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Doctrine of ultra vires
 

Doctrine of ultra vires

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    Doctrine of ultra vires Doctrine of ultra vires Document Transcript

    • Doctrine of Ultra Vires In Company Law Raghvendra Singh Raghuvanshi ♣ TABLE OF CONTENTS Introduction Origin Of Doctrine Of Ultra Vires Is It Ultra Vires Or Illegal? Protection Of Creditors And Investors Establishment Of The Doctrine Evasion Cohen Committee & Jenkins Committee Ascertainment Of The Ultra Vires Evasion By Businessmen And Principle Developed By The Courts To Prevent Such Evasion Independent Objects Clause Effect Of Ultra Vires Transactions Ø Ultra vires contracts Ø Ultra vires borrowings Ø Ultra vires torts or crimes Liability Of Directors Ø Liability towards the company Ø Liability towards the third party Exceptions To The Doctrine Of Ultra Vires Present Position Ø England Ø India Conclusion ♣ IV Year student of B.A., LL.B. (Hons.), National Law Institute University, Bhopal, India. indlaw.com 1
    • STATEMENT OF PURPOSE: In this research paper I endeavour to discuss the intricacies involved in doctrine of ultra vires vis-à-vis Company Law. The areas that I shall discuss are viz. origin and establishment of the doctrine, whether investors and creditors are protected by this doctrine? I shall also deal with as to how this doctrine is ascertained. The research shall also include effect of ultra vires transactions, liability of the directors and exceptions to this doctrine with the help of decided case laws. The paper also focuses on the comparison between English Law and Indian Law regarding the doctrine of ultra vires. Introduction The object clause of the Memorandum of the company contains the object for which the company is formed. An act of the company must not be beyond the objects clause, otherwise it will be ultra vires and, therefore, void and cannot be ratified even if all the members wish to ratify it. This is called the doctrine of ultra vires, which has been firmly established in the case of Ashtray Railway Carriage and Iron Company Ltd v. Riche. The expression “ultra vires” consists of two words: ‘ultra’ and ‘vires’. ‘Ultra’ means beyond and ‘Vires’ means powers. Thus the expression ultra vires means an act beyond the powers. Here the expression ultra vires is used to indicate an act of the company which is beyond the powers conferred on the company by the objects clause of its memorandum. An ultra vires act is void and cannot be ratified even if all the directors wish to ratify it. Sometimes the expression ultra vires is used to describe the situation when the directors of a company have exceeded the powers delegated to them. Where a company exceeds its power as conferred on it by the objects clause of its memorandum, it is not bound by it because it lacks legal capacity to incur responsibility for the action, but when the directors of a company have exceeded the powers delegated to them. This use must be avoided for it is apt to cause confusion between two entirely distinct legal principles.1 Consequently, here we restrict the meaning of ultra vires objects clause of the company’s memorandum. Origin Of The Doctrine The doctrine of ultra vires was first introduced in relation to the statutory companies.2 However, the doctrine was not paid due attention up to 1855. The reason appears to be this that doctrine was not felt necessary to protect the investors and creditors. The companies prior to 1855 were usually in the nature of an enlarged partnership and they were governed by the rules of partnership. Under the law of partnership the fundamental changes in the business of partnership cannot be made without the consent of all of the partners and also the act of one partner cannot be binding on the other partners if the act is found outside his actual or apparent authority, but it can always be ratified by all the partners. These rules of partnership were considered sufficient to protect the investors. On account of the unlimited liability of the members, the creditors also felt themselves protected and did not require any other device for their protection. Besides, during early days the doctrine had no philosophical support. The doctrine is based on the view that a company after 1 Cf. Grower, “The Principle of modern Company Law”, p. 78. 2 Sealy, L.S., “Cases and Materials on Company Law”. indlaw.com 2
    • incorporation is conferred on legal personality only for the purpose of the particular objects stated in the objects clause of ite memorandum and transaction not authorized expressly or by necessary implication must be taken to have been forbidden, but this view was not followed during early days and contrary to it, the view that a company has all the powers of a natural person unless it has been taken away expressly or by necessary implication was given a big support.3 In 1855 some important developments took place. One of them was the introduction of the principle of limited liability. After the introduction of this principle, it was possible to make the liability of the members limited. Set Off long as the liability of the members was unlimited, the creditors of the company considered themselves protected, but after the development of doctrine of limited liability, they found themselves in a miserable state. This necessitated a device to protect the creditors; this moulded the minds of the pioneers towards the doctrine of ultra vires. In addition to it, the companies were required to have two important documents, the memorandum and articles. The memorandum was to contain the objects of the company. The alteration of the memorandum was made difficult. Thus the importance of memorandum was realized and the management of the company was desired to observe the objects