The Capacity of a Company to Contract

Introduction

In Ireland every company registered under the Companies Act 1963-2009 must have a memorandum and articles of association. Under s.16 of the Companies Act all registered companies must have a memorandum of association in the form set out in Sch.1 “or as near thereto as circumstances permit [1] “. The main reason for the memorandum of association is so that a company can set out its objectives for doing business and outline what contractual agreements the company are able to enter into too. As Courtney says Section 6(1)(b) of CA 1963 provides that a memorandum of association must state “the objects of the company”, accordingly every company has to have an objects clause which states the purpose for which the company was formed and the legitimate activities it can pursue [2] . The issue in Ireland is the strictness and in some cases harshness of this rule, that a company can only enter into contracts which its objects clause permits. If it is found that if a company is acting outside its objects clause then it is acting ultra vires and the contract is void. For example hypothetically if a sweet shop has an objects clause that says it can only sell sweets, and then decides to sell newspapers also, it would be deemed to be acting ultra vires and therefore its contract would not be legally binding. In the Ashbury railway case [3] the company which had agreed to purchase a concession for constructing a railway in Belgium, claimed that it was not bound by that agreement because the entire action was ultra vires. Its objects clause suggested that it was principally in the rolling stock business.

The rationale of the objects clause and the doctrine of ultra vires were and remain the protection of the company’s shareholders and creditors [4] , however sometimes the opposite can happen. The doctrine of constructive notice is the rule that because people have access to a company’s memorandum of association which includes its objects clause people should know the capacity of the company and what contracts it is able to enter into. The case of Re Jon Beauforte [5] outlines the harshness of this rule. Here the company’s main object was to operate the business of veneer panel makers. The transaction in issue was a contract to supply coke (type of fuel) from a fuel merchant, a substance which could be used in either business. Because of the fact that the company’s object clause was a matter of public knowledge, being registered in the Companies Registration Office (‘CRO’), and because the notepaper on which the order was sent to the fuel merchant was headed ‘Veneer Panel Manufactures’ the fuel merchant was held to have constructive notice of the ultra vires purpose for which the coke was intended, and so the contract was unenforceable and was not admitted as a debt when the company went into liquidation [6] . This was a very harsh and unfair ruling under the doctrine of constructive notice. Today the doctrine of constructive notice is ousted and the contract would only be unenforceable if the fuel merchant was actually aware of the ultra vires purpose for which the coke was to be used [7] . This may seem like progress in the law but realistically how many people know what a company’s objects clause contains and if by entering into a contract with them it is ultra vires? There are many issues that arise from this area of company law and its effect on today’s business environment in Ireland and contractual agreements between Irish companies. The capacity of a company to contract relies solely on the objects clause in the memorandum of association is a massive restrain on Irish business.

Today’s Law

After cases such as Re Jon Beauforte, it was clear that the area of ultra vires and the objects clause needed to be regulated. The legislator needed to step in, in order for the rule to be more clearly understood and so that innocent outsiders were protected from the unjust effects of the ultra vires rule. It is interesting to note that In Ireland, the Report of the Company Law Reform Committee 1958 (“the Cox Report”) seemed at first to be of the opinion that the ultra vires rule should be abolished, that its purpose was largely defeated and that it gave little protection to shareholders and creditors [8] . However they did not enforce this view, properly because the “Cohen Report” in England had a similar view and it was not adopted by the British Government. The Cox Report then assumed that there were “strong reasons” for the ultra vires rule [9] . The Irish Companies Act was introduced in 1963 and S.6(1)(c) simply read “The memorandum of the company must state the objects of the company” Thus every company was subject to the ultra vires rule [10] . The Companies Act 1963 dealt with the issue of ultra vires in s.8(1) which states.,

Any act or thing done by a company which if the company had been empowered to do the same would have been lawfully and effectively done, shall, notwithstanding that the company had no power to do such act or thing, be effective in favour of any person relying on such act or thing was not within the powers of the company, but any director or officer of the company who was responsible for the doing by the company of such act or thing who is not shown to have been actually aware, at the time when he so relied thereon, that such act or thing shall be liable to the company for any loss or damage suffered by the company in consequence thereof [11] .

