THE LAW OF BUSINESS ASSOCIATIONS

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 money‟s worth into a common stock and who employ it for
some common purpose. Our legal system provides for three 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

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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 company‟s creditors;

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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

This is by 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, company‟s 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. It simply states that the company‟s nominal capital shall be xxx
amount of shillings. The fees that one pays on registration will be determined by the
share capital that the company has stated. The higher the share capital, the more
that the company will pay in terms of stamp duty.

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

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 to register a public company, Section 184 (4) of the Companies Act also requires
the registration of a list of persons who have agreed to become directors and
Section 182 (1) requires the written consents of the Directors.

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

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

Section 108(1) of the statute should be filed within 14 days of incorporation;

2. Particulars of Directors and Secretary which under Section 201

of the statute are normally required within 14 days of the appointment of the
directors and secretary.

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

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

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 TYPES OF REGISTERED COMPANIES
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
company‟s debts. It is unlikely that promoters will wish to form an unlimited
liability company if the company is intended to trade. But if the company is merely
for holding land or other investments the absence of limited liability would not
matter.

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

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

company. Section 30 of the Companies Act defines a private company as one
which by its articles restricts
(i) the rights to transfer shares;
(ii) restricts the number of its members to fifty (50);
(iii) Prohibits the invitation of members of the public to subscribe
for any shares or debentures of the company.

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

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

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ADVANTAGES OF INCORPORATION
A corporation is a legal entity distinct from its members, capable of enjoying rights
being subject to duties which are not the same as those enjoyed or borne by the
members.

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

Facts of the case

Salomon was a prosperous lender/merchant. He sold his business to Salomon and Co. Limited
which he formed for the purpose at the price of £39,000 satisfied by £1000 in cash, £10,000 in
debentures conferring a charge on the company‟s 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 20,001 shares in the company and each
member of the family had 1 share as Salomon„s 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, agent or nominee 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
Hals bury “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 a company and there is not”
In the words of Lord Mcnaghten “the company is at a law a different person altogether from
the subscribers and though it may be that after incorporation the business is precisely the same as it
was before, and the same persons are managers, and the same hands receive the profits, the company
is not in law the agent of the subscribers or trustee for them nor are the subscribers as members
liable in any shape or form except to the extent and manner prescribed by the Act … in order to
form a company limited by shares the Act requires that seven (7) persons who are each to take one
share at least should sign a Memorandum of Association. If those conditions are satisfied, what

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

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

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

The significance of the Salomon decision is threefold.

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

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

Since the decision in Salomon‟s 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 Saw mills Company Limited for a consideration
of £42,000. Payment was effected by the allotment to the Appellant of 42,000
shares fully paid up in £1 shares in the company. No other shares were ever issued.
The company proceeded with the cutting of the timber. In the course of these
operations, the Appellant lent the company some £19,000. Apart from this the
company‟s debts were minimal. The Appellant then insured the timber against fire
by policies effected in his own name. Then the timber was destroyed by fire. The

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insurance company refused to pay any indemnity to the appellant on the ground
that he had no insurable interest in the timber at the time of effecting the policy.

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

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

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

“ ... That it was the logical consequence of the decision in Salomon‟s 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 Ankole 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 Ankole African
Commercial Society Ltd of whom all the shareholders were natives was also a
native.

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 The court held that a limited liability company is a corporation and as such it has
existence that 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 it‟s
own name to enforce its legal rights. Conversely it may be sued for breach of its
legal duties. The only restriction on a company‟s right to sue is that a lawyer in all
its actions must always represent it.

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 installments. 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 either party made no appearance 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

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 all along to be represented at the hearing by its manager and that the manager in
fact went to the law courts but ended in the wrong court. It was held that a
corporation such as a limited liability company cannot appear in person as a legal
entity without any visible person and having no physical existence it cannot at
common law appear by its agent but only by its lawyer. The Kenya Companies Act
does not change this common law rule so as to enable a limited company to appear
in court by any of its officers.

4. PERPETUAL SUCCESSION As an artificial person, the company

has no 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 that 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 device 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 crystallized or fixed.’ The
ease with which this is done is facilitated by the Chattels Transfer Act that exempts
companies from compiling an inventory on the particulars of such charges and also
by the Bankruptcy Act that 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.

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 The only disadvantages are three:
(i) Too many formalities required in the formation of the company,
(ii) There is maximum publicity of the company‟s affairs;
(iii) There is expense incurred in the formation and in the management of a
company.

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

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

IGNORING THE CORPORATE ENTITY (LIFTING THE VEIL OF

INCORPORATION)
Although Salomon‟s 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

Although a company is liable for its own debt which will be the logical consequence
of the Salomon rule, the members themselves are held liable which is therefore a
departure from principle. The rights of creditors under this section are subject to
certain limitations namely (under statutory provision)

REDUCTION IN THE NUMBER OF MEMBERS - Section 33 refers to membership

that has fallen below the statutory minimum in a public company. The Act
provides that only those members who remain after the six month during which the
company has fallen below the provided minimum period can be sued; 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.

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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 William‟s business as a
furniture manufacturer. The directors of the company were William and his wife
and they appointed William as the Managing Director at a Salary of £1000 per
annum. Within the period of one month, the company was debited with an amount
which was £500 more than what was actually due to William. By that time the
company had made a loss of £2500. Within 2 years of formation, and while the
company was still in financial problems, the directors paid to themselves the
dividends of £250. By the end of the 3rd year since incorporation the company was
in such serious difficulties such that it could not pay debts as they fell due. In spite
of this William ordered goods worth £6000 which became subject to a charge
contained in a debenture held by them. At the same time he continued to repay
himself a loan of £600 (six hundred pounds) which he had lent to the company at
the beginning of the 4th year the company with the knowledge of William owed
£6500 for goods supplied. In the winding up of the company the official receiver
applied for a declaration that in no circumstances William had carried on the
company‟s business with intent to defraud and therefore should be held responsible
for the repayment of the company‟s debts. It was held that since that company
continued to carry on business at a time when William knew that the company
could not comfortably pay its debts, then this was fraudulent trading within the
meaning of Section 323 and William should be responsible for repaying the debts.
These are the words of Justice Maugham J. “if a company continues to carry on business
and to incur debts at a time when there is to the knowledge of the directors no reasonable prospects
of the creditors ever receiving payments of those debts, it is in general a proper inference that the
company is carrying on business with intent to defraud.”

The test is both subjective and objective. In the Case of Re Patrick Lyon Ltd (1933)
Ch. 786 on facts which were similar to the Williams case, the same Judge Maugham

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 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 company‟s general assets available to all creditors or should it go back to those
creditors who are actually defrauded.

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

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

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

HOLDING AND SUBSIDIARY COMPANIES

One of the most important limitations imposed by the Companies Act on the
recognition of the separate personality of each individual company is in connection
with associated companies within the same group enterprise. In practice it is
common for a company to create an organisation of inter-related companies each of
which is theoretically a separate entity but in reality part of one concern represented
by the group as a whole. Such is particularly the case when one company is the
parent or holding company and the rest are its subsidiaries.

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 Under Section 154 of the Companies Act Cap 486 a company is deemed to be a
subsidiary of another if but only if
(a) That other company either
(i) is a member of it and controls the composition of its board of
directors or
(ii) Holds more than half in nominal value of its equity share capital or

(b) The first mentioned company is a subsidiary of any company which is that other‟s
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
company‟s own balance sheet and profit and loss account are also laid. This means
that group accounts must be laid before the general meeting.

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

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 company‟s name should
appear whenever it does business on its Seal and on all business documents. Under
paragraph 4 of this Section, if an officer of a company or any person who on its
behalf signs or authorises to be signed on behalf of the company any Bill of
Exchange, Promissory Note, Cheque or Order for Goods wherein the Company‟s
name is not mentioned as required by the Section, such officer shall be liable to a
fine and shall also be personally made liable to the holder of a Bill of Exchange
Promissory Notes, Cheque or order for the goods for the amount thereof unless it

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is paid by the company. The effect of this section is that it makes a company‟s
officer incur personal liability even though they might be contracting as the
company‟s agents. Liability under this Section normally arises in connection with
cheques and company officers have been held liable where for instance the word
limited has been omitted or where the company has been described by a wrong
name.

IGNORING THE CORPORATE ENTITY UNDER COMMON LAW

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 Salomon‟s case shows how difficult it is to convince the
courts that a company is an agent of its members. In spite of this there have been
occasions in which the courts have held that registered companies were not carrying
on in their own right but rather were carrying on business as agents of their holding
companies. Reference may be made to the case of
Smith Stone & Knight v. Birmingham Corporation (1939) 4 All E.R. 116

In this case the Plaintiffs were paper manufacturers in Birmingham City. In the
same city there was a partnership called Birmingham Waste 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 company‟s property. The plaintiffs then caused the partnership to be
registered as a company in the name of Birmingham Waste 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.

