Section 185 Companies Act: loans to directors explained

What section 185 prohibits outright

Section 185 exists because directors control the company's money and also stand to benefit from it. Sub-section (1) draws a hard line: no company shall, directly or indirectly, advance any loan, including a loan represented by a book debt, or give any guarantee or provide any security in connection with a loan taken by, the people listed there.

The prohibited list under sub-section (1) is:

• Any director of the company.
• Any director of its holding company.
• Any partner or relative of such a director.
• Any firm in which such a director or relative is a partner.

Two words carry weight. Indirectly means a routed transaction is still caught, so a loan passed through an intermediary to reach a director does not escape the section. Book debt means a receivable created in substance as funding is treated as a loan, which is where informal director current accounts get companies into trouble.

The permitted route with a special resolution

Sub-section (2) deals with a different category: a person in whom a director of the company is interested. That lending is permitted, but only on two conditions being met together.

1. A special resolution is passed by the company in general meeting. The explanatory statement to the notice must disclose full particulars of the loan, guarantee or security, the purpose for which the recipient will use it, and any other relevant fact.
2. The borrowing company uses the loan for its principal business activities.

Both conditions are substantive. An approved resolution with a vague explanatory statement fails the disclosure requirement, and a compliant resolution does not cure end-use that has nothing to do with the borrower's principal business.

Who counts as a person a director is interested in

The Explanation to sub-section (2) defines the expression, and this is the part most group structures need to map before lending internally.

Test the twenty-five per cent threshold on aggregate holdings of the relevant directors, not one director at a time. The influence test is factual, so a formal shareholding under the threshold does not settle it.

The carve-outs in sub-section (3)

Sub-sections (1) and (2) do not apply to the following, each with its own condition attached:

• A loan to a managing or whole-time director as part of the conditions of service extended by the company to all its employees, or under a scheme approved by the members by special resolution.
• A company which, in the ordinary course of its business, provides loans or gives guarantees or securities for repayment of a loan, where interest is charged at a rate not less than the prevailing yield of the one year, three year, five year or ten year Government security closest to the tenor of the loan.
• A loan by a holding company to its wholly owned subsidiary, or a guarantee or security given by a holding company for a loan made to its wholly owned subsidiary.
• A guarantee or security given by a holding company for a loan made by any bank or financial institution to its subsidiary company.

The proviso matters for the last two: those loans must be used by the subsidiary for its principal business activities. End-use is a live condition, not a formality recorded once at sanction.

Penalty exposure under sub-section (4)

Contravention exposes three parties, not just the company. Where a loan is advanced, or a guarantee or security is given, provided or utilised in contravention:

Note the word utilised. A transaction that was compliant when sanctioned can become a contravention if the money is used contrary to the condition on which it was permitted, which is why end-use confirmation belongs in the file.

How 185 sits beside sections 186 and 188

These three sections are often triggered by the same transaction and answer different questions. Clear the applicable ones in sequence rather than choosing between them.

Read section 186 and section 188 beside section 185 when the counterparty is inside the group. Clearing one section does not clear the others.

Board process to document before money moves

1. Identify the borrower precisely, then test it against sub-section (1) and against the Explanation to sub-section (2).
2. If a carve-out is claimed, record which clause of sub-section (3) applies and the facts that satisfy its condition.
3. If the special resolution route applies, draft the explanatory statement with full particulars and the stated purpose, not a generic description.
4. Check the section 186 limits and the Board resolution requirements for the same transaction.
5. Check whether section 188 is triggered, and for a listed entity whether the related-party framework under SEBI listing regulations applies as well.
6. Document the interest rate basis where an ordinary-course or rate-linked carve-out is claimed.
7. Put an end-use confirmation and periodic monitoring in place, and record the disclosure in the financial statements where required.

How to verify the current position

1. Read the operative text of section 185 in full, including the Explanation and the provisos, rather than a summary table.
2. Check India Code for the amendment Acts that have touched the section.
3. Check the MCA notifications page for the commencement notification behind the version you are reading, and for any exemption notification relied on for a private company.
4. Read the rules made under the chapter on Board meetings and powers for the procedural requirements attached to the transaction.
5. Take professional advice on the specific structure before the funds move. The section is penal, and the analysis turns on facts about control and end-use.

Common section 185 mistakes

• Treating a director's current account or a book debt as something other than a loan.
• Assuming a special resolution can authorise a direct loan to a director.
• Applying the wholly owned subsidiary carve-out to a subsidiary that is not wholly owned.
• Claiming the ordinary-course carve-out without meeting the interest-rate condition.
• Testing the twenty-five per cent voting power director by director instead of in aggregate.
• Clearing section 185 and forgetting the section 186 limits or the section 188 approval.
• Relying on a conditional private-company exemption without checking the conditions against the company's own facts.
• Recording end-use at sanction and never monitoring it afterwards.

Where Complied AI fits

Section 185 has been rewritten once already, and its practical effect also depends on rule amendments and exemption notifications. Complied AI keeps MCA updates in one feed with the source document attached, and puts the text of section 185 one click away, so the provision and the notification that changed it can be read together.