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Doctrine Of Ultra Vires In Common Law

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Questions:

1. Doctrine of Ultra Vires in Common Law and its relevance?

2. Narrow Interpretation of Ultra Vires Concept?

3. Broad Interpretation of Ultra Vires Concept?

4. Ultra Vires abolition by Corporation Act?

5. Ultra vires doctrine abolition extent?

 

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Answers:

1. Doctrine of Ultra Vires in Common Law and its relevance

There is an agency relationship between the investors who are the real owners and the directors of the company and thereby it is imperative that the there should be limitations with regards to the decision making powers of the directors so as not to indulge in activities that the company is not formed for. A key role in this regard is played by the object clause which is part of the company’s memorandum and sheds light with regards to the company’s objective.  As a result, any action by the company which does not lie within the ambit the object clause will be categorised as ultra vires and hence considered void even though such a move or action is ratified by all the members. This is known as the doctrine of ultra vires. The literal meaning of the expression “ultra vires” denotes any action which is beyond power. Here the word “ultra” denotes beyond and “vires” denotes power. Thus, the term ultra vires captures any action by the company which is not provided by the powers given by the object clause of the company constitution.  Besides, at times, ultra vires also refers to a scenario where the company directors exceed the powers that have been delegated to them by the object clause.

This doctrine has been developed to safeguard the valid interests of the stakeholders of the company primarily shareholders and creditors. This is primarily achieved by ensuring that the investors money is not diverted to any other activity which is stated in the object clause of the memorandum of the company. As a result, the presence of this clause reassures the stakeholders that any investment made in the company would not be diverted into activities that are not sanctioned by the company memorandum.  Further, the presence of this clause informs the investors with regards to the activities towards which the company can divert money. Besides, the creditors would also be assured that the money would not be diverted into unauthorised activities and thus, would result in lower level of overall risks.  The doctrine acts as a check and balances against the diversion of assets of the company to unsanctioned activities and business which may lead the company to insolvency. It also provides guidance to directors with regards to the scope of activities that can be pursued and hence serves as a constant reminder with regards to the decision making boundary.

A leading case with regards to application of this doctrine is the Ashbury Railway Carriage and Iron Company Ltd v. Riche, (1875) L.R. 7 H.L. 653.  As per this case, the company’s object clause stated that the company was to engage in the making or selling, lending on hire wagons and carriages meant for railway transport along with various kinds of railway fittings, rolling stock, machinery and railway plaint. Additionally, the object clause authorised the company to engage in the capacity of general contracts for the purchasing and selling of various items such as coal, metal, timber etc. as merchant and earn commissions on the same. The company directors executed a contract with Riche with regards to the financing a railway line construction in Belgium, however the contract was later repudiated and hence Riche sued the company citing breach of contract. The House of Lords in this particular case opined that the contract was not in line with the objects clause and thus the given contract was considered void as the company did not have the capacity to ratify the same. Further, it was opined that if such contract are allowed to be ratified by the shareholders, then this would amount to empowering them to carry on with an action that is prohibited by the Act of Parliament.

However, with regards to Evans v. Brunner Mond & Company, (1921) Ch 359, the company dealt with conducting a business focused around manufacturing of chemicals. Further, the object clause stated that company is authorised to conduct all such businesses and activities that may be helpful or required to attain the above mentioned objectives.  The directors through a board resolution authorised the distribution of £ 100,000 to those UK universities that may assist in scientific research and education going forward. The resolution was challenged in the light of the object clause but the expenditure was held authorised as the company faced immense challenge of trained manpower and thus, this expenditure could result in easier availability of trained manpower which is critical for continued progress of the company.  As is evident from the verdict of the above case that restraint should be exhibited with regards to the implementation of the ultra vires doctrine and hence any contract that may be considered as incidental to the activities held authorised by the object clause should not be considered void unless the same is explicitly mentioned in the memorandum.  The coverage of incidental activities varies from case to case basis and also from one business to another.

