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Introduction to Company Law

Note 2 of 7 Notes

Universiti Kebangsaan MalaysiaFaculty of Law PHD Program in Law

Musbri MohamedDIL; ADIL ( ITM )MBL ( UKM )

The memorandum and articles of association

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2. The memorandum and articles of association

Lim Beng Hui & Ors v. Ling Beng Sung [1990] 2MLJ 186

Per Hakim Haidar :-

“……the Memorandum and Articles of Association constitute a contract between the members inter se. The contract is deemed to contain covenants that each member will observe all the provisions of the Memorandum and Articles – see Section 33(1) of the Companies Act 1965…….”

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Eley v. Positive Government Security Life Assurance Co [1875] 1Ex.D.20 where the Articles provided that Eley should be solicitor to the company, it was held that this was not a right given to him as a member and he could not rely on the Articles as a contract for professional services.

In Rayfield v. Hands [1958] 2 All E.R 194 it was held that the Articles which required the directors to be members, i.e. to hold qualification shares and to purchase shares from any member who wished to sell, were enforceable.

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In Fong Poh Yoke & Ors v The Central Construction Co (M) Sdn Bhd [1998] 4 CLJ Supp 112 the articles of the company also did not provide for an empowering provision to 'suspend' directors. However, it was held that the company had the power of suspension. The rationale according to the decision is that since a company has power to 'remove' a director, it also has the lesser power to 'suspend'.

The ramifications of the decision in Fong Poh Yoke are very serious. It has the potential of arming majority directors and the interests they represent with an extremely powerful weapon to silence or get rid of opposite views of minority directors in a summary way.

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In Fong Poh Yoke case, the power of suspension is capable of becoming a legitimate weapon to aggrandize de facto majority by one group of directors over the other group. The aggrandizement of power in creating a majority which did not previously exist is not something which the law condones. In Fong Poh Yoke case itself, it is to be noted that the number of directors on the board was evenly divided between the Tham family and the Zee family (3:3). With the power of 'suspension' and the suspension of one of the directors representing the Zee family by the Tham family's directors, the Tham family created a de facto majority for themselves and subsequently pushed through several resolutions after the 'suspension' was effected. Of the several resolutions passed after the power of suspension was exercised, the Zee family's directors was outvoted on at least one crucial resolution as reported -- the approval and adoption of accounts and directors' report all of which were prepared by the directors representing the Tham family. The harsh realities of a commercial world are capable of producing an infinite variety of situations which will go beyond the simple factual matrix found in Fong Poh Yoke case -- the director there had deliberately failed to inform the secretary of changes in his particulars pursuant to s 135(1)(c) of the Act and in respect of which the director is personally liable.

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Companies cannot by their memorandum and articles of association give themselves more or greater powers than that provided for under the Act.

Whilst it is true that the Act is silent on whether a company has power to suspend its director, the validity of the existence of this power (whether under the articles or the common law) must be tested by reference to the legislative scheme of the law governing companies as revealed by the Act.

The Act does not make provision for the suspension of directors but for their removal and disqualification in defined circumstances. The power of suspension, if it exists, when invoked by companies, has the effect of giving holidays to directors with respect to their statutory functions and duties under the Act.

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The Act in disciplining directors for the purposes of upholding and enforcing the statutory functions and duties of directors also provides for offences by directors and for their punishment, including the machinery for enforcement.

The idea that the purpose of the power of suspension is meant to protect companies against breaches of the Act arising from breach of duties by directors involves determination by companies of the issue of guilt or otherwise on the part of directors. Companies do not have this jurisdiction. This jurisdiction belongs to the court.

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Bowen LJ in Guinness v Land Corporation of Ireland (1882) 22 Ch D 349 (CoA, Eng)

The memorandum contains the fundamental conditions upon which alone the company is allowed to be incorporated. They are conditions introduced for the benefit of the creditors, and the outside public, as well as of the shareholders.

The articles of association are the internal regulations of the company.

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Memorandum

Statutory requirements s 18(1)

•The name of the company •The objects of the company•A share capital clause•A liability clause•An association clause•A subscriber clause

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Alteration of the Memorandum

•S 23- the company’s name•S 25- unlimited <-> limited•S 26- public<-> private•S 28- object clauses•S 62- share capital•S 64- reduce the share capital•Etc; s 181- for a unfair treatment

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Alteration of objects clauses

•S 28 (2) & (3): 21 days notice to members/debenture holders/trustee•S 152(2): shorten if 95% members agree; By way of special resolution (3/4 majority)•S 28(8): 21-day grace period for any objection•S 28(9): 14 days time to lodge with the Registrar•S 28(10): effective only after lodgment•S 21(4): The certificate by R is a conclusive evidence for duly lodgment

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Who may object?

