This article is written by Mr. Ravi Karan Kakkar, a sales and finance strategist who has a rich experience of working in India, Singapore, Saudi Arabia, and Indonesia. Ravi is currently on an assignment in Jakarta, Indonesia, and is pursuing Diploma in Companies Act, Corporate Governance and SEBI Regulations with LawSikho.com.

Introduction

Why would a company like to source finance from the third party if there is an option of accepting the loan from their directors? There are certainly many doubts which must have been raised in readers mind regarding the legal viability and compliance requirements for such transactions.

Before we discuss the issue in hand comprehensively, let us try to gauge the importance of securing a loan by a company from its director.

A director’s loan to a company can be with or without interest rate thereby giving an option of better credit terms in the loan arrangement. Also unlike in the case of bank financing wherein security has to be pledged, there is always an option of raising a collateral free loan from the director.

Unsecured loans are usually given at a fairly higher interest rate by the financial institutions as compared to secured loans. Also, at times, it takes a lot of time for lenders to decide whether to issue an unsecured loan to the company as they assess company’s credit history, recent borrowings, and various other parameters.

There are circumstances wherein a company is in urgent need of financing.  As a contingency plan, it may become relevant to take the loan from the directors.  Such kind of arrangement has its own perk of raising loan with low or no rate of interest in the hands of a company. Directors, who are often founders, may be able to park available funds for the purpose of expanding the business.

Loans from director fall into the category of related party transactions?

It is explicitly stated in section 2 (76) of the companies act 2013, that any director or key managerial personnel is a related party except for managing director or whole-time director. However, lending money does not fulfill the criteria of related party transactions as per section 188 of the companies act 2013. Therefore, there is no need to follow the compliance and legal requirements of section 188.

Loans Vs Deposits

There must be clarity on whether the amount given by the director to the company falls under the category of a LOAN or a DEPOSIT. As per Rule 2 (1) (c) (viii) of Chapter V of the companies (acceptance of deposit) rules 2014, if the director gives a declaration in writing that the amount given to the company by him/her is not being given out of borrowed funds, then the transaction would not fall under the category of deposit. Thus, it can be considered as a loan to the company.

Rule 2 (1) (c) of Chapter V of the companies (acceptance of deposit) rules 2014 states that a deposit includes any receipt of money by way of loan or deposit except in some cases. The exception covered under this rule does not mention the amount given by the director to the company, in case the director has given the money out of borrowed funds.

Thus, in that case, wherein the director has given the money out of borrowed funds, the transaction would fall under the category of “DEPOSIT”.  

Compliance Requirements in case of a loan by directors in public companies

Director must give a declaration in writing stating that the amount given by the director to the company is not borrowed by him/her, and the same will be disclosed in the board’s report.

   1)     If total borrowings (amount to be borrowed + existing borrowings) of the company <
      paid up capital + security premium + free reserves, then

 1.1) As per Sec 179 (3) of the companies act, the board of directors will pass the resolution to approve the borrowing from the director.

   1.2) Company will file form MGT-14 with ROC within 30 days.

    2)     If total borrowings (amount to be borrowed + existing borrowings – temporary loans) of
      the company > paid up capital + security premium + free reserves, then

     2.1) As per Sec 180 of the Companies Act 2013, a special resolution has to be passed in
        the general meeting to take approval from the members.

       2.2) Company will file form MGT-14 with ROC within 30 days

      2.3) As per Sec 179 (3) of the companies act, the board of directors will pass the                       resolution to approve the borrowing from the director.

Compliance Requirements in case of a loan by directors in private companies

             1)  Total borrowings (amount to be borrowed + existing borrowings of the company) < paid
    up capital + security premium + free reserves

     1.1) As per Sec 179 (3) of the companies act, the board of directors will pass the resolution to approve the borrowing from the director.

        2)  Total borrowings (amount to be borrowed + existing borrowings of the company –
     temporary loans) > paid up capital + security premium + free reserves

     2.1) As per Sec 179 (3) of the companies act, the board of directors will pass the resolution to approve the borrowing from the director.            

Private companies are exempted from Sec 180 as per the notification on 5th June 2015, thus there is no need to pass a special resolution in this case.

