Inter-Corporate Loan from One Private to Another Private Company

Inter-Corporate Loan from One Private to Another Private Company. Various companies need funds for different purposes such as expansion, purchase of new assets, meeting working capital needs or initiation of a new project. Some companies may have extra funds that they are not using immediately. Instead of keeping that money idle in a bank, the company may lend it to another company that needs funds for its business. This is generally known as an inter-corporate loan.
For example, suppose A Private Limited has surplus funds of Rs.50 lakh, while B Private Limited needs Rs.30 lakh for expanding its business. In such a case, A Private Limited can lend Rs.30 lakh to B Private Limited. However, before giving the loan, both companies have to make sure that the requirements of the Companies Act, 2013 are properly followed. Although giving a loan to another company may seem like a simple transaction, there are certain legal provisions that need to be considered. The two main provisions in this regard are Section 185 and Section 186 of the Companies Act, 2013. Section 186 generally deals with loans given by a company, while Section 185 becomes relevant when the borrowing company has a connection with a director of the lending company.
Meaning of Inter-Corporate Loan
An inter-corporate loan basically means a loan given by one company to another company for a certain period and at an agreed rate of interest. For example, if ABC Private Limited gives Rs.1 crore to XYZ Private Limited for three years at an agreed interest rate, it would be considered an inter-corporate loan.
These types of loans are quite common between companies belonging to the same group. For instance, a company having surplus funds may lend money to its group company when that company needs funds for expansion, working capital or some other business requirement. However, even when the companies are part of the same group, the applicable legal requirements still need to be checked before the loan is given. A holding company may give a loan to its subsidiary company or two companies under the same management may take loans from each other. However, it must be noted that the relationship between the companies has to be scrutinized carefully as the involvement of a common director may make the transaction governed by Section 185.
Section 185 of the Companies Act, 2013
Section 185 deals with loans to directors and loans to persons in whom directors are interested. As per Section 185(1), a company cannot give, directly or indirectly, a loan or a guarantee or security in respect of a loan to its director or another person in whom its director is interested. It may be noted that a guarantee or a security also falls under the ambit of this section. Section 185 becomes important in inter-corporate loans because it is possible for the same person to be a director in both the lending and borrowing companies.
For example, suppose Mr. A is a director of both ABC Private Limited and XYZ Private Limited. If ABC Private Limited wants to give a loan to XYZ Private Limited, the company will need to check whether Section 185 applies to the transaction. The main purpose of Section 185 is to make sure that the company’s money is not misused for the personal benefit of a director or for the benefit of another person or company in which the director has an interest.
The Explanation to this section lays down certain situations in which a person is said to be “in whom director is interested”. Hence, the relationship between the director and the borrowing company has to be examined in detail in order to ascertain whether this section applies or not. It may be noted that in such a case, the mere fact that the borrowing and the lending company are private companies will not override the application of this section. Hence, the relationship between the borrowing company and the director has to be examined.
Section 185(2) deals with punishment for violation of this section. Hence, by virtue of this section, a company cannot take advantage of a guarantee or security given by another company in contravention of this section. Thus, it is seen that not only do the restrictions apply to the companies but the violators also suffer the consequences of their acts. However, it may be noted that various exemptions have been provided to avoid the application of this section in certain cases. Therefore, before concluding that a loan has been made to a person in whom a director is interested, it is essential to go through all the facts and circumstances of the case. Further, various private companies also enjoy the benefit of certain exemptions as notified by the Ministry of Corporate Affairs. Hence, while dealing with a private company, it is essential to check whether the exemption as contemplated under a specific notification is available or not.
Section 186 – Loan and Investment by a Company
When it comes to inter-corporate loans, Section 186 is the most relevant section. As per Section 186(2)(a), a company cannot directly or indirectly give any loan to any person or other body corporate except as provided under this section. Hence, when a private company proposes to give a loan to another private company, the provisions of this section have to be examined.
It may be noted that this section does not prohibit a company from giving a loan but it places various restrictions and obligations on a company that proposes to give a loan.
Restrictions under Section 186(2)
