Conflicts, Disclosure, Loans and Investments
Chapter Forty-Five
Syllabus topic 2, "ORGANISATION AND MANAGEMENT"
Pages 243 to 249 of 998
In one line
A director must disclose his interests once a year and again whenever a particular contract touches them, must leave the room when it is discussed, and the company may not lend to him at all, though it may lend to companies he is interested in if the members pass a special resolution and the money is used for the borrower's own business.
In exam wording: under section 184(1) every director shall disclose his concern or interest in any company, body corporate, firm or association, including his shareholding, at the first Board meeting he attends, at the first Board meeting of every financial year, and at the first Board meeting after any change; under section 184(2) a director concerned or interested in a contract with a body corporate in which he, alone or with other directors, holds more than two per cent shareholding, or of which he is promoter, manager or chief executive officer, or with a firm or entity in which he is a partner, owner or member, shall disclose the nature of his concern at the Board meeting where it is discussed and shall not participate in that meeting.
Why the law has this at all
Section 166(4) forbids a director to place himself in a position of conflict. Taken literally that would stop a company dealing with anybody connected to its own board, which is impossible in an economy of family and group enterprise. So the Act does not prohibit conflicted dealing; it manages it, through three devices that escalate with the danger.
Disclosure, s.184, for any interested contract. The Board is told, and the interested director withdraws.
Members' consent, s.185(2) and s.188, where the company's money is going to a person connected with a director, or where the transaction is with a related party. Here the Board itself is not trusted, so the general meeting decides.
Prohibition, s.185(1), for the narrowest and most dangerous class: lending the company's money to its own directors and their immediate circle. No amount of disclosure or approval makes that lawful, because it is not a transaction at all in substance; it is the extraction of the company's funds by the people who control them.
Sections 186 and 187 then police a different risk, the movement of the company's funds outwards into other companies through layers and nominee holdings, which is how group opacity is built.
Section 184: disclosure and withdrawal
184(1): the general disclosure. Every director shall disclose his concern or interest in any company or companies or bodies corporate, firms, or other association of individuals, including his shareholding, in the prescribed manner, at three moments: the first Board meeting in which he participates as a director, the first Board meeting in every financial year thereafter, and, where there is any change in the disclosures already made, the first Board meeting held after the change.
Conflicts, Disclosure, Loans and Investments
184(2): the transactional disclosure and the withdrawal. Every director who is in any way, directly or indirectly, concerned or interested in a contract or arrangement, or a proposed one, entered into or to be entered into:
(a) with a body corporate in which he, or he in association with any other director, holds more than two per cent shareholding, or is a promoter, manager or Chief Executive Officer of that body corporate; or (b) with a firm or other entity in which he is a partner, owner or member,
shall disclose the nature of his concern or interest at the Board meeting in which the contract is discussed and shall not participate in that meeting. A proviso covers the director who becomes interested after the contract is entered into: he shall disclose at the first Board meeting held after he becomes so concerned or interested.
184(3): the consequence of non-disclosure. A contract or arrangement entered into by the company without disclosure under sub-section (2), or with the participation of a director who is concerned or interested in any way, shall be voidable at the option of the company.
184(4) provides the penalty on the defaulting director; 184(5) exempts from the section any contract between two companies, or between one or more companies and one or more bodies corporate, where the directors concerned hold, singly or together, not more than two per cent of the paid-up share capital in the other, which is the counterpart of the two-per-cent threshold in sub-section (2).
Three points for an answer. Disclosure under s.184(1) is periodic and general; under s.184(2) it is transaction-specific, and is accompanied by an obligation not to participate. The sanction is voidability at the company's option, not nullity, so the company may affirm a good bargain. And the consequences elsewhere are severe: contravention of s.184 or failure to disclose vacates the office under s.167(1)(c) and (d).
Section 185: lending to directors
185(1): the absolute prohibition. No company shall, directly or indirectly, advance any loan, including any loan represented by a book debt, to, or give any guarantee or provide any security in connection with any loan taken by:
(a) any director of the company, or of a company which is its holding company, or any partner or relative of any such director; or (b) any firm in which any such director or relative is a partner.
185(2): the conditional permission. A company may advance a loan, or give a guarantee or security for a loan taken by, any person in whom any of the directors of the company is interested, subject to two conditions: (a) a special resolution is passed in general meeting, the explanatory statement disclosing the full particulars of the loan, guarantee or security, the purpose for which it will be used by the recipient, and any other relevant fact; and (b) the loans are utilised by the borrowing company for its principal business activities.
Conflicts, Disclosure, Loans and Investments
The Explanation defines "any person in whom any of the directors of the company is interested" as: (a) any private company of which such a director is a director or member; (b) any body corporate at a general meeting of which not less than twenty-five per cent of the total voting power may be exercised or controlled by such a director or by two or more of them together; and (c) any body corporate whose Board, managing director or manager is accustomed to act in accordance with the directions or instructions of the Board or of any director of the lending company.
