Reports on Section 295 (Loan to Directors)

Reports on Section 295 (Loan to Directors)

1.      295        Making of loans, or to give guarantee or to provide

                    security to directors or their related parties.

Rational Behind prohibition of loan to directors: the object of this enlargement of the scope of the present section is to cover loans given to those companies which although registered as public companies, are really private companies. A director of the lending Company may not be ostensible be associated with the management of the borrowing company but he may be the moving spirit behind it.

Restrictions on providing loan to a director or to a person connected with a director: Section 295 put restrictions on a public company or a private company being a subsidiary of a public company intending to make any type of transaction with a director of the company or partner or relative of a director, etc. whether, directly or indirectly to make any loan, or to give any guarantee, or to provide any security in connection with a loan made by any other person to, or to any other person by, and it calls for obtaining the previous approval of the Central Government.

1. Section 295 (Loan to Directors)

Section 295 provides that:

(1) Save as otherwise provided in sub-section (2) no company (hereinafter in this section referred to as "the lending company") without obtaining the previous approval of the Central Government in that behalf shall, directly or indirectly, make any loan to, or give any guarantee, or provide any security in connection with a loan made by any other person to, or to any other person by,—

(a) any director of the lending company, or of a company which is its holding company, or any partner, or relative of any such director;

(b)   any firm in which any such director or relative is a partner;

(c)   any private company of which any such director is a director or member;

(d)  any body corporate at a general meeting of which not less than twenty-five per cent of the total voting power may be exercised or controlled by any such director, or by two or more such directors, together; or

(e)  any body corporate, the Board of directors, managing director or manager     whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company.

(2)  Sub-section (1) shall not apply to—

(a)   any loan made, guarantee given, or security provided—

(i) by a private company unless it is a subsidiary of a public         company, or (ii) by a banking company;

(b)   any loan made by a holding company to its subsidiary company;

(c)    any guarantee given, or security provided by a holding company in respect of any loan made to its subsidiary company.

3.Where any loan made, guarantee given, or security provided by a lending company and outstanding at the commencement of this Act could not have been made, given or provided, without the previous approval of the Central Government, if this section had then been in force, the lending company shall, within six months from the commencement of this Act or such further time not exceeding six months as the Central Government may grant for that purpose, either obtain the approval of the Central Government to the transaction or enforce the repayment of the loan made, or in connection with which the guarantee was given or the security was provided, notwithstanding any agreement to the contrary.

4. Every person who is knowingly a party to any contravention of sub-section (1) or (3), including in particular any person to whom the loan is made or who has taken the loan in respect of which the guarantee is given, or the security is provided, shall be punishable either with fine which may extend to fifty thousand rupees or with simple imprisonment for a term which may extend to six months:

Provided that where any such loan, or any loan in connection with which any such guarantee or security has been given or provided by the lending company, has been repaid in full, no punishment by way of imprisonment shall be imposed under this sub-section; and where the loan has been repaid in part, the maximum punishment which may be imposed under this sub-section by way of imprisonment shall be proportionately reduced.

(5) All persons who are knowingly parties to any contravention of sub-section (1)

 or (3) shall be liable, jointly and severally, to the lending company for the repayment of the loan or for making good the sum which the lending company may have been called upon to pay in virtue of the guarantee given or the security provided by such company.

(6) No officer of the lending company or of the borrowing body corporate shall be punishable under sub-section (4) or shall incur the liability referred to it sub-section (5) in respect of any loan made, guarantee given, or security provided after the 1st day of April, 1956 in contravention of clause (d) or (e) of sub-section (1) unless at the time when the loan was made, the guarantee was given, or the security was provided by the lending company, he knew or had express notice that clause was being contravened thereby.

3.      Applicability

Section 295 is applicable to a public company or a private company, which is a subsidiary of a public company. Therefore, a private company shall be exempted from the provisions of section 295 of the Act.

Section 295 applies to the loans, etc. given by a company 'directly or indirectly'. Indirect loan means that the company shall not give a loan through the agency of one or more intermediaries; the word 'indirectly' in the section cannot be read as converting what is not a loan into a loan. As such, a debt, which is not in the nature of loan cannot be said to be the case of an indirect loan. Fredie Ardeshir Mehta (Dr.) v Union of India (1989) 2 CLA 244 (Bom): (1991) 70 Comp Cas 210 (Bom): (1991) 1 Comp LJ 437 (Bom)]

3. Exemption

Following companies are exempted from provisions of section 295 and these companies can give loan to their directors without the approval of Central Government:

(a) Private Company which is not a subsidiary of public company; (b) Banking Company;

(c)   Government Company'

(d)   Loan made by holding company to its subsidiary company;

(e) Guarantee given or security provided by holding company in respect of any loan made to its subsidiary company.

4. Persons covered under section 295

The section has wider scope and any transaction with the following types of persons by a public company or a private company which is a subsidiary of a public company shall be within the purview of section:—

(a) any director of the lending company; (b) any director of the holding company; (c) any partner of any such director; (d) any relative of any such director;

(e)   any firm in which any such director is a partner;

(f) any firm in which a relative of such a director is a partner; (g) any private company of which any such director is a director; (h) any private company of which any such director is a member;

(i) any body corporate of which not less than 25% of the total voting power may be exercised or controlled at a general meeting by any director or by two or more directors together; and

(j) any body corporate, the Board of directors, managing director or manager whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company.

5. Non-applicability of the provisions of section 295

Any transaction of making any loan or giving any guarantee or providing any security in connection with a loan made by any other person to, or to any other person will not apply on:—

1.     any loan made to an employee of the company, who is not a relative of any director;

2.     any loan or advance made to a trust in which directors are trustees;

3.     any quasi-loan;

4.     any advance or deposit made in connection with leasing/hire-purchase transaction;

5.     any advance payment of salary given to an employee who is a relative of a director as per the rules of the company; [M.R. Electronic Components Ltd. v Asst. Registrar of Companies (1987) 61 Comp Cas 8 (Mad)]

6.     any investment made in acquiring residential accommodation for director(s) (whether by way of purchase or entering into a lease agreement);

7.     house building loan given to a director subject to the guidelines issued for that purpose by the Central Government;

8.     any loan made to a Registered Co-operative Society;

9.     any loan given by a holding company to any director of its subsidiary company;

10.    advance given for services to be rendered or goods to be supplied provided it is reasonable and commensurate with the services to be rendered or goods to be supplied;

11.    section 295(1) does not apply to a government company provided that such company has obtained the approval of the Ministry or Department of the Central Government, which is administratively in charge of the company, or as the case may be or the State Government.

6. Requirement for obtaining previous approval of the Central Government

Previous approval of the Central Government (Ministry of Corporate Affairs) is required before making any loan or giving any guarantee or providing security in connection with any loan.

security was provided by the lending company, he knew or had express notice that clause was being contravened thereby.

Department clarification:

The issue relating to applicability of section 295/370, in respect of inter corporate deposits has been reconsidered in this department in consultation with the law ministry that deposit kept by one Company with another company is “Loan” as envisaged under section 295/ 370 (Section 370 is substituted by section 372A) of the Companies Act, 1956, and therefore the provision of section 370 of the Companies Act,1956 are attracted in such a case. In this connection, your attention is invited to the decision of the Rajasthan high court in Totalal v.State, AIR 1963 Raj {press note dated 04.06.1985 ;( 1986)59 com cases (St) 8}

Thanking You

Prashant Kumar Kesharwani

Company Secretary