4 The Doctrine of Ultra Vires PDF

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4. THE DOCTRINE OF ULTRA VIRES 

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One of the great innovations - or it has been heralded as such - of the CA 2014 is that it has abolished the ultra vires doctrine. You might wonder: in that case, do I need to know about that doctrine at all? First, because a popular question for the last number of years has been one which asks you to discuss whether ultra vires has been abolished; second, because the ultra vires doctrine is only abolished in relation to private companies limited by shares. It remains for DACs and PLCs. This course - and the FE1 company exam - has always only been concerned with LTDs, but with this new addition of the DAC, we still don't know yet if the exam might feature a question on a DAC, in which case, the ultra vires doctrine will still be required knowledge. We looked at DACs previously, the objects in the memo set out the legal parameters in which a company must act. Any transaction which is beyond the objects in the memorandum is deemed to be outside the company’s powers, or ultra vires. If so, the act is invalid (or void) in law and has no legal effect. The objects are entirely a matter for the promoters, and they can insert any object they wish so long as it is lawful. The rationale firstly, is to protect members so they know the purpose to which their money would be applied. Secondly, is the protection of outside creditors, who could discover from the objects clause the extent of the company’s powers and ensure that the company funds are not dissipated in unauthorised activities. Before we get into that, let us look at the new state of affairs for the LTD. It now has the same capacity to contract as a natural person. This is set out in s 38 of CA 2014. It states that a company shall have, (whether acting inside or outside of the State) (a) full and unlimited capacity to carry on and undertake any business or activity, do any act or enter into any transaction; and (b) for the purposes of paragraph (a), full rights, powers and privileges. Section 39(1) of CA 2014 states: Where the board of directors of a company authorises any person as being a person entitled to bind the company ... the company may notify the Registrar ... and the Registrar shall register the authorisation. Section 39(2) of CA 2014 states: A person so authorised ... is referred to in this Act as a "registered person"; where, in a provision of this Act, that expression appears without qualification, it shall be taken as a reference to a registered person authorised by the board of the directors of the company. Section 39(3) of CA 2014 states: Where the board of directors of a company revokes an authorisation of a person as a person entitled to bind the company ... the person shall, notwithstanding that revocation, continue to be regarded for the purposes of this Act as a registered person unless and until the company notifies the Registrar in the prescribed form of that revocation. Section 39(4) of CA 2014 states: References in this section to a person's entitlement to bind the company are references to his or her authority to exercise any power of the company and to authorise others to do so. Section 39(5) of CA 2014 states: "power of the company" does not include— (a) any power of management of the company exercisable by its board of directors (as distinct from any power of the board to enter into transactions with third parties), or (b) a power of the company which this Act requires to be exercised otherwise than by its board of directors. Section 39(6) of CA 2014 states: For the avoidance of doubt, for the purposes of this section the provisions of a company's constitution with regard to a person's office or powers shall not, in themselves, be taken as an authorisation by the board of the directors of the company of the person as a person entitled to bind the company (i.e. the person must be registered with the CRO).

Regulation 6 of the First EU Directive on Company Law

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In the previous legislation, third parties were protected to some extent by s 8 of CA 1963 and also by an EU directive which was implemented in Ireland by Statutory Instrument (S.I.) 163 of 1973 (the EC Companies Regulations 1973, Regulation 6). The enactment of CA 2014 does not effect this Regulation. It continues in force, though it might not be as necessary now, given the changes brought about by s 38 and s 973. Regulation 6 states that: (1) In favour of a person dealing with a company in good faith, any transaction entered into by an 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 ... 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 shown. (3) For the purposes of this Regulation, the registration of a person authorised to bind the company shall be effected by delivering to the Registrar of Companies a notice giving the name and designation of the person concerned. The concept of dealing in good faith has received consideration in the English courts. In [4-10] International Sales Agencies Ltd v Marcus,1 it was held that: "good faith ... will not be found ... in proof of his actual knowledge that the actual transaction was ultra vires the company or where it can be shown that such a person could not in view of all the circumstances have been unaware that he was a party to an ultra vires contract." Regulation 6 only applies where the outsider deals with the board of directors or a person registered under the regulations. Thus, reg 6 could not be relied upon if an outsider dealt with a body whom he mistakenly thought was the board of directors. (In these circumstances, he may still be able to rely upon the doctrine of ostensible authority.

