Contractual capacity of companies Pre incorporation contracts The promoters The role of the promoters Prior to incorporation, there exist promoters who seek to realise business for the company. It is often convenient for them to sign contracts on behalf of the yet to be formed company. They want to bind the company, not themselves. Contrary to the principle of privity of contract. The duties of promoters Fiduciary duties they act on behalf of a company and must account to the company for its money etc Erlanger v New Sombrero Phosphate Co A syndicate purchased a phosphate mine for 55,000 The syndicate proceeded to form a company The mine was sold to the company via a third party, without revealing their interest or identity. They did not reveal to the company that they had made a profit on the sale of the mine. The House of Lords recognised that promoters stand in a fiduciary position. Lord Cairns considered that they stood in a fiduciary position as they have it in their power to define in what form the company will come into existence and trade. As they hadn't disclosed their interest, the contract was voidable at the companies option. Common remedies for breach of promoters' duties The court will sometimes find the existence of a constructive trust. A constructive trust will imply a constructive trust where it is unconscionable to deny the rights of another part to property. HKN Invest OY v Incotrade The defendants received a lot of pre incorporation commissions in the course of setting up a fraudulent company. They set up a company, but the company did not receive the commissions raised on its behalf. Costello J held that a constructive trust can be imposed in relation to pre incorporation commissions The efficacy of pre incorporation contracts Common law position: promoter not an agent of the company Kelner v Baxter It was found that a promoter could not be an agent, as there was no principal company and thus it could have no agent. This created a difficult position for promoters, as the promoter would then be personally liable on the contract. Statutory intervention to permit ratification
s. 37 (1) A company could choose to ratify pre incorporation contracts This gives the ratification retrospective effect Promoters still run the risk that the company will not ratify the contract Ratification of pre incorporation contracts Manner of ratification depends on company's constitution. Normally occurs at a general meeting Sometimes, they can choose for the board to ratify the contract. One question is whether informal behaviour can count as ratification In some circumstances, the courts will accept informal ratification HKN Invest v Incotrade Costello J held that the effect of ratification is to give legal existence to a contract which would otherwise be a nullity. It creates contractual rights and obligations on the same basis as if the company had been in existence and accepted the contract. It was recognised that in appropriate circumstances, ratification could occur informally, without a formal meeting of the directors taking place. e.g. if the controlling shareholder started to implement the contract and act on it. Mere acceptance of the controlling shareholder of sums paid by way of commission in relation to pre incorporation contracts was insufficient. Default liability of promoters for pre incorporation dealing s. 37 (2) a prospective director or shareholder is in default bound by the contract and might be liable in the case that the contract isn't ratified. Forms of contracts Companies sign documents by affixing their seal. The use of the company's seal is governed by s. 38 (1) (a) of the 1963 Act It requires two directors and a director plus company secretary to affix the seal they must sign as well. The Articles of Association will typically say that the seal can only be affixed with the authority of the board of directors. 16 Electronic Commerce Act 2000 It is now possible to have an electronic company seal The ultra vires rule Human beings can enter any contract they like subject to the constraints of public policy. Companies are much more restricted. The ultra vires rule restricts what kind of contracts and business they can get involved in. Origin and purpose Statutory requirement of an objects clause In the Memorandum of Association, there is an objects clause. Required by s. 6 (1) (b) 1963 Protects investors by limiting the purposes for which the company can use their money Contracts outside the objects clause will be beyond the power of the company.
