Professional Documents
Culture Documents
LBA I Notes Amended
LBA I Notes Amended
LBA I Notes Amended
Section 3 (1) of the Companies Act No. 17 of 2015 Laws of Kenya states
what company means as means a company formed and registered under this
Act or an existing company. This is a very vague definition, in the statute
the word company is not a legal term hence the vagueness of the definition.
The legal attributes of the word company will depend upon a particular legal
system.
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.
1
FUNDAMENTAL CONCEPTS OF COMPANY LAW
LIMITED LIABILITY
Under Section (3) (1) of the Companies Act,2015 in a company formed and
registered under this Act or an existing company by shares the members
liability to contribute to the companies assets is limited to the amount if any
paid on their shares.
Under Section 3(1) and 7 of the Companies Act, 2015 defines a company
limited by guarantee, where the members undertake to contribute a certain
amount to the assets of the company in the event of the company being
wound up. Note that it is the members’ liability and not the companies’
2
liability which is limited. As long as there are adequate assets, the company
is liable to pay all its debts without any limitation of liability. If the assets
are not adequate, then the company can only be wound up as a human being
who fails to pay his debts. Note that in England the Insolvency Act has
consolidated the relationships relating to …. That does not apply here.
Nearly all statutory rules in the Companies Act are intended for one or two
objects namely
1. The protection of the company’s creditors;
2. The protection of the investors in this instance being the members.
3
nominal capital shall be xxx amount of shillings. The fees that one
pays on registration will be determined by the share capital that the
company has stated. The higher the share capital, the more that the
company will pay in terms of stamp duty.
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:
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
4
The difference between a statutory corporation (or parastatal) and a
company registered under the companies Act is that a statutory corporation
is created directly by an Act of Parliament. The Companies Act does not
create any corporations at all. It only lays down a procedure by which any
two or more persons who so desire can themselves create a corporation by
complying with the rules for registration which the Act prescribes.
A company which does not fall under this definition is described as a public
company.
5
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.
ADVANTAGES OF INCORPORATION
The full implications of corporate personality were not fully understood till
1897 in the case of Salomon v. Salomon [1897] A C 22
6
In the words of Lord Mcnaghten “the company is at a law a different person
altogether from the subscribers and though it may be that after
incorporation the business is precisely the same as it was before, and the
same persons are managers, and the same hands receive the profits, the
company is not in law the agent of the subscribers or trustee for them nor
are the subscribers as members liable in any shape or form except to the
extent and manner prescribed by the Act. … in order to form a company
limited by shares the Act requires that a Memorandum of Association should
be signed by seven (7) persons who are each to take one share at least. If
those conditions are satisfied, what can it matter, whether the signatories
are relations or strangers. There is nothing in the Act requiring that the
subscribers to the Memorandum should be independent or unconnected or
that they or anyone of them should take a substantial interest in the
undertaking or that they should have a mind and will of their own. When the
Memorandum is duly signed and registered though there be only seven (7)
shares taken the subscribers are a body corporate capable forthwith of
exercising all the functions of an incorporated company.
There were several other Law Lords who decided business in the House.
7
Macaura V. Northern Assurance Co. Ltd (1925) A.C. 619
The Appellant owner of a timber estate assigned the whole of the timber
to a company known as Irish Canadian Sawmills Company Limited for a
consideration of £42,000. Payment was effected by the allotment to the
Appellant of 42,000 shares fully paid up in £1 shares in the company. No
other shares were ever issued. The company proceeded with the cutting
of the timber. In the course of these operations, the Appellant lent the
company some £19,000. Apart from this the company’s debts were
minimal. The Appellant then insured the timber against fire by policies
effected in his own name. Then the timber was destroyed by fire. The
insurance company refused to pay any indemnity to the appellant on the
ground that he had no insurable interest in the timber at the time of
effecting the policy.
The courts held that it was clear that the Appellant had no insurable
interest in the timber and though he owned almost all the shares in the
company and the company owed him a good deal of money,
nevertheless, neither as creditor or shareholder could he insure the
company’s assets. So he lost the Company.
Lee’s company was formed with capital of £3000 divided into 3000 £1
shares. Of these shares Mr. Lee held 2,999 and the remaining one share
was held by a third party as his nominee. In his capacity as controlling
shareholder, Lee voted himself as company director and Chief Pilot. In
the course of his duty as a pilot he was involved in a crash in which he
died. His widow brought an action for compensation under the
Workman’s Compensation Act and in this Act workman was defined as
“A person employed under a contract of service” so the issue was
whether Mr. Lee was a workman under the Act? The House of Lords
Held:
8
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.
ADVANTAGES OF INCORPORATION
9
company’s right to sue is that it must always be represented by a
lawyer in all its actions.
In East Africa Roofing Co. Ltd v Pandit (1954) 27 KLR 86 here the
Plaintiff a limited liability company filed a suit against the defendant
claiming certain sums of money. The defendant entered appearance
and filed a defence admitting liability but praying for payment by
instalments. The company secretary set down the date on the suit for
hearing ex parte and without notice to the defendant. This was
contrary to the rules because a defence had been filed. On the hearing
day the suit was called in court but no appearance was made by either
party and the court therefore ordered the action to be dismissed. The
company thereafter applied to have the dismissal set aside. At the
hearing of that application, it was duly represented by an advocate.
The only ground on which the company relied was that it had intended
all along to be represented at the hearing by its manager and that the
manager in fact went to the law courts but ended in the wrong court.
It was held that a corporation such as a limited liability company
cannot appear in person as a legal entity without any visible person
and having no physical existence it cannot at common law appear by
its agent but only by its lawyer. The Kenya Companies Act does not
change this common law rule so as to enable a limited company to
appear in court by any of its officers.
10
transferability only relates to public companies and not private
companies.
11
IGNORING THE CORPORATE ENTITY (LIFTING THE VEIL OF
INCORPORATION)
Although a company is liable for its own debt which will be the logical
consequence of the Salomon rule, the members themselves are held liable
which is therefore a departure from principle. The rights of creditors under
this section are subject to certain limitations namely (under statutory
provision)
12
wife and they appointed William as the Managing Director at a
Salary of £1000 per annum. Within the period of one month, the
company was debited with an amount which was £500 more than
what was actually due to William. By that time the company had
made a loss of £2500. Within 2 years of formation, and while the
company was still in financial problems, the directors paid to
themselves the dividends of £250. By the end of the 3 rd year since
incorporation the company was in such serious difficulties such
that it could not pay debts as they fell due. In spite of this William
ordered goods worth £6000 which became subject to a charge
contained in a debenture held by them. At the same time he
continued to repay himself a loan of £600 (six hundred pounds)
which he had lent to the company at the beginning of the 4 th year
the company with the knowledge of William owed £6500 for
goods supplied. In the winding up of the company the official
receiver applied for a declaration that in no circumstances William
had carried on the company’s business with intent to defraud and
therefore should be held responsible for the repayment of the
company’s debts. It was held that since that company continued to
carry on business at a time when William knew that the company
could not comfortably pay its debts, then this was fraudulent
trading within the meaning of Section 323 and William should be
responsible for repaying the debts. These are the words of Justice
Maugham J. “if a company continues to carry on business and to
incur debts at a time when there is to the knowledge of the
directors no reasonable prospects of the creditors ever receiving
payments of those debts, it is in general a proper inference that the
company is carrying on business with intent to defraud.”
The test is both subjective and objective. In the Case of Re Patrick Lyon Ltd
(1933) Ch. 786 on facts which were similar to the Williams case, the same
Judge Maugham J. said as follows: “the words fraud and fraudulent
purpose where they appear in the Section in question are words which
connote actual dishonesty involving according to the current notions of fair
trading among commercial men real moral blame. No judge has ever been
willing to define fraud and I am attempting no definition.”
The statutes are not clear as to the meaning of fraud the question arises that
once the money has been recovered from the fraudulent director, is it to be
13
laid as part of the company’s general assets available to all creditors or
should it go back to those creditors who are actually defrauded.
In the case of Re William Justice Eve J. stated that such money should form
part of the company’s general assets and should not be refunded to the
defrauded creditors.
In the case of Re Cyona Distributors Ltd (1967) Ch. 889 the Court of Appeal
ruled that if the application under Section 323 is made by the debtor then the
money recovered should form part of the company’s general assets but
where the application is made by a creditor himself, then that creditor is
entitled to retain the money in the discharge of the debts due to him.
Lifting the Veil – Lifting the veil of corporate entity under statute
- lifting the veil of corporate entity under common law.
One of the most important limitations imposed by the Companies Act on the
recognition of the separate personality of each individual company is in
connection with associated companies within the same group enterprise. In
practice it is common for a company to create an organisation of inter-
related companies each of which is theoretically a separate entity but in
reality part of one concern represented by the group as a whole. Such is
particularly the case when one company is the parent or holding company
and the rest are its subsidiaries.
14
(d) is a holding company of a company that is that other company's holding
company;
Under Section -3(1) of the Companies Act,2015 a company is deemed to be
a subsidiary of another if but only if "wholly-owned subsidiary company"
(of another company) means a company that has no members other
than that other company and that other company's wholly owned subsidiaries
(or persons acting on behalf of that other company or its wholly-owned
subsidiaries;
(a) That other company either
(i) is a member of it and controls the composition of its board of
directors or
(ii) Holds more than half in nominal value of its equity share capital or
Under Section - where at the end of the financial year a company has
subsidiaries, the accounts dealing with the profit and loss of the company
and subsidiaries should be laid before the company in general meeting when
the company’s own balance sheet and profit and loss account are also laid.
