Companies borrow money to finance operations and growth. The Companies Act regulates HOW companies borrow (powers and limits), WHAT instruments they use (debentures), and HOW they secure borrowings (charges on assets). Registration of charges is MANDATORY failure renders the charge void against liquidator and creditors.
Legal Framework
| Provision | Subject |
|---|---|
| S.179(3)(d) | Board may borrow; special resolution if exceeding paid-up capital + free reserves |
| S.180(1)(c) | Borrowing beyond paid-up capital + free reserves: special resolution needed |
| S.71 | Debentures |
| S.77 | Registration of charges (within 30 days of creation) |
| S.82 | Company to report satisfaction of charge |
| S.83 | Power of ROC to make entries of satisfaction |
| S.84 | Consequence of non-registration (charge void against liquidator/creditors) |
| S.100 | Charge on assets in India of foreign companies |
Borrowing Powers
| Power | Limit | Authority Required |
|---|---|---|
| Board can borrow | Up to aggregate of paid-up share capital + free reserves + securities premium | Board resolution (S.179(3)(d)) |
| Beyond limit | Exceeding above aggregate | Special resolution at general meeting (S.180(1)(c)) |
| Secured borrowing | Creating charge on company assets | Board resolution + charge registration (S.77) |
| Acceptance of deposits | Regulated separately (S.73-76; deposit rules) | Board resolution + compliance with deposit rules |
Why: Borrowing limits exist to protect SHAREHOLDERS directors should not be able to pledge the entire company without shareholder consent. Requiring special resolution (75% majority) for heavy borrowing ensures informed investor participation in major financial decisions.
Debentures (S.71)
| Aspect | Content |
|---|---|
| Definition | A debenture includes debenture stock, bonds, and any other securities of a company whether or not constituting a charge on assets (S.2(30)) |
| Nature | DEBT instrument acknowledges a loan; creates debtor-creditor relationship |
| Holder | CREDITOR of company (not a member; no voting rights on business matters) |
| Return | Fixed interest (regardless of profit unlike dividend which depends on profit) |
| Security | May be secured (charge on assets) or unsecured |
| Redemption | Must be redeemed within 10 years from issue (S.71(1)); infrastructure companies: 30 years |
| Trust deed | If secured debentures issued to 500+ holders: debenture trust deed mandatory (S.71(5)) |
| Voting | No voting rights at general meetings (but may vote at meetings of debenture-holders) |
Types of Debentures
| Type | Feature |
|---|---|
| Secured | Backed by charge on company assets (fixed or floating) |
| Unsecured (Naked) | No charge; holder is ordinary creditor on winding up |
| Registered | Recorded in register; transfer by instrument of transfer |
| Bearer | Transferable by delivery (like currency note) |
| Redeemable | Company repays principal on specified date |
| Convertible | May be converted into shares on specified terms/date |
| Non-convertible | Redeemed only in cash; no conversion right |
| Perpetual/Irredeemable | No fixed redemption date (now restricted under S.71: max 10/30 years) |
Charges (S.77-87)
A charge is a security interest on company property in favour of a creditor giving the creditor priority in recovering debt from that specific asset.
