We know that purpose of the doctrine ultra-vires is to protect the interest of the shareholders and creditors of the company. But some people argued it as an illusory protection. Explain and illustrate.
Introduction
The object clause of the Memorandum of the company contains the object for which the company is formed. An act of the company must not be beyond the objects clause, otherwise it will be ultra vires and, therefore, void and cannot be ratified even if all the members wish to ratify it. This is called the doctrine of ultra vires, which has been firmly established in the case of Ashtray Railway Carriage and Iron Company Ltd v. Riche. The expression “ultra vires” consists of two words: ‘ultra’ and ‘vires’. ‘Ultra’ means beyond and ‘Vires’ means powers. Thus the expression ultra vires means an act beyond the powers. Here the expression ultra vires is used to indicate an act of the company which is beyond the powers conferred on the company by the objects clause of its memorandum. An ultra vires act is void and cannot be ratified even if all the directors wish to ratify it. Sometimes the expression ultra vires is used to describe the situation when the directors of a company have exceeded the powers delegated to them. Where a company exceeds its power as conferred on it by the objects clause of its memorandum, it is not bound by it because it lacks legal capacity to incur responsibility for the action, but when the directors of a company have exceeded the powers delegated to them. This use must be avoided for it is apt to cause confusion between two entirely distinct legal principles.1 Consequently, here we restrict the meaning of ultra vires objects clause of the company’s memorandum.
1 Cf. Grower, “The Principle of modern Company Law”, p. 78.
Origin of the Doctrine
The doctrine of ultra vires was first introduced in relation to the statutory companies.2 However, the doctrine was not paid due attention up to 1855. The reason appears to be this that doctrine was not felt necessary to protect the investors and creditors. The companies prior to 1855 were usually in the nature of an enlarged partnership and they were governed by the rules of partnership. Under the law of partnership the fundamental changes in the business of partnership cannot be made without the consent of all of the partners and also the act of one partner cannot be binding on the other partners if the act is found outside his actual or apparent authority, but it can always be ratified by all the partners. These rules of partnership were considered sufficient to protect the investors. On account of the unlimited liability of the members, the creditors also felt themselves protected and did not require any other device for their protection. Besides, during early days the doctrine had no philosophical support. The doctrine is based on the view that a company after incorporation is conferred on legal personality only for the purpose of the particular objects stated in the objects clause of ite memorandum and transaction not authorized expressly or by necessary implication must be taken to have been forbidden, but this view was not followed during early days and contrary to it, the view that a company has all the powers of a natural person unless it has been taken away expressly or by necessary implication was given a big support.3
In 1855 some important developments took place. One of them was the introduction of the principle of limited liability. After the introduction of this principle, it was possible to make the liability of the members limited. Set Off long as the liability of the members was unlimited, the creditors of the company considered themselves protected, but after the development of doctrine of limited liability, they found themselves in a miserable state. This necessitated a device to protect the creditors; this moulded the minds of the
2 Sealy, L.S., “Cases and Materials on Company Law”.
3 Prof. Grower, Supra, p. 80.
pioneers towards the doctrine of ultra vires. In addition to it, the companies were required to have two important documents, the memorandum and articles. The memorandum was to contain the objects of the company. The alteration of the memorandum was made difficult. Thus the importance of memorandum was realized and the management of the company was desired to observe the objects stated in the memorandum. All these created an atmosphere favorable for the development of doctrine of ultra vires.
Is It Ultra Vires Or Illegal?
The ultra vires act or transaction is different from an illegal act or transaction, although both are void. An act of a company which is beyond its objects clause is ultra vires and, therefore, void, even if it is illegal. Similarly an illegal act will be void even if it falls within the objects clause. Unfortunately the doctrine of ultra vires has often been used in connection with illegal and forbidden act. This use should also be prevented.
Basic principles:
1. An ultra vires transaction cannot be ratified by all the shareholders, even if they wish it to be ratified.
2. The doctrine of estoppel usually precluded reliance on the defense of ultra vires where the transaction was fully performed by one party
3. A fortiori, a transaction which was fully performed by both parties could not be attacked.
4. If the contract was fully executory, the defense of ultra vires might be raised byeither party.
5. If the contract was partially performed, and the performance was held to einsufficient to bring the doctrine of estoppel into play, a suit for quasi contract for ecovery of benefits conferred was available.
6. If an agent of the orporation committed a tort within the scope of his or her employment, the corporation could not defend on the ground the act was ultra-vires.
Protection of Creditors and Investors
Doctrine of ultra vires has been developed to protect the investors and creditors of the company. This doctrine prevents a company to employ the money of the investors for a purpose other than those stated in the objects clause of its memorandum. Thus, the investors and the company may be assured by this rule that their investment will not be employed for the objects or activities which they did not have in contemplation at the time of investing their money in the company. It enables the investors to know the objects in which their money is to be employed. This doctrine protects the creditors of the company by ensuring them that the funds of the company to which they must look for payment are not dissipated in unauthorized activities. The wrongful application of the company’s assets may result in the insolvency of the company, a situation when the creditors of the company cannot be paid.
This doctrine prevents the wrongful application of the company’s assets likely to result in the insolvency of the company and thereby protects creditors. Besides the doctrine of ultra vires prevents directors from departing the object for which the company has been formed and, thus, puts a check over the activities of the directions. It enables the directors to know within what lines of business they are authorized to act.
