Loan and Investment by a Company

Clause (i) is a rule of practicality. India cannot restructure a foreign company's own subsidiary chain as the price of an acquisition. Clause (ii) is a rule of necessity: where another law compels the layer, the Companies Act does not forbid it.

And note the reach of sub-section (1). Sub-section (11) exempts several classes of company from the whole section, but it says "except sub-section (1)". The two-layer rule binds even the exempted classes.

The ceiling: section 186(2)

No company shall directly or indirectly:

• (a) give any loan to any person or other body corporate;
• (b) give any guarantee or provide security in connection with a loan to any other body corporate or person; and
• (c) acquire by way of subscription, purchase or otherwise, the securities of any other body corporate,

exceeding sixty per cent of its paid-up share capital, free reserves and securities premium account, or one hundred per cent of its free reserves and securities premium account, whichever is more.

Two figures, and the company gets the higher one. Take a company with paid-up capital of one crore, free reserves of two crore and securities premium of fifty lakh. Sixty per cent of three crore fifty lakh is two crore ten lakh. One hundred per cent of free reserves plus premium, two crore fifty lakh, is two crore fifty lakh. The ceiling is two crore fifty lakh, the higher of the two.

"Directly or indirectly" closes the obvious route of routing the loan through an intermediary.

The Explanation, inserted in 2017, provides that for the purposes of sub-section (2) the word "person" does not include any individual who is in the employment of the company. So a staff loan is outside the ceiling, which is sensible, because an employee advance is not an investment decision.

Crossing the ceiling: section 186(3)

Where the aggregate of the loans and investment so far made, the amount for which guarantee or security so far provided to or in all other bodies corporate along with the investment, loan, guarantee or security proposed to be made or given by the Board, exceed the limits specified under sub-section (2), no investment or loan shall be made or guarantee shall be given or security shall be provided unless previously authorised by a special resolution passed in a general meeting.

Three things to notice.

It is the aggregate that counts, past and proposed together, not each transaction on its own.

The authorisation must be previous. A special resolution passed after the money has gone out does not cure the breach.

It is a special resolution, so a three-fourths majority, not an ordinary one.

The first proviso, substituted in 2017, exempts three relationships: where a loan or guarantee is given, or a security provided, by a company to its wholly owned subsidiary company or a joint venture company, or where an acquisition is made by a holding company of the securities of its wholly owned subsidiary company by subscription, purchase or otherwise, sub-section (3) does not apply.

The second proviso keeps the transparency even where the resolution is excused: the company shall disclose the details of such loans, guarantee, security or acquisition in the financial statement as provided under sub-section (4).

Disclosure, Board consent and the institution's approval: section 186(4) and (5)

Section 186(4). The company shall disclose to the members in the financial statement the full particulars of the loans given, investment made, guarantee given or security provided, and the purpose for which the loan, guarantee or security is proposed to be utilised by the recipient.

Note that the purpose is the recipient's purpose, not the lender's. The member is entitled to know where the money is going and what it will do there.

Section 186(5): two conditions on the Board's own decision.

• the resolution sanctioning it must be 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 must be obtained where any term loan is subsisting.

"Consent of all the directors present" is unanimity of those present, and it cannot be done by circulation, because the sub-section says at a meeting.

The proviso relaxes the second condition. Prior approval of a public financial institution is not required where the aggregate, past and proposed, does not exceed the limit in sub-section (2) and there is no default in repayment of loan instalments or payment of interest as per the terms of the loan to that institution. Both conditions must hold.

Four more restrictions: section 186(6), (7), (8) and (9)

Section 186(6): registered intermediaries. A company registered under section 12 of the Securities and Exchange Board of India Act, 1992 and covered under such class of companies as may be prescribed shall not take inter-corporate loan or deposits exceeding the prescribed limit, and shall furnish the details of the loan or deposits in its financial statement.

Section 186(7): a floor for the interest rate. No loan shall be given under this section 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.

This is the anti-subsidy rule. A cheap loan to a friendly company is a transfer of value dressed as a loan, so the Act fixes the floor by reference to the Government Security nearest in tenor.

Section 186(8): default on deposits. A company in default in the repayment of any deposits accepted before or after the commencement of this Act, or in payment of interest on them, shall not give any loan, guarantee or security or make any acquisition till the default is subsisting.

