Types of borrowing- Under Companies Act 2013

Introduction
Proper flow of funds within an organisation can be termed as the lifeline of the
organization. In the course of the each and every activity, organization stands in need of
money over and above their capital. Therefore, in order to meet the financial needs,
they are prone to depend on external sources for funding. The source of funds would
typically depend on the purpose and duration for which the fund is required.

For example, if the Company requires funds for making a capital expenditure it would go
for long term finance like term loans or external commercial borrowings. However, if the
company requires funding to meet its working capital needs, it would go for short term
financing sources like working capital loans or overdraft facility from banks.

Apart from the tenure or purpose of fund raising there is one more factor which
influences the choice of funding source and that is the borrowing cost. Eventually, over
the years, this factor has become the most crucial of all.

Companies try various kind of fund raising techniques to achieve the lowest borrowing
cost and in this regard it is very important to take note of the regulatory aspects of
raising funds.

Meaning of borrowing cost

In general, Borrowing Cost means the interest and other costs incurred by an
organization in relation to the borrowing of funds. However, the same has also been
defined in Accounting Standard 16 in the following manner:

Borrowing costs may include:

(a) interest and commitment charges on bank borrowings and other short-term and
long-term borrowings;
(b) amortisation of discounts or premiums relating to borrowings;
(c) amortisation of ancillary costs incurred in connection with the arrangement of
borrowings;
(d) finance charges in respect of assets acquired under finance leases or under other
similar arrangements; and
(e) exchange differences arising from foreign currency borrowings to the extent that
they are regarded as an adjustment to interest costs’.

To sum up, Borrowing Costs are the expenses incurred by the organization in borrowing
the funds.
 Power of company to borrow

Under the power of a company exercise by its directors who cannot borrow more than the
sum authorised. Under these two company directors can only be exercised for borrowing
money by issuing debentures. Under section 179 (3) (c)and (d),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. Under section 180,he 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. According to Section 180, temporary loans are
the loans which are re-payable on the demand within 6 months from the date.

Unauthorised Borrowings
When a company borrow something without the authority or beyond the amount set out in
the articles it is an unauthorised 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.

INTRA VIRES BORROWING BUT OUTSIDE THE SCOPE OF AGENTS AUTHORITY

There is an always a distinction between a company’s borrowing powers and authority of
the directors to borrow. The following which is done beyond the authority of the director is
not ultra vires where as such borrow is known as ultra vires.If the borrowing is done within
the directors then the company will be liable of such borrowing.

Types of borrowing
There are various types of borrowing which can be classified as
Long term borrowings
Under the long term the funds are borrowed from a period ranging from 5 years or
more.
Short term borrowings
Under the short-term borrowed for a very short period that is up to 1 year. These funds
are generally borrowed so that working capital amount can be made.
Medium term borrowings11
These are the borrowing under which the funds world from a period of 2 to 5 years.
Secured borrowing
Under the secured borrowing, if a creditor has the re-course of assets of the company
or a proprietary then a debt obligation is considered as security.
Unsecured borrowing
Under the unsecured borrowing the debt comprises of financial obligations.
Syndicated borrowing
Under the syndicated borrowing, if a borrower requires a large fund, it is generally
provided by a group of lenders. Under this one agreement is used by borrower covering
the whole group of bank and different types of facilities rather than entering into series
of separate loans.
Bilateral borrowing
When a company makes a borrowing from a particular meaning of financial institution it
is known as bilateral Borrowing. There is only single type of contract between the
company and the borrower in this type of borrowing.
Private borrowing
The private borrowing consists of bank loan obligations. Under this the company take
loan from Bank of financial institution.
Public borrowing
Public borrowing consists of all the financial institutions that are freely tradable on a
public exchange.

Modes of Borrowings
Next, with respect to modes of borrowing, the modes of funding can be distinguished
majorly between long term borrowing and short term borrowing.

A. Modes of Short Term Borrowings and the cost involved in raising the
same:
1. Temporary loans like loans repayable on demand, cash credit facilities and
overdraft arrangements

A loan is repayable on demand when:

(a) there is no time for repayment specified (and hence, the obligation to repay on
demand is implied by law); or
(b) the parties actually express the obligation to repay on demand or request (i.e., the
same is an express term).

Therefore, a loan with no repayment terms, or loan agreement with no repayment date,
is a loan repayable on demand. The borrowing company is required to pay the loan
along with the interest amount determined by the lender. Example of a demand loan
can be the overdraft facilities provided by the Banks.