Types of Charges
| Type | Definition | Example |
|---|---|---|
| Fixed charge | Created on SPECIFIC, identified, ascertained asset; company cannot deal with asset without consent | Mortgage on factory building; charge on specific machinery |
| Floating charge | Created on a CLASS of assets (present and future) without identifying specific ones; company CAN deal freely with assets until "crystallisation" | Charge on "all stock-in-trade" or "all book debts" or "all assets present and future" |
Fixed vs Floating Charge
| Aspect | Fixed Charge | Floating Charge |
|---|---|---|
| Asset | Specific, identified, ascertained | Class of assets (present + future); unidentified |
| Company's power | Cannot deal with asset without chargee's consent | CAN deal freely (sell stock, collect debts) until crystallisation |
| Crystallisation | Not applicable (already fixed) | Converts to fixed on: (a) winding up, (b) default, (c) appointment of receiver |
| Priority on winding up | FIRST priority (after costs) | After fixed charges + preferential creditors |
| Example | Mortgage on office building | Charge on "all current assets" |
| Registration | Mandatory (S.77) | Mandatory (S.77) |
Registration of Charges (S.77)
| Requirement | Rule |
|---|---|
| Filing | Particulars of charge must be filed with ROC within 30 days of creation |
| Extension | ROC may allow up to 300 days additional (on application showing cause) |
| Who files | Company OR charge-holder (creditor) |
| Consequence of non-registration | Charge is VOID against liquidator and other creditors (S.84) |
| Debt remains | The debt itself is NOT void but the SECURITY is lost (becomes unsecured) |
| Company + officer penalty | Fine for default in registration (company + officer in default) |
Why: Registration protects SUBSEQUENT creditors if a charge is not registered, a later lender might lend money believing the asset is unencumbered. Without registration, priorities between creditors become uncertain. The register of charges (maintained by ROC) is the PUBLIC RECORD of which assets are already pledged.
Illustrations
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Fixed vs floating charge (the stock example): ABC Ltd mortgages its FACTORY BUILDING to Bank A (charge on specific asset = FIXED charge). ABC cannot sell the building without Bank A's consent.
ABC also pledges "all its stock-in-trade present and future" to Bank B (charge on a class of changing assets = FLOATING charge). ABC continues selling goods from stock daily (floating charge allows normal business). But if ABC defaults on Bank B's loan: the floating charge CRYSTALLISES it fixes on whatever stock exists at that moment. ABC can no longer sell that stock Bank B's charge is now fixed.
Priority on winding up: Bank A (fixed) gets paid FIRST from building proceeds. Bank B (floating) gets paid AFTER Bank A and preferential creditors (employee wages, taxes) from remaining stock.
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Non-registration disaster (S.84): XYZ Ltd creates a charge on its machinery in favour of Lender L for a Rs.1 crore loan. L forgets to register within 30 days. XYZ subsequently borrows Rs.50 lakhs from Bank B (which checks the ROC register shows no charge on machinery and takes a registered charge on the SAME machinery). XYZ goes into liquidation.
Result: L's unregistered charge is VOID against the liquidator and Bank B (S.84). Bank B (registered) has priority over the machinery. L is relegated to UNSECURED creditor status recovers only from general assets (pennies in the rupee). The Rs.1 crore DEBT is still valid but L lost the SECURITY for failure to register. Lesson: register immediately.
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Debenture vs Share (the investor's choice): You invest Rs.10 lakhs in ABC Ltd. Two options:
- BUY SHARES: You become a MEMBER (owner). You get dividends (only if company makes profit). On winding up, you get paid LAST (after all creditors). High risk, high reward (share price may multiply).
- BUY DEBENTURES: You become a CREDITOR. You get fixed interest (regardless of profit). On winding up, you get paid BEFORE shareholders. Lower risk, fixed return.
Shares = ownership + risk. Debentures = lending + security. The company issues both to different types of investors with different risk appetites.
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Crystallisation (when floating becomes fixed): Company has a floating charge on "all assets present and future" in favour of Bank. Day 1-100: Company buys and sells inventory normally (floating charge permits). Day 101: Company defaults on loan. Bank appoints a receiver. At that MOMENT: the floating charge CRYSTALLISES. Whatever assets exist on Day 101 are now FIXED company cannot sell, move, or dispose of them. The receiver takes control and sells assets to repay Bank. Before crystallisation: company's assets; after crystallisation: Bank's security.
Recall Check
- When does a company need a special resolution to borrow?
- What is the difference between a fixed charge and a floating charge?
- What is the consequence of failing to register a charge within 30 days?
Key Cases
Atul Drug House v. State of Gujarat (1970) Atul-Drug-House-v-State-of-Gujarat-1970 Issue: Whether an unregistered charge is enforceable in winding up. Rule: Non-registration under S.77 (then S.125 of 1956 Act) renders the charge void against the liquidator and other creditors the debt survives but the security does not. Held: Unregistered charge was void against liquidator. The charge-holder was relegated to unsecured creditor status. Registration is mandatory for priority.
