Doctrine of Ultra Vires under Company Law

Setting the Frame

The term ultra vires is a Latin locution for “beyond the powers” or “beyond the authority”. It is used to describe acts which require legal authority to perform but are done without such authority[1]. Such acts are considered void in the eyes of law. It means that if a person or an entity does any act which it is legally not authorised to do and by such act, it causes any damage (violation of any legal right), such act cannot be enforced against that entity in a court of law. In other words, it means that if later, the person or entity refuses to perform the act, no specific performance of that act can be claimed because the act is ultra vires or void. Doctrine of Ultra Vires

For instance, ABC Ltd. is a company engaged in thebusiness of providing fire and marine insurance. It enters into a contract withMr. X to provide him life insurance and takes a sum of money as advance. Laterif the company refuses to perform the contract or there is a loophole in thelife insurance policy, the company cannot be held liable since providing lifeinsurance was beyond the powers of the company. This is known as ultra vires.

The doctrine of ultravires and the legal issue giving rise to the doctrine can arise in threeareas of law:

1. Company Law:When the company undertakes any activity not specifically provided for in theobject clause of the Memorandum of Association (hereinafter referred as ‘MoA’)of the company.
2. Constitutional Law: When the Centre or State Government passes any legislation that itdoes not have the authority to pass under Schedule 7 of the Constitution.
3. Administrative Law: When a subordinate or delegated legislation is passed without theauthority to make such legislation.

This article endeavours to analyse the doctrine of ultra vires under Company Law and morespecifically under the Companies Act, 2013. The article shall delve into thequestions such as meaning of the rule, its application in various areas ofcompany law and exceptions to the rule.

Memorandum of Association – Form and Content

A company is said to be established after thecertificate of incorporation from the Registrar of Companies is granted after aduly filled application form in Form INC-1 is submitted. The form requires twomost essential documents to be attached with it, i.e. the Memorandum ofAssociation (hereinafter referred as MoA) and the Articles of Association (hereinafterreferred as AoA). The MoA is the primary document of a company, also known asthe Charter or the Constitution of the company. The principalismunus of the MoA is to define the relationship of thecompany with outsiders, i.e. its customers or investors (excludingshareholders)[2].

Palmer believes that the MoA is “a document of great importance in relation to the proposed company”[3]. According to Section 4 of the Companies Act, 2013, the MoA of the company must contain the following information about the company:

1. Nameof the company with indication as to whether it is a public limited company orprivate limited company[4].
2. Nameof the State where the registered office of the company is situated[5].
3. Theobjectives of the company for which it is incorporated[6].
4. Extentof liability of the members and/or shareholders[7]and
5. Theamount of share capital with which the company is to be incorporated and thedivision of such capital into requisite number of shares[8].

The Objects Clause – Meaning Thereof

The Companies Act, 2013 provides that every MoA muststate the objects of the proposed company[9].Hence, as it rests with the subscribers to the MoA to declare the objects, itfollows that the subscribers are, by the Act, furnished with the means notmerely to initiate the creation of a corporation authorised by statute but alsoto form the body for such purposes as they think fit, provided, of course, thatthose purposes are not illegal.

The Objects Clause – Categories Thereof The object cause is usually divided into three categories, i.e. ‘the main object’, ‘the ancillary objects’ and ‘other objects’. Accomplishing the main objects in the object clause is the raison d’être of a company, and performing any activities or entering into any transactions by the company in furtherance of achieving the main object are the ancillary objects.

The Objects Clause – Purpose interpreted by the Courts

The objectclause is considered to be the heart and soul of the MoA; it defines theobjects for the existence and operation of the company. As was observed in Cotman v. Brougham[10],the purpose of the objects clause is “to enable the shareholders, creditors andthose dealing with the company to know what its permitted range of enterpriseis”. There are three essential legal functions that make the object clausemomentous and needed to be considered[11]. Firstly, to define the capacity ofthe company with respect to third parties. Secondly, to provide the limits onthe authority of the directors as agents of the company. Lastly, since theobject clause is a part of the MoA of the company, it becomes a bindingcontract between the members of the company interse and between each member and the company under Section 10 of theCompanies Act, 2013.

Interpretation of the Objects Clause

Section 10 makes every terms and clauses in the MoA ofa company binding upon the company and its members. It means that the companyis also bound by the objectives enlisted in the objects clause of the MoA. Therefore,interpretation of the MoA acquires significant importance to determine thescope of activity of the company. Lord Chelmsford observed in Scott v. Corporation of Liverpool[12]that to construe a document means to arrive at the meaning intended to be givento the document by the concerned parties. Similarly, the Court of Appealpointed out that ‘the natural and ordinary meaning of the language used inseveral clauses should be taken into consideration for determining whether aparticular transaction falls or does not fall within the objects stated in theMoA’[13].

