Loan to a Director? Section 185 Bans It — With Four Narrow Escape Routes

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 of the Companies Act, 2013. The fine starts at ₹5 lakh. He can also go to jail for six months.

The bottom line

A company cannot lend to its own directors, their relatives, or their partnership firms — no exceptions, no special resolution that fixes 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 core 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.

Can my company lend to its own director?

No. 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 here. First, a guarantee or security counts even when no cash moves. If your company mortgages its property so a director can take a bank loan, that's a contravention — the company never "lent" anything, but it's caught all the same. Second, "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, no board minute rescues a loan that falls inside this list. The bar is absolute.

Who counts as a "director" — and a "connected person"?

The prohibited list above is narrow and personal: directors and their immediate orbit. But Section 185(2) opens a conditional door for a wider category — "any person in whom a director is interested." That phrase has a precise statutory meaning, and it's where the section gets its teeth:

• a private company in which the director is a director or member;
• a body corporate in which such director(s) 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 matters

Loan to a director, his relative, or his firm → banned outright (s.185(1)).

Loan to a company the director is interested in → allowed with conditions (s.185(2)).

Putting a transaction in the wrong bucket is the single most common — and most expensive — mistake.

The four routes that are still legal

The 2017 amendment (effective 7 May 2018) replaced the old blanket ban with a more workable regime. Here is everything you can legitimately do.

📋 The form you'll actually file

The special resolution under s.185(2) or s.185(3)(a) must be filed with the Registrar in Form MGT-14 within 30 days of passing. Miss the window and you have a separate default on your hands, even if the loan itself was clean.

A note on that "interest rate" exception: the rate floor only applies to the ordinary-course-of-business route. For a one-off s.185(2) loan, the Act prescribes no minimum rate — but a zero or token rate invites Section 2(22)(e) of the Income-tax Act, which can tax the whole amount as a deemed dividend in the recipient's hands. Cheap money is rarely free.

Is my private company exempt?

Maybe. 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 that satisfies all three conditions:

1. no other body corporate has invested money in its share capital;
2. 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
3. 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 to your private company exactly as it does to a public one. Founders routinely assume "we're a Pvt Ltd, the rule's relaxed for us" and stop reading there. That assumption is where prosecutions begin.

What's the penalty if I get it wrong?

🚫 Penalty under Section 185(4)

Company: fine of ₹5 lakh to ₹25 lakh.

Every officer in default: imprisonment up to 6 months, or fine of ₹5 lakh to ₹25 lakh, or both.

The director / person who took the loan: imprisonment up to 6 months, or fine of ₹5 lakh to ₹25 lakh, or both.

Three features of this penalty deserve emphasis, because they're routinely underestimated.

The 2017 amendment widened "officer in default" to capture not just the director who benefited but the CS, the CFO, and anyone on whose instructions the Board is accustomed to act. Compliance failure is no longer the borrower's problem alone — it's the finance team's.

Repaying the loan does not undo the offence. Once the money goes out in contravention, the offence is complete; the Registrar can prosecute even after the director has paid every rupee back. People treat repayment as an eraser. It isn't.

And the floor is ₹5 lakh — not a nominal penalty a small company can absorb as a cost of doing business. The drafting deliberately 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.

Walk it through:

• Is the private-company exemption available? Borrowings (₹3 cr) exceed twice the paid-up capital (₹1 cr). Exemption fails on limb 2. Section 185 applies in full.
• Is Sharma Realty LLP a "director, relative, or firm in which the director is a partner"? An LLP is a body corporate, not a partnership firm in the s.185(1) sense — but Mr Sharma is a partner. Caution: if it were a traditional partnership firm, this would be a flat s.185(1) ban, no resolution possible.
• Treated as a body corporate the director is interested in, the loan can proceed under s.185(2) — if the company passes a special resolution, discloses full particulars in the explanatory statement, files MGT-14 in 30 days, and the LLP uses the ₹40 lakh strictly for its own construction business, not 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.

Five mistakes that trigger Section 185

1. Treating a guarantee as harmless. Mortgaging company property for a director's personal bank loan is caught even though no company cash moves.
2. Assuming "Pvt Ltd" means automatically exempt. The 5 June 2015 exemption is conditional, and the borrowing limit knocks most growing companies out of it.
3. Believing repayment cures the breach. The offence completes the moment the loan goes out. Paying it back is good housekeeping, not a legal defence.
4. Confusing the s.185(1) ban with the s.185(2) door. A loan to the director's own firm can never be resolved by a special resolution — only loans to interested entities can.
5. Forgetting the borrower-use restriction. Even a properly approved s.185(2) loan turns illegal if the borrower invests it or on-lends it instead of using it for its core business.

Checklist before you release a single rupee

• [ ] Identify the borrower precisely: director / relative / firm (banned) vs interested entity (conditional)?
• [ ] If private, test all three limbs of the 5 June 2015 exemption — and document the test.
• [ ] If using s.185(2): pass a special resolution, with full particulars in the explanatory statement.
• [ ] File MGT-14 within 30 days of the resolution.
• [ ] Confirm in writing that the borrower will use the funds only for 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 — this is your evidence if the Registrar asks.

FAQ

Can a private limited company give a loan to its director? Only if it clears all three conditions of the 5 June 2015 exemption. If it does, Section 185 doesn't apply. If it fails even one, 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 s.185(1) prohibition.

We already paid the loan back. Are we safe? No. The contravention is complete when the loan is advanced. The Registrar of Companies can still prosecute after repayment.

Is a corporate guarantee for a director's loan covered, even with no cash outflow? Yes. Guarantees and security are expressly within Section 185, regardless of whether company money actually moves.

What's 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.

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 (private companies) - Section 2(22)(e), Income-tax Act, 1961 (deemed dividend)