This article is written by Sharanya Ramakrishnan who is pursuing a Diploma in Companies Act, Corporate Governance and SEBI Regulations from LawSikho.
Table of Contents
Introduction
The law relating to companies claims a position of utmost importance in the corporate legislative milieu as it not only deals with the structure, management and administration of a company but also lays a significant emphasis on how a company conducts its affairs. It gives due recognition to the legitimate interests of shareholders and creditors.
It, therefore, becomes important for a company to ensure that its acts do not prejudicially affect the interests of its stakeholders. However, a company being an artificial entity, the persons assuming responsibility for its daily functioning would be held liable for any unwarranted acts or omissions.
Taking into consideration the necessity of a company to function within the scope of its powers without exceeding its authority, the doctrine of ultra vires came into being. The term ultra vires is a Latin locution for “beyond the powers” or “beyond the authority”. It essentially refers to acts undertaken by a company or its officers, which are outside the powers granted to them under law or corporate charter.
This article endeavours to analyse the concept of ultra vires with respect to companies and its applicability in India. It deals with the meaning of the rule under company law, more specifically under the Companies Act, 2013, the evolution of the rule, its consequences, exceptions and its relevance in today’s scenario.
This article will reflect on the concept of ultra vires, right from its evolution to its development and finally, the present scenario in India in the light of judicial pronouncements. It will also emphasize what methods have been used to circumvent this rule and the consequences of the same. Finally, we deal with the exceptions to the rule of ultra vires in the corporate world.
Meaning of ultra vires under Indian company law
As stated above, ultra vires essentially mean any act or transaction which is beyond the lawful powers of a company. As far as company law is concerned, for a transaction to be ultra vires, it has to be any of the following four things:
- It is beyond the scope of the legislation governing companies itself, namely the Companies Act, 2013.
- It is ultra vires the Memorandum of Association of the company.
- It is ultra vires the Articles of Association of the company.
- It is beyond the powers of the directors or officers of the company.
In view of the above, it can be said that an ultra vires transaction can arise either due to lack of capacity or owing to lack of authority. Lack of capacity arises in a situation where a company does not have the power to act on its own because it’s either is beyond the mandate of the Companies Act, 2013, or it violates its memorandum or articles.
On the other hand, lack of authority deals with situations where the officers of the company act within the object of the company but without authority to do so. In both instances, the act would be ultra vires, although it attracts different legal consequences as described below.
Ultra Vires the Companies Act, 2013
It is an undisputed fact that the power of a company is essentially derived from the statute governing it. As per Section 2(20) of the Companies Act, 2013 (hereinafter referred to as “the Act”) a company is said to mean a company incorporated under the Act itself or under any previous company law. It effectively cannot do anything beyond the powers expressly or impliedly conferred upon it by the statute.
Section 6 of the Act expressly provides that the provisions of the Act shall prevail notwithstanding anything to the contrary contained in the memorandum or articles of a company, or in any agreement executed by it, or in any resolution passed by the company in general meeting or by its Board of Directors, whether the same be registered, executed or passed, as the case may be, before or after the commencement of this Act.
It also declares a provision contained in the memorandum, articles, agreement or resolution void if it’s repugnant to any of the provisions in the Act. Thus, no legal effect would be given to provisions opposing the fundamental principles of the company’s jurisprudence.
Ultra Vires the Memorandum of Association of a company
The Memorandum of Association (MOA) being a document setting out the constitution of a company, essentially represents the foundation on which the structure of the company is built. It contains clauses detailing the scope of the company’s activities and its relations with the outside world.
The heart and soul of the MOA is considered to be its “objects clause”. Section 4(1)(c) of the Act requires every company to state in their MOA, the objects for which the company is proposed to be incorporated (the raison d’être of a company) and any matter considered necessary in furtherance thereof (ancillary objects).
The objects clause is of great importance as it determines the purpose for which the company has been set up and its actual capability, besides its sphere of activities. If a registered company fails to confine itself within the permissible activities as provided in its MOA, such acts are regarded as ultra vires. Not only are these acts declared as void, they also cannot be ratified by the entire body of shareholders.
In the case of Ashbury Railway Carriage and Iron Company v. Riche, a company entered into a contract with Riche, a firm of railway contractors to finance the construction of a railway line in Belgium. However, the company subsequently repudiated the contract on the ground that the objects clause of its memorandum did not include the activity of construction of railway lines, thereby being ultra vires.
Aggrieved by the same, Riche sued the company for damages on the ground of breach of contract and further contended that the contract was enforceable as it was ratified by a majority of shareholders.
