Constitution of Company and Relationships

‘Section 31(1) of the Companies Act 2006 is a retrograde step in terms of a company’s capacity. The provision re-asserts the ultra vires problem encountered by creditors in cases such as Ashbury Railway Carriage & Iron Co v. Riche (1875) LR 7 HL 653.” Critically evaluate this statement with reference to the changes wrought by the Companies Act 1989 and Companies Act 2006 in relation to company constitutions

The constitution of the company has effects on the relationships between the directors and the shareholders. The 2006 draft model articles for companies state; the directors are responsible for the management of the company’s business, and exercise all the company’s powers. The shareholders may, by especial resolution, direct the directors to take or refrain from taking, special actions.’ [1] However, where the board cannot act, the case law has established that, the powers of the board revert to the shareholders in general meeting. [2] A Company’s capacity may be constrained by provisions in its articles. This essay aims to highlight some issues; the main changes that the Companies Act 1989 (CA 1989) and Companies Act 2006 (CA 2006) will make in relation to company’s capacity and the memorandum of association; ultra vires doctrine; Professor Prentice recommendations in relation to CA 1989 and CA 2006; internal aspects of the ultra vires doctrine; the doctrine of ultra vires was set out clearly in the House of Lords in many cases such as case of Ashbury Railway Carriage & Iron Co v. Riche [3]

Today, companies have powers to do all things incidental or conductive to carry on any trade or business. This is now in the provision of s.31of the CA 2006, a company is not required to state its objects in a separate clause contain the articles of association. According to that, s. 31 provide that ‘unless the articles of the company specifically restrict the objects of the company, its objects are unrestricted’; it will have unlimited capacity’. [4] So, that companies incorporated under the CA 2006 have unlimited objects. [5] Companies will be able to enter into any lawful activity, except as specifically prohibited by their articles. [6] Companies have legal capacity to engage in many activities, so it is liable through the acts of its agents and its employees. The company may add, remove or amend objects at anytime by altering its article, except charitable companies which subject to certain restrictions, [7] but without any particular right of appeal to the court for dissentient minorities as previously provided for in relation to alteration of objects clauses. [8] If a company chooses to adopt restrictions on its object, as a necessary part in the articles of association rather than the memorandum of association, those restrictions will not affect the validity the Companies Acts. [9] However, companies incorporated under earlier companies legislation limited objects clause to limit their capacity. By s. 28 [10] the objects clause will be treated as a provision of the articles of the company. The memorandum of association usually contains the activities that company is authorised to carry on. However, 2006 Act, allow a company to do anything lawful that is not expressly prohibited by its constitution [11] . The memorandum of association also governs the relationship between the company and the third party. In particular it defines the capacity of the company. Anything outside the objects and powers of a company is ultra vires. [12] The legislation requires the company to include statement of its objects in its memorandum of association, and according to that the court concluded that company did not have legal capacity to act outside its objects. Section 39 must be read in conjunction with s. 171 of the CA 2006, which provides that director must be act accordance to the company’s constitutions. Despite Section 39 [13] has removed the problem of corporate capacity; the directors are still subject to limitations on their powers.

Historically, purported acts outside these nominated objects were void. This was normally called the ultra vires doctrine. [14] Ultra vires is a Latin expression to describe acts under taken beyond the legal powers of those who have granted to undertake them. [15] By the nineteenth century courts, the doctrine of the ultra vires was developed on the grounds of both shareholder and creditor protection; that shareholders and creditors should not find that the company in which they have invested or advanced credit was engaged in different business, because the object of the memorandum was incapable of change after the creation of the company, and ultra virse could not be ratified by the shareholders. On the other hand, the benefit of the both shareholders and creditors might be enhanced by moving into new fields of operation, so that prohibition on such step was too strong rule. [16] Additionally, third parties can be protected from ultra vires by (AC 2006 s39 (1)) [17] . The aim behind the ultra vires doctrine was to protect the shareholders. They have invested money in the company to for certain purposes set out the object clause of the memorandum, or the proposed contract is within the powers of the company. If the directors applied it for other purposes, the shareholders would not prejudice, since those acts would be void. [18]

Further reform came in 1989 [19] following recommendation made by Professor Prentice to undertake review of the position and to make recommendations; some of his recommendation was enacted in the Companies act 1989. Third parties were concerned of containing the clear statement that ‘the validity of an act done by a company shall not be called into question on the ground of lack of capacity by reason of anything in the company’s memorandum’. [20] The CA2006 largely following the recommendations of the Company Law Review, and some of unimplemented reforms suggested by Professor Prentice, takes a more radical approach by removing the doctrine underpinnings of the ultra vires rule. It is no longer necessary for a company to set out its objects’. [21] Over the years it was sometimes used to get around a potential ultra vires problem. If they found that its object clause did not permit some new transaction and that the statutory power to alter the memorandum was not enough to produce a solution, so one solution might be to use the s. 110 procedure [22] to roll the business of the old company into a newly formed company. Moreover, the CA 1989 created a more extensive power to alter the objects; it contained a provision which aimed to abolish the constructive notice doctrine; not only of the in the context of ultra vires, but for all the areas of the company law. It also contained a package of provisions which were made to restrict the doctrine by implementing Company Law Directive, which had required the doctrine to be removed, as against outsiders dealing with the company [23] .

