On Sticky Wickets ??
Hunting Pvt. Ltd. is a closely held company with paid up share capital Rs.10 lakh and borrowings from banks amounting to Rs.40 crore . Mr.Goodwill is its Managing Director and Majority shareholder (70%). Mrs. Goodwill is the only other shareholder of the company. Mr.Goodwill wants to purchase a condo in Seychelles and for this purpose takes an amount of Rs.40 crore from the company in the form of an interest free loan.
At the end of the year when the auditor of the company enquires about this transaction , Mr Goodwill justifies it by saying that since it is his own company the transaction would be like taking money from one pocket and putting it into another. It is at this point that the auditor points out that the justification given by Mr Goodwill is not tenable as , in the eyes of law Hunting Pvt. Ltd and Mr. Goodwill are two distinct persons because the company is a separate legal entity. Next he points out to a provision in the Companies Act 2013 which prohibits such transactions.
Section 185 of Companies Act 2013
- No Company shall advance any loan to,
- its director or any other person in whom director is interested,
- either directly or indirectly.
Any Other Person in whom director is interested means
- Any other director of the lending company or its holding company (if any)
- Any relative of the director.
- Any firm in which the either the director , or his relative is partner.
- Any private company in which the director is a director or a member
- Any body corporate in which such director(s) holds > 25% of the voting power.
- Any body corporate whose Management acts in accordance with the directions of the Board or any director(s) of the lending Company
The auditor also pointed out that a recent circular had been issued by the Ministry of Corporate Affairs excluding Private companies (fulfilling all the following criteria) from the provisions mentioned above.
1.) No other Body Corporate should have invested in its share capital.
2.) Borrowings from Banks and Financial Institutions is less than the lower of the following;
- i) 2 times the Paid Up Share Capital
- ii) Rs. 50 Crore
3.) The Company had not defaulted in repayment of the said borrowings.
After hearing this Mr.Goodwill made a quick analysis that Hunting Pvt. Ltd. would not be covered under the aforementioned notification (as it had borrowings from Banks amounting to Rs. 40 crore while its Paid Up share capital was only Rs 10 lakh.) and wrinkles started to appear on his face as he grimly asked his auditor as regards the penalty for contravention of the provision. The auditor stated that the penalties were as follows;
1.) For the Company : Fine – Minimum Rs 5 lakh , Maximum Rs 25 lakh
2.) For Mr.Goodwill : Either Imprisonment upto 6 months or with fine (min. & max. limit same as that of company) or both.
Further the auditor also stated that there was a simple solution to side-step this legal pot hole and said that if a Special Resolution was passed by the company approving such a scheme of lending then these stringent provisions shall not apply. This, he said , was possible only due to the fact that Mr.Goodwill had designated himself as the Managing Director of the Company,( for this solution is available only to Managing Directors , Whole Time Directors or Managers of the company.). Thus Mr Goodwill was happy that he had found a solution for his perplexing problem and now he could look forward to spending a vacation at his new condo.
Moral of the Story : Company is a Separate Legal Entity.