THE LAW OF BUSINESS ASSOCIATIONS I Lecture 1 5.9.

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Section 2 (1) of the Companies Act Cap 486 Laws of Kenya states what company
means as '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 moneys worth into a common stock and who employ it
for some common purpose. Our legal system provides for two types of associations
namely
1. Companies
2. Partnerships.
3. Upcoming is the cooperative society.

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 which
is the current Cap 486 Laws of Kenya. It should denote that the Kenya Companies
Act is not a self contained Act of legal rules of company law because it was
borrowed from the English Companies Act of 1948 which was itself not a codifying
Act but rather a consolidating Act.

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-

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 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 (2) (a) of the Companies Act, in a company limited by shares the
members liability to contribute to the companies assets is limited to the amount if
any paid on their shares.

Under Section 4 (2) (b) of the Companies Act in a company limited by guarantee
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 companys 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

First in relation to 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

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 association contain the rules and regulations by which its internal affairs
are governed dealing with such matters as shares, share capital,
companys 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. The fees that one pays on registration will be determined
by the share capital that the company has stated.

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 where it is
intended to register a public company, Section 184 (4) of the Companies
Act also requires the registration of a list of persons who have agreed to
become directors and Section 182 (1) 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 108 of the statute should be filed within 14 days of
incorporation;
2. Particulars of Directors and Secretary which under Section 201 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

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The difference between a statutory corporation 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 of more persons who so desire can
themselves create a corporation by complying with the rules for registration which
the Act prescribes.

TYPES OF REGISTERED COMPANY

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 4

(2) (c) 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 companys 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 they decide upon a limited company, they must make up their minds
whether it is to be limited by shares or by guarantee. 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.

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

Section 30 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.

In order to form a public company, there must be at least seven (7) subscribers
signing the Memorandum of Association whereas only two (2) persons need to sign
the Memorandum of Association in the case of a private company.

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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 companys 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 Salomons 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 Macnaghten 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

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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 Salomons 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 companys 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 companys assets. So he lost the Company.

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

Lees 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

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 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 Workmans 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 Salomons 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.

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3. Suing and Being Sued: As a legal person, a company can take action in its
own name to enforce its legal rights. Conversely it may be sued for breach of
its legal duties. The only restriction on a companys 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 devise 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

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 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 companys 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

documents 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.

7. IGNORING THE CORPORATE ENTITY (LIFTING THE VEIL OF

INCORPORATION)

Although Salomons 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

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
(i) Only those members who remain after the six month period can be
sued;
(ii) 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.

(iii) 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

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 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 Williams 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 3rd 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 companys business with intent to defraud and
therefore should be held responsible for the repayment of the
companys 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

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of the companys 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 companys 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 companys 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.

HOLDING & SUBSIDIARY COMPANIES

LAW OF BUSINESS ASSOCIATION Lecture 2 20th February 2004

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 companys 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.

Under Section 154 of the Companys Act Cap 486 a company is deemed to be a
subsidiary of another if but only if

(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
others subsidiary.

Under Section 150 (1) 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

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companys 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 151(2) 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

Under Section 109 of the Companies Act it requires that a companys 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 Companys
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 companys officer
incur personal liability even though they might be contracting as the companys
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.

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 Salomons 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 West 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 companys property. The plaintiffs then caused the partnership to be
registered as a company in the name of Birmingham West Company Limited. Its

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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?

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 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. Llewelln (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 prize
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 companys European
interests.

There have been cases where Salomons 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

14
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 Companys 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 Cs 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.

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 plaintiffs customers. He formed a company to run a
competing distance. 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 defendants company was a mere cloak or sham and that it
was the defendant himself through this device who was soliciting the plaintiffs
customers. An injunction was granted against the both the defendant and the
company not to solicit the plaintiffs customers.

Jones v. Lipman (1912) 1 W.L.R. 832

15
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 COMPANYS 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 faade of the company and its place of registration
in order to determine its residence.

16
THE DOCTRINE OF ULTRA VIRES

A Company which is registered under the Companys 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.
2. It is also said to be intended for the protection of the creditors by
ensuring that the Companys 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

In this case the Companys 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 rectify 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

17
which the times have not been able to uphold. At the present day, the doctrine is
not as rigid as in Ashburys 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 Ashburys 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 objects 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 companys
objects 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 directors 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 companys business was requisitioned for vacant land and
the erection thereon of Housing Estates. Its objects are set up in the Memorandum

18
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 companys managing director
met an agent of the Defendants who required some finance to the tune of about 1
million pounds. The Plaintiffs Managing Director intimated to the Defendants
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 plaintiffs companys objects and powers.

LAW OF BUSINESS ASSOCIATIONS Lecture 3 27TH FEBRUARY 04

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

19
 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 companys 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 companys
Memorandum of Association and at the material time knew that the companys
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
companys Memorandum of Association.
2. Even an independent object clause cannot convert what are in fact powers
into objects.

