Critical evaluation of Inter-Corporate loans and investments as per the laws of Corporate Finance

September 22, 2020

The notion of giving a corporate guarantee or security is also beneficial as giving a loan, the reason behind is that the person to whom guarantee or loan is given can determine to implement it in specific prerequisites, and in such a scenario, the company will be paying such amount. Thus, besides loans and investments, limits are also imposed on the guarantees which the company can render or security it can supply for a loan.

The securities which are acquired/ borrowed by corporations instead of individual investors are highlighted under inter-corporate and advances. Inter-corporate investments authorize a company to attain maximum growth rates in comparison to keeping all of its finance in cash. These investments can also be used for strategic purposes like forming a joint venture or making acquisitions. Companies acquire securities from different companies, financial institutions, and governments so as to take benefit of the profits from these securities. Profitable securities that can easily be marketed for cash like notes and stocks are commonly suggested for this kind of investment[i].

A ‘body corporate’ or ‘corporation’ is a suitable term that can borrow loans and advances as per these provisions (according to the act).

Though the law in enforcing had shifted from the Companies Act 1956 to the Companies act of 2013 with effect from 1st April 2014 with the initiation of a fresh accounting period, the important alterations regarding the topic has been explained below.

The Companies Act 1956

Shareholders, investors, and lenders invest funds in a company only after analyzing the returns, risk factors of the project, and appraising the financial position, viability of the project, future prospects, and other relevant factors. To keep a check on diversion of such finances, the following procedure was established regarding the borrowing of loans and making investments in any other venture.

As per section 372(A) of the Companies Act, 1956, directors of a company are authorized to make investments and loans, provide security and guarantees to different bodies corporate, only up to a particular percentage only. The board of directors has to get the approval of the members through a special resolution if these percentages are surpassed. There also exist exceptions to particular transactions from the implementation of this clause[ii].

Analysis of Section 372(A)

Requirements of approvals

(a) Board of Directors:

Consent of the Board is required before making a loan, investment, guarantee, or security. Unanimous approval of all directors’ attending the meeting is needed. Also, the consent of the Board shall be taken by passing a resolution in aboard the meeting.

(b) A company by Passing Special Resolution:

Special Resolution must be passed in a General Meeting if the amount of making a loan, investment, guarantee or security is exceeding the following:

60% of the paid-up share capital + free reserves, or,

100 % of free reserves of the company

If any yearly loan acquired from Public Financial Institution has already taken a loan, the company, only with the prior consent of the PFI, can make investment, guarantee or security only with following exemptions:

If the amount of present loan, investment, guarantee, or security is given does not surpass 60% of the paid-up capital and free reserves.

(d) No Default in Respect of Public Deposits is Subsisting:

A company that has failed to pay in conformity with section 58(A) (regarding public deposits) cannot make any loan, investment, guarantee, or, security, up to such non-payment is subsisting.

(e) Register of Inter-corporate Loans and Investments:

Every company should maintain a register mentioning the particulars in respect of every investment or loan made, guarantee given or security furnished by it about a body corporate.

(f) Contravention of Other Provisions

The company and every officer of the company who is in default shall be punishable with imprisonment up to 2 years or a fine up to Rs. 50,000. However, if the loan is paid in full, no imprisonment shall be imposed, and where the loan is repaid in part, the imprisonment shall be proportionately reduced[iii].

The Companies Act 2013[iv]

The statute has come up with an alteration in the approach of ‘Loan and Investment by Company’. The 2013 statute mentions that companies can make investments only through two layers of investment companies along with exceptions, which comprises of a company incorporated outside India. Section 186 of the act of 2013 is related to it.

Definition Of Section 186

[(1) Without prejudice to the provisions contained in this Act, a company shall unless otherwise prescribed, make an investment through not more than two layers of investment companies:

Provided that the provisions of this subsection shall not affect-

(i) a company from acquiring any other company incorporated in a country outside India if such other company has investment subsidiaries beyond two layers as per the laws of such country;

(ii) a subsidiary company from having any investment subsidiary for the purposes of meeting the requirements under any law or under any rule or regulation framed under any law for the time being in force.]

[(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

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

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

[(5) No investment shall be made or loan or guarantee or security is given by the company unless the resolution sanctioning it is 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 where any term loan is subsisting, is obtained:

Provided that prior approval of a public financial institution shall not be required where the aggregate of the loans and investments so far made, the amount for which guarantee or security so far provided to or in all other bodies corporate, along with the investments, loans, guarantee or security proposed to be made or given does not exceed the limit as specified in sub-section (2), and there is no default in repayment of loan installments or payment of interest thereon as per the terms and conditions of such loan to the public financial institution.]

