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Company Lawyers the Ultra Vires Doctrine Maintains

Info: 2796 words (11 pages) Law Essay
Published: 18th Nov 2020

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Jurisdiction(s): UK Law

A familiar principle by company lawyers, the ultra vires doctrine, maintains that for registered companies, since the objects clauses of its constitutions defines the company’s business capacity any business contract entered into which does not form part of the objects, falls outside the capacity of the company and, therefore, void [1] and ultra vires the company. [2] The company is merely not capable of going into such an agreement and hence, it is considered as a nonexistent contract. On matters of governance, it is significant that complaints regarding ultra vires acts can be brought about by a creditor or any member of the company no matter what the extent of their financial interest in the company.

The ultra vires has been firmly established in the case of Ashbury Railway Carriage & Iron Co v Riche [3] . [4] Here, the incorporation of a company under the Companies Act 1862 declared its objects as to make, sell, lend or hire, railway carriages, wagons , plant machinery, and so on. The House of Lords affirmed to be void and ultra vires a contract financing the building of a railway in Belgium for the reason that a contract of this kind could not imply to have fallen under the main objects. Moreover it was held that the contract’s ratification would not have been effective despite a clause implying to give power to members to continue company business further than that stated in the objects to conform to a special resolution. This move to ultra vires was quickly followed by a number of cases which steadily weakened or yet again adjusted this construction altogether but a certain category – the cases of gift. [5] The courts conclusively abandoned during the 1970s their dismissal of corporate gifts as void and ultra vires. Legal aversion of such gifts is clearly summarised in Hutton’s [6] well-known pronouncement that “the law does not say that there are to be no cakes and ale, but there are to be no cakes and ale except such as are required for the benefit of the company.” [7]

Ashbury and cases like it laid the foundation stones of the doctrine of ultra vires [8] , the courts started to adopt a more flexible stance concerning what business could be regarded as not within the capacity of the company. It was held that it was not ultra vires contract if such was reasonably inconsequential to the main objects. [9] The courts, for a time, sustained Ashbury’s main objects rule. It was held by the court that if its main object was not met by the company, a petition could be raised by a shareholder to have it closed on fair and reasonable grounds. [10] This rule was, however, thrown out by the House of Lords in the case of Cotman v Brougham [11] and sustained an object clause which permitted multi-clauses to be regarded as separate clauses, not supplementary to a main clause. [12] Throughout the 1960s the court permitted the directors to make a decision for themselves on what may comprise as ultra vires, under what known as the ‘subjective clause’ [13] where the plaintiff company have the power to operate any other business in any means which in the board of directors’ judgment can favorably be continued with regard to or as supplementary to the company’s general business. [14]

However, in Cotman v Brougham [15] these subsequent decisions were reduced in plain business language. Although the House of Lords were a bit reluctant to arrive at their decision, because the more limited the objects stated in the memorandum the less risk to the subscriber, they eventually acceded to the protection of those who carry out trade with the company since that would encourage business enterprise. [16] In addition, directors had a duty to the company and it was recognised that the company to be the interests of shareholders collectively. This duty was consequently to yield profits for the business and that noble activity should not be restrained by a legal doctrine that is outdated.

on the other hand, if this seemingly plain narrative of rising adaptability for companies is considered in the perspective of the historical progress of corporate power, it can be observed that the law altered the balance of power on the side of controlling directors and shareholders at a point when shifting ownership trends hinted that it should concern more in diminishing the power relished by these actors. A prudent examination of the framework in which Ashbury was held confirms this view. When the Ashbury case was decided, several companies of smaller size continued to be regarded as partnership in form, just as they had right after the enactment of the 1844 Act. [17]

Partnership law’s normative principles, mutual trust for instance, continued to affect the interpretation of the court regarding rights and duties of members. Members in these companies inclined to be involved and there was slight or no difference (as in partnerships) between the company and members. [18] Although in the framework of larger companies, the company as a distinct entity and as a separate legal form was progressively upheld by the court. This is shown by the interpretation in cases which wanted to separate those owned by the company from those owned by the shareholders. The capability of separate ownership could mean an acknowledgment of the company as a particular legal entity with the capacity to own and deal with property. Several decided cases involving large companies within the mid-19 century made apparent that shareholders, in contrast to a firm’s partners, did not encompass an interest in the company’s assets other than in the profits generated by these assets which were company property. [th]

This change in interpretation of the company share is significant to the ultra vires doctrine. It confirmed the separate distinction between the shareholders and the company in essential convenient ways. Shareholders had no direct entitlement on the assets of the company, since the shares that they owned merely entitled them to right of claim to company dividends. They were investors outside of the company and were not investors inside the company who were involved in management. They were separate from the activity of the company and were not participating members. In this framework the ultra vires doctrine was the means to safeguard outside investors since as investors taking risk of their investment, at the very least they had the right to know into what they were investing. Shareholders were, therefore, notified since that information was contained in the objects of the company and the courts guaranteed their investment was applied for this reason with the ultra vires doctrine. Hence, the rational interpretation of the Ashbury decision, as understood in the context of shifting patterns in shareholding, would appear to be, if strictly construed, that the ultra vires doctrine helped protect the outside investor by making possible for him to keep track of his investment. When the company was into trade not stated, as a consequence this entitled the investors and creditors to declare as ultra vires and to have that contract nullified. Ultra vires guaranteed that the balance of power in the company did not lean disproportionately to the majority shareholders and directors.

