BORROWING POWERS OF A COMPANY

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CHAP CHAPTE TER R 8 – BORR BORROW OWIN INGS GS & CHAR CHARGE GES S

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CHAPTER 8

BORROWING POWERS OF A COMPANY BORROWING POWERS •

Every trading company has an implied power to borrow, as borrowing is implied in the object for which it is incorporated. A trading company can exercise this power even if it is not included in the Memorandum. However non-trading company has no implied power to borrow and such power can be taken by it implied power to borrow and such power can be taken by it by including a clause to that effect in the Memorandum.

Restrictions on borrowing power •

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A public company can borrow only after the receipt receipt of Commencem Commencement ent Certificat Certificate. e. [Section [Section 149(1)]. 149(1)]. But a private company can borrow immediately after the incorporation The Board of Directors may borrow moneys by passing a resolution resolution passed at the meetings of the Board. The board may delegate its borrowing borrowing powers to a Committee of Directors. Directors. Such a resolution should specifically specifically mention the aggregate amount upto which the moneys can be borrowed by the Committee, the Managing Director, Manager or any other p rincipal officer of the company on such conditions as it may prescribe [Section 292 (1) (c)] The moneys borrowed together with the moneys already borrowed by the company (excluding loans obtained from banks i.e. working capital) capital) shall not exceed the aggregate aggregate of the paid up capital and the free reserves. [Section 293(1)(d)] It may be noted that a company may borrow in excess of its paid up capital and free reserves if it is so consented and authorized by the shareholders at a general meeting.

Transactions, Transactions, which are not borrowing •

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Temporary loans (repayable within six months or on demand) obtained from the company’s banker in the ordinary course of business. Borrowing of money by a banking company in the ordinary course o f business. Hire purchase and leasing transactions. Purchase of machinery on deferred payment.

ultra vires

BORROWING

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A Company is said to resort to ultra vires borrowing if it exceeds the authority given to it in this respect by the Companies Act, the Memorandum Memorandum and the Articles of the the company. An act of borrowing by the company company may be ultra vires (outside the power of) the company or ultra vires the directors or ultra vires the Articles.

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Void ab initio borrowings - Where such loan is ultra vires the company, such loan is null and void and does not create an actionable debt. Any securities given in respect thereof thereof are inoperative. inoperative. Thus, the lender lender cannot sue the company for the return of the loan and shall be under an obligation to return back the se curities, if any. •

However, if the lender has acted in good faith that is without any knowledge that the company borrowed the money beyond its powers, he may have the following remedies 1. Injunction - If the company has not spent the money so borrowed, the lender may obtain an injunction order against the company restraining it from spending the amount and recover the same. 2. Restitution - If the money has been invested in some particular asset, he may claim that asset, or if such asset cannot be ascertained he may claim that any increase in the assets as a result of such borrowing be restored to him in the even of a winding up. 3. Subrogation - If the money has been applied in paying off some debts of the company, he is entitled to step into the shoes of the creditors so paid off and can rank as a creditor of the company to the extent of the money so applied. 4. Suit for breach of warranty - The lender may sue the directors personally for breach of implied warranty of authority and claim damages for the same. 5. Ratificat Ratification ion of borrowing borrowing - If the borrowing borrowing power exercise exercised d by the company company is ultra ultra vires vires the Memorandum, that is beyond the powers given to its by the Memorandum, such borrowing cannot be ratified afterwards in any way, even by a unanimous resolution of the shareholders in a general meeting. But if the borrowing is ultra vires the Articles, but intra views the Memorandum the act of borrowing can be ratified by the shareholders in general meeting by altering the Articles or by passing a resolution as per Articles. If the borrowing is ultra vires the directors but intra vires the Memorandum, that is within the powers given by the Memorandum but beyond the authority of the directos, the company in general meeting may ratify ratify such act of the directors. directors. In that case the debt will be valid valid and binding on the company. LECTURES BY PROF. S N GHOSH

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Even if the borrowing is not ratified by the company, the lender in good faith will be protected since the directors directors in borrowing borrowing the money money had acted as agent of the company. company. However However in that case the directors will be liable to indemnify the company against the loss incurred thereby. Even in the case of unauthorized borrowings, the company will be liable to repay, I it is shown that the money had gone into company’s pocket [Lakshmi [Lakshmi Ratan Cotton Mills Co. Ltd v. J K Jute Mills Co; Ltd (1957) 27 Comp. Cas. 660 (All).]

