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The ultra vires rule in relation to English company law

It was in the nineteenth century 1 that the courts established the doctrine, which became known as the ultra vires doctrine. The actual term ‘ultra vires’ itself means ‘beyond the powers’, and the rule specified that a company did not possess the legal capacity to enter into transactions which happened to fall outside that which was specified in its objects clause. As a result, the rule had the effect that any such transaction which fell outside of the objects clause, would be deemed null and void, and as a result, not binding upon the company 2. The main authority for this proposition can be found in the case of Ashbury Railway Carriage and Iron Company v. Riche (1875) 3, in which, a company contracted to build a railway line which ran from Antwerp to Tournai, in Belgium. The objects clause, however, which was contained withiin the company’s memorandum, stated that the company had in fact been established; “to make, sell, or lend, railway carriages, wagons and all kinds of railway plant, fittings, machinery and rolling stock".

In other words, the objects of the company permitted it to manufacture train stock and parts for railways; however, they were not to actually construct railway lines themselves. The court thus held that the contract with Riche was void, and as such the directors of Ashbury were entitled to repudiate the contract.

Ashbury, although being arguably considered the most prominent authority concerning the ultra vires doctrine 4, actually built upon earlier precedent, particularly the case of East Anglian Railways Co v Eastern Counties Railway Co (1851) 5 in a case between statutory companies, and also Shrewsbury and Birmingham Railway Co v North-Western Railway Co (1857) 6.

1 French, D, Mayson, S and Ryan C. Mayson, French and Ryan on Company Law, 26th Edition, Oxford University Press, Oxford, (2009) p. 103

2 Hannigan, B. Company Law, 5th Edition, Oxford University Press, Oxford, 2003, p. 101

3 (1875) LR 7 HL 653

4 French, D, Mayson, S and Ryan C. Mayson, French and Ryan on Company Law, 26th Edition, Oxford University Press, Oxford, (2009) p. 604

5 (1851) 11 CB 775

6 (1857) 6 HL Cas 113

The legal rationale behind the ultra vires doctrine was originally shareholder protection. The court believed that prospective shareholders would make their decision to invest based upon the content of a company’s object clause, and therefore it would be unfair to allow the company to thereafter engage in activity of a wholly different nature, which would be of a kind unanticipated by the shareholders: contrast Re German Date Coffee Co [1882] 7. One example could be, if a company had its main object as ship building. Originally, it was firmly believed that it would be inappropriate (and also unjust from a shareholder perspective, who had invested money in the company on the basis of the objects clause) for such a company to then suddenly diversify into another industry, for instance a high risk business activity such as diamond mining 8.

Recent times witnessed a growing realisation that shareholders are actually less concerned with the particular lines of business which directors take a company into, as long as those businesses generate the profits which are necessary to pay a healthy dividend and assist in raising the share value.

It soon became clear that those who are placed at the highest risk by the operation of the ultra vires doctrine, were the creditors who had supplied the goods or services to a company for a purpose which was not included in its objects clause 9. If a company with a situation such as this entered insolvent liquidation, then the creditors would be denied the opportunity to even submit a claim, and the liquidator would thus treat such debts as being based upon a void transaction and any ultra vires creditor would be left with an unpaid debt 10 as a result.

As a result, it soon became standard practice for companies to draft objects clauses which contained a very large number of broadly framed objects and powers, which would as such allow companies the capacity to undertake a wide variety of business pursuits. This was a practice which was tested in the case of Cotman v Brougham [1918] 11, in which an objects clause was drafted in such a manner, and with such care, that it permitted a company to do almost anything it chose.

7 [1882] 20 Ch 169

8 Keenan, D. and Bisacre, J. Smith and Keenan’s Company Law, 11th Edition, Pitman Publishing, London (1999) p. 74

9 Grier, N., UK Company Law, Wiley & Sons, (1998) p. 82 et seq

10 Keenan, D. and Bisacre, J. Smith and Keenan’s Company Law, 11th Edition, Pitman Publishing, London (1999) p. 74

11 [1918] AC 514 HL

The House of Lords, with considerable reluctance, actually ruled that the clause was legal – particularly due to the fact that it had already been endorsed by the Registrar of Companies as the company had been granted a certificate of incorporation. As a result, such widely framed objects clauses then became known as ‘Cotman v Brougham clauses’ and they remained effective and popular for many decades to follow, as demonstrated in the case decisions of Bell Houses Ltd v City Wall Properties Ltd [1966] 12 and Re Introductions Ltd [1970] 13, although in the latter case it was held that on occasion, limitations in objects clauses still prejudiced creditors.

