THE LAW OF BUSINESS ASSOCIATIONS

THE LAW OF BUSINESS ASSOCIATIONS I Lecture 1

Section 3 (1) of the Companies Act No. 17 of 2015 Laws of Kenya states what
company means as means a company formed and registered under this Act or
an existing company. This is a very vague definition, in the statute the word
company is not a legal term hence the vagueness of the definition. The legal
attributes of the word company will depend upon a particular legal system.

In legal theory company denotes an association of a number of persons for

some common object or objects in ordinary usage it is associated with
economic purposes or gain. A company can be defined as an association of
several persons who contribute money or money’s worth into a common stock
and who employ it for some common purpose. Our legal system provides for
three major types of associations namely
1. Companies
2. Partnerships.
3. co-operative societies.

The law treats companies in company law distinctly from partnerships in

partnership law. Basically company law consists partly of ordinary rules of
Common law and equity and partly of statutory rules. The common law rules
are embodied in cases. The statutory rules are to be found in the Companies
Act No.17 of 2015. The New Act borrows heavily from the UK Companies
Act, 2006. The legislation is more comprehensive .This new Act replaces old
Companies Act Cap 486 of Laws of Kenya. The Sixth Schedule of the New
Act also embodies the Transitional and Saving Provisions.

Exceptions to the Rules are stated in the Act but not the rules themselves.
Therefore fundamental principles have to be extracted from study of numerous
decided cases some of which are irreconcilable. The true meaning of company
law can only be understood against the background of the common law.

FUNDAMENTAL CONCEPTS OF COMPANY LAW

There are two fundamental legal concepts

1. The concept of legal personality; (corporate personality) by

which a company is treated in law as a separate entity
from the members.

2. The concept of limited liability;

Concept of legal personality

 (i) A legal person is not always human, it can be described as any
person human or otherwise who has rights and duties at law; whereas
all human persons are legal persons not all legal persons are human
persons. The non-human legal persons are called corporations. The
word corporation is derived from the Latin word Corpus which inter
alia also means body. A corporation is therefore a legal person brought
into existence by a process of law and not by natural birth. Owing to
these artificial processes they are sometimes referred to as artificial
persons not fictitious persons.

LIMITED LIABILITY

Basically liability means the extent to which a person can be made to account
by law. He can be made to be accountable either for the full amount of his
debts or else pay towards that debt only to a certain limit and not beyond it. In
the context of company law liability may be limited either by shares or by
guarantee.

Under Section (3) (1) of the Companies Act,2015 in a company formed and
registered under this Act or an existing company by shares the members
liability to contribute to the companies assets is limited to the amount if any
paid on their shares.

Under Section 3(1) and 7 of the Companies Act, 2015 defines a company
limited by guarantee, where the members undertake to contribute a certain
amount to the assets of the company in the event of the company being wound
up. Note that it is the members’ liability and not the companies’ liability
which is limited. As long as there are adequate assets, the company is liable to
pay all its debts without any limitation of liability. If the assets are not
adequate, then the company can only be wound up as a human being who fails
to pay his debts. Note that in England the Insolvency Act has consolidated the
relationships relating to …. That does not apply here.

Nearly all statutory rules in the Companies Act are intended for one or two
objects namely
1. The protection of the company’s creditors;
2. The protection of the investors in this instance being the
members.

These underlie the very foundation of company law.

FORMATION OF A LIMITED COMPANY

This is by registration under the Companies Act

In order to incorporate themselves into a company, those people wishing to

trade through the medium of a limited liability company must first prepare and
register certain documents. These are as follows
a. Memorandum of Association: this is the document in which
they express inter alia their desire to be formed into a
company with a specific name and objects. The
 Memorandum of Association of a company is its primary
document which sets up its constitution and objects;
b. Articles of Association; whereas the memorandum of
association of a company sets out its objectives and
constitution the articles of association contain the rules
and regulations by which its internal affairs are governed
dealing with such matters as shares, share capital,
company’s meetings and directors among others;

Both the Memorandum and Articles of Associations must each be signed

by seven persons in the case of a public company or two persons if it is
intended to form a private company. These signatures must be attested by a
witness. If the company has a share capital each subscriber to the share
capital must write opposite his name the number of shares he takes and he
must not take less than one share.

c. Statement of Nominal Capital – this is only required if the

company has a share capital. It simply states that the
company’s nominal capital shall be xxx amount of
shillings. The fees that one pays on registration will be
determined by the share capital that the company has
stated. The higher the share capital, the more that the
company will pay in terms of stamp duty.

d. Declaration of Compliance: this is a statutory declaration

made either by the advocates engaged in the formation of
the company or by the person named in the articles as the
director or secretary to the effect that all the requirements
of the companies Act have been complied with. Under
section 16(2) the Statement of proposed officers a list of
persons who have agreed to become the first director or
directors of the company and any person appointed as an
authorized signatory and Section 16(4) requires the
written consents of the Directors.
These are the only documents which must be registered in order to secure the
incorporation of the company. In practice however two other documents
which would be filed within a short time of incorporation are also handed in at
the same time. These are:

1. Notice of the situation of the Registered Office

which under Section 13(2)(b) of the statute
should be filed with the application for
registration;

2. Particulars of Directors and Secretary which

under Section 136 and 137 of the Act of the
statute are normally required within 14 days
of the appointment of the directors and
secretary.

The documents are then lodged with the registrar of companies and if they are
in order then they are registered and the registrar thereupon grants a certificate
of incorporation and the company is thereby formed. Section 16(2) of the Act
provides that from the dates mentioned in a certificate of incorporation the
subscribers to the Memorandum of Association become a body corporate by
the name mentioned in the Memorandum capable of exercising all the
functions of an incorporated company. It should be noted that the registered
company is the most important corporation.

STATUTORY CORPORATIONS

The difference between a statutory corporation (or parastatal) and a company

registered under the companies Act is that a statutory corporation is created
directly by an Act of Parliament. The Companies Act does not create any
corporations at all. It only lays down a procedure by which any two or more
persons who so desire can themselves create a corporation by complying with
the rules for registration which the Act prescribes.

TYPES OF REGISTERED COMPANIES

Before registering a company the promoters must make up their minds as to

which of the various types of registered companies they wish to form.

1. They must choose between a limited and unlimited company;

Section 8 of the Companies Act states that ‘a
company not having the liability of members limited in
any way is termed as an unlimited company. The
disadvantage of an unlimited company is that its
members will be personally liable for the company’s
debts. It is unlikely that promoters will wish to form an
unlimited liability company if the company is intended to
trade. But if the company is merely for holding land or
other investments the absence of limited liability would
not matter.
2. If members forming a company decide upon a limited
company, they must make up their minds whether it is to
be limited by shares or by guarantee (Section 5). This
will depend upon the purpose for which it is formed. If it
is to be a non-profit concern, then a guarantee company
is the most suitable, but if it is intended to form a profit
making company, then a company limited by shares is
preferable (Section 7). A company is limited by shares if
the liability of its members is limited by the company’s
articles to any amount unpaid on the shares held by the
members. (section 6)

3. They have to choose between a private company and a public

company. Section 9 of the Companies Act defines
a private company as one which by its articles restricts
(i) the rights to transfer shares;
(ii) restricts the number of its members to fifty
(50);
 (iii) prohibits the invitation of members of the
public to subscribe for any shares or
debentures of the company.

A company which does not fall under this definition is described as a public
company. Section 10 provides that a public company grants its members the
right to transfer shares and the public the right to subscribe for ots shares and
debentures.

In order to form a public company, there must be at least seven (7) subscribers
signing the Memorandum of Association whereas only one (1) person need to
sign the Memorandum of Association in the case of a private company.

ADVANTAGES OF INCORPORATION

A corporation is a legal entity distinct from its members, capable of enjoying

rights being subject to duties which are not the same as those enjoyed or borne
by the members.

The full implications of corporate personality were not fully understood till
1897 in the case of Salomon v. Salomon [1897] A C 22

Facts of the case

Salomon was a prosperous lender/merchant. He sold his business to

Salomon and Co. Limited which he formed for the purpose at the price of
£39,000 satisfied by £1000 in cash, £10,000 in debentures conferring a charge
on the company’s assets and £20,000 in fully paid up £1 shares. Salomon was
both a creditor because he held a debenture and also a shareholder because
he held shares in the company. Seven shares were then subscribed for in cash
by Salomon, his wife and daughter and each of his 4 sons. Salomon therefore
had 20,101 shares in the company and each member of the family had 1 share
as Salomon‘s nominees. Within one year of incorporation the company ran
into financial problems and consequently it was wound up. Its assets were not
enough to satisfy the debenture holder (Salomon) and having done so there
was nothing left for the unsecured creditors. The court of first instance and the
court of appeal held that the company was a mere sham an alias, agents or
nominees of Salomon and that Mr. Salomon should therefore indemnify the
company against its trade loss.

The House of Lords unanimously reversed this decision. In the words of Lord
Halsbury “Either the limited company was a legal entity or it was not. If it
was, the business belonged to it and not to Salomon. If it was not, there was no
person and no thing at all and it is impossible to say at the same time that
there is the company and there is not”

In the words of Lord Mcnaghten “the company is at a law a different person

altogether from the subscribers and though it may be that after incorporation
the business is precisely the same as it was before, and the same persons are
managers, and the same hands receive the profits, the company is not in law
the agent of the subscribers or trustee for them nor are the subscribers as
members liable in any shape or form except to the extent and manner
prescribed by the Act. … in order to form a company limited by shares the Act
requires that a Memorandum of Association should be signed by seven (7)
persons who are each to take one share at least. If those conditions are
satisfied, what can it matter, whether the signatories are relations or
strangers. There is nothing in the Act requiring that the subscribers to the
Memorandum should be independent or unconnected or that they or anyone of
them should take a substantial interest in the undertaking or that they should
have a mind and will of their own. When the Memorandum is duly signed and
registered though there be only seven (7) shares taken the subscribers are a
body corporate capable forthwith of exercising all the functions of an
incorporated company.

… The company attains maturity on its birth. There is no period of minority

and no interval of incapacity. A body corporate thus made capable by statutes
cannot lose its individuality by issuing the bulk of its capital to one person
whether he be a subscriber to the Memorandum or not.”

There were several other Law Lords who decided business in the House.

The significance of the Salomon decision is threefold.

1. The decision established the legality of the so called one man

company;
2. It showed that incorporation was as readily available to the
small private partnership and sole traders as to the large
private company.
3. It also revealed that it is possible for a trader not merely to
limit his liability to the money invested in his enterprise
but even to avoid any serious risk to that capital by
subscribing for debentures rather than shares.

Since the decision in Salomon’s case the complete separation of the

company and its members has never been doubted.

Macaura V. Northern Assurance Co. Ltd (1925) A.C. 619

The Appellant owner of a timber estate assigned the whole of the timber to
a company known as Irish Canadian Sawmills Company Limited for a
consideration of £42,000. Payment was effected by the allotment to the
Appellant of 42,000 shares fully paid up in £1 shares in the company. No
other shares were ever issued. The company proceeded with the cutting of
the timber. In the course of these operations, the Appellant lent the
company some £19,000. Apart from this the company’s debts were
minimal. The Appellant then insured the timber against fire by policies
effected in his own name. Then the timber was destroyed by fire. The
insurance company refused to pay any indemnity to the appellant on the
ground that he had no insurable interest in the timber at the time of
effecting the policy.
The courts held that it was clear that the Appellant had no insurable
interest in the timber and though he owned almost all the shares in the
company and the company owed him a good deal of money, nevertheless,
neither as creditor or shareholder could he insure the company’s assets. So
he lost the Company.

Lee v Lee’s Air Farming Ltd. (1961) A.C. 12

Lee’s company was formed with capital of £3000 divided into 3000 £1
shares. Of these shares Mr. Lee held 2,999 and the remaining one share
was held by a third party as his nominee. In his capacity as controlling
shareholder, Lee voted himself as company director and Chief Pilot. In the
course of his duty as a pilot he was involved in a crash in which he died.
His widow brought an action for compensation under the Workman’s
Compensation Act and in this Act workman was defined as “A person
employed under a contract of service” so the issue was whether Mr. Lee
was a workman under the Act? The House of Lords Held:

“that it was the logical consequence of the decision in Salomon’s case that
Lee and the company were two separate entities capable of entering into
contractual relations and the widow was therefore entitled to
compensation.”

Katate v Nyakatukura (1956) 7 U.L.R 47A

The Respondent sued the Petitioner for the recovery of certain sums of
money allegedly due to the Ankore African Commercial Society Ltd in
which the petitioner was a Director and also the deputy chairman. The
Respondent conceded that in filing the action he was acting entirely on
behalf of the society which was therefore the proper Plaintiff. The action
was filed in the Central Native Court. Under the Relevant Native Court
Ordinance the Central Native Court had jurisdiction in civil cases in which
all parties were natives. The issue was whether the Ankore African
Commercial Society Ltd of whom all the shareholders were natives was
also a native.

The court held that a limited liability company is a corporation and as such
it has existence which is distinct from that of the shareholders who own it.
Being a distinct legal entity and abstract in nature, it was not capable of
having racial attributes.

ADVANTAGES OF INCORPORATION

1. Limited Liability – since a corporation is a separate person from

the members, its members are not liable for its debts. In the
absence of any provisions to the contrary the members are
completely free from any personal liability. In a company limited
by shares the members liability is limited to the amount unpaid
on the shares whereas in a company limited by guarantee the
members liability is limited to the amount they guaranteed to
pay. The relevant statutory provision is Section 213 of the
Companies Act.

2. Holding Property: Corporate personality enables the property of

 the association to be distinguishable from that of the members. In
an incorporated association, the property of the association is the
joint property of all the members although their rights therein
may differ from their rights to separate property because the joint
property must be dealt with according to the rules of the society
and no individual member can claim any particular asset to that
property.

3. Suing and Being Sued: As a legal person, a company can take

action in it’s own name to enforce its legal rights. Conversely it
may be sued for breach of its legal duties. The only restriction on
a company’s right to sue is that it must always be represented by
a lawyer in all its actions.

In East Africa Roofing Co. Ltd v Pandit (1954) 27 KLR 86 here the
Plaintiff a limited liability company filed a suit against the defendant
claiming certain sums of money. The defendant entered appearance and
filed a defence admitting liability but praying for payment by
instalments. The company secretary set down the date on the suit for
hearing ex parte and without notice to the defendant. This was
contrary to the rules because a defence had been filed. On the hearing
day the suit was called in court but no appearance was made by either
party and the court therefore ordered the action to be dismissed. The
company thereafter applied to have the dismissal set aside. At the
hearing of that application, it was duly represented by an advocate. The
only ground on which the company relied was that it had intended all
along to be represented at the hearing by its manager and that the
manager in fact went to the law courts but ended in the wrong court. It
was held that a corporation such as a limited liability company cannot
appear in person as a legal entity without any visible person and having
no physical existence it cannot at common law appear by its agent but
only by its lawyer. The Kenya Companies Act does not change this
common law rule so as to enable a limited company to appear in court
by any of its officers.

4. PERPETUAL SUCCESSION As an artificial person, the

company has neither body mind or soul. It has been said that a
company is therefore invisible immortal and thus exists only
intendment consideration of the law. It can only cease to exist by
the same process of law which brought it into existence
otherwise, it is not subject to the death of the natural body. Even
though the members may come and go, the company continues to
exist.

5. TRANSFERABILITY OF SHARES Section 75 of the

Companies Act states as follows “ The Shares or any other
interests of a member in a company shall be moveable property
transferable in the manner provided by the Articles of Association
of the Company.” In a company therefore shares are really
transferable and upon a transfer the assignee steps into the shoes
of the assignor as a member of the company with full rights as a
member. Note however that this transferability only relates to
public companies and not private companies.
 6. BORROWING FACILITIES: in practice companies can raise
their capital by borrowing much more easily than the sole trader
or partnership. This is enabled by the device of the ‘floating
charge’ a floating charge has been defined as a charge which
floats like a cloud over all the assets from time to time falling
within a certain description but without preventing the company
from disposing of these assets in the ordinary course of its
business until something happens to cause the charge to become
crystallised or fixed. The ease with which this is done is
facilitated by the Chattels Transfer Act which exempts companies
from compiling an inventory on the particulars of such charges
and also by the bankruptcy Act which exempts companies from
the application of the reputed ownership clause. As far as
companies are concerned the goods in the possession of the
company do not fall within the reputed ownership clause.
The only disadvantages are three

(i) Too many formalities required in the formation

of the company
(ii) There is maximum publicity of the company’s
affairs;
(iii) There is expense incurred in the formation
and in the management of a company.

In order to form a company, certain documents must be prepared whereas no

such docum%nts need to be prepared to establish business as a sole proprietor
or partnership and throughout its life a company is required to file such
documents as balance sheets and profits and loss accounts on dissolution of
the company it is required to follow a certain stipulated procedure which does
not apply to sole traders and partnerships.

IGNORING THE CORPORATE ENTITY (LIFTING THE VEIL OF

INCORPORATION)

Although Salomon’s case finally established that a company is a separate and

distinct entity from the members, there are circumstances in which these
principle of corporate personality is itself disregarded. These situations must
however be regarded as exceptions because the Salomon decision still obtains
as the general principle

Although a company is liable for its own debt which will be the logical
consequence of the Salomon rule, the members themselves are held liable
which is therefore a departure from principle. The rights of creditors under this
section are subject to certain limitations namely (under statutory provision)

(i) REDUCTION IN THE NUMBER OF MEMBERS - Section

33 refers to membership that has fallen below the
statutory minimum in a public company. The Act
provides that only those members who remain after the
six month during which the company has fallen below
the provided minimum period can be sued; Even these
members are liable if they have knowledge of the fact
 and only in respect of debts contracted after the
expiration of the six months. Moreover the Section is
worded in such a way as to suggest that the remaining
members will be liable only in respect of liquidated
contractual obligations.
(ii) FRAUDULENT TRADING – the provisions of Section 323
of the Companies Act come into operation here. It is
provided that if in the course of the winding up of the
company it appears that any business has been carried on
with the intent to defraud the creditors, or for any
fraudulent purpose, the courts on the application of the
official receiver, the liquidator or member may declare that
any persons who are knowingly parties to the fraud shall be
personally responsible without any limitation on liability
for all or any of the debts or other liabilities of the
company to the extent that the court might direct the
liability. This Section does not define the term fraud nor
have the courts defined it. However, in Re William C.
Leitch Ltd (1932) 2 Ch. 71 the company was incorporated
to acquire William’s business as a furniture manufacturer.
The directors of the company were William and his wife
and they appointed William as the Managing Director at a
Salary of £1000 per annum. Within the period of one
month, the company was debited with an amount which
was £500 more than what was actually due to William. By
that time the company had made a loss of £2500. Within 2
years of formation, and while the company was still in
financial problems, the directors paid to themselves the
dividends of £250. By the end of the 3 rd year since
incorporation the company was in such serious difficulties
such that it could not pay debts as they fell due. In spite of
this William ordered goods worth £6000 which became
subject to a charge contained in a debenture held by them.
At the same time he continued to repay himself a loan of
£600 (six hundred pounds) which he had lent to the
company at the beginning of the 4th year the company with
the knowledge of William owed £6500 for goods supplied.
In the winding up of the company the official receiver
applied for a declaration that in no circumstances William
had carried on the company’s business with intent to
defraud and therefore should be held responsible for the
repayment of the company’s debts. It was held that since
that company continued to carry on business at a time
when William knew that the company could not
comfortably pay its debts, then this was fraudulent trading
within the meaning of Section 323 and William should be
responsible for repaying the debts. These are the words of
Justice Maugham J. “if a company continues to carry on
business and to incur debts at a time when there is to the
knowledge of the directors no reasonable prospects of the
creditors ever receiving payments of those debts, it is in
general a proper inference that the company is carrying on
business with intent to defraud.”
The test is both subjective and objective. In the Case of Re Patrick Lyon Ltd
(1933) Ch. 786 on facts which were similar to the Williams case, the same
Judge Maugham J. said as follows: “the words fraud and fraudulent purpose
where they appear in the Section in question are words which connote actual
dishonesty involving according to the current notions of fair trading among
commercial men real moral blame. No judge has ever been willing to define
fraud and I am attempting no definition.”

