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written by | April 26, 2022

Section 186 of the Companies Act, 2013

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By revising the 58-year-old Companies Act of 1956, the Companies Act of 2013 brought forth a radical transformation in the Indian corporate climate. The goal of updating the Companies Act of 1956 was to improve corporate administration, simplify rules, protect minority investors' interests and create an Act tailored to the current business climate and international standards.

Did you know?

On September 12, 2013, the government announced Section 186 of the 2013 Act and 97 additional sections of the 2013 Act.

What is the Section 186 Companies Act?

A company's ability to make loans and investments is governed by Section 186 of the Companies Act of 2013. It specifies that a business can invest through more than two tiers of investment firms.

A firm cannot, directly or indirectly, according to Section 186 of the Companies Act of 2013,:

  • Give a loan to anyone or anything.
  • Give any security or guarantee in connection with a loan to any other person or corporation, 
  • and acquire the securities of any other corporation through purchase, subscription, or other means.
  • Exceeding 60% of its paid-up share capital, free reserves, and securities premium account, whichever is greater, or 100% of its free reserves and securities premium account

Also Read: Competition Act 2002: Everything You Need to Know

What Is an Investment and Investment Company?

In everyday language, "investment" refers to any asset or property in which an individual or a company invests cash or revenue. It is an investment in equity capital, mutual funds, debentures or other commodities. A corporation whose primary activity is the selling and acquisition of shares, debentures and other forms of securities is referred to as an "Investment Company." 

The Companies Act of 2013 has a section 186 that deals with "credit and investments by the firm." Approval matrices, monetary threshold, archiving, exemption from compliance requirements, guarantee, security and limits on lending or investing in some other firms. Rules promulgated under Section 186 of the Act also apply. 

Provisions Followed by the Corporations

The Monetary Threshold For Approval of the Board of Directors

With the permission of the Board of Directors, a corporation (whether private or public) can: 

  1. Grant any loan to any individual and perhaps other corporate entity.
  2. Offer any guarantee or even provide collateral in connection with a loan to any other corporate entity or individual. 
  3. Acquire the collateral of any other corporate entity, up to 60% of its compensated share capital, free reserves and securitisation, explicitly or implicitly. 

The accounts team, budget committee, Chief Financial Officer (CFO) or Corporate Secretaries (CS) is responsible for regularly monitoring such boundaries.

Exclusion from the Said Monetary Limit

The term "person" will not include the representative of the firm. Therefore any loans, guarantees or collateral generated by the firm to its workers is not in the above restrictions. As a result, any mortgages, guarantees or security provided by the firm to its workers are not in the monetary restrictions.

The Monetary Threshold For Approval of the Shareholders

Suppose the total of such invested capital, debt, guarantee or collateral made or granted by the Board of Directors exceeds the stipulated restrictions. The corporation cannot make any further incentive to invest, loan, guarantee or security unless it is initially permitted by a special resolution adopted in a general meeting.

The BOD should specify the entire sum up to which the Board of Directors is authorised to offer such mortgage or collaterals, provide further assurance, or undertake such purchase should be specified in the special resolution voted at a general meeting. The corporation must first gain the shareholders' approval, and the proposal must have a monetary cap, as opposed to being an open-ended resolution.

Exemption From the Approval of Shareholders

A special resolution of the stockholders is not obligated when a line of credit or guarantee is offered when a corporation provides security for its entirely owned subsidiary company. And perhaps a strategic partnership organisation, or when a holding company acquires its wholly-owned subsidiary firm's collateral by subscription, purchase or otherwise. However, in the financial report, the corporation must reveal the specifics of such loans, guarantees, collateral or acquisitions.

Disclosure in the Financial Statement

The company must disclose the full details of the loans granted, investments made, guarantees provided, or security offered to the representatives in the financial report and the intent by which the mortgage, guarantee or security is intended to be used by the beneficiary of the loan. Organisations can include this information in the Board's reports [Section 134(3)(g) of the Act] and the appendices to the accounts.

Mode of Obtaining the Approval of the Board of Directors

The corporation may only make an investment, loan, assurance or collateral after the Board of Directors authorises it with the consent of all of the directors participating in the meeting, rather than via circular resolution. According to Section 179(3) of the Act, a firm's Board of Directors has the authority to finance the company's capital through resolutions voted at the Board of Director's gatherings. The Board of Directors can designate such authority to any panel of directors, general manager or senior executive of the firm, or, in the event of a subsidiary, the foremost officer of the subsidiary. The BOD should do such delegation at the conference, not by a circular resolution.

