Law and You > Corporate Laws > Companies Act, 2013 > The Doctrine of Ultra Vires

Anything which is beyond the authority or power is called ultra-vires. Since the application of the European Community Law in England, the doctrine of ultra vires stands restricted to a certain extent In India, the original of the doctrine dates back to 1866 when the Bombay High Court applied it to a Joint Stock company and held on the facts of the case before it that the purchase by the directors of a company on behalf of the company of share in other joint-stock company, unless expressly authorized in the memorandum is ultra vires. Since then, the rule has been applied and acted upon in a number of cases.

Section 4 (1)(c) of the Companies Act, 2013, states that all the objects for which incorporation of the company is proposed any other matter which is considered necessary in its furtherance should be stated in the memorandum of association of the company. A Memorandum of Association of a company is a constitution of the company. It sets out the internal and external scope and area of the company’s operation along with its objectives, powers, scope. It is a binding document which describes the scope of the company among other things. The object clause of the memorandum of the company contains the object for which the company is formed. If a company departs from its MOA, then such an act is called ultra vires. Thus, anything which is done by the company or its directors which is beyond their legal authority or which was outside the scope of the object of the company is ultra-vires.

The Doctrine of Ultra Vires

The Doctrine of Ultra Vires is a fundamental rule of Company Law. It states that the objects of a company, as specified in its Memorandum of Association, can be departed from only to the extent permitted by the Act. Hence, if the company does an act, or enters into a contract beyond the powers of the directors and/or the company itself, then the said act/contract is void and not legally binding on the company.

The doctrine of ultra vires confines corporate action within fixed limits, while it handicaps the ambitious manager; it lays a trap for the unwary creditor. That is why there has been a revolt against it almost ever since its inception. The businessmen have always endeavoured to evade the limitation imposed by the doctrine on their freedom of action. It was later on held that the doctrine of ultra vires should be applied reasonably and unless it is expressly prohibited, a company may do an act which is necessary for or incidental to the attainment of its objects.

By the doctrine of ultra vires company is restrained from using its funds for purposes other than those specified in the Memorandum and carrying on trade different from the one authorized. This doctrine assures the creditors and the shareholders of the company that the funds of the company will be utilized only for the purpose specified in the memorandum of the company. In this manner, investors of the company can get assured that their money will not be utilized for a purpose which is not specified at the time of investment. This doctrine draws a clear line beyond which directors of the company are not authorized to act. It puts a check on the activities of the directors and prevents them from departing from the objective of the company. It is to be noted that the ultra vires act may be legal or illegal.

Basic Principles Regarding the Doctrine of Ultra Vires :

1. Shareholders cannot ratify an ultra-vires transaction or act even if they wish to do so.
2. Where one party has entirely performed his part of the contract, reliance on the defense of the ultra-vires was usually precluded in the doctrine of estoppel.
3. Where both the parties have entirely performed the contract, then it cannot be attacked on the basis of this doctrine.
4. Any of the parties can raise the defense of ultra-vires.
5. If a contract has been partially performed but the performance was insufficient to bring the doctrine of estoppel into the action, a suit can be brought for the recovery of the benefits conferred.
6. If an agent of the corporation commits any default or tort within the scope of his employment, the company cannot defend it from its consequences by saying that the act was ultra-vires.

Types of Ultra Vires Acts:

There are three types of ultra vires acts. They are-

1. Ultra vires the Memorandum or the company: If the act done by the company is beyond the powers given in the objects clause of the Memorandum, it is called an act, which is ultra vires the Memorandum or the company.
2. Ultra vires the Articles but intra vires the company: If the act done by the company is beyond the powers given by the Articles but are within the powers of the Memorandum are called ultra vires the Articles but intra vires the company.
3. Ultra vires the directors but intra vires the company: If the act done by the directors, which are ultra vires the directors, but intra vires the company. These acts can be ratified by the company and can make it binding.

Case Laws:

In Ashbury Railway Carriage and Iron Co. Ltd. v. Riche, (1878) L.R. 7 H.L. 653 case, the company, and M/s. Riche entered into a contract where the company agreed to finance the construction of a railway line. Later on, directors repudiated the contract on the ground of its being ultra-vires of the memorandum of the company. Riche filed a suit demanding damages from the company. According to Riche, the words “general contracts” in the objects clause of the company meant any kind of contract. Thus, according to Riche, the company had all the powers and authority to enter and perform such kind of contracts. Later, the majority of the shareholders of the company ratified the contract.  However, directors of the company still refused to perform the contract as according to them the act was ultra-vires and the shareholders of the company cannot ratify any ultra-vires act. The House of Lords held that the contract was ultra-vires the memorandum of the company, and, thus, null and void. They also stated that even if every shareholder of the company would have ratified this act, then also it had been null and void as it was ultra-vires the memorandum of the company. Memorandum of the company cannot be amended retrospectively, and any ultra-vires act cannot be ratified.

