INTRODUCTION

Businesses have several options to raise money. If they are able to trade publicly on the stock market, they can sell shares of stock in the company and quickly raise capital. However, shares are actually ownership in the company, and investors who buy them become partial owners with at least a small say in how the company is run. Business may not want this extra ownership, may not be able to sell anymore stock or may simply need to balance out its capital activities with an alternative method. The other method of raising capital is through debt.

Debt capital is money that a business has raised through debt. Essentially, investors agree to make a loan to a business immediately. The business receives the debt capital and agrees to pay the loan back at a certain time with additional interest payments that are compounded as long as the loan is active.

Debt capital in a company's capital structure refers to borrowed money that is at work in the business. The safest type is generally considered long�term bonds because the company has years, if not decades, to come up with the principal, while paying interest only in the meantime.

A debenture is a document that either creates a debt or acknowledges it, and it is a debt without collateral. In corporate finance, the term is used for a medium� to long�term debt instrument used by large companies to borrow money. In some countries the term is used interchangeably with bond, loan stock or note. A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital. Senior debentures get paid before subordinate debentures, and there are varying rates of risk and payoff for these categories.

Debentures are generally freely transferable by the debenture holder. Debenture holders have no rights to vote in the company's general meetings of shareholders, but they may have separate meetings or votes e.g. on changes to the rights attached to the debentures. The interest paid to them is a charge against profit in the company's financial statements.

BORROWING POWERS AND METHODS 

A company needs capital to finance its activities. Part of this requirement is met by the issue of shares and the rest a company may resort to borrowing. A trading or a commercial company unless prohibited by the memorandum and articles has implied powers to borrow money for its purposes and to give security or charge its assets by way of security for the amount borrowed. 

A non�trading company requires express powers to borrow. In that case it must be stated in the memorandum or articles. A private company is entitled to exercise borrowing powers immediately upon registration but a public company cannot exercise borrowing powers until it acquires a certificate of incorporation and a certificate of commencement of business.

The power of a company to borrow is exercised by the directors subject to the restrictions which may be placed by its memorandum or articles of association or by the Act. Sometimes the memorandum limits the borrowing powers of directors to a specific sum or to a sum not exceeding a paid up capital.

Where a company has powers to borrow, it has incidental powers to secure the repayment of the borrowed money by mortgage or charge of all or any of its property real or personal, present or future. 

Borrowing by a company may thus be ultra vires the company that is, unauthorized borrowing or ultra vires the directors that is, beyond the powers of the directors. 

Borrowing ultra vires 

Where a company has no borrowing powers or where the memorandum or articles fix a limit to the borrowing powers of the company, any borrowing in the one case and any borrowing in excess of such limit in the other case, is ultra vires. If a company borrows money beyond its powers the borrowing is ultra vires the company and is void. Where the borrowing is ultra vires the company the lender has no legal or equitable right against the company. 

However, a lender of money ultra vires to the company may have the following equitable remedies:

1.         Proceedings for injunction

If the company has not spent the money so advanced to any transaction so far, a lender may obtain an injunction to restrain the company from spending the money and may recover the money as actually existing. 

2.         He can claim for an order of subrogation 

If the money so borrowed is applied in paying off the lawful debts of the company the lender is entitled to step into the shoes of the creditors who have been paid off and be subrogated to their rights. He can thus ranks as a creditor of the company to the extent to which his money has been so applied. 

3.         Identification and tracing 

If the money has been so expended in purchasing some particular assets which can be traced into the company's possession the lender can obtain a tracing order and may recover that asset. 

4.         Recovery of damages 

The lender under a transaction, which is ultra vires, may claim damages from the directors personally for a breach of implied warranty of authority unless the fact that the borrowing was ultra vires could have been discovered from the public documents of the company.

Borrowing Ultra Vires the Directors and the Rule of Indoor Management

Borrowing ultra vires is the borrowing in excess merely of the powers of the directors but not of the company. In such a case the borrowing can be ratified and thus be validated by the company. If the company ratifies the borrowing, then the loan binds both the lender and the company as if it had been made with the company's authority in the first place. 