An overdraft is an arrangement by which a company is allowed to draw more than what

is to the credit of its account at the bank. The charges for overdraft facility has to be
paid by the company to the Bank, when such facility is utilised.

Cash credit is an arrangement by which a company borrows from its bankers up to a

certain limit against a bond of credit by one or more securities or some other security.
The company is charged interest on the amount actually utilized and not on the limit
sanctioned.

2. Commercial Papers (CPs)

Commercial Papers are unsecured money market instrument which can be issued
either in the form of a promissory note or in a dematerialised form through any of the
depositories approved by and registered with SEBI. Further, commercial papers are
instruments issued by the company, so as to fulfil the short-term fund requirement and
have easy liquidity in the market with less compliance burden.

However, before issuing commercial paper, the eligible issuers must obtain the credit
rating for the issuance of commercial paper from any one of the SEBI registered Credit
Rating Agencies.

Raising finance through issuance of these would not qualify to be deposits for the
purpose of Companies Act as the term deposits exclude any money received by issuing
money market instruments.
3. Working capital loans

A working capital loan is a loan that has the purpose of financing the everyday
operations of a company. Working capital loans are not used to buy long-term assets or
investments and are instead used to finance the day to day expenses such as to buy
inventory, cover payroll, wages, etc. The lender charges interest for lending the working
capital loans.

4. Issuance of NCDs with less than one year maturity

Companies having a tangible net worth as per the latest audited balance sheet, of not
less than Rs.4 crore can issue Non-Convertible Debentures (NCDs) of maturity less
than one year. The eligible corporate intending to issue NCDs is required to obtain
credit rating for issuance of the NCDs from one of the rating agencies specified by RBI
and the companies are even required to ensure at the time of issuance of NCDs that the
rating so obtained is current and has not fallen due for review. Therefore, raising such
funds shall require fulfilment of eligibility criteria and expenses for credit rating.

Like commercial papers, these are also money market instruments. Therefore, raising of
finance through issuance of NCDs would not be treated as money market instrument for
the purpose of Companies Act.

5. Letter of Credit

A Letter of Credit (L/C) is a letter from a bank guaranteeing that a buyer’s payment to a
seller will be received on time and for the correct amount. Here the banks act as
disinterested third parties and they release funds only after certain conditions are met.
Banks issue letters of credit when a company applies for the same and has the assets
or credit to get approved.

6. Trade Credit
A trade credit is an agreement or understanding between agents engaged in business
with each other, it allows the exchange of goods and services without any immediate
exchange of money. When the seller of goods or service allows the buyer to pay for the
goods or service at a later date, the seller is said to extend credit to the buyer. This is a
type of instrument where no cost is involved. Sometime, the payment terms may also
offer discount as an incentive for early payment.

B. Modes of Long Term Borrowings and the cost involved in raising the
same:
1. Loan from Bankers

Long-term loans are a type of business financing in which the maturity date of the loan
extends past a year and can even last for as long as 20 years (e.g. commercial property
loans). These are mainly used to finance long-term projects such as business
expansion, franchising, purchase of property, plant, and equipment and other fixed
assets. Companies may also avail loan from Bankers on the basis of their credibility.
The company has to pay interest on the full amount of the loan sanctioned by the bank,
irrespective of the amount utilised by the company. The longer the tenure extends, the
more amount of interest money has to be paid in total.

2. Issuance of Debentures

A debenture is a securitised loan and is backed by a certificate. It is the most crucial

method of obtaining loan for a longer period by the companies. On the basis of coupon,
the debentures can be çategorised into two categories – coupon bearing [These
debentures are issued at face value and the specified rate of interest is earned by the
holders of these securities] and zero coupon [These debentures are issued at a
discounted price and redeemed at par; and these do not carry any coupon rate.].
Mostly, the following types of debentures are issued by the companies:

(a) Compulsorily Convertible debentures (CCDs): These debentures are mandatorily

converted into equity shares of the company, as per the terms specified at the time of
issue or on the expiry of specified period.
(b) Non-convertible Debentures (NCDs): These debentures do not carry the option of
conversion into equity shares and are therefore, redeemed on the expiry of certain
specified period. Most commonly, entities issued NCDs for meeting their long term
capex requirements.

NCDs issued to corporates or listed or fully secured do not qualify to be deposits for the
purpose of Companies Act.

(c) Optionally convertible debentures (OCDs): The investor has an option to convert
into shares at the pre-determined price and time.

3. Inter-Corporate Deposits

An Inter-Corporate Deposit (ICD) is an unsecured borrowing by corporates from other

corporate entities registered under the Companies Act, 2013 (or the erstwhile
Companies Act, 1956). Corporates having surplus funds lend to another corporate in
need of funds.

