Doctrine of Ultra Vires
In the case of a company whatever is not stated in the memorandum as the objects or powers is prohibited by the doctrine of ultra vires* . As a result, an act which is ultra vires is void, and does not bind the company. Neither the company nor the contracting party can sue on it. Also, as stated earlier, the company cannot make it valid, even if every member assents to it.
The general rule is that an act which is ultra vires the company is incapable of ratification. An act which is intra vires the company but outside the authority of the directors may be ratified by the company in proper form [Rajendra Nath Dutta v. Shilendra Nath Mukherjee, (1982) 52 Com Cases 293 (Cal.)].
The rule is meant to protect shareholders and the creditors of the company. If the act is ultra vires (beyond the powers of) the directors only, the shareholders can ratify it. If it is ultra vires the articles of association, the company can alter its articles in the proper way.
The memorandum of the company in the said case defined its objects thus: “The objects for which the company is established are to make and sell, or lend or hire, railway plants............ to carry on the business of mechanical engineers and general contractors...........”.
The company entered into a contract with M/s. Riche, a firm of railway contractors to finance the construction of a railway line in Belgium. On subsequent repudiation of this contract by the company on the ground of its being ultra vires, Riche brought a case for damages on the ground of breach of contract, as according to him the words “general contractors” in the objects clause gave power to the company to enter into such a contract and, therefore, it was within the powers of the company. More so because the contract was ratified by a majority of shareholders.
The House of Lords held that the contract was ultra vires the company and, therefore, null and void. The term “general contractor” was interpreted to indicate as the making generally of such contracts as are connected with the business of mechanical engineers. The Court held that if every shareholder of the company had been in the room and had said, “That is a contract which we desire to make, which we authorise the directors to make”, still it would be ultra vires. The shareholders cannot ratify such a contract, as the contract was ultra vires the objects clause, which by Act of Parliament, they were prohibited from doing.
However, later on, the House of Lords held in other cases that the doctrine of ultra vires should be applied reasonably and unless it is expressly prohibited, a company may do an act which is necessary for or incidental to the attainment of its objects. Section 13(1)(d) of the Companies Act, 1956 [Corresponds to section 4(1)(c) of the Companies Act, 2013] provides that the objects for which the company is proposed to be incorporated and any matter considered necessary in furtherance thereof be stated in the memorandum. However, even when the matters considered necessary in furtherance of the objects are not stated, they would be allowed by the principle of reasonable construction of the memorandum.
The Supreme Court held that the payment was ultra vires the company. Directors could not spend company’s money on any charitable or general objects. They could spend for the promotion of only such charitable objects as would be useful for the attainment of the company’s own objects. It is pertinent to add that the powers vested in the Board of directors, e.g., power to borrow money, is not an object of the company. The powers must be exercised to promote the company’s objects. Charity is allowed only to the extent to which it is necessary in the reasonable management of the affairs of the company. Justice Shah held: “There must be proximate connection between the gift and the company’s business interest”. Thus “gifts to foster research relevant to the company’s activities” and “payments to widows of ex-employees on the footing that such payments encourage persons to enter the employment of the company” have been upheld as valid and intra vires.
A bank or any other person lending to a company, for purposes ultra vires the memorandum, cannot recover [National Provincial Bank v. Introductions Ltd., (1969) 1 All. E.R. 887].
Further, in the case of Bell Houses Ltd. v. City Wall Properties Limited (1966) 36 Com Cases 779, the objects clause included a power to “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.” The Court has held the same to be in order.
Corporate bona fide charitable spending under Section 181 and ultra vires rule
Section 181 of the Companies Act, 2013 authorises the Board of directors to contribute to bona fide charitable and other funds. However, prior consent of the company in general meeting, has to be obtained in order to contribute for any bona fide charitable or other purpose any amount exceeding five per cent of the average net profits for the three immediately preceding financial years.
