Question

The articles of association of Cedar Ltd. provide that the companys business is the
production of organic food. The articles further provide that the company has the power to
borrow money and the power to purchase plant and machinery in furtherance of the business
of the company. Since the companys formation in 1995, the companys business of producing
organic food has been profitable. However, in light of a recent economic downturn, the
company has not been able to make a profit from the business as demand for organic food
has waned. Cedar Ltds board of directors resolve that, in order to arrest the decline in the
companys fortunes, company should switch to the production of non-organic food. For this
purpose, the directors enter into the following contracts on the companys behalf:
I.
II.

A secured loan agreement with HBAS Bank plc

The purchase of a substantial quantity of chemical fertilizers, insecticides and
pesticides from Direct Land Ltd.

Giles, a minority shareholder of Cedar Ltd and a committed organic grower, is concerned with
the activities of the board of directors, in particular (a) the validity of the two contracts and (b)
the action, if any, that can be taken. Advise Giles as to his legal position.
General Advice
There is a lot going in this extract but the essence of the question boils down to two themes:
I.
II.

Consideration of Cedar Ltds capacity to enter into contracts. This will require an
evaluation of the companys objects. If a companys objects are restricted, its powers
cannot be exercised for a purpose which lies beyond the restriction.
Consideration of any relief available to Giles as a minority shareholder of Cedar Ltd.
The Chancery Division of the High Court will intervene in circumstances in which the
majority shareholders have sought to oppress Giles or have committed a fraud.

We can note several things of importance from the outset:

I.
II.

III.

IV.

The main objects of Cedar Ltd are the production of organic food.
Cedar Ltd is a private limited company in the event of a dispute between the
members / directors of a private company, Courts are more likely to intervene since
share securities cannot be traded as easily as can be done with public limited
companies (PLCs).
Since the company was formed in 1995, section 31(1) of the Companies Act 2006
does not apply and thus Cedar Ltds objects are restricted. Any existing objects
clause will now be a provision of the articles of association by virtue of section 28 of
the Companies Act 2006. Such articles may only be deleted by a special resolution of
the shareholders, as per section 21 of the Companies Act 2006.
Cedar Ltds articles provide for two express powers of the directors:
a. The power to borrow money and raise capital
b. The power to purchase plant and machinery in furtherance of the business of
the company.

V.

VI.

The directors have resolved to switch to the production of non-organic food. This, in
theory, would authorize any action which purports to violate the objects clause.
However, since any pre-existing objects clause is now an article of the company
constitution, the resolution may only pass if the shareholders vote to amend the
companys articles by a qualified majority vote (75%) of the subscribing members, as
per section 21(1) of the Companies Act 2006.
Giles is a minority shareholder. As such, he is entitled to apply to a Court for relief
from maladministration.

When answering problem questions in law, the best approach is to adopt the CLEO method:

C Case / Cause of Action. Who can sue and what for? What rights have been
prejudiced and who is responsible? What are the grounds for the action - Statutory /
Common Law / Equity?
L Law. What are the relevant provisions of law applicable to the case.
E Evaluation. How do the relevant provisions of law apply to the facts of the
problem? (This is the hardest part.)
O Outcome. What are you advising your client to do? What relief is available? What
do the academics suggest?

See below for answer.

Model Answer
Introduction to Contractual Capacity and Ultra Vires Transactions
This problem concerns discussion of the validity of contracts beyond Cedar Ltds capacity and
contracts beyond the directors authority. As an aggrieved shareholder, Giles may wish to
initiate proceedings in the Chancery Division of the High Court, claiming relief for
maladministration against the actions of the directors. At common law, contracts that
exceeded a companys objects, were illegal, void, and unratifiable (ASHBURY RAILWAY
CARRIAGE & IRON CO. -v- RICHE). Historically, this position was known as the ultra vires
rule. The modern position is now covered under Section 39 of the Companies Act 2006 which
states that the validity of an act done by a company shall not be called into question on the
ground of lack of capacity by reason of anything in the companys constitution. This is
reflective of the principles of the EUs First Company Law Directive that sought to reduce
detriment on third parties by removing limitations on directors to enter into company contracts.
Since the coming into effect of the Companies Act 2006, companies already formed under
earlier iterations of the Companies Acts will continue to have the same restrictions on their
objects but the clause will now be deemed to be contained within the articles of the company
(CA 2006, s 28), and thus can only be amended by a special resolution of the shareholders
(CA 2006, s 21).
Giles right to petition or seek relief from the Chancery Division
As a shareholder, Giles may petition the Court to have Cedar Ltd wound up on just and
equitable grounds, as the company has indicated it wants to change to its product base from
organic to non-organic food, a move which seems totally contrary to the companys original
purpose. A winding-up petition can be lodged if that which the company was formed to do can
no longer be done (RE BRISTOL JOINT STOCK BANK), and the substratum or raisondetre of the company ceases to exist (RE SUBURBAN HOTEL COMPANY). Assuming
Cedar Ltd is registered in England, the relevant legislation would be Section 122(1)(g) of the
Insolvency Act 1986. When deciding upon a question of equity between company with
restricted objects and its members, a court may consider an action to be intra vires only if it is
within what it considers to be the companys main object. Giles could make the case that
because the main object of Cedar Ltd (i.e. the manufacture of organic foodstuffs) has failed,
whatever else the company might do is sufficiently outside its objects to justify compulsory
winding up. For example, in RE GERMAN DATE COFFEE COMPANY, the first paragraph of
the companys objects stated that it was the companys purpose to acquire, purchase and use
a particular invention for making coffee from dates, under protection of a patent from the
Empire of Germany. Ultimately, the grant of patent was not offered and, the company
proceeded to manufacture coffee from dates without intellectual property protection. Two
shareholders petitioned for compulsory winding up on the ground that the substratum had
failed. The Court of Appeal held it was the companys business not to make a substitute for
coffee from dates, but to work a particular patent. As Lindley LJ held,
General words construed literally may mean anything; but they must be taken in
connection with what are shown by the context to be the dominant or main objects. It
will not do under general words to turn a company for manufacturing one thing into a
company for importing something else, however general the words are.
In ANGLO OVERSEAS AGENCIES LTD -v- GREEN, the Court held that where company
objects are multitudinous and it is possible to identify a main object, then all other object
clauses are treated as being ancillary to the main object. Whilst there may be some ambiguity
as to the meaning of organic food, Giles may argue that the purchase of fertilizers,
insecticides and pesticides falls outside the scope of what is meant by organic food and that
the substratum of Cedar Ltd has, therefore, failed.
Validity of Contracts
Despite criticism in COTMAN -v- BROUGHAM as regards the necessity of detailing each and
every express power required to enter into a transaction, it is common case that many
companies went down the route of detailing the multitude of transactions that they may enter
into in an attempt to counter the main objects rule as outlined in RE GERMAN DATE
COFFEE CO. Thus, each and every object clause was argued to be as important as the next

