Debt Funding

So far, we studied:

• Power of the companies to borrow

• Exemptions and Exclusion
• Lenders’ Responsibilities
• Effect of ‘Doctrine of Indoor Management”
• Case Laws

In Krishnan Kumar Rohatgi and Others v. State Bank of India and Others,
(1980):
• The company borrowed Rs. 5 lakhs from the Bank under a Promissory Note.

• The repayment was guaranteed by a person by executing a guarantee in favor of

the company.

• The company used to make payments towards loan and the promissory note used

to be renewed from time to time.

In the suit for recovery, the company contended that:

• The pro-note was executed by the Chairman

• Without there being a resolution of the Board of Directors authorizing the

Chairman to execute the pro-note

• As required under Sec 292(1)(c) of the Act,1956 and [Sec 179(1)(d) of the

Companies Act, 2013].

• Rejecting these contentions, the Patna High Court held that:

• In cases where the directors borrow funds without their having authorization from

the company and

• If the money has been used for the benefit of the company, the company cannot

repudiate its liability to repay.

Case: What if…
• AoA has fixed the borrowing limit for the Board as INR 100 lakhs.

• Directors borrowed INR 150 lakhs.

• Company refuses to ratify.

• Is lender protected?

Held: Doctrine of Constructive Notice

o MoA and AoA are public documents.

o The contents are deemed to be known by the lenders.

o Lender will have no right of action against the company.

Ultra Vires Borrowing:

• Borrowing without having authority under the AoA or beyond the limits set

out in the AoA, is ultra vires borrowing.

• Ultra vires acts are void.

• The securities given for such ultra-vires borrowing are also void and

inoperative.

• Ultra vires borrowings cannot even be ratified by shareholders.

• Lender cannot sue the company for the return of the loan and enforce any

security granted to him.

• No agent can have a power which is not with the principal.

➢ Therefore, if the borrowing is ultra vires the company so that the company has

no capacity to undertake it, the lender can have no rights at common law.

➢ No debt is created and any security which may have been created in respect of

the borrowing is also void. The lender cannot sue the company for the

repayment of the loan- Held in the case - Sinclain v. Brouguham (1914).

No Bona Fide:

Where the managing agent of a company:

➢ Who is not authorized to borrow,

➢ Has borrowed money

➢ Which is not necessary,

➢ Neither bona fide,

- Nor for the benefit of the company, the company is not liable for the amount

borrowed – held in the case - Equity Insurance Co. Ltd. v. Dinshaw & Co., AIR 1940

Intention to Bind the Company:

Case: L & Co. was in liquidation. ‘P’ the manager borrowed a sum of money from ‘J’

in his own name. In one letter to ‘J’ he indicated that the loan was for a requirement

of L & Co. L & Co had actually benefited.

Held: It was held that there was no intention to bind the company. “The mere fact that

the company had benefited was not in itself sufficient to bind the company” – held in

the case - Suraj Babu v. Jaitly & Co. AIR 1946

Lenders’ Remedies:

o Injunction and Recovery

o Subrogation

o Suit against Directors

Injunction and Recovery:

Under the Equitable Doctrine of Restitution Lender can obtain an Injunction:

o If he can trace and identify the money lent, and

o Any property which the company has bought with it or

o At least prove that the company has been benefited thereby.

Subrogation:

• If the void borrowing was used for repayment of valid borrowing…….

• The lender of void borrowing would be subrogated to the position of creditor paid

off and to that extent would have the right to recover his loan from the company.

• Since, the total indebtedness of the company remains the same and debt burden

of the company is in no way increased.

Suit against Directors:

• If the void borrowing was used for repayment of valid borrowing…….

• The lender may sue the directors for breach of warranty of authority. This is more

so, if the directors deliberately misrepresented their authority – held in the case -

Executors v. Humphreys (1866).

Types of Borrowing:

• Term

• Security

• Parties

• Private / Public

A. Term

1. Long Term Borrowings:

• Whose term of borrowing is 5+ years,

• Purpose: Big Projects Normally with creation of charge

 2. Medium Term Borrowings:

• Whose term of borrowing is 2 to 5 yrs.

• Purpose: Assets Purchase Normally with charge

3. Short Term Borrowings:

• Whose term of borrowing is up to 2 years

• Purpose: Working Capital Hypothecation on stocks and debtors.

B. Security:

• Secured Debts - creditors have recourse to the assets ahead of other

Claims

• Unsecured Debts - creditors DO NOT have recourse to the assets

C. Parties:

1. Syndicated Borrowing: Group of lenders lent under one agreement to the

borrower

2. Bilateral Borrowing: Lending under direct Agreement between lender and

borrower

D. Private / Public:

1. Private borrowing: Lender and borrower are private entities. Lending under a direct

agreement.

2. Public Borrowing: Debentures, Bonds etc., issued to public, freely tradable on a

public exchange or over the counter

Security for Borrowing:

• Mortgage: On immovable property, possession remains with borrower.

• Hypothecation: On movable assets, the possession remains with the borrower

• Lien: Right of detaining the property until the claim be satisfied.

• Pledge: On movable assets, the possession is taken by lender

Guarantee: This is a promise by one party to assume the debt obligation of a

borrower if that borrower defaults.

A loan taken by a company may be secured by any of the following:

a) A legal mortgage of specific part of its property;

b) An equitable mortgage by deposit of title deeds;

c) A mortgage of movable property;

d) Issuing Bonds;

e) Issuing Promissory notes and Bills of Exchange;

f) A charge on uncalled capital;

g) A charge on calls made but not paid;

h) A floating charge on the assets of the company;