Section 186(9) and (10): the register. Every company giving a loan, guarantee or security or making an acquisition under the section shall keep a register with the prescribed particulars, kept in the prescribed manner. It shall be kept at the registered office, open to inspection at that office, and extracts may be taken by any member and copies furnished to any member on payment of such fees as may be prescribed.

Who is outside the section: section 186(11)

Nothing in the section, except sub-section (1), applies to:

• (a) any loan, guarantee, security or investment by a banking company, an insurance company, or a housing finance company in the ordinary course of its business, or by a company established with the object of and engaged in the business of financing industrial enterprises or of providing infrastructural facilities; and
• (b) any investment made (i) by an investment company; (ii) in shares allotted in pursuance of section 62(1)(a) or in shares allotted in a rights issue by a body corporate; or (iii) in respect of investment or lending activities, by a non-banking financial company registered under Chapter III-B of the Reserve Bank of India Act, 1934, whose principal business is the acquisition of securities.

The logic is plain. For these companies lending or investing is the business, and a ceiling tied to their own capital would stop them trading. But the exemption is expressly "except sub-section (1)", so the two-layer rule still binds them.

Rules, punishment and definitions: section 186(12), (13) and the Explanation

Section 186(12). The Central Government may make rules for the purposes of the section.

Section 186(13): the punishment, and note that it is still an offence. The company is punishable with fine of not less than twenty-five thousand rupees, extending to five lakh rupees; and every officer in default with imprisonment which may extend to two years and with fine of not less than twenty-five thousand rupees, extending to one lakh rupees.

Contrast the neighbouring sections. Section 187(4) and section 189(6) impose penalties, recoverable in adjudication; section 186(13) imposes fine and imprisonment, which means a prosecution. When an answer asks about consequences, that difference is worth a sentence.

The Explanation defines two expressions.

"Investment company" means a company whose principal business is the acquisition of shares, debentures or other securities; and, by the words added in 2017, a company is deemed to be principally engaged in that business if its assets in the form of investment in shares, debentures or other securities are not less than fifty per cent of its total assets, or if its income from investment business is not less than fifty per cent of its gross income. Either test suffices.

"Infrastructure facilities" means the facilities specified in Schedule VI.

Investments to be held in the company's own name: section 187

Section 187(1). All investments made or held by a company in any property, security or other asset shall be made and held by it in its own name.

The proviso allows the company to hold shares in its subsidiary company in the name of a nominee or nominees, if it is necessary to do so to ensure that the number of members of the subsidiary is not reduced below the statutory limit. So a wholly owned subsidiary whose entire holding sits with the parent still needs its second member on paper, and that nominee holding is lawful.

Section 187(2): four things the section does not prevent.

• (a) depositing with a bank, being the bankers of the company, any shares or securities for the collection of any dividend or interest payable on them;
• (b) depositing with, transferring to, or holding in the name of, the State Bank of India or a scheduled bank, being the bankers of the company, shares or securities in order to facilitate the transfer of them;
• (c) depositing with or transferring to any person any shares or securities by way of security for the repayment of a loan advanced to the company or the performance of an obligation undertaken by it; and
• (d) holding investments in the name of a depository where the investments are in the form of securities held by the company as a beneficial owner.

A time limit sits inside clause (b). If within six months of the transfer to, or first holding in the name of, the State Bank of India or a scheduled bank, no transfer takes place, the company must, as soon as practicable after that period, have the shares or securities re-transferred to it or again hold them in its own name.

Section 187(3). Where, under clause (d), shares or securities are not held in the company's own name, the company shall maintain a register with the prescribed particulars, open to inspection by any member or debenture-holder without any charge during business hours, subject to such reasonable restrictions as the company may impose by its articles or in general meeting.

Note who may inspect. Under section 186(10) it is members; under section 187(3) it is members or debenture-holders, and without any charge.

Section 187(4), substituted by the Companies (Amendment) Act, 2020. If a company is in default in complying with the section, the company is liable to a penalty of five lakh rupees and every officer in default to a penalty of fifty thousand rupees.

A worked example

Vasai Engineering Limited has paid-up share capital of two crore rupees, free reserves of three crore rupees and a securities premium account of one crore rupees.

The ceiling. Sixty per cent of the sum of all three, six crore, is three crore sixty lakh. One hundred per cent of free reserves plus securities premium, four crore, is four crore. The higher figure governs, so the ceiling under section 186(2) is four crore rupees.

