A Company Should be Given Full Contractual Capacity

The term ‘company has no strictly technical meaning in law’ according to Keane, but he refers to it ‘to mean a number of people combined for some common object.’ [1]

‘A company is an association of at least two or more persons (except for “one-person” companies) who themselves possess a legal personality of their own, so that there is nothing inconsistent with attributing to companies many of the legal characteristics of those who constitute them’ in the words of Forde, Michael. [2]

However, Forde, M and Kennedy, H define a ‘company’ as ‘an association of persons constituted for some purpose, generally to carry on a business. It can be an informal arrangement between persons, or it can take the form of a joint venture or partnership’. [3]

The majority of companies today are registered under the Companies Act 1963-2006 [4] and it is permissible for a company to compromise of a single member since 1994 [5] in ‘the case of a private company’. [6]

In Ireland today, there are many types of companies which can be formed which include;

Sole Trader: this is a business that is set up by an individual of which they are the sole owner. There are very few legal requirements, however it is required that;

books of accounts are kept and returns are made for tax purposes; and

registration for Value Added Tax (VAT) for turnover that peaks above a certain limit is required.

Partnership: this is an agreement between two or more people (maximum of twenty partners) to go into business together with a view to making a profit. The advantage of the partnership is that extra capital is available to finance the business, and profits and losses are shared between the partners. All risks and responsibilities are shared. A partnership deed/agreement is usually drawn up which gives details in relation to profits, capital inputs, duties, etc.

Limited Company: this is a legal entity that is separate from its owners. The shareholders have limited liability and are not held personally liable for the debts of the company, the maximum that the shareholders can lose amounts to the value of their investment.

The distinction between a Private Limited Company (Ltd) and a Public Limited Company (Plc) is that a private limited company must have a minimum of one shareholder and can have a maximum of fifty shareholders. A private limited company has to ‘go public’ or ‘float’, both of which are terms used in reference to trading on the Irish Stock Exchange, if it requires extra capital that can be sourced from the public. A public limited company is quoted on the stock exchange, allowing members of the public to purchase shares and become shareholders in that company. The advantage of trading as a public limited company is that one can raise money and there is also limited liability whilst also having an enhanced credit rating.

‘Contractual capacity’ refers to a company’s legal ability to engage in an agreement with another party and be held liable to the terms of the contract. It is known that a company has a separate legal personality and is therefore capable of entering contracts with other parties for consideration.

The term ‘separate legal personality’ refers to the company as being of a different legal existence to that of its shareholders. It allows the company to sue and be sued in its own name and the company possesses the property, it is not seen as that of its shareholders i.e. the shareholders of the company do not own the assets nor are they held liable for the company’s liabilities. A distinctive characteristic of corporate status is that the legal rights and obligations of a registered company are entirely separate from the duties and entitlements of its owner’s.

The general rule relating to the capacity of a company is that ‘a company registered under the Acts is an artificial legal entity separate and distinct from the members of which it is composed.’ [7]

This principal was first applied in the case of Salomon & Salomon Company Ltd. [8]

In this case, Mr Salomon, a boot manufacturer, having operated for years, decided to transfer, in its entirety, his business to a newly registered company, which was owned and controlled by himself and his family. The business was therefore transferred to the company, who paid the sum of £39,000 for the acquisition. Part of the purchase price was to be satisfied through the issue by the company of 20,000 £1 shares to Mr. Salomon and his nominees. The remaining sum constituted a debt owed to Mr. Salomon by the company, which was secured by the issue of a debenture to Mr. Salomon over the assets of the company. When the company went into liquidation, the debenture issued to Mr. Salomon took priority over the claims of the company’s unsecured creditors i.e. he would get paid first out of the remaining proceeds of the company as he was the priority creditor. The liquidator tried to claim that the company was merely the agent of Mr. Salomon and that Salomon was carrying on the business as before, through its agency and that accordingly he was personally liable for all the debts of the company. The House of Lords, however, held that the creditors must respect the principles of incorporation and that the company could not be treated as an agent of the controller. The company was separate and distinct from those within it and legally had to be treated separately. It was immaterial that one individual controlled the company and that the other members were mere nominees, or, indeed, that the intention of setting up the company was solely to avail of the limited liability protection. In law, companies are not the agents or the trustees of their members, who are therefore not liable for the company’s debts.