Or as Anderson puts it in the ‘Evolution of the Ultra Vires Rule in Irish Company Law’ that the company, or more particularly the relevant officer of that company, was obliged to honour the ultra vires transaction “lawfully and effectively” entered into with the outsider, provided that the outsider, who relied upon the ultra vires act, was not shown to have been “actually aware” at the time when he so relied thereon, that such an act was not within the powers of the company [12] . This is an interesting concept in that if you are able to prove that the contract was legal and that the person entering the company was not “actually aware” at the time that the contract was ultra vires then the contract is binding. Courtney says that “the use of these words show that acts or things prohibited by the Companies Acts and the general law of the land cannot be validated by CA 1963, s8(1) [13] . This was tested in the case of Bank of Ireland finance v Rockfield Ltd [14] , The court looked at the claim of the plaintiff bank who sought to rely on s.8(1) to uphold a transaction which they had entered into with a company whereby they had loaned money to the company to purchase its own shares. The company were not authorised to borrow money for this purpose. The bank sought repayment of the loan, but they were not able to rely on s.8(1) because the transaction would not have been lawful even if the company was authorised to do it in the objects clause, because under s. 60of the 1963 Act a company cannot borrow money for the purchase of its own shares. Similarly in Re Frederick Inns Case [15] , the courts found that a company could not make gratuitous payments when insolvent, so the Revenue could not rely on s.8(1) to uphold the payment.

The term “actually aware” is a key and sensible defence for creditors who have entered into ultra vires contracts and are not aware of the corporate incapacity. The leading case for this provision is the case Northern Bank Finance Co Ltd v Quinn and Achates Investment Co [16] , In this case Mr. Quinn borrowed £145,000 from the plaintiff bank. The loan was secured by a guarantee of the defendant company supported by a mortgage of certain property. When Mr. Quinn defaulted on the repayment instalments, the bank issued proceedings against him and the company. The Bank sought to rely on CA 1963, s8(1) arguing it was not actually aware of the incapacity of the company. However evidence showed that the bank’s solicitor had read the memorandum of association and the objects clause and by failing to understand the clause the solicitor came to the conclusion that the company could guarantee the loan. Keane J. found that s8(1) did not apply as ‘the bank, because of the knowledge of their agent….which must be imputed to them, were aware of the objects of the company’. [17] The only criticism with this ruling is that Kean J. expects that if someone reads something then they are automatically meant to understand it, in general terms this is usually true however there are instances when after reading something you still have not grasped the full understanding. Mac Cann mentions in the article ‘Capacity of a Company’ which was published in the Irish Time in 1992 , “It would appear Keane J. is confusing actual knowledge with actual notice. A person having read the objects clause may be actually aware of what it states, but unless he understands the meaning of that clause, he cannot be said to be actually aware that the act or thing in question was ultra vires [18] .

In 1973 the European Community (now known as the European Union) set up the first company directive and addresses the issue of the capacity of the company and ultra vires. Since Ireland had only recently entered the E.C. at the time of the directive, it gave a new aspect and goes further than s.8(1) of the 1963 Act. The rule allows that if good faith was shown at the time of the transaction then it is intra vires. Article 6 of the E.C. (Companies) Regulations 1973 Directive states.

“(1) In favour of a person dealing with a company 70  [ The regulations apply only to companies with limited liability: European Communities (Companies) Regulations, 1973, reg. 3. ] in good faith, any transaction entered into by any organ of the company, being its board of directors or any person registered under these regulations as a person authorised to bind the company, shall be deemed to be within the capacity of the company and any limitation of the powers of that board or person, whether imposed by the memorandum or articles of association or otherwise, may not be relied upon as against any person as dealing within the company.

(2) Any such person shall be presumed to have acted in good faith unless the contrary is proved [19] .”

It is arguable that the solicitor in Northern Bank Finance Ltd [20] was acting in good faith and that by simply not understanding the wording of the objects clause that the contract was therefore intra vires, however Keane J. probably saw it as negligence as it is a solicitors profession to be able to read and understand legal writings.