The doctrine has also been influenced by the EEC over time. Section 35 of the Companies Act 1985 14 constituted the United Kingdom’s transposition of Article 9 of the First EEC company law harmonisation directive 15, which aimed to establish a level playing field across the common market. Section 35 provided that the validity of an act of a company could not be called into question on the grounds of anything in the company’s memorandum, and this provision can now be found under s. 39 (1) of the Companies Act 2006.

As a result of this, companies could no longer refuse to honour a contract based on the grounds that it was outside of the company’s objects, which they could have done under the application of the traditional ultra vires doctrine.

It must be considered, had the Ashbury Railway Carriage litigation taken place with section 35 in operation, the contract would have been enforceable against the company by outsiders. The ultra vires doctrine would still however, have had effect internally, and would permit members of a company to seek an injunction in order to restrain the directors from entering into or continuing with transactions which were/are ultra vires transactions.

12 [1966] 2 All ER 674

13 [1970] Ch 199 CA

14 Later amended by the Companies Act 1989

15 First Directive on Company Law (68/151)

Section 35, had been designed to protect the interests of creditors, however, it had less of an impact than might have been expected at one stage, as thanks to the Cotman v Brougham styled clauses, most companies had been incorporated with very widely framed objects. However, lawyers and the courts still encountered practical problems as they wrestled with the distinction between company objects’ and directors’ powers, as was evidenced in the case of Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1982] 16.

It was decided by Parliament to deal with this issue, and this was done in the Companies Act 1989 in two different ways. Firstly, the insertion of section 3A by the 1989 Act into the 1985 Act was to permit companies to adopt a new kind of objects clause, which was known as a general trading clause and included all commercial objects. Secondly, clarification of the ultra vires rule was made in sections 35, 35A and 35B.

In the present day, the pendulum appears to have swung very far from the position originally articulated in the case of Ashbury Railway Carriage and Iron Company v Riche (1875). Now, a company is entitled to restrict its objects by way of a provision in its articles of association. Section 31 (1) of the Companies Act 2006, however, provides that unless a company’s articles do specifically restrict its objects, then such objects will be deemed unrestricted. Prior to 1 October 2009, each and every company had an obligation to state its objects in its old style memorandum and also to restrain itself to pursuing those objects 17. From that date, however, the objects’ clauses of existing companies became a provision of its articles under section 28 of the 2006 Act – thereafter becoming susceptible to removal or amendment by way of a special resolution 18.

Current legislation now affords protection to bona fide outsiders dealing with companies which would have been the envy of nineteenth and early twentieth century creditors. Under section 40 (1) of the Companies Act 2006, as far as individuals are concerned, the power which directors have to bind a company or to authorise others to, is now untrammelled and unaffected by any purported limitation which may be set down in the company’s constitution.

16 [1982] Ch 478

17 French, D, Mayson, S and Ryan C. Mayson, French and Ryan on Company Law, 26th Edition, Oxford University Press, Oxford, (2009) p. 101

18 By section 21 of the Companies Act 2006

Furthermore, those bona fide outsider parties dealing with a company are not legally obliged to enter into detective work prior to entering into transactions. Section 40 (2) (b) (i) of the 2006 Act provides that there is no obligation to investigate whether or not there are any limitations placed on a director’s power to bind their company 19. As a result, the current legal framework for those dealing with a company has changed, representing a polar shift in the orientation of the legal matrix from the perspective of external interests 20.

However, internally, the doctrine of ultra vires still remains to an extent. It is fairly unusual for a companies objects to be restricted within the modern world, as a result of the legislative developments since 1985 and also due to the practice of companies drafting lengthy objects clauses since the case of Cotman v Brougham [1918] 21, which have both rendered almost all potential commercial objectives intra vires 22. Company directors do still however owe a duty to act within the company’s powers under section 171 of the Companies Act 2006. Furthermore, where companies do still possess restricted objects, it is impossible to give authority to directors or their agents to enter into transactions that do not happen to be aligned with, or reasonably incidental to, the pursuit of those objects, as was seen in the case of Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] 23.