20
2. LOSS OF SUBSTRATUM

Where the main object of a company has failed, a petitioner will be granted an
order for the winding up 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 companys 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.

21
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 companys 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 Westcorp 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
companys 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.

22
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 companys money and that money can only be spent for
purposes reasonably incidental to the carrying on of the companys 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
companys 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

Parker 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 companys 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 companys
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

23
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 companys 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 partys
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 As agent for obtaining such information
and therefore his knowledge was not the companys 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 companys 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.

24
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 discharging the
companys 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 companys 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 3rd 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 companys 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
object of the company.

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

of not less than three quarters of those members voting a companys 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

25
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 5.3.04

ARTICLES OF ASSOCIATION

A Companys 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 Companys 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.

26
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 Companys 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 Companys 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 companys articles of
association.

27
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 enforce
against the company.
3. Articles regulating the right and obligation of the members
generally are 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 companys 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 companys 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

28
Here the companys 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
Plaitniff 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 companys
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 Companys 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. This 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.

29
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 his behalf. Under a general meeting of the company a
special resolution was passed. That the article 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 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[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.

30
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 CONTRCT 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.

31
If however, a directors 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 companys 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 the Managing Director ceased to be a director, he would ipso facto
cease to be Managing Director. The Companys 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 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 Companys 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 companys 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 companys articles the Plaintiffs
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?

32
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 Plaintiffs company,
the Plaitniffs 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 Companys 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

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 who 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 varies 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.

33
However, under Section 25 sub-section 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 companys 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) 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 Selfcleaning Filter Syndicate v. Cunningham (1906) A.C. 442

34
The companys articles provided that subject to such regulations as might be made
by extra ordinary resolution, the Management of the companys 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 companys 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 companys affairs is embodied in Article
80 of Articles 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 require 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 companys articles of
association.

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

Here the Directors were empowered to manage the companys affairs. They
commenced an action for and on behalf of the company and in the companys
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

35
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 companys 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.

CO-OPERATE LIABILITIES FOR ACTS OF OFFICIALS

There are certain situations in which the law doesnt recognize vicarious liability
but insists on personal fault as a prelude to liability
In such cases a company couldnt be liable if the courts apply rigidly the rule that
the company is an artificial person and therefore can only act through the directors
If practice and for certain purposes the courts have elected to treat the acts of
certain offices as acts of the company itself.

This sometimes referred to as the organic theory of companies

The theory sprang from the case of

Lennards Carrying Company v. Asiatic Petroleum Co. Ltd.

A ship and a cargo were lost due to sea unworthiness. The owners of the ship were
a limited company. The managers of the company were another limited company
whose MD a Mr. Lennard managed the ship on behalf of the owners. He knew or
ought to have known of the sea unworthiness but took no steps to prevent the ship
from going to sea.

Under the relative shipping act, the owner of a sea going ship wasnt liable to make
good any laws or damage happening without his fault. The issue was whether
Lennards knowledge was the companys knowledge that ship was sea unworthy.

Held - Leonard was the directing mind and will of the company and his knowledge
was the knowledge of the company. His fault was the fault of the company and

36
since he knew that the ship was sea unworthy his fault was also the companys fault
and therefore the company was liable.

As per Viscount L.J.,

My Lords a corporation is an abstraction it has no mind of its own and more that
it has a body of its own.
Its active and directive will must consequently be sought in the person of
somebody who for some purposes may be called an agent but who is really the
directive mind and will of the corporation the very ego and center of the
personality of the corporation.

Case
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 premise 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
had to consider the question but the managing directors had clearly manifested the
intention to occupy the premises for the companys business.

It was held that the intention manifested by the directors was the companys
intention and therefore the tenants were not entitled to a renewal of the tenancy.

Denning L.J., stated

A company may in many ways be likened to a human being, it has a brain and a
nerve center which controls what it does it also has hands which hold all the tools
and acts in accordance with the directions of the center. Some of the people of the
company and merely 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.
Others 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 companys intention depends on the nature of the matter under
consideration relating to the position of the officer and agent and other relative
facts and circumstances of the case.

Closely related to this is the rule is the rule in Turguands case

It deals with the companys liability for acts of its officers.

Question as to whether or not the company is bound or not depends on the normal
agency principles, if a companys officer or a companys 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 of the

37
officers authority their 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 valid if done by the board of directors or the general meeting the
meeting might have been convened on improper notice or the resolution might 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 3rd party dealing
with the company always ascertain that the companys 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. Turguand

Here under the companys constitution the directors were given power to borrow
on bond such sums of money as from time to time by a general resolution be
authorized to be borrowed. Without such a resolution having been passed the
directors borrowed money from the plaintiff bank. Upon the company liquidation
the bank sought to recover form the liquidator who argued that the bank cant
recover it as it was borrowed without authority from the meeting.