The House of Lords held that the contract, being ultra vires, the memorandum of the company is null and void. It further stated any attempted departure cannot be validated even if is asserted by all the shareholders of the company.
It, therefore, becomes essential to ensure that no attempt shall be made to transgress the ambit of the objects’ clause.
Ultra Vires the Articles of Association of a company
In terms of Section 5(1) of the Act, the Articles of Association (AOA) of a company shall contain the bye-laws and regulations for the management of the internal affairs of the company. It plays a vital role in governing a company’s affairs and also defines the rights of its members inter-se.
The AOA is however subordinate and subject to the MOA of a company and if it contains any clause that goes beyond the memorandum, it will be held to be ultra vires. As the articles are only internal regulations over which the members of the company have complete control, they may alter them by means of ratification.
It is important to note that, if there is any ambiguity in the memorandum of a company, the articles may be referred to explain it, but not so as to extend the objects contained in the memorandum.
In Re. South Durham Brewery Company((1875) LR 7 HL 653), the memorandum of the company was unclear as to the classes of shares to be issued by it, but the articles gave power to the company to issue shares of different classes as described therein. The court held that articles can be used to explain the ambiguity contained in the memorandum.
Ultra Vires the directors of the company
If the directors of a company do not have the requisite authority to enter into transactions, despite the same being within the purview of the object clause of the MOA, the acts are said to be ultra vires the directors and intra vires the company. Such acts can be ratified by the company in a proper form.
Evolution and need of the doctrine
The existence of the concept of ultra vires can be traced back to the United Kingdom wherein the doctrine was considered to be a regulatory device that sought to curb a company from entering into transactions that exceeded its contractual capacity. Until the introduction of the Joint Stock Companies Act 1856, the ultra vires rule had no application to a joint-stock company.
The reason was that prior to 1855, the contractual capacity of a joint-stock company was akin to that of a partnership firm. Consequently, any act or transaction was considered to be valid only after it was ratified by way of unanimous consent of the members.
Subsequently, on the enactment of the Limited Liability Act 1855, the members of a joint-stock company were afforded the protection of limited liability. As a result, the position of prospective creditors was rendered perilous because the introduction of limited liability gave ammunition to the members of the company to avert their personal liability for corporate debts.
In order to protect the interest of creditors as well as those of the existing and prospective shareholders, the legislature thought it fit to administer the ambit of corporate capacity. Although the 1856 Act sought to include an objects clause in the memorandum of a company, it failed to stipulate a method to alter the same, which resulted in an ambiguity of the status of the clause and its effect on the contractual capacity of a company. This led to the flourishing of the rule of ultra vires.
Rise and fall of the doctrine of ultra vires in the UK
The doctrine of ultra vires was not a codified law and it emerged through a series of judicial pronouncements. Seeing as the doctrine was evolved in India through the adoption of the common law principles, in order to appreciate the position of the Indian judiciary on the rule of ultra vires, it is first necessary to understand the contribution of common law in the regulation of registered companies. The rule of ultra vires has come a long way in company law and its jurisprudential journey along with subsequent statutory enactments can help understand how its scope is considerably narrowed.
Strict interpretation of objects clause
The clarification of the legal nature and contents of the objects clause required judicial elucidation. The first authoritative pronouncement on the rule was made by the House of Lords in the above-mentioned case of Ashbury Railway Carriage and Iron Company v. Riche. Here, the court justified the doctrine of ultra vires on two grounds, namely:
- The protection of investment interests of the company’s shareholders.
- The protection of the security interests of its creditors.
The doctrine was therefore promulgated to thwart the diversion of corporate funds into avenues different from those outlined in the corporate objects clause. The House of Lords restricted the scope in which objects were to be given effect.
In doing so, the objects could not be given their true literal meaning but instead had to be inferred in the context of the company’s main object.
Rule of reasonable construction
Subsequently, the courts however realised that the rule operated to the detriment of third parties dealing with the company. The House of Lords observed that their ruling in the Asbury’s case had been draconian. Therefore, while accepting the validity of the ultra vires rule, they sought to weaken the strict application of the rule.
In Attorney General v. The Great Eastern Railway Company, the defendant company was authorised by an Act of Parliament to construct railways. Two other companies collaborated and contracted to supply rolling stock to the defendant. An injunction was sought to restrain the same stating that such a contract was not expressly provided for in any of the Acts incorporating the companies.
The court held that the rule of ultra vires should be applied reasonably and unless it is expressly prohibited, a company may pursue a course of business that is necessary for or incidental to the attainment of its principal object.
