Company Law

Unit-1

Borrowings

Fund is required by a company to finance its business activities. A company has to borrow money to raise its
funds and running its business activities. The financial requirement of companies are met by the following ways
from the public :-

1- by issue of shares,
2- by public borrowings, ex- by bonds, debentures, promissory notes and by floating charge of the company.

This chapter deals with the borrowing powers of company and legal provisions relating to it.

In Books &Co. Vs Blackburn benefit society (1884), it was held that obtaining an over draft from the bank is
regarded as one of the modes of borrowing.

Extent of borrowing powers

The memorandum or the articles of a company generally specifies the maximum limit of borrowing powers of the
board of directors and also it may impose restrictions to borrow money. The articles of a company provides that
subject to the provisions of sections 179 and 180 of the Act. The board may at its discretion from time to time
borrow money for the purpose of the company by passing resolution of shareholders. For the purpose of
borrowings the companies are divided into two categories, namely trading companies and non trading
companies.
1- Trading company
Trading companies are those which carry on business for buying and selling of goods for profit motive. Such
companies have the implied power to borrow money for the purpose of its business. It is not necessary that these
companies must be authorised by its memorandum to borrow money. Every trading company has an implied
power to borrow.
2- Borrowing by non trading companies
The non trading companies are those companies which do not carry on its business for buying and selling of
goods. For example, companies of its professionals. Such companies have no implied powers to borrow money.
These companies can borrow money only if it is authorised by its memorandum. The Articles of Association of non
trading company must provide how and by whom the borrowing powers can be exercised and also fix of the
borrowing limit
According to sec.179(3) of the Act, power of board of directors to borrow money shall be exercised by way of
resolution passed at the meeting of board. However the board can delegate its power to any committee of
directors, managing director or manager, principal officer of the company on such terms and conditions as it may
prescribed. The resolution passed for the purpose must express the total amount up to which the delegate may
borrow money [sec.179(3),proviso].

Sec.180- Restriction on powers of Board

Section 180 provides statutory restrictions on the borrowing power of the Board to borrow money. The Directors
can not borrow money exceeding the aggregate of the paid up share capital of the company and its free reserves
and security premium accounts. According to this section the B.O.D of a company shall borrow money with the
consent of the company by a special resolution of the company in general meeting exceeding the aggregate of
paid up share capital and free reserves ( i.e reserves not set apart for any specific purpose) and securities
premium accounts. This restriction is in respect of total borrowing ( i.e money borrowed already and to be
borrowed).
Borrowing may be authorised borrowing and unauthorised borrowing or ultra vires borrowing.

Authorised borrowing
It means money borrowed within the powers given by the Memorandum of Association of the company. Such
borrowings are valid and enforceable. The company is liable for the repayment of money borrowed.

Unauthorised/Ultra vires borrowing

Ultra vires borrowing means money borrowed without any power to borrow expressly or impliedly. The ultra vires
borrowing is of two kinds, namely
•Borrowing ultra vires the company .
•Borrowing ultra vires the Directors but intra vires the company .

A-Borrowing ultra vires the company

These are the borrowing which are with out any express or implied authority of the company. The ultra vires
borrowing are void and unenforceable. The lender of the money has no legal or equitable debt against the
company and he has no right against the company for recovery of his loan. Also the securities given by the
company to the lender for such a loan are void and unenforceable.
The Madras High court in Re Madras Native Permanent Fund Ltd. (1931), held that loans which are ultra vires
the company are no loans at all as " they do not create the relationship of creditor and debtor." The lender has
the following remedies against ultra vires borrowing by the company.
1. Injunction :- If the money advanced to the company has not been spent by it, the lender may file a suit for
injunction against the company restraining the company from utilizing the money. The reason being that the
lender continues to be the owner of that money and has a right to claim it back.

2. Subrogation :- It means the substitution of one person for another. If the unauthorised borrowed money has
been used by the company in paying off its lawful debt of the creditors, the lender will subrogated to the rights of
the creditors who were paid up. He will rank as a creditor of the company in paying off its debt and can recover
the money from the company to that extent.

In Re Wrexham Mold & Connahs Quay Rly Co.(1899)ch, it was held that the subrogated lender shall not have the
same priority as that of the original creditor in recovering the loan.

