THE LAW OF BUSINESS ASSOCIATIONS I Lecture 1

5.9.03

Section 2 (1) of the Companies Act Cap 486 Laws of Kenya states what company means as
'a company formed and registered under this Act or an existing company. This is a very
vague definition, in the statute the word company is not a legal term hence the vagueness of
the definition. The legal attributes of the word company will depend upon a particular legal
system.
In legal theory company denotes an association of a number of persons for some common
object or objects in ordinary usage it is associated with economic purposes or gain. A
company can be defined as an association of several persons who contribute money or
moneys worth into a common stock and who employ it for some common purpose. Our
legal system provides for two types of associations namely
1.
Companies
2.
Partnerships.
3.
Upcoming is the cooperative society.
The law treats companies in company law distinctly from partnerships in partnership law.
Basically company law consists partly of ordinary rules of Common law and equity and
partly of statutory rules. The common law rules are embodied in cases. The statutory rules
are to be found in the Companies Act which is the current Cap 486 Laws of Kenya. It
should denote that the Kenya Companies Act is not a self contained Act of legal rules of
company law because it was borrowed from the English Companies Act of 1948 which was
itself not a codifying Act but rather a consolidating Act.
Exceptions to the Rules are stated in the Act but not the rules themselves. Therefore
fundamental principles have to be extracted from study of numerous decided cases some of
which are irreconcilable. The true meaning of company law can only be understood
against the background of the common law.
FUNDAMENTAL CONCEPTS OF COMPANY LAW
There are two fundamental legal concepts
1.

The concept of legal personality; (corporate personality) by which a company is

treated in law as a separate entity from the members.

2.

The concept of limited liability;

Concept of legal personality

(i)
A legal person is not always human, it can be described as any person
human or otherwise who has rights and duties at law; whereas all human persons
are legal persons not all legal persons are human persons. The non-human legal
persons are called corporations. The word corporation is derived from the Latin

word Corpus which inter alia also means body. A corporation is therefore a legal
person brought into existence by a process of law and not by natural birth. Owing
to these artificial processes they are sometimes referred to as artificial persons not
fictitious persons.
LIMITED LIABILITY
Basically liability means the extent to which a person can be made to account by law. He
can be made to be accountable either for the full amount of his debts or else pay towards
that debt only to a certain limit and not beyond it. In the context of company law liability
may be limited either by shares or by guarantee.
Under Section (2) (a) of the Companies Act, in a company limited by shares the members
liability to contribute to the companies assets is limited to the amount if any paid on their
shares.
Under Section 4 (2) (b) of the Companies Act in a company limited by guarantee the
members undertake to contribute a certain amount to the assets of the company in the event
of the company being wound up. Note that it is the members liability and not the
companies liability which is limited. As long as there are adequate assets, the company is
liable to pay all its debts without any limitation of liability. If the assets are not adequate,
then the company can only be wound up as a human being who fails to pay his debts. Note
that in England the Insolvency Act has consolidated the relationships relating to . That
does not apply here.
Nearly all statutory rules in the Companies Act are intended for one or two objects namely
1.
The protection of the companys creditors;
2.
The protection of the investors in this instance being the members.
These underlie the very foundation of company law.
FORMATION OF A LIMITED COMPANY
First in relation to registration under the Companies Act
In order to incorporate themselves into a company, those people wishing to trade through
the medium of a limited liability company must first prepare and register certain
documents. These are as follows
a.
Memorandum of Association: this is the document in which they express inter
alia their desire to be formed into a company with a specific name and objects.
The Memorandum of Association of a company is its primary document which
sets up its constitution and objects;
b.
Articles of Association; whereas the memorandum of association of a company
sets out its objectives and constitution the articles of association contain the
rules and regulations by which its internal affairs are governed dealing with

such matters as shares, share capital, companys meetings and directors among
others;
Both the Memorandum and Articles of Associations must each be signed by seven
persons in the case of a public company or two persons if it is intended to form a
private company. These signatures must be attested by a witness. If the company has a
share capital each subscriber to the share capital must write opposite his name the
number of shares he takes and he must not take less than one share.
c.

Statement of Nominal Capital this is only required if the company has a share
capital. The fees that one pays on registration will be determined by the share
capital that the company has stated.

d.

Declaration of Compliance: this is a statutory declaration made either by the

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

These are the only documents which must be registered in order to secure the incorporation
of the company. In practice however two other documents which would be filed within a
short time of incorporation are also handed in at the same time. These are
1.
2.

Notice of the situation of the Registered Office which under Section 108
of the statute should be filed within 14 days of incorporation;
Particulars of Directors and Secretary which under Section 201 of the
statute are normally required within 14 days of the appointment of the
directors and secretary. The documents are then lodged with the
registrar of companies and if they are in order then they are registered
and the registrar thereupon grants a certificate of incorporation and the
company is thereby formed. Section 16(2) of the Act provides that from
the dates mentioned in a certificate of incorporation the subscribers to
the Memorandum of Association become a body corporate by the name
mentioned in the Memorandum capable of exercising all the functions of
an incorporated company. It should be noted that the registered
company is the most important corporation.

STATUTORY CORPORATIONS
The difference between a statutory corporation and a company registered under the
companies Act is that a statutory corporation is created directly by an Act of Parliament.
The Companies Act does not create any corporations at all. It only lays down a procedure

by which any two of more persons who so desire can themselves create a corporation by
complying with the rules for registration which the Act prescribes.
TYPES OF REGISTERED COMPANY
Before registering a company the promoters must make up their minds as to which of the
various types of registered companies they wish to form.
1.

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

2.

If they decide upon a limited company, they must make up their minds whether
it is to be limited by shares or by guarantee. This will depend upon the purpose
for which it is formed. If it is to be a non-profit concern, then a guarantee
company is the most suitable, but if it is intended to form a profit making
company, then a company limited by shares is preferable.

3.

They have to choose between a private company and a public company. Section
30 of the Companies Act defines a private company as one which by its articles
restricts
(i)
(ii)
(iii)

The rights to transfer shares;

Restricts the number of its members to fifty (50);
Prohibits the invitation of members of the public to subscribe for any
shares or debentures of the company.

A company which does not fall under this definition is described as a public company.
In order to form a public company, there must be at least seven (7) subscribers signing the
Memorandum of Association whereas only two (2) persons need to sign the Memorandum
of Association in the case of a private company.
ADVANTAGES OF INCORPORATION
A corporation is a legal entity distinct from its members, capable of enjoying rights being
subject to duties which are not the same as those enjoyed or borne by the members.
The full implications of corporate personality were not fully understood till 1897 in the
case of Salomon v. Salomon [1897] A C 22
Facts of the case.

Salomon was a prosperous lender/merchant. He sold his business to Salomon and Co.
Limited which he formed for the purpose at the price of 39,000 satisfied by 1000 in cash,
10,000 in debentures conferring a charge on the companys assets and 20,000 in fully
paid up 1 shares. Salomon was both a creditor because he held a debenture and also a
shareholder because he held shares in the company. Seven shares were then subscribed for
in cash by Salomon, his wife and daughter and each of his 4 sons. Salomon therefore had
20,101 shares in the company and each member of the family had 1 share as Salomons
nominees. Within one year of incorporation the company ran into financial problems and
consequently it was wound up. Its assets were not enough to satisfy the debenture holder
(Salomon) and having done so there was nothing left for the unsecured creditors. The court
of first instance and the court of appeal held that the company was a mere sham an alias,
agents or nominees of Salomon and that Mr. Salomon should therefore indemnify the
company against its trade loss.
The House of Lords unanimously reversed this decision. In the words of Lord Halsbury
Either the limited company was a legal entity or it was not. If it was, the business
belonged to it and not to Salomon. If it was not, there was no person and no thing at all
and it is impossible to say at the same time that there is the company and there is not
In the words of Lord Macnaghten the company is at a law a different person altogether
from the subscribers and though it may be that after incorporation the business is precisely
the same as it was before, and the same persons are managers, and the same hands receive
the profits, the company is not in law the agent of the subscribers or trustee for them nor
are the subscribers as members liable in any shape or form except to the extent and
manner prescribed by the Act. in order to form a company limited by shares the Act
requires that a Memorandum of Association should be signed by seven (7) persons who are
each to take one share at least. If those conditions are satisfied, what can it matter,
whether the signatories are relations or strangers. There is nothing in the Act requiring
that the subscribers to the Memorandum should be independent or unconnected or that
they or anyone of them should take a substantial interest in the undertaking or that they
should have a mind and will of their own. When the Memorandum is duly signed and
registered though there be only seven (7) shares 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.
3.

It showed that incorporation was as readily available to the small private

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

Since the decision in Salomons case the complete separation of the company and its
members has never been doubted.
Macaura V. Northern Assurance Co. Ltd (1925) A.C. 619
The Appellant owner of a timber estate assigned the whole of the timber to a company
known as Irish Canadian Sawmills Company Limited for a consideration of 42,000.
Payment was effected by the allotment to the Appellant of 42,000 shares fully paid up
in 1 shares in the company. No other shares were ever issued. The company
proceeded with the cutting of the timber. In the course of these operations, the
Appellant lent the company some 19,000. Apart from this the companys debts were
minimal. The Appellant then insured the timber against fire by policies effected in his
own name. Then the timber was destroyed by fire. The insurance company refused to
pay any indemnity to the appellant on the ground that he had no insurable interest in the
timber at the time of effecting the policy.
The courts held that it was clear that the Appellant had no insurable interest in the
timber and though he owned almost all the shares in the company and the company
owed him a good deal of money, nevertheless, neither as creditor or shareholder could
he insure the companys assets. So he lost the Company.
Lee v Lees Air Farming Ltd. (1961) A.C. 12
Lees company was formed with capital of 3000 divided into 3000 1 shares. Of these
shares Mr. Lee held 2,999 and the remaining one share was held by a third party as his
nominee. In his capacity as controlling shareholder, Lee voted himself as company
director and Chief Pilot. In the course of his duty as a pilot he was involved in a crash
in which he died. His widow brought an action for compensation under the Workmans
Compensation Act and in this Act workman was defined as A person employed under
a contract of service so the issue was whether Mr. Lee was a workman under the Act?
The House of Lords Held:
that it was the logical consequence of the decision in Salomons case that Lee and the
company were two separate entities capable of entering into contractual relations and
the widow was therefore entitled to compensation.
Katate v Nyakatukura (1956) 7 U.L.R 47A
The Respondent sued the Petitioner for the recovery of certain sums of money allegedly
due to the Ankore African Commercial Society Ltd in which the petitioner was a

Director and also the deputy chairman. The Respondent conceded that in filing the
action he was acting entirely on behalf of the society which was therefore the proper
Plaintiff. The action was filed in the Central Native Court. Under the Relevant Native
Court Ordinance the Central Native Court had jurisdiction in civil cases in which all
parties were natives. The issue was whether the Ankore African Commercial Society
Ltd of whom all the shareholders were natives was also a native.
The court held that a limited liability company is a corporation and as such it has
existence which is distinct from that of the shareholders who own it. Being a distinct
legal entity and abstract in nature, it was not capable of having racial attributes.
ADVANTAGES OF INCORPORATION
1. Limited Liability since a corporation is a separate person from the members, its
members are not liable for its debts. In the absence of any provisions to the
contrary the members are completely free from any personal liability. In a company
limited by shares the members liability is limited to the amount unpaid on the
shares whereas in a company limited by guarantee the members liability is limited
to the amount they guaranteed to pay. The relevant statutory provision is Section
213 of the Companies Act.
2. Holding Property: Corporate personality enables the property of the association to
be distinguishable from that of the members. In an incorporated association, the
property of the association is the joint property of all the members although their
rights therein may differ from their rights to separate property because the joint
property must be dealt with according to the rules of the society and no individual
member can claim any particular asset to that property.
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 SUCCESSIONAs an artificial person, the company has neither body
mind or soul. It has been said that a company is therefore invisible immortal and
thus exists only intendment consideration of the law. It can only cease to exist by
the same process of law which brought it into existence otherwise, it is not subject
to the death of the natural body. Even though the members may come and go, the
company continues to exist.
5. TRANSFERABILITY OF SHARES Section 75 of the Companies Act states as
follows The Shares or any other interests of a member in a company shall be
moveable property transferable in the manner provided by the Articles of
Association of the Company. In a company therefore shares are really transferable
and upon a transfer the assignee steps into the shoes of the assignor as a member of
the company with full rights as a member. Note however that this transferability
only relates to public companies and not private companies.
6. BORROWING FACILITIES:in practice companies can raise their capital by
borrowing much more easily than the sole trader or partnership. This is enabled by
the devise of the floating charge a floating charge has been defined as a charge
which floats like a cloud over all the assets from time to time falling within a
certain description but without preventing the company from disposing of these
assets in the ordinary course of its 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)
(ii)
(iii)

Too many formalities required in the formation of the company

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

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

documents need to be prepared to establish business as a sole proprietor or partnership and
throughout its life a company is required to file such documents as balance sheets and
profits and loss accounts on dissolution of the company it is required to follow a certain
stipulated procedure which does not apply to sole traders and partnerships.
7.