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 Apart from the name, it was as if the manager was managing a department of the
plaintiff company.

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

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

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

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

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

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

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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. Llewellin (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 price
received after deducting costs and a certain percentage. It was agreed that the
distributors will not obtain their supplies from anyone else. The issue was whether
the subsidiary company in Britain was selling its own goods or whether it was selling
goods of an American company.

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

There have been cases where Salomon‟s case has been upheld that a company is a
legal entity.

17
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 Companies Act where an offer was made to
purchase out a company if 90% of shareholders agreed. There were 3 shareholders
in the company. A, B and C.

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

The court held that this was a bare faced attempt to evade the fundamental
principle of company law which forbids the majority unless the articles provide to
expropriate the minority shareholders.
Lord Justice Cohen said “the company was nothing but a legal hut. Built round the majority
shareholders and the whole scheme was nothing but a hollow shallow.” All the minority
shareholder had to do was shout and the walls of Jericho came tumbling down.

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

Here the Defendant was a former employee of the plaintiff company and had
covenanted not to solicit the plaintiff‟s customers. He formed a company to run a
competing business. The company did the solicitation. The defendant argued that

18
he had not breached his agreement with the plaintiffs because the solicitation was
undertaken by a company which was a separate legal entity from him.

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

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

This case the Defendant entered into a contract for the sale of some property to the
plaintiff. Subsequently he refused to convey the property to the plaintiff and
formed a company for the purpose of acquiring that property and actually
transferred the property to the company. In an action for specific performance the
Defendant argued that he could not convey the property to the Plaintiff as it was
already vested in a third party.
Justice Russell J. observed as follows
“the Defendant company was merely a device and a sham a mask which he holds before his face in
an attempt to avoid recognition by the eye of equity”

GROUP ENTERPRISE
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.

19
 DETERMINATION OF A COMPANY’S RESIDENCE
De Beers Consolidated Mines Ltd (1906) K.C. 455

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

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

The courts also look behind the façade 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 Company‟s Act cannot effectively do
anything beyond the powers which are either expressly or by implication conferred
upon in its Memorandum of Association. Any purported activity in excess of those
powers will be ineffective even if agreed to by the members unanimously. This is
the doctrine of ultra vires in company law.

The purpose of this doctrine is said to be twofold

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

thereby know the objects in which their money is to be applied. It is also said to be
intended for the protection of the creditors by ensuring that the Company‟s 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 Company‟s Memorandum of Association gave it powers in its

objects clause
1. To make sell or lend on hire railway carriages and wagons.
2. To carry on the business of mechanical engineers and general
contractors
3. to purchase, lease work and sell mines, minerals, land and realty.

20
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 ratify it.
Lord Cairns stated as follows:
“The words general contractors referred to the words which went immediately
before and indicated such a contract as mechanical engineers make for the purpose
of carrying on a business. This contract was entirely beyond the objects in the
Memorandum of Association. If so, it was thereby placed beyond the powers of
the company to make the contract. If so, it was not a question whether the contract
was ever ratified or not ratified. If the contract was going at its beginning it was
going because the company could not make it and by purporting to ratify it the
shareholders were attempting to do the very thing which by the act of parliament
they were prohibited from doing.”

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

The first inroad into the doctrine was made five years later in the case of Attorney
General V. Great Eastern Railway 1880) 5 A.C. 473
Lord Selbourne stated as follows:
“the doctrine of ultra vires as it was explained in Ashbury‟s 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 object‟s clause but also when it can be interpreted as
reasonably incidental to the specified objects. As a result of this decision, there is
now a considerable body of case law deciding what powers will be implied in a case

21
of particular types of enterprise and what activities will be regarded as reasonably
incidental to the act.

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

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

Unfortunately this does not ensure preservation of the Companies assets or any
adequate control over the director‟s 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
company‟s business was requisitioned for vacant land and the erection thereon of
Housing Estates. Its objects as set up in the Memorandum of Association
contained the Clause authorising the company to “carry on any other trade or
business whatsoever which can in the opinion of the Board of Directors be
advantageously carried on by the company in connection with or as ancillary to any
of the above businesses or a general business of the company”.

In connection with its various development skills the company‟s managing director
met an agent of the Defendants who required some finance to the tune of about 1
million pounds. The Plaintiff‟s Managing Director intimated to the Defendant‟s

22
 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 plaintiff‟s company‟s objects and powers.”

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

23
 objects clause will contain a paragraph to the effect that each of the preceding sub-
paragraphs shall be construed independently and shall not in any way be limited by
reference to any other sub-clause and that the objects set out in each sub-clause
shall be independent objects of the company. Reference may be made to the case
of Cotman v. Brougham [1918]A.C. 514

In this case the objects clause of the company contained 30 sub-clauses. The first
sub-clause authorised the company to develop rubber plantations and the fourth
clause empowered the company to deal in any shares of any company. The objects
clause concluded with a declaration that each of the sub clauses was to be construed
independently as independent objects of the company. The company underwrote
and had allotted to it shares in an oil company. The question that arose was
whether this was intra vires the company‟s objects. The court held that the effect of
the independent objects clause was to constitute each of the 30 objects of the
company as independent objects. Therefore the dealing of shares in an oil company
was within the objects and thus intra vires. However the power to borrow money
cannot be construed as an independent object of the company in spite of this
decision.

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 company‟s Memorandum of
Association and at the material time knew that the company‟s sole business was that
of pig breeding. The issue was, whether the loan and debentures were valid in view
of the fact one of the sub clauses empowered the company to borrow money and
the last sub clause was an independent object clause.

The court held that borrowing was a power and not an object. The power to
borrow existed only for furthering intra vires objects of the company and was not
an object in itself. Therefore
1. The exercise of powers which will be intra vires is exercised for the
objects of the company and is ultra vires only if used for the objects not covered by
the company‟s Memorandum of Association.

24
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 company‟s object had entirely failed.

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

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

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

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

25
John Beauforte (1953) Ch.d 131
A company was authorised by its Memorandum of Association to carry on the
business of costumiers, gown makers and other activities ejusdem generis. The
company decided to undertake the business of making veneered panels which was
admittedly ultra vires and for this purpose, it constructed a factory at Bristol. The
company later went into compulsory liquidation. Several proofs of debts were
lodged with the liquidator which he rejected on the ground that the contracts which
they related to were ultra vires.

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 company‟s 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 West Cork 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
company‟s general meeting authorising the payments of a gratuity to the directors
and dismissed employees.

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

26
 “The law does not say that there are not to be cakes and ale but there are to be no cakes and
ale except such as are required for the benefit of the company”

The question is, suppose there is a clause in the Memorandum of Association that
such payments shall be made, is payment ultra vires? The authority that dealt with
this position was the case of

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

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

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

Justice Eve stated as follows

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

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

27
Parke 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 company‟s business.
The company was not legally bound to make any payments by way of
compensation. One shareholder claimed that the proposed payment was ultra vires.
The court held that the proposed payment was motivated by a desire to treat the ex-
employees generously and was not taken in the interest of the company as it was
going to remain and that therefore it was ultra vires.
The Court 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 company‟s funds which the law
will not allow.”

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

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

The court held that even though the payment was not under an express power, it
was reasonably incidental to the company‟s 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 party‟s
dealing with that company. Such is the case as regards borrowing contracts.
Consider the case of

28
 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 A‟s agent for obtaining such information
and therefore his knowledge was not the company‟s 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 company‟s public documents. Where a contract with that
company is ultra vires, generally speaking the party dealing with that company has
no rights under the contract. The transaction being null and void cannot confer
rights on the 3rd party nor can it impose any obligation on the company.
In many instances however, property will be transferred under an ultra vires
transaction. Such transaction cannot vest rights in the transferee and cannot divest
the transferor of his rights.

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

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

29
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
company‟s 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 company‟s 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 company‟s documents and
activities. In spite of the fact that the doctrine of ultra vires is over due for reform,
it has not undergone any reform in Kenya unlike in the United Kingdom where it
has been severely eroded.

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

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

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

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

30
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.

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

Section 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 Company‟s Articles of
Association may adopt any of the provisions which are set out in Schedule 1 Table
A of the Companies Act Cap 486.

31
 Table A is the model form of Articles of Association of a Company Limited by
Shares. It is divided into two parts designed for public companies in part A and for
private companies in part B (II) thus a company has three options. It may either

(a) Adopt Table A in full; or

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

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

are registered insofar as they do not modify or exclude Table A the regulations in
Table A automatically become the Company‟s 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 Company‟s 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.

32
 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 company‟s articles of
association.
The court held that the company was entitled to have the action stayed since the
articles amount to a contract between the company and the Plaintiff one of the
terms of which was to refer such matters to arbitration.
Justice Ashbury had the following to say: “That the law was clear and could be reduced to 3
propositions
1. That no Article can constitute a contract between the company and a third
party;
2. No right merely purporting to be conferred by an article to any person whether a
member or not in a capacity other than that of a member for example solicitor, promoter or director
can be enforced against the company.
3. Articles regulating the right and obligation of the members generally as such do
not create rights and obligations between members and the company”.

