DOCTRINE OF ULTRA VIRES AND ITS RELEVANCE IN PRESENT INDUSTRIAL ATMOSPHERE
Author: Komal
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| DOCTRINE OF ULTRA VIRES |
INTRODUCTION
The company should devote itself only to the subjects set out in the memorandum. It is the function of memorandum to delimit and identify the objects in such plain and unambiguous manner as that the reader can identify the field of industry within which the corporate activities are to be confined.[1] It is the function of court to see that the company does not move away from the field.[2] This causes emergence of doctrine of ultra vires.
Doctrine of Ultra Vires, Meaning
The word ultra means beyond and the word vires means powers. Ultra vires means beyond powers. So, when it is used with reference to company it means beyond the power of the company. The power of the company is essentially derived from the statute constituting it and the memorandum of association.
A company which owes its incorporation to statutory authority cannot effectively do anything beyond the powers expressly or impliedly conferred upon it by the statute or memorandum of association. Any purported activity beyond such powers will be ineffective even if agreed to by all the members. This rule is commonly known as doctrine of ultra vires.
Purpose of Doctrine of Ultra Vires
The purpose of law is to regulate human behaviour. Law exists to make balance between rights and duties of individuals. Company is conferred with personality. It is separate legal entity having rights and duties conferred upon it by law to regulate its functions.
Any Company is incorporated with a vision to achieve certain objects. The object clause defines the object of the company and indicates the sphere of its activities. As per section 4(1)(c), this clause must state the object for which the company is proposed to be incorporated and any matter considered necessary in furtherance thereof. A company cannot do anything beyond or outside the objects and any act done beyond that will be ultra vires and void and cannot be ratified even by the assent of the whole body of shareholders.
However, company may do anything which is incidental to and consequential upon the objects specified and such act will not be an ultra vires act. In case Attorney General v. G.E. Rly. Co[3] an Act of Parliament authorized a company to construct a railway. Two other companies combined and contracted with the first to supply rolling stock. An injunction was brought to try to restrain this, saying that such a contract was not explicitly provided for in any of the Acts incorporating the companies. The contract was not ultra vires but was warranted by the Acts. Powers conferred by statute are taken to include, by implication, a right to take any steps which are reasonably necessary to achieve the statutory purpose: ‘whatever may fairly be regarded as incidental to, or consequential upon, those things which the Legislature has authorized, unless expressly prohibited to be held, by judicial construction, to be ultra vires. The object of the company must not be illegal, immoral or opposed to public policy or in contravention of the Act.
Development of Doctrine of Ultra Vires
The Doctrine of Ultra Vires
has its genesis in the case of Ashbury Rly. Carriage & Iron Company v. Riche[4] wherein the directors of the company entered into a contract with Riche to provide finance to the company for the construction of a railway line. However, the directors later repudiated the contract on the grounds of the ultra vires of the memorandum of association. The House of Lords held that the contract at the time of making it was void ab initio and invalid and it cannot be ratified at a later stage, hence it was ultra vires. In this case object of the doctrine was explained by Lord Justice Cairns as: to protect investors of the company so that they may know the objects in which the money is to be employed; and to protect the creditors by ensuring that the company funds, to which they must look for payment are not dissipated in unauthorized activities.
has its genesis in the case of Ashbury Rly. Carriage & Iron Company v. Riche[4] wherein the directors of the company entered into a contract with Riche to provide finance to the company for the construction of a railway line. However, the directors later repudiated the contract on the grounds of the ultra vires of the memorandum of association. The House of Lords held that the contract at the time of making it was void ab initio and invalid and it cannot be ratified at a later stage, hence it was ultra vires. In this case object of the doctrine was explained by Lord Justice Cairns as: to protect investors of the company so that they may know the objects in which the money is to be employed; and to protect the creditors by ensuring that the company funds, to which they must look for payment are not dissipated in unauthorized activities.
The new Companies Act, 2006 of UK does not require objects to be stated in the memorandum. The objects, if at all, have only to be stated in the articles. If there is no such statement, the company would be with unrestricted objects. Thus, the statement of objects, if any, would operate as a contract between the company and its members. This has the effect of eliminating all the complications caused by the doctrine of ultra vires. This doctrine would no longer be operative in dealing by the company with outsiders.
Choice of object lies with the subscribers to the memorandum of association and their freedom in this respect is almost unrestricted. The only obvious restrictions are that the objects should not go against the law of the land and the provisions of the Companies Act. For Example, law
prohibits gambling. No company can be incorporated for this purpose. Thus, where a company was incorporated for conducting a lottery, it was ordered to be wound up, that object being illegal.[5]
It may, however, be noted that section 4(1)(c) of the Act provides that any matter considered necessary in furtherance of the main objects can well be pursued. Thus, in case any incidental object has not been specified, it would be allowed by the principal of reasonable construction of the memorandum.[6]
It is important to note that the ultra vires doctrine is now a days very largely frustrated by the ingenuity of the company promoters, who, by enumerating all objects possible under the sun have in actual practice fouled the doctrine and made it ineffective, except in very rare cases. In the case of Bell Houses Limited v. City Wall Properties Limited [7], the objects clause included a power to carry on any other trade or business whatsoever which can, in the opinion of the Board of directors, be advantageously carried on by the company.
