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The House of Lords expounded the doctrine of ultra vires in the case of Ashbury Railway Carriage v Riche. The House of Lords held that the purpose of the existence of the company is to pursue the objects in the Memorandum. Hence, a company lacks the contractual capacity to act outside the limits defined by the object clause. Any contract outside the object clause is therefore a nullity.
The Companies Act 1985, s35(1) abolished the common law rule of ultra vires that makes any act beyond the capacity of the company void. Before the 1985 Act, the intrinsic ability of a company to enter into agreement may be limited by inserting an object clause in the memorandum of the company. This limitation comes from the doctrine of ultra vires. This essay will explore whether the doctrine of ultra vires still holds relevance in today’s company law.
Apart from setting limit on the contractual capacity of the company, the object clause also acts an overall limit on the directors’ powers. Thus, without shareholders’ special resolution, if the directors lacking power authorised a contract, applicable statutory mitigation would bind the company. This lack of power is termed Ultra Vires. The directors are agents of the company and their acts can bind the company only if they acted with actual or apparent authority. An actual authority signifies the power of the directors that are derived from the constitution of the company. The apparent authority of the directors may be wider than the actual authority. It may reflect the full scope of the contractual capacity of the company that is provided for by the object clause to enter into various transactions as independent objects of the company.
Does this mean that the company can escape liability from a third party arising from the acts of the directors that were without actual or apparent authority? No. The doctrine of ultra vires does not stop an affected third party from enforcing the contract on the company. If the director had apparent or ostensible authority, and the third party did not have any actual or constructive notice of the director’s lack of actual authority, the third party can enforce the contract.
The Companies Act 1985, s35(1) abolished the common law rule of ultra vires that makes any act beyond the capacity of the company void. The capacity of the company is not limited by the memorandum of the company. This means that the company has unrestricted power and authority to enter into contract with third parties.
Even before the legislation came into being, the courts’ rulings have shown that they have departed from the strict application of the ruling in Ashbury. In AG v The Great Eastern Railway Company, the House of Lords ruled that the doctrine of ultra vires should be applied reasonably. Accordingly, it held that the company can for legitimate purpose pursue a business other than the one defined as principle object in the memorandum. This business should be incidental to the principle business. It does not matter if the power employed was not provided expressly in the object clause. Thus, the company can enter into transaction beyond the purpose that is provided in the object clause of the memorandum. The only condition is that the transaction or business should be connected with the principle business as provided in the memorandum.
The dilution of the doctrine was further seen in the case of Re David Payne. The court ruled that the doctrine was not concerned with how a transaction had been conducted or how a power of the company had been employed. It concerned whether or not the company had the capacity to conduct the transaction or use the power. Before Re David Payne, the position of the judiciary was that any act outside the stated objects was ultra vires. Re David Payne provided a flexible interpretation of the ultra vires doctrine. Any object that is outside those stated in the memorandum does not necessarily become ultra vires.
The dilution of the doctrine could be seen in the case of Rolled Steel Products (Holdings) Ltd v British Steel Corp. In this case, the object clause enabled the directors to give guarantees. A director entered into a guarantee to benefit themselves in breach of their duties as a director. The Court of Appeal ruled that the guarantee was not ultra vires as the transaction even if for an improper purpose was within the contractual capacity of the company. A transaction will become ultra vires if the act was wholly outside a company's objects.
Another case that has pushed the doctrine of ultra vires to the point of being irrelevant is that of Bell Houses Ltd v City Wall Properties Ltd. This case concerned a subjective objects clause that stated that the directors were empowered to carry out a trade or business which they believed to be advantageous to the company. The company then contracted to introduce a financier to another company for a procuration fee. The clause was held intra vires and hence valid. This case recognised the capacity of the directors to exercise its fiduciary duties towards the benefit of the company.
