Borrowing Powers of a Company

Dr. Ashish Chaurasia

Introduction
• Every company needs unexpected additional capital for its business
from time to time.
• The company can meet such requirement of capital, to an extent, by
the issue of share, but it is not always possible to get the capital
through the issue of shares as and when it is required.
• As a result, the company has to take the recourse of public loans.
• Normally, most companies are empowered by their articles to borrow
money for the purpose of their business.
Introduction
• It has been held in the case of General Auction Estate Co. v.
Smith that even if it is not explicit in a trading company’s
articles, every company has the right to borrow money and
to charge its assets by way of security for the amount
borrowed.
• So far as non trading companies are concerned, they cannot
seek any public loan unless it is expressly stated in their
memorandum and articles that they are authorized to do so.
• A company’s memorandum defines the maximum limit to
which the company may take loans whereas their article
defines the procedure for taking such loans.
• Where the memorandum of a company has stated the limit
of a company’s right to borrow money, any borrowing
beyond such limit is beyond the authority of the company.
• In such a case any guarantee given the loan is invalid, and
the loan is not deemed to be a debt against the company.
• Any such contract is void ab initio and cannot be
implemented even if all members of the company confirm
the contract.
Restrictions on Powers of Board to Borrow Money

• RESTRICTIONS ON POWERS OF BOARD

• As per the provisions of section 180 of the companies act
provides the rules regarding the restriction on power to
borrow by the board of directors.
Restrictions on Powers of Board to Borrow Money

• The Board of Directors of a company shall exercise the

following powers only with the consent of the company by
a special resolution, namely:—
• (i) To sell, lease or otherwise dispose of the whole or
substantially the whole of the undertaking of the company
or where the company owns more than one undertaking, of
the whole or substantially the whole of any of such
undertakings.
Restrictions on Powers of Board to Borrow Money

• (ii) To invest otherwise in trust securities the amount of

compensation received by it as a result of any merger or
amalgamation;
• (iii) To borrow money, where the money to be borrowed,
together with the money already borrowed by the company
will exceed aggregate of its paid-up share capital and free
reserves, apart from temporary loans obtained from the
company’s bankers in the ordinary course of business
Restrictions on Powers of Board to Borrow Money

• (iv) To remit, or give time for the repayment of, any debt due
from a director.
• (v) Every special resolution passed by the company in general
meeting in relation to the exercise of the borrowing shall
specify the total amount up to which monies may be
borrowed by the Board of Directors.
Restrictions on Powers of Board to Borrow Money

• vi) The title of a buyer or other person who buys or takes on

lease any property, investment or undertaking as is referred
to in that clause, in good faith; or the sale or lease of any
property of the company where the ordinary business of the
company consists of, or comprises, such selling or leasing.
Restrictions on Powers of Board to Borrow Money

• (vii) Any special resolution passed by the company

consenting to the transaction as is referred to in clause (a) of
sub-section (1) may stipulate such conditions as may be
specified in such resolution, including conditions regarding
the use, disposal or investment of the sale proceeds which
may result from the transactions:
Restrictions on Powers of Board to Borrow Money

• viii) No debt incurred by the company in excess of the limit

imposed by clause (c) of Sub-section (1) shall be valid or
effectual, unless the lender proves that he advanced the loan
in good faith and without knowledge that the limit imposed
by that clause had been exceeded.
ULTRA VIRUS BORROWING

• The power to borrow money is specified by the

memorandum and articles of association of the Company
and directors cannot go beyond such authority ,if the
director borrows beyond the power prescribed by the MOA
and AOA then the borrowings is considered as ultra-virus
borrowings.
• Borrowing by a company may be—
• 1. A borrowing which is ultra vires the company, or
• 2. A borrowing which is intra virus the company but ultra vires the
directors.
Consequences of borrowing ultra- virus the company

• When a company has no borrowing powers, or where the

memorandum of association fixes a limit on the borrowing
powers of the company, any borrowing in the first case and
any borrowing in excess of such limit in the other case is
ultra- virus the company.
• In such a case the contract is void ab initio –and the lender
cannot sue the company for the return of the loan. The
lender will also be under an obligation to return back the
securities, if any. The company cannot ratify the ultra vires
loan by resolution in general meeting.
• The lender has the following remedies;
• 1. Injunction. If a lender intervenes before the money has
been spent, he has a right to follow his money and to obtain
an injunction restraining the company from parting with it.
• 2. Subrogation. If the money borrowed ultra vires has been used to
pay off legitimate debts of the company (whether incurred before or
after the money was borrowed), the lender is entitled to treat his
loan as intra-vires to the extent to which the money was so applied.
He can sue the company by virtue of principle of subrogation. Here
subrogation is allowed for the simple reason that when a company
which borrows to pay off existing debts, does not thereby, increase its
general indebtedness because there is merely replacement of one
debt by another of the same amount.
• 3. Identification and tracing. If the money lent to the
company can be traced in the hands of the company in
original form or even if it has been employed for the
purchase of property which is still capable of identification,
the ultra vires lender can obtain a tracing order and may
claim that asset or money.
• But when the lender’s money and that of the company have
become mixed up and the two cannot be separated from
each other, the lender may claim parripassu distribution of
the assets with the shareholders in the event of the winding
up of the company.
• 4. Recovery of Damages. The lender may hold the directors
personally liable for contracting an ultra vires loan of the company.
The directors are liable for damages to the lender for the breach of
the implied warranty of authority. But if the fact that the company
has no powers to borrow is apparent upon reference to the
company’s registered documents i.e. memorandum and articles, the
lender cannot claim damages from directors upon this ground
because he will be deemed to have knowledge of these public
documents.
 Consequences of borrowing intra vires the company but ultra vires the
directors

• A distinction must be drawn between borrowing ultravires

the company i.e. outside the objects set out in the
memorandum and borrowing ultra vires the directors.
• Borrowing in the first category is void and cannot under any
circumstances by ratified by the company.
• Borrowing ultra vires the directors, but within the power
conferred by the memorandum, is voidable only and may be
ratified by the company.
• If the borrowing is ratified, the company becomes liable to
repay the money.
• Where such borrowing is not ratified by the company, the
remedies available to lender are :
• 1. Doctrine of indoor management. By relying on the rule in
Royal British Bank v. Turquand he can recover the amount of
loan from the company provided the borrowing was due to
non-compliance with some internal regulations of the
company.
• 2. No notice for unauthorised business. A lender is deemed to have
notice of the limitations imposed by the memorandum and articles
on the borrowing powers of the directors.
• A company can avoid the liability on the ground that borrowing was
known or deemed to be known to be ultra vires.
• But if restrictions on the director’s authority are secret or not obvious
from these documents, or otherwise the lender does not know of it
from some other source, the company will be bound.