ULTRA VIRES DOCTRINE

ULTRA VIRES DOCTRINE

1. INTRODUCTION

One of the important documents that should be lodged when incorporating a company is memorandum of association. By section 16(1) of the Act, persons desiring to incorporate a company are required to lodge the memorandum and articles (if any) of the proposed company with the Registrar together with all other necessary documents. It is known as the external constitution of the company. This is because it contains matters between the company and outsiders.  Memorandum of association must contain:

1. Name clause as required by s 18(1)(a) of CA 1965 – this will state what the company’s name is.

2. Objects clause as required by s 18(1)(b) of CA 1965 – this will state what the object of the company is. Thus, one would be able to know what the business of the company is. It is important to understand that the objects clause sets a limitation on the activities of company.

3. Share capital clause as required by s 18(1)(c) of CA 1965 – this will provide what the authorised share capital of the company is. The clause will also provide the division of the share capital.

4. Liability clause as required by s 18(1)(d)(e) and (f) of CA 1965 – this will state what the liability of the company is. The company could be limited by shares, limited by guarantee, limited by shares and guarantee or, it could be an unlimited company. Thus the liability of a member will depend on the type of the company. Creditors should be aware as to what type of company they are dealing with. Those who wish to invest in a company should also be aware of the liability clause so that they know the nature of their liability.

5. Subscribers clause as required by s 18(1)(g) of CA 1965 – the clause requires information as regard to the names and addresses of the subscribers to the M/A.

6. Association clause as required by s 18(1)(h) of CA 1965 – this clause requires subscribers to the M/A (at least two persons) declare to take up the number of shares agreed.

2. OBJECT CLAUSE

One of the clauses should be contained in memorandum of association is object clause. This clause is a short statement of the company’s object and the ancillary’s power required to carry out the objects being implied. The main function of the objects clause is to define the activities in which the company wishes to engage. It is usual for companies to enumerate a wide range of activities, whether or not they intend to participate in all of them. The objects clause usually has provisions regarding the main or independent objects, dependent objects and power.

The main or independent objects are those activities which are specifically stated in the objects clause. These are important in determining whether the company has acted beyond its capacity or ultra vires. The dependent objects are activities which are unspecified but in which a company is permitted to engage in association with one of the stated objects.

The object of a company is important for the following reasons:

—  To determine the nature of the company’s business.

—  It defines what the company’s powers are.

—  It states the purpose for which the company exists.

—  To determine the legal capacity of the company.

When a company does an act that is beyond its objects clause, i.e. it enters into a contract that is beyond its corporate powers or acts beyond its legal authority, such an act is called an ultra vires act.

To ascertain whether a particular act is ultra vires or not, the main purpose must first be ascertained, then special powers for effecting that purpose must be looked for, if the act is neither within the main purpose nor the special powers expressly given by the statute, the inquiry should be made whether the act is incidental to or consequential upon. An act is not ultra vires if it is found:

(a) Within the main purpose, or

(b) Within the special powers expressly given by the statute to effectuate the main purpose, or

(c) Neither within the main purpose nor the special powers expressly given by the statute but incidental to or consequential upon the main purpose and a thing reasonably done for effecting.

In ATTORNEY GENERAL v. MERSEY RAILWAY CO, (1907) 1 Ch. 81, the company was incorporated for carrying on a hotel business. It entered into a contract with some third party for purchasing furniture, hiring servants and for maintaining omnibus. The purpose or object of the company was only to carry on a hotel business and it was not expressly mentioned in the objects clause of the memorandum of the company that they can purchase furniture or hire servants. This deal was challenged and was sought from the court that this act of the directors be held as ultra vires.

The issue arise here is whether the transaction was ultra vires?

The court held that a company incorporated for carrying on a hotel could purchase furniture, hire servants and maintain omnibus to attend at the railway station to take or receive the intending guests to the hotel because these are reasonably necessary to effectuate the purpose for which the company has been incorporated and consequently these are within the powers of the company, although these are not expressly mentioned in the objects clause of the memorandum of the company, or the statute creating it.