(6) No company, which is registered under section 12 of the Securities and Exchange Board of India Act, 1992 and covered under such class or classes of companies as may be prescribed, shall take an inter-corporate loan or deposits exceeding the prescribed limit and such company shall furnish in its financial statement the details of the loan or deposits.

[(7) No loan shall be given under this section at a rate of interest lower than the prevailing yield of one year, three years, five years or ten years Government Security closest to the tenor of the loan.]

(8) No company which is in default in the repayment of any deposits accepted before or after the commencement of this Act or in payment of interest thereon, shall give any loan or give any guarantee or provide any security or make an acquisition till such default is subsisting.

(9) Every company giving loan or giving a guarantee or providing security or making an acquisition under this section shall keep a register which shall contain such particulars and shall be maintained in such manner as may be prescribed.

(10) The register referred to in sub-section (9) shall be kept at the registered office of the company and —

(a) shall be open to inspection at such office; and

(b) extracts may be taken therefrom by any member, and copies thereof may be furnished to any member of the company on payment of such fees as may be prescribed.

[(11) Nothing contained in this section, except sub-section (1), shall apply—

(a) to any loan made, any guarantee is given or any security provided or any investment made by a banking company, or an insurance company, or a housing finance company in the ordinary course of its business, or a company established with the object of and engaged in the business of financing industrial enterprises, or of providing infrastructural facilities;

(b) to any investment—

(i) made by an investment company;

(ii) made in shares allotted in pursuance of clause (a) of sub-section (1) of section 62 or in shares allotted in pursuance of rights issues made by a body corporate;

(iii) made, 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 and whose principal business is the acquisition of securities]

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

(13) If a company contravenes the provisions of this section, the company shall be punishable with fine which shall not be less than twenty-five thousand rupees but which may extend to five lakh rupees and every officer of the company who is in default shall be punishable with imprisonment for a term which may extend to two years and with fine which shall not be less than twenty-five thousand rupees but which may extend to one lakh rupees.

Significant Alterations

(a) Restriction on layers: Firstly, this section prohibits investment through more than 2 layers of investment companies. However, this limit is not appropriate for investment in a company registered outside India which has investment subdivision further two layers according to the laws of that nation.

(b)Limits: The limits are the same as of the 1956 act but these limits not only cover the transactions with bodies corporate but also transactions with any person.

(c)Disclosure: This is a new requirement. Section 186(4) provides that a revelation has to be made in the financial statement about the full details of loans provided, investments made or guarantees or security given, and the objective for which the recipient is going to appropriate the loans/guarantees/security.

(d)Restriction on companies registered with SEBI: This is also a new requirement to protect the shareholder’s interest. The central government may inform such a class of companies that will be banned from taking inter-corporate loans or deposits surpassing the specified limit and shall make a revelation of loans or deposits acquired in their financial statement.

(e)Rate of Interest: The rate of interest on loans given cannot be less than the prevailing yield rate on 1 year,3-year, 5 year or 10-year government securities closest to the tenor of the loan.

(f)Withdrawal of exemption: This section is applicable to both private and public Ltd while section 372-A is applicable only to public Ltd companies[v].

Procedures in making loan

The Company while providing loans to any other body corporate may adhere to following procedures, providing guarantee or security in relation to a loan or acquisition through subscription, purchase the securities of another body corporate.

(i) It is to be kept in mind that a company can give any loan or give any guarantee or provide security and acquire securities of any Body corporate through Board resolution not exceeding 60% of its paid-up capital, free reserves and security premium account or 100% of its free reserves and security premium whichever is higher.

(ii) Based on aforesaid prerequisites and necessities of the company meeting of Board of Directors is to be summoned after furnishing suitable notice and suggestions of giving loan or giving guarantee or providing security etc. are to be considered.

(iii) No investment should be made or a loan or guarantee or security provided by the company except the resolution confirming it is passed at a meeting of the board with the approval of all the directors present at the meeting.

(iv) It is to be checked whether there is an existing loan from any public financial institution if so, prior approval of that public financial institution is also required for any subsequent loan from any other source. However, approval of Public Financial institutions should not be needed where the cumulative loan, investment, guarantee, and security suggested is under the limits as prescribed under section 186(2) and there is no failure in repayment of loan or interest subsequently to the Public Financials Institution.