one, and there could be no main object. However, in RE HORSLEY AND WEIGHT LTD,
Buckley LJ opined that such objects must be interpreted as powers incidental to the true
objects of the company. Following the authority of ROLLED STEEL PRODUCTS
(HOLDINGS) LTD -v- BRITISH STEEL CORPORATION, each paragraph of an objects clause
constitutes a separate object unless:
a) The subject matter of the paragraph is by its nature incapable of constituting a
separate object; or,
b) The wording of the objects clause shows expressly or by implication that the
paragraph was intended to constitute an ancillary power.
A Court may construe the secured lending facility with HBAS Bank PLC as having been
exercised under a general power to borrow money. In RE INTRODUCTIONS LTD, the High
Court held that an express power to borrow money could not amount to a substantive object
but that money could only be borrowed only for the purposes of the companys true objects. If
Cedar Ltds is currently involved in business outside the scope of its restricted objects (i.e. the
manufacture of non-organic food) then such a contract would lie beyond the directors actual
authority. The directors, however, may try to rely on Section 39 of the CA 2006, which states
that an act of a director cannot be called into question for lack of capacity. The validity of
contract with HBAS Bank PLC cannot, therefore, be called into question. Cedar Ltds directors
have, however, acted in breach of their general duties in that they have failed to act in
accordance with the companys constitution, contrary to Section 171 of the CA 2006. Any
director of a company who is responsible for entering into a transaction outside its restricted
objects is personally liable to replace the monies the company expended on the transaction
(RE LANDS ALLOTMENT CO LTD) unless the members ratify the transaction. This is now
possible as the objects now form part of Cedar Ltds articles of association.
In respect of the contract with Direct Land Ltd, the directors have clearly exceeded the
limitation in the companys articles in relation to the power to purchase plant and machinery in
furtherance of the business of the company, as fertilizers, pesticides, and insecticides do not
fall within the scope of plant and machinery. This is therefore an unauthorized contract
which, at common law, is voidable at the instance of Cedar Ltd (CA 2006, s 41). However,
Direct Land Ltds rights in respect of the contract are protected under the rule in
TURQUANDS CASE which states that a third party is entitled to presume that the directors of
Cedar Ltd are acting lawfully in what they do. This was developed into the indoor
management rule, which directs that a company cannot escape contractual liability on the
grounds that the obligation was entered into as a result of an inquorate board ( MAHONY -vEAST HOLYFORD MINING CO LTD), and latterly into the doctrine of ostensible authority
which allows commercial persons to assume that a director has a range of authority by virtue
of his position (ARMAGAS LTD -v- MUNDOGAS). Moreover, Direct Land Ltd were not under
an obligation to enquire as to any limitation on the part of Cedar Ltds directors as regards
their capacity to enter into the contract (CA 2006, s 40(2)(a)). From this, it would appear that
Cedar Ltd is liable to Direct Land Ltd under the contract. However, one get-out tactic
depends on the willingness of the Court to interpret the section in the broadest way possible
to give effect to the spirit of both the CA 2006 and the EU Company Law Directives and to
allow people to deal with a company in good faith without being adversely affected by any
limits on the companys capacity (TCB LTD -v- GRAY). In contrast, the Court of Appeal in
SMITH -v- HENNIKER MAJOR adopted a narrower approach, with Walker LJ postulating an
irreducible minimum of a genuine decision taken by a person who can on substantial
grounds claim to be the board of directors acting as such, even if the proceedings are marred
by procedural irregularities. In this regard, it could be argued that the Court has a legal
obligation to interpret domestic legislation so far as possible in the light of the wording and
purpose of any EU directive (MARLEASING SA -v- LA COMERCIAL INTERNATIONAL DE
ALIMENTACION SA).
What should Giles do?
In respect of the two contracts, it would appear that both bind Cedar Ltd, but the directors
would be personally liable to indemnify the company as to any particulars of loss. It is
suggested that Giles can do one of two things:

1. Petition the Chancery Division of the High Court to compulsorily wind-up Cedar Ltd
on the ground that the substratum has failed (as per RE GERMAN DATE COFFEE
CO). This would be advisable if Giles feels so strongly about the move to non-organic
food stuffs that he can no longer remain a shareholder.
2. Apply to the Chancery Division for an order for an injunction. On the application of
any ordinary member of the Company, the Court may order the company not to enter
into a proposed transaction beyond the companys restricted objects (SIMPSON -vWESTMINSTER PALACE HOTEL CO).