This means that group accounts must be laid before the general meeting.
The group accounts should consist of a consolidated balance sheet for the
company and subsidiary and also of a consolidated profit and loss account
dealing with the profit and loss account of a company.
MISDESCRIPTION OF COMPANIES
Part 4 prescribes the requirements for a name of a company under the Act.
Under Section 67 of the Companies Act, 2015, a company is mandated to
disclose its name it requires that a company’s name should appear whenever
it does business on its Seal and on all business documents. Under paragraph
4 of this Section, if an officer of a company or any person who on its behalf
signs or authorises to be signed on behalf of the company any Bill of
15
Exchange, Promissory Note, Cheque or Order for Goods wherein the
Company’s name is not mentioned as required by the Section, such officer
shall be liable to a fine and shall also be personally made liable to the holder
of a Bill of Exchange Promissory Notes, Cheque or order for the goods for
the amount thereof unless it is paid by the company. The effect of this
section is that it makes a company’s officer incur personal liability even
though they might be contracting as the company’s agents. Liability under
this Section normally arises in connection with cheques and company
officers have been held liable where for instance the word limited has been
omitted or where the company has been described by a wrong name.
Generally there is no reason why a company may not be an agent of its share
holders. The decision in Salomon’s case shows how difficult it is to
convince the courts that a company is an agent of its members. In spite of
this there have been occasions in which the courts have held that registered
companies were not carrying on in their own right but rather were carrying
on business as agents of their holding companies. Reference may be made
to the case of
Smith Stone & Knight v. Birmingham Corporation (1939) 4 All E.R. 116
16
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 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.
17
2. are the persons conducting the business appointed by the
parent company?
3. Is the parent company the head and brain of the trading
venture?
4. Does the parent company govern the venture decide what
should be done and what capital should be embarked on in
the venture?
5. Does the company make the profits by its skill and
direction?
6. Is the company in effectual and constant control?
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.
18
was selling its own goods or whether it was selling goods of an American
company.
The court held that the substance of the arrangement was that the American
company traded in England through the subsidiary as its agent and that the
sales by their subsidiary, were a means of furthering the American
company’s European interests.
There have been cases where Salomon’s case has been upheld that a
company is a legal entity.
Ebbw Vale UDC V. South Wales Traffic Authority (1951) 2 K.B 366
Lord Justice Cohen L.J “Under the ordinary rules of law, a parent company
and a subsidiary company even when a hundred percent subsidiary are
distinct legal entities and in the absence of an agency contract between the
two companies, one cannot be said to be an agent of the other.”
This was based on Section 210 of the Companies Act where an offer was
made to purchase out a company if 90% of shareholders agreed. There were
3 shareholders in the company. A, B and C.
A held 45% of the shares, B also held 45% of the shares and C held the
remaining 10% of the shares. A and B persuaded C to sell his shares to them
but he declined. Consequently A and B formed a new company call it AB
Limited, which made an offer to ABC Limited to buy their shares in the old
19
company. A and B accepted the offer, but C refused. A and B sought to use
provisions of Section 210 in order to acquire C’s shares compulsorily.
The court held that this was a bare faced attempt to evade the fundamental
principle of company law which forbids the majority unless the articles
provide to expropriate the minority shareholders.
Lord Justice Cohen said “the company was nothing but a legal hut. Built
round the majority shareholders and the whole scheme was nothing but a
hollow shallow.” All the minority shareholder had to do was shout and the
walls of Jericho came tumbling down.
Here the Defendant was a former employee of the plaintiff company and had
covenanted not to solicit the plaintiff’s customers. He formed a company to
run a competing business. The company did the solicitation. The defendant
argued that he had not breached his agreement with the plaintiffs because the
solicitation was undertaken by a company which was a separate legal entity
from him.
The court held that the defendant’s company was a mere cloak or sham and
that it was the defendant himself through this device who was soliciting the
plaintiff’s customers. An injunction was granted against the both the
defendant and the company not to solicit the plaintiff’s customers.
Jones v. Lipman (1912) 1 W.L.R. 832
This case the Defendant entered into a contract for the sale of some property
to the plaintiff. Subsequently he refused to convey the property to the
plaintiff and formed a company for the purpose of acquiring that property
and actually transferred the property to the company. In an action for
specific performance the Defendant argued that he could not convey the
property to the Plaintiff as it was already vested in a third party.
Justice Russell J. observed as follows
“the Defendant company was merely a device and a sham a mask which he
holds before his face in an attempt to avoid recognition by the eye of equity”
GROUP ENTERPRISE
20
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.
The courts also look behind the façade of the company and its place of
registration in order to determine its residence.
21
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 court held that the contract was ultra vires the company and void so that
not even the subsequent consent of the whole body of shareholders could
ratify it. Lord Cairns stated as follows:
“The words general contractors referred to the words which went
immediately before and indicated such a contract as mechanical engineers
make for the purpose of carrying on a business. This contract was entirely
beyond the objects in the Memorandum of Association. If so, it was thereby
placed beyond the powers of the company to make the contract. If so, it was
not a question whether the contract was ever ratified or not ratified. If the
contract was going at its beginning it was going because the company could
not make it and by purporting to ratify it the shareholders were attempting to
22
do the very thing which by the act of parliament they were prohibited from
doing.”
The courts construed the object clause very strictly and failed to give any
regard to that part of the Objects clause which empowered the company to
do business as general contractors. This construction gave the doctrine of
ultra vires a rigidity which the times have not been able to uphold. At the
present day, the doctrine is not as rigid as in Ashbury’s case and
consequently it has been eroded.
The first inroad into the doctrine was made five years later in the case of
Attorney General V. Great Eastern Railway 1880) 5 A.C. 473
An act of the company therefore will be regarded as intra vires not only
when it is expressly stated in the object’s clause but also when it can be
interpreted as reasonably incidental to the specified objects. As a result of
this decision, there is now a considerable body of case law deciding what
powers will be implied in a case of particular types of enterprise and what
activities will be regarded as reasonably incidental to the act.
However businessmen did not wish to leave matters for implication. They
preferred to set up in the Memorandum of Association not only the objects
for which the company was establish but also the ancillary powers which
they thought the company would need. Furthermore instead of confining
themselves to the business which the company was initially intended to
follow, they would also include all other businesses which they might want
the company to turn to in the future. The original intention of parliament
was that the companies object should be set out in short paragraphs in the
Memorandum of Association. But with a practice of setting out not only the
present business but also any business which the promoters would want the
company to turn to, the result is that a company’s object’s clause could
contain about 30 or 40 different clauses covering every conceivable business
and all that incidental powers which might be needed to accomplish them.
23
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.
In this case the Plaintiff company’s business was requisitioned for vacant
land and the erection thereon of Housing Estates. Its objects as set up in the
Memorandum of Association contained the Clause authorising the company
to “carry on any other trade or business whatsoever which can in the opinion
of the Board of Directors be advantageously carried on by the company in
connection with or as ancillary to any of the above businesses or a general
business of the company”.
24
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.
“It may be that the Directors take the wrong view and infact the
business in question cannot be carried on as they believe but it matters not
how mistaken they might be provided that they formed their view honestly
then the business is within the plaintiff’s company’s objects and powers.”
The courts have introduced 2 methods of curbing the evasion of the ultra
vires doctrine.
1. The ejusdem generis rule is also referred to as the main objects rule
of construction. Here a Memorandum of Association expresses the
objects of a company in a series of paragraphs and one paragraph
or the first 2 or 3 paragraphs appear to embody the main object of
the company all the other paragraphs are treated as merely
ancillary to this main object and as limited or controlled thereby.
Business persons evaded this method by use of the independent
objects clause. The objects clause will contain a paragraph to the
effect that each of the preceding sub-paragraphs shall be construed
independently and shall not in any way be limited by reference to
any other sub-clause and that the objects set out in each sub-clause
shall be independent objects of the company. Reference may be
made to the case of Cotman v. Brougham [1918]A.C. 514
25
independent objects of the company. The company underwrote and had
allotted to it shares in an oil company. The question that arose was
whether this was intra vires the company’s objects. The court held that
the effect of the independent objects clause was to constitute each of the
30 objects of the company as independent objects. Therefore the dealing
of shares in an oil company was within the objects and thus intra vires.
However the power to borrow money cannot be construed as an
independent object of the company in spite of this decision.
The court held that borrowing was a power and not an object. The power
to borrow existed only for furthering intra vires objects of the company
and was not an object in itself. Therefore
1. The exercise of powers which will be intra vires is exercised for the
objects of the company and is ultra vires only if used for the objects
not covered by the company’s Memorandum of Association.
2. Even an independent object clause cannot convert what are in fact
powers into objects.
2. LOSS OF SUBSTRATUM
Where the main object of a company has failed, a petitioner will be granted
an order for the winding up of a company. Such a petitioner must however
be a member or shareholder in the company.
26
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.
In this case the major object of the company was to acquire a German Patent
for manufacturing coffee from dates. The German patent was never granted
but the company acquired a Swedish Patent for the same purpose. The
company was solvent and the majority of the members wished to continue in
business. However, two of the shareholders petitioned for winding up of the
company on the grounds that the company’s object had entirely failed.
The court held that upon the failure to acquire the German patent, it was
impossible to carry out the objects for which the company was formed.
Therefore the sub stratum had disappeared and therefore it was just
inevitable that the company should be wound up.
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
27
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.
3. GRATUITOUS GIFTS
Can a company validly make a gift out of corporate property or asset? The
law is that a company has no power to make such payments unless the
particular payment is reasonably incidental to the carrying out of a
company’s business and is meant for the benefit and to promote the property
of the company.
