Introduction to the Doctrine of Ultra Vires
Ultra vires' is a Latin phrase which means 'beyond the powers'. It refers in legal matters to acts, transactions or decisions which are legally ineffective and void due to the lack of authority granted to a legal entity or individual. It is a key element of company law and public/administrative law. At the heart of the doctrine is the idea that artificial legal persons (eg incorporated companies, municipal councils and statutory government departments) lack unconstrained natural freedom, as do human beings.
Rather, they are legal persons, who acquire their powers, capacities and legal personality exclusively from the constitutional instruments or by law that created them. Any act performed outside these limits is, therefore, not an irregular act, nor an error, but a nullity, and therefore cannot be rectified by the act of the parties, because the act never existed. The basic content of expression and of historical application is the same, although it is slightly different for commercial business activity and for public regulatory activity: authority is limited to what is established in the law, and it is illegal to act beyond its scope. This establishes an important structure of safeguards for shareholders and investors, creditors and citizens against the arbitrary expansion or abuse of power.
Origins and Evolution in Company Law
The Landmark Ashbury Precedent
The modern corporate crystallisation of the doctrine of ultra vires was the case of Ashbury Railway Carriage and Iron Co. Ltd. v. Riche (1875) decided by the House of Lords. In this instance a company was formed under the Companies Act of the UK to produce and sell railway carriages and equipment. It later entered into a commercial contract, however, to finance the building of a railway line in Belgium, an activity that it was not engaged in by the terms of its memorandum of association. On disagreements of contract, company tried to repudiate the contract on the basis it was ultra vires.
It is important that the contract had been tried to be ratified by a resolution of the shareholders that followed. The House of Lords unanimously ruled that the contract was ‘utterly null and effectless’ and could never be ratified or validated even by the ‘unanimous consent of all the shareholders’. Lord Cairns pointed out that the purpose of the legislation for statutory incorporation had to be followed with great scrupulosity of the registered objects clause. The outer limits of the legal capacity of the company are defined by the memorandum, and therefore, the company simply does not have the capacity to perform and ratify acts beyond that.
Judicial Application in India
The Indian judiciary was also very stringent. The Supreme Court of India in A. Lakshmanaswami Mudaliar v. Life Insurance Corporation of India (1963) discussed a donation by the directors of an insurance company, which was supposedly given under a special resolution of the shareholders. The Court ruled ultra vires and void the donation. The bench has ruled that a company's money must be spent on objects mentioned in its memorandum. The company never had the authority to make such political and extraneous donations, so a shareholder resolution would not remedy the underlying inability to have the capacity to make such donations.
Statutory Framework and Modern Flexibility in India
In the past under section 13 of the Companies Act, 1956, a company's memorandum had to exhaustively explain each and every object or activity it was going to undertake. This is a rigid interpretation of these objects by Indian courts, which followed the Ashbury principle. If a beneficial and profitable transaction was not one of the objects of the memorandum then the company was subjected to serious legal uncertainty and commercial paralysis.
Much of this was modernised and added to with the implementation of the Companies Act, 2013, which gave the needed flexibility to this system. Section 4(1)(c) of the 2013 Act requires a company to define its objects in the memorandum, but the law has changed to create more flexible commercial 'straight-jackets' for companies and to free them from narrowly drawn objects without reducing the existing accountability of companies. In addition, the 2013 Act added strong provisions in the statute that permitted existing class actions by members and depositors to enjoin oppressive or unauthorized management, including Section 245.
Legal Consequences of Ultra Vires Corporate Acts
- Zero Ratification Capacity: An ultra vires transaction has no legal consequences for the company, no rights, duties or interests of the company will arise from it.
- No Estoppel Against Inapplicability: An ultra vires transaction can not be estopped to be enforced even if the other party relied extensively upon it and did so in good faith.
- Personal Liability of Directors: Directors who use company property and funds for ultra vires undertaking will be held liable for restoring the value of such property and funds to the company.
- Injunctive Relief: Shareholders have the legal right to obtain injunctions against the company and/or its board to prevent the company from engaging in the unauthorised acts, and modern class action remedies under Section 245.
Balancing Protection: Constructive Notice and Indoor Management
In corporate law, the ultra vires rule is very harsh and may leave beneficial third parties who interact with the company vulnerable to undue liability. The common law provided for two counterbalances to this harshness:
As a matter of law, anyone dealing with a company is presumed to have read, understood and noticed a company's constitutional documents (Memorandum and Articles of Association) which are open documents filed with the Registrar of Companies. This safeguards the company from outside attackers, but places a burdensome investigation job on the shoulders of the public.
The Relational Database Model & The Doctrine of Indoor Management
This doctrine was created in Royal British Bank v. Turquand (1856) for the protection of third parties against the irregularities of the internal procedures. It is presumed that outsiders are aware of public documents, but they do not have to look into the internal management and the regular performance of each company's internal procedures. If an act is "regular on its face," an outsider may presume that it is in fact regular. Conversely, Indian jurisprudence strictly applied the doctrine of constructive notice in the case of Kotla Venkataswamy v. Chinta Ramamurthy, where the court held that an outsider could not enforce a mortgage bond because they were presumed to have noticed that it lacked the mandatory signatures required by the company's publicly filed Articles of Association.
Ultra Vires in Public and Administrative Law
The concept of ultra vires plays a similarly important role in public law, both in theory and in practice, as a theoretical and operational basis for judicial control of the action of the administration. A government body, a municipal council, a tribunal or a statutory body exercising power shall act within the four corners of the statute which gave it the power. The executive action is null and void if there is any deviation from it.
In India, there are two types of public law ultra vires:
- Substantive Ultra Vires: Happens when the public authority decides, formulates a rule or makes a discretion on a matter that is completely beyond the powers granted in the parent statute. In Dwarka Prasad Laxmi Narain v. State of Uttar Pradesh (1954), for instance, the Supreme Court declared a control order to be ultra vires since it gave licensing authorities discretionary powers which they are not statutorily authorized to exercise. This was the same in the case of General Officer Commanding-in-Chief v. Subhash Chandra Yadav (1988).
- Procedural Ultra Vires: Where an authority has the substantive power to act, but has not taken the necessary steps, precautions or consulted in the required manner or at the required times in accordance with the mandatory procedures in the governing statute.
Conclusion
The principle of ultra vires has continued to be an essential legal mechanism to maintain order, discipline and accountability in the field of corporate governance and public administration. The essence of the idea remains the same: artificial entities have no natural rights, and can only be given a range of legal powers for them to exercise. By adopting statutory changes, judicial evolution, and fairer concepts such as the doctrine of indoor management, modern legal systems are able to achieve a balance between flexibility of organisation and adequate protection for all stakeholders: investors, shareholders, creditors, and citizens.
References
- Royal British Bank v. Turquand, (1856) 6 E&B 327
- Ashbury Railway Carriage and Iron Co. Ltd. v. Riche, (1875) LR 7 HL 653
- Mahony v. East Holyford Mining Co., (1875) LR 7 HL 869
- Ruben v. Great Fingall Consolidated, [1906] AC 439
- Kotla Venkataswamy v. Chinta Ramamurthy, AIR 1934 Mad 579
- Dwarka Prasad Laxmi Narain v. State of Uttar Pradesh, AIR 1954 SC 224
- A. Lakshmanaswami Mudaliar v. Life Insurance Corporation of India, AIR 1963 SC 1185
- General Officer Commanding-in-Chief v. Subhash Chandra Yadav, (1988) 2 SCC 351
- Companies Act, 1956, s. 13
- Companies Act, 2013, ss. 4(1)(c) and 245