Evasion of the rule of ultra vires
Although the rule was modified to include incidental objects, it continued to provide hardship to the officers of the company. Therefore, in order to avoid the harsh effects of the rule, the promoters of companies started resorting to several devices to circumvent the rule.
Mushrooming of objects
The first of these devices was the mushrooming of the objects clause by stating every imaginable object thereby making it extremely comprehensive. The courts reacted to this by adopting the ejusdem generis rule and identifying the main or dominant object and treating all other objects generally expressed as ancillary to this dominant object.
The main object being considered as the substratum of the company, its failure would be treated as losing the basis of the existence of the company itself. Consequently, anything done by the company in such a situation would be ultra vires.
In the case of In Re, German Date Coffee Co, the object clause of the company required it to use a German patent to manufacture coffee from dates, to further acquire any other patents or inventions for that or similar purposes and to import and export food products.
However, the German patent was not granted and so the company bought a Swedish patent instead and resorted to making coffee from dates in Germany without a patent. Although a majority of its members wished to continue, on an action brought by two shareholders, the court held that the substratum had failed and as the company was unable to secure its main object, it was liable to be wound up.
Independent object clauses
In order to counteract the main object rule of construction, the company promoters employed the practice of adding an express declaration providing that all objects are independent and are not subordinate to or restricted by the other object clauses. Although this practice was criticised, it was still accepted by the courts.
In the case of Cotman v. Brougham, a rubber company contained an objects clause consisting the independent object’s formula, meaning that each of its objects had to be considered separately. One of such objects was a subscription of shares of companies.
The company underwrote the issue of shares by an oil company. The court upheld the validity of underwriting stating that it was an independent clause and hence not ultra vires the objects.
Subjective object clauses
Another device employed to evade the doctrine of ultra vires is to include a provision in the objects clause stating that the company had the power to carry on any business which in the opinion of the board of directors, is ancillary to any of the businesses specified in the objects clause.
In Bell Houses Ltd v City Wall Properties Ltd, although the main object of the plaintiff company was to develop housing estates, the object clause also empowered the company to carry on any other trade or business in connection with the main object of the company if the board of directors think it to be advantageous to the company as a whole.
The company through its chairman thereafter entered into a mortgage brokerage agreement with the defendant. However, the defendant declined to pay the amount charged and contended that the contract was beyond the powers of the plaintiff company.
The court refused to accept this contention and held that the clause was valid as it sought to empower the company to carry on a business that could be advantageously carried on in line with its principal business.
At this stage of judicial intervention, the ultra vires rule lost its practical importance but it still remained a fundamental principle of company law. Nevertheless, the ultra vires doctrine stood in the way of commercial enterprises especially at the turn of the 20th century where corporations were feeding off debt finance and were seeking to broaden their objects clause to pursue emerging business opportunities.
This was coupled with the rule of “constructive notice” under which a third party was deemed to have constructive knowledge of a company’s objects clause. This rule caused apprehension on part of the creditors to willingly enter into contractual obligations with the companies due to the risk of default caused by the transaction being ultra vires.
The judiciary however brought clarity over the distinction between companies objects and directors’ powers. In Rolled Steel v British Steel Corporation, the plaintiff company although guaranteed borrowings using the powers contained in its memorandum, the same was for certain improper purposes.
The court held that merely because directors of the plaintiff were performing improper acts in the name of the company for purposes other than those set out in the memorandum, it cannot be said that the acts were ultra vires the company itself.
Although the judiciary brought much-needed clarity to the application and scope of the rule of ultra vires, its application gradually diminished which ultimately resulted in statutory reforms. The Companies Act, 1989 played a significant role in the erosion of the doctrine of ultra vires by facilitating contractual freedom, revoking ultra vires rule vis-a-vis third party transactions and abolishing the rule of constructive notice. Presently, the Companies Act, 2006 invalidated the rule of ultra vires by removing the objects clause from a company’s MOA.
Adoption of the doctrine of ultra vires in India
Personal liability of directors
The judicial trend regarding the rule of ultra vires is quite similar to that of the UK Authorities. The doctrine of ultra vires was first applied by the Bombay High Court in the judgment of Jahangir R. Modi V Shamji Ladha in 1866. In this case, the plaintiff was a registered shareholder of 601 shares in the Financial Association of Europe and India Limited.
The defendants were the original directors of the association. The objects contained in the MOA of the association did not include dealing in shares nor purchase of the company’s own shares. Despite this, the defendants as directors made dealings in shares and suffered losses on behalf of the company.
