With reference to ultra-vires borrowings. it is important to distinguish between borrowings which is ultra-vires the company and borrowings which are intra (within) vires the company but ultra-vires the Directors.
Borrowings ultra-vires the Company
Borrowings ultra-vires the company means:
(i) Borrowings by a company where it does not have the power to borrow. A company shall not have a power to borrow where it is a non-trading company and the Memorandum doesn’t specifically contain a power to borrow or where, though a trading company, the Memorandum specifically disallows borrowing.
(ii) Borrowings in excess of the limits fixed under the Memorandum or Articles.
Any borrowing which is ultra-vires the company is void. Also the securities given
in respect thereof are inoperative and void. Ultra-vires loans do not create a relationship of a creditor and a debtor. The borrowings which are ultra-vires the company cannot be ratified even by a resolution passed by the company in its general meeting. An ultra-vires borrowing by a person acting on behalf of a company does not give rise to any indebtedness either at law or equity on the part of such company [Sinclair Vs. Brougham (1914)].
Remedies of the Lender
1. Injunction. In case the money advanced to the company has not been spent, the lender may obtain an injunction from the Court restraining the company from parting with it.
2. Restitution. Under the doctrine of restitution, the lender can obtain a ‘tracing order’. Accordingly, if the money of the lender is in the hands of the company in its original form or its products are capable of identification, he may claim that money or its products. But where the moneys of the lender have got mixed up with those of the company, the lender may perhaps be helpless. But even in such a case, if the company is wound up, he may claim pari passu distribution of the assets with shareholders. This was done in the case of Sinclair Vs. Brougham.
3. Subrogation. If the company has used the money borrowed to payoff any of its intra-vires debts, the lender may be subrogated to the rights of the creditors and he will rank as a creditor upto the amount so used. Subrogation is allowed for the simple reason that when a lawful debt has been paid off with an ultra-vires loan, the total indebtedness of the company remains unchanged. By subrogating the ultra-vires lender, the courts are able to protect him from loss, while the debt burden of the company is in no way increased.
However, the subrogated creditor will not enjoy the priority of the original creditor [Wrexham, Mold Conanah’s Quay Rly. Co. Ltd., Re].
4. Suit for Breach of Warranty of Authority. The lender may also sue the directors for breach of warranty of authority unless the borrowing is intra-vires the company and the company has ratified th same. It is based upon the principle of agency. An agent’s act outside the scope of the authority does’flot bind the principal unless the principal ratifies the same. The agent, however, incurs a personal liability .