A company sold its assets and continued in business only for the purpose of
winding up. While it was awaiting winding up, a resolution was passed in
the company’s general meeting authorising the payments of a gratuity to the
directors and dismissed employees.
The court held that as the company was no longer a going concern such a
payment could not be reasonably incidental to the business of the company
and therefore the resolution was invalid. In the words of the Lord Justice
Bowen said
28
“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 object clause of the company contained an express power to provide for
the welfare of employees and ex employees and also their widows, children
and other dependants by the grant of money as well as pensions. Three
years before the company was wound up, the Board of Directors decided
that the company should undertake to pay a pension to the widow of a
former managing director but after the winding up the liquidator rejected her
claim to the pension.
The court held that the transaction whereby the company covenanted to pay
the widow a pension was not for the benefit of the company or reasonably
incidental to its business and was therefore ultra vires and hence null and
void.
Whether they reneged an express or implied power, all such grants involved
an expenditure of the company’s money and that money can only be spent
for purposes reasonably incidental to the carrying on of the company’s
business and the validity of such grants can be tested by the answers to three
questions:
(i) Is the transaction reasonably incidental to the carrying on of
the company’s business?
(ii) Is it a bona fide transaction?
(iii) Is it done for the benefit and to promote the prosperity of the
company?
29
Sometimes ultra vires can be excluded by good and clever draftsmanship
In this case the company transferred the major portion of its assets and
proposed to distribute the purchase price to those employees who are going
to become redundant after reduction in the stock of the company of the
company’s business. The company was not legally bound to make any
payments by way of compensation. One shareholder claimed that the
proposed payment was ultra vires.
The court held that the proposed payment was motivated by a desire to treat
the ex-employees generously and was not taken in the interest of the
company as it was going to remain and that therefore it was ultra vires.
The court held that even though the payment was not under an express
power, it was reasonably incidental to the company’s business and therefore
valid.
This is one of the few cases where payment was recognised as being valid.
30
THE RIGHTS OF THE COMPANY & 3 RD PARTIES UNDER ULTRA
VIRES TRANSACTIONS:
X was a director of company B and at the same time had some interests in
company A. He learnt that company B wished to borrow some money
which it intended to apply to unauthorised activities. He urged company A
to lend the money on the security of debentures. The issues were
(a) Whether the debentures were valid security;
(b) Whether the knowledge of X as to the intended application of the
money could be imputed to the company.
The court held that X was not company A’s agent for obtaining such
information and therefore his knowledge was not the company’s knowledge
and consequently the debentures were valid security.
1. At common law therefore, the first remedy of a person who parts with
property under an ultra vires transaction is that he has a right to trace and
recover that property from the company as long as he can identify it.
This principle also applies to money lent to the company on an ultra vires
borrowing so long as the money can be traced either in law or in equity. The
31
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.
2. The 3rd party has a personal right against the directors or other agents
with whom he has dealt. The rationale is that such directors or other agents
are treated as quasi trustees from which it follows that a 3 rd party is entitled
to a claim against them for restitution.
The intra vires creditor does not have the locus standi to prohibit ultra vires
actions. Again there is the presumption of knowledge of a company’s
documents and activities. In spite of the fact that the doctrine of ultra vires
is over due for reform, it has not undergone any reform in Kenya unlike in
the United Kingdom where it has been severely eroded.
All the company can do is to alter its objects under the power conferred by
Section 8 of the Companies Act Cap 486. The effect of the Section is that a
company may by special resolution alter the provisions in its Memorandum
with respect to the objects of the company. Alteration must be lodged with
the Register section 28(2)
32
company’s general meeting either in person or by proxy and of which notice
has been given of the intention to propose it as a special resolution.
Within 30 days of the date on which the resolution altering the objects is
passed, an application for the cancellation of the Resolution may be made to
Court by or on behalf of the holders who have not voted in favour of the
Resolution, of not less than 15% of the nominal value of the issued share
capital of any class and if the company does not have a share capital, the
application can be made by at least 15% of the members of the company.
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.
ARTICLES OF ASSOCIATION
33
A Company’s constitution is composed of two documents namely the
Memorandum of Association and the Articles of Association. The Articles
of Association are the more important of the two documents in as much as
most court cases in Company Law deal with the interpretation of the
Articles.
Section 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.
34
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.
They further provide a dividing line between the powers of share holders
and those of the directors.
Here the Articles of the Company provided that any dispute between any
member and the company should be referred to arbitration. A dispute arose
between Hickman and the company and instead of referring the same to
arbitration, he filed an action against the company. The company applied
for the action to be stayed pending reference to arbitration in accordance
with the company’s articles of association.
The court held that the company was entitled to have the action stayed since
the articles amount to a contract between the company and the Plaintiff one
of the terms of which was to refer such matters to arbitration.
35
Justice Ashbury had the following to say: “That the law was clear and could
be reduced to 3 propositions
1. That no Article can constitute a contract between the company
and a third party;
2. No right merely purporting to be conferred by an article to any
person whether a member or not in a capacity other than that
of a member for example solicitor, promoter or director can be
enforced against the company.
3. Articles regulating the right and obligation of the members
generally as such do not create rights and obligations between
members and the company”.
In this case, the company’s articles provided that Eley should become the
company Solicitor and should transact all legal affairs of the company for
mutual fees and charges. He bought shares in the company and thereupon
became a member and continued to act as the company’s solicitor for some
time. Ultimately the company ceased to employ him. He filed an action
against the company alleging breach of contract.
The court held: that the articles constitute a contract between the company
and the members in their capacity as members and as a solicitor Eley was
therefore a third party to the contract and could not enforce it. The contract
relates to members in their capacity as members and the company so its only
a contract between the company and members of that company and not in
any other capacity such as solicitor. But note that there can be an intra
member contract.
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
36
shareholders and the company but also between the individual shareholders
and every other.”
Here the company’s articles provided that every member who intends to
transfer his shares shall inform the directors who will take those shares
between them equally at a fair value. The Plaintiff called upon the directors
to take his shares but they refused. The issue was did the articles give rise to
a contract between the Plaintiff and the directors. In their capacity as
directors they were not bound.
The court here held that the Articles related to the relationship between the
Plaintiff as a member and the Defendants not as directors but as members of
the company. Therefore the Defendants were bound to buy the Plaintiff
shares in accordance with the relevant article.
ALTERATION OF ARTICLES
Section 13 of the Companies Act gives the company power to alter the
articles by special resolution. This is a statutory power and a company
cannot deprive itself of its exercise. Reference may be made to the case of
The issue herein was whether a company which under its Memorandum and
Articles had no power to issue preference shares could alter its articles so as
to authorise the issue of preference shares by way of increased capital
The court held that as long as the Constitution of a Company depends on the
articles, it is clearly alterable by special resolution under the powers
conferred by the Act. Therefore it was proper for the company to alter those
articles and issue preference shares. Any regulation or article which
purports to deprive the company of this power is therefore invalid, on the
ground that such an article or regulation will be contrary to the statute. The
only limitation on a company’s power to alter articles is that the alteration
must be made in good faith and for the benefit of the company as a whole.
37
Allen v. Gold Reefs of West Africa (1900) 1 Ch. 626
In this case the company had a lien on all debts by members who had not
truly paid up for their shares. The Articles were altered to extend the
Company’s lien to those shares which were fully paid up.
The court held that since the power to alter the Articles is statutory, the
extension of the lien to fully paid up shares was valid. These were the words
of Lindley L.J.
Here the Articles of the Company provided that the Plaintiff and 4 others
should be the first directors of the company. Further each one of them
should hold office for life unless he should be disqualified on any one of
some six specified grounds, bankruptcy, insanity etc. The Plaintiff failed to
account to the company for certain money he had received on its behalf.
Under a general meeting of the company a special resolution was passed that
the articles be altered by adding a seventh ground for disqualification of a
director which was a request in writing by his co-directors that he should
resign. Such request was duly given to the Plaintiff and there was no
evidence of bad faith on the part of shareholders in altering the articles.
The Plaintiff sued the company for breach of an alleged contract contained
in their original articles that he should be a permanent director and for a
declaration that he was still a director.
The court held that the contract if any between the Plaintiff and the company
contained in the original articles in their original form was subject to the
statutory power of alteration and if the alteration was bona fide for the
38
benefit of the company, it was valid and there was no breach of contract.
Lord Justice Bankes observed as follows
“In this case, the contract derives its force and effect from the Articles
themselves which may be altered. It is not an absolute contract but only a
conditional contract.”
The question here is who determines what is for the benefit of the company?
Is it the shareholders or the Courts?
“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.”
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..
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
39
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.
40
of a director from office subject to the terms of any subsisting agreement.
The Articles further provided that if the Managing Director ceased to be a
director, he would ipso facto cease to be Managing Director. The
Company’s Articles were subsequently changed to give the Directors power
to remove a fellow director from office by notice. Such notice was given to
the Plaintiff who thereupon filed an action claiming damages from the
company for breach of contract.
It was held that since his appointment was not subject to the articles, he
could only be removed from office in accordance with the terms of his
appointment and not by way of alteration of the articles. Damages were
therefore payable.
Lord Atkins said “if a party enters into an arrangement which can only take
effect by the continuance of an existing state of circumstances there is an
implied undertaking on his part that he shall be done of his own motion to
put an end to that state of circumstances which alone the arrangement can
be operative.”