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

In this case, the company‟s articles provided that Eley should become the company
Solicitor and should transact all legal affairs of the company for mutual fees and

33
charges. He bought shares in the company and thereupon became a member and
continued to act as the company‟s solicitor for some time. Ultimately the company
ceased to employ him. He filed an action against the company alleging breach of
contract.

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

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

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

ALTERATION OF ARTICLES

34
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 company‟s power to alter
articles is that the alteration must be made in good faith and for the benefit of the
company as a whole.

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

In this case the company had a lien on all debts by members who had not truly paid
up for their shares. The Articles were altered to extend the Company‟s lien to those
shares which were fully paid up.
The court held that since the power to alter the Articles is statutory, the extension
of the lien to fully paid up shares was valid. These were the words of Lindley L.J.
“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 KB29
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

35
money he had received on its behalf. Under a general meeting of the company a
special resolution was passed that the articles be altered by adding a seventh ground
for disqualification of a director which was a request in writing by his co-directors
that he should resign. Such request was duly given to the Plaintiff and there was no
evidence of bad faith on the part of shareholders in altering the articles.

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

The court held that the contract if any between the Plaintiff and the company
contained in the original articles in their original form was subject to the statutory
power of alteration and if the alteration was bona fide for the benefit of the
company, it was valid and there was no breach of contract. Lord Justice Bankes
observed as follows
“In this case, the contract derives its force and effect from the Articles themselves which may be
altered. It is not an absolute contract but only a conditional contract.”

The question here is who determines what is for the benefit of the company? Is it
the shareholders or the Courts?
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 & C0.[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

36
 and since the members considered it beneficial to the company to get rid of
competitors, the alteration was valid..

Contrast this case with that of

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

Here a public company was in urgent need of further capital which the majority of
the members who held 98% of the shares were willing to supply if they could buy
out the minority. They tried persuasion of the minority to sell shares to them but
the minority refused. They therefore proposed to pass a Special Resolution adding
to the Articles a clause whereby any shareholder was bound to transfer his shares
upon a request in writing of the holders of 98% of the issued capital.

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

EFFECT OF ALTERATION ON CONTRACT OF DIRECTORS

Sometimes the Articles may be altered in such a way that the implementation of
those articles in the altered form would give rise to breach of an existing contract
between the company and a third party and particularly so as regards contracts
between companies and their directors.
A director may hold office either
1. Under the Articles without a service contract;
2. Under a contract of service which is entirely independent of the
articles; or
3. Under a service contract which expressly or by implication embodies
the relevant provisions in the Articles.

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

37
If however, a director‟s 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 company‟s Managing Director
for 10 years. The agreement was not expressed to be subject to the Articles in any
way. The Articles provided various grounds for the removal of a director from
office subject to the terms of any subsisting agreement. The Articles further
provided that if the Managing Director ceased to be a director, he would ipso facto
cease to be Managing Director. The Company‟s Articles were subsequently
changed to give the Directors power to remove a fellow director from office by
notice. Such notice was given to the Plaintiff who thereupon filed an action
claiming damages from the company for breach of contract.

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

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

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 Company‟s 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 company‟s Managing Director 17
years later the directors decided to relieve him of his duties as Managing Director.

38
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 company‟s articles the Plaintiff‟s
appointment was immediately and automatically terminated on passing of the
Resolution at the general meeting since the company had expressly reserved to itself
the power to dismiss the Managing Director.

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 Defendant‟s company,
the Plaintiff‟s 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 Company‟s Articles of Association.

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

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

39
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
In this case an article was altered in such a way as to prejudice one shareholder.
The article gave a lien on partly-paid shares for debts of members. Zuccani owed
money in respect of unpaid calls on partly-paid shares but was the only holder of
fully paid shares as well. The court held that it was for the benefit of the company
to recover moneys due to it and the alteration in its terms related to all holders of
fully-paid shares. The fact that Zuccani was the only member of that class at that
moment did not invalidate it.

VARIATION OF CLASS RIGHTS

Although the Companies Act recognises the existence of class of shareholders, it
does not define the term „class‟ the best definition is found in the case of

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

In that case Bowen L.J. stated as follows: “The word Class is vague it must be confined to
those persons whose rights are not dissimilar as to make it impossible for them to concert together
with a view to their common interest.”

Under Article 4 of Table A where the Share Capital is divided into different classes
of Shares, the rights attached to any class may be varied only with a consent in
writing of the holders of three quarters of the issued share of that class or with
assumption of a special resolution passed at a separate meeting of the holders of the
shares of that class.

However, under Section 25 (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

40
 Since a company is an artificial person, it can only act through an agency of a
human person. For this purpose, a company has two primary organs.
1. The general Meeting;
2. The Board of Directors.
The authority to exercise a company‟s 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) of the Companies Act every appointment must be voted on
individually except in the case of private companies or unless the meeting
unanimously agrees to include two or more appointments in the same resolution.
The appointment is usually effected by an ordinary resolution. However, no matter
how a director is appointed, under Section 185 of the Companies Act he can always
be removed from office by an ordinary resolution in addition to any other means of
removal which may be embodied in the articles.

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.

41
Automatic Self-cleaning Filter Syndicate v. Cunningham (1906) A.C. 442
The company‟s articles provided that subject to such regulations as might be made
by extra ordinary resolution, the Management of the company‟s 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 company‟s assets on certain terms and instructing
the directors to carry the sale into effect. The Directors were of the opinion that a
sale on those terms was not of any benefit to the company and therefore refused to
carry it into effect. The issue was, whether the directors were under an obligation to
act in accordance with the directives.

The court held that the Articles constituted a contract by which the members had
agreed that the Directors alone should manage the affairs of the company unless
and until the powers vested in the Directors was taken away by an alteration in the
Articles they could ignore the general meeting directives on matters of management.
They were therefore entitled to refuse to execute the sale.

The division of the power to manage the company‟s affairs is embodied in Article
80 of Table 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 required 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 company‟s articles of
association.

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

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

42
 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 company‟s business was at a standstill as Barron refused to
attend any Board meeting with Porter.

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

CORPORATES’ LIABILITIES FOR ACTS OF ITS ORGANS &

OFFICERS
There are certain situations in which the law does not recognise vicarious liability
but insists on personal fault as a prelude to liability. In such cases a company could
never be liable if the courts applied rigidly the rule that a company is an artificial
person and therefore can only act through the directors. In practice and for certain

43
purposes the courts have elected to treat the acts of certain officers as those of the
company itself. This is sometimes referred to as THE ORGANIC THEORY OF
COMPANIES.

The theory sprung from the case of Lennard’s Carrying Co. v. Asiatic Petroleum
Co. Ltd. (1950) A.C. 705. In this case a ship and her cargo were lost owing to
unseaworthiness. The owners of the ship were a limited company. The managers
of the company were another limited company whose managing director a Mr.
Lennard managed the ship on behalf of the owners. He knew or ought to have
known of the Ship‟s unseaworthiness but took no steps to prevent the ship from
going to sea. Under the relevant shipping Act the owner of a sea going ship was
not liable to make good any loss or damage happening without his fault. The issue
was whether Lennard‟s knowledge was also the company‟s knowledge that the ship
was unseaworthy. The court held that Lennard was the Directing mind and will of
the company his knowledge was the knowledge of the company, his fault the fault
of the company and since he knew that the ship was unseaworthy, his fault was also
the company‟s fault and therefore the company was liable. As per Viscount
Haldane “My Lords a corporation is an abstraction. It has no mind of its own
anymore than it has a body of its own. Its active and directing will must
consequently be sought in the person of somebody who for some purposes may be
called an agent but who is really the directing mind and will of the corporation, the
very ego and centre of the personality of the corporation.

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 premises themselves for their business purposes. The issue was
whether the Defendant company had effectively formed this intention. There had
been no formal general meeting or Board of Directors meeting held to consider the
question but the managing director‟s clearly manifested the intention to occupy the
premises for the company‟s business.

The court held that the intention manifested by the Directors was the company‟s
intention and therefore the tenants were not entitled to a renewal of the tenancy.

44
Denning L.J. as he then was stated as follows:
“a company may in many ways be likened to a human being. It has a brain and
nerve centre which controls what it does. It also has hands which hold the tools
and act in accordance with the directions from the centre. Some of the people in
the company are mere servants and agents who are nothing more than hands to do
the work and cannot be said to represent the mind and will of the company. Other
are directors and managers who represent the directing mind and will of the
company and control what it does. The state of mind of these managers is the state
of mind of the company and are treated by the law as such. Whether their intention
is the company‟s intention depends on the nature of the matter under consideration,
the relative position of the officer or agent and other relevant facts and
circumstances of the case.”

