DOCTRINE OF ULTRA VIRES-EFFECTS AND EXCEPTIONS

CONCEPT

The object clause of the Memorandum of the company contains the object for which
the company is formed. An act of the company must not be beyond the objects
clause, otherwise it will be ultra vires and, therefore, void and cannot be ratified
even if all the members wish to ratify it. This is called the doctrine of ultra vires,
which has been firmly established in the case of Ashtray Railway Carriage and Iron
Company Ltd v. Riche. Thus the expression ultra vires means an act beyond the
powers. Here the expression ultra vires is used to indicate an act of the company
which is beyond the powers conferred on the company by the objects clause of its
memorandum. An ultra vires act is void and cannot be ratified even if all the directors
wish to ratify it. Sometimes the expression ultra vires is used to describe the
situation when the directors of a company have exceeded the powers delegated to
them. Where a company exceeds its power as conferred on it by the objects clause of
its memorandum, it is not bound by it because it lacks legal capacity to incur
responsibility for the action, but when the directors of a company have exceeded the
powers delegated to them. This use must be avoided for it is apt to cause confusion
between two entirely distinct legal principles. Consequently, here we restrict the
meaning of ultra vires objects clause of the company’s memorandum.

Basic principles included the following:

1. An ultra vires transaction cannot be ratified by all the shareholders, even if

they wish it to be ratified.
2. The doctrine of estoppel usually precluded reliance on the defense of ultra
vires where the transaction was fully performed by one party
3. A fortiori, a transaction which was fully performed by both parties could not
be attacked.
4. If the contract was fully executory, the defense of ultra vires might be raised
by either party.
5. If the contract was partially performed, and the performance was held to be
insufficient to bring the doctrine of estoppel into play, a suit for quasi
contract for recovery of benefits conferred was available.
6. If an agent of the corporation committed a tort within the scope of his or her
employment, the corporation could not defend on the ground the act was
ultra vires.

ORIGIN AND DEVELOPMENT

Doctrine of ultra vires has been developed to protect the investors and creditors of
the company. The doctrine of ultra vires could not be established firmly until 1875
when the Directors, &C., of the Ashbury Railway Carriage and Iron Company (Limited)
v Hector Riche, (1874-75) L.R. 7 H.L. 653 was decided by the House of Lords. A
company called “The Ashbury Railway Carriage and Iron Company,” was
incorporated under the Companies Act, 1862. Its objects, as stated in the
Memorandum of Association, were “to make, and sell, or lend on hire, railway
carriages and waggons, and all kinds of railway plant, fittings, machinery, and
rolling-stock; to carry on the business of mechanical engineers and general
contractors ; to purchase, lease, work, and sell mines, minerals, land, and buildings;
to purchase and sell, as merchants, timber, coal, metals, or other materials, and to
buy and sell any such materials on commission or as agents.” The directors agreed
to purchase a concession for making a railway in a foreign country, and afterwards
(on account of difficulties existing by the law of that country), agreed to assign the
concession to a Société Anonyme formed in that country, which société was to
supply the materials for the construction of the railway, and to receive periodical
payments from the English company.

The objects of this company, as stated in the Memorandum of Association, were to

supply and sell the materials required to construct railways, but not to undertake
their construction. The contract here was to construct a railway. That was contrary
to the memorandum of association; what was done by the directors in entering into
that contract was therefore in direct contravention of the provisions of the Company
Act, 1862

It was held that this contract, being of a nature not included in the Memorandum of
Association, was ultra vires not only of the directors but of the whole company, so
that even the subsequent assent of the whole body of shareholders would have no
power to ratify it. The shareholders might have passed a resolution sanctioning the
release, or altering the terms in the articles of association upon which releases
might be granted. If they had sanctioned what had been done without the formality
of a resolution, that would have been perfectly sufficient. Thus, the contract entered
into by the company was not a voidable contract merely, but being in violation of the
prohibition contained in the Companies Act , was absolutely void. It is exactly in the
same condition as if no contract at all had been made, and therefore a ratification of
it is not possible. If there had been an actual ratification, it could not have given life
to a contract which had no existence in itself; but at the utmost it would have
amounted to a sanction by the shareholders to the act of the directors, which, if
given before the contract was entered into, would not have made it valid, as it does
not relate to an object within the scope of the memorandum of association. 