The statutes are not clear as to the meaning of fraud the question arises that
once the money has been recovered from the fraudulent director, is it to be laid
as part of the company’s general assets available to all creditors or should it go
back to those creditors who are actually defrauded.

In the case of Re William Justice Eve J. stated that such money should form
part of the company’s general assets and should not be refunded to the
defrauded creditors.

In the case of Re Cyona Distributors Ltd (1967) Ch. 889 the Court of Appeal
ruled that if the application under Section 323 is made by the debtor then the
money recovered should form part of the company’s general assets but where
the application is made by a creditor himself, then that creditor is entitled to
retain the money in the discharge of the debts due to him.

LAW OF BUSINESS ASSOCIATION Lecture 2

Lifting the Veil – Lifting the veil of corporate entity under statute - lifting the
veil of corporate entity under
common law.

HOLDING AND SUBSIDIARY COMPANIES

One of the most important limitations imposed by the Companies Act on the
recognition of the separate personality of each individual company is in
connection with associated companies within the same group enterprise. In
practice it is common for a company to create an organisation of inter related
companies each of which is theoretically a separate entity but in reality part of
one concern represented by the group as a whole. Such is particularly the case
when one company is the parent or holding company and the rest are its
subsidiaries.

A holding company under section3 (1) of the Company’s Act 2015 is defined
"holding company" (of another company) means a company of which the
other company is a subsidiary company of the company;
"holding company", in relation to another company, means a company that-
(a) controls the composition of that other company's board of directors;
(b) controls more than half of the voting rights in that other company; (c)
holds more than half of that other company's issued share capital; or (d) is a
holding company of a company that is that other company's holding company;
Under Section -3(1) of the Companies Act,2015 a company is deemed to be
a subsidiary of another if but only if "wholly-owned subsidiary company" (of
another company) means a company that has no members other than that other
company and that other company's wholly owned subsidiaries (or persons
acting on behalf of that other company or its wholly-owned subsidiaries;
(a) That other company either
(i) is a member of it and controls the composition of its board of
directors or
(ii) Holds more than half in nominal value of its equity share
capital or

(b) The first mentioned company is a subsidiary of any company which is that
other’s subsidiary.

Under Section - where at the end of the financial year a company has
subsidiaries, the accounts dealing with the profit and loss of the company and
subsidiaries should be laid before the company in general meeting when the
company’s own balance sheet and profit and loss account are also laid. This
means that group accounts must be laid before the general meeting.

The group accounts should consist of a consolidated balance sheet for the
company and subsidiary and also of a consolidated profit and loss account
dealing with the profit and loss account of a company.

Section -) – it may be observed that the treatment of these accounts in a

consolidated form qualify an old rule that each company constitutes a separate
legal entity. The statute here recognises enterprise entity rather than corporate
entity i.e. the veil of incorporation will be lifted so that they will not be
regarded as separate legal entities but will be treated as a group.

MISDESCRIPTION OF COMPANIES
Part 4 prescribes the requirements for a name of a company under the Act.
Under Section 67 of the Companies Act, 2015, a company is mandated to
disclose its name it requires that a company’s name should appear whenever it
does business on its Seal and on all business documents. Under paragraph 4 of
this Section, if an officer of a company or any person who on its behalf signs
or authorises to be signed on behalf of the company any Bill of Exchange,
Promissory Note, Cheque or Order for Goods wherein the Company’s name is
not mentioned as required by the Section, such officer shall be liable to a fine
and shall also be personally made liable to the holder of a Bill of Exchange
Promissory Notes, Cheque or order for the goods for the amount thereof unless
it is paid by the company. The effect of this section is that it makes a
company’s officer incur personal liability even though they might be
contracting as the company’s agents. Liability under
this Section normally arises in connection with cheques and company officers
have been held liable where for instance the word limited has been omitted or
where the company has been described by a wrong name.

IGNORING THE CORPORATE ENTITY UNDER COMMON LAW

WHERE THERE IS AN AGENCY RELATIONSHIP

Generally there is no reason why a company may not be an agent of its share
holders. The decision in Salomon’s case shows how difficult it is to convince
the courts that a company is an agent of its members. In spite of this there have
been occasions in which the courts have held that registered companies were
not carrying on in their own right but rather were carrying on business as
agents of their holding companies. Reference may be made to the case of
Smith Stone & Knight v. Birmingham Corporation (1939) 4 All E.R. 116

In this case the Plaintiffs were paper manufacturers in Birmingham City. In

the same city there was a partnership called Birmingham Waste Company.
This partnership did business as merchants and dealers in waste paper. The
plaintiffs bought the partnership as a going concern and the partnership
business became part of the company’s property. The plaintiffs then caused
the partnership to be registered as a company in the name of Birmingham
Waste Company Limited. Its subscribed capital was 502 pounds divided into
502 shares. The Plaintiff holding 497 shares in their own name and the
remaining shares being registered in the name of each of the Directors.
Thereafter the Directors executed a declaration of trust stating that their shares
were held by them on trust for the Plaintiff company. The new company had
its name placed upon the premises and on the note paper invoices etc. as
though it was still the old partnership carrying on business. There was no
agreement of any sort between the two companies and the business carried on
by the new company was never assigned to it. The manager was appointed but
there were no other staff. The books and accounts of the new company were
all kept by the plaintiff company and the manager of this company did not
know what was contained therein and had no access to those books. There was
no doubt that the Plaintiff Company had complete control over the waste
company. There was no tenancy agreement between them and the waste
company never paid any rent. Apart from the name, it was as if the manager
was managing a department of the plaintiff company.

The Birmingham Corporation compulsorily acquired the premises upon which

the subsidiary company was carrying on business and the Plaintiff company
claimed compensation for removal and disturbance. Birmingham Corporation
replied that the proper claimants were the subsidiary company and not the
holding company since the subsidiary company was a separate legal entity.

If this contention was correct the Birmingham Corporation would have

escaped liability for paying compensation by virtue of a local Act which
empowered them to give tenants notice to terminate the tenancy.
The court held that occupation of the premises by a separate legal entity was
not conclusive on a question of a right to claim and as a subsidiary company it
was not operating on its own behalf but on behalf of the parent company. The
subsidiary company was an agent. Lord Atkinson had the following to say
“It is well settled that the mere fact that a man holds all the shares in a
company does not mean the business carried on by the company is his
business nor does it make the company his agent, for the carrying on of that
business. However, it is also well settled that there maybe such an
arrangement between the shareholders and the company as will constitute the
company. The shareholders agents for the purpose of carrying on the business
and make the business that of the shareholders. It seems to be a question of
fact in each case and the question is whether the subsidiary is carrying on the
business as the parents business or as its own. In other words who is really
carrying on the business.

His Lordship then stated that in order to answer the question six points must
be taken into account.

1. Are the profits treated as the profits of the

parent company?
2. Are the persons conducting the business
appointed by the parent company?
3. Is the parent company the head and brain of the
trading venture?
4. Does the parent company govern the venture
decide what should be done and what
capital should be embarked on in the
venture?
5. Does the company make the profits by its skill
and direction?
6. Is the company in effectual and constant
control?

If the answers are in the affirmative, then the subsidiary company is an agent
of the parent company.

Reference may also be made to the case of

RE F G FILMS LTD [1953] 1 W.L.R.

Here a British company was formed with a capital of 100 pounds of which 90
pounds was contributed by the president of an American Film Company.
There were 3 directors, the American and 2 Britons. By arrangement between
the two companies, a film was shot in India nominally by the British Company
but all the finances and other facilities were provided by the American
Company. The British Board of Trade refused to recognize the Film as having
been made by a British company and therefore refused to
register it as a British film.

The court held that insofar as the British company had acted at all it had done
so as an agent or nominee of the American company which was the true maker
of the film.

Firestone Tyre & Rubber Company v. Llewellin (1957) 1 W.L.R 464

Again in this case an American company had an arrangement with its

distributors on the European continent whereby the distributors obtained the
supplies from the English manufacturers who were a wholly owned subsidiary
of an American company. The English subsidiary credited the American
company with a price received after deducting costs and a certain percentage.
It was agreed that the distributors will not obtain their supplies from anyone
else. The issue was whether the subsidiary company in Britain was selling its
own goods or whether it was selling goods of an American company.

The court held that the substance of the arrangement was that the American
company traded in England through the subsidiary as its agent and that the
sales by their subsidiary, were a means of furthering the American company’s
European interests.

There have been cases where Salomon’s case has been upheld that a company
is a legal entity.

Ebbw Vale UDC V. South Wales Traffic Authority (1951) 2 K.B 366

Lord Justice Cohen L.J “Under the ordinary rules of law, a parent company
and a subsidiary company even when a hundred percent subsidiary are
distinct legal entities and in the absence of an agency contract between the
two companies, one cannot be said to be an agent of the other.”

2. FRAUD & IMPROPER CONDUCT

Where there is fraud or improper conduct, the courts will immediately

disregard the corporate entity of the company. Examples are found in those
situations in which a company is formed for a fraudulent purpose or to
facilitate the evasion of legal obligations.

Re Bugle Press Limited [1961] Ch. 270

This was based on Section 210 of the Companies Act where an offer was
made to purchase out a company if 90% of shareholders agreed. There were 3
shareholders in the company. A, B and C.
A held 45% of the shares, B also held 45% of the shares and C held the
remaining 10% of the shares. A and B persuaded C to sell his shares to them
but he declined. Consequently A and B formed a new company call it AB
Limited, which made an offer to ABC Limited to buy their shares in the old
company. A and B accepted the offer, but C refused. A and B sought to use
provisions of Section 210 in order to acquire C’s shares compulsorily.

The court held that this was a bare faced attempt to evade the fundamental
principle of company law which forbids the majority unless the articles
provide to expropriate the minority shareholders.

Lord Justice Cohen said “the company was nothing but a legal hut. Built
round the majority shareholders and the whole scheme was nothing but a
hollow shallow.” All the minority shareholder had to do was shout and the
walls of Jericho came tumbling down.

Gilford Motor Co. v. Horne (1933) Ch. 935

Here the Defendant was a former employee of the plaintiff company and had
covenanted not to solicit the plaintiff’s customers. He formed a company to
run a competing business. The company did the solicitation. The defendant
argued that he had not breached his agreement with the plaintiffs because the
solicitation was undertaken by a company which was a separate legal entity
from him.
The court held that the defendant’s company was a mere cloak or sham and
that it was the defendant himself through this device who was soliciting the
plaintiff’s customers. An injunction was granted against the both the defendant
and the company not to solicit the plaintiff’s customers.
Jones v. Lipman (1912) 1 W.L.R. 832

This case the Defendant entered into a contract for the sale of some property
to the plaintiff. Subsequently he refused to convey the property to the plaintiff
and formed a company for the purpose of acquiring that property and actually
transferred the property to the company. In an action for specific performance
the Defendant argued that he could not convey the property to the Plaintiff as
it was already vested in a third party.
Justice Russell J. observed as follows

“the Defendant company was merely a device and a sham a mask which he
holds before his face in an attempt to avoid recognition by the eye of equity”

GROUP ENTERPRISE

In exercise of their original jurisdiction, the courts have displayed a tendency

to ignore the separate legal entities of various companies in a group. By so
doing, the courts give regard to the economic entity of the group as a whole.

Authority is the case of

Holsworth & Co. v. Caddies [1955]1W.L.R. 352

The Defendant Company had employed Mr. Caddies as their Managing

Director for 5 years. At the time of that contract the company had two
subsidiaries and Caddies was appointed Managing Director of one of those
subsidiaries. He fell out of favour with the other Directors consequent upon
which the board of directors stated that Caddies should confine his attention to
the affairs of the subsidiary company only. He treated this as a breach of
contract and sued the company for damages. It was held that since all the
companies form but one group, there was no breach of contract in directing
Caddies to confine his attention to the activities of the subsidiary company.

DETERMINATION OF A COMPANY’S RESIDENCE

De Beers Consolidated Mines Ltd (1906) K.C. 455

Lord Lorenburn said “in applying the conception of residence to a company,

we ought to proceed as nearly as possible on the analogy of an individual. A
company cannot eat or sleep but it can keep house or do business. A company
resides for purposes of Income Tax where its real business is carried on. The
real business is carried on where the central management and control actually
abides.”

The courts also look behind the façade of the company and its place of
registration in order to determine its residence.
THE DOCTRINE OF ULTRA VIRES

A Company which is registered under the Company’s Act cannot effectively

do anything beyond the powers which are either expressly or by implication
conferred upon in its Memorandum of Association. Any purported activity in
excess of those powers will be ineffective even if agreed to by the members
unanimously. This is the doctrine of ultra vires in company law.

The purpose of this doctrine is said to be twofold

1. It is said to be intended for the protection of the investors

who thereby know the objects in which their money is to
be applied. It is also said to be intended for the
protection of the creditors by ensuring that the
Company’s assets to which the creditors look for
repayment of their debt are not wasted in unauthorised
activities. The doctrine was first clearly articulated in
1875 in the case of Ashbury Railway Carriage v. Riche
(1875) L.R. CH.L.) 653
2. Protection of third parties- to know what the company can
deal in.

In this case the Company’s Memorandum of Association gave it powers in its

objects clause
1. To make sell or lend on hire railway carriages and wagons. 2.
To carry on the business of mechanical engineers and general
contractors
3. to purchase, lease work and sell mines, minerals, land and
realty.

The directors entered into a contract to purchase a concession for constructing

a railway in Belgium. The issue was whether this contract was valid and if not
whether it could be ratified by the shareholders.

The court held that the contract was ultra vires the company and void so that
not even the subsequent consent of the whole body of shareholders could
ratify it. Lord Cairns stated as follows:
“The words general contractors referred to the words which went
immediately before and indicated such a contract as mechanical engineers
make for the purpose of carrying on a business. This contract was entirely
beyond the objects in the Memorandum of Association. If so, it was thereby
placed beyond the powers of the company to make the contract. If so, it was
not a question whether the contract was ever ratified or not ratified. If the
contract was going at its beginning it was going because the company could
not make it and by purporting to ratify it the shareholders were attempting to
do the very thing which by the act of parliament they were prohibited from
doing.”
The courts construed the object clause very strictly and failed to give any
regard to that part of the Objects clause which empowered the company to do
business as general contractors. This construction gave the doctrine of ultra
vires a rigidity which the times have not been able to uphold. At the present
day, the doctrine is not as rigid as in Ashbury’s case and consequently it has
been eroded.

The first inroad into the doctrine was made five years later in the case of
Attorney General V. Great Eastern Railway 1880) 5 A.C. 473

Lord Selbourne stated as follows:

“the doctrine of ultra vires as it was explained in Ashbury’s case should … but
this doctrine ought to be reasonably and not unreasonably understood and
applied and whatever may fairly be regarded as incidental to or consequential
upon those things that the legislature has authorised ought not to be held by
judicial construction to be ultra vires.”
An act of the company therefore will be regarded as intra vires not only when
it is expressly stated in the object’s clause but also when it can be interpreted
as reasonably incidental to the specified objects. As a result of this decision,
there is now a considerable body of case law deciding what powers will be
implied in a case of particular types of enterprise and what activities will be
regarded as reasonably incidental to the act.

However businessmen did not wish to leave matters for implication. They
preferred to set up in the Memorandum of Association not only the objects for
which the company was establish but also the ancillary powers which they
thought the company would need. Furthermore instead of confining
themselves to the business which the company was initially intended to
follow, they would also include all other businesses which they might want the
company to turn to in the future. The original intention of parliament was that
the companies object should be set out in short paragraphs in the
Memorandum of Association. But with a practice of setting out not only the
present business but also any business which the promoters would want the
company to turn to, the result is that a company’s object’s clause could contain
about 30 or 40 different clauses covering every conceivable business and all
that incidental powers which might be needed to accomplish them.

In practice therefore the objects laws of practically every company does not
share the simplicity originally intended in favour of these practice it may be
argued that the wider the objects the greater is the security of the creditors
since it will not be easy for the company to enter into ultra vires transactions
because every possible act will probably be covered by some paragraph in the
Objects clause.

Unfortunately this does not ensure preservation of the Companies assets or

any adequate control over the director’s activities thus the original protection
intended vanishes, the highpoint of this development came in 1966 in the case
of Bellhouse v. City Wall Properties (1966) 2 Q.B 656

In this case the Plaintiff company’s business was requisitioned for vacant land
and the erection thereon of Housing Estates. Its objects as set up in the
Memorandum of Association contained the Clause authorising the company to
“carry on any other trade or business whatsoever which can in the opinion of
the Board of Directors be advantageously carried on by the company in
connection with or as ancillary to any of the above businesses or a general
business of the company”.

In connection with its various development skills the company’s managing

director met an agent of the Defendants who required some finance to the tune
of about 1 million pounds. The Plaintiff’s Managing Director intimated to the
Defendant’s agent that he knew of a source from which the Defendant could
obtain finance and accordingly referred them to a Swiss syndicate of
financiers. In this action the Plaintiffs alleged that for that service, the
Defendants had agreed to pay a commission of 20,000 pounds and in the
alternative they claimed 20,000 pounds for breach of contract. The Defendants
argued that there was no contract between the parties. In the alternative they
argued that even if there was a contract such contract was in
effect one whereby the Plaintiffs undertook to act as money-brokers which
activity was beyond the objects of the plaintiff company and which was
therefore ultra vires.