Section 38 of the Companies Act 1963 [9] provides that a company can enter a contract by three means; written, oral, or contracts under seal. In order for a company seal to be valid, the signatures of the company director and the countersignature of another director or secretary are required. However, such requirements may be altered depending on the company itself. The company is restricted in terms of its ability to contract as it a prerequisite for it to comply with the limitations stated in its objects clause.

The ‘objects clause’ of a company is the term used to express the company’s intentions and the purpose of its existence. A company can have any legal activity listed in its objects clause. Shareholders and creditors of the company are protected by the objects clause being limited to an extent so as to ensure the above are aware of the type of business in which the company is involved. This requirement for a company’s memorandum of association to incorporate an objects clause identifying the type of business it may undertake [10] is at the kernel of the common law ultra vires doctrine. [11]

The objects clause is available for members of the public to view, and it can be found within the company’s Memorandum of Association.

The memorandum of association is defined by Keane, R. As ‘the fundamental document of the company’s constitution and contains the conditions upon which the company is granted incorporation. The name and objects of the company must be stated and, if it is to be a company with limited liability, that fact must also be stated.’ [12]

According to Keane, R. the contents of the objects clause ‘are entirely a matter for the promoters: provided they are not unlawful (e.g. the running of illegal lotteries), they may adopt whatever objects they wish.’ [13] The classic judicial statement of the doctrine is that of Lord Cairns L.C. in Ashbury Railway Carriage and Iron Company v Riche [14] where he stated that “no object shall be pursued by the company, or attempted to be attained by the company in practice, except an object which is mentioned in the memorandum of association”. Such transactions are void and of no effect and cannot be ratified by retrospectively changing the company’s objects. [15]

Prior to the enactment of the Companies Act 1963, the ultra vires doctrine had the effect that a transaction entered into by a company which did not come within the objects listed in the objects clause in its memorandum of association, or which was not reasonably incidental to its objects, was void and therefore unenforceable by either party to the transaction. This unfortunate trap for the unwary derived in part from an application of the equitable doctrine of constructive notice whereby any person entering into a transaction with a company is deemed to be aware of both the existence and contents of a company’s memorandum as a public document. [16]

If a company does not comply with its objects clause, it is said to be contracting outside of its capacity and therefore acting ultra vires. ‘Ultra vires’ is referred to by Keane, R. as a company having “no power to enter into a contract which was not expressly or impliedly authorised by its constitution.” [17] Such a contract is deemed void between the company, its members and the outsider who entered the contract with the party. This rule was seen to be very harsh on the outsider who was oblivious to the fact that the company was acting outside of its capacity, resulting in their inability to have the contract performed. Another injustice of this principal to the outsider was that of the doctrine of constructive notice. The named doctrine provided that parties who deal with a company are presumed to be aware of the company’s public document contents, i.e. the articles of association and the memorandum of association. However, these rules have been subject to statute modification in recent times.

Prior to the passing of s.37 (1) of the 1963 Act [18] it was not possible to ratify a contract which had been entered into precedent to the company being incorporated.

S.37 (1) of the 1963 Act provides that:

“[A]ny contract or other transaction purporting to be entered into by a company prior to its formation or by any person on behalf of the company after its formation and thereupon the company shall become bound by it and entitled to the benefit thereof as if it had been in existence at the date of such contract or other transaction and had been a party thereto”. [19]

It is not an unusual occurrence for promoters and those who are involved in establishing the company to engage in contracts at a time prior to the existence of the company in law. This provision however grants the company the option to ratify the contract at a general meeting and validate the previous contract once incorporated if it wishes to do so. The contract entered into by the promoter is said to be held bound by the terms of the contract, personally, until the contract has been ratified by the company. If a situation arises whereby it does not ratify the contract, the company can neither sue nor be sued on the contract. In the United Kingdom under s.36(c) of the Companies Act 1985 [20] , the ratification of a pre-incorporated contract is not permissible, thus holding the individual who entered the contract personally liable to the terms of the contract. If it is authorised by the company, the contract can be ratified by a resolution of the members or the Board of Directors. 1690

In the case of HKN Invest OY v Incotrade PVT Ltd [21] , it was held by Costello J. that in the circumstances where a contract was implemented without formal ratification by a shareholder who possessed control it was regarded as sufficient indication that the company consented to be bound by the contract, i.e. the contract was ratified by the shareholder’s conduct.