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CHARGES •

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Borrowing has become an equally important method along with share capital of financing projects. Corporate borrowing has its own peculiarities. No single individual may in normal circumstances be in a position to meet the loan loan requir requireme ements nts of a compan company. y. Loan-m Loan-mone oney y has, has, theref therefore ore,, to be raised raised from from a large large number number of individuals very much in the same way as share capital. Loans may have to be obtained in a sequence one after the other. The problem was solved by the evolution, on the one hand, of debentures and, on the other, of the concept of floating charge, both being reserved only for the corporate sector. The same assets are charged to several lenders and also to several lenders in a series. That raises a question as to who shall have priority. This gave pari passu ranking. Since other trade creditors have also to seek payment only out of the rise to the concept of pari company's assets, the problem had to be tackled as to how they should know, before supplying more credit, what assets would be available as security for their payments?

The Act prescribes for registration of charges with the Registrar of Companies, and also gives a list of assets a charge on which must be registered. Registration of charges identifies the assets, which are subject to the charge. It becomes a source of knowledge, and, therefore, operates as constructive notice and a protection, to "all classes of persons interested in knowing the assets position of the company. It makes the charge effective against all quarters including the liquidator. Types of charges Fixed charge - a charge is fixed when it is made specifically to cover definite an ascertained 1. assets of permanent nature such as land, building, building, o heavy machinery. A fixed charge passes legal title title to certain specific assets and the company loses the right to dispose of the property unencumbered, though the company retains possession of the property. Floating charge – it is a charge on the current assets of the company, present or future which 2. changes from time to time in the ordinary course of business e.g. stock in trade, bills receivable, cash in hand, work in progress, goods in transit, inventory etc. When floating charge becomes crystallised (i) When the company goes into liquidation; (ii) When the company ceases to carry on the business; (iii (iii)) When When the the cre credi dito tors rs or or the the debe debent ntur ure e hold holder ers s take take ste steps ps to to enfo enforc rce e this this sec secur urit ity y e.g. e.g. by by appo appoin inti ting ng receiver to take possession of the property charged; (iv) On th the ha happening of of th the ev even sp specified in in th the de deed. Registration of chares [Section 125] The security created and charged for the following purposes must be registered with the ROC within 30 days (or further period of 30 days with additional fees) after the date of their creation: (i) Securi uring any issue of debe ebenture ures; (ii (ii) Uncal ncallled shar share e ca capit pital of the com company pany;; (iii) Any immovable property; (iv) (iv) Book Book deb debts ts,, stoc stock k in tra trade de or or othe otherr curr curren entt asse assets ts of of the the comp compan any; y; (v) (v) Any movab ovablle pr proper operty ty (not not bei being ng a pl pledge) dge);; (vi) Calls ma made bu but no not paid; (vii) IPRs of of th the co company. The ROC shall with respect to each company maintain a Register of charges containing all the specified particulars. Upon registration of charge by the company, company, ROC shall issue a Certificate Certificate of charges, which shall be conclusive evidence. Memorandum of satisfaction [Section [Section 138-140] On payment or satisfaction of any charge in full, the company must notify the fact to the ROC within 30 days from the date of such payment or satisfaction. satisfaction. The ROC shall on receipt thereof, thereof, shall record the same after send due notice to the concerned creditor and on receipt on him being satisfied (the creditor may issue NOC to the satisfaction) shall register the the satisfaction of the charge. A memorandum of satisfaction satisfaction shall be entered in the Register by the ROC. •

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LECTURES BY PROF. S N GHOSH

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Rectification of register of charges by the Central Government [Section 141] The Central Government has been empowered to extend time for registration of charge or satisfaction of charge of issue of debenture of a series and to order that the omission or mis-statement in the Register of Charges be rectified.

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DEBENTURES

Debenture includes debentures stock, bonds, and any other securities of a company, whether constituting a charge on the assets of the company or not. [SEC [SEC 2(12)]. Features of a Debenture The usual features of a debenture are as follows: (i) in the form of a certi certific ficate ate (like (like a share share certifi certificat cate) e) issued issued under the the common common seal of the company. company. The certificate is an acknowledgement by the company of indebtedness to a holder. (ii) provides provides for the payment payment of a specified specified principa principall sum at a specified specified date with with contracted contracted rate rate of interest. interest. (iii (iii)) issu issued ed in seri series es.. (iv) Secured Secured by a charge charge on the undertak undertaking ing of the the company, company, or on some some class class of its assets assets or on on some part part of its profits. [Unsecured debenture is a deposit with the meaning of the Companies (Acceptance of Deposits) Rules 1975]. Debenture stock Debenture Debenture stock is of the same nature as debentures debentures but instead instead of each lender having separate separate debenture debenture bond he gets a certificate entitling him to a specified portion one large loan. It is borrowed capital consolidated into one mass for the sake of co nvenience. Loan It is a right in the creditor to demand repayment, - a liability upon the debtor to repay the money Debentureholder Shareholder •

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A document, which creates or acknowledges a debt. A debenture holder is a creditor to the company -either secured or unsecured Entitled to interest at a rate fixed by the terms of issue. It is a charge to the income.