IGNORING THE CORPORATE

INCORPORATION)

ENTITY

(LIFTING

THE

VEIL

OF

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 courts defined it. However, in Re William C. Leitch Ltd
(1932) 2 Ch. 71 the company was incorporated to acquire Williams
business as a furniture manufacturer. The directors of the company were
William and his wife and they appointed William as the Managing Director
at a Salary of 1000 per annum. Within the period of one month, the
company was debited with an amount which was 500 more than what was
actually due to William. By that time the company had made a loss of
2500. Within 2 years of formation, and while the company was still in
financial problems, the directors paid to themselves the dividends of 250.
By the end of the 3rd year since incorporation the company was in such
serious difficulties such that it could not pay debts as they fell due. In spite
of this William ordered goods worth 6000 which became subject to a
charge contained in a debenture held by them. At the same time he
continued to repay himself a loan of 600 (six hundred pounds) which he
had lent to the company at the beginning of the 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 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 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

10

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)
(ii)

is a member of it and controls the composition of its board of directors or

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.
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.

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WHERE THERE IS AN AGENCY RELATIONSHIP

Generally there is no reason why a company may not be an agent of its share holders. The
decision in Salomons case shows how difficult it is to convince the courts that a company
is an agent of its members. In spite of this there have been occasions in which the courts
have held that registered companies were not carrying on in their own right but rather were
carrying on business as agents of their holding companies. Reference may be made to the
case of
Smith Stone & Knight v. Birmingham Corporation (1939) 4 All E.R. 116
In this case the Plaintiffs were paper manufacturers in Birmingham City. In the same city
there was a partnership called Birmingham West Company. This partnership did business
as merchants and dealers in waste paper. The plaintiffs bought the partnership as a going
concern and the partnership business became part of the companys property. The plaintiffs
then caused the partnership to be registered as a company in the name of Birmingham West
Company Limited. Its subscribed capital was 502 pounds divided into 502 shares. The
Plaintiff holding 497 shares in their own name and the remaining shares being registered in
the name of each of the Directors. Thereafter the Directors executed a declaration of trust
stating that their shares were held by them on trust for the Plaintiff company. The new
company had its name placed upon the premises and on the note paper invoices etc. as
though it was still the old partnership carrying on business. There was no agreement of any
sort between the two companies and the business carried on by the new company was never
assigned to it. The manager was appointed but there were no other staff. The books and
accounts of the new company were all kept by the plaintiff company and the manager of
this company did not know what was contained therein and had no access to those books.
There was no doubt that the Plaintiff Company had complete control over the waste
company. There was no tenancy agreement between them and the waste company never
paid any rent. Apart from the name, it was as if the manager was managing a department
of the plaintiff company.
The Birmingham Corporation compulsorily acquired the premises upon which the
subsidiary company was carrying on business and the Plaintiff company claimed
compensation for removal and disturbance. Birmingham Corporation replied that the
proper claimants were the subsidiary company and not the holding company since the
subsidiary company was a separate legal entity.
If this contention was correct the Birmingham Corporation would have escaped liability for
paying compensation by virtue of a local Act which empowered them to give tenants notice
to terminate the tenancy.
The court held that occupation of the premises by a separate legal entity was not conclusive
on a question of a right to claim and as a subsidiary company it was not operating on its
own behalf but on behalf of the parent company. The subsidiary company was an agent.
Lord Atkinson had the following to say

12

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.
2.
3.
4.
5.
6.

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

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

If the answers are in the affirmative, then the subsidiary company is an agent of the parent
company.
Reference may also be made to the case of
RE F G FILMS LTD [1953] 1 W.L.R.
Here a British company was formed with a capital of 100 pounds of which 90 pounds was
contributed by the president of an American Film Company. There were 3 directors, the
American and 2 Britons. By arrangement between the two companies, a film was shot in
India nominally by the British Company but all the finances and other facilities were
provided by the American Company. The British Board of Trade refused to recognize the
Film as having been made by a British company and therefore refused to register it as a
British film.
The court held that insofar as the British company had acted at all it had done so as an
agent or nominee of the American company which was the true maker of the film.
Firestone Tyre & Rubber Company v. Llewelln (1957) 1 W.L.R 464
Again in this case an American company had an arrangement with its distributors on the
European continent whereby the distributors obtained the supplies from the English
manufacturers who were a wholly owned subsidiary of an American company. The English
subsidiary credited the American company with a prize received after deducting costs and a
certain percentage. It was agreed that the distributors will not obtain their supplies from

13

anyone else. The issue was whether the subsidiary company in Britain was selling its own
goods or whether it was selling goods of an American company.
The court held that the substance of the arrangement was that the American company
traded in England through the subsidiary as its agent and that the sales by their subsidiary,
were a means of furthering the American companys European interests.
There have been cases where Salomons case has been upheld that a company is a legal
entity.
Ebbw Vale UDC V. South Wales Traffic Authority (1951) 2 K.B 366
Lord Justice Cohen L.J Under the ordinary rules of law, a parent company and a
subsidiary company even when a hundred percent subsidiary are distinct legal entities and
in the absence of an agency contract between the two companies, one cannot be said to be
an agent of the other.
2.

FRAUD & IMPROPER CONDUCT

Where there is fraud or improper conduct, the courts will immediately disregard the
corporate entity of the company. Examples are found in those situations in which a
company is formed for a fraudulent purpose or to facilitate the evasion of legal obligations.
Re Bugle Press Limited [1961] Ch. 270
This was based on Section 210 of the Companys Act where an offer was made to purchase
out a company if 90% of shareholders agreed. There were 3 shareholders in the company.
A, B and C.
A held 45% of the shares, B also held 45% of the shares and C held the remaining 10% of
the shares. A and B persuaded C to sell his shares to them but he declined. Consequently A
and B formed a new company call it AB Limited, which made an offer to ABC Limited to
buy their shares in the old company. A and B accepted the offer, but C refused. A and B
sought to use provisions of Section 210 in order to acquire Cs shares compulsorily.
The court held that this was a bare faced attempt to evade the fundamental principle of
company law which forbids the majority unless the articles provide to expropriate the
minority shareholders.
Lord Justice Cohen said the company was nothing but a legal hut. Built round the
majority shareholders and the whole scheme was nothing but a hollow shallow.
Gilford Motor Co. v. Horne (1933) Ch. 935

14

Here the Defendant was a former employee of the plaintiff company and had covenanted
not to solicit the plaintiffs customers. He formed a company to run a competing distance.
The company did the solicitation. The defendant argued that he had not breached his
agreement with the plaintiffs because the solicitation was undertaken by a company which
was a separate legal entity from him.
The court held that the defendants company was a mere cloak or sham and that it was the
defendant himself through this device who was soliciting the plaintiffs customers. An
injunction was granted against the both the defendant and the company not to solicit the
plaintiffs customers.
Jones v. Lipman (1912) 1 W.L.R. 832
This case the Defendant entered into a contract for the sale of some property to the
plaintiff. Subsequently he refused to convey the property to the plaintiff and formed a
company for the purpose of acquiring that property and actually transferred the property to
the company. In an action for specific performance the Defendant argued that he could not
convey the property to the Plaintiff as it was already vested in a third party.
Justice Russell J. observed as follows
the Defendant company was merely a device and a sham a mask which he holds before his
face in an attempt to avoid recognition by the eye of equity
GROUP ENTERPRISE
In exercise of their original jurisdiction, the courts have displayed a tendency to ignore the
separate legal entities of various companies in a group. By so doing, the courts give regard
to the economic entity of the group as a whole.
Authority is the case of
Holsworth & Co. v. Caddies [1955]1W.L.R. 352
The Defendant Company had employed Mr. Caddies as their Managing Director for 5
years. At the time of that contract the company had two subsidiaries and Caddies was
appointed Managing Director of one of those subsidiaries. He fell out of favour with the
other Directors consequent upon which the board of directors stated that Caddies should
confine his attention to the affairs of the subsidiary company only. He treated this as a
breach of contract and sued the company for damages. It was held that since all the
companies form but one group, there was no breach of contract in directing Caddies to
confine his attention to the activities of the subsidiary company.
DETERMINATION OF A COMPANYS RESIDENCE
De Beers Consolidated Mines Ltd (1906) K.C. 455

15

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

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.
2.

It is said to be intended for the protection of the investors who thereby know the
objects in which their money is to be applied.
It is also said to be intended for the protection of the creditors by ensuring that
the 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.
2.
3.

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

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

The directors entered into a contract to purchase a concession for constructing a railway in
Belgium. The issue was whether this contract was valid and if not whether it could be
ratified by the shareholders.
The court held that the contract was ultra vires the company and void so that not even the
subsequent consent of the whole body of shareholders could rectify it. Lord Cairns stated
as follows:
The words general contractors referred to the words which went immediately
before and indicated such a contract as mechanical engineers make for the purpose of

16

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.
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.

