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The Reform of the Ultra Vires Rules

Info: 3101 words (12 pages) Essay
Published: 18th Nov 2020

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Jurisdiction / Tag(s): UK Law

S (31) (1) of the Companies Act 2006 is a retrograde step in terms of a company’s capacity. The provision re assert the ultravires problem encountered by the creditors, in case such as Ashbury Railway Carriage v. Riche.

Critically evaluate this statement with reference to the changes wrought by the Companies Act 1989 and Companies Act 2006 in relation to company’s constitution.

The Doctrine of Ultravires:

Ultra Vires is a Latin expression which the lawyers and civil servants use to describe acts undertaken (ultra) the legal power (vires) of those who have purported to undertake them. [1] The doctrine of ultra vires is established when a in company law the company goes beyond the powers it has been given to it under the Memorandum of association and that transaction will be considered void [2] .It cannot be ratified even if all the members wish to ratify it. [3] This has been firmly established in the case of Ashbury Railway Carriage And Iron Company v. Richie. [4]

“The doctrine was established for the shareholder and creditors protection, they do not want shareholders to enter into the risk with their investment which they have made in the company by and they therefore do not want directors to use their investment and put it in a risky position. [5] It however made the position of the third party very uncomfortable, and it was at their expense, that they had to do their own research as to the contract they were entering to see what the main object clause are”. [6]

The ultra vires rule applied where the company had it separate legal personality, it however did not apply to the partnerships Sutton hospital. [7] When the Ultra vires problem arise the question arises is that, does the company has the capacity to act in certain way and also that are the members for that company authorized or do they have a express power to act on behalf of the company’s constitution. There are certain things which are prohibited under the act but it can be explained in the sense that it is only doing what the company memorandum authorized it to do the case of Re Halt Garage [8] , and Aveling Barford Ltd v. Perion Ltd [9] where the remuneration and other activities related to sale of company’s share are thus ultra vires and void. The use of the term ultra vires, although within the scope of the powers of the company, but they have been entered into for an unauthorized purpose. There can be rights conferred on third party who do not know of the improper purpose [10] .in Rolled steel products (holdings) Ltd v. British Steel corp. [11] Slade and Browne- Wilkinson LJJ “rightly commented on the potential for confusion caused by the term ultra vires in these wider senses and suggested that its use should be confined to its strict sense”. [12]

The Position Before the Companies Act (1989):

The Term ultra vires was used in the strict sense that, one a certain act is ultra vires then that cannot be ratified even by shareholder voting. As it is established in the case of Ashbury Railway Carriage and Iron Co v. Riche [13] where the House of Lords held that the actions of the company was ultra vires because they were beyond the objects expressed in the memorandum. [14]

The ultra vires doctrine was never used that harshly and as to makes everything void, which was not expressly authorized by the memorandum, because the courts accepted that whatever might fairly be regarded as incidental to or consequential upon the objects specified ought not, unless expressly prohibited to be held outside the powers of the company. [15] In the case of A-G v Great Eastern Railway Co [16] Lord Selborne LC stated “The doctrine ought reasonably and not unreasonably to be understood and applied…” [17]

The Judicial practice of analysing and construing various objects and powers in the memorandum and defining the main as opposed to the ancillary objects of the company’s activities. The court applied the Edjusdem generis rule of construction, by deciding that the powers could only be used in relation to the company’s objects. [18] Re Haven Gold Mining Co [19] it was held that the court will look in to the main object clause paragraph and the other will be a ancillary to the main objects.

The companies latter onward started to read each paragraph of the object clause separately from the other to avoid the main object rule. [20] In Cotman v. Brougham [21] ‘where it was established that given to an independent objects clause paragraph by treating every object and power specified in the objects clause as independent objects and not as ancillary to the main object’. [22] Which Swinfen Eady J had disapproved of in the case of Stephens v Mysore Reefs (Kangundy) mining co Ltd [23] However In Re introduction Ltd v National provincial bank Ltd [24] . Harman J considered that not all powers could be objects: ‘you cannot have an object to do every moral thing you want, because that is to have no object at all’ [25] similar approach was seen in the Anglo-Overseas Agencies v Green [26]

In the case of Bell Houses Ltd v city wall properties Ltd [27] the Concept of ultra vires was defeated where they allowed the directors to decide what was appropriate for the company to carry on any trade it wished to do so, it is considered as a marked shift in the judicial attitude towards ultravires doctrine, however later court of appeal a more rigorous approach was taken.