185(3): what is outside the section. Sub-sections (1) and (2) do not apply to: (a) a loan to a managing or whole-time director as part of the conditions of service extended to all employees, or pursuant to a scheme approved by the members by special resolution; (b) a company which in the ordinary course of its business provides loans, guarantees or securities, where interest is charged at a rate not less than the prevailing yield of one, three, five or ten year Government security closest to the tenor of the loan; (c) a loan by a holding company to its wholly owned subsidiary, or a guarantee or security by a holding company for a loan to its wholly owned subsidiary; and (d) a guarantee or security by a holding company for a loan made by a bank or financial institution to its subsidiary, with a proviso that loans under (c) and (d) be utilised by the subsidiary for its principal business activities.
185(4): the penalties. The company is punishable with a fine of not less than five lakh rupees, extending to twenty-five lakh rupees; every officer in default with imprisonment up to six months or the same fine; and the director or other person to whom the loan was advanced or the guarantee or security given with imprisonment up to six months or the same fine, or both.
Note that the recipient is punished too, which is unusual and deliberate: the mischief is a joint enterprise between the company's controllers and the person receiving its money.
Conflicts, Disclosure, Loans and Investments
Sections 186 and 187: layers, limits and nominee holdings
186(1): layers. A company shall, unless otherwise prescribed, make investment through not more than two layers of investment companies, with provisos preserving the acquisition of a foreign company having more layers under its own law, and a subsidiary having an investment subsidiary to meet requirements under any law.
186(2): the ceiling. 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, or (c) acquire by 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.
186(3) allows the limits to be exceeded with previous authorisation by a special resolution in general meeting. 186(4) requires disclosure in the financial statement of the full particulars of loans, investments, guarantees and securities and the purpose for which they are proposed to be utilised. 186(5) requires the consent of all the directors present at a Board meeting for any investment, loan, guarantee or security, and, where a term loan from a public financial institution is subsisting, its prior approval as well, subject to a proviso where the aggregate is within the limits and there is no default. 186(7) forbids a loan at a rate of interest lower than the prevailing yield of one, three, five or ten year Government security closest to the tenor of the loan. 186(8) disqualifies a company in default in repayment of deposits from giving loans or guarantees until the default is made good. 186(11) exempts, among others, banking companies, insurance companies and housing finance companies in the ordinary course of business, and specified acquisitions.
187: investments in the company's own name. All investments made or held by a company in any property, security or other asset shall be made and held in its own name, with exceptions in the section, including deposit of shares with a bank for collection of dividend, holdings to comply with law, and shares held as security. Where investments are not so held, the company must maintain a register with the prescribed particulars, open to inspection by members.
Section 187 is short and important: it is what stops a company's investments being held by directors or nominees, where they can be dealt with as if they were private property. Combined with s.89's beneficial-interest declarations, it keeps ownership visible.
Section 189: the register of interested contracts
Every company shall keep one or more registers giving separately the particulars of all contracts or arrangements to which s.184(2) or s.188 applies, in the prescribed manner. Every director or key managerial personnel shall, within thirty days of appointment or of a relevant change, disclose to the company the particulars of his concern or interest in other associations, in the prescribed manner. The register shall be kept at the registered office, be open to inspection by members, and extracts and copies furnished as the section provides; and it shall be produced at every annual general meeting and remain open and accessible during the meeting to any person having the right to attend.
Conflicts, Disclosure, Loans and Investments
A worked example
Konkan Marine Limited has paid-up capital of ten crore rupees, free reserves of six crore and securities premium of two crore. Its director Mr. Kamat is also a partner in a firm of ship chandlers and a director and member of a private company, Kamat Logistics Private Limited.
The supply contract. The company proposes to buy stores from the chandlery. Mr. Kamat is a partner in a firm with which the contract is proposed, so s.184(2)(b) applies: he must disclose the nature of his interest at the Board meeting where it is discussed and shall not participate in that meeting. If he does not disclose, or if he participates, the contract is voidable at the option of the company, s.184(3); and his office may be vacated under s.167(1)(c) and (d).
A personal loan. He asks the company for a loan of twenty lakh rupees. It cannot lend, at all: s.185(1)(a) prohibits a loan, book debt, guarantee or security for any director. If it did, the company would face a fine of five to twenty-five lakh rupees, the officers in default imprisonment up to six months or the same fine, and Mr. Kamat himself the same exposure.
A loan to his private company. Kamat Logistics Private Limited, of which he is a director and member, falls within limb (a) of the Explanation to s.185(2), so it is a "person in whom a director is interested". The company may lend, but only if a special resolution is passed, the explanatory statement disclosing the full particulars and the purpose, and the money is used by Kamat Logistics for its principal business activities.
