Companies Act clause a hurdle to debt raising

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Banks wary of giving project loans over no-guarantee rule

Banks are wary of giving fresh project loans to companies or their subsidiaries because a provision in the new Companies Act debars holding companies from providing guarantees to sister concerns and vice versa. The law, already passed by Parliament, is yet to be notified.

Banks under the Indian Banks Association (IBA) have moved the ministry of corporate affairs to amend the section so that credit flow to various sectors can be facilitated with sufficient guarantees.

Failing to do so will result in many corporate loans being classified as unsecured loans or banks altogether refusing to sanction loans. The law prescribes penalties if companies offered guarantees to subsidiary companies.

A senior banker said, “Unless the new provision is amended, it will be difficult for banks to issue fresh loans to companies. IBA has put across to the ministry and also to RBI the banks’ concerns. Before it is notified we hope the subsection will be amended."

The law also restricts companies from giving security of subsidiary companies for loans. A company can offer only its own securities or property as a guarantee

Further, the new law bars companies from providing any loans to directors or guarantees for any personal loans they take. Amit Aggarwal, partner in SNG & Partners, said, “The legislature has left no ambiguity and the intention is clear, that this section aims to prohibit related party transaction. It is unfortunate that this section has not provided for required exceptions, unlike Section 295 of the old Companies Act of 1956, and has been extended to private limited companies. Since the section has penal sanctions, it has to be interpreted strictly.”

Section 186 of the new Act says “no company shall directly or indirectly give any loan to any person or other body corporate; give any guarantee or provide security in connection with a loan.” Section 185, which replaced Section 295 in the old law, says, ‘No company shall, directly or indirectly, advance any loan, including any loan represented by a book debt, to any of its directors or any other person in whom the director is interested or give any guarantee or provide any security in connection with any loan taken by him or such other person.”

According to experts, both these sections basically debar firms from offering any inter-corporate guarantees or securities. Even if guarantees are offered for sister concerns, there is a stiff penalty. The Act says that if a loan is advanced or a guarantee or security is provided, the company will invite a minimum fine of Rs 5 lakh and maximum of Rs 25 lakh. Also, in such cases, the director or the other person to whom the loan or guarantee or security is given or provided in connection with any loan taken by him, will face jail up to six months or fine of a minimum Rs 5 lakh and maximum Rs 25 lakh, or both.

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