Thus a company which has been authorized to deal with its property has implied power to pledge or Mortgage the property for its debts. It is to be noted that if the act of the company is neither within the objects clause in its memorandum or the statute creating it, nor necessary for or incidental to or consequential upon the attainment of the objects stated in the objects clause of the memorandum.

3. THE POSITION UNDER COMMON LAW

At common law, if a company does an ultra vires act, the contract or the act is null and void. An ultra vires act is void and cannot be ratified even if the company wishes to ratify it.

In ASHBURY RAILWAY CARRIAGE AND IRON COMPANY LTD v. RICHE, (1875) L.R. 7 H.L. 653., In this case, the objects of the company as stated in the objects clause of its memorandum, were ‘to make and sell, or lend on hire railway carriages and wagons, and all kinds of railway plaint, fittings, machinery and rolling stock to carry on the business of mechanical engineers and general contractors to purchase and sell as merchants timber, coal, metal or other materials; and to buy and sell any materials on commissions or as agents.’ The directors of the company entered into a contract with Riches for financing a construction of a railway line in Belgium. All the members of the company ratified the contract, but later on the company repudiated it. Riche sued the company for breach of contract.

The issue arise as whether the contract was valid and if not, whether it could be ratified by the members of the company?

The House of Lords held unanimously that the contract was beyond the objects as defined in the objects clause of its memorandum and therefore it was void and the shareholders had no capacity to ratify the contract.

The House of Lords has held that an ultra vires act or contract is void in its inception and it is void because the company had not the capacity to make it and since the company lacks the capacity to make such contract, how it can have capacity to ratify it. If the shareholders are permitted to ratify an ultra vires act or contract, it will be nothing but permitting them to do the very thing which, by the Act of Parliament, they are prohibited from doing.

The House of Lords has expressed the view that a company incorporated under the Companies Act has power to do only those things, which are authorized by its objects clause of its memorandum, and anything not so authorized is ultra vires the company and cannot be ratified or made effective even by the unanimous agreement of the members.The Company cannot be prosecuted based on an Ultra Vires Contract

In RE JON BEAUFORTE (LONDON) LTD [1953] Ch. 131, a company set up to manufacture clothes and to carry on the business of tailors decided to manufacture veneered panels, an activity outside the stated objects. The company had a factory built for the purpose and purchased veneers from supplier, and also coke for use in the process of making the veneered panels. The company was wound up, and its liquidator would not accept as valid the claims submitted by the builder, the supplier of veneers and coke, on the grounds that they were ultra vires and void. A supplier of coke failed to enforce payment as the contract was ultra vires and the supplier was deemed to have constructive notice of the objects. The basis of claim by the coke supplier was that his contract was ex facie intra vires, i.e if he had compared the contract with the memorandum, it would not necessarily have appeared ultra vires because coke might well be used in the business of manufacturing ladies’ clothing. However, it appeared that the company had ordered the coke on notepaper describing the company as ‘veneered wall panel manufacturer’, and giving further particulars of its work in that capacity, and not referring to the clothing business. Therefore, the liquidator was right in rejecting the proof.          

     

An ultra vires contract cannot be enforced by or against the company. In other words, the company cannot sue or be sued. The company cannot be sued for damages for not performing the contract since the contract is null or void. It also means that a company can avoid a contract on the basis that it is beyond its objects clause although it may have initiated the idea.

Although this may seem unfair to the other party to the contract, it is justified on the basis of the doctrine of constructive notice. This doctrine provides that since the objects clause is a compulsory clause in the M/A, which is a public document available for public inspection at the ROC, the other party should have checked to find out whether the contract is within the capacity of the company.

It is assumed that the other party to the contract would have checked the objects clause of the company. The fault is upon him if he did not check the objects clause.

The reason the common law provides that an ultra vires act is null and void is to protect the members and creditors of the company, i.e. it is to ensure that their investment is only used for the company’s business. In COTMAN v BROUGHAM [1918 AC 514, the parties to this action were liquidators. Cotman was liquidator of Essequibo Rubber Estates Ltd, and Brougham was liquidator of Anglo-Cuban Oil Co. It appeared that E underwrote the shares in A-C although the main clause of E’s object clause was to develop rubber estates abroad. However, a sub-clause allowed E to promote companies and deals in the shares of other companies and gave numerous other power. The final clause of E’s objects clause said in effect that each sub-clause should be considered as an independent main object. The E company, not having paid for the shares which it had agreed to underwrite, was put on the list of contributories of A-C, and E’s Liquidator asked that his company be removed from that list because the contract of underwrite was ultra vires and void.

