Borrowing
By Asok Nadhani
A company needs
money from time to time to finance its business activities. A company can raise
money by issue of Shares. Apart from that, the company may also borrow money from
other sources.
9.1 Borrowing Powers
a.
Trading Company: It has implied
power to borrow money for the purposes of its business (unless
prohibited by Articles). It can give security for the loan by creating a
mortgage or charge on its property.
b.
Non-trading Company: It has no implied power
to borrow unless specified by Memorandum or the Articles.
9.1.1 Exercise
of borrowing powers
a.
Public Company: It can exercise
its borrowing powers only after it receives the certificate of commencement of
business. (Section 149)
b. Private Company: It can exercise borrowing
powers immediately on incorporation.
9.1.2 Borrowings
Ultra Vires
i. The borrowing of
a company powers are regulated by the Act and by the Articles. Sometimes, the
company borrows beyond its powers (called ultra
vires borrowings), which are :
-
Ultra Vires the Company,
-
Ultra Vires the Directors but intra vires the Company.
ii.
Ultra Vires borrowings are
invalid and non-enforceable.
9.1.3 Borrowing ultra vires the company
a.
The following types of Borrowings
are ultra vires the company’.
§ For Non-Trading
Company: If the power to borrow money is not
specifically stated in the memorandum of association.
§ For all
Companies: Borrowings made for a purpose which is
outside the object clause of memorandum of the company.
b.
Consequences of
‘borrowings ultra vires the company’
i. Borrowings are void:
Borrowings ultra vires the company are void ab initio. Consequently, the
agreement between the company and the lender of money is not enforceable. The
lender cannot sue the company for the recovery of such loan.
ii. No ratification:
Since the ‘borrowings ultra vires the company’ are void ab initio, the
shareholders cannot, even if acting unanimously, ratify the borrowings.
iii. No right to securities:
The lender shall not be entitled to any securities that he has received under
the ultra vires borrowings.
iv. However, the lender enjoys the following
rights on the principles of equity:
a.
Injunction:
If the money lent to the
company has not been spent and is traceable, the Tribunal may grant an
injunction to restrain the company from using such money. The lender remains
the owner of the money and is entitled to get back the money.
b.
Subrogation:
If the money borrowed has
been used by the company in discharging any lawful debts, the lender shall
become the creditor of the company and can recover it from the company. [Neath
Building Society v. Luce]
c.
Identification and tracing: If the lender can identify his money (i.e., the money is still in the
hands of the company) or any property purchased with it which the lender can
identify, the lender can claim the money or the property purchased with the
money. The company in such a case is regarded as trustee of the money of the
lender.
d.
Liability of directors: The lender may
hold the directors liable for breach of authority. But if the lender was aware
that the borrowings were unauthorised, he cannot make the directors liable. [Firbank's
Executors v. Humphreys]
9.1.4 Borrowings ultra vires the directors
If the borrowing
is just excess of the powers of the directors but not ultra vires the company,
following rules apply:
a.
When it is
ratified by the company : When the company ratifies and validates it, the
loan binds both the lender and the company as if it had been made with the
company's authority in the first place.
b.
When it is not
ratified by the company : In such
case, the normal principles of agency apply.
i.
If the lender has knowledge that the directors are
exceeding authority, the lender has no right of action against the Company.
ii.
If the excess borrowing arises from non-compliance
with some internal regulation of the company, the lender may recover the loan
from the company.
9.1.5 Restriction on powers of a company to borrow
Section 292 regarding borrowing powers of a company applies to both
Private and Public Company.
a.
The power to borrow money
by issue of debentures shall be exercised by the Board of directors by passing
a resolution at a Board meeting only and cannot be delegated to anyone.
b.
The power to borrow money
otherwise than by issue of debentures shall be exercised by the Board of
directors by passing a resolution at a Board meeting only. However, such a
power may be delegated by the Board, in following cases:
§ The power may be delegated to a committee of Directors, Managing
director, Manager, Principal officer of the company or its branch.
§ Resolution delegating such power shall be passed at a Board meeting only.
§ The resolution passed shall specify the maximum amount outstanding at any
time.
9.1.6 Statutory limits on borrowings
a.
Public company.
i.
Directors of a public
company shall not borrow amount money exceeding the aggregate of paid up
capital and free reserves, without the sanction of shareholders through
ordinary resolution at a general meeting. (S. 293)
ii.
The resolution must
specify the total amount upto which the borrowings can be made.
iii.
Borrowings in excess of
aggregate of paid up capital and free reserves shall not be valid unless the
lender proves that he lent the money in good faith, and without any knowledge
that such limit had been exceeded.
b.
Private company.
Section 293 does not apply to a private company.
Therefore, the directors of a private company can borrow money exceeding the
aggregate of paid up capital and free reserves without requiring the sanction
of shareholders in general meeting.
9.1.7 Methods
of Borrowing
a.
Borrowings may be either secured (borrowing is
backed by an asset of the company) or unsecured. An unsecured loan is not
backed by any asset. A loan or advance not fully covered by the security is treated
as partly secured.
b.
Borrowings may be by way of one or more of the
following methods namely:
i. Loans from
financial institutions and banks: These loans are
mostly secured by assets of the company.
ii. Debentures: These
instruments may or may not be secured.
iii. Bonds: These
instruments are quite similar to debentures and are usually secured.
iv. Deposits: These are
unsecured small borrowings from Public.
9.1.8 Methods of securing borrowings
i. Lien: Money can be raised by placing goods with
the lender while giving a right to retain the goods until the money is paid. A
general lien, is normally available to bankers, factors, wharfinger, attorneys
of High Court and policy brokers.
ii. Pledge: Pledge is bailment of
goods as security for payment of a debt or performance of a promise.
iii. Hypothecation:
a.
Hypothecation means creation of some claim in goods
or related documents without transferring their possession to the lender. An
undertaking is given to give possession of the goods to the creditor upon failure
to pay the principal debt with interest.
b.
Sometimes, advances and loans of the borrower are
also hypothecated (called as hypothecation of book debts). This mode of charging
book debt is more convenient than the assignment of book debts. The borrower submits
the statement of the outstanding debts hypothecated to the bank as in the case
of hypothecation against goods. The agreement and statements form the basis of
the advance against the security of book debts.
iv. Assignment: Assignment of debt may be
made to the third party, to secure the borrowing. Actionable claim (claim to
any unsecured debt or any beneficial interest in immovable property not in the
possession of the claimant) may also be taken as a form of assignment.
v. Mortgage: A mortgage is the transfer
of an interest in specific immovable property for securing the payment.
vi. Charge: Where property of one
person is, made security for the payment of money to another and the
transaction does not amount to a mortgage, the latter person is said to have a
charge on the property, and all the provisions applicable to a simple mortgage,
shall also apply to such charge.
For more details, refer to Business & Corporate Laws, by
Asok Nadhani, BPB Publications-ww.bpbonline.com, bpbpublications@gmail.com
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