In Days of Financial Hardship, Can Directors Take Loans From Their Company?

With the current state of the economy, the need for cash flow has never been higher. Whilst the option of procuring a loan from a financial institution is always present, an alternative method may be available for directors.

A director is generally not allowed to take loans from a company. However, there are instances where the same is allowed. This piece seeks to examine said instances, what happens if there is an abuse of power by the director, and what recourse does a company have when faced with such a scenario.

The Law

Without laboring into the jurisprudence of separate legal entities, it must be borne in mind that the assets of the company and the assets of a director, even if the director runs the company in its entirety, are separate and distinct in law.

A director is merely entitled to remuneration in performing his fiduciary duties to the company. This does not entitle the director to the assets of the company.

The governing provision in the Companies Act, 2016 (the “Act”) makes it clear that directors are not entitled to loans from a company. Section 224 of the Act (previously encapsulated in Section 133 of the Companies Act, 1965) reads as follows:

224. Loans to director

1. A company shall not:

(a) make a loan to a director of the company or of a company which by virtue of section 7 is deemed to be related to that company; or

(b) enter into any guarantee or provide any security in connection with a loan made to such a director by any other person.

The Statutory Exception

The same provision is very thoroughly drafted and contains express provisions which deal with circumstances where such a restriction as mentioned above would not apply. The relevant portions of Section 224 are reproduced below.

224 Loans to director

2.Nothing in this section shall apply:

(a) to an exempt private company;

(b)… provide such director with funds to meet the expenditure incurred or to be incurred by him for the purposes of the company …;

(c) … provide such a director … with funds to meet expenditure incurred or to be incurred by him in purchasing or otherwise acquiring a home; or

(d) … where the company has passed a resolution to approve a scheme for the making of loans to employees of the company and the loan is in accordance with that scheme.

3.Paragraph (1)(a) or (b) shall not authorize the making of any loan, or the entering into any guarantee or the provision of any security except with the prior approval of the company on the resolution in which the purpose of the expenditure and the amount of the loan or the extent of the guarantee or security, as the case may be, are disclosed.

4.If there is no prior approval given under subsection (2), the company may authorize the making of any loan or the entering into any guarantee or the provision of any security

(a) in the case of a public company, at or before the next following annual general meeting; or

(b) in the case of a private company, within six months from the making of the loan, the entering into any guarantee, or the provision of any security.

For clarity and as referred to at Section 224 (2) (a), an exempt private is a company where the beneficial interest of shares in the company are not held directly or indirectly by any corporation i.e. no corporate shareholder and which have not more than 20 members none of whom is a corporation.

Abuse by Directors

Section 224 was designed and crafted with the protection of the company, its shareholders, and its creditors as the main consideration. The provision acts as a safeguard to prevent any unlawful dissipation of the company’s assets to the hands of directors or their related parties.

See: Section 225 - for loans to persons connected to a director.

As alluded to above, the law is clear and so are its exceptions. A plain reading of the provisions will elaborate how and when a director can obtain a loan for the company and the proper measures in place to ensure that approval is obtained for the same. A predicament then arises when said rules are not adhered to and directors then misappropriate funds out of the company under the guise of a loan.

It is common place in the commercial world where a director of a company enters into an agreement in his personal capacity (not in the interest of the company in which he is a director) and where said agreement requires a security, the director then does the necessary so that the company provides said security.

Whilst we know that a company is generally not allowed to provide security pursuant to Section 224 (1) (b) due to the explicit prohibition of the same, agreements are often still entered into under such circumstances.

In such situations of a clear abuse by the director, the question that then arises pertains to the validity of the security provided by the company for said agreement.  Can a company be bound to provide security to an agreement which it never truly authorized and is for all intents and purposes, not made in the best interests of the company. 

This issue was considered in the Court of Appeal decision below where the appellate court held that a security (in the form of a charge in the facts of this case) created pursuant to a loan that was in contravention to Section 133 of the Companies Act, 1965 (the equivalent to Section 224 of the Act) was deemed invalid.

Harta Empat Sdn Bhd v Koperasi Rakyat Bhd [1997] 1 MLJ 381, COA, as per N H Chan JCA at pages 386 to 388 of the report.

“From the judge's finding, it is clear that the charge in the instant case was intended to provide the security in connection with a loan made to a director of the appellant company so as to enable the borrowed funds to be used for the purposes of the appellant.

We do not think that the situation in the instant case, as found by the judge, absolves the appellant company from the restriction against providing the security for the loan made to its director by the respondent. We do not think that the appellant can be absolved by s 133(1)(a)

…

The upshot is this. Under the Code, the immovable property in the instant case could be charged but the charge was subject to any prohibition imposed by written law. Section 133(1) of the Act forbade the appellant company from providing the security for the loan made to its director by the respondent. The prohibition in s 133(1) had rendered the charge unfit for registration under s 301(c) of the Code. The charge is therefore invalid.”

The above is a good decision by the appellate court which essentially shows that when an agreement is entered into in contravention of Section 224, the courts will render said agreement to be void for breaching a ‘prohibition imposed by written law’.

The Company’s Recourse

Mr Walter Woon in his book on Company Law, at p 179:

 

'How can the company be liable under the guarantee

or security unless they are valid and enforceable against it?'

 

Assuming the company did not authorize the loan and it was indeed an abuse by said director, the Act has in place safeguards to ensure that the company has some recourse against the director to recoup its loss.

The first of which is a provision where upon satisfying the Court that there was indeed no authorization and/or approval given by the company for said loan or security, the Act provides that the director who authorized the loan or who entered into said guarantee will now be jointly and severally liable to indemnify the company in the event the company suffers losses.

The second avenue is more conventional where the company initiates an action against the director for contravening his statutory and fiduciary duties owed to the company.

(See: Section 224 (6) & (7) of the Act)

The authority below is a decision by Justice Mohd Nazlan Ghazali which discussed how monies that were remitted to the directors in contravention of the relevant provisions would need to be returned to the company.

Cimb Bank Bhd v. Jaring Communications Sdn Bhd, [2017] 4 CLJ 465, HC, Justice Mohd Nazlan Ghazali

[63] The granting of the loans or the making of the advances to the three individuals are too glaring not to be legally objectionable, more so they are closely related to Dato' Norhisam. Even if these are indeed loans and advances, at least for the sisters, they are clearly caught by s. 133 which proscribes the making of loans by a company to its director (since Nurhaslina is said to be a director) and by s. 133A which prohibits company loans be given to persons connected with a director of the company.

…

[77] Quite apart from s. 305, even the interplay between ss. 133 (and 133A) and 223 of the CA in the instant application would require the payment of the relevant sums back to the company. For argument's sake, in the very unlikely scenario that a validation order could be obtained to render such payments not void, they would still have remained as advances in the nature of loans (as alleged) in violation of s. 133 (in respect of advances to himself and Nurhaslina, a fellow director) and s. 133A (in respect of Nurhaliza). Both these sections expressly stipulate that nothing in the respective Sections shall operate to prevent the company from recovering the amount of any loan given contrary to the said sections.

Conclusion

Ultimately, a company is not allowed to give loans to its directors or provide security for its directors unless there is clear approval given at a board meeting where the purpose and nature of the loan are clearly disclosed.

The provisions are in place to protect the company and all its relevant stakeholders from any misappropriation of funds and assets out of the company. If utilized properly, the ability for a director to obtain a loan from the company can be of great benefit, especially in these difficult times, but it must be for an appropriate purpose.