In Rolled Steel Products v. British Steel Corp [28] and Green [29] , Brown-Wilkinson LJ clarified the confusion which was in the earlier cases stating that ‘there clearly exists a distinction between act done in excess of the capacity of the company and acts done in excess or abuse of the powers of the company, where is acts outside the capacity of a company then its ultravires and where it abuses its power it is in reality liable to legal transaction’. [30]

Street J when interpreting the Australian Uniform Companies Act which contains similar provisions aptly observed:

‘… strikes down the absolute effect of the ultra vires doctrine. An ultra vires transaction is no longer a complete nullity, incapable of being recognized as a transaction at all. On the contrary it is a transaction which, in general terms, is not invalid by reason of the fact that the company was without capacity or power to enter the transaction. But whilst the general nullifying effect of ultra vires has been abolished by s20(1), the legislature has marked out certain fields within which significance will still attach to an excess by a company or its officers of the legitimate scope for its activities as enunciated and restricted by the terms of its objects clause.’ [31]

The Reforms which lead to (1989) Act:

The problems with the ultra vires rules were long recognized. The Cohen Committee (cmnd 6659 (1945), Para 12) recommended that ultra vires rules should be abolished but there was no recommendation for the modification of the doctrine of constructive notice which was closely related to the doctrine of ultra vires. The Jerkin committee ( Cmnd 1749 (1962), Para 42), it recommended that the doctrine of constructive notice should be replaced by a set of statutory rules, but did not recommend the abolition of ultra vires rule. The reforms were carried out when the UK accession to the EEC in 1972. Art 9 of the first EEC company law directive ( 68/151/EEC), s 9(1) of the European communities act 1972 ( replaced by CA 1985 , S( 35) , it was passed to protect any person dealing in good faith with the company from the effect of transaction not being within the capacity of the company. [32] Later it changed the position in the Ss 35, 35 A, 35B Companies Act (1985) and now have been changed into S 31, S 39 and S 40).

The Position under the 1989:

The company (1985) S.35 was thought to be the most unsatisfactory. It applied only to transactions decided on by the directors and only operated in favor of persons who dealt in good faith with the company. The doctrine of constructive notice as against the Third parties also remained intact. [33] The Recommendation made by professor Prentice dealt with the constrictive notice issue and S 3A of the companies Act 1985 it said that where a company memorandum said that the company can carry any trade or a business, the company could carry any business, the section intended for the use of short term object clause. There were however certain un resolved issues concerning S 3 A of the CA 1985, it was not clear what interpretation was to be given to the words ‘General Commercial Companies’ clearly not all companies were general commercial companies, and secondly it was arguable that since under a common practice they were willing to draft long form object and they even now wished to do the same thing [34] , the problem with long object clauses was that it would be too much extensive reading and often the third party would avoid reading the whole object clause and simply would enter the contract. However further steps were taken to abolish the ultra vires rules S ( 35) of the 1985 act and stated that the any act by the company shall not be questioned on grounds of lack of capacity by reason of anything in the memorandom.That means the company as well as the third party cannot reply on the strict ultra vires rules. S 35A it dealt with the director’s lack of authority, the third party acting in good faith the directors can exercise the company’s powers. [35]

The Nourse J, said in section 9 of the European communities act, 1972: “what it comes to is that a person who deals with a accompany in circumstances where he ought anyway to know that the company has no power to enter into the transaction will not necessarily act in good faith. Sometimes, perhaps often, he will not. And a fortiori where he actually know” [36] , Barclays Bank Ltd v TOSG Trust Fund Ltd. [37] This dictum might be thought to put the emphasis the wrong way around; a person with actual knowledge will not necessarily be regarded as acting bad faith. [38]

Section 35B was red together with S 711A of the Ca 1985, the third party does not necessarily need to know the corporate document in the memorandum, and the doctrine of Constructive notice has been abolished. [39] However the Act has removed the need for memorandum of association in the object clause and the company can have unlimited capacity now Section 31 and section 39 has replaced Section 35 1985 Act. [40]

The 2006 Act:

Section 31 of the company Act 2006 provides that unless a company’s article specifically restrict the objects of a company, its object are unrestricted [41] . The s ( 31) of the CA act 2006 provided a new approach question to the company’s object based on the recommendation of the company law review Group in its final report [42] Where it was stated that the company has unlimited objects unless it chooses to restrict itself by the articles. This is to ensure the freedom for companies to engage in commercial dealings without any impediment or limitation in the object clause, the ultra vires doctrine is no longer applicable [43] , the charitable companies may choose to restrict their object clause for lawful purpose [44] if there is no lawful purpose behind the company in that case, if it does not do so it can be held to be in breach of their s 31 CA 2006, even the directors can be breach of the duty unless they promote that they acted in good faith. [45]

The reason for the Omission of the s 35 of CA 1985 are set out in the explanatory Notes to the 2006 Act “It is considered that the combination of the fact that under the (2006) act a company may have unrestricted objects (where it has directors powers are correspondingly restricted), and the fact that a specific duty on directors to abide by the company’s constitution is provided for in section 171, makes these provisions unnecessary” [46]

However if the Company decides to adopt an object clause so as to limit the capacity of the company, then the doctrine of ultra vires will still remain relevant internally( i.e. with respect o deciding whether its directors have exceeded their powers and entered into a transaction that is ultra vires the company’s object clause. [47] Even though the doctrine of ultra vires has been completely been abolished, but it is still alive in cases of companies internal matter therefore the doctrine itself has not been completely washed out of the company law transactions.

S (39) of the act is mentioned that no question will be asked regarding the company’s capacity and combined effect of s 39 and s 31 of CA 2006 would mean it is free to do business with any one as it wish to until and unless it wishes to restrict some of its objects clauses however giving the company an unlimited power to deal with anything, it however does put creditors in a risky position regarding their money, however the company was developing alternative rules to protect shareholders and creditors against the dissipation by the director of the funds made available to the company, the provision of the insolvency legislation attacking preferences or transactions at an undervalue also sought to prevent unwarranted disposal of corporate field. [48] But here has been check on the director duties to keep monitoring the transactions and contract and they must act in good faith, otherwise they will be in breach of their fiduciary duties or be personally liable for wrong full trading.

The reform of the ultra vires rules could be seen from the point that it is the company is given the unlimited capacity instead of a limited one as stated in S (31) of CA 2006 unless it wants to restrict itself, and secondly that the doctrine of constructive notice has been abolished which burdened the third party with a responsibility to know everything on their own regarding company main objects. [49]

As according to the s (39) Act 2006 it has been stated that no act shall be questioned and the company has the unlimited capacity, now under the Ashbury case [50] Mr. Richie would have been able to enforce the contract as the capacity of the company will not be a question now. [51] Due to the company having an unlimited power to do anything and, it will not be questioned for any act done, it has however put the creditors under a risky position, however there has been provisions made in 2006 Act, to keep a check on the directors duty to act in an appropriate way and abide by their general duties in good faith so that they cannot be liable for fiduciary duties or being personally liable.

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Ashbury Railway Carriage And Iron Company v. Richie. (1875) L.R/ 7 H.L 635

Re Halt Garage (1982) 3 ALL ER 1016

Aveling Barford Ltd v. Perion Ltd (1989) B.C.L.C. 626

Rolled steel products (holdings) Ltd v. British Steel Corp (1986) CH 246

A-G v Great Eastern Railway Co (1880) 5 App Cas 473 HL

Re Haven Gold Mining Co (1882) 20 Ch D 151

Cotman v. Brougham (1918) AC 514 (HL)

Re introduction Ltd v National provincial bank Ltd (1970) Ch 199

Stephens v Mysore Reefs (Kangundy) mining co Ltd (1902) 1 Ch 745

Anglo-Overseas Agencies v Green (1961) 1 QB .1

Bell Houses Ltd v city wall properties Ltd (1966) 2 QB 656

Rolled Steel Products v. British Steel Corp (1985) 3 All ER 52

Barclays Bank Ltd v TOSG Trust Fund Ltd. (1984) B.C.L.C 1


Gower and Davies, Principles of Modern Company Law (Sweet and Maxwell. London 2008)

Charles wild and Stuart Weinstein, Smith & Kennan’s Company law 14th edition ( Pearson education limited) 2009

Ben Pettet’s , Company and Capital Markets Law, (Pearson Education Limited 2001, 2009)

Andrew Hicks & S.H Goo, Cases & material on company law ( oxford University Press, 2004)

Saleem Shaikh, A guide to the companies Act 2006 ( Routledge Cavendish,) 2008

Boyle and Birds’ , Company law, 7th edition, Jordon (2009)

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