Doctrine of Ultra Vires

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Doctrine of Ultra Vires

A company being an artificial person, its powers are defined in its memorandum. The Memorandum of Association (MOA) is the constitution of the company. Under section 4[1] of the companies act, 2013 it contains the name, address, objects, and scope of the company and sets out the power for the directors of the company. The Object Clause in the memorandum of the company contains the object for which the company is formed. If the company or the directors and members of the company act beyond their authority enumerated in the object clause then that will amount to ultra vires. The Latin term ‘ultra vires’ means beyond power. An ultra vires act is null and void and cannot be ratified by the directors even if they wish to later on. Under section 4(1)(c)[2] of the companies act states that any matter which is considered to be necessary must be mentioned in the object clause of the memorandum because if at a later stage the directors or the company presumes that such an act/transaction comes under their power and act and commit breach of the contract then section 245 (1)(b) comes into play which prevents the company from doing so.

The Doctrine of Ultra Vires has its genesis in the case of Ashbury Railway Carriage and Iron Co. Ltd. vs Riche wherein the directors of the company entered into a contract with Riche to provide finance to the company for the construction of a railway line. However, the directors later repudiated the contract on the grounds of the ultra vires of the memorandum of association. The House of Lords held that the contract at the time of making it was void ab initio and invalid and it cannot be ratified at a later stage, hence it was ultra vires.

However, the company is authorised to do anything that is incidental to the main purpose or consequential to the attainment of the objects of the company, i.e., there should be reasonable proximate nexus. It can do any transaction that directly or indirectly promotes the company’s own objects – Principle of Reasonable Construction[3]. Hence, this principle is an exception to the doctrine of ultra vires.

The main aim of the doctrine of ultra vires is to protect the investors and the creditors of the company from suffering any kind of loss for which the company is responsible to pay. This doctrine prevents the company from employing the money of the investors and creditors elsewhere which is outside the scope of the object clause of the memorandum of the company. It allows them to know the objects of the company by keeping a check on their money and the transaction of the directors on behalf of the company

The concept of Ultra Vires 

In the company law, the ultra vires mean “to go beyond the object clause of a memorandum of association of a company”. The company, being an artificial person, its objects and powers are specified in the memorandum of association (MoA) of the company. The Memorandum is the most crucial document for a company. It contains the object clause which enables the company in achieving its purpose for which it was formed.

In India, the doctrine of ultra vires holds a very important role in the legal framework in order to restrain the companies from surpassing its power as mentioned in the object clause of the memorandum. The doctrine, in India, was first accepted in the case of Jahangir R. Modi vs Shamji Ladha in 1866. In this case, the court held that the directors of the company had acted beyond their scope as specified in its memorandum. Further, the new companies act, 2013, section 245(1)(a)[4] aims “to restrain the company from committing an act which is ultra vires the articles or memorandum of the company”. And under section 245(1)(b)[5] “to restrain the company from committing the breach of any provision of company’s memorandum or articles”.   

The doctrine of ultra vires is applicable to all companies which are incorporated under companies act and have separate legal existence in the eyes of law. The companies that are not registered such as partnership and sole proprietorship will not have the applicability of the ultra vires, however, the doctrine is applicable to Limited Liability Partnership (LLP) as it is an artificial being, having separate legal existence and it is governed by LLP agreement which prevents them from doing unauthorized act to protect the interests of the partners and creditors and even if such an act is committed by the partners, LLP will not be liable, the partners are personally held liable. Thus, the doctrine is applicable to only those companies that are incorporated and have an independent existence in the law.

Moreover, every illegal act or transaction or abuse of power done by the director or member or the company cannot be said ultra vires. It will apply to only those acts or transaction which were specified in the object clause of memorandum of the company, the breach of which is committed or when the company surpasses its object clause – this will be declared null and void and cannot be ratified later by the company or its members because it lacks the legal capacity to incur liability for its action. The company or the directors on behalf of it cannot amend/alter or by passing a special resolution in its general meeting change any of its object clauses to give effect to the ultra vires act already done. Section 6 under the companies act, 2013 provides for any provision contained in the memorandum and articles overriding this act or any statute enacted by the parliament will be void and invalid.

 Ultra Vires and Illegal

 An Ultra Vires act/transaction is different from that of illegal, however, both are void. If a company and its members exceed its object clause in the memorandum, then the act will be, therefore, void even if it is illegal. And an illegal act even though within the object clause of the memorandum of the company will be void.