Strict interpretation of Object Clause

In general, the courts have adopted a strict sense of interpretation or in legal terms, the literal rule of interpretation of object clause. It means that the object clause is construed according to the words prescribed in the clause and very slight swaying from such objects can be allowed. In Re: Eastern Telegraph Co. Ltd.[14], the English Chancery Division held that ‘if the objects clause has a specific main object followed by general words, the general words should not be interpreted as enabling the company to throw its main object altogether’.

To sum up, in modern law, the courts are unlikely tohold any contract (in the form of transaction) to be null and void unless, on areasonable construction of the objects clause, there are compelling grounds toarrive at the result[15].

The Doctrine of Ultra Vires

A company is incorporated under the Companies Act, 2013 and in accordance to the terms set out in its MoA. Thus, a company which owes its incorporation to a statutory authority, cannot effectively do anything beyond the powers expressly or impliedly conferred upon it by the Statute or the MoA. In precise terms, a company is bound by the provisions of the Companies Act, 2013 and that agreed and enlisted in the MoA. Any act or transaction conducted beyond such powers will be ineffective and void[16]. This is known as the ‘doctrine of ultra vires’.

The Joint Stock Companies Act, 1856, enacted in theUnited Kingdom brought the dawn of an era of emerging joint stock companies.The legislation provided a lucid administrative procedure enabling any group ofseven persons or more to incorporate a limited liability company and commencethe business[17].This resulted in the indiscriminate augmentation in the incorporation of jointstock companies and diluted the regulatory mechanisms. As a result, companiesstarted ignoring the objective for which they were established but focussedonly on maximising profits, and also, since liability was limited, there was nothreat of personal loss.

After the advent of joint stock companies, the rule ofultra vires was for the first timelaid down by the House of Lords in the much celebrated case of Ashbury Railway Carriage & Iron Co. v.Riche[18].In this case, the objects clause of the MoA of the appellant company allowed itto “make or sell or lend on hire, railway carriages and waggons; to carry onthe business of mechanical engineers and general contractor … and to do allsuch other things as are necessary and incidental to all or any of suchobjects”[19].The company entered into a contract with the plaintiff (here, Riche) forfinancing of the construction of a railway line in Belgium.

The House of Lords held that the contract is ultra vires the objects of the companyand void. It further stated that any act which becomes void due to the vice of ultra vires cannot be ratified even byunanimous consent of all the shareholders. Holding such, Lord Cairns explainedthe purpose of the doctrine in the following two points:

1. Toallow the investors and stakeholders to know the objects of the company inwhich their money is employed and thereby protect them from any unauthorisedact or transaction; and
2. Toprotect the creditors by ensuring that the funds of the company generated throughthe creditors are not dissipated in unwarranted or forbidden activities[20].

Evolution of the Doctrine of Ultra Vires

After the doctrine was propounded in Ashbury, all it required was exposition;guidelines as to how the rule should be applied and in what circumstancesshould companies be exempted. In the absence of any particular legislation,this burden fell on shoulders of the judiciary which engaged itself in the taskof evolution of this rule. Five years after Ashburywas decided, the English Court of Appeal ruled in Attorney General v. Great Eastern Railway[21]that the rule must be “reasonably understood and applied”. The court held thatif any act can fairly be regarded as an act incidental or ancillary to what isallowed by the statute or the MoA, the courts ought not to declare such act ultra vires.

One of the earliest cases to adopt the doctrine in India was Dr. Lakshmanaswamy Mudaliar v. LIC[22].The apex court in this case held that it is ‘proscribable for a company to act beyond the scope of its MoA. An act beyond the objects mentioned in the MoA is ultra vires and void and cannot be ratified’. The Doctrine of Ultra Vires was further upheld by the Calcutta High Court in Radha Cinemas & Co. v. Chitralipi Films[23]. The court averred that ‘where no connection or nexus exists between the exercise of a power and the attainment of the prescribed object, the exercise of such power will be ultra vires’.

Application of the Doctrine

The Doctrine of Ultra Vires has to be applied reasonably and only after due consideration to the interests of the company[24]. In the case of Lee Behrens & Co. ltd.[25], Eve J. laid down the three fundamental tests to be followed by a company to avoid the application of the doctrine of ultra vires. These are:

1. Isthe transaction reasonably incidental tothe company’s business?
2. Isit a bona fide transaction?
3. Isit done for the benefit of and to promote the prosperity of the company?

