SECTION 39 AND 40 OF CA2006 1

THE ULTRA VIRES DOCTRINE

Name

Professor

Date
SECTION 39 AND 40 OF CA2006 2

Introduction

Section 39 of the Companies Act 2006 states that the validity of a company’s action

cannot generally be called to question due to a lack of capacity in the constitution of the

company. Further, they can bind the company under section 40 clauses 1 to 5 Subject to good

faith limitations. The gist of the section is that a person transacting with the company need not

inquire on the company’s director’s ability to undertake particular transactions. It is also

stipulates that third parties will not be found to have acted in bad faith unless they actually had

knowledge of a lack of powers to enter into a transaction in the specific case. In discussion of the

statement this essay shall seek to analyse the doctrine of ultra vires attracting decisions based on

the doctrine and further review inconsistencies on the legislation.

The ultra vires doctrine

The ultra vires rule laid down in Ashbury1 was a regulatory mechanism that sought to

restrain directors of a registered company from executing any transactions that exceeded the

scope of a company’s contractual capacity. The main motive for the house of Lords decision was

for the protection of the creditors and shareholders, a prospective shareholder of a third party

company would therefore need to inspect the company’s constitution to decide whether to

transact with a company. However, there was judicial departure to the rule which tremendously

weakened the doctrine. In AG v The Great Eastern Railway Company2 the court sought

reasonable application of the doctrine, five years after decision of the Ashbury case.

Further the doctrine would be highly diluted by decision in Re David Payne3 which

averred that the rule was not concerned at the mode which the transaction took place or how the

power of the company was deployed but rather if such company had capacity to enter into such a

1
Ashbury Railway Carriage Co. w. Riche, LR, 7 H.L. 653 (1875).
2
5 App. 473 (1880).
3
Re David Payne & C0 Ltd, 1904 Ch. 2 608 (1904).
SECTION 39 AND 40 OF CA2006 3

transaction or to employ relevant power4. In Cotman5 it was held that the acceptance by the

registrar to register a company based on its constitution was evidence that all requirements had

been fulfilled further contradicting the earlier substratum and euisden generuis rule applied in

Ashbury67. The above case laws severely hampered the application of the doctrine. The

inconsistency of the common law regime on the aspects of the doctrine pushed for the remedy of

the doctrine but retained various aspects of the original doctrine of ultra vires8.

Section 40 of the Companies Act 20069 allows a third party to restrain themselves form

making inquiries into the constitutional documents of a company to ascertain whether directors

have the capacity to bind the company to a transaction. The section grants companies unfettered

leeway to take advantage of the provisions10. The directors, thus, have unlimited powers with

unlimited objectives11. The question thus arises as to whether the transacting third party should

rely on statutory protection availed by section 3912 or be inclined to inquire a detailed assessment

of constitutional documents of the transacting corporation. Relying on statutory protection may

result to detrimental outcomes. This is in relation to the following aspects; (a) the third party

must be acting in good faith, (b) a breach of a director’s duty, (3) connected party issues, (4) risk

of board meetings that meet no quorum and five existing threat of a challenge from the

shareholders.

4
Re Lee Behrens and Co Ltd.
5
Cotman v Brougham [1918]AC514
6
Nyombi, C., 2014. The gradual erosion of the ultra vires doctrine in English company law. International Journal of
Law and Management, 56(5), pp.347-362.
7
Bell Houses Ltd v City Wall Properties Ltd [1966]2QBD656.
8
ibid
9
Sec 40 CA 2006
10
Stephen Griffin, 'The Rise and fall of the Ultra Vires Rule in Corporate Law' [1998] Mountbatten journal of Legal
Studies.
11
Sharma, Y.S., 2015. Judicial Response to Winding up An analysis of Just, and Equitable ground.
12
Sec 39 CA 2006
SECTION 39 AND 40 OF CA2006 4

On issues of good faith the Companies Act 2006 lays good faith as a key component for

the protection under section 4013. However, a mere knowledge of the breach of the director’s

powers does not effectively denote bad faith. Benefit with knowledge of power misuse and the

third party tends to gain constitutes bad faith. Since the documents of an obligator are not

assessed, good faith can be assumed. In practical terms, good faith is bound to apply

retrospectively when it is late for salvaging an arrangement. The motives to the transaction and

the transactions themselves would most likely be assessed by liquidators where the company

becomes insolvent. Thereby, dealing with a company in financial strains would be viewed with

greater degrees of suspicion.