Within the ceiling. The Board proposes to lend one crore to Palghar Castings Private Limited and to acquire fifty lakh of shares in Bhiwandi Logistics Limited. The aggregate, one crore fifty lakh, is within four crore, so no special resolution is needed. But section 186(5) still applies: the resolution must be passed at a Board meeting with the consent of all the directors present, and, a term loan from a public financial institution being subsisting, prior approval of that institution is required unless the proviso is satisfied. Here the aggregate is below the sub-section (2) limit and the company has not defaulted on instalments or interest, so both conditions of the proviso hold and the institution's approval is not needed.

The rate. The loan to Palghar Castings is for five years. Under section 186(7) the rate must not be lower than the prevailing yield of the Government Security closest in tenor, which here is the five year Security. A loan at two per cent below that yield contravenes the section, however commercially friendly the intention.

Crossing the ceiling. The Board later proposes a further guarantee of three crore. Aggregated with what has gone before, the total is four crore fifty lakh, which exceeds four crore. Under section 186(3) the guarantee cannot be given unless previously authorised by a special resolution in general meeting. If the guarantee is given first and the resolution passed a month later, the section is still contravened, because the authorisation must be previous.

The wholly owned subsidiary. Suppose instead the three crore guarantee is given to Vasai Precision Private Limited, a wholly owned subsidiary. The first proviso to sub-section (3) applies and no special resolution is required, but the second proviso requires the details to be disclosed in the financial statement under sub-section (4).

Default on deposits. If Vasai Engineering is in default in repaying deposits accepted from the public, section 186(8) stops it from giving any loan, guarantee or security or making any acquisition until the default is cured. The special resolution cannot cure that, because sub-section (8) is not tied to the ceiling at all.

Layers. The company wishes to invest through Vasai Holdings Private Limited, which will invest through Konkan Investments Private Limited, which will in turn invest through Thane Capital Private Limited. That is three layers of investment companies and sub-section (1) forbids it. Two would be permissible.

The name. The shares in Bhiwandi Logistics are registered in the name of the company's finance director, for convenience. That contravenes section 187(1), because investments must be made and held in the company's own name, and the director is not within any of the exceptions in sub-section (2). The company is liable to a penalty of five lakh rupees and every officer in default to fifty thousand rupees: section 187(4).

A holding that is lawful. The company's holding in Vasai Precision includes one share registered in the name of a nominee, so that the subsidiary keeps its minimum number of members. That is expressly saved by the proviso to section 187(1).

Punishment for the section 186 breaches. Under section 186(13) the company is punishable with fine of not less than twenty-five thousand rupees extending to five lakh rupees, and every officer in default with imprisonment up to two years and fine of not less than twenty-five thousand rupees extending to one lakh rupees.

Distinctions that carry marks

What this does NOT mean

It does not mean a special resolution permits anything. It lifts the ceiling in sub-section (2) only. The two-layer rule in sub-section (1), the interest floor in sub-section (7), the deposit-default bar in sub-section (8) and the unanimity of directors present in sub-section (5) all continue to apply.

It does not mean the exempted companies in sub-section (11) are outside the whole section. Sub-section (11) says "except sub-section (1)", so the two-layer restriction still binds them.

It does not mean the ceiling is calculated transaction by transaction. Sub-section (3) speaks of the aggregate of what has been done and what is proposed.

It does not mean staff advances count. The Explanation to sub-section (2) excludes from "person" any individual in the employment of the company.

It does not mean the section 186(13) consequence is a mere penalty. It is fine, and for officers in default imprisonment up to two years, unlike section 187(4).