Held even though no resolution had been passed the company has nevertheless
been bound by the act of the directors and therefore was bound to repay the money.
The words of Javis C.J

A party dealing with a company is bound to read the companys deed of settlement
memo of association but isnt bound to do more. In this case a 3rd party reading a
companys documents would find not a prohibition from borrowing but permission
to do so on certain conditions finding the authority may be found complete by
resolution he may have a right to infer the fact of a resolution authorizing that
which on the face of the document appeared to be legitimately done.

This is the case, which has the rule as to indoor management.

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

First a 3rd party dealing with a company has no access to a companys indoor
activities

2) It would be difficult to run business if everyone who had dealings with the
company had first to examine the companys internal operations before engaging
in business with the company. It would be very affair to the companys creditors if
the company could escape liability on the ground that its officials acted irregularly
but should the company always behave liable for the act of any people purporting
to act on the companys behalf. Suppose these people are imposters what happens?
In order the avoid this some limitations have been imposed on the rule. Later cases
have referred to the rule to be that ordinary agency principles will always apply

38
a) Any body dealing with the company is deemed to have notice of the contents
of the companys 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 isnt defined in the companys act but so far as the registered
companies are concerned the expression is not restricted to the
memorandum and articles of association but it also includes some of those
documents found in the companys registry these include special resolutions
particulars of secretaries, charges
provided that everything appears to be regular so far as can be checked from the
public documents a 3rd party dealing with the 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 putting him on inquiry.

Case

Mahoney v. East Holyford Mining Co

A mining company was founded by a W his friends and relatives. Subscriptions

were obtained for applicants shares. This was paid into the bank, which was
described in the prospectus as the companys bank. The communication of the
letter was sent to the bank by a person describing himself as the companys
secretary to the effect that in accordance with a resolution passed on that day
the bank was to pay out cheques signed by wither 2 of the 3 named directors
whose signatures were attached and counter signed by the secretary.

The bank then honoured debts so signed when the company funds were almost
exhausted the company was ordered to wind up. It was then discovered that no
meeting of the shareholders had been held and no appointment of secretary
made but that with his friends and relatives, W had held themselves to be
secretary and directors and had appropriated subscription money.

The issue was whether the bank was liable to refund money it had paid back to
the company.

Held the bank wasnt liable to refund any money to the company as it had
honoured the companys cheques on reliance on the letter received and in good
faith.

When there are person 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

39
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 3rd party dealing with a company through an officer who is or
is held out by the company as a particular type of officer for example an MD
and who purports to exercise a power which that type officer will usually have is
entitled to hold the company liable for the officers acts even though the officer
has not been so appointed or instructs exceeding his authority as long as the 3rd
party doesnt know that the companys officer has so not appointed or has no
actual authority.

A 3rd party however will not be protected if the circumstances are such as to put
him on inquiry he will also loose protection if the public documents make it
clear that the officer has no actual authority or will not have authority unless a
reosution had been passed which requires filing in the company registry and no
such resolution has been filed these are normal agency principles.

Case
Freeman & Lockyer v. Buckhurst Park Properties

In this case Kapoor and Hoon formed a private company, which purchase
Buckhurst Park estate. The board of directors consisted of Kapoor, Hoon and 2
others. The articles of the company contained a power to appoint a managing
director but none was appointed. Though never appointed as such Kapoor acted
as managing director. In that capacity he engaged the plaintiffs who were a firm
of architect to do certain work for the company, which was duly done.

When the plaintiffs claim remuneration according to the agreement the

company replied that its wasnt liable, because Kapoor had no authority to
engage him.

Held the act of engaging architects was within the ordinary ambit of the
authority of a managing director was of Property Company and the plaintiffs
didnt have to enquire 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.

4 conditions must be fulfilled in order to entitle a 3rd party to enforce a contract

entered into by 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 companys business either generally or in respect of
those matters to which the contract relates.

40
3) It must be shown that the contract was induced by such representation

4) It must be shown that neither in its memorandum nor under its articles was
the company deprived of the capacity either to enter into a contract of the
kind so as to be enforced or to delegate authority to do so to the agent.

Case
Emco Plastica International v. Freeberne

Here by a resolution of the company at a meeting of the board of directors the

respondent was appointed as the companys secretary. Nothing was decided in
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 day-to-day affairs of the company but didnt
have express authority to appoint a secretary or offer such unusually generous
terms as contained in the letter.
After 2 years service the company purported to dismiss the respondent by 5
days notice. The secretary sued for benefits under the contract. The company
contended that the managing director didnt have authority to offer the terms of
the contract there being no resolution of the company to support it and nothing
in the companys articles conferring such powers on a managing director.