Later on, in the case of Attorney General v. Great Eastern Railway Co.4, this doctrine
was made clearer. In this case the House of Lords affirmed the principle laid down in
Ashbury Railway Carriage and Iron Company Ltd v. Riche5 but held that the doctrine
of ultra vires “ought to be reasonable, and not unreasonable understood and applied
and whatever may fairly be regarded as incidental to, or consequential upon, those
things which the legislature has authorized, ought not to be held, by judicial
construction, to be ultra vires.”

The doctrine of ultra vires was recognised in Indian the case of Jahangir R. Mod i v.
Shamji Ladha and has been well established and explained by the Supreme Court in
the case of A. Lakshmanaswami Mudaliar v. Life Insurance Corporation Of India8.
Even in India it has been held that the company has power to carry out the objects
as set out in the objects clause of its memorandum, and also everything, which is
reasonably necessary to carry out those objects.9 For example, a company which
has been authorized by its memorandum to purchase land had implied authority to
let it and if necessary, to sell it.However it has been made clear by the Supreme
Court that the company has, no doubt, the power to carry out the objects stated in
the objects clause of its memorandum and also what is conclusive to or incidental to
those objects, but it has no power to travel beyond the objects or to do any act which
has not a reasonable proximate connection with the object or object which would only
bring an indirect or remote benefit to the company.

To ascertain whether a particular act is ultra vires or not, the main purpose must
first be ascertained, then special powers for effecting that purpose must be looked
for, if the act is neither within the main purpose nor the special powers expressly
given by the statute, the inquiry should be made whether the act is incidental to or
consequential upon. An act is not ultra vires if it is found:

(a) Within the main purpose, or

(b) Within the special powers expressly given by the statute to effectuate the main
purpose, or
(c) Neither within the main purpose nor the special powers expressly given by the
statute but incidental to or consequential upon the main purpose and a thing
reasonably done for
effectuating the main purpose.
The doctrine of ultra vires played an important role in the development of corporate
powers. Though largely obsolete in modern private corporation law, the doctrine
remains in full force for government entities. An ultra vires act is one beyond the
purposes or powers of a corporation. The earliest legal view was that such acts were
void. Under this approach a corporation was formed only for limited purposes and
could do only what it was authorized to do in its corporate charter.

This early view proved unworkable and unfair. It permitted a corporation to accept
the benefits of a contract and then refuse to perform its obligations on the ground
that the contract was ultra vires. The doctrine also impaired the security of title to
property in fully executed transactions in which a corporation participated.
Therefore, the courts adopted the view that such acts were voidable rather than
void and that the facts should dictate whether a corporate act should have effect.

Over time a body of principles developed that prevented the application of the ultra
vires doctrine. These principles included the ability of shareholders to ratify an ultra
vires transaction; the application of the doctrine of estoppel, which prevented the
defense of ultra vires when the transaction was fully performed by one party; and
the prohibition against asserting ultra vires when both parties had fully performed
the contract. The law also held that if an agent of a corporation committed a tort
within the scope of the agent's employment, the corporation could not defend on the
ground that the act was ultra vires.

Despite these principles the ultra vires doctrine was applied inconsistently and
erratically. Accordingly, modern corporation law has sought to remove the
possibility that ultra vires acts may occur. Most importantly, multiple purposes
clauses and general clauses that permit corporations to engage in any lawful
business are now included in the articles of incorporation. In addition, purposes
clauses can now be easily amended if the corporation seeks to do business in new
areas. For example, under traditional ultra vires doctrine, a corporation that had as
its purpose the manufacturing of shoes could not, under its charter, manufacture
motorcycles. Under modern corporate law, the purposes clause would either be so
general as to allow the corporation to go into the motorcycle business, or the
corporation would amend its purposes clause to reflect the new venture.

State laws in almost every jurisdiction have also sharply reduced the importance of
the ultra vires doctrine. For example, section 3.04(a) of the Revised Model Business
Corporation Act, drafted in 1984, states that "the validity of corporate action may
not be challenged on the ground that the corporation lacks or lacked power to act."
There are three exceptions to this prohibition: it may be asserted by the corporation
or its shareholders against the present or former officers or directors of the
corporation for exceeding their authority, by the attorney general of the state in a
proceeding to dissolve the corporation or to enjoin it from the transaction of
unauthorized business, or by shareholders against the corporation to enjoin the
commission of an ultra vires act or the ultra vires transfer of real or personal
property.