The court held that on a true construction of the company’s articles the
Plaintiff’s appointment was immediately and automatically terminated on
passing of the Resolution at the general meeting since the company had
expressly reserved to itself the power to dismiss the Managing Director.
41
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?
British Murac Syndicate Ltd v. Alperton Rubber Co. Ltd. 1950 2 Ch. 186
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.
This case had words to the effect that the company cannot be restrained but
this was overruled in the case of
Allen v. Goldreef
42
alteration in its terms related to all holders of fully-paid shares. The fact that
Zuccani was the only member of that class at that moment did not invalidate
it.
In that case Bowen L.J. stated as follows: “The word Class is vague it must
be confined to those persons whose rights are not dissimilar as to make it
impossible for them to concert together with a view to their common
interest.”
Under Article 4 of Table A where the Share Capital is divided into different
classes of Shares, the rights attached to any class may be varied only with a
consent in writing of the holders of three quarters of the issued share of that
class or with assumption of a special resolution passed at a separate meeting
of the holders of the shares of that class.
43
Section 177 of the Companies Act requires every public company to have at
least two directors and every private company at least one director. The Act
does not provide for the means of appointing Directors but in practice the
Articles of Association provide for initial appointments by subscribers to the
Memorandum of Association and thereafter to annual retirement of a certain
number of directors and the filling of vacancies at the annual general
meeting.
Under Section 184 (1) of the Companies Act every appointment must be
voted on individually except in the case of private companies or unless the
meeting unanimously agrees to include two or more appointments in the
same resolution. The appointment is usually effected by an ordinary
resolution. However, no matter how a director is appointed, under Section
185 of the Companies Act he can always be removed from office by an
ordinary resolution in addition to any other means of removal which may be
embodied in the articles.
44
the company’s assets on certain terms and instructing the directors to carry
the sale into effect. The Directors were of the opinion that a sale on those
terms was not of any benefit to the company and therefore refused to carry it
into effect. The issue was, whether the directors were under an obligation to
act in accordance with the directives.
The court held that the Articles constituted a contract by which the members
had agreed that the Directors alone should manage the affairs of the
company unless and until the powers vested in the Directors was taken away
by an alteration in the Articles they could ignore the general meeting
directives on matters of management. They were therefore entitled to refuse
to execute the sale.
Here the Directors were empowered to manage the company’s affairs. They
commenced an action for and on behalf of the company and in the
company’s name, in order to recover some money owed to the company.
The general meeting thereafter passed a resolution disapproving the
commencement of the suit and instructing the Directors to withdraw it
It was held that the resolution of the general meeting was a nullity Greer L.J.
stated
45
opportunity arises under the articles by refusing to re-elect the directors or
whose actions they disapprove. They cannot themselves reserve the powers
which by themselves are vested in the Directors any more than the directors
can reserve to themselves the powers vested by the articles in the general
body of shareholders.”
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.
There are certain situations in which the law does not recognise vicarious
liability but insists on personal fault as a prelude to liability. In such cases a
company could never be liable if the courts applied rigidly the rule that a
company is an artificial person and therefore can only act through the
directors. In practice and for certain purposes the courts have elected to treat
the acts of certain officers as those of the company itself. This is sometimes
referred to as THE ORGANIC THEORY OF COMPANIES.
46
The theory sprung from the case of
Lennard’s Carrying Co. v. Asiatic Petroleum Co. Ltd. (1950) A.C. 705
In this case a ship and her cargo were lost owing to unseaworthiness. The
owners of the ship were a limited company. The managers of the company
were another limited company whose managing director a Mr. Lennard
managed the ship on behalf of the owners. He knew or ought to have known
of the Ship’s unseaworthiness but took no steps to prevent the ship from
going to sea. Under the relevant shipping Act the owner of a sea going ship
was not liable to make good any loss or damage happening without his fault.
The issue was whether Lennard’s knowledge was also the company’s
knowledge that the ship was unseaworthy.
The court held that Lennard was the Directing mind and will of the company
his knowledge was the knowledge of the company, his fault the fault of the
company and since he knew that the ship was unseaworthy, his fault was
also the company’s fault and therefore the company was liable. As per
Viscount Haldane
“My Lords a corporation is an abstraction. It has no mind of its own
anymore than it has a body of its own. Its active and directing will must
consequently be sought in the person of somebody who for some purposes
may be called an agent but who is really the directing mind and will of the
corporation, the very ego and centre of the personality of the corporation.
Here the Plaintiffs who were tenants in certain business premises were
entitled to a renewal of their tenancy unless the landlords who were a limited
company intended to occupy the premises themselves for their business
purposes. The issue was whether the Defendant company had effectively
formed this intention. There had been no formal general meeting or Board
of Directors meeting held to consider the question but the managing
director’s clearly manifested the intention to occupy the premises for the
company’s business.
The court held that the intention manifested by the Directors was the
company’s intention and therefore the tenants were not entitled to a renewal
of the tenancy.
47
Denning L.J. as he then was stated as follows:
“a company may in many ways be likened to a human being. It has a
brain and nerve centre which controls what it does. It also has hands which
hold the tools and act in accordance with the directions from the centre.
Some of the people in the company are mere servants and agents who are
nothing more than hands to do the work and cannot be said to represent the
mind and will of the company. Other are directors and managers who
represent the directing mind and will of the company and control what it
does. The state of mind of these managers is the state of mind of the
company and are treated by the law as such. Whether their intention is the
company’s intention depends on the nature of the matter under
consideration, the relative position of the officer or agent and other relevant
facts and circumstances of the case.”
Crossly connected with this aspect is the so called rule in Turquand’s case:
This rule deals with a company’s liability for acts of its officers. The
question as to whether or not the company is bound or not depends on the
normal agency principles. If a company’s officer or a company’s organ does
an act within the scope of its authority, the company will be bound. The
problem which might arise is that even if the Act in question is within the
scope of the organs or officers authority, there might be some irregularity in
the action of the organ concerned and consequently in the exercise of
authority. For example, if a particular act can only be valued if done by the
Board of Directors or the general meeting, the meeting might have been
convened on improper notice or the resolution may not have been properly
carried. In the case of the Directors, they may not have been properly
appointed. In these circumstances can the company disclaim an act which
was so done by arguing that the meeting was irregular? Must a third party
dealing with the company always ascertain that the company’s internal
regulations have been complied with before holding the company liable?
The answer to this question was given in the negative in the case of
Here under the Company’s constitution the directors were given power to
borrow on bond such sums of money as from time to time by a general
48
resolution be authorised to be borrowed. Without any such resolution
having been passed, the directors borrowed a certain sum of money from the
Plaintiff’s bank. Upon the company’s liquidation the bank sought to recover
from the liquidator who argued that the Bank was not bound to recover it as
it was borrowed without authority from the general meeting.
The court held that even though no resolution had been passed, the company
was nevertheless bound by the act of the directors and therefore was bound
to repay the money.
This is the rule in Turquand’s Case which is often referred to as the rule as
to indoor management.
But should the company always be held liable for the act of any people
purporting to act on the company’s behalf? Suppose these persons are
impostors, what happens?
49
In order to avoid this some limitations have been imposed on the rule. Later
cases have refined the rule to a point where the position appears to that
ordinary agency principles will always apply
Here a mining company was founded by W and his friends and relatives.
Subscriptions were obtained from applicants for shares. These monies were
paid into the bank which had been described in the prospectus as the
company’s bank. The communication of the letter was sent to the Bank by a
person describing himself as the Company’s secretary to the effect that in
accordance with a resolution passed on that day, the bank was to pay out
cheques signed by either two of the three named directors whose signatures
were attached and countersigned by the Secretary. The bank thereafter
honoured cheques so signed. When the company’s funds were almost
exhausted, the company was ordered to be wound up. It was then
discovered that no meeting of the Shareholders had been held, and no
appointment of Directors and Secretary met but that with his friends and
relatives, W had held themselves to be secretary and directors and had
appropriated the subscription money. The issue was whether the Bank was
liable to refund the money it had paid back to the borrower.
The court held that the bank was not liable to refund any money to the
company as it had honoured the company’s cheques in reliance on a letter
received and in good faith.
50
Lord Hatherly stated
Directors will not necessarily and for all purposes be insiders. The test
appears to be whether the acts done by them are so closely related to their
position as directors as to make it impossible for them not to be treated as
knowing the limitations on the powers of the officers of the company with
whom they have dealt. Otherwise a third party dealing with a company
through an officer who is or is held out by the company as a particular type
of officer e.g. a Managing Director and who purports to exercise a power
which that sort of officer will usually have is entitled to hold the company
liable for the officer’s acts even though the officer has not been so appointed
or is in fact exceeding his authority as long as the third party does not know
that the company’s officer has not been so appointed or has no actual
authority.
A third party however, will not be protected if the circumstances are such as
to put him on inquiry. He will also lose protection if the public documents
make it clear that the officer has no actual authority or could not have
authority unless a resolution had been passed which requires filing in the
Companies Registry and no such resolution had been filed. These are
normal agency principles.
In this case Kapool & Hoon formed a private company which purchased
Buckhurst Park Estate. The Board of Directors consisted of Kapool, Hoon
and two others. The Articles of the company contained a power to appoint a
Managing Director but none was appointed. Though never appointed as
such, Kapool acted as Managing Director. In that capacity he engaged the
Plaintiffs who were a firm of Architects to do certain work for the company
which was duly done. When the Plaintiff’s claimed remuneration, according
51
to the agreement, the company replied that it was not liable because Kapool
had no authority to engage them.