stated in the memorandum. All these created an atmosphere favorable for the development of doctrine of ultra vires. Is It Ultra Vires Or Illegal? The ultra vires act or transaction is different from an illegal act or transaction, although both are void. An act of a company which is beyond its objects clause is ultra vires and, therefore, void, even if it is illegal. Similarly an illegal act will be void even if it falls within the objects clause. Unfortunately the doctrine of ultra vires has often been used in connection with illegal and forbidden act. This use should also be prevented. Protection Of Creditors And Investors Doctrine of ultra vires has been developed to protect the investors and creditors of the company. This doctrine prevents a company to employ the money of the investors for a purpose other than those stated in the objects clause of its memorandum. Thus, the investors and the company may be assured by this rule that their investment will not be employed for the objects or activities which they did not have in contemplation at the time of investing their money in the company. It enables the investors to know the objects in which their money is to be employed. This doctrine protects the creditors of the company by ensuring them that the funds of the company to which they must look for payment are not dissipated in unauthorized activities. The wrongful application of the company’s assets may result in the insolvency of the company, a situation when the creditors of the company cannot be paid. This doctrine prevents the wrongful application of the company’s assets likely to result in the insolvency of the company and thereby protects creditors. Besides the doctrine of ultra vires prevents directors from departing the object for which the company has been formed and, thus, puts 3 Prof. Grower, Supra, p. 80. indlaw.com 3
    • a check over the activities of the directions. It enables the directors to know within what lines of business they are authorized to act. Establishment Of The Doctrine The doctrine of ultra vires could not be established firmly until 1875 when the following case was decided by the House of Lords. The decision in this case confirmed the application of this doctrine to the companies by registration under Companies Act. In Ashbury Railway Carriage and Iron Company Ltd v. Riche, (1875) L.R. 7 H.L. 653., In this case, the objects of the company as stated in the objects clause of its memorandum, were ‘to make and sell, or lend on hire railway carriages and wagons, and all kinds of railway plaint, fittings, machinery and rolling stock to carry on the business of mechanical engineers and general contractors to purchase and sell as merchants timber, coal, metal or other materials; and to buy and sell any materials on commissions or as agents.’ The directors of the company entered into a contract with Riches for financing a construction of a railway line in Belgium. The contract was ratified by all the members of the company, but later on it was repudiated by the company. Riche sued the company for breach of contract. Issue: whether the contract was valid and if not, whether it could be ratified by the members of the company? The House of Lords held unanimously that: (a) The contract was beyond the objects as defined in the objects clause of its memorandum and, therefore it was void, and (b) The company had no capacity to ratify the contract. Decision: The House of Lords has held that an ultra vires act or contract is void in it inception and it is void because the company had not the capacity to make it and since the company lacks the capacity to make such contract, how it can have capacity to ratify it. If the shareholders are permitted to ratify an ultra vires act or contract, it will be nothing but permitting them to do the very thing which, by the Act of Parliament, they are prohibited from doing. The House of Lords has expressed the view that a company incorporated under the Companies Act has power to do only those things which are authorized by its objects clause of its memorandum and anything not so authorized (expressly or implie dly) is ultra vires the company and cannot be ratified or made effective even by the unanimous agreement of the members. Later on, in the case of Attorney General v. Great Eastern Railway Co. 4, this doctrine was made clearer. In this case the House of Lords affirmed the principle laid down in Ashbury Railway Carriage and Iron Company Ltd v. Riche5 but held that the doctrine of ultra vires “ought to be reasonable, and not unreasonable understood and applied and whatever may fairly be regarded as 4 (1880) 5 A.C. 473. 5 Supra at note 4. indlaw.com 4
    • incidental to, or consequential upon, those things which the legislature has authorized, ought not to be held, by judicial construction, to be ultra vires.” After the case of Attorney General v. Great Eastern Railway Co.6 a company incorporated under the company Act has power to carry out the objects set out I the objects clause of its memorandum and also everything that is reasonably necessary to enable it to carry out those objects. The doctrine of ultra vires was recognised in Indian the case of Jahangir R. Mod i v. Shamji Ladha 7 and has been well established and explained by the Supreme Court in the case of A. Lakshmanaswami Mudaliar v. Life Insurance Corporation Of India 8. In this case, a company formed “ buy, sell and deal in coal” may for the purpose of carrying out to the stated objects, employ labour, open shops, buy and hire lorries, draw and accept bills of exchange, borrow and give security and employ agents. In addition to the powers specifically conferred by the memorandum, a company has the power to do whatever may fairly be regarded as incidental to its express objects. Even in India it has been held