Distinctions
| Aspect | Debenture | Share |
|---|---|---|
| Holder is | CREDITOR (lender to company) | MEMBER (owner of company) |
| Return | Fixed interest (regardless of profit) | Dividend (only if profits and board declares) |
| Voting | No voting rights at general meetings | Voting rights (one share, one vote in equity) |
| Winding up priority | BEFORE shareholders (creditor priority) | LAST (after all creditors paid) |
| Capital/Revenue | Interest is revenue expense (deductible for company) | Dividend is profit distribution (not deductible) |
| Risk | Lower (fixed return; secured if charge exists) | Higher (return uncertain; last in winding up) |
| Redeemable | Must be redeemed (S.71: within 10 years) | Generally not redeemable (except redeemable preference shares) |
| Convertible | May be converted to shares | Cannot convert shares to debentures |
| Aspect | Fixed Charge | Floating Charge |
|---|---|---|
| Asset | Specific and identified | Class of changing assets |
| Dealing | Company CANNOT deal without consent | Company CAN deal freely until crystallisation |
| Priority | HIGHER (first after winding up costs) | LOWER (after fixed charges + preferential debts) |
| Crystallisation | Not needed (already fixed) | Required for enforcement (default/winding up/receiver) |
| Example | Mortgage on building | Charge on stock-in-trade |
Flashcards
Q: When does borrowing require a special resolution? A: When aggregate borrowings exceed paid-up share capital + free reserves + securities premium (S.180(1)(c)). Below this: board resolution suffices.
Q: What is a debenture? A: A debt instrument issued by a company acknowledging a loan. Creates debtor-creditor relationship. Holder gets fixed interest. May be secured (charge on assets) or unsecured.
Q: What is the difference between a fixed and floating charge? A: Fixed: on specific identified asset; company cannot deal without consent. Floating: on a class of changing assets; company can deal freely until crystallisation (default/winding up/receiver appointment).
Q: What is the consequence of not registering a charge (S.84)? A: The charge is VOID against the liquidator and other creditors. The debt survives but the security is lost holder becomes unsecured creditor.
Q: Within what time must a charge be registered? A: 30 days from creation (S.77). Extension up to 300 additional days possible on application to ROC with cause shown.
Q: What is crystallisation of a floating charge? A: The moment a floating charge converts into a fixed charge company can no longer deal with the assets. Triggers: (a) winding up, (b) default, (c) appointment of receiver, (d) company ceases business.
Exam Scenario
Beta Ltd creates a floating charge on "all present and future assets" in favour of Bank A on 1 January 2025. On 1 March 2025, Beta creates a FIXED charge on its factory machinery in favour of Bank B. Both charges are duly registered. Beta goes into liquidation on 1 June 2025. The factory machinery is worth Rs.30 lakhs. Bank A is owed Rs.50 lakhs; Bank B is owed Rs.25 lakhs. Advise on priority.
Rule of priority: (1) Fixed charges have priority OVER floating charges even if the floating charge was created EARLIER. (2) Floating charges rank after: (a) winding up costs, (b) preferential debts (employee wages, govt taxes), (c) fixed charges.
Application:
- Bank B's fixed charge (created 1 March, registered): FIRST priority over the factory machinery (Rs.30 lakhs).
- Bank A's floating charge (created 1 January, registered): SECOND priority crystallised on 1 June (winding up date). But on the specific machinery, Bank B's fixed charge prevails.
Distribution of machinery proceeds (Rs.30 lakhs):
- Bank B (fixed charge): Recovers Rs.25 lakhs (full claim satisfied from machinery).
- Remaining Rs.5 lakhs from machinery: Goes to Bank A (floating charge now crystallised on remaining assets).
- Bank A's remaining Rs.45 lakhs claim: Recovers from OTHER company assets (if any) subject to preferential debts ranking above floating charge.
Principle: A later FIXED charge beats an earlier FLOATING charge on the same assets (unless the floating charge agreement prohibits subsequent fixed charges AND the subsequent lender had notice of the prohibition). This incentivises specific-asset lending over blanket security.