Evolution of the doctrine of Ultra Vires – India

In India, the concept of ultra vires was first traced in the case Jahangir R. Modi vs Shamji Ladha[6] wherein the plaintiff had purchased 600 shares of a company. And the directors also the defendants had purchased a certain number of shares in the same company. The object clause of the memorandum of the company, however, did not allow its directors to sell or purchase the shares of the company. The plaintiff sued the directors and asked compensation for the loss incurred due to such purchase from the court. The Bombay High Court held that “a shareholder can maintain an action against the directors to compel them to restore to the company the funds to it that have been employed by them in a transaction that they have no authority to enter into, without making the company a party to the suit”.

The other important case which helped in shaping the concept of ultra vires is A. Lakshmanswamy Mudaliar vs Life Insurance Company[7]. In this case, the memorandum of the company stated that the directors were authorised to donate a part of the company’s profit to a charitable organisation which would help the public or any benevolent object. In accordance with the shareholder’s resolution, the directors donated Rs. 2 lacs to a charitable organisation for promoting the technical and business knowledge. Eventually, the court held it to be ultra vires stating that the directors cannot spend the company’s money on any charitable trust of their choice. They could only spend such amount on the charitable trust that enables them to promote the company’s own business, i.e., the money could be donated to a charitable trust which enables them for the attainment of the company’s own objects. However, the company’s business having been taken over by the life insurance corporation, it had no business left to promote. The court held that the payment made by the directors towards the charitable trust was, therefore, unauthorised and the trustees acquired no right to the amount paid by the directors. Further, the court made the directors of the company personally liable for the payment made by them. The appeal was, therefore, dismissed.

Moreover, the supreme court also laid down guidelines for the same –

1.) “That a company’s funds cannot be diverted to every kind of charity even if there is an unrestricted power to that effect in the company’s memorandum”.

2.) “That objects must be distinguished from powers. And objects must be stated in the memorandum, but not powers. Even if the powers are stated, they can be used only to effectuate the objects of the company”.

3.) “That there must be a proximate connection between the gift and the company’s business interests”.

In S. Shivashanmugam And Others vs Butterfly Marketing Pvt Ltd.[8] the butterfly marketing Pvt Ltd. was a company partner in a partnership firm. This partnership firm was engaged in the business of manufacturing garments. It had a clause that if any dispute arose, they will go to the arbitrator under the arbitration act.

1. Shivashanmagam was also a partner to the partnership firm who filed a suit before the Madras high court contending that the company had exceeded its power by doing the ultra vires transaction, i.e., entering into the partnership firm. However, the court stated that “the ultra vires doctrine is meant to protect the company against itself so as to safeguard its members and creditors. We prima facie are of the view that the third party may not take the advantage of this doctrine in order to avoid the performance of the obligation which is voluntarily undertaken with full opportunity to know the extent the company’s power before entering into the transaction”. The court, further, stated that it is not necessary for them to decide the question pertaining to the provision contained in the companies MoA since they are sufficiently wide enough to enable the company to enter into the partnership with the defendant in the suit.

Establishment of Doctrine of Ultra Vires in England

The Doctrine of ultra vires, however, has its genesis in the English case of Ashbury Railway Carriage and Iron company ltd vs Riche[9]. In this case, the directors of the company, i.e., Ashbury Railway Carriage & Iron Co. Ltd entered into a contract with Mr Riche for providing finance for the construction of railway line in Belgium. However, the object clause of memorandum of the company was “to make and sell, or lend on hire railway carriages and wagons, and all kinds of railway plaint, fittings, machinery and rolling stock to carry on the business of mechanical engineers and general contractors to purchase and sell as merchant timber, coal, metal or other materials; and to buy and sell any materials on commissions or as agents”. The object clause of a memorandum of the company did not include in its scope the construction of the railway line. So, owing to this, the company repudiated the contract. Mr Riche filed a suit against the company and claimed the damages on the ground of the cancellation of the contract. The company later ratified the contract with the majority of the stakeholders of the company. Eventually, the House of Lords unanimously held that the object clause of the memorandum is essentially for the purpose of the objectives to be achieved by the company and what it is supposed to do. And the memorandum is the most important document of the company cannot be overridden by the ratification in the object clause of the memorandum of the company. Moreover, it observed that “An ultra vires, being void ab initio, cannot be made intra vires by reason of estoppel or ratification”. Thus, the contract will be considered void from its inception due to invalid consideration. Hence, Mr Riche was not awarded any compensation due to the lack of a valid contract.

In the next leading case of Attorney- General vs Great Eastern Railway Co.[10] the House of Lords upheld the doctrine of ultra vires to be maintained in the subsequent cases, however, it reduced the effect and importance of the doctrine providing it flexibility in this case. It observed that the doctrine should be understood reasonably and not unreasonably be applied and whatever may be considered as incidental to the main purpose or has a proximate connection with the objects of the company which directly or indirectly promotes the company’s own business must not be held as ultra vires.

