Recently, the Parliament introduced the Companies (Amendment) Bill, 2016 (Bill) to usher changes in the recently amended Companies Act, 2013 (Act of 2013). The Parliament seeks to make substantial changes in the pattern of trade and commerce in the country by liberalizing the procedures and requirements for running a company. Among the reforms proposed, one proposal is to do away with the need to have an ‘object clause’ in the Memorandum of Association (MOA). This article investigates the reasons behind this proposed amendment and the pros and cons it entails
Section
4 (1) (c) of Act of 2013 lays down a requirement of drafting an object clause
in the MOA which include the objectives behind the incorporation of a company
and mandates every MOA to state “the
objects for which the company is proposed to be incorporated and any matter
considered necessary in furtherance thereof”. This was a departure from
Section 13(d) of the Companies Act, 1956 (Act of 1956) which provided that
every company should separately provide for ‘main’ and ‘other’ objects.[1]
The actions undertaken by any company are required to be within bounds of its object clause and any action beyond its realms is to be considered ultra vires, a principle established in the case of Ashbury Railway Carriage & Iron Company Ltd. v. Roche.[2] However, such ultra vires act is different from an illegal act.
For example, an act performed by a company may be otherwise legal and done for attainment of the purpose of carrying out a transaction but may amount to be ultra vires its MOA owing to an ill drafted object clause which does not cover within its ambit the power to carry out such activity. In such cases the burden is shifted on courts to determine whether the action concerned is incidental to or consequential upon the object clause, and thereby treating the transaction as intra vires.[3]
Ultra vires acts largely impact the third parties/outsiders dealing with the company who enter into contracts without thoroughly going through the objects and determining whether the action concerned are within the bounds of company’s objectives. Under such conditions they are neither able to sue the company for breach of contract nor seek specific performance. Such actions undertaken ultra vires the objects were considered void.[4]Thus, the only actions which the company could have undertaken are those within the ambit of objects clause and ones which could be incidental to or consequential upon such clause or the actions essential in the fulfillment of the objects so stated or the actions otherwise authorized to be done by the Companies Act, in the course of its business.
An argument which warranted avoidance of such ultra vires agreements was the principle of constructive notice stating that since outsiders/third parties have access to the MOA which contains the object clause, they would be deemed to have knowledge about extent of company’s ability to enter into transactions.
The detrimental impacts of dealings, on third parties, which were otherwise bona fide but ultra vires the object clause, were identified and Section 31(1) was introduced in the (English) Companies Act, 2006. The provision states that unless the articles of company specifically restrict the objects of a company, its objects are unrestricted.
On similar lines, the Bill pending before the lower house of the Parliament seeks to do away with the requirement of having a specific object clause. It extends an option to the company to either merely mention that it will engage in lawful activities or choose to enumerate specific objects in detail. However if a company chooses to lay down specific objects it won’t be permitted to engage in activities ultra vires its ambit.
The amendment seeks to grant maximum autonomy to persons controlling the affairs of company to enter into any transaction unhindered and un-impacted by any ill-drafted clauses in the Memorandum. But the transactions entered into are subject to laws in force and hence the transactions can still be challenged and be vitiated by laws applicable. Thus the defense that transactions done beyond object clause being void and not binding upon the company is relinquished the moment a company decides not to have an object clause. It is clearly beneficial for third parties since any contract, if breached, could be brought before the court for redressal, without having the burden to defend the vires of transaction.
However, it is not clear what the Parliament tries to achieve through the proviso clause. It merely allows the company to proceed with the traditional approach of laying down an exhaustive object clause. It does not in any way unburden the court of the need to decide on basis of factual analysis whether certain action would be incidental or consequential to what has been expressly mentioned in the clause.
Due to the mandate of having a detailed object clause, the practice had slowly grown to have the clause as wide as possible and which was in direct correlation to obviating the necessity to seek consent of general meeting by special resolution whenever any new venture was contemplated. The proposed clause in the Bill would give unlimited power in the hands of persons controlling the company to enter into any possible transaction as deemed correct without having the need to amend the clause or to seek consent from time to time. But, this has its flip side too. While making all actions intra vires the Memorandum through such clause, the shareholders need to keep adequate check on the exercise of such power by adding appropriate internal management control clauses and distributing powers proportionately. The main stakeholders which could be affected are minority shareholders since with every action not requiring sanction might lead to situations in which the actions otherwise intra vires the MOA would end up causing serious prejudice to their rights. The main reason which Daphtary Sastri Committee gave for having a detailed object clause was to give all the stakeholders (shareholders and other interested parties) a clear idea of what the objects were. With such liberal position, there is higher possibility of their rights being impaired without the presence of adequate check and balance. Thus in such case, a more comprehensive delineation of directors’ powers and duties would become necessary. While the Act of 2013 only liberalized the need to have a bifurcated object clause, this is a step ahead. The proposed amendment, as even the Company Law Committee Report noted, is in line with the need to facilitate easier incorporation and to provide greater flexibility for carrying out business.