The issues were

1. Whether the contracts were ultra vires
2. Whether it was open to the defendant to raise this point;

The court of first instance decided that the company was ultra vires and it was
open to the defendant to raise the defence of ultra vires. However a unanimous
court of appeal reversed the decision and hailed that the words stated must be
given their natural meaning and the natural meaning of those words was such
that the company could carry on any business in connection with or ancillary
to its main business provided that the directors thought that could be
advantageous to the company.

Lord Justice Salomon L.J stated as follows:

“It may be that the Directors take the wrong view and infact the
business in question cannot be carried on as they believe but it matters not
how mistaken they might be provided that they formed their view honestly
then the business is within the plaintiff’s company’s objects and powers.”

LAW OF BUSINESS ASSOCIATIONS Lecture 3

ULTRA VIRES DOCTRINE

The courts have introduced 2 methods of curbing the evasion of the ultra vires
doctrine.
1. The ejusdem generis rule is also referred to as the main
objects rule of construction. Here a Memorandum of
Association expresses the objects of a company in a
series of paragraphs and one paragraph or the first 2 or 3
paragraphs appear to embody the main object of the
company all the other paragraphs are treated as merely
ancillary to this main object and as limited or controlled
thereby. Business persons evaded this method by use of the
independent objects clause. The objects clause will
 contain a paragraph to the effect that each of the
preceding sub-paragraphs shall be construed
independently and shall not in any way be limited by
reference to any other sub-clause and that the objects set
out in each sub-clause shall be independent objects of the
company. Reference may be made to the case of Cotman
v. Brougham [1918]A.C. 514

In this case the objects clause of the company contained 30 sub-clauses.

The first sub-clause authorised the company to develop rubber plantations
and the fourth clause empowered the company to deal in any
shares of any company. The objects clause concluded with a declaration
that each of the sub clauses was to be construed independently as
independent objects of the company. The company underwrote and had
allotted to it shares in an oil company. The question that arose was whether
this was intra vires the company’s objects. The court held that the effect of
the independent objects clause was to constitute each of the 30 objects of
the company as independent objects. Therefore the dealing of shares in an
oil company was within the objects and thus intra vires. However the
power to borrow money cannot be construed as an independent object of
the company in spite of this decision.

Re Introductions (1962) W.L.R. 791

In this case the company was formed to provide accommodation and

services to those overseas visitors going to a festival in Britain. The
company did this during the first few years of existence. Later the company
switched over to pig breeding as its sole business. While so engaged it
borrowed money from a bank on a security of debentures. The bank was
given a copy of the company’s Memorandum of Association and at the
material time knew that the company’s sole business was that of pig
breeding. The issue was, whether the loan and debentures were valid in
view of the fact one of the sub clauses empowered the company to borrow
money and the last sub clause was an independent object clause.

The court held that borrowing was a power and not an object. The power to
borrow existed only for furthering intra vires objects of the company and
was not an object in itself. Therefore
1. The exercise of powers which will be intra vires is exercised for
the objects of the company and is ultra vires only if used for the
objects not covered by the company’s Memorandum of
Association.
2. Even an independent object clause cannot convert what are in
fact powers into objects.

2. LOSS OF SUBSTRATUM

Where the main object of a company has failed, a petitioner will be granted an
order for the winding up/liquidation of a company. Such a petitioner must
however be a member or shareholder in the company.

The object of the ultra vires rule is to make the members know how and to
what their money is being applied. This is the rationale of members’
protection.

RE GERMAN DATE COFFEE CO. (1882) 20 Ch. 169

In this case the major object of the company was to acquire a German Patent
for manufacturing coffee from dates. The German patent was never granted
but the company acquired a Swedish Patent for the same purpose. The
company was solvent and the majority of the members wished to continue in
business. However, two of the shareholders petitioned for winding up of the
company on the grounds that the company’s object had entirely failed.

The court held that upon the failure to acquire the German patent, it was
impossible to carry out the objects for which the company was formed.
Therefore the sub stratum had disappeared and therefore it was just inevitable
that the company should be wound up.

Kay J. stated “where a company is formed for a primary purpose, then

although the Memorandum may contain other general words which include
the doing of other objects, those general words must be read as being
ancillary to that which the Memorandum shows to be the main purpose and if
the main purpose fails and fails altogether, then the sub-stratum of the
association fails.”

This substratum rule is too narrow and cannot sufficiently uphold the ultra
vires rule. Questions are, are members or shareholders really protected? Do
they know what the objects are? The Directors may choose any amongst the
many.

Secondly a member has to petition first and the court has to decide

John Beauforte (1953) Ch.d 131

A company was authorised by its Memorandum of Association to carry on the

business of costumiers, gown makers and other activities ejusdem generis. The
company decided to undertake the business of making veneered panels which
was admittedly ultra vires and for this purpose, it constructed a factory at
Bristol. The company later went into compulsory liquidation. Several proofs
of debts were lodged with the liquidator which he rejected on the ground that
the contracts which they related to were ultra vires.

Applications by way of Appeal were lodged by the 3 creditors one of whom

had actual knowledge that the veneer business was ultra vires. The 3 creditors
were a firm of builders who built the factory, a firm which supplied the
veneers to the company and a firm which had contractual debts with the
company.

The courts held dismissing the applications that no judgment founded on an

ultra vires contract could be sustained unless it embodied a decision of the
court on the issue of ultra vires or a compromise on that issue. The contracts
being founded on an ultra vires transaction were void.

3. GRATUITOUS GIFTS
Can a company validly make a gift out of corporate property or asset? The law
is that a company has no power to make such payments unless the particular
payment is reasonably incidental to the carrying out of a company’s business
and is meant for the benefit and to promote the property of the company.

This issue was first decided in the case of

Hutton V West Cork Railway Co. (1893) Ch.d

A company sold its assets and continued in business only for the purpose of
winding up. While it was awaiting winding up, a resolution was passed in the
company’s general meeting authorising the payments of a gratuity to the
directors and dismissed employees.

The court held that as the company was no longer a going concern such a
payment could not be reasonably incidental to the business of the company
and therefore the resolution was invalid. In the words of the Lord Justice
Bowen said

“The law does not say that there are not to be cakes and ale but there
are to be no cakes and ale except such as are required for the benefit of the
company”

The question is, suppose there is a clause in the Memorandum of Association

that such payments shall be made, is payment ultra vires? The authority that
dealt with this position was the case of

RE LEE BEHRENS & CO. [1932] 2 Ch. D 46

The object clause of the company contained an express power to provide for
the welfare of employees and ex employees and also their widows, children
and other dependants by the grant of money as well as pensions. Three years
before the company was wound up, the Board of Directors decided that the
company should undertake to pay a pension to the widow of a former
managing director but after the winding up the liquidator rejected her claim to
the pension.

The court held that the transaction whereby the company covenanted to pay
the widow a pension was not for the benefit of the company or reasonably
incidental to its business and was therefore ultra vires and hence null and void.

Justice Eve stated as follows

Whether they reneged an express or implied power, all such grants involved
an expenditure of the company’s money and that money can only be spent for
purposes reasonably incidental to the carrying on of the company’s business
and the validity of such grants can be tested by the answers to three
questions:
(i) Is the transaction reasonably incidental to the
carrying on of the company’s business?
(ii) Is it a bona fide transaction?
(iii) Is it done for the benefit and to promote the
prosperity of the company?

These questions must be answered in the affirmative. The question may be

posed as to whether these tests apply where there is an express power by the
objects. This is one area where the courts are still insistent that creditors’
security must be reserved.

Sometimes ultra vires can be excluded by good and clever draftsmanship

Parke v. Daily News [1962] 2 Ch.d 927

In this case the company transferred the major portion of its assets and
proposed to distribute the purchase price to those employees who are going to
become redundant after reduction in the stock of the company of the
company’s business. The company was not legally bound to make any
payments by way of compensation. One shareholder claimed that the proposed
payment was ultra vires.

The court held that the proposed payment was motivated by a desire to treat
the ex-employees generously and was not taken in the interest of the company
as it was going to remain and that therefore it was ultra vires.

The Court observed as follows “the defendants were prompted by motives

which however laudable and however enlightened from the point of view of
industrial relations were such as the law does not recognise as sufficient
justification. The essence of the matter was that the Directors were proposing
that a very large part of its assets should be given to its employees in order to
benefit those employees rather than the company and that is an application of
the company’s funds which the law will not allow.”

Evans v. Brunner Mound & Co. 1921 Ch.d 359

The company carried on the business of chemical manufacturers. Its object

clause contained a power to do all such things as maybe incidental or
conducive to the attainment of its objects. The company distributed some
money to some universities and scientific institutions, which was meant to
encourage scientific education and research. The company thereby hoped to
create a reservoir of qualified scientists from which the company could recruit
its staff.

The court held that even though the payment was not under an express power,
it was reasonably incidental to the company’s business and therefore valid.
This is one of the few cases where payment was recognised as being valid.
THE RIGHTS OF THE COMPANY & 3RD PARTIES UNDER ULTRA
VIRES TRANSACTIONS:

These are remedies

Whether or not a contract is ultra vires depends on the knowledge of the

party’s dealing with that company. Such is the case as regards borrowing
contracts. Consider the case of

David Payne & Co. (1904) 2 Ch.d 608

X was a director of company B and at the same time had some interests in
company A. He learnt that company B wished to borrow some money which it
intended to apply to unauthorised activities. He urged company A to lend the
money on the security of debentures. The issues were
(a) Whether the debentures were valid security;
(b) Whether the knowledge of X as to the intended application of the money
could be imputed to the company.

The court held that X was not company A’s agent for obtaining such
information and therefore his knowledge was not the company’s knowledge
and consequently the debentures were valid security.

This loophole however will be applied very rarely because everybody is

presumed to know the contents of a company’s public documents. Where a
contract with that company is ultra vires, generally speaking the party dealing
with that company has no rights under the contract. The transaction being null
and void cannot confer rights on the 3rd party nor can it impose any obligation
on the company.
In many instances however, property will be transferred under an ultra vires
transaction. Such transaction cannot vest rights in the transferee and cannot
divest the transferor of his rights.

1. At common law therefore, the first remedy of a person who parts with
property under an ultra vires transaction is that he has a right to trace and
recover that property from the company as long as he can identify it.

This principle also applies to money lent to the company on an ultra vires
borrowing so long as the money can be traced either in law or in equity. The
basis of this principle is that the company is deemed to hold the money or the
property as a trustee for the person from whom it was obtained.

Therefore, if the money received is paid into a separate account, or is

sufficiently earmarked e.g by the purchase of some particular items, it can be
followed and claimed by the lender. Where tracing is impossible, because
the money has become mixed with other money, the lender is entitled in
equity to a charge on the mixed fund together with the other creditors
according to the respective amounts otherwise money obtained on ultra vires
transaction generally cannot be followed once it has been spent. But if such
money has been spent by dischargin' the company’s intra vires debts then the
lender is entitled to rank as a creditor to the extent to which the money has
been so applied. Since the company’s liabilities are not increased but in fact
decreased, equity treats the borrowing as valid to the extent of the legal
application of such money.

2. The 3rd party has a personal right against the directors or other agents with
whom he has dealt. The rationale is that such directors or other agents are
treated as quasi trustees from which it follows that a 3 rd party is entitled to a
claim against them for restitution.

TO WHAT EXTENT ARE MEMBERS PROTECTED BY THE ULTRA

VIRES DOCTRINE

The intra vires creditor does not have the locus standi to prohibit ultra vires
actions. Again there is the presumption of knowledge of a company’s
documents and activities. In spite of the fact that the doctrine of ultra vires is
over due for reform, it has not undergone any reform in Kenya unlike in the
United Kingdom where it has been severely eroded.

All the company can do is to alter its objects under the power conferred by
Section 8 of the Companies Act Cap 486. The effect of the Section is that a
company may by special resolution alter the provisions in its Memorandum
with respect to the objects of the company. Alteration must be lodged with the
Register section 28(2)

Section 141 defines Special Resolution as a resolution which is passed by a

majority of not less than three quarters of those members voting at a
company’s general meeting either in person or by proxy and of which notice
has been given of the intention to propose it as a special resolution.

Within 30 days of the date on which the resolution altering the objects is
passed, an application for the cancellation of the Resolution may be made to
Court by or on behalf of the holders who have not voted in favour of the
Resolution, of not less than 15% of the nominal value of the issued share
capital of any class and if the company does not have a share capital, the
application can be made by at least 15% of the members of the company.

If such an application is made, the alteration will not be effective except to the
extent that it is confirmed by a court. Normally a court has an absolute
discretion to confer, reject or modify the alteration.

Re Private Boarding House Limited (1967) E.A. 143

In this case, it was held that the registrar of companies is entitled to receive a
notice of any such application and to appear and be heard at the hearing of the
Application on the ground that such matters affect his record.

Under Section 8 (9) of the Companies Act Cap 486 if no application is made
to the court, within 30 days the alteration cannot subsequently be challenged.
The effect of this provision is that as long as an alteration is supported by
more than 85% of the shareholders or so long as no one applies to the court
within 30 days of the resolution, companies have complete freedom to alter
their objects.
Note however, that such alterations do not operate retrospectively. Their effect
relates only to the future.

LAW OF BUSINESS ASSOCIATIONS Lecture 4

ARTICLES OF ASSOCIATION

A Company’s constitution is composed of two documents namely the

Memorandum of Association and the Articles of Association. The Articles of
Association are the more important of the two documents in as much as most
court cases in Company Law deal with the interpretation of the Articles.

Section 9 of the Companies Act provides that a Company limited by guarantee

or an unlimited company must register with a Memorandum of Association
Articles of Association describing regulations for the company. A company
limited by shares may or may not register articles of Association. A
Company’s Articles of Association may adopt any of the provisions which are
set out in Schedule 1 Table A of the Companies Act Cap 486.

Table A is the model form of Articles of Association of a Company Limited

by Shares. It is divided into two parts designed for public companies in part A
and for private companies in part B (II) thus a company has three options. It
may either

(a) Adopt Table A in full; or

(b) Adopt Table A subject to modification or
(c) Register its own set of Articles and thereby exclude Table
A altogether.

In the case of a company limited by shares, if no articles are registered or if

articles are registered insofar as they do not modify or exclude Table A the
regulations in Table A automatically become the Company’s Articles of
Association.

Section 12 of the Companies Act requires that the Articles must be in the
English language printed, divided into paragraphs numbered consecutively
dated and signed by each subscriber to the Memorandum of Association in the
presence of at least one attesting witness.

As between the Memorandum and the Articles the Memorandum of

Association is the dominant instrument so that if there is any conflict between
the provisions in the Memorandum and those in the Articles the Memorandum
provisions prevail. However if there is any ambiguity in the Memorandum one
may always refer to the Articles for clarification but this does not apply to
those provisions which the Companies Act requires to be set out in the
Memorandum as for instance the Objects of the Company.

Whereas the Memorandum confers powers for the company, the Articles
determine how such powers should be exercised.

Articles regulate the manner in which the Company’s affairs are to be

managed. They deal with inter alia the issue of shares, the alteration of share
capital, general meetings, voting rights, appointment of directors, powers of
directors, payment of dividends, accounts, winding up etc.

They further provide a dividing line between the powers of share holders and
those of the directors.

LEGAL EFFECTS OF THE ARTICLES OF ASSOCIATION

Under Section 22 of the Companies Act it is provided that subject to the

provisions of the Act, when the Memorandum and Articles are registered, they
bind the company and the members as if they had been signed and sealed by
each member and contained covenants for the part of each member to observe
all their provisions. This Section has been interpreted by the courts to mean
that the Memorandum gives rise to a contract between the Company and each
Member.

Reference may be made to the case of

Hickman v. Kent (1950) 1 Ch. D 881

Here the Articles of the Company provided that any dispute between any
member and the company should be referred to arbitration. A dispute arose
between Hickman and the company and instead of referring the same to
arbitration, he filed an action against the company. The company applied for
the action to be stayed pending reference to arbitration in accordance with
the company’s articles of association.

The court held that the company was entitled to have the action stayed since
the articles amount to a contract between the company and the Plaintiff one of
the terms of which was to refer such matters to arbitration.

Justice Ashbury had the following to say: “That the law was clear and could
be reduced to 3 propositions
1. That no Article can constitute a contract between the
 company and a third party;
2. No right merely purporting to be conferred by an
article to any person whether a member or not in a
capacity other than that of a member for example
solicitor, promoter or director can be enforced
against the company.
3. Articles regulating the right and obligation of the
members generally as such do not create rights
and obligations between members and the
company”.

Eley v. Positive Government Security Life Association Co. (1876) Ex 88

In this case, the company’s articles provided that Eley should become the
company Solicitor and should transact all legal affairs of the company for
mutual fees and charges. He bought shares in the company and thereupon
became a member and continued to act as the company’s solicitor for some
time. Ultimately the company ceased to employ him. He filed an action
against the company alleging breach of contract.

The court held: that the articles constitute a contract between the company and
the members in their capacity as members and as a solicitor Eley was therefore
a third party to the contract and could not enforce it. The contract relates to
members in their capacity as members and the company so its only a contract
between the company and members of that company and not in any other
capacity such as solicitor. But note that there can be an intra member contract.

Wood v. Odessa Waterworks Company [1880] 42 Ch. 636

Here the Plaintiff who was a member of the company petitioned the court to
stay the implementation of a resolution not to pay dividends but issue
debentures instead. Holding that a member was entitled to the stay of the
implementation of the Resolution Sterling J. had the following to say: “the
articles of association constitutes a contract not merely between shareholders
and the company but also between the individual shareholders and every
other.”
This case was followed in

Rayfield v. Hands (1960) Ch.d 1

Here the company’s articles provided that every member who intends to
transfer his shares shall inform the directors who will take those shares
between them equally at a fair value. The Plaintiff called upon the directors to
take his shares but they refused. The issue was did the articles give rise to a
contract between the Plaintiff and the directors. In their capacity as directors
they were not bound.

The court here held that the Articles related to the relationship between the
Plaintiff as a member and the Defendants not as directors but as members of
the company. Therefore the Defendants were bound to buy the Plaintiff shares
in accordance with the relevant article.