that the company has power to carry out the objects as set out in the objects clause of its memorandum, and also everything, which is reasonably necessary to carry out those objects.9 For example, a company which has been authorized by its memorandum to purchase land had implied authority to let it and if necessary, to sell it.10However it has been made clear by the Supreme Court that the company has, no doubt, the power to carry out the objects stated in the objects clause of its memorandum and also what is conclusive to or incidental to those objects, but it has no power to travel beyond the objects or to do any act which has not a reasonable proximate con nection with the object or object which would only bring an indirect or remote benefit to the company. Evasion Very soon after the Ashbury’s case, the shortcomings or disadvantages of this rule became apparent. The doctrine creates hardships both for the management and outsiders dealing with the company. An outsider dealing with the company is, in law, presumed to have knowledge of the provisions of the memorandum and articles of the company. A contract made by an outsider with the company in respect of anything which is not covered under the objects clause in its memorandum is ultra vires and therefore void. Suppose the contract is in favour of the outsider and on account of it he wishes to enforce it and again suppose that the shareholders of the company who wish to behave equitably and honour the contract by validating it by ratification in order to enable the outsider to enforce the contract, they are unable to do so. Besides, it causes much hardship to the management. The activities of the management of a company becomes subject to restrictions. At every step the management is required to see whether the acts which are sought to 6 Id. 7 (1868) 4 Bom. HCR 185. 8 (1963) 1 SCJ 521. 9 Gujarat Mining& Manufacturing Company v. Motilal H.S. Weaving Company, AIR 1930 Bom. 84. 10 Ibid. indlaw.com 5
    • be done are covered in the objects clause of its memorandum. It restricts the frequency of the business activities. No doubt, if the act sought to be done by the management is not covered by the objects clause in the memorandum of the company, the objects clause may be altered so as to cover it, but for such alteration a long procedure is to be followed and consequently the aleration will take much time. t Thus the rule causes much nuisance by preventing from changing its activities in a direction upon which all members have agreed. Cohen Committee & Jenkins Committee Ballantine has described it as a mischievous doctrine. The Cohen Committee has recommended the abolition of this doctrine for it serves no positive purpose and is a cause of unnecessary prolixity and vexation. In the opinion of this committee it is an illusionary protection for the shareholders and a pitfall for the third parties dealing with the company. The Jenkins Committee has also expressed its dissatisfaction with this doctrine. In England an Act called the European Communities Act, 1972 has been passed and it has modified the doctrine ultra vires to a large extent. Soon after Ashbury’s case the shortcomings of the doctrine were realized and the reaction against it stated. Both the courts and business community began to make attempts to reduce the rigours of the doctrine. The courts have developed the following principles to reduce the rigours of the doctrine of ultra vires: 1. Powers implied by statute: According to this principle a company has a capacity to do an act or to exercise a power, which has been conferred on it by the companies Act. Or any other statute, even if such act is not covered by the objects clause in the memorandum of the company. 2. The principle of implied and incidental powers: This principle has been established in the Attorney General’s case. According to this principle a company, in addition to the powers conferred on it by the objects clause of its memorandum, has power to do all those acts, which are: (a) Necessary for, or (b) Incidental to, or (c) Incidental to or consequential upon, the exercise of those powers. Thus this principle is of implied and incidental powers makes it clear that a company has not only the powers on it by the objects clause of its memorandum or the statute creating it but also the powers which are necessary for a incidental to or consequential upon the powers so conferred. For example, a company formed for the object of carrying on the business of buying and selling coal has capacity to purchase or hire trucks, carts and labors etc. because they are necessary for the business of buying and selling coal. indlaw.com 6
    • An interesting question as to the implied and incidental powers arose in the following case. In Evans v. Brunner Mond & Company, (1921) Ch 359., In this case, a company was incorporated for carrying on business of manufacturing chemicals. The objects clause in the memorandum of the company authorized the company to do “all such business and things as may be incidental or conductive to the attainment of the above objects or any of them” by a resolution the directors were authorized to distribute £ 100,000 out of surplus reserve account to such universities in U.K. as they might select for the furtherance of scientific research and education. The resolution was challenged on the ground that it was beyond the objects clause of the memorandum and therefore it was ultra vires the power of the company. The directors proved that the company had great difficulty in finding trained men and the purpose of the resolution was to encourage scientific training of more men so as to enable the company to recruit staff and continue its progress. Decision: The court held that the expenditure authorized by the resolution was necessary for the continued progress of the company as chemical manufacturers and thus the resolution was incidental or conductive to the attainment of the main object of the company and consequently it was not ultra vires. “Acts incidental or ancillary” are those acts, which have a reasonable proximate connection with the objects stated in the objects clause of the memorandum. 