Borrowing power of a company by Vanshika Chauhan at LEXCLIQ

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


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‟. A public company can, however, offer its shares and debentures simultaneously after its commencement of business. 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. The directors of a public company or its subsidiary cannot, except with the consent of company in a general meeting, borrow money 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.


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

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