The Companies Act 2006, s39 and s40 provide for company and its directors’ capacity respectively to bind the company. Section 39(1) provides that the act of the company cannot be invalidated due to the lack of capacity defined in the company's constitution. Likewise, section 40 provides that the directors can bind the company in respect to a third party dealing with the company in good faith. Such power of the directors or their authorisation of others to bind the company is free of any limitation that may be set out in the company's constitution. In Criterion Properties Plc v Stratford UK Properties LLC & Others, it was ruled that the ‘knowing assistance’ of a third party to a director in their attempt to breach their duty may indicate that the third party is acting in good faith. Section 40(2)(b)(ii) provides that a third party is presumed to have acted in good faith unless a contrary is proved. Section 40(2)(b)(iii) further provides that the third party should not be regarded as acting in bad faith by the reason that he knows that the act of the director is beyond his/her power under the constitution of the company.
The Companies Act 2006, s31 also removed the requirement of objects clause, unless the articles specifically restrict the objects of the company. Thus, a company has unrestricted capacity, which makes the doctrine of ultra vires inapplicable.
The above provisions, thus, confer unlimited and full legal capacity on the company in respect to its acts and transactions. Section 39(1) provision precludes both the other party and the company to the transaction from disputing the validity of the acts of the company on the ground that the act was beyond the objects or powers of the company. Ultra vires doctrine cannot, thus, be applied to challenge the acts or the transactions. As such, the abolition of the objects clause indicates the end of ultra vires.
What the statutory exclusion of the ultra vires doctrine does is two-fold. First, it abolishes the doctrine in respect to the external relations of the company. Second, it retains the status quo of its internal relations between the company and the directors. Thus, statutory provisions limit the directors to maintain the duty arising from being a director to the limitation of the powers conferred by the memorandum. Also, any action by the director beyond this limitation can be ratified by a special resolution. Such ratification, however, does not affect the liability of the director.
By abolishing the ultra vires doctrine, the interest of the third party dealing with the company is protected. A shareholder cannot directly intervene as they cannot pursue an action to get the contract declared void. However, the director would be liable to the company for any loss resulting from the act beyond the object, power or authority except when the act is ratified by the company. The director will be liable for breach of Section 171 duty to act within powers. The application of Section 40, however, provides certain requirements to be met in order that the company is bound by a transaction by a director not authorised to do so. The main requirement is that the acts must be that of the directors or those authorised by the directors.
In the light of the above provisions, the doctrine of ultra vires does not have any relevance when it comes to acts and transactions concerning a third party. It however holds relevance in regard to the relations between the company and the directors. As such, even if a company is liable for acts or transactions beyond what the objects of the company, the director who is responsible for this liability or has bound the company will be liable to the company for the acts they performed beyond the objects of or power or authority provided by the company.
Thus, the ultra vires doctrine continues to have some relevance. The relevance is found in sections 31, 41 and 42. Section 31 retains the requirement of objects clause where companies can restrict the objects of the company through its articles. Sections 39 and 40 could also be stated to have retained the need for an objects clause. Also, Section 41 provides constitutional limitations where the transactions involving directors or their associates could be voidable transaction at the instance of the company, as per 41(2). So, if the company rectify the transaction, it will not be void. Further, the doctrine of ultra vires lives in so far related to the internal relations in Section 41(3) that provides that a party to the transaction or a director of the company who authorised the transaction will still be liable. Sections 39 and 40 are not applicable to acts of companies that are charities.
Irrespective of the provision of Section 40 of the 2006 Act, at the common law the directors are authorised to represent the company if they acted jointly as the board. This cannot be overcome by Section 40.
To conclude, the ultra vires doctrine is no longer applicable in relation to external relations where a third party can enforce a contract with the company even of the transaction was entered beyond the stated object. It is, however, applicable to the internal relations where the company can make the director who entered into the transaction liable.
Ashbury Railway Carriage v Riche (1875) LR 7 HL 653
AG v The Great Eastern Railway Company (1880) 5 App Cas 473 HL
Bell Houses Ltd v City Wall Properties Ltd  2 QBD 656
Criterion Properties Plc v Stratford UK Properties LLC & Others  UKHL 28
Re David Payne  2 Ch 608
Rolled Steel Products (Holdings) Ltd v British Steel Corp  Ch 246
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189 Fleet Street, London
25 Fenchurch Avenue
Date: 16 December 2020
Our ref. no.: L34618C
Thank you for sharing your concerns with us. There are a few concerns regarding the current matter in the areas of the statutory order of payment in insolvency proceedings; the conduct of the directors in running the business; issues of legitimacy of the floating charge; and issues regarding repayment of director’s loan against the rights of the creditors.