Clause 1 of section 40 provides that the powers of a director are deemed to be free of any

limitations as stipulated by a company’s constitution. The provision thereby infers that

individuals with knowledge or ought to possess knowledge that the directors are in breach of

duties other than a mere duty to observe constitutional limits on powers granted to them cannot

rely on statutory protection14. A candid example is the application of section 172 of the

Companies Act 2006 which grants the directors a statutory to act in any way they consider good

faith in exercise of their powers for the sole purpose of benefiting the shareholders or to achieve

authorised purposes of the company. As laid down in Rolled Steel Products (Holdings) Limited

v. British Steel Corporation15 the assertions were reinforced.

Further the Companies Act seeks to reverse the common law doctrine that a company is

bound by its article of association as reiterated above. It merely thrusts the doctrine of ultra vires

to the precincts of the director’s duty and a need for good faith16. A key distinction of the act
13
Sec 40 CA 2006
14
The city of London law Society <http://www.citysolicitors.org.uk/attachments/article/121/20110805-Checking-
Constitutional-Documents-(on-letterhead)-.pdf> accessed 8 January 2017.
15
1986 Ch 246 (1986).
16
ADRIAN DIETHELM and DAMIAN REICHEL, 'Objects And Powers In Company Law In Re HORSLEY &
WIGHT LTD.' [1984] The Sydney Law review.
SECTION 39 AND 40 OF CA2006 5

specifically on amending provisions of the act of 1985 is that section 40(1) targets the directors

specifically rather than the board of directors17. Thereby in practice, it is deemed that a

corporation can be bound by the transaction of a single director who acts in actual authority or

implied authority of the board or company respectively.

Such acts will even be in circumstances where they are in contravention of the articles of

association. In addition, section 43(1) the act permits contractual undertakings by persons

impliedly or expressly authorised by the company’s authority. Application of section 40 is

premised on good faith, however good faith is a presumption unless proven otherwise. The court

of appeal has also held that section 40 CA does not eliminate a duty to inquire on the authority of

the director where such authority is put to question.

Recent case law is testament to the development, in Magical Marking Ltd & Anor v Holly

& Ors 200818 the notion of ostensible authority arose. The court read that a person of prudent

mind would apprehend that an agent possess authority to act, -the acts of the agent shall bind the

principal even where the agent lacked authority. The principal is bound by making implied or

express representation that an agent is authorised to act on his behalf.

Further ostensible authority arises in circumstances where a person within the company

holds a position which in an ordinary setting would place such person with a position deemed to

be of authority within the firm. This aspect is in lieu of positions such as the executive directors.

An example would be a person placed in a position such as the financial director. The common

dealing would dictate implied authority to act in all areas and partake of all necessary actions in

fulfilment of the role by virtue of their appointment. An illustration is the ruling in Smith v Butler

& Anor19; the court had to decide whether the managing director had authority to dismiss the

17
De Lacy, J. ed., 2013. Reform of UK Company Law. Routledge.
18
[2008] EWHC (Ch) 2428
19
[2011] EWHC 2301 (Ch)
SECTION 39 AND 40 OF CA2006 6

chairman, a majority shareholder, under the implied authority. The court decided that the

managing director had no such authority and ruled in favour of the chairman. Further it was

stipulated that a managing director could not use his powers to amass powers that would be

exercisable by the board. The court of appeal however granted leave for appeal of the decision.

In general sense, section 40 transfers protection of shareholder to the third party from adverse

consequences of the acts of the directors. Further as held in Smith V Henniker-Major 200220 it

will be hard to rely on these provisions where a narrow issue of legality of procedural

mechanisms within the company are violated. This is particularly so for the directors who are

insiders. The shareholders however as held in EIS services V Phipps 200321 can be protected

where a third party deemed notice of any restrictions.

There also exists a problem with words used in section 40(2) (b), which states ‘authorise

others to do so’ though the difficulties can be dealt with, the subsection and clause contrary to

established case law does not bind a party to enquire22. Thus, if read in purview of section 40 (2)

(2) it should be felt as a deeming provision but provides a focussed but an indirect elimination of

the constructive common law notice doctrine.

