BORROWING POWER OF A COMPANY IN INDIA

I. 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. It has been held in the case of General Auction Estate Co. v. Smith1 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.

The purpose of this study is to study the scope of borrowing power of company under the
Companies Act, 1956.

II. Lawful Borrowing

According to the Companies Act, a company cannot exercise its right to take a loan till such time
that it is authorized to commence its business. Thus, a private company can exercise its right to
take loan when it receives its „certificate of incorporation‟, and a public company can exercise
this right only on receiving the „certificate of commencement of business‟.2 A public company
can, however, offer its shares and debentures simultaneously after its commencement of
business.

1
(1891) 3 CH 432.
2
Section 149 of the Companies Act.

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It is normally provided in the articles of a company that the power to borrow is exercised by its
directors or such decision is taken by the company‟s general meeting. In practice, the directors
are empowered to borrow up to a specified limit and, if the amount required is more, the decision
to borrow is taken by the company‟s general meeting.

According to Section 293, any borrowing by the directors of the company should not exceed the
aggregate of its paid-up capital and free reserves.3 The directors of a public company or its
subsidiary cannot, except with the consent of company in a general meeting, borrow money

3
293. (1) The Board of directors of a public company, or of a private company which is a subsidiary of a public
company, shall not, except with the consent of such public company or subsidiary in general meeting,-

(a) 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 such
undertaking;

(b) remit, or give time for the re- payment of, any debt due by a director [ except in the case of renewal or
continuance of an advance made by a banking company to its director in the ordinary course of business];

(c) invest, otherwise than in trust securities, 3[ the amount of compensation received by the company in respect of
the compulsory acquisition, after the commencement of this Act], of any such undertaking as is referred to in
clause (a), or of any premises or properties used for any such undertaking and without which it cannot be carried
on or can be carried on only with difficulty or only after a considerable time;

(d) borrow moneys after the commencement of this Act, where the moneys to be borrowed, together with the
moneys already borrowed by the company (apart from temporary loans obtained from the company' s bankers in
the ordinary course of business), will exceed the aggregate of the paid- up capital of the company and its free
reserves, that is to say, reserves not set apart for any specific purpose; or

(e) contribute, after the commencement of this Act, to charitable and other funds not directly relating to the
business of the company or the welfare of its employees, any amounts the aggregate of which will, in any financial
year, exceed 1[ fifty thousand rupees] or five per cent. of its average net profits as determined in accordance with
the provisions of sections 349 and 350 during the three financial years immediately preceding, whichever is
greater.

Explanation I. Every resolution passed by the company in general meeting in relation to the exercise of the power
referred to in clause (d) or in clause (e) shall specify the total amount up to which moneys may be borrowed by the
Board of directors under clause (d) or as the case may be, the total amount which may be contributed to charitable
and other funds in any financial year under clause (e).

Explanation II.- The expression" temporary loans" in clause (d) means loans repayable on demand or within six
months from the date of the loan such as short term, cash credit arrangements, the discounting of bills and the
issue of other short term loans of a seasonal character, but does not include loans raised for the purpose of
financing expenditure of a capital nature.]

Explanation [ III].- Where a portion of a financial year of, he company falls before the commencement of this Act,
and a portion falls after such commencement, the latter portion shall be deemed to be financial year within the
meaning, and for the purposes, of clause (e).

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 BORROWING POWER OF A COMPANY IN INDIA

which, together with those already borrowed (apart from temporary loans obtained from the
company‟s bankers in the ordinary course of business) is more than its paid-up capital and free
reserves.

Restriction on Borrowing Power of a Company

The restrictions on the borrowing power of a company are as under:

1. A public company after obtaining the certificate of commencement of business, and a

private company on obtaining the certificate of incorporation, may exercise its borrowing
power to get any loans. A public company can, however, issue its shares and debentures
simultaneously on the receipt of the certificate of commencement of business.
2. A public company cannot borrow more money than the aggregate of its paid-up capital
and free reserve. Here free reserve implies any reserve which is set aside for a specific
purpose.
3. Although every company has the implicit right to borrow money, no company may
borrow any money in contravention of the provisions of its memorandum or articles of
association. Any borrowing which is not in accordance with such provision shall be
deemed to be unauthorized.
4. A company has right to borrow money but the borrowing creates a liability on the
company‟s properties. Unless it is otherwise provided in the company‟s memorandum
and articles, its borrowing are also a liability on the company‟s unpaid capital. But a
company‟s borrowings do not create any liability on its reserve capital. A company
cannot, therefore, take any loan against its reserve capital.
III. Ultra vires Borrowings

