What is the legal position if a company enters into a business transaction which goes beyond its powers as a company or beyond the powers of the director who negotiated it?
Every registered company must have an objects clause. Towards the end of the 19th century the House of Lords decided authoritatively that nothing could be done outside the ambit of a company’s objects clause. Any contract outside the company’s objects clause would be ultra vires and void (Ashbury Railway Carriage & Iron Co v Riche (1875) LR 7 HL 653). Ultra vires was said to protect investors and creditors by ensuring that a company’s funds could be used only for stated purposes.
Businessmen, however, had other ideas and, by careful drafting of objects clauses, they were able to provide extended capacity for their companies. This is sometimes done by setting out a long list of objects. As Harman LJ said in Re Introductions Ltd [9] 1 All ER 887, “the little man starting a grocery business usually combines groceries with the power to bridge the mighty Zambesi”. Such lists would be accompanied by a statement that all the objects were main and independent (as in Cotman v Brougham [1918] AC 514) to prevent the courts cutting down the list. Another drafting technique which is used to provide that the company “can 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 businesses or the general business of the company”: see Bell Houses Ltd v City Wall Properties Ltd [1966] 2 QB 656.
At the same time, when the United Kingdom entered the European Economic Community, UK law had to be brought into line with the First EEC Directive on Company Law. This directive, among other matters, provided for the protection of third parties dealing with a company in transactions beyond the company’s capacity. Section 9(1) of the European Communities Act 1972 (now section 35 of the Companies Act 1985) provided that “in favour of a person dealing with a company in good faith, any transaction decided on by the directors is deemed to be one which it is within the capacity of the company to enter into, and the power of the directors to bind the company is deemed to be free of any limitation under the memorandum and articles”. This represented a partial abolition of the doctrine of ultra vires allowing a person dealing with a company to enforce a transaction with the company even though it was outside the company’s capacity. However, several restrictions are built into the provision.
(1)The outsider has to act in good faith, although this will be presumed (section 35(2)). Thus, for example, the outsider cannot enforce the transaction if he knows that it is ultra vires.
(2)The outsider has to be “dealing with” the company. This covers cases of contract, but it does not extend to cases of gift as here there is no dealing.
(3)Most obscurely the transaction has to be one “decided on by the directors”. This has been interpreted widely so that, if it were possible to trace a chain of delegation back to the board, then the transaction falls within the subsection. See International Sales & Agencies Ltd v Marcus [2] 3 All ER 551 and TCB Ltd v Gray [1986] 1 All ER 587. The above reform of the law was far from perfect. Ultra vires lingered on. There was still pressure on the Government and the courts to reform the law.
In Rolled Steel Products (Holdings) Ltd v British Steel Corporation [6] Ch 246 the doctrine of ultra vires was further restricted. The law of ultra vires was confined to situations where the company was acting outside its objects, and it was held that it did not cover situations where the act was within the scope of the company’s constitution, even if the transaction was entered into for the furtherance of a purpose not authorised by the company’s objects clause, eg borrowing money (permitted by the company’s constitution) for a purpose not authorised by the company’s objects clause. This would be intra vires the company (ie within its powers).
This represented one more nail in the coffin of ultra vires. The cumulative effect of these various developments was to throw into doubt the value of the doctrine.
The Government therefore set up a one-man committee (the best sort!) by commissioning a report from Dr Dan Prentice of Oxford University. He was asked to investigate the manner in which the doctrine might be reformed and to “examine the legal and commercial implications of abolishing the ultra vires rule as it applies to companies registered under the Companies Act, and to make recommendations on any legislative changes which might be necessary consequent on abolition”. The Companies Act 1989 transforms many of Dr Prentice’s recommendations into legislative form. They are likely to be brought into force in November 1990.
Under the Companies Act 1989, which inserts a new section 35 into the 1985 Act, the validity of an act done by a company is not to be called into question on the ground of a lack of capacity by reason of anything in its memorandum. The wording of the new section is surprising in that it is generally an omission in the objects clause which causes the problem rather than a statement in the objects clause or any other part of the memorandum.
There are to be exceptions to this new rule in cases where a member of the company (shareholder) seeks to restrain a company from acting ultra vires, where a director, or a director of the company’s holding company, or his associate is the person dealing with the company, or where the company is a charity.
For an examination of the law of charities see: “Mainly for Students”, September 30 1989, p 183 and October 14 1989, p 139
Proceedings by a shareholder
A shareholder may bring proceedings to restrain a company from engaging in ultra vires activities. This right is an exception to the general rule of company law known as the “rule in Foss v Harbottle” (1843) 2 Hare 461. This rule states that the proper plaintiff to take action against any wrong done to the company is the company itself, not a discontented shareholder, or collection of shareholders, of that company. (Lord Eldon laid the foundations for this rule when he stated, in Carlen v Drury (1812) 35 ER 61: “This court is not to be required, on every occasion, to take the management of every playhouse and brewhouse in the Kingdom.”) The new section 35 is, therefore, adding to the list of exceptions to this general principle of majority rule. Nevertheless, this section is, itself, subject to exceptions, for it does not allow proceedings to be brought in respect of an ultra vires activity if a binding legal obligation has already been entered into. Furthermore, since a company can now ratify an ultra vires act by special resolution (section 35(3)), this further restricts the ability of shareholders to obtain injunctive relief.
