, 1956 which is still in operation, holding or parent company can provide Corporate Guarantee to banks for the loan being provided to its subsidiary company or other smaller Group Company.

As on date Section 372A of the Companies Act 1956 permits giving Corporate Guarantee by holding or parent company to the bank for the loan being provided to subsidiary company or other smaller Group Company by any Bank.

The statutory provisions of Section 372A of the Companies Act 1956 specifically deals with inter-corporate loans and exempts loans advanced or Corporate Guarantee by holding company to its wholly owned subsidiary.

Conclusion

Based upon the above analysis of Sections 185 and Section 372A of the Companies Act 1956, even after the effectiveness of Section 185 of the New Companies Act 2013, the Bank can take the Corporate Guarantee from holding or parent company to the Bank for the loan being provided to subsidiary company or other smaller Group Company in accordance with the existing Section 372A of the Companies Act, 1956, which is operative as of now along with ensuring required compliance with Section 185 the New Companies Act 2013.

Even, as per the recent Circular No. 18/2013 dated 19.11.2013 of the Ministry of Corporate Affairs, a clarification has been issued with regard to applicability of provision of Section 372A of the Companies Act, 1956 on account of number of representations received consequent upon notifying Section 185 of the Companies Act, 2013 dealing with loans to directors which is corresponding to Section 295 of the Companies Act, 1956.

It was unequivocally clarified in the said Circular that Section 372A of the Companies Act, 1956 dealing with inter-corporate loans continue to remain in force till section 186, of the Companies Act, 2013 is notified.

It should be undoubtedly noted that no law can ever restrict the smooth flow of trade & commerce or creates bottlenecks in the economic growth of any nation. The ultimate objective of any economic legislation like New Companies Act 2013 is to facilitate the economic growth of any in line with the changing business requirements.

But, recently lot of banks in the country, only on account of narrow and wrong interpretations of Section 185 of the New Companies Act 2013, stopped taking Corporate Guarantee as a security as one of security from holding companies for sanctioning loans to its subsidiary.

Ultimately, this narrow interpretation has created speed breaker or bottlenecks in the flow of loaned funds from banks to corporates which can definitely and adversely affect the economic growth of the resources starved nation like India.

The banking industry should be advised to review the narrow interpretation of Section 185 and start taking Corporate Guarantees from the respective holding or parent companies for the credit facilities/loan being provided to subsidiary company or other smaller group company in accordance with the existing Section 372A of the Companies Act, 1956.

Sanjay Lalit is an Advocate & Legal Consultant, in Mumbai and can be reached at cssklco@gmail.com

Companies Acts - Section 185, 186 and 372A - Ambiguities come fully loaded!

BY  Lalit Kumar, 

First this circular states that section 185 prohibits giving of guarantee or security by a holding company in respect of any loan taken by its subsidiary.

Section 470 of the new Companies Act, 2013 gives power to central government to remove difficulties which arise in giving effect to the provisions of the new law but the manner in which the Ministry of Corporate Affairs (MCA) is releasing circulars to clarify certain provisions of the new law, it only compounds the already existing difficulties, what to talk about removing them. Although, none of the circulars so far issued has been under its power of section 470 (although they have been issued to clarify doubts) but all of them make the issues more ambiguous. The case in point is MCA’s circular of February 14 on clarification with regard to Section 185 of the Companies Act, 2013.  

It appears that this circular wanted to further clarify the ambiguity which persisted after MCA’s earlier circular dated November 19, 2013 on a similar issue. But, it suffers from many flaws. First this circular states that section 185 prohibits giving of guarantee or security by a holding company in respect of any loan taken by its subsidiary. This is not correct. Nowhere does section 185 give a clear language that a holding company is prohibited from giving guarantee or security in respect of any loan taken by its subsidiary.

