THE LAW OF BUSINESS ASSOCIATIONS I Lecture 1 5.9.

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Section 2 (1) of the Companies Act Cap 486 Laws of Kenya states what company
means as 'a company formed and registered under this Act or an existing
company. This is a very vague definition, in the statute the word company is
not a legal term hence the vagueness of the definition. The legal attributes of
the word company will depend upon a particular legal system.

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

some common object or objects in ordinary usage it is associated with
economic purposes or gain. A company can be defined as an association of
several persons who contribute money or moneys worth into a common stock
and who employ it for some common purpose. Our legal system provides for
two types of associations namely
1. Companies
2. Partnerships.
3. Upcoming is the cooperative society.

The law treats companies in company law distinctly from partnerships in

partnership law. Basically company law consists partly of ordinary rules of
Common law and equity and partly of statutory rules. The common law rules
are embodied in cases. The statutory rules are to be found in the Companies
Act which is the current Cap 486 Laws of Kenya. It should denote that the
Kenya Companies Act is not a self contained Act of legal rules of company law
because it was borrowed from the English Companies Act of 1948 which was
itself not a codifying Act but rather a consolidating Act.

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

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FUNDAMENTAL CONCEPTS OF COMPANY LAW

There are two fundamental legal concepts

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

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

2. The concept of limited liability;

Concept of legal personality

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

LIMITED LIABILITY

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

Under Section 4 (2) (a) of the Companies Act, in a company limited by shares
the members liability to contribute to the companies assets is limited to the
amount if any paid on their shares.

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Under Section 4 (2) (b) of the Companies Act in a company limited by
guarantee the members undertake to contribute a certain amount to the
assets of the company in the event of the company being wound up. Note that
it is the members liability and not the companies liability which is limited. As
long as there are adequate assets, the company is liable to pay all its debts
without any limitation of liability. If the assets are not adequate, then the
company can only be wound up as a human being who fails to pay his debts.
Note that in England the Insolvency Act has consolidated the relationships
relating to . That does not apply here.

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

These underlie the very foundation of company law.

FORMATION OF A LIMITED COMPANY

First in relation to registration under the Companies Act

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

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

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dealing with such matters as shares, share capital, companys meetings and
directors among others;

Both the Memorandum and Articles of Associations must each be signed by

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

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

has a share capital. The fees that one pays on registration will be determined
by the share capital that the company has stated.

d. Declaration of Compliance: this is a statutory declaration made

either by the advocates engaged in the formation of the company or by the
person named in the articles as the director or secretary to the effect that all
the requirements of the companies Act have been complied with where it is
intended to register a public company, Section 184 (4) of the Companies Act
also requires the registration of a list of persons who have agreed to become
directors and Section 182 (1) requires the written consents of the Directors.

These are the only documents which must be registered in order to secure the
incorporation of the company. In practice however two other documents
which would be filed within a short time of incorporation are also handed in at
the same time. These are

1. Notice of the situation of the Registered Office which under

Section 108 of the statute should be filed within 14 days of incorporation;
2. Particulars of Directors and Secretary which under Section 201
of the statute are normally required within 14 days of the appointment of the
directors and secretary. The documents are then lodged with the registrar of
companies and if they are in order then they are registered and the registrar

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

STATUTORY CORPORATIONS

The difference between a statutory corporation and a company registered

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

TYPES OF REGISTERED COMPANY

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

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

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

Section 4 (2) (c) of the Companies Act states that a company not having the
liability of members limited in any way is termed as an unlimited company.
The disadvantage of an unlimited company is that its members will be
personally liable for the companys debts. It is unlikely that promoters will
wish to form an unlimited liability company if the company is intended to
trade. But if the company is merely for holding land or other investments the
absence of limited liability would not matter.

2. If they decide upon a limited company, they must make up their

minds whether it is to be limited by shares or by guarantee. This will depend
upon the purpose for which it is formed. If it is to be a non-profit concern,

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then a guarantee company is the most suitable, but if it is intended to form a
profit making company, then a company limited by shares is preferable.

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

company. Section 30 of the Companies Act defines a private company as one
which by its articles restricts

(i) the rights to transfer shares;

(ii) restricts the number of its members to fifty (50);
(iii) prohibits the invitation of members of the public to subscribe
for any shares or debentures of the company.
(iv) The minimum number of share holders is 2 who must also
sign the MEMO and AOA.

A company which does not fall under this definition is described as a public
company.

In order to form a public company, there must be at least seven (7) subscribers
signing the Memorandum of Association and has unlimited number or has no
maximum number of share holders. Whereas only two (2) persons need to
sign the Memorandum of Association in the case of a private company and has
maximum number of share holders as 50.

ADVANTAGES OF INCORPORATION

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

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

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

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Facts of the case.

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

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

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

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

altogether from the subscribers and though it may be that after incorporation
the business is precisely the same as it was before, and the same persons are
managers, and the same hands receive the profits, the company is not in law
the agent of the subscribers or trustee for them nor are the subscribers as
members liable in any shape or form except to the extent and manner
prescribed by the Act. in order to form a company limited by shares the Act

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requires that a Memorandum of Association should be signed by seven (7)
persons who are each to take one share at least. If those conditions are
satisfied, what can it matter, whether the signatories are relations or
strangers. There is nothing in the Act requiring that the subscribers to the
Memorandum should be independent or unconnected or that they or anyone
of them should take a substantial interest in the undertaking or that they
should have a mind and will of their own. When the Memorandum is duly
signed and registered though there be only seven (7) shares taken the
subscribers are a body corporate capable forthwith of exercising all the
functions of an incorporated company.

The company attains maturity on its birth. There is no period of minority and
no interval of incapacity. A body corporate thus made capable by statutes
cannot lose its individuality by issuing the bulk of its capital to one person
whether he be a subscriber to the Memorandum or not.

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

The significance of the Salomon decision is threefold.

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

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

Since the decision in Salomons case the complete separation of the company
and its members has never been doubted.

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

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The Appellant owner of a timber estate assigned the whole of the timber to a
company known as Irish Canadian Sawmills Company Limited for a
consideration of 42,000. Payment was effected by the allotment to the
Appellant of 42,000 shares fully paid up in 1 shares in the company. No other
shares were ever issued. The company proceeded with the cutting of the
timber. In the course of these operations, the Appellant lent the company
some 19,000. Apart from this the companys debts were minimal. The
Appellant then insured the timber against fire by policies effected in his own
name. Then the timber was destroyed by fire. The insurance company refused
to pay any indemnity to the appellant on the ground that he had no insurable
interest in the timber at the time of effecting the policy.

The courts held that it was clear that the Appellant had no insurable interest in
the timber and though he owned almost all the shares in the company and the
company owed him a good deal of money, nevertheless, neither as creditor or
shareholder could he insure the companys assets. So he lost the Company.

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

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

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

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

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

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

ADVANTAGES OF INCORPORATION

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

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

2. Holding Property: Corporate personality enables the property of the

company to be distinguishable from that of the members. In an incorporated
company, the property of the company is the joint property of all the members
although their rights therein may differ from their rights to separate property
because the joint property must be dealt with according to the rules of the

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society and no individual member can claim any particular asset to that
property.

3. Suing and Being Sued: As a legal person, a company can take action in
its own name to enforce its legal rights. Conversely it may be sued for breach
of its legal duties. The only restriction on a companys right to sue is that it
must always be represented by a lawyer in all its actions.

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

4. PERPETUAL SUCCESSION As an artificial person, the company has

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

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5. TRANSFERABILITY OF SHARES Section 75 of the Companies Act
states as follows The Shares or any other interests of a member in a company
shall be moveable property transferable in the manner provided by the Articles
of Association of the Company. In a company therefore shares are really
transferable and upon a transfer the assignee steps into the shoes of the
assignor as a member of the company with full rights as a member. Note
however that this transferability only relates to public companies and not
private companies.

6. BORROWING FACILITIES: in practice companies can raise their

capital by borrowing much more easily than the sole trader or partnership.
This is enabled by the devise of the floating charge a floating charge has been
defined as a charge which floats like a cloud over all the assets from time to
time falling within a certain description but without preventing the company
from disposing of these assets in the ordinary course of its business until
something happens to cause the charge to become crystallised or fixed. The
ease with which this is done is facilitated by the Chattels Transfer Act which
exempts companies from compiling an inventory on the particulars of such
charges and also by the bankruptcy Act which exempts companies from the
application of the reputed ownership clause. As far as companies are
concerned the goods in the possession of the company do not fall within the
reputed ownership clause. The only disadvantages are three

(i) Too many formalities required in the formation of the

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

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

such documents need to be prepared to establish business as a sole proprietor
or partnership and throughout its life a company is required to file such

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documents as balance sheets and profits and loss accounts on dissolution of
the company it is required to follow a certain stipulated procedure which does
not apply to sole traders and partnerships.