When a company exercises its power to borrow money which is beyond the limits specified in its
memorandum or articles, it is said to be ultra vires borrowing. Such borrowings by a company
are void, and include:

1. Borrowings which are ultra vires of the company, i.e. beyond the authority of the
company, or

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 BORROWING POWER OF A COMPANY IN INDIA

2. Borrowings which are ultra vires the directors, i.e. beyond the authority of the directors.

1. Borrowing ultra vires the Company

Any borrowing by a company beyond its authority or exceeding the limit of its authority are
void. Any guarantee given for such borrowings are void, and is not legally binding by any
means. Where the borrowing is within the powers of the company, the lender would not be
prejudiced simply because its officers have applied the loan to unauthorized activities, provided
that the lender had no knowledge of the intended misuse. Thus, for example, in V.K.R.S.T.
Firm v. Oriental Investment Trust Ltd:4

Under the authority of a company, its managing director borrowed large sums of money and
misappropriated them. The company was nevertheless held liable.

But where a lender provides finance for a business which (within his knowledge) is not within
the company‟s objects, the loan is ultra vires and the lenders cannot enforce the security.5

Consequences of unauthorized borrowing

Borrowing without express or implied authority is ultra vires. The consequences of such a
borrowing as worked out in various cases are as follows:

A. No loan

In the first place, an ultra vires lender has no legal or equitable debt against the company.
Consequently he cannot sue the company to recover his loan.6 Ultra vires borrowings are
forbidden on ground of public policy. To allow such borrowing to be recovered would be an
evasion of that policy.7

B. Injunction

4
AIR 1944 Mad 532.
5
Introductions Ltd, Re [1968] 2 Comp LJ 28: [1969] 2 WLR 791 : [1969] 1 All ER 887 CA.
6
Ultra vires loans are void and in truth have no existence. They do not create the relationship of creditor and
debtor. See National Permanent Building Society, Re, (1869) 5 Ch App 309.
7
SEE Sinclair v Bruogham, 1914 AC 398: 111 LT 1 : [1914-15] All ER Rep 622.

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 BORROWING POWER OF A COMPANY IN INDIA

But if the money advanced to the company has not been spent, the lender may by means of an
injunction restrain the company from parting with it.8

C. Subrogation

Where the money of an ultra vires lender has been used to pay off lawful debts of the company,
he would be subrogated to the position of the debtor paid off and to that extent would have the
right to recover his loan from the company.9 Subrogation is allowed for the simple reason that
when a lawful debt has been paid off with an ultra vires loan, the total indebtedness of the
company remains the same. By subrogating the ultra vires lender, the courts are able to protect
him from loss, while the debt burden of the company is in no way increased.

But the subrogated creditor will not enjoy the priority of the original creditor. The best
illustration is Wrexham, Mold & Connah’s Quay Rly Co Ltd, Re;10

A company had borrowed to the full extent of its powers by issuing three different series of
debentures, A, B and C. A had priority over B and B over C. The company took a fresh ultra
vires loan from the plaintiff to pay interest on A debentures. It was held that to the extent to
which the plaintiff‟s money was used to pay off legal debts, he became a legal creditor, but he
was not entitled to the priority of A debentures.

D. Identification and Tracing

Fourthly, as long as the money of the lender is in the hands of the company in its original form or
its products are still capable of identification, he may claim that money or its products. But the
problem is much more difficult when the lender‟s money and that of the company have become
mixed up. There is only a common fund composed of the lender‟s money and the company‟s
money, but no part of it is traceable as belonging to one or the other. In such a case the lender
may perhaps be helpless. But in the winding up of the company he may claim pari passu

8
The reason for this rule is that the loan is ultra vires, the company, therefore, does not become the owner of that
company. The lender continues to be the owner and he has the right to take back the property in specie.
9
See Neath Building Society v Luce, (1889) 43 Ch 158.
10
[1899] 1 Ch D 440: [1895-9] All Rep Ext 1519 : 80 LT 130.

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 BORROWING POWER OF A COMPANY IN INDIA

distribution of the assets with the shareholders. This was done in the complicated case of
Sinclair v. Brougham:11

A building society started banking business which was ultra vires the society. On its winding up
the assets appeared to have been composed partly of the shareholder‟s money and partly of the
depositor‟s money. But it was not possible to trace out which part of the mixed fund belonged to
the shareholders or the creditors. Nor were the assets sufficient to pay both in full. It was,
therefore, held that the entire remaining amount should be apportioned between the depositors
and the shareholders in proportion to the amount paid by them, respectively. Nearest approach
practicable to substantial justice would be done.

