Doctrine of Ultra Vires in Company Law

The Doctrine of Ultra Vires: The Memorandum of Association of a company defines the objects a company is working for and the powers and rights through the exercise of which it seeks to achieve those objects. Section 4(1)(c) states that a company should lay down its objects and anything necessary in furtherance of such objects in its memorandum. This specified list of objects and powers bind the company and its directors within its limit. This means that no representative of the company can act outside the scope of these objects.

Neither can the Directors exercise a power not given in the memorandum, nor can they exercise a permissible power for any other purpose than the furtherance of the given objects therein. This is called the doctrine of ultra vires. in Company Law such that all acts which lie outside the scope of the Memorandum, or in other words, are not directly or indirectly for the furtherance of the given objects in the memorandum shall be deemed to be void ab initio. The term "ultra vires" stands for "beyond powers", and the term "void ab initio" stands for "void from the initiation".

I. The Need and Importance of the Doctrine of Ultra Vires

The doctrine intends to protect the subscribers of a company and its investors. The people investing in a company are assured by the doctrine that their money shall only be used for the purpose they have read and understood in the memorandum and not for any other purpose. Many a time, a company's ultra vires actions lead to its insolvency. Hence, the doctrine empowers the investors to first seek a remedy such as an injunction against the ultra vires act, and later demand their money during insolvency.

II. Not an Illegality Per Se

It is pertinent to understand that the acts ultra vires are deemed as void ab initio and not an illegality. This means that once it is proved that an act is not authorized by the memorandum, it will be so pretended that the act was never done at all. Hence, ultra vires contracts would not bind either party legally as they were never made at all. Repudiation of such contracts is not a breach, which would be illegality. Unless the acts violate a legal provision, they are not illegal and hence, a punitive or compensatory liability is not incurred on the company for doing such an Act, except in certain cases as will be detailed later.

III. Landmark Cases of Origin

The doctrine is a long-standing dictum of common law, first propounded by Lord Cairns in the House of Lords in the landmark decision of Ashbury Railway Carriage and Iron Co. Ltd. v. Riche [1]. The facts of the case are such that company A defines its object in the memorandum as "… to carry on the business of mechanical engineers and general contractors…"

A perusal of the object clause gives that the company intends to deal in mechanical engineering contracts in buying, selling and lending railway plants. The company enters into a contract with R for financing the construction of a railway line for the latter. It realizes that the contract is ultra vires, and repudiates it. R brings a suit for breach of contract with two main arguments. One, that the term 'general contractors' is wide enough to include the given contract. Two, that the majority shareholders were present and ratified the contract at its formation.

It was held that the term "general contract" is to be read in the light of the rest of the clause, which means that the company may only deal in mechanical engineering contracts and may enter to general contracts related to that purpose only. The House clarified in unequivocal terms that if every shareholder of the company submits that he authorizes the said contract, even then it would be a nullity from the beginning. Acts ultra vires the memorandum cannot be ratified by the shareholders.

In the landmark case of A. Lakshmanaswami Mudaliar v. L.I.C. [2], Justice Shah has upheld the Doctrine of Ultra Vires which brings it in the common law of India as well. The facts are such that a given power in the memorandum authorizes the Director to make a payment towards any charitable or benevolent object. A resolution of shareholders is passed and Rs. 2 lakhs are paid to a charitable trust for promoting technical and business knowledge. However, the company having been acquired by the LIC had no business of its own to promote.

The act was held ultra vires and therefore void by the Hon'ble judge. The Court highlighted that the powers of directors and the object of the company are distinct clauses where the former is bound by the latter. That is, the power of the Director to make payments, or borrow money may only be exercised for the furtherance of the objects stated, and not for any and all purposes.

It further said that for payment towards charitable purposes, a nexus should exist between the charitable purpose and the business of the company. For instance, a company dealing in chemicals may contribute towards a charitable organization researching in that field. Charitable donations for bona fide purposes are dealt with in Section 181 and are different from the above powers.

In Re Jon Beauforte (London) Ltd. [3], a company had in its objects the business of costumes and gowns. It entered ultra vires into the manufacture of veneers. Unknown to this, several creditors entered into contracts with the company. The company went under forced liquidation. Their claims of debt were rejected by the liquidator as their contracts were based on ultra vires acts. Held, the liquidator has been justified and ultra vires acts do not give rise to enforceable contracts.

In Re Introductions, Ltd. v. National Provincial Bank Ltd.[4], a company entered into the business of pig breeding ultra vires its object clause. This was not challenged in appeal. The company had an account with a Bank (defendant) who was in return issued as security two debentures. The company went into liquidation and the bank sought to enforce the debentures but was rejected on the basis of the doctrine.

