Doctrine of Ultra Vires and Consequences under Company Law

INTRODUCTION

Doctrine of Ultra Vires says that those then are the reasons which explain the necessity of an object clause. The same reasons require that the company should devote itself only to the objects set out in the memorandum and to no others. It is the only function of the memorandum 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”. And it is the function of the courts to see that the company does not move in a direction away from that field. That is where the doctrine of ultra sires comes into play in relation to joint stock companies.

 “Ultra” means beyond, “Vires” means powers. An action outside the memorandum is ultra vires the company.

Its application to such companies was first demonstrated by the House of Lords in the case of Ashbury Railway Carriage and Iron Co Ltd v Riches (Ashbury).

The memorandum of association of a company thus defined its objects: “The objects for which the company is established are to make and sell, or lend on hire, railway carriages and wagons and all kinds of railway plants, etc., …; to carry on the business of mechanical engineers, and general contractors ….” The company entered into a contract with Riche, a firm of railway contractors, to finance the construction of a railway line in Belgium. The company, however, repudiated the contract as one ultra vires. And Riche brought an action for damages for breach of contract.His contentions were that-

1. The contract in question came well within the meaning of the words “general contractors” and, was, therefore, within the powers of the company, and,
2. Secondly, that the contract was ratified by a majority of the shareholders.

But the House of Lords held that the contract was ultra vires and, there-fore, null and void. In substance the judgment of Lord Cairns LC was this: “The subscribers are to state the objects for which the proposed company is to be established and then the company comes into existence for those objects only.

But in the next leading case of Attorney General vs Great Eastern Railway Company the House of Lords observed that the doctrine of ultra views as it was explained in the Ashbury Case, should be maintained. But it ought to be reasonably and not unreasonably understood and applied. Thus, a company may do an act of which is :-

1. Necessary for or
2. Incidental to the attainment of its objects or
3. Which is otherwise authorized by the Act.

In India the origin of the doctrine dates back to 1866 when the Bombay High Court applied it to a joint stock company and held on the facts of the case before it that “the purchase by the directors of a company, on behalf of the company, of shares in other joint stock companies, unless expressly authorized in the memorandum is ultra vires” Since then the rule has been applied and acted upon in a number of cases.

The doctrine has been affirmed by the Supreme Court in its decision in A Lakshmanaswami Mudaliar v LIC 1963. . The directors of a company were authorized “to make payments towards any charitable or any benevolent object, or for any general public, general or useful object”. In accordance with a shareholders’ resolution the directors paid two lakh rupees to a trust formed for the purpose of promoting technical and business knowledge.

`The payment was held to be ultra vires. The court said that the directors could not spend the company’s money on any charitable or general object which they might choose. They could spend for the promotion of only such charitable objects as would be useful for the attainment of the company’s own objects. The company’s business having been taken over by the Life Insurance Corporation, it had no business left to promote.

Consequences of ultra vires transactions :-

When a company gets involved in an ultra vires transaction the question arises as to what are its effects.

Injunction

In the first place, that members are entitled to hold a registered company to its registered objects has been recognized long since.

Hence whenever an ultra vires act has been or is about to be undertaken, any member of the company can get an injunction to restrain it from proceeding with it.

 Personal liability of directors

It is one of the duties of directors to see that the corporate capital is used only for the legitimate business of the company. If any part of it has been diverted to purposes foreign to the company’s memorandum, the directors will be personally liable to replace it. Thus, for example, the Bombay High Court in Jehangir R Modi v Shami Ladha held that a shareholder can maintain an action against the directors to compel them to restore to the company the funds of the company that have been employed by them in transactions that they have no authority to enter into, without making the company a party to the suit.

• Breach of warranty of authority. – It is the duty of an agent to act within the scope of his authority. For if he goes beyond he will be personally liable to the third party for breach of warranty of authority. The directors of a company are its agents. As such it is their duty to keep within the limits of the company’s powers. If they induce, however innocently, an outsider to contract with the company in a matter in which the company does not have the power to act, they will be personally liable to him for his loss.
  

Ultra Vires acquired properly

If company’s money has been spent ultra Vires in purchasing some property, the company’s right over the property must be held secure. For that asset, though wrongly acquired, represents the corporate capital. Thus, for example, the Madras High Court: allowed a company to sue on a mortgage to recover the money lent in spite of the fact that the transaction was beyond the powers of the company.

The court relied upon the following observation of BRICK ON THE DOCTRINE OF ULTRA VIRES:

“Property legally and by formal transfer or conveyance transferred to a corporation is in law duly vested in such corporation, even though the corporation was not empowered to acquire such property.”

 Similarly, in Selangor United Rubber Estates Ltd v Cradock it was held that “the fact that the Companies Act makes it unlawful for a company to give any financial assistance for anyone to purchase any of its shares does not prevent such a person from being held a constructive trustee for the company of such of its money as is unlawfully provided for such purpose” A Canadian court allowed recovery of ultra vires payments 43 years after they were made.

Ultra vires contracts

“A contract of a corporation”, observed GRAY ], “which is ultra vires, that is to say, outside the objects as defined by its memorandum is wholly void and of no legal effect.

Ultra vires Torts

The rule of constructive notice of memorandum and articles explains why a company is not liable for an ultra vires contract, but that does not solve the problem of injustice involved. Moreover, the rule altogether fails to hold ground when a company is sought to be made liable for a tort committed by a servant of the company while acting beyond the company’s powers. Anyone dealing with a company may, at the pain of losing the bargain, be required to acquaint himself with the company’s memorandum. But that can hardly be expected of a person who has been the victim of an ultra vires tort.

 For example, a company is operating omnibuses-a venture entirely alien to its objects as described in the memorandum. The driver of one such bus negligently injures the plaintiff who sues the company for the tort. It can, no doubt, be contended against him that the driver was not a servant of the company. The company, having no existence outside its corporate sphere, could not have appointed him.106 But can it be said that the plaintiff ought to have known that fact. Doubtless the plaintiff deserves to be compensated. But the law has not yet clearly declared the justice of his demand. As the law seems to stand at present, to make a company liable for any tort it must be shown

1. That the activity in the course of which it has been committed falls within the scope of the memorandum, and
2. That the servant committed the tort within the course of his employment. Officers and employees who bring about such a situation can be held liable personally.

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