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Doctrine of Ultra Vires in Company Law

Definition of Ultra Vires

The term “Ultra Vires” originated from a Latin phrase meaning “beyond the power.” Actions beyond the corporate charter’s ambit or most appropriately beyond the predetermined power could be cited as ultra vires. Ultra vires acts shall always exceed the limitation of power so approved or determined. It could also include legally forbidden acts subject to corporate law. Every company or organization has got its directives, article and memorandums that demarcate its actions to function efficiently.

The ultra vires doctrine originated from the landmark judgment of Ashbury Railway Carriage and Iron Co. Ltd v. Riche. The case came into existence when the company’s directors initiated a contract with Riche, a railway contractor, in order to obtain finance to construct a railway line at Belgium. However, the directors later repudiated the contract on the grounds of being ultra vires the memorandum of association. Riche sued the company on the ground of breach of contract. The House of Lords held that the contract at the time of making it was void ab initio and invalid. Therefore, being ultra vires, the contract cannot be ratified later.[1]

Memorandum of Association (MOA) and Article of Association (AOA), the two documents of a corporation, which in collaboration serves as the constitution of a company. These two corporate documents demarcate the conditions under which an organization must undertake their functions and initiate commercial relationships with the shareholders. The MOA guides the external and internal matters of an organization. In contrast, the AOA guides internal matters such as the directors’ duty and powers[2]. Government organizations and agencies are not exempted from the scope of ultra vires. Any government actions beyond the ambit of their power so granted by law could be ultra vires. If any company employee or directors use company resources outside their legal power; such an act could be defined as ultra vires.

Appropriation of revenue or shares of a company exceeding the legal ownership or using company assets for personal needs could be aptly classified as ultra vires act. The directors of a company shall be held personally liable for any ultra vires acts done by them on behalf of the company.

The provision of Section 4 (1) (c) of the Companies Act 2013 states that a company must incorporate all the MOA objectives, based on which the company came into existence along with other necessary matters responsible for its effective functioning. A detailed draft of the MOA shall prevent confusion among the company members and the company, thereby restraining any contract breach. Section 245 (1) (b) of the 2013 Act prevents the Company from committing any ultra vires acts or transactions. The section explains the members and depositors’ right to apply to the tribunal against any conduct of the company or any of its members, which could be detrimental to the company’s interest and shareholders.[3] The concerned section is a legal weapon to restrain a company’s acts and its members ultra vires transactions, which could naturally breach the objectives mentioned in their MOA and AOA.

Features of Doctrine of Ultra Vires

An ultra vires act is void, and it never binds the company. For any ultra vires act, neither the company nor the parties could sue each other. Any acts that have been clearly stated as ultra vires by the company charter could not be granted a valid intra vires status even if the company’s members assent to it. In India, the doctrine of ultra vires was applied for the first time in the leading judgment of Jahangir R. Modi v. Shamji Ladha, where the Bombay High Court held that the buying of a Joint Stock Company by the directors were ultra vires the MOA of the company as the company charter had not approved such purchase.[4] The doctrine’s objective is to make the creditors and the shareholders aware that the company’s assets and resources could only be utilized as per the MOA procedure and not beyond it. The creditor must ensure that his dealing with the company is within the scope of the MOA’s objectives and not ultra vires. In case the transaction is ultra vires, the creditor could always safeguard its interest by rescinding the transaction.

Any contract or dealings initiated based on ultra vires act will be void and such shall never bind the company nor the other party could enforce such contract.  However, the company members could bring a suit for an injunction against the company to prevent it from engaging into any ultra vires act. Any estoppel or ratification cannot turn any ultra vires contract into intra vires which holds an invalid status from the very onset.[5] Usage of company’s asset ultra vires to acquire any property would always hold the company’s right over such property intact. Any ultra vires relationship of debtor and creditor could never present a remedy in personam.

Exceptions to Doctrine of Ultra Vires

Intra vires acts include those activities that are essential for accomplishing the objectives mentioned in the object clause of the MOA, within the permissible limits of conducting a business and are authorized by the Companies Act. Excluding the activities mentioned above, the activities performed in excess of power shall be considered ultra vires within Company Law’s purview. However, there are exceptions to the conditions mentioned above, which shall be our discussion topic. They are as follows:

1. Acts or contracts ultra-vires to the Companies Act

Acts which are ultra vires the company act, if a company performs any such act or its MOA or AOA authorizes such act, it will still hold the status of void ab initio and cannot be ratified in any case. Similarly, any act which the Companies Act authorizes to be intra vires, and the MOA or AOA of a company does not mention such an act, and it will still hold such an act intra vires.[6] Therefore, while applying the doctrine, any incidental or consequential effect of an act will not be held as invalid unless the Companies Act expressly prohibits them.

2. Acts or contracts ultra-vires to the memorandum of the company

Acts or contracts that a company initiates beyond the powers provided by its MOA shall be considered ultra vires. If such activities are performed which partly persists within the scope of MOA and partly beyond the scope, then the part which is within the scope will be considered as intra vires and the other part as ultra vires. However, only if they are separable. In case they are inseparable, the entire activity will be considered ultra vires. Therefore, shall be void ab initio and cannot be granted an intra vires status even after the shareholders’ ratification.[7]

3. Acts or contracts which are ultra-vires to the Articles but intra-vires to the memorandum

The acts beyond the AOA’s powers but within the power provided by MOA, are termed as ultra vires the AOA but intra vires the MOA. However, the shareholders hold the right to ratify the ultra vires part to turn it into intra vires by altering the AOA for the same purpose.