17

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 connection with or as ancillary to any of the above businesses
or a general business of the company.
In connection with its various development skills the companys managing director met an
agent of the Defendants who required some finance to the tune of about 1 million pounds.
The Plaintiffs Managing Director intimated to the Defendants agent that he knew of a
source from which the Defendant could obtain finance and accordingly referred them to a
Swiss syndicate of financiers. In this action the Plaintiffs alleged that for that service, the
Defendants had agreed to pay a commission of 20,000 pounds and in the alternative they
claimed 20,000 pounds for breach of contract. The Defendants argued that there was no
contract between the parties. In the alternative they argued that even if there was a contract
such contract was in effect one whereby the Plaintiffs undertook to act as money-brokers
which activity was beyond the objects of the plaintiff company and which was therefore
ultra vires.
The issues were
1.
Whether the contracts were ultra vires
2.
Whether it was open to the defendant to raise this point;
The court of first instance decided that the company was ultra vires and it was open to the
defendant to raise the defence of ultra vires. However a unanimous court of appeal
reversed the decision and hailed that the words stated must be given their natural meaning
and the natural meaning of those words was such that the company could carry on any
business in connection with or ancillary to its main business provided that the directors
thought that could be advantageous to the company.
Lord Justice Salomon L.J stated as follows:
It may be that the Directors take the wrong view and infact the business in
question cannot be carried on as they believe but it matters not how mistaken they might be
provided that they formed their view honestly then the business is within the plaintiffs
companys objects and powers.
LAW OF BUSINESS ASSOCIATIONS Lecture 3

27TH FEBRUARY 04

18

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 subclause 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 subclause authorised the company to develop rubber plantations and the fourth clause
empowered the company to deal in any shares of any company. The objects clause
concluded with a declaration that each of the sub clauses was to be construed
independently as independent objects of the company. The company underwrote and
had allotted to it shares in an oil company. The question that arose was whether this
was intra vires the companys objects. The court held that the effect of the independent
objects clause was to constitute each of the 30 objects of the company as independent
objects. Therefore the dealing of shares in an oil company was within the objects and
thus intra vires. However the power to borrow money cannot be construed as an
independent object of the company in spite of this decision.
Re Introductions (1962) W.L.R. 791
In this case the company was formed to provide accommodation and services to those
overseas visitors going to a festival in Britain. The company did this during the first
few years of existence. Later the company switched over to pig breeding as its sole
business. While so engaged it borrowed money from a bank on a security of
debentures. The bank was given a copy of the companys Memorandum of Association
and at the material time knew that the companys sole business was that of pig
breeding. The issue was, whether the loan and debentures were valid in view of the fact
one of the sub clauses empowered the company to borrow money and the last sub
clause was an independent object clause.
The court held that borrowing was a power and not an object. The power to borrow
existed only for furthering intra vires objects of the company and was not an object in
itself. Therefore:

19

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.
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 substratum of the association fails.
This substratum rule is too narrow and cannot sufficiently uphold the ultra vires rule.
Questions are, are members or shareholders really protected? Do they know what the
objects are? The Directors may choose any amongst the many.
Secondly a member has to petition first and the court has to decide
John Beauforte (1953) Ch.d 131
A company was authorised by its Memorandum of Association to carry on the business of
costumiers, gown makers and other activities ejusdem generis. The company decided to
undertake the business of making veneered panels which was admittedly ultra vires and for
this purpose, it constructed a factory at Bristol. The company later went into compulsory

20

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 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

21

widow of a former managing director but after the winding up the liquidator rejected her
claim to the pension.
The court held that the transaction whereby the company covenanted to pay the widow a
pension was not for the benefit of the company or reasonably incidental to its business and
was therefore ultra vires and hence null and void.
Justice Eve stated as follows
Whether they reneged an express or implied power, all such grants involved an expenditure
of the 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 exemployees generously and was not taken in the interest of the company as it was going to
remain and that therefore it was ultra vires.
The Court observed as follows the defendants were prompted by motives which however
laudable and however enlightened from the point of view of industrial relations were such
as the law does not recognise as sufficient justification. The essence of the matter was that
the Directors were proposing that a very large part of its assets should be given to its
employees in order to benefit those employees rather than the company and that is an
application of the companys funds which the law will not allow.
Evans v. Brunner Mound & Co. 1921 Ch.d 359

22

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 intended to apply to
unauthorised activities. He urged company A to lend the money on the security of
debentures. The issues were
(a)
Whether the debentures were valid security;
(b)
Whether the knowledge of X as to the intended application of the money could be
imputed to the company.
The court held that X was not company As agent for obtaining such information and
therefore his knowledge was not the companys knowledge and consequently the
debentures were valid security.
This loophole however will be applied very rarely because everybody is presumed to know
the contents of a companys public documents. Where a contract with that company is ultra
vires, generally speaking the party dealing with that company has no rights under the
contract. The transaction being null and void cannot confer rights on the 3rd party nor can it
impose any obligation on the company.
In many instances however, property will be transferred under an ultra vires transaction.
Such transaction cannot vest rights in the transferee and cannot divest the transferor of his
rights.

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1.
At common law therefore, the first remedy of a person who parts with property
under an ultra vires transaction is that he has a right to trace and recover that property from
the company as long as he can identify it.
This principle also applies to money lent to the company on an ultra vires borrowing so
long as the money can be traced either in law or in equity. The basis of this principle is that
the company is deemed to hold the money or the property as a trustee for the person from
whom it was obtained.
Therefore, if the money received is paid into a separate account, or is sufficiently
earmarked e.g by the purchase of some particular items, it can be followed and claimed by
the lender. Where tracing is impossible, because the money has become mixed with other
money, the lender is entitled in equity to a charge on the mixed fund together with the other
creditors according to the respective amounts otherwise money obtained on ultra vires
transaction generally cannot be followed once it has been spent. But if such money has
been spent by discharging the companys intra vires debts then the lender is entitled to rank
as a creditor to the extent to which the money has been so applied. Since the companys
liabilities are not increased but in fact decreased, equity treats the borrowing as valid to the
extent of the legal application of such money.
2.
The 3rd party has a personal right against the directors or other agents with whom he
has dealt. The rationale is that such directors or other agents are treated as quasi trustees
from which it follows that a 3rd party is entitled to a claim against them for restitution.
TO WHAT EXTENT ARE MEMBERS PROTECTED BY THE ULTRA VIRES
DOCTRINE
The intra vires creditor does not have the locus standi to prohibit ultra vires actions. Again
there is the presumption of knowledge of a companys documents and activities. In spite of
the fact that the doctrine of ultra vires is over due for reform, it has not undergone any
reform in Kenya unlike in the United Kingdom where it has been severely eroded.
All the company can do is to alter its objects under the power conferred by Section 8 of the
Companies Act Cap 486. The effect of the Section is that a company may by special
resolution alter the provisions in its Memorandum with respect to the object of the
company.
Section 141 defines Special Resolution as a resolution which is passed by a majority of not
less than three quarters of those members voting a companys general meeting either in
person or by proxy and of which notice has been given of the intention to propose it as a
special resolution.
Within 30 days of the date on which the resolution altering the objects is passed, an
application for the cancellation of the Resolution may be made to Court by or on behalf of
the holders who have not voted in favour of the Resolution, of not less than 15% of the

24

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
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)
(b)
(c)

Adopt Table A in full; or

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

25

In the case of a company limited by shares, if no articles are registered or if articles are
registered insofar as they do not modify or exclude Table A the regulations in Table A
automatically become the Companys Articles of Association.
Section 12 of the Companies Act requires that the Articles must be in the English language
printed, divided into paragraphs numbered consecutively dated and signed by each
subscriber to the Memorandum of Association in the presence of at least one attesting
witness.
As between the Memorandum and the Articles the Memorandum of Association is the
dominant instrument so that if there is any conflict between the provisions in the
Memorandum and those in the Articles the Memorandum provisions prevail. However if
there is any ambiguity in the Memorandum one may always refer to the Articles for
clarification but this does not apply to those provisions which the Companies Act requires
to be set out in the Memorandum as for instance the Objects of the Company.
Whereas the Memorandum confers powers for the company, the Articles determine how
such powers should be exercised.
Articles regulate the manner in which the Companys affairs are to be managed. They deal
with inter alia the issue of shares, the alteration of share capital, general meetings, voting
rights, appointment of directors, powers of directors, payment of dividends, accounts,
winding up etc.
They further provide a dividing line between the powers of share holders and those of the
directors.
LEGAL EFFECTS OF THE ARTICLES OF ASSOCIATION
Under Section 22 of the Companies Act it is provided that subject to the provisions of the
Act, when the Memorandum and Articles are registered, they bind the company and the
members as if they had been signed and sealed by each member and contained covenants
for the part of each member to observe all their provisions. This Section has been
interpreted by the courts to mean that the Memorandum gives rise to a contract between the
Company and each Member.
Reference may be made to the case of
Hickman v. Kent (1950) 1 Ch. D 881
Here the Articles of the Company provided that any dispute between any member and the
company should be referred to arbitration. A dispute arose between Hickman and the
company and instead of referring the same to arbitration, he filed an action against the
company. The company applied for the action to be stayed pending reference to arbitration
in accordance with the companys articles of association.

26

The court held that the company was entitled to have the action stayed since the articles
amount to a contract between the company and the Plaintiff one of the terms of which was
to refer such matters to arbitration.
Justice Ashbury had the following to say: That the law was clear and could be reduced to
3 propositions
1.
That no Article can constitute a contract between the company and a third
party;
2.
No right merely purporting to be conferred by an article to any person
whether a member or not in a capacity other than that of a member for
example solicitor, promoter or director can be enforce against the company.
3.
Articles regulating the right and obligation of the members generally are
such do not create rights and obligations between members and the
company.
Eley v. Positive Government Security Life Association Co. (1876) Ex 88
In this case, the companys articles provided that Eley should become the company
Solicitor and should transact all legal affairs of the company for mutual fees and charges.
He bought shares in the company and thereupon became a member and continued to act as
the companys solicitor for some time. Ultimately the company ceased to employ him. He
filed an action against the company alleging breach of contract.
The court held: that the articles constitute a contract between the company and the
members in their capacity as members and as a solicitor Eley was therefore a third party to
the contract and could not enforce it. The contract relates to members in their capacity as
members and the company so its only a contract between the company and members of that
company and not in any other capacity such as solicitor. But note that there can be an intra
member contract.
Wood v. Odessa Waterworks Company [1880] 42 Ch. 636
Here the Plaintiff who was a member of the company petitioned the court to stay the
implementation of a resolution not to pay dividends but issue debentures instead. Holding
that a member was entitled to the stay of the implementation of the Resolution Sterling J.
had the following to say: the articles of association constitutes a contract not merely
between shareholders and the company but also between the individual shareholders and
every other.
This case was followed in
Rayfield v. Hands (1960) Ch.d 1
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

27

did the articles give rise to a contract between the Plaitniff and the directors. In their
capacity as directors they were not bound.
The court here held that the Articles related to the relationship between the Plaintiff as a
member and the Defendants not as directors but as members of the company. Therefore the
Defendants were bound to buy the Plaintiff shares in accordance with the relevant article.
ALTERATION OF ARTICLES
Section 13 of the Companies Act gives the company power to alter the articles by special
resolution. This is a statutory power and a company cannot deprive itself of its exercise.
Reference may be made to the case of
Andrews v. Gas Meter Co. (1897) 1 Ch. 361
The issue herein was whether a company which under its Memorandum and Articles had
no power to issue preference shares could alter its articles so as to authorise the issue of
preference shares by way of increased capital
The court held that as long as the Constitution of a Company depends on the articles, it is
clearly alterable by special resolution under the powers conferred by the Act. Therefore it
was proper for the company to alter those articles and issue preference shares. Any
regulation or article which purports to deprive the company of this power is therefore
invalid, on the ground that such an article or regulation will be contrary to the statute. The
only limitation on a companys power to alter articles is that the alteration must be made in
good faith and for the benefit of the company as a whole.
Allen v. Gold Reefs of West Africa (1900) 1 Ch. 626
In this case the company had a lien on all debts by members who had not truly paid up for
their shares. The Articles were altered to extend the Companys lien to those shares which
were fully paid up.
The court held that since the power to alter the Articles is statutory, the extension of the lien
to fully paid up shares was valid. This were the words of Lindley L.J.
Wide however as the language of Section 13 mainly the power conferred by it must be
exercised subject to the general principles of law and equity which are applicable to all
powers conferred on majorities and enabling them to bind minorities. It must be exercised
not only in the manner required by law but also bona fide for the benefit of the company as
a whole.
Further reference may be made to the case of
Shuttleworth v. Cox Brothers Ltd (1927) 2 KB 29

28

Here the Articles of the Company provided that the Plaintiff and 4 others should be the first
directors of the company. Further each one of them should hold office for life unless he
should be disqualified on any one of some six specified grounds, bankruptcy, insanity etc.
The Plaintiff failed to account to the company for certain money he had received on his
behalf. Under a general meeting of the company a special resolution was passed. That the
article be altered by adding a seventh ground for disqualification of a director which was a
request in writing by his co-directors that he should resign. Such request was duly given to
the Plaintiff and there was no evidence of bad faith on the part of shareholders in altering
the articles.
The Plaintiff sued the company for breach of an alleged contract contained in their original
articles that he should be a permanent director and for a declaration that he was still a
director.
The court held that the contract if any between the Plaintiff and the company contained in
the original articles in their original form was subject to the statutory power of alteration
and if the alteration was bona fide for the benefit of the company, it was valid and there
was no breach of contract. Lord Justice Bankes observed as follows
IN this case, the contract derives its force and effect from the Articles themselves
which may be altered. It is not an absolute contract but only a conditional contract.
The question here is who determines what is for the benefit of the company? Is the
shareholders or the Courts?
Scrutton L.J. had the following to say
to adopt such a view that a court should decide will be to make the court the
manager of the affairs of innumerable companies instead of shareholders themselves. It is
not the business of the court to manage the affairs of the company. That is for the
shareholders and the directors.
Sidebottom v. Kershaw Leese[1920]1 Ch. 154
Director controlled share company had a minority shareholder who was interested in some
competing business. The company passed a special resolution empowering the directors to
require any shareholder who competed with the company to transfer his shares at their fair
value to nominees of the directors. The Plaintiff was duly served with such a notice to
transfer his shares. He thereupon filed an action against the company challenging the
validity of that article.
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..

