Loan and Investment by a Company

In one line

A company may lend, guarantee, secure and invest, but not beyond a ceiling fixed by its own capital and reserves without a special resolution, not through more than two layers of investment companies, not below a floor rate of interest, not while it is in default on deposits, and not in anybody's name but its own.

In exam wording: section 186(2) caps loans, guarantees, securities and acquisitions at sixty per cent of paid-up share capital, free reserves and securities premium account, or one hundred per cent of free reserves and securities premium account, whichever is more; section 186(3) allows the cap to be crossed only with a special resolution; and section 187(1) requires all investments to be made and held by the company in its own name.

Why the law has this at all

A company's money belongs to its members, and a director who cannot lend it to himself under section 185 may still be tempted to lend it to a company he is interested in, or to bury it under a chain of investment companies until nobody can trace it. The Act's answer has three parts, and it is worth seeing them as three separate ideas.

A ceiling. Beyond a certain proportion of the company's own resources, lending and investing stops being incidental to the business and becomes the business. Past that point the members, not the Board, must decide.

A limit on layering. Investment through investment companies stacked one above another hides the ultimate destination of the money. The Act allows two layers and no more.

A rule about the name. Money invested in a nominee's name is money the company may find hard to prove is its own. Section 187 requires the company's own name, with narrow exceptions.

Some words this chapter uses

Free reserves are reserves available for distribution as dividend, defined in section 2(43). Securities premium account is the account under section 52 holding the premium on shares issued above par. A layer, in relation to a holding company, means a subsidiary or subsidiaries: section 2(87), Explanation (d). An investment company is defined in the Explanation to section 186. A special resolution is one passed by a three-fourths majority under section 114(2). A public financial institution is defined in section 2(72).

Two layers of investment companies: section 186(1)

Without prejudice to the provisions contained in this Act, a company shall unless otherwise prescribed, make investment through not more than two layers of investment companies.

The proviso saves two situations.

• (i) a company acquiring any other company incorporated in a country outside India where that other company has investment subsidiaries beyond two layers as per the laws of that country; and
• (ii) a subsidiary company having any investment subsidiary for the purposes of meeting the requirements under any law, rule or regulation for the time being in force.