According Section 295(1) of the Companies Act, 1956, previous approval of the Central Government will be required, if a company directly or indirectly, to:
i) Make any loan to any of the persons mentioned in Section 295 (1); or
ii) Give any guarantee in connection with a loan made by any person to any of the persons mentioned in Section 295 (1); or
iii) Give any guarantee in connection with the loan made to any person by any of the persons mentioned in Section 295 (1); or
iv) Provide any security in connection with a loan made by any person to any of the persons mentioned in Section 295 (1); or
v) Provide any security in connection with a loan made to any person by any of the persons mentioned in Section 295 (1).
Following persons mentioned in Section 295 (1);
i) Any director of the lending company;
ii) Any director of the lending company’s holding company;
iii) Any partner of a director of the lending company;
iv) Any partner of a director of the lending company’s holding company;
v) Any relative of a director of the lending company;
vi) Any relative of a director of the lending company’s holding company;
vii) Any firm in which a director of the lending company is partner;
viii) Any firm in which any relative of a director of the lending company is a partner;
ix) Any private company of which a director of the lending company is a Director or member;
x) Any body corporate at a general meeting of which not less than 25% or more of the total voting power is exercised or controlled by one or more directors of the lending company;
xi) Any body corporate, the Board of Directors, managing director or manager whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company.
Meaning of Loan:
The word ‘Loan’ is not defined in the Act. Hence we can take the general meaning. According to Black’s Law Dictionary ‘loan’ means a lending; delivery by one party to and receipt by another party of a sum of money upon agreement, express or implied, to repay it with or without interest. Hence essential requirements of a loan is the advance of money upon the understanding that it shall be returned, and it may or may not carry interest.
This section also applies to any transactions represented by Book debt which was from its inception in the nature of a loan or an advance vide section 296.
Applicability of Section 295 under certain situations:
1. Applicability of Section 292
Any loan falling within the purview of section 295 would attract the provisions of section 292 i.e. exercise of the powers only by means of resolutions passed at the Board meeting. Hence this power is to be exercised ny means of Board resolution not otherwise. However Board can delegate the power to any committee of directors, managing director, manager or any other principal officer of the company, in accordance with the provisions of the Act.
2. Applicability of Section 372A
Following provisions of Section 295 will also apply to section 372A. Hence compliance of both sections besides section 292 is required for any loan made to, or any guarantee given or security provided in connection with a loan made by any other person to, or to any other person by, -
i) Any private company of which director of lending company is a director or member;
ii) Any body corporate at a general meeting of which not less than 25% or more of the total voting power is exercised or controlled by one or more directors of the lending company;
iii) Any body corporate, the Board of Directors, managing director or manager whereof is accustomed to act in accordance with the directions or instructions of the Board, or of any director or directors, of the lending company.
3. Applicability on Debt
A loan contracted creates a debt, but there may be a debt contracted without contracting a loan. Therefore every debt is not a loan. In order to attract section 295 there has to be the making of loan. For example: In case of sale/supply of goods on credit, the outstanding amount on such sale on credit is debt but it was not of the nature created by Loan. The Bombay high court held that the deferred amount payable by a director a consideration for sale of flat by the Company to the Director is a Debt but not in the nature of loan.
4. Applicability on Advances
Section 295 is not applicable for all types of advances. Section 295 would not be attracted if the person taking advance against his salary is an employee. Suppose an advance against salary given to the wife of director who was employed by the company on a monthly salary, the provisions of section 295 would not applicable provided such advance facility should be available to all employees of the Company. However if advance is given on the her capacity as Wife of Director, then Section 295 will be applicable.
5. Housing loans to managing and whole-time directors
The Central Government has permitted the Companies granting of loans to their managing and whole-time directors for the purpose of housing without the approval of the Central Government subject to certain conditions i.e. the provisions of section 295 is not applicable if housing loan was given the managing/ whole-time directors under the housing loan scheme of the Company for its employees and for the purpose said loan, the managing director shall be treated in all respects like other employee in a particular grade and loan is granted on the terms and conditions as applicable to the other employees in the identical category.
6. Loans to directors of Government Companies
The Government Companies have been exempted by notification no. SO 729 dated 27.05.1978, provided that such company shall obtain the approval of the Ministry or Department of the Central Government which is administratively in-charge of the Company, or as the case may be, the State Government.
7. No retrospective effect
On the question whether the approval of the Central Government under sub-section (1) will be required to be obtained after any exempted loans (under sub-section (2)) ceases to be such or after the exempted company ceases to be eligible to enjoy the exemption, such as conversion of private company to public. The Department has advised that the provisions of section 295 would not be applicable to loans already made by the exempted companies even though they ceased to be so and compliance of section 295 would not be required.
Criteria followed by the Government in considering the applications under Section 295
In considering the applications under section 295, the following important aspects will scrutinized by the Central Government –
i) Purpose of loan;
ii) Financial position of lender and borrower;
iii) Whether lending company possesses surplus fund to lend;
iv) Whether loan is secured, if yes whether security is adequate;
v) Whether the rate of interest offered is reasonable;
vi) Whether loan is for a definite period;
vii) Whether the borrower is fully solvent;
viii) If the borrower is a company, whether it has a good profit record etc.
Exempted loans, guarantees and securities
According Sub-section (2), following transactions are exempted from the restrictions of sub-section (1)
i) Any loan made, guarantee given or security provided – by a private company which is not a subsidiary of a public company,
ii) Any loan made – by a holding company to its subsidiary,
iii) Any guarantee given or security provided – by a holding company in respect of a loan made to its subsidiary.
Penalty for contravention of provisions of Section 295
Section 295 (4) provides that every person who is knowingly a party to any contravention of sub-section (1), including in particular any person to whom the loan is made or who has taken the loan in respect of which the guarantee is given or the security is provided, shall be punishable either with fine which may extend to Rs. 5000/- or with a simple imprisonment for a term which may extend to 6 months; provided that where any such loan, or any loan in connection with which any such guarantee or security has been given or provided by the lending company, has been repaid in full, no punishment by way of imprisonment shall be imposed under sub-section (4); and where the loan has been repaid in part, the maximum punishment which may be imposed by way of imprisonment shall be proportionately reduced.
Further, according to sub-section (5), all persons who are knowingly parties to any contravention of this section shall be liable, jointly or severally, to the lending company for the repayment of the loan or for making good the sum which the lending company may have been called upon to pay in virtue of the guarantee given or the security provided by such company.