29

Contrast this case with that of

Brown v. British Abrasive Wheel Co. (1990) 1 Ch. 290
Here a public company was in urgent need of further capital which the majority of the
members who held 98% of the shares were willing to supply if they could buy out the
minority. They tried persuasion of the minority to sell shares to them but the minority
refused. They therefore proposed to pass a Special Resolution adding to the Articles a
clause whereby any shareholder was bound to transfer his shares upon a request in writing
of the holders of 98% of the issued capital.
The court held that this was an attempt to add a clause which will enable the majority to
expropriate the shares of the minority who had bought them when there was no such power.
Such an attempt was not for the benefit of the company as a whole but for the majority. An
injunction was therefore granted to restrain the company from passing the proposed
resolution.

EFFECT OF ALTERATION ON CONTRCT OF DIRECTORS

Sometimes the Articles may be altered in such a way that the implementation of those
articles in the altered form would give rise to breach of an existing contract between the
company and a third party and particularly so as regards contracts between companies and
their directors.
A director may hold office either
1.
2.
3.

Under the Articles without a service contract;

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

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

30

terms of any subsisting agreement. The Articles further provided that the Managing
Director ceased to be a director, he would ipso facto cease to be Managing Director. The
Companys Articles were subsequently changed to give the Directors power to remove a
fellow director from office by notice. Such notice was given to the Plaintiff who thereupon
filed an action claiming damages from the company for breach of contract.
It was held that since his appointment was not subject to the articles, he could only be
removed from office in accordance with the terms of his appointment and not by way of
alteration of the articles. Damages were therefore payable.
Lord Atkins said if a party enters into an arrangement which can only take effect by the
continuance of an existing state of circumstances there is an implied undertaking on his
part that he shall done of his own motion to put an end to that state of circumstances which
alone the arrangement can be operative.
If a director is appointed in very general terms and without limitation of time, then the
provisions in the Articles are deemed to be incorporated in the appointment and in the
absence of any provision in the articles to the contrary, the company may dismiss him at
any time and even without notice.
Read v. Astoria Garage (1952) 1 All.E.R 922
A Companys Articles provided, that the appointment of a Managing Director shall be
subject to termination if he ceases for any reason to be a director or if the company in
general meeting resolved that his tenure of office as managing director be terminated. The
Plaintiff was appointed as the companys Managing Director 17 years later the directors
decided to relieve him of his duties as Managing Director. The decision was subsequently
ratified by the company in general meeting. He claimed damages for wrongful dismissal.
The court held that on a true construction of the companys articles the Plaintiffs
appointment was immediately and automatically terminated on passing of the Resolution at
the general meeting since the company had expressly reserved to itself the power to dismiss
the Managing Director.
The question is, can a company be restrained by injunction from altering its articles if the
alteration is likely to give rise to a breach of contract?
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.

31

Another Article provided that the number of directors should not be less than 3 nor more
than 7. The Plaintiff syndicate had recently nominated 2 persons as directors. The
Defendant company objected to these two persons as directors and refused to accept the
nomination and a meeting of shareholders was called for the purpose of passing a special
resolution under Section 13 of the Companies Act cancelling the article.
The court held that the defendant company had no power to alter its articles of association
for the purpose of committing a breach of contract and that an injunction ought to be
granted to restrain the holding of the meeting for that purpose.
Punt v. Symens & Co. 1903 2 Ch.d 506
This case had words to the effect that the company cannot be restrained but this was
overruled in the case of
British Equitable Assurance Co. v. Baily (1906) S.C. 35
Allen v. Goldreef
VARIATION OF CLASS RIGHTS
Although the Companies Act recognises the existence of class of shareholders, it does not
define the term class the best definition is found in the case of
Sovereign Life Assurance Co. v. Dodd (1892) 2 QB 573
In that case Bowen L.J. stated as follows: The word Class is vague it must be confined to
those persons who rights are not dissimilar as to make it impossible for them to concert
together with a view to their common interest.
Under Article 4 of Table A where the Share Capital is divided into different classes of
Shares, the rights attached to any class may be varies only with a consent in writing of the
holders of three quarters of the issued share of that class or with assumption of a special
resolution passed at a separate meeting of the holders of the shares of that class.
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.
2.

The general Meeting;

The Board of Directors.

32

The authority to exercise a companys powers is normally delegated not to the members
nor individual directors but only to the directors as a Board. The directors may however
delegate powers to an individual Managing Director.
Section 177 of the Companies Act requires every public company to have at least two
directors and every private company at least one director. The Act does not provide for the
means of appointing Directors but in practice the Articles of Association provide for initial
appointments by subscribers to the Memorandum of Association and thereafter to annual
retirement of a certain number of directors and the filling of vacancies at the annual general
meeting.
Under Section 184 (1) the Companies Act every appointment must be voted on individually
except in the case of private companies or unless the meeting unanimously agrees to
include two or more appointments in the same resolution. The appointment is usually
effected by an ordinary resolution. However, no matter how a director is appointed, under
Section 185 of the Companies Act he can always be removed from office by an ordinary
resolution in addition to any other means of removal which may be embodied in the
articles.
Unless the Articles so provide Directors need not be members of a company, but if the
articles require a share qualification, then the shares must be taken up within two months
otherwise the office will be vacated. Undischarged Bankrupts are not allowed to act as
directors without leave of the court. A director need not be a natural person. A company
may be appointed a director of another. The disqualifications of directors are set out in
article 88 of Table A. The division of powers between the general meeting and the Board
of Directors depends entirely on the construction of the Articles of Association and
generally where powers of management are vested in the Board of Directors, the general
meeting cannot interfere with the exercise of those powers.
Automatic Selfcleaning Filter Syndicate v. Cunningham (1906) A.C. 442
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.

33

The court held that the Articles constituted a contract by which the members had agreed
that the Directors alone should manage the affairs of the company unless and until the
powers vested in the Directors was taken away by an alteration in the Articles they could
ignore the general meeting directives on matters of management. They were therefore
entitled to refuse to execute the sale.
the division of the power to manage the companys affairs is embodied in Article 80 of
Articles A which states that the business of the company shall be managed by the directors
who may exercise all such powers of a company as are not by the Act or by these
regulations require to be exercised by the company in general meeting. Where this article
is adopted as it is invariably done in practice the general meeting cannot interfere with a
decision of the directors unless they are acting contrary to the provisions of the Companies
Act or the particular companys articles of association.
Shaw & Sons Ltd v. Shaw (1935) 2 KB 113
Here the Directors were empowered to manage the companys affairs. They commenced
an action for and on behalf of the company and in the companys name, in order to recover
some money owed to the company. The general meeting thereafter passed a resolution
disapproving the commencement of the suit and instructing the Directors to withdraw it
It was held that the resolution of the general meeting was a nullity Greer L.J. stated
A company is an entity distinct from its shareholders and its directors. Some of its
powers may be according to its articles exercised by the Directors and certain other
powers may be reserved for shareholders in general meeting. If powers of management are
vested in the Directors, they and they alone can exercise these powers. The only way in
which the general body of the shareholders can control the exercise of the powers vested by
the articles in the directors is by altering the articles or if opportunity arises under the
articles by refusing to re-elect the directors or whose actions they disapprove. They cannot
themselves reserve the powers which by themselves are vested in the Directors 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.

34

The court held that it was competent for the general meeting to appoint additional directors
even if the power to do so was by articles vested in the Board of Directors.
CO-OPERATE LIABILITIES FOR ACTS OF OFFICIALS
There are certain situations in which the law doesnt recognize vicarious liability but insists
on personal fault as a prelude to liability
In such cases a company couldnt be liable if the courts apply rigidly the rule that the
company is an artificial person and therefore can only act through the directors
If practice and for certain purposes the courts have elected to treat the acts of certain offices
as acts of the company itself.
This sometimes referred to as the organic theory of companies
The theory sprang from the case of
Lennards Carrying Company v. Asiatic Petroleum Co. Ltd.
A ship and a cargo were lost due to sea unworthiness. The owners of the ship were a
limited company. The managers of the company were another limited company whose MD
a Mr. Lennard managed the ship on behalf of the owners. He knew or ought to have known
of the sea unworthiness but took no steps to prevent the ship from going to sea.
Under the relative shipping act, the owner of a sea going ship wasnt liable to make good
any laws or damage happening without his fault. The issue was whether Lennards
knowledge was the companys knowledge that ship was sea unworthy.
Held - Leonard was the directing mind and will of the company and his knowledge was the
knowledge of the company. His fault was the fault of the company and since he knew that
the ship was sea unworthy his fault was also the companys fault and therefore the
company was liable.
As per Viscount L.J.,
My Lords a corporation is an abstraction it has no mind of its own and more that it has a
body of its own.
Its active and directive will must consequently be sought in the person of somebody who
for some purposes may be called an agent but who is really the directive mind and will of
the corporation the very ego and center of the personality of the corporation.
Case
Bolton Engineering Co. v. Graham
Here the plaintiffs who were tenants in certain business premises were entitled to a renewal
of their tenancy unless the landlords who were a limited company intended to occupy the
premise themselves for their business purposes.

