“Dive into the intricate world of corporate law beyond the Memorandum of Association (MoA). Uncover the doctrine of ultra vires, its origins, and present-day applicability. Explore its evolution in England and India, exceptions, and implications in safeguarding stakeholder rights. For comprehensive insights, read the full article. Disclaimer: This content is for informational purposes only and not legal advice.”
In the complicated domain of corporate law, where the Memorandum of Association (MoA) lays down the framework for establishing the company, a legal principle defines the boundaries of its powers—the doctrine of ultra vires. This doctrine serves as the watchdog, ensuring companies stay within the limits set by their MoA and operate in adherence to the law. This article will delve into the concept of the ‘doctrine of ultra vires’ and its evolution and applicability.
What is the Doctrine of Ultra Vires?
The term ultra vires is a Latin phrase that means “beyond the power”. When a company acts beyond the scope of the memorandum, such action is considered ultra vires. The expression ‘ultra vires’ refers to any act or transaction which, though it may not be illegal, travels beyond the scope of the powers because it does not figure in the objects clause of the company’s memorandum.[1]
This doctrine prohibits a company from using the investors’ funds for purposes other than those mentioned in the object clause of its memorandum. Thus, by this principle, both the company and the investor are assured that their investment will not be employed for the object or activities they did not consider when investing their capital in the company.
“Any action which is beyond the memorandum is ultra vires and void and incapable of being ratified as held in Dr Lakshmanaswami Mudaliar v LIC, (1963)
Origin Of Doctrine of Ultra Vires.
The House of Lords first applied the Doctrine of ultra-vires in the case of Ashbury Railway Carriage and Iron Co. Ltd. v. Riche, (1878) L.R. 7 H.L. 653. In this case, the company was formed to conduct business as “mechanical engineers and general contractors”. The company entered into a contract with M/s.Riche to finance the construction of a railway line in Belgium. Directors later renounced the agreement, citing it as ultra-vires of the company’s memorandum. Riche brought an action against the company for damages for breach of contract. According to Riche, “general contracts” in the company’s object clause meant any contract. Thus, according to Riche, the company had all the powers and authority to enter and perform such contracts.
When the matter went to the House of Lords, it was held that the contract was ultra-vires, and hence it was null and void. Rejecting Riche’s contention that the contract was within the meaning of “General Contract,” the House of Lords held that the term “General Contract” must be taken to indicate the making generally of such contracts as are connected with the business of mechanical engineers. They also stated that even if a majority of shareholders had ratified the agreement, then it had been null and void because” an ultra vires contract, being void ab initio, cannot become intra vires because of estoppel, lapse of time, ratification acquiescence or delay.”
Purpose of Doctrine of Ultra Vires
Protecting the interests of creditors and investors is the fundamental principle of this doctrine. It restricts a corporate entity from utilising its capital for purposes other than those listed in the object clause of the company’s memorandum. The doctrine of ultra vires assures the creditors and investors that their money cannot be used for a purpose other than the agreed object when investing their money in the company. As a result, both the investors and creditors have confidence that their money will not be used for objects or activities that they did not indicate while investing in the company because if the financial assets of the company are wrongfully utilised, then the company may go into insolvency and the creditors of the company cannot be paid in such circumstances; thus it prevents the company from doing unlawful activities which may result into insolvency and protects the rights of creditors and investors.
Mr Justice Marshall said: “The doctrine of ultra vires is a most powerful weapon to keep private corporations within their legitimate spheres and to punish them for the violation of their corporate charters and is probably not invoked too often, but to place that power in the hands of the corporation itself or a private individual, to be used by him as a means of obtaining or retaining something of value which belongs to another, would turn an instrument, intended to effect justice between the state and corporation Into one of fraud as between the latter and innocent parties. Such is the modern doctrine. . . . If such a body transcends its powers, it commits a wrong against the state, and ordinarily, It Is for the state, only, to call it to account for such violation”[2]
Scope of the Doctrine of ultra vires
The doctrine of ultra vires applies to all those companies that have been incorporated and have a separate existence in the eyes of the law. All those companies that have yet to be registered, such as partnerships and sole proprietorships, will not come under the scope of the doctrine of ultra vires. Only incorporated companies with an independent existence in the eyes of the law will be considered under this doctrine[3]. Every illegal transaction or abuse of power by a director/ employee will not fall under the ambit of the doctrine of ultra vires[4]. Only those transactions beyond the scope of what a company can do will be censured under the doctrine. What a company can do or the purpose of the company is always mentioned in the object clause of the Memorandum of Associations of the Company. Thus, if the company is exceeding the authority it has given itself in the object clause of the Memorandum of Association, it will be censured under this doctrine.
Evolution of Doctrine in England
In England, the doctrine’s fundamental importance came to light after introducing the Limited Liability Act in 1855, which introduced the concept of limited liability partnerships (LLPs).
