Ultravires. cons.notice & indoor


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Ultravires. cons.notice & indoor

  1. 1. NOTES ON „ULTRA VIRES‟, DOCRINE OF “CONSTRUCTIVE NOTICE” and “PRE-INCORPORATION CONTRACTS” and “INDOOR MANAGEMENT”, Ultra vires means, beyond power or beyond the objects as stipulated in the “objects clause” of the Memorandum of Association of the company. Intra vires means within power, or within objects. Why Objects? Why Objects clause? -The ownership of the Corporate capital vests in the company but contributed by the shareholders. It is held by the company as though in trust for them. How the fund would be utilized should be clearly defined. -Certain degree of protection to creditors also. The creditors have to seek their repayment only out of the Company‟s assets. The fact that the corporate capital cannot be spent on any project not directly within the terms of the company‟s objects gives a feeling of security to the creditors. -By confining the corporate activities within a defined field, the statement of objects serves the public interest also. -prevents diversion of funds. An action outside the memorandum is ultra vires the Company and the leading case on the subject is “Ashbury railway carriage company Ltd., Vs Riche” An ultra vires contract being void ab initio, cannot become intra vires by reason of estoppels, lapse of time, ratification, acquiescence or delay. „Constructive notice‟ of Memorandum of Association (M/A)and Articles of Association(A/A) seeks to protect the company against the outsiders. The „Doctrine of Indoor management‟ seeks to protect the outsiders against the company. This doctrine connotes that if a contract is consistent with the public documents, the persons contracting will not be prejudiced by the irregularities that may beset the indoor work of the company. This rule had its genesis in the case “Royal British Bank Vs. Turquand. „Objects‟ must be distinguished from „Powers‟. The power, for eg., to borrow or make a charity is not an Object. Objects have to be stated in the memorandum but not the powers. In consequences of the registration of the M/A and A/A of the Company with the Registrar of Companies(ROC), a person dealing with the company is deemed to have constructive notice of their contents. This is because these documents are construed as “Public documents” under Section 610 of the Companies Act, 1956. Accordingly, if a person deals with a company in a manner incompatible with the provisions of the aforesaid documents or enters into transactions which are ultravires these documents, he must do so at his peril. If someone supplies goods to a company in which it cannot deal according to its objects clause, he will not be able to recover the price from the company. Suppose the A/A provides that a Bill of Exchange must be signed by two directors and if the Bill of Exchange is actually signed by one director only, the holder thereof cannot claim payment thereon. In the „Doctrine of indoor management‟, if an act or transaction is authorized by the A/A or M/A, an outsider is ENTITLED to assume that ALL THE DETAILED FORMALITIES FOR DOING THE ACT OR TRANSACTION HAVE BEEN OBSERVED. Thus, the doctrine of Indoor management is the only limitation to the doctrine of Constructive notice. Exceptions to the Doctrine of Indoor management:1) Knowledge of irregularity:- The rule does not protect any person who has actual or constructive notice of the want of or lack of authority of the person acting on behalf of the company.
  2. 2. Example:- The articles of a company empowered the directors to borrow up to Rs. One lakh. They could exceed the limit of Rs. One lakh with the consent of the company in general meeting. Without such consent, they borrowed Rs. 3.5 lakhs from themselves and took debentures. The Company refused the pay the amount. Held, the debentures were good to the extent of Rs. One lakh only as they had notice of the internal irregularity. In Howard V. Patent Ivory Co.(38 Ch.D 156) 2) No knowledge of articles:- The rule cannot be invoked in favour of a person who did not consult the M/A and A/A and thus did not rely on them. Example:- T was a director in the Investment Company. He, purporting to act on behalf of the company, entered into a contract with the Rama corporation and took a cheque from the latter. The articles of the Company did provide that the directors could delegate their powers to one of them. But Rama Corporation people had never read the articles. Later, it was found that the directors of the company did not delegate their powers to T. Rama Corporation, the plaintiffs (ie who filed the case), relied on the doctrine of Indoor management. Held, they could not, because they even did not know that power could be delegated. Rama corporation Vs. Proved Tin and General Investment Co.(1952) 3) Void or illegal transaction or forgery:- The rule does not apply to transactions which are void or illegal ab initio. Example:-The secretary of a company forged signatures of two of the directors required under the articles on a Share certificate and issued the certificate without authority. The applicant claimed to be entitled to be registered as members of the company. Held:- The certificate was a nullity and the holder of the share certificate could not take advantage of the doctrine of indoor management. In case of forgery, it is not that there is absence of free consent but there is no consent at all. The person whose signatures have been forged is not even aware of the transaction and the question of his consent being free or otherwise does not arise. Since there is no consent at all , there is no transaction. Ruben Vs. Great Fingal consolited[1906] AC 439. 4) Negligence:- The „doctrine of Indoor management‟ in no way, rewards those who behaves negligently. If an officer of a company does something which would not ordinarily be within his powers, the person dealing with him must make proper enquiries and satisfy himself as to the officer‟s authority. If he fails to make enquiry, he cannot rely on the rule. Example:- A person who was a sole director and principal shareholder of a company, paid into his own account Cheques drawn in favour of the company. The bank should have made enquiries as to the power of the director. The bank was put upon enquiry and was accordingly not entitled to rely upon the ostensible authority of director. In AL Underwood Vs. Bank of Liverpool[1924] 1 KB 775. 