Dealings with directors
If the person dealing with the company is a director of that company, or a director of the company’s holding company, or a person connected with him, then, once again, the principle in the new section 35(1) does not apply with its full rigour.
Clearly, whenever an act is outside a company’s capacity it is also outside the actual authority of the company’s directors or officers. So far as outsiders are concerned the power of the board of directors to bind the company (or to authorise others to do so) is deemed to be free from any limitation under the company’s constitution. This is broader than the old section 35 (Companies Act 1985) in that there is no longer a requirement that the transaction should be decided on by the directors.
Further, a person may be said to be “dealing with” a company even where he is a donee. Previously it was thought that dealing with the company was limited to cases of contract.
A further reform relates to the meaning of “good faith”. Under the existing law the meaning of “good faith” is not set out although it does provide that the onus of proof is on the company to establish lack of good faith. Under the unamended section it is thought that a person would be in bad faith if he had actual knowledge of any limitation on the powers of the directors of the company. The new section 35A(2)(b) provides that a person shall not be regarded as acting in bad faith by reason only of his knowing that an act is beyond the powers of the directors under the company’s constitution. (This is a reference to the company’s articles of association as well as to its memorandum.) The question of good faith and bad faith does not arise in the case of knowledge of the company’s powers (as opposed to the directors’ powers) because, if the person dealing with the company is not one of its directors (etc), it will not generally matter that the transaction is ultra vires the company.
The new section 35 provides that limitations of the directors’ powers under the company’s constitution include limitations deriving:
(a)from a resolution of the company in general meeting or a meeting of shareholders, or
(b)from any agreement between the members of the company or any class of shareholders.
The provision is not all-embracing. It offers no protection if the act is illegal or if there is a breach of duty of which the outsider is aware. The section does not cover cases where a single director is acting, only where the board is acting. However, if one of the parties to the transaction is a director of the company, or the company’s holding company, or is connected therewith and the board of directors exceeds any limitation on its authority under the company’s constitution the director cannot rely upon section 35A.
Charitable companies
Sections 111 and 112 of the Companies Act 1989 make certain alterations to the law regarding charitable companies. The mitigation of the ultra vires rule does not apply in respect of charities, except in favour of a person who:
(a)gives full consideration, in money, or money’s worth, in relation to the act in question; and
(b)does not know that the act is not permitted by the company’s memorandum or, as the case may be, is beyond the powers of the directors, or who does not know at the time the act is done that the company is a charity.
Constructive notice
Independently of section 35A the doctrine of constructive notice is abolished. The third party need not inquire into the objects of the company, or the power of the board of directors of the company to bind the company. Section 711A(1) provides that “a person shall not be taken to have notice of any matter merely because of its being disclosed in any document kept by the registrar of companies (and thus available for inspection) or [being] made available by the company for inspection”.
However, the subsection goes on: “This does not affect the question whether a person is affected by notice of any matter by reason of a failure to make such inquiries as ought reasonably to be made.” This throws some doubt on the precise scope of the “abolition” of the doctrine of constructive notice in company law.
Objects clauses
Section 110 of the Act permits a company to state that its object is to carry on business as a general commercial company. The effect of this provision is that the object of the company will be to carry on any trade or business whatsoever and the company has power to do all such things as are incidental or conducive to the carrying on of any trade or business by it.
Furthermore, a company may be special resolution alter its memorandum with respect to the statement of the company’s objects. It will no longer be necessary to fit within the limited categories set out in the unamended section 4, which effectively restricted changes of objects clauses.
Liability of directors
It is the duty of directors to observe any limitation on their powers. The company may bring an action against directors for exceeding the capacity of the company. Such acts may be ratified by special resolution, however, and the directors may be absolved from liability by a separate special resolution.
If the Act is within the company’s objects clause but the directors are acting outside their powers then the matter may be ratified by an ordinary resolution. It may still be important therefore to distinguish objects and powers in the way set out in Rolled Steel Products (Holdings) Ltd v British Steel Corporation [6] Ch 246.
Conclusion
The Companies Act 1989 makes fundamental reforms. However, questions of the company’s capacity will still arise. It will be important where a shareholder seeks injunctive relief or where a director is dealing with the company or where the company is a charity.
It may also be important if it is necessary to determine whether the company needs to ratify an ultra vires act by special resolution or whether the act may be ratified by ordinary resolution if the act is an act beyond the powers of the directors. Ultra vires may be dead, but it will not lie down.