January 20, 2022

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Essential clauses in an inter-corporate loan agreement

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This article has been written by Mukul Vats, pursuing the Diploma in Law Firm Practice: Research, Drafting, Briefing and Client Management from LawSikho. The article has been edited by Tanmaya Sharma (Associate, LawSikho), Ruchika Mohapatra (Associate, LawSikho) and Indrasish Majumder (Intern at LawSikho).

This article has been published by Oishika Banerji.

Table of Contents

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Inter-corporate loans are defined as any loan, guarantee, or security given by one company to another company or individual. Inter-corporate loan, as defined by the Companies Act of 2013, plays a critical role in the development of Indian enterprises. There is a constant flow of finances for the group as well as other enterprises in need of capital. Inter-corporate loan means when one firm gives a loan, security, or guarantee to another company or corporation. Inter-corporate investment occurs when one firm invests in another company in any way. After receiving approval from the board of directors or shareholders, a corporation can give loans, investments, guarantees, or security to another company. Section 186 of the Companies Act describes the regulations by which a corporation can give a loan and to whom it can provide, as well as the legislation governing company loans and investments. Given India’s ongoing industrialization, the corporation may require additional capital. As a result, they may require the assistance of an inter-corporate loan. Section 186 of the Companies Act, 2013 has made a few changes to the Inter Corporate Loans and Investments made by a company to simplify the company’s operation and processes. This statute establishes the rules under which a firm may or may not grant a loan, provide a guarantee, or make an investment.

The inter-corporate loan serves a variety of purposes. Loans provided from one business unit of a firm to another are known as inter-corporate loans. This is frequently done for the following reasons and goals:

  • To transfer cash to a company unit and to avoid a cash shortage.
  • To move money into a business unit (typically corporate) where it will be pooled for investment.

For the following reasons, an inter-corporate loan is particularly beneficial:

  • There is no need to go through the elaborate and tedious process like a bank loan which requires a lot of documentation and approvals.
  • Cash is available to any corporation on very short notice.
  • The payback terms are substantially more favourable.

Inter-corporate loans are subject to significant restrictions under the Companies Act of 2013. The maximum amount of an inter-corporate loan is capped at the following for all the companies-

  • A company can lend, guarantee, or secure a loan, guarantee, or security above 60% of its paid-up share capital to any person or corporation.
  • If the total amount of inter-corporate loans does not exceed the prescribed limit, the loan and investment will be processed by board resolution.
  • The board resolution will be approved by all of the directors present at the meeting.
  • If the total amount of inter-corporate loans exceeds the set limit, a special resolution must be passed beforehand.

The limits listed below must be considered while establishing arrangements for an inter-corporate loan.

  • If a corporation defaults on interest payments, it is forbidden from making any inter-corporate loans under the Companies Act of 2013, and this prohibition will remain in effect until the problem is fully addressed.
  • No inter-corporate loans shall be made at a rate lower than the current bank lending rate.

According to Section 186(4) of the Companies Act, 2013, if a company makes inter-corporate loans, it must disclose the following information to its members in its financial statement:

  • Amount of loan provided.
  • The investment made/guarantee given.
  • Purpose of providing the loan.
  • Source of funding for meeting the proposal.
  • The particulars of the body corporate interested in making such loans.
  • Before making any inter-corporate loans, every company must obtain the consent of all directors under Section 186 (5) of the Companies Act, 2013.
  • If a company has already taken a loan from a public financial institution, it is mandatory to obtain prior approval from that public financial institution.

The procedure to be followed when offering inter-corporate loans is as follows:

  • The firm can lend or guarantee up to 60% of its paid-up capital and 100% of its free reserves and security premium, whichever is more, through board decision.
  • A meeting of the Board of Directors must be held with notice, and no investment may be made unless the board resolution is passed.
  • If a loan from a public financial institution is already in place, prior approval from that financial institution is required.
  • However, if the total loan amount does not exceed the restrictions set out in Section 186(2) of the Companies Act, 2013, no prior authorization from that financial institution is required.
  • The Company Board can approve one of the directors or any other person to apply for financial institution permission after deciding on the source of funds and the amount required.
  • The holding of a general meeting of shareholders is essential.
  • Within 30 days of passing the resolution, the copy must be filed in form No. MGT-14 (Filing of resolution and agreements to the Register) with the fees stipulated in the Companies Rules, 2014.
  • The corporation must attach essential documentation by the resolution form’s requirements.
  • Every company that makes a loan or provides a guarantee must keep a record in Form MBP-2 (Register of loans, guarantees, security, and acquisition). Entries in the register must be made for each loan transaction.
  • The company must ensure that no loan is given at a rate of interest lower than the current rate of Government security, and it must publish the loan’s full details in the financial statement.
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The loan

It includes the loan amount. The loan is made on the terms and conditions outlined in the deal. The loan clause also specifies how the borrower shall use the proceeds of the loan. For example- It can be for general working capital purposes or business expansion.