Quick revision

• 186(1): investment through not more than two layers of investment companies; proviso saves acquiring a foreign company with deeper layers under its own law, and a subsidiary's investment subsidiary required by any law.
• 186(2): no loan to any person or body corporate, guarantee or security for a loan to a body corporate or person, or acquisition of securities of another body corporate, exceeding sixty per cent of paid-up capital, free reserves and securities premium, or one hundred per cent of free reserves and securities premium, whichever is more. Explanation: "person" excludes an individual in the employment of the company.
• 186(3): the aggregate, past and proposed, above the limit needs a previously passed special resolution. Not needed for a loan, guarantee or security to a wholly owned subsidiary or joint venture, or a holding company's acquisition of its wholly owned subsidiary's securities, but the details must still be disclosed in the financial statement.
• 186(4): disclose to members in the financial statement the full particulars and the purpose for which the recipient will use it.
• 186(5): Board resolution at a meeting with the consent of all directors present, plus prior approval of the public financial institution where a term loan subsists; approval not needed if the aggregate is within the sub-section (2) limit and there is no default to that institution.
• 186(6): a company registered under section 12 of the SEBI Act, 1992 in a prescribed class shall not take inter-corporate loan or deposits beyond the prescribed limit and must disclose them.
• 186(7): no loan below the prevailing yield of the one, three, five or ten year Government Security closest to the tenor.
• 186(8): no loan, guarantee, security or acquisition while a default in repaying deposits or interest subsists.
• 186(9) and (10): a register, kept at the registered office, open to inspection, extracts by any member, copies on fees.
• 186(11): the section, except sub-section (1), does not apply to banking, insurance and housing finance companies in the ordinary course, companies financing industrial enterprises or providing infrastructural facilities, and to investments by an investment company, in section 62(1)(a) or rights shares, or by an NBFC under Chapter III-B of the RBI Act, 1934 whose principal business is acquisition of securities.
• 186(13): company fined twenty-five thousand to five lakh rupees; officer in default imprisoned up to two years and fined twenty-five thousand to one lakh rupees.
• Explanation: an investment company is one whose principal business is acquiring securities, deemed so if such investments are fifty per cent or more of total assets or investment income is fifty per cent or more of gross income; infrastructure facilities are those in Schedule VI.
• 187(1): all investments made and held in the company's own name; nominee holding in a subsidiary permitted to keep the members above the statutory minimum.
• 187(2): does not prevent deposit with the company's bankers for collection of dividend or interest; deposit with or holding in the name of the State Bank of India or a scheduled bank being its bankers to facilitate transfer, with re-transfer if no transfer within six months; deposit or transfer to any person as security for a loan to the company; or holding in the name of a depository where the company is the beneficial owner.
• 187(3): where clause (d) applies, a register open to members and debenture-holders without charge during business hours.
• 187(4): company five lakh rupees, officer in default fifty thousand rupees.

Test yourself

1. State the ceiling in section 186(2) and how it is computed. A company shall not directly or indirectly give a loan to any person or body corporate, give a guarantee or provide security for a loan to any body corporate or person, or acquire the securities of any other body corporate, exceeding sixty per cent of its paid-up share capital, free reserves and securities premium account, or one hundred per cent of its free reserves and securities premium account, whichever is more.

2. When is a special resolution required, and when is it dispensed with? It is required where the aggregate of loans, investments, guarantees and securities already made and those proposed exceeds the sub-section (2) limits, and it must be previously passed. It is not required where the loan, guarantee or security is given to a wholly owned subsidiary or a joint venture company, or where a holding company acquires the securities of its wholly owned subsidiary, though the details must still be disclosed in the financial statement.

3. What is the minimum rate of interest on a loan under section 186? Not lower than the prevailing yield of the one year, three year, five year or ten year Government Security closest to the tenor of the loan: section 186(7).

4. Which companies are outside section 186, and what still binds them? Banking, insurance and housing finance companies in the ordinary course of business, companies established to finance industrial enterprises or provide infrastructural facilities, and investments by an investment company, in shares under section 62(1)(a) or in a rights issue, or by an NBFC registered under Chapter III-B of the Reserve Bank of India Act, 1934 whose principal business is the acquisition of securities. Sub-section (1), the two-layer rule, still binds them, because sub-section (11) says "except sub-section (1)".

5. In whose name must a company's investments be held, and what are the exceptions? In the company's own name: section 187(1). The exceptions are a nominee holding in a subsidiary to keep its membership above the statutory minimum; deposit with the company's bankers for collection of dividend or interest; deposit with or holding in the name of the State Bank of India or a scheduled bank being the company's bankers to facilitate transfer, with re-transfer if no transfer occurs within six months; deposit or transfer to any person as security for a loan to the company; and holding in the name of a depository where the company is the beneficial owner.

6. How does the consequence of breaching section 186 differ from that of breaching section 187? Section 186(13) provides fine on the company of twenty-five thousand to five lakh rupees and, for every officer in default, imprisonment up to two years with fine of twenty-five thousand to one lakh rupees. Section 187(4) provides only a penalty, of five lakh rupees on the company and fifty thousand rupees on every officer in default.