Introduction
Section 186 of the Companies Act, 2013 governs the provisions relating to loans, investments, guarantees, and security that a company can extend. This section ensures that companies engage in financially responsible behaviour while protecting stakeholder interests. It brings transparency, accountability, and a structured decision-making process into corporate financial transactions.
Any business that wants steady governance usually relies on a strong corporate compliance service, and Section 186 is one of the core areas they look at.
1. Scope and Applicability of Section 186
Section 186 applies to all companies, whether private, public, or listed, except for the following entities when acting in the ordinary course of business:
- Banking Companies
- Insurance Companies
- Housing Finance Companies
- NBFCs
- Companies engaged in providing loans or guarantees as their primary business activity
The section regulates:
- Loans given to any person or body corporate
- Guarantees or security provided in connection with any loan to any person or body corporate
- Investments made in securities of any other body corporate
2. Monetary Limits Prescribed Under Section 186
A company may extend loans, guarantees, security, or investments only within the following limits without shareholder approval:
- 60% of its paid-up share capital, free reserves, and securities premium; or
- 100% of its free reserves and securities premium account,
whichever is higher.
If a company crosses the above limits, it must obtain:
- Prior approval of shareholders by a Special Resolution.
The Board must pass a resolution at a duly convened meeting, and unanimous approval of directors present is required for such transactions. This is where a good corporate compliance service helps businesses avoid mistakes.
3. Requirement of Interest Rate on Loans
Any loan provided must carry an interest rate not lower than the prevailing yield of:
- One-year government security
- Three-year government security
- Five-year government security
- Ten-year government security
Closest to the tenor of the loan.
This prevents companies from giving concessional loans that could compromise financial stability.
4. Prohibitions and Restrictions
Certain restrictions ensure responsible financial management:
- A company cannot make investments through more than two layers of investment companies.
- A company in default of repayment of deposits or interest cannot extend any loan, guarantee, or security until the default is cleared.
- Loans or guarantees cannot be used by subsidiaries to acquire shares of another company engaged in similar business, preventing indirect business takeovers.
5. Disclosure and Reporting Requirements
Section 186 mandates robust record-keeping and disclosure:
- Full particulars of loans, guarantees, security, and investments must be disclosed in the financial statements.
- A company must maintain a register in Form MBP-2, detailing all such transactions.
- The register must be kept at the registered office and be available for inspection by members.
- Board reports must include details of such transactions, showing transparency in financial dealings.
6. Special Exemptions
Exemptions exist for certain categories of transactions:
- Loans, guarantees, or securities made to wholly-owned subsidiaries or joint ventures do not require shareholder approval, provided disclosures are made.
- Investments by holding companies in wholly-owned subsidiaries are also exempt from shareholder approval.
7. Penalties for Non-Compliance
Non-compliance with Section 186 invites strict penalties:
- Company: Fine up to ₹5,00,000
- Officers in default: Fine up to ₹1,00,000
The penalties reinforce the importance of compliance and proper documentation.
8. Practical Considerations and Best Practices
To ensure smooth compliance under Section 186, companies should adopt best practices:
- Maintain an updated MBP-2 register at all times.
- Conduct internal limit calculations before approving any transaction.
- Obtain appropriate approvals and maintain supporting documents.
- Regularly disclose all transactions in financial statements and board reports.
- Consult legal and financial advisors for complex transactions to avoid breaches.
Conclusion
Section 186 is a crucial provision ensuring prudent financial management and corporate governance. By regulating loans, investments, guarantees, and securities, it safeguards a company’s financial stability and ensures accountability to shareholders and stakeholders. Understanding and adhering to Section 186 is essential for sound business operations and long-term sustainability.