If the company refuses to ratify then the normal principles of agency and the rule of indoor management will apply as long as the lender proves that he lent the money in good faith and without notice. 

When the articles of association of a company prescribed a particular procedure for doing a thing, the duty of carrying out the provisions lies on the person in charge of the management of the company. Outsiders are entitled to assume that the rules have been complied with. This is known as the doctrine of indoor management.

The principle of indoor management was laid down in the Royal British vs. Turquand. In this case Turquand was sued as the official manager of a coal mining and railway company on a bond for �2,000, which had been given by the company to the plaintiff bank to secure its drawings on a current account. The bond was given under the seal of the company and signed by two directors and the secretary but the company alleged that under the terms of its registered deed of settlement, the directors had powers to borrow only such sums as had been authorized by a general resolution of the company and in this case no sufficiently specific resolution had been passed. The court held that the company was bound by the bond. 

However, the principal is liable if the agent does; 

i) what he is actually authorized to do or:  ii) what an agent of that type would normally have authority to do or;  iii) what he has been 'held out' by the principal as having authority to do. 

For the rule to apply the other party must not have known that the agent was exceeding his actual authority. Therefore the third parties dealing with the company are not bound to ensure that the internal regulations of the company have been complied with. This rule laid down in the Tarquand's case is normally referred to as rule of indoor management. 

The rule is based on the convenience of business transactions because business could not be carried out effectively if everybody who had dealings with the company had meticulously to examine its internal machinery in order to ensure that the official he dealt with had actual authority. However, the rule must not be overstretched. The mere fact that someone purports to act on behalf of the company cannot alone impose liability on the company. The soi distant agent may be a complete impostor. 

Thus the courts have developed the following rules or propositions in the application of the rule of indoor management: 

Rule 1 

Anyone dealing with the company is deemed to have notice of its public documents. Hence every act, which is clearly contrary to these documents, will not bind the company unless subsequently ratified by the company acting through its appropriate organ.  

Rule2 

Provided that everything appears to be regular so far as this can be checked from the public documents, an outsider dealing with the company is entitled to assume that all the internal regulations of the company have been complied with unless he has knowledge to the contrary or there exist suspicious circumstances putting him on inquiry. 

Rule 3 

An outsider dealing with the company through an officer who is or is held out by the company as a particular type of officer for example managing director and who purports to act or exercise a power which that officer would normally/usually have is entitled to hold the company liable for the officer's acts even though the officer has not been so appointed or is in fact exceeding his actual authority. 

In Freeman and Lockyer vs. Buckhurst Part Properties Ltd the defendant company was formed to buy and resell a large estate by Kapoor, a property developer, and Hoon, who contributed half of the capital but played no active part in the company's business. Kapoor, Hoon and a nominee of each were appointed the four directors of the company, and under the articles all four were needed to constitute a quorum. Hoon spent much time abroad, leaving all the dayto�day management of the company's affairs to Kapoor. After the initial plan to resell the land failed, Kapoor decided to develop the estate and engaged the plaintiff, a firm of architects and surveyors, to apply for planning permission. The company later refused to pay the plaintiffs fees on the ground that Kapoor had had no authority to engage them.  

The court was held that the company was liable since by its own acquiescence, it had represented that the director was managing director with the usual authority of that office. 

The court also found that the plaintiffs intended to contract with Kapoor as agent for the company and not on his own account and that, Kapoor although never appointed as managing director, had throughout been acting as such to the knowledge of the board. 

But this is not so if the officer is in fact exceeding his actual authority and: 

a)    the outsider knows that the officer has not been so appointed or has no actual authority. 

b)    the circumstances are such as to put him on inquiry or 

c)    the public documents make it clear that the officer has no actual authority or could not have actual authority unless a resolution had been passed which requires filing as a public document and no such document has been filed. 

Rule4

If the officer is purporting to exercise an authority, which that sort of officer would not usually have, the outsider will not be protected if the officer exceeds his actual authority unless the company has held him out as having authority to act in the manner and the outsider relied thereon.

