CMA Final · Corporate and Economic Laws

Investment and Loans: formula sheet

Full chapter guide

Key formulas

Limit under Section 186(2): Limit = higher of (60% × [Paid-up share capital + Free reserves + Securities premium]) and (100% × [Free reserves + Securities premium]); Covers loans, guarantees, security and acquisition of securities taken together.
Special resolution trigger, Section 186(3): Existing loans + investments + guarantees + security + proposed amount > Limit ⇒ special resolution in general meeting; Needed before the transaction. Not needed for a loan, guarantee or security to a wholly owned subsidiary or a joint venture company, or for acquisition of securities of a wholly owned subsidiary by its holding company.
Layers of investment companies, Section 186(1): Maximum 2 layers of investment companies; Subject to the two provisos: foreign acquisitions and subsidiaries required by law.
Board approval, Section 186(5): Board meeting resolution with consent of all directors present; Prior approval of the public financial institution is needed where a term loan is subsisting, unless the aggregate is within the limit and there is no default.
Interest rate floor, Section 186(7): Interest rate ≥ prevailing yield of 1, 3, 5 or 10 year Government Security closest to the tenor of the loan; Applies to loans given under this section.
Default bar, Section 186(8): Default in repayment of deposits or interest ⇒ no loan, guarantee, security or acquisition; The bar lasts while the default subsists.
Limit under section 186(2): Limit = higher of [60% × (Paid-up share capital + Free reserves + Securities premium)] and [100% × (Free reserves + Securities premium)]; Use the figures as per the last audited balance sheet unless the question says otherwise. Compute both and take the larger.
Aggregate test under section 186(3): Existing loans + investments + guarantees + security (to all bodies corporate) + proposed amount > Limit ⇒ special resolution needed; The test is on the total, not on the new proposal alone.
Headroom: Headroom = Limit − Existing aggregate; If the proposal is within headroom, only Board approval under section 186(5) is needed, subject to other conditions.
Board approval rule, section 186(5): Board resolution at a meeting with consent of all directors present; Applies to every investment, loan, guarantee or security, even within the limit.
Public financial institution approval: Needed if a term loan is subsisting, unless aggregate ≤ limit and no default in instalments or interest; Prior approval, taken before the investment, loan, guarantee or security.
Exception to special resolution: Loan, guarantee or security to WOS or JV company; acquisition by holding company of securities of its WOS; Disclosure in the financial statements is still required under section 186(4).
Minimum interest rate (S.186(7)): Rate of interest ≥ prevailing yield of the 1, 3, 5 or 10 year Government Security closest to the tenor of the loan; Applies to loans. Choose the Government Security whose tenor is closest to the loan's tenor.
Board approval (S.186(5)): Board meeting + consent of ALL directors present; Unanimity of those present, not of the whole Board. Passed at a meeting.
Prior approval of public financial institution: Needed if a term loan subsists, unless (aggregate loans, investments, guarantees and security including proposed ≤ S.186(2) limit) AND (no default in instalments or interest); Both exception conditions must be met together.
S.186(2) limit: Higher of: 60% × (paid-up share capital + free reserves + securities premium) OR 100% × (free reserves + securities premium); Above this limit, a special resolution in a general meeting is needed under S.186(3).
Default bar (S.186(8)): Default in repayment of deposits or interest thereon → no loan, guarantee, security or acquisition while default subsists; Applies until the default is cured.
Core rule: Investment through investment companies ≤ 2 layers; No company shall make any investment through more than two layers of investment companies. A third layer breaches section 186(1).
Exception (a): foreign acquisition: Acquiring a company incorporated outside India with investment subsidiaries beyond two layers, as per that country's laws → not affected; The deeper layers must arise under the foreign country's laws. The exception protects the acquisition, not a fresh Indian chain of your own.
Exception (b): legal requirement: Subsidiary having an investment subsidiary to meet a requirement under any law, rule or regulation → not affected; The exception is for a subsidiary company, and the reason must be a legal or regulatory requirement.
Where the rule sits: Section 186(1), Companies Act, 2013; It is a structural limit. It is separate from the monetary limits on investments, loans and guarantees.
Register of loans, guarantees, security and acquisitions: Section 186(9): every company giving a loan, guarantee, security or making an acquisition keeps a register in the prescribed particulars and manner (Form MBP-2); The Act says the register is as prescribed. The form number MBP-2 comes from the rules, not the section text.
Place and inspection of register: Kept at registered office; open to inspection there; members may take extracts and get copies on payment of prescribed fee; Section 186(10). The right belongs to members, and copies are on payment of a fee.
Disclosure in financial statements: Full particulars of loans given, investments made, guarantees given or security provided + purpose of utilisation by the recipient; Section 186(4). The purpose applies to loans, guarantees and security as proposed to be utilised by the recipient.
Penalty on company: Fine: minimum ₹25,000, maximum ₹5,00,000; Section 186(13).
Penalty on officer in default: Imprisonment up to 2 years and fine: minimum ₹25,000, maximum ₹1,00,000; Section 186(13). Both imprisonment and fine apply to the officer in default.
Exempt entities and transactions (s.186(11)(a)): Loan, guarantee, security or investment by a banking company, insurance company or housing finance company in the ordinary course of its business; or by a company established to finance industrial enterprises or provide infrastructural facilities; The company must be engaged in that business. Relief covers the whole section except sub-section (1).
Exempt investments (s.186(11)(b)): (i) by an investment company; (ii) in shares allotted under s.62(1)(a) or rights issues by a body corporate; (iii) by a registered NBFC (Chapter III-B of the RBI Act, 1934) whose principal business is acquisition of securities, for investment or lending activities; Clause (iii) needs both RBI registration and principal business of acquiring securities.
What is never exempt: Section 186(1): investment through not more than two layers of investment companies; Sub-section (11) says 'except sub-section (1)'.
Definitions: Investment company = principal business is acquisition of shares, debentures or other securities. Infrastructure facilities = facilities specified in Schedule VI; Both come from the Explanation to the section.
Relief from special resolution, s.186(3) provisos: No special resolution needed for loan, guarantee or security to a wholly owned subsidiary or joint venture company, or for acquisition by a holding company of securities of its wholly owned subsidiary, even if the s.186(2) limits are exceeded; Only the sub-section (3) requirement is lifted. Disclosure under (4), Board resolution with consent of all directors present under (5), the register under (9), and sub-sections (7) and (8) still apply.
Layer provisos, s.186(1): Two-layer rule does not affect (i) acquiring a foreign company with investment subsidiaries beyond two layers under that country's law; (ii) a subsidiary having investment subsidiaries to meet a legal requirement; Two narrow exceptions only.
Section 185 vs 186: s.185(1): bar on loans, guarantees and security to directors, their relatives and firms in which they are partners. s.185(2): loans etc. to a person in whom a director is interested are allowed with a special resolution and use of the loan for the borrower's principal business activities. s.185(3)(c),(d): a holding company may lend to, or give guarantee or security for, its wholly owned subsidiary, or give guarantee or security for a bank or financial institution loan to its subsidiary, if the loan is used for the subsidiary's principal business activities. s.186: loans, guarantees, investments in any body corporate or person, with limits; A transaction may need to be tested under both. Each section has its own exemptions.