Representations and warranties of borrower

There are many declarations and statements made by the borrower in a loan agreement. These representations and statements are relied on by the lender, to decide whether or not to enter into the loan agreement and to decide whether or not to advance money to the borrower. These declarations and statements are generally referred to as “representations and warranties”

Pending cases

Borrower must specify that there is no litigation pending against the company. As of the date hereof, the borrower is not aware of any action, suit, or procedure pending in any court, or before any arbitrator of any sort, or before or by any governmental body.

Taxes

It states that the borrower has filed all required tax returns and paid and discharged all taxes, assessments, and governmental charges presently due and payable on it or against its properties, failure to file or pay which, as applicable, would have a material detrimental effect on the borrower.

Covenants of borrower

Preserving a corporation’s existence, according to laws, and so on

The borrower must preserve and maintain its corporate existence, rights (charter and statutory), and material franchises, and must follow all applicable laws, rules, regulations, and orders in all material respects (including all environmental laws and laws requiring payment of all taxes, assessments, and governmental charges imposed on it or its property).

Visitation rights

The borrower shall permit the Lender to visit the borrower and discuss the borrower’s affairs, finances, accounts, and reserve performance with officers of the borrower and independent certified public accountants of the borrower and any of its subsidiaries at such reasonable times and intervals as the lender may desire, provided that an event of default, or an event which with the giving of notice or the passage of time, or both, occurs, the borrower shall allow the lender to visit the borrower.

Books and records 

The borrower shall keep proper books of record and account, and shall cause each of its subsidiaries to keep proper books of record and account, in which full and correct entries shall be made of all financial transactions, as well as the borrower’s and each subsidiary’s assets and business, by generally accepted accounting principles.

Events of default

This clause clarifies the events of default. The following events are deemed to be “Events of Default:” 

Sample clause

(a) If the Borrower fails to pay any principal or any interest or any other amount payable hereunder within two business days after it is due, or any interest or any other amount payable hereunder within five business days after it is due; or 

(b) If any representation or warranty made or deemed made by the Borrower herein or by the Borrower (or any of its officers) in connection with this Agreement proves to be incorrect in any material respect when made or deemed

(c) The Borrower fails to perform or observe any other term, covenant, or agreement contained in this Agreement that the Borrower is required to perform or observe, and any such failure remains unremedied for 30 days after the Lender has provided the Borrower written notice of such failure; or

(d) The Effect of a Default Event: The Lender may, upon notice to the Borrower, declare all interest thereon, and all other amounts payable under this Agreement to be immediately due and payable, whereupon all such interest, and all such amounts shall become and be immediately due and payable, without presentment, demand, protest, or further notice of any kind, all of which are hereby expressly waived by the Borrower.

Miscellaneous

Notices 

It provides clarity regarding notices and other means of communication. All notices and other communications required hereunder shall be in writing and mailed by certified mail, return receipt requested and postage prepaid, or telecopied, telefax, or otherwise, tele transmitted or delivered, if to the Borrower, at the agreed-upon location to each party, at such other address as such party shall designate in a written notice to the other parties.

Indemnification 

The borrower agrees to indemnify and hold the lender harmless from and against any claims, damages, liabilities, and expenses (including legal fees and disbursements) incurred by or asserted against the lender in connection with or arising out of any investigation, litigation, or proceeding (whether or not the lender is a party thereto) related to any use or proposed use of the debt proceeds by the borrower (excluding any claims, damages, liabilities, or expenses).

Money is one of the most critical resources required to run any business. Share capital, loans, and other forms of financing are available to businesses. For most businesses, loans are the primary source of capital. Nowadays, an inter-corporate loan is one of the most effective ways for businesses to raise funds. The inter-corporate loan satisfies all of a company’s capital needs and requirements. A company must only provide an inter-corporate loan to another company or body corporate with the authorization and approval of the board of directors and shareholders.


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