Another case of Evans vs Brunner & Mond Co.[11] a company was incorporated which engaged in the business of manufacturing chemicals. The company’s object clause in the memorandum authorized the company to do “all such business and things as may be incidental or conducive to the attainment of the objects of the company”. By a resolution passed, the manufacturers of the company could distribute a certain sum of money out of the surplus to universities in furtherance of scientific research and training. However, the resolution was challenged on the grounds of it being the ultra vires the power of the company and beyond the object clause of the memorandum. The directors of the company proved that for the purpose of the trained people to be employed it was difficult for the company to find such trained men in the field of scientific research and education, therefore, in order to promote such field of education among people, the company had to pass such a resolution.

Eventually, the court upheld the decision in the favour of the company by stating that the resolution passed by the directors of the company cannot be held as ultra vires since the resolution was ancillary/incidental or conducive to the attainment of the main object of the company. It further explained that “Acts which are ancillary, or incidental are those acts which have a proximate connection with the objects stated in the memorandum and which directly or indirectly enables the company to promote its own business”. And ‘gifts’ and ‘ex- gratia’ payments given to workers to induce them to work hard have been upheld by the court.

The court in the cases Evans vs Brunner & Mond Co. and Attorney General vs Great Eastern Railway Co. have reduced the rigidity of the doctrine of ultra vires by making it flexible and introducing the principle of reasonable construction. The principle of reasonable construction is an exception to the doctrine of ultra vires. However, the doctrine is still applicable to the companies. Even if the company uses the principle of reasonable construction, it cannot make an ultra vires act to intra vires as that will amount to ratifying an invalid act. Further, the consequences of invalid acts committed by the directors of the company will make them personally liable as well as that will amount to the breach of warranty of authority also –

  • Personal liability of directors: It is the duty of the directors of the company to see that the company’s capital is used only for the legitimate purpose of the business and is not diverted to any unlawful act because after all the company is just a mode of doing business.
  • Breach of warranty of authority: It is the duty of the agent of the company to act within his/her scope of authority. If any member acts beyond his authority, then he shall be personally liable to the third party for the breach of warranty of authority.   

Lastly, even though the companies are bound by the objects clause of the memorandum of the company but still it has the defence of Reasonable construction.

Analysis of applicability of the Doctrine

USA, England and India – A comparison

Looking at the companies at the USA, the applicability of the doctrine of ultra vires has been reduced to such an extent or in the wider sense, the usage of doctrine is restricted due to the introduction of the Model Business Corporation, 2002. However, its applicability could be found in several states- run a corporation and not for profit organisation. It is also applied to-

1.) Charitable Contribution

2.) To the loans given to the directors of the company

3.) To the pensions, stock option plan and other benefits received by the employees.

4.) In case of Guarantee of indebtedness to another

4.) In case of a contract of entering into the partnership

The main reason for the doctrine of ultra vires to be restricted there in the USA is because of its economy. As it is a hub of multinationals and big corporation the country’s major part of the GDP is formed due to such big corporations and business. And as the doctrine aims at restricting the companies to its object clause of the memorandum – this does not allow the company to do anything beyond those objects even if it will help its own business, eventually. Restricting the business by the object clause of the company is seen as exceeding beyond the necessity in the united states of America. The government there wants people to expand the corporations by trying out new ways as that will eventually help in the growth of the country and its GDP. Hence, the doctrine of ultra vires is against the principle of it’s country’s economy.

In England, the doctrine is restricted by the European Communities Act, 1972. Section 9(1) of this act states that “a party with the company dealing in any transaction which is decided by its directors will be considered and shall be deemed to be in the capacity of the company while the other party need not make inquiries about such things and thus, the transaction may be enforced by the former who is acting in good faith against the company. The company cannot plead the transaction to be ultra vires. However, the company cannot enforce it against the former party because the other party can still plead ultra vires”. But if it is proved that the party is not acting under good faith then the company can take the defence of ultra vires.

The doctrine is, however, not abolished the applicability of the doctrine is restricted in England. This is done so that the innocent third party could be protected for whom this doctrine is created.

On the other hand, in India the doctrine of ultra vires is codified in the Companies Act, 2013 under section 245 (1)(a)(b). The doctrine in India puts emphasizes on its need to control and prevent malpractices of business in the companies undertaken by the directors or other members of the company. Moreover, in a developing country like India if the corporations are allowed to expand their business by surpassing the object clause of the company’s memorandum then new business will find it very difficult to incorporate their company in the market for they will lack in new ideas because the established company would expand their business according to the ideas that promote their own business by exceeding their delegated power as per the object clause and eventually the new companies would not like to start a business that has already been undertaken by somebody else. So, in order to give equal opportunity and be fair and just to all players in the market the doctrine has to play an important role in India. Further, the doctrine, at the same time, by putting restrictions on the unscrupulous actions of the company helps in the country’s economic growth. Lastly, it also protects investors and creditors.