In Evans v. Brunner Mond & Company, (1921) Ch 359 case, a company was incorporated for carrying on business of manufacturing chemicals. The objects clause in the memorandum of the company authorized the company to do “all such business and things as may be incidental or conducive to the attainment of the above objects or any of them”. By a resolution, the directors were authorized to distribute some amount out of surplus reserve account to such universities in the U.K. for scientific research and education. The resolution was challenged on the ground that it was ultra vires the power of the company. The directors proved that such help to students of the university was to encourage the scientific training of more men to enable the company to recruit staff and continue its progress. The court held that the expenditure authorized by the resolution was necessary for the continued progress of the company as chemical manufacturers and thus the resolution was incidental or conducive to the attainment of the main object of the company and consequently, it was not ultra vires. 

Exceptions to the Doctrine of Ultra Vires:

1. Any act which is done irregularly, but otherwise it is intra-vires the company, can be validated by the shareholders of the company by giving their consent.
2. Any act which is outside the authority of the directors of the company but otherwise it is intra-vires the company can be ratified by the shareholder of the company.
3. If the company acquires property in a manner which is ultra-vires of the contract, the right of the company over such property will still be secured.
4. Any incidental or consequential effect of the ultra-vires act will not be invalid unless the Companies Act expressly prohibits it.
5. If any act is deemed to be within the authority of the company by the Company’s Act, then it will not be considered as ultra-vires even if they are not expressly stated in the memorandum.
6. Articles of association can be altered with retrospective effect to validate an act which is ultra-vires of articles.

In Attorney General v. Mersey Railway Co, (1907) 1 Ch. 81 case, where a 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 the 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 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. Thus the act of the company is not ultra vires.

The company cannot sue on an ultra vires transaction. Further, it cannot be sued too. If a company supplies goods or offers service or lends money on an ultra vires contract, then it cannot obtain payment or recover the loan. However, if a lender loans money to a company which has not been extended yet, then he can stop the company from parting with it via an injunction. The lender has this right because the company does not become the owner of the money as it is ultra vires to the company and the lender remains the owner. Further, if the company borrows money in an ultra vires transaction to repay a legal loan, then the lender is entitled to recover his loan from the company.

Sometimes an act which is ultra vires can be regularized by the shareholders of the company. For example,

• If an act is ultra vires the power of directors, then the shareholders can ratify it.
• If an act is ultra vires the Articles of the company, then the company can alter the Articles.

A company through an ultra vires contract. Estoppel, acquiescence, the lapse of time, delay, or ratification cannot make it ‘Intravires’.

Disadvantages of the Doctrine of Ultra Vires:

The Doctrine of Ultra Vires acts as a protection of shareholders and creditors, but it suffers from major disadvantages too. The doctrine prevents the company from changing its activities in a direction agreed by all members. Similarly, it prevents ambitious directors to take quick decisions and grab business opportunities. Further, a special resolution can alter the object clause of the Memorandum. This defeats the core purpose of the doctrine.

In this article, we shall study types of ultra vires acts and consequences of such ultra vires transactions.

Consequences of Ultra Vires Transactions:

Considering various positions of director in company as the Trustees, Organs and Agents as well Officers of the respective companies in which they occupy the responsible post, they should be made liable for making any ultra vires transactions by the companies and the following remedies will be available against the Company and as well against the erring directors, namely.

Injunction to restrain the company:

The members are entitled to hold a registered company to its registered objects. Thus members can obtain injunction against company’s ultra vires act.

In Attorney-General v. Great Eastern Rly Co (1880) 5 AC 473 case, the Court held that whenever an ultra vires act has been or is about to be undertaken, any member of the company can get an injunction to restrain it from proceeding with it.

In London County Council v. Attorney General, (1902) AC 165 case, the council having statutory power to work tramways was restrained from running omnibus in connection with tramways. The court found that the omnibus business was in no way incidental to the business of working tramways, and therefore, could not be undertaken although it might have materially contributed to the success of the council’s tramways. 

Personal Liability of Directors:

Under the law of agency, an agent must act only within the scope of his agency, and if he does not, he becomes liable to third parties for breach of warranty of authority. Directors are agents of company. Hence it is one of the duties of the directors to see that the shareholder’s fund is used only for the legitimate business of the company. If any part of it has been diverted to purpose foreign to the company’s memorandum, it will be ultra vires act and the directors will be personally liable to replace it.