RULE IN TURQUAND’S CASE

Crossly connected with this aspect is the so called rule in Turquand‟s case:
This rule deals with a company‟s liability for acts of its officers. The question as to
whether or not the company is bound or not depends on the normal agency
principles. If a company‟s officer or a company‟s organ does an act within the
scope of its authority, the company will be bound. The problem which might arise
is that even if the Act in question is within the scope of the organs or officers
authority, there might be some irregularity in the action of the organ concerned and
consequently in the exercise of authority. For example, if a particular act can only
be valued if done by the Board of Directors or the general meeting, the meeting
might have been convened on improper notice or the resolution may not have been
properly carried. In the case of the Directors, they may not have been properly
appointed. In these circumstances can the company disclaim an act which was so
done by arguing that the meeting was irregular? Must a third party dealing with the
company always ascertain that the company‟s internal regulations have been
complied with before holding the company liable?

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

The Royal British Bank v. Turquand (1856) 6 E & B 327

Here under the Company‟s constitution the directors were given power to borrow
on bond such sums of money as from time to time by a general resolution be
authorised to be borrowed. Without any such resolution having been passed, the

45
 directors borrowed a certain sum of money from the Plaintiff‟s bank. Upon the
company‟s liquidation the bank sought to recover from the liquidator who argued
that the Bank was not bound to recover it as it was borrowed without authority
from the general meeting.

The court held that even though no resolution had been passed, the company was
nevertheless bound by the act of the directors and therefore was bound to repay the
money.
The words of Jarvis C.J. were as follows:
“a party dealing with a company is bound to read the company‟s deed of settlement
(Memorandum of Association) but he is not bound to do more. In this case a third party reading
a company‟s documents will find not a prohibition from borrowing but permission to do so on
certain conditions. Finding that the authority might be made complete by resolution, he would have
had a right to infer the fact of a resolution authorising that which on the face of the document
appeared to be legitimately done.”

This is the rule in Turquand‟s Case which is often referred to as the rule as to
indoor management.
This rule is based not on logic but on business convenience.
1. A third party dealing with a company has no access to the company‟s
indoor activities;
2. It would be very difficult to run business if everyone who had dealings
with the company had first to examine the company‟s internal operations before
engaging in any business with the company;
3. It would be very unfair to the company‟s creditors if the company
could escape liability on the ground that its officials acted irregularly.

But should the company always be held liable for the act of any people purporting
to act on the company‟s behalf? Suppose these persons are impostors, what
happens?

In order to avoid this some limitations have been imposed on the rule. Later cases
have refined the rule to a point where the position appears to that ordinary agency
principles will always apply

46
Anybody dealing with a company is deemed to have notice of the contents of the
company‟s 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 is not
defined in the companies Act but so far as registered companies are concerned, the
expression is not restricted to the Memorandum and Articles but it also includes
some of those documents filed at the companies registry. These include special
resolutions, particulars of directors and secretary, charges etc. provided that
everything appears to be regular, so far as can be checked from the public
documents, a third party dealing with a 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 circumstances putting him on
inquiry. Reference is made to the case of

Mahoney v. East Holyford Mining Co. (1875) L.R. 7 HL 869

Here a mining company was founded by W and his friends and relatives.
Subscriptions were obtained from applicants for shares. These monies were paid
into the bank which had been described in the prospectus as the company‟s bank.
The communication of the letter was sent to the Bank by a person describing
himself as the Company‟s secretary to the effect that in accordance with a resolution
passed on that day, the bank was to pay out cheques signed by either two of the
three named directors whose signatures were attached and countersigned by the
Secretary. The bank thereafter honoured cheques so signed. When the company‟s
funds were almost exhausted, the company was ordered to be wound up. It was
then discovered that no meeting of the Shareholders had been held, and no
appointment of Directors and Secretary met but that with his friends and relatives,
W had held themselves to be secretary and directors and had appropriated the
subscription money. The issue was whether the Bank was liable to refund the
money it had paid back to the borrower.
The court held that the bank was not liable to refund any money to the company as
it had honoured the company‟s cheques in reliance on a letter received and in good
faith.
Lord Hatherly stated
“When there are persons 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

47
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
third party dealing with a company through an officer who is or is held out by the
company as a particular type of officer e.g. a Managing Director and who purports
to exercise a power which that sort of officer will usually have is entitled to hold the
company liable for the officer‟s acts even though the officer has not been so
appointed or is in fact exceeding his authority as long as the third party does not
know that the company‟s officer has not been so appointed or has no actual
authority.

A third party however, will not be protected if the circumstances are such as to put
him on inquiry. He will also lose protection if the public documents make it clear
that the officer has no actual authority or could not have authority unless a
resolution had been passed which requires filing in the Companies Registry and no
such resolution had been filed. These are normal agency principles.

Freeman & Lockyer V Buckhurst Park Properties (1964) 2 Q.B. 480

In this case Kapool & Hoon formed a private company which purchased Buckhurst
Park Estate. The Board of Directors consisted of Kapool, Hoon and two others.
The Articles of the company contained a power to appoint a Managing Director but
none was appointed. Though never appointed as such, Kapool acted as Managing
Director. In that capacity he engaged the Plaintiffs who were a firm of Architects
to do certain work for the company which was duly done. When the Plaintiff‟s
claimed remuneration, according to the agreement, the company replied that it was
not liable because Kapool had no authority to engage them.

The Court held that the act of engaging Architects was within the ordinary ambit of
the authority of a Managing Director of a property company and the Plaintiffs did
not have to inquire whether a person with whom they were dealing with was
properly appointed. It was sufficient for them that under the Articles, the Board of
Directors had the power to appoint him and had in fact allowed him to act as

48
 Managing Director. Four conditions must however be fulfilled in order to entitle a
third party to enforce a contract entered to on behalf of the company by a person
who has no actual authority.

1. It must be shown that there was a representation that the agent had
authority to enter into a contract of the kind sought to be enforced;
2. Such representation must be made by a person or persons who had
actual authority to manage the company‟s business either generally or in respect of
those matters to which the contract relates;
3. It must be shown that the contract was induced by such
representation;
4. It must be shown that neither in its Memorandum or under its Articles
was the company deprived of the capacity either to enter into a contract of the kind
sought to be enforced or to delegate authority to do so to the agent.

Emco Plastica International vs Freeberne (1971) E.A. 432

Here by a resolution of the company at a meeting of the Board of Directors, the
Respondent was appointed as the company‟s secretary. Nothing was decided at the
meeting as regards his remuneration or other terms of service. The terms of his
appointment were contained in a letter signed on behalf of the company by its
Managing Director which provided that the appointment was for a maximum
period of 5 years. The Managing Director dealt with the day to day affairs of the
company but had no express authority to appoint a Secretary or to offer such
unusually generous terms as contained in the letter. After two years service the
company purported to dismiss the Respondent by five days notice. The Secretary
sued for benefits under the Contract. The Company contended that the Managing
Director had no authority from the Company to offer the terms of the contract.
There being no resolution of the board to support it and nothing in the company‟s
articles conferring any such powers on a Managing Director.

The court held that as a chairman he performed the functions of the Managing
Director with a full knowledge of the Board of Directors and that a contract of
service as the one entered into with the Secretary was one which a person
performing the duties of a Managing Director would have power to enter into on
behalf of the company. Therefore, the contract was genuine, valid and enforceable.
If however, the officer is purporting to exercise some authority which that sort of

49
officer would not normally have, a third party will not be protected if the officer
exceeds his actual authority unless the company has held him out as having
authority to act in the matter and the third party has relied thereof i.e. unless the
company is estopped. However, a provision in the Memorandum or Articles or
other public document cannot create an estoppel unless the third party knew of the
provision and has relied on it. For this purpose, regulations at the Companies
Registry do not constitute notice because the doctrine of constructive notice
operates negatively and not positive. If a document purporting to be received by or
signed on behalf of the company is proved to be a forgery, it does not bind the
company. However, the company may be estopped from claiming the document as
a forgery if it has been put forward as genuine by an officer acting within his usual
or ostensible authority.

Look at

Rama Corp v Proved Tin & General Investment (1952) 2 Q.B. 147

PROMOTERS
The Companies Act does not define the term promoter but Section 45(5) says
“A promoter is a promoter who was a party to the preparation of the
prospectus. Apart from the fact that this definition does not speak much, it
nevertheless shows that the definition is only given for the purposes of that section.

At common law the best definition is that by Chief Justice Cockburn in the case of

Twyfords – v – Grant (1877) 2C.P.D. 469

Cockburn says “a promoter is one who undertakes to form a company with

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

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 will not qualify as promoters because they are
simply performing their normal professional duties. But they can also become

50
promoters or find others who will. Whether a person is a promoter or not
therefore, is a question of fact. The reason is that Promoter of is not a term of law
but of business summing up in a single word the number of business associations
familiar to the commercial world by which a company is born.