Government entities created by a state are public corporations governed by

municipal charters and other statutorily imposed grants of power. These grants of
authority are analogous to a private corporation's articles of incorporation.
Historically, the ultra vires concept has been used to construe the powers of a
government entity narrowly. Failure to observe the statutory limits has been
characterized as ultra vires.

In the case of a private business entity, the act of an employee who is not authorized
to act on the entity's behalf may, nevertheless, bind the entity contractually if such
an employee would normally be expected to have that authority. With a government
entity, however, to prevent a contract from being voided as ultra vires, it is normally
necessary to prove that the employee actually had authority to act. Where a
government employee exceeds her authority, the government entity may seek to
rescind the contract based on an ultra vires claim.

EFFECT OF ULTRA VIRES TRANSACTIONS

A contract beyond the objects clause of the company’s memorandum is an ultra

vires contract and cannot be enforced by or against the company as was decided in
the cases of In Re, Jon Beaufore (London) Ltd ., (1953) Ch. 131, In S. Sivashanmugham
And Others v. Butterfly Marketing PrivateLtd., (2001) 105 Comp. Cas Mad 763,

A borrowing beyond the power of the company (i.e. beyond the objects clause of the
memorandum of the company) is called ultra vires borrowing.

However, the courts have developed certain principles in the interest of justice to
protect such lenders. Thus, even in a case of ultra vires borrowing, the lender may be
allowed by the courts the following reliefs:

(1) Injunction --- if the money lent to the company has not been spent the lender can
get the injunction to prevent the company from parting with it.
(2) Tracing--- the lender can recover his money so long as it is found in the hands of
the company in its original form.
(3) Subrogation---if the borrowed money is applied in paying off lawful debts of the
company, the lender can claim a right of subrogation and consequently, he will
stand in the shoes of the creditor who has paid off with his money and can sue the
company to the extent the money advanced by him has been so applied but this
subrogation does not give the lender the same priority that the original creditor may
have or had over the other creditors of the company.

EXCEPTIONS TO THE DOCTRINE OF ULTRA VIRES

There are, however, certain exceptions to this doctrine, which are as follows:
1. An act, which is intra vires the company but outside the authority of the directors
may be ratified by the shareholders in proper form.20
2. An act which is intra vires the company but done in an irregular manner, may be
validated by the consent of the shareholders. The law, however, does not require
that the consent of all the shareholders should be obtained at the same place and in
the same meeting.
3. If the company has acquired any property through an investment, which is ultra
vires, the company’s right over such a property shall still be secured.
4. While applying doctrine of ultra vires, the effects which are incidental or
consequential to the act shall not be invalid unless they are expressly prohibited by
the Company’s Act.
5. There are certain acts under the company law, which though not expressly stated
in the memorandum, are deemed impliedly within the authority of the company and
therefore they are not deemed ultra vires. For example, a business company can
raise its capital by borrowing.
6. If an act of the company is ultra vires the articles of association, the company can
alter its articles in order to validate the act.

CASE NOTES:

Eley v The Positive Government Security Life Assurance Company, Limited,

(1875-76) L.R. 1 Ex. D. 88

It was held that the articles of association were a matter between the shareholders
inter se, or the shareholders and the directors, and did not create any contract
between the plaintiff and the company and article is either a stipulation which
would bind the members, or else a mandate to the directors. In either case it is a
matter between the directors and shareholders, and not between them and the
plaintiff. 
The Directors, &C., of the Ashbury Railway Carriage and Iron Company
(Limited) v Hector Riche, (1874-75) L.R. 7 H.L. 653.

The objects of this company, as stated in the Memorandum of Association, were to

supply and sell the materials required to construct railways, but not to undertake
their construction. The contract here was to construct a railway. That was contrary
to the memorandum of association; what was done by the directors in entering into
that contract was therefore in direct contravention of the provisions of the Company
Act, 1862

It was held that this contract, being of a nature not included in the Memorandum of
Association, was ultra vires not only of the directors but of the whole company, so
that even the subsequent assent of the whole body of shareholders would have no
power to ratify it. The shareholders might have passed a resolution sanctioning the
release, or altering the terms in the articles of association upon which releases
might be granted. If they had sanctioned what had been done without the formality
of a resolution, that would have been perfectly sufficient. Thus, the contract entered
into by the company was not a voidable contract merely, but being in violation of the
prohibition contained in the Companies Act , was absolutely void. It is exactly in the
same condition as if no contract at all had been made, and therefore a ratification of
it is not possible. If there had been an actual ratification, it could not have given life
to a contract which had no existence in itself; but at the utmost it would have
amounted to a sanction by the shareholders to the act of the directors, which, if
given before the contract was entered into, would not have made it valid, as it does
not relate to an object within the scope of the memorandum of association. 