•1. member(s) holding >5% issued or class of share•2. >5% of the members for unlimited company•3. a debenture holder(s) of >5% of the debentures

Procedure

•S 28(7)(a): The Court will give regard to members/creditors’ interests•S 28(7)(d): The court will confirm the alteration (partly or wholly or none)•S 28(9): the resolution to be lodged with the Registrar within 14 days•S 28(10): effective only upon lodgment

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Alteration of the Articles

S 31(1) the company is free to alter its articles by special resolutionLindley MR in Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656: a member must vote ‘bona fide for the benefit of the company as a whole’Latham CJ in Peter’s American Delicacy Co Ltd v Heath (1939) 61 CLR 457: The Court will not interfere unless the decision is one that no reasonable person could make.Evershed MR in Greenhalgh v Ardene Cinemas Ltd [1951] Ch 286: the majority may not oppress or treat the minority unfairly.

Remedy: s 181

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Restrictions on alteration of Articles

•S 31(1) – Memorandum may impose conditions•S 15(1) – Private companies must:•(a) limit membership <50•(b) restrict transfer of shares•(c) no public deposit or subscription for shares and/or debentures•S 27(2) – any breach renders the company ceased to be a private company•S 65 – if the alteration will affect class rights, provided they are protected by M&A•S 33(4) – No amendment to require the member to subscribe more shares

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The object clause of the Memorandum of the company contains the object for which the companyis formed.

An act of the company must not be beyond the objects clause, otherwise it will be ultra vires and, therefore, void and cannot be ratified even if all the members wish to ratify it. This is called the doctrine of ultra vires, which has been firmly established in the case of Ashtray Railway Carriage and Iron Company Ltd v. Riche.

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The expression “ultra vires” consists of two words: ‘ultra’ and ‘vires’. ‘Ultra’ means beyond and ‘Vires’ means powers. Thus the expression ultra vires means an act beyond the powers. Here the expression ultra vires is used to indicate an act of the company which is beyond the powers conferred on the company by the objects clause of its memorandum. An ultra vires act is void and cannot be ratified even if all the directors wish to ratify it. Sometimes the expression ultra vires is used to describe the situation when the directors of a company have exceeded the powers delegated to them.

Where a company exceeds its power as conferred on it by the objects clause of its memorandum, it is not bound by it because it lacks legal capacity to incur responsibility for the action, but when the directors of a company have exceeded the powers delegated to them. This use must be avoided for it is apt to cause confusion between two entirely distinct legal principles.

Consequently, here we restrict the meaning of ultra vires objects clause of the company’s memorandum.

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The ultra vires act or transaction is different from an illegal act or transaction, although both are void. An act of a company which is beyond its objects clause is ultra vires and, therefore, void, even if it is illegal.

Similarly an illegal act will be void even if it falls within the objects clause.

Unfortunately the doctrine of ultra vires has often been used in connection with illegal andforbidden act. This use should also be prevented.

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Doctrine of ultra vires has been developed to protect the investors and creditors of the company. This doctrine prevents a company to employ the money of the investors for a purpose other than those stated in the objects clause of its memorandum. Thus, the investors and the company may be assured by this rule that their investment will not be employed for the objects or activities which they did not have in contemplation at the time of investing their money in the company. It enables the investors to know the objects in which their money is to be employed.

This doctrine protects the creditors of the company by ensuring them that the funds of the company to which they must look for payment are not dissipated in unauthorized activities. The wrongful application of the company’s assets may result in the insolvency of the company, a situation when the creditors of the company cannot be paid.

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There are, however, certain exceptions to this doctrine, which are as follows:

1. An act, which is intra vires the company but outside the authority of the directors may be ratified by the shareholders in proper form.

2. An act which is intra vires the company but done in an irregular manner, may be validated by the consent of the shareholders. The law, however, does not require that the consent of all the shareholders should be obtained at the same place and in the same meeting.

3. If the company has acquired any property through an investment, which is ultra vires, the company’s right over such a property shall still be secured.