ALTERATION OF ARTICLES

Section 13 of the Companies Act gives the company power to alter the articles
by special resolution. This is a statutory power and a company cannot deprive
itself of its exercise. Reference may be made to the case of

Andrews v. Gas Meter Co. (1897) 1 Ch. 361

The issue herein was whether a company which under its Memorandum and
Articles had no power to issue preference shares could alter its articles so as to
authorise the issue of preference shares by way of increased capital

The court held that as long as the Constitution of a Company depends on the
articles, it is clearly alterable by special resolution under the powers conferred
by the Act. Therefore it was proper for the company to alter those articles and
issue preference shares. Any regulation or article which purports to deprive the
company of this power is therefore invalid, on the ground that such an article
or regulation will be contrary to the statute. The only limitation on a
company’s power to alter articles is that the alteration must be made in good
faith and for the benefit of the company as a whole.

Allen v. Gold Reefs of West Africa (1900) 1 Ch. 626

In this case the company had a lien on all debts by members who had not truly
paid up for their shares. The Articles were altered to extend the Company’s
lien to those shares which were fully paid up.

The court held that since the power to alter the Articles is statutory, the
extension of the lien to fully paid up shares was valid. These were the words
of Lindley L.J.
“Wide however as the language of Section 13 mainly the power conferred by
it must be exercised subject to the general principles of law and equity which
are applicable to all powers conferred on majorities and enabling them to
bind minorities. It must be exercised not only in the manner required by law
but also bona fide for the benefit of the company as a whole.”

Further reference may be made to the case of

Shuttleworth v. Cox Brothers Ltd (1927) 2 KB 29

Here the Articles of the Company provided that the Plaintiff and 4 others
should be the first directors of the company. Further each one of them should
hold office for life unless he should be disqualified on any one of some six
specified grounds, bankruptcy, insanity etc. The Plaintiff failed to account to
the company for certain money he had received on its behalf. Under a general
meeting of the company a special resolution was passed that the articles be
altered by adding a seventh ground for disqualification of a director which was
a request in writing by his co-directors that he should resign. Such request was
duly given to the Plaintiff and there was no evidence of bad faith on the part of
shareholders in altering the articles.

The Plaintiff sued the company for breach of an alleged contract contained in
their original articles that he should be a permanent director and for a
declaration that he was still a director.

The court held that the contract if any between the Plaintiff and the company
contained in the original articles in their original form was subject to the
statutory power of alteration and if the alteration was bona fide for the benefit
of the company, it was valid and there was no breach of contract. Lord Justice
Bankes observed as follows

“In this case, the contract derives its force and effect from the Articles
themselves which may be altered. It is not an absolute contract but only a
conditional contract.”

The question here is who determines what is for the benefit of the company?
Is it the shareholders or the Courts?

Scrutton L.J. had the following to say

“to adopt such a view that a court should decide will be to make the
court the manager of the affairs of innumerable companies instead of
shareholders themselves. It is not the business of the court to manage the
affairs of the company. That is for the shareholders and the directors.”

Sidebottom v. Kershaw Leese & C0.[1920]1 Ch. 154

Director controlled share company had a minority shareholder who was

interested in some competing business. The company passed a special
resolution empowering the directors to require any shareholder who competed
with the company to transfer his shares at their fair value to nominees of the
directors. The Plaintiff was duly served with such a notice to transfer his
shares. He thereupon filed an action against the company challenging the
validity of that article.

The court held that the company had a power to re-introduce into its articles
anything that could have been validly included in the original articles provided
the alteration was made in good faith and for the benefit of the company as a
whole and since the members considered it beneficial to the company to get
rid of competitors, the alteration was valid..

Contrast this case with that of

Brown v. British Abrasive Wheel Co. (1990) 1 Ch. 290

Here a public company was in urgent need of further capital which the
majority of the members who held 98% of the shares were willing to supply if
they could buy out the minority. They tried persuasion of the minority to sell
shares to them but the minority refused. They therefore proposed to pass a
Special Resolution adding to the Articles a clause whereby any shareholder
was bound to transfer his shares upon a request in writing of the holders of
98% of the issued capital.

The court held that this was an attempt to add a clause which will enable the
majority to expropriate the shares of the minority who had bought them when
there was no such power. Such an attempt was not for the benefit of the
company as a whole but for the majority. An injunction was therefore granted
to restrain the company from passing the proposed resolution.

EFFECT OF ALTERATION ON CONTRACT OF DIRECTORS

Sometimes the Articles may be altered in such a way that the implementation
of those articles in the altered form would give rise to breach of an existing
contract between the company and a third party and particularly so as regards
contracts between companies and their directors.

A director may hold office either

1. Under the Articles without a service contract;

2. Under a contract of service which is entirely independent of
the articles; or
3. Under a service contract which expressly or by implication
embodies the relevant provisions in the Articles.

Where a director holds office under the Articles without a contract of service,
then his appointment is conditional on the footing that the articles may be
altered at any time in exercise of statutory power.
If however, a director’s appointment is entirely independent of the articles
then any alterations which affects his contract with the company will
constitute a breach of contract for which the company will be liable in
damages.

Southern Foundries v. Shirlaw (1940) A.C. 701

The Plaintiff by a written contract was appointed the company’s Managing

Director for 10 years. The agreement was not expressed to be subject to the
Articles in any way. The Articles provided various grounds for the removal of
a director from office subject to the terms of any subsisting agreement. The
Articles further provided that if the Managing Director ceased to be a director,
he would ipso facto cease to be Managing Director. The Company’s Articles
were subsequently changed to give the Directors power to remove a fellow
director from office by notice. Such notice was given to the Plaintiff who
thereupon filed an action claiming damages from the company for breach of
contract.

It was held that since his appointment was not subject to the articles, he could
only be removed from office in accordance with the terms of his appointment
and not by way of alteration of the articles. Damages were therefore payable.
Lord Atkins said “if a party enters into an arrangement which can only take
effect by the continuance of an existing state of circumstances there is an
implied undertaking on his part that he shall be done of his own motion to put
an end to that state of circumstances which alone the arrangement can be
operative.”

If a director is appointed in very general terms and without limitation of time,

then the provisions in the Articles are deemed to be incorporated in the
appointment and in the absence of any provision in the articles to the contrary,
the company may dismiss him at any time and even without notice.

Read v. Astoria Garage (1952) 1 All.E.R 922

A Company’s Articles provided that the appointment of a Managing Director

shall be subject to termination if he ceases for any reason to be a director or if
the company in general meeting resolved that his tenure of office as managing
director be terminated. The Plaintiff was appointed as the company’s
Managing Director 17 years later the directors decided to relieve him of his
duties as Managing Director. The decision was subsequently ratified by the
company in general meeting. He claimed damages for wrongful dismissal.

The court held that on a true construction of the company’s articles the
Plaintiff’s appointment was immediately and automatically terminated on
passing of the Resolution at the general meeting since the company had
expressly reserved to itself the power to dismiss the Managing Director.
The question is, can a company be restrained by injunction from altering its
articles if the alteration is likely to give rise to a breach of contract?

Part of the answer to this question was given in the case of British Murac

Syndicate Ltd v. Alperton Rubber Co. Ltd. 1950 2 Ch. 186

By an agreement binding on the Defendant company it was provided that so

long as the operative syndicate should hold over 5000 shares in the
Defendant’s company, the Plaintiff’s syndicate should have the right of
nominating two directors on the Board of the Defendant Company. A clause to
the same effect was contained in Article 88 of the Defendant Company’s
Articles of Association.

Another Article provided that the number of directors should not be less than 3
nor more than 7. The Plaintiff syndicate had recently nominated 2 persons as
directors. The Defendant company objected to these two persons as directors
and refused to accept the nomination and a meeting of shareholders was called
for the purpose of passing a special resolution under Section 13 of the
Companies Act cancelling the article.

The court held that the defendant company had no power to alter its articles of
association for the purpose of committing a breach of contract and that an
injunction ought to be granted to restrain the holding of the meeting for that
purpose.

Punt v. Symens & Co. 1903 2 Ch.d 506

This case had words to the effect that the company cannot be restrained but
this was overruled in the case of

British Equitable Assurance Co. v. Baily (1906) S.C. 35

Allen v. Goldreef

In this case an article was altered in such a way as to prejudice one

shareholder. The article gave a lien on partly-paid shares for debts of
members. Zuccani owed money in respect of unpaid calls on partly-paid shares
but was the only holder of fully paid shares as well. The court held that it was
for the benefit of the company to recover moneys due to it and the alteration in
its terms related to all holders of fully-paid shares. The fact that Zuccani was
the only member of that class at that moment did not invalidate it.

VARIATION OF CLASS RIGHTS

Although the Companies Act recognises the existence of class of shareholders,

it does not define the term ‘class’ the best definition is found in the case of
Sovereign Life Assurance Co. v. Dodd (1892) 2 QB 573

In that case Bowen L.J. stated as follows: “The word Class is vague it must be
confined to those persons whose rights are not dissimilar as to make it
impossible for them to concert together with a view to their common interest.”

Under Article 4 of Table A where the Share Capital is divided into different
classes of Shares, the rights attached to any class may be varied only with a
consent in writing of the holders of three quarters of the issued share of that
class or with assumption of a special resolution passed at a separate meeting
of the holders of the shares of that class.

However, under Section 25 (2) if the rights are contained in the Memorandum
of Association and if the Memorandum prohibits alteration of those rights,
then class rights cannot be varied.

THE COMPANIES ORGANS & OFFICERS

Since a company is an artificial person, it can only act through an agency of a

human person. For this purpose, a company has two primary organs.

1. The general Meeting;

2. The Board of Directors.

The authority to exercise a company’s powers is normally delegated not to the

members nor individual directors but only to the directors as a Board. The
directors may however delegate powers to an individual Managing Director.

Section 177 of the Companies Act requires every public company to have at
least two directors and every private company at least one director. The Act
does not provide for the means of appointing Directors but in practice the
Articles of Association provide for initial appointments by subscribers to the
Memorandum of Association and thereafter to annual retirement of a certain
number of directors and the filling of vacancies at the annual general meeting.

Under Section 184 (1) of the Companies Act every appointment must be voted
on individually except in the case of private companies or unless the meeting
unanimously agrees to include two or more appointments in the same
resolution. The appointment is usually effected by an ordinary resolution.
However, no matter how a director is appointed, under Section 185 of the
Companies Act he can always be removed from office by an ordinary
resolution in addition to any other means of removal which may be embodied
in the articles.
Unless the Articles so provide Directors need not be members of a company,
but if the articles require a share qualification, then the shares must be taken up
within two months otherwise the office will be vacated. Undischarged
Bankrupts are not allowed to act as directors without leave of the court. A
director need not be a natural person. A company may be appointed a director
of another. The disqualifications of directors are set out in article 88 of Table
A. The division of powers between the general meeting and the Board of
Directors depends entirely on the construction of the Articles of Association
and generally where powers of management are vested in the Board of
Directors, the general meeting cannot interfere with the exercise of those
powers.

Automatic Self-cleaning Filter Syndicate v. Cunningham (1906) A.C. 442

The company’s articles provided that subject to such regulations as might be

made by extra ordinary resolution, the Management of the company’s affairs
should be vested in the Directors who might exercise all the powers of the
company which were not by statute or articles expressly required to be
exercised by the company in general meeting. In particular the articles gave
the directors power to sell and deal with any property of the company on such
terms as they must deem fit. At a general meeting of the company, a
Resolution was passed by a simple majority of the members for the sale of the
company’s assets on certain terms and instructing the directors to carry the
sale into effect. The Directors were of the opinion that a sale on those terms
was not of any benefit to the company and therefore refused to carry it into
effect. The issue was, whether the directors were under an obligation to act in
accordance with the directives.

The court held that the Articles constituted a contract by which the members
had agreed that the Directors alone should manage the affairs of the company
unless and until the powers vested in the Directors was taken away by an
alteration in the Articles they could ignore the general meeting directives on
matters of management. They were therefore entitled to refuse to execute the
sale.

The division of the power to manage the company’s affairs is embodied in

Article 80 of Table A which states that the business of the company shall be
managed by the directors who may exercise all such powers of a company as
are not by the Act or by these regulations required to be exercised by the
company in general meeting. Where this article is adopted as it is invariably
done in practice the general meeting cannot interfere with a decision of the
directors unless they are acting contrary to the provisions of the Companies
Act or the particular company’s articles of association.

Shaw & Sons Ltd v. Shaw (1935) 2 KB 113

Here the Directors were empowered to manage the company’s affairs. They
commenced an action for and on behalf of the company and in the company’s
name, in order to recover some money owed to the company. The general
meeting thereafter passed a resolution disapproving the commencement of the
suit and instructing the Directors to withdraw it
It was held that the resolution of the general meeting was a nullity Greer L.J.
stated

“A company is an entity distinct from its shareholders and its directors.

Some of its powers may be according to its articles exercised by the Directors
and certain other powers may be reserved for shareholders in general
meeting. If powers of management are vested in the Directors, they and they
alone can exercise these powers. The only way in which the general body of
the shareholders can control the exercise of the powers vested by the articles
in the directors is by altering the articles or if opportunity arises under the
articles by refusing to re-elect the directors or whose actions they disapprove.
They cannot themselves reserve the powers which by themselves are vested in
the Directors any more than the directors can reserve to themselves the
powers vested by the articles in the general body of shareholders.”

To this there are two exceptions

1. in relation to litigation – here a general meeting can institute
proceedings on behalf of the company if the board of
directors refuses or neglects to do so.
2. When there is a deadlock in the Board of Directors as for
instance in the case of

Barron v. Porter (1914) 1 Ch. 895

The articles of association vested the power to appoint additional directors in

the Board of Directors. There were only two directors namely, Barron and
Porter and the conduct of the company’s business was at a standstill as Barron
refused to attend any Board meeting with Porter.

The court held that it was competent for the general meeting to appoint
additional directors even if the power to do so was by articles vested in the
Board of Directors.

LAW OF BUSINESS ASSOCIATIONS Lecture 5

CORPORATES’ LIABILITIES FOR ACTS OF ITS ORGANS & OFFICERS

There are certain situations in which the law does not recognise vicarious
liability but insists on personal fault as a prelude to liability. In such cases a
company could never be liable if the courts applied rigidly the rule that a
company is an artificial person and therefore can only act through the
directors. In practice and for certain purposes the courts have elected to treat
the acts of certain officers as those of the company itself. This is sometimes
referred to as THE ORGANIC THEORY OF COMPANIES.

The theory sprung from the case of

Lennard’s Carrying Co. v. Asiatic Petroleum Co. Ltd. (1950) A.C. 705

In this case a ship and her cargo were lost owing to unseaworthiness. The
owners of the ship were a limited company. The managers of the company
were another limited company whose managing director a Mr. Lennard
managed the ship on behalf of the owners. He knew or ought to have known of
the Ship’s unseaworthiness but took no steps to prevent the ship from going to
sea. Under the relevant shipping Act the owner of a sea going ship was not
liable to make good any loss or damage happening without his fault. The
issue was whether Lennard’s knowledge was also the company’s knowledge
that the ship was unseaworthy.

The court held that Lennard was the Directing mind and will of the company
his knowledge was the knowledge of the company, his fault the fault of the
company and since he knew that the ship was unseaworthy, his fault was also
the company’s fault and therefore the company was liable. As per Viscount
Haldane
“My Lords a corporation is an abstraction. It has no mind of its own
anymore than it has a body of its own. Its active and directing will must
consequently be sought in the person of somebody who for some purposes
may be called an agent but who is really the directing mind and will of the
corporation, the very ego and centre of the personality of the corporation.

Bolton Engineering Co. v. Graham

Here the Plaintiffs who were tenants in certain business premises were entitled
to a renewal of their tenancy unless the landlords who were a limited company
intended to occupy the premises themselves for their business purposes. The
issue was whether the Defendant company had effectively formed this
intention. There had been no formal general meeting or Board of Directors
meeting held to consider the question but the managing director’s clearly
manifested the intention to occupy the premises for the company’s business.

The court held that the intention manifested by the Directors was the
company’s intention and therefore the tenants were not entitled to a renewal of
the tenancy.

Denning L.J. as he then was stated as follows:

“a company may in many ways be likened to a human being. It has a
brain and nerve centre which controls what it does. It also has hands which
hold the tools and act in accordance with the directions from the centre. Some
of the people in the company are mere servants and agents who are nothing
more than hands to do the work and cannot be said to represent the mind and
will of the company. Other are directors and managers who
represent the directing mind and will of the company and control what it does.
The state of mind of these managers is the state of mind of the company and
are treated by the law as such. Whether their intention is the company’s
intention depends on the nature of the matter under consideration, the relative
position of the officer or agent and other relevant facts and circumstances of
the case.”

RULE IN TURQUAND’S CASE

Crossly connected with this aspect is the so called rule in Turquand’s case:

This rule deals with a company’s liability for acts of its officers. The question
as to whether or not the company is bound or not depends on the normal
agency principles. If a company’s officer or a company’s organ does an act
within the scope of its authority, the company will be bound. The problem
which might arise is that even if the Act in question is within the scope of the
organs or officers authority, there might be some irregularity in the action of
the organ concerned and consequently in the exercise of authority. For
example, if a particular act can only be valued if done by the Board of
Directors or the general meeting, the meeting might have been convened on
improper notice or the resolution may not have been properly carried. In the
case of the Directors, they may not have been properly appointed. In these
circumstances can the company disclaim an act which was so done by arguing
that the meeting was irregular? Must a third party dealing with the company
always ascertain that the company’s internal regulations have been complied
with before holding the company liable?

The answer to this question was given in the negative in the case of

The Royal British Bank v. Turquand (1856) 6 E & B 327

Here under the Company’s constitution the directors were given power to
borrow on bond such sums of money as from time to time by a general
resolution be authorised to be borrowed. Without any such resolution having
been passed, the directors borrowed a certain sum of money from the
Plaintiff’s bank. Upon the company’s liquidation the bank sought to recover
from the liquidator who argued that the Bank was not bound to recover it as it
was borrowed without authority from the general meeting.

The court held that even though no resolution had been passed, the company
was nevertheless bound by the act of the directors and therefore was bound to
repay the money.

The words of Jarvis C.J. were as follows:

“a party dealing with a company is bound to read the company’s deed

of settlement (Memorandum of Association) but he is not bound to do more. In
this case a third party reading a company’s documents will find not a
prohibition from borrowing but permission to do so on certain conditions.
Finding that the authority might be made complete by resolution, he would
have had a right to infer the fact of a resolution authorising that which on the
face of the document appeared to be legitimately done.”

This is the rule in Turquand’s Case which is often referred to as the rule as to
indoor management.

This rule is based not on logic but on business convenience.

1. A third party dealing with a company has no access to the

company’s indoor activities;
2. It would be very difficult to run business if everyone who had
dealings with the company had first to examine the
company’s internal operations before engaging in any
business with the company;
3. It would be very unfair to the company’s creditors if the
company could escape liability on the ground that its
officials acted irregularly.