Shuttleworth v Cox Brothers and Company (Maidenhead), Limited, and Others,

[1927] 2 K.B. 9

It was held that

 the contract, if any, between the plaintiff and the company contained in the
articles in their original form was subject to the statutory power of alteration
and
 if the alteration was bona fide for the benefit of the company it was valid and
there was no breach of that contract;

 there was no ground for saying that the alteration could not reasonably be
considered for the benefit of the company;
  there being no evidence of bad faith, there was no ground for questioning the
decision of the shareholders that the alteration was for the benefit of the
company; and,

 the plaintiff was not entitled to the relief claimed. 

In Re New British Iron Company, [1898] 1 Ch. 324

It was held that the article is not in itself a contract between the company and the
directors; it is only part of the contract constituted by the articles of association
between the members of the company inter se. But where on the footing of that
article the directors are employed by the company and accept office the terms of art.
62 are embodied in and form part of the contract between the company and the
directors. Under the article as thus embodied the directors obtain a contractual right
to an annual sum of 1000l as remuneration. It was held also that although these
provisions in the articles were only part of the contract between the shareholders
inter se, the provisions were, on the directors being employed and accepting office
on the footing of them, embodied in the contract between the company and the
directors; that the remuneration was not due to the directors in their character of
members, but under the contract so embodying the provisions; and that, in the
winding-up of the company, the directors were entitled to rank as ordinary
creditors in respect of the remuneration due to them at the commencement of the
winding-up. 

Rayfield v Hands and Others, [1957 R. No. 603.]

Field-Davis Ltd. was a private company carrying on business as builders and

contractors, incorporated in 1941 under the Companies Act, 1929 , as a company
limited by shares, having a share capital of £4,000, divided into 4,000 ordinary
shares of £1 each, of which 2,900 fully-paid shares had been issued. The plaintiff,
Frank Leslie Rayfield, was the registered holder of 725 of those shares, and the
defendants, Gordon Wyndham Hands, Alfred William Scales and Donald Davies were
at all material times the sole directors of the company. The plaintiff was a
shareholder in a company. Article 11 of the articles of association of the company
required to inform the directors of his intention to transfer shares in the company,
and which provided that the directors “will take the said shares equally between
them at a fair value.” In accordance with this the plaintiff so notified the directors,
who contended that they need not take and pay for the plaintiff’s shares, on the
ground that the articles imposed no such liability upon them.
The plaintiff’s claimed for the determination of the fair value of his shares, and for
an order that the directors should purchase such shares at a fair value. It was found
that the true construction of the articles required the directors to purchase the
plaintiff’s shares at a fair price. Article 11 is concerned with the relationship
between the plaintiff as a member and the defendants, not as directors, but as
members of the company.

Guinness v Land Corporation of Ireland, (1883) L.R. 22 Ch. D. 349

The Land Corporation of Ireland, Limited , was incorporated under the Companies
Act on the 12th of July, 1882, as a company limited by shares. By the memorandum of
association of a company limited by shares it was stated that the objects of the
company were, the cultivation of lands in Ireland , and other similar purposes there
specified, and to do all such other things as the company might deem incidental or
conducive to the attainment of any of those objects.

The 8th clause of the articles of association, provided that the capital produced by the
issue of B shares shall, so far as is necessary, be applied in making good to the
holders of A shares the preferential dividend of £5 per cent., which they are to
receive on the amounts paid up on their shares. This action was brought by one of
the B shareholders on behalf of himself and the others, to restrain the directors from
issuing any A shares on the footing of their being entitled to the benefit of that
article, and to restrain the directors from applying in accordance with it the capital
arising from the B shares.

It was held that the application of the B capital provided for by the articles is not an
application of capital to carrying on the business of the company, but is providing an
inducement to people to take shares and subscribe capital to carry on the business
and that article 8 was invalid, as it purported to make the B capital applicable to
purposes not within the objects of the company as defined by the memorandum of
association, and in a way not incidental or conducive to the attainment of those
objects, and that the directors must be restrained from acting upon it. The articles of
association of a company cannot, except in the cases provided for by sect. 12 of the
Companies Act, 1862 , modify the memorandum of association in any of the
particulars required by the Act to be stated in the memorandum. 

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