35

The issue was whether the defendant company had effectively formed this intention, there
had been no formal general meeting or board of directors meeting had to consider the
question but the managing directors had clearly manifested the intention to occupy the
premises for the companys business.
It was held that the intention manifested by the directors was the companys intention and
therefore the tenants were not entitled to a renewal of the tenancy.
Denning L.J., stated
A company may in many ways be likened to a human being, it has a brain and a nerve
center which controls what it does it also has hands which hold all the tools and acts in
accordance with the directions of the center. Some of the people of the company and
merely servants and agents who are nothing more than hands to do the work and cannot be
said to represent the mind and will of the company.
Others are directors and managers who represent the directing mind and will of the
company and control what it does. The state of mind of these managers is the state of mind
of the company and are treated by the law as such. Whether their intention is the companys
intention depends on the nature of the matter under consideration relating to the position of
the officer and agent and other relative facts and circumstances of the case.
Closely related to this is the rule is the rule in Turguands case
It deals with the companys liability for acts of its officers.
Question as to whether or not the company is bound or not depends on the normal agency
principles, if a companys officer or a companys organ does an act within the scope of its
authority the company will be bound. The problem which might arise is that even if the act
in question is within the scope of the organs of the 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 3 rd 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

36

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 party reading a companys
documents would find not a prohibition from borrowing but permission to do so on certain
conditions finding the authority may be found complete by resolution he may have a right
to infer the fact of a resolution authorizing that which on the face of the document appeared
to be legitimately done.
This is the case, which has the rule as to indoor management.
1) This rule is based not on logic but on business convenience.
First a 3rd party dealing with a company has no access to a companys indoor activities
2) It would be difficult to run business if everyone who had dealings with the company had
first to examine the companys internal operations before engaging in business with the
company. It would be very affair to the companys creditors if the company could escape
liability on the ground that its officials acted irregularly but should the company always
behave liable for the act of any people purporting to act on the companys behalf. Suppose
these people are imposters what happens? In order the avoid this some limitations have
been imposed on the rule. Later cases have referred to the rule to be that ordinary agency
principles will always apply
a) Any body dealing with the company is deemed to have notice of the contents of the
companys public documents therefore any act, which is contrary to those
provisions, will not bind the company unless it is subsequently ratified by the
company acting through its appropriate organ. The term public document isnt
defined in the companys act but so far as the registered companies are concerned
the expression is not restricted to the memorandum and articles of association but it
also includes some of those documents found in the companys registry these
include special resolutions particulars of secretaries, charges
provided that everything appears to be regular so far as can be checked from the public
documents a 3rd party dealing with the company is entitled to assume that all internal
regulations of the company have been complied with unless he has knowledge to the
contrary or there are suspicious putting him on inquiry.
Case
Mahoney v. East Holyford Mining Co

37

A mining company was founded by a W his friends and relatives. Subscriptions were
obtained for applicants shares. This was paid into the bank, which was described in the
prospectus as the companys bank. The communication of the letter was sent to the
bank by a person describing himself as the companys secretary to the effect that in
accordance with a resolution passed on that day the bank was to pay out cheques signed
by wither 2 of the 3 named directors whose signatures were attached and counter signed
by the secretary.
The bank then honoured debts so signed when the company funds were almost
exhausted the company was ordered to wind up. It was then discovered that no meeting
of the shareholders had been held and no appointment of secretary made but that with
his friends and relatives, W had held themselves to be secretary and directors and had
appropriated subscription money.
The issue was whether the bank was liable to refund money it had paid back to the
company.
Held the bank wasnt liable to refund any money to the company as it had honoured the
companys cheques on reliance on the letter received and in good faith.
When there are person conducting the affairs of a company in a manner which appears
to be perfectly consonant with the articles of association then those dealing with them
externally are not to be affected by any irregularities which may take place in the
internal management of the company.
Directors will not necessarily and for all purposes be insiders. The test appears to be
whether the acts done by them are so closely related to their position as 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 3 rd 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

38

In this case Kapoor and Hoon formed a private company, which purchase Buckhurst
Park estate. The board of directors consisted of Kapoor, Hoon and 2 others. The articles
of the company contained a power to appoint a managing director but none was
appointed. Though never appointed as such Kapoor acted as managing director. In that
capacity he engaged the plaintiffs who were a firm of architect to do certain work for
the company, which was duly done.
When the plaintiffs claim remuneration according to the agreement the company
replied that its wasnt liable, because Kapoor had no authority to engage him.
Held the act of engaging architects was within the ordinary ambit of the authority of a
managing director was of Property Company and the plaintiffs didnt have to enquire
whether a person with whom they were dealing with was properly appointed.
It was sufficient for them that under the articles the board of directors had the power to
appoint him and had in fact allowed him to act as managing director.
4 conditions must be fulfilled in order to entitle a 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
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.

39

The Managing director dealt with day-to-day affairs of the company but didnt have
express authority to appoint a secretary or offer such unusually generous terms as
contained in the letter.
After 2 years service the company purported to dismiss the respondent by 5 days notice.
The secretary sued for benefits under the contract. The company contended that the
managing director didnt have authority to offer the terms of the contract there being no
resolution of the company to support it and nothing in the companys articles conferring
such powers on a managing director.
It was held that as a chairman he performed the functions of a managing director with
the full knowledge of the board of directors and that a contract for service as the one
entered into with the secretary was one which a person performing the duties of a
managing director would have power to enter into on behalf of the company.
Therefore the contract was genuine, valid and enforceable.
If however the officer is purporting to exercise some authority which that sort of officer
wouldnt normally have a 3rd party wont be protected if the officer exceeds his actual
authority unless the company has held him out as having authority to act in the matter
and the 3rd party has denied thereof.
Unless the company is estopped, however unless a provision in the memorandum or
articles or other public documents cant create an estoppel unless the 3 rd 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

40

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

given project and to set it going and he takes the necessary steps to accomplish that
purpose.
The term is also used to cover any individual undertaking to become a director of a
company to be formed. Similarly it covers anyone who negotiates preliminary
agreements on behalf of a proposed company.
But those who act in a purely professional capacity e.g. advocates wont qualify as
promoters for they are simply performing their normal professional duties. But they can
also become promoters or find others who will.
Whether a person is a promoter or not is a question of fact. The answer is promoter isnt
a term of law but of business summing up in a single word the number of business
associations familiar with the commercial world by which a company is born.
It may therefore be said that the promoters are those responsible for its formation. They
decide the scope of its business activity the negotiate for he purchase of an existing
business if necessary, they instruct advocates to prepare the advocates to make the
necessary documents, they secure services for directors, they provide registration fees and
they carry out all other duties involved in company formation they also take responsibility
in case of a company in respect of which a prospectus is to be issued before incorporation
and the report of those whose report must accompany the prospectus.
DUTIES OF PROMOTERS
Their duties are to act bonafide towards the company. Though they may not strictly be an
agent or a trustee for a company any one who can be properly guarded as promoter stands
in a fiduciary relationship vis-avis the company.
These carries the duties of disclosure and proper accounting particularly a promoter must
not make any profit out of promotion without disclosing to the company the nature and the
extent of such promotion.
Failure to do so may lead to recovery of the profits by the company.
The question, which arises, is since the company is a separate legal entity from members
how is this disclosure effected.
Case
Erlanger v. New Sombrero Phosphates Co.
The promoters of a company sold a lease to a company at twice the price paid for it without
disclosing this fact to the company.
It was held that the promoters breached their duties and that they should have disclosed this
fact to the companys board of directors.
As Lord Caines

41

The owner of the property who promotes and form a company to which he sell his
property is bound to declare that he sells it to the company through the medium of a Board
of Directors who can exercise an independent judgment on the transaction and who are not
left under belief that the property belongs to the promoters and not to another person.
Since the decision in the case of Salomon, it has never been doubted that a disclosure to the
members themselves will be equally effective.
It would appear that disclosure must be made to the company either by making it to an
independent Board of Directors or to the existing and potential members.
If to the former the promoters duty to the company is duly discharged, thereafter it is upon
the directors to disclose to the subscribers.
If made to the members it must appear in a prospectus and the articles so that those who
become members can have full information regarding it. Since a promoter owes his duty to
a company in the event of any non-disclosure the primary remedy is for the company to
bring proceedings for
1) Either rescission of any contract with the promoter
2) Recovery of any profits form the promoter.
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

42

can it be entitled under any contract purported to have been made on its behalf on its
incorporation.
Ratification is not possible when the ostensible principle is non-existent in law when the
contract was entered into.
Case
Price v. Kelsall
One of the issues was whether or not a company could ratify a contract entered into on its
behalf before incorporation.
The alleged contract was that the respondent had undertaken to sell some property to a
company, which was proposed to be formed between him and the appellant. In holding that
the company cant ratify such an agreement the president of the court of appeal was then
constituted by the Okolo L.J.,
A company cant ratify a contract purporting to be made by someone on its behalf before
its incorporation by there may be circumstances from which it may be inferred that the
company after its incorporation has made a new contract to the effect of the old agreement.
The mere confirmation and adoption by directors of a contract made before formation of a
company by persons purporting to act on behalf of the company creates no contractual
relation whatsoever between the company and the party to the contract.
However acts may be done by a company after its formation, which give rise to an
inference of a new contract on the same terms as the old one.
Question whether there is a new contract or not is always a question of fact, which depends
on the circumstances of each individual case.
Case
Mawagola Farmers & Growers Ltd v. Kanyanja
Prior to incorporation the promoters held public meetings and the public asked to purchase
shares in a proposed company. The respondents paid for the shares bought before and after
the incorporation but the company didnt a lot any shares to them but instead after
incorporation allotted shares to others people.
The respondent prayed for orders that the shares they paid for be allotted to them and the
company registered name be rectified accordingly.
The company argued that the respondent paid for money for the purchase of their shares
money, the claim could be against the promoters because the company couldnt even after
incorporation ratify of adopt any such contract
Mustafa J.A
In order that the company may be bound by agreements entered into before incorporation
there must be anew contract to the same effect as the old agreement. This contract may
however be inferred from the acts of the company when incorporated.

43

The allotment of shares to the respondents after the incorporation was held to be sufficient
evidence of a new contract between the company and the respondents. Therefore the
respondents were entitled to be allotted the shares agreed upon.
If any preliminary arrangements are made these must therefore be left must be left to mere
gentleman agreements or otherwise the promoters may have to undertake personal liability.
Although the principle is clear those engaged in the formation of companies often cause
contracts to be entered into on behalf of proposed company.
As to whether the promoters they will be liable will depend on the terminology implored.
Case
Kelner v. Baxter
In this case A,B and C entered into a contract with the plaintiff to purchase goods on behalf
of the proposed Gravesand Royal Alexandra Hotel Company, the goods were duly supplied
and consumed.
Shortly after incorporation, the company in question collapsed and the plaintiff sued A,B
and C for the price of the goods supplied.
Held A,B and C were liable
Chief justice Earl
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.

44

PROSPECTUSES
When the public is asked to subscribe for shares or debentures of a company the invitation
involves the issue of documents, which set out the advantages to accrue from an investment
in a company. This document is called a prospectus and may be issued either by the
company itself or by a promoter.
It is only in the case of a public company that a prospectus may be issued. A private
company must always raise its capital privately as required by section 30 of the Company
Act. Section 20 defines prospectuses as
Any prospectus, notice, circular, advertisement or other invitation offering to the public
for subscription or purchase of any shares or debentured in the company
The word invitation and offering in that definition are loosely used because when a
company issues a prospectus it doesnt offer to sell any shares but rather invite offers from
members of the public. A prospectus is therefore not an offer but an invitation to treat. The
word prospectus is vague and uncertain when an invitation is made to the public it is a
question of fact.
The question of public isnt restricted to a certain section of the public but includes any
member of the general public.
Re South of England Natural Gas Co.
A newly formed company issued 3,000 copies of a document, which offered for
subscription shares in a company was headed For private circulation only
These copies were then circulated to the shareholders of a number of gas companies. So the
question here was this a prospectus?
It was held that this was an offer to the public and therefore constituted a prospectus.
CONTENTS OF A PROSPECTUS
The object of a Companys act is to compel a company to disclose in a prospectus all the
necessary information which would enable a potential investor in deciding whether or not
to subscribe for a companys shares or debentures.
Therefore section 40 requires that every prospectus shall state the matters specified in
article 1 of the 3rd schedule to the Act and that it will also set out the report specified in part
2 of that schedule.
The provisions in that schedule are designed mainly to provide information about the
following matters
1)
Who the directors are
And what benefit they will get form directorship
45

2)
In the case of a new company what profits are being made by the promoters
3)
Amount of capital required by the company to be subscribed the amount actually
received or to be received, the precise nature of consideration which is not paid in case
4)
In the case of an existing company what the companys financial record in the past.
5)
The companys obligations under any contract entered into.
6)
The voting and dividend right of each class of shares.
If a prospectus includes any statement by an expert then the expert must have given written
consent to the inclusion of the statement and the prospectus must take it like he has done
so. Section 42.
Contravention of these requirements renders the company and any person who knowingly a
party to the issue of prospectus to a fine not exceeding Ksh. 10,000
Section 42 defines expert
Including Engineer, Valuer, Accountant or any other person whose profession gives
authority any statement made by him.
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/

