ULTRA VIRES DOCTRINE 2

1. INTRODUCTION
2. OBJECTIVES
3. MAIN CONTENT
4. CONCLUSION
5. SUMMARY
6. TUTOR MARKED ASSIGNMENT
7. REFERENCE/FURTHER READING

INTRODUCTION:

Further to our discussion in unit I, the ultra vires doctrine as we have seen is simply that the company is not allowed to do anything that is not included in its object clause as it is not permissible for the company to engage in such business. It follows that whenever the company engages in any business not included in its objects clause it is regarded as ultra vires the company. The rule no doubt works severe hardship on the company as well as third parties. The rule itself has been said to be a protection for both the third parties and investors of the company, but exactly how this is done is not clear. In this unit we shall explore ways the companies have utilized in the past to avoid the rule and the response of the courts.

OBJECTIVES

At the end of this unit, the student should be able to explain the constructive notice rule and the attempts made by the companies to evade the ultra vires doctrine.

MAIN CONTENT

 CONSTRUCTIVE NOTICE RULE

The constructive notice rule was established even before the ultra vires doctrine. It was based on the fact that the law made provisions for the registration of the memorandum and articles of associations of the company and other important documents. Once registered, this document constituted notice to the whole world. It follows that anybody dealing with the company must first take steps to inquire from the registered documents of the company, not only the permitted activities of the company but also the power exercisable by the organs of the company. The rule was clear that anyone dealing with the company was deemed to have notice of the registered documents which were regarded as public documents. This rule was evolved to protect the company shareholders and innocent investors, how this is done is doubtful. However, from the authorities, the rule only works hardship on third parties especially those dealing with the company in good faith.

The adverse effect of the constructive notice rule is exemplified by the case of Re Jon Beauforte (London) Ltd (1953) Ch.131 ,the objects of an insolvent company was the manufacture of dresses but it deviated into the manufacture of veneered panels. The claims of the creditors of the company who supplied the raw materials for the panels were declared ultra vires because they have constructive notice of the objects of the company. Even the claim of a supplier of fuel which would have been used for intra vires activities, failed since the fuel was ordered on the company’s note paper which read “veneered panel manufacturers.” The court held that on that basis, the supplier had actual notice of the present business of the company.

The complication is that when the articles of association place certain limitations on the powers of directors, or where certain acts ought to be done by the General Meeting and it was not done such irregularities will be held void as it is contrary to the company’s registered regulation and the third party is presumed to be aware of these self-imposed conditions.

“The result, therefore, of this constructive notice rule was that where the business being carried on by the company is known to the other party and whether he actually knew it or not, it is ultra vires,and he would be unable to sue the company.  This rule worked  injustice on third parties who deal with the company without reading the public documents of the company. To mitigate the injustice occasioned by the rule, the court introduced the rule  in the case of Royal British bank v Turqand. By this rule, a person dealing with a company is bound to ascertain the public document of the company to see that the proposed transaction is not ultra vires. Having done that, he is entitled to assume that all matters of internal management have been complied with. This general rule is subject to some exceptions. The rule would not apply-

1. Where the third party knew or ought to have known of the irregularity
2. When the irregularity results in the third party relying on a document which is a forgery
3. When the third party has failed to make any investigation after being put on enquiry by unusual circumstances

It is important to note that constructive notice rule has been abolished both in Nigeria (section 68 CAMA,) and the United Kingdom. The effect of the abolition of the constructive notice rule is discussion below.

EVASION THE ULTRA VIRES DOCTRINE

In view of its effects, the ultra vires rule could hardly be said to protect the creditors and shareholders of the company. Instead, it worked untold hardship on them and prevented the company from exploiting good business opportunities and advantages which might present itself to the company in the course of its business. (see O.O. Oladele, 1996, Reform  of Ultra Vires Rule In Nigeria, Nigeria Current Law Review, 141).In effect just as the rule is beneficial to the company; it also works severe lordship On it, and if there is a profitable business opportunity which was not included in the object clause, the company will only be doing the illegal if it should do it, and the court may if called to do so nullify the action of the company should it embark or such business. If a creditor gives a loan or supplies any good to the company on ultra vires business, the creditor cannot recover his money if the company refuses to pay, and so it works against the company as well.

