DOCTRINES UNDER COMPANY LAW

INTRODUCTION

India has received numerous enactments from England. Company law is one such enactment that was embraced from England. In 1850 the first Company enactment was introduced in India for the registration of a joint company which was based on the English Company Act 1844. The idea of limited liability was introduced in the English Company Act of 1856 which was later presented in India in the year 1857. The Companies Act was altered a few times between 1850 and 1852 and the Act in 1852 repealed all other Acts and stayed till 1912. The Indian Companies Act of 1913 was based on the British Companies Act of 1908. This Act experienced a few amendments. After independence it was detected that the Companies Act must be changed to fit into the Indian situation, consequently the Companies Act 1956 was passed. This Act is currently substituted by the Companies Act 2013 which got approval from the President on 29 August 2013.

Under company law, there are different doctrines listed. In this article, the author will endeavor to explain such doctrines under the Company law.

DOCTRINES UNDER COMPANY LAW

1. DOCTRINE OF ULTRA VIRES

A company that owes its incorporation to statutory authority cannot effectively do anything beyond the powers expressly or impliedly conferred upon it by the statute or memorandum of association. Any purported activity beyond such powers will be ineffective even if agreed to by all the members. This rule is commonly known as the ‘doctrine of ultra vires’. The word ‘ultra’ means beyond and the word ‘vires’ means the powers. ‘Ultra vires’, therefore, means beyond the powers. So, when used concerning a company, it means beyond the powers of the company. The powers of a company are essentially derived from the statute constituting it and the memorandum of association. After the advent of Joint Stock Companies, the rule of ultra vires was for the first time laid down by the House of Lords in Ashbury Rly. Carriage & Iron Company v. Riche [1875] LR 7 HL 653. In this case, the object of the doctrine was explained by Lord Justice Cairns as follows :

1. to protect investors of the company so that they may know the objects in which their money is to be employed; and

2. to protect the creditors by ensuring that the company funds, to which they must look for payment are not dissipated in unauthorized activities.

In Ashbury Rly. Carriage and Iron Co. v. Riche (supra), the company had been formed with the object of carrying on business as ‘Mechanical Engineers and General Contractors’. The contractors agreed to finance the construction of a railway in Belgium and there was evidence that the agreement had been ratified by all the members. The company repudiated the agreement and was sued for breach of contract. The other party brought an action for damages for breach of contract. His contentions were: firstly, that the contract in question came well within the meaning of the words ‘general contractors’ and, was, therefore, within the powers of the company, and secondly, that the contract was ratified by the majority of the shareholders. The Court held that the term ‘general contractors’ must be taken to indicate the making generally of such contracts as were connected with the business of mechanical engineers. If, the term ‘general contractors’ was not so interpreted, it would authorize the making of contracts of any kind and every description, such as, for instance, fire and marine insurance and the memorandum in place of specifying the particular kind of business, would virtually allow the carrying on the business of any kind whatsoever and would, therefore, be altogether unmeaningful. Hence the contract was entirely beyond the objects in the Memorandum of Association. The doctrine of ultra vires has been upheld in a large number of Indian cases also. In the case of Lakshmanaswami Mudaliar v. L.I.C. AIR 1963 SC 1185, the directors of the company were authorized ‘to make payments towards any charitable or any benevolent object or for any general public or useful object’. Following shareholders’ resolution, the directors paid Rs. 2 lakhs to a trust to promote technical and business knowledge. The company’s business having been taken over by LIC, it had no business left of its own. The Supreme Court held that the payment was ultra vires the company. They could spend for the promotion only on such charitable objects as would be useful for the attainment of the company’s objects. It may, however, be noted that section 3(1)(c) of the Act provides that any matter considered necessary in furtherance of the main objects can well be pursued. Thus, in case any incidental object has not been specified, it would be allowed by the principle of reasonable construction of the memorandum. The doctrine of ultra vires - An illusory protection - It is important to note that the ultra vires doctrine is nowadays very largely frustrated by the ingenuity of company promoters, who, by enumerating all objects possible under the sun have in actual practice fouled the doctrine and made it ineffective, except in very rare cases. For example, in the case of Bell Houses Limited v. City Wall Properties Limited [1966] 36 Comp. Cas. 779, the objects clause included a power ‘to carry on any other trade or business whatsoever which can, in the opinion of the Board of directors, be advantageously carried on by the company’. The said clause was held to be quite an in order by the court. Implied powers: As made out in the doctrine of ultra vires, the powers exercisable by a company are to be confined to the objects specified in the memorandum. However, the powers exercisable in respect of the objects specified may be express or implied. Every company possesses certain powers by its being an incorporated body, such as, for instance, a power to appoint and act through agents, and where it is a trading company, a power to borrow and give security for its business, and also a power to sell. Such powers as these are incidental or properly to be inferred from the powers expressed in the memorandum—Oak Bank Oil Company v. Crum [1882] 8 App. Cas. 65. As regards implied powers, the rule is to assume that “quite apart from any general words in a company’s memorandum, it has the power to do all that is reasonably necessary for attaining its objects. The Courts have become increasingly ready to imply powers of this nature” (Palmer’s Company Precedents, 17th Edn., Part I, page 278).