7. IGNORING THE CORPORATE ENTITY (LIFTING THE VEIL OF

INCORPORATION)

Although Salomons case finally established that a company is a separate and

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

for its own debt which will be the logical consequence of the Salomon rule
the members themselves are held liable which is therefore a departure from
principle. The rights of creditors under this section are subject to certain
limitations namely
(i) Only those members who remain after the six month period can
be sued;
(ii) Even these members are liable if they have knowledge of the fact
and only in respect of debts contracted after the expiration of the six months.
Moreover the Section is worded in such a way as to suggest that the remaining
members will be liable only in respect of liquidated contractual obligations.

(iii) FRAUDULENT TRADING the provisions of Section 323 of the

Companies Act come into operation here. It is provided that if in the course of
the winding up of the company it appears that any business has been carried
on with the intent to defraud the creditors, or for any fraudulent purpose, the
courts on the application of the official receiver, the liquidator or member may
declare that any persons who are knowingly parties to the fraud shall be
personally responsible without any limitation on liability for all or any of the
debts or other liabilities of the company to the extent that the court might
direct the liability. This Section does not define the term fraud nor have the

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courts defined it. However, in Re William C. Leitch Ltd (1932) 2 Ch. 71 the
company was incorporated to acquire Williams business as a furniture
manufacturer. The directors of the company were William and his wife and
they appointed William as the Managing Director at a Salary of 1000 per
annum. Within the period of one month, the company was debited with an
amount which was 500 more than what was actually due to William. By that
time the company had made a loss of 2500. Within 2 years of formation, and
while the company was still in financial problems, the directors paid to
themselves the dividends of 250. By the end of the 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 companys
business with intent to defraud and therefore should be held responsible for
the repayment of the companys debts. It was held that since that company
continued to carry on business at a time when William knew that the company
could not comfortably pay its debts, then this was fraudulent trading within
the meaning of Section 323 and William should be responsible for repaying the
debts. These are the words of Justice Maugham J. if a company continues to
carry on business and to incur debts at a time when there is to the knowledge
of the directors no reasonable prospects of the creditors ever receiving
payments of those debts, it is in general a proper inference that the company is
carrying on business with intent to defraud.

The test is both subjective and objective. In the Case of Re Patrick Lyon Ltd
(1933) Ch. 786 on facts which were similar to the Williams case, the same
Judge Maugham J. said as follows: the words fraud and fraudulent purpose
where they appear in the Section in question are words which connote actual
dishonesty involving according to the current notions of fair trading among

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commercial men real moral blame. No judge has ever been willing to define
fraud and I am attempting no definition.

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

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

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

HOLDING & SUBSIDIARY COMPANIES

LAW OF BUSINESS ASSOCIATION Lecture 2 20th February 2004

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

HOLDING AND SUBSIDIARY COMPANIES

One of the most important limitations imposed by the companys Act on the
recognition of the separate personality of each individual company is in
connection with associated companies within the same group enterprise. In

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practice it is common for a company to create an organisation of inter-related
companies each of which is theoretically a separate entity but in reality part of
one concern represented by the group as a whole. Such is particularly the case
when one company is the parent or holding company and the rest are its
subsidiaries.

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

(a) That other company either

(i) is a member of it and controls the composition of its board of

directors or
(ii) Holds more than half in nominal value of its equity share capital or

(b) The first mentioned company is a subsidiary of any company which is that
others subsidiary.

Under Section 150 (1) where at the end of the financial year a company has
subsidiaries, the accounts dealing with the profit and loss of the company and
subsidiaries should be laid before the company in general meeting when the
companys own balance sheet and profit and loss account are also laid. This
means that group accounts must be laid before the general meeting.

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

Section 151(2) it may be observed that the treatment of these accounts in a

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

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MISDESCRIPTION OF COMPANIES

Under Section 109 of the Companies Act it requires that a companys name
should appear whenever it does business on its Seal and on all business
documents. Under paragraph 4 of this Section, if an officer of a company or
any person who on its behalf signs or authorises to be signed on behalf of the
company any Bill of Exchange, Promissory Note, Cheque or Order for Goods
wherein the Companys name is not mentioned as required by the Section,
such officer shall be liable to a fine and shall also be personally made liable to
the holder of a Bill of Exchange Promissory Notes, Cheque or order for the
goods for the amount thereof unless it is paid by the company. The effect of
this section is that it makes a companys officer incur personal liability even
though they might be contracting as the companys agents. Liability under this
Section normally arises in connection with cheques and company officers have
been held liable where for instance the word limited has been omitted or
where the company has been described by a wrong name.

WHERE THERE IS AN AGENCY RELATIONSHIP

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

In this case the Plaintiffs were paper manufacturers in Birmingham City. In the
same city there was a partnership called Birmingham West Company. This
partnership did business as merchants and dealers in waste paper. The

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

The Birmingham Corporation compulsorily acquired the premises upon which

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

If this contention was correct the Birmingham Corporation would have escaped
liability for paying compensation by virtue of a local Act which empowered
them to give tenants notice to terminate the tenancy.

The court held that occupation of the premises by a separate legal entity was
not conclusive on a question of a right to claim and as a subsidiary company it

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 was not operating on its own behalf but on behalf of the parent company.
The subsidiary company was an agent. Lord Atkinson had the following to say
It is well settled that the mere fact that a man holds all the shares in a
company does not mean the business carried on by the company is his business
nor does it make the company his agent, for the carrying on of that business.
However, it is also well settled that there maybe such an arrangement between
the shareholders and the company as will constitute the company. The
shareholders agents for the purpose of carrying on the business and make the
business that of the shareholders. It seems to be a question of fact in each
case and the question is whether the subsidiary is carrying on the business as
the parents business or as its own. In other words who is really carrying on the
business.

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

1. Are the profits treated as the profits of the parent company?

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

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

Reference may also be made to the case of

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

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

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

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

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

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

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

There have been cases where Salomons case has been upheld that a company
is a legal entity.

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

20
Lord Justice Cohen L.J Under the ordinary rules of law, a parent company and
a subsidiary company even when a hundred percent subsidiary are distinct
legal entities and in the absence of an agency contract between the two
companies, one cannot be said to be an agent of the other.

2. FRAUD & IMPROPER CONDUCT

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

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

Re Bugle Press Limited [1961] Ch. 270

This was based on Section 210 of the Companys Act where an offer was made
to purchase out a company if 90% of shareholders agreed. There were 3
shareholders in the company. A, B and C.

A held 45% of the shares, B also held 45% of the shares and C held the
remaining 10% of the shares. A and B persuaded C to sell his shares to them
but he declined. Consequently A and B formed a new company call it AB
Limited, which made an offer to ABC Limited to buy their shares in the old
company. A and B accepted the offer, but C refused. A and B sought to use
provisions of Section 210 in order to acquire Cs shares compulsorily.

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

Lord Justice Cohen said the company was nothing but a legal hut. Built round
the majority shareholders and the whole scheme was nothing but a hollow
shallow.

21
Gilford Motor Co. v. Horne (1933) Ch. 935

Here the Defendant was a former employee of the plaintiff company and had
covenanted not to solicit the plaintiffs customers. He formed a company to
run a competing distance. The company did the solicitation. The defendant
argued that he had not breached his agreement with the plaintiffs because the
solicitation was undertaken by a company which was a separate legal entity
from him.

The court held that the defendants company was a mere cloak or sham and
that it was the defendant himself through this device who was soliciting the
plaintiffs customers. An injunction was granted against both the defendant
and the company not to solicit the plaintiffs customers.

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

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

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

GROUP ENTERPRISE

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

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

22
Authority is the case of

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

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

DETERMINATION OF A COMPANYS RESIDENCE

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

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

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

The courts also look behind the faade of the company and its place of
registration in order to determine its residence.

THE DOCTRINE OF ULTRA VIRES

23
A Company which is registered under the Companys Act cannot effectively do
anything beyond the powers which are either expressly or by implication
conferred upon in its Memorandum of Association. Any purported activity in
excess of those powers will be ineffective even if agreed to by the members
unanimously. This is the doctrine of ultra vires in company law.

The purpose of this doctrine is said to be twofold

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

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

In this case the Companys Memorandum of Association gave it powers in its

objects clause

1. To make sell or lend on hire railway carriages and wagons.

2. To carry on the business of mechanical engineers and general
contractors
3. to purchase, lease work and sell mines, minerals, land and realty.