46

The company issued a prospectus, which in all material facts was correct. It further
specified that the dividends paid were high.
But the dividends wee being made out of abnormal profits from 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.
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)
i)
ii)
iii)

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

Knowingly
Without belief in its truth
Recklessly not caring whether it be true or false

47

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.
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

48

telegram which was intended by a defendant to operate in the plaintiffs mind and on the
mind of others and did operate to his prejudice and the advantage of the defendant.
In this case the function of the prospectus wasnt exhausted and the false telegram was
brought into play by the defendant to reflect back upon and countenance the false statement
in the prospectus
The purchaser of shares induced to buy shares by the mis-statement in the prospectus has
an action for damages in negligence. He has also an action for negligent mis-statement.
Under the case of
Hedley Byrne & Co. v. Heller & Partners
All these actions are directed to the directors personally.
Rescission
As against the company a person induced to buy shares by a misrepresentation in the
prospectus may rescind the contract.
On buying shares ones contract is with a company itself, the remedy is available only
against the company. To be entitled to this remedy it is not necessary for the purchaser of
the shares to show that the statement was fraudulent or negligent.
Even if the misrepresentation was innocent rescission lies. The right to rescind is subject to
two limitations.
a)
The allotee looses the right to rescind if he shows any election to affirm the
contract. For example by attending and voting at the companys meetings or by accepting
to sell the shares
b)
If the allotee doesnt rescind the contract before the company is wound up he looses
the right to do so as from the moment winding up proceedings are commenced.
Directors Duties
Firstly there are 3 preliminary positions
a)
Whereas directors authority to bind the company depends on the acting collectively
as a Board, the duties to the company are owed by each director individually. These duties
are owed to the company and the company alone and not to individual shareholders.
Case
Percival v. Wright
Certain shareholders wrote to the companys secretary asking if he knew anyone willing to
buy their shares.

49

Negotiations took place and eventually the companys chairman and two other directors
bought the plaintiffs shares at 12 pounds 10 shillings per share.
The plaintiff latter discovered that prior to and during their negotiations for sale the
chairman and the Board of Directors had been approached by a 3rd party with a view to
purchase the entire companys assets at more than 12 shillings.
The plaintiff brought an action to set aside share sales on the ground that the directors owed
them a duty to disclose negotiations with a 3rd party.
It was held that the directors arent agents for individual shareholders and didnt owe them
a duty to disclose.
Therefore the same was proper and couldnt be set aside.
b)
However if the directors are authorized by the members to negotiate on their behalf
for example on potential purchase then the directors would be in a position to be agents for
such members and owed a duty to them accordingly.
Case
Allen v. Hyall
c)
These duties except where expressly stipulates in the Company Act arent restricted
to directors alone but apply equally to any official of a company who is authorized to act as
agents and in particular to those acting in a managerial capacity.
This is particularly so as regards to fiduciary duties.
Directors duties proper
These fall into 2 broad categories
i)
ii)

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

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

50

general manager and the case in bank and hand included some 13,000 pounds. In the hands
of a firm of stock brokers at which the managing director was partner
On the companys winding up an investigation on its affairs disclosed a shortage of its
funds at more than 1.2 m pounds incurred mainly due to the delinquent fraud of the
managing director for which he was convicted and sentenced. The other directors had all
along acted in good faith and honestly but the liquidator sought to make them liable for
damages.
It was held that the directors were negligent. Justice romer states the directors duty and care
and skill as follows.
A director neednt exhibit in the performance of his duties a greater degree of skill than
may reasonably be expected from a person of his knowledge and experience.
This proposition describes the standard of skill exhibited in actions undertaken by directors.
The test is partly objective and subjective because a reasonable man would be expected to
have knowledge of the director with his experience.
Re Brazilian Rubber and Plantations Estates Ltd.
A company had 5 directors and one of them confessed that he was absolutely ignorant of
business. The 2nd one was 75 years old and very deaf and the 3rd agreed to be a director
because he saw one of his friends name in the roll. The other 2 were fairly able
businessmen.
The directors caused a contract to be entered between the company a certain syndicate for
purchase of a rubber plantation in Brazil.
The issued prospectus contained false statements about the acreage of the plantation, the
type of trees e.t.c.
The information contained therein was given to the directors by a person who had an
original option to purchase that property he had never been to Brazil and the debtor was
based on his own imagination. The directors caused the company to purchase.
It was held that the conduct didnt amount to gross negligence.
Neville L.J.,
It has been laid down that so long as they act honestly directors cant be made responsible
in damages unless they are guilty of gross negligence.
A directors duty required him to act with such care as is reasonably expected from him
having regard to his knowledge and experience.
He isnt bound to bring any special qualifications to his office. He may undertake
management of a rubber company in complete ignorance of anything connected to rubber
without incurring responsibility from mistakes resulted from such ignorance while if he is
acquainted with rubber business he must give the company the advantage of his knowledge
while transacting the companys business.
He isnt bound to take any definite part in the conduct of the companys business in so far
as he undertakes it he must use reasonable care.

51

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.
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.

52

Dovey v. Cory
In this case a bank sustained heavy losses by advances made improperly to customers.
The irregular nature of advances was concealed by means of fraudulent balance sheets,
which were the work of the general manager and the chairman in assenting to payment of
dividends out of capital, and those advances on improper securities were done on the
advice of the general manager and chairman
It was held that the reliance placed on the co-director by the general manager and chairman
was reasonable.
He wasnt negligent and was therefore not liable for not having discovered the fraud as he
wasnt in the absence of circumstances of suspicion bound to examine the companys
books to see if the balance sheet is correct..
It may be said therefore that the duties of care and skill appear to be negative duties.
II)

Fiduciary Duties

The directors fiduciary duties are divisible into 4 sub categories

a)
The directors must always act bonafide in what they consider and not what the court
may consider to be the best interest of the company. In this context the term company
means the company will be continued as a going concern thereby balancing long term
views against short term interest of existing members.
b)
The directors must always exercise their powers for the purpose for which they
were conferred and not for extraneous purposes even if the latter are considered to be in the
best interest of the company. For example the directors are invariably empowered to issue
capital and this power should be exercised for raising more funds when the company
requires it. Hence it will be a breach of directors duties to issue companys share for the
purpose of entrenching themselves in the companys affairs.
Case
Punt v. Symons
In this case the directors issued shares with the object of creating a sufficient majority to
enable them pass a special resolution depriving the shareholders special rights conferred
upon them by the companys articles.
It was held that the power of a kind exercised by the directors in this case is power to be
exercised for the benefit of the company.
Primarily this power is given to them for the purpose of raiding capital for the purpose of
the company.

53

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 themselves and friends of the
affairs of the company or even merely for the purpose of defeating the wishes of the
existing majority of shareholders.
The plaintiff and his friends held a majority of shares in the company and as long as that
majority remained they were entitled to have their wishes prevail in accordance with a
companys regulation/
Therefore it wasnt open for the purpose of defeating the wishes if the majority to issue the
shares in dispute.
In those circumstances where the directors have breached their duty in the exercise of
proper purpose the shareholders may forgive them by ratifying their actions.
Case
Hugg v. Cramphorn Ltd.
In this case the company had 2 classes of shares ordinary and preference.
Each share carried out one vote. The power to issue company shares was vested in the
directors. They learnt that a take over bid was to be made to the shareholders in the
bonafide belief that acquisition control of the prospective take over bidder wont be in the
interest of the company or staff. The directors decided to forestall this move.
They attached 10 votes to each of the preference shares and allotted them to a trust, which
was controlled by chairman of the board and one of his partners in the audit department and
an employee of the company to enable the trustee to pay for the shares. The directors
provided them with an interest free percent loan out of the companys reserve fund.
An action challenged by the plaintiff who was an associate of the take over bidder and
registered holder of 50 ordinary shares in the company was started.
After finding that it was improper for the directors to attach such special voting rights the
courts stood over the action in order to enable a General Meeting to be held and debate
whether or not to ratify the directors actions. The General Meeting ratified the action.

54

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 3rd parties as to how they will vote at future board
meetings.
However where they have entered into a contract on behalf of the company they may
validly agree to take such further action at board meetings as may be necessary to carry out
such a contract.
LAW OF BUSINESS ASSOCIATIONS Lecture 7

26th March 04

FIDUCIARIES CONTINUED
4.

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

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

The Defendant company entered into a contract to purchase a quantity of chairs from the
Plaintiff partnership. At the time that the contract was entered into a Director of the
company was also one of the partners. The issue was, was the company entitled to avoid
the contract? The court held that the company was entitled to avoid the contract. The
Judge said that as a body corporate can only act by agents and it is the duty of those agents

55

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 not question is entertained as to the fairness or unfairness of the contract so
entered into. However, it is possible for such contract to be given effect by the articles of
association. At their narrowest the Articles might provide that a Director who is interested
in a Company contract should disclose his interests and he will not be counted to decide
that a quorum is raised and his votes will also not be counted on the issue.
At their widest the articles might allow the director to be counted at Board meeting.
In order to create a balance between these two extremes and ensure that a minimum
standard prevails Section 200 was incorporated into the Companies Act. Under this
Section it is the duty of a director who is interested in any contract or proposed contract to
disclose the nature and extent of his interest to the Board of Directors when the contract
comes up for discussion. Failure to do so renders the defaulting director liable to a fine not
exceeding 2000 shillings. In addition the failure also brings in the equitable doctrine
whereby the contract becomes voidable at the option of the company and any profit made
by the director is recoverable by the company.
The shortcoming of the Section is that the Director has to disclose to the Board of Directors
and not to the general meeting. It is not sufficient for a Director to say that he is interested.
He must specify the nature and extent of his interests. If the companys articles take the
form of Article 84 of Table A then a Director who is so interested is required to abstain
from voting at the Board meeting and his vote will not be taken in determining whether or
not there is a quorum on the Board. Once the Director has complied with Section 200 and
Article 84 then he can escape liability.
In respect of all other profits which a Director may make are out of his position as a
Director the equitable principle which requires the Directors to account for any such profits
is vigorously enforced. This is because the Courts have equated Directors to trustees and
their duties have also been equated to those of Trustees. The question is, are they really
trustees?
Selanger United Rubber Estates v. Craddock (1968) 1 All E.R. 567
Re Forest of Dean Coal Mining Company (1879) 10 Ch. D 450
In the latter case, the directors of a company were seen to be trustees only in respect of the
companys funds or property which was either in their hands or which came under their
control. But this does not necessarily make directors trustees. There are two basic
differences between Directors as Trustees and Ordinary Trustees.
(a)
The function of ordinary trustee is to preserve the Trust Property but the role
of a director is to explore possible channels of investment for the benefit of

56

(b)

the company and these necessitates some elements of having to take a risk
even at the expense of the companys property.
Whereas trust property is vested in the Trustees, a companys property is
held by the company itself and is not vested in the trust.