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

DUTIES OF A PROMOTER
His duty is to act bona fide towards the company. Though he may not strictly be an
agent, or trustee for a company, anyone who can be properly regarded as a
promoter stands in a fiduciary relationship vis-à-vis the company. This carries the
duties of disclosure and proper accounting particularly a promoter must not make
any profit out of promotion without disclosing to the company the nature and
extent of such a Promotion. Failure to do so may lead to the recovery of the profits
by the company.

The question which arises is – Since the company is a separate legal entity from
members, how is this disclosure effected?

Erlanger v New Sombrero Phosphates Co. (1878) 3 A.C. 1218

The facts were as follows
The promoters of a company sold a lease to the company at twice the price paid for
it without disclosing this fact to the company. It was held that the promoters
breached their duties and that they should have disclosed this fact to the company‟s
board of directors. As Lord Cairns said

“the owner of the property who promotes and forms that company to which he sells his property
is bound to take care that he sells it to the company through the medium of a Board of Directors

51
 who can exercise an independent judgment on the transaction and who are not left under belief that
the property belongs not to the promoters and not to another person.”

Since the decision in Salomon‟s case it has never been doubted that a disclosure to
the members themselves will be equally effective. It would appear that disclosure
must be made to the company either by making it to an independent Board of
Directors or to the existing and potential members. If to the former the promoter‟s
duty to the company is duly discharged, thereafter, it is upon the directors to
disclose to the subscribers and if made to the members, it must appear in the
Prospectus and the Articles so that those who become members can have full
information regarding it.

Since a promoter owes his duty to a company, in the event of any non-disclosure,
the primary remedy is for the company to bring proceedings for
1. Either rescission of any contract with the promoter or
2. recovery of any profits from the promoter.
As regards Rescission, this must be exercised with keeping in normal principles of
the contract.
1. the company should not have done anything to ratify the action
2. There must be restitutio in intergram (restore the parties to their original
position),

REMUNERATION OF PROMOTERS
A promoter is not entitled to any remuneration for services rendered for the
company unless there is a contract so enabling him. In the absence of such a
contract, a promoter has no right to even his preliminary expenses or even the
refund of the registration fees for the company. He is therefore under the mercy of
the Directors. But before a company is formed, it cannot enter into any contract
and therefore a promoter has to spend his money with no guarantee that he will be
reimbursed.

But in practice the articles will usually have provision authorising directors to pay
the promoters. Although such provision does not amount to a contract, it
nevertheless constitutes adequate authority for directors to pay the promoter.

PRELIMINARY CONTRACTS BY PROMOTERS

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Until a company is formed, it is legally non-existent and therefore cannot enter into
any contract or even do any other acts in law. once incorporated, it cannot be liable
on any contract nor can it be entitled under any contract purported to have made
on its behalf before incorporation.

Ratification is not possible when the ostensible principle is non-existent in law when
the contract was entered into.

Price v. Kelsall (1957) E.A. 752

One of the issues in this case was whether or not a company could ratify a contract
entered into on its behalf before incorporation. The alleged contract was that the
Respondent had undertaken to sell some property to a company which was
proposed to be formed between him and the Appellant. In holding that a company
cannot ratify such an agreement, the Eastern Africa Court of Appeal as then
constituted O‟Connor President said as follows
“A company cannot ratify a contract purporting to be made by someone on its
behalf before its incorporation but there may be circumstances from which it may
be inferred that the company after its incorporation has made a new contract to the
effect of the old agreement. The mere confirmation and adoption by Directors of a
contract made before the formation of the company by persons purporting to act
on behalf of the company creates no contractual relations whatsoever between the
company and the other party to the contract.”

However, acts may be done by a company after its formation which give rise to an
inference of a new contract on the same terms as the old one.

The question whether there is a new contract or contracts is always a question of

facts which depends on the circumstances of each individual case.

Mawagola Farmers & Growers Ltd. V Kanyanja (1971) E.A. 272

Here, prior to the incorporation of a company the promoters held public meetings
at which members of the public were asked to purchase shares in a proposed
company. The Respondents paid for the shares both before and after incorporation
of the company but the company did not allot any shares to them. Instead after
incorporation, it allotted shares to other people.

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The Respondents filed actions praying for orders that the shares they paid for be
allotted to them and the company‟s registered members be rectified accordingly.

The Company argued that as the Respondents had paid money for the purchase of
their shares before incorporation, their claim could only be directed against
promoters because no pre incorporation agreement could bind the company and
the company could not even after incorporation ratify or adopt any such contract.

Mustafa J.A. replied as follows:

“in order that the company may be bound by agreements entered into before
incorporation, there must be a new contract to the same effect as the old
agreements. This contract may however be inferred from the acts of the company
when incorporated.”

The allotment of shares to the Respondents after the incorporation was held to be
sufficient evidence of a new contract between the company and the Respondents.
Therefore the Respondents were entitled to be allotted the shares agreed upon.

If any preliminary arrangements are made, these must therefore be left to mere
gentlemen‟s agreements or otherwise the promoters might 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 their proposed companies.

As to whether the promoters will be personally liable on such contracts of nought

might depend on the terminology employed. In the case of

Kelner v. Baxter (1886) L.R. 2 C.P. 174

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

It was held that A B and C were liable. Chief Justice Erne stated as follows:

54
 “where a contract is signed by one who professes to be signing as agent but
who has no principal existence at the time, then the contract will hold together the
inoperative unless binding against the person who signed it. He is bound thereby
and a stranger cannot by subsequent ratification relieve him from that responsibility.
When the company came afterwards into existence, it had rights and obligations
from that time but no rights or obligations by reason of anything which might have
been done before.”

Contrast this case with the case of Newborn v. Sensolid (G.B Ltd) (1954) 1 Q.B.
45
Here a contract was entered into between Leopold Newborn London Ltd and the
Defendant for purchase of goods by the latter. The defendant subsequently refused
to take delivery of the goods and an action was commenced by Leopold Newborn
Ltd.

It was discovered that at the time the contract was entered into, the company had
not been incorporated. Leopold Newborn thereupon sought personally to enforce
the contract.

It was held that the signature on the document was the company‟s signature and as
the company was not in existence when the contract was signed, there never was a
contract and Mr. Newborn could not come forward and say that it was his contract.
The fact was that he made a contract for a company which did not exist.

PROSPECTUSES
Basically when the public is asked to subscribe for shares or debentures in a
company the invitation involves the issue of documents which set out the
advantages to accrue from an investment in the 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 13
of the Companies Act Cap 486.

55
 Section 20 of the Statute defines Prospectus as “any prospectus notice circular
advertisement or other invitation offering to the public for subscription or purchase
of any shares or debentures in the company.”

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

The word prospectus is thus a vague and uncertain term. Whether an invitation is
made to members of the public is always a question of fact. The question “public”
is not restricted to a certain section of the public but includes any members of the
general public. Reference may be made to the case of

Re South of England Natural Gas Co. (1911) 1 Ch. 573

A newly formed company issued 3000 copies of a document which offered for
subscription shares in a company and which was headed “for private circulation
only”. These copies were then circulated to the shareholders of a number of gas
companies and the question arose Was this a prospectus?

The court held that this was an offer to the public and therefore constituted a
prospectus.

CONTENTS OF A PROSPECTUS
The object of the Companies Act is to compel a company to disclose in a
prospectus all the necessary information which will enable a potential investor in
deciding whether or not to subscribe for a company shares or debentures.
Therefore Section 40 requires that every Prospectus shall state the matter specified
in Article 1 of the 3rd Schedule to the Act and that it will also set out the report
specified in Part II 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 benefits they will get from the
Directorship;
2. In the case of a new company, what profits are being made by the
promoters;

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3. the amount of capital required by the company to be subscribed,
the amount actually received or to be received, the precise nature of the
consideration which is not paid in cash;
4. In the case of an existing company, what the company‟s financial
records has been in the past.
5. the company‟s obligations under any contracts it has entered into;
6. the voting and dividend rights of each class of shares;
7. If a Prospectus includes any statement by an expert, then the expert
must have given his written consent to the inclusion of the statement and the
prospectus must state that he has done so as per Section 42 of the Companies Act.
Contravention of these requirements renders the company and every person who
was knowingly a party to the issue of the prospectus to a fine not exceeding
10,000/-

Section 42 defines Expert as including “Engineer, Valuer, Accountant or any other

person whose profession gives authority to the statement made by him.”

In addition to these requirements the prospectuses must also be dated and the date
stated therein is taken to be the date of publication of the prospectus. However,
there are two instances when a prospectus need not contain the matter set out in
Schedule III namely
1. When the prospectus is issued to existing members or shareholders of
the company;
2. When the prospectus relates to shares or debentures uniform with
previously issued shares or debentures.