Prior Approval of the Public Financial Institution, in Certain Cases

Where a credit facility is in place, and there is a default in payment of the debt instalments or interest payments as per the terms of the debt to the public banking institution, prior permission from the public mortgage lender is necessary. When there is a default setup in debt or interest payments, a public financial organisation's prior consent is required rather than when an organisation makes payments on a regular schedule.

Rate of Interest of the Loan

An organisation cannot make the loan under Section 186 of the Act at an interest rate that is less than the current yield on a one-year, three-year, five-year or ten-year government securities comparable to the loan's tenure.

Restriction on Giving Loan, Guarantee or Security

A corporation that has defaulted in the return of any funds taken or in the interest payments on those deposits may not issue a loan, offer a guarantee, provide collateral, or make acquisitions until the authorities resolve the default. This rule applies when a corporation defaults on a loan or interest on deposits.

Loan, Guarantee or Security to Directors or Relatives of Directors

The Amendment's Section 185 deals with "lending to directors." A corporation (either private or public) should not provide any loan (such as any loan indicated by a ledger debt to) or give a guarantee or collateral in conjunction with any loan made by:

  1. Any director of a corporation or a business that is its holding company and any associate or relatives of any such director. 
  2. Any business whereby any such director or relative is a shareholder. As a result, before extending any loan, making any guarantees or offering any collateral associated with any loan, the corporation must authenticate the client and its relationship with the directors. The corporation must guarantee that it follows Sections 185 and 186 of the Act in such situations.

Maintenance of Register

Every corporation that makes a loan provides a guarantee, provides security or makes an acquisition must keep a record that contains the required information in the prescribed manner. 

The following are some key factors to remember when it comes to keeping the registration up to date:

  1. Beginning with its establishment, the firm must keep the record in Form MBP 2 and individually record the details of loans and assurances offered, securities furnished, and acquisitions completed. 
  2. Within seven days after executing the loan, delivering the guarantee, providing security or undertaking the acquisition, the organisation must make the records in the register sequentially. 
  3. The firm's Company Secretary must possess the register or any other individual approved by the Board. 
  4. The record can be physically or electronically maintained. 
  5. The firm's Company Secretary or any other individual appointed by the Board of Directors for the assignment must validate the updates in the record (whether manual or digital).

Inspection and Extracts of the Register

The corporation's corporate headquarters must retain the record required by Section 186 of the Act. At such a location, such records should be available for inspection. Any person may obtain excerpts from the record, and duplicates of the register might well be provided to any individual in the company for a price.

Also Read: SARFAESI Act, 2002 - Complete Guide

Non-Applicability of the Provisions

Section 186 of the Act is not relevant (save for the requirements related to tiers of investment firms):

  1. To any loan granted, any assurance offered, any collateral provided or any money invested in the normal course of business by a financial institution, an insurance provider, a residential financial institution or a company established with the object of and involvement in the industry of financing business operations or providing infrastructure and facilities.
  2. To any capital invested by an investment firm, the investment made in shareholdings made available in pursuit of rights is issuable by an investment group. 
  3. To any investment undertaken by a Non-Banking Financial Company (NBFC) licenced under the Reserve Bank of India (RBI) Ordinance and whose primary activity is the procurement of equities.

Punishment for Non-Compliance

Companies and their evaders who act in violation of the regulations mentioned above face penalties under Section 186(13). Fines of not less than ₹25,000 but not more than ₹5 lakh rupees would be imposed on the firms. Every company official in violation is subject to a jail term of up to two years and a fine of not below ₹25,000 but not more than ₹1 lakh rupees.

Conclusion

The supply of loans and investments is dealt with under Section 186 of the Companies Act, 2013. The Companies Act of 2013 brought about a shift in the "Loan and Investment by Corporation" idea. Inter-corporate acquisitions must be undertaken through no more than two layers of investing entities, according to the new Act. The Companies Act of 1956 did not have such a clause.
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FAQs

Q: Is investment in mutual funds covered under Section 186?

Ans:

According to SEBI laws, most mutual funds are administered by trusts that are not corporations. As a result, the Section doesn't govern mutual fund investments.

Q: What are the two layers of investment?

Ans:

The following are the definitions of the two layers of investment firms: The flow of investments (or mortgage, or any other transaction described in section 186) from a holding company to its second step-down affiliate is referred to as "two layers of investment firms."

Q: Is Section 186 of the Companies Act, 2013 applicable to a private company?

Ans:

The application of section 186(1) to Authorised IFSC Public and Private Companies has been exempted by the Central Government.

Q: What is Section 186 of the Companies Act, 2013?

Ans:

Section 186 of the Companies Act of 2013 governs a firm's ability to make financial intermediation, and it specifies that a business can invest via more than two tiers of investment firms.

Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.
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Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.