· Powers which are not implied: The following powers have been held not to be implied and it is, therefore, prudent in cases where deemed necessary, to include them expressly in the objects—

1. acquire any business similar to the company’s own— Ernest v. Nicholls [1857] 6 HLC 401;

1. entering into an agreement with other persons or companies for carrying on business in partnership or for sharing profits, joint adventure, or other arrangements. Very clear powers are necessary to justify such transactions - Re European Society Arbitration Act [1878] 8 Ch. 679;

2. taking shares in other companies having similar objects Re Barned’s Banking Company, ex parte. The Contract Corporation [1867] 3 Ch. App. 105; Re William Thomas & Co. Ltd. [1915] 1 Ch. 325;

3. taking shares of other companies where such investment authorizes doing indirectly that which will not be intra vires if done directly;

4. promoting other companies or helping them financially— Joint Stock Discount Company v. Brown [1869] LR 8 Eq 381;

5. a power to use funds for political purposes;

6. a power to give a gift and make donations or contributions for charities not relating to the objects stated in the memorandum;

7. a power to sell and dispose of the whole of a company’s undertaking;

8. entering into contracts of suretyship or guarantee;

9. the making of loans by a company not engaged in financing or banking business.

· Effects of ultra vires transactions

(1) Void ab initio

(2) Injunction

(3) Personal Liability of Directors

(4) Acquisition of property that is ultra vires

(5) Directors personally liable to third parties

2. DOCTRINE OF CONSTRUCTIVE NOTICE

Section 399 provides that the Memorandum and Articles when registered with Registrar of Companies ‘become public documents’ and then they can be inspected by anyone by electronic means on payment of the prescribed fee. Again, Section 17 read along with Rule 34 of the Company (Incorporation) Rules, 2014 provides that a company shall on payment of the prescribed fee send a copy of each of the following documents to a member within seven days of the request being made by him: 1. the memorandum; 2. the articles, if any; 3. every agreement and every resolution referred to in sub-section (1) of section 117, if and so far as they have not been embodied in the memorandum and articles. Failure to supply the copy(es), as above, will make the company as well as every officer in default liable to a fine @ Rs. 1,000 per day for each day of the default or Rs. 1,00,000, whichever is less.

Therefore, any person who contemplates entering into a contract with the company has the means of ascertaining and is thus presumed to know the powers of the company and the extent to which they have been delegated to the directors. In other words, every person dealing with the company is presumed to have read these documents and understood them in their true perspective. This is known as the “doctrine of constructive notice”. Even if the party dealing with the company does not have actual notice of the contents of these documents it is presumed that he has an implied (constructive) notice of them. Example One of the articles of a company provides that a bill of exchange to be effective must be signed by two directors. A bill of exchange is signed only by one of the directors. The payee will not have a right to claim under the bill.

