As the late Lady Oliver put it:
'The objects clause ... is not a 'capacity' clause ... It is a clause which, taken with any other relevant provisions in the articles, specifies the scope of the directors' authority ... Restrictions on this authority have no effect on third parties in the absence of fraud, although directors who disregard them commit a breach of duty towards ... the company.' The Private Company in Germany (London : Macdonald and Evans, 1976), p12.
The first EEC directive: Not yet fully implemented
In my view, instead of taking a fleeting glance at the US Model Business Corporations Act, the laws of Canada and New Zealand and decisions of the Courts of Appeal of British Columbia and New Zealand, the report should have examined in depth the first EEC directive, and looked at the laws of France, Germany and Italy and the decision of the European Court of Justice in Haaga.
In Haaga or, to give it its full name, Firma Friedrich Haaga GmbH v Rechtspfleger, case 32/74 [1974] ECR 1201, [1975] 1 CMLR 32, Friedrich Haaga GmbH, a German limited liability company (Gesellschaft mit beschränkter Haftung -- GmbH) had at the time only one director who, under German law, had authority to represent his company alone. Nevertheless, the Amtsgericht, which maintains the local company register, requested the company specifically to register the sole director's sole power to represent the company, which the company refused to do alleging 'bureaucratic red tape' on the part of the Amtsgericht. In a reference from the German Federal Supreme Court (Bundesgerichtshof) requesting the interpretation of Art 2(1)(d) of the first EEC directive on company law, the European Court upheld the decision of the Amtsgericht ruling that, where only a single person authorised to represent the company is appointed, it is to be stated that the latter represents the company alone even if such authority results automatically from national law. The subsequent decision of the German Federal Supreme Court is also of interest and has been translated: [1975] 1 CMLR 124.
Citing Haaga, the Commission of the European Communities has said (OJ 1977, C 289/1) that the British government had failed to implement the first directive and Professor Lasok noted: 'A failure to implement correctly a binding directive will constitute a breach of the Treaty [of Rome].' The Law of the Economy in the European Communities (London:Butterworths, 1980), p148 at note 10.
Reluctance to implement the first directive
I have no evidence to show that Dr Prentice knows about the decision in Haaga, but he has certainly known since 1973 that the first directive has not been implemented. In an article published in (1973) 89 LQR 518, he wrote:
'It is arguable that subsection 9(1) [of the European Communities Act 1972, now Section 35 of the Companies Act 1985] is also defective in not implementing fully the provisions of the first directive' (at p528).
After citing Art 9(2) of the first directive which provides that limitations on the powers of company organs imposed by the articles or other company organs 'can never be invoked against third parties', Dr Prentice said:
'This provision was inserted to reflect the theory of German company law that a company is deemed to act through its various organs, which are not treated as corporate agents but as the company itself, and which are precluded from imposing restrictions on each other, their power being defined by law. This, of course, is not the position in England where ... it is permissible for the shareholders to alter the corporate constitution so as to curb, in whatever way they see fit, the powers of the directors. The directors of an English company derive their authority to manage from the constitution and not from any rule of law. To have introduced Article 9(2) of the first directive into English company law would have constituted a considerable doctrinal shift' (at p529).
*13 After examining the doctrine of apparent authority, Dr Prentice said: 'Presumably, it was because of this doctrine that it was not considered necessary to implement Article 9(2) of the first directive' (at p529), adding: 'There is, however, a critical difference between Article 9(2) and the doctrine of apparent authority.' (Ibid).
Dr Prentice concluded as follows:
'Some limitation, however, has to be placed on the scope of this provision. When the issue was being debated during the drafting of the first directive the Council of Ministers made it clear that the Article was not intended to bind a company in cases of fraudulent collusion between a company's representative and a third party. However, it would appear that fraudulent collusion is narrower than good faith as the Commission refused to accept an amendment to Article 9(2) which would have provided that third parties would only be protected if they had been acting in good faith' (at p530).
In other words, according to Art 9(2) of the first directive, in the absence of fraud, 'actual knowledge' of the limitations on the powers of directors can never be invoked against a third party.
Section 35(1) of the Companies Act 1985 provides that 'the power of the directors to bind the company is deemed to be free of any limitation under the memorandum or articles' and by s35(2), a third party 'is not bound to inquire as to ... any ... limitation on the powers of the directors.
Section 35 (as its predecessor, s9(1) of the European Communities Act 1972) repeals the doctrine of constructive notice but leaves wide open the defence of 'actual knowledge'.
This defence, though banned by the directive, is authorised by the report, at p32:
'There may be circumstances where a third party has acquired actual knowledge that a transaction is outside the authority of the board or of an individual director. Where this is in fact the case, it is proposed that the transaction should only be binding on the company where it expressly ratifies it. There is no justification for permitting a person to escape the consequences of known facts. Actual knowledge in this context should extend to a situation where a person 'wilfully shuts his eyes' or 'wilfully and recklessly fails to make such inquiries as an honest and reasonable man would make' (at p32).