Nevertheless if the directors make any secret profits out of their positions then the effect is
identical to that of ordinary trustees. They must account for all such profits and refund the
company.
Regal Hastings v. Gulliver (1942) 1 All E.R. 378
Herein the company owned a cinema and the directors decided to acquire two other
cinemas with a view to the sale of the entire undertaking as a going concern. Therefore
they formed a subsidiary company to invite the capital of 5000 pounds divided into 5000
shares of 1 pound each. The owners of the two cinemas offered the directors a lease but
required personal guarantees from the Directors for the payment of rent unless the capital
of the subsidiary company was fully paid up. The directors did not wish to give personal
guarantees. They made arrangements whereby the holding company subscribed for 2000
shares and the remaining shares were taken up by the directors and their friends. The
holding company was unable to subscribe for more than 2000 shares. Eventually the
companys undertakings were sold by selling all the shares in the company and subsidiary
and on each share the Directors made a profit of slightly more than two pounds. After
ownership had changed the new shareholders brought an action against the directors for the
recovery of profits made by them during the sale.
The court held that the company as it was then constituted was entitled to recover the
profits made by the Directors. Lord Macmillan had the following to say:
The directors will be liable to account if it can be shown that what they did is so
related to the affairs of the company that it can properly be said to have been done in the
course of their management and in utilisation of the opportunities and special knowledge
and what they did resulted in a profit to themselves.
Phipps v. Boardman (1966) 3 All E.R. 721
In this case Boardman was a solicitor to the trust of the Phipps family. The trust held some
shares in the company. Boardman and his colleagues were not satisfied with the companys
accounts and therefore decided to attend the companys general meeting as representatives
of the Trust. At the meeting they received information pertaining to the companys assets
and their value. Upon receipt of the information, they decided to buy shares in the
company with a view to acquiring the controlling interest. Their takeover bid was
successful and they acquired control. Owing to the fact that Boardman was a man of
extraordinary ability, the company made progress and the profits realised by Boardman and
his friends on the one hand and the trusts on the other were quite extensive. One of the
beneficiaries of the Trust brought an action to recover the profits which were realised by
Boardman and his friends.

57

The court held that in acquiring the shares in the company, Boardman and his friends made
use of information obtained on behalf of the trust and since it was the use of that
information which prompted them to acquire the shares, then the shares were also acquired
on behalf of the trust and thus the solicitors became constructive trustees in respect of those
shares and therefore liable to account for the profits derived therefrom to the trust.
Peso Silver mines v. Cropper (1966) 58 D.L.R. 1
The Defendant was the companys Managing Director. The Board of Directors was
approached by a prospector who offered to sell his claims to the company. The companys
consulting geologists advised that it was in order for the company to acquire the claims.
The directors decided that it was inadvisable for the company to acquire the same mainly
because of its strained financial resources. Subsequently at the suggestion of the
geologists, some of the Directors agreed to purchase the claims at the price at which they
had been offered to the company. Thereafter they formed a company which took over the
claims and a second company for developing the resources. After the controlled of Peso
Silver Mines had changed the new directors brought an action against the Defendant to
account to the company for the shares held by them in the new companies. But here the
court held that since the company could not have taken over the claims, there was no
conflict of interest between the Directors and the Company and therefore the Defendant
was not liable to account for the shares.
Directors may make use of opportunities originally offered to the company and thereby
make profits provided that some 4 conditions are satisfied namely
1.
The opportunity must have been rejected by the company;
2.
If the directors acted in connection with that rejection, they must have acted
bona fide in the best interests of the company.
3.
The information about that opportunity should not have been given to them
confidentially on behalf of the company.
4.
Their subsequent use of that information must not relate to them as directors but
as any other ordinary person.
Industrial Development Consultants v. Cooley (1972) 2 All E.R. 162
The Defendant who was an architect was appointed the companys Managing Director.
The companys business was to offer design and construction services to industrial
enterprises. One of the defendants duties was to obtain new business for the company
particularly from the gas companies where he had worked before joining the Plaintiff.
While the Defendant was still so employed by the Plaintiff a representative of one gas
company came to seek his advice on some personal matters. In the course of their
conversation the Defendant learnt that the gas company in question had various projects all
requiring design and construction 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

58

Plaintiff had unsuccessfully tried to obtain that work. After the Defendants acquiring the
contract, the company sued him alleging that he obtained the information as a fiduciary of
the company and he should therefore account to the company for all the remuneration fees
and all dues obtained.
The court held that until the Defendant left the Plaintiff, he stood in a fiduciary relationship
to them and by failing to disclose the information to the company, his conduct was such as
to put his personal interests as a potential contracting party to the gas company in conflict
with the existing and continuing duty as the Plaintiffs Managing Director.
Roskill J.
It is an overriding principle of equity that a man must not be allowed to put
himself in a position where his fiduciary duty and interest conflict. It was the
defendants duty to disclose to the plaintiff the information he had obtained from
the Gas Board and he had to account to them for the profits he made and will
continue to make as a result of allowing his interests and duty to conflict. It makes
no difference that a profit is one which the company itself could not have obtained.
The question being not whether the company could have acquired it but whether the
defendant acquired it while acting for the company.
CONTROLLING SHARE HOLDERS
By controlling share holders is meant those who hold the majority of the voting rights in
the company. Such share holders can always ensure control of the companys business by
virtue of their voting power to ensure that the controlling shareholders do not use their
voting power for exclusively selfish ends, the Law requires that in exercise of their voting
power, these shareholders must not defraud a minority. For example by endeavouring
directly or indirectly to appropriate to themselves any money property or advantage which
either belong to the company or in which the minority shareholders are entitled to
participate.
Brown v. British Abrasive Wheel Co. (1919) 1 Ch. 290
Menier v. Hoopers Telegraphy Works (1874) L.R. Ch. A 350
In the latter case the company brought action against its former Managing Director for a
declaration that the concessions for laying down a telegraph cable from Portugal to Brazil
was held by that former Director as a trustee for the company. While this action was still
pending, the Defendants who were the majority shareholders in the company approached
that former Managing Director with a view to striking a compromise. It was agreed
between the parties that if that 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.

59

The court said that the resolution was invalid since the defendants had used their voting
power in such a way as to appropriate to themselves the concessions which if the earlier
action had succeeded should have belonged to the whole body of shareholders and not
merely to the majority. Lord Justice Mellish stated as follows:
although the shareholders of the company may vote as they please and for the
purpose of their own interest, yet the majority of the shareholders cannot sell the assets of
the company itself and give the consideration but must allow the minority to have their
share of any consideration which may come to them.
Cook v. Deeks (1916) 1 A.C. 554
The Toronto Construction Company carried on business as Railway Construction
contractors. The Shares in the company were held equally among Cook, G S Deeks and G
M Deeks. And another party called Hinds. The company carried out several large
construction contracts for the Canadian Pacific Railway. When the two Deeks and Hinds
learnt that a new contract was coming up, they obtained this contract in their own names to
the exclusion of the company and then formed a new company to carry out the work. At a
general meeting of the shareholders of Toronto Construction company a resolution was
passed owing to the two powers of Deeks and Mr. Hinds declaring that the company was
not interested in the new contract of the Canadian Pacific Railway. Cook brought an action
and the court held: that the benefit of the contract belonged properly to the Company and
therefore the Directors could not validly use their voting power as shareholders to vest it in
themselves.
ENFORCEMENT OF DIRECTORS DUTIES
As the company is a distinct entity from the members and since directors owed their duties
to the company and not to individual shareholders, in the event of breach of those duties
any action for remedies should be brought by the company itself and not by any individual
shareholder. The company and the company alone is the proper Plaintiff. This is generally
referred to as the rule in Foss V. Harbottle (1843) 2 Hare 461
In this case the Directors who were also the companys promoters sold the companys
property at an undisclosed profit. Two shareholders brought action against them alleging
that in so doing, that the directors had breached their duties to the company. It was held
that if there was any breach of duty, it was a breach of duty owed to the company and
therefore the Plaintiffs had no locus standi for the company was the proper plaintiff. This
rule has two practical advantages namely:
1.
Insistence on an action by the company avoids multiplicity of actions;
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;

60

(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.
2.
3.
4.

The wrong complained of was such as to involve a fraud on the minority which
is not ratifiable by the company in general meeting;
It must be shown that the wrong doers hold the controlling interests
The company must be joined as a nominal defendant;
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

61

petition under this section if the company is insolvent. If the company is solvent to wind it
up, contrary to the majority wishes will only be granted where a very strong case against
the majority is established.
Winding up a company merely to end oppression appears rather awkward as it may not be
of any benefit to the petitioners themselves. Owing to these shortcomings,
Section 211 was incorporated into the Companies Act as an alternative remedy for the
minority of the shareholders. Section 211 provides that any member who complains that
the affairs of a company are being conducted in a manner oppressive to some part of the
members including himself may petition the court which if satisfied that the facts will
justify our winding up order but that this will unduly prejudice that part of the members,
may make such order as it thinks fit. Such an order may regulate the conduct of the
companys affairs in the future or may order the purchase of member shares by others or by
the Company itself. This remedy is available only to the members. An oppressed director
or creditor cannot obtain any remedy under Section 211 of the Companies Act for this is
expressly restricted to oppression of the members even if a director or creditor also happens
to be a member.
Elder V. Elder & Watson (1952) AC 49
The two Plaintiffs were the company director and secretary and factory manager
respectfully. As this was a small family concern, serious differences arose between the
plaintiffs and the beneficial owners of the undertaking. Consequently the Plaintiff brought
action under Section 211 alleging oppression. It was held that if there was any oppression
of the Plaintiffs, it related to them as directors and the remedy under Section 211 is only
available to members. The suit was dismissed.
WHAT IS OPPRESSION
This term has been defined to mean something burdensome, harsh or wrongful.
Scottish Cooperative Wholesale Society v. Meyer (1959) AC 324
Here the Society wished to enter into the retail business. For this purpose a subsidiary
company was formed in which the two Respondents and 3 Nominees of 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

62

directors offered to buy some of the shares of the Respondent at their nominal value which
was one pound per share but their worth was actually 6 pounds per share. When the
Respondents declined to sell their shares to the society, the society threatened to cause the
liquidation of the company. About 5 years later, Cotton control was abolished which meant
that the society would obtain the raw materials and weave cloth without a licence. It
accordingly started to do the same and also started starving the subsidiary by refusing to
manufacture for it except for an economic crisis. As all the other Mills were fully
occupied, the subsidiary company was being starved to death and when it was nearly dead
the Respondent brought the petition claiming that the affairs of the company were being
conducted in an oppressive manner.
It was held that by subordinating the interests of the company to those of the society, the
nominee directors of the society had thereby conducted the affairs of the company in a
manner oppressive to the other shareholders. The fact that they were perhaps guilty of
inaction was irrelevant. The affairs of the company can be conducted oppressively by the
Directors doing nothing to protect its interests when they ought to do so.
Re Hammer(1959) 1 WL.R. 6
In this case Mr. Hammer senior was a Philatelist (stamp collector) dealer and incorporated
business in 1947 forming a company with two types of ordinary shares class A shares
which were entitled to a residue of profit and Class B Shares carrying all the votes. He
gave out the shares to his two sons and at the time of the petition each son held 4000 Class
A shares and the father owned 1000 shares. Of the Class B Shares, the father and his wife
held nearly 800 to the 100 held by each son. Under the Companys articles of association,
the father and two sons were appointed directors for life and the father was further
appointed chairman of the Board with a casting vote. The father assumed powers he did
not possess ignored decisions of the Board and even in court, during the hearing asserted
that he had full power to do as he pleased while he had voting control. He dismissed
employees using his casting vote to co-opt self directors, he prohibited board meetings,
engaged detectives to watch the staff and secured payment of his wives expenses out of the
companys funds. He negotiated sales and vetoed leases all contrary to the decisions and
wishes of the other directors.
The sons filed an action claiming that the father had run the affairs of the company in a
manner oppressive to them. The father was 88 years.
The court held that by assuming powers which he did not possess and exercising them
against the wishes of those who had the major beneficial interests, Mr. Hammer senior had
conducted the companys affairs in an oppressive manner.
These two cases are among the few where an application under Section 211 has succeeded.
This is because section 211 has been subjected to a very restrictive meaning. To succeed
under Section 211, one must establish a case of oppression.

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1.

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

The petitioner alleged oppression on grounds that the companys Managing Director was
extremely incompetent. The court ruled that even though the allegation suggested that the
Managing Director was unwise in efficient and careless in the performance of his duties,
this did not mean that he had at any time acted unscrupulously, unfairly or with any lack of
probity towards the petitioner or to other members of the company. Therefore his conduct
was not oppressive.
2.