In Jehangir R. Modi v. Shamji Ladha, (1866) 4 Bom HCR 185 case, the Bombay High Court held that a shareholder can maintain an action against the directors without impleading the company to compel them to restore to the company, the funds of the company that have been employed in transactions that they have no authority to enter in to.

In Laksmanaswami Mudaliar v. L.I.C., AIR 1963 S.C. 1185 case, the United India Life Insurance Co. Ltd. was an incorporated company having the principal objects of carrying of the life insurance business. In 1956, the business of the company was taken over by the Life Insurance Corporation of India. In December 1955, shortly before the acquisition, the directors of the company in terms of the power vested in the objects clause supported by the resolution of shareholders made payment of two Lac rupees as a donation to a trust formed with the object of promoting technical or business knowledge, including knowledge in insurance. It was held by the Apex Court that the donation of rupees two Lac was ultra vires and resultantly, the directors were held personally liable to refund the amount paid to the trust. The court also observed that: “As office bearers of the company are responsible for passing the resolution ultra vires the company, they will be personally liable to make good the amount belonging to the company which was unlawfully disbursed in pursuance of the resolution.”

In Aviling Barford Ltd. v. Perion Ltd., (1989) BCLC 626 Ch. D case, the Court held that the directors who spent money on unauthorized objects were personally liable to restore it.

Liability of Directors for Breach of Warranty of Authority:

It is the duty of an agent to act within the scope of his authority. For, if he goes beyond, he will be personally liable to the third party for breach of warranty of authority. The directors of a company are its agents. As such it is their duty to keep within the limits of company’s powers. If they induce, however innocently, an outsider to contract with the company in a matter in which the company does not have the power to act, they will be personally liable to him for his loss.

In Weeks v. Propet (1873) LR 8 CP 427 case, a railway company invited proposals for a loan on debentures. At the time, the advertisement was published, the company had issued debentures of the amount of 60,000 pounds, being the full amount which it was by its constitution authorized to issue. It had thus exhausted its borrowing powers. The plaintiff offered a loan of 500 pounds upon the footing of that advertisement. The directors accepted it and issued to him a debenture of the company. The loan being ultra vires was held to be void. In an action by the plaintiff against directors, it was held that the directors are personally liable because by accepting the loan, they had warranted that the company had not exhausted its borrowing powers, a representation that amounted to a false warranty. The directors were, therefore, personally liable to compensate the plaintiff.

It must however, be remembered that the representation of authority which the directors hold out must be a representation of facts and not of law. For example, whether a company is authorized by its memorandum to borrow is a question of law which every man dealing with the company is supposed to know. But where, the memorandum authorizes a company to borrow whether that power has been fully exercised or not becomes a question of fact. A misrepresentation of the former will not, but that of the latter will, give a cause of action against the directors.

Effect on Property Acquired Under Ultra Vires Contract:

If a company’s money has been spent ultra vires in purchasing some property, the company’s right over the property must be held secure. For, that asset, though wrongly acquired, represents the corporate capital. When the funds of a company are applied in purchasing some property, the company’s right over that property will be protected even though the expenditure on such purchasing has been ultra vires.

In Ayers V South Australian Banking Co. (1871) LR 3 PC 548 case, the court observed: “Property legally and by formal transfer or conveyance transferred to a corporation is in law duly vested in such corporation even though the corporation was not empowered to acquire such property.”

In Great Eastern Railway v Turner (1872) LR 8 Ch case, the Court observed: “The directors are the mere trustees or agents of the company, trustees of the company’s money and property, agents in the transactions which they enter into on behalf of the company”.

In Ahmed Sait v. Bank of Mysore (1930) 59 MLJR 28 case, the Madras High Court allowed a company to sue on a mortgage to recover the money lent in spite of the fact that the transaction was beyond the powers of the company.

In Selangor United Rubber Estates v. Crackdock (NO.), (1968) 2 All ER 1073 case, the Court held that the fact that the Companies Act makes it unlawful for a company to give any financial assistance for anyone to purchase any of its shares does not prevent such a person from being held a constructive trustee for the company such of its money as is unlawfully provided for such purpose”.

Effect of Ultra Vires Contracts:

Any contract made by a company which falls outside its objects as defined in the memorandum is wholly void and is a nullity in the eyes of law.  

In Ashbury Railway Carriage & Iron Co. V Riche, (1875) LR 7 HL 653 case, the Court held that an ultra vires contract, being void- ab- initio, cannot become intra vires by reason of estoppels, lapse of time, ratification, acquiescence or delay. No performance on either side can give the unlawful contract any validity or be the foundation of any right of action upon it.

In Central Transportation Co V Pullman’s Car Co. (1890) 139 US 24 case, Justice Gray observed: “which is ultra vires, that is to say, outside the objects as defined by the memorandum of association is wholly void and of no legal effect.”

