Many promoter-led companies treat fund transfers within the group as routine business decisions. However, a transaction that appears commercially harmless may violate Section 185 of the Companies Act, 2013.
The Basic Rule
A company cannot directly or indirectly:
- Advance a loan to a director.
- Give a loan represented by a book debt to a director.
- Provide a guarantee or security in connection with a loan taken by a director.
The restriction also extends to relatives of directors, firms in which a director or relative is a partner, and certain entities connected with directors. Contrary to what many assume, these transactions cannot simply be approved through a Board resolution and regularised later.
The Wholly Owned Subsidiary Exception
Section 185 does provide an important carve-out. A holding company may grant loans, guarantees, or securities to its wholly owned subsidiary, provided the funds are utilised for the subsidiary's principal business activities. The exemption is available only when the prescribed conditions are satisfied.
The Cost of Non-Compliance
A violation of Section 185 can result in:
- A penalty of Rs 5 lakh to Rs 25 lakh on the company.
- A penalty of up to Rs 25 lakh, imprisonment up to six months, or both, for officers in default.
- Similar consequences for the recipient director or connected person.
The Compliance Lesson
Many Section 185 violations arise not from deliberate misconduct, but from routine fund movements between promoters, directors, and group entities. Before approving any intra-group loan or financial assistance, companies should first examine whether Section 185 permits the transaction at all.