The actions undertaken by any company are required to be within bounds of its object clause and any action beyond its realms is to be considered ultra vires, a principle established in the case of Ashbury Railway Carriage & Iron Company Ltd. v. Roche.[2] However, such ultra vires act is different from an illegal act.
For example, an act performed by a company may be otherwise legal and done for attainment of the purpose of carrying out a transaction but may amount to be ultra vires its MOA owing to an ill drafted object clause which does not cover within its ambit the power to carry out such activity. In such cases the burden is shifted on courts to determine whether the action concerned is incidental to or consequential upon the object clause, and thereby treating the transaction as intra vires.[3]
Ultra vires acts largely impact the third parties/outsiders dealing with the company who enter into contracts without thoroughly going through the objects and determining whether the action concerned are within the bounds of company’s objectives. Under such conditions they are neither able to sue the company for breach of contract nor seek specific performance. Such actions undertaken ultra vires the objects were considered void.[4]Thus, the only actions which the company could have undertaken are those within the ambit of objects clause and ones which could be incidental to or consequential upon such clause or the actions essential in the fulfillment of the objects so stated or the actions otherwise authorized to be done by the Companies Act, in the course of its business.
An argument which warranted avoidance of such ultra vires agreements was the principle of constructive notice stating that since outsiders/third parties have access to the MOA which contains the object clause, they would be deemed to have knowledge about extent of company’s ability to enter into transactions.
The detrimental impacts of dealings, on third parties, which were otherwise bona fide but ultra vires the object clause, were identified and Section 31(1) was introduced in the (English) Companies Act, 2006. The provision states that unless the articles of company specifically restrict the objects of a company, its objects are unrestricted.
On similar lines, the Bill pending before the lower house of the Parliament seeks to do away with the requirement of having a specific object clause. It extends an option to the company to either merely mention that it will engage in lawful activities or choose to enumerate specific objects in detail. However if a company chooses to lay down specific objects it won’t be permitted to engage in activities ultra vires its ambit.
The amendment seeks to grant maximum autonomy to persons controlling the affairs of company to enter into any transaction unhindered and un-impacted by any ill-drafted clauses in the Memorandum. But the transactions entered into are subject to laws in force and hence the transactions can still be challenged and be vitiated by laws applicable. Thus the defense that transactions done beyond object clause being void and not binding upon the company is relinquished the moment a company decides not to have an object clause. It is clearly beneficial for third parties since any contract, if breached, could be brought before the court for redressal, without having the burden to defend the vires of transaction.
However, it is not clear what the Parliament tries to achieve through the proviso clause. It merely allows the company to proceed with the traditional approach of laying down an exhaustive object clause. It does not in any way unburden the court of the need to decide on basis of factual analysis whether certain action would be incidental or consequential to what has been expressly mentioned in the clause.
Due to the mandate of having a detailed object clause, the practice had slowly grown to have the clause as wide as possible and which was in direct correlation to obviating the necessity to seek consent of general meeting by special resolution whenever any new venture was contemplated. The proposed clause in the Bill would give unlimited power in the hands of persons controlling the company to enter into any possible transaction as deemed correct without having the need to amend the clause or to seek consent from time to time. But, this has its flip side too. While making all actions intra vires the Memorandum through such clause, the shareholders need to keep adequate check on the exercise of such power by adding appropriate internal management control clauses and distributing powers proportionately. The main stakeholders which could be affected are minority shareholders since with every action not requiring sanction might lead to situations in which the actions otherwise intra vires the MOA would end up causing serious prejudice to their rights. The main reason which Daphtary Sastri Committee gave for having a detailed object clause was to give all the stakeholders (shareholders and other interested parties) a clear idea of what the objects were. With such liberal position, there is higher possibility of their rights being impaired without the presence of adequate check and balance. Thus in such case, a more comprehensive delineation of directors’ powers and duties would become necessary. While the Act of 2013 only liberalized the need to have a bifurcated object clause, this is a step ahead. The proposed amendment, as even the Company Law Committee Report noted, is in line with the need to facilitate easier incorporation and to provide greater flexibility for carrying out business.
[1]
Section 13(d) was amended through the Companies (Amendment) Act, 1965. The
changes were in line with the suggestions of Daphtary Sastri Committee.
[2]
Ashbury Railway Carriage Co. v. Riche, (1875) LR 7 HL 653
[3]
Gujarat Mining & Manufacturing Co. v. Motilal HS Weaving Co., AIR 1930 Bom
84
[4] Supra note 2
0 comments:
Post a Comment