The Court held that the act of engaging Architects was within the ordinary
ambit of the authority of a Managing Director of a property company and the
Plaintiffs did not have to inquire whether a person with whom they were
dealing with was properly appointed. It was sufficient for them that under
the Articles, the Board of Directors had the power to appoint him and had in
fact allowed him to act as Managing Director. Four conditions must
however be fulfilled in order to entitle a third party to enforce a contract
entered to on behalf of the company by a person who has no actual authority.
1. It must be shown that there was a representation that the agent had
authority to enter into a contract of the kind sought to be enforced;
2. Such representation must be made by a person or persons who had
actual authority to manage the company’s business either generally
or in respect of those matters to which the contract relates;
3. It must be shown that the contract was induced by such
representation;
4. It must be shown that neither in its Memorandum or under its
Articles was the company deprived of the capacity either to enter
into a contract of the kind sought to be enforced or to delegate
authority to do so to the agent.
52
The court held that as a chairman he performed the functions of the
Managing Director with a full knowledge of the Board of Directors and that
a contract of service as the one entered into with the Secretary was one
which a person performing the duties of a Managing Director would have
power to enter into on behalf of the company. Therefore, the contract was
genuine, valid and enforceable. If however, the officer is purporting to
exercise some authority which that sort of officer would not normally have,
a third party will not be protected if the officer exceeds his actual authority
unless the company has held him out as having authority to act in the matter
and the third party has relied thereof i.e. unless the company is estopped.
However, a provision in the Memorandum or Articles or other public
document cannot create an estoppel unless the third party knew of the
provision and has relied on it. For this purpose, regulations at the
Companies Registry do not constitute notice because the doctrine of
constructive notice operates negatively and not positive. If a document
purporting to be received by or signed on behalf of the company is proved to
be a forgery, it does not bind the company. However, the company may be
estopped from claiming the document as a forgery if it has been put forward
as genuine by an officer acting within his usual or ostensible authority.
Look at
Rama Corp v Proved Tin & General Investment (1952) 2 Q.B. 147
PROMOTERS
The Companies Act does not define the term promoter but Section 45(5)
says
“A promoter is a promoter who was a party to the preparation of the
prospectus.’
‘Apart from the fact that this definition does not speak much, it nevertheless
shows that the definition is only given for the purposes of that section.
At common law the best definition is that by Chief Justice Cockburn in the
case of
53
Cockburn says “a promoter is one who undertakes to form a company with
reference to a given project and to set it going and who takes the necessary
steps to accomplish that purpose.”
DUTIES OF A PROMOTER
His duty is to act bona fide towards the company. Though he may not
strictly be an agent, or trustee for a company, anyone who can be properly
regarded as a promoter stands in a fiduciary relationship vis-à-vis the
company. This carries the duties of disclosure and proper accounting
particularly a promoter must not make any profit out of promotion without
disclosing to the company the nature and extent of such a Promotion.
Failure to do so may lead to the recovery of the profits by the company.
The question which arises is – Since the company is a separate legal entity
from members, how is this disclosure effected?
54
The facts were as follows
The promoters of a company sold a lease to the company at twice the price
paid for it without disclosing this fact to the company. It was held that the
promoters breached their duties and that they should have disclosed this fact
to the company’s board of directors. As Lord Cairns said
“the owner of the property who promotes and forms that company to
which he sells his property is bound to take care that he sells it to the
company through the medium of a Board of Directors who can exercise an
independent judgment on the transaction and who are not left under belief
that the property belongs not to the promoters and not to another person.”
Since the decision in Salomon’s case it has never been doubted that a
disclosure to the members themselves will be equally effective. It would
appear that disclosure must be made to the company either by making it to
an independent Board of Directors or to the existing and potential members.
If to the former the promoter’s duty to the company is duly discharged,
thereafter, it is upon the directors to disclose to the subscribers and if made
to the members, it must appear in the Prospectus and the Articles so that
those who become members can have full information regarding it.
Since a promoter owes his duty to a company, in the event of any non-
disclosure, the primary remedy is for the company to bring proceedings for
1. the company should not have done anything to ratify the action
2. There must be restitutio in intergram (restore the parties to their
original position),
REMUNERATION OF PROMOTERS
A promoter is not entitled to any remuneration for services rendered for the
company unless there is a contract so enabling him. In the absence of such a
55
contract, a promoter has no right to even his preliminary expenses or even
the refund of the registration fees for the company. He is therefore under the
mercy of the Directors. But before a company is formed, it cannot enter into
any contract and therefore a promoter has to spend his money with no
guarantee that he will be reimbursed.
But in practice the articles will usually have provision authorising directors
to pay the promoters. Although such provision does not amount to a
contract, it nevertheless constitutes adequate authority for directors to pay
the promoter.
One of the issues in this case was whether or not a company could ratify a
contract entered into on its behalf before incorporation. The alleged contract
was that the Respondent had undertaken to sell some property to a company
which was proposed to be formed between him and the Appellant. In
holding that a company cannot ratify such an agreement, the Eastern Africa
Court of Appeal as then constituted O’Connor President said as follows
“A company cannot ratify a contract purporting to be made by
someone on its behalf before its incorporation but there may be
circumstances from which it may be inferred that the company after its
incorporation has made a new contract to the effect of the old agreement.
The mere confirmation and adoption by Directors of a contract made before
the formation of the company by persons purporting to act on behalf of the
company creates no contractual relations whatsoever between the company
and the other party to the contract.”
However, acts may be done by a company after its formation which give rise
to an inference of a new contract on the same terms as the old one.
56
The question whether there is a new contract or contracts is always a
question of facts which depends on the circumstances of each individual
case.
The Respondents filed actions praying for orders that the shares they paid
for be allotted to them and the company’s registered members be rectified
accordingly.
The Company argued that as the Respondents had paid money for the
purchase of their shares before incorporation, their claim could only be
directed against promoters because no pre incorporation agreement could
bind the company and the company could not even after incorporation ratify
or adopt any such contract.
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.
57
Although the principle is clear, those engaged in the formation of companies
often cause contracts to be entered into on behalf of their proposed
companies.
In this case, A, B and C entered into a contract with the Plaintiff to purchase
goods “on behalf of the proposed Gravesand Royal Alexandra Hotel
Company” the goods were duly supplied and consumed. Shortly after
incorporation the company in question collapsed and the Plaintiff sued A B
and C for the price of the goods supplied.
It was held that A B and C were liable. Chief Justice Erne stated as follows:
“where a contract is signed by one who professes to be signing as
agent but who has no principal existence at the time, then the contract will
hold together the inoperative unless binding against the person who signed
it. He is bound thereby and a stranger cannot by subsequent ratification
relieve him from that responsibility. When the company came afterwards
into existence, it had rights and obligations from that time but no rights or
obligations by reason of anything which might have been done before.”
Here a contract was entered into between Leopold Newborn London Ltd and
the Defendant for purchase of goods by the latter. The defendant
subsequently refused to take delivery of the goods and an action was
commenced by Leopold Newborn Ltd.
It was discovered that at the time the contract was entered into, the company
had not been incorporated. Leopold Newborn thereupon sought personally
to enforce the contract.
It was held that the signature on the document was the company’s signature
and as the company was not in existence when the contract was signed, there
never was a contract and Mr. Newborn could not come forward and say that
58
it was his contract. The fact was that he made a contract for a company
which did not exist.
PROSPECTUSES
The word invitation and offering in that definition are loosely used because
when a company issues a prospectus it does not offer to sell any shares but
rather invites offers from members of the public. A prospectus is therefore
not an offer but an invitation to treat.
59
A newly formed company issued 3000 copies of a document which offered
for subscription shares in a company and which was headed “for private
circulation only”. These copies were then circulated to the shareholders of a
number of gas companies and the question arose Was this a prospectus?
The court held that this was an offer to the public and therefore constituted a
prospectus.
CONTENTS OF A PROSPECTUS
1. Who the directors are; and What benefits they will get from the
Directorship;
2. In the case of a new company, what profits are being made by
the promoters;
3. the amount of capital required by the company to be subscribed,
the amount actually received or to be received, the precise
nature of the consideration which is not paid in cash;
4. In the case of an existing company, what the company’s
financial records has been in the past.
5. the company’s obligations under any contracts it has entered
into;
6. the voting and dividend rights of each class of shares;
7. If a Prospectus includes any statement by an expert, then the
expert must have given his written consent to the inclusion of
the statement and the prospectus must state that he has done so
as per Section 42 of the Companies Act.
60
Section 42 defines Expert as including “Engineer, Valuer, Accountant or any
other person whose profession gives authority to the statement made by
him.”
In addition to these requirements the prospectuses must also be dated and the
date stated therein is taken to be the date of publication of the prospectus.
However, there are two instances when a prospectus need not contain the
matter set out in Schedule III namely
1. When the prospectus is issued to existing members or shareholders
of the company;
2. When the prospectus relates to shares or debentures uniform with
previously issued shares or debentures.
In this case the company had sustained continuous loses for over 6 years
from 1921 to 1927. The company issued a prospectus which in all material
facts was correct. It further specified that the dividends being paid were
high. But these dividends were being paid out of abnormal profits made
after World War 1. Therefore the Prospectus was misleading in its context.
CIVIL REMEDIES
61
There are two primary remedies for those who subscribe for shares in a
company as a result of a misrepresentation in a prospectus
(a) Damages;
(b) Rescission of any resulting contract.
