subject: Consequences of unauthorized Borrowings [print this page] Consequences of unauthorized Borrowings Consequences of unauthorized Borrowings
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.
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, if 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).]