If the answer to these questions is in affirmative,the court shall hold the transaction intravires. This test was found to be ambiguous and subjective as it raisedseveral questions such as whether the transaction has to be outside thecapacity of the company or merely an abuse of authorised power will amount toan ultra vires act. Therefore, tofill the lacuna in the law existing at the time of Lee’s case, a new four point rule was established by the court in Rolled Steel Products Ltd. v. British SteelCorp.[26]

The rules as laid down by Wilkinson J. are[27]:

1. Tobe ultra vires, a transaction has tobe outside the capacity of the company and not merely in excess or abuse of thepowers of the company.
2.  The capacity of the company is determined fromits objects. There can be provisions in the objects clause that provide onlypower to the company but do not lay down any object. Thus, to determine thecapacity, those objects must be considered which are able to existindependently irrespective of other objects.
3. Ifa company enters into a transaction which is intra vires but in excess or abuse of its powers, such transactionis voidable at the option of the shareholders.
4. Athird party, who has the notice of any activity performed by the company inexcess of its powers, cannot enforce such transaction against the company andshall be held accountable for any money received by the company from the thirdparty.

These rules form the basis for application of thedoctrine in the present company law jurisprudence. Besides the above rules, ifthe company engages into any activity contrary to the law but enabled by itsMoA, such activity shall also be ultravires and void.

Who Can Plead and When?

The main object of the Doctrine of Ultra Vires is to protect the interest of the company from zealous directors and members who act beyond their authorised powers motivated to earn profits. This doctrine enables the company to avoid any such act or transaction that the members were not authorised to perform and which shall be detrimental to the interest of the company. Since the doctrine was propounded to protect the company’s interest, it is obvious that it cannot be used against the interest of the company[28]. It means that a person (a creditor or investor) who enters into a contract with the company knowing it to be beyond the powers of the company cannot avoid the performance on his part using the doctrine of ultra vires.

The question was posed before the Queen’s Bench in Anglo Overseas Agencies Ltd. v. Green[29]but however, the court did not requireto answer the same as it concluded that the transaction was intra vires. It was again raised in Bell Houses Ltd. v. City Wall PropertiesLtd.[30].In this case, the managing director, representing the company, providedconsultancy services outside the scope of company’s objects and later refusedto pay the consultancy charges collected from the customers to the companyclaiming that the transaction was ultravires and hence, void ab initio.The court made a very critical observation in this case stating that “otherscannot defeat the claims of the company on grounds of ultra vires when such claim has already matured”. The court heldthat the plea of ultra vires can betaken only when the act or transaction is in an executory stage.

In India, the issue was resolved by the division benchof the Madras High Court in Sivashanmugham(S) v. Butterfly Marketing Pvt. Ltd.[31].The court held that ‘a third party may not take advantage of the doctrine of ultra vires in order to avoid theperformance of obligations voluntarily taken with full opportunity to know theextent of the company’s power before entering into the transaction’.

Rights of the Shareholders vis-à-vis the Rule of Ultra Vires

According to the rule laid down in Foss v. Harbottle[32],the shareholders of a company do not have a separate cause of action for anywrong done to the company. It means that the company and only the company canbring action against the wrongdoer to protect the interests of theshareholders. However, it is considered to be an accepted exception to thisrule that a shareholder can bring a direct action to restraint the company andthe managers from pursuing any ultravires activities[33]. Consequently,the shareholders can also bring an action against the directors or managingauthorities of the company to get an order to make good the loss caused to thecompany owing to their unauthorised acts.

Rights of Minority Shareholders

Now, when the unauthorised act affects the majorityshareholders, it is very convenient to file a suit and get an order ofinjunction against the company and the directors. However, the question arisescan minority shareholders bring action to restrain the joint decision of thecompany directors and the majority shareholders. The question was answered intwo vital cases, i.e. the Australian case of Oatmont Pty. Ltd. v. Australian Agriculture Company Ltd.[34]and the Indian case of Bharat InsuranceCo. Ltd. v. Kanhaya Lal Gauba.[35].

The courts in both the cases held that the minorityshareholders of a company may bring an action to restraint the controllers ofthe company from jeopardising the assets of the company. The court furtheradded that even a single member of a company can maintain a suit if it relatesto the interpretation of the true meaning of the objects clause of the MoA ofthe company.

Charitable Expense and Ultra Vires Rule

Under Section 181 of the Companies Act, 2013, the boardof directors of a company can contribute any amount to a bona fide charitabletrust. The upper limit of Rs. 50,000 under the Companies Act, 1956 has beenremoved by the Companies Act, 2013[36],however, prior permission of the company in general meeting is necessary tocontribute any amount exceeding 5% of the average net profits of threeimmediately preceding financial years. This power of the company is derivedfrom the statute itself and its virescannot be challenged before any court of law

Case of Simmonds v. Heffer

‘League against Cruel Sports Ltd.’ was a not forprofit corporation working to prevent sports hurling cruelty upon animals. Thecompany contributed £ 80,000 to a political party which claimed to ban certainsports that exhibit animal cruelty after it came to power. The money wasdonated in two parts; £ 30,000 was given with specific direction to use it to advertisethe objectives of the company and the remaining £ 50,000 was given without anydirection. The payment of £ 30,000 was held to be proper since it was bona fidecontribution to advertise the commitment of the company towards animal welfare.However, the court held that £ 50,000 contribution was ultra vires the company’s powers[37].