2. Narrow Interpretation of Ultra Vires Concept

As per Section 25(1) of the Corporations Act the company should not carry any business that is not authorised by the requisite regulations and must not exceed the powers that have been provided by the act. Also, section 124(1) establishes a company’s legal capacity akin to that of an individual with regards to enactment contract and to sue and be sued.  Further, as per Section 125(1) and (2), this capacity of the company is not bound by any restrictions that may be stated in the company’s object clause including its constitution. As per Section 124(1), there are certain powers that are extended to the company but no for human beings. The various powers available to a corporate body are summarised below.

  • Power to issues shares and cancel the same;
     
  • Power to issue debentures and redeem them;
     
  • Power to grant options with regards to unissued shares;
     
  • Power to distribute any of the property amongst the members
     
  • Power to issue security by levying an uncalled capital charge
     
  • Power to use the company’s property to issue a floating charge
 

The verdict of the ANZ Executor & Trustee Co Ltd v Quintex Australia Ltd (1990) 8 ACLC 980 at 988 case adequately displays the effect of ultra vires doctrine with regards to the power of a corporate. As per this case, the company (Quintex Australia Ltd) had raised capital through the issuance of unsecured notes and the various subsidiaries of the company were supposed to extend guarantee with regards to the repayment of the loan. However, the company failed before the execution of guarantees by subsidiary firms. Even though ANZ demanded the execution of the guarantees by the subsidiaries, but the court ruled against the specific performance of the debt covenants.  It is noteworthy that the Corporations Law has abolished the traditional concept of ultra vires as has been discussed above since it effects the capacity of the company to take decisions. Thus, the narrow concept of ultra vires that primarily deals with company power has been eliminated thorough the alterations made in 1998.

3. Broad Interpretation of Ultra Vires Concept

The broad concept of ultra vires doctrine is expressed primarily through the company’s members and directors. The directors possess the requisite power to manage the day to day affairs of the company. Thus, indulging in any action that is contrary to the object clause of the company is not permissible in the Corporations Act 2001. This is primarily because it would lead to corporate constitution breach and thus would be regarded as a statutory contract breach as per Section 140(1). Another reason is that Section 125 deals only the capacity of the company and thus its repealing has not altered the wider concept of the given doctrine. As per Section 139, the actions of members in various meeting such as board and shareholders meeting must be conducted  in line with the provisions related to normal business way.

4. Ultra Vires abolition by Corporation Act

With regards to the Corporations law 2001 in Australia, Section 124 indicates that a company is a legal entity and thereby possess all the requisite powers to enact contracts, issue shares and be sued for the conduct.  The implementation of ultra vires doctrine tends to restrict the flexibility available with the company and thus proves to be adverse to the shareholder’s interest. As a result, the company cannot continue with profit generation opportunities if they are not defined within the object clause.  For indulging in such activities, it would be required to amend the constitution of the company which is a time consuming process and thus would be result is loss of business opportunities. Additionally, the ultra vires doctrine is prone to being misused specially by third parties for not fulfilling their contracts by citing the scope of activities lying outside the company object clause. As a result, the court opined that narrow interpretation of the ultra vires doctrine leads to unreasonable regulations on the functioning of the company. As per Section 124 and 125,  a corporate entity have constitution which highlights the objectives and the limit on exercise  of power would be eligible for application of this doctrine only when the corresponding constitution has objectives and restraints on power.

However, after the alteration in the Corporation Law in 1998, now the company does not necessarily has a constitution but the replaceable rules tend to drive the internal management. The clear distinction with regards to exercise of power by company and limitations that directors and members need to fulfil is clearly demonstrated in the Hillig v Darkinjung [2006] NSWSC 594 case. Further, for the removal of directors, the constitution required that a special majority vote needs to be held. In this case, the constitution limitation was highlighted which limited the power of the members with regards to decision making in general meeting  Also, section 125(1) was not applicable with regards to validation of removal of direction since it primarily dealt with regards to the internal company management.