Status Income

Repayment

Must be repaid as per the terms of issue.

Order of repayment

Debentures must be repaid before any amount is paid to preference or equity shareholders. Regulated by Companies Act 1956 for unlisted companies; SEBI (DIP) Guidelines, 2000 (issue of Debentures) for listed companies. Debenture holders have no rights and privileges and they can attend and vote only at meetings of debenture holders and creditors called on winding up or to discuss matters affecting their interest. Debenture with voting rights shall not be issued by a company.

Conditions of issue

Rights and Privileges

A shareholder is a member to the company. Entitled to receive a part of the distributable profit, known as dividend. It an appropriation to the profits. Moneys paid on shares not repayable (except Redeemable Preference Shares). In the event of winding up, shareholders cannot claim payment unless all the outsider creditors have been paid in full. Regulated by Companies Act 1956 for unlisted companies; SEBI (DIP) Guidelines, 2000 (issue of shares) for listed companies The Articles govern the rights and privileges of shareholders and these include the right to attend and vote at the company meetings

KINDS OF DEBENTURES •

Debenture may be of different kinds as follows: (i) (i) Rede Redeem emab able le Deb Deben entu ture res; s; (ii) Perpetual or Irredeemable Debentures; Debentures; (iii) Registered and Bearer Debentures (iv) Secured and Unsecured or Naked Debentures; Debentures ; (v) Convertible Convertible Debentures - A convertible debenture mean, which by the terms of its issue gives the holder the right of exchange debenture wholly or in part with fully, paid shares. Section 81(3)(b) provides that the terms of issue of debentures may provide for an option to convert such debentures or loans into shares in the company.

SEBI (DIP) Guidelines 2000 – Salient Points Particulars

Compliance requirement

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Purpose of Issue

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FCD* FCD*** (with with a conver conversio sion n

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May be issued for any purpose - for financing; replenishing funds or acquiring shareholding of other companies. The conversion is to be made with `put`(means `put`(means an option to sell) sell ) and `call` (means an LECTURES BY PROF. S N GHOSH

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period of more than 36 months) months ) Credit rating PrePre-de dete term rmiinati nation on of Premium on conversion and time of conversion Interest rate Debenture Trustee Monitoring  Debe Debent ntur ure e Redem Redempt ptio ion n  Reserve (DRR) 

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Distribution of dividends Non certificate

encumbrance

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Debenture trust deed

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Disclosure and Creation of Security

** FCD – Fully Convertible Debenture

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option to buy) option. Mandatory for debentures redeemable after 18 months. months . Two ratings from different agencies if the issue size is more than of Rs. 100 or more. The premium on conversion of PCDs and FCDs and the time of conversion in stages if any to be pre-determined and stated in the prospectus Freely determinable. Only SEBI Registered person may act as a Debenture Trustee. The names, address and fees etc of debenture trustees should be stated in the prospectus. Lead financial institution /investment institution shall monitor the funds utilization. Creation of DRR is compulsory (except for debentures having maturity period of 18 months or less). DRR equivalent to 50% of amount of redeemable debenture before commencement of redemption. redemption. Considered Considered as part of General Reserve Reserve for bonus issue proposals proposals and for price fixation. New companies shall require approval of the trustees to the issue and the l ead institution, if any. Existing companies, prior permission for declaring dividend exceeding 20%. Non-encumbrance certificate from the bankers/lending institutions of the company to be enclosed along with draft prospectus by the merchant banker. Should be executed within six months of the closure of the issue. Trustee shall ensure the compliance of the prescribed guidelines and SEBI (Debenture Trustee) Regulations. Charge must be created within 12 months from the date of issue of debentures, failing 2% penal interest shall be paid to the debenture holder. If security is not created even after after 18 months a meeting of the debenture holder should be called within 21 days to explain the reasons and the date by what the security would be created.

