A promoter wires ₹40 lakh from his private company to his own savings account to close on a flat, fully intending to adjust it against next year's dividend. Clean intent, routine in closely-held companies, and a straight contravention of Section 185. The fine starts at ₹5 lakh, and he can go to jail for six months.
A company cannot lend to its own directors, their relatives or their firms at all — no resolution fixes it — though it can lend to a company a director is merely interested in, after a special resolution and only for that borrower's core business.
The bottom line
A company cannot lend to its own directors, their relatives, or their partnership firms. No exceptions, and no special resolution that cures it.
It can lend to a company or body corporate a director is merely "interested" in, but only after a special resolution and only if the money funds that borrower's principal business.
Get it wrong and the penalty is a ₹5–25 lakh fine on the company, plus up to six months' imprisonment for the director who took the money.
Lending to your own director
You cannot. This is the part with no wiggle room.
Section 185(1) prohibits a company from directly or indirectly advancing any loan — including a loan represented by a book debt — or giving any guarantee or providing any security in connection with a loan, to:
- any director of the company, or of its holding company;
- any partner or relative of such a director;
- any firm in which such a director or relative is a partner.
Two things trip people up. A guarantee or security counts even when no cash moves: if the company mortgages its property so a director can take a bank loan, that is a contravention, though the company never lent anything. And "indirectly" is doing real work — routing the money through a friendly third party who passes it on does not launder the transaction clean.
No special resolution, no shareholder approval and no board minute rescues a loan inside this list. The bar is absolute.
What "a person in whom a director is interested" means
The prohibited list is narrow and personal. Section 185(2) opens a conditional door for a wider category, and the phrase has a precise statutory meaning:
- a private company in which the director is a director or member;
- a body corporate in which such directors hold 25% or more of the voting power, alone or together;
- a body corporate whose Board, MD or manager is accustomed to act on the directions of the lending company's Board or directors.
The line that decides everything: a loan to a director, his relative or his firm is banned outright under Section 185(1), while a loan to a company the director is interested in is allowed with conditions under Section 185(2). Putting a transaction in the wrong bucket is the most common and most expensive mistake in this area.
The four routes that remain legal
The Companies (Amendment) Act, 2017, effective 7 May 2018, replaced the old blanket ban with a workable regime. This is everything you can legitimately do.
| Route | What it allows | The conditions you cannot skip |
|---|---|---|
| Special resolution (s.185(2)) | Loan / guarantee / security to a person the director is interested in | (a) Special resolution in general meeting, with full particulars in the explanatory statement; (b) borrower uses the money only for its principal business activity — no onward lending or investing |
| Loan to MD/WTD (s.185(3)(a)) | Loan to a managing or whole-time director | Either part of service conditions offered to all employees, or under a scheme approved by special resolution |
| Ordinary course of business (s.185(3)(b)) | Lending by a company that lends as its business | Interest charged not below the prevailing yield of the 1, 3, 5 or 10-year Government Security closest to the loan's tenor |
| Holding → subsidiary (s.185(3)(c)/(d)) | Loan by a holding company to its WOS; guarantee/security for a bank loan to a subsidiary | Loan used for the subsidiary's principal business activity |
The special resolution under Section 185(2) or 185(3)(a) must be filed with the Registrar in Form MGT-14 within 30 days of passing. Miss that window and you have a separate default, even where the loan itself was clean.
One note on the interest rate. The rate floor applies only to the ordinary-course-of-business route. For a one-off Section 185(2) loan the Act prescribes no minimum — but a zero or token rate invites Section 2(22)(e) of the Income-tax Act, 1961, which can tax the whole amount as a deemed dividend in the recipient's hands. Cheap money is rarely free.
Whether the private company exemption applies
This is the exemption everyone half-remembers and half-applies.
Under the MCA notification dated 5 June 2015, Section 185 does not apply to a private company — but only one satisfying all three conditions:
- no other body corporate has invested money in its share capital;
- its borrowings from banks, financial institutions or any body corporate are less than twice its paid-up capital or ₹50 crore, whichever is lower; and
- it has no subsisting default in repaying such borrowings at the time of the transaction.
Fail any one limb and the full force of Section 185 applies exactly as it does to a public company. Founders routinely reason "we are a Pvt Ltd, the rule is relaxed for us" and stop reading. That assumption is where prosecutions begin, and the borrowing limit knocks most growing companies out of the exemption long before anyone checks.
