Ashbury Railway Carriage v Riche: The Ultra Vires Doctrine

Ashbury Railway Carriage and Iron Co v Riche (1875) LR 7 HL 653 decided that a company registered under the Companies Acts has no capacity to do anything outside the objects stated in its memorandum, and that a contract outside those objects is void and cannot be ratified even by every shareholder acting unanimously.

It is the source of the ultra vires doctrine in company law, and it is taught today mainly for how completely that doctrine has been undone. The reasoning is still worth following, because the modern statutory provisions only make sense as answers to the problem this case created.

The facts

The company's memorandum stated its objects as making and selling, or lending on hire, railway carriages and wagons, and all kinds of railway plant, fittings, machinery and rolling stock; carrying on the business of mechanical engineers and general contractors; purchasing, leasing, working and selling mines, minerals, land and buildings.

The directors agreed with Riche to finance the construction of a railway line in Belgium. The shareholders subsequently approved the arrangement. The company then repudiated it, and Riche sued for breach of contract.

The dispute therefore had an uncomfortable shape from the outset. The party arguing that the company had no power to make the contract was the company itself, and it was doing so in order to escape an obligation its own directors had assumed and its own members had approved.

The decision

The House of Lords held the contract void.

The phrase "general contractors" did not save it. Read in its context, following mechanical engineers and in a memorandum otherwise concerned with railway rolling stock, it meant contracts of the kind the rest of the clause described, not contracting in general. A construction wide enough to cover financing a railway would have made the objects clause meaningless, since every commercial undertaking is a contract of some kind.

The critical step was what followed. Because the contract was outside the objects, it was not merely unauthorised but beyond the company's capacity. A company incorporated by registration exists for the purposes stated in its memorandum, and it has no existence for any other purpose. An act outside those purposes is not the act of the company at all.

From that proposition the rest followed inexorably. Ratification could not cure the defect, because there was nothing capable of being ratified: unanimous shareholder approval cannot confer a capacity the statute withheld. The company could not be estopped from raising the point, because capacity is not a matter the parties can agree away. And the outsider's ignorance was irrelevant, because the memorandum was a public document.

Why the doctrine was defended

The justification offered was the protection of two classes of person, and it was not a foolish argument in 1875.

Shareholders subscribed on the faith of a stated purpose. Someone who invested in a wagon manufacturer had not agreed to have their capital used to build a foreign railway, and the objects clause was the term of the bargain that said so.

Creditors lent against a known field of activity. A lender could read the memorandum and know the boundaries of the enterprise whose assets stood behind the debt.

Both arguments assume that reading the memorandum is a realistic precaution. That assumption weakened as registered companies multiplied, and it collapsed once drafters responded to the doctrine in the obvious way.

How the doctrine was evaded in practice

Three devices emptied the rule of most of its content long before Parliament abolished it, and each is worth naming because the modern law absorbed all three.

The first was the long objects clause. If capacity is fixed by the memorandum, the answer is a memorandum that lists everything. Clauses ran to pages, covering every conceivable trade, and the protection the doctrine offered shareholders and creditors disappeared into the drafting.

The second was the independent-objects clause, upheld in Cotman v Brougham. A provision stating that each paragraph of the objects clause is to be construed as an independent main object, and not limited by reference to any other, defeats the contextual reading that decided the Ashbury case itself. The courts disliked it and enforced it.

The third was the subjective objects clause, upheld in Bell Houses Ltd v City Wall Properties Ltd. A clause empowering the company to carry on any business which in the opinion of the directors can advantageously be carried on in connection with its general business is valid, and it makes capacity turn on the directors' honest opinion rather than on the words of the memorandum.

By the middle of the twentieth century a competently drafted memorandum made the doctrine almost impossible to invoke, while an incompetently drafted one occasionally destroyed a contract on which an innocent outsider had relied. The rule had inverted: it no longer protected investors, and it still punished third parties.

Capacity and authority, which are different questions

A great deal of confusion in this area comes from running two questions together, and separating them is usually the first mark available.

Capacity asks whether the company could do the act at all. That was the Ashbury question, and the answer under the old law was found in the objects clause.

Authority asks whether the person who acted could bind the company. That is agency, and it is answered by the actual and apparent authority of directors and officers. The rule in Royal British Bank v Turquand allowed an outsider dealing in good faith to assume that the company's internal procedures had been complied with, which solved a great many problems of authority — but it could not solve a problem of capacity, because no assumption about internal process can supply a power that does not exist.

That is the precise gap the case left open, and it is why statutory intervention had to address capacity directly instead of extending the agency rules.

What the law now provides

The modern position is the reverse of the decision, and it was reached in stages.

The validity of a company's acts is no longer to be called into question on the ground of anything in the company's constitution. Capacity, as a limit enforceable by or against an outsider, is gone.

In favour of a person dealing with a company in good faith, the power of the directors to bind the company is deemed free of any limitation under the company's constitution. Good faith is presumed, and a person is not bound to enquire as to any limitation. Knowing that an act is beyond the directors' powers does not by itself amount to bad faith.

Unless a company's articles specifically restrict the objects of the company, its objects are unrestricted. Companies formed under the current legislation therefore have no objects clause at all unless they choose one, and the question the Ashbury case turned on does not arise for them.

What survives is internal. A director who causes the company to act outside a restriction in its constitution breaches the duty to act within powers, and the company may sue them or a shareholder may seek an injunction before the act is carried out. The constraint has moved from the contract with the outsider to the relationship between the company and its own directors, which is where the original justification always pointed.

Where restricted capacity still bites

Two categories keep the doctrine alive in narrowed form.

Charitable companies retain a genuine objects restriction, because the restriction is what makes the entity charitable, and the protection given to third parties is correspondingly qualified.

Companies incorporated by statute or by charter for a defined public purpose, not by registration, take their capacity from the instrument that created them. Local authorities are the practical example, and the modern cases in which a contract has been held void for want of capacity are overwhelmingly cases of that kind, not of registered companies.

Reading the case today

The case is a rare example of a decision that is doctrinally clear, internally consistent, and wrong in its practical effect, and the sequence of responses to it is more instructive than the holding.

The courts could not overrule it, because it rested on the construction of a statute that gave the company its existence. They could only construe memoranda generously, which encouraged drafters to write memoranda nobody would ever read. Parliament could remove the doctrine, and did, but only after a century in which the rule's costs were borne by outsiders who had done nothing wrong.

The general lesson, and the reason the case appears in courses that are not primarily historical, is that a protective rule which can be drafted around does not protect anybody. It merely transfers the risk to whichever party failed to anticipate it.

How it is examined

The question is almost always whether a company can escape a contract, and the sequence is short.

Establish how the company was incorporated, because a registered company and a statutory body are governed by different rules. For a registered company, state that capacity is no longer a ground on which the validity of an act can be challenged, and that the objects are unrestricted unless the articles say otherwise.

Then move to the real issue, which will be authority and not capacity: whether the individual who acted could bind the company, whether the outsider dealt in good faith, and whether any constitutional limitation on the directors' powers is enforceable against them.

Finish inside the company. If the act breached a restriction, the remedy lies against the directors for exceeding their powers, and possibly in an injunction sought before performance. An answer that stops at "the contract is void because it was ultra vires" is applying a rule that was abolished, and it is the single most common error on these facts.