Dr.K.Kanag-Isvaran
President’s Counsel
One consequence of the artificial nature of a company as a legal person is that decisions for and actions by it have to be taken for it by natural persons. This is inevitable.
Decisions on behalf of a company may be taken either,
(a) by its primary organs .,
(i) the board of directors or
(ii) the members in general meeting. or
(b) by officers, agents or employees of the company.
Acts done on behalf of the company will perforce be by its officers, agents or employees.
Consequently, in either event questions may arise as to whether the decisions or acts have been taken or done in such a way that they can be attributed to the company.
Similar problems of attribution arise where the question is simply whether the company ‘knew’ about a certain fact or situation. In which event further questions arise as to whose knowledge in which circumstances should be attributed to the company? Questions relating to ‘constructive notice’ also arise.
It is in this background that the doctrine of ultra vires grew in relation to companies.
Ultra Vires is a latin expression used to describe acts undertaken beyond (ultra) the legal powers (vires) of those who have purported to undertake them.
The ultra vires doctrine when applied to ‘bodies of persons’ is used in three different senses, which have to be kept in mind.
First. – in the strict sense – namely whether an incorporated body as such has capacity to act.
Second. – even where the company is acting within its capacity , whether those who purported to act on its behalf were authorized to do so?
[ Authority to act is determined according to normal agency principles. What is contemplated here is acting in excess of authority by the company’s organs or agents and consequent focus upon the impact of the excess of authority upon the transaction between the company and the third party. Another aspect is whether the directors by exceeding their authority have acted in breach of their duty to the company.]
Third – where courts sometimes describe ultra vires as any activity which a company cannot lawfully undertake because it infringes some prohibition laid down in an Act. Such acts are really simply “unlawful” or “illegal”.
Eg., prohibition on a company returning its capital to its shareholders.
Ultra Vires acts strictly so called
The 1982 Act required all companies to have incorporated in their memorandum of association the primary objects for which the company was formed. This was called the objects clause.
The landmark decision in Ashbury Railway Carriage & Iron Co. v Riche (1875) LR 7 HL 653, the House of Lords finally decided that if a company, incorporated by or under a statute acted beyond the scope of the objects stated in the statute or in its memorandum of association such acts were void as beyond the company’s capacity even if ratified by all the members . That is, the act of the company was ultrs vires its objects clause.
[ This decision proved unpopular with the business world and several devices were adopted to circumvent it by draftsman of memorandum of association and the value of the doctrine of ultra vires as a protection for members and creditors were destroyed]
Although ultra vires transactions were said to be void, whether a third party was affected by the voidness in some circumstances depended on the state of the third party’s knowledge.
At common law ‘knowledge’ meant, not only actual knowledge about the improper purpose but also when the third party had knowledge ‘constructively’. This meant that anyone dealing with a registered company was deemed to have notice of the contents of its ‘public documents’ – which included the memorandum and articles of association. Royal British Bank v Turquand (1856)
This also meant that anyone dealing with the company was deemed to have knowledge of its objects clause.
Thus in the case of Re Jon Beauforte (London) Ltd (1953) where the company’s stated objects were to manufacture dresses, but the company had for sometime instead been making veneered panels the doctrine of constructive notice resulted in the creditors’ claims being ultra vires. This means that the creditor cannot sue the company nor would the company be able to sue the creditor on the transaction.
Abolition of the ultra vires doctrine under the Act No. 7 of 2007
The Act of 2007 (the Act) abolishes the doctrine of ultra vires in its strict sense –i.e., in relation to the company’s capacity and powers.
This it achieves in the following manner –
First – upon an application for incorporation , by requiring a person to forward certain documentation to the Registrar of Companies, as before no doubt, but no memorandum of association was required. Section 4 of the Act, relating to method of incorporation, requires inter alia, that only articles of association signed by each of the initial shareholders be provided, if it differed from the articles set out in the First Schedule to the Act. First Schedule contained model articles which could be adopted if so desired.
[ Under the 1982 Act, the required documentation included both the memorandum of association with its objects clause and the articles of association. Table A could be adopted if desired]
Second – though a memorandum of association stating the objects was not required, there is no prohibition in stating “objects of the company” in the articles of association of the company. Section 13 of the Act provided that
“ The articles of association of a company ………in
particular may provide for –
(a) the objects of the company”
The option to include objects in the articles of association was necessary because companies limited by guarantee , which are non-profit making and permitted to be formed for promoting the objects set out in Section 34 of the Act, were required to state their objects in the articles by Section 33(a). Obviously, the model articles in the First Schedule could not be adopted unless suitably modified.