THE CONSEQUENCE FOR A DAC OF ACTING ULTRA VIRES 

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In the old days, it used to be possible for a private company to act beyond its powers. Now, given section 38 for LTDs and section 973 for DACs, the landscape has changed. Even if a DAC does act beyond its objects, s 973 says that the act can be ratified by special resolution and that the company can pursue the directors for having permitted the transaction to go ahead. In the old days, the transaction was simply void. Not so anymore. Ashbury Railway Carriage and Iron Company v Riche (1875) – the company was incorporated with, inter alia, the object of making and selling railway carriages. w/o regard to the company’s objects, the directors purported to construct a railway line. They subsequently claimed they were not bound by the agreement because the entire transaction was ultra vires the objects clause. The House of Lords held that because the memorandum was a public document, all persons were deemed to have constructive notice of its contents. It was held that the contract was ultra vires, void and unratifiable by the shareholders. Re Job Beaufort (London) Limited (1953) – the company was engaged in manufacturing veneer panels, which was not authorised by the objects. They ordered fuel from a fuel merchant. Since the co’s notepaper indicated that it was in the business of manufacturing veneer panels, the fuel merchant was held to be actually aware that the fuel would be used for that purpose, and thus was assumed to have constructive notice of the ultra vires purpose of the fuel contract.

INTERPRETING OBJECTS CLAUSES 1 [1982] 3 All ER. 9

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As a result of this harsh approach to acting ultra vires, lawyers began drafting very lengthy objects clauses, a process which was upheld in Cotman v Broughman (1918). However, the courts developed the ‘main objects rule’, which meant that the main objects would be found, and all ancillary objects would only be valid to the extent that they fitted with the main objects. This rule was then followed by the ‘independent objects clause’ which was developed by lawyers. This was inserted into the memorandum which stated that each sub-clause was independent and not to be read in terms of the other objects clauses. Another device frequently used is the Bell House Clause, named after a case called Bell Houses Limited v City Wall Properties (1966). This clause empowers directors to enter into any contract which they consider advantageous to the company. In the Bell House case it was stated that all that was necessary for the act to be intra vires was that the directors hold a bona fide opinion that the activity be advantageous. Northern Bank Finance Corp v Quinn (1979) – this case suggests that the decision reached by the directors must be reached “reasonably”. In this case the company gave a guarantee to the plaintiff in respect of a loan to one of its directors. The company contained a Bell House type clause. Keane J held that the giving of the guarantee could not reasonably be regarded as ancilliary to the company’s main business nor was it advantageous to the company.

‘OBJECTS’ V ‘POWERS’ The Distinction 

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In some cases, the courts may conclude that a clause in a memorandum is not an object, but a power which the company has to achieve its objects. Keane offers the following examples of incidental powers; to employ labour/borrow/contract for the purpose of supplies bonuses or pensions. It was historically the case that a distinction had no effect and the transaction was simply ultra vires and void. However, recently, a substantial change in the views of the courts can be seen. The case below is the seminal case on this distinction. Rolled Steel Products v British Steel Corporation (1985) – this case involved the giving on guarantees and it was held that while this could constitute the objects of the company, in this case it was an ancillary power and not a substantive object. Slade LJ accepted that a company could have an independent objects clause, which meant each object be consider independently. Thus each clause must be treated as containing a substantive object unless either (i) the subject of this sub-paragraph is by its nature incapable of constituting a substantive object or (ii) the wording of the memo shows expressly or by implication that the sub-clause was intended merely to constitute an ancilliary power only’. However, in this case, not even the presence of a separate objects clause can “save” what purports to be an object from being construed as a power “if in fact that is what it is”.

Powers can only be exercised for the benefit of the company   

Courtney points out the most common limitation on pwers is that they are exercisable only ‘as may seem expedient for the futherance of the objects of the company’. There must be a commercial benefit to the company. Even if there is no express condition to this effect, there will always be an implied condition that the power be exercised in this way. This was affirmed by Slade LJ in Rolled Steel, where it was held that the giving of the guarantees by one co to another could not be deemed for the benefit of the first company.

Consequences of failing to exercise power for the benefit of the company

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The law here can be divided into the old school of thought and the new school. The old school of thought states that a power exercised in a way which does not benefit the company is an ultra vires act. An example can be seen in this case below. Introductions Ltd v National Provincial Bank Ltd (1970) – the co went into the pig breeding business even though its main objects were the provision of tourists services. The co borrowed money for this, which it had a power to do in the memorandum. The bank was aware of the objects and its new line of business. The business went into liquidation. The co claimed that the loan was ultra vires. The bank argued that the co had the power to borrow, but the court held that this power was used for ultra vires activities. Thus, the loan was held to be ultra vires. The new school of thought however, takes an entirely different approach. This school states that the use of a power in this way is not ultra vires the capacity of the company but is an abuse of the director’s powers, since the directors must always act bona fide and in the interests of the co. Thus, if an outsider dealing with the co is unaware of this abuse, the contract will be unenforceable against the company. See the seminal case below. Rolled Steel – 2 directors of the PL co caused the co to give a guarantee with a supporting charge to another company owned by one of the directors. It was held that this was not a proper exercise of the power in question. However, the court held that the exercise of this power did not effect the capacity of the co to guarantee. He said such an action could constitute an abuse of the director’s powers but was not ultra vires. This distinction was subsequently accepted in Ireland in the following case. Parkes & Sons v Hong Kong and Shanghai Bank – In this case the plaintiff co gave a guarantee and supprorting charge to the def bank in relation to monies owed by another company. Blayney J accepted that “while a disposition in such circumstances may constitute a breach of duty on the part of the directors, it does not follow that it would be ultra vires the company.” This distinction was recognised in the SC in the case of Re Fredricks Inns Ltd (1994). The result of the new school means that wherea an outsider enters into a transaction with a company and is not aware of the abuse of power, the transaction will be enforceable. This is a general principle that an outsider is entitled to presume that the directors are acting properly and regularly in relation to the internal management of the company’s affairs. If however, the outsiders are aware of the abuse or the internal irregularity, they may be estopped from denying the transaction is valid.