The objection to an ultra vires contract is, not merely that the corporation ought not to have made it, but that it could not make it. The question is not as to the legality of the contract; the question is as to the competency and power of the company to make it. The incapacity of the company to make contract sometimes caused great injustice and hardships to the person who had no knowledge of such incapacity of the company.

In Beauforte (Jon) London, Ltd. Re: (1953) Ch 131 case, the company, Jon Beauforte Ltd., was authorized by its memorandum of association to carry on the business of costumers, gown, robe, dress and mantle makers, tailors and other activities of allied nature. But later the directors of the company decided to carry on the business of manufacturing veneered panels, which was admittedly ultra vires the objects of the company. For this purpose, the company erected a factory. A firm of builders who constructed the factory had brought an action claiming 2078 pounds. Another firm supplied veneer to the company and had a claim of 1011 pounds. A firm sought to prove for a simple contract debt of 107 pounds in respect of fuel supplied to the factory. The builders of the factory had obtained a consent judgment in the nature of compromise, but it was obviously arrived at on the footing that the contract was ultra vires and all the three applications were dismissed.

In Port Canning & Land Investment Co. Re (1871) 7 Bengal LR 583 case, A company purchased and operated a rice mill beyond its powers. The rice was consigned to certain persons who had paid the price. The consignees had to sell the rice, owing to its inferior quality, at a considerable loss. The company gave them drafts promising to pay for the loss. The company went into liquidation and the question about the enforceability of the drafts arose. The court held that trading in rice was a transaction ultra vires the company; the directors, therefore, could not bind the company, and the consignees could not recover. The Court observed that anyone who deals, with the company is supposed to know its powers. In India, there is an even earlier authority on this point.

In India, there is no specific statutory provision under which an innocent third party making the contract with the company may be protected. Thus, in India if the doctrine of ultra vires is strictly applied, where the contract entered into by a third party with a company is found ultra vires the company, it will be void and cannot be ratified by the company and neither the company can enforce it against the third party nor the third party can enforce it against the company. However, it is to be noted that even in India the courts have evolved certain principles to reduce the rigors of the doctrine of ultra vires. The following principles may be deduced from the judicial decisions.

1. If the ultra vires contract is fully executed on both sides, the contract is effective and the courts will not interfere to deprive either party of what has been acquired under it.
2. If contract is executor on both sides, as a rule, neither party can maintain an action for its non-performance. Such a contract cannot be enforced by either party to the contract.
3. If the contract is executor on one side (i.e. one party has not performed the contract) and the other party has fully performed the contract, the court differ as to whether an action will be on the contract against the party who has received benefits. However, the majority of the courts appear to be in favour of requiring the party who has taken the benefit either to perform his part of the contract or to return the benefit.

Effect of Ultra Vires Torts:

Civil wrongs are called torts in the eyes of law, and the rule of constructive notice says that anyone dealing with the company must have notice of the memorandum and articles of association of the company. That’s why a company is not liable for an ultra vires contract however it does solve the problem of injustice caused. On the other hand the company is made liable for the tort committed by its servant while acting ultra vires the company. There is no measurement as to the limit to which a company may be held liable for damages caused from its ultra vires acts. But the modern company law makes a company liable in torts if it is proved that-

1. The activity in course of which the alleged tort has been committed falls within the ambit of memorandum of the company; and
2. The tort was committed by the servant within the scope of his employment

Ultra Vires Acts Leading to Crime:

A company will be liable for anything which its officers do with the actual or usual scope of their authority in connection with or ancillary objects but it will not be liable for a tort or crimes committed by its officers in connection with some entirely different business. Thus a company may be held liable for any tort or crime if:-

1. The tort or crime has been committed by the officers (or agents as director) or servants of the company within the course of his employment, and
2. The tort or crime has been committed in respect of or in pursuance of an activity which falls within the scope of the objects clause of its memorandum.

It is to be noted that whether or not the company is liable for ultra vires torts or crimes, the officers or servants committing the act will no doubt be personally liable therefore.

Conclusion:

To protect the interest of the investors and the creditors, specific provisions are made in the memorandum of the company which defines the objectives of the company. It is a public document. All the actions of company must be to protect the interest of the creditors and investors. Directors of the company can act only within the purview of the authority provided to them under these objectives specified in the memorandum. Any act done beyond that allowed in the memorandum is ultra vires. Such act cannot be ratified by the shareholders. Hence the directors must be very cautious.

The application of Doctrine of ultra vires has often resulted in injustice. Similarly, it is criticised on the ground that it is not based on any fundamental principle of company law. The critics are of the opinion that every contract entered into by a company should be binding on it – whether within or beyond its power. Several European countries have refused to apply the doctrine of ultra vires.

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