The Doctrine Of Ultra Vires
The doctrine of ultra vires derives itself from the mother theory of Corporate Law i.e. the Theory of Perpetual Succession. This theory envisages that the company is a distinct entity and therefore exists independent from the members that constitute it. Every company that is established is for a purpose and its existence is complimented by that purpose. When a member of the company in particular the director of boards, does an act or puts forth an object that is not within the purpose or object of that company then the company will not be bound by such a contract and that object of purpose shall be ultra-vires of the company. This theory was established only after the late 1800's in England by virtue of the decision of Ashbury Railway Carriage & Iron Co Ltd v. Riche and then was strengthened and applied to cases of Attorney General v. Great Eastern Railway Company, Cotman v. Broughametc.
By virtue of this project the researcher seeks to analyze the evolution of the doctrine and the final version after the process of modification through various cases. The position that is prevailing in England shall also be seen and thereafter the Indian Position shall be established. The general trend of criticizing the doctrine has been seen in the case of English law and therefore an amendment bill in 2006 was taken out. The doctrine has therefore gone through a radical process of change and stands now at a position where legal scholars from around the world criticize its working to “old ways”.
Evolution Of The Doctrine Of Ultra Vires
In the early 19th Century the companies that were formed came into existence as a result of the Charters or grants from the crown or the Parliament. The church and other companies herein were the first to exploit such a system and therefore gained corporate status. This grant of status was directly related and a consequence of the public function that they performed. The legal theory behind the doctrine of ultra vires finds its roots from this system. The parliament had conferred some powers upon these bodies and therefore the bodies were restricted by those powers. Any act done by these bodies which went beyond the power conferred to them stood as “ultra-vires”. The rationale behind this kind of a restriction was the democracy argument i.e. to say if a company acts in powers which are more than the powers conferred by elected representatives of the people. Then such acts have no legitimacy. Another argument was one wherein the interests of the share-holder and the creditors would be jeopardy. By limiting the powers and the scope of the acts that can be done by the directors, the position of the shareholder and the creditor became secure since the directors would thenceforth be restricted in their choice of business.
Enlarged partnerships were the only form of corporations which were present prior to 1855 after which statutory registered corporations came into existence. The functioning of these kind of partnerships was premised on the fact that the act of one partner cannot be binding on the others if it is outside the scope of the actual or apparent authority. Furthermore, changes could not be made in the nature of business without prior or post facto ratification or consent of all of the partners. The creditor or the investor therefore had adequate safeguards.
With the introduction of the 1855 Act the doctrine stood established with provisions such as the pre-requisite of a Memorandum of association and therein an object clause. The powers which a corporation is authorized to exercise are set forth in its charter, or in its articles of incorporation. Statutes too, may place express prohibitions upon the exercise of certain powers. If the corporation enters into a transaction which is beyond the powers expressly or impliedly contained in the charter or articles of incorporation or in violation of the statutory restriction, the transaction is said to be ultra vires, i.e., beyond the powers of the corporation.
This question first came up for consideration in the case of Ashbury Railway Carriages & Iron Co v. Riche. The Ashbury Railway Carriage and Iron Company was established with an object clause which stated that the business that was purported to be carried on was to be one of mechanical engineers and general contractors who dealt in the buying selling and hiring of railway-carriages and wagons, and all kinds of railway plant, fittings, machinery, and rolling-stock. Also to buy sell and hire as merchants, timber, coal, metals, or other materials; and to buy and sell any such materials on commission, or as agents. As a result of the repudiation of a contract to supply funds for the construction of a railway line in Belgium entered into on behalf of the company by its directors, a case was brought forth against it. The court herein dealt with the object clause in detail. The court rightly pointed out that objects of M/s Ashbury Company, as stated in the Memorandum of Association, were to supply and sell the materials required to construct railways, but not to undertake their construction. The contract here was to construct a railway, using Messrs. Riche only as the persons to be employed in the construction which was contrary to the memorandum of association. Moreover, in constructing the scope of the words “general contractors” the court took a narrow view. The court herein concluded that according to the principles of construction, the term “general contractors” would be refer to that which precedes, and would indicate, in that theme of contracts, the making generally of contracts connected with the business of mechanical engineers in particular contracts as mechanical engineers are in the habit of making, and are in their business required, or find it convenient, to make for the purpose of carrying on their business.