There has been a variance of views of the construction of the objects clause between the legislator and the courts. The judicial construction of the objects clause has resulted in, as Courtney puts it “a cat and mouse game between the judiciary and the draughtsmen [21] “. The courts look at three main rules when deciding if a company is acting outside the capacity of its objects clause, they are the main objects rule, the independent objects clause and the ‘Bell House’ clause.

The main objects rule. This rule originates in the case of Ashbury Railway Carriage and Iron Co. v Riche [22] and provides that if a main or dominant object can be ascertained from the objects clause; all other stated objects are to be treated as merely ancillary to the main object and are only capable of being pursued while the main object is being pursued. The main object is generally to be found in the first paragraph of the objects clause [23] .The particular device used by the courts to defend what they perceived to be the legislative intention was the ejusdem generis rule of interpretation, which says that when particular words are followed by general words are limited so as to have the same import implicit in the particular words [24] . Therefore in some case broadly stated objects may subordinated to specific objects as in Ashbury Railway Carriage and Iron Co. v Riche [25] where the power to act as ‘general contractors’ was subordinated to the specific object of manufacturing rolling stock [26] . Not only will a contract which is not in furtherance of the main objects be ultra vires, but so also might a company which does not pursue its main objects be wound up for failure of substratum [27] : Re German Date Coffee Co Ltd [28] .

The independent objects clause.

The draughtsman however felt that this was way of getting around the ultra vires rule, so they “rallied by devising so-called independent objects clauses which ousted the main objects rule [29] “. The independent objects clause is usually the last paragraph of the objects clause and will state that each of the previously stated objects is independent of the others and should be so construed and that none of the objects is to be treated as merely subordinate or ancillary to any other [30] . The validity of such a clause was upheld by the House of Lords in Cotman v Brougham [31] , on the basis that the Registrar of Companies has issued the company, which had been registered with such an objects clause, with a certificate of incorporation which was conclusive evidence as to the validity of the contents of the memorandum of association. In that case the objects clause contained 35 sub-clauses which if, if valid, would have permitted the company to pursue almost any object. Were it not for the insertion of an independent objects clause, the main object would have been found to be the development of rubber plantations. However the twelfth sub-clause permitted the buying of stocks or shares in any company. The thirtieth sub-clause was an independent objects clause that all sub-clauses should be construed as substantive clauses. The company underwrote and had allotted to it shares in an oil company. Problems arose when the oil company was wound up and the company was placed on the list of contributories. In spite of protest to the contrary from both sides of the bench, It was held that the contract in respect of the shares was intra vires the company. Lord Wrenbury held: ‘The language of c 13(30) is such that I cannot say that such a transaction was ultra vires because it was not ancillary to or connected with or in furtherance of something which I find elsewhere in the company’s memorandum to have been its “business”.’

Although the independent objects clause will provide that every fact set out in the preceding paragraphs of the objects clause is to be treated as an independent object, however, as noted previously, some of the acts contained in the objects clause are not actual objects but are mere powers. It seems clear that not every power can be raised to the status of an independent object by the inclusion of an independent objects clause [32] . This can be seen from the case of Re Introductions Ltd [33] .

The ‘Bell Houses’ clause.

A ‘Bell Houses clause’ so called after a case of that name gives a company the capacity to pursue any business which the directors believe would be advantageous to the company. Accordingly, the company’s capacity to pursue a particular business will be determined by the directors subjective discretion [34] . Interestingly the Bell Houses type clause was first approved by the High Court of Australia a number of years earlier in the case of H A Stephenson & Son Ltd v Gillanders Arbuthnot & Co [35] . In Bell Houses Ltd v City Wall Properties Ltd [36] the principal business set out in the company’s memorandum was the development of housing estates. However, the objects clause contained a clause which empowered the directors to pursue any business they considered advantageous to the company. The objects clause also contained an independent clause similar to that in the Cotman case. The company contracted to introduce a financier to another company for a procuration fee. The Court of Appeal held that in view of the clause use, the transaction was intra vires. Dankwerts LJ said the impact of the clause was ‘to make the bona fide opinion of the directors sufficient to decide whether an activity of the plaintiff company is intra vires [37] .’