It was held that as a chairman he performed the functions of a managing

director with the full knowledge of the board of directors and that a contract for
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 wouldnt normally have a 3rd party wont 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 3rd party has denied thereof.

Unless the company is estopped, however unless a provision in the

memorandum or articles or other public documents cant create an estoppel
unless the 3rd party knew of the provision and has relied on it.
For this purpose regulations at the companys registry dont constitute notice
because the doctrine of constructive notice operates negatively and not
positively.

41
 If a document purporting to be sealed and signed on behalf of the company is
proved to be forgery it doesnt bind a company.
However the company can be estopped as putting as a forgery if it has been put
forward as genuine by an officer acting within his actual, usual or ostensible
authority.

Rama Corporation v. Proved Tin & General Investments

Promoters
The company Act doesnt define the term promoter but section 45 (5) says
A promoter is a promoter who was a party to the preparation to the
prospectus. Apart from the fact that this definition doesnt say much, the
definition is only given for the purposes of the definition.

At common law the best definition is by chief justice

In the case of
Twyfords v. Grant

He said, A promoter is one who undertakes to form a company with reference

to a given project and to set it going and he 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 wont qualify
as promoters for 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 is a question of fact. The answer is

promoter isnt a term of law but of business summing up in a single word the
number of business associations familiar with the commercial world by which a
company is born.

It may therefore be said that the promoters are those responsible for its formation.
They decide the scope of its business activity the negotiate for he purchase of an
existing business if necessary, they instruct advocates to prepare the advocates to
make the necessary documents, they secure services for 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 the report of those whose report must
accompany the prospectus.

42
DUTIES OF PROMOTERS
Their duties are to act bonafide towards the company. Though they may not strictly
be an agent or a trustee for a company any one who can be properly guarded as
promoter stands in a fiduciary relationship vis-avis the company.

These 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 the extent of such promotion.
Failure to do so may lead to 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.

Case
Erlanger v. New Sombrero Phosphates Co.

The promoters of a company sold a lease to a 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 companys board of directors.

As Lord Caines
The owner of the property who promotes and form a company to which he sell his
property is bound to declare 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 to the promoters and
not to another person.

Since the decision in the case of Salomon, 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 promoters duty to the company is duly discharged, thereafter it
is upon the directors to disclose to the subscribers.

If made to the members it must appear in a 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

2) Recovery of any profits form the promoter.

43
 As regards rescission this must be exercised in keeping with normal principles
of contract.
a) The company shouldnt have done anything to ratify the action.
b) There must be restitution in inter gram restoring the parties to the
origin position.

REMUNERATION OF PROMOTERS
A promoter isnt entitled to remuneration to services rendered to 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.

He is therefore at the mercy of the directors but before a company is formed it cant
enter into a contract and therefore a promoter has to spend his money with no
guarantee that he will be re-inbursed but in practice the articles will usually have
provision authorizing the directors to pay the promoters. Although such provision
doesnt amount to a contract it nevertheless constitutes adequate authority for
directors to pay promoters.

PRELIMINARY CONTRACTS BY PROMOTERS

Until a company is formed it is legally non-existent and therefore cant enter into
any contract or do any other act in law. Once incorporated it cannot be liable in any
contract nor can it be entitled under any contract purported to have been made on
its behalf on its incorporation.
Ratification is not possible when the ostensible principle is non-existent in law
when the contract was entered into.

Case
Price v. Kelsall

One of the issues 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 the company cant ratify such an agreement the president of the court
of appeal was then constituted by the Okolo L.J.,

A company cant ratify a contract purporting to be made by someone on its behalf

before its incorporation by 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
formation of a company by persons purporting to act on behalf of the company
creates no contractual relation whatsoever between the company and the party to
the contract.

44
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.

Question whether there is a new contract or not is always a question of fact, which
depends on the circumstances of each individual case.

Case
Mawagola Farmers & Growers Ltd v. Kanyanja

Prior to incorporation the promoters held public meetings and the public asked to
purchase shares in a proposed company. The respondents paid for the shares
bought before and after the incorporation but the company didnt a lot any shares
to them but instead after incorporation allotted shares to others people.
The respondent prayed for orders that the shares they paid for be allotted to them
and the company registered name be rectified accordingly.
The company argued that the respondent paid for money for the purchase of their
shares money, the claim could be against the promoters because the company
couldnt even after incorporation ratify of adopt any such contract

Mustafa J.A
In order that the company may be bound by agreements entered into before
incorporation there must be anew contract to the same effect as the old agreement.
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 must be left
to mere gentleman agreements or otherwise the promoters may 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 proposed company.

As to whether the promoters they will be liable will depend on the terminology
implored.

Case
Kelner v. Baxter

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.