The size of the lending. The s.186(2) ceiling is the higher of sixty per cent of paid-up capital, free reserves and securities premium, that is sixty per cent of eighteen crore, or one hundred per cent of free reserves and securities premium, that is eight crore. Sixty per cent of eighteen crore is ten crore eighty lakh, which is the higher, so that is the limit; beyond it a special resolution under s.186(3) is needed. Any loan needs the consent of all directors present at a Board meeting, s.186(5), and may not carry interest below the prevailing Government-security yield for the closest tenor, s.186(7).
Conflicts, Disclosure, Loans and Investments
Where the shares are held. The company's investment in Kamat Logistics must be held in the company's own name, s.187, not in Mr. Kamat's, and the particulars of the contract must go into the register under s.189, which any member may inspect and which is produced at the annual general meeting.
Distinctions
| s.184 | s.185 | s.186 | |
|---|---|---|---|
| Concerned with | Interested contracts | Loans, guarantees and security for directors and their circle | Loans, guarantees, security and investments generally |
| Technique | Disclosure and withdrawal | Prohibition for the director group; special resolution plus use condition for interested entities | Ceiling with a special-resolution escape, plus consent and interest-rate rules |
| Sanction | Contract voidable at the company's option; office vacated under s.167 | Fine on the company, and imprisonment or fine on officers and on the recipient | Penalties under the section |
| Threshold | More than two per cent shareholding in a body corporate | Interest defined by the Explanation, including twenty-five per cent voting power | Sixty per cent of capital plus free reserves plus premium, or one hundred per cent of free reserves plus premium |
What it does NOT mean
Not that an interested contract is void. Section 184(3) makes it voidable at the option of the company, which may affirm it.
Not that s.185 stops all lending in a group. Section 185(3) preserves loans to a wholly owned subsidiary, guarantees for bank loans to a subsidiary, service-condition loans to managing or whole-time directors, and lending by companies whose ordinary business it is, at the specified interest floor.
Not that s.186's limit is a single figure. It is the higher of the two measures, and it may be exceeded by special resolution.
Quick revision
s.184(1): general disclosure at the first meeting attended, the first meeting of each financial year, and the first meeting after a change. s.184(2): specific disclosure and no participation where the contract is with a body corporate in which the director, alone or with others, holds more than two per cent or is promoter, manager or CEO, or with a firm or entity in which he is partner, owner or member; a director becoming interested later discloses at the next meeting. s.184(3): contract voidable at the company's option. s.184(5): two-per-cent exemption for inter-company contracts.
s.185(1): absolute prohibition on loans, book debts, guarantees or security for a director of the company or its holding company, his partner or relative, or a firm in which such a person is a partner. s.185(2): permitted for a person in whom a director is interested on a special resolution with full disclosure, and the loan used for the borrower's principal business activities; Explanation covers a private company where he is director or member, a body corporate where he or they control twenty-five per cent of voting power, and a body corporate accustomed to act on his directions. s.185(3): exceptions for service-condition or approved-scheme loans to MD or WTD, ordinary-course lenders at the Government-security yield, wholly owned subsidiaries, and holding-company guarantees for bank loans to a subsidiary. s.185(4): fine five to twenty-five lakh rupees, imprisonment up to six months for officers, and the recipient liable too.
Conflicts, Disclosure, Loans and Investments
s.186: two layers of investment companies; ceiling of sixty per cent of capital, free reserves and premium, or one hundred per cent of free reserves and premium, whichever is more, exceeded only by special resolution; disclosure in the financial statement; consent of all directors present and, where applicable, the public financial institution's prior approval; no interest below the closest-tenor Government-security yield; barred while in default on deposits.
s.187: investments in the company's own name, with the stated exceptions and a register. s.189: register of contracts under ss.184(2) and 188, disclosures within thirty days, open to members and produced at the annual general meeting.
Test yourself
1. When must a director disclose under s.184(1), and how does that differ from s.184(2)? Under s.184(1) generally, at the first Board meeting he attends, the first meeting of each financial year, and the first meeting after any change; under s.184(2) specifically, at the meeting where the interested contract is discussed, and he must not participate in that meeting.
2. May a company lend to a firm in which a director's relative is a partner? No: s.185(1)(b) prohibits a loan, guarantee or security in connection with a loan taken by any firm in which such a director or relative is a partner, and no resolution can validate it.
3. What conditions permit a loan to a private company in which a director is a member? A special resolution in general meeting, with the explanatory statement disclosing the full particulars and the purpose, and the loan being utilised by the borrowing company for its principal business activities, s.185(2).
4. State the s.186(2) ceiling. The higher of sixty per cent of the company's paid-up share capital, free reserves and securities premium account, or one hundred per cent of its free reserves and securities premium account; the limit may be exceeded with the previous authorisation of a special resolution, s.186(3).
5. What happens to a contract entered into without the disclosure s.184(2) requires? It is voidable at the option of the company, s.184(3); and the director's office may become vacant under s.167(1)(c) or (d).
The rest of this subject
These notes are cut from the University's printed syllabus. Open the syllabus itself, or the past papers, for the same subject.