Third – The effect of stating the objects in the articles is to restrict carrying on any business or activity that is not within those objects, unless the articles expressly provide otherwise.
Section 17(1) provided that –
“Where the articles of a company sets-out the objects of
the company, there shall be deemed to be a restriction
placed by the articles in carrying on any business or
activity that is not within those objects, unless the articles
expressly provide otherwise.”
Fourth – Notwithstanding the restriction placed on the business or activities the company may engage in by including in the articles an object clause, the
Act nevertheless proceeded to abolish the doctrine of ultra vires in its strict sense – i.e., as relating to capacity. This it did in Section 17
Section 17 (2) provided –
“ Where the articles of a company provide for any restriction on the business or activities in which the company may engage –
(a) the capacity and powers of the company shall not be affected by such restriction ; and
(b)no act of the company, no contract or other obligation entered into by the company and no transfer of property by or to the company, shall be invalid by reason only of the fact that it was done in contravention of such restriction”
In other words transactions will not be declared invalid by reason only of the fact that it was ultra vires the objects of the company as stated in the articles. The use of the words by “reason only of the fact that it was done in contravention of such restriction” emphasizes the position that transactions entered into by the company in contravention of the second and third sense in which the doctrine of ultra vires is used may be struck down i.e., lack of authority or prohibited by law.
Fifth – A director of a companyisunder a duty not to act or agree to the company acting ina manner that contravenes any provisions of the Act or the provisions contained in the articles of the company. Section 188. Necessarily therefore the abolition of the doctrine of ultra vires does not exculpate the directors from the consequences of a breach of duty where he has permitted the violation of the ultra vires rule. Section 17 (3) (b).declares that nothing in subsection 2 of section 17 will affect the liability of a director of the company for acting in breach of section 188. Section 188 declares
“A director of a company shall not act or agree to the company
acting, in a manner that contravenes any provisions of this Act or
the provisions contained in the articles of the company.”
Sixth – Any shareholder or a director is, subject to certain restrictions, entitled to apply to court to restrain the company from acting in a manner inconsistent with a restriction placed by the articles, prior to the company entering into a binding contract or obligation to do so -.Section 17(3)(a). The provision relating to such restraining orders are to be seen in Section 233 of the Act.
As pointed out before the acts of thecompany will not beheld invalid by reason only of the fact that the company had carried on any business or activities which were not within the objects of the company . This protects third parties entering into transaction with the company. But acts of the company may br avoided by reason of those acts not being attributable to the company because persons who purported to act on behalf of the company were not authorized to do so. Or by reason of the fact that the acts, though authorized to be undertaken were legally prohibited i.e., unlawful or illegal.
Clearly where acts of a company are deemed unlawful or illegal, the subject transaction will be void and the third party cannot enforce it against the company.
But what is the impact on a transaction with a third party where an officer or agent of a company exceeds his or her authority? Here unlike the ultra vires cases , the transaction is not void. Rather it is not binding on the company unless the company ratifies it , i.e., unless it is approved by the body which does have authority , actual or ostensible , to approve such transactions on behalf of the company or it is approved by ordinary resolution of the shareholders. Grant v United Kingdom Switchback Renting Co (1988).
This is the position at common and it continues to be unaffected by the provisions of the new Companies Act No. 7 of 2007.
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Dr. Kanaganayagam Kanag-Isvaran, is a President’s Counsel, having taken Silk in January 1988. He is a Barrister-at-Law of Lincoln’s Inn (1964), a Graduate in Law from the University of London (1965) and an Advocate of the Supreme Court of Sri Lanka.(1966). He was conferred the Degree of Doctor of Laws – LLD (Honoris Causa) by the University of Colombo at its Convocation on the 24th of November 2017. He has completed over 50 years of active practice at the Sri Lankan Bar.
He has an extensive practice on the civil side in both the original and appellate courts and specializes in several areas of law including, Corporate Law, Intellectual Property Law, Banking and Finance, Shipping and Admiralty, Telecommunication, I.T., and International Commercial Arbitration.
He was the Chairman of the Advisory Commission on Intellectual Property Law, which drafted the ‘Intellectual Property Act No. 36 of 2003 making it TRIPS compliant. He also presided as the Chairman of the Advisory Commission on Company Law, from 1994 to 2008 which spearheaded the drafting and enactment of the Companies Act No.7 of 2007.
He has written extensively, lectured and presented papers both locally and abroad, in professional, social, religious and other public fora on several subjects touching his area of practice and otherwise and is the co-editor of “Arbitration Law in Sri Lanka” (3rd Ed 2013) published by the ICLP and the co-author of “Company Law” (2014).