LIABILITY IN RESPECT OF PROSPECTUS

If a prospectus contains untrue statements, the Companies Act prescribes both
penalty at Criminal Law and also Civil Liability for payment of damages. As
concerns Criminal Liability, under Section 46 where a prospectus includes any
untrue statement, any person who authorised the issue of the prospectus is guilty of
an offence and liable to imprisonment of a term not exceeding two years or a fine
not exceeding 10,000/- or both such a fine and imprisonment unless he proves
either that the statement was immaterial or that he had reasonable grounds to
believe and did up to the time of issue of the prospectus that the statement was
true.

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 A statement is deemed to be untrue if it is misleading in the form and context in
which it is included.

R. v. Kylsant (1932) 1 K.B. 442

In this case the company had sustained continuous loses for over 6 years from 1921
to 1927. The company issued a prospectus which in all material facts was correct. It
further specified that the dividends being paid were high. But these dividends were
being paid out of abnormal profits made after World War 1. Therefore the
Prospectus was misleading in its context.

CIVIL REMEDIES
There are two primary remedies for those who subscribe for shares in a company as
a result of a misrepresentation in a prospectus

(a) Damages;
(b) Rescission of any resulting contract.

DAMAGES
Section 45 provides for compensation to all persons who subscribe for any shares
or debentures on the faith of the Prospectus for loss or damage they may have
sustained by reason of untrue statements included therein. If the statement is false
to the knowledge of those who made it, then this amounts to fraud and damages
will be recoverable from all those who made the statement intending it to be acted
upon. Refer to the case of

Derry v. Peek (1889) 14 A.C. 337

Herein a company had power to construct tramways to be moved by animal power
and with the consent of the British 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.

In reliance on this misrepresentation, the Plaintiff bought shares in the company.

Subsequently the Board of Trade refused to give consent to the use of Steam or
mechanical power and as a result the company was wound up. The Plaintiff
brought an action for deceit alleging fraudulent misrepresentation.

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 The Court held that the Defendants were not liable as they had made the incorrect
statement in the honest belief that it was true. Lord Herschell said “the authorities
establish two major propositions.In order to sustain an action of Deceit, there must
be proof of fraud and nothing short of that will suffice;
(i) Fraud is proved when it is shown that a false representation has
been made either;
(a) Knowingly or
(b) Without belief in its truth; or
(c) Recklessly not caring whether it be true or false.
In order to succeed in an action for damages for fraud the plaintiff must show that
the Misrepresentation was made to him or that he was one of a class of persons
who were intended to act upon it. The ordinary purpose of a prospectus is to invite
members of the public to become allottees of shares in a company. Once the
shares have been allotted therefore the prospectus will have served its purpose and
thereafter it cannot be used as a ground for filing an action for fraud in respect of
shares bought at a later date from another source. Reference made to the case of

Peek v. Gurney (1873) L.R. 377

The allotment of shares in the company began on July 24th and was completed on
28th July. In October, the Plaintiff bought shares on the stock exchange. He
subsequently found that the prospectus issued in July contained some untrue
statements and therefore brought an action in respect thereof.

The issue was could he sue?

The court held that the Plaintiff could not base his action on the prospectus which
was intended to be addressed only to the original company subscribers to the
company shares. The Directors of a company are not liable after the full original
allotment of shares for all the subsequent dealings which may take place with regard
to those shares on the stock exchange.

However, the rule in Peek v. Gurney will not apply where a prospectus is intended
to induce not only the original subscribers for the company shares but also to
influence the subsequent purchase of those shares

59
Andrews v. Mockford (1896) 1 QB 372
Here the Plaintiff alleged that the Defendant sent him a prospectus inviting him to
buy shares in the company which they knew would be a sham but the Plaintiff did
not subscribe for the shares. The prospectus eventually produced a very scanty
subscription and the Defendant caused a telegram to be published in the local
Newspaper to the effect that they had struck a vain of Gold. And this they alleged
had confirmed the statistics in the prospectus.

The Plaintiff immediately bought shares on this basis. The company was wound
up. The question arose, Had the Prospectus served its purpose.

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

Lord Justice Smith stated as follows

“there was proved against the Defendant a continuous fraud on their part
commencing with ascending of the prospectus to the Plaintiff and culminating in
the direct lie told in a telegram which was intended by the defendant to operate
upon the Plaintiff‟s mind and minds of others and did so operate to his prejudice
and the advantage of the Defendant. In this case the function of the prospectus
was not exhausted and a false telegram was brought in to play by the Defendant to
reflect back upon and countenance the false statements in the prospectus.”

The purchaser of shares induced to buy shares by the misstatement in the

prospectus has an action for damages in negligence. He has also an action for
negligent misstatement under the Hedley Byrne & Co. v. Heller & Partners (1974)
A.C. 465 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. However, the rights to rescind is subject to two limitations

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1. The allotee loses the right to rescind if he shows any election to affirm
the contract; e.g. by attending and voting at the company‟s meetings or by
accepting dividends or by selling or attempting to sell the shares.

2. If the allotee does not rescind the contract before the company is
wound up, he loses the right to do so as from the moment the winding up
proceedings commenced. The rationale is the protection of the other company‟s
creditors.

DIRECTORS DUTIES
First, three preliminary observations
1. Whereas the Directors‟ authority to bind the company depends on
their acting collectively as a Board, their 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.

Percival v. Wright (1902) 2 Ch. 421

Certain Shareholders wrote to the Company‟s Secretary asking if he knew anyone
willing to buy their shares. Negotiations took place and eventually the company
chairman and two other directors bought the Plaintiff Shares at £12 10s per share.
The Plaintiff subsequently discovered that prior to and during their own
negotiations for sale, the Chairman and the Board of Directors had been
approached by 3rd Party with a view to the purchase of the entire company‟s assets
at more than the price of 12 pounds 10 shillings per share.

The Plaintiff brought an action to set aside the share sales on the ground that the
directors owed them a duty to disclose the negotiations with the 3rd Party.

It was held that the Directors were not agents for the individual shareholders and
did not owe them any duty to disclose. Therefore the sale was proper and could
not be set aside. However, if the Directors are authorised by the members to
negotiate on their behalf e.g. with a potential purchaser then the Directors will be in
a position of agents for such members and will owe them a duty accordingly.

Allen v. Hyatt (1914) 30 T.L.R. 444

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 These duties except where expressly stipulated in the Companies Act are not
restricted to directors alone but apply equally to any officials of the company who
are authorised to act as agents of the company and in particular to those acting in a
managerial capacity. This is particularly so as regards fiduciary duties.

DIRECTORS’ DUTIES PROPER

These fall into two broad categories
1. duties of care and skill in the conduct of the company‟s affairs; and
2. Fiduciary duties of loyalty and good faith.

DUTIES OF CARE & SKILL

Duties of care and skill were summed up by Romer J. in the case of

Re City Equitable Fire Insurance Co. (1925) Ch. D 447

Here the Directors of an insurance company left the management of the company‟s
affairs almost entirely to the Managing Director. Owing to the managing Director‟s
fraud, a large amount of the company‟s funds disappeared. Certain items appeared
in the balance sheet under the heading “loans at call or short notice and “Cash in
Bank or in Hand”. The Directors did not inquire how these items were made up.
If they had inquired they would have found that the loans were chiefly to the
Managing Director himself and to the Company‟s General Manager and the cash at
Bank or in hand included some £13,000 in the hands of a firm of stockbrokers at
which the managing director was a partner.

On the company‟s winding up, an investigation of its affairs disclosed a shortage in

its funds of more than £1.2 million 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 the damages.

It was held that the Directors were negligent. Justice Romer reduced the Directors
duties of care and skill as follows
“A Director need not exhibit in the performance of his duties a greater degree of
skill than may reasonably be expected from a person of his knowledge and
experience.”

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

Re Brazilian Rubber & Plantations Estates Ltd. (1911) 1 Ch. 405

In this case a company had five directors and one of them confessed that he was
absolutely ignorant of business. A second one was 75 years old and very deaf. A
third one said he only agreed to become a director because he saw one of his
friends names on the list of directors. The other two were fairly able businessmen.
The directors caused a contract to be entered into between the company and a
certain syndicate for purchase by that company of some rubber plantation in Brazil.
The prospectus issued by the company contained false statements about the acreage
of the Plantation, the types of trees and so forth. The information given therein
was given to the Directors by a person who had an original option to purchase that
property. He had never been to Brazil and the data was based on his own
imagination. The Directors caused the company to purchase the property. The
question arose, were they negligent in so doing?

The court held that their conduct did not amount to gross negligence. Neville J.
had the following to say:
“It has been laid down that so long as they act honestly, Directors cannot be made responsible in
damages unless they are guilty of gross negligence. A Director‟s duty requires him to act with such
care as is reasonably expected from his having regard to his knowledge and experience. He is not
bound to bring any special qualifications to his office. He may undertake the Management of a
Rubber Company in complete ignorance of anything connected with Rubber without incurring
responsibility for the mistakes which may result from such ignorance. While if he is acquainted
with the Rubber business, he must give the company the advantage of his knowledge when
transacting the company‟s business. He is not bound to take any definite part in the conduct of the
company‟s business but insofar as he undertakes it he must use reasonable care. Such reasonable
care must be measured by the care an ordinary man might be expected to take in the same
circumstances on his own behalf.”