Held A,B and C were liable

Chief justice Earl

45
Where a contract is signed by one who prophesies to be signing as agent but who
has no principle existing at the time and the contract will altogether be 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 having rights and obligations form that
time but no rights or obligations by reason of anything which might have been
done before.

Contrast this with the case of

Newborn v. Sensolid Great Britain Limited

Here, the contract was entered into between Leopold Newbold London Limited
and the defendant for the purchase of goods by the latter.
The defendant refused to take delivery of the goods and an action commenced by
Leopold Newbold. It was discovered that at the time the contract had been entered
into the company hadnt been incorporated.

Leopold Newbold sought personally to enforce the contract.

It was held that the signature on the document was the companys signature and as
the company was not in existence when the contract was signed there was never a
contract and Mr. Newbold couldnt come forward and say it was his contract nut
was that he made a contract for a company which didnt exist.

PROSPECTUSES

When the public is asked to subscribe for shares or debentures of a company the
invitation involves the issue of documents, which set out the advantages to accrue
from an investment in a 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 30 of the
Company Act. Section 20 defines prospectuses as
Any prospectus, notice, circular, advertisement or other invitation offering to the
public for subscription or purchase of any shares or debentured in the company

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

The question of public isnt restricted to a certain section of the public but
includes any member of the general public.

46
Re South of England Natural Gas Co.

A newly formed company issued 3,000 copies of a document, which offered for
subscription shares in a company was headed For private circulation only
These copies were then circulated to the shareholders of a number of gas
companies. So the question here was this a prospectus?
It was held that this was an offer to the public and therefore constituted a
prospectus.

CONTENTS OF A PROSPECTUS

The object of a Companys act is to compel a company to disclose in a prospectus

all the necessary information which would enable a potential investor in deciding
whether or not to subscribe for a companys shares or debentures.

Therefore section 40 requires that every prospectus shall state the matters
specified in article 1 of the 3rd schedule to the Act and that it will also set out the
report specified in part 2 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 benefit they will get form directorship

2) In the case of a new company what profits are being made by the promoters
3) Amount of capital required by the company to be subscribed the amount
actually received or to be received, the precise nature of consideration which is not
paid in case
4) In the case of an existing company what the companys financial record in
the past.
5) The companys obligations under any contract entered into.
6) The voting and dividend right of each class of shares.

If a prospectus includes any statement by an expert then the expert must have
given written consent to the inclusion of the statement and the prospectus must
take it like he has done so. Section 42.

Contravention of these requirements renders the company and any person who
knowingly a party to the issue of prospectus to a fine not exceeding Ksh. 10,000

Section 42 defines expert

Including Engineer, Valuer, Accountant or any other person whose profession
gives authority any statement made by him.

47
In addition to the requirements it must be dated and the date stated therein is date
of publication of the prospectus. However there are 2 instances when a prospectus
need not contain matters set out in schedule 3 namely
i) When the prospectus is issued to existing members or shareholders of
the company.
ii) When the prospectus relates to shares or debentures uniform to previous
debentures or shares.

LIABILITY IN RESPECT OF PROSPECTUSES

If a prospectus contains untrue statements the Act subscribes both a penalty at

criminal law and also civil liability if payment of damages.
As concerns criminal liability section 46 where a prospectus includes any untrue
statements any person who authorized the issue of the prospectus is guilty of an
offence and liable to imprisonment not exceeding 2 years or a fine not exceeding
10,000 or both. Such a fine and imprisonment unless he proves the statement was
material or that he had reasonable grounds to believe or did at the time of issue of
prospectus believe the statement true.

A statement is deemed untrue and misleading in the form and context in which it is
included.
Case

R v. Kylsant

In this case the company sustained continuous losses for 6 years between 1921-
1927/
The company issued a prospectus, which in all material facts was correct. It further
specified that the dividends paid were high.
But the dividends wee being made out of abnormal profits from 1st world war and
the prospectus was misleading in its context.

CIVIL REMEDIES

There are 2 remedies for those who subscribe for shares as a result of misleading
statements in a prospectus.

a) Damages
b) Rescission
Section 45 provides for compensation to all persons who subscribe for shares or
debentures on the faith of prospectus for loss or damage sustained for statements
included therein.

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If the statement is false to the knowledge of those who made it, it amounts to fraud
and damages recoverable from all those who made the statement intending on it to
be referred upon.
Case

Derry v. Peek

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

and with the consent of the 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. On reliance of this misrepresentation the plaintiff bought
shares. Subsequently the Board of Trade refused to give trade to use of steam and
mechanical power and as a result the company was wound up.

The plaintiff brought an action for deceit alleging fraudulent misrepresentation. It

was held that the defendant werent liable, as they had made the incorrect
statement in the honest belief that it was true.