5) Doctrine does not apply where question is in regard to very existence of agency. Example:- In Varkey Souriar Vs. Keraleeya Banking Co.Ltd.(1957) 27 Comp. Cas.591(Ker), the kerala High Court held that the doctrine of Indoor management cannot apply where the question is not one as to the scope of the power exercised by an apparent agent of the company, but is regard to the very existence of the agency. 6) The Doctrine is not applicable where a pre-condition is required to be fulfilled before the company itself can exercise a particular power. In other words, the act or transaction is not merely ultra vires the directors/ officers but ultra vires the company itself. Pacific Coast coal mines Vs. Arbuthnot(1917) AC 607 CONSEQUENCES OF AN ULTRA VIRES TRANSACTION:1) Void ab initio :- Ultra vires transactions are void ab initio. The Company is not bound by these acts; even the Company cannot sue or be sued upon it. Ashbury Railway carriage company v. Riche 2)Injunction:- In case a company is about to undertake an ultra vires act, the members (even a single member) can get an order of injunction from the court restraining the company from going ahead with the ultra vires act. Attorney general vs. G.R. Eastern Railway Company 3) Personal liability of Directors:- If any part of the corporate capital is used for purposes foreign or external
  3. 3. to the company‟s memorandum, the directors will be personally liable to replace it. In case of deliberate mis-application, criminal action can also be taken for fraud. Here a distinction must be drawn between transactions which are ultra vires the company and the transactions which are ultra vires the directors. Where the directors exceed their authority and do some thing , the same may be ratified by the general body of the shareholders provided the company has the capacity to do that transaction as per its memorandum of association. 4) Acquisition of property that is ultra vires:- 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 the 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. Property, legally and by formal transfer or conveyance, transferred to a corporation is in law duly vested in such corporation eventhough the corporation was not empowered to acquire such property. WHAT ARE THE EFFECTS OF MEMORANDUM OF ASSOCIATION(M/A) AND ARTICLES OF ASSOCIATION(A/A):S. 36 of the Companies Act, 1956 deals with the binding force of M/A and A/A. It provides that the M/A and A/A, when registered, bind the company and it members to the same extent as if they had been signed and sealed by each member and contained covenants(agreements)on the part of each member to observe and be bound by all the provisions of the M/A and A/A. Thus, (1) the company is bound to the members, (2) the members are bound to the company, and (3) the members are bound to the other members by whatever is contained in these documents. But neither a company nor its members are bound to OUTSIDERS. It is important to note that even between a member and the company, the A/A constitute a contract only in respect of his rights and liabilities AS A SHAREHOLDER but not in respect of rights and liabilities which he has IN A CAPACITY OTHER THAN THAT OF A MEMBER. Relevant case law on the effects of M/A and A/A :The A/A of a Company provided that „E‟ should be Advocate for life and should be removed from office only for “misconduct”. Later on „E‟ became a member of the Company. But after employing him as Advocate for a number of years, the company discontinued his services. „E‟, being a member, sued the company for damage for breach of the contract contained in the A/A. E‟s suit was DISMISSED on the ground that he, as an Advocate, was no party to the A/A. He must prove a contract INDEPENDENT OF THE ARTICLES. There was no infringement (breaking) of his right AS A MEMBER.- Eley V.Positive Govt.security Life Assurance Co.1876. WHAT ARE PRE-INCORPORATION CONTRACTS? Contracts entered into by promoters of a company before incorporation of a company are called preliminary or pre incorporation contracts. These contracts are entered into by the promoters on behalf of a company before that company comes into existence through its registration by the Registrar of Companies (ROC) and the subsequent grant of “certificate of incorporation”. But no contract can bind a company before it becomes capable of contracting by incorporation. In the case of Kelner v.Baxter, it was decided that two consenting parties are necessary to a contract, whereas the company before incorporation is a non-entity. Promoters enter into contract as agents of the company which is not yet incorporated and hence the company is not liable for the acts done by the promoters before it came into existence by incorporation. Further, the company also, after its incorporation cannot sue the other party (with whom the promoters have entered into contract on behalf of the company) if the other party fails to carry out the contract. The promoters remain personally liable on such contracts entered into before incorporation. The company is neither bound by nor can have the BENEFITS OF SUCH PRE INCORPORATION CONTRACTS. In 1963, Specific relief Act,1963 was enacted which changed the position of the pre incorporation contracts to some extent. This Act provides that where the promoters of a Public company have made a contract before its Incorporation for the purposes of the company and if the contracted is WARRANTED BY THE TERMS OF ITS INCORPORATION, the Company MAY enforce it. It is not only the company which is allowed under the Specific
  4. 4. Relief Act to adopt and enforce its pre-incorporation claims/contracts against third parties. The Act also allows the other party to enforce the contract against the company if (1) the company had adopted the same after incorporation and (2) the contract is warranted by the terms of incorporation. “WARRANTED BY THE TERMS OF INCORPORATION” means within the scope of and as necessitated by the company‟s objects as stated in the Memorandum of Association of the Company. What if the Company does not execute a fresh contract after incorporation and the contract is NOT one warranted for the purpose of incorporation of the company? What will be the legal position of the promoter who brings about such a contract? The contract takes effect as a personal contract with the persons who purport or intend to contract on behalf of the Company‟s behalf. Promoters shall be liable to pay damages for failure to perform the promises made in the company‟s name.