We must note however, that probably in realization of this hardship the courts have explained the rule that it is also a rule of construction of the objects clause of the memorandum of association and therefore if cannot be inherently rigid. Therefore the court created a relaxation to the rule. In the case of A.G. v  Great Eastern Railway (1880) 5 AC

473. Here the House of Lords in England ruled that the ultra vires doctrine would be applied reasonably so that whatever may be regarded as reasonably incidental will be intra-vires to the carrying on of the company. In this case, the LTS Railway co. was authorized by statute to make Railway. The G.E. Rly Co. entered into a contract with the LTS to supply rolling stock to them. The contract was adopted by the shareholders of both companies. An injunction was claimed to restrain the G.E Rly from executing the contract as ultra vires. By statute both companies might enter into any contract or agreements for effecting all or any of the purposes of this Act”, or any objects incidental to the execution thereof and every such contract might contain such covenants, clauses etc. as might be mutually agreed upon by the parties. It was held, that the contract was expressly authorized by the statute and was not ultra vires. Lord Selborne,  said,  “the  doctrine  of  ultra  vires  ought  to  be  reasonably  and  not unreasonably understood and applied. Whatever may fairly be regarded as incidental to or consequential upon, those things which the legislature has authorized ought mot (unless expressly prohibited) to be held by judicial construction to be ultra vires.”

You may see also the decision of Bowen L.J in Hutton v West Cork Railway Company (1883) 23 ch.D. 654.

The law is that the act must be strictly incidental to the carrying on of the business as a going concern. In the Hutton’s case, the court held thatwhere the company in liquidation passed a resolution to pay compensation to directors for their past services, that since the gratuitous payment were not incidental to and connected with the winding up nor the carrying on of the company’s business as the company was no longer a going concern the transaction was ultra vires the company in the winding up and the resolution was invalid.

See also Deuchar v Gas Light and Company. (1934) All 720

In the case of Evans v Brunner Mond& Co. Ltd. (1921) 1 Ch. 359. The defendant company was in business of a chemical manufacturing. Its objects clause gave an express power to do “all such business and things as may be incidental or conducive to the attainment of the above object or any of them. The company by resolution gave the directors authority to make a research grant out of the company’s fund, to scientific institutions. A shareholder brought on action claiming that the payment was ultra vires. The court held that , The proposal was incidental or conducive to the attainment of the main object of the company, as the evidence was that the advantage to the company was substantial and not too remote and the expenditure was necessary for the continued progress of the company as chemical manufacturer. The resolution was not ultra vires.

The problem was how to decide what is reasonably incidental. This is more difficult when the company decides to stretch this liberal interpretation to justify gratuitous payment to employees, in the Hutton’s case, Lord Bowen explained the position of the law when he said,

“the law does not say that there are to be no cake and ale, except such that are required for the benefit of the company. It is not charity sitting in the Board of directors qua charity. There is however a kind of charity dealing which is for the interest of those who practice it and to that extent and in that garb charity may sit at the board but for no other purpose”

Such payment is a gift and if allowed will amount to gratuitous payment of the assets of a company which will be unfair to creditors. Even if the directors have powers to expressly or impliedly make such payment, it will be ultra vires unless he can prove that it is reasonably incidental to the objects of the company or to achieving them.

see Re Lee Brechens& Company Ltd. (1932) 2 Ch. 46.