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

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

The court held that the contract was ultra vires the company and void so that
not even the subsequent consent of the whole body of shareholders could
rectify it. Lord Cairns stated as follows:

24
The words general contractors referred to the words which went immediately
before and indicated such a contract as mechanical engineers make for the
purpose of carrying on a business. This contract was entirely beyond the
objects in the Memorandum of Association. If so, it was thereby placed
beyond the powers of the company to make the contract. If so, it was not a
question whether the contract was ever ratified or not ratified. If the contract
was going at its beginning it was going because the company could not make it
and by purporting to ratify it the shareholders were attempting to do the very
thing which by the act of parliament they were prohibited from doing.

The courts construed the object clause very strictly and failed to give any regard
to that part of the Objects clause which empowered the company to do
business as general contractors. This construction gave the doctrine of ultra
vires a rigidity which the times have not been able to uphold. At the present
day, the doctrine is not as rigid as in Ashburys case and consequently it has
been eroded.

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

Lord Selbourne stated as follows:

the doctrine of ultra vires as it was explained in Ashburys case should but
this doctrine ought to be reasonably and not unreasonably understood and
applied and whatever may fairly be regarded as incidental to or consequential
upon those things that the legislature has authorised ought not to be held by
judicial construction to be ultra vires.

An act of the company therefore will be regarded as intra vires not only when it
is expressly stated in the objects clause but also when it can be interpreted as
reasonably incidental to the specified objects. As a result of this decision,
there is now a considerable body of case law deciding what powers will be
implied in a case of particular types of enterprise and what activities will be
regarded as reasonably incidental to the act.

25
However businessmen did not wish to leave matters for implication. They
preferred to set up in the Memorandum of Association not only the objects for
which the company was establish but also the ancillary powers which they
thought the company would need. Furthermore instead of confining
themselves to the business which the company was initially intended to follow,
they would also include all other businesses which they might want the
company to turn to in the future. The original intention of parliament was that
the companies object should be set out in short paragraphs in the
Memorandum of Association. But with a practice of setting out not only the
present business but also any business which the promoters would want the
company to turn to. The result is that a companys objects clause could
contain about 30 or 40 different clauses covering every conceivable business
and all that incidental powers which might be needed to accomplish them.

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

Unfortunately this does not ensure preservation of the Companies assets or

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

In this case the Plaintiff companys business was requisitioned for vacant land
and the erection thereon of Housing Estates. Its objects are set up in the
Memorandum 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

26
connection with or as ancillary to any of the above businesses or a general
business of the company.

In connection with its various development skills the companys managing

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

The issues were

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

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

Lord Justice Salomon L.J stated as follows:

It may be that the Directors take the wrong view and infact the business in
question cannot be carried on as they believe but it matters not how mistaken

27
they might be provided that they formed their view honestly then the business
is within the plaintiffs companys objects and powers.

LAW OF BUSINESS ASSOCIATIONS Lecture 3 27TH FEBRUARY 04

ULTRA VIRES DOCTRINE

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

In this case the objects clause of the company contained 30 sub-clauses. The
first sub-clause authorised the company to develop rubber plantations and the
fourth clause empowered the company to deal in any shares of any company.
The objects clause concluded with a declaration that each of the sub clauses
was to be construed independently as independent objects of the company.
The company underwrote and had allotted to it shares in an oil company. The
question that arose was whether this was intra vires the companys objects.
The court held that the effect of the independent objects clause was to
constitute each of the 30 objects of the company as independent objects.

28
Therefore the dealing of shares in an oil company was within the objects and
thus intra vires. However the power to borrow money cannot be construed as
an independent object of the company in spite of this decision.

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

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

The court held that borrowing was a power and not an object. The power to
borrow existed only for furthering intra vires objects of the company and was
not an object in itself. Therefore:

1. The exercise of powers which will be intra vires is exercised for the
objects of the company and is ultra vires only if used for the objects not
covered by the companys Memorandum of Association.
2. Even an independent object clause cannot convert what are in fact
powers into objects.
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.

29
The object of the ultra vires rule is to make the members know how and to
what their money is being applied. This is the rationale of members
protection.

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

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

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

Kay J. stated where a company is formed for a primary purpose, then although
the Memorandum may contain other general words which include the doing of
other objects, those general words must be read as being ancillary to that
which the Memorandum shows to be the main purpose and if the main
purpose fails and fails altogether, then the sub-stratum of the association
fails.

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

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

John Beauforte (1953) Ch.d 131

30
A company was authorised by its Memorandum of Association to carry on the
business of costumiers, gown makers and other activities ejusdem generis.
The company decided to undertake the business of making veneered panels
which was admittedly ultra vires and for this purpose, it constructed a factory
at Bristol. The company later went into compulsory liquidation. Several proofs
of debts were lodged with the liquidator which he rejected on the ground that
the contracts which they related to were ultra vires.

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

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

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

3. GRATUITOUS GIFTS

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

This issue was first decided in the case of

Hutton V Westcorp Railway Co. (1893) Ch.d

A company sold its assets and continued in business only for the purpose of
winding up. While it was awaiting winding up, a resolution was passed in the

31
companys general meeting authorising the payments of a gratuity to the
directors and dismissed employees.

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

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

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

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

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

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

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

Justice Eve stated as follows

32
Whether they reneged an express or implied power, all such grants involved an
expenditure of the companys money and that money can only be spent for
purposes reasonably incidental to the carrying on of the companys business
and the validity of such grants can be tested by the answers to three questions:
(i) Is the transaction reasonably incidental to the carrying on of the
companys business?
(ii) Is it a bona fide transaction?
(iii) Is it done for the benefit and to promote the prosperity of the
company?

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

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

Sometimes ultra vires can be excluded by good and clever draftsmanship

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

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

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

The Court observed as follows the defendants were prompted by motives

which however laudable and however enlightened from the point of view of
industrial relations were such as the law does not recognise as sufficient

33
justification. The essence of the matter was that the Directors were proposing
that a very large part of its assets should be given to its employees in order to
benefit those employees rather than the company and that is an application of
the companys funds which the law will not allow.

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

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

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

The court held that even though the payment was not under an express power,
it was reasonably incidental to the companys business and therefore valid.

This is one of the few cases where payment was recognised as being valid.

THE RIGHTS OF THE COMPANY & 3RD PARTIES UNDER ULTRA VIRES
TRANSACTIONS:

These are remedies

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

partys dealing with that company. Such is the case as regards borrowing
contracts. Consider the case of

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

X was a director of company B and at the same time had some interests in
company A. He learnt that company B wished to borrow some money which it

34
 intended to apply to unauthorised activities. He urged company A to lend the
money on the security of debentures. The issues were
(a) Whether the debentures were valid security;
(b) Whether the knowledge of X as to the intended application of the money
could be imputed to the company.

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

This loophole however will be applied very rarely because everybody is

presumed to know the contents of a companys public documents. Where a
contract with that company is ultra vires, generally speaking the party dealing
with that company has no rights under the contract. The transaction being
null and void cannot confer rights on the 3 rd party nor can it impose any
obligation on the company.

In many instances however, property will be transferred under an ultra vires

transaction. Such transaction cannot vest rights in the transferee and cannot
divest the transferor of his rights.

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

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

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

sufficiently earmarked e.g by the purchase of some particular items, it can be
followed and claimed by the lender. Where tracing is impossible, because the

35
money has become mixed with other money, the lender is entitled in equity to
a charge on the mixed fund together with the other creditors according to the
respective amounts otherwise money obtained on ultra vires transaction
generally cannot be followed once it has been spent. But if such money has
been spent by discharging the companys intra vires debts then the lender is
entitled to rank as a creditor to the extent to which the money has been so
applied. Since the companys liabilities are not increased but in fact
decreased, equity treats the borrowing as valid to the extent of the legal
application of such money.

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

TO WHAT EXTENT ARE MEMBERS PROTECTED BY THE ULTRA VIRES DOCTRINE

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

All the company can do is to alter its objects under the power conferred by
Section 8 of the Companies Act Cap 486. The effect of the Section is that a
company may by special resolution alter the provisions in its Memorandum
with respect to the object of the company.

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

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

36
Within 30 days of the date on which the resolution altering the objects is
passed, an application for the cancellation of the Resolution may be made to
Court by or on behalf of the holders who have not voted in favour of the
Resolution, of not less than 15% of the nominal value of the issued share
capital of any class and if the company does not have a share capital, the
application can be made by at least 15% of the members of the company.