In Blackburn & District Benefit building society Vs. Cunliffe Brooks Co. (1882) Ch.D, it was held if the ultra vires
borrowing is used by the company to repay the share capital. The lender is not subrogated to the rights of the
share holders who have been repaid.

3. Identification & tracing order :- The unauthorised money is used by the company for purchase of some
property movable r immovable or is in the hands of the company in the original form. In such cases, the lender
may claim the property or money if it can be identified and traced in the possession of company.
Sinclair v. Brougham [1914]AC

In this case a building society started banking business which was ultra vires the society. The company was wound
up and its assets comprised partly of share holders money and partly of depositors money. It was not possible to
trace act which part of mixed fund belonged to share holders or the creditors. The assets were also not sufficient
to pay off both in full. It was held that the entire remaining amount should be distributed between the share
holders and creditors in proportion to amount paid by them so that no injustice would be caused to any of them.

4- Suit for breach of warranty of authority against the directors

The lender may file a suit against the directors personally for recovery of damages for breach of warranty of
authority and can claim money from them for deliberately misrepresenting their authority and company will not
be liable. If the borrowing was ultra vires could be discovered from the memorandum or articles of the company,
then the directors will not be liable.

In Re Introduction Ltd. (1908), it was held that if the company has borrowing power, but the money is borrowed
for an ultra vires object clause the borrowing is ultra vires the company.

B- Borrowing ultra vires the directors but intra vires the company

It means the borrowing which are within the power of the company but beyond the power of the directors. Here
the money is borrowed for the purpose set out in the memorandum of company but the directors have exceeded
their authority. If the directors exercise their borrowing power with the sanctioning of general meeting of the
company, such borrowing would be ultra vires the directors.

Consequences of ultra vires borrowings by the Directors

1- Ratification by the company :- The borrowings ultra vires the directors may be ratified by the company. If
the borrowings are ratified by the company, then the company becomes bound by the act of director and
liable to repay the loan. If the company refuses to ratify the act of director the doctrine of Indoor
Management [ i.e. Royal British Bank v. Turquand (1850)] shall protect he lender if he can establish that
he gave the loan in good faith. The company may in turn seek reimbursement from the directors at
default.

In krishan Kumar Rohatagi vs State Bank of India 1980, it was held that if the money borrowed
by the directors in excess of their authorisation has been used for the benefit of the company, the
company can not repudiate its liability to repay. This rule is based on the general principle of agency.

According to sec.180(5) the money borrowed in contravention of this provision shall not be valid
unless the lender proves that the advanced loan in good faith and without knowledge the limit had been
exceeded.

2- Misappropriation of money to unauthorised activities :- If the borrowings are within the powers of the
company but the directors misappropriated and applied the money to unauthorised activities. The
company will be liable as if the lender had no knowledge of misuse of money.
 In V.K.R.S.T. firm vs Oriental investment Trust Ltd., AIR 1944, in this case a company was authorised to
borrow money for its business. Under the authority to borrowed large amount of money from a money lender
and misappropriated the same. The money lender had no knowledge of the intended misuse of the money by the
company managing director. It was held that the company was liable to repay the loan.

Inter corporate loans and Investments (sec.186)

According to sec.186 of Company Act,2013,there is no need for the approval of the Central Government
for inter corporate loans and investments and the companies will have their own internal control of these
transaction. As a result of this the B.O.D of the company subscribe ,purchase or otherwise the securities up to
60% of its paid-up share capital and free reserve, whichever is more.

Investments literally means any penalty or right in which money or capital is invested. Investment in relation
to companies means the investing of money in share, debenture bonds, stocks or other securities.

1- Layers of investment:-
According to sec.186(1) a company cannot make more than two layers of investments.

2- Prohibitions on loans, guarantees, securities, investments:-

According to sec.186(2) no company shall directly or indirectly –
a- give any loan to any person or other body corporate,
b- give any guarantee or provide security in connection with a loan to any other body corporate or persons
and
c- acquire by way of subscription, purchase of securities of other body corporate exceeding 60% of its paid-
up share capital, free reserve securities premium account or 100% of its free reserve of securities
premium account whichever is more.