DEBENTURE TRUST DEED

[SECTION 117A, 117B and 117C, 118 -121 READ WITH SEBI (DEBENTURE TRUSTEES) REGULATIONS, 1993]

Purpose and nature of trust deed •

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The issue of debentures is commonly secured by a trust deed by which the property forming the security is charged by way of mortgage to the trustees. The trust deed provides the terms and conditions on which the charge is held and may be enforced. It has been provided that every debenture trustee shall a mongst other matter accept the trust deed, which shall contain the matter specified in Schedule Schedule IV to the said regulations. The duties of the Trustees has also been provided. CONTENTS OF DEBENTURE TRUST DEED Schedule VI to the SEBI (Debenture Trustees) Regulations, 1993 provides for inclusion of the following matters in the Debenture Trust Deed (a) (a) Prov Provis isio ions ns for for red redre ress ssal al of grie grieva vanc nces es of debe debent ntur ure e hol holde ders rs (b) Time Time limi limitt with within in which which the securi security ty for the issue issue of debent debenture ures s shall shall be create created d (c) Obliga Obligatio tion n not to to create create furt further her char charge ge or encu encumbr mbranc ance e of the the trust trust prope property rty withou withoutt the prio priorr approv approval al of the the trust trustee ee (d) Obliga Obligatio tion n of of the body body corp corpora orate te to the debent debenture ure trust trustees ees and debent debenture ure holder holders s (e) Events co constituting de defaults (f) (f) Proc Proced edur ure e for for appo appoin intm tmen entt of of new new trus truste tees es and and the their ir rem removal oval (g) Remova Removall of deben debentur ture e truste trustees es on a reso resolut lution ion pass passed ed by at least least 75% 75% if the the total total debent debenture ure hold holders ers of of a body body corpor corporate ate (h) (h) Righ Rights ts of debe debent ntur ure e hol holde ders rs inca incase se of defa default ult by the the bod body y cor corpo pora rate te (i) (i) Fees Fees or comm ommiss ission ion of debe debent ntu ure trus truste tees es (j) (j) Circ Circum umst stan ance ces s whe when n the the secu securi rity ty will will bec becom ome e enf enforce orceab able le.. (k) (k) Rede Redemp mpti tion on of of the the debe debent ntur ures es in in term terms s of the the iss issue ue to to the the debe debent ntur ure e hold holder ers s (l) Obliga Obligatio tion n to to conv convert ert the debent debenture ures s into into equity equity in accord accordanc ance e with with the terms terms of the issue issue (m) (m) Debt Debt equ equit ity y rat ratio io and and deb debtt ser servi vice ce cove covera rage ge rat ratio io (n) Method Method and mode mode of of pres preserv ervati ation on of of ass assets ets charge charged d as as secu securit rity y for for debent debenture ure holder holders s (o) Circum Circumst stanc ances es spec specify ifying ing when when the the secur security ity may may be dispos disposed ed of or or leased leased out with with the the appro approval val of of trust trustees ees.. (p) Proced Procedure ure for allowi allowing ng insp inspect ection ion of char charged ged asse assets ts by by trust trustees ees or any any pers person on auth authori orised sed by them them.. (q) Obliga Obligatio tion n to infor inform m debent debenture ure trus trustee tee abou aboutt any chan change ge in natu nature re and and conduc conductt of busin business ess by by the the body corpor corporat ate e before before such change. (r) (r) Obli Obliga gati tion on of body body corpo corpora rate te to keep keep the debe debent ntur ure e trust trustee ee infor informe med d of all the order orders, s, dire direct ctio ions ns or notic notices es of court court or tribunal affecting or likely to a ffect the charged assets (s) Obliga Obligatio tion n to inform inform debent debenture ure trust trustee ee of of any any change change in compos compositi ition on of of its its Boar Board d of Direct Directors ors.. (t) Obliga Obligatio tions ns of the the body body corpo corporat rate e to forwa forward rd a quart quarterl erly y report report to to debent debenture ure trus truste tees es conta containi ining ng the the follow following ing part particu icular lars s ** Updated list of the names and addresses of the debenture debenture holders ** Details of interest due but unpaid and reason thereof.

Right to obtain copies of an inspect trust deed [Sec 118] •

A copy of the trust deed shall be forwarded to the debenture holder at his request and with in seven days of the making thereof on payment. Upon failure to do so, the company and every officer of the company who is in default shall be punishable for each offence with fine.


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BORROWING POWERS OF A COMPANY

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