Section 186 of the companies Act,2013 and its comparison with the predecessor provision Section 372A

Section 186 of the Companies Act 2013 – More rigorous law than Section 372A in the erstwhile 1956 Act- A Study

Section 186 in the Companies Act 2014 (herein after referred to as “The Act”) corresponds to Section 372A in the erstwhile 1956 Act. The intention of both the provisions is   by and large  identical   namely to regulate primarily Inter-corporate Investments and loans. Although the provisions are substantially the same in spirit, there are certain subtle differences between the two in content which make Section 186 a much   more rigourous and potent  regime as compared to its predecessor in the 1956 Act.

The differences are enumerated as under:

· Section 186 is applicable without prejudice to the  provisions in the Act. There was no similar provision in Section 372A. Section 186 has been so worded with a view to isolate it from Section 185 which carries a blanket embargo on loans to Directors and their relatives.

· Section 186 imposes embargo on multi-layered Investments

Section 186(1) restrains a company from making investments beyond two layers of subsidiary companies subject to certain exceptions as provided under the Section which are as follows:

a) Where an Indian company is seeking to acquire any other company incorporated outside India, if such other company  has investment subsidiaries beyond two layers as per the laws of the concerned Country.

b) A subsidiary company is not restrained from having any investment subsidiary for the purposes of meeting the requirements of any law for the time being in force.

c) The above restriction did not apply under the erstwhile regime of Section 372A.The fact that investments could be made through  multi-layered structures gave the investor company the much needed flexibility in the process of planning and structuring the   investments. Sub-section (1) in Section 186 is therefore constrictive in its approach.

· Section 186 restrains   loans to Non-corporate Entities as well

Whereas Section 372A regulated only inter corporate loans and investments, Section 186 applies also to the provision of loans, guarantees, to non-corporate bodies. Clause (a) under sub-section   (2) introduces this fetter by making the Section applicable to any person or other body corporate. Therefore by a strange   quirk of logic or lack of it ,if you may, a company cannot provide loans to a non-corporate entity such as a  partnership firm or a sole proprietor without approvals u/s 186.For that matter, even a loan given to an employee of a company will come within the ambit of the collective wisdom of the Board which will have to, willy-nilly, sit in pompous  judgement on this  triviality and approve of  an innocuous application for financial support  at a duly convened meeting!

Having said this, the new Act, to its credit, does have some novel characteristics which are laudable. However,  the flip side is that the contents of clause (a) in sub-section (2) above  pushes its quality or the lack of it   to a nadir - to a , bottomless pit, as it were. Surely there could not be anything more archaic  and retrograde  than this provision, in a legislation which is supposed to be contemporary and which seeks to supplant the 1956 Act which was considered as an anachronism and well  past its useful shelf life. To be fair to the law makers, our surmise is  that this was an unintended aberration in drafting, the consequence of which they had not comprehended. Now that the MCA has   set in motion the process of mitigating  the hardships   caused  to stakeholders by some of the impractical  provisions in the new Act through  a slew of  circulars to ease the rigours of several provisions, our optimism  is that MCA will soon rectify the anomalous situation arising out of the above as well.

· Section 186 only regulates Inter-corporate Investments

Where it comes to investments, Section 186 regulates only investments made by a Company into any other body corporate. The term “body corporate” has to be given the meaning provided by Section 2(11) of the Act and   includes a company incorporated outside India.

It follows from the above that investments made by companies   into non-corporate avenues  such as mutual funds will not be subject to compliance with the procedure of  Section 186.

· Section 186 exemptions are less liberal  than its predecessor Section 372A 

The other major difference is that the provisions of Section 372A were in totality inapplicable to certain categories of Companies including companies, involved inter alia, in providing infrastructural facilities.

As against this, as stated in sub -section (11) u/s 186, the section does not apply only to loans made, guarantees given or securities provided, inter alia, by a Company engaged in providing infrastructural facilities. The expression ”infrastructural facilities” refers to the facilities  specified in Schedule VI to the Act. Therefore, if such a company makes an acquisition by subscription, purchase or otherwise, in the securities of any other body corporate, the limits laid down in section 186 shall apply.

In the same vein, NBFCs registered with RBI whose principal business shall be in respect of its investment and lending activities will not have to seek approvals for making investments. In their case, the provision of loan and guarantees will come under the radar of the Board and in applicable cases, involve approval of the members as well.

· Section 186 considers “securities premium” for determining thresholds for loans and Investments

For computing the aggregate value of investments/loans that can be made, the lender/Investor company is allowed to include the amount of ‘Securities premium” standing to the credit of its Books, in addition to its paid up capital and Free Reserves. By contrast under Section 372A one could consider only the aggregate of the paid up share capital and free reserves. It is pertinent to note that  in the 1956 Act, the term “free Reserves” was not specifically defined except by way of  a passing reference in Section 293(1)(d) wherein the term has been referred to as “Reserves not set apart for any specific purpose”. In contrast, Section 2(43) in the Act, provides a restricted ”means” definition to the expression  “Free Reserves” by describing it as” such  reserves  which as per the latest audited Balance Sheet of a company ,are available for distribution as dividend”. In the light of the above, it is perhaps appropriate   to allow the “Securities Premium’ as a concomitant to the  aggregate threshold for investments and loans.

· Can loans be extended at subsidized rates of Interest?