But should the company always be held liable for the act of any people
purporting to act on the company’s behalf? Suppose these persons are
impostors, what happens?

In order to avoid this some limitations have been imposed on the rule. Later
cases have refined the rule to a point where the position appears to that
ordinary agency principles will always apply

Anybody dealing with a company is deemed to have notice of the contents of

the company’s public documents. Therefore any act which is contrary to those
provisions will not bind the company unless it is subsequently ratified by the
company acting through its appropriate organ. The term public document is
not defined in the companies Act but so far as registered companies are
concerned, the expression is not restricted to the Memorandum and Articles
but it also includes some of those documents filed at the companies registry.
These include special resolutions, particulars of directors and secretary,
charges etc. provided that everything appears to be regular, so far as can be
checked from the public documents, a third party dealing with a company is
entitled to assume that all internal regulations of the company have been
complied with unless he has knowledge to the contrary or there are suspicious
circumstances putting him on inquiry. Reference is made to the case of

Mahoney v. East Holyford Mining Co. (1875) L.R. 7 HL 869

Here a mining company was founded by W and his friends and relatives.
Subscriptions were obtained from applicants for shares. These monies were
paid into the bank which had been described in the prospectus as the
company’s bank. The communication of the letter was sent to the Bank by a
person describing himself as the Company’s secretary to the effect that in
accordance with a resolution passed on that day, the bank was to pay out
cheques signed by either two of the three named directors whose signatures
were attached and countersigned by the Secretary. The bank thereafter
honoured cheques so signed. When the company’s funds were almost
exhausted, the company was ordered to be wound up. It was then discovered
that no meeting of the Shareholders had been held, and no appointment of
Directors and Secretary met but that with his friends and relatives, W had held
themselves to be secretary and directors and had appropriated the subscription
money. The issue was whether the Bank was liable to refund the money it had
paid back to the borrower.

The court held that the bank was not liable to refund any money to the
company as it had honoured the company’s cheques in reliance on a letter
received and in good faith.

Lord Hatherly stated

“When there are persons conducting the affairs of a company in a manner

which appears to be perfectly consonant with the articles of association, then
those dealing with them externally are not to be affected by any irregularities
which may take place in the internal management of the company.”

Directors will not necessarily and for all purposes be insiders. The test appears
to be whether the acts done by them are so closely related to their position as
directors as to make it impossible for them not to be treated as knowing the
limitations on the powers of the officers of the company with whom they have
dealt. Otherwise a third party dealing with a company through an officer who
is or is held out by the company as a particular type of officer e.g. a Managing
Director and who purports to exercise a power which that sort of officer will
usually have is entitled to hold the company liable for the officer’s acts even
though the officer has not been so appointed or is in fact exceeding his
authority as long as the third party does not know that the company’s officer
has not been so appointed or has no actual authority.

A third party however, will not be protected if the circumstances are such as to
put him on inquiry. He will also lose protection if the public documents make
it clear that the officer has no actual authority or could not have authority
unless a resolution had been passed which requires filing in the Companies
Registry and no such resolution had been filed. These are normal agency
principles.

Freeman & Lockyer V Buckhurst Park Properties (1964) 2 Q.B. 480

In this case Kapool & Hoon formed a private company which purchased
Buckhurst Park Estate. The Board of Directors consisted of Kapool, Hoon and
two others. The Articles of the company contained a power to appoint a
Managing Director but none was appointed. Though never appointed as such,
Kapool acted as Managing Director. In that capacity he engaged the Plaintiffs
who were a firm of Architects to do certain work for the company which was
duly done. When the Plaintiff’s claimed remuneration, according
to the agreement, the company replied that it was not liable because Kapool
had no authority to engage them.

The Court held that the act of engaging Architects was within the ordinary
ambit of the authority of a Managing Director of a property company and the
Plaintiffs did not have to inquire whether a person with whom they were
dealing with was properly appointed. It was sufficient for them that under the
Articles, the Board of Directors had the power to appoint him and had in fact
allowed him to act as Managing Director. Four conditions must however be
fulfilled in order to entitle a third party to enforce a contract entered to on
behalf of the company by a person who has no actual authority.

1. It must be shown that there was a representation that the agent

had authority to enter into a contract of the kind
sought to be enforced;
2. Such representation must be made by a person or persons who
had actual authority to manage the company’s
business either generally or in respect of those matters to
which the contract relates;
3. It must be shown that the contract was induced by such
representation;
4. It must be shown that neither in its Memorandum or under its
Articles was the company deprived of the capacity
either to enter into a contract of the kind sought to be
enforced or to delegate authority to do so to the agent.

Emco Plastica International vs Freeberne (1971) E.A. 432

Here by a resolution of the company at a meeting of the Board of Directors,

the Respondent was appointed as the company’s secretary. Nothing was
decided at the meeting as regards his remuneration or other terms of service.
The terms of his appointment were contained in a letter signed on behalf of the
company by its Managing Director which provided that the appointment was
for a maximum period of 5 years. The Managing Director dealt with the day to
day affairs of the company but had no express authority to appoint a Secretary
or to offer such unusually generous terms as contained in the letter. After two
years service the company purported to dismiss the Respondent by five days
notice. The Secretary sued for benefits under the Contract. The Company
contended that the Managing Director had no authority from the Company to
offer the terms of the contract. There being no resolution of the board to
support it and nothing in the company’s articles conferring any such powers on
a Managing Director.

The court held that as a chairman he performed the functions of the Managing
Director with a full knowledge of the Board of Directors and that a contract of
service as the one entered into with the Secretary was one which a person
performing the duties of a Managing Director would have power to enter into
on behalf of the company. Therefore, the contract was genuine, valid and
enforceable. If however, the officer is purporting to exercise some authority
which that sort of officer would not normally have,
a third party will not be protected if the officer exceeds his actual authority
unless the company has held him out as having authority to act in the matter
and the third party has relied thereof i.e. unless the company is estopped.
However, a provision in the Memorandum or Articles or other public
document cannot create an estoppel unless the third party knew of the
provision and has relied on it. For this purpose, regulations at the Companies
Registry do not constitute notice because the doctrine of constructive notice
operates negatively and not positive. If a document purporting to be received
by or signed on behalf of the company is proved to be a forgery, it does not
bind the company. However, the company may be estopped from claiming the
document as a forgery if it has been put forward as genuine by an officer
acting within his usual or ostensible authority.

Look at

Rama Corp v Proved Tin & General Investment (1952) 2 Q.B. 147

PROMOTERS

The Companies Act does not define the term promoter but Section 45(5) says
“A promoter is a promoter who was a party to the preparation of the
prospectus.’
‘Apart from the fact that this definition does not speak much, it nevertheless
shows that the definition is only given for the purposes of that section.

At common law the best definition is that by Chief Justice Cockburn in the
case of

Twyfords – v – Grant (1877) 2C.P.D. 469

Cockburn says “a promoter is one who undertakes to form a company with

reference to a given project and to set it going and who takes the necessary
steps to accomplish that purpose.”

The term is also used to cover any individual undertaking to become a director
of a company to be formed. Similarly it covers anyone who negotiates
preliminary agreements on behalf of a proposed company. But those who act
in a purely professional capacity e.g. advocates will not qualify as promoters
because they are simply performing their normal professional duties. But they
can also become promoters or find others who will. Whether a person is a
promoter or not therefore, is a question of fact. The reason is that Promoter of
is not a term of law but of business summing up in a single word the number
of business associations familiar to the commercial world by which a company
is born.

It may therefore be said that the promoters of a company are those responsible
for its formation. They decide the scope of its business activities, they
negotiate for the purchase of an existing business if necessary, they instruct
advocates to prepare the necessary documents, they
secure the services of directors, they provide registration fees and they carry
out all other duties involved in company formation. They also take
responsibility in case of a company in respect of which a prospectus is to be
issued before incorporation and a report of those whose report must
accompany the prospectus.

DUTIES OF A PROMOTER

His duty is to act bona fide towards the company. Though he may not strictly
be an agent, or trustee for a company, anyone who can be properly regarded as
a promoter stands in a fiduciary relationship vis-à-vis the company. This
carries the duties of disclosure and proper accounting particularly a promoter
must not make any profit out of promotion without disclosing to the company
the nature and extent of such a Promotion. Failure to do so may lead to the
recovery of the profits by the company.

The question which arises is – Since the company is a separate legal entity
from members, how is this disclosure effected?

Erlanger v New Sombrero Phosphates Co. (1878) 3 A.C. 1218

The facts were as follows

The promoters of a company sold a lease to the company at twice the price
paid for it without disclosing this fact to the company. It was held that the
promoters breached their duties and that they should have disclosed this fact to
the company’s board of directors. As Lord Cairns said

“the owner of the property who promotes and forms that company to
which he sells his property is bound to take care that he sells it to the company
through the medium of a Board of Directors who can exercise an independent
judgment on the transaction and who are not left under belief that the property
belongs not to the promoters and not to another person.”

Since the decision in Salomon’s case it has never been doubted that a
disclosure to the members themselves will be equally effective. It would
appear that disclosure must be made to the company either by making it to an
independent Board of Directors or to the existing and potential members. If to
the former the promoter’s duty to the company is duly discharged, thereafter,
it is upon the directors to disclose to the subscribers and if made to the
members, it must appear in the Prospectus and the Articles so that those who
become members can have full information regarding it.

Since a promoter owes his duty to a company, in the event of any non
disclosure, the primary remedy is for the company to bring proceedings for

1. Either rescission of any contract with the promoter or

2. recovery of any profits from the promoter.
As regards Rescission, this must be exercised with keeping in normal
principles of the contract.

1. the company should not have done anything to ratify the action
2. There must be restitutio in intergram (restore the parties to their original
position),

REMUNERATION OF PROMOTERS

A promoter is not entitled to any remuneration for services rendered for the
company unless there is a contract so enabling him. In the absence of such a
contract, a promoter has no right to even his preliminary expenses or even the
refund of the registration fees for the company. He is therefore under the
mercy of the Directors. But before a company is formed, it cannot enter into
any contract and therefore a promoter has to spend his money with no
guarantee that he will be reimbursed.

But in practice the articles will usually have provision authorising directors to
pay the promoters. Although such provision does not amount to a contract, it
nevertheless constitutes adequate authority for directors to pay the promoter.

PRELIMINARY CONTRACTS BY PROMOTERS

Until a company is formed, it is legally non-existent and therefore cannot enter

into any contract or even do any other acts in law. once incor0orated, it cannot
be liable on any contract nor can it be entitled under any contract purported to
have made on its behalf before incorporation.

Ratification is not possible when the ostensible principle is non-existent in law

when the contract was entered into.

Price v. Kelsall (1957) E.A. 752

One of the issues in this case was whether or not a company could ratify a
contract entered into on its behalf before incorporation. The alleged contract
was that the Respondent had undertaken to sell some property to a company
which was proposed to be formed between him and the Appellant. In holding
that a company cannot ratify such an agreement, the Eastern Africa Court of
Appeal as then constituted O’Connor President said as follows
“A company cannot ratify a contract purporting to be made by someone
on its behalf before its incorporation but there may be circumstances from
which it may be inferred that the company after its incorporation has made a
new contract to the effect of the old agreement. The mere confirmation and
adoption by Directors of a contract made before the formation of the company
by persons purporting to act on behalf of the company creates no contractual
relations whatsoever between the company and the other party to the
contract.”
However, acts may be done by a company after its formation which give rise
to an inference of a new contract on the same terms as the old one.

The question whether there is a new contract or contracts is always a question

of facts which depends on the circumstances of each individual case.

Mawagola Farmers & Growers Ltd. V Kanyanja (1971) E.A. 272

Here, prior to the incorporation of a company the promoters held public

meetings at which members of the public were asked to purchase shares in a
proposed company. The Respondents paid for the shares both before and after
incorporation of the company but the company did not allot any shares to
them. Instead after incorporation, it allotted shares to other people.

The Respondents filed actions praying for orders that the shares they paid for
be allotted to them and the company’s registered members be rectified
accordingly.
The Company argued that as the Respondents had paid money for the
purchase of their shares before incorporation, their claim could only be
directed against promoters because no pre incorporation agreement could bind
the company and the company could not even after incorporation ratify or
adopt any such contract.

Mustafa J.A. replied as follows:

“in order that the company may be bound by agreements entered into
before incorporation, there must be a new contract to the same effect as the old
agreements. This contract may however be inferred from the acts of the
company when incorporated.”

The allotment of shares to the Respondents after the incorporation was held to
be sufficient evidence of a new contract between the company and the
Respondents. Therefore the Respondents were entitled to be allotted the shares
agreed upon.

If any preliminary arrangements are made, these must therefore be left to mere
gentlemen’s agreements or otherwise the promoters might have to undertake
personal liability.

Although the principle is clear, those engaged in the formation of companies

often cause contracts to be entered into on behalf of their proposed companies.

As to whether the promoters will be personally liable on such contracts of

nought might depend on the terminology employed. In the case of

Kelner v. Baxter (1886) L.R. 2 C.P. 174

In this case, A, B and C entered into a contract with the Plaintiff to purchase
goods “on behalf of the proposed Gravesand Royal Alexandra Hotel
Company” the goods were duly supplied and consumed. Shortly after
incorporation the company in question collapsed and the Plaintiff sued A B
and C for the price of the goods supplied.

It was held that A B and C were liable. Chief Justice Erne stated as follows:
“where a contract is signed by one who professes to be signing as agent
but who has no principal existence at the time, then the contract will hold
together the inoperative unless binding against the person who signed it. He is
bound thereby and a stranger cannot by subsequent ratification relieve him
from that responsibility. When the company came afterwards into existence, it
had rights and obligations from that time but no rights or obligations by reason
of anything which might have been done before.”

Contrast this case with the case of

Newborn v. Sensolid (G.B Ltd) (1954) 1 Q.B. 45

Here a contract was entered into between Leopold Newborn London Ltd and
the Defendant for purchase of goods by the latter. The defendant subsequently
refused to take delivery of the goods and an action was commenced by
Leopold Newborn Ltd.
It was discovered that at the time the contract was entered into, the company
had not been incorporated. Leopold Newborn thereupon sought personally to
enforce the contract.

It was held that the signature on the document was the company’s signature
and as the company was not in existence when the contract was signed, there
never was a contract and Mr. Newborn could not come forward and say that it
was his contract. The fact was that he made a contract for a company which
did not exist.

LAW OF BUSINESS ASSOCIATIONS Lecture 6

PROSPECTUSES

Basically when the public is asked to subscribe for shares or debentures in a

company the invitation involves the issue of documents which set out the
advantages to accrue from an investment in the company. This document is
called a prospectus and may be issued either by the company itself or by a
promoter. It is only in the case of a public company that a prospectus may be
issued.

A private company must always raise its capital privately as required by

Section 13 of the Companies Act Cap 486.

Section 20 of the Statute defines Prospectus as “any prospectus notice circular

advertisement or other invitation offering to the public for subscription or
purchase of any shares or debentures in the company.”

The word invitation and offering in that definition are loosely used because
when a company issues a prospectus it does not offer to sell any shares but
rather invites offers from members of the public. A prospectus is therefore not
an offer but an invitation to treat.

The word prospectus is thus a vague and uncertain term. Whether an invitation
is made to members of the public is always a question of fact. The question
“public” is not restricted to a certain section of the public but includes any
members of the general public. Reference may be made to the case of

Re South of England Natural Gas Co. (1911) 1 Ch. 573

A newly formed company issued 3000 copies of a document which offered for
subscription shares in a company and which was headed “for private
circulation only”. These copies were then circulated to the shareholders of a
number of gas companies and the question arose Was this a prospectus?
The court held that this was an offer to the public and therefore constituted a
prospectus.

CONTENTS OF A PROSPECTUS

The object of the Companies Act is to compel a company to disclose in a

prospectus all the necessary information which will enable a potential investor
in deciding whether or not to subscribe for a company shares or debentures.
Therefore Section 40 requires that every Prospectus shall state the matter
specified in Article 1 of the 3rd Schedule to the Act and that it will also set out
the report specified in Part II of that Schedule. The provisions in that Schedule
are designed mainly to provide information about the following matters:

1. Who the directors are; and What benefits they will get
from the Directorship;
2. In the case of a new company, what profits are being
made by the promoters;
3. the amount of capital required by the company to be
subscribed, the amount actually received or to be
received, the precise nature of the consideration
which is not paid in cash;
4. In the case of an existing company, what the
company’s financial records has been in the past.
5. the company’s obligations under any contracts it has
entered into;
6. the voting and dividend rights of each class of shares;
7. If a Prospectus includes any statement by an expert,
then the expert must have given his written consent
to the inclusion of the statement and the prospectus
must state that he has done so as per Section 42 of
the Companies Act.

Contravention of these requirements renders the company and every person

who was knowingly a party to the issue of the prospectus to a fine not
exceeding 10,000/-

Section 42 defines Expert as including “Engineer, Valuer, Accountant or any

other person whose profession gives authority to the statement made by him.”

In addition to these requirements the prospectuses must also be dated and the
date stated therein is taken to be the date of publication of the prospectus.
However, there are two instances when a prospectus need not contain the
matter set out in Schedule III namely
1. When the prospectus is issued to existing members or
shareholders of the company;
2. When the prospectus relates to shares or debentures uniform
with previously issued shares or debentures.
LIABILITY IN RESPECT OF PROSPECTUS

If a prospectus contains untrue statements, the Companies Act prescribes both

penalty at Criminal Law and also Civil Liability for payment of damages. As
concerns Criminal Liability, under Section 46 where a prospectus includes any
untrue statement, any person who authorised the issue of the prospectus is
guilty of an offence and liable to imprisonment of a term not exceeding two
years or a fine not exceeding 10,000/- or both such a fine and imprisonment
unless he proves either that the statement was immaterial or that he had
reasonable grounds to believe and did up to the time of issue of the prospectus
that the statement was true.

A statement is deemed to be untrue if it is misleading in the form and context

in which it is included.
R. v. Kylsant (1932) 1 K.B. 442

In this case the company had sustained continuous loses for over 6 years from
1921 to 1927. The company issued a prospectus which in all material facts
was correct. It further specified that the dividends being paid were high. But
these dividends were being paid out of abnormal profits made after World
War 1. Therefore the Prospectus was misleading in its context.

CIVIL REMEDIES

There are two primary remedies for those who subscribe for shares in a
company as a result of a misrepresentation in a prospectus

(a) Damages;
(b) Rescission of any resulting contract.

