A new Section prohibits banks to lend money to smaller subsidiaries companies despite Corporate Guarantee from the parent.
This Article make the crucial scrutiny of Section 185 of New Companies Act 2013 which relates to giving of Corporate Guarantee by larger/bigger companies (often a known flagship or holding or parent company) for providing loans to its smaller or its subsidiary companies who may not be well known or have developed a relationship with the banks/lenders.
The wrongful interpretations of Section 185 resulted de facto prohibition by banks from taking Corporate Guarantee as a security for sanctioning loans to its subsidiary.
Corporate Guarantee is a written affirmation payment made by a known flagship or holding company, on behalf of its other business entity who would be normally smaller company.
Since Section 185 of the New Companies Act 2013 became operative effective September 2013, there is all around ambiguity in banking sector whether the bank can stipulate Corporate Guarantee as one of security or not.
Section 185 is in fact replacement of old section 295 of the Companies Act, 1956, which provides for loans to directors.
As per the objective of the legislation, there is a control for loans to directors etc. and to any other person in whom the director is interested, which was earlier allowable under Section 295 of the Companies Act, 1956.
But true spirit of every economic legislation/statutory enactment should ever facilitate and improve the efficacy of the economic structure of a nation in line with the changing and dynamic requirements of a vibrant Indian economy.
Proviso of new Companies Act should never put speed-breakers or bottlenecks for the growth of trade & commerce.
Because when the Corporate Guarantees are provided to any Bank, the Bank lend monies in the economic system of the country and that funds are usually used in the ordinary course of business for productive purposes in the overall growth the economy of the country.
The eventual purpose of Section 185 of the New Companies Act, 2013 is to put additional restrictions on loan to directors only and not on giving of Corporate Guarantee by the holding company to its subsidiary company.
This new proviso of Section 185 unintentionally hampered the acceptance of Corporate Guarantees as one of security by banks. Even under the (old) Section 295 of the Companies Act, 1956, a Corporate Guarantee by the holding company to its subsidiary company is permissible.
Section 372A of the Companies Act, about inter-corporate loans and investments, including giving of Corporate Guarantee 1956 which is still in operation, specifically deals with inter-corporate loans, giving of any guarantee including Corporate Guarantee or providing any security to the Banks.
In view of all these related proviso of Section 372A of the Companies Act, 1956 which is still in operation, holding or parent company can provide Corporate Guarantee to banks for the loan being provided to its subsidiary company or other smaller Group Company.
As on date Section 372A of the Companies Act 1956 permits giving Corporate Guarantee by holding or parent company to the bank for the loan being provided to subsidiary company or other smaller Group Company by any Bank.
The statutory provisions of Section 372A of the Companies Act 1956 specifically deals with inter-corporate loans and exempts loans advanced or Corporate Guarantee by holding company to its wholly owned subsidiary.
Based upon the above analysis of Sections 185 and Section 372A of the Companies Act 1956, even after the effectiveness of Section 185 of the New Companies Act 2013, the Bank can take the Corporate Guarantee from holding or parent company to the Bank for the loan being provided to subsidiary company or other smaller Group Company in accordance with the existing Section 372A of the Companies Act, 1956, which is operative as of now along with ensuring required compliance with Section 185 the New Companies Act 2013.
Even, as per the recent Circular No. 18/2013 dated 19.11.2013 of the Ministry of Corporate Affairs, a clarification has been issued with regard to applicability of provision of Section 372A of the Companies Act, 1956 on account of number of representations received consequent upon notifying Section 185 of the Companies Act, 2013 dealing with loans to directors which is corresponding to Section 295 of the Companies Act, 1956.
It was unequivocally clarified in the said Circular that Section 372A of the Companies Act, 1956 dealing with inter-corporate loans continue to remain in force till section 186, of the Companies Act, 2013 is notified.
It should be undoubtedly noted that no law can ever restrict the smooth flow of trade & commerce or creates bottlenecks in the economic growth of any nation. The ultimate objective of any economic legislation like New Companies Act 2013 is to facilitate the economic growth of any in line with the changing business requirements.
But, recently lot of banks in the country, only on account of narrow and wrong interpretations of Section 185 of the New Companies Act 2013, stopped taking Corporate Guarantee as a security as one of security from holding companies for sanctioning loans to its subsidiary.
Ultimately, this narrow interpretation has created speed breaker or bottlenecks in the flow of loaned funds from banks to corporates which can definitely and adversely affect the economic growth of the resources starved nation like India.
The banking industry should be advised to review the narrow interpretation of Section 185 and start taking Corporate Guarantees from the respective holding or parent companies for the credit facilities/loan being provided to subsidiary company or other smaller group company in accordance with the existing Section 372A of the Companies Act, 1956.
Sanjay Lalit is an Advocate & Legal Consultant, in Mumbai and can be reached at email@example.com