There is still good law found in the form of Re Lands Allotment Co [1894] 24 and directors who cause a company to enter into a transaction outside of the company’s restricted objects clauses will remain personally liable to account to the company for any costs or losses which may arise from entering such a transaction. This will be the case, unless under section 239 of the Companies Act 2006, the other members of the company are minded to ratify the transaction, and other penalties may also be brought to bear.

19 French, D, Mayson, S and Ryan C. Mayson, French and Ryan on Company Law, 26th Edition, Oxford University Press, Oxford, (2009) p. 103

20 Davies, P. Gower and Davies: The Principles of Modern Company Law, 8th Edition, Sweet & Maxwell, London, (2008) 7-2

21 [1918] AC 514 HL

22 Within the powers.

23 [1986] Ch 246

24 [1894] 1 Ch 616

For instance, if a director invested money in activities outside of a companies restricted objects, which subsequently cause the company financial loss, could be disqualified from holding the post of director for a period of five years 25.

Further to the above mentioned, potential internal limitations on directors’ powers, a member of a company may seek an injunction in order to prevent the company from entering into a proposed transaction which is beyond its restricted objects: contrast the decisions in Stephens v Mysore Reefs (Kangundy) Mining Co Ltd [1902] 26 and Simpson v Westminster Palace Hotel Co (1860) 27. In practice, it is a matter for the general membership and the members can collectively approve of transactions which are found to be beyond a company’s restricted objects, and they can subsequently alter the objects to allow such activity.

In conclusion, the law has come along a very long way since the case of Ashbury Railway Carriage and Iron Company v Riche (1875). It is true, as the essay title suggests that the original raison d’être of the ultra vires doctrine was the protection of shareholders. However, over time this focus quite quickly shifted to the protection of creditors when it became obvious that the basis of shareholder interest was a healthy dividend payment and a rising share value, and that due to this they were much less concerned with the specific means by which these two goals were achieved 28.

There is also truth in the statement contained within the essay title that the ultra vires doctrine proved to be a thorn in the side of entrepreneurs who wished to take their companies in a different direction from that which is anticipated when those companies were incorporated and their objects clauses drafted. The doctrine of ultra vires was certainly deemed unduly restrictive by nineteenth and early twentieth century incorporators whom wished to exploit unanticipated business opportunities. Lawyers found a way around this however, when they began to draft increasingly expansive and comprehensive objects clauses as a result of the decision in Cotman v Brougham, which was supported by the House of Lords (albeit reluctantly) in 1918.

25 French, D, Mayson, S and Ryan C. Mayson, French and Ryan on Company Law, 26th Edition, Oxford University Press, Oxford, (2009) p. 102

26 [1902] 1 Ch 745

27 (1860) 8 HL Cas 712

28 Sealy, L and Worthington, S. Cases and Materials in Company Law, 8th Edition, Oxford University Press, Oxford, (2007) p. 101 et seq

Further developments were seen with the 1985 and 1989 Companies Act’s which introduced a general trading clause and also provisions designed to protect creditors who deal in good faith with a company. As a result of these developments, companies can no longer point to transactions outside their objects clause and refuse to honour them, and the developments effectively put large parts of the doctrine of ultra vires to the sword, confining them to history.

However, whilst the external consequences of the ultra vires doctrine have been nullified, it is still possible to invoke remnants of the doctrine on an internal level to the company. Thus, directors may still be liable to account for ultra vires transactions if their company has restricted objects and the membership of the company cannot be persuaded to ratify such transactions. Furthermore, potential disqualification as a company director may arise as a consequence of such ultra vires transactions. Accompanying this, company members can still seek an injunction to restrain companies from entering into transactions should the transaction fall outside of that company’s restricted objects clause.

The phrase of this essay question is made in the past tense, and that is in essence where it belongs. Whilst the comment makes an accurate statement of the history of the law, modern developments have drastically changed this position. There is nothing to fear today, by creditors and those who deal with a company, from the faded spectre of the ultra vires doctrine. Entrepreneurs now also possess much more freedom to diversify, due to the fact that the ultra vires doctrine has been considerably relaxed. However, that said where those who are in control of a company do positively decide to exempt themselves from the general rule and policy and do restrict a company’s objects, such objects must be respected by the company directors or else they may face personal liability and potential disqualification. Members can also enforce such rules by the gaining of an injunction in an effort to prevent proposed ultra vires transactions.

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