The power of the Board as regards contribution to funds, which do directly relate to business of the company is unrestricted. It should not be inferred from the language of the section that with the consent of the company in general meeting, the board of directors may contribute to charitable funds to an unlimited extent, unless MoA and AoA authorizes such expenditure. If it does not authorize so it will be ultra vires the powers of the company.
Loans, borrowings, guarantees and ultra vires rule
An ultra vires borrowing does not create a relationship of a debtor and creditor. In a case, a company had accepted deposits from outsiders which was outside the scope of the Memorandum. When the company was ordered to be wound up, a question was raised whether the depositors were creditors of the company and whether the contributories could be asked to contribute towards payment of deposits. The Court held that the relationship between the company and the depositors was not that of debtor and creditor. But if the lender had lent the amount for discharging lawful expenses, he may recover the amount.
Whether a transaction is ultra vires the company can be decided on the basis of the following:
The powers exercisable by a company are to be confined to the objects specified in the memorandum. While the objects are to be specified, the powers exercisable in respect of them may be express or implied and need not be specified.
Every company may necessarily possess certain powers which are implied, such as, a power to appoint and act through agents, and where it is a trading company, a power to borrow and give security for the purposes of its business, and also a power to sell. Such powers are incidental and can be inferred from the powers expressed in the memorandum. [Oakbank Oil Co. v. Crum (1882) 8 App Cas 65]. The principle underlying the exercise of such powers is that a company, in carrying on the business for which it is constituted, must be able to pursue those things which may be regarded as incidental to or consequential upon that business. [See Egyptian Salt and Soda Co. v. Port Said Salt Association].
Powers which are not implied
The following powers have been held not to be implied and it is, therefore, prudent to include them expressly in the objects clauses:
Shareholder’s right in respect of ultra vires acts
An ultra vires contract is as null and void as a contract with a minor [Steel Equipment & Construction Co. (P) Ltd. Re (1968) 38 Com Cases 82, (1967) 1 Comp LJ 172 (Cal)].
A shareholder can get back the money paid by him to the company under an ultra vires allotment of shares. A transferee of shares from him would not have been so allowed. [Margarate Linz v. Electric Wire Co. of Salestine Ltd. (1948) 18 Com Cases 201, 205 : AIR 1949 PC 51].
Effects of ultra vires Transactions
(i) Void ab initio – The ultra vires acts are null and void ab initio. The company is not bound by these acts. Even the company cannot sue or be sued upon [Ashbury Railway Carriage and Iron Company v. Riche ].
Ultra vires contracts are void ab initio and hence cannot become intra vires by reason of estoppel or ratification.
(ii) Injunction: The members can get an injunction to restrain a company wherein ultra vires act has been or is about to be undertaken [Attorney General v. Gr. Eastern Rly. Co., (1880) 5 A.C. 473].
(iii) Personal liability of Directors: It is one of the duties of directors to ensure that the corporate capital is used only for the legitimate business of the company and hence if such capital is diverted to purposes alien to the company’s memorandum, the directors will be personally liable to replace it. In Jehangir R. Modi v. Shamji Ladha, [(1866-67) 4 Bom. HCR (1855)], the Bombay High Court held, “A shareholder can maintain an action against the directors to compel them to restore to the company the funds of the company that have by them been employed in transactions that they have no authority to enter into, without making the company a party to the suit”.
In case of deliberate misapplication, criminal action can also be taken for fraud.
However, a distinction must be drawn between transactions which are ultra vires the company and the transactions which are ultra vires the directors. Where the directors exceed their authority the same may be ratified by the general body of the shareholders. Provided the company has the capacity to do that transaction as per its memorandum of association.
(iv) Where a company’s money has been used ultra vires to acquire some property, the company’s right over such property is held secure and the company will be the right party to protect the property. This is because, though the property has been acquired for some ultra vires object, it represents the money of the company.
(v) Ultra vires borrowing does not create the relationship of creditor and debtor [In Re. Madras Native Permanent Fund Ltd., (1931) 1 Com Cases 256 (Mad.)].