They also purchased 1,422 shares of the company itself. The plaintiff on behalf of himself and other shareholders of the company brought an action against the defendants seeking compensation for losses suffered on account of such purchase.
The court applying the rule of ultra vires held that the purchase by the directors of the company of its own shares well as shares of other companies being outside the scope of the company’s memorandum is ultra vires.
It also held that members of the company are empowered to bring a suit against the directors thereby making them personally liable and compel them to restore the funds of the company that have been employed for unauthorised purposes.
Promotion of charitable objects in line with the company’s objects
The landmark case in the context of the rule of ultra vires was A. Lakshmanaswami Mudaliar v. L.I.C. In this case, the directors of a company were permitted “to make payments towards any charitable or any benevolent object or for any general public or useful object”. As per the shareholders’ resolution, the directors paid Rs 2 lakhs to a trust which was set up with the object to promote technical and business knowledge.
However, LIC having taken over the company’s business contended that the charitable donation was beyond the scope of the object clause of the MOA.
The Supreme Court ruled that the payment made by directors was ultra vires the company. The directors were not capable to spend the company’s money on charitable or general objects. They could spend for the promotion of only such charitable purposes as would enable the company to attain its own objects. The court held that charity is allowed only to the extent it is integral to effectively manage the company’s internal affairs.
Applying the rule in Asbury’s case, the court also held that any ultra vires act of the company will be considered to be void and cannot be ratified even by all the shareholders of the company.
As far as donating towards charitable objects is concerned, Section 181 of the Act gives the Board of Directors of a company discretion to contribute to bona fide charitable and other funds. However, the proviso to the section requires the directors to obtain prior consent of the company to contribute a sum exceeding 5% of the average net profits for the 3 immediately preceding financial years.
Therefore, the power of the Board as regards the contribution of funds directly relating to the business of the company is unrestricted. However, it is important to note that merely obtaining permission from the shareholders in the general meeting would be of no effect if the MOA did not authorise such expenditure. If it does not authorise, it would be deemed to be ultra vires the company.
Ultra vires borrowing does not create the relationship of creditor and debtor
In Re Madras Native Permanent Fund Ltd, the objects of the company as stated in the memorandum was to make advances to shareholders upon security of movable and immovable properties to enable them to purchase, build and repair houses. The company started a new branch called the deposit branch and carried on banking business at a large scale. It was wound up. It was held that in as much as the taking in the deposit branch from the strangers was ultra vires the company, the so-called contracts of loan were void.
The court observed that ultra vires transactions create no debt whether legal or equitable and unequivocally declared that ultra vires transactions do not create the relationship of debtor and creditor.
Considering the above, it raises an important question as to what remedies a lender can avail of. In circumstances where a lender has parted with his money to the company under an ultra vires borrowing, and is, thus, unable to sue for its return or enforce any security granted to him, he nevertheless has, in equity, the following remedies:
Injunction and recovery
The lender can obtain an injunction under the equitable doctrine of restitution as long as he can trace and identify the money lent and any property that the company has bought with it. In cases where the money cannot be traced, the lender can still claim repayment if he can prove that the company has been benefitted thereby.
Subrogation
In case the company has used the money of ultra vires borrowing for paying off lawful debts, the lender assumes the exact position as the creditor that had been paid off and to that extent would have the right to recover the money lent to the company. On subrogation, the lender is protected by the court from loss, while the debt burden of the company remains the same.
Suit against directors
In cases where the directors purposefully misrepresented their authority, the lender may sue the directors on the ground of breach of warranty of authority.
Ultra vires the directors but intra vires the company
In the case of T.R. Pratt (Bombay) Ltd v E.D. Sassoon & Co, the directors of the company were authorised by the articles to borrow money up to a certain limit. However, they entered into a transaction to borrow money exceeding the authority given to them. The court held that moneys borrowed ultra vires could never be the property of the company but remained the property of the money-lenders, and as such the moneys could be recovered by the lender in an action for money had and received.
The court expressly stated that where the act of borrowing is beyond the authority of the directors but not ultra vires the company, the company is liable to pay. If any act is ostensibly authorised by the MOA and AOA, the third parties dealing with the company are not obliged to see whether the company has put itself in a position to exercise its power properly.
Further, in the case of Rajendra Nath Dutta v Shibendra Nath Mukherjee And Ors, a lease deed was executed by the managing directors of a company without the common seal. The articles of the company provided that the seal must be embossed to bind the company. A plaintiff filed a suit to avoid the lease deed without making the company a party.
It was admitted that the deed was executed by one of the directors and the company had accepted rent thereunder for the whole period. It was held that the suit was not maintainable as framed and that there was no fraud.
