Section 186 of Companies Act, 2013 - Loans, Investments & Guarantees

Section 186 of the Companies Act, 2013 is an important provision that regulates how an Indian company can give loans, invest in other entities, provide guarantees, or offer securities to other persons or corporate bodies. Its main purpose is to ensure financial prudence, transparency, and protection of shareholder interests by setting limits and approval requirements before a company’s funds can be exposed to such transactions. This section applies to most companies incorporated in India and serves as a safeguard so that corporate resources are not misused through excessive lending or risky investments.

What does Section 186 cover?

Section 186 deals with four types of financial exposures a company may undertake:

1. Loans to any person or body corporate
2. Guarantees and securities in connection with loans
3. Investments in securities or shares of another body corporate
4. Limits on layers of investment companies (investment structure depth)

These provisions are meant to prevent companies from making open-ended commitments that could jeopardize their financial health or lead to the misuse of corporate funds.

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Key Requirements and Limits

1. Monetary Limits (Sub-section 2)

Under Section 186(2):

A company cannot directly or indirectly:

• Give any loan to a person or another corporation,
• Give any security or guarantee in respect of a loan to another person or corporation, or
• Acquire securities of another body corporate

Exceeding the higher of:

• 60% of its paid-up share capital + free reserves + securities premium, or
• 100% of its free reserves + securities premium.

This ensures that a company’s obligations are within its financial strength and do not expose it to disproportionate risk.

2. Layer Limit on Investments (Sub-section 1)

A company generally cannot make investments through more than two layers of investment companies. The intent is to prevent complex and opaque corporate structures that may hide actual beneficial ownership or diversion of funds.
There are exceptions, for example, foreign acquisitions permissible under other laws or required investment subsidiaries under legal or regulatory mandates.

Approval and Compliance Steps

Board Approval

• Before a company gives a loan, makes an investment, creates a guarantee, or provides security, approval of the Board of Directors is required.
• A unanimous resolution at a Board meeting is necessary, and mere resolutions by circulation or committee are not sufficient.

Special Resolution (Shareholder Approval)

• If the aggregate value of existing plus proposed financial exposures (loans + securities + guarantees + investments) exceeds the specified monetary limits, prior approval by a special resolution in the General Meeting is needed.
• Note: Transactions with a wholly-owned subsidiary (WOS) or joint venture company (JVC) may be exempt from this requirement, but the details must still be disclosed in financial statements.

Interest Rate Minimum (Sub-section 7)

If a company gives a loan under Section 186, it should not be at an interest rate lower than the prevailing yield on government securities (e.g., 1-year, 3-year, 5-year) closest to the loan’s tenure, a measure to ensure arms-length pricing and protect creditors’ interests.

Defaults Restriction

A company that is in default on deposit repayments or interest cannot grant new loans, provide guarantees, offer security, or make investments until such default is rectified. This prevents companies in weak financial positions from extending further financial exposure.

Disclosure and Register Maintenance

Every company undertaking such transactions must maintain a register of loans, guarantees, securities provided, and investments made. This register must be retained at the registered office and be available for inspection by members, ensuring transparency.

Exemptions specifically provided

Section 186 does not apply to:

• Loans, guarantees, securities, or investments made by banks, insurance companies, housing finance companies, or certain finance entities in the ordinary course of their business.
• Other exemptions exist under sub-section (11) for specific entities whose principal business includes financial activities, meaning normal operations of such entities are not constrained by the monetary limits.

Practical Example

ABC Ltd. has:

• Paid-up capital: ₹10 crore
• Free reserves: ₹5 crore
• Securities premium: ₹2 crore

Under Section 186:

• The first limit: 60% of (10+5+2) = 60% of ₹17 crore = ₹10.2 crore
• Second limit: 100% of (5+2) = ₹7 crore
• The higher number is ₹10.2 crore.

So ABC Ltd. can extend loans + investments + guarantees + securities up to ₹10.2 crore without shareholder approval. If it proposes more, it must get a special resolution from shareholders.

Why Section 186 matters?

• Protects the company’s financial health by limiting undue exposure.
• Promotes accountability through Board and shareholder participation.
• Prevents misuse of corporate funds for speculative or risky outside interests.
• Enhances transparency via disclosures and registers.

Overall, Section 186 balances corporate flexibility with governance safeguards.

Conclusion

Section 186 of the Companies Act, 2013, lays down comprehensive rules for a company’s loans, investments, guarantees, and securities. It enforces financial prudence by specifying limits tied to a company’s capital and reserves, mandates Board and shareholder approvals, sets minimum interest requirements, and requires detailed disclosure and registers. Certain financial institutions and business types are exempt when exposed to such transactions during their ordinary operations. Compliance with this section helps protect stakeholders and maintain corporate financial integrity.