As per this sub-section, a company cannot give a loan to any person or other body corporate in excess of the limits specified in this section. The limits are as follows:
60% of paid up share capital + free reserves + securities premium account OR
100% of free reserves + securities premium account
whichever is higher.
Therefore, if the proposed loan along with other transactions such as guarantees, securities, and investments fall within the aforesaid limits, the application of other sub-sections such as 186(3) and 186(5) will depend on the facts and circumstances of the case. If the proposed loan along with other transactions such as guarantees, securities, and investments exceed the aforesaid limits, the special resolution as contemplated under 186(3) will have to be passed.
Section 186(3) – Special Resolution
As per this section, if the proposed aggregate value of loans, guarantees, securities, and investments exceeds the limits as provided under this section, the company will have to obtain the consent of members by passing a special resolution. This means that a company cannot give a loan just on the grounds that it has surplus funds; the company cannot give a loan to one of its subsidiaries just because the subsidiary needs funds.
For example, if a certain company has already given various loans and guarantees and the proposed new loan will exceed the aforesaid limits, the company will have to pass a special resolution before giving the loan. This is because the company’s funds belong to its shareholders and the company cannot alienate them without the consent of the shareholders.
Section 186(4) – Disclosure
As per this section, a company has to disclose all the relevant details of the loan, guarantee, or investment given by the company. Further, the company has to disclose the purpose for which the loan or any other facility is proposed to be availed by the receiver. This is done to ensure transparency in financial dealings. For example, if ABC Private Limited gives a loan of Rs.50 lakh to XYZ Private Limited for the purpose of purchasing a machine, such a disclosure has to be made by ABC Private Limited.
Section 186(5) – Approval of the Board
As per this section, no investment shall be made or loan, guarantee, or security shall be given unless the resolution passed in the Board approving the investment, loan, guarantee, or security has been approved by all the directors present at the meeting. This is a very practical requirement. Hence, before a company gives a loan to another company, it has to place the same before its Board and record the decision in terms of a Board resolution. A company should not just transfer the amount to the bank account of the other company without completing the formalities of passing a Board resolution.
Section 186(7) – Rate of Interest
One of the most pertinent requirements is contained in this sub-section. As per this sub-section, no loan shall be given at a rate of interest lower than the yield of the Government Security closest to the tenure of the loan. The relevant Government Security can be the one year, three year, five year, or ten year Government Security, depending on the term of the loan. For example, if a loan is proposed to be given for a period of three years, the rate of interest should not be lower than the yield of the 3 year Government Security.
This provision is extremely relevant because it prevents companies from taking undue advantage of other companies by giving loans at a lower rate of interest. Hence, a company cannot give a loan to a group company at a lower rate of interest merely because it is a connected party.
Section 186(8) – Default in Deposits
As per this section, if a company defaults in repayment of deposits received by it or repayment of interest on such deposits, it will not be able to give a loan or provide a guarantee or security or make any acquisition until the default continues. Hence, a company has to review its liabilities before giving a loan to another company.
Section 186(9) and 186(10) – Register
As per these sections, a register containing the relevant details of all the loans, guarantees, securities, and investments has to be maintained by the company at the registered office. The register has to be opened as per the provisions contained in these sections. The objective of this requirement is to ensure transparency and accountability in case of any defaults.
Section 186(11)
This section provides that certain categories of companies such as banking companies, insurance companies, housing finance companies, and companies engaged in financing or infrastructure development, among others are exempted from the application of this section subject to the conditions prescribed in this section. Thus, it becomes essential to go through this section before applying the other sub-sections of Section 186.
Practical Example
The following example will help illustrate the applicability of various sections discussed above:
ABC Private Limited has surplus funds of Rs.2 crore. The management decides to give Rs.75 lakh as a loan to XYZ Private Limited for setting up a new manufacturing unit. The first step in this regard will be to check whether any of the directors of ABC Private Limited is connected with XYZ Private Limited.
If one of the directors of ABC Private Limited is also a director of XYZ Private Limited, then the applicability of Section 185 will have to be ascertained. Once the applicability of Section 185 is ruled out, ABC Private Limited will have to check whether the Rs.75 lakh loan to XYZ Private Limited would exceed the limits stipulated under Section 186(2).
