Page 212 - DCOM106_COMPANY_LAW

Unit 13: Borrowing and Debentures

The power to borrow money is generally exercised by the directors but Articles normally Notes
provide for certain restrictions on their power to borrow. Section 293 also limits the directors’
power to borrow, to the aggregate of the paid-up capital of the company and its free reserves
apart from temporary loans obtained from the company’s bankers in the ordinary course of
business.

Task The loan of the Debenture-holders was secured by a floating charge on the assets of
the company. The company had the power to sell the whole of its undertaking as per a
clause in its Memorandum. The company sold the undertaking. The Debenture-holders
insisted that their floating charge had been crystallised by the act of the sale of the
undertaking. Is their contention correct? [Hint: The contention of Debenture-holders is
not correct as none of the conditions for the conversion of the floating charge into a fixed
charge has been satisfied].

13.2.2 Ultra Vires Borrowing

Borrowing by a company shall be deemed to be ultra vires where the company borrows in spite
of no power to borrow, or borrows beyond the limit fixed by the Memorandum or Articles. Any
such loan to the company is null and void and does not create an actionable debt. However, the
following remedies shall be available to such a lender:
1. Injunction and Recovery: If the money, assets, property, etc., purchased with such money
is identifiable and are still in the possession of the company, the lender can obtain an
injunction to restrain the company from parting with them and seek a tracing order to
trace and recover them.
2. Subrogation: If the borrowed money was applied in payment of lawful creditors of the
company, the lender can subrogate to the rights of those creditors, i.e., he will step into the
shoes of the old creditors for the purpose of recovering his money [Sinclair vs. Brougham
(1914) A.C. 398]. However, he shall not have any priority over other creditors even if the
debts paid off had priority [Re. Wirexhan Mold & Cohmah’s Quau Rly. (1899) 1Ch. 440].
3. Suit against the Directors: The lender may claim damages from the directors and sue
them personally for a breach of warranty of authority [Firbank’s Executors vs. Humphreys
(1866) 18 O.B.D.64]. But if the fact that, the company has no powers to borrow was apparent
upon reference to the company’s Memorandum or Articles, the lender shall not be entitled
to claim damages from directors upon this ground as he was not misled because he is
deemed to have knowledge of these public documents [Ranshdall vs. Ford (1866) E.R.Q.
Fq Cas. 750].

13.2.3 Borrowing Intra Vires the Company but Ultra Vires the Directors

If the borrowing is in excess merely of the power of directors but not of the company, e.g., where
the Articles provide that the directors shall have power to borrow only up to 2,00,000 and, for
borrowing beyond this amount prior approval of the shareholders in general body meeting
must be obtained, any borrowing beyond 2,00,000 without shareholders’ approval (i.e., ultra
vires the directors) can be ratified and rendered valid by the company. If ratified, the loan shall
become perfectly valid and binding upon the company. However, even where the company
refuses to ratify the directors’ act, the ‘Doctrine of Indoor Management’ shall protect a lender
provided he can establish that he advanced the money in good faith. The company may in turn
proceed against the directors and claim indemnity.

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