CS Devender Jaglan
THE DOCTRINE OF ULTRA-VIRES IS LIKELY TO LOSE ITS SANCTITY AFTER COMING INTO FORCE OF COMPANIES AMENDMENT BILL, 2016?
DOCTRINE OF ULTRA-VIRES
The word ‘ultra’ means beyond and the word ‘vires’ means powers.
In the case of a company whatever is not stated in the memorandum as the objects or powers is prohibited by the doctrine of ultra vires. As a result, an act which is ultra vires is void, and does not bind the company. Neither the company nor the contracting party can sue on it. The general rule is that an act which is ultra vires the company is incapable of ratification.
An act which is intra vires the company but outside the authority of the directors may be ratified by the company in proper form. [Rajendra Nath Dutta v. Shilendra Nath Mukherjee, (1982) 52 Com Cases 293 (Cal.)]
DECIDING FACTORS TO DOCTRINE OF ULTRA-VIRES
Whether a transaction is ultra vires the company can be decided on the basis of the following:
(a) Transaction within the objects of the Company:- if a transaction entered into by a company falls within the objects, it is not ultra vires and hence not void;
(b) Transaction outside the objects of the Company:- if a transaction is outside the capacity (objects) of the company, it is ultra vires;
(c) Transaction in excess or abuse of Company’s powers:- if a transaction is in excess or abuse of the company’s powers, such transaction will be set aside by the shareholders;
EFFECTS OF ULTRA VIRES TRANSACTIONS
The following are the effects of ultra vires transactions:
(i) Void ab initio – The ultra vires acts are null and void ab initio. The company is not bound by these acts. Even the company cannot sue or be sued upon [Ashbury Railway Carriage and Iron Company v. Riche ]. Ultra vires contracts are void ab initio and hence cannot become intra vires by reason of estoppel or ratification.
(ii) Injunction: The members can get an injunction to restrain a company wherein ultra vires act has been or is about to be undertaken [Attorney General v. Gr. Eastern Rly. Co., (1880) 5 A.C. 473].
(iii) Personal liability of Directors: It is one of the duties of directors to ensure that the corporate capital is used only for the legitimate business of the company and hence if such capital is diverted to purposes alien to the company’s memorandum, the directors will be personally liable to replace it. However, a distinction must be drawn between transactions which are ultra vires the company and the transactions which are ultra vires the directors. Where the directors exceed their authority the same may be ratified by the general body of the shareholders. Provided the company has the capacity to do that transaction as per its memorandum of association.
(iv) Where a company’s money has been used ultra vires to acquire some property, the company’s right over such property is held secure and the company will be the right party to protect the property. This is because, though the property has been acquired for some ultra vires object, it represents the money of the company.
(v) Ultra vires borrowing does not create the relationship of creditor and debtor [In Re. Madras Native Permanent Fund Ltd., (1931) 1 Com Cases 256 (Mad.)].
ENUNCIATION OF DOCTRINE OF ULTRA-VIRES
The doctrine of ultra vires was first enunciated by the House of Lords in a classic case, Ashbury Railway Carriage and Iron Co. Ltd. v. Riche, (1878) L.R. 7 H.L. 653.
The memorandum of the company in the said case defined its objects thus: “The objects for which the company is established are to make and sell, or lend or hire, railway plants………… to carry on the business of mechanical engineers and general contractors………..”.
The company entered into a contract with M/s. Riche, a firm of railway contractors to finance the construction of a railway line in Belgium. On subsequent repudiation of this contract by the company on the ground of its being ultra vires, Riche brought a case for damages on the ground of breach of contract, as according to him the words “general contractors” in the objects clause gave power to the company to enter into such a contract and, therefore, it was within the powers of the company. More so because the contract was ratified by a majority of shareholders.
The House of Lords held that the contract was ultra vires the company and, therefore, null and void. The term “general contractor” was interpreted to indicate as the making generally of such contracts as are connected with the business of mechanical engineers. The Court held that if every shareholder of the company had been in the room and had said, “That is a contract which we desire to make, which we authorise the directors to make”, still it would be ultra vires. The shareholders cannot ratify such a contract, as the contract was ultra vires the objects clause, which by Act of Parliament, they were prohibited from doing.
However, later on, the House of Lords held in other cases that the doctrine of ultra vires should be applied reasonably and unless it is expressly prohibited, a company may do an act which is necessary for or incidental to the attainment of its objects.
PROVISIONS UNDER COMPANIES ACT, 2013
Existing provision: Section 4(1)(c) of the Companies Act, 2013 provides that “the objects for which the company is proposed to be incorporated and any matter considered necessary in furtherance thereof” be stated in the memorandum.
New provision proposed to be inserted vide Companies Amendment Bill, 2016: Sec 4(1)(c) provides that the memorandum of a company shall state that the company may engage in any lawful act or activity or business, or any act or activity or business to pursue any specific object or objects, as per the law for the time being in force:
Provided that in case a company proposes to pursue any specific object or objects or restrict its objects, the Memorandum shall state the said object or objects for which the company is incorporated and any matter considered necessary in furtherance thereof and in such case the company shall not pursue any act or activity or business, other than specific objects stated in the Memorandum.
Analysis of proposed changes
The Companies Amendment Bill, 2016 proposes to provide a freeway to business by enabling them to adopt a model memorandum instead of universal memorandum or we can say by not defining the exact main object in MOA for which it is to be formed. Companies to be formed after commencement of new Act, will enjoy this benefit by having a single line object clause stating that they will engage in any lawful act or activity or business.
As the company can do any lawful act or activity or business as per the law for the time being in force once the proposed changes came into effect, it would be a difficult task in the times to come to determine whether a particular act would be ultra vires to the company because there would not be a concept of universal model of memorandum wherein the main objects for which the company is to be incorporated and any matter considered necessary in furtherance thereof has been defined. However an option has also been provided to companies to specify the exact business activity in place of general clause.
So far not specifying the “any other matter considered necessary in furtherance thereof” in the memorandum is concerned, they would be allowed by the principle of reasonable construction of the memorandum provided the main objects for which the company is to be incorporated had been defined in the memorandum. But once the Companies Amendment Bill, 2016 become law there would be a model memorandum wherein single line object could be specified for the company. Therefore, the doctrine of ultra-vires to lose its sanctity as the company can do any lawful act or activity or business as per the law for the time being in force and also that act or activity would not be treated as outside the scope of the company. There could be other kind of confusions/problems such as in determining the exact category, business segment, NIC code for a particular year, etc. of the company. Hopefully some harmonized solution is expected from the government alongside the notification of new law.