In case of insolvency, Liquidator's costs are usually paid first. This payment is followed by fixed chargeholders, preferential creditors, floating chargeholders and unsecured creditors at the last.
Liquidation expenses. In any insolvency proceedings, expenses of insolvency must be paid out of the assets of the insolvent’s estate before distribution to creditors or contributories.
Liquidation expenses include fees, charges, costs, and other expenses incurred in the course of the liquidation. These expenses are payable out of the company assets. The assets include property comprised in or subject to a floating charge.
Liquidation incurs primary expenses or costs chargeable and incurred by the official receiver or liquidator or trustee, which must be paid. The priority for payment of primary costs and expenses must be followed as set out in the Insolvency Rules 1986, Rule 4.218(3) governing company liquidations. This rule is subject to 4.218A to 4.218E, which deal with litigation expenses and property that are subject to a floating charge.
Preferential creditors. The Insolvency Act 1986, s175 provides that preferential debts must be paid in priority over other debts.
Preferential creditors include employees, who are entitled to arrears of wages up to four months wages up to £800, and holiday pay and other payment, according to Insolvency 1986. s386, Sch6.
Preferential payment of employees' unpaid wages is subject to the statutory limit under the Insolvency Act 1986, particularly Schedule 6 titled “preferential debts”.
In the current case, BB does not have any fixed chargeholders. Based on the order of payment, liquidation expenses, including Oliver’s expenses of £6,000 must be paid out first.
Secondly, preferential creditors must be paid. Thus, the outstanding employee wages of £60,000 must be paid second.
Thirdly, floating chargeholders must be paid. Floating charges are crystallised and become fixed charges. A floating charge creditor, which in the case is ABS, is paid after preferential creditors.
Fourthly, at the point when the floating charge is paid, a sum of money is set aside for unsecured creditors. The Enterprise Act 2002 priorities payment of debts of unsecured creditors over payment of inland revenue.
In this case, the unsecured creditors of £75,000 must be paid.
The inland revenue of £50,000 must be paid lastly.
Please also be informed that after the liquidation process, the liquidator will investigate all actions taken by the directors while the company was trading insolvent.
Trading insolvent means a company facing problem of cash flow and is in arrears, but still continues its trade. In such situation, the liabilities exceed the assets.
In the current case, BB was in this situation as it continued to lose its market share and was facing financial troubles. Despite the fact that the accountant informed Tia and Mia about insolvency, they carried on with the celebrity event.
In case of trading insolvent, the directors did not act in the best interests of the creditors. They may be liable for wrongful trading under s214, and declare them to be liable to make contribution to the company’s assets.
They may be found guilty for wrongful trading and consequently would be banned from acting as directors of any limited company for up to 15 years post the liquidation.
Overdraft is the appropriate method of financing to help day-to-day trading and cash flow. The customer must not be short of cash at all times.
In the current case, BB has been struggling financially for the last 18 months. Thus, the overdraft was not appropriate. The floating charge created to secured the overdraft is invalid as per s245, Insolvency Act 1986 as the time it was made was a relevant time when BB was unable to pay its debts so as to make the floating charge invalid.
In relevance, the loan repayment to Mia in November 2019 before the winding up in December 2019 constitute preference and Mia will be order to pay back the amount to the Oliver. She can claim that amount as an unsecured creditor.
We have covered all the necessary aspect of the matter in question. If you have any question, please feel free to contact us and we will be happy to answer them.
