DEBENTURES AND CHARGES, BORROWING POWER

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DEBENTURES AND CHARGES, BORROWING POWER

Table of Contents

QUESTION BANK

  1. Define debenture. What are the kinds of debentures?
  2. Define debenture. Distinguish between debenture holders and shareholders.
  3. Define debenture, its meaning, fixed and floating charges and kinds of debentures.
  4. Debentures, meaning, kinds of debentures-discuss.
  5. Define debentures. What are the rights of a debenture holder?
  6. Explain borrowing power of company. What is consequences of unauthorised borrowing?

SHORT NOTES

  1. Floating Charge
  2. Fixed Charge
  3. Debenture
  4. Borrowing power/ effect of unauthorised borrowing.
  5. Charge, mortgage, debentures, kinds of debentures, Distinguish between

        shareholders and debentures holders.

  1. charge – fixed – Floating

[A] DEBENTURES[1]

I]        INTRODUCTION:-

          Whenever a company takes a loan, it gives a document as evidence of a debt or issues a certificate of indebtedness; such a certificate is called a ‘Debenture’.

          Debenture includes debenture stock, bonds, and any other security measures of the company. The debenture holder is the company’s creditor. He is not a member of the company. Therefore, he does not have the right to vote. S. 71 lays down provisions relating to debutantes.

II]      MEANING:-

          The meaning of debenture is indebtedness.[2] However, in a company’s parlance, debentures are an acknowledgement of its indebtedness.

In Laxman Bharamji V/s Emperor[3]

          The Bombay High Court observed that the document in question is an acknowledgement of debt and, therefore, a debenture.

          A company pays interest and redeems the debenture in accordance with the terms and conditions of its issue (S. 71 (8)). A contract with the company to take up and pay for any debenture may be enforced by a decree of specific performance (S. 71 (12)).

III]      DEFINITION OF DEBENTURE:-

(i) According to Section 2(30) of the Companies Act, 2013:-

“Debenture” includes debenture stock, bonds or any other instrument of a company evidencing a debt, whether constituting a charge on the company’s assets or not.

(ii)      According to Tophan:-

                    A debenture is a document given by a company as evidence of a debt to the holder, usually arising out of a loan and most commonly secured by a Charge.[4].

IV]     CHARACTERISTICS OF DEBENTURE:-

          Characteristics of debentures are as follows-

(i)       A document creates a debt or acknowledges the debt.

(ii)      A document usually provides for the payment of a specified sum at a fixed date.

(iii)     It is usually under the company’s seal but is not always necessary.

In British India Steam Navigation Company V/s Commissioners[5]

           Facts: The certificate was signed by two company directors but did not bear the company’s seal.

It was held to be a valid debenture.

(iv)     There may be a single debenture or series of debentures issued to an individual.

(v)      A debenture may or may not constitute a charge on the company’s assets.

(vi) Debenture does not carry voting rights (S. 71 (2)).

(vii) A contract with the company to take up and pay for any debenture of the company may be enforced by a decree for specific performance (S. 71 (12)).

V]       KINDS OF DEBENTURES:-

          The debentures may be-

(i)       Debentures payable to “registered holder[6]” and debentures payable to       “bearer”:-

When a company issues debentures, it maintains the register of holders of the debentures.

A debenture holder whose name is on the debenture certificate or the company’s register of debenture holders is called a “registered holder.”

The debentures payable to such a registered holder are known as “registered debenture”. Such debentures are issued in the name of the person who is registered as a “debenture holder“.

A debenture payable to a bearer is known as a “bearer debenture“. Such debenture possesses the characteristics of a negotiable instrument.

(ii)      Redeemable Debentures[7] and Perpetual Debentures[8]:-

Redeemable debts can be redeemed by paying the amount due on them at the expiry of a certain period.

Perpetual Debentures do not contain any payment of the amount due thereon, and there is no fixed time within which the company may redeem them.

(iii)     “Naked Debentures”[9] and “Mortgaged Debentures”:-

An unsecured debenture is called “naked debenture”. Such debentures do not carry any charge on the property of the company. They contain only a promise to pay and nothing more. Therefore, they are also called “unsecured debentures”.

‘Mortgage Debentures’ or ‘secured debentures’ are those which are secured by a charge on the whole or part of the company’s property. Secured debentures may be issued on such terms and conditions as may be prescribed (S. 71 (3)).

(iv)     Convertible Debentures[10] (S. 71 (1)):-

Convertible Debentures contain a clause which entitles the holder to convert his debenture into shares at the time specified in the debentures. A company may issue debentures with an option to convert such debentures into shares, either wholly or partly, at the time of redemption. However, such conversion shall be approved by a special resolution passed at a general meeting.

VI]     RIGHTS OF DEBENTURE HOLDERS:-

(i)      A debenture holder is a creditor of a company; i.e. he is not a member of the company; therefore, he has no voting right.

