Although the Directors of a Company are its Basic Organs

“Subject to the provisions of the Act, the Board of directors of a company shall be entitled to exercise all such powers, and to do all such acts and things, as the company is authorised to exercise and do.”1

The powers of the company emanate from its memorandum which is required to state its objects.2 The stated objects confer upon the company the power to carry them out and those become the powers of the company and its directors.3 It is in the interest of all concerned in a joint-stock enterprise that the directorate be held to function within the limits set by the company’s constitution.4

This is the role which the doctrine of ultra vires was called upon to play when its application to joint-stock companies was first dramatised by the House of Lords in Ashbury Railway Carriage and Iron Co.v. Riche.5 The rule came into existence as a preserver of the corporate fund in the hands of “that impalpable thing the corporation”.6 There are at least three pertinent reasons for the conservation of corporate capital.

Firstly, the contributors of the capital, namely, the company’s share-holders, agree to part with their money permanently on the faith that it shall be invested in the stated objects and in no others.7

Secondly, “the creditors give credit to the company on the faith of the implied representation that the capital shall be applied only for the purposes of business.”8

Thirdly, stability in corporate business can be best attained by stabilising business and by preventing proliferation of activities. That also prevents concentration of economic power.9

The doctrine has adequately fulfilled these promises. There is no reported case in which it failed zealously to safeguard the corporate capital against exploitation.

Yet there has been a revolt against the doctrine almost ever since its inception. It has been condemned in strongest possible terms. For example, Justice Thompson of the United States, who is also a great writer on Corporations,10 only two decades after its demonstrated application, had this to say about the doctrine:

“Such was the doctrine our ancestral lawyers mouthed with owl-like wisdom, and which our ancestral judges rolled as a sweet morsel under their tongues.”11

More recently L.H. Leigh in a note on the doctrine says:

“The modern doctrine of ultra vires is now almost a century old. It is a reproach to Parliament that it still exists in its present form. It is a reproach to the courts that it is even now obscure in its details and caparicious in its incidence.”12

Similarly Professor Aharan Barak says13:

“It seems that today everyone is agreed that there is no justification for this rule, and that it should be discarded.”14

Equally strong words have been used by the Right Hon. Lord Wilber-force: 15

“This (the doctrine of ultra vires) seems to be a vestigial survival from the days of chartered companies when the purpose for which the charter was granted had to be approved and was as it were consecrated by the charter. There seems to be no obvious reason a priori why this doctrine should be grafted upon the limited company which, as the courts themselves held, was based not on the conception of the grant of a status, but of a contract between entrepreneurs. In fact it was not until 1875 that the fetters were firmly placed upon it by the House of Lords in the Ashbury Carriage Co. case.16 Since then with the casuistic ingenuity of the judges the web has been spun finer.”

In view of these strong expressions, to say a word in defence of ultra vires would be to incur further reproach.17 Yet it shall be the burden of this Chapter to demonstrate that none of the reformers has ever demanded the total abolition of the doctrine.18 The only area in which reform is demanded is the mitigations of some of its consequences. It came into existence partly as a technique of protecting the interest of creditors of limited companies. The extent to which it operates to protect creditors at the risk of other creditors is the defect which is ought to be remedied. As the doctrine operates at present, it is a protection for some creditors and a trap for others. The instrument of creditor protection has become a trap for them.

The reason why creditors are being protected at the expense of other creditors is not far to seek. Once it is held that a company is incapable of contracting outside the scope of its stated objects, the question at once arises whether a contract outside such scope shall be voidable, void, unenforceable or illegal.19

If a contract is voidable, the party seeking its rescission is bound to restore the benefits, if any, obtained by him under it.20 So is generally true of an unenforceable and a void contract.21 Even where a contract is illegal, if one of the parties is in ignorance of the illegal purpose, he may, if the contract is still executory, require restitution.22

It follows that by making an ultra vires lender totally helpless against the company, the courts have placed an ultra vires contract in a class worst than an illegal contract. Two reasons seem to have promoted the courts to adopt this attitude. In the first place, a creditor can, if he chooses, protect himself by consulting the company’s memorandum beforehand, and, if he does not do so, he takes the risk. Secondly, the courts, in their zeal to conserve the shareholders’ money or the guarantee fund of creditors, thought it improper to compel a company to appropriate a portion of its capital for activities which are prohibited by certain documents which have the force of law, and of which there is also constructive notice.23 The rule of constructive notice was laid down by the House of Lords in Earnest v. Nicholls24 and was explained by Lord Hatherely in Mahony v. East Holyford Mining Co.: 25

“(The memorandum and articles) are open to all who are minded to have any dealings whatsoever with the company and those who so deal with them must be affected with notice of all that is contained in those documents.”