Conclusion – Reformation Brought to the Doctrine of Ultra Vires

The first attempt to reform the rule was made by theBritish Parliament in 1972 by enacting the European Communities Act. UnderSection 9 of the Act, the first European Economic Community’s Company LawDirective was implemented[38].The Directive required coordination of safeguards to protect the interests ofthe company and the shareholders and one such safeguard was the rule of ultra vires. For the first time, thedoctrine was penned down in the form of a statute but as Palmer states, itspurpose was only to do the minimize necessity to comply with the communityguidelines[39].Not very late, the European Communities Act wassubstituted by a new Companies Act, 1989 which added a new provision, Section35 which provides:

“The validity ofan act done by a company shall not be called into question on the ground oflack of capacity by reason of anything in the company’s memorandum”.

The effect of the section was to abolish the doctrineof ultra vires completely and leavethe legal consequence of violation of objects clause in the hands of commonlaw. The doctrine is still applicable in India and by virtue of Section 10 ofthe Companies Act, 2013, a company or its controllers cannot go beyond thecapacity of the company as enumerated in the objects clause of the MoA.

References:

1]A.K.Majumdar et al, Taxmann’s Company Law and Practice 119 (2014).

[2]Ibid at 110.

[3]1Palmer & Morse, Palmer’sCompany Law 2067 (2004).

[4]Companies Act, No. 18, Act ofParliament, §4(1) (a), 2013 (India).

[5]Companies Act, No. 18, Act ofParliament, §4(1) (b), 2013 (India).

[6]Companies Act, No. 18, Act ofParliament, §4(1) (c), 2013 (India).

[7]Companies Act, No. 18, Act ofParliament, §4(1) (d), 2013 (India).

[8]Companies Act, No. 18, Act ofParliament, §4(1) (e), 2013 (India).

[9]Companies Act, No. 18, Act ofParliament, §4(1) (c), 2013 (India).

[10]Cotmanv. Brougham, 1918 AC 514.

[11]1M.C. Bhandari, Guide toCompany Law Procedure 167 (20th ed. 2017).

[12]Scott v. Corporation of Liverpool,(1858) 3 De G. & J. 334.

[13]Bell Houses Ltd. v. City WallProperties Ltd. (1966) 2 All ER 674 (CA).

[14]In Re: Eastern Telegraph Co. Ltd.,(1947) 2 All ER 104.

[15]Palmer, supra note 3 at 2126 – 27.

[16]Majumdar,supra note 1 at 119.

[17] Mayson et al., Mayson, Frenchand Ryan on Company Law 606 – 07 (31st ed. 2014 – 15).

[18]Ashbury Railway Carriage & IronCo. v. Riche, (1875) L.R. 7 H.L.  653.

[19]Palmer, supra note 3 at 2604.

[20]Majumdar,supra note 1 at 120.

[21]Attorney General v. Great EasternRailway, (1880) 5 AC 473.

[22]Dr. LakshmanaswamyMudaliar v. LIC,AIR 1963 SC 1185.

[23]Radha Cinemas & Co. v.Chitralipi Films,

[24]Bhandari, supranote 11 at 191.

[25]Re: Lee Behrens & Co. ltd., (1932) 2 Ch 46.

[26]Rolled Steel Products Ltd. v. British Steel Corp.,1984 BCLC 466.

[27]Ibid at 517 – 18.

[28]1 A. Ramaiya, Guide to theCompanies Act 367 (16th ed. 2004).

[29]Anglo Overseas Agencies Ltd. v.Green, (1960) 3 All ER 244.

[30]Supranote 13.

[31]Sivashanmugham (S) v. ButterflyMarketing Pvt. Ltd., (2001) 105 Com. Cases 763.

[32]Foss v. Harbottle, (1843) 67 ER 189.

[33]Ramaiya, supranote 24.

[34]Oatmont Pty. Ltd. v. Australian AgricultureCompany Ltd., (1991) 5 ACSR (Aust).

[35]Bharat Insurance Co. Ltd. v. Kanhaya Lal Gauba,(1934) 4 Com. Cases 411 (Lah).

[36] Bhandari, supra note 11 at 211 – 12.

[37]Simmonds v. Heffer, 1983BCLC 298 (Ch. D).

[38]Directive 68/151 of March 9, 1968, ([1968] J.O.L65/8).

[39]Palmer, supranote 3 at 2129 – 30.