DAMAGES

Section 45 provides for compensation to all persons who subscribe for any
shares or debentures on the faith of the Prospectus for loss or damage they
may have sustained by reason of untrue statements included therein. If the
statement is false to the knowledge of those who made it, then this amounts to
fraud and damages will be recoverable from all those who made the statement
intending it to be acted upon. Refer to the case of

Derry v. Peek (1889) 14 A.C. 337

Herein a company had power to construct tramways to be moved by animal

power and with the consent of the British Board of Trade by steam or
mechanical power. The Directors issued a prospectus stating that the company
had power to use steam or mechanical power.

In reliance on this misrepresentation, the Plaintiff bought shares in the

company. Subsequently the Board of Trade refused to give consent to the use
of Steam or mechanical power and as a result the company was wound up.
The Plaintiff brought an action for deceit alleging fraudulent
misrepresentation.
The Court held that the Defendants were not liable as they had made the
incorrect statement in the honest belief that it was true. Lord Herschell said
“the authorities establish two major propositions.
(i) In order to sustain an action of Deceit, there must be
proof of fraud and nothing short of that will
suffice;
(ii) Fraud is proved when it is shown that a false
representation has been made either;
(a) Knowingly or
(b) Without belief in its truth; or
(c) Recklessly not caring whether it be true
or false.
In order to succeed in an action for damages for fraud the plaintiff must show
that the Misrepresentation was made to him or that he was one of a class of
persons who were intended to act upon it. The ordinary purpose of a
prospectus is to invite members of the public to become allottees of shares in a
company. Once the shares have been allotted therefore the prospectus will
have served its purpose and thereafter it cannot be used as a ground for filing
an action for fraud in respect of shares bought at a later date from another
source. Reference made to the case of

Peek v. Gurney (1873) L.R. 377

The allotment of shares in the company began on July 24 th and was completed
on 28th July. In October, the Plaintiff bought shares on the stock exchange. He
subsequently found that the prospectus issued in July contained some untrue
statements and therefore brought an action in respect thereof.

The issue was could he sue?

The court held that the Plaintiff could not base his action on the prospectus
which was intended to be addressed only to the original company subscribers
to the company shares. The Directors of a company are not liable after the full
original allotment of shares for all the subsequent dealings which may take
place with regard to those shares on the stock exchange.

However, the rule in Peek v. Gurney will not apply where a prospectus is
intended to induce not only the original subscribers for the company shares
but also to influence the subsequent purchase of those shares

Andrews v. Mockford (1896) 1 QB 372

Here the Plaintiff alleged that the Defendant sent him a prospectus inviting
him to buy shares in the company which they knew would be a sham but the
Plaintiff did not subscribe for the shares. The prospectus eventually produced
a very scanty subscription and the Defendant caused a telegram to be
published in the local Newspaper to the effect that they had struck a vain of
Gold. And this they alleged had confirmed the statistics in the prospectus.

The Plaintiff immediately bought shares on this basis. The company was
wound up. The question arose, Had the Prospectus served its purpose.

The court held that the prospectus was intended to induce the Plaintiff both to
subscribe for shares initially and also to buy them in the Market thereafter.
The telegram was part of the prospectus.
Lord Justice Smith stated as follows
“there was proved against the Defendant a continuous fraud on their
part commencing with ascending of the prospectus to the Plaintiff and
culminating in the direct lie told in a telegram which was intended by the
defendant to operate upon the Plaintiff’s mind and minds of others and did so
operate to his prejudice and the advantage of the Defendant. In this case the
function of the prospectus was not exhausted and a false telegram was brought
in to play by the Defendant to reflect back upon and countenance the false
statements in the prospectus.”

The purchaser of shares induced to buy shares by the misstatement in the

prospectus has an action for damages in negligence. He has also an action for
negligent misstatement under the Hedley Byrne & Co. v. Heller & Partners
(1974) A.C. 465 All these actions are directed to the Directors personally.

RESCISSION

As against the company a person induced to buy shares by a misrepresentation

in the prospectus may rescind the contract. On buying shares ones contract is
with a company itself. The remedy is available only against the company. To
be entitled to this remedy, it is not necessary for the purchaser of the shares to
show that the statement was fraudulent or negligent. Even if the
misrepresentation was innocent, rescission lies. However, the rights to rescind
is subject to two limitations

1. The allotee loses the right to rescind if he shows any election

to affirm the contract; e.g. by attending and voting at the
company’s meetings or by accepting dividends or by
selling or attempting to sell the shares.

2. If the allotee does not rescind the contract before the company
is wound up, he loses the right to do so as from
the moment the winding up proceedings commenced.
The rationale is the protection of the other company’s
creditors.

DIRECTORS DUTIES

First, three preliminary observations

1. Whereas the Directors’ authority to bind the company

depends on their acting collectively as a Board, their
duties to the company are owed by each Director
individually. These duties are owed to the company and
the company alone and not to individual shareholders.
Percival v. Wright (1902) 2 Ch. 421
Certain Shareholders wrote to the Company’s Secretary asking if he knew
anyone willing to buy their shares. Negotiations took place and eventually the
company chairman and two other directors bought the Plaintiff Shares at £12
10s per share. The Plaintiff subsequently discovered that prior to and during
their own negotiations for sale, the Chairman and the Board of Directors had
been approached by 3rd Party with a view to the purchase of the entire
company’s assets at more than the price of 12 pounds 10 shillings per share.

The Plaintiff brought an action to set aside the share sales on the ground that
the directors owed them a duty to disclose the negotiations with the 3 rd Party.

It was held that the Directors were not agents for the individual shareholders
and did not owe them any duty to disclose. Therefore the sale was proper and
could not be set aside. However, if the Directors are authorised by the
members to negotiate on their behalf e.g. with a potential purchaser then the
Directors will be in a position of agents for such members and will owe them a
duty accordingly.

Allen v. Hyatt (1914) 30 T.L.R. 444

These duties except where expressly stipulated in the Companies Act are not
restricted to directors alone but apply equally to any officials of the company
who are authorised to act as agents of the company and in particular to those
acting in a managerial capacity. This is particularly so as regards fiduciary
duties.

70. (1) A private company, whether limited or unlimited,can convert itself into
a public company limited by shares if (but only if)-
(a) it passes a special resolution to that effect; companv
(b) the conditions specified in subsection (2) are satisfied; and (c) an
application for registration of the conversion is lodged with the Registrar in
accordance with section 74, together with the documents required by that
section.
(2) The conditions are-
(a) that the company has a share capital;
(b) that the requirements of section 7l are satisfied as regards its share capital;
(c) that the requirements of section 72 are satisfied as regards its net assets; (d)
if section 73 applies, that the requirements of that section are satisfied; (e) that
the company has not previously been converted itself into an unlimited
company;
(f) that the company has made such changes to itsname and to its articles as
are necessary inorder for it to become a public company; and (g) if the
company is unlimited, that it has alsomade such changes to its articles as are
necessary in order for it to become a company limited by shares.
7l (1) Requirements
DIRECTORS’ DUTIES PROPER

These fall into two broad categories

1. duties of care and skill in the conduct of the company’s

affairs; and
2. Fiduciary duties of loyalty and good faith.

DUTIES OF CARE & SKILL

Duties of care and skill were summed up by Romer J. in the case of

Re City Equitable Fire Insurance Co. (1925) Ch. D 447

Here the Directors of an insurance company left the management of the

company’s affairs almost entirely to the Managing Director. Owing to the
managing Director’s fraud, a large amount of the company’s funds
disappeared. Certain items appeared in the balance sheet under the heading
“loans at call or short notice and “Cash in Bank or in Hand”. The Directors did
not inquire how these items were made up. If they had inquired they would
have found that the loans were chiefly to the Managing Director himself and
to the Company’s General Manager and the cash at Bank or in hand included
some £13,000 in the hands of a firm of stockbrokers at which the managing
director was a partner.

On the company’s winding up, an investigation of its affairs disclosed a

shortage in its funds of more than £1.2 million incurred mainly due to the
delinquent fraud of the Managing Director for which he was convicted and
sentenced. The other Directors had all along acted in good faith and honestly
but the liquidator sought to make them liable for the damages.

It was held that the Directors were negligent. Justice Romer reduced the
Directors duties of care and skill as follows
“A Director need not exhibit in the performance of his duties a greater
degree of skill than may reasonably be expected from a person of his
knowledge and experience.”

This proposition prescribes the standard of skill to be exhibited in actions

undertaken by directors. The test is partly objective and also partly subjective
because a reasonable man would be expected to have the knowledge of a
director with his experience. Refer to

Re Brazilian Rubber & Plantations Estates Ltd. (1911) 1 Ch. 405

In this case a company had five directors and one of them confessed that he
was absolutely ignorant of business. A second one was 75 years old and very
deaf. A third one said he only agreed to become a director because he saw one
of his friends names on the list of directors. The other two were fairly able
businessmen. The directors caused a contract to be entered into between the
company and a certain syndicate for purchase by that company of some rubber
plantation in Brazil. The prospectus issued by the company contained false
statements about the acreage of the Plantation, the types of trees and so forth.
The information given therein was given to the Directors by a person who had
an original option to purchase that property. He had never been to Brazil and
the data was based on his own imagination. The Directors caused the company
to purchase the property. The question arose, were they negligent in so doing?

The court held that their conduct did not amount to gross negligence. Neville
J. had the following to say:
“It has been laid down that so long as they act honestly, Directors
cannot be made responsible in damages unless they are guilty of gross
negligence. A Director’s duty requires him to act with such care as is
reasonably expected from his having regard to his knowledge and
experience. He is not bound to bring any special qualifications to his
office. He may undertake the Management of a Rubber Company in
complete ignorance of anything connected with Rubber without
incurring responsibility for the mistakes which may result from such
ignorance. While if he is acquainted with the Rubber business, he must
give the company the advantage of his knowledge when transacting the
company’s business. He is not bound to take any definite part in the
conduct of the company’s business but insofar as he undertakes it he
must use reasonable care. Such reasonable care must be measured by
the care an ordinary man might be expected to take in the same
circumstances on his own behalf.”

3. A director is not bound to give continuous attention to the

affairs of his company. His duties are of an intermittent
nature to be performed at periodical Board Meetings and
at meetings of any committee of the Board on which he is
placed. He is not bound to attend all such meetings
though he ought to attend whenever in the circumstances
he is reasonably able to do so. Refer to the case of

Re Denham & Co. Ltd (1883) 2 Ch. D 752

Here a company was incorporated in 1873. Under the Articles 3 Directors

were appointed namely, Denham, Taylor and Crook. A fourth Director was
appointed later. The articles conferred on Denham supreme control of the
company’s affairs. He was given power to override decisions of the general
meeting and a Board of Directors. He was responsible for declaring dividends
and he managed the company’s affairs entirely alone and without consulting
the other directors. Between 1874 and 1877 a dividend of 15% per annum was
recommended and paid and the total amount paid was some £21,600. In 1880
the company went into liquidation and an investigation revealed that the
money paid as dividends had been paid not out of profits but out of capital.
Thereafter Denham became bankrupt, Taylor was dead and his estate was
worthless and the third man was a man of straw. The creditors directed their
claims against Crook who had property. Crooks argued that since the
formation of the company, he had never attended Board Meetings and
therefore could not be accountable for fraudulent statements in the Company’s
Balance Sheets. He attended one meeting in 1876 where he formally put forth
a Resolution for the payment of a dividend for that year.

The Court held that a Director is not bound to attend every Board meeting and
that he is not liable for misfeasance committed by his co-directors at Board
meetings at which he was never present.

Marquis Of Butes (1892) 2 Ch. 100

Here the Director never attended any Board meetings for 38 years. It was held
that he was not liable.

3. In respect of all duties which having regard to all exigencies of business and
articles of association may properly be left to some other official. A Director
in the absence of grounds for suspicion will not be liable in trusting that other
official to perform that other duty honestly.

Dovey v. Cory (1901) A.C. 477

A bank sustained heavy losses by advances made improperly to customers.

The irregular nature of advances was concealed by means of fraudulent
Balance Sheets which were the work of the General Manager and the
Chairman in assenting to the payment of dividends out of capital and those
advances on improper security were done on the advice of the general
manager and chairman.

The court held that the reliance placed by the co-director on the general
manager and chairman was reasonable. He was not negligent and therefore
was not liable for not having discovered the fraud as he was not in the absence
of circumstances of suspicion bound to examine entries in the Company’s
Books to see that the Balance Sheet was correct.

It may be said that the duties of care and skill appear to be negative duties.
What about fiduciary duties?

FIDUCIARY DUTIES

Basically a Director’s fiduciary duties are divisible into 4 sub categories

1. The Directors must always act bona fide in what they

consider and not what the courts may consider to be in
the best interest of the company. In this context, the term
company means the present and future members of the
company on the basis that the company will be continued
as a going concern thereby balancing long-term view
against short term interests of existing members.

2. The directors must always exercise their powers for the

particular purpose for which they were conferred and not
for extraneous purposes even if the latter are considered
to be in the best interests of the company. For example
the Directors are invariably empowered to issue capital
and this power should be exercised for only raising more
funds when the company requires it. Hence it will be a
breach of the Directors’ duties to issue the company
 shares for the purpose of entrenching themselves in the
control of the company’s affairs. Refer to the case of
Punt v. Symons (1903) 2 Ch. 506 in this case the
directors issued shares with the object of creating a
sufficient majority to enable them to pass a special
resolution depriving the other shareholders of some
special rights conferred upon them by the company’s
articles. It was held that a power of a kind exercised by
the Directors in this case was a power which must be
exercised for the benefit of the company. Primarily this
power is given to them for the purpose of enabling them
to raise capital for the purposes of the company.
Therefore a limited issue of shares to persons who are
obviously meant and intended to secure the necessary
statutory majority in a particular interest was not a fair
and bona fide exercise of the power.

Piercy v. Mills & Co. (1920) 1 Ch. 78

A company had two directors. They fell out of favour with the
majority of the shareholders who were therefore threatened with the
election of 3 other directors to the Board. The directors issued
shares with the object of creating a sufficient majority to enable
them to resist the election of the 3 additional directors whose
election would have put the two directors in the minority on the
Board.

The Court held that the Directors were not entitled to use their
powers of issuing shares merely for the purpose of maintaining their
control or the control of themselves and their friends over the affairs
of the company or even merely for the purpose of defeating the
wishes of the existing majority of shareholders. The Plaintiff and his
friends held the majority of shares in the company and as long as that
majority remained, they were entitled to have their wishes prevail in
accordance with a company’s regulations. Therefore it was not open
to the directors for the purpose of converting a minority into a
majority and purely for the purpose of defeating the wishes of the
existing majority to issue the shares in dispute.

In those circumstances where the directors have breached their duty

to exercise their powers for the proper purpose, the shareholders
may forgive them by ratifying their action

Hogg v. Cramphorn Ltd. (1967) Ch. 254

In this case the company had two classes of shares, ordinary and
preference shares. Each share carried 1 vote. The power to issue the
company shares was vested in the Directors. They learnt that a
takeover bid was to be made to the Shareholders. In the Bona fide
belief that the acquisition of control by the prospective take over
bidder will not be the interest of the company or its staff. The
Directors decided to forestall this move. They therefore attached 10
votes to each of the unissued preference shares and allotted to a trust
 which was controlled by the Chairman of the Board of Directors and
one of his partners in the company’s audit department and an
employee of the company. To enable the trustees to pay for the
shares, the directors provided them with an interest free loan out of
the company’s reserve fund.

An action challenged by the Plaintiff who was an associate of the

prospective take-over bidder and registered holder of 50 ordinary
shares in the company was started. After finding that it was
improper for the directors to attach such special voting rights, the
Court stood over the action in order to enable a general meeting to
be held and to debate whether or not to ratify the Director’s actions.
The general meeting ratified the action.

Bamford v. Bamford (1969) 1 All ER. 969

There were similar facts as in the former case but a meeting was
held before proceeding to court and that general meeting ratified the
Director’s action. The question also arose in this case, could a
decision of the general meeting cure the irregularity?

The court held if the allotment was made in bad faith, it was
voidable at the instance of the company because it was a wrong done
to the company and that being so, the company which has the rights
to recall the allotment has also the right to approve it and forgive the
breach of duty.

3. They must not fetter their displeasure to act for the company
for example, the directors cannot contract either among
themselves or with third parties as to how they will vote
at future Board meetings. However, where they have
entered into a contract on behalf of the company they
may validly agree to take such further action at Board
meetings as maybe necessary to carry out such a contract.

LAW OF BUSINESS ASSOCIATIONS Lecture 7

FIDUCIARIES CONTINUED

4. As fiduciaries the Directors must not place themselves

without consent of the company in a position in which
there is a conflict between their duties to the company
and their personal interests. Good faith must not only be
done but it must also manifestly be seen to be done. The
law will not allow the fiduciary to place himself in a
position where he will have his judgments to be biased
and then argue that he was not biased. This principle
applies particularly when a Director enters into a contract
with his company or where he makes any secret profit by
being a Director. As far as contracts are concerned a
contract entered into by the Board on behalf of the
 company and another Director is governed by the
equitable principle which ordains that a fiduciary
relationship between the Director and his company
vitiates such contracts. Such contract is therefore
voidable at the instance of the company. Reference may
be made to the case of

Aberdeen Railway v. Blaikie (1854) 1 Macc. 461

The Defendant company entered into a contract to purchase a quantity of

chairs from the Plaintiff partnership. At the time that the contract was entered
into a Director of the company was also one of the partners. The issue was,
was the company entitled to avoid the contract? The court held that the
company was entitled to avoid the contract. The Judge said that as a body
corporate can only act by agents and it is the duty of those agents so to act as
best to promote the interests of the corporation whose affairs they are
conducting. Such an agent has a duty of a fiduciary nature to discharge
towards his principal. It is a rule of universal application that no one having
such duties to discharge shall be allowed to enter into or can have a personal
interest conflicting or which may possibly conflict with the interests of those
whom he is bound to protect. This principle is strictly applied no question is
entertained as to the fairness or unfairness of the contract so entered into.
However, it is possible for such contract to be given effect by the articles of
association. At their narrowest the Articles might provide that a Director who
is interested in a Company contract should disclose his interests and he will
not be counted to decide that a quorum is raised and his votes will also not be
counted on the issue. At their widest the articles might allow the director to be
counted at Board meeting.

In order to create a balance between these two extremes and ensure that a
minimum standard prevails Section 200 was incorporated into the Companies
Act. Under this Section it is the duty of a director who is interested in any
contract or proposed contract to disclose the nature and extent of his interest to
the Board of Directors when the contract comes up for discussion. Failure to
do so renders the defaulting director liable to a fine not exceeding 2000
shillings. In addition the failure also brings in the equitable doctrine whereby
the contract becomes voidable at the option of the company and any profit
made by the director is recoverable by the company.

