Doctrine of Ultra Vires

Introduction

Ultra Vires is a Latin term and translates to ‘beyond the powers’. The term is used for acts done by a company beyond the powers prescribed in the object clause of the memorandum of association or the articles of association. Such an act is not simply beyond the authority of the directors but beyond the capacity of the company itself. Hence, it is treated as nullity by law and has no effect whatsoever.

Definitions

1. Articles of Association

The Articles of Association (“the articles”) of a company is a document containing the regulations for the management of the company [Section 5(1) of the Act]. It is the user manual according to which the company operates. The articles must be in the forms specified in Tables F. G, H, I and J in Schedule I of the Act, according to the type of the company [Section 5(6) of the Act];

Company limited by shares – Table F
Company limited by guarantee and not having share capital – Table G
Company limited by guarantee and having a share capital – Table H
Unlimited company and having share capital – Table I

2. Memorandum of Association

The Memorandum of Association (“the memorandum”) of a company is a document that regulates the external affairs of the company and complements the articles. According to Section 4 of the Act, the memorandum must state the following;

Name of Company – suffixed with “Limited” or “Private Limited”. This is not applicable to Section 8 companies (i.e., not-for-profit companies).
Location – state in which the registered office is located.
Objects – for which the company is proposed to be incorporated.
Liability of the members – whether limited or unlimited and other details.
Subscription – for company limited by shares, the amount of share capital and division into shares of fixed amount; subscribers agree to subscribe to not less than 1 share.
One Person Company – who will become member in the event of death of the subscriber.

The articles and memorandum need to be signed by all the subscribers and filed, along with other documents, with the Registrar for incorporating the company. [Section 7(1)]

Origin of Doctrine of Ultra Vires

The doctrine of ultra vires was firmly laid down in the case of Ashbury Railway Carriage and Iron Co. Ltd. v. Riche [(1875) 7 HL 653]. A company had been constituted with the following objects stated in its Memorandum:

To make, sell or give on hire railway carriages and wagons (Clause 3); and
To carry on the business of mechanical engineers and general contractors (Clause 4).

The directors entered into an agreement for financing the construction of a railway line in Belgium. The company passed a special resolution to ratify the contract.

The House of Lords held that the contract was ultra vires the company and void. The worlds “general contractors” did not cover the act, because these words had to be read along with the preceding words “mechanical engineers” for the company’s business. It was further held that the contract did not become valid even by the consent of all the shareholders.

The decision became the genesis of what subsequently came to be known as the “main objects rule” of construction. “For otherwise” said Lord Cairns “it would authorise the making of contract of any and every description and the memorandum in place of specifying the particular kind of business, would virtually point to the carrying on of the business of any kind whatsoever and would, therefore, be altogether unmeaning“.

Subsequently, there was a departure from strictly applying the doctrine of ultra vires by the English judiciary. In the case of Attorney General and Another v. Great Eastern Railway Company [(1880) 5 App Cas 473 HL], the House of Lords stated that the doctrine of ultra vires should be applied reasonably. According to the House, it was legitimate for a company to pursue a course of business other than the one defined as the company’s principal object, provided that the business purpose in question was reasonably incidental to the principal object. In addition, the House concluded that a company was entitled to employ any power reasonably incidental to the use of a company’s stated objects, irrespective of the fact that the power was not expressly provided for within the company’s object clause.

Evolution of Ultra Vires in India

The doctrine of ultra vires was first applied, in India, in the case of Jehangir R. Modi v. Shamji Ladha, [(1866-67) 4 Bom. HCR (1855)]. In this case, the plaintiff was the registered shareholder of 601 shares in the Financial Association of Europe and India (Limited) (“the Company”). The defendants were the original directors of the Company. It was stated in the plaint that the objects, as defined in the memorandum of the Company, did not include dealing in shares nor the purchase of the Company’s own shares. Yet, the defendants as directors did deal in shares, and thereby incurred losses on behalf of the Company, and did purchase 1,422 shares of the Company. The plaintiff prayed for the following;

Defendants to be held accountable for all dealings in shares purchased on behalf of the Company and pay all the losses incurred by the Company.
Defendants to repay to the Company all the monies of the Company spent by them in the purchase of the Company’s shares.
Shares of the Company so purchased to be entered in the register of the Company in the defendants’ names.

The defendants stated that the plaintiff was not the beneficial owner of the shares but only a trustee of them for 2 other persons and therefore, he could not maintain the suit. Further, the beneficial owners of the plaintiff’s shares were aware of the purchases made by the defendants. The defendants admitted they had dealt in shares and these dealings, till December 31, 1865, were included in the audited report and balance sheet and duly adopted by the shareholders at the general meeting. Since then, the defendants stated that they had purchased 1, 750 shares and these purchases were made in accordance with the resolution of the Board of Directors in bona fide exercise of powers conferred on them.

The Bombay High Court (“the Court”), relying on several English judgements, held that purchases by the defendants, as directors of the Company, was in the absence of authority and thus, ultra vires. The Court further held that a shareholder has a right of action against the directors of a company to compel them to restore the funds of the company when they employ the funds in transactions without any authority.

Also Read What are Corporate Crimes ?

The order was affirmed by the Supreme Court in Dr. A. Lakshamana Swami Mudaliar v. Insurance Corporation of India [1963 AIR 1185]. At an Extraordinary General Meeting (EGM) of the shareholders of the United India Life Assurance Company Ltd. (“the Company”), a resolution was passed sanctioning a donation of Rs. 2 lakhs form out of the Shareholder’s Dividend Account to a Trust proposed to be formed with the object of promoting technical and business knowledge, including the knowledge of insurance. The Company, under S.15(l)(a) of the Life Insurance Corporation Act, applied to the Tribunal for relief in respect of the payment of Rs. 2 lakhs and said that the payment was ultra vires of the powers of the company and was not reasonably necessary for controlled business. The Tribunal ordered the applicants to restore the amount. An appeal was filed in the Supreme Court against the order.