The rule is extremely unrealistic because, in practice, very few people, if any, dealing with a company consult its documents.26 The company is known to them through its officers and not through its documents. They place reliance upon what the company’s officers tell them and not what the documents provide. This gap between the legal theory and practice is mainly responsible for the predicament of the unwary creditor, and this is what brings to bad light an otherwise wholesome doctrine of ultra vires.

The rule that prejudices the just claims of a creditor on the ground that the company has outstepped its objects is assailable on another equally cogent ground. Ever since the joint-stock companies have been allowed to be incorporated by registering a deed of settlement,27 or, subsequently, memorandum and articles of association, the courts have held that these documents constitute a contract between the company and its members.28 It has frequently been emphasised that an outsider cannot take the benefit of, nor be bound by, the provisions of the company’s registration documents.29 If these documents are not binding upon outsiders how could the “objects clause” be set up as a defence against a person who has contracted with the company in good faith not knowing that the subject-matter of his contract was outside the scope of corporate powers. This is probably because of the doctrine of notice which imputes him a constructive knowledge of the purposes for which a company can contract.30

If this aspect of the doctrine of ultra vires is remedied, most of the difficulties would disappear and its potentialities would then be confined only between the managers and members of a company. The Jenkins committee proposed reform on this line. In their report presented to the Parliament in June 1962,31 the committee made the following proposals to the company’s objects and powers: 32

“A contract between a company and another party contracting in good faith should not be invalid as against the other party on the ground that it was ultra vires the company.

In entering into such a contract the other party should be entitled to assume without investigation that the company is possessed of the necessary power, and should not by reason of his omission to investigate be deemed not to have acted in good faith, or be deprived of his right to enforce the contract on the ground that he had constructive notice of any limitation on the powers of the company, or on the powers of any director or other person to act on the company’s behalf, imposed by its memorandum or articles.”

These proposals have not yet found expression in the Companies Act,33 but they may perhaps be given effect to in the next overhaul of the company legislation whenever it takes place.

The Australian legislature have already adopted the rule. Section 20(1) of the Uniform Companies Act provides that:

“No act of a company (including the entering into an agreement by the company) shall be invalid by reasons only of the fact that the company was without capacity or power to do such acts.”

A learned commentator on the section says that “taken as a whole the section substantially modifies the doctrine of ultra vires but by no means abolishes it”.34

The doctrine will remain vital as between shareholders and their company and “may be asserted or relied on in proceedings to restrain the doing of acts by the company or in proceedings against present or former officers of the company”.35

As long as the equity share capital is a risk capital and the position of the shareholder is not reduced to that of an investor with a guaranteed interest on investment, ultra vires would have a role to play in the functioning of joint-stock enterprises. It would operate as a check on extravagant or speculative spending by management. But a lot of reform would be necessary to make it effective even in this limited role.

As it stands at present it affords no real protection to either shareholders.36 In their struggle against it the businessmen have evolved a number of evasive devices which not only nullify the doctrine but also defeat the very purpose of stating objects in the memorandum. One of the well-known techniques of evasion is to include in the memorandum a profusion of objects and powers. The practice was described by the House of Lords in the most unmistakable terms in Cotman v. Brougham.37 Describing this practice as “pernicious”, Lord Wrenbury said:

“The function of the memorandum is taken to be, not to specify, not to disclose, but to bury beneath a mass of words the real object or objects of the company with the intent that every conceivable form of activity shall be found included somewhere within its terms. Such a memorandum is not a compliance with the Act.”38

In requiring objects to be stated the “original intention of the legislature obviously was to set out the company’s objects succinctly in just a few paragraphs, specifying in general terms the business which it proposed to carry on”. It becomes apparent from the speech of Lord Wrenbury in Cotman v. Brougham,39 that the objects clause is “to delimit and identify the objects in such plain and unambiguous manner as that the reader can identify the field of industry within which the corporate activities are to be confined”.40 An objects clause which contains hundreds of objects does not serve this purpose.