4. While applying doctrine of ultra vires, the effects which are incidental or consequential to the act shall not be invalid unless they are expressly prohibited by the Company’s Act.

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5. There are certain acts under the company law, which though not expressly stated in the memorandum, are deemed impliedly within the authority of the company and therefore they are not deemed ultra vires. For example, a business company can raise its capital byborrowing.

6. If an act of the company is ultra vires the articles of association, the company can alter its articles in order to validate the act

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In England the doctrine of ultra vires has been restricted by the European Communities Act, 1 9 7 2. According to Section 9(1) of the Act in favour of a person dealing with a company anytransaction decided by its directors shall be deemed to be within the capacity of the company to enter into validity and the other party is not required to inquire about the capacity of the companyand thus such transaction may be enforced by the other party acting in good faith against the company and the company cannot plead that the transaction was ultra vires, but it cannot beenforced by the company against the other party for the other party can still plead that the act was ultra vires.

It is to be noted that in England, the Act merely restricts the application of the doctrine of ultra vires but does not abolish it.

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The actual authority of an agent is a relationship between principal and agent; the rest of the world is a stranger to this relationship. A third party dealing with the agent of a company does not know what the agent's actual authority is, nor in most cases can he find out. Sometimes the authority of an agent to do certain acts depends on compliance with certain formalities. For instance, it may be provided by the company's articles that the affixing of the company's seal can only be authorised by a resolution of the board. Sometimes, there is some irregularity in the management which vitiates the authority conferred upon an agent. For instance, a directors' meeting may have been irregularly held. A party outside the company has no way of determining whether the company's internal regulations have been complied with. However, the law does not require an outside party to do so. If an agent has apparent authority to do an act, a person dealing with the company is entitled to assume that all matters of internal management and procedure prescribed by the articles have been complied with. This is known as the 'indoor management rule' or the rule in Turquand's case ...

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The rule in Turquand's case is a presumption of regularity. In other words, a person who deals with a company is entitled to assume that all procedural matters have been taken care of by the company. There is a good practical reason for this: an outsider cannot discover whether the company's internal procedures have been complied with. If a company could get out of a transaction by pleading non-compliance with its internal procedures, commercial certainty would be thrown out of the window.‘

The rule in Turquand's case provides protection to persons dealing with a company in good faith (see Standard Chartered Bank v Central Wood Tiles Sdn Bhd , where it was held by Haidar J (as he then was) that the rule in Turquand's case only applies to persons dealing in good faith). An outsider dealing with a company does not need to enquire into the regularity in the internal affairs and proceedings of the company, and may assume that all is being done regularly (see K Sivapragasam a/l Krishnar v Renominium Development Sdn Bhd & Ors ).

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There are exceptions to the Turquand’s rule :-

•a person who deals with a company and who is on notice of an irregularity in its internal management in connection with the subject matter of his dealings (Morris v Kanssen ; •a company, where it has a common officer with that other company, eg a common director or secretary, and 'the common officer had some duty imposed upon him to communicate that knowledge to the other company, and had some duty imposed upon him by the company which is alleged to be affected by the notice (of irregularity) to receive the notice (of irregularity)' (per Vaughan Williams J in Re Hampshire Land Co ; approved by himself in Young v David Payne & Co ); •persons on inquiry; and •where there is forgery.

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The following as situations where a third party cannot rely on the presumption of regularity:

•if the contracting party knows or should know of the agent's lack of authority; •if an examination of the company's memorandum or articles would have made it plain that the agent's authority was limited; •the nature of the transaction may be such as to put the third party on enquiry as to the agent's authority, and if the contracting party does not make reasonable enquiries; and •if the contracting party conspires with the company's agent to procure an unauthorised transaction.

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Questions for Discussion during Tutorials

1.Where there’s a conflict between the Memorandum and the Articles, which would take precedence?

2. What is normally contained in the Memorandum of Association? 3. Is it easier to alter the Articles of Association or the Memorandum of Association?

4. Explain what is the purpose of the Memorandum of Association? 5. When lending to a company is it important for the banker to examine the Memorandum and Articles of Association of the borrower company?

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6. Explain the following :(i) actual authority (ii) ostensible authority (iii) usual authority

7. What is the “rule in Turquand’s case”? 8. When is an act said to be “ultra vires”?

9. Can a company contract on any matter regardless of what their memorandum and articles of association specify?

Continue to Note 3…………………….

Musbri Mohamed