DAMAGES
Section 45 provides for compensation to all persons who subscribe for any
shares or debentures on the faith of the Prospectus for loss or damage they
may have sustained by reason of untrue statements included therein. If the
statement is false to the knowledge of those who made it, then this amounts
to fraud and damages will be recoverable from all those who made the
statement intending it to be acted upon. Refer to the case of
The Court held that the Defendants were not liable as they had made the
incorrect statement in the honest belief that it was true. Lord Herschell said
“the authorities establish two major propositions.
(i) In order to sustain an action of Deceit, there must be proof of
fraud and nothing short of that will suffice;
(ii) Fraud is proved when it is shown that a false representation has
been made either;
(a) Knowingly or
(b) Without belief in its truth; or
(c) Recklessly not caring whether it be true or false.
In order to succeed in an action for damages for fraud the plaintiff must
show that the Misrepresentation was made to him or that he was one of a
62
class of persons who were intended to act upon it. The ordinary purpose of a
prospectus is to invite members of the public to become allottees of shares in
a company. Once the shares have been allotted therefore the prospectus will
have served its purpose and thereafter it cannot be used as a ground for filing
an action for fraud in respect of shares bought at a later date from another
source. Reference made to the case of
The court held that the Plaintiff could not base his action on the prospectus
which was intended to be addressed only to the original company
subscribers to the company shares. The Directors of a company are not
liable after the full original allotment of shares for all the subsequent
dealings which may take place with regard to those shares on the stock
exchange.
However, the rule in Peek v. Gurney will not apply where a prospectus is
intended to induce not only the original subscribers for the company shares
but also to influence the subsequent purchase of those shares
Here the Plaintiff alleged that the Defendant sent him a prospectus inviting
him to buy shares in the company which they knew would be a sham but the
Plaintiff did not subscribe for the shares. The prospectus eventually
produced a very scanty subscription and the Defendant caused a telegram to
be published in the local Newspaper to the effect that they had struck a vain
of Gold. And this they alleged had confirmed the statistics in the
prospectus.
The Plaintiff immediately bought shares on this basis. The company was
wound up. The question arose, Had the Prospectus served its purpose.
63
The court held that the prospectus was intended to induce the Plaintiff both
to subscribe for shares initially and also to buy them in the Market
thereafter. The telegram was part of the prospectus.
RESCISSION
2. If the allotee does not rescind the contract before the company is
wound up, he loses the right to do so as from the moment the
winding up proceedings commenced. The rationale is the
protection of the other company’s creditors.
64
DIRECTORS DUTIES
The Plaintiff brought an action to set aside the share sales on the ground that
the directors owed them a duty to disclose the negotiations with the 3 rd Party.
It was held that the Directors were not agents for the individual shareholders
and did not owe them any duty to disclose. Therefore the sale was proper
and could not be set aside. However, if the Directors are authorised by the
members to negotiate on their behalf e.g. with a potential purchaser then the
Directors will be in a position of agents for such members and will owe
them a duty accordingly.
These duties except where expressly stipulated in the Companies Act are not
restricted to directors alone but apply equally to any officials of the company
who are authorised to act as agents of the company and in particular to those
acting in a managerial capacity. This is particularly so as regards fiduciary
duties.
65
70. (1) A private company, whether limited or unlimited,can convert itself
into a public company limited by shares if (but only if)-
(a) it passes a special resolution to that effect; companv
(b) the conditions specified in subsection (2) are satisfied; and
(c) an application for registration of the conversion is lodged with the
Registrar in accordance with section 74, together with the documents
required by that section.
(2) The conditions are-
(a) that the company has a share capital;
(b) that the requirements of section 7l are satisfied as regards its share
capital;
(c) that the requirements of section 72 are satisfied as regards its net assets;
(d) if section 73 applies, that the requirements of that section are satisfied;
(e) that the company has not previously been converted itself into an
unlimited company;
(f) that the company has made such changes to itsname and to its articles as
are necessary inorder for it to become a public company; and
(g) if the company is unlimited, that it has alsomade such changes to its
articles as are necessary in order for it to become a company limited by
shares.
7l (1) Requirements
66
DIRECTORS’ DUTIES PROPER
1. duties of care and skill in the conduct of the company’s affairs; and
2. Fiduciary duties of loyalty and good faith.
It was held that the Directors were negligent. Justice Romer reduced the
Directors duties of care and skill as follows
“A Director need not exhibit in the performance of his duties a greater
degree of skill than may reasonably be expected from a person of his
knowledge and experience.”
67
subjective because a reasonable man would be expected to have the
knowledge of a director with his experience. Refer to
In this case a company had five directors and one of them confessed that he
was absolutely ignorant of business. A second one was 75 years old and
very deaf. A third one said he only agreed to become a director because he
saw one of his friends names on the list of directors. The other two were
fairly able businessmen. The directors caused a contract to be entered into
between the company and a certain syndicate for purchase by that company
of some rubber plantation in Brazil. The prospectus issued by the company
contained false statements about the acreage of the Plantation, the types of
trees and so forth. The information given therein was given to the Directors
by a person who had an original option to purchase that property. He had
never been to Brazil and the data was based on his own imagination. The
Directors caused the company to purchase the property. The question arose,
were they negligent in so doing?
The court held that their conduct did not amount to gross negligence.
Neville J. had the following to say:
“It has been laid down that so long as they act honestly, Directors
cannot be made responsible in damages unless they are guilty of gross
negligence. A Director’s duty requires him to act with such care as is
reasonably expected from his having regard to his knowledge and
experience. He is not bound to bring any special qualifications to his
office. He may undertake the Management of a Rubber Company in
complete ignorance of anything connected with Rubber without
incurring responsibility for the mistakes which may result from such
ignorance. While if he is acquainted with the Rubber business, he
must give the company the advantage of his knowledge when
transacting the company’s business. He is not bound to take any
definite part in the conduct of the company’s business but insofar as
he undertakes it he must use reasonable care. Such reasonable care
must be measured by the care an ordinary man might be expected to
take in the same circumstances on his own behalf.”
68
committee of the Board on which he is placed. He is not bound to
attend all such meetings though he ought to attend whenever in the
circumstances he is reasonably able to do so. Refer to the case of
The Court held that a Director is not bound to attend every Board meeting
and that he is not liable for misfeasance committed by his co-directors at
Board meetings at which he was never present.
Here the Director never attended any Board meetings for 38 years. It was
held that he was not liable.
69
A bank sustained heavy losses by advances made improperly to customers.
The irregular nature of advances was concealed by means of fraudulent
Balance Sheets which were the work of the General Manager and the
Chairman in assenting to the payment of dividends out of capital and those
advances on improper security were done on the advice of the general
manager and chairman.
The court held that the reliance placed by the co-director on the general
manager and chairman was reasonable. He was not negligent and therefore
was not liable for not having discovered the fraud as he was not in the
absence of circumstances of suspicion bound to examine entries in the
Company’s Books to see that the Balance Sheet was correct.
It may be said that the duties of care and skill appear to be negative duties.
What about fiduciary duties?
FIDUCIARY DUTIES
1. The Directors must always act bona fide in what they consider and
not what the courts may consider to be in the best interest of the
company. In this context, the term company means the present and
future members of the company on the basis that the company will
be continued as a going concern thereby balancing long-term view
against short term interests of existing members.
2. The directors must always exercise their powers for the particular
purpose for which they were conferred and not for extraneous
purposes even if the latter are considered to be in the best interests
of the company. For example the Directors are invariably
empowered to issue capital and this power should be exercised for
only raising more funds when the company requires it. Hence it
will be a breach of the Directors’ duties to issue the company
shares for the purpose of entrenching themselves in the control of
the company’s affairs. Refer to the case of Punt v. Symons (1903)
2 Ch. 506 in this case the directors issued shares with the object of
creating a sufficient majority to enable them to pass a special
resolution depriving the other shareholders of some special rights
conferred upon them by the company’s articles. It was held that a
70
power of a kind exercised by the Directors in this case was a power
which must be exercised for the benefit of the company. Primarily
this power is given to them for the purpose of enabling them to
raise capital for the purposes of the company. Therefore a limited
issue of shares to persons who are obviously meant and intended to
secure the necessary statutory majority in a particular interest was
not a fair and bona fide exercise of the power.
A company had two directors. They fell out of favour with the
majority of the shareholders who were therefore threatened with
the election of 3 other directors to the Board. The directors issued
shares with the object of creating a sufficient majority to enable
them to resist the election of the 3 additional directors whose
election would have put the two directors in the minority on the
Board.
The Court held that the Directors were not entitled to use their
powers of issuing shares merely for the purpose of maintaining
their control or the control of themselves and their friends over the
affairs of the company or even merely for the purpose of defeating
the wishes of the existing majority of shareholders. The Plaintiff
and his friends held the majority of shares in the company and as
long as that majority remained, they were entitled to have their
wishes prevail in accordance with a company’s regulations.
Therefore it was not open to the directors for the purpose of
converting a minority into a majority and purely for the purpose of
defeating the wishes of the existing majority to issue the shares in
dispute.
In this case the company had two classes of shares, ordinary and
preference shares. Each share carried 1 vote. The power to issue
the company shares was vested in the Directors. They learnt that a
71
takeover bid was to be made to the Shareholders. In the Bona fide
belief that the acquisition of control by the prospective take over
bidder will not be the interest of the company or its staff. The
Directors decided to forestall this move. They therefore attached
10 votes to each of the unissued preference shares and allotted to a
trust which was controlled by the Chairman of the Board of
Directors and one of his partners in the company’s audit
department and an employee of the company. To enable the
trustees to pay for the shares, the directors provided them with an
interest free loan out of the company’s reserve fund.
