Doctrine of Ultra Vires (Company Law)

Introduction

The doctrine of ultra vires posits that a company’s activities must be confined to the objects explicitly outlined in its memorandum of association. The memorandum serves as a charter, defining the company’s scope and preventing it from venturing into unrelated business domains. To uphold this principle, courts act as guardians, ensuring that the company operates within the parameters outlined in its foundational document.

Memorandum of Association

Any action undertaken by a company that exceeds the authority granted to it in its memorandum of association is considered ultra vires. The House of Lords in Ashbury Railway Carriage and Iron Co Ltd v Riche[1] (Ashbury) first demonstrated its application to such companies.

The memorandum of association of a company thus defined its objects in the case as: “The objects for which the company is established are to make and sell or lend on hire, railway carriages, and wagons and all kinds of railway plants, etc., to carry on the business of mechanical engineers and general contractors.”

Evolution of Doctrine of Ultra Vires

The Case of Ashbury Railway Carriage and Iron Co Ltd v. Riche[2]

The company entered into a financial agreement with Riche, a railway contractor, to fund the construction of a railway line in Belgium. This decision, however, proved controversial. The company subsequently rejected the contract, claiming it exceeded the company’s authorized powers (ultra vires).

 Riche disputed this, arguing that the contract fell within the company’s scope as a ‘general contractor.’ Riche also asserted that even if the contract was beyond the company’s powers, it had been ratified by a majority of shareholders.

Judgment by the House of Lords

The House of Lords decisively ruled against the company, declaring the contract ultra vires and void. Lord Cairns delivered a landmark judgment, asserting that a company’s existence is confined to the specific objects outlined in its memorandum. This document serves as a dual-purpose framework: it delineates the company’s powers and simultaneously imposes limitations on its actions.

The company argued that the term “general contractors” justified its involvement in railway construction. However, the court disagreed, interpreting the term narrowly to encompass contracts related to mechanical engineering, not the broader realm of railway development. Consequently, the contract was deemed beyond the company’s authorized scope.

Significance of the Decision

While the Ashbury case and subsequent rulings were instrumental in establishing the doctrine of ultra vires, their significance has somewhat diminished in modern English law. In the past, companies had to very strictly define what they could do in a document called the ‘Memorandum of Association.’ This meant they couldn’t easily change their plans.

Now, companies have more flexibility. They can still list their goals in the memorandum but include them in another document called the ‘Articles of Association.’ This document is like a contract between the company and its shareholders, outlining how the company will be run.

The memorandum is no longer the sole document defining a company’s purpose; the doctrine’s impact is reduced because of the following reasons:

• Flexibility: Companies can adapt and change their business activities without major legal hurdles. If their initial plans change, they can modify the articles of association, which is generally easier than amending the memorandum.
• Reduced Void Contracts: Since the company’s objectives can be more broadly defined, the chances of a contract being declared ‘ultra vires’ are decreased.

Attorney-General v. Great Eastern Railway Co.[3]

The subsequent Attorney-General v. Great Eastern Railway Co. case refined the stringent ultra vires doctrine. While upholding its core principle, the House of Lords introduced a more pragmatic approach. Recognizing that companies often undertake activities closely related to their primary objectives, the court ruled that actions incidental to authorized purposes should generally be permitted unless explicitly prohibited. This decision shifted towards a more flexible interpretation of a company’s powers.

Acts Incidental to Objects

Thus, a company may act in a manner that is:

 (a) necessary for, or

(b) incidental to, the attainment of its objects, or

(c) otherwise authorized by the Act.

Evolution of Doctrine of Ultra Vires in India

The doctrine of ultra vires took root in India in 1866 when the Bombay High Court in Jahangir R. Modi v. Shamji Ladha[4] ruled that a company’s purchase of shares in other companies was beyond its powers unless explicitly permitted by its memorandum of association. This landmark decision marked the beginning of the application of the ultra vires doctrine to Indian companies.

Bypassing Ultra Vires

To circumvent the restrictions imposed by the ultra vires doctrine, companies often resorted to a tactic known as “object clause inflation.” By including an excessive number of unrelated activities within the company’s memorandum, they sought to expand their operational scope beyond the original intent of the doctrine.

This practice reached its zenith in cases like Cotman v Brougham[5], where a company’s memorandum contained a staggering thirty sub-clauses, granting it the power to engage in virtually any business imaginable. Clearly, such overly broad clauses undermined the core purpose of the memorandum. To curb this abuse, courts introduced the “main objects rule,” focusing on the primary purpose of the company and interpreting the memorandum accordingly. This principle was rooted in the Ashbury case, where the court emphasized that general clauses like “general contractors” should be interpreted in the company’s core business context.

Consequences of ultra vires transactions

When a company gets involved in an ultra vires transaction, the question arises about its effects. The following are the effects:

• Injunction– Shareholders have long held the right to ensure that a company adheres to the activities specified in its memorandum of association. Consequently, if a company is about to undertake or has already engaged in actions beyond its authorized scope—an ultra vires act—any shareholder can seek a court order to prevent such actions. This legal remedy, known as an injunction, serves as a safeguard for shareholders’ interests.
• Personal liability of directors– Directors are legally obligated to safeguard a company’s assets and ensure they are used exclusively for authorized business purposes. If directors misappropriated company funds for activities outside the company’s stated objectives, they can be held personally accountable. This means they may be required to reimburse the company for any losses incurred due to their actions.
• Breach of warranty of authority– Directors are essentially company agents. As such, they are bound to act within the scope of their authority. Third parties can hold them personally liable if a director oversteps these boundaries. This personal liability arises from a breach of warranty of authority, where the director has impliedly represented to the third party that they have the power to act on behalf of the company.
• Ultra vires acquired property– If a company uses its funds to purchase property for a purpose outside its authorized objectives, this is considered an ultra vires act. However, the company generally retains ownership of the property. Since the property was acquired using the company’s money, it is considered part of the company’s assets.
• Ultra vires contracts– When a company enters into a contract that falls outside the scope of its authorized activities, as defined by its memorandum, the contract is deemed ultra vires. This means the contract is not merely invalid but entirely void, as if it never existed. As Justice Gray aptly observed, the issue isn’t solely about whether the company should have made the contract but rather its fundamental incapacity to do so.
• Ultra vires torts– The doctrine of constructive notice presumes that individuals dealing with a company know its constitutional documents (memorandum and articles) and generally shield companies from liability for ultra vires contracts. However, this principle proves inadequate when addressing the complexities of tort law.

If a company is to be held responsible for a tort committed by its employee, two primary conditions must be met:

1. The wrongful act must have occurred within the scope of the company’s authorized activities as defined by its memorandum.
2. The employee must have acted within their employment when committing the tort.

Notably, individuals who are instrumental in causing such harm, whether directors or employees, may be held personally liable for their actions.

Conclusion

While historically significant, the doctrine of ultra vires has evolved over time. While it once served as a rigid constraint on corporate activities, modern legal interpretations, particularly the recognition of incidental powers, have provided companies greater flexibility. However, the core principle remains that companies must operate within the boundaries set by their constitutive documents.

Failure to adhere to these boundaries can lead to severe consequences, including contract invalidity, personal liability for directors, and potential loss of corporate assets. As corporate structures and business landscapes continue to evolve, the doctrine’s relevance and application will undoubtedly be subject to further scrutiny and refinement.

[1] (1875) LR 7 HL 653.

[2] Ibid.

[3] [1880] UKHL 2.

[4] (1866) 4 Bom HCR 185.

[5] [1918] UKHL 358.