Inter Corporate Loans

A company can lend money, offer guarantees, buy stocks, invest in other companies or carry out other business activities, but it needs approval from its board of directors or shareholders. When one company loans money to another or invests in another company, it’s called inter corporate loans and investments.

The rules for inter corporate loans and investments are outlined in Section 186 of the Companies Act, 2013 (referred to as the “Act”). According to Section 186 of the Act, a company must follow its guidelines when providing loans, offering guarantees, purchasing securities or making investments.

Meaning of Inter Corporate Loans

Inter corporate loans refer to any financial assistance provided by one company to another, be it in the form of a loan, guarantee or security. These loans play a crucial role in supporting the growth of Indian businesses by ensuring a steady flow of funds for various companies in need of capital.

Inter corporate investment, on the other hand, happens when one company invests in another.

To provide such financial assistance, a corporation needs approval from its board of directors or shareholders. Section 186 of the Companies Act specifies the regulations governing these transactions, outlining who the company can provide loans, guarantees or investments to.

As India continues its industrialisation, companies may find themselves in need of additional capital, making inter corporate loans an essential option. Section 186 of the Companies Act, 2013 has introduced some changes to simplify the process and operations of inter corporate loans and investments. This statute establishes the guidelines for when a company can or cannot grant a loan, provide a guarantee or make an investment.

Why it is Needed?

Inter corporate loans hold immense importance in the business world. These transactions facilitate the efficient flow of capital and financial resources between companies, thereby supporting growth, investment and corporate operations.

They enable companies to access much-needed funds for various purposes, including expansion, research and development and working capital. Inter corporate loans are a crucial source of finance for corporations and can help maintain financial stability within the corporate sector. Properly regulated and reported loans enhance transparency and legal compliance, ensuring that companies operate within the bounds of the law.

By offering a means to access capital, inter corporate loans play a vital role in economic development, employment generation and sustaining businesses. They serve as a financial lifeline, strengthening the corporate landscape and contributing to overall economic growth and stability.

Inter Corporate Loans and Investments under the Companies Act, 2013

Under Section 186(2) of the Act, a company is allowed to provide loans and guarantees to other companies and corporate bodies. This section permits a company to do the following, either directly or indirectly:

• Extend a loan to another corporate entity.
• Offer a guarantee or security in exchange for a loan to another corporate organisation.
• Purchase, subscribe to or otherwise acquire securities of other corporate bodies.

However, there is a limit to the amount a company can borrow, guarantee or invest in securities. It’s capped at 60% of its paid-up share capital, securities premium account and free reserves or 100% of those amounts, whichever is higher.

Section 186(1) of the Act sets restrictions on the number of layers through which a company can invest, with exceptions in place:

• The restriction does not apply when acquiring a company established outside of India, provided the foreign company’s own investments in subsidiaries exceed the first two tiers according to local laws.
• A subsidiary company can also invest in other companies beyond the first two layers if it’s necessary to comply with laws, regulations or rules established under the law and currently in effect.

Exceptions to Inter Corporate Loans

The Companies Act of 2013 specifies certain exceptions to the rules governing inter corporate loans. The following situations are not covered by the Act’s inter corporate lending provisions:

• Transactions carried out as part of the regular commercial activities of a banking company, housing finance company or insurance company.
• Activities of a company established to finance industrial enterprises or provide infrastructural facilities.
• Authorised Non-Banking Finance Companies (NBFCs) primarily focused on stock investments.

Restrictions and Limitations on Inter Corporate Loans

Inter corporate loans are subject to specific limitations under the Companies Act of 2013. The maximum allowable inter corporate loan amount is determined as follows:

• A company can lend, guarantee or secure a loan or security up to 60% of its paid-up share capital for any individual or corporation.
• For cases where the total inter corporate loans remain within the prescribed limit, a board resolution is sufficient for loan approval. The resolution must be agreed upon by all directors present at the meeting.
• If the total inter corporate loans exceed the set limit, a special resolution is required before proceeding.

When setting up arrangements for an inter corporate loan, the following limits must be taken into account:

• A company that defaults on interest payments is prohibited from making any more inter corporate loans under the Companies Act of 2013 until the issue is fully resolved.
• Inter corporate loans cannot be issued at an interest rate lower than the prevailing bank lending rate.

According to Section 186(4) of the Companies Act, 2013, companies making inter corporate loans must disclose the following information to their members in their financial statements:

• The loan amount provided.
• Details of the investment made or guarantee provided.
• The purpose of providing the loan.
• The source of funding for the proposed loan.
• Particulars of the corporate entity interested in receiving such loans.

Interest rates on inter corporate loans must not be lower than the prevailing yield of government securities with a tenor similar to the loan term. However, this rule does not apply to companies where the government holds 26% or more of the paid-up capital and the loans are for industrial and research development projects.

Interest Rates on Inter Corporate Loans

Companies providing inter corporate loans are required to disclose the following information to their members in their financial statements:

• Full details of the loans granted.
• Comprehensive information about the investments made.
• Full particulars of any guarantees or securities provided.
• The purpose for which the recipient intends to utilise the loan, guarantee or security.

Procedure for Granting Inter Corporate Loans

Here is the procedure to be followed when offering inter corporate loans:

• The company is allowed to lend or guarantee up to 60% of its paid-up capital and 100% of its free reserves and security premium, whichever is higher, through a board decision.
• A board meeting must be convened with proper notice and no investment should be made until the board resolution is passed.
• If there is an existing loan from a public financial institution, prior approval from that financial institution is necessary.
• However, if the total loan amount does not exceed the restrictions outlined in Section 186(2) of the Companies Act, 2013, prior authorisation from the financial institution is not required.
• After deciding on the source of funds and the required amount, the Company Board can designate one of the directors or any other person to apply for financial institution permission.
• It is essential to hold a general meeting of shareholders.
• Within 30 days of passing the resolution, a copy must be filed in Form No. MGT-14 (Filing of resolution and agreements with the Registrar), accompanied by the requisite fees as specified in the Companies Rules, 2014.
• The company must provide the necessary documentation as required by the resolution form.
• Every company that provides a loan or guarantee must maintain a record in Form MBP-2 (Register of loans, guarantees, security and acquisition). Entries in the register must be made for each loan transaction.
• The company must ensure that no loan is provided at an interest rate lower than the current rate of Government security and must disclose the full loan details in its financial statements.

Penalty for Contravention of Section 186

For the Company:

If a company is found to be in default under Section 186, it may face a penalty ranging from a minimum of Rs. 25,000 to a maximum of Rs. 5 lakhs.

For the Officer:

Any officer of the company who is also found to be in default can be subject to penalties, including imprisonment for a maximum term of up to 2 years. Additionally, the officer may be liable for a fine of not less than Rs. 25,000, which can go up to Rs. 1 lakh.

Conclusion

Inter corporate loans are financial transactions involving one company lending money to another company or entity. These loans can take various forms, such as direct loans, guarantees or providing security for another company’s borrowing. They are governed by legal regulations and often require approval from the lending company’s board of directors or shareholders.

Inter corporate loans play a significant role in providing capital and financial support within the corporate sector, facilitating business expansion, investment and the smooth functioning of companies. These loans are subject to specific limits and reporting requirements to ensure transparency and compliance with legal provisions, contributing to the financial stability and growth of companies and the overall economy.