Any company which wants to conduct the business need to borrow money for its commencement and unless it is authorized by the Memorandum the company cannot borrow. If the company borrows without any authority such an act is ultra vires. The effects of such an act are: –
- No Loan – an ultra vires borrowing has no legal debt against the company and consequently it can be sued for the recovery of that loan. It is forbidden on the ground of public policy.
- Injunction – if the whole or part of the money is not spent then the lender can get restraining injunction order against the company.
- Subrogation – when money is used to pay lawful debts of the company then the lender will be subrogated to the position of the debtor to recover his loan. In simple words, the ultra vires lender can take the place of the previous debtor and the company still has the liability to pay off the debts. This way lender’s money is protected and the company is also burdened to pay. But the subrogated lender will not get any priority over other creditors of the company.
When the borrowing is authorized and it’s lawful then simply because the money is used in a prejudiced manner doesn’t mitigate the remedy of the lender. The lender can lawfully recover his dues from the company provided that the lender had no knowledge of the misuse of money. In VKRST Firm v. Oriental Investment Trust Ltd., it was held that under the authority of the company, its managing director borrowed large sums of money and misappropriated them the also company was made liable.
When borrowing is within the power of the company but outside the powers of its directors/managers then also the company may be made liable if the funds are used for lawful purpose but the Supreme Court applied this principle on circumstances and facts of each case.
The power to borrow also includes the creation of charge on the asset of the company. Under section 2(16) of the 2013 Act, it is defined as an interest or lien created on the property or assets of a company or any of its undertakings or both as security and includes a mortgage. The company by creating the charge gives the lender security on his money. After creation, it is the duty of the company under section 77 (2013) to register every charge created by it with the Registrar. A charge created on property or assets whether tangible or intangible and situated inside or outside of India has to be registered with the Registrar. The instrument is to be signed by both the company and charge and has to be registered with 30 days of its creation with required fees. Without the certificate of registration, the charge will not be taken into consideration at the time winding up by the liquidator or the creditors. Thereafter the register of charge has to be kept by both the Registrar and the Company.
Further charges are of two kinds of charges:- a fixed charge which is fixed and decided at the time of the creation of charge and floating charge which keeps on changing from time to time.