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

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

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

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

Note however, that such alterations do not operate retrospectively. Their effect
relates only to the future.
LAW OF BUSINESS ASSOCIATIONS Lecture 4 5.3.04

ARTICLES OF ASSOCIATION

37
A Companys constitution is composed of two documents namely the
Memorandum of Association and the Articles of Association. The Articles of
Association are the more important of the two documents in as much as most
court cases in Company Law deal with the interpretation of the Articles.

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

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

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

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

(a) Adopt Table A in full; or

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

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

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

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

38
As between the Memorandum and the Articles the Memorandum of
Association is the dominant instrument so that if there is any conflict between
the provisions in the Memorandum and those in the Articles the
Memorandum provisions prevail. However if there is any ambiguity in the
Memorandum one may always refer to the Articles for clarification but this
does not apply to those provisions which the Companies Act requires to be set
out in the Memorandum as for instance the Objects of the Company.

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

Articles regulate the manner in which the Companys affairs are to be managed.
They deal with inter alia the issue of shares, the alteration of share capital,
general meetings, voting rights, appointment of directors, powers of directors,
payment of dividends, accounts, winding up etc.

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

LEGAL EFFECTS OF THE ARTICLES OF ASSOCIATION

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

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

Reference may be made to the case of

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

39
Here the Articles of the Company provided that any dispute between any
member and the company should be referred to arbitration. A dispute arose
between Hickman and the company and instead of referring the same to
arbitration, he filed an action against the company. The company applied for
the action to be stayed pending reference to arbitration in accordance with the
companys articles of association.

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

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

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

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

The court held: that the articles constitute a contract between the company
and the members in their capacity as members and as a solicitor Eley was

40
therefore a third party to the contract and could not enforce it. The contract
relates to members in their capacity as members and the company so its only a
contract between the company and members of that company and not in any
other capacity such as solicitor. But note that there can be an intra member
contract.

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

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

This case was followed in

Rayfield v. Hands (1960) Ch.d 1

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

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

ALTERATION OF ARTICLES

41
Section 13 of the Companies Act gives the company power to alter the articles
by special resolution. This is a statutory power and a company cannot deprive
itself of its exercise. Reference may be made to the case of

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

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

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

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

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

The court held that since the power to alter the Articles is statutory, the
extension of the lien to fully paid up shares was valid. This were the words of
Lindley L.J.

Wide however as the language of Section 13 mainly the power conferred by it

must be exercised subject to the general principles of law and equity which are
applicable to all powers conferred on majorities and enabling them to bind

42
minorities. It must be exercised not only in the manner required by law but
also bona fide for the benefit of the company as a whole.

Further reference may be made to the case of

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

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

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

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

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

43
The question here is who determines what is for the benefit of the company?
Is the shareholders or the Courts?

Scrutton L.J. had the following to say

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

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

Director controlled share company had a minority shareholder who was

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

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

Contrast this case with that of

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

Here a public company was in urgent need of further capital which the majority
of the members who held 98% of the shares were willing to supply if they
could buy out the minority. They tried persuasion of the minority to sell shares

44
to them but the minority refused. They therefore proposed to pass a Special
Resolution adding to the Articles a clause whereby any shareholder was bound
to transfer his shares upon a request in writing of the holders of 98% of the
issued capital.

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

EFFECT OF ALTERATION ON CONTRCT OF DIRECTORS

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

A director may hold office either

1. Under the Articles without a service contract;

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

Where a director holds office under the Articles without a contract of service,
then his appointment is conditional on the footing that the articles may be
altered at any time in exercise of statutory power.

45
If however, a directors appointment is entirely independent of the articles then
any alterations which affects his contract with the company will constitute a
breach of contract for which the company will be liable in damages.

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

The Plaintiff by a written contract was appointed the companys Managing

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

It was held that since his appointment was not subject to the articles, he could
only be removed from office in accordance with the terms of his appointment
and not by way of alteration of the articles. Damages were therefore payable.

Lord Atkins said if a party enters into an arrangement which can only take
effect by the continuance of an existing state of circumstances there is an
implied undertaking on his part that he shall done of his own motion to put an
end to that state of circumstances which alone the arrangement can be
operative.

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

then the provisions in the Articles are deemed to be incorporated in the
appointment and in the absence of any provision in the articles to the contrary,
the company may dismiss him at any time and even without notice.
Read v. Astoria Garage (1952) 1 All.E.R 922

46
A Companys Articles provided, that the appointment of a Managing Director
shall be subject to termination if he ceases for any reason to be a director or if
the company in general meeting resolved that his tenure of office as managing
director be terminated. The Plaintiff was appointed as the companys
Managing Director 17 years later the directors decided to relieve him of his
duties as Managing Director. The decision was subsequently ratified by the
company in general meeting. He claimed damages for wrongful dismissal.

The court held that on a true construction of the companys articles the
Plaintiffs appointment was immediately and automatically terminated on
passing of the Resolution at the general meeting since the company had
expressly reserved to itself the power to dismiss the Managing Director.

The question is, can a company be restrained by injunction from altering its
articles if the alteration is likely to give rise to a breach of contract?

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

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

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

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

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

47
The court held that the defendant company had no power to alter its articles of
association for the purpose of committing a breach of contract and that an
injunction ought to be granted to restrain the holding of the meeting for that
purpose.

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

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

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

Allen v. Goldreef

VARIATION OF CLASS RIGHTS

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

it does not define the term class the best definition is found in the case of

Sovereign Life Assurance Co. v. Dodd (1892) 2 QB 573

In that case Bowen L.J. stated as follows: The word Class is vague it must be
confined to those persons 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.

48
However, under Section 25 sub-section 2 if the rights are contained in the
Memorandum of Association, and if the Memorandum prohibits alteration of
those rights, then class rights cannot be varied.

THE COMPANIES ORGANS & OFFICERS

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

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

1. The general Meeting;

2. The Board of Directors.

The authority to exercise a companys powers is normally delegated not to the

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

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

Under Section 184 (1) the Companies Act every appointment must be voted on
individually except in the case of private companies or unless the meeting
unanimously agrees to include two or more appointments in the same
resolution. The appointment is usually effected by an ordinary resolution.
However, no matter how a director is appointed, under Section 185 of the
Companies Act he can always be removed from office by an ordinary
resolution in addition to any other means of removal which may be embodied
in the articles.

49
Unless the Articles so provide Directors need not be members of a company,
but if the articles require a share qualification, then the shares must be taken
up within two months otherwise the office will be vacated. Undischarged
Bankrupts are not allowed to act as directors without leave of the court. A
director need not be a natural person. A company may be appointed a
director of another. The disqualifications of directors are set out in article 88
of Table A. The division of powers between the general meeting and the Board
of Directors depends entirely on the construction of the Articles of Association
and generally where powers of management are vested in the Board of
Directors, the general meeting cannot interfere with the exercise of those
powers.

Automatic Selfcleaning Filter Syndicate v. Cunningham (1906) A.C. 442

The companys articles provided that subject to such regulations as might be

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

The court held that the Articles constituted a contract by which the members
had agreed that the Directors alone should manage the affairs of the company
unless and until the powers vested in the Directors was taken away by an
alteration in the Articles they could ignore the general meeting directives on

50
matters of management. They were therefore entitled to refuse to execute the
sale.

the division of the power to manage the companys affairs is embodied in

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

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

Here the Directors were empowered to manage the companys affairs. They
commenced an action for and on behalf of the company and in the companys
name, in order to recover some money owed to the company. The general
meeting thereafter passed a resolution disapproving the commencement of
the suit and instructing the Directors to withdraw it

It was held that the resolution of the general meeting was a nullity Greer L.J.
stated

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

51
Directors any more than the directors can reserve to themselves the powers
vested by the articles in the general body of shareholders.

To this there are two exceptions

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

Barron v. Porter (1914) 1 Ch. 895

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

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

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

CO-OPERATE LIABILITIES FOR ACTS OF OFFICIALS

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

This sometimes referred to as the organic theory of companies

52
The theory sprang from the case of

Lennards Carrying Company v. Asiatic Petroleum Co. Ltd.

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

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

Held - Leonard was the directing mind and will of the company and his
knowledge was the knowledge of the company. His fault was the fault of the
company and since he knew that the ship was unsea worthy his fault was also
the companys fault and therefore the company was liable.

As per Viscount L.J.,

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

Case
Bolton Engineering Co. v. Graham

53
Here the plaintiffs who were tenants in certain business premises were entitled
to a renewal of their tenancy unless the landlords who were a limited company
intended to occupy the premise themselves for their business purposes.