There were similar facts as in the former case but a meeting was
held before proceeding to court and that general meeting ratified
the Director’s action. The question also arose in this case, could a
decision of the general meeting cure the irregularity?
The court held if the allotment was made in bad faith, it was
voidable at the instance of the company because it was a wrong
done to the company and that being so, the company which has the
rights to recall the allotment has also the right to approve it and
forgive the breach of duty.
3. They must not fetter their displeasure to act for the company for
example, the directors cannot contract either among themselves or
with third parties as to how they will vote at future Board
meetings. However, where they have entered into a contract on
behalf of the company they may validly agree to take such further
action at Board meetings as maybe necessary to carry out such a
contract.
72
LAW OF BUSINESS ASSOCIATIONS Lecture 7
FIDUCIARIES CONTINUED
73
not be counted on the issue. At their widest the articles might allow the
director to be counted at Board meeting.
In order to create a balance between these two extremes and ensure that a
minimum standard prevails Section 200 was incorporated into the
Companies Act. Under this Section it is the duty of a director who is
interested in any contract or proposed contract to disclose the nature and
extent of his interest to the Board of Directors when the contract comes up
for discussion. Failure to do so renders the defaulting director liable to a
fine not exceeding 2000 shillings. In addition the failure also brings in the
equitable doctrine whereby the contract becomes voidable at the option of
the company and any profit made by the director is recoverable by the
company.
The shortcoming of the Section is that the Director has to disclose to the
Board of Directors and not to the general meeting. It is not sufficient for a
Director to say that he is interested. He must specify the nature and extent
of his interests. If the company’s articles take the form of Article 84 of
Table ‘A’ then a Director who is so interested is required to abstain from
voting at the Board meeting and his vote will not be taken in determining
whether or not there is a quorum on the Board. Once the Director has
complied with Section 200 and Article 84 then he can escape liability.
In respect of all other profits which a Director may make are out of his
position as a Director the equitable principle which requires the Directors to
account for any such profits is vigorously enforced. This is because the
Courts have equated Directors to trustees and their duties have also been
equated to those of Trustees. The question is, are they really trustees?
In the latter case, the directors of a company were seen to be trustees only in
respect of the company’s funds or property which was either in their hands
or which came under their control. But this does not necessarily make
directors trustees. There are two basic differences between Directors as
Trustees and Ordinary Trustees.
74
(a) The function of ordinary trustee is to preserve the Trust
Property but the role of a director is to explore possible
channels of investment for the benefit of the company and these
necessitates some elements of having to take a risk even at the
expense of the company’s property.
(b) Whereas trust property is vested in the Trustees, a company’s
property is held by the company itself and is not vested in the
trust.
Nevertheless if the directors make any secret profits out of their positions
then the effect is identical to that of ordinary trustees. They must account
for all such profits and refund the company.
Herein the company owned a cinema and the directors decided to acquire
two other cinemas with a view to the sale of the entire undertaking as a
going concern. Therefore they formed a subsidiary company to invite the
capital of 5000 pounds divided into 5000 shares of 1 pound each. The
owners of the two cinemas offered the directors a lease but required personal
guarantees from the Directors for the payment of rent unless the capital of
the subsidiary company was fully paid up. The directors did not wish to
give personal guarantees. They made arrangements whereby the holding
company subscribed for 2000 shares and the remaining shares were taken up
by the directors and their friends. The holding company was unable to
subscribe for more than 2000 shares. Eventually the company’s
undertakings were sold by selling all the shares in the company and
subsidiary and on each share the Directors made a profit of slightly more
than two pounds. After ownership had changed the new shareholders
brought an action against the directors for the recovery of profits made by
them during the sale.
The court held that the company as it was then constituted was entitled to
recover the profits made by the Directors. Lord Macmillan had the
following to say:
75
of the opportunities and special knowledge and what they did resulted in a
profit to themselves.”
In this case Boardman was a solicitor to the trust of the Phipps family. The
trust held some shares in the company. Boardman and his colleagues were
not satisfied with the company’s accounts and therefore decided to attend the
company’s general meeting as representatives of the Trust. At the meeting
they received information pertaining to the company’s assets and their value.
Upon receipt of the information, they decided to buy shares in the company
with a view to acquiring the controlling interest. Their takeover bid was
successful and they acquired control. Owing to the fact that Boardman was
a man of extraordinary ability, the company made progress and the profits
realised by Boardman and his friends on the one hand and the trusts on the
other were quite extensive. One of the beneficiaries of the Trust brought an
action to recover the profits which were realised by Boardman and his
friends.
The court held that in acquiring the shares in the company, Boardman and
his friends made use of information obtained on behalf of the trust and since
it was the use of that information which prompted them to acquire the
shares, then the shares were also acquired on behalf of the trust and thus the
solicitors became constructive trustees in respect of those shares and
therefore liable to account for the profits derived therefrom to the trust.
76
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.
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
77
potential contracting party to the gas company in conflict with the existing
and continuing duty as the Plaintiff’s Managing Director.
Roskill J.
“It is an overriding principle of equity that a man must not be allowed
to put himself in a position where his fiduciary duty and interest
conflict. It was the defendant’s duty to disclose to the plaintiff the
information he had obtained from the Gas Board and he had to
account to them for the profits he made and will continue to make as a
result of allowing his interests and duty to conflict. It makes no
difference that a profit is one which the company itself could not have
obtained. The question being not whether the company could have
acquired it but whether the defendant acquired it while acting for the
company.”
By controlling share holders is meant those who hold the majority of the
voting rights in the company. Such share holders can always ensure control
of the company’s business by virtue of their voting power to ensure that the
controlling shareholders do not use their voting power for exclusively selfish
ends, the Law requires that in exercise of their voting power, these
shareholders must not defraud a minority. For example by endeavouring
directly or indirectly to appropriate to themselves any money property or
advantage which either belong to the company or in which the minority
shareholders are entitled to participate.
In the latter case the company brought action against its former Managing
Director for a declaration that the concessions for laying down a telegraph
cable from Portugal to Brazil was held by that former Director as a trustee
for the company. While this action was still pending, the Defendants who
were the majority shareholders in the company approached that former
Managing Director with a view to striking a compromise. It was agreed
between the parties that if that director surrendered the concessions to the
Defendants then the Defendants would use their voting power to ensure that
the action was discontinued. At a subsequent general meeting of the
78
company, by virtue of the defendant’s voting power, a resolution was passed
that the company should be wound up.
The court said that the resolution was invalid since the defendants had used
their voting power in such a way as to appropriate to themselves the
concessions which if the earlier action had succeeded should have belonged
to the whole body of shareholders and not merely to the majority. Lord
Justice Mellish stated as follows:
“although the shareholders of the company may vote as they please
and for the purpose of their own interest, yet the majority of the shareholders
cannot sell the assets of the company itself and give the consideration but
must allow the minority to have their share of any consideration which may
come to them.”
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
79
In this case the Directors who were also the company’s promoters sold the
company’s property at an undisclosed profit. Two shareholders brought
action against them alleging that in so doing, that the directors had breached
their duties to the company. It was held that if there was any breach of duty,
it was a breach of duty owed to the company and therefore the Plaintiffs had
no locus standi for the company was the proper plaintiff. This rule has two
practical advantages namely:
1. Insistence on an action by the company avoids multiplicity of
actions;
2. If the irregularity complained of is one which could have been
effectively ratified by the company in general meeting, then it is
pointless to commence any litigation except with the consent of the
general meeting.
80
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.
Another remedy against directors for breach is found in Section 324 of the
statute which provides as follows:
“If in the course of the winding up of the company it appears that any
person who has taken part in the formation or promotion of the company or
any past or present director has misapplied or retained any money or
property of the company, or been guilty of any breach of trust in relation to
the company on the application of the liquidator, a creditor or member or a
court may compel such person to restore the money or property to the
company or to pay damages instead.”
This section is designed to deal with actual breaches of trust which come to
light in the winding up proceedings or during the winding up proceedings
but winding up itself may be used as a means of ending a course of
oppression by those formally in control. Among the grounds for the
winding up is one which is particularly appropriate for such circumstances.
Under Section 219 (f) of the Companies Act the court may order a company
to be wound up if it is of the opinion that it is “just unequitable” the courts
have so ordered when satisfied that it is essential to protect the members or
any of them from oppression in particular they have done so when the
conduct of those in control suggests that they are trying to make intolerable
the position of the minority so as to be able to acquire the shares held by the
minority on terms favourable only to the majority. But a member cannot
petition under this section if the company is insolvent. If the company is
solvent to wind it up, contrary to the majority wishes will only be granted
where a very strong case against the majority is established.
81
being conducted in a manner oppressive to some part of the members
including himself may petition the court which if satisfied that the facts will
justify a winding up order but that this will unduly prejudice that part of the
members, may make such order as it thinks fit. Such an order may regulate
the conduct of the company’s affairs in the future or may order the purchase
of member shares by others or by the Company itself. This remedy is
available only to the members. An oppressed director or creditor cannot
obtain any remedy under Section 211 of the Companies Act for this is
expressly restricted to oppression of the members even if a director or
creditor also happens to be a member.