The bank's argument was such that even if the borrowing was for an ultra vires purpose, it was expressly given in the objects clause that the company had the power to borrow by issuing debentures, and it was further declared in the last clause that each clause is independent of other clauses. Thus, they should be entitled to the debentures. The court disregarded this argument again iterating that borrowing was not an end in itself. Borrowing must be done in pursuance of an object, and since that object is not intra vires, the doctrine is attracted nevertheless.

IV. Implied Powers

It has been held by both the House of Lords and Indian courts that the doctrine of ultra vires is not to be applied in the strictest sense so as to prohibit anything that is not expressly written in the memorandum. This means that matters necessary for the attainment of the given objects and issues incidental to it may be read into the memorandum by reasonable construction. Section 4(1)(c) requires that the objects and other matters necessary must be written. However, some flexibility of interpretation is shown in this regard to include related and implied matters.

Similarly, the requirement is to write the objects and necessary powers. The rest of the powers of the representatives of the company may not be written, and be inferred from the written powers and objects. For instance, a company made for the object of trading impliedly acquires the power to lend and borrow money. This was held in Oakbank Oil Co. v. Crum [5]. This is construed from the nature of its business and may not be written without any damage. The underlying principle, as held in Egyptian Salt and Soda Co. v. Port Said Salt Association [6] is that the company constituted for a particular object must be able to pursue those things incidental to or consequential upon that object.

It goes without saying that a company is free to have a long, detailed list of individual objects writing all that it feels necessary. It was held in Cotman v Brougham [7] that such a list of objects and the stipulation that they would be deemed individual objects and not sub-clauses to the same object is valid.

V. Powers to be Expressly Included

Although necessary and incidental powers have been read into the memorandum of a company, decisions of the court provide us that certain clauses must be expressly mentioned in the memorandum or the doctrine will be attracted. The following powers are not implied:

• Power to acquire any business is similar to the company's business. (Ernest v. Nicholls [8]) Also, taking shares in companies having similar objects. (Re William Thomas & Co. Ltd. [9])
• Very clear objects are required to authorize entering into agreements with other companies to work in partnership or joint venture and share profits. (Re European Society Arbitration Act [10])
• Power to Promote or financially help other companies (Joint Stock Discount Co. v. Brown [11])
• Power to sell the whole of a company's undertaking
• Power to use funds for political purposes.
• Power to act as a surety or guarantor.

VI. Effect of Ultra Vires Acts

As stated, an ultra vires act is considered void ab initio. The doctrine has the following effects in the given situations:

• Void ab initio: The company cannot sue or be sued on these acts as they are deemed to have not taken place at all. Ultra vires cannot be subsequently made valid by either Ratification or i.e., the shareholders cannot vote an ultra vires act as valid, as they could have in case of a Director having acted in excess of his powers. Nor can the conduct of the other party to a contract ultra vires bind them to the contract (estoppel).
• Injunction: A remedy in the nature of injunction can be sought against the company preventing it from acting ultra vires the memorandum. (Attorney General v. Gr. Eastern Rly. Co. [12])
• Borrowing and Lending of Money: An ultra vires act of borrowing or lending money by a company does not create a creditor-debtor relationship. Hence, the contract does not exist and cannot be enforced. Held in Madras Native Permanent Fund Ltd. [13]
• Buying a property with company money ultra vires: A property bought for a purpose ultra vires the memorandum will still belong to the company as it represents the money of the company even if the purpose of acquiring it was ultra vires.
• Personal Liability of Directors: It is the duty of the Directors to see that the investors' money is utilized for the purposes laid down in the memorandum. On failure of the duty, resulting in money being used for alien objects they can be sued personally without making the company a party, and be made liable for compensation. If the ultra vires act is proved to be deliberate or mala fide, criminal action may also be brought. This was held in Jehangir R. Modi v. Shamji Ladha [14].

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References

[1] (1878) L.R. 7 H.L. 653

[2] A.I.R. 1963 S.C. 1185

[3] [1953] 1 Ch. 131

[4] [1969] 1 All E.R. 887

[5] (1882) 8 App Cas 65.

[6] [1931] UKPC 47

[7] [1918] AC 514.

[8] (1857) 6 HLC 40

[9] (1915) 1 Ch 325

[10] (1878) 8 Ch 679

[11] (1869) LR 8 EQ 381

[12] (1880) 5 A.C. 473

[13] (1931) 1 Com Cases 256 (Mad.).

[14] (1866-67) 4 Bom. HCR (1855).

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