Quick revision

Section 186(2) limit: 60% of paid-up share capital, free reserves and securities premium, or 100% of free reserves and securities premium, whichever is more.
The limit covers loans, guarantees, security and acquisition of securities of other bodies corporate.
If total exposure including the proposed one exceeds the limit, a special resolution in general meeting is needed beforehand.
Loans, guarantees or security to a wholly owned subsidiary or joint venture company are outside the special resolution requirement, as is acquisition by a holding company of its wholly owned subsidiary's securities. Details must still be disclosed.
Board resolution needs the consent of all directors present at the meeting.
Prior approval of a public financial institution is needed where a term loan subsists, unless exposure is within the limit and there is no default.
Loan interest cannot be lower than the prevailing Government Security yield closest to the tenor of the loan.
A company in default on deposit repayment or interest cannot give loans, guarantees, security or make acquisitions while the default continues.
Investment through not more than two layers of investment companies, subject to the provisos.
Register must be kept at the registered office, open to inspection, with extracts available to members on payment of fee.
Penalty on company: fine of ₹25,000 to ₹5,00,000. Officer in default: up to two years' imprisonment and fine of ₹25,000 to ₹1,00,000.
Sub-section (11) exempts banks, insurers, housing finance companies and certain others, but sub-section (1) on layers still applies.

Common mistakes

Using only 60% of the base and ignoring the 100% of free reserves and securities premium alternative. Fix: Always compute both figures and pick the higher one.
Checking each transaction separately against the limit. Fix: Add all loans, investments, guarantees and security made so far plus the new proposal, as sub-section (3) requires.
Using only 60% of paid-up capital, free reserves and securities premium and ignoring the 100% alternative. Fix: Always compute both figures and pick the higher. Compare 0.6 × A with B every time.
Testing only the new proposal against the limit. Fix: Add all existing loans, investments, guarantees and security to the new amount before comparing.
Saying the Board resolution needs consent of all directors of the company. Fix: Write "all the directors present at the meeting". Absent directors do not affect the resolution.
Applying the Government Security yield test to investments and guarantees. Fix: Sub-section (7) speaks of loans only. Apply the floor only when the question involves a loan.
Treating three layers as allowed because the limit sounds like three tiers in total. Fix: Count only investment companies in the chain. Two are permitted. A third investment company in the chain is the breach.
Confusing this rule with the restriction on layers of subsidiaries in section 2(87). Fix: Keep them apart. Section 186(1) is about investing through investment companies. Section 2(87) is about layers of subsidiaries. Read the question for which one it tests.
Saying the wholly owned subsidiary exemption removes the disclosure requirement. Fix: The second proviso to sub-section 3 states the company shall still disclose the details in the financial statement.
Writing that imprisonment can be imposed on the company. Fix: Company: fine only. Officer in default: imprisonment up to 2 years and fine.

Exam tips

In MCQs, watch for "whichever is more". Compute both limits before choosing an option.
Learn the sub-section (11) list as a checklist: bank, insurance, housing finance, industrial or infrastructure financing company, investment company, rights issue shares, qualifying NBFC.
In case scenarios, check if the borrower is a director, relative or related firm. If so, mention Section 185 as well.
Use the exact words: special resolution for the limit breach, Board resolution with all directors present consenting.
Remember the penalty: fine of ₹25,000 to ₹5 lakh on the company, and on every officer in default imprisonment up to two years and fine of ₹25,000 to ₹1 lakh.
Always show both limit calculations, even if one is clearly larger. Marks are given for the method.
In case-based MCQs, check whether the investee is a wholly owned subsidiary or joint venture company before declaring that a special resolution is needed.
Include guarantees and security in the aggregate. Examiners often hide them in the case facts.