If it does not exceed the limits, then the company will have to ensure that the aforesaid resolution is passed by the Board as contemplated under Section 186(5). The company will also have to ensure that the rate of interest charged on the loan is not lower than the yield on the Government Securities as stipulated under Section 186(7). Thus, before actually disbursing the amount of Rs.75 lakh, ABC Private Limited will have to ensure that all the requirements of the Companies Act, 2013 are met.
Case Study – Hewlett Packard Enterprise India Private Limited
A useful case in this regard is the case of Hewlett Packard Enterprise (India) Private Limited and Others v. Registrar of Companies, Bangalore. In this case, Hewlett Packard Enterprise India Private Limited had given an inter-corporate loan of Rs.360.40 crore to its associate company, Hewlett Packard Enterprise Globalsoft Private Limited. However, both the companies had a common non-executive professional director. The loan had been approved by the Board of Directors of the lending company, i.e., Hewlett Packard Enterprise India Private Limited. The issue of applicability of Section 185 came up before the National Company Law Appellate Tribunal.
The crucial point that emerged from this case is that an inter-corporate loan between group companies cannot be treated as a loan between independent companies just because both the companies are separate entities. The fact that a common director is involved in both the companies has to be taken into consideration while determining the applicability of Section 185.
The parties to the appeal before the tribunal took the view that since the transaction between the companies did not fall under the ambit of Section 185, the restrictions imposed by this section did not apply to them. They further argued that since the loan amount was reasonable and the interest rate was comparable to the interest rate charged by banks, no restrictions should be imposed on them. However, the tribunal noted that the exception under Section 185(2)(b) did not apply because the interest rate was not lower than the interest rate charged by a bank. This case is significant because it highlights the fact that both, Sections 185 and 186 have to be considered while analyzing an inter-corporate loan.
Inter-corporate Loan – Compliance Checklist
Before a company contemplates giving a loan to another company, it has to consider the following:
Whether the transaction falls under the ambit of Section 185. The company has to check whether any of its directors has an interest in the borrowing company. If this is the case, then the next step will be to determine whether any of the exceptions as provided under Section 185 applies to the transaction. Whether the proposed loan would exceed the limits stipulated under Section 186(2). If the proposed loan falls within the limits, the company will then have to ensure that the resolution passed by the Board of Directors in this regard is in compliance with Section 186(5). If the proposed loan exceeds the aforesaid limits, then the company will have to apply to the Registrar of Companies for registration of a special resolution as contemplated under Section 186(3).
Further, the company will have to ensure that the application made under Section 186(3) is in compliance with the other requirements such as the interest rate stipulated under 186(7) and the disclosure requirements under 186(4). The company will also have to ensure that it is not in default in repayment of deposits or repayment of interest on deposits as such a default will affect its ability to give a loan to another company under Section 186(8). All the relevant details of the transaction including the terms and conditions of the loan have to be recorded in a register as mandated by 186(9) and 186(10). Apart from the aforesaid requirements, the lending company and borrowing company have to execute a proper contract containing all the details of the loan such as the amount of the loan, tenure, interest rate, purpose of the loan, mode and terms of repayment, among others. Finally, the companies will have to ensure that various other laws and regulations applicable to them, if any, have been complied with.
Conclusion
Inter-corporate loans are an effective way of utilizing the surplus funds of a company by giving a loan to another company. However, such transactions cannot be treated as routine transactions since various provisions of the Companies Act, 2013 apply to such transactions. The object of Section 185 is to ensure that directors are not in a position to take undue advantage of the company by obtaining a loan at a concessional rate of interest. On the other hand, Section 186 applies to all transactions involving loans and lays down various restrictions such as the requirement of special resolution and limits on the amount of the loan. Thus, while analyzing an inter-corporate loan between two private companies, both, Sections 185 and 186 have to be borne in mind.
As highlighted in the Hewlett Packard case, the fact that a common director is involved in both the companies has to be scrutinized carefully and the applicability of Section 185 has to be determined. Similarly, apart from the requirement of passing a special resolution, a company also has to comply with the requirements of disclosure and maintenance of records as mandated by Section 186.