(v) After deciding the source of fund and quantum of requirement, the Board may authorize one of the directors of the company or any other person to apply for the concerned public financial institutions for approval.

(vi) Prepare to conduct a general meeting of shareholders after sending proper notice and to pass a special resolution within, where the providing of any loan or guarantee or providing any security or the acquisition surpasses the limits stated which are 60% of its paid-up capital, free reserves and security premium account or 100% of its reserves and security premium whichever is higher.

(vii) File the xerox of special resolution in form No. MGT-14 together with the fee as prescribed in Companies (Registration of offices and fees) Rules, 2014 before the Registrar within 30 days of passing of the resolution. Essential documents are needed to be attached according to the necessities of the form.

(viii) Registers are to be maintained in Form MBP-2 by every company giving loan or giving guarantee or providing security or making an acquisition shall, from the date of its registration and the details of loan and guarantee provided, securities provided and acquisition are to be filed within.

(ix) Entries in the register shall be made chronologically in respect of each such transaction of making such a loan or giving guarantee or providing security or making an acquisition.

(x) It is to be ensured that no loan shall be given at a rate of interest lower than the prevailing yield of one year, three-year, five years, or ten-year Government security adjacent to the purport of the loan.

(xi) The company shall disclose to the members in the financial statement the full particulars of the loans given, the investment made or guarantee given or security provided and the purpose for which the loan or guarantee or security is suggested to be employed by the beneficiary of the loan or guarantee or security.

(xii) Scrutinize the repayment history of the company with regards to repayment of any deposits or interest thereon. No company that cannot pay any deposits or in payment of interest thereon shall provide any loan or give any guarantee or provide any security or make any investment through the procurement of another company until such default exists[vi].

Non-applicability of section 186

Section 186 (excluding subsection 1) of the Companies Act, 2013 is not applicable in the circumstances:

(a) to a loan made, guarantee given or security provided by a banking company or an insurance company or a housing finance company in the regular operation of its business or a company involved in the venture of financing of companies or of providing infrastructural amenities;

(b) to any procurement: (i) made by a non-banking financial company registered within Chapter III(B) of the Reserve Bank of India Act, 1934 and whose chief business is the procurement of securities: Proviso: exemption to the non-banking financial company shall be in regard to its investment and supplying of loan activities; (ii) made by a company whose main business is the procurement of securities; (iii) of shares appropriated in accordance of clause (a) of sub-section (1) of section 62[vii].

Penalty for contravention of section 186

For Company:

Every Company which infringes the provisions of this clause shall be subject to a penalty that should not be less than Rupees 25,000 but which may extend to Rupees 5,00,000.

For Officers:

Every officer of the Company who fails to pay shall be punishable with imprisonment for a term which is up to two years and fine and which shall not be less than Rupees 25,000 but which may extend to Rupees 1,00,000[viii].

Case Laws

(1) The Hon’ble Supreme Court in the case of Shree Ram Mills Ltd Vs. Commissioner of Excess Profit Tax, MANU/SC/0054/1954 [AIR 1953 SC 485] has defined the word “Loan” in the following words: -At bottom, this is a question of fact. Of course, money so left, could by a proper agreement between the parties, be converted into a loan, but in the absence of an agreement, mere inaction on the part of the managing agents cannot convert the money due to them, and not withdrawn, into a loan. A loan imports a positive act of lending coupled with an acceptance by the other side of the money as a loan.

(2) The Hon’ble Madras High Court in the case of KM. Mohammed Abdul Kadir Rowther Vs. S. MuthiaChettiar TN/0424/1959 that advance means literally a payment beforehand. In particular cases, it may be a loan but it cannot be assumed that a sum paid through advance will necessarily be a loan.

(3)The Hon’ble Privy Council in the case of Raja of Venkatagiri vs. Krishnayya Rao Bahadur MANU/PR/0017/1948 : [AIR 1948 PC 150]has observed that ordinarily advance does not connote any idea of repayment is, hence the loan is completely different from an advance as is understood in the common parlance in the sense of payment of money beforehand and which is likely to become due at some future time.

(4) In the judgment passed by Madras High Court in K.M. Mohamad Abdul Kadir Rowther vs S. MuthiahChettiar on 5 August 1959, it was contended that the advance was not to be considered as a loan, the amount was intended to be recovered, and that, therefore a duty to repay the sum should be understood; there being thus an obligation to repay a personal liability would subsist. The learned Advocate for the appellant urged that the word ‘Advance’ itself would imply a loan. ‘Advance’ implies literally a payment beforehand; in particular cases, it may be a loan but it cannot be implied that a sum paid by way of advance is necessarily a loan, this decision was based on London Financial Association v. Kelk L.R. (1884) 26 Ch. D. 107, where it was held, that the words-‘advancing’ and ‘lending’ each have wide importance, the money might be ‘advanced’ without being ‘lent’[ix].