Sub-section (7) to Section 186 which corresponds to sub-section(3) in Section 372A provides that no loans can be provided  to a body corporate at a rate of interest which is lower than the prevailing bank rate being the standard rate made public under Section 49 of the RBI Act,1934.This throws up  a pertinent  question as to whether a Holding Company can provide to its 100% Subsidiary loans at either zero or subsidized rates of interest for business exigencies. The answer to this question would be an emphatic “No” as appears from a plain reading of Rule 11 (1) of the Companies (Meetings of Board and its powers) Rules,2014. The above Rule merely clarifies that where a loan or guarantee is given or an investment is made in the securities of a wholly owned Subsidiary or a joint venture company , the requirement of sub-section(3) of Section 186  shall not apply. Sub-section(3) calls for the passing of a special resolution where the limits contemplated in subsection(2) are proposed to be exceeded. Hence only the procedure of a special resolution can be dispensed with. All other requirements of section 186 will have to be met.

On the other hand, in as much as clause (c) in subsection (8) of Section 372A exonerated a Holding Company from  complying with Section 372A for loans made to its wholly owned Subsidiary, it was possible under the previous regime to provide interest free loans to a wholly owned subsidiary.

The above is yet another fetter in the new law which is perhaps oblivious to the realities of business. In many circumstances it may be necessary for a Holding Company to nurse back an ailing   wholly owned Subsidiary to good health through the provision of subsidized loans .By denying this benefit the new law could push many  a subsidiary to the throes of an unprecedented financial crisis. This anomalous position needs to be addressed urgently in the interest of business.

· Conflict between Section 179 and 186- which provision carries greater force?

The new law also throws up a conflict as between Section 179 and 186   in the matter of precedence very similar to the question which was raised between Section 292 and Section 372A in the 1956 Act once the latter provision was introduced in the Statute Book by  the Companies (Amendment)Act,1999 with effect from 31.10.1998.

We are aware that Section 179(3) in the Act, lists out the powers that are exercisable by the Board  by means of resolutions passed at its meetings. Some of the powers listed out can be  delegated by the Board to a Committee of Directors, the Managing Director ,the Manager or any other principal officer of the company.

The following powers can thus be delegated:

a) the power to borrow monies;

b) to invest the funds of the company.

c) to grant loans or give guarantee or provide security in respect of loans.

We are also aware that Section 186 provides that any decision to make investments or to make loans ,extend guarantees has to be approved unanimously by the Board at a duly convened Meeting even if the investments proposed or loans to be made are within the limits of the Board’s authority.

The question therefore arises whether the power to invest the funds or to grant loans or guarantees can be exercised through the scope of delegated authority as envisaged in Section 179 by bypassing the rigmarole stipulated in Section 186.Our view is that as Section 186 is a specific and composite code to rein in inter-corporate investments and loans, if there is a conflict , competition between Section 179 and 186 ,having regard to the settled principles of judicial interpretation, Section 179 being a general provision will have to yield place to Section 186 since the latter is a specific provision. 

Conclusion

In the above discussion we have endeavoured to capture the nuances of the new provision Section 186 and bring home the differences between the same and its predecessor Section 372A in the 1956 Act both in terms of their forcefulness and subtlety. Without doubt Section 186 comes off as a more potent and rigid  law. Our view is that there exists still considerable headroom for making the law more pliable and friendly to companies.

Ceiling u/s 186Sub section (2) provides that 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

c) acquire by way of subscription, purchase or otherwise,the securities of any other body corporate.

if a Company subscribes to the securities of any other body corporate, the following limits shall apply :-

Unanimous approval of the Board required:-

Where the value of investment does not exceed 60% of the Company’s paid up share capital, free reserves and securities premium account or

Where the investment does not exceed 100% of its free reserves and securities premium account whichever is more

Approval of Board has to be at a Meeting and if the Company has obtained loans from any public financial institutions which are outstanding, prior approval of the institution would also be needed.

If the above limits are exceeded, approval of members by special resolution will be needed.

Rule 11 in the Companies (Meetings of Board) Rules, 2014 provides that where the loans or guarantees or securities have been given to a wholly owned subsidiary or a joint venture Company or where the investment is made by holding Company in its wholly owned subsidiary it will not be necessary to obtain shareholders approval by special resolution u/s 186(3).

It is pertinent to note that where any Company subscribes to the shares of another Company under a Rights issue which is covered by Section 62, Section 186 shall not apply. In other words if shares are acquired pursuant to a rights issue, the ceiling laid down u/s 186 as stated above shall not apply.

In view of the above, the applicability of section 186 to Companies such as ours which are into infrastructural facilities is restricted to the following:-

Provision of loans, guarantees or securities can be made without any ceiling and without requiring compliance with Section 186.

Investment in securities of non corporate bodies such as mutual funds can be made without the regulation of the above provision.

The ceiling laid down in Section 186(1) shall apply for any acquisition of the securities of any other Company. Whenever any investment is proposed by a Company such as ours into the securities of any other body corporate, approval of the Board should be obtained at a duly held meeting with the unanimous consent of the members, provided the investment is within the limits prescribed. If the investment exceeds the limits prescribed, approval of the shareholders has to be taken. The best strategy to get away the above from rigours of compliance is to make investments in the securities of another Company pursuant to a Rights issue made by it. In such a case the above section shall not apply. Therefore, whenever we are making investments into any of our subsidiaries, we should make sure that the subsidiary is raising subscription through the rights issue. Otherwise the ceiling laid down in Section 186 shall apply.

Regards 

R Kalidas