2. Borrowings ultra vires the Directors

Any borrowing which is within the authority of the company but is beyond the authority of its
directors is said to be ultra vires the directors. In case the company ratifies such borrowing, the
loan shall become valid and binding on the company. When the company does not ratify the
borrowing, the „doctrine of indoor management‟ and the accepted principles of agency protect
the lender if the latter can prove that he had given the loan in good faith. The company in such
case, can claim an indemnity from the directors.

Whether the company would be liable in such a case was the question in T.R. Pratt (Bom) Ltd
v. E.D. Sasoon & Co Ltd:12

There was no limit on borrowing for business in the memorandum of a company. But the
directors could not borrow beyond the limit of the issued share capital of the company without
the sanction of the general meeting. The directors borrowed money from the plaintiff beyond
their powers.

It was held that the money having been borrowed and used for the benefit of the principal either
by paying its debts, or for its legitimate business, the company cannot repudiate its liability on
the ground that the agent had no authority from the company to borrow. When these facts are
established a claim on the footing of money had and received would be maintainable.

11
1914 AC 398: 111 LT 1: [1914-15] All ER Rep 622: 83 LJ Ch 465: 30 TLR 315.
12
AIR 1936 Bom 62.

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 BORROWING POWER OF A COMPANY IN INDIA

But in Equity Insurance Co Ltd v. Dinshaw & Co:13

It was held that where the managing agent of the company, who is not authorized to borrow, has
borrowed money which is not necessary bona fide, nor for the benefit of the company, the
company is not liable for the amount borrowed.

Where a loan has not been taken in the name of the company it will not be liable even though it
may have benefited. An illustration in point is Suraj Babu v. Jaitly & Co:14

P & Co were the managing agents of L & Co which was in liquidation. P was the manager. P
borrowed a sum of money from J in his own name. In one letter to J he indicated that the loan
was for a requirement of L & Co and that company had actually benefited. But it was held that
there was no intention to bind L & Co. “The mere fact that the company had benefited was not in
itself sufficient to bind the company.”

Where a promissory note was executed on a paper the top of which bore the rubber stamp of the
company and was signed “Joshi, Treasurer”, an intention to bind the company was held to be
clear.15 But where a note was endorsed in this manner:

“Mitter and Sons,

Managing Agents,

Lister Antiseptic Co Ltd”,16

It was held that the intention to involve the responsibility of the company was not clear from the
endorsement.

IV. Mortgages and Charges

The power to borrow includes the power to mortgage the company‟s assets or to create a charge
upon them. The reason is that lenders always insist on some security and the only security that a

13
AIR 1940 Oudh 202.
14
AIR 1946 All 372.
15
Poona chitrashala Steam Press v Gajanan Industrial & Tramway Co, AIR 1923 Bom 29.
16
Sreelal Mangatulal v Lister Antiseptic Dressing Co Ltd, AIR 1925 Cal 1062.

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 BORROWING POWER OF A COMPANY IN INDIA

company can give is to charge its assets. Any charge or mortgage created on any of the following
assets of a company must be registered with the Registrar of Companies under Section 125 of the
Act:17

1. a charge for the purpose of securing any issue of debenture;

2. a charge on uncalled share capital of the company;
3. a charge on any immovable property, wherever situate or any interest therein;
4. a charge on any book debts of the company;
5. a charge not being a pledge, on any movable property of the company;
6. a floating charge on the undertaking or any property of the company including stock in
trade;
7. a charge on calls made, but not paid;
8. a charge on a ship or any share in a ship;18
9. a charge on goodwill, or a patent or licence under a patent, on a trade-mark, or on a
copyright or a licence under a copyright.

The Registrar has to issue a certificate under his hand of the registration of any charges stating
the amounts secured. The certificate is the conclusive evidence that the requirements as to
registration have been complied with.19

Registration must be effected within thirty days of the creation of the charge.20 However, the
Registrar may extend the time up to next thirty days. He has to be convinced that there was a
sufficient cause for the default. The company has t pay an additional fee as may be required by
the Registrar but it should not exceed ten times the amount of fees specified in Schedule X. The
advantage of registration is that the charge becomes binding on the company even in its winding

17
Section 124 says that in this part, the expression “charge” includes a mortgage. Where the company defaulted in
registering the charge, the court, at the instance of the charge, compelled the company to comply with the
requirement of registration. ICICI Bond Ltd v Klen & Marshall Manufacturers & Exporters Ltd, [2000] 4 Comp LJ 411
CLB.
18
A charge on a share in horses has been held to be not a floating charge because they are choses in action.
19
See Section 132 of the Companies Act.
20
Registration may be effected either by the company or by the interested party. Section 134. A copy of the charge
should be kept at the registered office. Section 136, 145 provides that pre-existing charges would also have to be
registered if they were not satisfied at the time that the registration requirements came into force.