If the above limit is being exceeded, prior approval by means of a special resolution passed at a general
meeting or shareholders shall be necessary,

Provided that nothing contained in the above provision shall apply to any loan made by a holding company to
its wholly owned subsidiary.

3- Disclosure to members in financial statement :-

According to sec.186(4) it is mandatory that the company shall disclose to the members in the
financial statement the full particulars of loans given, investment made or guarantee given or security
provided. Also the purpose of such transaction and its utilisation must be disclosed.
4- Unanimous resolution of the Board and Approval of public :-
The resolution sanctioning, it is passed at a meeting of the Board Of Director with the consent of all
the directors present at the meeting with the prior approval of public financial institution concerned.[
sec.186(5)]
5- When prior approval of a public financial institution is not required :-
 Prior approval of a financial institution is not required where the 60% is not to be exceeded and there
is no default in payment towards the concerned bank /public financial institution.

6- Companies registered under SEBI Act,1992 :-

According to sec.186(6) a company which is registered under section 12,SEBI Act,1992 covered
under such class or classes of companies as may be prescribed is not to take inter corporate loans or deposits
exceeding the prescribed limit. Also such a company has to furnish on its financial statement the details of
the loans or deposits.

7- No loan at a lower interest prevailing :-

According to sec.186(7), no loan is to be given at a rate of interest lower than the prevailing yield of
one year, three year, five year or ten year Government security closest to the tenor of the loan.
8- No loan and investment during period of default :-
According to sec.186(8) a company which has defaulted in making payment of fixed deposits or
interest due on that cannot during the period of such default make any loans, investments provided any
guarantee
9- To prepair register of investments and loans :-

According to sec.186(9) & (10), the company has to keep a register sharing the particulars about
investments, loans, guarantees and securities as may be prescribed and has to kept in the prescribed manner
by virtue of the Articles Of Association of such company.

The said register of loan shall be kept at the register office of the company and shall be open to
inspection copies at such office and the extracts may be taken there from by any member on such fee as may
be prescribed.

Exceptions u/s 186(11)

The provisions of sec.186 are not applicable :-

i- to a company, insurance company or a housing finance company in dealing with ordinary course
of business,
ii- any acquisition made by a non-banking financial company,
iii- a company whose principal business is the acquisition of shares, stock, debenture or other
securities.

Rule making power

According to sec.186(12), the Central Government may prescribe regulation for the purposes of this section.

Penalty

According to sec.186(13), if the company contravenes the provisions of this section, the company shall be punishable
with a fine which shall not be less than Rs. 25,000 but which may extend to Rs.5 lakhs and every officer of the
company who is in default shall be punishable with imprisonment for a term which may extend to 2 years and with
fine shall not be less than Rs.25,000 but which may extend to one lakh rupees.
Investment of company to be held in its own name (sec.187)

The parliament has made a clear cut provision in this regard in order to prevent benami investment and to maintain
its accountability by the companies.

According to sec.187(1) all investments regarding shares, debentures, securities etc. made by a company shall be and
held in its own name. This provision shall not apply to investments made by a company whole principal business
consists of buying and selling of shares, debentures or securities.

Exceptions :-

1- This section does not apply to investment made by a company whole principal business consists of
buying and selling of shares and securities.
2- A company may hold shares in its subsidiary company in the name of one or more nominees if it is
necessary to ensure the number of members from going below the statutory minimum limit.
3- A company may deposit with its bankers, shares or securities for collection of dividends or to facilitate
their transfer. If the transfer is not effected within six months they shall be held back by the company n
its own name.
4- A company may transfer its shares or securities to another person as a security for a loan or performance
of an obligation.

Register of investments not held in the own name of company [sec.187(3)]

Where any share or securities in which investments are not held by own name of the company, the company shall
maintain a register which shall contain such particulars as may be prescribed by its articles. Such register shall be
open to inspection by any member or debenture holder of the company without any charge during business hours.

This is subject to such reasonable restrictions as the company may by its articles of association or in a general
meeting of share holder may impose.

Penalty [ sec.187(4)]

If a company contravenes the provision of this section, it shall be punishable with fine not less than Rs.25,000 but it
may extend to 25 lakhs.

Every officer in default is to be punishable with imprisonment extending up to 6 months or with fine not less
than Rs. 25,000 but which may extend to Rs. 1 lakh rupees, or with both.