The memorandum of association, the court concluded, defines the limitation of the powers of a company to be established under the Act and is the constituting document of a company. Therefore, if anything which goes beyond that memorandum, or is not warranted by it, the question will arise whether that which is so done is ultra vires , not only of the directors of the company, but of the company itself. While interpreting the scheme of the act the court scrutinized the act and its clauses and saw that the incorporation of the company found its foundation in the memorandum of association. The memorandum in return mandated the presence of an object clause which would prescribe the limits of the business, which according to the 11th clause has to be respected by every individual that makes the company and the company in itself. The court explicitly therein laid down that with respect to the contents of the memorandum of association -
“It states affirmatively the ambit and extent of vitality and power which by law are given to the corporation, and it states, if it is necessary so to state, negatively, that nothing shall be done beyond that ambit, and that no attempt shall be made to use the corporate life for any other purpose than that which is so specified.”
Another case that requires mention herein is the case of Re David Payne & Co Ltd wherein the court laid down on basis of the Ashbury principle that a corporation cannot do anything except for the purposes of its business, borrowing or anything else; everything else is beyond its power, and is ultra-vires.
The Indian Experience With The Doctrine Of Ultra Vires
The Indian experience of Ultra vires doctrine began in 1866 with the case of Jahangir Rastamji Modi v. Shamji Ladha. But, before going into the case law analysis and evolution of the doctrine, it is essential to trace the statutory evolution.
The 1st legislation for companies was the Joint Stock Company Act of 1850. The basis for incorporation of a company, which in common parlance is a memorandum of association, was seen omitted and instead the company was to be registered and incorporated by virtue of a petition and deed of partnership. A distinct feature of this legislation was that there was no objects clause that needed to be specified in the petition or in the deed. The 1857 Act which repealed the 1850 Act had certain new features, one of which was that the need of a petition and deed to incorporate the company was replaced by a memorandum of association and articles of association. Therefore, the basis of the company would become the memorandum of association. Though the act did not provide for a definition of the memorandum of association, but yet Section 3(3) of the Act provided for the presence of an objects clause in the memorandum of association. The 1866 Act was a further improvement of the 1850 and 1857 act. It made the observance of the object clause a mandatory requirement through its provisions. Section 6 of the act clearly stated that incorporation happens when 7 or more persons for a lawful purpose subscribe to a memorandum of association. The memorandum of Association was to contain, beside other things, an objects clause. Section 11 of the Act further stated that the memorandum was to bind the company and its members. Therefore, it can be said that the synthesis of these sections unequivocally point towards the conclusion that the members were under a covenant to observe and respect the conditions given in the memorandum of association.
The doctrine of Ultra Vires was first pronounced in a judicial decision by virtue of the decision in Jahangir Rastamji Modi v. Shamji Ladha by J Sargent. In this case it was seen that the defendants who were the directors of a company in which the plaintiffs were shareholders. It was seen that the directors started to dealing in the shares of the company and thereby incurred losses. The Plaintiffs thereafter sued claiming that the dealing of shares was not present as an object in the memorandum of association. The court herein through J Sargent laid down the doctrine as a part of Indian Law based upon English principles. He said
“ A long Series of decisions of the courts of law and equity in England has decided that an incorporated joint stock company can do no act which is not expressly or impliedly authorized by…the deed of settlement of the company… it is therefore to the memorandum and articles of association that we must turn to determine whether those transactions are expressly or impliedly authorized; or as it has been sometimes expressed, whether they fall within the scope of the objects which the company was established”.
A pertinent point herein is the fact that the relevant provisions of the 1866 act were not mentioned and therefore it can be said that the decision was taken on other considerations. The main consideration was the provision of an assurance to the investors and the public that the companies' funds would not be used for purposes other than the legitimate objects of the company. This provides for investor security and encourages investment into companies from the general public.
Subsequently the doctrine was developed through many decisions like those of Re Port Canning Co Ltd and Kathiwar Trading Co Ltd v. Virchand Dipchand and the later decisions of The Imperial Bank of India v. Bengal National Bank and Wamanlal Chhotalal Parekh v. Scindia Steam Navigation Co Ltd. In the later decisions the court has applied the plethora of authorities coming down from the English decisions and have decided to take a “ejusdem generis” construction of the memorandum of association. These cases saw elaborately constructed object clauses and the language of the clause was couched in such a way that it could be construed in a wide way. The court in turn did not restrict the object clause but instead gave it a full and unrestricted meaning, but contextually construed such meaning.
