“Law Master’s” Publication
Debentures & Charges
Prof. .S. D. Bhosale
118
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DEBENTURES AND CHARGES, BORROWING POWER
QUESTION BANK
1.
2.
3.
Define debenture. What are the kinds of debentures?
Define debenture. Distinguish between debenture holders and shareholders.
Define debenture, its meaning, fixed and floating charges and kinds of
debentures.
4.
5.
6.
Debentures, meaning, kinds of debentures-discuss.
Define debentures. What are the rights of a debenture holder?
Explain the borrowing power of the company. What is consequences of
unauthorised borrowing?
SHORT NOTES
1.
Floating Charge
Fixed Charge
Debenture
2.
3.
4.
5.
Borrowing power/ effect of unauthorised borrowing.
Charge, mortgage, debentures, kinds of debentures, Distinguish between
shareholders and debentures holders.
6.
charge - fixed – Floating
Table of content
INTRODUCTION:-............................................................................................120
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Debentures & Charges
Prof. .S. D. Bhosale
119
According to Tophan:-.......................................................................................121
KINDS OF DEBENTURES:- ...........................................................................121
Convertible Debentures (S. 71 (1)):- .................................................................122
Position:-..................................................................................................123
Right to Vote:- .........................................................................................124
Share in Profit:-........................................................................................124
Redemption:- ...........................................................................................124
Priority in Payment:-................................................................................124
Charge:- ...................................................................................................124
[B] CHARGE .................................................................................................................124
Definition of “Charge” (S. 2 (16)):- ...................................................................124
Kinds of Charge:- ..............................................................................................124
(i) Fixed Charge or Specific Charge:-........................................................................125
Floating Charge:- ...............................................................................................125
[C] BORROWING POWER........................................................................................126
As to Borrowing:- ................................................................................................126
(i) Implied power to borrow:- ....................................................................................126
Charge on Property:-..........................................................................................126
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Debentures & Charges
Prof. .S. D. Bhosale
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Exceptions to the rule:-.....................................................................................126
Modes of Borrowing:-..........................................................................................127
Unauthorized Borrowing:-..................................................................................127
In National Provincial Bank Ltd.....................................................................127
Borrowing Ultra Vires the company:- ...............................................................128
Remedies in case of ultra-vires borrowing:-......................................................128
(i) Injunction:-..................................................................................................128
Subrogation:- ...........................................................................................128
(iii) Identification and Trading:-.....................................................................128
No Recovery of Loan:-.............................................................................128
[A] DEBENTURES
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. However, in a company's parlance,
debentures are an acknowledgement of its indebtedness.
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
1 AIR 1946 Bom 18
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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..
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.
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" 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".
2 (1881) 7 QBD 156
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A debenture payable to a bearer is known as a "bearer debenture". Such
debenture possesses the characteristics of a negotiable instrument.
(ii)
Redeemable Debentures and Perpetual Debentures:-
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” 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 (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
The Debenture holder has the right to inspect trust deeds.
.
(ii)
(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)
(a)
Where the company makes default in payment of principal money or
interest on the secured debentures-
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.
He has a right to file a petition for the company to wind up, i.e.,
(vi)
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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]
(1)
Distinction between Debenture holders and Shareholders:-
Position:-
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Debentures & Charges
Prof. .S. D. Bhosale
124
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:-
Debentures can be redeemed, whereas shares (except preference shares) cannot
be paid back.
(5) Priority in Payment:-
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
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 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
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charge may be.-
(i)Fixed Charge or Specific Charge:-
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:-
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.
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:-
The floating charge becomes fixed in the following circumstances, viz.
(i)
at the time of liquidation
.
(ii)
at the time of closing the business.
(iii)When the debenture holder enforces it
.
(iv)On the happening of a specified event stipulated in an agreement.
3(1897 AC 81)
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After it becomes fixed, the floating charge gets first priority at repayment, like
the fixed charge.
[C] BORROWING 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,
(i)
where the money is to be borrowed (together with what has already been
borrowed) by the company.
(ii)
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
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ordinary course of business
.
“Temporary loans” means the loans repayable on demand or within six months
from the date of the loan., 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)
mortgage (i.e. by deposit of title deeds, etc.).
(ii) By a floating charge on the whole undertaking of the company.
(iii) By Bonds,
On a legal mortgage of any specific portion of its property by equitable
(iv)
(v)
By Promissory Notes,
By Debentures,
(vi)
By Debenture Stocks,
(vii) By obtaining an overdraft from the Bank.
III]
(1)
Unauthorized Borrowing:-
Borrowing may be ultra vires in the following circumstances-
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.
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,
4(1970) Ch. 99
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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:-
He has a right to follow his money and to obtain an injunction restraining the
company from parting (spending) with it.
(ii)
Subrogation:-
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.
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.
The Madras H.C. has held that the ultra virus loan is void and is treated as a
5(1970) Ch. 99
6(1931) 605
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non-existing debt. The Court held that an ultra-virus loan does not create any
relationship between the creditor and the debtor among the debenture holders and the
company.
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