(ii)      The Debenture holder has the right to inspect trust deeds.

(iii)     Debenture holders have the right to inspect the register, and Index of Debenture holders also have the right to require the company to furnish copies.

(iv)     Debenture Holder may sue the company for the recovery of the money secured by the debentures and execute the decree against the property of the company.

(v)      Where the company makes default in payment of principal money or interest on the secured debentures-

(a)      He may sue on behalf of himself and all other debenture holders of the same class.

          (b)      He may sell property charged through the trustee.

(vi)     He has a right to file a petition for the company to wind up, i.e., compulsory winding up, by the court.

VII]   DEBEBTUE REDEMPTION RESERVE ACCOUNT (S.71 (4)):-

          Where a company issues the debentures under this section, the company shall create a debenture redemption reserve account out of the profits of the company, available for payment of the dividend, and the company shall not utilise the amount credited to such account except for the redemption of debentures.

VIII]    DEBENTURE TRUSTEES (S. 71 (5):-

a)       Appointment of Debenture Trustees (S. 71 (5)):-

No company shall issue a prospectus or make an offer or invitation to the public or its members exceeding five hundred for the subscription of its debentures unless the company has, before such issue or offer, appointed one or more debenture trustees and the conditions governing the appointment of such trustees shall be such as may be prescribed.

b)       Duties of Debenture Trustees (S. 71 (6)):-

    The debenture trustee shall take steps to protect the interest of the debenture holders and redress their grievances in accordance with such rules as may be prescribed.

c)        Liability of Debenture Trustee (S. 71 (7)):-

          Debenture Trustees are liable for any loss caused to the interest of debenture holders due to the failure of Trustees to show the degree of care and due diligence required of them as trustees. No provision exempting the Debenture Trustee from his liability be put in the debenture trust deed; otherwise, such provision would become void.

          However, liabilities of the Debenture Trustee shall be subject to such exemptions as may be agreed upon by the majority of debenture holders holding not less than three-fourths in value of the total debentures at a meeting held for the purpose.

d)       Right of Debenture Trustees to file a petition (S. 71 (9)):-

          Where at any time the debenture trustee comes to the conclusion that the assets of the company are insufficient or are likely to become insufficient to discharge the principal amount as and when it becomes due, the debenture trustee may file a petition before the Tribunal and the Tribunal may, after hearing the company and any other person interested in the matter, by order, impose such restrictions on the incurring of any further liabilities by the company as the Tribunal may consider necessary in the interest of debenture holders.

IX]     Distinction between Debenture holders and Shareholders:-

(1)      Position:-

          Debentures constitute loans to the company, while shares are parts of the company’s capital. The debenture holder is a creditor of the company, while the shareholder is a member of the company and enjoys all membership rights.

(2)      Right to Vote:-

          Debenture holders are not members of the company, so they do not have the right to vote, while shareholders are members of the company, so they possess the right to vote.

(3)      Share in Profit:-

          Debenture holders are entitled to a fixed rate of interest regardless of profit, while shareholders are entitled to dividends only from profit.

(4)      Redemption[11]:-

          Debentures can be redeemed, whereas shares (except preference shares) cannot be paid back.

(5)      Priority in Payment[12]:-

          Debenture holders, the company’s creditors, get priority in payment over the shareholders at the time of winding up of a company.

(6)      Charge:-

Usually, debentures have a charge over the company’s property, but shares have no such charge. Shareholders have the right to control and interfere in the company’s affairs, whereas debenture holders have no such control.

[B] CHARGE[13]

I]       Definition of “Charge” (S. 2 (16)):-

“Charge” means-

“(i) an interest or lien

(ii) created on the property or assets of a company or any of its undertakings or both,

(iii) as security[14] and

(iv) includes a mortgage.”

The company creating a charge within or outside India must register the charge on its property or assets or any of its undertakings (S.77). The company must also give the registrar intimation of the payment or satisfaction in full of any charge registered with him (S. 81).

Debentures are normally secured by the charge. A charge may be a fixed charge or a floating charge.

II]       Kinds of Charge:-

          The company can issue debentures keeping a charge on its property; such a charge may be.-

(i) Fixed Charge or Specific Charge[15]:-

          When the Charge is created on a definite and ascertained property, it is called a “fixed charge.”

          Under fixed charge, a company’s certain property is mortgaged to the holder of the debenture; the company cannot transfer such property without the holder’s consent.

Examples of fixed charges- are charges on land, buildings, etc., which are definite properties.

(ii)      Floating Charge[16]:-

          A floating charge is a charge on the property which keeps changing. It is not fixed but changing or unstable.

          When assets are subject to a floating charge, they can be dealt with in the ordinary course of business. This means all the company’s present or future property is subject to the charge. It is an unstable property; a charge created thereon, for example, a charge for the company’s raw materials, will be floating.