The shortcoming of the Section is that the Director has to disclose to the Board
of Directors and not to the general meeting. It is not sufficient for a Director to
say that he is interested. He must specify the nature and extent of his interests.
If the company’s articles take the form of Article 84 of Table ‘A’ then a
Director who is so interested is required to abstain from voting at the Board
meeting and his vote will not be taken in determining whether or not there is a
quorum on the Board. Once the Director has complied with Section 200 and
Article 84 then he can escape liability.

In respect of all other profits which a Director may make are out of his
position as a Director the equitable principle which requires the Directors to
account for any such profits is vigorously enforced. This is because the Courts
have equated Directors to trustees and their duties have also been equated to
those of Trustees. The question is, are they really trustees?
Selanger United Rubber Estates v. Craddock (1968) 1 All E.R. 567

Re Forest of Dean Coal Mining Company (1879) 10 Ch. D 450

In the latter case, the directors of a company were seen to be trustees only in
respect of the company’s funds or property which was either in their hands or
which came under their control. But this does not necessarily make directors
trustees. There are two basic differences between Directors as Trustees and
Ordinary Trustees.
(a) The function of ordinary trustee is to preserve the
Trust Property but the role of a director is to
explore possible channels of investment for the
benefit of the company and these necessitates
some elements of having to take a risk even at the
expense of the company’s property.
(b) Whereas trust property is vested in the Trustees, a
company’s property is held by the company itself
and is not vested in the trust.

Nevertheless if the directors make any secret profits out of their positions then
the effect is identical to that of ordinary trustees. They must account for all
such profits and refund the company.

Regal Hastings v. Gulliver (1942) 1 All E.R. 378

Herein the company owned a cinema and the directors decided to acquire two
other cinemas with a view to the sale of the entire undertaking as a going
concern. Therefore they formed a subsidiary company to invite the capital of
5000 pounds divided into 5000 shares of 1 pound each. The owners of the two
cinemas offered the directors a lease but required personal guarantees from the
Directors for the payment of rent unless the capital of the subsidiary company
was fully paid up. The directors did not wish to give personal guarantees. They
made arrangements whereby the holding company subscribed for 2000 shares
and the remaining shares were taken up by the directors and their friends. The
holding company was unable to subscribe for more than 2000 shares.
Eventually the company’s undertakings were sold by selling all the shares in
the company and subsidiary and on each share the Directors made a profit of
slightly more than two pounds. After ownership had changed the new
shareholders brought an action against the directors for the recovery of profits
made by them during the sale.

The court held that the company as it was then constituted was entitled to
recover the profits made by the Directors. Lord Macmillan had the following
to say:

“The directors will be liable to account if it can be shown that what they
did is so related to the affairs of the company that it can properly be said to
have been done in the course of their management and in utilisation of the
opportunities and special knowledge and what they did resulted in a profit to
themselves.”
Phipps v. Boardman (1966) 3 All E.R. 721

In this case Boardman was a solicitor to the trust of the Phipps family. The
trust held some shares in the company. Boardman and his colleagues were not
satisfied with the company’s accounts and therefore decided to attend the
company’s general meeting as representatives of the Trust. At the meeting
they received information pertaining to the company’s assets and their value.
Upon receipt of the information, they decided to buy shares in the company
with a view to acquiring the controlling interest. Their takeover bid was
successful and they acquired control. Owing to the fact that Boardman was a
man of extraordinary ability, the company made progress and the profits
realised by Boardman and his friends on the one hand and the trusts on the
other were quite extensive. One of the beneficiaries of the Trust brought an
action to recover the profits which were realised by Boardman and his friends.

The court held that in acquiring the shares in the company, Boardman and his
friends made use of information obtained on behalf of the trust and since it
was the use of that information which prompted them to acquire the shares,
then the shares were also acquired on behalf of the trust and thus the solicitors
became constructive trustees in respect of those shares and therefore liable to
account for the profits derived therefrom to the trust.

Peso Silver mines v. Cropper (1966) 58 D.L.R. 1

The Defendant was the company’s Managing Director. The Board of Directors
was approached by a prospector who offered to sell his claims to the company.
The company’s consulting geologists advised that it was in order for the
company to acquire the claims. The directors decided that it was inadvisable
for the company to acquire the same mainly because of its strained financial
resources. Subsequently at the suggestion of the geologists, some of the
Directors agreed to purchase the claims at the price at which they had been
offered to the company. Thereafter they formed a company which took over
the claims and a second company for developing the resources. After the
control of Peso Silver Mines had changed the new directors brought an action
against the Defendant to account to the company for the shares held by them in
the new companies. But here the court held that since the company could not
have taken over the claims, there was no conflict of interest between the
Directors and the Company and therefore the Defendant was not liable to
account for the shares.

Directors may make use of opportunities originally offered to the company

and thereby make profits provided that some 4 conditions are satisfied namely
1. The opportunity must have been rejected by the company; 2.
If the directors acted in connection with that rejection, they must
have acted bona fide in the best interests of the
company.
3. The information about that opportunity should not have been
given to them confidentially on behalf of the company.
4. Their subsequent use of that information must not relate to
them as directors but as any other ordinary person.

Industrial Development Consultants v. Cooley (1972) 2 All E.R. 162

The Defendant who was an architect was appointed the company’s Managing
Director. The company’s business was to offer design and construction
services to industrial enterprises. One of the defendant’s duties was to obtain
new business for the company particularly from the gas companies where he
had worked before joining the Plaintiff. While the Defendant was still so
employed by the Plaintiff a representative of one gas
company came to seek his advice on some personal matters. In the course of
their conversation the Defendant learnt that the gas company in question had
various projects all requiring design and construction services of the type
offered by the Plaintiff. Upon acquiring this information and without
disclosing it to the company, the Defendant feigned illness as a result of which
he was relieved by the company from his duties. Thereafter, he joined the gas
company and got the contract to do the work. Two years previously, the
Plaintiff had unsuccessfully tried to obtain that work. After the Defendant
acquiring the contract, the company sued him alleging that he obtained the
information as a fiduciary of the company and he should therefore account to
the company for all the remuneration fees and all dues obtained.

The court held that until the Defendant left the Plaintiff, he stood in a
fiduciary relationship to them and by failing to disclose the information to the
company, his conduct was such as to put his personal interests as a potential
contracting party to the gas company in conflict with the existing and
continuing duty as the Plaintiff’s Managing Director.

Roskill J.
“It is an overriding principle of equity that a man must not be allowed
to put himself in a position where his fiduciary duty and interest
conflict. It was the defendant’s duty to disclose to the plaintiff the
information he had obtained from the Gas Board and he had to account
to them for the profits he made and will continue to make as a result of
allowing his interests and duty to conflict. It makes no difference that a
profit is one which the company itself could not have obtained. The
question being not whether the company could have acquired it but
whether the defendant acquired it while acting for the company.”

CONTROLLING SHARE HOLDERS

By controlling share holders is meant those who hold the majority of the
voting rights in the company. Such share holders can always ensure control of
the company’s business by virtue of their voting power to ensure that the
controlling shareholders do not use their voting power for exclusively selfish
ends, the Law requires that in exercise of their voting power, these
shareholders must not defraud a minority. For example by endeavouring
directly or indirectly to appropriate to themselves any money property or
advantage which either belong to the company or in which the minority
shareholders are entitled to participate.

Brown v. British Abrasive Wheel Co. (1919) 1 Ch. 290

Menier v. Hoopers Telegraphy Works (1874) L.R. Ch. A 350

In the latter case the company brought action against its former Managing
Director for a declaration that the concessions for laying down a telegraph
cable from Portugal to Brazil was held by that former Director as a trustee for
the company. While this action was still pending, the Defendants who
were the majority shareholders in the company approached that former
Managing Director with a view to striking a compromise. It was agreed
between the parties that if that director surrendered the concessions to the
Defendants then the Defendants would use their voting power to ensure that
the action was discontinued. At a subsequent general meeting of the company,
by virtue of the defendant’s voting power, a resolution was passed that the
company should be wound up.

The court said that the resolution was invalid since the defendants had used
their voting power in such a way as to appropriate to themselves the
concessions which if the earlier action had succeeded should have belonged to
the whole body of shareholders and not merely to the majority. Lord Justice
Mellish stated as follows:
“although the shareholders of the company may vote as they please and
for the purpose of their own interest, yet the majority of the shareholders
cannot sell the assets of the company itself and give the consideration but must
allow the minority to have their share of any consideration which may come to
them.”

Cook v. Deeks (1916) 1 A.C. 554

The Toronto Construction Company carried on business as Railway

Construction contractors. The Shares in the company were held equally among
Cook, G S Deeks and G M Deeks. And another party called Hinds. The
company carried out several large construction contracts for the Canadian
Pacific Railway. When the two Deeks and Hinds learnt that a new contract
was coming up, they obtained this contract in their own names to the exclusion
of the company and then formed a new company to carry out the work. At a
general meeting of the shareholders of Toronto Construction company a
resolution was passed owing to the two powers of Deeks and Mr. Hinds
declaring that the company was not interested in the new contract of the
Canadian Pacific Railway. Cook brought an action and the court held: that the
benefit of the contract belonged properly to the Company and therefore the
Directors could not validly use their voting power as shareholders to vest it in
themselves.

ENFORCEMENT OF DIRECTORS DUTIES

As the company is a distinct entity from the members and since directors owed
their duties to the company and not to individual shareholders, in the event of
breach of those duties any action for remedies should be brought by the
company itself and not by any individual shareholder. The company and the
company alone is the proper Plaintiff. This is generally referred to as the rule
in Foss V. Harbottle (1843) 2 Hare 461

In this case the Directors who were also the company’s promoters sold the
company’s property at an undisclosed profit. Two shareholders brought action
against them alleging that in so doing, that the directors had breached their
duties to the company. It was held that if there was any breach of duty, it was
a breach of duty owed to the company and therefore the Plaintiffs had no locus
standi for the company was the proper plaintiff. This rule has two
practical advantages namely:
 1. Insistence on an action by the company avoids multiplicity of
actions;
2. If the irregularity complained of is one which could have been
effectively ratified by the company in general
meeting, then it is pointless to commence any litigation
except with the consent of the general meeting.

However there are four exceptions to this rule in which an individual member
may bring action against the directors namely:
(a) Where it is complained that the company
through the directors is acting or proposing
to act ultra vires;
(b) Where the act complained of even though not
ultra vires, the company can effectively be
done by a special resolution;
(c) Where it is alleged that the personal rights of
the Plaintiff have been infringed and/or are
about to be infringed;
(d) Where those who control the company are
perpetuating the fraud on the minority;
The problem likely to arise is that if the directors themselves are also
controlling shareholders, the rule in Foss v. Harbottle if strictly applied in
exercise of their voting powers, the Directors may easily block any attempt to
bring an action against themselves. In such cases a shareholder will be allowed
to bring an action in his own name against the directors even if the wrong
complained of has been done to the company. Such an action is called a
derivative action.

In order to be entitled to commence a Derivative Action, it must be shown that

1. The wrong complained of was such as to involve a fraud on

the minority which is not ratifiable by the company in
general meeting;
2. It must be shown that the wrong doers hold the controlling
interests
3. The company must be joined as a nominal defendant;
4. The action must be brought in a representative capacity on
behalf of the plaintiff and all other shareholders except
the Defendant.

The question is are these exceptions effective?

There are situations where the rule does not apply.

Another remedy against directors for breach is found in Section 324 of the
statute which provides as follows:
“If in the course of the winding up of the company it appears that any
person who has taken part in the formation or promotion of the company or
any past or present director has misapplied or retained any money or property
of the company, or been guilty of any breach of trust in relation to the
company on the application of the liquidator, a creditor or member or a court
may compel such person to restore the money or property to the company or to
pay damages instead.”

This section is designed to deal with actual breaches of trust which come to
light in the winding up proceedings or during the winding up proceedings but
winding up itself may be used as a means of ending a course of oppression by
those formally in control. Among the grounds for the winding up is one which
is particularly appropriate for such circumstances.

Under Section 219 (f) of the Companies Act the court may order a company to
be wound up if it is of the opinion that it is “just unequitable” the courts have
so ordered when satisfied that it is essential to protect the members or any of
them from oppression in particular they have done so when the conduct of
those in control suggests that they are trying to make intolerable the position
of the minority so as to be able to acquire the shares held by the minority on
terms favourable only to the majority. But a member cannot petition under this
section if the company is insolvent. If the company is solvent to wind it up,
contrary to the majority wishes will only be granted where a very strong case
against the majority is established.

Winding up a company merely to end oppression appears rather awkward as it

may not be of any benefit to the petitioners themselves. Owing to these
shortcomings, Section 211 was incorporated into the Companies Act as an
alternative remedy for the minority of the shareholders. Section 211 provides
that any member who complains that the affairs of a company are being
conducted in a manner oppressive to some part of the members including
himself may petition the court which if satisfied that the facts will justify a
winding up order but that this will unduly prejudice that part of the members,
may make such order as it thinks fit. Such an order may regulate the conduct
of the company’s affairs in the future or may order the purchase of member
shares by others or by the Company itself. This remedy is available only to the
members. An oppressed director or creditor cannot obtain any remedy under
Section 211 of the Companies Act for this is expressly restricted to oppression
of the members even if a director or creditor also happens to be a member.

Elder V. Elder & Watson (1952) AC 49

The two Plaintiffs were the company director and secretary and factory
manager respectfully. As this was a small family concern, serious differences
arose between the plaintiffs and the beneficial owners of the undertaking.
Consequently the Plaintiff brought action under Section 211 alleging
oppression. It was held that if there was any oppression of the Plaintiffs, it
related to them as directors and the remedy under Section 211 is only available
to members. The suit was dismissed.
WHAT IS OPPRESSION

This term has been defined to mean something burdensome, harsh or

wrongful.

Scottish Cooperative Wholesale Society v. Meyer (1959) AC 324

Here the Society wished to enter into the retail business. For this purpose a
subsidiary company was formed in which the two Respondents and 3
Nominees of the Society were the directors. The society had majority
shareholders and the Respondents were the minority. The Company required 3
things namely;
1. Sources of supplies of raw material;
2. A licence from a regulatory organisation called cotton control
3. Weaving Mills.

The Respondents provided the first two but weaving Mills belonged to the
society. For several years, the business prospered because of mainly the
knowhow provided by the Respondent. The company paid large dividends and
accumulated substantial results. Due to the prosperity, the society decided to
acquire more shares and through its nominee directors offered to buy some of
the shares of the Respondent at their nominal value which was one pound per
share but their worth was actually 6 pounds per share. When the Respondents
declined to sell their shares to the society, the society threatened to cause the
liquidation of the company. About 5 years later, Cotton control was abolished
which meant that the society would obtain the raw materials and weave cloth
without a licence. It accordingly started to do the same and also started
starving the subsidiary by refusing to manufacture for it except for an
economic crisis. As all the other Mills were fully occupied, the subsidiary
company was being starved to death and when it was nearly dead the
Respondent brought the petition claiming that the affairs of the company were
being conducted in an oppressive manner.

It was held that by subordinating the interests of the company to those of the
society, the nominee directors of the society had thereby conducted the affairs
of the company in a manner oppressive to the other shareholders. The fact
that they were perhaps guilty of inaction was irrelevant. The affairs of the
company can be conducted oppressively by the Directors doing nothing to
protect its interests when they ought to do so.

Re Hammer(1959) 1 WL.R. 6

In this case Mr. Hammer senior was a Philatelist (stamp collector) dealer and
incorporated business in 1947 forming a company with two types of ordinary
shares class A shares which were entitled to a residue of profit and Class B
Shares carrying all the votes. He gave out the shares to his two sons and at the
time of the petition each son held 4000 Class A shares and the father owned
1000 shares. Of the Class B Shares, the father and his wife held nearly 800 to
the 100 held by each son. Under the Company’s articles
of association, the father and two sons were appointed directors for life and
the father was further appointed chairman of the Board with a casting vote.
The father assumed powers he did not possess ignored decisions of the Board
and even in court, during the hearing asserted that he had full power to do as
he pleased while he had voting control. He dismissed employees using his
casting vote to co-opt self directors, he prohibited board meetings, engaged
detectives to watch the staff and secured payment of his wife’s expenses out of
the company’s funds. He negotiated sales and vetoed leases all contrary to the
decisions and wishes of the other directors.

The sons filed an action claiming that the father had run the affairs of the
company in a manner oppressive to them. The father was 88 years.
The court held that by assuming powers which he did not possess and
exercising them against the wishes of those who had the major beneficial
interests, Mr. Hammer senior had conducted the company’s affairs in an
oppressive manner.

These two cases are among the few where an application under Section 211
has succeeded. This is because section 211 has been subjected to a very
restrictive meaning. To succeed under Section 211, one must establish a case
of oppression.

There is no clear definition of the term and therefore it is not easy to tell when
a company’s affairs are being conducted oppressively. For example in the case
of Re Five Minute Car Wash Ltd (1966) 1 W.L.R. 745

The petitioner alleged oppression on grounds that the company’s Managing

Director was extremely incompetent. The court ruled that even though the
allegation suggested that the Managing Director was unwise inefficient and
careless in the performance of his duties, this did not mean that he had at any
time acted unscrupulously, unfairly or with any lack of probity towards the
petitioner or to other members of the company. Therefore his conduct was not
oppressive.
1. The conduct which is complained of must relate to the affairs
of the company and must also relate to the
petitioner in his capacity as a member. Personal
representatives cannot petition nor can trustees in
bankruptcy petition.

2. the wording of the section suggests that there must be a

continuous cause of conduct and not merely isolated acts
of impropriety.

3. The conduct must be such as to make it just and equitable to

wind up the company. In other words, the members must
be entitled to a winding up order.

Re Bella Dor Sick Ltd (1965) 1 All E.R. 667

In a small family concern, there developed two factions among shareholders.
Owing to these personal differences the petitioner filed a petition under
Section 211 complaining inter alia that the distribution of profits had not been
fairly made. That he had been excluded from the Board of Directors and that
the affairs of the company were being conducted irregularly. In particular, he
alleged that the company had failed to repay its debts to another company in
which he had some interests.

It was held that the petitioner had not made a case of oppression and the
petition must be dismissed.

Three reasons were given

(a) This petition had been brought for the collateral
purpose of enforcing repayment of debts to some
third party;
 (b) The conduct complained of and particularly the
removal of the petitioner from the Board related to
him as a director not as a member;
(c) That the circumstances were not such as to justify a
winding up order at the instance of the petitioner
because the company was insolvent and therefore
the shareholders had no tangible interests.

It is an unfortunate mistake to link up Section 211 with winding up. The

courts are construing the Section very restrictively. Section 211 has therefore
failed to live up to expectations. It is no real remedy.