The conduct which is complained of must relate to the affairs of the company
and must also relate to the petitioner in his capacity as a member. Personal
representatives cannot petition nor can trustees in bankruptcy petition.

3.

the wording of the section suggests that there must be a continuous cause of
conduct and not merely isolated acts of impropriety.

4.

The conduct must be such as to make it just and equitable to wind up the
company. In other words, the members must be entitled to a winding up order.

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

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

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

LAW OF BUSINESS ASSOCIATIONS Lecture 8

23rd April 04

RAISING AND MAINTENANCE OF CAPITAL

The basis of the whole concept or a companys capital was explained by Jessel M.R. in the
Flitcrafts Case 1882 21 Ch. D 519 in this case for several years the directors had been in
the habit of laying before the meeting of shareholders reports and balance sheets which
were substantially untrue inasmuch as they included among other assets as good debts a
number of debts which they knew to be bad. They thus made it appear that the business
had produced profits whereas in fact it had produced none. Acting on these reports, the
meetings declared dividends which the directors paid. It was held here that since the
directors knew that the business had not made any profit, they were liable to refund to the
company the monies paid by way of dividends.
Jessel M.R said as follows when a person advances money to a company, his debtor is that
artificial entity called the corporation which has no property except the assets of the
business. The creditor therefore gives credit to that capital or those assets. He gives credit
to the company on the faith of the implied representation that the capital shall be applied
only for the purposes of the business and he has therefore a right to say that the corporation
shall keep its capital and shall not return it to the shareholders.
The capital fund is therefore seen as a substitute for unlimited liability of the members.
Courts have developed 3 basic principles for ensuring that the companys represented
capital is actually what it is and for the distribution of that capital.
1.
Once the value of the companys shares has been stated it cannot subsequently
be changed. The problem which arises in this respect is that shares may be
issued for non-monetary consideration. For instance for services or property in
such cases the companys valuation of the consideration is generally accepted as
conclusive. If the property has been over valued, provided the valuation has
been arrived at bona fide, the courts will not question the adequacy of the
consideration but if it appears on the face of the transaction that the value of the
property is less than that of the shares, then the court will set aside that
transaction. For this reason the shares in a company must be given a definite
value. The law tries to ensure that the company initially receives assets at least
equivalent to the nominal value of the paper capital. Refer to Section 5 of the
Companies Act. Unfortunately if in the insistence that shares do have a definite
fixed value is not an adequate safeguard because there is no legal minimum as
to what the nominal value of the shares should be.
2.

The Rule in Trevor v. Whitworth [1887] 12 A.C 449. Under this rule a
company is not allowed to purchase its own shares even if there is an express

65

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.
b.

3.

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

company;
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.

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

Before a company can declare dividends, it must be solvent. Dividends will

not be paid if this will result in the companys inability to pay its debts as
and when they fall due;

(ii)

If the value of the companys fixed assets has fallen thereby causing a loss
in the value of those assets, the company does not need to make good that
loss before treating revenue profits as available for 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.

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CORPORATE SECURITIES
Basically securities is a collective description of the various forms of investment which one
can buy for sale at the stock exchange. A company can issue two primary classes of
securities. These are shares and debentures. The basic distinction between a share and a
debenture is that a share constitutes the holder. A member of the company whereas a
debenture holder is a creditor of a company and not a member of it.
The best definition of the term share is that given by Farwell J. in the case of Borlands
Trustee v. Steel [1901] Ch. D 279 stated a share is the interest of a member in a company
measured by a sum of money for the purpose of liability in the first place and of interest in
the second and also consisting of a series of mutual covenants entered into by all the
shareholders among themselves in accordance with Section 22 of the Companies Act.
The contract contained in the Articles of Association is one of the original incidents of a
share. A share is therefore not a sum of money but an abstract interest measured by a sum
of money and made up of various rights contained in a contract of membership.
In contrast a debenture means a document which either creates or acknowledges a debt and
any document which fulfils either of these conditions is called a debenture. A debenture
may take any of 3 forms
1.
2.
3.

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

The indebtedness acknowledged by a debenture is normally but not necessarily secured by

charge over the companys property. Such charge could either be a specific charge or a
floating charge. Both were defined by Lord Mcnaghten in the case of Illingsworth v.
Houlsworth [1904] A.C. 355 AT 358 He stated
a specific charge is one that without more fastens on ascertained and definite property or
property capable of being ascertained and defined. A floating charge on the other hand is
ambulatory and shifting in its nature, hovering over and so to speak floating with the
property which it is intended to affect until some event occurs or some act is done which
causes it to settle and fasten on the subject of the charge within its reach or grasp.
A floating charge has 3 basic characteristics.
1.
2.

It must be a charge on a class of a companys assets both present and future;

That class must be one which in the ordinary cause of business of the company
keeps changing from time to time;

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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)

(b)
(c)
(d)

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;
Upon the appointment of a receiver in the course of a companys winding up;
Upon commencement of recovery proceedings against the company;
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.
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.
2.
3.

Payment of dividends;
Refund of Capital on winding up;
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

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preference over the others in respect of either payment of dividends or capital or both. This
is the method by which classes of shares are created i.e. by giving some of the shareholders
preference over others.
In practice therefore most companies with classes of shares will have ordinary shares and
preference shares. The preference shares being those that enjoy some preference with
reference to voting rights, refund of capital or payment of dividends.
There are certain rules that courts use to interpret or construe on shares.
(a)

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

(b)

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

(c)

If however, any rights in respect of any of these matters are expressly stated,
the statement is presumed to be exhaustive so far as that matter is
concerned. For instance the preference dividend is presumed to be nonparticipating in regard to other dividends. Refer to Re Isle of Thanet
Electricity Supply Co. (1950) Ch. 1951 where Justice Wynn Parry stated
the effect of the authorities as now in force is to establish two principles.
First that in construing an article which deals with the rights to share all
profits, that is dividend rights and rights to shares in the companys property
in liquidation, the same principle is applicable and secondly that principle is
that where the articles sets out the rights attached to a class of shares to

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participate in profits while the company is a going concern or to share in the

property of a company in liquidation, prima facie the rights so set out are in
each case exhaustive.
(d)

Where a preferential dividend is provided for it is presumed to be

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

WINDING UP
Section 212 of the Companies Act provides that a company may be wound up as follows
1.
Voluntarily;
2.
Order of the Court;
3.
By supervision of the Court.
The circumstances under which the company may be voluntarily wound up are outlined in
Section 217 of the Companies Act. Here a company may be wound up
a.

b.
c.

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;
If it resolves by special resolution that it should be wound up
voluntarily;
If the company resolves by special resolution that it cannot by reason of
its liabilities continue its business and that it be advisable that it be
wound up.

Basically the second circumstance is the most important because in practice at least the first
circumstance does not arise and in the 3rd circumstance the creditors themselves will
resolve that the company be wound up.
In any winding up those in need of protection are the creditors and the minority
shareholders. Where it is proposed to wind up a company voluntarily Section 276 of the
Companies Act requires the directors to make a declaration to the effect that they have

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made a full inquiry in to the affairs of the company and having so done have found the
company will be able to pay its debts in full within such period not exceeding one year
after the commencement of the winding up as may be specified in the declaration. Such
declaration suffices as a guarantee for the repayment of the creditors. If the directors are
unable to make the declaration, then the creditors will take charge or the winding up
proceedings in which case they may appoint a liquidator.
WINDING UP BY THE COURT
Winding up after an order to that effect by the court is the most common method of
winding up companies.
Section 218 of the Companies Act gives the High Court jurisdiction to wind up any
company registered in Kenya. The circumstances under which a company may be wound
up by a court order are spelt out in Section 219 of the Companies Act.
These cover situations in which
1.
the company has by special resolution resolved that it be wound up by court;
2.
Where default is made by the company in delivering to the registrar the
statutory report or on holding the statutory meeting;
3.
When the company does not commence business within one year of
incorporation or suspends its business for more than one year;
4.
Where the number of members is reduced in the case of a private company
below 2 or in the case of a public company below 7;
5.
Where the company is unable to pay its debts;
6.
Where the court is of the opinion that it is just and equitable to wind up the
company;
7.
In the case of a company registered outside Kenya and carrying on business, the
court will order the company to be wound up if winding up proceedings have
been instituted against the company in the country where it is incorporated or in
any other country where it has established business.
Under Section 221 of the Companies Act an Application for winding up by an order of the
court may be presented either by a creditor or a contributory. However a contributory
cannot make the application unless his name has appeared on the register of members at
least 6 months before the date of the application and in any event he can only petition
where the number of members has fallen below the statutory minimum.
In practice the creditors will petition for a compulsory winding up where the company is
unable to pay its debts. The companys inability to pay its debts under Section 220 is
deemed in the following circumstances
1.

If a creditor to whom the company is indebted in a sum exceeding 1000

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

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2.

If execution issued on a judgment against the company is returned

unsatisfied;

3.

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

Before a creditor can petition it must be shown as a preliminary issue that he is in fact a
creditor or a company creditor. This is a condition precedent to petitioning and the
insolvency of the company is a condition precedent to a winding up order.
PETITION BY A CONTRIBUTOR
Section 221 of the Companies Act speaks not of members but of contributories.
Section 214 defines the term contributory as follows every person liable to contribute to
the assets of the company in the event of its being wound up. The persons falling under
this category are defined in section 213 of the Companies Act and include both present and
past members. A past member however, is not liable to contribute if he ceased to be a
member one year or more before the commencement of the winding up and he is not liable
to contribute for any debt or liability contracted after he ceased to be a member. Even then
he is not liable to contribute unless it appears to the court that the existing members are
unable to satisfy the contributions required.
The most important limitation on liability of contributories is found in Section 213 (1) (d)
of the Companies Act. Under that clause no contribution shall be required from any
member exceeding the amount unpaid on their shares in respect of which he is liable as a
present or past member.
The petitioning contributor must establish that on winding up there will be prima facie a
surplus for distribution among the members i.e. he must establish a tangible interest. If
therefore the 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:

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1.
2.
3.

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

which constitutes operation on the minority;
The courts have also exercised this power where the substratum of the company
has disappeared;
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.
Also usual in such companies is the restriction of the transfer of a members shares without
the consent of all the other members.
If any of these principles were violated in a partnership, the courts will readily order the
partnership to be dissolved. In the case of a small private company, the courts have also
held that such companies are run on the same principles as partnerships and therefore if the
company was run on such principles it is just and equitable to wind it up where a
partnership would have been dissolved in similar circumstances.
RE YENIDGE TOBACCO CO. LTD [1916] 2 Ch. 426
Here W and R who traded separately as Tobacco and Cigarette manufacturers agreed to
amalgamate their business. In order to do so, they formed a private company in which they
were the only shareholders and the only directors. Under the Articles both W and R had
equal voting powers. Differences arose between them resulting in a complete deadlock in
the management of the company. The issue was whether it was just and equitable to wind
up the company. Lord Justice Warrington stated as follows
It is true that these two people are carrying on business by means of the
machinery of the limited company but in substance they are partners. The litigation in
substance is an action for dissolution of the partnership and we should be unduly bound by
matters of form if we treated the relations between them as other than that of partners or the
litigation as other than an action brought by one for the dissolution of the partnership
against the other.
The Model Retreading Co. [1962] E.A. 57
Here the petitioner who was a shareholder in a small private company petitioned for
winding up mainly on the ground that this was just and equitable. The Affidavits sworn by
the petitioner and his co-shareholders disclosed that there had been bitter and unresolved
quarrelling between the parties going to the root of the companies business but none of
these stated that the companys affairs had reached a deadlock. It was however conceded
by all the parties that as a result of the quarrelling the petitioner had been prevented from
participating in the management of the companys affairs.

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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 reYenidge 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.
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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