11 Ascertainment Of The Ultra Vires To ascertain whether a particular act is ultra vires or not, the main purpose must first be ascertained, then special powers for effecting that purpose must be looked for, if the act is neither within the main purpose nor the special powers expressly given by the statute, the inquiry should be made whether the act is incidental to or consequential upon. An act is not ultra vires if it is found: (a) Within the main purpose, or (b) Within the special powers expressly given by the statute to effectuate the main purpose, or (c) Neither within the main purpose nor the special powers expressly given by the statute but incidental to or consequential upon the main purpose and a thing reasonably done for effectuating the main purpose. In Attorney General v. Mersey Railway Co, (1907) 1 Ch. 81, There was a company and it was incorporated for carrying on a hotel business. It entered into a contract with some third party for purchasing furniture, hiring servants and for maintaining omnibus. The purpose or object of the company was only to carry on a hotel business and it was not expressly mentioned in the objects clause of the memorandum of the company that they can purchase furniture or hire servants. This deal was challenged and was sought from the court that this act of the directors be held as ultra vires. Issue: Whether the transaction was ultra vires? 11 See also Deuchar v. Gas Lights & Coke Co., (1925) A.C. 691. indlaw.com 7
    • Decision: The court held that a company incorporated for carrying on a hotel can purchase furniture, hire servants and maintain omnibus to attend at the railway station to take or receive the intending guests to the hotel because these are reasonably necessary to effectuate the purpose for which the company has been incorporated and consequently these are within the powers of the company, although these are not expressly mentioned in the objects clause of the memorandum of the company, or the statute creating it. Thus a company which has been authorized to deal with its property has implied power to pledge or mortgage the property for its debts.12 It is to be noted that if the act of the company is neither within the objects clause in its memorandum or the statute creating it, nor necessary for or incidental to or consequential upon the attainment of the objects stated in the objects clause of the memorandum or the statute, it cannot be ultra vires and valid merely because it is beneficial to the company. Evasion By Businessmen And Principle Developed By The Courts To Prevent Such Evasion The businessmen have also made number of attempts to evade the ultra vires rule. Their tendency has been to make the objects clause too wide. All sorts of objects, which a company may wish to adopt, are stated in the objects clause. This tendency makes the objects clause incapable to indicate properly the main objects clause saying that if the main objects of the company are followed by wide powers expressed in general words the latter (i.e. the power expressed in general words) will be construed as covering their exercise only for the purpose of the main objects. In other words, where not only main objects but also general powers are stated in the objects clause of the memorandum, the general powers will be construed ancillary to the main objects. If the main objects fail the company may be wounded up on the petition of the shareholder thereof. In Re, German Date Coffee Co., (1882) 20 Ch. D. 169, In this case, the main objects rule of construction was applied. There was a company and was formed to acquire and use a German patent for making coffee from dates. It was also to acquire other patents and inventions by purchase or otherwise for the improvements and extensions of the German patent. On learning that the German patent could not be obtained, the majority of shareholders allowed the company to continue but two shareholders presented a petition for winding up of the company on the ground that the main object of the company was to acquire the German patent and since it had become impossible to acquire, the company should be wound up. Issue: Whether the doctrine of ultra vires can be applied? Decision: The court held that the that the main object for which the company was formed was to acquire the German patent and the other objects stated in the objects clause of its memorandum were merely ancillary to that object and since the main object had failed, it was just and equitable that the company should be wound up. 12 In Re, Patent File Co., (1970) L.R. Ch. 83. indlaw.com 8
    • Independent Objects Clause The main object rule of construction has been avoided by inserting a statement in the objects clause to that effect that “all the objects are independent and in no way ancillary or subordinate to one another.” this is known as ‘independent objects clause’. Thus, where a clause stating that all objects specified in the objects clause are independent and not ancillary or subordinate to one another is inserted, the failure of anyone of them cannot be a ground for ordering the winding up of the company.tht is to say that a company cannot be wound up merely because one of the two main objects has failed. 