Facts
in Brief
An India Private Limited Company (The Company) has
advanced certain amounts to one of its subsidiary namely “S Private Limited”
The
Company had planned to acquire 100% stake in the subsidiary vide Share purchase
agreement from the shareholders of the subsidiary.
Pursuant
to the above planned purchase of shares in the subsidiary, the Company had
nominated its two directors as additional directors in the subsidiary which
resulted in having common directors in both the companies.
The
Company also had the responsibility of running the operations of the subsidiary
and for this purpose it had appointed the employees in the Subsidiary for the
same. Further, to run the subsidiary company, the Company also advanced certain
amounts to the subsidiary for running the operations smoothly and shown as advance
in the Balance Sheet of Subsidiary Company.
Later
on, there were disputes amongst the then shareholders of the subsidiary and the
Company on certain matters and the company could not complete the 100% stake in
the subsidiary. Due to the disputes, the Company could not recover the amounts
advanced earlier and also the investment in the subsidiary. Accordingly,
various legal suits were filed in the court of law.
As
the Company had hired employees for the subsidiary, the Company kept on paying
the salary of the staff and showed the same as advances recoverable from the
subsidiary company.
Finally,
the Company and the then shareholders of the subsidiary has entered into a
settlement agreement in the year 2015-16 and settled the entire claim of the
Company via one time full and final settlement which included investment, loans
and advances etc.
The
Company wants to understand whether the above said advances given attracts the provisions of Section 185 and
186 of the Companies Act, 2013 or not.
Answer:
Relevant
provisions regarding providing of Loan to Directors, etc
Section 185(1) of
the Companies Act, 2013 provides that no company
shall, directly or indirectly, advance
any loan, including any loan represented by a book debt, to any of its
directors or to any other person in whom the director is interested or give any
guarantee or provide any security in connection with any loan taken by him or
such other person:
Explanation.—For the purposes of this section, the expression “to any
other person in whom director is interested” means—
(a) any director of the lending company, or of a company which is its holding company or any partner or relative of any such director;
(b) any firm in which any such director or relative is a partner;
(c) any private company of which any such director is a director or member;
(d) any body corporate at a general meeting of which not less than twenty five per cent. of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together; or
(e) any body corporate, the Board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company.
(a) any director of the lending company, or of a company which is its holding company or any partner or relative of any such director;
(b) any firm in which any such director or relative is a partner;
(c) any private company of which any such director is a director or member;
(d) any body corporate at a general meeting of which not less than twenty five per cent. of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together; or
(e) any body corporate, the Board of directors, managing director or manager, whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company.
Analysis:
The
company affianced to appoint two of its directors in the Subsidiary vide its Share
Purchase, ergo both having common directors.
The
pre requisite for the applicability of the provisions of Sub section 1 of
Section 185 of the Companies Act, 2013 is whether the company has advanced loan
to any of its directors or to any other person in whom the director is interested.
As
per the terms and conditions stipulated in the covenant, the company had
advanced certain amounts to the subsidiary for meeting the operational expenses.
This amount of money cannot be construed to be loan to the directors of the
company or any other person in whom the director is interested as the
incumbents did not hold any prior interest at the time of advancing the loan, but
were appointed only to fullfil the requirement of the Agreement as nominee of
acquirer, thus is not repugnant to the above provisions.
Further
in view of the serious implications in the event of violation of the provisions
of section 185 it is absolutely necessary to understand the precise and concise
meaning of word “loan” and “Advances”;
Loan:
Loan
has not been defined under Companies
Act, 2013. Therefore we have to rely on the
dictionary meaning of the term “Loan” and judicial clarification in this regard.
As per dictionary meaning, loan is a sum of money or other valuables or
consideration that an individual, group or other legal entity borrows from
another individual, group or legal entity with the condition that it be
returned or repaid at a later date with or without interest.
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.
The Calcutta High Court in the case of Saradindu
Sekhar Banerjee Vs. Lalit Mohan MANU/WB/0045/1941, AIR 1941 Cal. 538
Every loan is a debt but every debt is not a loan.
ADVANCE:
The Hon’ble Madras High Court in the case of KM.
Mohammed Abdul Kadir Rowther Vs. S. Muthia Chettiar MANU/TN/0424/1959
that advance means literally a payment
beforehand. In certain cases, it may be a loan but it cannot be said that a
sum paid by way of advance is necessarily a loan.
The Hon’ble Privy Council in the case of Raja of Venkatagiri
vs. Krishnayya Rao Bahadur MANU/PR/0017/1948 : AIR 1948 PC
150 at p. 155, has observed that ordinarily advance does not connote any idea
of repayment is, hence 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.
In
the judgement passed by Madras High Court in K.M. Mohamad Abdul Kadir
Rowther vs S. Muthiah Chettiar on 5 August, 1959, it was contended that, the advance
were not to be considered as a loan, the amount was intended to be
recovered, and that, therefore an obligation to repay the sum should be
inferred; 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' means literally a payment before hand; in certain cases it may be a
loan but it cannot be said 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
observed, that the words-'advancing'
and 'lending' each have a different significance, the money might be 'advanced' without being
'lent'.
