Security and Guarantee given by one Company to another Company under the same Management

Section 370 of the Companies Act, applies both to loans given to and loans taken by a company and allow a company of the same group or management to provide security in respect of the loan transaction upon the passage of a special resolution of the lending company. Thus, even if the company which is providing security is not a party to the loan transaction, it can still give security for the same, as long as the special resolution is passed as provided for. There is no legal impediment under the Companies Act 1956 for such a party providing security for the loan transaction without being made a party in the loan documents. [1]

The provisions of section 370 can be evaded where the names of the managing agents of the lending and the borrowing companies are different, although, the constitution of the two managing agents and the policy they pursue in respect of the managed companies is the same. Hence companies ‘of the same group’ may or may not come within the ambit of this section.

By the Companies (Amendment) Act, 1960 amendments were made to this section , the purpose of which was stated in the note to clause 136. A more comprehensive definition of ‘companies under the same group’ was sought to be given. The draft section as contained in the Amendment Bill was further amended by the Joint Committee with the following observations: “The Committee feels that it should be made clear that section 370 of the Act would be attracted also in the case of a loan made or guarantee given by a company to a partnership firm, any partner of which is a body corporate under the same management as the lending company.”

It is possible for guarantee to be given by the subsidiary companies to the holding company. Guarantee from the subsidiary takes place when the main issuer is the parent company. The operating companies in these cases guarantee the debt issued by the parent company. It is clear that if there is no structural subordination amongst the parent and operating company and that the parent company is rated the same as the overall strength of the operating companies, then the same is possible. (see http://www.dbrs.com/research/232136.)

Under  Section 370, no company is to make any loan or give any guarantee in connection with a loan made by any person to or to other person by, any body corporate, unless the loan or guarantee has been previously been authorised by a special resolution of the lending company. The section comes into play only when there is a common managing agent. It does not apply when neither the borrowing nor the lending party has a managing agent, although both may have common boards of directors. Also, it is not specified which company is the holding company and which is the subsidiary company and neither is the structural subordination between the two.

The section has been greatly amended by the Companies (Amendment) Act 1965[2]. After the amendment, it has been decided that, if the loan is proposed to be given up to 20% or 30% of the subscribed capital and free reserves of the lending company, it is not necessary for the lending company to set out the material terms of each individual loan in the special resolution to be passed under the aforementioned section. In cases where it is proposed to make loans in excess of the limit of 20% or 30%, it would be necessary to disclose terms of each individual loan.

It can be seen that a special resolution is required for a company to give guarantee in connection with a loan made by or to a body corporate which is under the same management. The section makes no indication as to which company is the holding and which is the subsidiary.

In the case of Life Insurance Corporation of India v. Haridas Mundhra & Ors.[3] the ratio of the decision was that although a holding company and its subsidiary are separate legal entities, for certain purposes, the affairs of a subsidiary have been treated by the Companies Act, 1956, as affairs of the holding company also. The distinction has not been clearly demarcated and for the purposes of section 370, and this fact could therefore imply that subsidiary companies can give guarantees for loans availed by holding companies and vice versa. There does not appear to be any legal hurdle in this regard.

An exception is made in Section 370(2) (a) (i) of the Companies Act to section 370 of the same by saying that this provision shall not apply to ‘any loan made, by a holding company to its subsidiary’. This again  illustrates that a holding company is permitted to lend to its subsidiary without the usual restriction mentioned in Section 370(1) of the Act. Therefore, such transactions between the holding company and its subsidiaries are within the exemption of the law expressly granted[4].


[1] Rule 11B of the Companies (Central Government’s) General Rules and Forms, 1956 provides that no special resolution shall be necessary in the case of loans made to other bodies corporate not under the same management of the lending company, where the aggregate of such loans do not exceed 30 percent of the aggregate of the subscribed capital of the lending company and its free reserves.

 [2] Which came into force w.e.f. 1-4-1967 in its amended form.

[3] 36 Comp. Cases 371

[4] Ibid.

 

About these ads

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s