Section 185 does not impose one blanket ban on every transaction connected to a director. It creates a prohibited core, a conditional category for persons in whom a director is interested, and specific exceptions. Board papers must identify the borrower and relationship first; only then can the company decide whether the transaction is prohibited, conditionally permitted or excepted.
At a glance
Identify the recipient and exact director connection.
Assuming a special resolution can cure a loan directly to a prohibited director/relative.
Recipient/director relationship and voting-control chart
Rules
| Control |
|---|
| Section 185 restricts loans, guarantees and security involving directors and specified connected persons, with defined exceptions/conditional permissions. |
| The analysis depends on recipient identity, shareholding/control connections and purpose of funds. |
| Even where section 185 permits a transaction, section 186, related-party, disclosure and accounting requirements can still apply. |
A company cannot directly or indirectly advance a loan, including a book-debt loan, or give guarantee/security for loans to specified directors, partners or relatives covered by Section 185(1).
For a person in whom a director is interested under Section 185(2), the transaction can be permitted subject to a special resolution and use of the borrowed funds for the recipient’s principal business activities.
The explanatory statement for the special resolution should disclose particulars, purpose and relevant facts; a vague blanket approval weakens compliance.
The statutory definition of “person in whom a director is interested” includes specified private companies and bodies corporate connected through director/member/voting-power relationships.
Exceptions cover identified situations such as loans to managing/whole-time directors under qualifying service conditions/schemes and ordinary-course lending businesses subject to statutory conditions.
Section 186 limits, interest-rate rules and register/disclosure obligations may apply even where Section 185 permits the transaction.
Indirect structures, back-to-back advances and guarantees should be tested on substance; routing money through another entity does not automatically avoid Section 185.
Section 185 uses three buckets: prohibited persons, conditional company recipients, and statutory exceptions
The first bucket is the direct prohibition: loans, guarantees or security to a director of the company or its holding company, or a partner/relative of such director, and to certain firms in which the director or relative is a partner. These transactions cannot be rescued merely by passing a special resolution because the statute treats them differently from the conditional company-recipient bucket.
The second bucket covers specified “persons in whom a director is interested,” including certain private companies and bodies corporate meeting voting-control or board-instruction tests. A loan/guarantee/security to these entities may be possible when the statutory conditions are met, including shareholder approval by special resolution and use of the funds for the borrower’s principal business activities.
The third bucket contains exceptions such as loans to managing/whole-time directors under specified service-condition or employee-scheme arrangements and lending/guarantee/security by a company in the ordinary course of a business of lending, subject to the statutory interest-rate condition. Group-company structures can also interact with separate section 186 limits and approvals, so clearing section 185 is not the end of the analysis.
The board memo should identify the exact recipient category before money moves. “Director-related” is too vague: a director personally, a director’s relative, a partnership firm, a private company in which the director is merely a member, and a wholly owned subsidiary can fall into different statutory routes.
| Situation | How to handle it |
|---|---|
| Loan directly to company director for personal use | Falls in the prohibited bucket unless a specific statutory exception genuinely applies. |
| Loan to private company in which lending-company director is director/member | Test the conditional section 185(2) route, special resolution and principal-business-use condition. |
| Company is in ordinary business of lending | Review the lending-business exception and minimum interest-rate condition, plus all other regulatory limits. |
Worked example 1
Company A proposes a ₹2 crore loan to Private Company B. One director of A is also a member/director of B. The board should first test whether B falls within the Section 185(2) connected-person definition. If so, it cannot approve the loan as an ordinary related-party matter: the required special resolution and principal-business-use condition must be satisfied, then Section 186 limits, interest and disclosures are checked separately.
Worked example 2
A manufacturing company proposes a ₹2 crore loan to another private company where one of its directors is also a member. Management labels it an “inter-corporate loan” and plans only a board resolution. That is incomplete. The recipient must be tested under section 185(2), the special-resolution disclosure and principal-business-use condition must be satisfied where applicable, and section 186 should then be checked separately. The transaction file should show why it is lawful before disbursement, not after audit queries arrive.
Mistakes
- Assuming a special resolution can cure a loan directly to a prohibited director/relative.
- Calling every related-party company loan an ordinary inter-corporate deposit without section 185 classification.
- Ignoring the principal-business-use condition for the conditional recipient route.
- Stopping at section 185 and forgetting section 186, related-party and banking/FEMA considerations.
Action steps
- Identify the recipient and exact director connection.
- Classify the case into prohibition, conditional route or exception.
- Obtain shareholder approval where section 185(2) requires it.
- Document principal-business end use.
- Check section 186 limits and approvals separately.
- Retain disbursement, interest and monitoring records.
Documents
- Recipient/director relationship and voting-control chart
- Board note classifying the transaction under section 185
- Special-resolution notice/explanatory statement where required
- End-use evidence and section 186 limit/approval working
FAQs
Can shareholders approve a personal loan to a director under section 185?
Not simply by special resolution. Direct loans to prohibited persons are treated differently from the conditional company-recipient route.
When does a special resolution matter?
It is relevant to specified entities in which a director is interested under section 185(2), together with the statutory end-use condition.
Does section 185 replace section 186?
No. A transaction that passes section 185 can still require separate analysis under section 186 and other laws.
What does “principal business activities” mean for the borrower?
The borrowed funds must be used for the borrower entity’s principal business activities where the conditional route requires it; evidence of end use should be retained.
Sources
Educational reference. Verify current official sources and facts.