What is a negative lien?
Let us first understand what is a negative lien. Actually, there is no legal definition of the term ‘negative lien’ in any of the Indian legislative enactments. However, as it is understood in the normal course of business, it is merely a negative covenant which restricts a person from creating any kind of encumbrance over his assets or otherwise disposing of them without the prior consent of the other person in whose favour he has given such an undertaking.
In banking and finance transactions (particularly in project finance transactions) the terms of various agreements generally include negative covenants or negative liens restricting the borrower company as well as in certain cases a promoter/sponsor company from disposing or otherwise creating any encumbrance over their assets (including shares) without the permission of the banks and/or financial institutions advancing the loan.
In other words, banks are obtaining an undertaking letter from the borrower that his assets like land, building, machinery, stocks and shares of the company etc. are free from any charge or encumbrance and he would not create any charge or encumbrance on any of these assets in favour of third parties during the period of bank finance. Such undertaking is called a negative covenant or negative lien.
What is a charge?
A charge is a right created by any person including a company referred to as “the borrower” on its assets and properties, present and future, in favour of a financial institution or a bank, referred to as “the lender”, which has agreed to extend financial assistance.
Section 2(16) of the Companies Act, 2014 defines charges as to mean an interest or lien created on the property or assets of a company or any of its undertakings or both as security and includes a mortgage. Thus, the term ‘Charge’ under the provisions of the Companies Act, would include any kind of lien including negative lien.
It may further be noted that in banking and finance transactions, the loan agreement as well as certain security documents like a deed of hypothecation or a deed or indenture of mortgage also contain a ‘negative lien’ over the assets charged or secured in terms of such deed. Given the foregoing, such deeds shall be registered with a specific mention of the negative lien over the assets created vide such deeds so as to register the said lien.
Why charge has to be registered?
The Hon’ble Bombay High Court in the case of Commissioner of Income Tax V/s.Roshanbabu Mohammed Hussein Merchant (2005) observed that the term lien used in the definition of charge in section 2(16) would also include ‘negative lien’ since a negative lien is a sub-set of lien. The Hon’ble court also said that the charge created by a company in favour of a person over its assets (including its share) in the form of a ‘negative lien’ is not exempted from registration of charge with ROC in terms of section 125 of Companies Act 1956.
Thus, the charge will not be regarded as secured in the eyes of the law unless it is registered with the Registrar of Companies. The certificate of registration of charge acts as conclusive proof to the public that a charge has been created over the property and the charge holder holds good interest in the same.
According to Section 77 of the Companies Act, 1956, all types of charges created by a company are to be registered by the ROC, where they are non-compliant and are not filed with the Registrar of Companies for registration; it shall be void as against the liquidator and any other creditor of the company.
Once a charge of any kind including a negative lien is registered, it acts as a notice to the public at large that the charge holder has an interest in the charged property. No person can take a defence against the charge holder that he was not aware that a charge was created against the property and it prevents a company from creating encumbrance over the assets over which it has conferred such negative lien in favour of the banks and/or financial institutions.
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