Legislation amends over the time therefore, immediately following Ashbury, several changes were taken upon ultra vires. Earlier, for instance, the objects clause was permitted to be modified under the Companies Act 1890 [19] (Memorandum of Association) for one of seven particular reasons pursuing a special resolution and by the court’s affirmation. This permitted companies to elude the constraint of their incorporation documents and cut away at the smaller shareholder’s power who could get themselves a company member with the extended objects most wanted by the controlling shareholders. Slight modifications of this kind transpired at moderate intervals over the ensuing decades. [20] It was, however, the terms of the Companies Act 1989, which continued by revising the Companies Act 1985, that drastically reframed the doctrine in such manner as to diminish the ability of shareholder to openly intervene. Under the Companies Act 1989, a contract which the company entered into and which exceeded the company’s capacity would not anymore be void. For any consequential loss, a director could be liable to the company, as it continues to be the directors’ duty to abide to any limitations on their powers arising from the constitution of the company. Directors, however, could be cleared from any such accountability by virtue of a special resolution. [21] This was equally true for contracts entered into by a director acting beyond his authority. A transaction involving a director acting beyond the scope of his powers under the company constitution could no longer be voided by the company if the person acted in good faith when he was dealing with the company. [22]

Now for that interesting point in the Companies Act 2006 where the remaining intervention powers that is present in the 1985 Act are taken out. From now on, all objections can only be taken up through probable violations of statutory duty which are moreover dependent on the discretion of the director or can be ratified by simple majority. [23] The legitimacy of transactions will now require a director to act in such manner that he believes (in good faith) would most possibly advance the objective of the company. In resolving to take this course of action, a director may have considered other stakeholders though they will not decide on the outcome. The power to resolve questions regarding capacity to management and majority shareholders is in effect given by these reforms. Hence, a legislative process instilled with the rhetoric of enlightened shareholder interest to boost generally the power and influence of the shareholder is really exercised to convey roughly the coup de grace to the ultra vires doctrine – a formerly potent means for upholding rights of the shareholder against management. Any question of the reform process that enlightened shareholders are actually controlling group is set aside by the 2006 Act.

An objects clause is a stipulation in the constitution of a company stating the extent and purpose of operations for which the company is established. An objects clause, in UK company law soon after reforms in the Companies Act 2006 and Act 1989, limited the capacity to act or power of a company. Any contract entered into which exceeded this capacity was ultra vires and was considered void from the very beginning. The legal issues in relation to objects clauses are at present mostly historical relics. Objects need not be registered by new companies under section 30 of the 2006 Act, and that although such were registered the doctrine of ultra vires has been purged against third parties. [24] It is only pertinent in a complaint against directors for breaches of duty where they failed to conform to the limitations of their constitutional power. [25]

Early on, chartered corporations first established objects clauses. Prior to the Industrial Revolution and the revocation of limitations for private persons to establish companies, concessions were conferred to corporations from the state to run an enterprise. The theory of concession presupposed that all power was granted to companies by the state. Acting beyond this given power was considered null and void and essentially contradictory to the interest of the public. The reality that people transacting with a company might be utterly frustrated and incur loss was legalised on the grounds that any member of the public could observe the law circumscribing the capacity of the corporation. In Attorney General v Great Eastern Railway Co. [26] companies possess the power to carry out activities rationally incidental to the company’s objects. Care must be considered when making distinction of cases where directors misused their authority but had not acted in excess of the company’s capacity. [27] While in Re Introductions Ltd [28] , it was held that the breeding of pigs was not contained in the company’s objects. The intention of the loan was for breeding pigs and this was known to the money lender. It was not able to put the loan into effect. Moreover, even if the company had the object to borrow money, it was taken to mean that this object was considered as not being a separate and essential object. The loan had to be for breeding pigs. [29]

It was proposed by the Cohen Committee that a company should have in relation to outside parties related powers as that of an individual [30] , notwithstanding anything excluded from the company’s memorandum of association. Present stipulations in memoranda concerning the powers of companies ought to function entirely as a contract between shareholders and the company regarding the powers applicable by the directors. [31] This was not discarded since it was believed that reform of the rule on constructive notice was very important, and necessitated further study – if an object is constructively known to D, then D would be bound.

Subsequently, the Jenkins Committee would have changed constructive notice with several statutory rules but did not abolish the doctrine of ultra vires itself. [32] The introduction of the European Communities Act 1972 established mandatory safeguards for people contracting with companies. [33] This requires companies to state objects but not to have them. Consequently, the Companies Act 1985 was revised. On the other hand, the Prentice Report brought about the Companies Act 1989. This proposed taking out constructive notice and for deficient of capacity, a company’s action could not be put into issue. However, there was still no discarding of ultra vires. [34]

In accordance with section 31 of the Companies Act 2006, companies are no longer required to register any objects. If such objects were registered, it does not bear any relevance for the contracts’ validity with third parties. [35] However, charitable institutions remain under the protection of the common law that they may be provided some greater safeguard. [36]

The ultra vires doctrine’s abolition nevertheless does not change the application of the agency law’s common principles. An outside party can still question that a contract is voidable – but not void in that equitable barriers to rescission of contracts apply – when it is apparent that the person they transacted with was acting themselves outside the range of their authority.

On the basis of a company’s objects, the doctrine of ultra vires is still completely useful for internal purposes. Directors should follow the constitutional limitations on their powers and they are accountable to compensate for failure to observe such limits. [37] An injunction can be sought after by a member to restrict an ultra vires act. For overstepping an objects clause, directors can be disqualified for such act. [38]

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