LAW OF BUSINESS ASSOCIATIONS Lecture 8

RAISING AND MAINTENANCE OF CAPITAL

The basis of the whole concept or a company’s capital was explained by Jessel
M.R. in the Flitcrafts Case 1882 21 Ch. D 519 in this case for several years the
directors had been in the habit of laying before the meeting of shareholders
reports and balance sheets which were substantially untrue inasmuch as they
included among other assets as good debts a number of debts which they knew
to be bad. They thus made it appear that the business had produced profits
whereas in fact it had produced none. Acting on these reports, the meetings
declared dividends which the directors paid. It was held here that since the
directors knew that the business had not made any profit, they were liable to
refund to the company the monies paid by way of dividends.

Jessel M.R said as follows “when a person advances money to a company, his
debtor is that artificial entity called the corporation which has no property
except the assets of the business. The creditor therefore gives credit to that
capital or those assets. He gives credit to the company on the faith of the
implied representation that the capital shall be applied only for
the purposes of the business and he has therefore a right to say that the
corporation shall keep its capital and shall not return it to the shareholders.”

The capital fund is therefore seen as a substitute for unlimited liability of the
members. Courts have developed 3 basic principles for ensuring that the
company’s represented capital is actually what it is and for the distribution of
that capital.
1. Once the value of the company’s shares has been stated it
cannot subsequently be changed the problem which
arises in this respect is that shares may be issued for non
monetary consideration. For instance for services or
property in such cases the company’s valuation of the
consideration is generally accepted as conclusive. If the
property has been over valued, provided the valuation has
been arrived at bona fide, the courts will not question the
adequacy of the consideration but if it appears on the face
of the transaction that the value of the property is less
than that of the shares, then the court will set aside that
transaction. For this reason the shares in a company must
be given a definite value. The law tries to ensure that the
 company initially receives assets at least equivalent to the
nominal value of the paper capital. Refer to Section 5 of
the Companies Act. Unfortunately if in the insistence
that shares do have a definite fixed value is not an
adequate safeguard because there is no legal minimum as
to what the nominal value of the shares should be.

2. The Rule in Trevor v. Whitworth [1887] 12 A.C 449 Under

this rule a company is not allowed to purchase its own
shares even if there is an express power to do so in its
Memorandum of Association as this would amount in a
reduction of its capital. This principle is now
supplemented by Section 56 of the Companies Act which
prohibits any direct or indirect provision of any form of
assistance in the purchase of the company shares.
However, there are 3 exceptions to this broad
prohibition.

a. where the lending of money is part of the

ordinary business of the company;
b. Where the company sets a trust fund for
enabling the trustees to purchase or
subscribe for the company shares to be held
or for the benefit of the employees of the
company until where the company gives a
loan to its employee other than directors to
enable them to purchase shares in the
company.

3. Payment of Dividends: In order to ensure that the company’s capital

is not refunded to the shareholders under the guise of dividends, the
basic principle is that dividends should not be paid otherwise than out of
profits. Refer to Article 116 of Table A of the Companies Act. The legal
problem in this respect has been the lack of an adequate definition of
what constitutes profits. To avoid the problem of definition the courts
have formulated certain rules for the payment of dividends. These are as
follows
(i) Before a company can declare dividends, it must be solvent.
Dividends will not be paid if this will result in the company’s
inability to pay its debts as and when they fall due;

(ii) If the value of the company’s fixed assets has fallen

thereby causing a loss in the value of those assets,
the company does not need to make good that loss
before treating revenue profits as available for
dividends. It is not legally essential to make
provision for depreciation in the fixed assets.
However Losses of circulating assets in the
current accounting period must be made good
before a dividend can be declared. The realised
profits on the sale of fixed assets may be treated as
 profit available for distribution as a dividend.
Unrealised profits on evaluation of the company’s
assets may also be distributed by way of dividends.
Refer to Dimbula Valley (Ceylon) Tea Co. V.
Laurie [1961] Ch. D 353 Losses on circulating
assets made in previous accounting periods need
not be made good. The dividend can be declared
provided that there is a profit on the current year’s
trading. Each accounting period is treated in
isolation and once a loss has been sustained in one
trading year, then it need not be made good from
the profits over subsequent trading periods.
Undistributed profits of past years still remain
profit which can be distributed in future years until
they are capitalised by using them to pay a bonus
issue.

CORPORATE SECURITIES

Basically securities is a collective description of the various forms of

investment which one can buy for sale at the stock exchange. A company can
issue two primary classes of securities. These are shares and debentures. The
basic distinction between a share and a debenture is that a share constitutes the
holder. A member of the company whereas a debenture holder is a creditor of
a company and not a member of it.

The best definition of the term share is that given by Farwell J. in the case of
Borlands Trustee v. Steel [1901] Ch. D 279 stated “ a share is the interest of
a member in a company measured by a sum of money for the purpose of
liability in the first place and of interest in the second and also consisting of a
series of mutual covenants entered into by all the shareholders among
themselves in accordance with Section 22 of the Companies Act.”

The contract contained in the Articles of Association is one of the original

incidents of a share. A share is therefore not a sum of money but an abstract
interest measured by a sum of money and made up of various rights contained
in a contract of membership.

In contrast a debenture means a document which either creates or

acknowledges a debt and any document which fulfils either of these conditions
is called a debenture. A debenture may take any of 3 forms

1. It may take the form of a single acknowledgment under seal

or the debts;
2. It may take the form of an instrument acknowledging the debt
and charging the company’s property with
repayment; or
3. It may take the form of an instrument acknowledging the debt
charging the company’s property with repayment
 and further restricting the company from creating any
other charge in priority over the charge created by the
debenture.

The indebtedness acknowledged by a debenture is normally but not

necessarily secured by charge over the company’s property. Such charge could
either be a specific charge or a floating charge. Both were defined by Lord
Mcnaghten in the case of Illingsworth v. Houlsworth [1904] A.C. 355 AT 358
He stated
“ a specific charge is one that without more fastens on
ascertained and definite property or property capable of being ascertained and
defined. A floating charge on the other hand is ambulatory and shifting in its
nature, hovering over and so to speak floating with the property which it is
intended to affect until some event occurs or some act is done which causes it
to settle and fasten on the subject of the charge within its reach or grasp.”

A floating charge has 3 basic characteristics.

1. It must be a charge on a class of a company’s assets both

present and future;
2. That class must be one which in the ordinary cause of business
of the company keeps changing from time to
time;
3. By the charge it must be contemplated that until future step is
taken by or on behalf of those interested, the company
may carry on its business in the ordinary way as far as
concerns the particular class of the assets charged.
CRYSTALISATION

A floating charge will crystallise under the following

(a) Where the company defaults in the payment of any portion

of the principal or interest thereon, when such portion or
interest is due and payable. In that event however, the
debenture holders rights will not crystallise
automatically. After the expiry of the agreed period for
repayment, the debenture still remained a floating
security until the holders take some step to enforce that
security and thereby prevent the company from dealing
with its property;
(b) Upon the appointment of a receiver in the course of a
company’s winding up;
(c) Upon commencement of recovery proceedings against the
company;
(d) If an event occurs upon which by the terms for the debenture
the lender’s security is to attach specifically to
the company’s assets.

Section 96 of the Companies Act requires every Charge created by a company

and conferring security on the company’s property to be registered within 42
days. Under this Section what must be registered are the particulars of the
charge and the instrument creating it. Failure to register renders the charge
void as against the liquidator or any creditor of the company.

Under Section 99 of the Companies Act the registrar is under a duty to issue a
certificate of the registration of a charge and once issued, that certificate is
conclusive evidence that all the requirements as to registration have been
complied with.

Re C.L. Nye [1970] 3 AER 1061

National Provincial & Union Bank V. Charmley [1824] 1 KB 431

SHARES

In a company with a share capital it is obvious that the company must issue
some shares and the initial presumption of the law is that all the shares so
issued confer equal rights and impose equal liabilities. Normally a
shareholder’s right in a company will fall under 3 heads.
1. Payment of dividends;
2. Refund of Capital on winding up;
3. Attendance and voting at company’s general meetings.
Unless there is indication to the contract all the shares will confer the same
rights under those heads. In practice companies issue shares which confer on
the holders some preference over the others in respect of either payment of
dividends or capital or both. This is the method by which classes of shares are
created i.e. by giving some of the shareholders preference over others.

In practice therefore most companies with classes of shares will have ordinary
shares and preference shares. The preference shares being those that enjoy
some preference with reference to voting rights, refund of capital or payment
of dividends.

There are certain rules that courts use to interpret or construe on shares.

(a) Basically all shares rank equally and therefore if

some shares are to have any priority over the
others, there must be provision to this effect in the
regulations under which these shares were issued.
Refer to the case of Birch V. Cropper (1889) 14
AC 525 here the company was in voluntary
winding up. The company discharged all its
liabilities and some money remained for
distribution to the members. The Articles being
silent on the issue, the question was on what
principle should the surplus be distributed among
the preference and ordinary shareholders? The
ordinary shareholders argued that they were
entitled to all the surplus. Alternatively the
division ought to be made according to the capital
subscribed and not the amount paid on the shares.
It was held that once the capital has been returned
 to the shareholders, they thereafter become equal
and therefore the distribution of the surplus assets
should be made equally between the ordinary and
preference shareholders.

(b) However if the shares are expressly divided into

separate classes thereby rebutting the presumed
equality, it is a question of construction in each
case what the rights of each class are. Hence if
nothing is expressly said about the rights of one
class in respect of either dividends, return of
capital or attendance and voting at meetings, then
that class has the same rights in that respect as the
other shareholders. The fact that a preference is
given in respect of any of these matters does not
imply that any right to preference in some other
respect is given e.g. a preference as to dividends
will not apply a preference as to capital i.e. the
shares enjoy only such preference as may be
expressly conferred upon them.
(c) If however, any rights in respect of any of these
matters are expressly stated, the statement is
presumed to be exhaustive so far as that matter is
concerned. For instance the preference dividend is
presumed to be non-participating in regard to other
dividends. Refer to Re Isle of Thanet Electricity
Supply Co. (1950) Ch. 1951 where Justice Wynn
Parry stated “the effect of the authorities as now in
force is to establish two principles. First that in
construing an article which deals with the rights to
share all profits, that is dividend rights and rights
to shares in the company’s property in liquidation,
the same principle is applicable and secondly that
principle is that where the articles sets out the
rights attached to a class of shares to participate in
profits while the company is a going concern or to
share in the property of a company in liquidation,
prima facie the rights so set out are in each case
exhaustive.”

(d) Where a preferential dividend is provided for it is

presumed to be cumulative for instance if no
preferential dividend is declared the arrears of
dividend are carried forward and must be paid
before any dividend is paid on the other shares.
But these presumption may be rebutted by words
tending to show that the shares are not intended to
be cumulative or words indicating that the
preferential dividend is only to be paid out of the
profits of each year i.e. if the company sustains
any financial loss during any year, there will be no
dividend for that year. Even then preferential
 dividends are payable only if and when declared.
Therefore arrears of cumulative dividends are not
payable on winding up unless the dividend has
been declared. Thix presumption could be
rebutted by any indication to the contrary.

WINDING UP

Section 212 of the Companies Act provides that a company may be wound up
as follows
1. Voluntarily;
2. Order of the Court;
3. By supervision of the Court.

The circumstances under which the company may be voluntarily wound up

are outlined in Section 217 of the Companies Act. Here a company may be
wound up

a. When the period fixed for its duration by the

articles expires or the event occurs on the
occurrence of which the articles provide that
the company is to be dissolved and thus a
company passes a resolution in general
meeting that it should be wound up
voluntarily;
b. If it resolves by special resolution that it should
be wound up voluntarily;
c. If the company resolves by special resolution
that it cannot by reason of its liabilities
continue its business and that it be advisable
that it be wound up.

Basically the second circumstance is the most important because in practice at

least the first circumstance does not arise and in the 3 rd circumstance the
creditors themselves will resolve that the company be wound up.

In any winding up those in need of protection are the creditors and the
minority shareholders. Where it is proposed to wind up a company voluntarily
Section 276 of the Companies Act requires the directors to make a declaration
to the effect that they have made a full inquiry in to the affairs of the company
and having so done have found the company will be able to pay its debts in
full within such period not exceeding one year after the commencement of the
winding up as may be specified in the declaration. Such declaration suffices
as a guarantee for the repayment of the creditors. If the directors are unable to
make the declaration, then the creditors will take charge or the winding up
proceedings in which case they may appoint a liquidator.

WINDING UP BY THE COURT

Winding up after an order to that effect by the court is the most common
method of winding up companies.

Section 218 of the Companies Act gives the High Court jurisdiction to wind
up any company registered in Kenya. The circumstances under which a
company may be wound up by a court order are spelt out in Section 219 of the
Companies Act.

These cover situations in which

1. the company has by special resolution resolved that it be
wound up by court;
2. Where default is made by the company in delivering to the
registrar the statutory report or on holding the statutory
meeting;
3. When the company does not commence business within one
year of incorporation or suspends its business for more
than one year;
4. Where the number of members is reduced in the case of a
private company below 2 or in the case of a public
company below 7;
5. Where the company is unable to pay its debts;
6. Where the court is of the opinion that it is just and equitable
to wind up the company;
7. In the case of a company registered outside Kenya and
carrying on business, the court will order the company to
be wound up if winding up proceedings have been
instituted against the company in the country where it is
incorporated or in any other country where it has
established business.

Under Section 221 of the Companies Act an Application for winding up by an

order of the court may be presented either by a creditor or a contributory.
However a contributory cannot make the application unless his name has
appeared on the register of members at least 6 months before the date of the
application and in any event he can only petition where the number of
members has fallen below the statutory minimum.

In practice the creditors will petition for a compulsory winding up where the
company is unable to pay its debts. The company’s inability to pay its debts
under Section 220 is deemed in the following circumstances

1. If a creditor to whom the company is indebted in a

sum exceeding 1000 shillings demands payment
from the company and 3 weeks elapse before the
company has paid that sum or secured it to the
reasonable satisfaction of a creditor;

2. If execution issued on a judgment against the

company is returned unsatisfied;
 3. If it is proved by any other method that a company is
unable to pay its debts.

Before a creditor can petition it must be shown as a preliminary issue that he is

in fact a creditor or a company creditor. This is a condition precedent to
petitioning and the insolvency of the company is a condition precedent to a
winding up order.

PETITION BY A CONTRIBUTOR

Section 221 of the Companies Act speaks not of members but of

contributories.
Section 214 defines the term contributory as follows “every person liable to
contribute to the assets of the company in the event of its being wound up”.
The persons falling under this category are defined in section 213 of the
Companies Act and include both present and past members. A past member
however, is not liable to contribute if he ceased to be a member one year or
more before the commencement of the winding up and he is not liable to
contribute for any debt or liability contracted after he ceased to be a member.
Even then he is not liable to contribute unless it appears to the court that the
existing members are unable to satisfy the contributions required.

The most important limitation on liability of contributories is found in Section

213 (1) (d) of the Companies Act. Under that clause no contribution shall be
required from any member exceeding the amount unpaid on their shares in
respect of which he is liable as a present or past member.

The petitioning contributor must establish that on winding up there will be

prima facie a surplus for distribution among the members i.e. he must establish
a tangible interest. If therefore the company’s affairs have been so managed
that there would be no assets available for distribution among the members
then a shareholder has no locus standi and will not be allowed to petition for
winding up.

Another possible limitation is that stated under Section 22(2) of the Act. Here
the court has a discretion not to grant the winding up order where it is of the
opinion that an alternative remedy is available to the petitioners and that they
are acting unreasonably in seeking to have the company wound up instead of
pursuing that other remedy.

WINDING UP ON JUST AND EQUITABLE GROUNDS

It is now established that the just and equitable clause in Section 219 of the
Act confers upon the court an independent ground of jurisdiction to make an
order for the compulsory winding up of the company. The courts have
exercised their powers under this clause in the following circumstances:

1. In order to bring to an end a cause of conduct by the majority

of the members which constitutes operation on
the minority;
2. The courts have also exercised this power where the
substratum of the company has disappeared;
 3. The courts have applied the partnership analogy to the small
private companies particularly those of a kind which
makes an analogy with partnerships appropriate.

In case of domestic private companies, there is normally an understanding

between the members that if not all of them, then the majority of them will
participate in the management of the company’s affairs. Such members impose
mutual trust and confidence in one another just as in the case of partnerships.
Also usual in such companies is the restriction of the transfer of a member’s
shares without the consent of all the other members.

If any of these principles were violated in a partnership, the courts will readily
order the partnership to be dissolved. In the case of a small private company,
the courts have also held that such companies are run on the same principles as
partnerships and therefore if the company was run on such principles it is just
and equitable to wind it up where a partnership would have been dissolved in
similar circumstances.

RE YENIDGE TOBACCO CO. LTD [1916] 2 Ch. 426

Here W and R who traded separately as Tobacco and Cigarette manufacturers

agreed to amalgamate their business. In order to do so, they formed a private
company in which they were the only shareholders and the only directors.
Under the Articles both W and R had equal voting powers. Differences arose
between them resulting in a complete deadlock in the management of the
company. The issue was whether it was just and equitable to wind up the
company. Lord Justice Warrington stated as follows
“It is true that these two people are carrying on business by
mean3 of the machinery of the limited company but in substance they are
partners. The litigation in substance is an action for dissolution of the
partnership and we should be unduly bound by matters of form if we treated
the relations between them as other than that of partners or the litigation as
other than an action brought by one for the dissolution of the partnership
against the other.”

The Model Retreading Co. [1962] E.A. 57

Here the petitioner who was a shareholder in a small private company

petitioned for winding up mainly on the ground that this was just and
equitable. The Affidavits sworn by the petitioner and his co-shareholders
disclosed that there had been bitter and unresolved quarrelling between the
parties going to the root of the companies business but none of these stated
that the company’s affairs had reached a deadlock. It was however conceded
by all the parties that as a result of the quarrelling the petitioner had been
prevented from participating in the management of the company’s affairs.

The issue was it just and equitable to wind up the company? Sir Ralph
Winndham C.J. said as follows:
“in these circumstances the principle which must be applied is that laid
down in re-Yenidge Tobacco namely that in the case of a small private
company which is in fact more in the nature of a partnership a winding up on
the just and equitable clause will be ordered in such circumstances as those in
which an order for dissolution of the partnership would be made. In that case
the shareholders were two and they had quarrelled irretrievably. In the present
case, if this were a partnership an order for its dissolution ought to be made at
the instance of one of the quarrelling partners. The material point is not which
party is in the right but the very existence of the quarrel which has made it
impossible for the company to be ran in the manner in which it was