Rule 5 

An outsider who can bring himself within the protection of rule 3 and 4 above would not necessarily loose his protection merely because the ostensible officer with whom he deals has never been validly appointed. 

Rule 6 

If a document purporting to be sealed by or signed on behalf of the company is proved to be a forgery, it does not bind the company. 

In Ruben vs. Great Fingall Consolidated Ltd. the plaintiffs Ladenburg, who were stockbrokers, had procured a loan for one Rowe (the secretary of the defendant company) on the security of a share certificate for 5,000 shares in the defendant company, to which Rowe had affixed his own signature and the company's seal and had forged the signatures of two directors. The plaintiffs, having reimbursed the mortgages, claimed damages from the company for failure to register them as owners of the shares 

The court held that the company was not stopped by the certificate. The forged certificate is a complete nullity and the doctrine of indoor management cannot apply to it. 

However, a company may be estopped from disclaiming the document as a forgery if it has been put forward as genuine by an officer acting within his actual, usual or apparent authority and if a transaction is binding on the company under the foregoing rules a company will be liable notwithstanding that the officer has acted fraudulently or committed a forgery. 

The doctrine of indoor management does not apply in certain cases: 

(a)        Void Acts

Where the act is void ab initio, the company is not bound, e.g., forgery.

Examples: 

i) An act ultra vires the memo or articles cannot bind a company.  ii) A share certificate forged by the secretary of the company and issued under the seal of the company cannot confer any right on the holder thereof. 

(b)   Knowledge of irregularity

Where the person dealing with the company has notice, actual or constructive, that the prescribed procedure has not been complied with the company is not bound.

For example X company lends money to Y company on a mortgage of its asset. The procedure laid down in the articles for such transaction was not complied with. The directors of the two companies were the same. Here it may be presumed that the lender had notice of the irregularity. Hence the mortgage is not binding

(c)    Lack of authority

 If an agent of a company makes a contract with a third party and if the act of the agent falls outside the ordinary authority of the agent, the company is not bound.

DEBENTURES

There is no legal definition of a debenture. However the Act provides that a debenture includes debenture stock, bonds and any other securities of a company whether constituting a charge on the assets of the company or not. 

All companies public or private can issue debentures. They may be issued at par, at a premium or at a discount either privately or through prospectus.

The legal requirements for issue and allotment of debentures are the same as those used in the case of issue and allotment of shares except that no 5% cash of nominal capital as nominal money no minimum subscription are required and no legal restriction is placed on the company's power to purchase its own debentures.

Characteristics of debentures

Some of the characteristics of debentures include:

1.      Each debenture is numbered 

2.      Each contains a printed statement of the terms and condition i.e., the rate of interest, the time of  payment of interest, the security against which the debenture is issued and what steps the debenture holder can take in case of non�payment of his dues. 

3.      A debenture usually creates a floating charge on the assets of the company, e.g., a charge which is enforceable upon non�payment of the interest or principal on the due dates. 

4.      A debenture may create a fixed charge instead of a floating charge. 

5.      Sometimes debenture holders are given the right to appoint a receiver In case of nonfulfilment of the terms of the debentures by the company. 

6.      Sometimes a series of debentures are issued with a trust deed by which trustees are appointed to whom some or all the properties of the company are transferred by way of security for the debenture holders.

Classes of Debentures  

Debentures can be categorized into the following  classes:

1.     Secured Debentures

2.     Unsecured/Naked debentures

3.     Registered Debentures

4.     Redeemable Debentures

5.     Irredeemable/perpetual Debentures

6.     Bearer/unregistered Debentures

7.     Convertible Debentures

1.       Secured Debentures 

These are debentures which are secured by some charge on the property of the company. The charge or mortgage may be fixed or floating hence there may be fixed mortgage debentures or floating mortgage debentures. 

2.       Unsecured/Naked debentures 

They are those that are not secured by any charge on the assets of the company. 

The holders of such debentures are just like ordinary unsecured creditors of the company. 

3.       Registered Debentures 

These are debentures which are payable to the registered holders. A registered holder is one whose name appears both on the debenture certificate and in the company's register of debentures required to be maintained by the company. He can transfer them like shares but the transfer has to be registered. 