The principles governing the ratification of contracts were stated by Wright J in Firth v Staines [22] to be as follows:

‘To constitute a valid ratification three conditions must be satisfied: first, the agent whose act is sought to be ratified must have purported to act for the principal; secondly, at the time the act was done the agent must have had a competent principal; and, thirdly at the time of ratification the principal must be legally capable of doing the act himself.’

Although now modified in the context of pre-incorporation contracts, the principles of ratification set out in Firth V Staines continue to apply to ratification of contracts generally in Ireland. [23]

The ultra vires rule which states that a company has no capacity, expressly nor impliedly, to enter a contract that has not been provided for in the company’s objects clause, was coupled with the principle that individuals are presumed to be aware of the company’s public documents, referred to as the doctrine of constructive notice. This principle implies that because individuals have access to the company’s public documents, including the objects clause, it is presumed they have taken action to investigate the company’s affairs and therefore do not have the right to enforce a contract by relying on the fact that one was unaware of the company’s incapacity. The main case in relation to this area is that of Re Jon Beauforte (London) Ltd. [24] In this case, the company’s main objective was to carry on business as costumiers and gown makers, but also manufactured veneer panels, an element that was not stated in the company’s objects clause. Re Jon Beauforte Ltd decided to build a factory to manufacture veneer panels. Neither the builders nor any of the suppliers of goods and materials for the factory knew that the building of the factory was ultra vires. Nevertheless, the court held that none of them could prove for their debts in the company’s liquidation, as they had acquired no contractual rights under their ultra vires contracts. [25]

The traditional application of the ultra vires rule rendered such contracts void, not only as between the company and its members, but also as between the company and the other party to the contract, the so-called “outsider”. The principle underlying this doctrine was that the constitution of the company, once it had been approved and registered with the Registrar of Companies, it became a public document; thus under an application of the doctrine of constructive notice, no creditor of the company could subsequently plead ignorance of the limitation of the company’s contractual capacity. The meticulous application of these principles was capable of causing serious injustice.  [As best exemplified by Re Jon Beauforte (London) Ltd. [1953] Ch. 131] [26]

The legislature then intervened to alleviate the stringency of this doctrine and also to protect innocent outsiders from the unjust effects that were consequential of the ultra vires rule. In Attorney-General v Great Eastern Railway Company [27] it was held that the doctrine of ultra vires:

‘ought to be reasonably … understood and applied, and … whatever may fairly be regarded as incidental to, or consequential upon, those things which the legislature has authorised, ought not (unless expressly prohibited) to be held, by judicial construction, to be “ultra vires”.’ [28]

Legislation provided in the 1963 Act, referring specifically to s.8 (1) [29] , was needed for he stated reason above and so allows for the reliance on a contract which was entered into by an outsider involving an incapacitated company. The circumstances under which an individual can claim to be relying on this legislation require subjection to;

(i) Any act or thing done by a company which if the company had been empowered to do the same would have been lawfully and effectively done, shall, notwithstanding that the company had no power to do such act or thing, be effective in favour of any person relying on such act or thing who is not shown to have been actually aware, at the time when he so relied thereon, that such act or thing was not within the powers of the company, but any director or officer of the company who was responsible for the doing by the company of such act or thing shall be liable to the company for any loss or damage suffered by the company in consequence thereof.

(ii) The court may, on the application of any member or holder of debentures of a company, restrain such company from doing any act or thing which the company has no power to do. [30]

Therefore, enabling the individual to enforce the contract against the company, unless at the time the contract was coming into being the person was aware of the company’s incapacity.

However, the means of proving the individual was unaware at the time of contracting would appear to rest on with the company which is seeking to avoid the transaction. It is a requisite for the individual to prove it relied on the “act or thing” in order to guarantee contract enforcement.

The first element of s.8 (1) provides that the third party cannot rely solely on s.8 to enforce a contract that was not ultra vires but however would have been illegal had it been sanctioned by the objects clause.