Lord Herschell stated

The authorities established 2 major propositions

a) In order to sustain an action for deceit there must be proof of fraud and
nothing short of that will suffice

b) Fraud is proved when it is shown a false representation is made either

i) Knowingly
ii) Without belief in its truth
iii) 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 cause of a prospectus is for the public to become allotees of shares to
a company. Once shares have been allotted, the prospectus wouldve served its
purpose and thereafter cant be used as a ground for filing an action for fraud in
respect of shares bought at a latter date from another source.

Case

Peek v. Gurney

The allotment of shares in the company began on July 24th and was completed on
28th July. In October the plaintiff bought some shares on the stock exchange. He
later found that the prospectus for July contained untrue statements and this
brought an action.
The question therefore is could he sue?

49
It was held hat the plaintiff couldnt base this action on the prospectus intended to
be based to the original subscribers.

The directors arent liable after full allotment of original shares for all subsequent
dealings, which may take place to those shares on the stock exchange.
The rule in Peek v. Gurney wont apply where a prospectus is intended to induce
not only the original subscribers of a companys shares but also to influence the
subsequent purchase of those shares.

Case in point
Andrews v. Mock Ford

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, didnt
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
struck a vein of gold and this they alleged they confirmed the statistics in the
prospectus.
The plaintiff bought shares on this basis and eventually the company wound up.

The question here is had the prospectus served its purpose?

It was held that the prospectus 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

There was proof 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 a defendant to operate in the
plaintiffs mind and on the mind of others and did operate to his prejudice and the
advantage of the defendant.

In this case the function of the prospectus wasnt exhausted and the false telegram
was brought into play by the defendant to reflect back upon and countenance the
false statement in the prospectus

The purchaser of shares induced to buy shares by the mis-statement in the

prospectus has an action for damages in negligence. He has also an action for
negligent mis-statement.

Under the case of

Hedley Byrne & Co. v. Heller & Partners

All these actions are directed to the directors personally.

50
 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. The right to rescind is
subject to two limitations.

a) The allotee looses the right to rescind if he shows any election to affirm the
contract. For example by attending and voting at the companys meetings or by
accepting to sell the shares

b) If the allotee doesnt rescind the contract before the company is wound up
he looses the right to do so as from the moment winding up proceedings are
commenced.

Directors Duties

Firstly there are 3 preliminary positions

a) Whereas directors authority to bind the company depends on the acting

collectively as a Board, the 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.

Case
Percival v. Wright

Certain shareholders wrote to the companys secretary asking if he knew anyone

willing to buy their shares.

Negotiations took place and eventually the companys chairman and two other
directors bought the plaintiffs shares at 12 pounds 10 shillings per share.

The plaintiff latter discovered that prior to and during their negotiations for sale
the chairman and the Board of Directors had been approached by a 3rd party with a
view to purchase the entire companys assets at more than 12 shillings.

The plaintiff brought an action to set aside share sales on the ground that the
directors owed them a duty to disclose negotiations with a 3rd party.
It was held that the directors arent agents for individual shareholders and didnt
owe them a duty to disclose.
Therefore the same was proper and couldnt be set aside.

51
b) However if the directors are authorized by the members to negotiate on
their behalf for example on potential purchase then the directors would be in a
position to be agents for such members and owed a duty to them accordingly.

Case
Allen v. Hyall

c) These duties except where expressly stipulates in the Company Act arent
restricted to directors alone but apply equally to any official of a company who is
authorized to act as agents and in particular to those acting in a managerial
capacity.
This is particularly so as regards to fiduciary duties.

Directors duties proper

These fall into 2 broad categories

i) Duties of care and skill in the conduct of a companys affairs and

ii) Fiduciary duties of loyalty and good faith

Duties of care and skill

The directors duty and skill were summed up by Justice Romer in the case of

Re City Equitable Fire Insurance

Here the directors of an insurance company left the management of the companys
affairs almost entirely to the Managing Director.
Owing to the managing directors fraud a large amount of the companys funds
disappeared.

Certain items appeared in the balance sheet under the heading: Loans at call or
short notice or Cash in bank or in hand
The directors didnt inquire how these items were made up. If they had inquired
they would have found the loans were chiefly to the managing director himself and
to the companys general manager and the case in bank and hand included some
13,000 pounds. In the hands of a firm of stock brokers at which the managing
director was partner
On the companys winding up an investigation on its affairs disclosed a shortage of
its funds at more than 1.2 m pounds 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 damages.

It was held that the directors were negligent. Justice romer states the directors
duty and care and skill as follows.
A director neednt 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.

52
This proposition describes the standard of skill exhibited in actions undertaken by
directors. The test is partly objective and subjective because a reasonable man
would be expected to have knowledge of the director with his experience.

Re Brazilian Rubber and Plantations Estates Ltd.