Whether section 185 is talking about
loan or advance or both?
Section 185(1) of
the Companies Act, 2013 inter-alia provides that no
company shall, directly or indirectly, advance
any loan, including any loan represented by a book debt, to any of its
directors or to any other person in whom the director is interested or give any
guarantee or provide any security in connection with any loan taken by him or
such other person
Here
words “advance any loan” are used, it is not used as “advance or loan/advance
and loan”, and hence the word “advance any loan shall be read together and
word advance is a verb and loan is a noun, accordingly “advance any loan” means
to give any loan This section is not at all include the words ‘Advance’ as noun
which means paying something in advance before it is actually due.
It is pertinent to refer
to the case of Pennwalt India Ltd. v. RoC , wherein the Hon’ble High Court of Bombay
has held that to ascertain whether a transaction is a loan or not, surrounding
circumstances, relationship and character of the transaction and the manner in
which parties treated the transactions will have to be considered. Hence,
with reference to each transaction with Directors and other person in whom the
Directors are interested; the nature of transactions has to be studied.
Purpose
of Section 185:
It seems that legislature
was intended to prohibit the flow of funds from the company to its directors or
other persons in whom the Director is interested, more emphasis is likely to be
laid on the fiduciary duty of the Directors and for such reason the loans, etc.
to Directors and other specified person are prohibited. It simply means that a
director shall not be enriched at the funds of the Company.
This provision is to curb the
misuse of the powers by directors, whereby they do not use their fiduciary
powers for self-benefit, and move the funds of the company away to their
personal pocket directly or through any intermediaries.
Although
the terms “loans and advances” are used together and in common parlance deemed
to be synonyms of each other but in view of various judicial decision as
illustrated above “Loan” and “Advance” both are two different words carrying
independent meaning. In the given case the
acquirer has given advances to its subsidiary company during the course of
acquisition of 100% shares in accordance with Share Purchase for business
purpose and to meet day to day running expenses and salary requirement of the
employees appointed by the acquirer. It seems that neither it was intended by
the acquirer to “advance any loan” nor has been reflected in the balance sheet
of the target company the said amount as loan and we presume that the said
amount has been shown as advance under sub head advance under the head “Loan
and Advance”.
Whether there is any direct or indirect
personal interest of Directors concerned?
There is no
question of personal interest of directors where the Holding Company advance
supports to its subsidiary company which was undergoing the course 100%
acquisition. If it is not wrong to have subsidiaries, it cannot be said to be
wrong to support subsidiaries. If the subsidiary does well, it augments the
asset value of the holding company, therefore, the well-being of the
subsidiaries is the well-being of the holding company. If the directors of the
company are helping the subsidiaries, they are helping the business of the
company, which is the very purpose for which they exist. Further in the given
case the subsidiary company was under the process to become 100% subsidiary of
the acquirer company in accordance with share purchase agreement and in
pursuance of that the acquirer has already acquired 51% of shares of the target
company as first trench acquisition and appointed two of its directors as its
nominee directors in the subsidiary company as mandated in Share Holders
Agreement and Share Purchase Agreement. Merely because of directorship in the
subsidiary as the nominee of the holding company, such advance could not be
treated as indirect loan to such
Directors.
Meaning of Direct & Indirectly:
When
section 185 is also talking about indirect loan, in the light of various
judicial pronouncements illustrated above “indirect loans” will connote that the company
shall not give loan through the mode of one or more intermediaries. However,
the word ‘indirectly’ cannot be read as converting what is not a loan into a
loan. Hence, the amount given must be
strictly a loan, which is not in the nature of loan, cannot be said to be the
case of an indirect loan.
Section 186(vii)- Loan and Investment by Company provides
that no loan
shall be given under this section at a rate of interest lower than the prevailing yield of one
year, three year, five year or ten year Government Security closest to the
tenor of the loan.
An
advance is not loan as discussed above hence there is no question of
applicability of section 186(iii) Although the terms “loans
and advances” are used together and in common parlance deemed to be
synonyms of each other but as per various judicial decisions there is a clear
line of demarcation between the two terms. Further nature and purpose of
transaction of the current case do not resemble with that of loan.
Inferences
Drawn
Therefore
in light of the above observations and examination of the provisions of the
Companies Act, 2013 and the rules framed there under and various judicial
decisions cited above, we are of the opinion that the company has not
contravened any provisions of Section
185 or Section 186.
Regards
CS
Ravi Bhushan Kumar
Partner
SR & Associates
9990339200
cs.ravibhushan@Gmail.com
Noida
Disclaimer
1.
The conclusions reached and views expressed are matters of opinion
based on my understanding of the related
laws, rules, notifications, circulars, etc.
2.
This is complete a personal opinion on the basis of imaginary facts
and figure.