3. A director is not bound to give continuous attention to the 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

63
placed. He is not bound to attend all such meetings though he ought to attend
whenever in the circumstances he is reasonably able to do so. Refer to the case of

Re Denham & Co. Ltd (1883) 2 Ch. D 752

Here a company was incorporated in 1873. Under the Articles 3 Directors were
appointed namely, Denham, Taylor and Crook. A fourth Director was appointed
later. The articles conferred on Denham supreme control of the company‟s affairs.
He was given power to override decisions of the general meeting and a Board of
Directors. He was responsible for declaring dividends and he managed the
company‟s affairs entirely alone and without consulting the other directors.
Between 1874 and 1877 a dividend of 15% per annum was recommended and paid
and the total amount paid was some £21,600. In 1880 the company went into
liquidation and an investigation revealed that the money paid as dividends had been
paid not out of profits but out of capital. Thereafter Denham became bankrupt,
Taylor was dead and his estate was worthless and the third man was a man of straw.
The creditors directed their claims against Crook who had property. Crooks argued
that since the formation of the company, he had never attended Board Meetings
and therefore could not be accountable for fraudulent statements in the Company‟s
Balance Sheets. He attended one meeting in 1876 where he formally put forth a
Resolution for the payment of a dividend for that year.

The Court held that a Director is not bound to attend every Board meeting and that
he is not liable for misfeasance committed by his co-directors at Board meetings at
which he was never present.

Marquis Of Butes (1892) 2 Ch. 100

Here the Director never attended any Board meetings for 38 years. It was held that
he was not liable.

3. In respect of all duties which having regard to all exigencies of business and
articles of association may properly be left to some other official. A Director in the
absence of grounds for suspicion will not be liable in trusting that other official to
perform that other duty honestly.

Dovey v. Cory (1901) A.C. 477

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 A bank sustained heavy losses by advances made improperly to customers. The
irregular nature of advances was concealed by means of fraudulent Balance Sheets
which were the work of the General Manager and the Chairman in assenting to the
payment of dividends out of capital and those advances on improper security were
done on the advice of the general manager and chairman.

The court held that the reliance placed by the co-director on the general manager
and chairman was reasonable. He was not negligent and therefore was not liable for
not having discovered the fraud as he was not in the absence of circumstances of
suspicion bound to examine entries in the Company‟s Books to see that the Balance
Sheet was correct.

It may be said that the duties of care and skill appear to be negative duties. What
about fiduciary duties?

FIDUCIARY DUTIES
Basically a Director‟s fiduciary duties are divisible into 4 sub categories

1. The Directors must always act bona fide in what they consider and not
what the courts may consider to be in the best interest of the company. In this
context, the term company means the present and future members of the company
on the basis that the company will be continued as a going concern thereby
balancing long-term view against short term interests of existing members.

2. The directors must always exercise their powers for the particular
purpose for which they were conferred and not for extraneous purposes even if the
latter are considered to be in the best interests of the company. For example the
Directors are invariably empowered to issue capital and this power should be
exercised for only raising more funds when the company requires it. Hence it will
be a breach of the Directors‟ duties to issue the company shares for the purpose of
entrenching themselves in the control of the company‟s affairs. Refer to the case of
Punt v. Symons (1903) 2 Ch. 506 in this case the directors issued shares with the
object of creating a sufficient majority to enable them to pass a special resolution
depriving the other shareholders of some special rights conferred upon them by the
company‟s articles. It was held that a power of a kind exercised by the Directors in
this case was a power which must be exercised for the benefit of the company.

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Primarily this power is given to them for the purpose of enabling them to raise
capital for the purposes of the company. Therefore a limited issue of shares to
persons who are obviously meant and intended to secure the necessary statutory
majority in a particular interest was not a fair and bona fide exercise of the power.

Piercy v. Mills & Co. (1920) 1 Ch. 78

A company had two directors. They fell out of favour with the majority of the
shareholders who were therefore threatened with the election of 3 other directors to
the Board. The directors issued shares with the object of creating a sufficient
majority to enable them to resist the election of the 3 additional directors whose
election would have put the two directors in the minority on the Board.

The Court held that the Directors were not entitled to use their powers of issuing
shares merely for the purpose of maintaining their control or the control of
themselves and their friends over the affairs of the company or even merely for the
purpose of defeating the wishes of the existing majority of shareholders. The
Plaintiff and his friends held the majority of shares in the company and as long as
that majority remained, they were entitled to have their wishes prevail in accordance
with a company‟s regulations. Therefore it was not open to the directors for the
purpose of converting a minority into a majority and purely for the purpose of
defeating the wishes of the existing majority to issue the shares in dispute.

In those circumstances where the directors have breached their duty to exercise
their powers for the proper purpose, the shareholders may forgive them by ratifying
their action

Hogg v. Cramphorn Ltd. (1967) Ch. 254

In this case the company had two classes of shares, ordinary and preference shares.
Each share carried 1 vote. The power to issue the company shares was vested in
the Directors. They learnt that a takeover bid was to be made to the Shareholders.
In the Bona fide belief that the acquisition of control by the prospective take over
bidder will not be the interest of the company or its staff. The Directors decided to
forestall this move. They therefore attached 10 votes to each of the unissued
preference shares and allotted to a trust which was controlled by the Chairman of

66
 the Board of Directors and one of his partners in the company‟s audit department
and an employee of the company. To enable the trustees to pay for the shares, the
directors provided them with an interest free loan out of the company‟s reserve
fund.

An action challenged by the Plaintiff who was an associate of the prospective 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 Court stood over the action in order to enable a general meeting to be
held and to debate whether or not to ratify the Director‟s actions. The general
meeting ratified the action.

Bamford v. Bamford (1969) 1 All ER. 969

There were similar facts as in the former case but a meeting was held before
proceeding to court and that general meeting ratified the Director‟s action. The
question also arose in this case, could a decision of the general meeting cure the
irregularity?

The court held if the allotment was made in bad faith, it was voidable at the instance
of the company because it was a wrong done to the company and that being so, the
company which has the rights to recall the allotment has also the right to approve it
and forgive the breach of duty.

3. They must not fetter their displeasure to act for the company for
example, the directors cannot contract either among themselves or with third
parties as to how they will vote at future Board meetings. However, where they
have entered into a contract on behalf of the company they may validly agree to
take such further action at Board meetings as maybe necessary to carry out such a
contract.

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

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

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

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

68
 Directors when the contract comes up for discussion. Failure to do so renders the
defaulting director liable to a fine not exceeding 2000 shillings. In addition the
failure also brings in the equitable doctrine whereby the contract becomes voidable
at the option of the company and any profit made by the director is recoverable by
the company.

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

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

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

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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 company‟s undertakings
were sold by selling all the shares in the company and subsidiary and on each share
the Directors made a profit of slightly more than two pounds. After ownership had
changed the new shareholders brought an action against the directors for the
recovery of profits made by them during the sale.

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

“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 company‟s accounts and therefore decided to attend the company‟s general
meeting as representatives of the Trust. At the meeting they received information
pertaining to the company‟s assets and their value. Upon receipt of the
information, they decided to buy shares in the company with a view to acquiring the
controlling interest. Their takeover bid was successful and they acquired control.

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 Owing to the fact that Boardman was a man of extraordinary ability, the company
made progress and the profits realised by Boardman and his friends on the one
hand and the trusts on the other were quite extensive. One of the beneficiaries of
the Trust brought an action to recover the profits which were realised by Boardman
and his friends.

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

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

The Defendant was the company‟s Managing Director. The Board of Directors was
approached by a prospector who offered to sell his claims to the company. The
company‟s 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 control 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.

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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 company‟s Managing
Director. The company‟s business was to offer design and construction services to
industrial enterprises. One of the defendant‟s 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
Plaintiff had unsuccessfully tried to obtain that work. After the Defendant
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 Plaintiff‟s
Managing Director.

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

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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
company‟s business by virtue of their voting power to ensure that the controlling
shareholders do not use their voting power for exclusively selfish ends, the Law
requires that in exercise of their voting power, these shareholders must not defraud
a minority. For example by endeavouring directly or indirectly to appropriate to
themselves any money property or advantage which either belong to the company
or in which the minority shareholders are entitled to participate.

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 defendant‟s voting power, a
resolution was passed that the company should be wound up.

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

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 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 company‟s promoters sold the
company‟s property at an undisclosed profit. Two shareholders brought action
against them alleging that in so doing, that the directors had breached their duties to
the company. It was held that if there was any breach of duty, it was a breach of
duty owed to the company and therefore the Plaintiffs had no locus standi for the
company was the proper plaintiff. This rule has two practical advantages namely:
1. Insistence on an action by the company avoids multiplicity of actions;
2. If the irregularity complained of is one which could have been
effectively ratified by the company in general meeting, then it is pointless to
commence any litigation except with the consent of the general meeting.

