Section 185 Guide: Rules for loans to Directors
In the corporate world, a company’s money belongs to its shareholders, not the people running the show. To make sure directors don't use the company as their personal piggy bank, the government introduced Section 185 of the Companies Act 2013. This is one of the strictest sections in corporate law. It basically puts a No Entry sign on most types of loans, guarantees, or securities given to directors or their close relatives. As we move through 2025-2026, the focus on corporate governance is higher than ever, and a single mistake here can lead to heavy fines or even jail time for the officers involved.
The Blanket Ban: Who cannot get a loan?
Section 185(1) starts with a very clear No. A company (whether private or public) cannot directly or indirectly provide any loan, guarantee, or security to:
- Any Director of the company or its holding company.
- Any Partner or Relative of such a director.
- Any Firm in which such a director or their relative is a partner.
What counts as a Loan? It's not just cash. Even Book Debts (where the company gives you a product but allows you a long time to pay) can be treated as a loan if the intent is to provide financial help.
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The Conditional Door: Section 185(2)
While the ban on directors is absolute, the law is a bit more flexible when it comes to other entities where a director might be interested. A company can give a loan or guarantee to a private company or a body corporate in which the director is a member or director, provided they follow two strict steps:
- Special Resolution: At least 75% of the shareholders must vote Yes in a general meeting.
- Business Purpose: The company receiving the loan must use the money only for its principal business activities. It cannot use the money to buy shares or give further loans.
The 2025-26 Exemptions: When is it allowed?
Not every transaction is seen as shady. There are four major Safe Harbors where Section 185 does not apply:
- Managing/Whole-Time Directors: You can give them a loan if it’s part of the service contract offered to all employees, or if shareholders approve a specific scheme via a special resolution.
- Ordinary Course of Business: If the company’s actual job is lending money (like a Bank or a registered NBFC), it can lend to directors, provided they charge interest at the prevailing Government Security (G-Sec) rate.
- Holding to Subsidiary: A holding company can give a loan or guarantee to its Wholly Owned Subsidiary (WOS), as long as the subsidiary uses it for its main business.
- Bank Guarantees: A holding company can provide security/guarantee for a loan taken by its subsidiary from a bank or financial institution.
Why private companies breathe easier?
There is a special Exemption Notification for private companies. A private company can ignore Section 185 entirely if it meets three criteria:
- No other body corporate has invested money in its share capital.
- Its total borrowings from banks/FIs are less than twice its paid-up capital or ₹50 Crore (whichever is lower).
- It hasn't defaulted on any existing bank loans at the time of making the transaction.
Summary Table: Section 185 at a glance
Category
Status
Requirement
Director / Relative
Prohibited
Absolute Ban
Director's Firm
Prohibited
Absolute Ban
Related Private Co.
Allowed
Special Resolution + Business Use
Wholly Owned Subsidiary
Allowed
Business Use Only
Managing Director
Allowed
As per the service rules/scheme
The Price of Breaking the Law
The penalties for violating Section 185 are quite steep to ensure companies take it seriously.
- For the Company: A fine ranging from ₹5 Lakh to ₹25 Lakh.
- For the Officer in Default: Imprisonment for up to 6 months or a fine of ₹5 Lakh to ₹25 Lakh (or both).
- For the Recipient (The Director): They too can face 6 months in jail and a fine of ₹5 Lakh to ₹25 Lakh.
Conclusion
Section 185 is designed to keep the Corporate Veil clean. In 2025-26, with auditors being more eagle-eyed than ever, companies must be extremely careful. Before you sign off on any transfer of funds to a director-related entity, ask yourself: Is it a prohibited category? Do we have a Special Resolution? Is the interest rate right? When in doubt, it’s always better to stick to the Safe Harbors or consult a legal expert at Motilal Oswal to ensure your compliance record stays spotless.