In this case, there was a power in a memorandum to make provision for the welfare of employees including former employees, their widow and children. Five years after the death of a former director, the company entered into a deed with his widow to pay pension to him annually. The company later went into voluntary liquidation. The widow asked for capitalization of the pension. The liquidator objected. The court upheld the liquidator’s objection that the grant was ultra vires, it was a gratuitous payment and was not for the benefit of the company. Eve J. observed that there is no doubt that the company has power to make such arrangement but it must be reasonably incidental to the carrying on of the business of the company, and it being not provided for in the memorandum. EveJ, thereafter gave  three tests that must be observed before the payment may be approved as intra vires, these are;

1. Is the transaction reasonably incidental to the carrying on of the company’s business?
2. Is it bonafide?
3. Is it done for the benefit and to promote the prosperity of the company

This case was followed in Re Roith Ltd. (1967) 1 All ER 427. The attitude of the court in those cases is rigid. see also Parke v Daily News (1962) 2 All ER 429. In the case such gratuitous payment was refused as it was not incidental to the carrying on of the business.

However, in the case of Continental Chemist Ltd. v Dr. Ifeokandu (1966) 1 All NLR 1.

The plaintiff company memorandum gave as its objects:

1. To import and export drugs
2. To buy and sell drugs
3. To manufacture drugs
4. To compound drugs
5. To enter into any business which the directors think will increase the profit of the company.

The memorandum also confers powers to borrow money; adding that the company can do all such business and things as may be incidental and conducive to the attainment of the above objects and powers or any of them.”

The parties made a contract whereby the company agreed to educate the defendant to become a medical doctor and he agreed to serve and to practice under them on a certain salary. After he qualified, he practiced in their clinic. The parties fell out, and the defendant resigned and the company sued for breach of contract. The judge found the company was running hospital business which they had no power to do under their objects and dismissed their claim. They appealed on the ground that the contract was intra vires paragraph (v) and the final ancillary paragraph of the company objects. It was held, that the fair meaning of the duty to “serve and practice under the company was to practice as a doctor, paragraph (v) of the company’s objects (which spoke of any business which the directors thought would profitable was indefinite and useless. The objects do not include the employment of a Doctor to examine patients so there is no basis for using the ancillary powers in the final paragraph of the company’s objects. Appeal dismissed.

Though the rule is that the objects clause must be given a liberal interpretation, and a reasonable application of the doctrine, so that all matters that may be incidental to the objects, even if not specified may be allowed. In spite of the liberal interpretation, the courts are not prepared to allow anything that is not reasonably referable to the original objects. The businessmen refused to allow this kind of uncertainty. The practice grew that, instead of an incidental and reasonably interpretation, they will load the objects clause with all conceivable objects and powers. In effect, the objects many as possible, and the company may not even attempt some of the listed businesses, but it was to avoid the ultra vires doctrine. However, the courts provided a counter measure by providing what is known as the “main object rule of construction” out of a multiplicity of objects in a memorandum, the court will pick out  the main objects and strike out others which do not fit in, this approach works fairly well in this way,

1. When the court discovers that the main object of the company is gone and the company had practically come to an end, the court applying the main object rule of construction will declare that the substratum of the company is gone
2. The court might allow the company to be wound up on the ground that it is just and equitable that it be wound up

The idea was that the investors and creditors put their money in the company for the purpose of the main object. This is due mainly to the old law in the 1862 Act which made the objects clause impossible to alter. Since it cannot be altered , then it was approved for the singular purpose in the objects and no more; this was done with the aim of protecting creditors and investors, so that they will know exactly the kind of company they are investing in, and not be taken by surprise.

See Re Crown Bank (1890) 44 Ch 684,

Re German Date Coffee Co. (1882) 20 Ch.D; Re Kitson& Co. Ltd. (1946) 1 All ER 436.

The second way in which the main object rule of construction works is by applying the ejustem generis rule of the construction. Where a specified word is followed by a general word, the latter is deemed to be limited to the things of the kind already specified. In short; what the courts say is that subsidiary clauses that follow main object will be treated as incidental object which are meant to facilitate the carrying on of the main object.