Various companies need funds for different purposes such as expansion, purchase of new assets, meeting working capital needs or initiation of a new project. Some companies may have extra funds that they are not using immediately. Instead of keeping that money idle in a bank, the company may lend it to another company that needs funds for its business. This is generally known as an inter-corporate loan.

For example, suppose A Private Limited has surplus funds of Rs.50 lakh, while B Private Limited needs Rs.30 lakh for expanding its business. In such a case, A Private Limited can lend Rs.30 lakh to B Private Limited. However, before giving the loan, both companies have to make sure that the requirements of the Companies Act, 2013 are properly followed. Although giving a loan to another company may seem like a simple transaction, there are certain legal provisions that need to be considered. The two main provisions in this regard are Section 185 and Section 186 of the Companies Act, 2013. Section 186 generally deals with loans given by a company, while Section 185 becomes relevant when the borrowing company has a connection with a director of the lending company.

Meaning of Inter-Corporate Loan

An inter-corporate loan basically means a loan given by one company to another company for a certain period and at an agreed rate of interest. For example, if ABC Private Limited gives Rs.1 crore to XYZ Private Limited for three years at an agreed interest rate, it would be considered an inter-corporate loan.

These types of loans are quite common between companies belonging to the same group. For instance, a company having surplus funds may lend money to its group company when that company needs funds for expansion, working capital or some other business requirement. However, even when the companies are part of the same group, the applicable legal requirements still need to be checked before the loan is given. A holding company may give a loan to its subsidiary company or two companies under the same management may take loans from each other. However, it must be noted that the relationship between the companies has to be scrutinized carefully as the involvement of a common director may make the transaction governed by Section 185.

Section 185 of the Companies Act, 2013

Section 185 deals with loans to directors and loans to persons in whom directors are interested. As per Section 185(1), a company cannot give, directly or indirectly, a loan or a guarantee or security in respect of a loan to its director or another person in whom its director is interested. It may be noted that a guarantee or a security also falls under the ambit of this section. Section 185 becomes important in inter-corporate loans because it is possible for the same person to be a director in both the lending and borrowing companies.

For example, suppose Mr. A is a director of both ABC Private Limited and XYZ Private Limited. If ABC Private Limited wants to give a loan to XYZ Private Limited, the company will need to check whether Section 185 applies to the transaction. The main purpose of Section 185 is to make sure that the company’s money is not misused for the personal benefit of a director or for the benefit of another person or company in which the director has an interest.

The Explanation to this section lays down certain situations in which a person is said to be “in whom director is interested”. Hence, the relationship between the director and the borrowing company has to be examined in detail in order to ascertain whether this section applies or not. It may be noted that in such a case, the mere fact that the borrowing and the lending company are private companies will not override the application of this section. Hence, the relationship between the borrowing company and the director has to be examined.

Section 185(2) deals with punishment for violation of this section. Hence, by virtue of this section, a company cannot take advantage of a guarantee or security given by another company in contravention of this section. Thus, it is seen that not only do the restrictions apply to the companies but the violators also suffer the consequences of their acts. However, it may be noted that various exemptions have been provided to avoid the application of this section in certain cases. Therefore, before concluding that a loan has been made to a person in whom a director is interested, it is essential to go through all the facts and circumstances of the case. Further, various private companies also enjoy the benefit of certain exemptions as notified by the Ministry of Corporate Affairs. Hence, while dealing with a private company, it is essential to check whether the exemption as contemplated under a specific notification is available or not.

Section 186 – Loan and Investment by a Company

When it comes to inter-corporate loans, Section 186 is the most relevant section. As per Section 186(2)(a), a company cannot directly or indirectly give any loan to any person or other body corporate except as provided under this section. Hence, when a private company proposes to give a loan to another private company, the provisions of this section have to be examined.

It may be noted that this section does not prohibit a company from giving a loan but it places various restrictions and obligations on a company that proposes to give a loan.

Restrictions under Section 186(2)

As per this sub-section, a company cannot give a loan to any person or other body corporate in excess of the limits specified in this section. The limits are as follows:

60% of paid up share capital + free reserves + securities premium account OR

100% of free reserves + securities premium account

whichever is higher.