13 Although the tendency of inserting an independent objects clause has been criticized by the House of Lords in the following case but the device was held to be valid and sufficient to exclude the ‘main objects rule’ of construction. In Cotman v. Brogham, (1918) A.C. 514, In this case a rubber company underwrote shares in an oil company. The objects clause in the memorandum of the company contained many objects and one of them was to subscribe for shares of other companies. There was a clause in the objects clause that each of the objects was t be considered independent and on this ground the court held o that the underwriting was not ultra vires. In Re, Introductions Ltd.,14 the court took a positive step to prevent such tendency. In this case the court held that an “independent objects clause” could not convert a power into an object. There is a difference between a power and an object. Only the objects are required to be stated in the objects clause of the memorandum and not powers but if the powers are also stated in the objects clause, they must be exercised to effectuate the objects stated therein. In Bell Houses Ltd., v. City Wall Properties Ltd. (1966) 2 WLR 1323, A company was authorized by the objects clause of its memorandum to carry on any other trade or business, which could, in the opinion of the directors be advantageously carried on by the company in connection with its general business. This clause was held valid. The court held that if there is such a clause and the directors decide to carry on a business which can be carried on advantageously in connection with or ancillary to the main business will be intra vires and not ultra vires even if it has no relationship with the main business of the company. The acceptance of such a clause may be taken to mean the death of ultra vires doctrine because a clause of this kind does not state any objects but leave the objects to be determined by the bona fide opinion of the board of directors. EFFECT OF ULTRA VIRES TRANSACTIONS I. ULTRA VIRES CONTRACTS 13 In Re, Kitson & Co. Ltd., [1946] ALL E.R. 435. 14 [1969] 1 ALL E.R. 887. indlaw.com 9
    • A contract beyond the objects clause of the company’s memorandum is an ultra vires contract and cannot be enforced by or against the company. In Re, Jon Beaufore (London) Ltd ., (1953) Ch. 131., A company was authorized by its memorandum to carry on the business of Contumiers, gown makers, tailors and other activities of allied nature. Later on the company decided to carry on the business of manufacturing Veneered Panels which was admittedly ultra vires and for this purpose erected a factory. A firm of builders, who constructed the factory, brought an action to recover £ 2078 from the company. Another firm supplied Veneers to the company and claimed £ 1011. A third firm claimed £ 107 for supplying the fuel to the factory. The claimants did not acknowledge that the Veneered business was ultra vires. Issue: Whether the transaction was ultra vires? Decision: However, the court held that the company was not liable to the claims of the aforesaid claimants because the money was taken from them for the business of veneered panels which was admittedly ultra vires the objects of the company, the court held that the memorandum is a constructive notice to the public and therefore if an act is ultra vires, it will be void and therefore will not be binding on the company and the outsider dealing with the company cannot take a plea that he had no knowledge of the contents of the memorandum. In S. Sivashanmugham And Others v. Butterfly Marketing PrivateLtd., (2001) 105 Comp. Cas. Mad 763, It was the case of the defendants that the partnership deed which contains the arbitration clause was a void instrument, as according to them, the plaintiff-company had done acts which were ultra vires its memorandum in entering into a partnership deed for the purpose of manufacturing and exporting garments. The memorandum of association of the plaintiff-company shows that the name of the company is "Butterfly Marketing Private Limited". The objects incidental or ancillary to the attainment of the main objects are listed under section III (B), Paragraph 2 reads as under: "To form, establish promote, subsidise aid, acquire, organise, or be interested in any other company or companies, syndicate or partnership for the purpose of acquiring all or any of the undertaking, property and liabilities of this company or of any share therein by way of exchange for its shares or otherwise or for any purpose which may seem calculated directly or indirectly to benefit the company." The other objects, not specified under caption (A) and (B) under section III of the memorandum of association, are set out under (C) which reads is as under: "To carry on the business of importers and exporters commission agents and distributors." This clause is in wide terms. It, inter alia, enables the company to form partnership for any purpose, which may seem calculated directly or indirectly to benefit the company. Interesting arguments were advanced by learned counsel for the appellant as also by the learned senior counsel for the respondent on the doctrine of ultra vires and the circumstances in indlaw.com 10
