Guarantees for subsidiary by foreign holding firm will act as security for loans

NEW DELHI: The government will soon clarify that corporate guarantee by a holding company for its subsidiary would be accepted as a security when the latter needs to raise money in India.

The clarification is needed after banks interpreted Section 185 of the new Companies Act to mean that they could not extend loans to subsidiaries on the strength of a corporate guarantee provided by the holding company.

This subsidiary structure is extensively used by the real estate and infrastructure sector to execute specific projects and also by large conglomerates. “We are likely to issue a clarification soon on Section 185 of the Companies Act 2013,” said the official privy to the matter.

Section 185, which is replacement of old section 295 of the Companies Act, 1956, states that no company shall, directly or indirectly, advance any loan, including any loan represented by a book debt, to any of its directors or to any other person in whom the director is interested.

The objective of this legislation is to control loans to directors and to any other person in whom the directors may be interested, earlier allowable under Section 295 of the Companies Act, 1956.

Usually, in large corporate groups, the holding and subsidiary tend to have some common directors, or holding company directors often hold significant shares in the subsidiary. Besides, Section 186 of the new law also states that Indian companies cannot have more than two layers of investments subsidiaries.

Banks have interpreted these provisions to mean that companies cannot provide corporate guarantees to their subsidiaries, freezing the flow of funds to many companies.