The issue was whether the defendant company had effectively formed this
intention, there had been no formal general meeting or board of directors
meeting had to consider the question but the managing directors had clearly
manifested the intention to occupy the premises for the companys business.

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

Denning L.J., stated

A company may in many ways be likened to a human being, it has a brain and
a nerve center which controls what it does it also has hands which hold all the
tools and acts in accordance with the directions of the center. Some of the
people of the company and merely servants and agents who are nothing more
than hands to do the work and cannot be said to represent the mind and will
of the company.
Others are directors and managers who represent the directing mind and will of
the company and control what it does. The state of mind of these managers is
the state of mind of the company and are treated by the law as such. Whether
their intention is the companys intention depends on the nature of the matter
under consideration relating to the position of the officer and agent and other
relative facts and circumstances of the case.

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

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

Question as to whether or not the company is bound or not depends on the

normal agency principles, if a companys officer or a companys organ does an

54
act within the scope of its authority the company will be bound. The problem
which might arise is that even if the act in question is within the scope of the
organs of the officers authority their might be some irregularity in the action of
the organ concerned and consequently in the exercise of authority for example
if a particular act can only be valid if done by the board of directors or the
general meeting the meeting might have been convened on improper notice or
the resolution might not have been properly carried in the case of the
directors they may not have been properly appointed in these circumstances
can the company disclaim an act which was so done by arguing that the
meeting was irregular. Must a 3rd party dealing with the company always
ascertain that the companys internal regulations have been complied with
before holding the company liable.

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

The Royal British Bank V. Turguand

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

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

The words of Javis C.J

A party dealing with a company is bound to read the companys deed of

settlement memo of association but isnt bound to do more. In this case a 3 rd

55
party reading a companys documents would find not a prohibition from
borrowing but permission to do so on certain conditions finding the authority
may be found complete by resolution he may have a right to infer the fact of a
resolution authorizing that which on the face of the document appeared to be
legitimately done.

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

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

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

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

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

contents of the companys public documents therefore any act, which is
contrary to those provisions, will not bind the company unless it is
subsequently ratified by the company acting through its appropriate organ.
The term public document isnt defined in the companys act but so far as the
registered companies are concerned the expression is not restricted to the
memorandum and articles of association but it also includes some of those
documents found in the companys registry these include special resolutions
particulars of secretaries, charges

56
provided that everything appears to be regular so far as can be checked from
the public documents a 3rd party dealing with the company is entitled to
assume that all internal regulations of the company have been complied with
unless he has knowledge to the contrary or there are suspicious putting him on
inquiry.

Case

Mahoney v. East Holyford Mining Co

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

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

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

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

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

When there are person conducting the affairs of a company in a manner which
appears to be perfectly consonant with the articles of association then those

57
dealing with them externally are not to be affected by any irregularities which
may take place in the internal management of the company.

Directors will not necessarily and for all purposes be insiders. The test appears
to be whether the acts done by them are so closely related to their position as
directors as to make it impossible for them not to be treated as knowing the
limitations on the powers of the officers of the company with whom they have
dealt, otherwise a 3rd party dealing with a company through an officer who is
or is held out by the company as a particular type of officer for example an MD
and who purports to exercise a power which that type officer will usually have
is entitled to hold the company liable for the officers acts even though the
officer has not been so appointed or instructs exceeding his authority as long
as the 3rd party doesnt know that the companys officer has so not appointed
or has no actual authority.

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

Case
Freeman & Lockyer v. Buckhurst Park Properties

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

58
When the plaintiffs claim remuneration according to the agreement the
company replied that its wasnt liable, because Kapoor had no authority to
engage him.

Held the act of engaging architects was within the ordinary ambit of the
authority of a managing director was of Property Company and the plaintiffs
didnt have to enquire whether a person with whom they were dealing with
was properly appointed.

It was sufficient for them that under the articles the board of directors had the
power to appoint him and had in fact allowed him to act as managing director.

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

entered into by the company by a person who has no actual authority

1) It must be shown that there was a representation that the agent had
authority to enter into a contract of the kind sought to be enforced.

2) Such representation must be made by a person or persons who had

actual authority to manage the companys business either generally or in
respect of those matters to which the contract relates.

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

representation

4) It must be shown that neither in its memorandum nor under its

articles was the company deprived of the capacity either to enter into a
contract of the kind so as to be enforced or to delegate authority to do so to
the agent.

Case

59
Emco Plastica International v. Freeberne

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

respondent was appointed as the companys secretary. Nothing was decided in
the meeting as regards his remuneration or other terms of service. The terms
of his appointment were contained in a letter signed on behalf of the company
by its managing director which provided that the appointment was for a
maximum period of 5 years.

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

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

director with the full knowledge of the board of directors and that a contract
for service as the one entered into with the secretary was one which a person
performing the duties of a managing director would have power to enter into
on behalf of the company.
Therefore the contract was genuine, valid and enforceable.

If however the officer is purporting to exercise some authority which that sort
of officer wouldnt normally have a 3 rd party wont be protected if the officer
exceeds his actual authority unless the company has held him out as having
authority to act in the matter and the 3rd party has denied thereof.

60
Unless the company is estopped, however unless a provision in the
memorandum or articles or other public documents cant create an estoppel
unless the 3rd party knew of the provision and has relied on it.
For this purpose regulations at the companys registry dont constitute notice
because the doctrine of constructive notice operates negatively and not
positively.

If a document purporting to be sealed and signed on behalf of the company is

proved to be forgery it doesnt bind a company.
However the company can be estopped as putting as a forgery if it has been put
forward as genuine by an officer acting within his actual, usual or ostensible
authority.

Rama Corporation v. Proved Tin & General Investments

Promoters

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

At common law the best definition is by chief justice

In the case of
Twyfords v. Grant

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

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

61
The term is also used to cover any individual undertaking to become a director
of a company to be formed. Similarly it covers anyone who negotiates
preliminary agreements on behalf of a proposed company.

But those who act in a purely professional capacity e.g. advocates wont qualify
as promoters for they are simply performing their normal professional duties.
But they can also become promoters or find others who will.

Whether a person is a promoter or not is a question of fact. The answer is

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

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

DUTIES OF PROMOTERS

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

These carries the duties of disclosure and proper accounting particularly a

promoter must not make any profit out of promotion without disclosing to the
company the nature and the extent of such promotion.
Failure to do so may lead to recovery of the profits by the company.

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The question, which arises, is since the company is a separate legal entity from
members how is this disclosure effected.

Case
Erlanger v. New Sombrero Phosphates Co.

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

As Lord Caines
The owner of the property who promotes and form a company to which he
sell his property is bound to declare that he sells it to the company through the
medium of a Board of Directors who can exercise an independent judgment on
the transaction and who are not left under belief that the property belongs to
the promoters and not to another person.

Since the decision in the case of Salomon, it has never been doubted that a
disclosure to the members themselves will be equally effective.

It would appear that disclosure must be made to the company either by making
it to an independent Board of Directors or to the existing and potential
members.

If to the former the promoters duty to the company is duly discharged,

thereafter it is upon the directors to disclose to the subscribers.

If made to the members it must appear in a prospectus and the articles so that
those who become members can have full information regarding it. Since a
promoter owes his duty to a company in the event of any non-disclosure the
primary remedy is for the company to bring proceedings for

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1) Either rescission of any contract with the promoter

2) Recovery of any profits form the promoter.

As regards rescission this must be exercised in keeping with normal principles

of contract.
a) The company shouldnt have done anything to ratify the action.
b) There must be restitution in inter gram restoring the parties to
the origin position.

REMUNERATION OF PROMOTERS

A promoter isnt entitled to remuneration to services rendered to the company

unless there is a contract so enabling him. In the absence of such a contract a
promoter has no right to even his preliminary expenses or even the refund of
the registration fees.

He is therefore at the mercy of the directors but before a company is formed it

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

PRELIMINARY CONTRACTS BY PROMOTERS

Until a company is formed it is legally non-existent and therefore cant enter

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

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Case
Price v. Kelsall

One of the issues was whether or not a company could ratify a contract entered
into on its behalf before incorporation.
The alleged contract was that the respondent had undertaken to sell some
property to a company, which was proposed to be formed between him and
the appellant. In holding that the company cant ratify such an agreement the
president of the court of appeal was then constituted by the Okolo L.J.,

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

behalf before its incorporation by there may be circumstances from which it
may be inferred that the company after its incorporation has made a new
contract to the effect of the old agreement.
The mere confirmation and adoption by directors of a contract made before
formation of a company by persons purporting to act on behalf of the
company creates no contractual relation whatsoever between the company
and the party to the contract.
However acts may be done by a company after its formation, which give rise to
an inference of a new contract on the same terms as the old one.

