Loans, guarantees and investments by an Indian company are not governed by a single approval rule. Two provisions of the Companies Act, 2013 often need to be read together: section 185 focuses on loans, guarantees and security involving directors and persons connected with directors, while section 186 sets broader financial limits and governance requirements for loans, guarantees, security and investments.
For finance teams and company secretarial professionals, the practical question is therefore not simply whether a company can lend money. The correct approach is to identify the recipient, test section 185, calculate the section 186 limits, obtain the required approvals and maintain the prescribed records.
Section 185: start with the identity of the borrower
Section 185 creates a direct prohibition for certain recipients. A company cannot directly or indirectly advance a loan, including a loan represented by a book debt, or give a guarantee or provide security in connection with a loan taken by a director of the company, a director of its holding company, a partner or relative of such director, or a firm in which such director or relative is a partner. The current statutory text can be checked on the India Code section 185 page.
This first bucket should be treated as a prohibition test, not merely an approval test. Passing a special resolution does not by itself convert every prohibited loan into a permissible transaction.
When section 185 allows a transaction with an interested person
Section 185 separately deals with a loan, guarantee or security involving a person in whom a director is interested. Such a transaction may be made if the statutory conditions are met, including approval by special resolution and use of the funds by the borrowing company for its principal business activities.
The explanatory statement for the special resolution must disclose the prescribed particulars, including the proposed loan, guarantee or security and the purpose for which it will be used. This makes the end-use of funds a substantive compliance point rather than a generic recital.
Section 185 exceptions also need to be tested
The Act contains specific exceptions. These include a loan to a managing or whole-time director when it is given as part of conditions of service extended to all employees or pursuant to a scheme approved by members by special resolution. It also contains an ordinary-course lending exception where the company is in the business of providing loans, guarantees or security and the interest condition in the section is met.
There are also holding-subsidiary exceptions: a holding company may make a loan to its wholly owned subsidiary, and may give a guarantee or provide security for a loan to its wholly owned subsidiary. A holding company may also give a guarantee or security for a bank or financial-institution loan to its subsidiary, subject to the statutory principal-business-activity condition. The consolidated statutory text is also available in the Ministry of Corporate Affairs Companies Act, 2013 PDF.
Section 186: calculate the financial limit separately
Even after section 185 is cleared, section 186 may apply. Section 186 covers loans to persons or other bodies corporate, guarantees or security connected with loans, and acquisition of securities of another body corporate.
The general limit in section 186(2) is the higher of: 60% of paid-up share capital, free reserves and securities premium account; or 100% of free reserves and securities premium account. The aggregate of existing transactions covered by the provision and the proposed transaction must be considered. The current provision and related subordinate material can be reviewed through the India Code section 186 material.
Worked example of the section 186 limit
Assume a company has paid-up share capital of ₹10 crore, free reserves of ₹6 crore and securities premium of ₹2 crore. Sixty per cent of the combined ₹18 crore base is ₹10.8 crore. One hundred per cent of free reserves plus securities premium is ₹8 crore. The section 186(2) threshold is therefore ₹10.8 crore, being the higher amount.
If the company's aggregate covered loans, guarantees, security and investments after including the proposed transaction would exceed ₹10.8 crore, the additional approval requirement in section 186(3) must be considered.
What approval is needed when the section 186 limit is exceeded?
Where the aggregate exceeds the section 186(2) limit, the transaction generally requires prior authorisation by a special resolution in general meeting. The provision contains specified relief for certain transactions involving a wholly owned subsidiary or joint venture, subject to the statutory conditions and financial-statement disclosure.
Section 186 also requires the Board resolution sanctioning the covered transaction to be passed at a Board meeting with the consent of all directors present. Where a term loan from a public financial institution is subsisting, prior approval of that institution may also be relevant, subject to the statutory exception.
Interest rate, deposit default and disclosures
For loans governed by section 186, the interest rate cannot be lower than the prevailing yield of the Government Security of one-year, three-year, five-year or ten-year tenor closest to the tenor of the loan. This should be documented at the time the loan is approved rather than reconstructed later during audit.
A company in default in repayment of deposits or interest on deposits cannot give a loan, guarantee or security or make an acquisition covered by section 186 while that default continues. The company must also disclose in its financial statements full particulars of covered loans, investments, guarantees and security and the purpose for which the recipient proposes to use the loan, guarantee or security.
Register and documentation controls
Section 186 requires a register of covered loans, guarantees, security and acquisitions to be maintained in the prescribed manner and kept at the registered office. Finance and secretarial teams should reconcile this register with Board minutes, general-meeting approvals, loan agreements and financial-statement disclosures.
Practical decision framework
- Identify the recipient: determine whether the borrower or beneficiary is a director, relative, firm, body corporate, subsidiary, joint venture or another person.
- Run section 185 first: classify the transaction as prohibited, conditionally permitted or within a specific exception.
- Document end-use: where section 185 requires principal-business-activity use, make the purpose explicit in approvals and transaction documents.
- Calculate section 186 exposure: aggregate existing covered transactions with the proposed transaction and compare it with both statutory thresholds.
- Obtain approvals: record the Board approval and obtain a special resolution or public-financial-institution approval where applicable.
- Check pricing and defaults: verify the minimum interest rule for loans and ensure no disqualifying deposit default subsists.
- Update records and disclosures: maintain the statutory register and align financial-statement disclosures with the approved purpose.
Common mistake: treating sections 185 and 186 as alternatives
A frequent analytical error is to ask whether a transaction falls under section 185 or section 186 as though only one can apply. In practice, section 185 answers the director-connected permissibility question, while section 186 can impose separate limits, approvals, pricing and record-keeping requirements. A transaction may therefore need to satisfy both provisions.
MCA has also issued clarification concerning loans and advances to employees under sections 185 and 186; the related official entry is available through India Code's circular record.
Key takeaway
For a company loan, guarantee or security, begin with section 185 to determine whether the recipient relationship creates a prohibition, conditional permission or exception. Then apply section 186 independently to calculate limits and determine approvals, interest, disclosures and register requirements. A documented two-stage review is far safer than relying on a single Board resolution or assuming that business purpose alone makes the transaction compliant.
