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Of ‘memarts’ and the power of a company to borrow—Part 7

2018-10-06 06:44:35

By Paul Kibuuka

Oftentimes, companies in Tanzania, as elsewhere in the world, have to borrow funds to finance every day operations or special projects in which they are engaged in. Loans are an indispensable part of corporate transactions, and are crucial to business growth. It is not surprising, therefore, that borrowed funds are shown in the liabilities section of balance sheets released by companies, including Dar es Salaam Stock Exchange listed companies.     

The borrowing power of a company is exercised by the company’s directors, who cannot borrow more than what is allowed. That power, which includes the power to give guarantee and to issue collateral to secure the borrowed funds, whether in or outside Tanzania can only be exercised by the directors at a duly convened board meeting at which the directors pass a resolution to borrow money on behalf of the company, subject to the provisions of the Companies Act, 2002. 

The resolution so passed by the directors must specify the total amount up to which money may be borrowed and it needs to be duly signed by two directors or one director and the company secretary, or in accordance with the company’s memorandum and articles of association (hereinafter, ‘memarts’).

Memarts are required for a company to be created in Tanzania under the Companies Act. Memarts stipulate how the company is run, governed and owned. Therefore, the memarts will include the borrowing powers of the company and the modus operandi by which such power is to be exercised by the directors on behalf of the company.

Where a company borrows without the authority conferred on it or yonder the amount specified in the memarts, then it is said to have resorted to ultra vires borrowing. The doctrine of ultra vires (Latin term: “ultra” means beyond and “vires” means power or authority) means an act beyond the powers. The doctrine assures a lending bank and shareholders of a borrower company that the funds of the company will be applied only for the purpose stated in the memarts.

Subject to certain exceptions, any act which is ultra vires the company is void. In this sense, the contract and the security given for such ultra-vires borrowing is void, and cannot be rectified by ratification of a resolution passed at the general meeting.

As alluded to earlier in this article, the power to borrow may exist though restricted to a given amount. In such case, would the excess loan be ultra vires or the entire loan transaction? As laid down in Deonarayan Prasad Bhadani v. Bank of Baroda (1957) 27 Com Cases 223 (Bom), the excess loan would be ultra vires and not the entire loan transaction.

If, however, the shareholders acquiesce in the excess loan obtained by the directors beyond their powers but not ultra vires the powers of the company, then such acquiescence would validate the excess loan.

On the other hand, if the entire loan transaction is ultra vires, the lending bank may have recourse to equity (not equity as in finance and accounting, but in law: the legal principles that were developed by the English Courts of Chancery to mitigate the harshness of the common law).

Thus, if in the event of an ultra-vires borrowing, the bank can, under the equitable doctrine of restitution, seek the assistance of the courts and apply for injunctive relief as long as the bank can trace and identify the loaned money and any property which has been bought using that money.

Still, if the money advanced by the bank cannot be traced, the bank, with the support of strong persuasive authorities, may be able to claim repayment of the loan if it can show that the company had received the money and gained benefit. 

Moreover, on the persuasive authority of Firbank’s Executors v. Humphreys (1886) 18 QBD 54 and Garrard v. James 1925 Ch.616, the lending bank may sue the directors of the borrower company for damages for breach of warranty of authority that they had the power to borrow.

As mentioned earlier, the borrowing power of a company includes the power to give security, which, as previous parts of this series have shown, may take the form of a mortgage, a charge, lien, guarantee, pledge, etc. The bank’s position is safer when security is taken, because the bank will be able to not only sue the borrower company, but also enforce its security to the extent of the outstanding loan, plus interest and other charges.

Paul Kibuuka is the managing partner of Isidora & Company Advocates, a corporate, commercial and financial law firm. This article was published in The Citizen on Saturday, 29 September 2018

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