The original use of the term of ultras vires indicated that the term is not concerned with

the duty placed on a firm to confine all its activities within its authorised objectives but on the

firm’s incapacity. The current legislative agenda fails to capture this aspect 23.

Conclusion

20
Smith v Hennicker-Major & Co [2002] BCC 768 (CA)
21
EIS services v Phipps [2003] BCC 931
22
ACCA http://www.accaglobal.com, 'Understanding Corporate Capacity | F4 Corporate And Buinsess Law |
ACCA Qualification | Students | ACCA Global' (Accaglobal.com, 2017)
<http://www.accaglobal.com/my/en/student/exam-support-resources/fundamentals-exams-study-resources/f4/
technical-articles/corporate-capacity.html#> accessed 8 January 2017.
23
Ahern, D., 2014. Codification of Company Law: Taking Stock of the Companies Act 2006. Statute Law
Review, 35(3), pp.230-243.
SECTION 39 AND 40 OF CA2006 7

In the purview of the above discussed scenarios the ostensible authority accruing to

directors is a new and complex new area of law. Further the courts have yet to consider matters

wholly on the relationship of section 40 CA 2006 and aspects of the agency law, thereby creating

a scenario for the third party to exercise caution when dealing with individual directors and in

possible instances request proof of the acting authority of a director on behalf of the firm by

requesting a form of the board’s resolutions. Section 39 is explicit on the use of the ultra vires

doctrine but the use of section 40 still elicits the statutory intervention as having a hit and miss

phenomena to it. The use of the legislative techniques suppresses some common law areas in

certain circumstances but the statute is sometimes ill-conceived showing a lack of proper

drafting. The courts however when pressed to inject life to its meaning will elaborate on the

intended outcomes and effects in addition to diminishing areas that a third party would be

affected adversely by restrictions placed by a company’s constitution. Prior to such decisions,

section 40 remains a complicated and inconsistent area of law.

SECTION 39 AND 40 OF CA2006 8

BIBLIOGRAPHY

ADRIAN DIETHELM and DAMIAN REICHEL, 'Objects And Powers In Company Law In Re

HORSLEY & WIGHT LTD.' [1984] The Sydney Law review.

AG v The Great Eastern Railway Company 5 App. 473 (1880).

Ahern, D., 2014. Codification of Company Law: Taking Stock of the Companies Act 2006.

Statute Law Review, 35(3), pp.230-243.

Ashbury Railway Carriage Co. w. Riche, LR, 7 H.L. 653 (1875).

Bell Houses Ltd v City Wall Properties Ltd [1966]2QBD656.

Companies Act 2006 CA2006

Cotman v Brougham [1918] AC514

De Lacy, J. ed., 2013. Reform of UK Company Law. Routledge

EIS services v Phipps [2003] BCC 931

Griffin s, 'The Rise and fall of the Ultra Vires Rule in Corporate Law' [1998] Mountbatten

journal of Legal Studies

http://www.accaglobal.com A, 'Understanding Corporate Capacity | F4 Corporate and Business

Law | ACCA Qualification | Students | ACCA Global' (Accaglobal.com, 2017)

<http://www.accaglobal.com/my/en/student/exam-support-resources/fundamentals-

exams-study-resources/f4/technical-articles/corporate-capacity.html#> accessed 8

January 2017

Magical Marking Ltd & Anor v Holly & Ors [2008] EWHC (Ch) 2428

Nyombi, C., 2014. The gradual erosion of the ultra vires doctrine in English company

law. International Journal of Law and Management, 56(5), pp.347-362.

Re David Payne & C0 Ltd, 1904 Ch. 2 608 (1904).

SECTION 39 AND 40 OF CA2006 9

Re Lee Behrens and Co Ltd.

Rolled Steel Products (Holdings) Limited v. British Steel Corporation [1986 Ch 246 (1986).

Sharma, Y.S., 2015. Judicial Response to Winding up An analysis of Just, and Equitable ground.

Smith v Butler & Anor [2011] EWHC 2301 (Ch)

Smith v Hennicker-Major & Co [2002] BCC 768 (CA)

The city of London law Society

<http://www.citysolicitors.org.uk/attachments/article/121/20110805-Checking-Constitutional-

Documents-(on-letterhead)-.pdf> accessed 8 January 2017.