Section 39 of the CA 2006 does not aim to deal with the internal aspects of the ultra vires doctrine, because these are matters to be dealt with according to: Firstly, the ordinary rules on the duties of directors. [24] The company’s articles are the main source of the director’s powers, and the articles are likely to be a source of constraints on the director’s powers. Section 171 (a) [25] requires a director to act in accordance with the constitution of the company. The duty usually involving the purported exercise by directors of powers which were ultra vires the company, [26] however, the directors break this duty if they act in fact in breach of the requirements of the company’s constitution; at common law, the directors’ act or decision which is outside the company’s constitution is void and it has no effect. So, the decision is only avoidable, where the directors simply exceed an authority which has been conferred on them; Hogg v. Cramphorn , was held that, the issue of the shares, the executions of the deed and the loan were all ultra vires the directors and invalid unless ratified in to company in general meeting. [27] A decision which is void may have a bigger impact upon third parties than a rule that the act or decision is merely avoidable; valid until set aside and incapable of being set aside if the rights of the third party have been intervened. Additionally, in the case of avoidable decisions, the impact of this rule on the interests of the third parties has now been protected by the statutory protection particularly section 40 for those dealing with the company in good faith. [28] Secondly, or the enforcement of the articles as between shareholders and company, the common law tends to classify the rule-book of associations as contractual in nature. The articles of association are no exception to this principle, but it classification is done by the Act. Section 33 provides that ‘the provisions of the company’s constitution bind the company and its members to the same extent as if there were covenants on the part of the company and of each member to observe it’. [29] According to that, the articles constitute a contract between the company and each member, [30] and also between the articles and the authority of the company’s agents which should concern third parties. [31] Under the ultra vires theory of the common law, third parties who contracting with the company could protect themselves by reading the objects clause. [32]

The doctrine of ultra vires was set out clearly in the House of Lords case of Ashbury Railway Carriage & Iron Co Ltd v. Riche; [33] a company was registered under the Joint Stock Companies Act 1862, its objects, as stated in the Memorandum of Association ‘to make and sell, or lend on hire, railway carriages and wagons, and all kinds of railway plant, fittings, machinery, and rolling stock; to carry on business of mechanical engineers and general contractors’ clause 4 of the article include ‘an extension of the company’s business beyond the objects in the memorandum of association shall take place by special resolution’. The company contracted with to provide Riche with finance for the construction of railway in Belgium, and he set about performance under the contract, and received some payment. The Article of Association recited an agreement to purchase the business of John Ashbury. Directors were to have the general conduct of the business of the company, and to exercise all such powers of the company by the Act or general meeting. Later the company repudiated its contract with Riche, who then sued for damages, pleaded that it was ultra vires the company to enter such contract. The lower courts, the question is whether the contract, though unauthorised, had been approved by the members under article 4. The question of ultra vires was depend on the following consideration [34] ; Firstly, the declaration of the objects of the company made in the Memorandum of Association; secondly, the words of several of the Articles of Association; finally, the acts of the Directors, and of meetings of the company. The House of Lords held that, [35] the contract was beyond the powers of the company, this contract, being of a nature not included in the Memorandum of Association, was ultra vires, and breach of fiduciary duty. [36] Riche was aware of the circumstances which highlighted that they were in breach of duty, he was aware of the nature of the contract, and had actual or constructive notice of the object clause, according to that he held the benefit of the contract on constructive trust for the company. Moreover, as regards corporate capacity, Rolled Steel Products Ltd v British Steel Corporation [37] here the claimant company had in its memorandum express power to give guarantees. It gave a guarantee of another company’s debt (SSS Ltd) to another company (C Ltd). In return for the guarantee the claimant received a loan from C Ltd to enable it pay off the claimant company’s excising debt to SSS Ltd. Later the claimant company ran into financial difficulties. It was held that, if the transaction was for a purpose not authorised by the memorandum it could be ultra vires, and the third party C Ltd, was aware that guarantee was partly and not for the benefit of the claimant company, and so it was unenforceable. So, directors have behaved unconstitutionally, exceeded their authorities, abused their powers, and acted in breach of their fiduciary duties. [38]

However, in the Re German Date Coffee Company [39] , the effectiveness of this was damaged by the development of a doctrine understood as ‘main objects rule’ under which the court would decide that, as construction matter, one object in the list was in fact the main object. This meant that, the trading would be ultra vires unless the main object was being persuaded. Additionally, in Cotman v. Brougham [40] it had been decided that since the main objects rule was no more than a canon for construction, so that a clause which suggested that each object was a separate and independent object and was not ancillary to any other object, would be effective to prevent a court from adopting the main objects rule when constructing a memorandum. Moreover, in Re Introduction Ltd [41] the company had been formed to provide facilitates for the Festival of Britain, was now involved in pig breeding. Debentures had been issued to a bank which had lent money to the company. The bank had been sent a copy of memorandum, and also was aware that the money was to be used for a pig breeding. The liquidator was arguing that the company did not have to pay the bank, because the loan was ultra vires and void. Despite the object clause of the memorandum of association contained an express power to borrow money, the Court of Appeal held that, since the pig breeding was ultra vires, then the borrowing for pig breeding was ultra vires. So, ss. 39 and 40 of 2006 Act may have opposed the factual result in Re Introduction.

Consequently, today, companies have powers to do all things incidental or conductive to carry on any trade or business. This is now in the provision of s.31of the CA 2006, a company is not required to state its objects in a separate clause contain the articles of association. Historically, purported acts outside these nominated objects were void. This was normally called the ultra vires doctrine. Ultra vires is a Latin expression to describe acts under taken beyond the legal powers of those who have granted to undertake them. The CA2006 largely following the recommendations of the Company Law Review, and Professor Prentice, takes a more radical approach by removing the doctrine underpinnings of the ultra vires rule. Despite the Companies Act 2006 has done much to reduce the effect of the doctrine, it has not completely disappeared. Internal aspects of the ultra vires doctrine are matters to be dealt according to; the ordinary rules on the duties of directors; or the enforcement of the articles as between shareholders and company. The doctrine of ultra vires was set out clearly in; the House of Lords case of Ashbury Railway Carriage & Iron Co Ltd v. Riche.