Column: New companies law makes cross-financing tougher

Dec 30 2013, 04:34 IST
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SummarySection 185 of the Companies Act, 2013, imposes near-blanket restrictions on inter-corporate financing

One of the avowed objectives of the new Companies Act, 2013, is to provide Indian companies with an evolved legal framework that is attuned to international standards. Needless to say, the new Act affects all constituents of the economy at a fundamental level including manufacturers, service providers, financing institutions and everything else in-between. In this context, it is interesting to analyse how the new Act affects cross-financing among companies and to question whether it’s actually conducive to growth.

A basic tenet of business expansion is that a well established company will leverage its financial strength to nurture other group entities during their formative stages, particularly in matters of raising capital. Typically, the stronger company will either provide support in the form of cash (investment or loan) or non-cash measures (say, guarantee or security for a bank loan). However, to safeguard the interests of stakeholders in the stronger company, the law has provisions that govern the manner and extent of such financial support.

Our analysis focuses on two specific provisions of the new Act—section 185 (governs loans to directors and persons related to directors) and section 186 (governs loans, investments and guarantees by a company). While section 185 is already in force since September 12, 2013, section 186 hasn’t been notified as yet. Conceptually, one expects that these two provisions should operate harmoniously such that section 186 enables companies to support each other’s financial needs whereas section 185 ensures that directors do not arrogate a company’s funds to the detriment of others. However, a closer look suggests that the two sections create undue (and perhaps unintended) restrictions on inter-corporate financing.

Section 185 (which corresponds to section 295 of the earlier Companies Act, 1956) casts a blanket restriction whereby no company can directly or indirectly provide financial support (in the form of loan, security or guarantee) to its directors or to persons in whom directors are interested.

Further, the coverage of the section is so wide that most group companies are likely to get covered one way or the other; the immediate consequence of section 185 is that most group companies (whether private or public) become ineligible to receive loans or non-cash support in the form of security/ guarantee. And the section is worded expansively enough to prohibit creative structures that indirectly achieve the same objective of financing.

Interestingly, the old section 295 provided three exemptions which were used by companies for group financing—the section was inapplicable

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