    • which a third party may invoke that doctrine to avoid paying to the company the benefits which the company was entitled to as a consequence of the alleged ultra vires acts. It was submitted by the learned senior counsel for the respondents that the doctrine of ultra vires has fallen to the ground in recent times and is no longer a doctrine which comes in the way of contracts being given their full effect where incorporated companies are parties to such contracts. He also invited our attention to the passage from Gower on Principles of Modern Company Law (fourth edition) wherein the learned author has commented that until very recently there was virtually no authority as to whether the third party could rely upon the theory of ultra vires to contend that the transaction with the company is void and that. It has also been noticed by the learned author that by statutory reforms in the U.K. the ambit of the rule has been curtailed when invoked by a company against a third party - but not when invoked by a third party. "Ultra vires doctrine" is one, as rightly observed by Gower15 is meant to protect the company against itself so as to safeguard its members and its creditors. Issue: Whether the transaction was ultra vires? These clauses provide ample power to the respondent-company to enter into partnership with others for any purpose, which may directly or indirectly benefit the company. The company has reserved to itself expressly the power to carry on business of importers or exporters. The submission made for the appellant that these clauses do not enable the company to form a partnership for the purpose of manufacturing garment is without any substance. The company not only may carry on business of exporters and importers, but it may al o enter into partnership with s any one for any purpose so long as that purpose is regarded by the company as being one which would benefit the company. Such benefit need not be direct and it may be indirect also. Decision: The court was of the view that the third party may not take advantage of this doctrine in order to avoid the performance of the obligations voluntarily undertaken with full opportunity to know the extent of the company's power before entering into the transaction. It was held by the court that the action of the company in entering into partnership was well within its powers and was not an ultra vires act. In England, S. 9(1) of the European Communities Act, 1972 has lessened the effect of the judgment given by the court in this case. In England a third person dealing with the company in good faith is protected and he can enforce the ultra vires contract against the company if: (1) The third person has acted in good faith and (2) The ultra vires contract has been decided on by the directors of the company. In other words, third person can enforce the ultra vires contract against the company if he had no knowledge of the fact that it was ultra vires and the contract was decided on by the directors of the company. The third party is presumed to have acted in good faith unless the contrary is proved by the company. However, the provisions operate in favour of a person dealing with the company in 15 At page 171. indlaw.com 11
    • good faith. Consequently the company cannot enforce the ultra vires contract against the third party but the third party can plead ultra vires. In India, there is no specific legislation like European Communities Act and therefore, there is no specific statutory provisions under which an innocent third party making contract with the company may be protected. Thus, in India, if the doctrine of ultra vires is strictly applied, where the contract entered into by a third party with a company is found ultra vires the company, it will be held void and cannot be ratified by the company and neither the company can enforce the contract against the third party nor the third party can enforce it against the company. However, it is to be noted that even in India the courts have evolved certain principles to reduce the rigors of the doctrine of ultra vires. The following principles may be deduced form the judicial decisions: Ø If the ultra vires contract is fully executed on both sides, the contract is effective and the courts will not interfere to deprive either party of what has been acquired under it. Ø If the contract is executory on both sides , as a rule, neither party can maintain an action for its non-performance. Such a contract cannot be enforced by either party to the contract. Ø If contract is executory on one side (i.e. one party has not performed the contract) and t e h other party has fully performed the contract, the courts differ as to whether an action will be on the contract against the party who has received benefits. However, the majority of courts appear to be in favour of requiring the party who has taken the benefit either to perform his part of the contract or to return the benefit.16 II. ULTRA VIRES BORROWINGS A borrowing beyond the power of the company (i.e. beyond the objects clause of the memorandum of the company) is called ultra vires borrowing. In England, S. 9(11) of the European Communities Act, 1972 provides, even such a borrowing can be enforced by a third party against the company if he has acted in good faith and the borrowing has been decide on by the directors of the company. In India, there is no specific legislation like the European Communities Act, 1972. Consequently the ultra vires borrowing is void and cannot be ratified by the company and the lender is not entitled to sue the company for return of the loan. However, the courts have developed certain principles in the interest of justice to protect such lenders. Thus, even in a case of ultra vires borrowing, the lender may be allowed by the courts the following reliefs: (1) Injunction --- if the money lent to the company has not been spent the lender can get the injunction to prevent the company from parting with it. (2) Tracing --- the lender can recover his money so long as it is found in the hands of the company in its original form. Where his money is applied in purchasing certain property, he can claim the property so long as it remains in the actual possession of the company. Where the lender’s 16 See Sen, S.C., “The New Frontiers of Company Law, pp. 109 &110; See also “ Dutta on the Company Law,” p. 538. indlaw.com 12