It was held by the House of Lords that it was not, and that the E company was liable to pay for the shares underwritten. The final clause of E’s objects clause meant that each object could be pursued alone.

Generally, members and creditors invest in a company only after ascertaining its objects clause, i.e. the business of the company. If a company were to use the investment for purposes other than its object, this would be unfair to the members and the creditors. On the other hand, it is not practicable for a person to check the objects clause of a company each time he is dealing with the company. Moreover, a company may decide to venture into a new business that would be profitable or beneficial to the company.

4. THE POSITION UNDER COMPANIES ACT 1965

Section 20(1) of CA 1965 provides that an ultra vires act is not invalid. This means that the company can sue or be sued on the contract. Furthermore, there is no need to ratify the ultra vires act since it is valid under s 20(1) of CA 1965. The relevant part of this subsection thereof is as follows:

No act or purported act of a company ...and no conveyance or transfer of property.... to or by a company shall be invalid by reason only on the fact that the company was without capacity or power to do the act or to execute or take the conveyance or transfer.

This means that if a transaction is otherwise valid and binding upon a company, the fact that it is ultra vires is irrelevant. This, however, oversimplifies matters. A company might yet get out of a transaction even though it is intra vires.

This might happen if the transaction was entered into by an agent who lacked authority, or if the company’s directors were acting for an improper purpose when committing the company to the transaction.

Whether a particular act or transaction is ultra vires depends primarily upon the construction of the objects clauses of the memorandum of association.

Apart from powers expressly stated in the objects clauses, a company has implied power to do anything that is reasonably incidental to the attainment of its objects. In addition, a company incorporated in Malaysia has the statutory powers set out in the Third Schedule to the Companies Act. An act which is not within a company’s express, implied or statutory powers is ultra vires.

Although this may imply that a third party need not check whether the company’s act is within its objects clause, note that there is also no express provision in CA 1965 that abolishes the doctrine of constructive notice.

In EXECUTIVE AIDS SDN BHD v KUALA LUMPUR FINANCE BERHAD [1992] 1 MLJ 89, the plaintiff, a company, were the owners of a piece of land which they had charged to the defendant as a security for the repayment of a loan granted by the defendant to a company R&G. Order for sale was granted following default in repayment of the loan. In this action plaintiff sought, inter alia, a declaration that the charge was void or unenforceable against the plaintiff and that the therefore the order for sale was null and void. The plaintiff alleged that all material times R&G and the plaintiff were not related to each other except there were common shareholders and directors.

The court held that, as the creation of a third party charge as security for a loan to R&G was within the ambit of the object clause of the memorandum of association of the plaintiff, the defendant had no business to enquire as to whether the plaintiff had misapplied the loan. The defendants were, insofar as the object clause was concerned, not put on any notice by an express requirement that the power to take a loan was only exercisable for the purpose of the plaintiff’s business.

CA 1965 has not abolished the doctrine of ultra vires but has modified the effect in that an ultra vires act is valid. Thus, a company that acts beyond its objects clause would still be guilty of an ultra vires act.

5. EFFECT OF SECTION 20 (1)

Although s 20(1) of CA 1965 provides that an ultra vires act is valid, the following implications should be noted:

Section 20(2)(a) of CA 1965 provides that a member of a company or a debenture holder secured by a floating charge may restrain the ultra vires act. This is to protect the members who may have invested in a company based on the objects and business of the company. The member can restrain the company from misusing the company’s assets for some other purposes.

