Borrowing Power

L36-37
LEARNING OUTCOME
Identify the legal consequences associated with
ultra vires actions
Why borrowing?
For running a new business effectively and successfully and adequate amount of capital is
required. In some of the case is the capital is arranged through internal sources that is by the
way of issuing equity share capital are true accumulated profit.
Whereas in some cases external resources are also used this can be external commercial,
borrowing, debentures, public fixed deposits, bank loans etc. Borrowing can be defined as
under which money is arrange with an external sources.
Power of a Company to Borrow
Under the power of a company exercise by its directors who cannot borrow more than the sum
authorized. Under these two company directors can only be exercised for borrowing money by
issuing debentures.
Directors have the power to pass a resolution to borrow money. However, the power to borrow money
can only be delegated by passing resolution. Under the resolution the total amount of money
which can be bothered must be written.
The board of directors of the company are restricted from borrowing a sum of money which is obtained
from temporary loans that are obtained from the company’s banker. Temporary loans are the
loans which are re-payable on the demand within 6 months from the date.
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.
Unauthorized Borrowings
When a company borrow something without the authority or beyond
the amount set out in the articles it is an unauthorized borrowing.
These borrowings are void. When these borrowings take place then
the contract is automatically void and the lender cannot sue the
company.
The securities which are given for these unauthorised borrowing are
void and inoperative.
Borrowing by a company may be—
1. A borrowing which is ultra vires the
company, or
2. A borrowing which is intra vires the company
but ultra vires the directors.
Consequences of borrowing ultra-
vires 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- vires 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.
Crux
Q1. Ultra vires borrowing are
__________________
a) Valid and enforceable
b) Void
c) Void and unenforceable
d) Void and enforceable
• C
Remedies for Lender
1. Injunction
2. Subrogation
3. Identification and tracing
4. Recovery of Damages
Injunction
Injunction means a court order restraining a person from doing a
particular thing.
If money is advanced by lender and is not spent by company , lender

can obtain injunction orders restraining company from
parting/spending his money.
Thus, lender can take money back so long it is actually in possession of

company.
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.
A company owed Rs. 2 lakh to Adam, one of its creditor. The
directors borrowed Rs. 3 lakh from Lakhan, a money lender. This
borrowing was ultra-vires the company to pay its legitimate debt
and remaining for its business activities. In this Lakhan is
subrogated to the rights of companys’ creditor Adam to the extent
of Rs. 2 lakh and can recover the same from the company. For
remaining rupees, Lakhan may exercise other rights available to
him.
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.
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.
Recovery and 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.
Legality of borrowings ultra-vires the
directors
1. Ratification by Company
2. Misappropriation of money to unauthorized
activities
Q3. ______means a court order restraining a
person from doing a particular thing.
a)Subrogation
b)Injunction
c) Misappropriation
d)None of the above
• B
Q4. 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
a) Subrogation
b) Injunction
c) Misappropriation
d) None of the above

• a

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L36-37

which can be bothered must be written.

An act of borrowing by the company may be ultra vires (outside the

3. Identification and tracing

If money is advanced by lender and is not spent by company , lender

Thus, lender can take money back so long it is actually in possession of

• But when the lender’s money and that of the company

• A distinction must be drawn between borrowing

d) None of the above

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