Under current Indian law, i.e. the Companies Act 1956, it is to be seen that Section 12 and 13 mandate the presence of an memorandum of association which would be the basis for the incorporation of the company. Therefore, 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. With the plethora of authorities on this point, Indian law has been evolved on these lines as well. In the case of Lakshmanaswami Mudaliar v. L.I.C. the court held that an act beyond the objects mentioned in the memorandum is ultra vires and void and cannot be ratified. This rule which was laid down suggests a minor point of departure from the English law but the basis remains similar.
The Doctrine & Its Aspects
The Laws in India and England make it mandatory for the presence of an Object clause in the Memorandum of Association This has the effect of outlining the objects, which the company seeks to pursue. If the company pursues any other object, which has not been mentioned inside the object clause, this action is said to be ultra vires.
The directors of the company therefore are under an obligation to ensure that the functioning of the company be within the framework provided for in the Memorandum of Association. The court in the case of Rolled Steel Products (Holdings) Ltd v. British Steel Corporation bought forth the principle behind this doctrine.
“It is not possible for a company to give its directors or other agents authority to cause it to enter into any transaction which is not for the purpose of, or reasonably incidental to, attaining or pursuing the company's objectives as prescribed in its memorandum”.
If the director has entered into a transaction of this kind then there is liability to compensate the company to the extent of the expense incurred by the company. English law has a peculiar aspect under Section 35 (3) which absolves the director of liability if there is adoption by an unanimous resolution to that effect by the members of the company. If an act of the company is found to be beyond or ultra vires the objects, but there is approval from the members of the company then the members of the company can suggest an amendment of the object clause so as to accommodate such activities. In this regard the company can repudiate such a contract.
The main object is complemented by objects which are not explicitly mentioned but are quintessential or facilitate the realization of the main object. These objects should not and will not be covered by the sweep of this doctrine. Therefore, in other words when a act is done which is not within the object of the company but falls incidental thereto or is in pursuance with the realization of the main object then the act is not ultra vires and nor is the object behind the act. The rationale for this was provided for in the case of Attorney General v. Great Eastern Railway Company, where the court through Lord Selbourne categorically said;
“The Ultra-vires rule ought to reasonably and not unreasonably understood and applied to statutory companies and that whatever may fairly be regarded as incidental to, or consequential upon, those things which the legislature has authorized, ought not unless expressly prohibited to be held by judicial construction to be ultra vires.”
To ascertain whether a case attracts the doctrine of ultra vires, the main object of the company, the special powers for effecting that purpose and ancillary objects are looked at. If the act falls in neither of the three categories then the act is said to be ultra vires.
A contract that is found to be beyond the objects clause is said to be an ultra vires contract. Therefore in other words the contract is tested upon the touchstone of the Objects clause of the memorandum. In the case of Re, Jon Beaufore (London) Ltd, the court held the company was not liable for maintaining the contract since the contract was executed for an object that was ultra-vires the company. Furthermore, 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 not binding on the company.
The directors are entrusted with the day to day functioning of the company and ensure the smooth functioning of the company towards its goals. The funds of the company are channelized by the directors towards the achievement of such objectives. But if the funds are used for objects which are beyond its memorandum then the directors will be liable personally to restore the funds herein. Therefore the shareholders can also sue the directors to restore the company funds, considering the fact that a company in essence comprises of its shareholders or proprietors. As agents of the company the duty of the directors is not to go beyond the memorandum and in this regard it should be seen that the directors are liable to any third party, if there is any representation of intra-vires made on behalf of the company.
The doctrine of ultra vires is firmly grounded by virtue of the plethora of authorities that have been cited herein. Indian Law with respect to this doctrine has not evolved as a result of provisions that are present in the statute but rather on the rules of equity and other common law principles. The case of Jahangir Rastamji Modi v. Shamji Ladha laid down the roots for this doctrine on the basis of the principle of protect the investor. The doctrine has been applied to many cases thereafter.
In essence the doctrine imports a obligation onto the directors which cannot be circumvented in any case to remain within the limits of the objects provided for. Therefore, the company cannot do or purport to do any activity which is beyond the objects of the company that have been provided for.
The investor can claim, on violation of this rule, against the company which in turn shifts the liability to the directors who have performed the wrongful act. Furthermore, other than the main objectives given therein, there are certain ancillary objects which facilitate the main objectives, though not specifically mentioned in the object clause can be bought within the purview of the objects clause. Such acts have the status of being void acts and are therefore incapable of being ratified.
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