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189 Fleet Street, London
Date: 16 December 2020
Our ref. no.: O34617B
Thank you for taking out time for contacting us. We are writing this letter to help you identify and understand the type of business structure that would be suitable for your prospective business. We have listed the type of business structure that you could opt for:
1. Partnership can be formed by two or more people acting in common in order to earn profit acting in common to form the business. This is one of the options available to individuals who want to form an association with each other for forming a business. Partnerships cannot use Ltd or Plc in their name as this nomenclature is applicable to only Limited liability companies or Public Limited companies.
A general partnership is formed by a deed. It does not have any separate identity. The assets and liabilities are those of the partners. The partners have joint and several liabilities.
The Partnership Act 1890, s5 makes a partner an agent of the firm and the other partners. Section 6 provides that partners are bound by acts on behalf of firm if the acts show an intention to bind the firm.
2. Limited Liability Partnerships are allowed under the Limited Liability Partnerships Act 2000. There are certain benefits to forming a partnership. First, the risk of business can be spread across more people. Second, there can be induction of more resources and capital into the business because each partner brings in money into business. Third, the capital of the business belongs to the partnership and this increases security of the partners’ contribution as Partnership Act 1890, Sections 20 and 21 identify property purchased with the help of partnership money to be property of the partnership. Fourth, there is increase in the credibility of the business as potential customers and suppliers see doing business with a limited liability partnership as a less risky option than dealing with sole traders.
Limited Liability Partnerships are also preferred because they combine features of partnership with companies. There are certain features of limited liability partnerships that are particularly advantageous. Two features in particular are to be noted. First, a limited liability partnership has a separate legal entity, which means that the personality of the firm is separate from the personality of the partners. Therefore, the property of the LLP, and its contracts and obligations are that of the partnership and not the individual partners. Second, unlike a regular partnership, partners in the LLP have liability limited, which is another feature of a company.
A disadvantage of the LLP is that its shares cannot be bought or sold, which means that there may be difficulty in expanding the business at a later date.
3. A limited company would be a better form of business where parties have desire for expansion in future as it allows them to sell the shares. There are other advantages offered by a company which may make it a more appropriate alternative to a limited liability partnership. First, a company is a separate legal entity with the powers to enter into contracts in its own name and to purchase and hold property in its own name. Second, shareholders have limited liability, which means that they are not exposed to unlimited liability. Moreover, the business can expand further as the shares of the company can be sold and capital can be raised. If the company is a private limited company, then the shareholders may be required to get the approval of the other members before selling their shares.
As companies have separate legal personality, they are sued in their own names and also sue in their own name. A company has perpetual succession, which means that the death or resignation of a shareholder does not mean that the company has come to an end as is the case with partnerships. Moreover, companies holding property in their own name means that the members have no proprietary interest in company property. This safeguards the property of the company. Incorporating a business as a company can also be beneficial to the members whose liability is limited and their personal assets cannot be made liable for the losses or liabilities of the company. Moreover, members can choose whether they want liability limited by shares or guarantee. Bank loans can also be obtained with guarantees by general partners.
The disadvantage of incorporation is that it is more complex to form as compared to a limited liability partnership. For the formation of private limited company, Memorandum of Association and Articles of Association have to be made and sent to the Registrar of Companies, who verifies the documents. A private limited company is registered only after the formalities are completed. The Companies Act 2006 will require the company to display the company’s name at the registered office and other such places of business on its documents and its websites.
Both limited liability partnerships and private limited company are available for setting up the business. Both forms have specific advantages and disadvantages and which form is chosen by the parties depends on their specific needs. If the parties are interested in raising capital in the future, then limited liability partnership is not an appropriate form. In this context, the form of private limited company is more appropriate. Other than this, both forms offer similar advantages in that they allow incorporation of a separate legal entity in the form of an LLP or a private limited company as the case may be. Both forms allow the parties to limit their liability for the losses and liabilities of the business.
We hope that we have outlined all concerned aspects of the concerned matter. Should there be any further questions or clarifications required, please approach us and we will do our best to clarify these questions for you.
Ebrahimi v Westbourne Galleries Ltd  AC 360
Macaura v Northern Assurance Co Ltd  AC 619
M Young Legal Associates Ltd v Zahid  EWCA Civ 613
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