It seems that the circular’s basis to interpret this is the expression used in explanation (e) of sub-section 1 of section 185 which covers a body corporate whose board of directors acts in accordance with the directions or instructions of the board of its holding company. That may not be always true i.e. it is not always true that a subsidiary will act according to the directions and instructions of the board of the holding company. There are concepts of separate legal entity and fiduciary duties of directors with respect to the company they represent. This concept of fiduciary duties is further strengthened by the new section 166 introduced in the Companies Act, 2013 which lays duties of directors. Therefore, whether a body corporate acts in accordance with the directions or instructions of the board of its holding company will depend upon the facts and circumstances of the case. If the board of a subsidiary is always bound to act as per the instructions of the board of its holding company, then that will always defeat the concept of fiduciary duties of directors of the subsidiary. 

Further explanation (e) of sub-section 1 uses the expression “acts in accordance with the directions or instructions of the board of the lending company.” So does it mean that section 185 only restricts lending activities because a company providing guarantee or security would in real terms not be called a lending company? So for this reason is giving of guarantee or security free from clutches of section 185? That cannot be the intent. The problem is the expression used here is copied from section 185’s earlier avatar section 295 of Companies Act, 1956 which clearly defined the expression lending company to mean a company advancing loan, giving guarantee and providing security, while explanation (e) has been copied verbatim, regrettably no mind was applied that it could mislead if expression lending company is also not copied verbatim.

Another flaw in the circular is it mentions that section 185 is not notified, however, that is not true, section 185 has already been notified on September 12, 2013. Surely, this circular meant to write section 186 but inadvertently mentions section 185. This being an important circular on an important issue, the MCA should be more careful to ensure the contents are accurate; otherwise it will again create confusion because of this inadvertent error.

Although, the principal concept of this circular is not on the issue of exemption in cases of “ordinary course of business”, which is another debatable point in section 185, however, the way this expression is used in the circular, it seems the MCA’s understanding of the meaning of the term “ordinary course of business” are those actions which are done in the usual and ordinary course of a company’s business and not necessarily as a ‘principal business’ for which the company was established. Further, since the circular provides for expression ‘ordinary course of business’ as an exception in the case of section 185 – does it mean that if things are done in ordinary course of business between the holding-wholly owned subsidiary, then the benefit of section 372A is in any case not needed (which this circular provides), as that will be covered by section 185 itself.

Noteworthy point is that this circular only provides exemption in cases when a bank or a financial institution advances loan to a subsidiary which is guaranteed and secured by the parent company. It does not exempt and cover the other aspect provided under section 372A in a case when a parent company gives a direct loan to its wholly owned subsidiary. Therefore, this circular will only bring relief where a bank finances a subsidiary on the basis of guarantee or security given by the parent company and not in cases where a parent company wants to itself extend a direct loan to its subsidiary. This circular has been released to facilitate smooth bank financing to a subsidiary which created ambiguity when section 185 was notified. This clarification comes with a condition that it will only apply to cases where the loans so obtained by subsidiary are exclusively utilised by the subsidiary for its principal business activities. There is no such condition in section 185 of Companies Act, 2013 and section 372A of Companies Act, 1956.

This circular will apply till section 186 is notified, and if and when section 186 is notified, there will be again ambiguity as section 186 does not grant exemptions in holding and wholly owned subsidiary cases (like section 372A does).

(Lalit Kumar is a partner with J. Sagar Associates. Views are personal.)

INSIGHT ON SECTION 186 OF THE NEW COMPANIES ACT, 2013

by CS.Vanaja, CS. J Smitha, and priyanka   on February 5, 2014

Section 186 of the Companies Act 2013 – Loan and Investment by Company:

Introduction:
The Companies Act, 2013 (Act) has come up with a change in the concept of ‘Loan and Investment by Company. The new Act provides that inter-corporate investments not to be made through more than two layers of investment companies. There is no such provision under section 372A of erstwhile Companies Act, 1956.
Applicability:
In pursuance to the provisions of Section 186(1) of the Act, a Company shall make investment through not more than two layers of investment companies.
‘layer’ in relation to a holding Company means its subsidiary or subsidiaries [explanation (d) of Section 2(87) of the Act]
‘investment Company’ means a Company whose principal business is the acquisition of shares, debentures or other securities”
The provisions of Section 186 (1) shall not have effect in the following cases:

·         A Company acquires any Company which is incorporated outside India. Such Company has Investment Subsidiary beyond Two layers as per the law of such country.