In order to eliminate the restriction with regards to the corporate capacity along with that of third party, amendments were introduced in the Corporations Act. These amendments have offered choice to the companies with regards to have a constitution and continue to incorporate ultra vires doctrine as shown below.

  • The company’s constitution may limit the exercise of power. However, this could set the objectives of the company. These objectives if set with clarity and intent could enable clarity to the management with regards to the mission.Any action in contradiction to the objectives could be dealt in a similar manner as with other rules.
     
  • While executing contracts with the company, the third parties as per Section 128 cannot assume that object compliance has been done by the company in cases where the company’s actions are suspect.

5. Ultra vires doctrine abolition extent

Prior to the enactment of the Company Law Review Act 1998(Cth), any action which was in contradiction to the objects of the company would be considered as a potential breach and hence could be taken into consideration.  Through the amendments made in 1998 with regards to Section 125(1 and 2) and Section 124(2), it can be concluded that the ultra vires doctrine in the narrow sense has been diluted. The Corporations Act 2001 has provided the requisite flexibility as has been explained above by maintained the essence of ultra vires doctrine in the broader sense. Hence, the 1998 amendment is a step in the right direction that has provided the requisite flexibility while ensuring that the interests of the stakeholders are safeguarded.

 

References

Cassidy, J 2005, Corporations Law: Text and Essential Cases, The Federation Press, Australia.

Cassidy, J, 2006, Concise Corporation Laws, 5th edn, The Federation Press, Australia.

Davies, P 1997, Gower’s Principles of Modern Company Law, 6th edn, Sweet & Maxwell, London

Fitzpatrick, J, Symes, C, Veljanovski, A, and Parker, D 2011, Business and Corporations Law, 1st edn, LexisNexis Butterworths, Australia.

Lipton, P, Herzberg, A and Welsh, M 2010, Understanding Company law, 15th edn, Lawbook Co, NSW, Australia.

Sweeney, B, and O’Reilly, J, Coleman, A 2010, Law in Commerce, 4th edn, LexisNexis Butterworths, Australia.

Owusu, E and Adarkwah, S, 2009, The doctrine of ultra vires and the protection of shareholders, creditors and third parties in Ghana: a balancing act, Commonwealth Law Bulletin.

Fitzpatrick, J, Symes, C, Veljanovski, A, and Parker, D 2011, Business and Corporations Law, 1st edn, LexisNexis Butterworths, Australia, p.496.

Fitzpatrick, J, Symes, C, Veljanovski, A, and Parker, D 2011, Business and Corporations Law, 1st edn, LexisNexis Butterworths, Australia, p.504.

Owusu, E and Adarkwah, S, 2009, The doctrine of ultra vires and the protection of shareholders, creditors and third parties in Ghana: a balancing act, Commonwealth Law Bulletin, 35:3, 535-543.

Lipton, P, Herzberg, A and Welsh, M 2010, Understanding Company law, 15 edn,Lawbook Co, NSW

Cassidy, J, 2005, Corporation Law: Text and Essential Cases, The Federation Press, p103.

Cassidy, J, 2006, Concise Corporation Law, 5th edn, The Federation Press, p103.

Owusu, E and Adarkwah, S, 2009, The doctrine of ultra vires and the protection of shareholders, creditors and third parties in Ghana: a balancing act, Commonwealth Law Bulletin, 35:3, 535-543.

Cassidy, J, 2005, Corporation Law: Text and Essential Cases, The Federation Press,

itzpatrick, J, Symes, C, Veljanovski, A, and Parker, D 2011, Business and Corporations Law, 1st edn, LexisNexis Butterworths, Australia, p.505-506.Ibid.8

P, Herzberg, A and Welsh, M 2010, Understanding Company law, 15 edn, Lawbook Co, NSW, p89.

Fitzpatrick, J, Symes, C, Veljanovski, A, and Parker, D 2011, Business and Corporations Law, 1st edn, LexisNexis Butterworths, Australia, p.506-507.

Cassidy, J, 2006, Concise Corporation Law, 5th edn, The Federation Press

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