4. Acts or contracts which are ultra-vires to the directors but intra-vires to the company

When the acts performed by the directors are beyond the powers that have been provided to them, such acts could be termed as ultra vires to the directors, but they could be intra vires to the company. However, such acts are open to ratification by the company, which could bind them.[8]

5. An irregular act or contract which is intra vires the company

The consent of the shareholders may validate such acts. However, it is not mandatory to obtain the shareholders’ consent simultaneously at the same meeting.[9]

6. Ultra vires Investment

A company retains its right over any property it acquires through an ultra vires investment.

Effects of Ultra Vires Transactions

The effects of ultra vires transaction undertaken by a company could be as follows:

1. Injunction

The company members could issue an injunction against the company to restrain it from engaging into any ultra vires activities.[10]

2. Ultra Vires Contract

It has already been mentioned earlier that ultra vires contract is the void ab initio, which cannot be provided with a valid status even by ratification or estoppel. The question here revolves around the company’s competency and authority regarding the contract but not its legality.[11]

3. Liability of the Company 

There are no certain principles concerning a company’s liability against the damages resulting from ultra vires acts. However, the tortious liability arises if it is proved with plausible evidence that the activity in the course of which the ultra vires act or the tort occurred falls within the ambit of MOA. It occurred in the course of employment.

4. Breach of Warranty

The acts that a Company cannot perform as stated under MOA, the directors being the company’s agents are also prohibited from performing such acts. Therefore the contracts that are ultra vires the company will be void. The directors must act within the ambit of the company’s power; contrary actions could hold the directors personally liable for their breach of warranty.[12]

5. Personal Liability of the Directors

In Trevor v. Whitworth, it was held that a company could never invest any of its funds for any objectives that do not come within the ambit of the objects specified in the MOA and should be utilized only for the authorized objectives.[13] If any director utilizes the company’s fund for any ultra vires investment, he could be held personally liable and refund the same to the company. Even without making the company a party to the suit, a shareholder can initiate a proceeding against an alleged director and make him restore to the company the funds he had invested without any appropriate authority. In case of intentional misuse of company fund, a suit for deceit or fraud could be brought against a director personally.[14]

Conclusion

The ultra vires doctrine safeguards the investors and the creditors’ interest. Repeated and continuous unbarred ultra vires activities within a company could be detrimental to its operability, resulting in winding up where a loss to the company is evident. Therefore, it is essential to incorporate the MOA’s objectives to protect the creditors and investors’ interests. Prevention of the ultra vires acts mostly depends on the directors while borrowing funds. It is of utmost necessity for a director to ensure that such an action must be within the company’s purview or those mentioned in MOA. The consequences of an ultra vires act would result in the directors’ liability and be effective in causing considerable losses to the investors and the creditors.

A corporation’s functioning largely depends upon this doctrine as almost every action of a corporation is being adjudged based on this principle. Albeit being uncodified for a considerable term, this doctrine has always been an evergreen one in continuing holding immense importance whenever the context of analyzing any corporate actions came into prominence. Critical analysis of a corporate action under the spotlight of the doctrine could prove resourceful for a company to determine its nature and objectives, achieve investors and creditors’ confidence, preserve the company reputation and goodwill, and safeguard any consequential or incidental losses and also in facilitating the business procedure. Implied incorporation of the doctrine under Section 245 (1) (b) of the 2013 Act further helped enhance the value and the objectives of the ultra vires concept.[15]

Abuse of power by a corporation and acting beyond the purview of its objectives often differs in the interpretation of individual cases. It must be strictly analyzed by treating each action independently based on its objectives stated in the company’s MOA and AOA. It is primarily essential to prevent such confusion. Courts must also be specific while interpreting the ultra vires and intra vires actions of a company. Therefore, corporations must incorporate their MOA objectives to avoid their members’ ultra vires actions resulting from any confusion or misinterpretation of facts. The doctrine of ultra vires has always been a perpetual remedy in restraining potential corporate crimes and frauds and shall continue holding intact importance in the long term.

References

[1] (1875) LR 7HL 653.

[2] Dr. Avtar Singh’s Company Law, (10th Ed.) p.50.

[3] Companies Act, 2013.

[4] (1867) 4 Bom HCR 185.

[5] Forrest v. Manchester etc. Rly. Co., (1861) 54 ER 803.

[6] In Re W & M Roith Ltd., (1967) 1 AII ER 427.

[7]  Chandok S, “CRITICAL ANALYSIS OF THE DOCTRINE OF ULTRA VIRES” <http://jcil.lsyndicate.com/wp-content/uploads/2016/09/Publication Submission-Simran-Chandak.pdf>

[8] Madhvan Pillai V State of Kerala AIR (1966) Kerala 214.

[9] Parker & Cooper Ltd. v. Reading, (1926) Ch 975.

[10] Attorney General v. Great Eastern Ry. Co., (1880) 5 AC 473.

[11] Ad Sait v. Bank of Mysore, (1930) 59 MLJ 28.

[12] National Provincial Bank v. Introductions Ltd., (1969) 1 AII ER 887.

[13] (1889) AC 409.

[14] Iron Traders v. Hiralal Mittal, AIR 1962 Punj 277.

[15] Mutual Guaranty Fire Ins. Co. v. Barker (i899) I07 Iowa, I43, 77 N. WV. 868.

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Amrapali Mukherjee

I have completed my Masters in Commercial and Corporate Law from the Queen Mary University of London with upper merit and a distinction in the dissertation, currently, I am working as a Legal Advisor for a partnership firm at Kolkata.


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