·         A subsidiary Company from having any investment subsidiary for the purpose of meeting of the requirement under any law framed under any law for the time being in force.

Limits for Loans /Guarantee/Security/Investment:
In pursuant to provisions of Section 186(2) of the Act, no Company shall directly or indirectly give any loan to any person or other body corporate, give any guarantee or provide security in connection with a loan to any other body corporate or person and acquire by way of subscription, purchase or otherwise, the securities of any other body corporate, exceeding 60% of its paid-up share capital plus free reserves plus securities premium account or 100% of its free reserves plus securities premium account, whichever is more.
Approval from members:
Though the Section 186(2) makes restriction as above, Section 186(3), empowers a Company to give loan, guarantee or provide any security or acquisition beyond the limit but subject to prior approval of members by a special resolution passed at a general meeting.
Disclosure of particulars of loan, guarantee given and security provided:
In pursuant to provisions of Section 186(4) of the Act, it is duty of the Company to disclose in the Financial Statement the full particulars of the loan, guarantee given and security provided and its utilization.
Approval of Board and Public Financial Institution:
In pursuant to provisions of Section 186(5) of the Act, every Company shall take consent of all the directors present at the board meeting before making any investment, giving loan and guarantee and providing security. In case of Company has already taken loan etc., from any Public Financial Institutions, then it is mandatory to take prior approval from such Public Financial Institution.
Provided that prior approval of Public Financial Institution shall not be required where the aggregate loan, investment, guarantee and security proposed is within the limits as specified under section 186(2) and there is no default in repayment of loan or interest thereon to the Public Financials Institution.
Companies Registered under Securities Exchange Board of India (SEBI):
Section 186(6) of the Act provides that those Companies which are registered under Section 12 of SEBI Act, 1992 and other prescribed Companies can take inter-corporate loans or deposits exceeding the prescribed limit. The intention of government is clear, if the Company is registered under SEBI, this section is not applicable for the part of limit but, simultaneously, prescribed a condition that:
Provided that such companies shall furnish details of loans or deposit in their Financial Statements.
Register to be maintained:
Section 186(10) of the Act mandates every Company to maintain a register which shall contain particulars of loan or guarantee given or security provided or investment made.
This register shall be opened for inspection and copies may be furnished to to members who demands for the same on payment of prescribed fee.
Non Applicability:
The Section 186 (except Sub Section 1) of the Companies Act, 2013 does not apply to the following:

·         Banking Company, Insurance Company, Housing Finance Company etc.,

·         Any Company whose main business of acquisition of shares or securities etc.,

Penalty:
For Company:
Every Company which contravenes the provisions of this Section shall be liable to a penalty which shall not be less than Rs. 25000/- but which may extend to Rs. 5.00 lacs.
For Officers:-
Every officer of the Company who is default shall be punishable with imprisonment for a term which may extend to two years and fine which shall not be less than Rs. 25000/- but which may extend to Rs. 1.00 lacs.
Note: Ministry of Corporate Affairs has issued a clarification through General Circular No. 18/2013. dated 19.11.2013 with regard to applicability of provision of Section 372A of the Companies Act, 1956. It was unequivocally clarified in the said Circular that Section 372A of the Companies Act, 1956 dealing with inter-corporate loans continue to remain in force till section 186, of the Companies Act, 2013 is notified.