A company had 5 directors and one of them confessed that he was absolutely
ignorant of business. The 2nd one was 75 years old and very deaf and the 3rd agreed
to be a director because he saw one of his friends name in the roll. The other 2 were
fairly able businessmen.

The directors caused a contract to be entered between the company a certain

syndicate for purchase of a rubber plantation in Brazil.
The issued prospectus contained false statements about the acreage of the
plantation, the type of trees e.t.c.
The information contained 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
debtor was based on his own imagination. The directors caused the company to
purchase.
It was held that the conduct didnt amount to gross negligence.

Neville L.J.,
It has been laid down that so long as they act honestly directors cant be made
responsible in damages unless they are guilty of gross negligence.
A directors duty required him to act with such care as is reasonably expected from
him having regard to his knowledge and experience.
He isnt bound to bring any special qualifications to his office. He may undertake
management of a rubber company in complete ignorance of anything connected to
rubber without incurring responsibility from mistakes resulted from such
ignorance while if he is acquainted with rubber business he must give the company
the advantage of his knowledge while transacting the companys business.

He isnt bound to take any definite part in the conduct of the companys business in
so far as he undertakes it he must use reasonable care.
Such reasonable care must be measured in the care an ordinary man might be
expected to take in the same circumstances of his own behalf.

ii) A director isnt bound to give continuous attention to 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
isnt bound to attend all such meetings though he is to attend whenever in the
circumstances he is reasonable able to do the same.

Case
Re Denham & Co.

53
Here a company was incorporated in 1973 under the articles3 directors were
appointed. Namely Denham, Taylor and Crook. The 4th was appointed later.
The articles conferred on Denham supreme control of the companys affairs. He
was given power to override decisions of the General Meeting and the Board of
Directors. He was responsible for declaring dividends and he managed the
companys affairs entirely alone without consulting the other directors.

Between 1874-1877 a dividend of 18% p.a. was recommended and paid and the
total amount paid was 21,600 pounds. In 1880 the company went into liquidation
and an investigation revealed that money paid as dividends were paid not out of
profit but out of capital.

Thereafter Denham became bankrupt, Taylor died and his estate was worthless.
Denham became a man of straw. The third party was of no means. The directors
addressed their claims to Crook who had property. Crook argued that since
formation of the company he hadnt attended meetings and couldnt be held
accountable for any fraudulent statements in the companys balance sheet.

It was held that a director isnt bound to attend all meetings and isnt liable for
misfeasance committed by his co-directors at board meetings at which he was
never present.

Case

Marquis of Butes
In this case the director didnt attend board meetings for 38 years. He was held not

liable.

iii) 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

In this case 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 payment of dividends out of capital, and those advances on improper securities
were done on the advice of the general manager and chairman

54
It was held that the reliance placed on the co-director by the general manager and
chairman was reasonable.
He wasnt negligent and was therefore not liable for not having discovered the
fraud as he wasnt in the absence of circumstances of suspicion bound to examine
the companys books to see if the balance sheet is correct..

It may be said therefore that the duties of care and skill appear to be negative
duties.

II) Fiduciary Duties

The directors fiduciary duties are divisible into 4 sub categories

a) The directors must always act bonafide in what they consider and not what
the court may consider to be the best interest of the company. In this context the
term company means the company will be continued as a going concern thereby
balancing long term views against short term interest of existing members.

b) The directors must always exercise their powers for the purpose for which
they were conferred and not for extraneous purposes even if the latter are
considered to be in the best interest of the company. For example the directors are
invariably empowered to issue capital and this power should be exercised for
raising more funds when the company requires it. Hence it will be a breach of
directors duties to issue companys share for the purpose of entrenching
themselves in the companys affairs.

Case

Punt v. Symons

In this case the directors issued shares with the object of creating a sufficient
majority to enable them pass a special resolution depriving the shareholders
special rights conferred upon them by the companys articles.

It was held that the power of a kind exercised by the directors in this case is power
to be exercised for the benefit of the company.
Primarily this power is given to them for the purpose of raiding capital for the
purpose of the company.

Therefore a limited use of shares to persons who are obviously meant and intended
to secure the necessary statutory majority in a particular interest wasnt a fair and
bonafide exercise of the power.

Case
Piercy v. Mills & Co.

55
In this case a company had 2 directors they fell out of favour with majority of the
shareholders who were thereupon threatened with reelection and election of 3
others to the board.

The directors issued shares with the object of creating sufficient majority to enable
them resist the election of the 3 additional directors who election would have put
the 2 directors in the minority of the board.
It was held that the directors arent entitled to use their powers for issuing shares
merely for the purpose of maintaining their control or the control of themselves
and friends of 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 a 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 companys regulation/
Therefore it wasnt open for the purpose of defeating the wishes if the majority to
issue the shares in dispute.

In those circumstances where the directors have breached their duty in the exercise
of proper purpose the shareholders may forgive them by ratifying their actions.

