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 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.
ULTRA VIRES DOCTRINE
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