The Companies Act requires any matter also to be stated in the memorandum which is considered necessary for furtherance of the stated objects. But even if they are not so stated, they would be allowed by the principle of reasonable construction.[8] A chemical manufacturer was allowed to distribute sum to universities and scientific institution for the further advancement of scientific education and research as it was conducive to the continued progress of the company as chemical manufacturers.[9] The ultra vires doctrine confines corporate action within the fixed limits. That is why there has been revolt against it almost since its inception. In a bid to control the tendency to adopt memorandum containing profusion of objects and powers, the court adopted the main object rule of construction. The rule owes it origin to the decision in the Ashbury case and also applied in German Date Coffee Co re,[10] where it has been found that real object of this company which is called German Date Coffee Co was to manufacture a substitute for coffee in Germany under a Patent. It is what the company was formed for and all the rest is subordinate to that. This principal will be of no help where a company is formed for general purposes as opposed to a defined subject matter. In Kitson & Co Ltd, re[11] the court said that the impossibility of applying such a construction seems manifest when one remembers that business is a thing which changes. It grows or it contracts. It changes; it disposes of the whole its plant; it moves like its factory; it entirely changes it range of products and so forth. It is more like an organic thing. In Cotman v. Brougham the main
object rule was excluded by a declaration that every clause should be construed as substantive clause.
object rule was excluded by a declaration that every clause should be construed as substantive clause.
EFFECT AND CONSEQUENCES OF DOCTRINE OF ULTRA VIRES
Firstly, ultra vires acts of any company are null and void ab initio. The company is not bound by these acts. Neither company can enforce any ultra vires act against others, nor the other person can enforce any such act against company. Company cannot sue or be sued upon it in this circumstance as held in case Ashbury Railway Carraige and Iron Company v. Riche. An ultra vires acts are void ab initio cannot become intra vires by reason of estoppel, lapse of time, ratification, acquiescence or delay. However, in NEPC India Ltd v. Registrar of Companies[12] the Madras High Court held that a complaint alleging that a company was indulging in activities not mentioned in the object clause of the memorandum of Association had to be filed with six months of the date of the knowledge.
Secondly if member of company apprehends of company undertaking ultra vires then even a single member can make application for injunction order from the court to restrain the company from going ahead with the ultra vires act as held in Attorney General v. G R Eastern Railway Company.[13]
Thirdly there can be personal liability of directors. It is the duty of an agent to act within the scope of his authority. If he goes beyond, he will be personally liable to third party for breach of warranty of authority. The directors of company are agents.
The court held in case of Jehangir R Modi v Shamji Ladha.[14] a shareholder can maintain an action against the directors to compel them to restore to the company the funds of the company that have been employed in a transaction that they have no authority to enter without making the company party to the suit. In case of deliberate misapplication, criminal action can also be taken for fraud. However, a distinction must be drawn between transactions which are ultra vires the company and the ultra vires the directors. Where the directors exceeded their authority and do something the same may be ratified by the general body of the shareholders provided the company has the capacity to do that transaction as per memorandum of association.
Fourthly where a company’s money has been used ultra vires to acquire some property, the company’s right over such property is held secured. Besides, the company will be right party to protect such property against damage by third persons. It is because, though the property has been acquired for some ultra vires object, it represents the money of the company.
In case of ultra vires transactions, directors and other officers shall be personally accountable to third parties. It seems strange that the third parties could take advantage of the doctrine manifestly for the protection of the shareholders, in order to deprive the company of the money which is injustice should be paid to it by the third party.[15]
The rule of constructive notice of memorandum and articles explains why a company is liable for an ultra vires contract, but that does not solve the problem of injustice involved. Moreover, the rule altogether fails to hold ground when company is ought to be held liable for a tort committed by servant of the company while acting beyond the company’s powers. As the law stands today to make a company liable for any tort it must be shown that activity in the course of which it is committed falls within the scope of memorandum and that the servant committed tort within the course of his employment. Officers and employees who brings such situation can be held liable personally.