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
Here the Society wished to enter into the retail business. For this purpose a
subsidiary company was formed in which the two Respondents and 3
Nominees of the Society were the directors. The society had majority
shareholders and the Respondents were the minority. The Company
required 3 things namely;
1. Sources of supplies of raw material;
2. A licence from a regulatory organisation called cotton control
3. Weaving Mills.
The Respondents provided the first two but weaving Mills belonged to the
society. For several years, the business prospered because of mainly the
knowhow provided by the Respondent. The company paid large dividends
82
and accumulated substantial results. Due to the prosperity, the society
decided to acquire more shares and through its nominee directors offered to
buy some of the shares of the Respondent at their nominal value which was
one pound per share but their worth was actually 6 pounds per share. When
the Respondents declined to sell their shares to the society, the society
threatened to cause the liquidation of the company. About 5 years later,
Cotton control was abolished which meant that the society would obtain the
raw materials and weave cloth without a licence. It accordingly started to do
the same and also started starving the subsidiary by refusing to manufacture
for it except for an economic crisis. As all the other Mills were fully
occupied, the subsidiary company was being starved to death and when it
was nearly dead the Respondent brought the petition claiming that the affairs
of the company were being conducted in an oppressive manner.
It was held that by subordinating the interests of the company to those of the
society, the nominee directors of the society had thereby conducted the
affairs of the company in a manner oppressive to the other shareholders.
The fact that they were perhaps guilty of inaction was irrelevant. The affairs
of the company can be conducted oppressively by the Directors doing
nothing to protect its interests when they ought to do so.
Re Hammer(1959) 1 WL.R. 6
In this case Mr. Hammer senior was a Philatelist (stamp collector) dealer and
incorporated business in 1947 forming a company with two types of
ordinary shares class A shares which were entitled to a residue of profit and
Class B Shares carrying all the votes. He gave out the shares to his two sons
and at the time of the petition each son held 4000 Class A shares and the
father owned 1000 shares. Of the Class B Shares, the father and his wife
held nearly 800 to the 100 held by each son. Under the Company’s articles
of association, the father and two sons were appointed directors for life and
the father was further appointed chairman of the Board with a casting vote.
The father assumed powers he did not possess ignored decisions of the
Board and even in court, during the hearing asserted that he had full power
to do as he pleased while he had voting control. He dismissed employees
using his casting vote to co-opt self directors, he prohibited board meetings,
engaged detectives to watch the staff and secured payment of his wife’s
expenses out of the company’s funds. He negotiated sales and vetoed leases
all contrary to the decisions and wishes of the other directors.
83
The sons filed an action claiming that the father had run the affairs of the
company in a manner oppressive to them. The father was 88 years.
The court held that by assuming powers which he did not possess and
exercising them against the wishes of those who had the major beneficial
interests, Mr. Hammer senior had conducted the company’s affairs in an
oppressive manner.
These two cases are among the few where an application under Section 211
has succeeded. This is because section 211 has been subjected to a very
restrictive meaning. To succeed under Section 211, one must establish a
case of oppression.
There is no clear definition of the term and therefore it is not easy to tell
when a company’s affairs are being conducted oppressively. For example in
the case of Re Five Minute Car Wash Ltd (1966) 1 W.L.R. 745
84
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.
85
Jessel M.R said as follows “when a person advances money to a company,
his debtor is that artificial entity called the corporation which has no
property except the assets of the business. The creditor therefore gives
credit to that capital or those assets. He gives credit to the company on the
faith of the implied representation that the capital shall be applied only for
the purposes of the business and he has therefore a right to say that the
corporation shall keep its capital and shall not return it to the shareholders.”
The capital fund is therefore seen as a substitute for unlimited liability of the
members. Courts have developed 3 basic principles for ensuring that the
company’s represented capital is actually what it is and for the distribution
of that capital.
1. Once the value of the company’s shares has been stated it cannot
subsequently be changed the problem which arises in this respect is
that shares may be issued for non-monetary consideration. For
instance for services or property in such cases the company’s
valuation of the consideration is generally accepted as conclusive.
If the property has been over valued, provided the valuation has
been arrived at bona fide, the courts will not question the adequacy
of the consideration but if it appears on the face of the transaction
that the value of the property is less than that of the shares, then the
court will set aside that transaction. For this reason the shares in a
company must be given a definite value. The law tries to ensure
that the company initially receives assets at least equivalent to the
nominal value of the paper capital. Refer to Section 5 of the
Companies Act. Unfortunately if in the insistence that shares do
have a definite fixed value is not an adequate safeguard because
there is no legal minimum as to what the nominal value of the
shares should be.
86
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.
(ii) If the value of the company’s fixed assets has fallen thereby
causing a loss in the value of those assets, the company does
not need to make good that loss before treating revenue profits
as available for dividends. It is not legally essential to make
provision for depreciation in the fixed assets. However Losses
of circulating assets in the current accounting period must be
made good before a dividend can be declared. The realised
profits on the sale of fixed assets may be treated as profit
available for distribution as a dividend. Unrealised profits on
evaluation of the company’s assets may also be distributed by
way of dividends. Refer to Dimbula Valley (Ceylon) Tea Co.
V. Laurie [1961] Ch. D 353 Losses on circulating assets made
in previous accounting periods need not be made good. The
dividend can be declared provided that there is a profit on the
current year’s trading. Each accounting period is treated in
isolation and once a loss has been sustained in one trading year,
then it need not be made good from the profits over subsequent
trading periods. Undistributed profits of past years still remain
87
profit which can be distributed in future years until they are
capitalised by using them to pay a bonus issue.
CORPORATE SECURITIES
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.”
88
The indebtedness acknowledged by a debenture is normally but not
necessarily secured by charge over the company’s property. Such charge
could either be a specific charge or a floating charge. Both were defined by
Lord Mcnaghten in the case of Illingsworth v. Houlsworth [1904] A.C. 355
AT 358 He stated
“ a specific charge is one that without more fastens on
ascertained and definite property or property capable of being ascertained
and defined. A floating charge on the other hand is ambulatory and shifting
in its nature, hovering over and so to speak floating with the property which
it is intended to affect until some event occurs or some act is done which
causes it to settle and fasten on the subject of the charge within its reach or
grasp.”
CRYSTALISATION
(a) Where the company defaults in the payment of any portion of the
principal or interest thereon, when such portion or interest is due
and payable. In that event however, the debenture holders rights
will not crystallise automatically. After the expiry of the agreed
period for repayment, the debenture still remained a floating
security until the holders take some step to enforce that security
and thereby prevent the company from dealing with its property;
(b) Upon the appointment of a receiver in the course of a company’s
winding up;
(c) Upon commencement of recovery proceedings against the
company;
89
(d) If an event occurs upon which by the terms for the debenture the
lender’s security is to attach specifically to the company’s assets.
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.
SHARES
In a company with a share capital it is obvious that the company must issue
some shares and the initial presumption of the law is that all the shares so
issued confer equal rights and impose equal liabilities. Normally a
shareholder’s right in a company will fall under 3 heads.
1. Payment of dividends;
2. Refund of Capital on winding up;
3. Attendance and voting at company’s general meetings.
Unless there is indication to the contract all the shares will confer the same
rights under those heads. In practice companies issue shares which confer
on the holders some preference over the others in respect of either payment
of dividends or capital or both. This is the method by which classes of
shares are created i.e. by giving some of the shareholders preference over
others.
90
There are certain rules that courts use to interpret or construe on shares.
(a) Basically all shares rank equally and therefore if some shares
are to have any priority over the others, there must be provision
to this effect in the regulations under which these shares were
issued. Refer to the case of Birch V. Cropper (1889) 14 AC
525 here the company was in voluntary winding up. The
company discharged all its liabilities and some money remained
for distribution to the members. The Articles being silent on
the issue, the question was on what principle should the surplus
be distributed among the preference and ordinary shareholders?
The ordinary shareholders argued that they were entitled to all
the surplus. Alternatively the division ought to be made
according to the capital subscribed and not the amount paid on
the shares. It was held that once the capital has been returned
to the shareholders, they thereafter become equal and therefore
the distribution of the surplus assets should be made equally
between the ordinary and preference shareholders.
91
First that in construing an article which deals with the rights to
share all profits, that is dividend rights and rights to shares in
the company’s property in liquidation, the same principle is
applicable and secondly that principle is that where the articles
sets out the rights attached to a class of shares to participate in
profits while the company is a going concern or to share in the
property of a company in liquidation, prima facie the rights so
set out are in each case exhaustive.”
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.
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
92
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.
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 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.
93
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.
In practice the creditors will petition for a compulsory winding up where the
company is unable to pay its debts. The company’s inability to pay its debts
under Section 220 is deemed in the following circumstances
94
PETITION BY A CONTRIBUTOR
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.
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.
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:
95
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.
96
other than an action brought by one for the dissolution of the partnership
against the other.”
The issue was it just and equitable to wind up the company? Sir Ralph
Winndham C.J. said as follows:
“in these circumstances the principle which must be applied is that
laid down in re-Yenidge Tobacco namely that in the case of a small private
company which is in fact more in the nature of a partnership a winding up on
the just and equitable clause will be ordered in such circumstances as those
in which an order for dissolution of the partnership would be made. In that
case the shareholders were two and they had quarrelled irretrievably. In the
present case, if this were a partnership an order for its dissolution ought to be
made at the instance of one of the quarrelling partners. The material point is
not which party is in the right but the very existence of the quarrel which has
made it impossible for the company to be ran in the manner in which it was
designed to be ran or for the parties disputes to be resolved in any other way
than by winding up.
4. Finally the just and equitable clause will also be applied where
there is justifiable loss of confidence in the manner in which the
company’s affairs are being conducted Continuous Cause of
Conduct
97
Once a company goes into liquidation, all that remains to be done is to
collect the company’s 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 company’s 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
company’s assets are not wasted. Once the company has gone into
liquidation, the directors become functus officio.
The powers of the liquidator are set out in Section 241 of the companies Act.
98