Case
Hugg v. Cramphorn Ltd.

In this case the company had 2 classes of shares ordinary and preference.
Each share carried out one vote. The power to issue company shares was vested in
the directors. They learnt that a take over bid was to be made to the shareholders in
the bonafide belief that acquisition control of the prospective take over bidder
wont be in the interest of the company or staff. The directors decided to forestall
this move.
They attached 10 votes to each of the preference shares and allotted them to a trust,
which was controlled by chairman of the board and one of his partners in the audit
department and an employee of the company to enable the trustee to pay for the
shares. The directors provided them with an interest free percent loan out of the
companys reserve fund.

An action challenged by the plaintiff who was an associate of the 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 courts stood over the action in order to enable a General Meeting to be
held and debate whether or not to ratify the directors actions. The General Meeting
ratified the action.

Case

Bamford v. Bamford

56
There were similar facts but a meeting was held before proceeding to court and at
that meeting ratified the directors action.

Question here is whether a decision of a general meeting could cure the irregularity?

It was held that if the allotment was done in bad faith it was voidable at the
instance of the company because it was a wrong done by the company with the
right to recall allotment has the right to approve it back and forgive breach of duty.

They mustnt fetter their discretion to act for the company for example the
directors cant contract either among themselves or with 3rd 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 may be
necessary to carry out such a contract.

LAW OF BUSINESS ASSOCIATIONS Lecture 7 26th March 04

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

57
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
not 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
companys 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 companys 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

58
 the benefit of the company and these necessitates some elements of
having to take a risk even at the expense of the companys property.
(b) Whereas trust property is vested in the Trustees, a companys
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 companys
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 companys accounts and therefore decided to attend the companys
general meeting as representatives of the Trust. At the meeting they received
information pertaining to the companys 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

59
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 companys Managing Director. The Board of Directors was
approached by a prospector who offered to sell his claims to the company. The
companys 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 controlled 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 companys Managing
Director. The companys business was to offer design and construction services to
industrial enterprises. One of the defendants 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

60
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 Defendants
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 Plaintiffs
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 defendants 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
companys 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

61
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 defendants 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 companys promoters sold the
companys 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;

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 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 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

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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 our 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 companys 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

64
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 know-how
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 Companys 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 wives
expenses out of the companys funds. He negotiated sales and vetoed leases all
contrary to the decisions and wishes of the other directors.

65
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 companys 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.

1. There is no clear definition of the term and therefore it is not easy to tell
when a companys 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 companys Managing

Director was extremely incompetent. The court ruled that even though the
allegation suggested that the Managing Director was unwise in efficient 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.

2. 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.

3. the wording of the section suggests that there must be a continuous

cause of conduct and not merely isolated acts of impropriety.

4. 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.

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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 23rd April 04

RAISING AND MAINTENANCE OF CAPITAL

The basis of the whole concept or a companys 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
companys represented capital is actually what it is and for the distribution of that
capital.

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 1. Once the value of the companys 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 companys 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 companys 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 companys inability
to pay its debts as and when they fall due;

(ii) If the value of the companys 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

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 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 companys 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 years
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 companys property with repayment; or

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 3. It may take the form of an instrument acknowledging the debt charging
the companys 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 companys 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 companys 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 companys 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 lenders
security is to attach specifically to the companys assets.

Section 96 of the Companies Act requires every Charge created by a company and
conferring security on the companys property to be registered within 42 days.

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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 shareholders 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 companys 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

71
 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 companys 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.

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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 3rd 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.

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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 companys 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.

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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 companys 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 companys affairs. Such members impose
mutual trust and confidence in one another just as in the case of partnerships.

75
Also usual in such companies is the restriction of the transfer of a members 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 means 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 companys 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 companys 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

76
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 designed to be ran or for the parties disputes
to be resolved in any other way than by winding up.

Mitha Mohamed V. Mitha Ibrahim [1967] EA 575

4. Finally the just and equitable clause will also be applied where there is
justifiable loss of confidence in the manner in which the companys
affairs are being conducted Continuous Cause of Conduct

CONSEQUENCES OF A WINDING UP ORDER

Once a company goes into liquidation, all that remains to be done is to collect the
companys assets, pay its debts and distribute the balance to the members.

Under Section 224 of the Companies Act, in a winding up by the Court, any dealing
with the companys property after the commencement of the winding up is void
except with the permission of the court.

The purpose is to freeze the corporate business in order to ensure that the
companys assets are not wasted. Once the company has gone into liquidation, the
directors become functus officio.

Thereafter a liquidator is appointed whose duty is to collect the assets, pay the
debts and distribute the surplus if any. In so doing, he must always have regard to
the interests of the creditors.

The powers of the liquidator are set out in Section 241 of the companies Act.

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