Exception to the Doctrine of Ultra Vires
There are certain exceptio
ns to the Doctrine of Ultra Vires. For instances, an act which is within the scope of the object clause of the company but outside the authority of directors can be ratified by the shareholders. The shareholders have the authority to validate an intra vires act performed in irregular manner in the company. If the company acquires any property through an ultra vires investment, even then the company right over that property shall be secured. An incidental or consequential effect of an act shall not be considered as ultra vires, unless it is expressly prohibited by the statute.
ns to the Doctrine of Ultra Vires. For instances, an act which is within the scope of the object clause of the company but outside the authority of directors can be ratified by the shareholders. The shareholders have the authority to validate an intra vires act performed in irregular manner in the company. If the company acquires any property through an ultra vires investment, even then the company right over that property shall be secured. An incidental or consequential effect of an act shall not be considered as ultra vires, unless it is expressly prohibited by the statute.
The power exercisable by the company are to be confined to the objects specified in the memorandum. However, the powers exercisable in respect of the objects specified may be express or implied. Every company, in fact, possess certain powers by virtue of its being an incorporated body, such as, for instance, a power to appoint and act through agents, and where it is a trading company, a power to borrow and give security for the purpose of its business, and also power to sell. Such powers expressed in the memorandum as held in Oak Bank Oil Company v Crum case.
The following powers have been held not to implied and it is, therefore, prudent in cases where deemed necessary, to include them expressly in the objects such as to acquire any business similar to the company, entering into an agreement with the other persons or companies for carrying on business in partnership or for sharing profits, joint adventure or other arrangements where very clear powers are necessary to justify such transactions, taking shares in other companies having similar objects ; taking shares of other companies where such investment authorizes doing indirectly that which will not be intra vires, if done directly; and promoting other companies or helping them financially .
There are certain other transactions for example power to use fund for political purposes; and a power to give gift and make donations or contributions for charities not relating to the objects stated in the memorandum; and a power to sell and dispose of the whole of a company’s undertaking; entering into contracts of suretyship or guarantee and making of loans by a company not engaged in financing or banking business.
CASE STUDY
A Lakshmanswamy Mudaliar v. Life Insurance Company case helped in helped in shaping the concept of ultra vires.
On July 15, 1955, at an Extraordinary General Meeting of the shareholders of the United India Life Assurance Company Ltd a resolution was passed, among other matters sanctioning a donation of Rs. 2 lakhs from out of the Shareholders Dividend Account to a Trust proposed to be formed with the object inter alia of promoting technical or business knowledge, including knowledge in insurance. On July 1, 1956, the Life Insurance Corporation Act came into force by the provisions of which on the appointed day all the assets and liabilities appertaining to the controlled business of an insurer vested in the Life Insurance Corporation.
Section 15(l)(a) of the Life Insurance Corporation Act power was given to the Corporation to apply to the Tribunal for relief in respect of payments made by the insurers, during the five years preceding the date of vesting, not reasonably necessary for the purpose of the controlled business. The Corporation went to the Tribunal for relief. The Tribunal ordered the appellants to restore the sum of Rs. 2 lakhs to the Corporation. On appeal by special leave the court also that the Shareholders Dividend Account provided for by the Articles did not confer any proprietary interest on the shareholders, though if was charged for the purpose of paying dividends to the shareholders and that the mere description of the dividend account as the exclusive property of the shareholders did not thereby create a proprietary interest in the shareholders.[16]
REFERRED CASES:
Bacha P. Guzdar v. Commissioner of Income-tax, Bombay[17], referred to and held that the meeting
in which the resolution was passed was a meeting of the Company &and it could not be contended that it was a meeting of the shareholders in their individual capacity. The resolution of the company and the acceptance by the appellants of the amount did not constitute a contract there being no consideration to support it. Further, the court said that the object of the company viz. to invest and deal with funds and assets of the company upon such securities or investments could not authorise the making of the donation and such a power which was not expressly provided for by the memorandum could not be found by reference to the general clause of the Memorandum giving power to do incidental things.
in which the resolution was passed was a meeting of the Company &and it could not be contended that it was a meeting of the shareholders in their individual capacity. The resolution of the company and the acceptance by the appellants of the amount did not constitute a contract there being no consideration to support it. Further, the court said that the object of the company viz. to invest and deal with funds and assets of the company upon such securities or investments could not authorise the making of the donation and such a power which was not expressly provided for by the memorandum could not be found by reference to the general clause of the Memorandum giving power to do incidental things.
The court referred Ashbury Railway Carriages and Iron Company v. Riche and held that the resort to the Articles of Association for the purpose of construing the Memorandum was permissible only on matters regarding which the Memorandum was silent or ambiguous.
The court held that the making of donations to the Trust which may or may not provide indirect or remote benefits to the business of insurance was not within the power of the company.
In Tomkinson v. South Eastern Railway,[18] the court held that the action of the Company being ultra vires, it created no legal effect and could not be ratified even if all the shareholders agreed.
Payments made pursuant to such action created no rights in the appellants and they were rightly directed under Section 15 of the Life Insurance Corporation Act to personally refund the amount.