The concept of ultra vires Nothing outside the objects clause could be attempted Cause significant commercial problems. Ashbury Railway Carriage and Iron v Riche Objects included the making and selling of railway carriages. The directors sought a concession to operate a railway in Belgium. It later became inconvenient for them to do this. The company sought to evade their contractual obligations by claiming it had been acting ultra vires. The court held that the contract was void for being ultra vires. The transaction could not be retrospectively ratified by changing the company's objects Creditors and shareholders expectations had to be protected. At that time it was not possible to amend the objects clause in any circumstances. Not so today. Special resolution 75% majority required The M&A and Articles, being public documents, put the public on constructive notice of the objects clause. Operates harshly on people who are unaware of company law Re John Beauforte (London) The company's notepaper indicated that its business was the manufacture of veneer panels. The company's object clause did not permit it to carry out these activities. A fuel merchant which provided the company with coke for use in its factory was held to have constructive notice of the objects clause and was unable to claim for the cost of fuel supplied under his contracts with the company. The voluminous objects clause Lawyers drafted objects clauses which contained every imaginable object. More convenient than having to constantly review objects clauses. The courts disapproved of this practice. Cotman v Brougham (HoL) The House of Lords described this practice as a pernicious practice. Nonetheless, they accepted that once the certificate of incorporation was granted, they could only treat the memorandum as granted. Judicial construction of objects clauses The main objects rule The courts would try to identify the main object All other objects treated as ancillary to the main object Like the ejusdem generis rule Where there is a broadly stated rule followed by more narrowly stated rules, the narrowly stated ones are subordinate to the general rule Narrow objects in service of the main object Re German Date Coffee
Courtney A company acquired a Swiss patent for manufacturing a substitute for coffee from dates. The objects expressly referred to a German Patent. The company was wound up as it was impossible to carry on its objects. Lindly LJ the real object of this company was to manufacture a substitute for coffee in Germany under a patent which is valid according to German law. All the rest is subordinate to that main object. Anglo Overseas Agencies v Green Held that where a memorandum of association contains an objects clause in a series of numbered paragraphs, and the first or first few paragraphs state what appears to the main object of a company, the following paragraphs will be viewed as ancillary to the main objects. Courtney where the memorandum of association expresses the object of the company in a series of paragraphs, and one paragraph, or the first two or three paragraphs, appear to embody the 'main object' of the company, all the other paragraphs are treated as merely ancillary to the 'main object', and as limited or controlled thereby. The independent objects rule Cotman v Brougham The company's main object appeared to be the development of rubber plantations. It had, however, moved on to an alternatively business in underwriting share allotments. The House of Lords upheld the independent objects clause Lord Finlay LC The court can only interpret the memorandum as it stands. it is possible that in some future case the question may arise on application for a mandamus if the registrar should refuse registration, taking the ground that the Act requires that the memorandum should be in such a form that the real objects of the company are made intelligible to the public. In the present case no such question arises. The registrar accepted the memorandum of association and gave a certificate of incorporation, and that certificate is conclusive. I find it impossible to say that the acquisition of these powers was ultra vires of the Essequibo company. Lord Parker Noted that there is a difference between winding up a company for failure of its substratum and deciding whether an act of the company is ultra vires. The truth is that the statement of a company's objects is intended to serve a double purpose. In the first place it gives protection to subscribers, who learn from it the purposes to which their money can be applied. In the second place it gives protection to persons who deal with the company, and who can infer from it the extent of the company's powers. Bell Houses clauses Driven by a fear that even with a voluminous objects clause, an intended line of business may fall outside it. Authority to carry out any business that, in the opinion of the directors, can be advantageously carried out by the company
Bell Houses v City Wall Properties The company the principal business of building houses but the objects clause permitted the company to enter into any contract which the directors considered advantageous to the company. The question for the Court of Appeal was whether it was ultra vires for the company to contract with the defendant company to introduce it to a financier company for a fee. Dankworths LJ Upheld the clause as valid. Headnote any trade or business which the directors bona fide believed could be advantageously carried on by the plaintiff company in connection with or ancillary to its main business was intra vires the plaintiff company...even though it had no objective connection with or relationship to the company's main business. since the directors, through the chairman bona fide believed that the transaction with the defendant could be advantageously carried on by the plaintiff company as ancillary to its main business, the alleged contract was intra vires the plaintiff company. The distinction between powers and objects Attempt to limit lawyer's ingenuity. Some elements of the objects clause are not objects, but powers. e.g. Borrowing money > considered a power in pursuit of the object of financing the company rather than an object in its own right Rolled Steel Products(Holdings) v British Steel Corporation The Court of Appeal said that even an independent objects clause will contain clauses incapable of being construed as independent objects. Treated as an ancillary power instead. Giving guarantees was considered a power rather than an object. RSC guaranteed the obligation of SSS, an associated company, to BSC and gave security over its property in transactions which were in no way for its own advantage but did benefit one of its own directors, Shenkman. Browne Wilkinson LJ For reasons which will appear, in my judgment, the use of the phrase 'ultra vires' should be restricted to those cases where the transaction is beyond the capacity of the company and therefore wholly void. i.e. not to acts within the capacity of the company but carried out otherwise that through the correct exercise of the powers of the company by its officers. [T]he objects of a company and the powers conferred on a company to carry out those objects are two different things...[i]t is clear that a transaction falling within the objects of a company is capable of conferring rights on third parties even though the transaction was an abuse of the powers of the company. In my judgment, for this purpose the position of a company is analogous to that of a human being who has fiduciary powers. If two trustees convey trust property in breach of trust, the conveyance is not void...so in the case of a limited company, if a transaction falls within the objects of the company (and is therefore within its capacity) it is effective to vest rights in a third party even if the transaction was carried out in excess or abuse of the powers of the company. [T]he principles of ostensible authority apply to acts of directors acting as agents of