Essentially, the Bell Houses clause is drafted in such a way as to leave it to the company itself, or to the board of directors, to decide whether the company should extend its activities into any other business. The only requirement is that the company or the directors as the case may be, honestly believe that the extension of activities would benefit the company’s main business. The test is therefore subjective rather than objective [38] . When the clause is coupled is coupled with an independent objects clause, the potential ambit of the doctrine of ultra vires is considerably reduced: almost any object can validly be pursued [39] .

Objects and Powers

As mentioned already the objects clause will commonly contain not only the objects of the company but also the powers. The difference between objects and powers is that powers are merely used in furtherance of the company’s objects. Keane gives the example that companies are frequently allowed to borrow money but in the case of most companies this is not an object of the company properly speaking but rather a power which it requires to achieve its objects [40] . Courtney classifies this corporate capacity under three headings; substantive objects, express ancillary powers and implied ancillary powers [41] .

Substantive objects: Most companies formed today have in excess of 20 sub-clauses within their objects clause. Many are merely ancillary powers, which a company would be implied to have e.g. the power to borrow, provide security in respect of borrowings etc. Whether a particular sub-clause is properly a substantive object or an ancillary power will, in every case, be a matter of construction for the courts [42] . It has been held in Rolled Steel Products (Holdings) Ltd v British Steel Corporation [43] that sub clauses are incapable of constituting a substantive object. Where this is found to be the case, the sub-clause in question must be construed as being an ancillary power.

Express ancillary powers: While express ancillary powers can be subject to express limitations which go to the very root of the power itself, the most common express limitation is that they are expressly said to be exercisable only ‘as may seem expedient for the furtherance of the object of the company’ [44] . Hence, express ancillary powers are always conditional and the board of directors must ensure that they are only exercised in furtherance of the objects of the company [45] .

Implied ancillary powers: Although companies are invariable incorporated with the voluminous objects clauses, the truth is that this results more from a nervous adherence to practice than from legal necessity. It has been long been the case that the courts will imply powers to a company which ‘may fairly be regarded as incidental to, or consequential upon’ a company’s express objects. Certain powers are a obviously incidental and necessary e.g. borrowing to finance the company’s main business, hiring employees, acquiring business premises. Others have traditionally been contentious: corporate gifts and other gratuitous payments, such as political donations, pensions, sponsorships, scholarships and even redundancy payments in excess of those which are required by law [46] .

International Comparison

England’s position on the ultra vires rule was outlined in the Companies Act 1989, which attempts to abolish the doctrine of ultra vires. The English courts took a more realistic view of the ultra vires rule and realised its burden on companies and on outsiders. The amendments in the Companies Act 1989 were based on a report called the Prentice Report in 1986 which called for the effective abolishment of the ultra vires rule [47] . The result of this report was the amendment found in section 35(1) of the Companies Act 1985 , as substituted by section 198 of the 1989 Act and which provides that:

‘The validity of an act done by the company shall not be called into question on the ground of lack of capacity by reason of anything in the company’s memorandum [48] .’

This idea basically protects the outsider in the case of corporate incapacity and effectively terminates the doctrine of constructive notice in England. Although ultra vires the rule has been virtually abolished as regards dealings between the company and outsiders, it still operates internally. Section 35(2) provides, in much the same way as section 8(2) of the Companies Act 1963 , that any member may bring proceedings to restrain the doing of any ultra vires act. However, the English subsection expressly provides that ‘no proceedings shall lie in respect of an act to be done in fulfilment of a legal obligation arising from a previous act of the company.’ Consequently an injunction could not be obtained if it would interfere with the performance of an ultra vires contract which has been entered into with an outsider. Furthermore, section 35(3) goes on to state that it remains the duty of the directors to act only within the capacity of the company [49] . Therefore a director who is responsible for the company pursuing an object which is not within the capacity of the company will be guilty of an abuse of power [50] . The position in England benefits and protects the outsider more than in Ireland and shows a more sensible attitude to companies’ contractual capacity than the Irish current position.