    • money gets mixed up with the company’s money in such a way that both cannot be separated from each other, the lender can claim pari-passu distribution of the assets of the company with the shareholder in the event of the winding up of the company, i.e. the mixed fund should be appointed between the shareholders and the creditors in proportion to the amount paid by them respectively.17 (3) Subrogation---if the borrowed money is applied in paying off lawful debts of the company, the lender can claim a right f subrogation and consequently, he will stand in the shoes of the creditor who has paid off with his money and can sue the company to the extent the money advanced by him has been so applied but this subrogation does not give the lender the same priority that the original creditor may have or had over the other creditors of the company. III ULTRA VIRES TORTS OR CRIMES As regards the extent to which the ultra vires rules applied to torts and crimes, the law is not well settled. The following views may be mentioned: Ø A company is allowed to do only those acts which are stated in the objects clause of its memorandum and, therefore, an act beyond the objects clause is not considered as an act of the company. Since the objects clause can never include the commission of wrongs, a company can never be liable in torts or crimes. In other words, a wrong committed by the servants or the agents of the company ostensibly on its behalf cannot be binding on the company because their acts are beyond the powers of the company. However, this is not the present law on this point and in practice companies are made liable in torts and convinced for crimes. Ø The second view is that the doctrine of ultra vires applies only to contract and property and never applies to tortuous or criminal liability. Ø The third view is that a company may be held liable in torts or crimes provided that they are committed in the course of an activity, which is warranted by the objects clause of its memorandum. In other words, an act of the company’s servants or agents beyond the objects clause is not an act of the company and therefore, the company cannot be held liable for the wrongs committed by its servants or agents in respect of an activity which is not covered by the objects clause of its memorandum. But the correct rule is that a company may be held liable for torts or crimes committed in pursuance of its stated objects but should not be liable for acts entirely outside its objects. For example, if the object of the company is to run tramway, the company will be liable for anything which its officer/employee do with the actual or usual scope of their authority in connection with or ancillary to running trams but it will not be liable for a tort or crime committed by its officers in connection with some entirely different business. Thus a company may be held liable for any tort or crime if: 17 Sinclair v. Brougham , (1914) A.C. 398. indlaw.com 13
    • v The tort or crime has been committed by the officers or agents or or directors or the servants of the company within the course of their employment, and v The tort or crime has been committed in respect of or in pursuance of any activity, which falls within the scope of the objects clause of its memorandum. It is to be noted that whether or not the company is liable for ultra vires torts or crimes, the officers or servants committing the act will, no doubt, be personally liable therefor.18 In Weeks v. Propert, (1873) L.R. 427, In this case, a railway company had borrowing powers under its Special Act but these powers had been fully exercised by the directors. Thus, the borrowing powers had been completely exhausted, nevertheless the directors advertised for loans on debentures. On the basis of the advertisement, the plaintiff offered a loan of £ 500 and the directors accepted the loan and issued to him a debenture. The debenture was declared void because it was in excess of the borrowing powers of the company. The plaintiff brought an action against the directors. Issue: Whether the transaction was ultra vires? Decision: It was held that the directors by the advertisement had warranted that they had the power to borrow while in fact they had no such power and consequently their warranty was broken and they were personally liable to the plaintiff for his loss. Thus the respondent was allowed to recover the £ 500 and interest by way of damages from the directors on account of the breach of warranty of authority that they had the power to borrow money and to issue debentures. Property Acquired Under Ultra vires Transactions: Where the funds of a company are applied in purchasing some property, the company’s right over that property will be protected even though the expenditure on such purchasing has been ultra vires.19 LIABILITY OF DIRECTORS 1. Liability towards the company: it is the duty of the directors to see that the funds of the company are used only for legitimate business of the company. Consequently if the funds of the company are used for a purpose foreign to its memorandum, the directors will be personally liable to restore to the company the funds used for such purpose. In other words, a shareholder can sue the directors to restore to the company the funds, which have been employed by them in the transactions, which they have no authority to enter into. 2. Liability towards the third party: the directors of a company are treated as agents of the company and therefore it is their duty not to go beyond the memorandum or 18 R. v. Ovenel, (1969) 1 Q.B. 17. 19 Ad. Salt v. Bank of Mysore, (1930) MLJ 59. indlaw.com 14