In case, the director is also a shareholder in the company, then he is eligible to give the loan to the company subject to declaration by the director that the amount has not been given out of borrowed funds.

Compliance Requirements in case of DEPOSIT by directors in public companies.

As per Section 76 of the Companies Act 2013, Eligible companies i.e. Public limited companies that have a yearly turnover of more than INR 500 Crores, or net-worth of INR 100 Crores are allowed to take deposits from the public. Thus, if a director lends an amount to the company out of borrowed funds, then that will be considered as the deposit, and this will be considered at par with the deposit from the public, which is only allowed in case of eligible companies.

If the director is also a shareholder in the company, then the contribution of the director will be counted as a deposit from the shareholder. Thus provisions of Section 73 (2) would have to be followed along with companies (acceptance of deposit) rules 2014. The company will issue circular, present their credit rating, provide the certificate that there has been no default in repayment of deposits by the company, file annual return of deposits in FORM DPT 3 with the registrar, and other compliance requirements as mentioned under section 73 (2) of the companies act 2013.

Compliance Requirements in case of a deposit by directors in private companies

As discussed above, a director’s contribution can also be qualified as a deposit in a private company if he/she is also a shareholder in the company. In that case, this will be treated as a deposit from the shareholder of the company which will come under the provision Sec 73 (2) of the companies act along with Companies (Acceptance of Deposit) Rules 2014.

If he is not a shareholder, once he provides the required declaration, the amount lent will not be considered a deposit at all.

As per Companies (Acceptance of Deposit) Second Amendment Rules 2017, there are no restrictions on the amount  of deposits from the members/shareholders provided

1. The private limited company in discussion is not an associate/subsidiary of any other company.
2. Borrowings of the private limited company are less than twice of paid-up share capital or INR 50 Crores, whichever is less.
3. There are no cases of default in repayment of borrowings at the time of acceptance of
   deposits.

Most private companies which are family owned or start-up entities will escape the first two conditions, however, the third condition would need to be taken care of, since even smaller entities may have availed of borrowings.

General compliance requirement to be followed in case of both loan and deposit for public and private companies

As per the recent amendment to companies (acceptance of deposit) rules 2014, every company (except govt company) must file a return in FORM DPT-3 of deposits, transactions that are not considered as deposits or both.

Also, the one-time return of outstanding receipt (for previous financial year) of money or loan but not considered as deposits, to be specified in Form DPT-3 within 90 days of the beginning of next financial year.

Disclosures in financial statement

As per Rule 16A of Chapter V Companies (Acceptance of Deposits) Rules, 2014, For both public and the private company, it is mandatory to disclose about the amount received from the director as an unsecured in their financial statements.

Punishment

Failure to comply with requirements of section 73 or section 76 of the Companies Act 2013 in case of deposits may result in a penalty of one crore rupees on the company that may extend to ten crore rupees. Default officers of the company may face imprisonment of up to seven years and the fine of anywhere between twenty-five lakh rupees up to two crore rupees. Also, as per companies (acceptance of deposits) rules 2014, the default officer and the company are punishable to a fine of five thousand rupees, and a penalty of five hundred rupees daily in case of continuous violation.

Conclusion

It is important to understand the nature of transaction whether it will be a loan or a deposit. Once it is clarified, the next step should be to check on the limitations and compliance requirements by referring to the corresponding sections of the companies act, and acceptance of deposit rules. If the loan given by the director is for short term, then it will be treated as a current liability. However, if it is for the long term, then IAS39 accounting standard needs to be followed.

                                                        Annexure

Following is the format of the declaration made by the director when he/she is giving loan to the company.

To                                                                                                                                    Date

The Board of Directors

Company Name

Subject :- Declaration pursuant to Rule 2(c) (viii) of the Companies (Acceptance of Deposits) Rules, 2014

I, ________________, S/o ___________________ R/o _____________________, acting in the capacity of director of ___________(company name)  ( hereinafter (hereinafter referred to as “the Company”), hereby declare that the amount of Rs. ………………being given as unsecured loan is not being given out of funds acquired by me by borrowing or accepting from others.

Director