Conclusion

It is evident from the above research paper that the doctrine of ultra vires plays an important in the companies and the findings are as follows: –

1.) The doctrine of ultra vires is null and void and cannot be ratified by the directors or the company itself.

2.) An Ultra vires act cannot be made intra vires by way of ratification and estoppel.

3.) That the companies act, 2013 provides for the provision of the breach of object clause and to restrain the company to commit ultra vires to act under section 245 (1)(a)(b). This is a safeguard to protect the investors and creditors.

4.) The doctrine is applicable to all the companies that have a separate legal existence and are incorporated under the companies act.

5.) There is a difference between ultra vires and illegal, however, both are considered void, eventually.

6) The effect of the doctrine of ultra vires is that of – Injunction, Personal liability of directors, subrogation and breach of warranty of authority.

7.) It has its genesis in the England case Ashbury Railway Carriage & Iron Co. Ltd vs Riche and in India, it was established in the case of Jahangir R. Modi vs Shamji Ladha.

8.) The doctrine, while comparing its applicability in different countries such as the USA and England – its usage is restricted whereas in India the doctrine is given more importance.

Frequently Asked Questions

1. What are the exceptions to this doctrine?

Exceptions to the Doctrine are:

  • Any act which is done irregularly, but otherwise it is intra-vires the company, can be validated by the shareholders of the company by giving their consent.
  • Any act which is outside the authority of the directors of the company but otherwise it is intra-vires the company can be ratified by the shareholder of the company.
  • If the company acquires property in a manner which is ultra-vires of the contract, the right of the company over such property will still be secured.
  • Any incidental or consequential effect of the ultra-vires act will not be invalid unless the Companies Act expressly prohibits it.
  • If any act is deemed to be within the authority of the company by the Company’s Act, then they will not be considered as ultra-vires even if they are not expressly stated in the memorandum.
  • Articles of association can be altered with retrospective effect to validate an act which is ultra-vires of articles.

2. What are the types of ultra vires act?

Ultra-vires acts can be generally of four types:

a. Acts which are ultra-vires to the Companies Act.

b. Acts which are ultra-vires to the Memorandum of the company.

c. Acts which are ultra-vires to the Articles of the company but intra-vires the company.

d. Acts which are ultra-vires to the directors of the company but intra-vires the company

3. What are the consequences of an ultra vires act?

a) Void ab initio: The ultra vires acts are null and void ab initio. These acts are not binding on the company. Neither the company can sue, nor it can be sued for such acts

b) Estoppel or ratification cannot convert an ultra-vires act into an intra-vires act.

c) Injunction: when there is a possibility that the company has taken or is about to undertake an ultra-vires act, the members can restrain it from doing so by getting an injunction from the court.

d) Personal liability of Directors: The directors have a duty to ensure that all corporate capital of the company is used for a legitimate purpose only. If such funds are diverted for a purpose which is not authorized by the memorandum of the company, it will attract a personal liability for the directors.

4 What are the key principles of this doctrine?

1. Shareholders cannot ratify an ultra-vires transaction or act even if they wish to do so.

2. Where one party has entirely performed his part of the contract, reliance on the defence of the ultra-vires was usually precluded in the doctrine of estoppel.

3. Where both the parties have entirely performed the contract, then it cannot be attacked on the basis of this doctrine.

4. Any of the parties can raise the defence of ultra-vires.

5. If a contract has been partially performed but the performance was insufficient to bring the doctrine of estoppel into the action, a suit can be brought for the recovery of the benefits conferred.

6. If an agent of the corporation commits any default or tort within the scope of his employment, the company cannot defend it from its consequences by saying that the act was ultra-vires.

 Edited by – Sakshi Agarwal

Approved & Published – Sakshi Raje

Reference

[1] Companies Act, 2013 – Section 4

[2]  Ibid.

[3] Evans vs Brunner & Mond Co. Ltd

[4] Companies Act,2013

[5] Ibid

[6] (1866-67) 4 Bom HCR 185

[7] AIR (1963) SC 1185  

[8] (2001) 5 Comp LJ Mad 763

[9] (1857) LR 7 HL 653

[10] (1880) LR 5 AC 473

[11] (1921) 1 Ch 359: 90 LJ Ch 294