Query No. 1

Subject:     

Whether Working Capital Demand Loan is a ‘Temporary Loan’ within the

meaning of the term under Section 293 of the Companies Act, 1956.^[1]

A. Facts of the Case

1. The querist has drawn attention to section 293(1)(d) of the Companies Act, 1956 which lays certain restrictions on borrowing powers of the directors as under:

“293(1) The Board of directors of a public company, or of a private company which is a subsidiary of a public company, shall not, except with the consent of such public company or subsidiary in general meeting, -

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(d)  borrow moneys after the commencement of this Act, where the moneys to be borrowed, together with the moneys already borrowed by the company (apart from temporary loans obtained from the company’s bankers in the ordinary course of business), will exceed the aggregate of the paid-up capital of the company and its free reserves, that is to say, reserves not set apart for any specific purpose;”

Explanation II to the section which explains the term ‘temporary loans’ reads as under:

“Explanation II - The expression “temporary loans” in clause (d) means loans 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 include loans raised for the purpose of financing expenditure of a capital nature.”

2. The querist has also made a reference to the following paragraph appearing in Ramaiya’s Guide to the Companies Act, 13th Edition - Reprint (March) 1996 (p. 1871):

“Temporary loans obtained from the company’s bankers in the ordinary course of business are to be excluded when reckoning the limit up to which a company may borrow.  See Cilum Mining Co., LR 7 Eq 88 (discounting bills for the purpose of wiping out overdraft, held neither lending nor borrowing); Water Law v. Sharp, (1869) LR 8 Eq 501,503 (held that cash credit with bank is not a ‘loan’ even if it is described as ‘loan account’); Medla Tea Co., ILR 9 Cal 14.  (Advances for business needs on the security of assets were not regarded as borrowing).”

3. The querist has stated that according to guidelines of the Reserve Bank of India as presently in force, the credit facility extended by banks for working capital purposes to borrowers enjoying working capital credit in excess of the limit specified in this behalf is required to be segregated into two components:

(a)  Loan component; and

 

(b)  Cash Credit component (CC).

The guidelines of the Reserve Bank also prescribe the minimum proportion of the loan component in the total working capital credit extended to a borrower.

B.    Query

4. The querist has sought the opinion of the Expert Advisory Committee as to whether the loan component of the working capital credit, which, according to the querist, is a part of the overall cash credit facility falls under the term ‘temporary loan’ and thus qualifies for exclusion while arriving at the limit on the board of directors’ borrowing power under section 293(1)(d).

C. Points Considered by the Committee

5. On an examination of the guidelines of the Reserve Bank of India on loan system for delivery of bank credit, the Committee is of the view that the loan component of the working capital credit extended by banks is not in the nature of cash credit.

6. The Committee notes that as per the Reserve Bank of India Guidelines, banks were required to bifurcate their existing cash credit facilities into loan component and cash credit component. In the opinion of the Committee, upon bifurcation of an existing cash credit facility into loan component and cash credit component pursuant to the aforesaid guidelines, the loan component acquires the characteristics of a loan. In other words, this component ceases to have the characteristics of a cash credit account. This position is particularly clear from the stipulations of the guidelines relating to the payment period, interest, early repayment, etc.

7. The Committee notes that the bifurcation of an existing cash credit facility into loan component and cash credit component would require modification to the agreement executed by the bank and the borrower at the time the cash credit facility was originally extended.  In other words, the bifurcation of a cash credit facility already extended cannot be deemed to have taken place automatically upon issuance of the aforesaid guidelines by the Reserve Bank of India.  The querist has not furnished any information as to whether or not the necessary changes in agreement have been effected between the bank and the borrower.  In the absence of such information, the Committee presumes that the bifurcation of the existing cash credit facility between loan component and cash credit component is in accordance with the agreement between the two parties.

8. Whether the loan component falls within the definition of “temporary loans” as given in Explanation II would therefore depend upon whether it is repayable on (a) demand or (b) within six months from the date of the loan.  If either condition is satisfied, the loan component would be in the nature of a temporary loan and would therefore be excluded for the purpose of applying the limit under section 293(1)(d) of the Companies Act, 1956.

D. Opinion

9. Based on the above, the Committee is of the opinion that the loan component of working capital credit extended by a bank is not in the nature of cash credit.  (The Committee presumes that in the case of existing cash credit facilities, their bifurcation into loan component and cash credit component is in accordance with the agreement between the bank and the borrower.)  The Committee is further of the opinion that such loan component would qualify as a ‘temporary loan’ within the meaning of section 293 of the Companies Act, 1956, only if, as per the terms and conditions of the loan agreement, it is repayable on demand or within six months from the date of the loan.

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^[1] Opinion finalised by the Committee on 24.12.1998.