Simpson v. Westminster Palace Co.[5]
In this case, the defendant company was established to build a hotel, “the carrying on the usual business of a hotel and tavern therein; and the doing of all such things as are incidental or otherwise conducive to the attainment of the above objects.” The company built a large hotel. Before it began business, the directors, with the consent of a majority of shareholders, agreed to let about one-half of the rooms to the India Board for offices for three years. The agreement was not regarded as a permanent arrangement nor an indication of the hotel’s future policy. One purpose was to obtain further capital.
The House of Lords held that the action was not ultra vires, and it found no difficulty in deciding that the temporary arrangement was a means to accomplish the company’s purpose.
Ashbury Railway Carriage and Iron Co. Ltd. v. Riche, (1878) L.R. 7 H.L. 653
As stated in its memorandum of organisation, the company’s objectives were to supply and sell certain materials needed to build railways. The contract was for the construction of railways, which was beyond the company’s memoranda because it wasn’t mentioned in them. The memorandum considered the agreement ultra-vires, meaning that only the consent of some shareholders could ratify it. It would have been sufficient to render the contract intra-vires if the sanction had been granted by a resolution passed before the contract’s execution. But because the contract was ultra-vires, the memorandum, in this case, a sanction cannot be given with a retroactive impact.
Attorney General V. Great Eastern Railway Co
The House of Lords held that the company had the implied capacity and power to enter into transactions that were incidental to the carrying out of the authorised objects, even if those transactions did not fall strictly within the objects expressly provided for in the company’s memorandum. This was the first time the Courts had decided to reduce the doctrine’s importance.
Bell Houses Ltd. v. City Wall Properties Ltd.
The plaintiff company’s principal business was the acquisition of vacant sites and the erection of housing estates thereon. While transacting the business, the chairman acquired knowledge of sources of finance for property development. The company introduced the financer to the defendant company and claimed the agreed fee of œ20,000.
The Court of Appeals held the above clause to be valid and fully operative to enable the directors to undertake any new business which, in their honest opinion, could be advantageously taken up. The agreement was thus intra vires, and the company could enforce it.[6]
Evolution of Doctrine in India
In India, the original doctrine dates back to 1866 when the Bombay High Court applied it to a Joint Stock company.
Jahangir R. Modi V Shamji Ladha
The Bombay High Court held that a shareholder could maintain an action against the directors without impleading the company to compel them to restore to the company the funds employed in transactions they have no authority to enter into.
Laksmanaswami Mudaliar v. L.I.C., AIR 1963 S.C. 1185
The United India Life Insurance Co. Ltd. was incorporated to carry out the life insurance business. In 1956, the Life Insurance Corporation of India took over the company’s business. In December 1955, shortly before the acquisition, the directors of the company, in terms of the power vested in the objects clause supported by the resolution of shareholders, made payment of two Lac rupees as a donation to a trust formed with the object of promoting technical or business knowledge, including knowledge in insurance. The Apex Court held that the donation of rupees two Lac was ultra vires, and as a result, the directors were held personally liable to refund the amount paid to the trust. The court also observed that: “As office bearers of the company are responsible for passing the resolution ultra vires the company, they will be personally liable to make good the amount belonging to the company which was unlawfully disbursed in pursuance of the resolution.”
Radhabari Tea Company Private Limited vs. Mridul Kumar Bhattacharjee and Other
The doctrine of ultra vires provides that an action, taken by the board of directors of a company or the company itself beyond the powers conferred on the company and its directors by the memorandum of association of the company, is ultra vires.
Present Applicability of Doctrine in England
In the Attorney General v. Great Eastern Railway Co. case, the court introduced the concept of reasonable construction, which made the Doctrine of Ultra views more flexible. The doctrine has an exception in the form of the reasonable construction principle. However, the doctrine is still relevant to companies. Companies can not make ultra vires into intra vires by using the principle of reasonable construction.
The straight-jacketed method of following the object clause of the memorandum has, to a very large extent, done away with S. 31[7] and S.39[8] of the Companies Act, 2006, which has dramatically decreased the importance of the doctrine of ultra vires in the country. S. 31 clearly stated that any objective not explicitly excluded from the object clause of the memorandum will not be deemed ultra vires. Also, the shareholders’ consensus can ratify the object clause to remove or add particular objectives to the object clause. Such an amendment will be held only after registration by the registrar. However, after registration, the amendments to the object clause are non-questionable. This was an essential change from the stance taken by the Court in the Ashbury case, Where the Court had stated that no such amendment made to the object clause of the memorandum would hold true despite shareholder consensus. Similarly, S. 39 also reiterated that the final decision on whether certain activities are within or outside the scope of the business will be determined by Courts based on the merit of the case.
It is reasonable to say that the doctrine of ultra vires has not been eradicated from England completely its application has been made limited.