When can it be said a power is being exercised for the benefit of the company? 

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It is sometimes difficult to say whether the exercise of a power is for the benefit of the company. We can see an example of a situation where the giving of guarantees was deemed to be valid in this case below. Re PMPA Garages (Longmile) Ltd et al (1992) – a number of companies in the group gave guarantees in favour of one member of the group (PMPS) in return for a loan to some of the guaranteeing companies. The court recognised that the giving of guarantees could be an onject but in this case it was a mere power. Murphy J decided that in a group situation like this one, guaranteeing loans was understandable and, as a matter of law, justifiable because of the particular relationship between the various companies within the group and the fact that the others received a commercial benefit. In particular he noted there was a “one for all and all for one” relationship between the various companies. However, this decision could be contrasted with the case below. However, this decision should be contrasted with Re Fredrick’s Inns – a group of companies under common ownership were indebted to the Revenue. It was agreed that the pubs would be

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sold to pay off some of the revenue debts of the group as a whole. The payments went above and beyond what the 3 companies themselves owed, and the revenues went to pay for the tax liabilities of 6 other companies who were in the same group. Lardner J sated that these constituted ex gratia payments to 3rd parties for no consideration and, in the absence of evidence that they benefited the companies, were ultra vires the capacity of the company. He held that the payment was ultra vires because – ‘(a)…it effected a gratuitous reduction or alientation of its assets and (b) it was done when the company was insolvent’. This decision was upheld by the Supreme Court and Blayney J pointed out that the payments were ultra vires as they were not within contemplation of the objects that were relied upon by the Revenue Commissioners.

GRATUITOUS DISPOSITIONS  

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Generally speaking, any transaction which purports to give away a company’s assets will be deemed suspect. The first issue is whether there is an express object or power allowing for such a transaction. A company’s objects can be drafted so as to allow these types of dispositions. If a co does contain an express power or object to make gratuitous dispositions, then any payment to this effect will not be ultra vires even if they do not benefit the company. That said, it seems that there may be a limitation on these express objects or powers. The courts will strictly construe the objects and powers and will only deem them capable of allowing gratuitous dispositions where it is clearly stated. In Re Fredricks inns the Revenue tried to argue that the payments to them were allowed in the companies memo. If there is no express power object allowing for gratuitous dispositions, it will be very difficult to argue that there is an implied power allowing for them unless there is a clear benefit to back the company. A key case is Re Horsley & Weight Ltd - the former director of a carpentry business was given a £10,000 retirement pension policy by the new directors. Soon after his retirement the company went into liquidation and the liquidator sought to recover that money as an ultra vires act. The Court said that the giving of the policy might have been misfeasance if the company had been "doubtfully solvent" on the date it was granted but this was not the case and the liquidator's suspicion that the company could not afford it was "largely based on hindsight. Buckley LJ stated that "[t]he objects of a company do not need to be commercial; they can be charitable of philanthropic; indeed, they can be whatever the original incorporators wish, provided that they are legal. Nor is there any reason why a company should not part with its funds gratuitously or for noncommercial reasons if to do so is within its declared objects Parke v Daily News Limited (1962) – the PL sold its newspaper business for £2 million. It purported to give £1.5 million to its employees in redundancy and pension payments. It was held that there was no implied power in the objects to make these payments as they were not “reasonably incidental or consequential” upon the company’s objects. Hutton v West Cork Railway (1883) – it was held that it is possible to have an implied power to give away assets, but only if this results in a benefit of sorts. Bowen LJ held that as long as a company is solvent there may be no problem with, for example, charitable donations if they were tantamount to public relations. However in this case an implied power to give gratuities to servants or employees was denied. Whilst there may have been a tangible benefit in terms of goodwill, the company was insolvent at the time and thus it could not be said that the company benefited. Finally, it must be made clear that if there is not express objects or power allowing gratuitous disposition and the company does not benefit from the disposition then the transaction will be

deemed ultra vires. This is notwithstanding the fact that the shareholders might all have assented to the transaction. This was made clear in the case below.  Re Greendale Developments Ltd (1998) – a company paid one of its directors £435,000. When the company was being wound up the liquidator sought the return of the monies. Keane J pointed out there was no object or power authorising the payment in question. The director argued that the payment had been made with the assent of all the shareholders and there was no evidence that the company had been insolvent at the time. Keane J accepted the principle (originally established in Buchanan v McVey (1954) that where all the corporators agree to a certain course of action, such an act is valid subject to 2 prere...