Doctrine of Ultra Vires in the Companies Act 2013 – What it says?

The doctrine of ultra vires gains its significance from the legality of Section 4 of the Companies Act 2013. Section 4 says that the objects for which a company is formed and the possible scope of its operations beyond which its actions cannot go must be clearly stated in the Memorandum of Association (MOA). But how is MOA connected to the fundamental rule of ultra vires?

In this article, we are going to discuss the meaning of the doctrine of ultra vires, its purpose, its applicability, and more.

The doctrine of ultra vires – meaning

‘Ultra vires’ is a Latin word made up of two terms, “ultra” which means beyond, and “vires” which means authority.

In the case of a corporation, whatever is not specified in the Memorandum as an object or power is prohibited by the doctrine of ultra vires. A corporation cannot deviate from the provisions of the Memorandum, however urgent the need for departure might be. It cannot enter into a contract or engage in any trade or business beyond the powers conferred on it by the Memorandum. If this is the case, it would be regarded as ultra vires the company.

Consequence

As a consequence, an act that is ultra vires is void and does not bind the corporation. Neither the company nor the contracting party can sue for it.

What is the general rule of doctrine of ultra vires?

The general rule of doctrine of ultra vires is that an act that is ultra vires the company is incapable of ratification. It cannot be given any formal consent. The organization cannot make it valid, even though it is agreed upon by each member.

Doctrine of ultra-vires

Are there any exceptions to the doctrine of ultra vires?

  • An act which is intra vires the company but outside the authority of its directors can be ratified by the company in the proper form [Rajendra Nath Dutta v. Shilendra Nath Mukherjee. 1982. 52 Com Cases 293 (Cal.)].This means that the act which is within the competence of the company but outside the jurisdiction of the directors may be ratified by the company and its shareholders.
  • If an act is within the powers conferred by the Memorandum but is ultra vires the Articles of Association, the company can alter its articles in the proper way.

Thus, from the above two points, it can be seen that an act can be ratified provided it is within the company’s powers. As long as it is within the competence of the company, it can be validated even if it falls outside the scope of directors’ authority or Articles of Association.

Moreover, if a company acquires some property under an ultra vires transaction, the company has the right to hold that property and protect it against damage by other parties. It means the company’s right in such property will still be secured.

The scenario where acts are ultra vires the company law

Any act or contract entered into by a corporation that is ultra-vires the Companies Act is void-ab-initio, even though it has been approved by Memorandum or Articles of the company. In any case, such an act cannot be ratified. Rather, they are illegal.

In the same way, certain activities are considered to be intra vires for the corporation even though they are not listed in the Memorandum or the Articles since they are permitted by the Companies Act.

Purpose of the doctrine of ultra vires

The purpose of embodying the doctrine of ultra vires in company law is to protect shareholders and the creditors of the company. It assures the creditors, investors, and shareholders of the company that the company’s funds will only be used for the purposes set out in the Memorandum. Their money would not be utilized for purposes other than those specified at the time of investment.

This doctrine puts a check on the activities of the directors and prevents them from breaking the objectives of the organization.

Example

The doctrine of ultra vires was first unfolded by the UK’s House of Lords in the famous case of Ashbury Railway Carriage and Iron Co. Ltd. v. Riche. 1878. L.R. 7 H.L. 653. In the said case, the Memorandum of the company defined its objects as: “The objects for which the company is established are to make and sell, or lend or hire, railway plants, fittings, etc. to carry on the business of mechanical engineers and general contractors…….”.

The directors of the company entered into a contract with M/s. Riche, a firm of railway contractors, for the financing of the construction of a railway line in Belgium. The company superseded its objects clause and agreed to give Riche’s the loan and financing they needed to build the railway line.

However, on subsequent rebuttal of this contract by the company on the ground of its being ultra vires, Riche filed a case for damages against breach of contract by the company. According to Riche, the words “general contractors” in the ‘objects clause’ gave power to the company to enter into such a contract. Moreover, he claimed that the contract was assented by the majority of the shareholders.

After due deliberation, the House of Lords held that the contract was ultra vires the company and, therefore, null and void. The term “general contractors” was interpreted to indicate the making generally of those contracts which are only connected with the business of mechanical engineers.

It was held by the Court that the contract was ultra vires the company even though every shareholder of the company desired and authorized the directors to make such a contract. By the Act of Parliament, the shareholders were prohibited from ratifying such a contract, since it was ultra vires the objects clause.

Injunction against the company

Any member may obtain an injunction order from the Court, i.e., an order of the Court restraining the company from proceeding with the ultra vires contract.

Personal liability of directors

If funds of the company are misapplied or wasted by entering into ultra vires transactions, the directors shall be personally liable to the company for breach of trust.

Types of Ultra-vires acts

To what extent the doctrine of ultra vires is still applicable?

As already discussed, the very purpose of the doctrine of ultra vires is to assure the creditors and shareholders that the company’s acts shall not be prejudicial to their interests.

However, a possible disadvantage of this doctrine is that it precludes the company to change its activities in a direction agreed by all members. This is so because the acts that are beyond the ambit of a company’s MOA can neither be operationalized nor can be ratified by its members.

The purpose of the doctrine of ultra vires has been defeated to an extent as now the objects clause can be easily altered by passing just a special resolution by the shareholders. This signifies that the applicability of this doctrine is now limited to those acts that either surpass the company’s powers contained in the Memorandum or do not constitute a part of the company’s objects by way of alteration.

Hope the information provided in this article proves helpful to you!

Ruchi Gandhi

The author enjoys to write informational content in the domain of company law and allied laws. She takes interest in doing thorough and analytical research on legal topics. She is a CA along with MBA (Fin) and M. Com.

You May Also Like

Leave a Reply

Your email address will not be published.