Ascertainment of the Ultra Vires:
To ascertain whether a particular act is ultra vires or not, the main purpose must first be ascertained, then special powers for effecting that purpose must be looked for, if the act is neither within the main purpose nor the special powers expressly given by the statute, the inquiry should be made whether the act is incidental to or consequential upon. An act is not ultra vires if it is found:
(a) Within the main purpose, or
(b) Within the special powers expressly given by the statute to effectuate the main purpose, or
(c) Neither within the main purpose nor the special powers expressly given by the statute but incidental to or consequential upon the main purpose and a thing reasonably done for effectuating the main purpose.
LIABILITY OF DIRECTORS
1. Liability towards the company: it is the duty of the directors to see that the funds of the company are used only for legitimate business of the company. Consequently if the funds of the company are used for a purpose foreign to its memorandum, the directors will be personally liable to restore to the company the funds used for such purpose. In other words, a shareholder can sue the directors to restore to the company the funds, which have been employed by them in the transactions, which they have no authority to enter into.
2. Liability towards the third party: the directors of a company are treated as agents of the company and therefore it is their duty not to go beyond the memorandum or powers of the company. Where the directors represents the third party that the contract entered into by them on behalf of the company is within the powers of the company while in reality the company has not such powers under its memorandum, the directors will personally be liable to the third party for his loss on account of the breach of warranty of authority. However, to make the directors personally liable for the loss to the third party, the following conditions must exist:
(a) There must be representation of authority by the directors. The representation must be of fact, not of law.
(b) By such representation the directors must have induced the third party to make a contract with the company inn respect of a matter beyond the memorandum or powers of the company.
(c) The third party must have acted on such inducement and suffered some loss.
EXCEPTIONS TO THE DOCTRINE OF ULTRA VIRES
A brief analysis of the doctrine of ultra vires with regard to its consequences would
reveal that only those activities of the company shall be valid i.e., intra vires, which are:
(a) Essential for the fulfillment of the objects stated in the main objects clause of the
memorandum;
(b) Incidental or consequential or reasonably within its permissible limits of business; and
(c) Which the company is authorized to do by the Company’s Act, in course of its business.
All other activities of the company excepting the above shall be ultra vires and therefore
invalid.
There are, however, certain exceptions to this doctrine, which are as follows:
1. An act, which is intra vires the company but outside the authority of the directors may be ratified by the shareholders in proper form.20
2. An act which is intra vires the company but done in an irregular manner, may be validated by the consent of the shareholders. The law, however, does not require that the consent of all the shareholders should be obtained at the same place and in the same meeting.
3. If the company has acquired any property through an investment, which is ultra vires, the company’s right over such a property shall still be secured.
4. While applying doctrine of ultra vires, the effects which are incidental or consequential to the act shall not be invalid unless they are expressly prohibited by the Company’s Act. indlaw.com
5. There are certain acts under the company law, which though not expressly stated in the memorandum, are deemed impliedly within the authority of the company and therefore they are not deemed ultra vires. For example, a business company can raise its capital by borrowing.
6. If an act of the company is ultra vires the articles of association, the company can alter its articles in order to validate the act.
CONCLUSION
(a) An ultra vires act is void and cannot be ratified even if all the directors wish to ratify it.
(b) The provisions similar to those inserted in the European Communities Act, 1972 should also be inserted in the Indian Companies Act, 1956 to protect the innocent third party.
(c) The tendency of inserting “independent objects clause” to exclude the main objects rule of construction is dangerous also because it makes the distinction between the object and power obscure.
(d) This doctrine prevents the wrongful application of the company’s assets likely to result in the insolvency of the company and thereby protects creditors.
(e) The doctrine of ultra vires also prevents directors from departing the object for which the company has been formed and, thus, puts a check over the activities of the directions. It enables the directors to know within what lines of business they are authorized to act
(f) In India , there is no specific legislation like European Communities Act and therefore, there is no specific statutory provisions under which an innocent third party making contract with the company may be protected. Thus, in India, if the doctrine of ultra vires is strictly applied, where the contract entered into by a third party with a company is found ultra vires the company, it will be held void and cannot be ratified by the company and neither the company can enforce the contract against the third party nor the third party can enforce it against the company.
Bibliography
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2. Alchian, Armen A. and Harold Demsetz, “Production, Information Costs, and Economic Organization” (1974) 62 American Economic Review 777
3. Anisman, Philip, “The Commission as Protector of Minority Shareholders” in Law Society of Upper Canada, 1989 Special Lectures (Ontario)
4. Arden, Dame Mary, “Company Law Reform” (1997) 2 CfiLR 159
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12. Berle, A.A., Jr, “For Whom Corporate Managers Are Trustees: A Note” (1932) 45 Harv. L. Rev. 1365
13. Bird, Peter, “What is ‘A True and Fair View’?” [1984] J.B.L. 480
14. Black, Bernard and Reinier Kraakman, “A Self-Enforcing Model of Corporate Law” (1996) 109 Harv. L. Rev. 1911
15. Blumberg, Phillip I, “Limited Liability and Corporate Groups” [1986] J. Corp. Law. 573
16. Booth, Richard A., “The Limited Liability Company and the Search for a Bright Line between Corporations and Partnerships” (1997) 32 Wake Forest L. Rev. 79
17. Booth, Richard A., “The Other Side of the Management Compensation Controversy” (1994) 22 Sec. Reg. L.J. 22
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