Inter-corporate deposits are free from the definition of deposits under Companies Act.
Therefore, this is a prominently widely used mode of finance.

However, the companies shall also contemplate applicability of the restrictions under
section 185 (dealing with loan to directors etc.) and section 186 (dealing with loans and
investments by companies) of the Act, 2013 on the lending and the borrowing
companies.
4. External Commercial Borrowings (ECBs)

ECB is basically debt aided by Indian companies in foreign currency, from a non-
resident lender, in accordance with the ECB Framework, issued by the Ministry of
Finance. There are no constraints on the use of such loans, except the items mentioned
in the negative list in relation to the end use mentioned by BRI in the ECB framework.
Once the RBI and Ministry of Finance approves a loan and its terms, no restrictions are
placed on interest and principal payments. However, entities are required to report to
the RBI through its designated banker each time an interest payment is made.

RBI vide RBI/2017-18/169 A.P. (DIR Series) Circular No.25[1] dated April 27, 2018 has
further liberalised certain norms of the framework. The erstwhile provision had
prescribed separate all-in-cost ceilings for different tracks in ECBs which were linked to
the maturity period. Now, a uniform all-in-cost ceiling of 450 basis points over the
benchmark rate is stipulated irrespective of the maturity period of ECB. Further, the
ECB Liability to Equity Ratio for ECB raised from direct foreign equity holder under
automatic route has been enhanced to 7:1 (as against 4:1 earlier). Therefore, by
liberalising the framework, the Government has broaden the scope of fund raising for
the companies.

Further, earlier, proceeds of ECBS could be used only for the purpose of meeting
capital expenditures, but vide the aforesaid change, the end use restriction has been
liberalised and the ECBs can now be used for the purpose of working capital
requirements as well.

Compliance for borrowings by a company under the Companies

Act, 2013
The borrowing powers of a company is included in section 179(3) and 180(1)(c) of the
Companies Act 2013.

Section 179 (3) (d): The powers to borrow money can only be employed by the
Directors at a duly summoned meeting of the board, to borrow money. However, the
power to borrow money may be envoyed by the Board by passing a resolution for such
delegation at a duly convened Board Meeting, to any committee of directors, the
managing director, the manager or any other principal officer of the company or in case
of a branch office of the company, the principal officer of the branch office.
Section 180 (1) (c): The provisions of this section curbs the Board of Directors of a
company from borrowing a sum which together with the money already borrowed by the
company, exceeds the aggregate of its paid-up share capital and free reserves, apart
from the temporary loans obtained by the company’s bankers in the ordinary course of
business unless the company has received the prior approval of the shareholders of the
company, through a special resolution in general meeting.

Therefore, the Board may continue borrowing within the limits approved by the
shareholders, however, in order to borrow beyond the above-mentioned limit, the Board
of Directors will have to obtain prior approval of the shareholders.
Meaning of the term ‘Temporary Loans’ in section 180(1)(C)
As per the explanation provided in section 180(1)(C), the expression “temporary loans
“implies loans that are repayable on demand or within six months from the date of the
loan such as short-term, cash credit arrangements, the discounting of bills and the issue
of other short-term loans of a seasonal character, but does not comprise loans raised
for the purpose of financial expenditure of a capital nature.

Borrowings by private companies

Private companies are exempted from the entire provisions of section 180 of Act, 2013
vide MCA Notification[2] dated June 5, 2015.
Borrowings by banking companies:
As per the conditon provided in section 180(1)(C), the acceptance of deposits of money
from the public, repayable on demand or otherwise, and withdrawable by cheque, draft,
order or otherwise, in the ordinary course of its business by a banking company, shall
not be considered to be borrowing of money by the banking company.
Ultra Vires Borrowings
As per the provision of section 180 (5), where a company borrows in excess of its
borrowing limits that are approved by the shareholders, then such borrowing in excess
of the limit shall not be valid unless the lender proves exceeded advances the loan in
good faith without knowledge that the limit imposed by the law has been crossed.

Conclusion
The above mentioned several modes of borrowings provide the numerous options of
fund raising by the companies. The various alternatives of borrowing further depends on
the need of the companies and the nature of borrowings. The most relevant part is the
fundamental idea is to identify and explore the avenues to minimize the borrowing costs
for companies. Recognizing low cost avenues is a joint responsibility of the treasury
department as well as the compliance team, while the treasury team should choose to
explore new avenues, the compliance team should see if the same fits into the existing
regulatory framework.

Reference
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