Therefore, if the proposed loan along with other transactions such as guarantees, securities, and investments fall within the aforesaid limits, the application of other sub-sections such as 186(3) and 186(5) will depend on the facts and circumstances of the case. If the proposed loan along with other transactions such as guarantees, securities, and investments exceed the aforesaid limits, the special resolution as contemplated under 186(3) will have to be passed.

Section 186(3) – Special Resolution

As per this section, if the proposed aggregate value of loans, guarantees, securities, and investments exceeds the limits as provided under this section, the company will have to obtain the consent of members by passing a special resolution. This means that a company cannot give a loan just on the grounds that it has surplus funds; the company cannot give a loan to one of its subsidiaries just because the subsidiary needs funds.

For example, if a certain company has already given various loans and guarantees and the proposed new loan will exceed the aforesaid limits, the company will have to pass a special resolution before giving the loan. This is because the company’s funds belong to its shareholders and the company cannot alienate them without the consent of the shareholders.

Section 186(4) – Disclosure

As per this section, a company has to disclose all the relevant details of the loan, guarantee, or investment given by the company. Further, the company has to disclose the purpose for which the loan or any other facility is proposed to be availed by the receiver. This is done to ensure transparency in financial dealings. For example, if ABC Private Limited gives a loan of Rs.50 lakh to XYZ Private Limited for the purpose of purchasing a machine, such a disclosure has to be made by ABC Private Limited.

Section 186(5) – Approval of the Board

As per this section, no investment shall be made or loan, guarantee, or security shall be given unless the resolution passed in the Board approving the investment, loan, guarantee, or security has been approved by all the directors present at the meeting. This is a very practical requirement. Hence, before a company gives a loan to another company, it has to place the same before its Board and record the decision in terms of a Board resolution. A company should not just transfer the amount to the bank account of the other company without completing the formalities of passing a Board resolution.

Section 186(7) – Rate of Interest

One of the most pertinent requirements is contained in this sub-section. As per this sub-section, no loan shall be given at a rate of interest lower than the yield of the Government Security closest to the tenure of the loan. The relevant Government Security can be the one year, three year, five year, or ten year Government Security, depending on the term of the loan. For example, if a loan is proposed to be given for a period of three years, the rate of interest should not be lower than the yield of the 3 year Government Security.

This provision is extremely relevant because it prevents companies from taking undue advantage of other companies by giving loans at a lower rate of interest. Hence, a company cannot give a loan to a group company at a lower rate of interest merely because it is a connected party.

Section 186(8) – Default in Deposits

As per this section, if a company defaults in repayment of deposits received by it or repayment of interest on such deposits, it will not be able to give a loan or provide a guarantee or security or make any acquisition until the default continues. Hence, a company has to review its liabilities before giving a loan to another company.

Section 186(9) and 186(10) – Register

As per these sections, a register containing the relevant details of all the loans, guarantees, securities, and investments has to be maintained by the company at the registered office. The register has to be opened as per the provisions contained in these sections. The objective of this requirement is to ensure transparency and accountability in case of any defaults.

Section 186(11)

This section provides that certain categories of companies such as banking companies, insurance companies, housing finance companies, and companies engaged in financing or infrastructure development, among others are exempted from the application of this section subject to the conditions prescribed in this section. Thus, it becomes essential to go through this section before applying the other sub-sections of Section 186.

Practical Example

The following example will help illustrate the applicability of various sections discussed above:

ABC Private Limited has surplus funds of Rs.2 crore. The management decides to give Rs.75 lakh as a loan to XYZ Private Limited for setting up a new manufacturing unit. The first step in this regard will be to check whether any of the directors of ABC Private Limited is connected with XYZ Private Limited.

If one of the directors of ABC Private Limited is also a director of XYZ Private Limited, then the applicability of Section 185 will have to be ascertained. Once the applicability of Section 185 is ruled out, ABC Private Limited will have to check whether the Rs.75 lakh loan to XYZ Private Limited would exceed the limits stipulated under Section 186(2).

