Companies Acts - Section 185, 186 and 372A - Ambiguities come fully loaded!

By Lalit Kumar

  • 16 Feb 2014

Section 470 of the new Companies Act, 2013 gives power to central government to remove difficulties which arise in giving effect to the provisions of the new law but the manner in which the Ministry of Corporate Affairs (MCA) is releasing circulars to clarify certain provisions of the new law, it only compounds the already existing difficulties, what to talk about removing them. Although, none of the circulars so far issued has been under its power of section 470 (although they have been issued to clarify doubts) but all of them make the issues more ambiguous. The case in point is MCA’s circular of February 14 on clarification with regard to Section 185 of the Companies Act, 2013.  

It appears that this circular wanted to further clarify the ambiguity which persisted after MCA’s earlier circular dated November 19, 2013 on a similar issue. But, it suffers from many flaws. First this circular states that section 185 prohibits giving of guarantee or security by a holding company in respect of any loan taken by its subsidiary. This is not correct. Nowhere does section 185 give a clear language that a holding company is prohibited from giving guarantee or security in respect of any loan taken by its subsidiary.

It seems that the circular’s basis to interpret this is the expression used in explanation (e) of sub-section 1 of section 185 which covers a body corporate whose board of directors acts in accordance with the directions or instructions of the board of its holding company. That may not be always true i.e. it is not always true that a subsidiary will act according to the directions and instructions of the board of the holding company. There are concepts of separate legal entity and fiduciary duties of directors with respect to the company they represent. This concept of fiduciary duties is further strengthened by the new section 166 introduced in the Companies Act, 2013 which lays duties of directors. Therefore, whether a body corporate acts in accordance with the directions or instructions of the board of its holding company will depend upon the facts and circumstances of the case. If the board of a subsidiary is always bound to act as per the instructions of the board of its holding company, then that will always defeat the concept of fiduciary duties of directors of the subsidiary. 


Further explanation (e) of sub-section 1 uses the expression “acts in accordance with the directions or instructions of the board of the lending company.” So does it mean that section 185 only restricts lending activities because a company providing guarantee or security would in real terms not be called a lending company? So for this reason is giving of guarantee or security free from clutches of section 185? That cannot be the intent. The problem is the expression used here is copied from section 185’s earlier avatar section 295 of Companies Act, 1956 which clearly defined the expression lending company to mean a company advancing loan, giving guarantee and providing security, while explanation (e) has been copied verbatim, regrettably no mind was applied that it could mislead if expression lending company is also not copied verbatim.

Another flaw in the circular is it mentions that section 185 is not notified, however, that is not true, section 185 has already been notified on September 12, 2013. Surely, this circular meant to write section 186 but inadvertently mentions section 185. This being an important circular on an important issue, the MCA should be more careful to ensure the contents are accurate; otherwise it will again create confusion because of this inadvertent error.

Although, the principal concept of this circular is not on the issue of exemption in cases of “ordinary course of business”, which is another debatable point in section 185, however, the way this expression is used in the circular, it seems the MCA’s understanding of the meaning of the term “ordinary course of business” are those actions which are done in the usual and ordinary course of a company’s business and not necessarily as a ‘principal business’ for which the company was established. Further, since the circular provides for expression ‘ordinary course of business’ as an exception in the case of section 185 – does it mean that if things are done in ordinary course of business between the holding-wholly owned subsidiary, then the benefit of section 372A is in any case not needed (which this circular provides), as that will be covered by section 185 itself.


Noteworthy point is that this circular only provides exemption in cases when a bank or a financial institution advances loan to a subsidiary which is guaranteed and secured by the parent company. It does not exempt and cover the other aspect provided under section 372A in a case when a parent company gives a direct loan to its wholly owned subsidiary. Therefore, this circular will only bring relief where a bank finances a subsidiary on the basis of guarantee or security given by the parent company and not in cases where a parent company wants to itself extend a direct loan to its subsidiary. This circular has been released to facilitate smooth bank financing to a subsidiary which created ambiguity when section 185 was notified. This clarification comes with a condition that it will only apply to cases where the loans so obtained by subsidiary are exclusively utilised by the subsidiary for its principal business activities. There is no such condition in section 185 of Companies Act, 2013 and section 372A of Companies Act, 1956.

This circular will apply till section 186 is notified, and if and when section 186 is notified, there will be again ambiguity as section 186 does not grant exemptions in holding and wholly owned subsidiary cases (like section 372A does).

(Lalit Kumar is a partner with J. Sagar Associates. Views are personal.)


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