Main Objects Rule

The Courts in a bid to restrain this practice resorted to the main objects rule of construction. The genesis of the rule is to be found in the Ashbury case41 itself where it was held that the words in the objects clause entitling the company “to act as general contractors” would be construed in the light of the company’s main objects. For otherwise, said Lord Cairns, L.C. “it would authorise the making of contract of any and every description and the memorandum in place of specifying the particular kind of business, would virtually point to the carrying on of the business of any kind whatsoever and would, therefore, be altogether unmeaning”.42

This rule of construction is used to serve two purposes. Firstly, it confines the activities of a company to what would appear on a reading of its objects clause to be its main or predominant objects for which it was originally conceived or created. Secondly, where that object has failed to materialise the company would be ordered to be wound up under the “just and equitable” clause of Section 433.43

But the “main objects rule” has also failed to work. Its failure was first demonstrated in Cotman v. Brougham44 where the House of Lords had to consider a memorandum which contained an objects clause with thirty sub-clauses enabling the company to carry on almost every conceivable kind of business which a company could adopt. The clause concluded with a declaration that “every clause should be considered as a substantive clause and not limited or restricted by reference to any other sub-clause or by the name of the company and none of them should be deemed as merely subsidiary or auxiliary”. Their Lordships expressed strong disapproval of the inclusion of such a clause but were constrained to hold that it excluded the operation of the “main objects rule” of interpretation.45

New Technique of Evasion

The already attenuated doctrine of ultra vires has been given another death-blow by the recent decision of the Court of appeals in Bell Houses Ltd.v. City Wall Properties Ltd.46 The decision has stamped its approval upon another and new technique of evasion. The decision, however, promotes substantial justice. The facts may be noted first.

The plaintiff company’s principal business was the acquisition of vacant sites and the erection thereon of housing estates. In the course of transacting the business, the chairman acquired knowledge of sources of finance for property development. The company introduced financer to the defendant company and claimed the agreed fee of œ20,000 for the same.

The trial Judge held47 that contract was ultra vires, because it was not covered by any of the stated objects of the company.48 Following Ashbury Railway Carriage Co.v. Riche,49 that an ultra vires contract is wholly null and void, the court dismissed the company’s claim. The learned judge50 pointed out that to hold the defendants liable on a non-existent contract would be to act contrary to all principle.51

The company relied upon a clause in its objects which authorised it “to carry on any other trade or business whatsoever 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 business”. The company claimed that their contract came within this clause. But the memorandum did not contain a declaration excluding the “main objects” rule of construction. Accordingly Macotta, J. applied the rule and held that the clause was meaningless as it would add nothing to the company’s business except the power to carry on the incidental objects and that would not enable a company for developing sites to become a money-broker.

But on appeal the decision of Macotta, J. was reversed.52 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.

The result has been welcome.53 Any other rule would have deprived the company of a valuable asset only because of technical doctrine which came into existence as a proctor of corporate interests.54

But the reasoning on which the court proceeded may become a precedent for total evasion of ultra vires not merely in reference to outsiders but also as between the company and its members. If the objects of a company are allowed to depend upon the directors’ bona fide opinion as to what is in the interests of the company, the future memoranda need only state that the objects of the company shall depend upon the bona fide opinion of directors. The Registrar shall be bound to register the memorandum as a sufficient compliance with the Act.