Question whether there is a new contract or not is always a question of fact,

which depends on the circumstances of each individual case.

Case
Mawagola Farmers & Growers Ltd v. Kanyanja

Prior to incorporation the promoters held public meetings and the public asked
to purchase shares in a proposed company. The respondents paid for the
shares bought before and after the incorporation but the company didnt a lot
any shares to them but instead after incorporation allotted shares to others
people.

65
The respondent prayed for orders that the shares they paid for be allotted to
them and the company registered name be rectified accordingly.
The company argued that the respondent paid for money for the purchase of
their shares money, the claim could be against the promoters because the
company couldnt even after incorporation ratify of adopt any such contract

Mustafa J.A
In order that the company may be bound by agreements entered into before
incorporation there must be anew contract to the same effect as the old
agreement. This contract may however be inferred from the acts of the
company when incorporated.

The allotment of shares to the respondents after the incorporation was held to
be sufficient evidence of a new contract between the company and the
respondents. Therefore the respondents were entitled to be allotted the
shares agreed upon.
If any preliminary arrangements are made these must therefore be left must be
left to mere gentleman agreements or otherwise the promoters may have to
undertake personal liability. Although the principle is clear those engaged in
the formation of companies often cause contracts to be entered into on behalf
of proposed company.

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

Case
Kelner v. Baxter

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

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Held A,B and C were liable
Chief justice Earl
Where a contract is signed by one who prophesies to be signing as agent but
who has no principle existing at the time and the contract will altogether be
inoperative unless binding against the person who signed it he is bound
thereby and a stranger cannot by subsequent ratification relieve him from that
responsibility when the company came afterwards into existence having rights
and obligations form that time but no rights or obligations by reason of
anything which might have been done before.

Contrast this with the case of

Newborn v. Sensolid Great Britain Limited

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

Leopold Newbold sought personally to enforce the contract.

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

PROSPECTUSES

When the public is asked to subscribe for shares or debentures of a company

the invitation involves the issue of documents, which set out the advantages to

67
accrue from an investment in a company. This document is called a prospectus
and may be issued either by the company itself or by a promoter.

It is only in the case of a public company that a prospectus may be issued. A

private company must always raise its capital privately as required by section
30 of the Company Act. Section 20 defines prospectuses as
Any prospectus, notice, circular, advertisement or other invitation offering to
the public for subscription or purchase of any shares or debentured in the
company

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

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

Re South of England Natural Gas Co.

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

CONTENTS OF A PROSPECTUS

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

prospectus all the necessary information which would enable a potential

68
investor in deciding whether or not to subscribe for a companys shares or
debentures.

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

The provisions in that schedule are designed mainly to provide information

about the following matters

1) Who the directors are

And what benefit they will get form directorship

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

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

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

Section 42 defines expert

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

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

LIABILITY IN RESPECT OF PROSPECTUSES

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

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

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

R v. Kylsant

In this case the company sustained continuous losses for 6 years between
1921-1927/
The company issued a prospectus, which in all material facts was correct. It
further specified that the dividends paid were high.

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But the dividends wee being made out of abnormal profits from 1 st world war
and the prospectus was misleading in its context.

CIVIL REMEDIES

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

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

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

Derry v. Peek

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

power and with the consent of the board of trade by steam or mechanical
power.
The directors issued a prospectus stating that the company had power to use
steam or mechanical power. On reliance of this misrepresentation the plaintiff
bought shares. Subsequently the Board of Trade refused to give trade to use of
steam and mechanical power and as a result the company was wound up.

The plaintiff brought an action for deceit alleging fraudulent misrepresentation.

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

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Lord Herschell stated
The authorities established 2 major propositions

a) In order to sustain an action for deceit there must be proof of fraud

and nothing short of that will suffice

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

i) Knowingly
ii) Without belief in its truth
iii) Recklessly not caring whether it be true or false

In order to succeed in an action for damages for fraud the plaintiff must show
that the misrepresentation was made to him or that he was one of a class of
persons who were intended to act upon it.
The ordinary cause of a prospectus is for the public to become allotees of
shares to a company. Once shares have been allotted, the prospectus wouldve
served its purpose and thereafter cant be used as a ground for filing an action
for fraud in respect of shares bought at a latter date from another source.

Case

Peek v. Gurney

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

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

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

Case in point
Andrews v. Mock Ford

The plaintiff alleged that the defendant sent him a prospectus inviting him to
buy shares in the company, which they knew would be a sham but the plaintiff,
didnt subscribe for the shares.
The prospectus eventually produced a very scanty subscription and the
defendant caused a telegram to be published in the local newspaper to the
effect that they struck a vein of gold and this they alleged they confirmed the
statistics in the prospectus.
The plaintiff bought shares on this basis and eventually the company wound up.

The question here is had the prospectus served its purpose?

It was held that the prospectus intended to induce the plaintiff both to
subscribe for shares initially and also to buy them in the market thereafter. The
telegram was part of the prospectus.

Lord Justice Smith

There was proof against the defendant a continuous fraud on their part
commencing with ascending of the prospectus to the plaintiff and culminating
in the direct lie told in a telegram which was intended by a defendant to
operate in the plaintiffs mind and on the mind of others and did operate to his
prejudice and the advantage of the defendant.

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

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

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

Under the case of

Hedley Byrne & Co. v. Heller & Partners

All these actions are directed to the directors personally.

Rescission
As against the company a person induced to buy shares by a misrepresentation
in the prospectus may rescind the contract.

On buying shares ones contract is with a company itself, the remedy is

available only against the company. To be entitled to this remedy it is not
necessary for the purchaser of the shares to show that the statement was
fraudulent or negligent.

Even if the misrepresentation was innocent rescission lies. The right to rescind
is subject to two limitations.

a) The allotee looses the right to rescind if he shows any election to

affirm the contract. For example by attending and voting at the companys
meetings or by accepting to sell the shares

b) If the allotee doesnt rescind the contract before the company is

wound up he looses the right to do so as from the moment winding up
proceedings are commenced.

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Directors Duties

Firstly there are 3 preliminary positions

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

acting collectively as a Board, the duties to the company are owed by each
director individually. These duties are owed to the company and the company
alone and not to individual shareholders.

Case
Percival v. Wright

Certain shareholders wrote to the companys secretary asking if he knew

anyone willing to buy their shares.

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

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

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

b) However if the directors are authorized by the members to negotiate

on their behalf for example on potential purchase then the directors would be
in a position to be agents for such members and owed a duty to them
accordingly.

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Case
Allen v. Hyall

c) These duties except where expressly stipulates in the Company Act

arent restricted to directors alone but apply equally to any official of a
company who is authorized to act as agents and in particular to those acting in
a managerial capacity.
This is particularly so as regards to fiduciary duties.

Directors duties proper

These fall into 2 broad categories

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

ii) Fiduciary duties of loyalty and good faith

Duties of care and skill

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

Re City Equitable Fire Insurance

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

companys affairs almost entirely to the Managing Director.
Owing to the managing directors fraud a large amount of the companys funds
disappeared.

Certain items appeared in the balance sheet under the heading: Loans at call
or short notice or Cash in bank or in hand
The directors didnt inquire how these items were made up. If they had
inquired they would have found the loans were chiefly to the managing
director himself and to the companys general manager and the cash in bank
and hand included some 13,000 pounds. In the hands of a firm of stock brokers
at which the managing director was partner.

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On the companys winding up an investigation on its affairs disclosed a shortage
of its funds at more than 1.2 m pounds incurred mainly due to the delinquent
fraud of the managing director for which he was convicted and sentenced. The
other directors had all along acted in good faith and honestly but the liquidator
sought to make them liable for damages.

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

A director neednt exhibit in the performance of his duties a greater degree of

skill than may reasonably be expected from a person of his knowledge and
experience.

This proposition describes the standard of skill exhibited in actions undertaken

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

Re Brazilian Rubber and Plantations Estates Ltd.

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

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

syndicate for purchase of a rubber plantation in Brazil.
The issued prospectus contained false statements about the acreage of the
plantation, the type of trees e.t.c.
The information contained therein was given to the directors by a person who
had an original option to purchase that property he had never been to Brazil
and the debtor was based on his own imagination. The directors caused the
company to purchase.
It was held that the conduct didnt amount to gross negligence.

