Restrictions on Powers of Board to Borrow Money with Ultra Virus Borrowings

Restrictions on Powers of Board to Borrow Money as per Section 180 of Companies Act Along with Ultra Virus Borrowings.

RESTRICTIONS ON POWERS OF BOARD

As per the provisions of section 180 of the companies act provides the rules regarding the restriction on power to borrow by the board of directors.

The Board of Directors of a company shall exercise the following powers only with the consent of the company by a special resolution, namely:—

(i) To sell, lease or otherwise dispose of the whole or substantially the whole of the undertaking of the company or where the company owns more than one undertaking, of the whole or substantially the whole of any of such undertakings.

(ii) To invest otherwise in trust securities the amount of compensation received by it as a result of any merger or amalgamation;

(iii) To borrow money, where the money to be borrowed, together with the money already borrowed by the company will exceed aggregate of its paid-up share capital and free reserves, apart from temporary loans obtained from the company’s bankers in the ordinary course of business:

(iv) To remit, or give time for the repayment of, any debt due from a director.

(v) Every special resolution passed by the company in general meeting in relation to the exercise of the shall specify the total amount up to which monies may be borrowed by the Board of Directors.

(vi) The title of a buyer or other person who buys or takes on lease any property, investment or undertaking as is referred to in that clause, in good faith; or the sale or lease of any property of the company where the ordinary business of the company consists of, or comprises, such selling or leasing.

(vii) Any special resolution passed by the company consenting to the transaction as is referred to in clause (a) of sub-section (1) may stipulate such conditions as may be specified in such resolution, including conditions regarding the use, disposal or investment of the sale proceeds which may result from the transactions:

(viii) No debt incurred by the company in excess of the limit imposed by clause (c) of Sub-section (1) shall be valid or effectual, unless the lender proves that he advanced the loan in good faith and without knowledge that the limit imposed by that clause had been exceeded.

ULTRA VIRUS BORROWING

The power to borrow money is specified by the memorandum and articles of association of the Company and directors cannot go beyond such authority ,if the director borrow beyond the power prescribed by the MOA and AOA than the borrowings is considered as ultra-virus borrowings.

Borrowing by a company may be—

1. A borrowing which is ultra vires the company, or

2. A borrowing which is intra virus the company but ultra vires the directors.

Consequences of borrowing ultra- virus the company

When a company has no borrowing powers, or where the memorandum of association fixes a limit on the borrowing powers of the company, any borrowing in the first case and any borrowing in excess of such limit in the other case is ultra- virus the company.

In such a case the contract is void ab initio –and the lender cannot sue the company for the return of the loan. The lender will also be under an obligation to return back the securities, if any. The company cannot ratify the ultra vires loan by resolution in general meeting.

The lender has the following remedies;

1. Injunction. If a lender intervenes before the money has been spent, he has a right to follow his money and to obtain an injunction restraining the company from parting with it.

2. Subrogation. If the money borrowed ultra vires has been used to pay off legitimate debts of the company (whether incurred before or after the money was borrowed), the lender is entitled to treat his loan as intra-vires to the extent to which the money was so applied. He can sue the company by virtue of principle of subrogation. Here subrogation is allowed for the simple reason that when a company which borrows to pay off existing debts, does not thereby, increase its general indebtedness because there is merely replacement of one debt by another of the same amount.

Example :  A building society became indebted to some of its members for principal and interest due on a mortgage. It borrowed money ultra vires to pay off principal and interest. It was held that the lenders were subrogated to the rights of the creditors paid off.

The right of subrogation does not entitle the lender to any security held by the original creditor or to any priority that the original creditors may have had over the other creditors of the company.

However, the lender can retain the securities given to him by the company because his security will be good to the extent to which money was so applied for intravires debts.

3. Identification and tracing. If the money lent to the company can be traced in the hands of the company in original form or even if it has been employed for the purchase of property which is still capable of identification, the ultra vires lender can obtain a tracing order and may claim that asset or money.

But when the lender’s money and that of the company have become mixed up and the two cannot be separated from each other, the lender may claim parripassu distribution of the assets with the shareholders in the event of the winding up of the company.

Example :  A building society started banking business which was ultra vires the society. On its winding up, the assets were composed partly of the shareholders’ money and partly of the ultra vires depositors’ money.  It was not possible to trace out which part of the mixed fund belonged to the shareholders or the creditors.  The assets were also not sufficient to pay both in full.  It was held that the entire remaining amount should be apportioned between the shareholders and ultra vires depositors in proportion to the amount paid by them respectively. [Sinclair v. Brougham, (1914) A.C. 398]

Moreover, the lender may obtain injunction from the court for restraining the company from parting with the property/money held the same in trust for the lender.

4. Recovery of Damages. The lender may hold the directors personally liable for contracting an ultra vires loan of the company. The directors are liable for damages to the lender for the breach of the implied warranty of authority. But if the fact that the company has no powers to borrow is apparent upon reference to the company’s registered documents i.e. memorandum and articles, the lender cannot claim damages from directors upon this ground because he will be deemed to have knowledge of these public documents.

Example :  F did construction work for a company and agreed to accept debentures in payment instead of cash. F did not know that all the debentures which the directors could issue were already issued.  As the company had no assets to satisfy F’s claim on debentures, F sued the directors.  The Court of Appeal held that the issue of debentures was an over issue, was ultra vires and void and that the directors were liable for breach of the implied warranty of authority.  They were ordered to pay F the par value of the debentures he ought to have received. [Firbanks Executors v. Humphereys (1886) 18 Q.B.D. 54]

Consequences of borrowing intra vires the company but ultra vires the directors

A distinction must be drawn between borrowing ultravires the company i.e. outside the objects set out in the memorandum and borrowing ultra vires the directors. Borrowing in the first category is void and cannot under any circumstances by ratified by the company.

Borrowing ultra vires the directors, but within the power conferred by the memorandum, is voidable only and may be ratified by the company. If the borrowing is ratified, the company becomes liable to repay the money.

Where such borrowing is not ratified by the company, the remedies available to lender are :

1. Doctrine of indoor management. By relying on the rule in Royal British Bank v. Turquand he can recover the amount of loan from the company provided the borrowing was due to non-compliance with some internal regulations of the company.

2. No notice for unauthorised business. A lender is deemed to have notice of the limitations imposed by the memorandum and articles on the borrowing powers of the directors. A company can avoid the liability on the ground that borrowing was known or deemed to be known to be ultra vires. But if restrictions on the director’s authority are secret or not obvious from these documents, or otherwise the lender does not know of it from some other source, the company will be bound.

Further, where money is borrowed and used for the benefit of the company either in paying its debts or for its legitimate business, the company cannot avoid its liability on the ground that the agent had no authority form the company to borrow.

Example :  There was no limit on the borrowing for business in the memorandum of the company.  But the directors of a company could not borrow beyond the limit of the issued share capital of the company without the sanction of the general meeting.

The directors borrowed money from the plaintiff beyond their powers.  It was held “the money having been borrowed and used for the benefit of the principal either in paying its debts, or for its legitimate business, the company cannot repudiate its liability on the ground that the agent had no authority to borrow. When these facts are established a claim on the footing that money had been received would be maintainable.”

Further, the company shall not be liable for the unauthorised borrowings of its directors if it can establish that the borrowing was neither necessary nor ‘bonafide’ or for the benefit of the company but if a loan has not been taken in the name of the company it will not be liable even if it has received some benefit.