Commenting upon the decision Profession R.C. Beuthin says:

“The judgment of the English Court of appeal has chalked up another victory for the businessman in his long endeavour to escape the limitations imposed by the doctrine of ultra vires.”55

More than two decades before this decision, the Bombay High Court had, in Wamanlal Chotalal Parekh v. Scindia Steam Navigation Co.,56 passed a vague and subjective clause like this in a company’s objects. The clause enabled the directors “to invest money of the company in such manner as the directors think fit”. They bought gold and silver. Holding the transaction as valid Kania, J. (afterwards Chief Justice of the Supreme Court) said: 57 “On a plain reading of this clause it is clear that it does not restrict the power of the company to utilize its money for any limited purpose.”

In India an attempt has been made to tackle the problem of prolexity of objects at both the legislative and administrative levels. The legislative measure was adopted in 1965 through the Companies (Amendment) Act of that year. Section 13 as amended requires the objects clause to be divided into two sub-clauses. The first sub-clause is required to state the main, incidental and ancillary objects of the company.58 In the second sub-clause may be included any other objects are not mentioned in the first sub-clause.59

The purpose of this division does not become clear unless it is taken in connection with the amendment of Section 149. This section deals with the certificate for the commencement of business which is necessary to enable every public company to commence its business activities. As the section stood before this amendment a company had to obtain this certificate only once in its life. But now a new certificate would be necessary every time a company picks up a new business from its stated objects. A company which was in existence at the enforcement date of the Act of 1965, would have to obtain a certificate “whenever it commences any new business which is not germane to the business which it is carrying on at the commencement of the Act60 In the case of a company incorporated after the enforcement date of the amendment, a certificate would be necessary whenever the company wants to commence any business stated in the second sub-clause of its objects.61

In either case the relevant and the most important requirement for the issue of a certificate is that the business in respect of which the certificate is desired must have been approved by a special resolution passed by the company in general meeting.62 Where, however, the company cannot manage a special resolution, it may pass an ordinary resolution63 and then obtain approval of the Central Government to commence any new business.64

Thus no new business can be commenced without consulting at least a majority of the company’s shareholders. This in essence is the adoption of the partnership principal, with only this difference that while under the Partnership Act,65 unless there is an agreement to the contrary, a new business can be adopted only with the consent of all the partners, the Companies Act requires the consent of only a special majority of shareholders. But even so it is likely to afford the same degree of protection as is afforded by the partnership principle and will make up for the illusory protection now provided by the ultra vires doctrine. It will also discourage a company from spreading its net wider and wider until it embraces diverse kinds of business. That this the purpose of the amendment becomes apparent from the following statement of Mr D.L. Mazumdar66:

“Ill-advised diversification by Boards of companies may result in building up a hotchpotch of business into an industrial holding company. Since the surplus funds of a company, which can be thus utilised by its Board are derived from withholding from shareholders the profits earned67 from its principal lines of business, it is only fair and just that before these surpluses are ploughed back for purposes which were not in the shareholders’ minds when they bought or subscribed for their shares, the shareholders’ wishes are ascertained. In other words the Board of company should not proceed with plans for diversification of its business, involving a substantial dilution of the existing equity without obtaining, in the first instance, the consent of the shareholders to the intended use of these funds.”68

Administrative Measures

At the administrative level Registrars of companies have been instructed to oppose petitions for courts’ confirmation for expansion of a company’s objects, particularly where a company proposes to adopt a totally new line of business. As the things stand at present, the court’s confirmation has become a needless ritual. Petitions for alteration of objects are seldom, if ever, opposed by either shareholders or creditors. The Registrar, therefore, steps in as protector of their interest as also of the public interest.69 But the Registrar’s efforts have not met with much success. In most of the cases where he puts up appearance, his objections were overruled.70 Thus, for example, in Juggilal Kamlapat Jute Mills v. Registrar of Companies, 71 despite the Registrar’s objections a company, originally formed for “business in Jute” was allowed to include “business in rubber” and in Re Modi Spinning and Weaving Mills Co.,72 a “spinning and weaving” company was allowed to manufacture “industrial and power alcohol”.73

Even in cases where alteration have not been confirmed, it is more due to the fact that the requirements of Section 17 were not satisfied than due to the efforts of the Registrar. But even so the Registrar played a very useful role inasmuch as in his absence there would have been nobody to tell the court that the proposed alteration is outside the limits set by Section 17.74

The fact that the courts have been guided by reasonable construction of Section 17 does not, however, mean that they are not aware of the socio-economic policies and problems of the country75 For one thing, their judgments show a lot of concern for such problems and, for another, the Companies Act, of which Section 17 is but a part, itself reflects the socio-economic policy of the country. The courts have to find such policy from within the framework of the Act.

