Ashbury Railway Carriage and Iron Co Ltd vs Riche - Essay Example

Introduction There are four recurring themes throughout company law: a company is a separate legal entity, the majority normally rules, Directors have a fiduciary relationship with the organization and that ultimate control rests in the general meeting. The majority of ‘conflict’ in company law derives from the attempt to balance these basic principles with the interests of shareholders, creditors and other stakeholders. Ashbury Railway Carriage and Iron Co Ltd v Riche [1875] The Memorandum and Articles of Association form the constitution of a company. The Memorandum of Association specifies the form and legal capacity of the company, whilst the Articles of Association regulate its internal dealings. The decision in Ashbury confirmed that a company cannot carry on any business not specified in its objects clause. Third parties were often unable to sue companies in contract because of the ultra vires rule pertaining to the objects clause – which specifies the business the company can carry on and the legal powers of the company - in the Memorandum of Association. When the rule applied it made any contract which was caught by the rule void and the creditor could receive no restitution. This was justified by the rule of constructive notice. This holds that since the Memorandum is a public document all parties are deemed to have had the opportunity to read it prior to committing to a transaction. Moreover the rule protected the shareholders’ capital from acts undertaken by Directors purportedly on the company’s behalf. The immediate result was increasingly long objects clauses as companies strove to include any business they might wish to carry on, or power they might wish to exercise, together with catch-all clause permitting the company to carry on any business which the Directors thought fit: Bell Houses Ltd v City Wall Properties Ltd [1966]. An aligned problem is that of Directors acting outside their authority. This may not be deliberate. For example a Director may have exceeded his authority by acting independently when the Articles required a board decision, or have failed to follow a specific procedure prior to entering a contract. Unless it could be established that the Director had ostensible or implied authority then the company would not be bound by the transaction. Further the rule in Royal British Bank v Turquand [1856] states that a third party need not determine whether internal rules have been followed prior to entering a contract with a company. Hence certain transactions might be enforceable even where the Directors had exceeded their authority if the shareholders ratified them and the transaction was otherwise in the company’s powers. The Companies Act 1989 dealt with the ultra vires rule by inserting provisions in the Companies Act 1985 retrospectively. Key alterations made by the Companies Act 1989 include: s3A - allowed companies to describe themselves as a ‘general commercial company’. This would allow companies to carry on any trade or business it wished with the requisite powers to do so and hence making objects clauses redundant. S108 – substituted a new s35 (1) into the Companies Act 1985. This new section prevents a company being called into question on the ground of lack of capacity by reason of anything in the Memorandum of Association. In effect this abolishes the ultra vires rule as the company and other parties are prevented from using the ultra vires rule to challenge the validity of a transaction. S108 also introduced s35A and s35B into the Companies Act 1985. s35A expressly allows a person dealing with a company in good faith to assume that the Directors will not be bound by any limitation in the company’s constitution. S35B states that a party to a transaction is not bound to enquire whether that transaction is permitted by the company’s memorandum. There is a presumption of good faith and s35 (2) states that a party shall not be regarded as acting in bad faith by reason only of knowing that an act is outside the Directors’ powers. Further members of the company cannot prevent an ultra vires transaction if the company is fulfilling a pre-existing legal obligation (s 35 (2)). S35 (3) – any act by a Director can be ratified by a special resolution. However, the Directors remain personally liable for ratified ultra vires actions unless a separate special resolution is passed absolving them of responsibility. Aberdeen Railway Co v Blaikie Brothers [1854] Directors are a fundamental part of a company’s structure hence the scope of their responsibilities and potential abuse of their position has resulted in considerable case law. In this case Lord Cranworth LC described Directors as ‘agents’ comparing their roles to that of a trustee. Sealy makes the point that that ‘the rule does not impose a duty but merely puts the Director under a disability.’ (Sealy: 271). Although strictly speaking Directors are not trustees they have similar fiduciary duties in the sense that they control the company’s assets and therefore have a duty to preserve those assets as far as possible as they utilize them to conduct the company’s business. Essentially this boils down to the Directors doing nothing which brings them into conflict with the company’s best interests. In particular in making decisions Directors are required to use their ‘unfettered discretion’ and base the decision purely on commercial grounds. Directors have a responsibility to act in good faith toward the company. It is a positive duty to act in the company’s best interests and not for some collateral purpose - even if it is believed that the company will benefit: Howard Smith Ltd v Ampol Petroleum [1974]. In that case it was held that Directors were in breach of their fiduciary duty when they used their powers to allot unissued share capital for the purpose of defeating a take over bid as they had no power to make such a use of unissued capital. Note however, it is possible for such actions to be ratified by the general meeting: Bamford v Bamford [1970]. Clemens v Clemens Bros Ltd [1976] Generally the only proper plaintiff when a wrong is done to a company is the company itself: Foss v Harbottle [1843]. Such actions would therefore be initiated by the board of Directors. In the event that the action is against the Directors then this must be initiated by the majority of shareholders on the company’s behalf. Generally the minority have no rights to interfere and the courts have proved reluctant to interfere with the exercise of the majority of their voting rights unless there is clearly bad faith. One such exception is usually referred to as a ‘fraud on the minority’. A minority shareholder is allowed to commence a ‘derivative action’ at the court’s discretion, although the court usually requires evidence of dishonesty before it will entertain such an action. In Clemens the definition of fraud was broadened to include the situation where a majority shareholder (the aunt) used her voting rights to increase the capital and dilute the minority shareholder’s voting rights. The ratio decidendi of the case seems to be that as a Director and a share holder the aunt had an equitable duty not to deprive minority shareholders of their existing rights. Clemens suggests that dilution of voting capital is inequitable but may be confined to the particular facts of a quasi-partnership company. The decision was concluded before s459 Companies Act 1985 came into force, and such actions would now fall under unfairly prejudicial conduct. Alternatively, Table A, regulations 2 and 32 can be altered so that the word ‘special’ is substituted for the word ‘ordinary’. Conclusion These three cases reflect the role of the law in attempting to balance the power between ownership of the organization (share holders) and control of the organization (directors). As it stands, the majority of the risk falls on share holders, and yet they have limited power to determine the day to day running of the organization. The ultra vires rule was an attempt to ensure that shareholders’ monies were invested in activities which they had approved when they became members of the company, and that creditors were able to undertake calculated risks when making loans to a limited company. In this way the corporate capital was safe from exploitation – albeit at the expense of the unwary creditor who had no hope of restitution. Attempts to curb self-dealings by directors – such as asset transfers, loan arrangements or taking advantage of corporate information - is another layer of protection for the shareholder and the creditor. It takes cognizance of the fact that only directors have sufficient time, motive and opportunity to benefit financially from the company, and to hide evidence of any bad faith transactions. References Pettet, B. (2005). Company Law. 2nd Edition. Longmans. Sealy, L. (2001). Cases and Materials in Company Law. 7th Edition. Butterworths. Cases Aberdeen Railway Co v Blaikie Brothers [1854] 1 Macq 461 Ashbury Railway Carriage and Iron Co Ltd v Riche [1875] LR 7 HL 653 Bamford v Bamford [1970] Ch 212 Bell Houses Ltd v City Wall Properties Ltd [1966] 2 QB 656 Clemens v Clemens Bros Ltd [1976] 2 All ER 268 Foss v Harbottle [1843] 2 Hare 461 Howard Smith Ltd v Ampol Petroleum [1974] AC 821 Royal British Bank v Turquand [1856] 6 E & B 327 Read More