77
Neville L.J.,
It has been laid down that so long as they act honestly directors cant be made
responsible in damages unless they are guilty of gross negligence.
A directors duty required him to act with such care as is reasonably expected
from him having regard to his knowledge and experience.
He isnt bound to bring any special qualifications to his office. He may
undertake management of a rubber company in complete ignorance of
anything connected to rubber without incurring responsibility from mistakes
resulted from such ignorance while if he is acquainted with rubber business he
must give the company the advantage of his knowledge while transacting the
companys business.

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

ii) A director isnt bound to give continuous attention to affairs of his company.
His duties are of an intermittent nature to be performed at periodical board
meetings and at meetings of any committee of the board on which he is
placed. He isnt bound to attend all such meetings though he is to attend
whenever in the circumstances he is reasonable able to do the same.

Case
Re Denham & Co.

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

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

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

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

Case

Marquis of Butes

In this case the director didnt attend board meetings for 38 years. He was held

not liable.

iii) In respect of all duties which having regard to all exigencies of

business and articles of association may properly be left to some other official.
A director in the absence of grounds for suspicion will not be liable in trusting
that other official to perform that other duty honestly.

Dovey v. Cory

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In this case a bank sustained heavy losses by advances made improperly to
customers.
The irregular nature of advances was concealed by means of fraudulent
balance sheets, which were the work of the general manager and the
chairman in assenting to payment of dividends out of capital, and those
advances on improper securities were done on the advice of the general
manager and chairman

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

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

II) Fiduciary Duties

The directors fiduciary duties are divisible into 4 sub categories

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

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

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a breach of directors duties to issue companys share for the purpose of
entrenching themselves in the companys affairs.

Case

Punt v. Symons

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

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

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

Case
Piercy v. Mills & Co.

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

The directors issued shares with the object of creating sufficient majority to
enable them resist the election of the 3 additional directors who election
would have put the 2 directors in the minority of the board.
It was held that the directors arent entitled to use their powers for issuing
shares merely for the purpose of maintaining their control or the control of

81
themselves and friends of the affairs of the company or even merely for the
purpose of defeating the wishes of the existing majority of shareholders.

The plaintiff and his friends held a majority of shares in the company and as
long as that majority remained they were entitled to have their wishes prevail
in accordance with a companys regulation/
Therefore it wasnt open for the purpose of defeating the wishes if the majority
to issue the shares in dispute.

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

Case
Hugg v. Cramphorn Ltd.

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

An action challenged by the plaintiff who was an associate of the take over
bidder and registered holder of 50 ordinary shares in the company was started.
After finding that it was improper for the directors to attach such special voting
rights the courts stood over the action in order to enable a General Meeting to

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be held and debate whether or not to ratify the directors actions. The General
Meeting ratified the action.

Case

Bamford v. Bamford

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

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

irregularity?

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

They mustnt fetter their discretion to act for the company for example the
directors cant contract either among themselves or with 3 rd parties as to how
they will vote at future board meetings.
However where they have entered into a contract on behalf of the company
they may validly agree to take such further action at board meetings as may be
necessary to carry out such a contract.

LAW OF BUSINESS ASSOCIATIONS Lecture 7 26th March 04

FIDUCIARIES CONTINUED

4. As fiduciaries the Directors must not place themselves without

consent of the company in a position in which there is a conflict between their
duties to the company and their personal interests. Good faith must not only

83
be done but it must also manifestly be seen to be done. The law will not allow
the fiduciary to place himself in a position where he will have his judgments to
be biased and then argue that he was not biased. This principle applies
particularly when a Director enters into a contract with his company or where
he makes any secret profit by being a Director. As far as contracts are
concerned a contract entered into by the Board on behalf of the company and
another Director is governed by the equitable principle which ordains that a
fiduciary relationship between the Director and his company vitiates such
contracts. Such contract is therefore voidable at the instance of the company.
Reference may be made to the case of

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

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

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

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

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

In respect of all other profits which a Director may make are out of his position
as a Director the equitable principle which requires the Directors to account
for any such profits is vigorously enforced. This is because the Courts have
equated Directors to trustees and their duties have also been equated to those
of Trustees. The question is, are they really trustees?

Selanger United Rubber Estates v. Craddock (1968) 1 All E.R. 567

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

In the latter case, the directors of a company were seen to be trustees only in
respect of the companys funds or property which was either in their hands or

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

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

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

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

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

The directors will be liable to account if it can be shown that what they did is
so related to the affairs of the company that it can properly be said to have
been done in the course of their management and in utilisation of the
opportunities and special knowledge and what they did resulted in a profit to
themselves.

Phipps v. Boardman (1966) 3 All E.R. 721

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

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

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

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

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

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

The Defendant who was an architect was appointed the companys Managing
Director. The companys business was to offer design and construction
services to industrial enterprises. One of the defendants duties was to obtain
new business for the company particularly from the gas companies where he

88
had worked before joining the Plaintiff. While the Defendant was still so
employed by the Plaintiff a representative of one gas company came to seek
his advice on some personal matters. In the course of their conversation the
Defendant learnt that the gas company in question had various projects all
requiring design and construction services of the type offered by the Plaintiff.
Upon acquiring this information and without disclosing it to the company, the
Defendant feigned illness as a result of which he was relieved by the company
from his duties. Thereafter, he joined the gas company and got the contract to
do the work. Two years previously, the Plaintiff had unsuccessfully tried to
obtain that work. After the Defendants acquiring the contract, the company
sued him alleging that he obtained the information as a fiduciary of the
company and he should therefore account to the company for all the
remuneration fees and all dues obtained.

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

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

CONTROLLING SHARE HOLDERS

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

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

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

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

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

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 sell the assets of the company itself and give the consideration but must allow
the minority to have their share of any consideration which may come to
them.
Cook v. Deeks (1916) 1 A.C. 554

The Toronto Construction Company carried on business as Railway Construction

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

ENFORCEMENT OF DIRECTORS DUTIES

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

In this case the Directors who were also the companys promoters sold the
companys property at an undisclosed profit. Two shareholders brought action
against them alleging that in so doing, that the directors had breached their
duties to the company. It was held that if there was any breach of duty, it was
a breach of duty owed to the company and therefore the Plaintiffs had no

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 locus standi for the company was the proper plaintiff. This rule has two
practical advantages namely:
1. Insistence on an action by the company avoids multiplicity of
actions;
2. If the irregularity complained of is one which could have been
effectively ratified by the company in general meeting, then it is pointless to
commence any litigation except with the consent of the general meeting.

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

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

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

minority which is not ratifiable by the company in general meeting;
2. It must be shown that the wrong doers hold the controlling
interests
3. The company must be joined as a nominal defendant;

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4. The action must be brought in a representative capacity on behalf
of the plaintiff and all other shareholders except the Defendant.

The question is are these exceptions effective?

There are situations where the rule does not apply.

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

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

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Winding up a company merely to end oppression appears rather awkward as it
may not be of any benefit to the petitioners themselves. Owing to these
shortcomings,

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

Elder V. Elder & Watson (1952) AC 49

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

WHAT IS OPPRESSION

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

wrongful.

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

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

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

It was held that by subordinating the interests of the company to those of the
society, the nominee directors of the society had thereby conducted the affairs
of the company in a manner oppressive to the other shareholders. The fact
that they were perhaps guilty of inaction was irrelevant. The affairs of the

95
company can be conducted oppressively by the Directors doing nothing to
protect its interests when they ought to do so.

Re Hammer(1959) 1 WL.R. 6

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

The sons filed an action claiming that the father had run the affairs of the
company in a manner oppressive to them. The father was 88 years.

The court held that by assuming powers which he did not possess and
exercising them against the wishes of those who had the major beneficial
interests, Mr. Hammer senior had conducted the companys affairs in an
oppressive manner.

These two cases are among the few where an application under Section 211
has succeeded. This is because section 211 has been subjected to a very

96
restrictive meaning. To succeed under Section 211, one must establish a case
of oppression.

1. There is no clear definition of the term and therefore it is not easy

to tell when a companys affairs are being conducted oppressively. For
example in the case of Re Five Minute Car Wash Ltd (1966) 1 W.L.R. 745

The petitioner alleged oppression on grounds that the companys Managing

Director was extremely incompetent. The court ruled that even though the
allegation suggested that the Managing Director was unwise in efficient and
careless in the performance of his duties, this did not mean that he had at any
time acted unscrupulously, unfairly or with any lack of probity towards the
petitioner or to other members of the company. Therefore his conduct was
not oppressive.

2. The conduct which is complained of must relate to the affairs of the

company and must also relate to the petitioner in his capacity as a member.
Personal representatives cannot petition nor can trustees in bankruptcy
petition.

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

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

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

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

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

In a small family concern, there developed two factions among shareholders.