The companies aided by lawyers, are not satisfied with the position and sought to evade this rule by the use of “Independent Object Clause.” In the case of Cotman v Brougham (1918) A.L 514, a company’s memorandum contained about thirty clauses dealing with a variety of businesses it will engage in. the clauses were drawn in such a way that the company could engage in anything at all e.g. it has power to acquire, hold and deal in shares, and what could be regarded as the main object was contained in the first paragraph and it merely authorized the company to develop Rubber Estate. To forestall the application of the rule, the memorandum concluded that ‘each clause shall not be restricted or limited by the name of the company and that no clause shall be treated as subsidiary to the first clause.” The House of Lords in England upheld the clause though general, as valid, and therefore any act based on it is valid.

In the case of Anglo-Oversees Agencies Ltd. (1960) 3 All ER 344, it was made clear that each clause as drafted in the Cotman v Brougham case is to be regarded as independent clauses and cannot be read together with other clauses.

Another way companies tried to evade the rule is by the use of subjective clauses.” This clause gives the directors opportunity to decide on any type of business and whatever business they engage in, is within the objects of the company. In the case of Bell Houses Ltd. v City Wall property Ltd (1965) 3 All ER 127., it was found out that the main object clause of the company according to the memorandum was the development of housing estate, three of the inflated objects clauses authorize the company.

1. The carry out any other trade or business which can in the opinion of the Board of directors be advantageously carried on by the company in connection with or ancillary to the general business of the company .
2. To acquire any of the property and assets for the time being of the company for such consideration as the company for such consideration as the company may think fits
3. To do all such other things as are incidental or incidental to the above objects or any of them

The Board of directors delegated management of the company to the chairman who thereby acquired substantial knowledge and skill in the sources of financial property developments projects. The company agreed to pay the chairman for his services, but refused to pay eventually, the chairman sued, and the company insisted that the agreement was ultra vires the company. At lower court, Mokatta J, agreed that the contract was ultra vires the company, and that the subjective clause was not useful.

On appeal, the court of Appeal in England, reversed the lower court’s decision and  the Ifeakandu’is case. The rationale for following the Mokatta J’s decision with respect to the court is faulty. This is because, the fact that it is an independent clause that is being considered, the court ought to have considered the strict interpretation of the clause relied upon by the companies, and the only issue ought to be whether the agreement is permissible under the objects clause or not, if it was, then it cannot be ultra vires.

Wedderbun is of the view however, that the position taken by the court of Appeal is correct based on the proper interpretation of the objects, and inevitably the court has destroyed altogether the vitality of the ultra vires rule with a well drafted sub-clause permitting the company to engage in any business which in the opinion of the its director is advantageous and or profitable no one “need to worry about the doctrine any longer (wedderbum, 1966, Death of ultra vires, M.L.R 637).

The Jenkins committee was of the opinion that, “in consequence the doctrine of ultra vires is an illusory protection for the shareholders and yet may be a pit fall to companies, the ultra vires doctrine serve no positive purpose but is on the other hand, a cause of unnecessary prolixity and vexation.” (Report On The Reform Of The Companies Law In England. Cwwd. 1749 p.10).we cannot agree more, the reason for so much effort in awarding the doctrine is simply because it has become an impediment to business and a trap to third parties; even before the legislative intervention, the doctrine has almost been rendered useless.

CONCLUSION

The doctrine of ultra vires has become a burden on the company, and trap to creditors and investors, the very parties the doctrine was said to have been laid to protect. There is now no other options than that the legislature use intervene to abolish the doctrine.

SUMMARY

We have learnt of various ways and means through which the businessmen aided by lawyers had tried to evade the doctrine of ultra vires. The courts too have ensured that the companies do not evade the rule. It is left for the legislature to intervene and streamline the position of the law.

TUTOR MARKET ASSIGNMENT

Discuss the various ways companies had tried to avoid the ultra vires doctrine and the position taken by the court.