Present Applicability of Doctrine in India
Even now, the ultra vires rule remains relatively important in India—the doctrine identified under section 245(1)(a) of the Companies Act. Suppose the company’s members believe that its operations are being conducted in a way that is detrimental to them. In that case, they can apply to the National Company Law Tribunal (NCLT). New businesses must be established to raise a company’s GDP in a nation like ours, where the economy is still expanding. For this reason, complying with the Ultravires doctrine is essential. This doctrine protects the lenders by giving them a guarantee of money back should the companies act outside the scope of their object clause. Thus, it is evident that the ultra vires doctrine will be significant. For shareholders and investors, it acts as an assurance of security.
The doctrine of ultra-vires in Companies Act, 2013
Section 4(1)(c)[9] of the Companies Act 2013 states that all the objects for which incorporation of the company is proposed, and any other matter considered necessary in its furtherance should be stated in the company’s memorandum.
Whereas Section 245(1)(b)[10] of the Act provides to the members and depositors a right to apply to the tribunal if they have reason to believe that the conduct of the affairs of the company or its members or depositors restrain the company from committing anything which can be considered as a breach of the provisions of the company’s memorandum or articles.
Exceptions to the doctrine of ultra vires
1. Any act done irregularly but otherwise is intra-vires the company can be validated by the shareholders of the company by giving their consent.
2. This indoor management doctrine protects third parties dealing with a company in good faith. They are not expected to have knowledge of the company’s internal affairs and can rely on the apparent authority of the company’s officers. Therefore, even if an act is ultra vires, it may be binding on the company if it was entered into by an authorised person and the third party was unaware of the lack of authority.
3. Suppose any action is deemed to be within the company’s authority by the Company’s Act. In that case, they will not be considered ultra-vires even if they are not expressly stated in the memorandum.
4. If the company acquires property in a manner that is ultra-vires of the contract, the right of the company over such property will still be secured.
5. Any incidental or consequential effect of the ultra-vires act will not be invalid unless the Companies Act expressly prohibits it.
Conclusion
The Doctrine of Ultra Vires remains a pivotal concept in corporate law, serving as a crucial safeguard to ensure that companies operate within the bounds defined by their Memorandum of Association (MoA). Originating in England with cases like Ashbury Railway Carriage and Iron Co. Ltd. v. Riche, this doctrine has evolved over time to adapt to changing business landscapes and legal frameworks.The primary purpose of the doctrine is to protect the interests of creditors and investors by preventing companies from utilizing funds for purposes not outlined in their MoA. By adhering to the object clause, both investors and creditors can trust that their capital will not be diverted towards activities they did not anticipate during their investment.The evolution of the doctrine in England, notably with cases like Simpson v. Westminster Palace Co. and Attorney General v. Great Eastern Railway Co., reflects a move towards a more flexible interpretation, introducing the concept of reasonable construction. However, its applicability in England has been somewhat limited by statutory provisions such as Section 31 and Section 39 of the Companies Act 2006.
In India, the doctrine’s roots trace back to the Bombay High Court’s application in 1866, and its relevance persists today, especially under Section 245(1)(a) of the Companies Act, 2013. Shareholders can approach the National Company Law Tribunal if they believe that the company’s actions deviate from its stated objectives, emphasizing the doctrine’s ongoing importance in the Indian legal landscape. Despite certain exceptions and amendments in both England and India, the Doctrine of Ultra Vires continues to play a crucial role in upholding corporate integrity and protecting the rights of stakeholders. It acts as a deterrent against corporate overreach and reassures investors and creditors that their investments are channelled toward agreed-upon objectives. As we navigate the complexities of corporate law, the Doctrine of Ultra Vires remains a steadfast guardian, ensuring that companies operate within the parameters set forth in their foundational documents.
[1] https://lexisnexis.duelibrary.in/document/?pdmfid=1523890&crid=a3fca601-d638-447d-a0a9-12fb17bcbdfa&pddocfullpath=%2Fshared%2Fdocument%2Fanalytical-materials-in%2Furn%3AcontentItem%3A6297-0TR1-F4NT-X3JN-00000-00&pdtocnodeidentifier=AABAABAADAAD&ecomp=pwgtk&prid=0681960f-76a0-4cf9-828e-f3a8af376718
[2] Zinc Carbonate Co. v. First Nat. Bk., 103 Wis. 125, 79 N. W. 229.
[3] Chandok S, “CRITICAL ANALYSIS OF THE DOCTRINE OF ULTRA VIRES”
[4] Rolled Steel Product (Holdings) Ltd v. British Steel Corp (1986) 1 Ch 306
[5] https://www.jstor.org/stable/758032?read-now=1&seq=4#page_scan_tab_contents
[6] In Defence of Ultra Vires by Avtar Singh *
[7] https://www.legislation.gov.uk/ukpga/2006/46/contents
[8] https://www.legislation.gov.uk/ukpga/2006/46/contents
[9] https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf
[10] https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf
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