If it does not exceed the limits, then the company will have to ensure that the aforesaid resolution is passed by the Board as contemplated under Section 186(5). The company will also have to ensure that the rate of interest charged on the loan is not lower than the yield on the Government Securities as stipulated under Section 186(7). Thus, before actually disbursing the amount of Rs.75 lakh, ABC Private Limited will have to ensure that all the requirements of the Companies Act, 2013 are met.

Case Study – Hewlett Packard Enterprise India Private Limited

A useful case in this regard is the case of Hewlett Packard Enterprise (India) Private Limited and Others v. Registrar of Companies, Bangalore. In this case, Hewlett Packard Enterprise India Private Limited had given an inter-corporate loan of Rs.360.40 crore to its associate company, Hewlett Packard Enterprise Globalsoft Private Limited. However, both the companies had a common non-executive professional director. The loan had been approved by the Board of Directors of the lending company, i.e., Hewlett Packard Enterprise India Private Limited. The issue of applicability of Section 185 came up before the National Company Law Appellate Tribunal.

The crucial point that emerged from this case is that an inter-corporate loan between group companies cannot be treated as a loan between independent companies just because both the companies are separate entities. The fact that a common director is involved in both the companies has to be taken into consideration while determining the applicability of Section 185.

The parties to the appeal before the tribunal took the view that since the transaction between the companies did not fall under the ambit of Section 185, the restrictions imposed by this section did not apply to them. They further argued that since the loan amount was reasonable and the interest rate was comparable to the interest rate charged by banks, no restrictions should be imposed on them. However, the tribunal noted that the exception under Section 185(2)(b) did not apply because the interest rate was not lower than the interest rate charged by a bank. This case is significant because it highlights the fact that both, Sections 185 and 186 have to be considered while analyzing an inter-corporate loan.

Inter-corporate Loan – Compliance Checklist

Before a company contemplates giving a loan to another company, it has to consider the following:

Whether the transaction falls under the ambit of Section 185. The company has to check whether any of its directors has an interest in the borrowing company. If this is the case, then the next step will be to determine whether any of the exceptions as provided under Section 185 applies to the transaction. Whether the proposed loan would exceed the limits stipulated under Section 186(2). If the proposed loan falls within the limits, the company will then have to ensure that the resolution passed by the Board of Directors in this regard is in compliance with Section 186(5). If the proposed loan exceeds the aforesaid limits, then the company will have to apply to the Registrar of Companies for registration of a special resolution as contemplated under Section 186(3).

Further, the company will have to ensure that the application made under Section 186(3) is in compliance with the other requirements such as the interest rate stipulated under 186(7) and the disclosure requirements under 186(4). The company will also have to ensure that it is not in default in repayment of deposits or repayment of interest on deposits as such a default will affect its ability to give a loan to another company under Section 186(8). All the relevant details of the transaction including the terms and conditions of the loan have to be recorded in a register as mandated by 186(9) and 186(10). Apart from the aforesaid requirements, the lending company and borrowing company have to execute a proper contract containing all the details of the loan such as the amount of the loan, tenure, interest rate, purpose of the loan, mode and terms of repayment, among others. Finally, the companies will have to ensure that various other laws and regulations applicable to them, if any, have been complied with.

Conclusion

Inter-corporate loans are an effective way of utilizing the surplus funds of a company by giving a loan to another company. However, such transactions cannot be treated as routine transactions since various provisions of the Companies Act, 2013 apply to such transactions. The object of Section 185 is to ensure that directors are not in a position to take undue advantage of the company by obtaining a loan at a concessional rate of interest. On the other hand, Section 186 applies to all transactions involving loans and lays down various restrictions such as the requirement of special resolution and limits on the amount of the loan. Thus, while analyzing an inter-corporate loan between two private companies, both, Sections 185 and 186 have to be borne in mind.

As highlighted in the Hewlett Packard case, the fact that a common director is involved in both the companies has to be scrutinized carefully and the applicability of Section 185 has to be determined. Similarly, apart from the requirement of passing a special resolution, a company also has to comply with the requirements of disclosure and maintenance of records as mandated by Section 186.