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CHAPTER 8 – BORROWINGS & CHARGES

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. A public company can borrow only after the receipt of Commencement Certificate. [Section 149(1)]. But a private company can borrow immediately after the incorporation The Board of Directors may borrow moneys by passing a resolution passed at the meetings of the Board. The board may delegate its borrowing powers to a Committee of Directors. Such a resolution should specifically mention the aggregate amount upto which the moneys can be borrowed by the Committee, the Managing Director, Manager or any other principal 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) shall not exceed the 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. 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 of business. Hire purchase and leasing transactions. Purchase of machinery on deferred payment.

Restrictions on borrowing power
• •

• • • • • •

Transactions, which are not borrowing

ultra vires BORROWING

• •

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 and the Articles of the company. An act of borrowing by the company may be ultra vires (outside the power of) the company or ultra vires the directors or ultra vires the Articles. 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 are inoperative. Thus, the lender cannot sue the company for the return of the loan and shall be under an obligation to return back the securities, 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. Ratification of borrowing - If the borrowing power exercised by the company is ultra 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 such act of the directors. In that case the debt will be valid and binding on the company.
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CHAPTER 8 – BORROWINGS & CHARGES 36 Even if the borrowing is not ratified by the company, the lender in good faith will be protected since the directors in borrowing the money had acted as agent of the company. 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 Ratan Cotton Mills Co. Ltd v. J K Jute Mills Co; Ltd (1957) 27 Comp. Cas. 660 (All).]

CHARGES
• 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 requirements of a company. Loan-money has, therefore, to be raised from a large 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 rise to the concept of pari passu ranking. Since other trade creditors have also to seek payment only out of the 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

1.

When floating charge becomes crystallised

Fixed charge - a charge is fixed when it is made specifically to cover definite an ascertained assets of permanent nature such as land, building, o heavy machinery. A fixed charge passes legal 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. 2. Floating charge – it is a charge on the current assets of the company, present or future which 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.

(i) (ii) (iii)

Registration of chares [Section 125]

When the company goes into liquidation; When the company ceases to carry on the business; When the creditors or the debenture holders take steps to enforce this security e.g. by appointing receiver to take possession of the property charged; (iv) On the happening of the even specified in the deed. 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) Securing any issue of debentures; (ii) Uncalled share capital of the company; (iii) Any immovable property; (iv) Book debts, stock in trade or other current assets of the company; (v) Any movable property (not being a pledge); (vi) Calls made but not paid; (vii) IPRs of the 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, ROC shall issue a Certificate of charges, which shall be conclusive evidence. 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. The ROC shall on receipt 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 satisfaction of the charge. A memorandum of satisfaction shall be entered in the Register by the ROC.

•

•

Memorandum of satisfaction [Section 138-140]

•

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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.

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 2(12)]. Features of a Debenture • The usual features of a debenture are as follows: (i) in the form of a certificate (like a share certificate) issued under the common seal of the company. The certificate is an acknowledgement by the company of indebtedness to a holder. (ii) provides for the payment of a specified principal sum at a specified date with contracted rate of interest. (iii) issued in series. (iv) Secured by a charge on the undertaking of the company, or on some class of its assets or on some part of its profits. [Unsecured debenture is a deposit with the meaning of the Companies (Acceptance of Deposits) Rules 1975]. Debenture stock • Debenture stock is of the same nature as debentures but instead of each lender having separate 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 convenience. Loan It is a right in the creditor to demand repayment, - a liability upon the debtor to repay the money
Debentureholder 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. Must be repaid as per the terms of issue. 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. Shareholder 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

Status Income Repayment Order of repayment Conditions of issue Rights and Privileges

KINDS OF DEBENTURES
• Debenture may be of different kinds as follows: (i) Redeemable Debentures; (ii) Perpetual or Irredeemable Debentures; (iii) Registered and Bearer Debentures (iv) Secured and Unsecured or Naked Debentures; (v) 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
  Purpose of Issue FCD** (with a conversion 

Compliance requirement
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 an option to sell) and `call` (means an LECTURES BY PROF. S N GHOSH

WLC period of more than 36 months) Credit rating Pre-determination of Premium on conversion and time of conversion Interest rate Debenture Trustee  Monitoring  Debenture Redemption Reserve (DRR)    Distribution of dividends Non certificate encumbrance      

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CHAPTER 8 – BORROWINGS & CHARGES

option to buy) option. Mandatory for debentures redeemable after 18 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. Considered as part of General Reserve for bonus issue proposals and for price fixation. New companies shall require approval of the trustees to the issue and the lead 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 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 Disclosure and Creation of Security

** FCD – Fully Convertible Debenture

DEBENTURE TRUST DEED [SECTION 117A, 117B and 117C, 118 -121 READ WITH SEBI (DEBENTURE TRUSTEES) REGULATIONS, 1993] Purpose and nature of trust deed
• • 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 amongst other matter accept the trust deed, which shall contain the matter specified in 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) Provisions for redressal of grievances of debenture holders (b) Time limit within which the security for the issue of debentures shall be created (c) Obligation not to create further charge or encumbrance of the trust property without the prior approval of the trustee (d) Obligation of the body corporate to the debenture trustees and debenture holders (e) Events constituting defaults (f) Procedure for appointment of new trustees and their removal (g) Removal of debenture trustees on a resolution passed by at least 75% if the total debenture holders of a body corporate (h) Rights of debenture holders incase of default by the body corporate (i) Fees or commission of debenture trustees (j) Circumstances when the security will become enforceable. (k) Redemption of the debentures in terms of the issue to the debenture holders (l) Obligation to convert the debentures into equity in accordance with the terms of the issue (m) Debt equity ratio and debt service coverage ratio (n) Method and mode of preservation of assets charged as security for debenture holders (o) Circumstances specifying when the security may be disposed of or leased out with the approval of trustees. (p) Procedure for allowing inspection of charged assets by trustees or any person authorised by them. (q) Obligation to inform debenture trustee about any change in nature and conduct of business by the body corporate before such change. (r) Obligation of body corporate to keep the debenture trustee informed of all the orders, directions or notices of court or tribunal affecting or likely to affect the charged assets (s) Obligation to inform debenture trustee of any change in composition of its Board of Directors. (t) Obligations of the body corporate to forward a quarterly report to debenture trustees containing the following particulars ** Updated list of the names and addresses of the 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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LECTURES BY PROF. S N GHOSH