    • powers of the company. Where the directors represents the third party that the contract entered into by them on behalf of the company is within the powers of the company while in reality the company has not such powers under its memorandum, the directors will personally be liable to the third party for his loss on account of the breach of warranty of authority. However, to make the directors personally liable for the loss to the third party, the following conditions must exist: (a) There must be representation of authority by the directors. The representation must be of fact, not of law. (b) By such representation the directors must have induced the third party to make a contract with the company inn respect of a matter beyond the memorandum or powers of the company. (c) The third party must have acted on such inducement and suffered some loss. EXCEPTIONS TO THE DOCTRINE OF ULTRA VIRES A brief analysis of the doctrine of ultra vires with regard to its consequences would reveal that only those activities of the company shall be valid i.e., intra vires, which are: (a) Essential for the fulfillment of the objects stated in the main objects clause of the memorandum; (b) Incidental or consequential or reasonably within its permissible limits of business; and (c) Which the company is authorized to do by the Company’s Act, in course of its business. All other activities of the company excepting the above shall be ultra vires and therefore invalid. There are, however, certain exceptions to this doctrine, which are as follows: 1. An act, which is intra vires the company but outside the authority of the directors may be ratified by the shareholders in proper form.20 2. 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. 3. 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. 4. 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. 20 Rajendra Nath Dutta v. Shailendra Nath Mukherjee, (1982) 52 Comp. Cas. 293 (Cal.). indlaw.com 15
    • 5. 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. 6. 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. PRESENT POSITION ENGLAND In England the doctrine of ultra vires has been restricted by the European Communities Act, 1972.according to Section 9(1) of the Act in favour of a person dealing with a company any transaction decided by its directors shall be deemed to be within the capacity of the company to enter into validity and the other party is not required to inquire about the capacity of the company and thus such transaction may be enforced by the other party acting in good faith against the company and the company cannot plead that the transaction was ultra vires, but it cannot be enforced by the company against the other party for the other party can still plead that the act was ultra vires. It is to be noted that in England, the Act merely restricts the application of the doctrine of ultra vires but does not abolish it. The company can still plead that the act was ultra vires, against the third party if it is proved that the third party has not acted in good faith. It can be pleaded by the company against the third party if the transaction or act has not been approved by the directors. Along with it, as has been already stated, the third party can still plead against the company that it has acted ultra vires, i.e. the ultra vires transaction cannot be enforced by the company against the third party. Thus the doctrine of ultra vires in England applies with certain restrictions and modifications and certain provisions have been inserted in the European Communities Act, 1972 in order to protect innocent third party from the hardship created by this doctrine for him. INDIA In India there is no legislation like the European Communities Act. Consequently, the principles laid down in Ashbury Railway Carriage and Iron Company Ltd v. Riche and Attorney General v. Great Eastern Railway Co. are still applied without restrictions and modifications. Thus, in India the ultra vires act is still regarded, as void and it cannot be validated by ratification even if all the shareholders consent to such ratification. Thus in India the ultra vires act or transaction neither can be enforced by the company against the third p arty nor by the third party against the company and thus, both the third party and company can plead against each other that the transaction or act was ultra vires. However, the provisions similar to those inserted in the European Communities Act, 1972 should also be inserted in the Indian Companies Act, 1956 to protect the innocent third party. indlaw.com 16
    • CONCLUSION AFTER A DEEP RESEARCH AND ANALYSIS OF THE DOCTRINE OF ULTRA VIRES, THE RESEARCH PAPER CAN BE CONCLUDED WITH THE FOLLOWING FINDINGS AND OBSERVATIONS: (a) An ultra vires act is void and cannot be ratified even if all the directors wish to ratify it. (b) The provisions similar to those inserted in the European Communities Act, 1972 should also be i serted in the Indian Companies Act, 1956 to protect the innocent n third party. (c) The tendency of inserting “independent objects clause” to exclude the main objects rule of construction is dangerous also because it makes the distinction between the object and power obscure. (d) This doctrine prevents the wrongful application of the company’s assets likely to result in the insolvency of the company and thereby protects creditors. (e) The doctrine of ultra vires also prevents directors from departing the object for which the company has been formed and, thus, puts a check over the activities of the directions. It enables the directors to know within what lines of business they are authorized to act. indlaw.com 17
    • (f) In India , there is no specific legislation like European Communities Act and therefore, there is no specific statutory provisions under which an innocent third party making contract with the company may be protected. Thus, in India, if the doctrine of ultra vires is strictly applied, where the contract entered into by a third party with a company is found ultra vires the company, it will be held void and cannot be ratified by the company and neither the company can enforce the contract against the third party nor the third party can enforce it against the company. indlaw.com 18