Conclusions

The doctrine of ultra vires has ceased to be any significant restraint upon corporate action.76 To the businessman it was always abnoxious. Even after incorporating a company, he wants the same freedom of action which he enjoys as an individual entrepreneur. To the creditors it was only an illusory protection for some and a real trap for others.

The trend of events has shown that successive attempts to curb corporate action within pre-set limits have proved generally abortive. The corporate managers have never cherished the idea of any restraint on their powers. Hence there has always been a debate whether companies should be given general as opposed to special powers. The important question that presents itself is thus stated by a learned writer: 77

“Is the interest of the community best served by adhering to the theory that a corporation is a legal person with limited powers, or by disregarding this theory in the determination to enforce all contracts, not immoral, which have been in fact entered into between the parties?”

If companies are to be invested with general powers, serious changes would have to be made in the structure and philosophy of the Companies Act as well as Company Law. “As yet no court has been found so iconoclastic as to shatter the venerable doctrine”78 Nor any legislation has so far conferred general powers upon incorporated enterprises. On the contrary legislatures have always shown a desire to impose restrictions upon corporate powers for the protection of public and private interests. Restrictions on the powers of those who deal with other people’s money are inevitable.79 Accordingly the only reform that has so far been proposed80 or attempted81 is to invest the company in reference only to outsiders with the contracting power of an individual irrespective of what the objects clause may provide. In this way, a minimum protection to the shareholders is retained while chances of injustice to creditors are completely wiped out.

Until this reform is adopted, the doctrine, though attenuated, remains in force. An attempt may, therefore, be made to examine some of it consequences.

* B.Com., LL.M., Lecturer in Law, Lucknow University. Return to Text

Section 291(1). This declaration is followed by two provisions which are as follows: “Provided that the Board shall not exercise any power or do any act or thing which is directed or required, whether by this or any other Act or by the memorandum or articles of the company or otherwise, to be exercised or done by the company in general meeting: Provided further that in exercising any such power or doing any such thing or act, the Board shall be subject to the provisions contained in that behalf in this or any other Act, or in the memorandum or articles of the company, or in any regulations not inconsistent therewith and duly made thereunder, including regulations made by the company in general meeting.” The effect of these provisions is to subject the exercise of the directors’ powers to the limits set by the Companies Act and the constitution of a particular company. Nearly all Companies Acts vest the company’s powers in its directors. The need is obvious. “1,00,000 share-holders could not possibly run the American Telephone and Telegraph company; indeed it is highly improbable that that number of individuals could run anything. No large enterprises could possibly go forward except under a unified and concentrated system of organisation and command.”-A.A. Berle: The Twentieth Century Capitalist Revolution, 20, 21 (1954). Return to Text

Section 13(1)(c). Even a Government company draws its powers from its memorandum and not from the State. Explained by the Supreme Court in Praga Tools Coporation v. Inamuel, AIR 1969 SC 1811. Return to Text

Explained in C.D. Goldberg: Article 80 of Table A of the English Companies Act, 33 Mod LR 177 (1970). Return to Text

Failing which there would be a lot of confusion and uncertainty, about the rights of the company and those who deal with it. Explained by Phear, J. in Re Port Canning and Land Investment Co., (1871) 7 Begal LR 583 at 598-611. Return to Text

(1875) 44 LJ Exch 185: (1875) LR 7 HL 653. The doctrine is, however, older than this decision as it existed and was in use in connection with statutory or chartered companies. But no case seems to be earlier than Eastern Counties Ry. v. Hawk, (1855) 10 ER 928. The judgment of the Lord Chancellor at p. 934 explains the doctrine. Return to Text

Per Jessel, M.R. in the Flitcroft case, (1882) 21 Ch D 519 at pp. 533-34, C.A. Return to Text