However there are four exceptions to this rule in which an individual member may
bring action against the directors namely:

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

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

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

minority which is not ratifiable by the company in general meeting;
2. It must be shown that the wrong doers hold the controlling interests
3. The company must be joined as a nominal defendant;
4. The action must be brought in a representative capacity on behalf of
the plaintiff and all other shareholders except the Defendant.

The question is are these exceptions effective?

There are situations where the rule does not apply.

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

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

Under Section 219 (f) of the Companies Act the court may order a company to be
wound up if it is of the opinion that it is “just unequitable” the courts have so
ordered when satisfied that it is essential to protect the members or any of them
from oppression in particular they have done so when the conduct of those in
control suggests that they are trying to make intolerable the position of the minority
so as to be able to acquire the shares held by the minority on terms favourable only
to the majority. But a member cannot petition under this section if the company is
insolvent. If the company is solvent to wind it up, contrary to the majority wishes
will only be granted where a very strong case against the majority is established.

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 a winding up order but that this will unduly
prejudice that part of the members, may make such order as it thinks fit. Such an
order may regulate the conduct of the company‟s affairs in the future or may order
the purchase of member shares by others or by the Company itself. This remedy is
available only to the members. An oppressed director or creditor cannot obtain any
remedy under Section 211 of the Companies Act for this is expressly restricted to
oppression of the members even if a director or creditor also happens to be a
member.

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

76
 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 knowhow provided
by the Respondent. The company paid large dividends and accumulated substantial
results. Due to the prosperity, the society decided to acquire more shares and
through its nominee directors offered to buy some of the shares of the Respondent
at their nominal value which was one pound per share but their worth was actually 6
pounds per share. When the Respondents declined to sell their shares to the
society, the society threatened to cause the liquidation of the company. About 5
years later, Cotton control was abolished which meant that the society would obtain
the raw materials and weave cloth without a licence. It accordingly started to do the
same and also started starving the subsidiary by refusing to manufacture for it
except for an economic crisis. As all the other Mills were fully occupied, the
subsidiary company was being starved to death and when it was nearly dead the
Respondent brought the petition claiming that the affairs of the company were
being conducted in an oppressive manner.

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

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

Re Hammer(1959) 1 WL.R. 6
In this case Mr. Hammer senior was a Philatelist (stamp collector) dealer and
incorporated business in 1947 forming a company with two types of ordinary shares
class A shares which were entitled to a residue of profit and Class B Shares carrying
all the votes. He gave out the shares to his two sons and at the time of the petition
each son held 4000 Class A shares and the father owned 1000 shares. Of the Class
B Shares, the father and his wife held nearly 800 to the 100 held by each son.
Under the Company‟s articles of association, the father and two sons were
appointed directors for life and the father was further appointed chairman of the
Board with a casting vote. The father assumed powers he did not possess ignored
decisions of the Board and even in court, during the hearing asserted that he had
full power to do as he pleased while he had voting control. He dismissed
employees using his casting vote to co-opt self directors, he prohibited board
meetings, engaged detectives to watch the staff and secured payment of his wife‟s
expenses out of the company‟s funds. He negotiated sales and vetoed leases all
contrary to the decisions and wishes of the other directors.

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

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

These two cases are among the few where an application under Section 211 has
succeeded. This is because section 211 has been subjected to a very restrictive
meaning. To succeed under Section 211, one must establish a case of oppression.

There is no clear definition of the term and therefore it is not easy to tell when a
company‟s affairs are being conducted oppressively. For example in the case of Re
Five Minute Car Wash Ltd (1966) 1 W.L.R. 745
The petitioner alleged oppression on grounds that the company‟s Managing
Director was extremely incompetent. The court ruled that even though the

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 allegation suggested that the Managing Director was unwise inefficient 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.
1. 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.

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

cause of conduct and not merely isolated acts of impropriety.

3. 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.

RAISING AND MAINTENANCE OF CAPITAL

The basis of the whole concept or a company‟s 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
company‟s represented capital is actually what it is and for the distribution of that
capital.
1. Once the value of the company‟s shares has been stated it cannot
subsequently be changed the problem which arises in this respect is that shares may
be issued for non-monetary consideration. For instance for services or property in
such cases the company‟s valuation of the consideration is generally accepted as
conclusive. If the property has been over valued, provided the valuation has been
arrived at bona fide, the courts will not question the adequacy of the consideration
but if it appears on the face of the transaction that the value of the property is less
than that of the shares, then the court will set aside that transaction. For this reason

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 the shares in a company must be given a definite value. The law tries to ensure that
the company initially receives assets at least equivalent to the nominal value of the
paper capital. Refer to Section 5 of the Companies Act. Unfortunately if in the
insistence that shares do have a definite fixed value is not an adequate safeguard
because there is no legal minimum as to what the nominal value of the shares
should be.

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

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

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

3. Payment of Dividends: In order to ensure that the company‟s 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 company‟s inability to pay its debts as and when they
fall due;

(ii) If the value of the company‟s fixed assets has fallen thereby causing
a loss in the value of those assets, the company does not need to make good that
loss before treating revenue profits as available for dividends. It is not legally

81
essential to make provision for depreciation in the fixed assets. However Losses of
circulating assets in the current accounting period must be made good before a
dividend can be declared. The realised profits on the sale of fixed assets may be
treated as profit available for distribution as a dividend. Unrealised profits on
evaluation of the company‟s assets may also be distributed by way of dividends.
Refer to Dimbula Valley (Ceylon) Tea Co. V. Laurie [1961] Ch. D 353 Losses on
circulating assets made in previous accounting periods need not be made good. The
dividend can be declared provided that there is a profit on the current year‟s trading.
Each accounting period is treated in isolation and once a loss has been sustained in
one trading year, then it need not be made good from the profits over subsequent
trading periods. Undistributed profits of past years still remain profit which can be
distributed in future years until they are capitalised by using them to pay a bonus
issue.

CORPORATE SECURITIES

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

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

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

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

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

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

debts;
2. It may take the form of an instrument acknowledging the debt and
charging the company‟s property with repayment; or
3. It may take the form of an instrument acknowledging the debt
charging the company‟s 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 company‟s property. Such charge could either be a
specific charge or a floating charge. Both were defined by Lord Mcnaghten in the
case of Illingsworth v. Houlsworth [1904] A.C. 355 AT 358 He stated
“ a specific charge is one that without more fastens on ascertained and
definite property or property capable of being ascertained and defined. A floating
charge on the other hand is ambulatory and shifting in its nature, hovering over and
so to speak floating with the property which it is intended to affect until some event
occurs or some act is done which causes it to settle and fasten on the subject of the
charge within its reach or grasp.”

A floating charge has 3 basic characteristics.

1. It must be a charge on a class of a company‟s assets both present and

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

CRYSTALISATION

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 A floating charge will crystallise under the following

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

Section 96 of the Companies Act requires every Charge created by a company and
conferring security on the company‟s 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 shareholder‟s right in a
company will fall under 3 heads.
1. Payment of dividends;

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2. Refund of Capital on winding up;
3. Attendance and voting at company‟s general meetings.

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

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

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 does not imply that any right to preference in some other respect is given e.g. a
preference as to dividends will not apply a preference as to capital i.e. the shares
enjoy only such preference as may be expressly conferred upon them.

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

expressly stated, the statement is presumed to be exhaustive so far as that matter is
concerned. For instance the preference dividend is presumed to be non-
participating in regard to other dividends. Refer to Re Isle of Thanet Electricity
Supply Co. (1950) Ch. 1951 where Justice Wynn Parry stated “the effect of the
authorities as now in force is to establish two principles. First that in construing an
article which deals with the rights to share all profits, that is dividend rights and
rights to shares in the company‟s property in liquidation, the same principle is
applicable and secondly that principle is that where the articles sets out the rights
attached to a class of shares to participate in profits while the company is a going
concern or to share in the property of a company in liquidation, prima facie the
rights so set out are in each case exhaustive.”

(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;

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3. By supervision of the Court.

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

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

Basically the second circumstance is the most important because in practice at least
the first circumstance does not arise and in the 3rd circumstance the creditors
themselves will resolve that the company be wound up.

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

WINDING UP BY THE COURT

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

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 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 company‟s 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 company‟s 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

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 that an alternative remedy is available to the petitioners and that they are acting
unreasonably in seeking to have the company wound up instead of pursuing that
other remedy.

WINDING UP ON JUST AND EQUITABLE GROUNDS

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

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

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

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

the members that if not all of them, then the majority of them will participate in the
management of the company‟s 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 member‟s 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

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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 company‟s 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
company‟s affairs.

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

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 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 company‟s 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
company‟s assets, pay its debts and distribute the balance to the members.

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

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

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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