Owing to these personal differences the petitioner filed a petition under
Section 211 complaining inter alia that the distribution of profits had not been
fairly made. That he had been excluded from the Board of Directors and that

97
the affairs of the company were being conducted irregularly. In particular, he
alleged that the company had failed to repay its debts to another company in
which he had some interests.

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

Three reasons were given

(a) This petition had been brought for the collateral purpose of
enforcing repayment of debts to some third party;

(b) The conduct complained of and particularly the removal of the

petitioner from the Board related to him as a director not as a member;

(c) That the circumstances were not such as to justify a winding up

order at the instance of the petitioner because the company was insolvent and
therefore the shareholders had no tangible interests.

It is an unfortunate mistake to link up Section 211 with winding up. The courts
are construing the Section very restrictively. Section 211 has therefore failed
to live up to expectations. It is no real remedy.

LAW OF BUSINESS ASSOCIATIONS Lecture 8 23rd April 04

RAISING AND MAINTENANCE OF CAPITAL

The basis of the whole concept or a companys capital was explained by Jessel
M.R. in the Flitcrafts Case 1882 21 Ch. D 519 in this case for several years the
directors had been in the habit of laying before the meeting of shareholders

98
reports and balance sheets which were substantially untrue inasmuch as they
included among other assets as good debts a number of debts which they
knew to be bad. They thus made it appear that the business had produced
profits whereas in fact it had produced none. Acting on these reports, the
meetings declared dividends which the directors paid. It was held here that
since the directors knew that the business had not made any profit, they were
liable to refund to the company the monies paid by way of dividends.

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

The capital fund is therefore seen as a substitute for unlimited liability of the
members. Courts have developed 3 basic principles for ensuring that the
companys represented capital is actually what it is and for the distribution of
that capital.
1. Once the value of the companys shares has been stated it cannot
subsequently be changed. The problem which arises in this respect is that
shares may be issued for non-monetary consideration. For instance for
services or property in such cases the companys valuation of the
consideration is generally accepted as conclusive. If the property has been
over valued, provided the valuation has been arrived at bona fide, the courts
will not question the adequacy of the consideration but if it appears on the
face of the transaction that the value of the property is less than that of the
shares, then the court will set aside that transaction. For this reason the
shares in a company must be given a definite value. The law tries to ensure
that the company initially receives assets at least equivalent to the nominal
value of the paper capital. Refer to Section 5 of the Companies Act.
Unfortunately if in the insistence that shares do have a definite fixed value is

99
not an adequate safeguard because there is no legal minimum as to what the
nominal value of the shares should be.

2. The Rule in Trevor v. Whitworth [1887] 12 A.C 449. Under this rule
a company is not allowed to purchase its own shares even if there is an express
power to do so in its Memorandum of Association as this would amount in a
reduction of its capital. This principle is now supplemented by Section 56 of
the Companies Act which prohibits any direct or indirect provision of any form
of assistance in the purchase of the company shares. However, there are 3
exceptions to this broad prohibition.

a. where the lending of money is part of the ordinary business of

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

3. Payment of Dividends: In order to ensure that the companys capital is not

refunded to the shareholders under the guise of dividends, the basic principle
is that dividends should not be paid otherwise than out of profits. Refer to
Article 116 of Table A of the Companies Act. The legal problem in this respect
has been the lack of an adequate definition of what constitutes profits. To
avoid the problem of definition the courts have formulated certain rules for
the payment of dividends. These are as follows:

(i) Before a company can declare dividends, it must be solvent. Dividends will
not be paid if this will result in the companys inability to pay its debts as and
when they fall due;

(ii) If the value of the companys fixed assets has fallen thereby
causing a loss in the value of those assets, the company does not need to make

100
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 companys assets may also be
distributed by way of dividends. Refer to Dimbula Valley (Ceylon) Tea Co. V.
Laurie [1961] Ch. D 353 Losses on circulating assets made in previous
accounting periods need not be made good. The dividend can be declared
provided that there is a profit on the current years trading. Each accounting
period is treated in isolation and once a loss has been sustained in one trading
year, then it need not be made good from the profits over subsequent trading
periods. Undistributed profits of past years still remain profit which can be
distributed in future years until they are capitalised by using them to pay a
bonus issue.

CORPORATE SECURITIES

Basically securities is a collective description of the various forms of investment

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

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

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

In contrast a debenture means a document which either creates or

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

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

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

The indebtedness acknowledged by a debenture is normally but not necessarily

secured by charge over the companys property. Such charge could either be a
specific charge or a floating charge. Both were defined by Lord Mcnaghten in
the case of Illingsworth v. Houlsworth [1904] A.C. 355 AT 358 He stated

a specific charge is one that without more fastens on ascertained and definite
property or property capable of being ascertained and defined. A floating
charge on the other hand is ambulatory and shifting in its nature, hovering
over and so to speak floating with the property which it is intended to affect
until some event occurs or some act is done which causes it to settle and
fasten on the subject of the charge within its reach or grasp.

A floating charge has 3 basic characteristics.

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

CRYSTALISATION

A floating charge will crystallise under the following

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

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

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

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

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

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

SHARES

In a company with a share capital it is obvious that the company must issue
some shares and the initial presumption of the law is that all the shares so
issued confer equal rights and impose equal liabilities. Normally a
shareholders right in a company will fall under 3 heads:

1. Payment of dividends;
2. Refund of Capital on winding up;
3. Attendance and voting at companys general meetings.

Unless there is indication to the contract all the shares will confer the same
rights under those heads. In practice companies issue shares which confer on
the holders some preference over the others in respect of either payment of
dividends or capital or both. This is the method by which classes of shares are
created i.e. by giving some of the shareholders preference over others.

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

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

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

(b) However if the shares are expressly divided into separate classes
thereby rebutting the presumed equality, it is a question of construction in
each case what the rights of each class are. Hence if nothing is expressly said
about the rights of one class in respect of either dividends, return of capital or
attendance and voting at meetings, then that class has the same rights in that
respect as the other shareholders. The fact that a preference is given in
respect of any of these matters does not imply that any right to preference in
some other respect is given e.g. a preference as to dividends will not apply a
preference as to capital i.e. the shares enjoy only such preference as may be
expressly conferred upon them.

(c) If however, any rights in respect of any of these matters are

expressly stated, the statement is presumed to be exhaustive so far as that
matter is concerned. For instance the preference dividend is presumed to be
non-participating in regard to other dividends. Refer to Re Isle of Thanet
Electricity Supply Co. (1950) Ch. 1951 where Justice Wynn Parry stated the
effect of the authorities as now in force is to establish two principles. First that
in construing an article which deals with the rights to share all profits, that is

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dividend rights and rights to shares in the companys property in liquidation,
the same principle is applicable and secondly that principle is that where the
articles sets out the rights attached to a class of shares to participate in profits
while the company is a going concern or to share in the property of a company
in liquidation, prima facie the rights so set out are in each case exhaustive.

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

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

WINDING UP

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

The circumstances under which the company may be voluntarily wound up are
outlined in Section 217 of the Companies Act. Here a company may be wound
up

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

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

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

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

WINDING UP BY THE COURT

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

Section 218 of the Companies Act gives the High Court jurisdiction to wind up
any company registered in Kenya. The circumstances under which a company

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may be wound up by a court order are spelt out in Section 219 of the
Companies Act.

These cover situations in which

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

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

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

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

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

exceeding 1000 shillings demands payment from the company and 3 weeks

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elapse before the company has paid that sum or secured it to the reasonable
satisfaction of a creditor;

2. If execution issued on a judgment against the company is

returned unsatisfied;

3. If it is proved by any other method that a company is unable to

pay its debts.

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

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

PETITION BY A CONTRIBUTOR

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

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

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

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

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

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

WINDING UP ON JUST AND EQUITABLE GROUNDS

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

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

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

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

between the members that if not all of them, then the majority of them will
participate in the management of the companys affairs. Such members
impose mutual trust and confidence in one another just as in the case of
partnerships.

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Also usual in such companies is the restriction of the transfer of a members
shares without the consent of all the other members.

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

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

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

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

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

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

petitioned for winding up mainly on the ground that this was just and
equitable. The Affidavits sworn by the petitioner and his co-shareholders
disclosed that there had been bitter and unresolved quarrelling between the

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parties going to the root of the companies business but none of these stated
that the companys affairs had reached a deadlock. It was however conceded
by all the parties that as a result of the quarrelling the petitioner had been
prevented from participating in the management of the companys affairs.

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

Mitha Mohamed V. Mitha Ibrahim [1967] EA 575

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

CONSEQUENCES OF A WINDING UP ORDER

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

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

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

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

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

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