The court observed that sometimes acts done are beyond or against the powers of the directors but within the powers of the company and hence they can be ratified. If these are ratified, they are deemed to have been done within the powers of the articles or directors.
Role of constructive notice with respect to third party rights
Every person who contemplates entering into a contract with a company is presumed to have knowledge of the powers of the company, the extent to which such powers are delegated to its directors and any limitations or restrictions placed on such powers. Strictly speaking, they are deemed to have constructive notice of the MOA and AOA of the company.
In the case of Kotla Venkataswamy v. Rammurthy, the AOA of a company expressly provided that all documents should be signed by the managing director, secretary and the working director on behalf of the company. A mortgage deed was executed only by the secretary and the working director.
The court held that no claim would lie under such a deed. As per the court, the mortgagee should have referred to the AOA prior to the execution of the deed. Therefore, even though the mortgagee may have acted in good faith and the money borrowed was applied by the company for genuine business purposes, the mortgage was invalid.
Further, in Sivashanmugham (S) v. Butterfly Marketing Pvt. Ltd, the defendants contended that a partnership deed containing an arbitration clause was void as the plaintiff company entered into a partnership deed to manufacture and export garments, thereby exceeding its scope as per its MOA. The court on observing the MOA held that, the objects clause was of a wide import and empowered the company to enter into partnerships for any purpose which benefitted its business.
The court rightly stated that third parties should not take advantage of the doctrine of ultra vires to avoid the performance of obligations undertaken by them despite having the opportunity to analyse the full extent of the company’s powers.
Consequences and exceptions to the doctrine
Taking into consideration the aforesaid judicial pronouncements, the following consequences and exceptions ensue.
Consequences
- Void ab initio: Any act that is ultra vires the company is null and void ab into and the company is not bound by them.
- Injunction: In cases where an ultra vires transaction has been or is about to be undertaken, the members of the company can seek an injunction to restrain the company.
- Directors’ personal liability: If the corporate capital of a company is used for purposes other than for the legitimate business of the company, the directors will be personally liable to replace it.
- Acquisition of property: Any money used by a company to acquire a property by entering into ultra vires transactions, will not affect the right of the company over the said property and it will be held securely.
- Ultra vires borrowing: Borrowing beyond the limits of a company does not establish a debtor-creditor relationship.
Exceptions
- Any act within the powers of the MOA but ultra vires the AOA can be validated by amending the AOA.
- Any act within the powers of the company but beyond the authority of the directors can be validated by ratification by shareholders of the company.
- Any transaction which is intra vires the company but is committed irregularly can be validated by shareholders’ consent.
- Any acts though not explicitly mentioned in the MOA but are considered to be impliedly within the company’s powers.
Relevance of the doctrine in India at present
The rule of ultra vires continues to play a major role in India to date. The Act under Section 245(1)(a) identifies the doctrine. It allows members or depositors of the company to make an application to the National Company Law Tribunal (NCLT) if they are of the opinion that the affairs of the company are being conducted in a manner prejudicial to its members or depositors and seek an order restraining the company from committing an act ultra vires the articles or memorandum of the company.
Therefore, as detailed above, although the doctrine lost relevance in the UK, specifically by provisions of the Companies Act, 2006, India continues to acknowledge the importance of the doctrine. As a result, any act found ultra vires the company can never be ratified nor can it be enforced against a third party.
Conclusion
One of the objectives underlying the company law legislation is to give due recognition to the legitimate interests of its shareholders and creditors and ensure that they are not jeopardised in any manner.
To achieve this objective, the rule of ultra vires enables to protect of the dual interests of investors and creditors of a company by restraining the company to carry out any unwarranted transactions. At the same time, third parties dealing with a company are also prevented from taking undue advantage of the doctrine as they are bound to have knowledge of the full extent of the company’s powers.
Moreover, not all ultra vires transactions are considered to be void with no legal effect, there are certain exceptions wherein transactions obtain validity through ratification. Therefore, the judiciary has been vastly instrumental in bringing the doctrine of ultra vires into company law and elucidating its effects on companies as well as third parties dealing with it.
References
- https://www.lexisnexis.co.uk/legal/glossary/ultra-vires
- https://shodhganga.inflibnet.ac.in/bitstream/10603/9793/17/17_summary.pdf
- ULTRA-VIRES-DOCTRINE-IN-COMPANY-LAW-TRULY-BEATEN-BUT-NOT-DEAD.pdf (researchgate.net)
- The Gradual Erosion of the Ultra Vires Doctrine in English Company Law by Chrispas Nyombi:: SSRN
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