3. DOCTRINE OF INDOOR MANAGEMENT

The rule of constructive notice proved too inconvenient for business transactions, particularly where the directors or other officers of the company were empowered under the articles to exercise certain powers subject only to certain prior approvals or sanctions of the shareholders. Whether those sanctions and approvals had been obtained or not could be ascertained because the investors, vendors, creditors, and other outsiders could not dare ask the directors in so many words about those sanctions having been obtained or to produce the relevant resolutions. Quite naturally, suppose if you desire to buy a ‘bond’ or ‘debenture’ issued by a company, you are not going to ask directors of the company to produce shareholders’ resolution authorizing them to issue such bonds before you subscribe the same. Likewise, if a director approaches you to buy certain goods worth, say, a few thousands of rupees, you will not ask him for a power of attorney or other relevant document authorizing him to make those purchases on behalf of the company. And if you do, maybe, you will lose a good customer once for all. Since there is no means to ascertain whether necessary sanctions and approvals have been obtained before a certain officer exercises his powers which, as per articles, can only be exercised subject to certain approvals, those dealing with the company can assume that if the directors or other officers are entering into those transactions, they would have obtained the necessary sanctions. This is known as the ‘doctrine of indoor management and was first laid down in the case of Royal British Bank v. Turquand [1856] 6 E & B 327. The facts of Turquand’s case were that the directors of a company were authorized by the articles to borrow on bonds such sums of money as should from time to time, by a resolution of the company in general meeting, be authorized to be borrowed. The directors gave a bond to T without the authority of any such resolution. The question arose whether the company was liable on the bond. Held, the company was liable on the bond, as T was entitled to assume that the resolution of the company in the general meeting had been passed. Once again, in the Madras case of Official Liquidator, Manasube & Co. (P.) Ltd. v. Commissioner of Police [1968] 38 Comp. Cas. 884 (Mad.). Also, see M. Rajendra Naidu v. Sterling Holiday Resorts (India) Ltd. [2009] 93 SCL 11 (Mad.). The learned judge observed that the lenders to a company should acquaint themselves with memorandum and articles, but they cannot be expected to embark upon an investigation as to legality, propriety, and regularity of acts of directors. Thus, you would have observed from the foregoing discussion that the ‘doctrine of constructive notice’ throws a burden on people entering into contracts with a company by making a presumption that they would have read the company’s memorandum and the articles even though they might not have read them. The ‘doctrine of indoor management, on the other hand, allows all those who deal with the company to assume that the provisions of the articles have been observed by the officers of the company. In other words, the persons dealing with the company are not bound to inquire into the regularity of internal proceedings

· Exceptions to the doctrine of indoor management

The above noted ‘doctrine of indoor management is, however, subject to certain exceptions. In other words, relief on the ground of ‘indoor management’ cannot be claimed by an outsider dealing with the company in the following circumstances:

1. Where the outsider had knowledge of irregularity

2. No knowledge of articles

3. Forgery

4. Negligence

5.The doctrine of indoor management does not apply where the question is regarding the very existence of an agency.

6. Doctrine is also not applicable where a pre-condition is required to be fulfilled before the company itself can exercise a particular power.

7. Oppression

4. DOCTRINE OF LIFTING OF OR PIERCING THE CORPORATE VEIL

The separate personality of a company is a statutory privilege and it must be used for legitimate business purposes only. Where a fraudulent and dishonest use is made of the legal entity, the individuals concerned will not be allowed to take shelter behind the corporate personality. The Court will break through the corporate shell and apply the principle/doctrine of what is called “lifting of or piercing the corporate veil”. The Court will look behind the corporate entity and take action as though no entity separate from the members existed and make the members of the controlling persons liable for debts and obligations of the company. The corporate veil is lifted when in defense proceedings, such as for the evasion of tax, an entity relies on its corporate personality as a shield to cover its wrongdoings. [BSN (UK) Ltd. v. Janardan Mohandas Rajan Pillai [1996] 86 Com Cases 371 (Bom).] However, the shareholders cannot ask for the lifting of the veil for their purposes. This was held in Premlata Bhatia v. Union of India (2004) 58 CL 217 (Delhi) wherein the premises of a shop were allotted on a license to the individual licencee. She set up a wholly-owned private company and transferred the premises to that company without Government consent. She could not remove the illegality by saying that she and her company were virtually the same people.

- Statutory Recognition of Lifting of Corporate Veil

The Companies Act, 2013 itself contains some provisions [Sections 7(7), 251(1), and 339] which lift the corporate veil to reach the real forces of action. Section 7(7) deals with punishment for incorporation of a company by furnishing false information, Section 251(1) deals with liability for making a fraudulent application for removal of the name of the company from the register of companies, and Section 339 deals with liability for fraudulent conduct of business during winding up.

5. DOCTRINE OF ALTER EGO

It is used by the courts to ignore the status of shareholders, officers, and directors of a company about their liability in their respective capacity so that they may be held personally liable for their actions when they have acted fraudulently or unjustly. In Lennards Carrying Co. Ltd. v. Asiatic Petroleum Co. Ltd. [1915] AC 705, Viscount Haldane propounded the “alter ego” theory and distinguished it from vicarious liability. The House of Lords stated that the default of the managing director who is the “directing mind and will” of the company, would be attributed to him and he is held for the wrongdoing of the company.

REFERENCES

1. https://www.icsi.edu/media/webmodules/publications/FinalCLStudy.pdf

2. Company Law and Practice, Dr. G.K Kapoor and Dr. Sanjay Dhamija, 24th Edition