In Government Stock company V/s Manilal Rail Co[17]

Lord Manghten has explained the nature of the floating charge in the following words. “A floating security is an equitable charge on the assets for the time being of a going concern”.

a)       Characteristics of Floating Charge:-

          Floating Charge shall consist of three important characteristics. They are-

(i)       It is a charge on a class of assets of a company present and future.

(ii)      That class of assets changes from time to time in the ordinary course of a company’s business. For example, raw material is used in production, and the final product is made of it, so raw materials change.

(iii)     It is contemplated by the charge that, until some steps are taken by the mortgagee or holder, the company shall have the right to use the assets comprised in the charge in the ordinary course of business.

b)       Crystallization of floating Charge[18]:-

          The floating charge becomes fixed in the following circumstances, viz.

  • at the time of liquidation[19].
  • at the time of closing the business.
  • When the debenture holder enforces it.
  • On the happening of a specified event stipulated in an agreement.

After it becomes fixed, the floating charge gets first priority at repayment, like the fixed charge.

[C] BORROWING[20]  POWER:-

          Capital is necessary for the establishment of a company. Borrowing is one of the important sources of capital. The Companies Act 2013 enacts laws regarding borrowing by public and private companies. This rule does not make any discrimination between public and private companies. The Companies Act 2013 lays down restrictions on borrowing, which was not included in the earlier Act.

I]       As to Borrowing:-

(i) Implied power to borrow:-

          In England and India, the Courts have recognised the power of borrowing for trading companies. However, non-trading companies cannot borrow money unless authorised by a memorandum of Association of the Company.

(ii)      Charge on Property:-

          When a company borrows money, it charges its property or mortgages its property as security for the repayment of the loan.

(iii)     Board of Directors (S. 179 (3) (b)):-

          Generally, the Board of Directors’ borrowing power is required to be exercised according to the provisions of the Memorandum and Articles of the Company. The present Companies Act empowers directors to borrow; however, such borrowing is restricted, as discussed in S. 180.

(iv)    Limits on the amount to be borrowed (S. 180 (1) (c)):-

          Generally, the Memorandum of Association and Article of Association may specify the maximum amount beyond which the company cannot borrow. However, the Companies Act, 2013 in S. 180 (1) (c) has laid down the limit on the borrowing power of the Board of Directors. The section imposes statutory limitations on borrowing power. It lays down that the Board of directors can only borrow money with the consent of the company, i.e., a General Meeting of shareholders with a special resolution,

  • where the money is to be borrowed (together with what has already been borrowed) by the company.
  • will exceed the aggregate of its paid-up share capital and free reserves.

Every such resolution shall specify the total amount up to which the Board of Directors may borrow money.

(v)       Exceptions to the rule:-

(i)      It does not include temporary loans from the company’s bankers in an ordinary course of business.

“Temporary loans” means the loans repayable on demand or within six months from the date of the loan.[21], such as short-term loans of a seasonal character, but do not include loans raised for the purpose of financial expenditure of a capital nature.

(ii)       Banking company:-

An acceptance by a banking company, in the ordinary course of its business, of deposits of money from the public, repayable on demand or otherwise, and withdrawable by cheque, draft, order or otherwise, shall not be deemed to be a borrowing of monies by the banking company within the meaning of this clause.

It means the routine business of a banking company as a banker does not amount to borrowing, requiring a special resolution of the company.

II]     Modes of Borrowing:-

          A company which has the power to borrow may borrow it in the following ways-

(i)       On a legal mortgage of any specific portion of its property by equitable mortgage (i.e. by deposit of title deeds, etc.).

(ii)      By a floating charge on the whole undertaking of the company.

(iii)     By Bonds,

(iv)     By Promissory Notes[22],

(v)      By Debentures,

(vi)     By Debenture Stocks,

(vii)    By obtaining an overdraft[23] from the Bank.

III]     Unauthorized Borrowing[24]:-

          Borrowing may be ultra vires in the following circumstances-

(1)      Borrowing beyond the authority of the directors (S. 180 (5)):-

          No debt incurred by the company in excess of the limit imposed by the special resolution 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 the clause had been exceeded.

In National Provincial Bank Ltd[25]

         Facts—A company borrows money from a bank and issues its debenture to the bank as security. The company uses the money so borrowed for an ultra-vires purpose. At the time of the borrowing contract, the bank knew that the borrowing was for an ultra-vires purpose.

           Held—The bank’s loan knowingly made for an ultra-virus purpose was invalid, and the debentures issued to the bank were not genuine.

(2)      Borrowing Ultra Vires the company:-

          Where a company has no borrowing power or where the memorandum of association fixed a limit on the borrowing powers of the company, in such cases, any borrowing or borrowing in excess of the limit is Ultra-Vires, the company.

