Every business requires a lot of financial amounts to operate effectively. A business becomes healthy only if it has a number of financing options available to capitalize on the assets which are a foundation of every business. Companies need money for a lot of reasons like buying new capital, fund the existing capital, expand the business, etc. Hence companies borrow money to facilitate the efficacious running of their business which cannot be solely run on profit generated.
Borrowing can be defined as a means through which Companies arrange financial funds through external sources like bank loans, shareholders, public investment, etc.
Power of Board to Borrow Money
- Powers of Board – The board of directors is a body of people who supervise the management of affairs in a company and represent the shareholders of the company. The board of directors has been disposed of powers by the Act to exercise power to borrow money on behalf of the company.[i] The same has to be done. They also have the power to issue debentures, securities in respect of loans. But when dealing with banks like RBI, SBI or any other established bank, the arrangement of loans is done based on overdraft or cash credit.
- Restrictions On Power – The board of directors under Section 180 have some restrictions where they have to pass a special resolution to borrow money. The money to be borrowed should be more than the paid-up share capital and free reserves apart from temporary loans obtained by the company’s bankers.[ii]The the board is prohibited from borrowing money in terms of Temporary loans and for more than six months which include short-term, cash credit arrangements, the discounting of bills.
- Special Resolution – The special resolution has to be passed by all board members in General Meeting. The amount to be borrowed is specified on the resolution which has to be duly approved by all people in or required people in the company. [iii]
- Limits on borrowing– There is a limit on borrowings of the company which has to be complied with unless the lender proves that it was in good faith and without knowledge that the limit imposed in Section 180.
Ultra Vires or Unauthorised Borrowings
- There is a limit that has been set under which companies can borrow money in the Act. If the companies go beyond and exceed the limit to borrow money specified by the articles of the Act, it is ultra vires borrowings. It is generally unauthorized borrowing as it is beyond the authority of the directors. [iv] The Relationship of a debtor and creditor is not created in an ultra-vires borrowing.[v]
- The concept of ultra vires originated in the famous case of Ashbury Railway Carriage and Iron Co. Ltd. v. Riche where it was decided that the contract between company and Richie was null and void as it was ultra vires. [vi] The borrowings are generally inoperative.
- Importance – It is essential to protect the interest of shareholders and creditors. In one of the cases, it was held by the Bombay High Court held, “A shareholder can maintain an action against the directors to compel them to restore to the company the funds of the company that have by them been employed in transactions that they have no authority to enter into, without making the company a party to the suit”.[vii]
- In the case of ultra vires or unauthorized borrowings, the company will be liable to repay, it is shown that the money had gone into the company’s pocket.[viii] The same was laid down in Krishan Kumar & others Vs. State Bank of India.[ix]
Consequences of Ultra Vires Borrowings
If the borrowings are ultra vires, there are some consequences for the same which company has to tolerate:
- Injunction – the lender has been given authority under law to restrain the company for using the money lent. ‘The members can restrain it from doing so by getting an injunction from the court’[x].
- Subrogation- refers to a situation when one individual or group is substituted in respect of a debt or loan which also led to the transfer of duties. 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 the principle of subrogation. [xi]
- Liability of directors- as the Board of directors has been entitled to issue borrowings and they have to responsibly use their authority. ‘It will attract personal liability for the directors’. [xii]
Types of borrowings
- Long Term Borrowings– Liabilities that represent money borrowed from banks or other lenders to fund the on-going operations of a business and that will not come due within one year.[xiii] Long term borrowings or debt are those which are borrowed for more than one year and generally extend up to 5 years.
- Short Term borrowings– Reflects the total carrying amount as of the balance sheet date of debt having initial terms less than one year or the normal operating cycle, if longer.[xiv]These are borrowings that have to be paid off within a year. It is a temporary support for business and meeting the working capital needs is the main purpose.
- Medium-term borrowings– The borrowings which are undertaken between short term borrowings and long term borrowings which is up to 2-5 years.
- Secured borrowing – These are the borrowings against collateral which is security.
- Unsecured borrowings- Under this, the debt consists of financial obligation.[xv] There is no collateral issued against the unsecured borrowings.
- Private borrowing– The company takes a loan from banks and other private institutions.
- Public borrowings– It consists of all institutions which are for public exchange.
Borrowings are an essential part of companies and they cannot operate without them. However, it is also necessary that the interest of the creditors and investors of companies are protected. Any irregular and irresponsible act may result in the insolvency of the company which may cause considerable losses to them. So to facilitate the smooth functioning of the company and protect the interests of shareholders, specific provisions are made in the Companies Act 2013 which defines the objectives of the company.
Frequently Asked Questions
Why there is a limit imposed on the borrowings of the company?
The companies borrow money to run a business effectively. There is a limit imposed to prevent misuse of funds by the board of directors.
Are the directors or company liable to pay if they indulge in ultra vires borrowing?
The companies are obligated to repay the entire amount back to the lender if they indulge in unauthorized borrowings.
Is it required to approve a resolution to borrow in Annual General Meeting?
The companies are entitled to pass a special resolution and get it approved by all the members in the AGM.
Edited by Shikhar Shrivastava
Approved & Published – Sakshi Raje
[i]Section 173(3), Companies Act 2013
[ii][ii] Section180(2), Companies Act 2013
[iii] Section 180(4), Companies Act 2013
[iv]In Re. Madras Native Permanent Fund Ltd., (1931) 1 Com Cases 256 (Mad.
[v]Re. Madras Native Permanent Fund Ltd., (1931) 1 Com Cases 256 (Mad.
[vi]Ashbury Railway Carriage and Iron Co. Ltd. v. Riche, (1878) L.R. 7 H.L. 653
[vii]Jehangir R. Modi v. ShamjiLadha, [(1866-67) 4 Bom. HCR (1855)
[viii]Lakshmi Ratan Cotton Mills Co. Ltd v. J K Jute Mills Co; Ltd (1957) 27 Comp. Cas. 660 (All)
[ix]Krishan Kumar & others Vs. State Bank of India, 1286/2015, C.M. NO.2282/2015 & 2283/2015
[x]Attorney General v. Gr. Eastern Rly. Co., (1880) 5 A.C. 473
[xi]Vinayakcharu, Restrictions on Powers of Board to Borrow Money with Ultra vires Borrowings, https://taxguru.in/company-law/restrictions-powers-board-borrow-money-ultra-virus-borrowings.html (last accessed on 31/01/2020)
[xii] Supra note 5
[xiii]https://indianmoney.com/financial-dictionary/l/long-term-borrowing (last accessed on 29/01/2020)
[xiv]https://www.stock-analysis-on.net/Knowledge-Base/Short-term-Borrowings (last accessed on30/01/2020)
[xv]https://blog.ipleaders.in/borrowing-lending-investments-and-contracts/ (last accessed on 31/01/2020)