Management and control of companies 297The validity of an act done by a company shall not be called into question on the ground of lack of
capacity by reason of anything in the company’s constitution.
Section 39(1) therefore means that when the act done on the company’s behalf is done by
a person who had authority to do it then the ultra viresrule cannot be used by anyone to
argue that the contract is invalid, even if the act was outside the objects clause.
A contract will not be binding upon the company if the person making the contract on
the company’s behalf had no actual or apparent authority to do so. This is the case whether
or not the contract was within the company’s objects clause. Even if the person making the
contract has been given authority to do so, it is possible that the contract might contravene
the company’s constitution. Section 40(1) of the 2006 Act, which replaced s. 35A of the 1985
Act, protects third parties by providing that:
In favour of a person dealing with a company in good faith, the power of the directors to bind the
company, or authorise others to do so, is deemed to be free of any limitation under the company’s
constitution.
We have seen that s. 39(1) provides protection where the contract made was a type of
contract which the company had no capacity to make, because the contract was outside the
company’s objects clause. Section 40(1) provides protection where the person who bound
the company otherwise contravened the company’s constitution by making the contract.
Section 40 does not prevent the company members from getting an injunction to prevent
the directors from doing an ultra viresact but if the directors have made a binding contract
the members cannot undo it. Nor does s. 40 prevent the directors from being liable to the
company for having exceeded their powers.
Different rules apply when an ultra virescontract is made between the company and a
director. Section 41 provides that an ultra virestransaction entered into by the company with
the directors of the company is voidable by the company despite s. 40. (For the meaning
of voidable see p. 127.) Whether the contract is avoided or not, the directors who made
the contract would then have to account to the company for any gain they have made and
compensate the company for any loss it has suffered. The contract ceases to be voidable if
the company affirms the transaction.
Holding out as a director
If a company represents that a person has the authority to make a transaction on the
company’s behalf then the company will be bound by such a transaction, whether or not
the person who made it really did have such authority. This is known as holding out. The
company is said to have held out that the person had authority, and will not be allowed
later to deny this.
Freeman & Lockyer vBuckhurst Park Properties Ltd (1964)
(Court of Appeal)A company was formed to buy and resell an estate. The directors had the power to appoint
a managing director but they never did so. One of the directors, Mr Kapoor, acted as if he
had been appointed managing director. The other directors knew this but did nothing about
it. Kapoor asked architects to do work on behalf of the company. When the architects sued
the company for their fees the company argued that Kapoor had no authority to employ
architects and therefore the contract was not binding on the company.