Section 185 vs. Section 186 under the Companies Act, 2013 - A Practical Guide for Business Owners

As businesses grow, companies often support group entities, joint ventures, and strategic partners through loans, guarantees, securities, or investments. Two key provisions of the Companies Act, 2013 govern these transactions: Section 185 and Section 186. Though they sound similar, they apply in very different situations. Understanding the distinction helps entrepreneurs structure transactions correctly and avoid compliance hurdles.

Section 185 - Loans to Directors & Related Parties

Section 185 is designed to prevent conflict of interest. It restricts a company from giving loans, guarantees, or securities to:

• Any director of the company or its holding company
• Any relative or partner of such director
• Any firm in which such director or relative is a partner

However, the company may extend a loan or give a guarantee/security to certain persons in whom a director is interested — but only with a special resolution and clear disclosure of the purpose.

These include:

• A private company where the director is a director or member
• A body corporate where such directors hold 25% or more voting power
• A company whose Board acts on the directions of the lending company's directors

Exemptions:

No special approval is needed for:

• Loans to MD/WTD under employee schemes
• Companies whose ordinary business is lending/financing
• Loans or guarantees to a wholly-owned subsidiary (used for its principal business)

In short: Section 185 asks, 'Are you transacting with a director or someone closely connected to them?'

Section 186 - Loans, Guarantees & Investments to Any Person or Body Corporate

Indian company law generally allows a business to route its investments through only two layers of investment companies. This rule is meant to keep corporate structures simple and transparent.

There are two key exceptions:

• Foreign acquisitions: If you buy a company overseas and that country permits more than two layers of subsidiaries, you can keep that structure.
• Legal requirements: If any law or regulation requires your subsidiary to create an additional investment subsidiary, it is allowed.

Section 186 applies to all other loans, guarantees, securities, and investments a company makes.

A company can extend these transactions up to the higher of:

• 60% of paid-up capital + free reserves + securities premium, or
• 100% of free reserves + securities premium

If the proposed amount exceeds this limit, a special resolution is required.

Key requirements:

• Board approval by unanimous consent of all the Directors present at the meeting
• Approval from public financial institutions (if a term loan exists and limits exceed)
• Loan interest must not be lower than the prevailing Government security yield
• Mandatory disclosure in financial statements
• A register must be maintained for all such transactions

Exemptions:

Section 186 does not apply to transactions by:

• Banks, insurance and housing finance companies
• Investment companies
• NBFCs (for investment/lending activities)
• Rights issue or Section 62(1)(a) share allotments

In short: Section 186 asks, 'Do you have the financial room and approvals to give this loan/guarantee/investment?'

Scope of income is based on residential status:

Why This Matters for Businesses

When planning inter-company funding or group restructuring:

• Check Section 185 first — to see whether the recipient is a director-connected entity
• Then check Section 186 — to ensure limits, approvals, and disclosures are met

A clear understanding of both provisions ensures clean governance and smooth execution of business strategies.

Disclaimer:

The information contained in this document is for information purposes only. In no way, this document should be treated as advice. Please reach out to us or your consultants for undertaking detailed analysis.

This author will not be liable for any loss or damage caused by the reader's reliance on information obtained through this report. The contents are provided for your reference only.

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