This right is only available to those specified in the provision. In PAMARON HOLDINGS SDN BHD v GANDA HOLDINGS BHD [1988] 3 MLJ 346, The High court held that an application for relief under s.20 could be made only by persons specified in that section and not outsiders. In this case, the Plaintiff and the defendant entered into a written agreement for the sale and purchase of shares in a private limited company. The defendant defaulted in the payment of the purchase price and the plaintiff applied for summary judgement against it. In opposing the application, the defendant contended, inter alia, that the transaction was ultra vires the plaintiff company.

Allowing the application, the court held that under s.20 a person other than a debenture holder or the minister may not raise ultra vires. The defendant, being an outsider and not a debenture holder or the minister had no right under the section.

In PUBLIC BANK BERHAD v METRO CONSTRUCTION SDN BHD [1991] 3 MLJ 56, the defendant company executed charges over its land in favour of the plaintiff bank to secure the repayment of loans given by the plaintiff to Tenaga Muhibbah Sdn Bhd (‘Tenaga’). Tenaga failed to repay the loan and the plaintiff obtained and order for sale of the defendant’s land. The defendant then applied ex parte to the High court to stay the order of sale. The defendant relied on the affidavit of one Lee Khai Hong who claimed to be one of the director and shareholder of the defendant company. Lee alleged that two men under pretext of acquiring all the shares in the company had tricked him and the directors to resign and to appoint both of them as directors. Both of the men without the knowledge of company secretary and shareholders passed a resolution authorising the defendant to create charges in the plaintiff‘s favour. The high court granted to stay the order for sale. The plaintiff applied to set aside the order. The defendant argued that the charges were ultra vires. The creation of the charges was outside of the borrowing powers as they were created not for the benefit of the company but for a third party. Even if the creating of charges is intra vires, they were created by directors acting outside and beyond their powers as provided in the article of association.

Court allowed the plaintiff’s application to set aside the order granting stay of the order for sale. Court ruled that even if the charges were ultra vires, they could be saved by section 20(1) of the Companies Act.

The restraint is only available if the contract has been entered into but has not been completed yet as decided in HAWKESBURY DEVELOPMENT CO LTD v LANDMARK FINANCE LTD (1969) 2 NSWR 782. In this case, Hawkesbury, the sole shareholder in Landmark Finance sought a declaration that certain debentures granted to UDC were ultra vires and void. Consequently, he wanted the court to restrain UDC from enforcing them. The court in refusing his application held that in order to succeed the applicant had to show that some substantive relief was relief against the company, and not against UDC.

Hence if the restraint is successful, it will affect the other party who has contracted with the company as regards the ultra vires act. In such a case, s 20(3) of CA 1965 provides that if any party suffered any loss due to restrain under s 20(2)(a), the party can be compensated

In practice, this provision does not truly protect members and debenture holders because normally it would be the directors and not the members who would know if the company has or intends to commit and ultra vires act. It would be unlikely that the BOD would inform the members since such act would in all likelihood be initiated by the BOD as the ‘mind’ of the company. With regard to debenture holders, they are even worse off than the members as being outsiders, they would likely not know the happenings in a company. Furthermore, the provision under s 20(2)(a) is restricted to debenture holders who are secured by floating charges and not fixed charges or those creditors who are not secured by any charges.

Section 20(2)(b) of CA 1965 provides that the company or a member can bring action against present as well as former officers where there is an ultra vires act. This provision is included because the officers of the company should have known the objects clause of the company and that the particular act is ultra vires. The purpose of this provision is to deter officers from making the company carry out an ultra vires act. Note that in the event an action is brought against the officers, it does not affect the validity of an ultra vires act by virtue of s 20(1) CA 1965.

Section 20(2)(c) of CA 1965 provides that the Minister can petition to the court to wind up the company. This provision will be invoked in cases where the company has completely diverted its business from its original business, i.e. its objects.

6. CONCLUSION

There is a difference rule between Common law and provisions under Companies Act 1965.  Under Common law an ultra vires act is null and void. The creditors cannot compensate for this contract, eventhough the shareholders ratify the act. The rationale behind that rule is the application of doctrine of constructive notice.

Under section 20(1) Companies Act an ultra vires contract is not invalid. If the company entered a contract and then it appeared an ultra vires, the other party still has right to compensate the contract if any breach done by the company. However, this section has certain effects which were discussed above.