A group CFO moves ₹2 crore from the flagship company to a sister company to cover a cash crunch, clears it with the two directors who happened to be in the office that afternoon, and books it. Routine treasury management — except the board approval was not unanimous, the amount breached the company's Section 186 ceiling, and no special resolution was passed. Three defaults in one wire transfer.
A company can lend, invest, guarantee or secure up to the higher of 60% of paid-up capital plus free reserves plus securities premium, or 100% of free reserves plus securities premium — and beyond that a special resolution is mandatory.
The bottom line
The ceiling is the higher of 60% of (paid-up capital + free reserves + securities premium) or 100% of (free reserves + securities premium). Above it, a special resolution — 75% of members voting — is mandatory.
Every such transaction needs a unanimous board resolution at a meeting, never by circulation, interest at or above the relevant Government security yield, and an MBP-2 register entry within 7 days.
Breach costs the company ₹25,000 to ₹5 lakh, and each officer in default up to 2 years' imprisonment plus ₹25,000 to ₹1 lakh.
Whether Section 186 applies
Almost certainly, if money or securities are leaving your company for another. The section governs any loan to any person or body corporate, any guarantee given or security provided in connection with such a loan, and any acquisition of securities of another body corporate by subscription, purchase or otherwise.
Section 185 deals with loans to directors and connected persons. Section 186 deals with everything else, the ordinary inter-corporate plumbing of a group. A single transaction can trip both, so settle the Section 185 question first and then come here.
There is also a quieter rule in Section 186(1) that catches structuring: a company cannot make investments through more than two layers of investment companies. The exceptions are narrow — a foreign acquisition with deeper layers abroad, or a layer another law requires.
The ceiling
Under Section 186(2), the aggregate of loans, guarantees, securities and investments cannot exceed the higher of 60% of paid-up share capital plus free reserves plus securities premium account, or 100% of free reserves plus securities premium account.
Read it as a single running total rather than a per-transaction allowance. A company that has already lent to its limit cannot make a fresh ₹10 lakh investment on board approval alone, because the aggregate is what is tested. Where a special resolution is needed, it must state the total amount up to which the Board is authorised to lend, guarantee, invest or secure.
The approvals
Three layers, and the first catches more companies than the other two combined.
Board approval, always, and unanimous. Whatever the amount, every Section 186 transaction needs a resolution passed at a duly convened board meeting with the consent of all directors present. A resolution by circulation will not do, and a committee cannot substitute for the Board. Finance teams treat small inter-company loans as routine and skip the meeting entirely, which is the most common default in this section.
Special resolution, only above the limit. Loans, guarantees or security to a wholly-owned subsidiary or a joint venture, and the acquisition of a wholly-owned subsidiary's securities, are exempt from the special resolution requirement — but not from unanimous board approval.
PFI approval, where a term loan is outstanding. If the company has a term loan from a public financial institution and there is a subsisting default, that institution's prior approval is required.
Interest, and why a friendly rate is not available
Section 186(7) requires the interest rate on a loan to be no lower than the prevailing yield of the 1, 3, 5 or 10-year Government Security closest to the loan's tenor.
An interest-free loan to a sister company is a contravention however friendly the group, and however clearly everyone intends to square it later.
The MBP-2 register
Maintain a register in Form MBP-2 at the registered office, with entries made chronologically within 7 days of each loan, guarantee, security or acquisition, authenticated by the company secretary or an authorised person.
Auditors check this first, which makes late entries an efficient way to turn one problem into two.
Who is exempt
The limits and several requirements work differently for banking companies, insurance companies, housing finance companies and infrastructure finance companies lending in the ordinary course of business; for NBFCs registered with the RBI whose principal business is the acquisition of securities, on the lending side; and for government companies, subject to conditions.
Loans, guarantees and security to a wholly-owned subsidiary or joint venture escape the special resolution requirement but not board approval. Do not read exempt as meaning the section can be ignored — the register and disclosure obligations usually still apply.
The penalty
Under Section 186(13) the company faces a fine of ₹25,000 to ₹5,00,000, and every officer in default faces imprisonment of up to 2 years and a fine of ₹25,000 to ₹1,00,000.
Note the conjunction. For officers it is imprisonment and fine, not one or the other, which makes the personal exposure stiffer than it first reads — and it lands on the people who actually pushed the transaction through rather than on the company alone.
A worked example
Apex Manufacturing Ltd has paid-up capital of ₹1 crore, free reserves of ₹3 crore and securities premium of ₹50 lakh. It wants to lend ₹3 crore to an associate company.
Run the ceiling. Sixty per cent of ₹4.5 crore is ₹2.7 crore. One hundred per cent of ₹3.5 crore is ₹3.5 crore. The higher figure governs, so the limit is ₹3.5 crore.
The ₹3 crore loan sits within that ceiling, so no special resolution is needed. Apex still needs a unanimous board resolution, must charge interest at or above the relevant G-Sec yield, and must enter the loan in MBP-2 within 7 days.
Had the associate been a wholly-owned subsidiary, the same applies without the ceiling test. Had the loan been ₹4 crore, the special resolution becomes mandatory.
Common mistakes
- Skipping the board meeting for small loans. Every Section 186 transaction needs unanimous board approval, with no de minimis exception.
- Passing the resolution by circulation, which the section explicitly does not permit.
- Making interest-free or token-rate loans, below the G-Sec yield floor in Section 186(7).
- Testing each transaction in isolation. The ceiling applies to the running aggregate.
- Forgetting MBP-2, or making entries after 7 days, which is its own default and the first thing an auditor looks at.
Before the money moves
- Confirm this is a Section 186 transaction and not a Section 185 one.
- Compute the ceiling, and add the proposed amount to the existing aggregate rather than testing it alone.
- Above the limit, pass a special resolution stating the total authorised amount.
- Pass a unanimous board resolution at a meeting, every time.
- Check the two-layer investment restriction if you are structuring through investment companies.
- Set interest at or above the relevant G-Sec yield.
- Obtain PFI approval where a term loan is outstanding or in default.
- Make the MBP-2 entry within 7 days.
Frequently asked questions
Can a company give an interest-free loan to its subsidiary? No. Section 186(7) requires interest at or above the relevant Government security yield. The wholly-owned subsidiary exemption removes the special resolution requirement, not the interest floor.
Is board approval needed even for a tiny inter-corporate loan? Yes, and it must be unanimous, at a meeting. There is no threshold below which board approval is excused.
Do I need a special resolution for a loan to my wholly-owned subsidiary? No, but you still need unanimous board approval and must comply with the interest, register and disclosure requirements.
How is the limit calculated? Take the higher of 60% of paid-up capital plus free reserves plus securities premium, or 100% of free reserves plus securities premium, and test your aggregate exposure against it.
What is the difference between Section 185 and Section 186? Section 185 restricts loans to directors and connected persons. Section 186 governs general inter-corporate loans, guarantees, security and investments, with its own limits, the MBP-2 register and the two-layer rule.
Does a guarantee count towards the ceiling even though no cash leaves? Yes. Guarantees and security count in the aggregate alongside loans and investments.
Primary sources
- Section 186, Companies Act, 2013 — MCA
- Companies (Meetings of Board and its Powers) Rules, 2014, Rules 11 and 13, and Form MBP-2
- MCA General Circular 06/2015 dated 9 April 2015, on the yield clarification for tax-free bonds
- As amended by the Companies (Amendment) Act, 2017