It was held that the object of the Company, i.e., “to invest and deal with funds and assets of the company upon such securities or investments”, could not authorise the making of donation and such a power was not expressly provided for by the memorandum. The act was ultra vires; it created no legal effect and could not be ratified even if all the shareholders agreed. The order of the Tribunal was upheld.

Company law allows companies to alter its objects, as defined in its memorandum, after incorporation.

1. The Companies Act, 1956

S.17 of the Companies Act, 1956 (“the Act of 1956”) laid down that the company may alter its objects to enable it to;

to attain its main purpose by new or improved means; or
to carry on some business which under existing circumstances may conveniently or advantageously be combined with the business of the company; or
to restrict or abandon any of the objects specified in the memorandum;

The procedure to be followed as per Section 18 of the Act of 1956 was that a company had to file with the Registrar

a special resolution passed by the company 1 month from the date of such resolution; or
a certified copy of the order of the Central Government made under Section 17(5) of the Act of 1956

confirming the alteration, within 3 months from the date of order together with a printed copy of the memorandum as altered. The Registrar registered the same and certified the registration under his hand within 2 months from the date of filing of such documents. The certificate was a conclusive evidence that all the requirements of the Act of 1956 with respect to the alteration and the confirmation had been complied with, and the memorandum so altered would be the memorandum of the company. Any alteration did not have effect until it has been duly registered. If the company fails to do so, all procedures connected were void and inoperative. [Section 18(1) & (2) of the Act of 1956]

2. The Companies (Amendment) Act, 1965

A Company Law Committee (“the Committee”) was constituted under the Chairmanship of Shri C.H. Bhabha for recommendations on revising the Companies Act, 1956, after World War II. The Committee had the occasion to consider the ultra vires rule in relation to the objects’ clause of the company and specially it considered whether any distinction could be made between the main and the subsidiary objects of the company. After due deliberations, the committee concluded that they were not in a position to suggest realistic measures by which any distinction could be drawn between the main and the subsidiary objects. They therefore left the matter to the responsible judgment of the management and the periodical vigilance of the shareholders. It was with the enactment of Companies Amendment Act, 1965 (“the Amendment Act of 1965”) that a distinction was made between the main objects and the subsidiary objects of the company.

Also Read Types of Companies under the Indian Company Law

By Section 13(d) of the Amendment Act of 1965, the objects of a company are divided into;

Main Objects – to be pursued by the company on its incorporation and objects incidental or ancillary to the attainment of the main objects;
Other Objects not included in sub-clause (i).

Also Read Intellectual Property Rights: Trade Secrets

3. The Companies Act, 2013

The clause of ‘other objects’ was done away with. Section 4(c) of the Act divides the objects of a company as;

Main objects;
Objects considered necessary in furtherance of the main objects.

Section 6(b) of the Act states that, save as expressly provided in the Act, any provision contained in memorandum, articles, agreement or resolution shall to the extent to which it is repugnant to the provision of this Act, become or be void.

Section 10(1) of the Act states that subject to the provisions of the Act, the memorandum and articles shall, when registered, bind the company and members to the same extent as if they respectively had been signed by the company and by each member, and contained covenants on its and his part to observe all provisions of the memorandum and of the articles. This means that subject to the provisions of the Act, the memorandum and articles have absolute binding effect and both the company and the member must operate within its provisions.

The doctrine of ultra vires is clearly mentioned in Section 245(1)(a) of the Act; the members and depositors of the company can file an application before the Tribunal on behalf of the members or depositors for restraining the company from committing an act which is ultra vires of the articles or memorandum of the company.

The memorandum can be altered by a special resolution [Section 13(1) of the Act]. The Registrar shall register any alteration of the memorandum with respect to the objects of the company and certify the registration within a period of 30 days from the date of filing of the special resolution in accordance with Section 13(6)(a) of the Act [Section 13(9) of the Act]. No alteration shall have any effect until it has been registered in accordance with the provisions of Section 13 of the Act [Section 13(10) of the Act].

4. The Companies (Amendment) Bill, 2016

The Companies (Amendment) Bill, 2016 (“the Bill”) was introduced in the Lok Sabha on March 16, 2016. It was referred to the Standing Committee on Finance on April 12, 2016. The Committee was scheduled to submit its report by the first week of the Monsoon session, 2016. However, the report has not been submitted yet. The Bill was introduced primarily to make it easier to do business in India and attract foreign investment.

The Bill proposes to substitute Section 4(1)(c) with “the company may engage in any lawful act or activity or business, or any act or activity or business to pursue any specific object or objects, as per the law for the time being in force”. Thus, the Bill makes stating specific objects in the memorandum optional, greatly reducing the significance of the doctrine of ultra vires. The memorandum and the articles constitute a company’s constitutional framework. The constitutional framework represents a binding agreement between the company and its membership. The doctrine of ultra vires provides a safeguard for the relationships between a company and its members. An act may be lawful but it may not be in the best interests of people who will be affected by that act. The scope should be reasonably restricted to benefit both the company and the members/shareholders.

The Bill also states that if the memorandum contains specific objects, it cannot pursue anything outside those objects. In such a situation, the memorandum would have to be amended through the procedure prescribed by the Act.

Conclusion

The doctrine of ultra vires was laid down by the UK courts. In India, it has been applied by the judiciary but is gradually losing strength. The doctrine of ultra vires is becoming a hurdle for economic growth as companies are coming together to form multi-industrial corporate groups.