4.       Redeemable Debentures 

This provides for the payment of the principal sum on a specified date or on demand or notice. They can be issued after 'redemption in accordance with the provisions of the articles of association. 

5.       Irredeemable/perpetual Debentures 

In such a case the issuing company does not fix a date by which they should be redeemed and the holder of such debenture cannot demand payment from the company so long as it is a going concern. They are normally payable on winding upor some serious default by the company or were made payable at a remote period of say, 100 years. 

6.       Bearer/Unregistered Debentures 

These are debentures which are payable toa bearer. They are regarded as compatible instruments and are transferable by delivery and therefore a bona fide transferee for value is not affected by the defect of title of the previous holders.

7.       Convertible Debentures 

A convertible debenture contain an option entitling the holder to convert his debt at times stated in the debenture to ordinary or preference shares of the company at a stated rate of exchange. If the holder exercises the right, he ceases to be a lender of the company and becomes a member instead. 

8. Debenture Stock 

This means the borrowed capital consolidated into one mass. The difference between debenture and debenture stock is the same as the difference between a share and stock, Like a share, the debenture is always of a fixed denomination, indivisible and transferable in its entity and like stock, the debenture stock is not any fixed amount.

Distinction between Debentures and Shares  

The following is distinction between debentures and shares: 

1.     A shareholder is part�owner of the company but a debenture holder is only a creditor. 

2.     A share is an ownership security usually non�repayable during the lifetime of the company but a debenture is a creditor ship security usually payable during the life time of the company. 

3.     Income on debentures is fixed and certain whether or not a company has made profits whereas income on shares (dividend) is uncertain and depends on the directors� discretion. 

4.     A shareholder has normal rights of a member for example  the right to receive notices of a general meeting, whereas a debenture holder is not a member and is not entitled to some of these rights. 

5.     A company may generally purchase its own debentures (redeemed) whereas it is not open to a company to purchase its own shares. 

6.     In case of winding up, debenture holders rank first for repayment whereas shareholders can only obtain payment after all the outside creditors have been paid. 

Similarities between debentures and shares 

Some of the similarities between debentures and shares include:

1.     Debentures can be issued in a series or class just like shares can be of several classes.           

2.     Shares and debentures are long term investment of a mostly long term naturepayable on winding up in case of shares and on winding up or the happening of the stated event or period in cases of debentures. 

3.     The two are normally issued in the same way and can be issued by prospectus where appropriate. 

4.     Debentures just like shares can be issued at par or at premium or in exceptional circumstances at a discount. 

5.     Both shares and debentures may be redeemable if stated to be so redeemable. 

Debenture Trust Deed 

Normally a debenture is one of a series issued to a number of lenders and it is often accompanied by a charge fixed or floating on the company's property. In practice therefore, in the case of mortgage debentures the issuing company usually mortgages property with a trustee who hold mortgaged property on trust for the benefit of debenture holders through a trust deedbecause it cannot possibly create a separate charge in favour of thousands of debenture holders . The trust deed 'contains detailed conditions and stipulations safeguarding the interest of debenture holders. A debenture trust deed is usually a long and elaborate document containing the following major elements:

a)  The appointment of a trustee for prospective debenture stockholders. 

The first trustee is normally appointed by the company as the other party to the deed. Any replacement trustee is to be appointed by the debenture stockholders. The trustee is usually a bank, insurance company or other institution but may be an individual trustee. 

b)  The nominal amount of the debenture stock is defined which is the maximum amount, which may be raised then or later. 

c)The date or period of payment is specified, as is the rate of interest and interest payment dates. 

d)  If the debenture stock is secured, the deed creates a charge or charges over the assets of the company and often of its subsidiaries, which are parties to the deed for that purpose 

e)  The trustee is authorized to enforce the security in case of default and in particular to appoint a receiver with suitable power of management. 

f)   The company enters into various covenants, for instance, to keep its assets fully insured or to limit its total borrowing among others 

g)  There may be other provisions regarding the following: 

i)            Register of a debenture stockholders 

ii)          Transfer of stock 

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