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 BORROWING POWER OF A COMPANY IN INDIA

up and also on every subsequent purchaser or encumbrancer of the property covered by the
charge. The effect of non-registration is that the charge would be void against the liquidator and
any creditor of the company. The lender would not have the benefit of the charge, although his
loan stands and it shall become immediately repayable. Where the creditor failed to get his
charge registered, the court said that he could not be regarded as a secured creditor. A mere
statement of account could not be taken as a proof of the charge. The agreement of the SFC with
the bank that the corporation should be treated as a secured creditor was held to be no roof of
charge.

It has been said that “the section makes void the security, not the debt, nor the cause of action,
but the security, and not as against everybody, not as against the company grantor, but against
the liquidator and against any creditor, and it leaves the security to stand as against the company
while it is a going concern. It does not make security binding on the liquidator as successor of
the company.

A charge on all the products, movable property and book debts of the company was held to be
void because the prescribed particulars were not filed with the Registrar within the time nor any
extension of time was sought for the propose.

The possessory lien of a warehouse keeper for his charges which included the power to sell the
goods to realize the outstanding charges was held as not amounting to a charge on the goods so
as to require registration. In a transaction for sale of goodwill and other rights to, the company, it
promised to pay the price by installments. This was held to be not a charge on the assets of the
company so as to require registration. An undertaking by the company with the backing of a
resolution to create a charge on its assets was held to be not a present charge so as to require
registration.

V. Conclusion

A company has express and implied power to borrow as per the limits laid down in the
Memorandum or Articles. Memorandum of Association of modern companies does no limit the
amount which they borrow. Articles of companies generally limit the amount the directors may
borrow without obtaining the consent of the shareholders meeting. The powers of directors to

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 BORROWING POWER OF A COMPANY IN INDIA

borrow are subject to the limitations such as the Companies Act, 1956 prohibits the directors
from borrowing an amount beyond the aggregate of the paid up capital of the company and its
free reserves. If any debt incurred by the company is in excess of this limit, the debt will not be
valid on effective, unless the lender proves that the loan was advanced in good faith and
without the knowledge of the fact that the limits imposed by the relevant clause had been
exceeded. Where borrowing is ultra vires the company, the securities given for the same are
inoperative. In such case the contract is absolutely void and incapable of ratification. The
lender has no legal or equitable debt against the company. Where borrowing is ultra vires the
directors, it is irregular and securities in that behalf are inoperative. Such borrowing may be
rendered valid by ratification by the general meeting of the company.

When a company exercises its borrowing power, it can give security by mortgage or change on
all or nay of its property. It is well settled that the borrowing powers of a company include
power to mortgage or charge the assets. A company cannot borrow on the security of reserve
capital. Borrowing power of a company under the Companies Act is a restricted and guided
power. On the one hand, the Act acknowledges the need of companies to receive money as
borrowings for trading purposes from time to time. On the other, it protects the interest of the
lender and shareholders by incorporating certain limitations on its exercise.

Bibliography

Books referred-

 Boyle & Bird’s Company Law, (3rd Edn, Universal Law Publishing Co. Pvt. Ltd 1997)
 Ramaiya A., Guide to the Companies Act, (16th Edn, Wadhawa Nagpur)

 Saharay H.K., Company Law (textbook) 5th

Edn.(books.google.com/books?isbn=8175346515 )
 Sharma A., Company Law and Secretarial
Practice,(books.google.com/books?isbn=8189611682)

Statutes referred-

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 BORROWING POWER OF A COMPANY IN INDIA

 The Companies Act, 1956

Cases referred-
 Equity Insurance Co Ltd v. Dinshaw & Co
 General Auction Estate Co. v. Smith
 Industrial Corpn Ltd v. Maxwell Dyes and Chemicals Ltd
 Neath Building Society v. Luce
 Poona chitrashala Steam Press v. Gajanan Industrial & Tramway Co
 Sinclair v. Bruogham
 Sreelal Mangatulal v. Lister Antiseptic Dressing Co Ltd
 Suraj Babu v. Jaitly & Co
 T.R. Pratt (Bom) Ltd v. E.D. Sasoon & Co Ltd
 V.K.R.S.T. Firm v. Oriental Investment Trust Ltd
 Wrexham, Mold & Connah’s Quay Rly Co Ltd, Re

Articles referred-

 Akhtar S., Directors’ Borrowing Powers, ournal-archieves22.webs.com/497-501.pdf

 Singh M.,Liability for Misstatement in Prospectus : Where to Stop?
www.manupatra.com/.../Articles/Liability%20for%20Misstatement%2...

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