The doctrine of Ultra Vires

Introduction

When a company is created, there is a memorandum for the company which can be said as the constitution of the company. The memorandum sets the objectives, planning powers, scope and its area of operation, both internal and external for the company. It should take any action in the memorandum’s scope. A company cannot perform which is not defined under objectives mentioned in the memorandum. Any act is out of the memorandum will be Ultra Vires. An ultra vires act will be void and cannot be valid even if the members wish to ratify. This is the Doctrine of Ultra Vires. Ultra Vires comprises two words: ‘Ultra’ and ‘Vires’. Ultra means Beyond and Vires means Power. Thus Ultra Vires means an act beyond power. They use sometimes ultra Vires to describe the situation when the directors of a company have exceeded the powers delegated to them. Under section 4(1) (c)[1]of the companies act states that any matter which is considered being necessary must be mentioned in the object clause of the memorandum because if at a later stage the directors or the company presumes that such an act/transaction comes under their power and act and commit a breach of the contract then section 245 (1) (b) comes into play which prevents the company from doing so.

Doctrine

The main aim of this doctrine is to ensure to the shareholders and the creditors that the fund and assets of the company will be used for the purpose only mentioned in the Memorandum, thus it prevents it from employing the shareholders and the creditors elsewhere which is outside the object clause of the memorandum. It won’t be used for any other purpose which is not mentioned in the Doctrine. Especially the creditors, while dealing with the company they can make themselves aware of the fact that transaction with the company is ultra vires or not. If the creditor finds that it is Ultra vires, he can avoid the transaction and safeguard his interest.

Origin of Doctrine of Ultra Vires

The doctrine of Ultra-vires first emerged with Ashbury Railway Carriage and Iron Co. Ltd. v. Riche[1], House of Lords decided which. Here the company and M/s. Riche entered 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 sued 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 contracts. Later, most 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 an ultra-vires memorandum of the company, and, thus, void. Term “general contracts” was interpreted for preceding words mechanical engineers, and it was held that here this term only meant any such contracts as related to mechanical engineers and not to include every kind of contract.

Difference between Ultra Vires & Illegal Act

People often think that ultra vires and illegal activities are the same but it differs completely from each other. These both terms are not the synonym of each other. Anything is beyond the objectives of the memorandum is Ultra Vires while anything which is an offence or draws civil liabilities or is prohibited by law is illegal. Anything which is ultra-vires, may or may not be illegal, but both of such acts are void-ab-initio.

Principles of the Doctrine of Ultra Vires

  1. Shareholders cannot agree to an ultra-vires transaction even if they wish to do.
  2. When both the parties have entirely performed the contract, then it cannot be attacked based on the Doctrine of Ultra Vires.
  3. If a contract has been performed partially but the performance did not bring the doctrine of estoppel into the action, it can bring a suit for the recovery of benefits conferred.
  4. Where one party has performed his part of a performance of the contract, reliance on the defence of the ultra-vires was usually precluded in the doctrine of estoppel.
  5. Any parties in the contract can raise the defence of a doctrine of ultra vires
  6. The company cannot defend the tort or any default made by the agent in employment by saying that the act was ultra-vires.

Effects of Doctrine of Ultra Vires

The effects of the Doctrine of Ultra Vires are –

  1. Ultra Vires Contract – Any contract which is ultra vires will be void ab initio and it will have no legal effect
  2. Ultra Vires Tort – A company will not be held liable for a tort committed by its employees is an outside aim as mentioned in the memorandum. They will only hold the company liable if it intra-vires.
  3. Personal Liability of the Directors –The funds of the company will only be used for the objectives as mentioned in the memorandum. The directors can’t make an unauthorised payment, it will compel him to refund the money. The director will be personally liable for any loss suffered because of his actions.
  4. Ultra Vires gained property – If the money has been spent on purchasing ultra vires property, the company will have the secured right over the property. If the property is legally and formally transferred, it will become the asset of the corporation, even though the company was not entitled to gain such property.
  5. The company can sue ultra Vires Lending –When the company makes any ultra vires lending or when a person borrows money from the company under an ultra vires contract to recover the amount. The promise to get back the money on the borrowed amount is not illegal.

Exceptions

  1. If the company has made any ultra vires lending, it may recover the money from the borrower.
  2. If the company has gained property under the ultra vires contract, by the order of the court it can recover the amount from the company.
  3. If the director makes a payment which is ultra vires the company, the director will be forced to refund the amount and he may also be indemnified.
  4. An act which ultra vires the articles but intra vires the memorandum of the company, it may be altered and included in the acts of the company.
  5. An act which is intra vires the company but ultra vires the director, the director is liable and but if it is out of the authority of the directors, the company can ratify it in proper form.
  6. If the act is ultra vires the company but it is done irregularly, the consent of the shareholders can validate it.

Effects of an act which is Ultra Vires on borrowing

Any borrowing made by the company which turns out to be ultra vires will be void-ab initio. It will not bind the company and company and outsiders cannot get them enforced in a court. The members of the company always have the power to prevent the company from making an ultra vires borrowing by bringing injunctions against the company. If the borrowed funds of the company are used for any ultra-vires purpose, then directors of the company will be personally liable to make good such an act. If the company gains any property from such funds, the company will have full right to such property.No estoppel or ratification can convert an ultra-vires borrowings into an intra-vires borrowings acts are void from the very beginning. As no debtor and creditor relationship is created in ultra-vires borrowings only a remedy in rem and not in personam is available.

Conclusion

The company always has certain norms, and regulations and they have to follow them. The company always should follow its objectives as mentioned in the memorandum for the welfare of the company and people. The Doctrine of Ultra Vires has played a major role in keeping the objectives as prescribed in the memorandum and restricts the directors and members from doing out of scope as mentioned in the memorandum. The doctrine at the same time protects the interest of the creditors and investors. The Doctrine also protects from the considerable loss from any irregular and irresponsible act. They will hold the directors liable if there is any transaction is out of the memorandum. Thus, the directors must be very cautious while making transactions and the must stick to the objectives of the memorandum.

Frequently Asked Questions (FAQs)

  1. What is the Doctrine of ultravirus?
  2. When was this Doctrine introduced?
  3. How is this doctrine different from an illegal act?
  4. What are the effects of this Doctrine?
  5. Are there any exception cases for this Doctrine?

Refrences

[1]Companies Act, 2013 – Section 4

[2](1875) LR 7 HL 653

[3] https://thefactfactor.com/facts/law/civil_law/company-law/doctrine-of-ultra-vires/5652/

[4] https://accountlearning.com/doctrine-of-ultra-vires-objectives-effects-ratification-types/

[5] https://blog.ipleaders.in/borrowing-company-deemed-ultra-vires/

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