The penalty
Under Section 185(4), the company faces a fine of ₹5 lakh to ₹25 lakh. Every officer in default faces imprisonment of up to 6 months, or a fine of ₹5 lakh to ₹25 lakh, or both. The director or person who took the loan faces the same.
Three features are routinely underestimated.
The 2017 amendment widened "officer in default" to capture not only the director who benefited but the company secretary, the CFO, and anyone on whose instructions the Board is accustomed to act. This stopped being the borrower's problem alone.
Repaying the loan does not undo the offence. Once the money goes out in contravention the offence is complete, and the Registrar can prosecute after every rupee has come back. People treat repayment as an eraser. It is not.
And the floor is ₹5 lakh, not a nominal sum a small company absorbs as a cost of doing business. The drafting removes the temptation to treat the rule as optional.
A worked example
Sharma Build Pvt Ltd has paid-up capital of ₹50 lakh and bank borrowings of ₹3 crore. Mr Sharma, a director, wants the company to lend ₹40 lakh to Sharma Realty LLP, where he is a partner.
Is the private company exemption available? Borrowings of ₹3 crore exceed twice the paid-up capital of ₹1 crore, so the exemption fails on the second limb and Section 185 applies in full.
Is Sharma Realty LLP caught by the outright ban? An LLP is a body corporate rather than a partnership firm in the Section 185(1) sense, though Mr Sharma is a partner. Had it been a traditional partnership firm, this would be a flat Section 185(1) ban with no resolution available.
Treated as a body corporate the director is interested in, the loan can proceed under Section 185(2) — if the company passes a special resolution, discloses full particulars in the explanatory statement, files MGT-14 within 30 days, and the LLP uses the ₹40 lakh strictly for its own construction business rather than to buy shares or re-lend.
Skip the resolution and wire the money to sort out later, and Sharma Build faces ₹5–25 lakh while Mr Sharma personally faces the same fine or six months inside.
Common mistakes
- Treating a guarantee as harmless. Mortgaging company property for a director's personal bank loan is caught even though no company cash moves.
- Assuming a private company is automatically exempt. The 5 June 2015 exemption is conditional, and the borrowing limit disqualifies most growing companies.
- Believing repayment cures the breach. The offence completes the moment the loan goes out.
- Confusing the Section 185(1) ban with the Section 185(2) door. A loan to a director's own firm can never be fixed by a special resolution.
- Forgetting the borrower-use restriction. Even a properly approved Section 185(2) loan turns illegal if the borrower invests it or on-lends it.
Before you release a single rupee
- Identify the borrower precisely: director, relative or firm, which is banned, against an interested entity, which is conditional.
- If private, test all three limbs of the 5 June 2015 exemption, and document the test.
- Using Section 185(2), pass a special resolution with full particulars in the explanatory statement.
- File MGT-14 within 30 days of the resolution.
- Get the borrower's written confirmation that the funds go only to its principal business.
- Set an interest rate that survives Section 2(22)(e) scrutiny.
- Keep the board minute, the resolution and the end-use undertaking in one file. That is your evidence if the Registrar asks.
Frequently asked questions
Can a private limited company give a loan to its director? Only if it clears all three conditions of the 5 June 2015 exemption. Fail even one and the loan to a director is banned outright.
Does Section 185 apply to a loan to a director's spouse? Yes. A spouse is a relative, and loans, guarantees or security for a director's relative fall squarely within the Section 185(1) prohibition.
We already paid the loan back. Are we safe? No. The contravention is complete when the loan is advanced, and the Registrar can prosecute after repayment.
Is a corporate guarantee covered even with no cash outflow? Yes. Guarantees and security are expressly within Section 185 whether or not company money moves.
What is the difference between Section 185 and Section 186? Section 185 governs loans to directors and connected persons. Section 186 governs inter-corporate loans and investments generally, with its own limits and the MBP-2 register. A single transaction can engage both.
Is there a minimum interest rate? Only for the ordinary-course-of-business route, which is pegged to the closest Government Security yield. Elsewhere the tax deemed-dividend rule is the practical constraint.
Primary sources
- Section 185, Companies Act, 2013 (as substituted) — MCA
- Companies (Amendment) Act, 2017, gazette notification dated 7 May 2018
- MCA exemption notification G.S.R. 464(E) dated 5 June 2015, for private companies
- Section 2(22)(e), Income-tax Act, 1961, on deemed dividend