Conclusion

The new statute is now enforced, having broad and significant impacts. It vitally strengthens the bar on governance. Companies have to initiate coordinating their mechanisms and procedure to adhere to the new statute. The definite norms have made some very radical alterations and it is encouraging to note that the ministry has taken into consideration various suggestions made by the corporate sector in settling these norms, keeping in view the real difficulties that would have been dealt by the corporate sector in enforcement.

The alterations in the final norms focus on the concerns and authentic adversities that companies confronted in funding their subsidiaries. The new preconditionsrender safe harbor in regard to both loans and guarantees provided by a holding company to its completely owned subsidiaries.

Exempting redeemable preference shares from the definition of total share capital is a beneficial development, notably since redeemable preference shares are more related to debt than equity. Although, it would have been helpful if the MCA had particularized the handling of optionally convertible preference shares.

Additionally, the need to reveal an explanation for deviation will also, in a transparent way, render reasoning to the users of financial statements. Revenue-based amortization will sustain status quo for companies having toll road projects.

Thus, the 2013 statute is a pile-up of many years of discussion on how to formulate the corporate law in India. The 2013 statute provided a boost to the administrative environment in companies. The rationale and reliefs enumerated in the final norms will definitely go a long way in helping companies enforcing this new statute.

“The views of the authors are personal“

Frequently Asked Questions

What were the provisions regarding the inter-corporate loans and advances in Companies Act 1956?

(a) Board of Directors:

Consent of the Board is required before making the loan, investment, guarantee or security. Unanimous approval of all directors’ attending the meeting is needed. Also, the consent of the Board shall be taken by passing a resolution in a board meeting.

(b) A company by Passing Special Resolution:

Special Resolution must be passed in a General Meeting if the amount of making the loan, investment, guarantee or security is exceeding of the following:

60% of the paid-up share capital + free reserves, or,

100 % of free reserves of the company

If the amount of present loan, investment, guarantee, or security is given does not surpass 60% of the paid-up capital and free reserves.

(d) No Default in Respect of Public Deposits is Subsisting:

A company that has failed to pay in conformity with section 58(A) (regarding public deposits) cannot make any loan, investment, guarantee, or, security, up to such non-payment is subsisting.

(e)Register of Inter-corporate Loans and Investments:

Every company should maintain a register mentioning the particulars in respect of every investment or loan made, guarantee given or security furnished by it about a body corporate.

What are the significant alterations in the Companies Act 2013 regarding inter-corporate loans and investments?

(b)Limits: The limits are the same as of the 1956 act but these limits not only cover the transactions with bodies corporate but also transactions with any person.

(e)Rate of Interest: The rate of interest on loans given cannot be less than the prevailing yield rate on 1 year,3-year, 5 year or 10-year government securities closest to the tenor of the loan.

(f)Withdrawal of exemption: This section is applicable to both private and public Ltd while section 372-A is applicable only to public Ltd companies.

What is the procedure regarding making a loan?

(vi) Prepare to conduct a general meeting of shareholders after sending proper notice and to pass special resolution within, where the providing of any loan or guarantee or providing any security or the acquisition surpasses the limits stated which is 60% of its paid-up capital, free reserves and security premium account or 100% of its reserves and security premium whichever is higher.

(ix) Entries in the register shall be made chronologically in respect of each such transaction of making such a loan or giving guarantee or providing security or making an acquisition.

Reference

[i] Manu Gupta and SaumyaParmarthi, A research report on Inter-Corporate Loans and Investments, available athttps://scholarticles.wordpress.com/2015/09/01/sp7/, last accessed at 4/05/2020 4:30PM.

[ii] Supra note 2

[iii] Supra note 1

[iv] Supra note 1

[v] Supra note 1

[vi] Supra note 1

[vii] Inter-Corporate Loans, Investments, Guarantees and Security, available at https://www.icsi.edu/media/webmodules/publications/Lesson%2016%20(ACLP).pdf, last accessed at 4/05/2020, 6:00pm

[viii] Supra note 7

[ix] Case Study on Section 185 and Section 186 of Companies Act 2013, available at https://taxguru.in/company-law/case-study-section-185-section-186-companies-act-2013.html, last accessed at 4/05/2020, 9:00pm