In Bank of Ireland Finance Ltd v Rockfield Ltd [31] the court examined the claim made by the plaintiff bank who sought to rely on s.8 (1) [32] in an effort to uphold the transaction in which they had engaged into with another company involving the loan of money to a company with the intention to purchase the company’s own shares. Such an act was not authorised by the company i.e. the borrowing of money for the purpose of share purchase. Bank of Ireland then sought loan repayment, but was unable to rely on s.8 (1) [33] due to the fact that the transaction would not have been a legally permitted act even if such an act had been quoted in the objects clause. Under s.60 of the 1963 Act [34] a company is prohibited from borrowing money for the purchase of its own shares, the section which was relied upon in the above case. A similar situation arose in the case of Re Frederick Inns Case [35] where it was held that an insolvent company was not permitted to make gratuitous payments, therefore the Revenue could not rely on s.8(1) to enforce the payment. The term “actually aware” which has been used throughout this passage was scrutinised in the case of Northern Bank Finance Corporation Ltd v Quinn & Achates Investment Co. [36]

In this case, the bank sought to rely on s.8 (1) [37] in an attempt to uphold an agreement whereby the company had guaranteed a loan which the bank had given to Mr. Quinn. The bank sought repayment of the loan but the company sought to avoid the agreement by stating that the giving of a guarantee was outside the capacity of the company, i.e. it had not been stated in its objects clause. Northern Bank Finance Corporation Ltd claimed that the agreement should be upheld under s.8 (1) [38] in that they were not “actually aware” of the company’s incapacity. However, the court looked at the fact that the bank’s solicitor had actually read through the memorandum and articles of association. The bank claimed that the solicitor had failed to understand the clause and thought that the company did have the capacity to guarantee the loan and that they were therefore not “actually aware” of the lack of capacity. It was then held by Keane J. that the bank had “actual notice” of the lack of capacity in that they had indeed read the documents and were therefore actually aware and could not rely on the guarantee. This decision has been criticised in that Keane J. was confusing “actual notice” with “actual awareness”. These two terms, awareness and notice, are very different in legal terms with the latter connoting something less than full knowledge. An individual is deemed to have notice of a matter when it has been brought to his attention. When he examines and reads it he will have actual knowledge, but in failing to understand what he reads, the question arises as to whether it can be really said that he has actual awareness” of the matter?

European intervention also sought to mitigate the rule of ultra vires as it affects outsiders. European intervention also sought to mitigate the rule of ultra vires as it affects outsiders. Article 6 of the European Communities (Companies) Regulations 1973 [39] provides that an outsider could have an ultra vires contract upheld if:

(1) In favour of a person dealing with a company in good faith, any transaction entered into by any organ of the company, being its board of directors or any person registered under these regulations as a person authorised to bind the company, shall be deemed to be within the capacity of the company and any limitation of the powers of that board or person, whether imposed by the memorandum or articles of association or otherwise, may not be relied upon as against any person so dealing with the company.

(2) Any such person shall be presumed to have acted in good faith unless the contrary is proved. [40]

The relationship of Article 6 [41] with s.8 (1) [42] is unclear and it is felt that because Ireland already has enacted legislation in this regard, it was not necessary to implement Article 6 and that it was a legislative misjudgement to do so. The protection that is offered under Article 6 is restricted to those contracts entered with the Board of Directors or a registered individual but however it is felt that Article 6 may save an outsider who has read the memorandum but did not realise that it precluded capacity, provided that the outsider can prove that he was acting in good faith and that Article 6 could therefore have a wider remit than s.8 (1) [43] . The plaintiff outsider would be advised to plead both sections. In the case of International Sales and Agencies v Marcus [44] , the test of good faith was whether a party actually knew that he was involved in an ultra vires act or whether in all the circumstances it can be established that the party cannot have been aware that this was an ultra vires act.

Bell Houses Clause:

A ‘Bell Houses clause’-so called after a case of that name- gives the company the capacity to pursue any business which the directors believe would be advantageous to the company. [45]

Subsequently, the capacity of a company to pursue a specific business will be determined by the directors’ subjective discretion. An example is:

‘To carry on any other trade or business which can, in the opinion of the board of directors, be advantageously carried on by the company in connection with or as ancillary to any of the above businesses or the general businesses of the company, or further any of its objects.’ [46]

In Bell Houses Ltd v City Wall Properties Ltd [47] the principal set out in the company’s memorandum was the development of housing estates. However, the objects clause contained a clause which empowered the directors to pursue any business they considered advantageous to the company. The objects clause also contained an independent objects clause similar to that in the Cotman case.

The company contracted to introduce a financier to another company for a procuration fee. The Court of Appeal held that in view of the clause used, the transaction was intra vires. [48] Danckwerts LJ said that the impact of the clause was ‘…to make the bona fide opinion of the directors sufficient to decide whether an activity of the plaintiff company is intra vires.’ [49]