This is, of course, subject to the special power of the special majority of shareholders to change objects with the sanction of the court under Section 17. Explained by Kania, J. (as he then was) in Waman Lal v. Scindia Steam Navigation Co., AIR 1944 Bom 131 at p. 135. Return to Text

Jessel, M.R., in Flitcroft case, (1882) 21 Ch D 519 at pp. 533-34. Return to Text

D.L. Mazumdar: Towards a Philosophy of the Modern Corporation, 119, (1967): R.K. Hazari; The Corporate Private Sector: Concentration, Ownership and Control, and the Report of Monopolies Enquiry Commission. Return to Text

Commentaries on the Law of Private Corporations, (3rd Edn.). Return to Text

Thompson: The Doctrine of Ultra Vires in relation to Private Corporations, 28 American Law Review, 376 at p. 380, cited by George Wharton Pepper: The Unauthorised or Prohibited Exercise of Corporate Power, (1895-96) 9 Harv LR 255 at p. 259. The learned writer maintains that Judge Thompson’s view that the American courts had fully accepted the doctrine of ultra vires is totally unfounded and, therefore, the learned judge has been unnecessarily severe to his ancestors. Return to Text

L.H. Leigh: Objects, Powers and Ultra Vires, (1970) 33 Mod LR 81. The note has been provoked by the recent case of Chaterbridge Corporation v. Lloyds Bank Ltd., (1969) 2 All ER 1185; although the defence of ultra vires was not allowed in that case to be used to defeat obligations incurred by the directors in the exercise in good faith of their powers under the constitution of the company. Return to Text

Professor of Commercial Law, Hebrew University of Jerusalem. Return to Text

Company Law Doctrines and the Law of Agency in Israel, (1969) 18 ICLQ 847 at p. 877. Return to Text

Law and Economics, (1966) JBL 301 at pp. 302-03. Return to Text

(1875) LR 7 HL 653. Return to Text

Following articles suggest reform of the doctrine of ultra vires: Carpenter: Should the Doctrine of Ultra Vires be Abolished, (1923) 33 Yale LJ 49; Stevens: A Proposal as to the Codification and Restatement of the Ultra Vires Doctrine, (1927) 36 Yale LJ 297; Gower: Company Law Reforms, (1962) 4 Malaya LR 36, 45 and also by the same writer: The Principles of Modern Company Law, (3rd Edn., 1969) p. 98, which deals with the area of “Proposed Reform”. Return to Text

This is shown by the articles cited above in f.n. 18. Return to Text

The problem of finding the exact nature of an ultra vires contract is discussed by George Wharton Pepper: The Unauthorised Exercise of Corporate Powers, (1895-96)9 Harv LR 255 and Jesse W. Lilienthal: Non-Public Corporations and Ultra Vires, 1897 (11) Harv LR 387 and a note by Holt on whether ultra vires contracts can be ratified, (1950) 66 LQR 493. Return to Text

Section 64 of the Indian Contract Act, (1872), provides for this right. The English law also provides the same relief of a party against whom a contract has been avoided. Anson: Principles of the English Law of Contract, 226 (22nd Edn., by A.G. Guest, 1964). Return to Text

As opposed to a contract which is illegal, because the scope of relief under an illegal contract is extremely limited. Return to Text

Anson: Principles of the English Law of Contract, 342 (22nd Edn., by A.G. Guest, 1964). Return to Text

It was so held by the House of Lords in Earnest v. Nicholls, (1857) 6 HLC 401. Return to Text

Ibid. Return to Text

(1875) LR 7 HL 869 at pp. 893-94. Return to Text

Referring to the rule Professor Gower says: “It is to this rule which is wholly unrealistic, that most of the difficulties are due.” Principles of Modern Company Law, 144 (2nd Edn., 1957). Return to Text

Registration under the Companies Act of 1844 was obtained by filing with the Registrar the “deed of settlement”. The requirement of filing two documents, namely, the memorandum and articles of association, was introduced by the Companies Act of 1862 and has been maintained since then. Return to Text

Now this is expressly provided in Section 36 of the (Indian) Companies Act, 1956 and Section 20 of the (English) Companies Act. The import of the section has been explained by Pro