          In such cases, the contract is not voidable but void and incapable of ratification. Such borrowing does not give rise to any indebtedness on the company’s part.

(3)      Remedies in case of ultra-vires borrowing:-

          In such cases, the money lender has the following remedies if he proves his good faith and lends without knowing that the directors or the company have exceeded the borrowing limits.

(i)       Injunction[26]:-

          He has a right to follow his money and to obtain an injunction restraining the company from parting (spending) with it.

(ii)      Subrogation[27]:-

          If the money borrowed has been applied to paying debts incurred by the company, he is considered a creditor to the extent to which the money has been applied.

(iii)     Identification and Trading:-

          If an ultra-virus lender can identify his money or any property purchased by such lending, he is entitled to know the trading order and how to recover it.

(iv)     Damages for Breach of Warranty of Authority:-

          In some cases, the lender has a right against the directors personally for breach of warranty or authority to borrow.

In the case of Weeks v/S Propers[28]

         Facts—A railway company had fully exercised its borrowing power. The directors advertised that they would receive money lent to secure debentures. Weeks lent £ 500 and received a debenture.

          Held – Weeks would successfully sue the directors for breach of warranty.

(v)     No Recovery of Loan:-

          Ultra-vire lenders cannot sue the company to recover their loan from the Company.

In case Madras Native Permanent Fund Ltd. V/s Re[29]

            The Madras H.C. has held that the ultra virus loan is void and is treated as a non-existing debt. The Court held that an ultra-virus loan does not create any relationship between creditor and debtor among debenture holders and the company.

*****

[1]  कर्जरोखे- जेव्हा कंपणी कर्ज घेते तेव्हा ती कर्जाचा पुरावा म्हणुन किंवा कर्जदार असल्याचा दाखला देते त्या पुराव्यास अथवा दाखल्यास कर्जरोखे म्हणतात [“ऋणपत्र”जब भी कंपनी ऋण लेती है]तो वह ऋण के प्रमाण के रूप में दस्तावेज देती है या ऋणग्रस्तता का प्रमाणपत्र जारी करती हैA ऐसे प्रमाणपत्र को डिबेंचर कहा जाता है।]

[2]   कर्जदार असण्याचा पुरावा [ऋण पत्र का अर्थ है ऋणग्रस्तता]

[3] AIR 1946 Bom 18

[4]“ऋणपत्र” एक कंपनी द्वारा एक ऋण के प्रमाण के रूप में धारक को दिया गया एक दस्तावेज हैA जो आम तौर पर एक ऋण से उत्पन्न होता है और आम तौर पर एक शुल्क द्वारा सुरक्षित होता हैA

[5] (1881) 7 QBD 156

[6] कायदेषीर धारक [पंजीकृतधारक]

[7]“प्रतिदेय ऋण पत्र” वे होते हैं जिन्हें एक निश्चित अवधिकी समाप्ति पर उस परदेय राशि का भुगतान कर के भुनाया जा सकता है |s

[8]   परत फेडीची मुदत निश्चीत नसलेले कर्जरोखे [ऐसा ऋण पत्र जिस के देय की अवधी निश्चित नही होती भुगतान नहीं होता है|]

[9] असंरक्षीत कर्जरोखे [खुला ऋणपत्र]

[10] भागांमधे परिवर्तेनषील कर्जरोखे [परिवर्तनीय ऋण पत्र]

[11] छुटकारा

 [12] परतफेड अग्रकृम [भुगतान में प्राथमिकता]

[13]बोझा [प्रभार]

[14] सुरक्षा

[15]पक्का/निश्चित बोझ [स्थिर किंवा निष्चित बोझा]

[16] चल किंवा तरता [अस्थायी/ चालता बोझ/प्रभार]

[17](1897 AC 81)

[18] चल किंवा तरता बोझा स्थिर किंवा निष्चित करने [कब चालता बोझ स्थिर होताहै|-

[19] कंपणीचा कारभाराचा गाषा गुंडाळताना. [परि समापन के समय]

[20] कर्ज काढणे/ ब-याच वेळा असे कर्ज हे तात्पुरत्या कारनासाठी काढलेले असते [ऋण लेना]

[21] “अस्थायी ऋण” का अर्थ है मांग पर या ऋण की तारीख से छह महीने के भीतर चुक ने योग्य ऋण

[22] हमीपत्र [वचनपत्र]

[23] Withdrawing amount more than balance in account.

[24] मान्य नसनारे कर्ज / अधिकार बाहय कर्ज [अनधिकृत कर्जा]

[25](1970) Ch. 99

[26] स्थगीती [मनाही-हुक्म]

[27] मुळ कर्जदाराचे स्थानी जाने [सप्रत्यासन]

[28](1970) Ch. 99

[29](1931) 605

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