DECISION OF THE COURT:
The court held it to be ultra vires stating that the directors cannot spend the company’s money on any charitable trust of their choice. They could only spend such amount on the charitable trust that enables them to promote the company’s own business, i.e., the money could be donated to a charitable trust which enables them for the attainment of the company’s own objects. However, the company’s business having been taken over by the life insurance corporation, it had no business left to promote.
The court held that the payment made by the directors towards the charitable trust was, therefore, unauthorised and the trustees acquired no right to the amount paid by the directors. Further, the court made the directors of the company personally liable for the payment made by them. The appeal was, therefore, dismissed.
Moreover, the supreme court also laid down guidelines for the same –
“That a company’s funds cannot be diverted to every kind of charity even if there is an unrestricted power to that effect in the company’s memorandum”. “That objects must be distinguished from powers. And objects must be stated in the memorandum, but not powers. Even if the powers are stated, they can be used only to effectuate the objects of the company”.
“That there must be a proximate connection between the gift and the company’s business interests”.
CONCLUSIONS & SUGGESTIONS
India is a developing country and a growing economy. In such a country, companies hold a lot of importance as they are required to give a boost to the GDP of the country. In the light of this fact, we can say that there is a need for a doctrine which would prevent companies from acting outside the authority as provided under the object of the Memorandum of Association. Hence, the existence of such a doctrine is quite important for the growth of the corporate sector of the country. At the initial stages, every business requires funds and for this, they are dependent upon the various banks and lending institutions. The doctrine of ultra vires protects the interest of the lenders by giving them assurance that their money would be returned if the company acts outside the authority given by their object clause.
The company, being an artificial person, its objects and powers are specified in the memorandum of association of the company. The Memorandum is the most crucial document for a company. It contains the object clause which enables the company in achieving its purpose for which it was formed.
An Ultra Vires act is different from that of illegal, however, both are void. If a company and its members exceed its object clause in the memorandum, then the act will be, therefore, void even if it is illegal. And an illegal act even though within the object clause of the memorandum of the company will be void.
The main aim of the doctrine of ultra vires is to protect the investors and the creditors of the company from suffering any kind of loss for which the company is responsible to pay. This doctrine prevents the company from employing the money of the investors and creditors elsewhere which is outside the scope of the object clause of the memorandum of the company. It allows them to know the objects of the company by keeping a check on their money and the transaction of the directors on behalf of the company.
There are, however, certain exceptions to this doctrine, such as an act, which is intra vires the company but outside the authority of the directors may be ratified by the shareholders. An act which is intra vires the company but done in an irregular manner, may be validated by the consent of the shareholders. The law, however, does not require that the consent of all the shareholders should be obtained at the same place and in the same meeting. If the company has acquired any property through an investment, which is ultra vires, the company’s right over such a property shall still be secured. While applying doctrine of ultra vires, the effects which are incidental or consequential to the act shall not be invalid unless they are expressly prohibited by the Company’s Act. There are certain acts under the company law, which though not expressly stated in the memorandum, are deemed impliedly within the authority of the company and therefore they are not deemed ultra vires. For example, a business company can raise its capital by borrowing. If an act of the company is ultra vires the articles of association, the company can alter its articles in order to validate the act.
[1] Cotman v. Brougham, 1918
AC 514.
AC 514.
[2] Port Canning & Land Investment Co re, (1871) 7 Bengal LR 583.
[3] Attorney General v. G.E. Rly. Co (1880) 5 AC 473.
[4] Ashbury Rly. Carraige &Iron Company v. Riche 1875 LR 7 HL 653.
[5] Avtar Singh, COMPANY LAW, 65 (17th ed, 2018).
[6] Section 4, The Companies Act, 2013.
[7] Bell Houses Limited v. City Wall Properties Limited 1966 36 Comp. Cas.779.
[8] Avtar Singh, COMPANY LAW, 63 (17th ed, 2018).
[9] Evans v Brunner, Mond & Co (1921) 1 Ch 359.
[10] German Date Coffee Co re, (1882) LR 20 Ch D 169.
[11]Kitson & Co Ltd, re (1946) 1 ALL ER 435 (CA).
[12]NEPC India Ltd v. Registrar of Companies [1999] 22 SCL 94.
[13]Attorney General v. G R Eastern Railway Company 1800 5 AC 473.
[14]
[15]Bell House Ltd v. City Wall Properties Ltd, (1996) 2 QB 656.
[16] Available at, Indian Kanoon, https://indiankanoon.org/ accessed on September 05, 2019.
[17] Bacha P. Guzdar v. Commissioner of Income-tax, Bombay,[1955] 1 S.C.R. 876.
[18] Tomkinson v. South Eastern Railway, (1887) 35 Ch, D,675.
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