Understanding Section 186 of the Companies Act, 2013: Regulations for Loans and Investments

Section 186 of the Companies Act, 2013 acts as a guardrail for a company's lending and investment activities. It outlines the limitations and requirements a company must adhere to when providing financial backing or acquiring shares in other entities.

Core Restrictions: Keeping Investments in Check

The section emphasizes responsible financial management by placing limitations on a company's ability to extend loans, provide guarantees, or invest in securities. These limitations are set to safeguard the company's financial health and prevent excessive risk-taking.

• Monetary Thresholds: A company cannot directly or indirectly surpass a specific limit when making investments, granting loans, or offering guarantees. This limit is calculated as the higher of two figures: 60% of the company's paid-up share capital, free reserves, and securities premium account; or 100% of the company's free reserves and securities premium account.

Approvals Ensuring Transparency and Oversight

To ensure responsible decision-making and transparency, Section 186 mandates various approval processes depending on the transaction size and nature.

• Board Approval: A unanimous resolution passed during a board meeting is mandatory for all loan, investment, guarantee, or security decisions, regardless of the amount involved. Resolutions passed through circulation or by a committee of directors are not sufficient.
• Special Resolution by Members: When the combined value of existing and proposed loans, investments, guarantees, or securities surpasses the limit set forth in Section 186(2), a special resolution passed by the company's members becomes necessary. This resolution specifies the total amount the board is authorized to approve for such activities.

Special Cases Exceptions

Section 186 acknowledges specific situations where the aforementioned limitations and approvals may not apply. These exceptions are intended to streamline operations for certain entities and activities.

• Government Companies: Companies wholly owned and controlled by the government are exempt from most of Section 186's restrictions. However, government companies other than listed entities might require approval from the relevant state government or central ministry depending on their administrative oversight.
• Specific Business Activities: Companies whose primary business involves acquiring securities (investment companies) and entities engaged in regular financial activities like insurance companies, housing finance companies, or infrastructure financing businesses are exempt from certain limitations.
• Loan Acquisition by Non-Banking Financial Institutions (NBFCs): NBFCs whose core business revolves around purchasing securities are exempt from restrictions on loan acquisition.

Additional Requirements

Beyond the limitations and approvals, Section 186 lays down additional guidelines for responsible financial management.

• Interest Rates: The interest rate charged on any loan provided by the company must be higher than the prevailing yield of government securities with a similar maturity period.
• No Default on Deposits: A company cannot engage in lending, investment, or guarantee activities if it has defaulted on repaying deposits or their interest to its depositors. Only after rectifying such defaults can the company resume these activities.
• Disclosure in Financial Statements: The company is obligated to disclose complete details of its loans, guarantees, investments, and securities in its financial statements. This disclosure includes the purpose for which the recipient intends to use the loan or guarantee.

Consequences of Non-Compliance

Companies and officials who disregard the regulations outlined in Section 186 face penalties. Companies can be fined between ₹25,000 and ₹5 lakh, while individual officials who violate the act may be subject to fines up to ₹1 lakh and imprisonment for up to two years.

Conclusion

Section 186 of the Companies Act, 2013 serves as a crucial safeguard for a company's financial well-being. By establishing limitations, requiring approvals, and mandating responsible practices, the section promotes sound financial management and protects companies from overextending themselves through excessive investments or loans.