Section 185: Loans to Directors Explained

Section 185 loan to directors is the Companies Act's flat prohibition on a company financing its own directors. The section as it now stands was substituted wholesale by Act 1 of 2018, section 61, with effect from 7 May 2018, which replaced an outright ban on a wider set of transactions with a two tier structure: an absolute prohibition for one group of borrowers, and a shareholder approval route for a second, wider group.

Tier one: the absolute prohibition

Section 185(1) bars a company, directly or indirectly, from advancing any loan (including one represented by a book debt), giving any guarantee, or providing any security in connection with a loan taken by:

• (a) any director of the company, or of a company which is its holding company, or any partner or relative of any such director; or
• (b) any firm in which any such director or relative is a partner

There is no approval that cures this. No resolution, ordinary or special, is offered by sub-section (1). The words "directly or indirectly" matter, because they reach structures routed through an intermediary rather than only a loan booked in the director's name.

Note also who is caught on the holding company side: a director of the holding company is covered, along with that director's partners and relatives.

Tier two: the connected persons, with a special resolution

Section 185(2) opens a route for a wider set of borrowers. A company may advance a loan, including a loan represented by a book debt, or give a guarantee or provide security in connection with a loan taken by any person in whom any of the directors of the company is interested, subject to two conditions, both of which must be met:

1. A special resolution is passed by the company in general meeting. The proviso requires the explanatory statement to the notice for that meeting to disclose the full particulars of the loans given, guarantee given or security provided, the purpose for which the recipient proposes to utilise it, and any other relevant fact.
2. The loans are utilised by the borrowing company for its principal business activities.

The Explanation defines "any person in whom any of the director of the company is interested" as three categories:

• (a) any private company of which any such director is a director or member
• (b) 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
• (c) any body corporate whose Board of directors, managing director or manager is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company

The four exemptions

Section 185(3) takes four situations outside both sub-sections (1) and (2), so neither the prohibition nor the special resolution requirement applies:

(a) Loans to a managing or whole-time director where the loan is either part of the conditions of service extended by the company to all its employees, or made pursuant to a scheme approved by the members by a special resolution.

(b) A company that lends in the ordinary course of its business, provided loans or guarantees or securities for the due repayment of any loan, where an interest is charged at a rate not less than the rate of prevailing yield of one year, three years, five years or ten years Government security closest to the tenor of the loan. The tenor matched benchmark is the same construction section 186(7) uses.

(c) A loan by a holding company to its wholly owned subsidiary, or a guarantee given or security provided by a holding company for a loan made to its wholly owned subsidiary.

(d) A guarantee given or security provided by a holding company for a loan made by any bank or financial institution to its subsidiary company. Note that (d), unlike (c), is not restricted to a wholly owned subsidiary, but it is limited to bank or financial institution lending.

A single proviso governs (c) and (d) together: the loans made under those clauses must be utilised by the subsidiary company for its principal business activities.

The penalty, and who it lands on

Section 185(4) applies where a loan is advanced, or a guarantee or security is given, provided or utilised in contravention of the section. It reaches three parties:

The recipient is the only one of the three exposed to imprisonment and fine together. Note also that the sub-section catches a transaction that is utilised in contravention, not only one that is advanced in contravention, so a use that departs from the principal-business-activities condition is itself within the penalty.

Section 185 against section 186

The two sections are the two halves of the inter-corporate lending rulebook, and they ask different questions. Section 185 asks who the counterparty is. Section 186 asks how large the total exposure has become.

Section 186 loans and investments covers the ceiling, the two-layer rule and the disclosure obligations in full.

Where this sits in the disclosure picture

The section 185(2) route generates a document an investor can actually read: the explanatory statement attached to the notice of the general meeting, which has to carry full particulars and the purpose. For a listed company that notice is a public document. The transaction itself will usually also engage the related party regime.

• Section 186 loans and investments is the companion section on aggregate exposure.
• What is a related party transaction covers the section 188 and LODR machinery that most section 185 counterparties also fall under.
• How to check related party transactions is the practical route to finding them in a company's filings.
• What is a postal ballot is one of the ways the special resolution under section 185(2) reaches members.

Flock reports the filings themselves, each stamped with its date and linked back to the exchange or regulator that published it. What any of it means for you is your call to make.