SECTION 186 OF THE COMPANY ACT, 2013 Restriction on making investment through not more than 2 layers Section 186 (1) provide that  Without prejudice to the provisions contained in this Act,2013 a company shall unless otherwise prescribed, make investment through not more than two layers of investment companies: Provided that the provisions of this sub-section shall not affect, - a company from acquiring any other company incorporated in a country outside India if such other company has investment subsidiaries beyond two layers as per the laws of such country; a subsidiary company from having any investment subsidiary for the purposes of meeting the requirements under any law or under any rule or regulation framed under any law for the time being in force. Restriction on providing loans, guarantee and investments, security to other body corporate or person Section 186 (2) provides that No company shall directly or indirectly - give any loan to any person or other body corporate; give any guarantee or provide security in connection with a loan to any other body corporate or person; and acquire by way of subscription, purchase or otherwise, the securities of any other body corporate, Limits up to 60 percent of CRP (Share Capital + Free Reserves + Securities Premium account) or 100 percent of RP, whichever is higher Approval of Shareholders is mandatory where BOD needs to make loans, guarantee and investment, security in excess of prescribed limits (SR) u/s 186(3) No loan or guarantee or providing any security or the acquisition exceeds the prescribed limits unless the proposal is previously authorised by special resolution passed in general meeting. In case of listed company the resolution needs to be passed by postal ballot process. [No blanket permission will be given by shareholders] Sec.186 (12) + Rule 13(1) - Special Resolution as required under section 186 may be passed before 31st March, 15. Limit to Investment in Wholly owned subsidiary Loan or guarantee given and security provided to its wholly owned subsidiary company or a JV, exempted from calculating the limits prescribed under section 186. Disclose requirement in the notice of general Meeting The Notice of general meeting for passing resolution shall indicate clearly the following: the limits that will be required in excess of prescribed limits involved in the proposal; the particulars of lending company or investing company the purpose of loans, guarantee , security and investments the source of funding for meeting the proposal and other details as may be specified Unanimous consent of all directors at the board meeting is required No investment shall be made or loan or guarantee or security given by the company unless the resolution sanctioning it is passed at a meeting of the Board with the consent of all the directors present at the meeting and the prior approval of the public financial institution concerned where any term loan is subsisting, is obtained Proviso of section 186 (5) provide that No Requirement for prior approval of FI within the prescribed limits subject to no default of repayment of loans and interest thereon  ( Further if there is default in repayment of installments of loan or payment of interest on a term loan, prior approval from such PFI is required.) Limitation on the power of a company Sec. 186(6) - Restriction on taking loan on the companies registered with SEBI u/s 12 of the SEBI Act. Sec. 186 (7)- Restriction on providing loans on lower rate of interest payable on the loans ( Clarification by MCA on 14.03.2014) Sec. 186(8) – Restriction on providing loan, guarantee or security in case of default committed in repayment of deposit and/or interest thereon Register of loans, investment, guarantee or security provided by company Sec. 186(9) + Rule 12(1)- Maintain (in electronic mode or manually) the register in the Form MBP-2 from the date of its incorporation Sec. 186(9) + Rule 12(2)- Entries to be made in the register within 7 days Sec. 186(9) + Rule 12(3)- Place of Keeping the register- Registered office Sec. 186(9) + Rule 12(4)- Authentication of the Register by secretary or authorised person by BOD Sec. 186(9) + Rule 12(6) - Inspection charges not exceed Rs. 10/-for each page. Record required to be maintained for such loans Yes, Company shall maintain a register in Form MBP 2 and enter therein separately, the particulars of loans and guarantees given, securities provided and acquisitions made as aforesaid. The entries in the register shall be made chronologically in respect of each such transaction within seven days of making such loan or giving guarantee or providing security or making acquisition. The entries in the register (either manual or electronic) need to be authenticated by the company secretary of the company or by any other person authorised by the Board for the purpose. Exemption for the applicability of Section 186(1) Nothing contained in this section, except sub-section (1), shall apply - to a loan made, guarantee given or security provided by a banking company or an insurance company or a housing finance company in the ordinary course of its business or a company engaged in the business of financing of companies or of providing infrastructural facilities; to any acquisition - made by a non-banking financial company registered under Chapter IIIB of the Reserve Bank of India Act, 1934 and whose principal business is acquisition of securities in respect of its investment and lending activities; made by a company whose principal business is the acquisition of securities; of shares allotted in pursuance of section 62(1) (a). Penalty Lender Company: Fine Rs. 5 lakhs to Rs. 25 lakhs Officer: Director or other person -Imprisonment upto 2 years or fine Rs. 5 lakhs to Rs. 25 Lakhs, or both. Compounding offence The offence committed under this section is compoundable in accordance with the provisions of section 441 of the Act.

By: CA C M JAIN - May 28, 2014