The proposal at p32 of the report is rather surprising in view of the earlier criticism (at p11) of the requirement of good faith in s35 of the Companies Act 1985:
'Many third parties ... will have acquired knowledge of the company's objects, some such as banks will have actually obtained copies of memorandum and articles, and although knowledge and good faith are not synonymous, the threat that they will be adjudged not to have acted in good faith is very real' (at p11).
Later, however, the report says:
'The case where a third party knew that the transaction was not authorised by a company's objects ... will rarely occur' (at p32).
Will there be many cases or only a few? Whatever the answer, the argument concerning knowledge of limitations imposed by the objects also applies to knowledge of limitations on the powers of the board arising from the articles.
The proposal (at p32 of the report) is also surprising in view of the criticism expressed by Dr Prentice in the LQR in 1973 which shows that he actually knows (no pun intended) that the defence of actual knowledge of limitations on powers of directors is not allowed by the first directive.
On this point, the directive follows German law. In Germany, the third party's mere knowledge of the limitations on the authority of the directors is not sufficient to prevent him from enforcing the transaction against the company. But the third party is not protected if there has been collusion, ie if he has acted, together with the company's representative, deliberately to the company's detriment. On collusion and abuse of corporate powers, see Wiedemann, Gesellschaftsrecht (Munich:Beck, 1980), Vol I, p525, with further references.
In France as in Germany, it was not thought necessary to mention expressly the availability of an exceptio doli. It is otherwise in Italy where Article 2384(2) of the Civil Code provides:
'Restrictions on the power to represent the company derived from the memorandum or articles, even if published, may not be invoked against third parties unless it is proved that the latter acted intentionally to the prejudice of the company (salvo che si provi che questi abbiano intenzionalmente agito a danno della società).
For the background, see La Villa, L'oggetto sociale (Milan:Giuffrè, 1974), p255.
The Alternative Models
The first directive
The issue is not whether the first directive has or has not been fully implemented. In my view, the real issue is whether the model proposed by the consultative document is better than the one proposed (or should I say imposed) by the directive. I believe the system adopted by the directive is far better. After it has been properly implemented, a third party dealing with a company will only have to look (i) at the Companies Act to check on the powers of the directors to represent the company (ii) at the public register kept by the Registrar of companies to ascertain the person or persons who can represent the company, either alone or jointly.
The consultative document
The consultative document seems to prefer a system which has been described by Lattin:
'Several recent statutes give the corporation the 'power and capacity' of a natural person or the 'capacity' of a *14 natural person but 'authority' only to do such acts as are necessary or proper to accomplish the corporate purposes, this latter type originating in the Model Business Corporation Act of 1928. In either type it would seem that the only defense open would be the lack of authority of the corporate agent to bind the corporation, a pure agency problem.... Some statutes ... make an exception [to the rule that the plea of ultra vires shall not be made by anyone] where the third party has actual notice.' Lattin on Corporations (Mineola, New York:Foundation Press, 1971), pp236-237.
This is precisely what the Report has done:
'The approach involving the conferral on a company of the full capacity of a natural person is to be preferred as it makes it more emphatically clear that the issue of a company's lack of capacity is one which cannot be raised' (at p20).
'A third party may on occasions possess actual knowledge that the board or an individual director does not possess the necessary authority to enter into a transaction. This would be the case where a third party knew that the transaction was not authorised by a company's objects' (at p32).
'A third party who has actual knowledge that a board or an individual director do not possess authority to enter into a transaction on behalf of the company should not be allowed to enforce it against the company ... The same result should obtain where a third party has actual knowledge that the transaction falls outside the company's objects ...' (at p36).
Lattin, Jennings and Buxbaum give the following recommendations to third parties dealing with corporation in the United States:
'In important matters, one dealing with a corporation through its officers should insist upon evidence of their authority in the form of a certified copy under the corporate seal of a resolution of the board of directors. This should state that the meeting was duly called and noticed, that there was a quorum present and that the following resolution (stating it verbatim) was adopted authorizing the loan, conveyance or other transaction and specifying the officer or officers who should do the act. A certified copy of a bylaw [internal regulations] duly adopted would likewise be satisfactory evidence of authority. The certificate should be signed by the secretary ...': cited by Grossfeld, 'Management and Control of Marketable Share Companies', in International Encyclopaedia of Comparative Law, Vol XIII, Chapter 4 (Tübingen:Mohr, ao, 1973), p45.
Is this a better system than the one described above?
Excursus : Agency, Mandate and Representation
What follows has been taken from the Introduction to Frommel and Thompson, Company Law in Europe (London:Kluwer, 1975), pp42-45, paras 210-220).
'210. The English company grew out of the partnership, where the partners are in a contractual relationship and each is an agent of the others. According to a contractual concept of the company, the memorandum and articles of association are a contract and the directors are agents of the company. However, the analogy is not exact, as the contract created by the memorandum and articles is between the company and its members -- not its directors.
(2) The Continental approach
'211. As in the United Kingdom, on the Continent both the contractual nature of the company and the view that the directors are agents of the company have been or are still popular in some countries.
'212. At the time the first EEC directive on company law was still under discussion, the idea that the company is a contract had been abandoned in Germany but was still firmly rooted in other Continental systems which had followed the French definition of société. In France itself, article 18 of the French Commercial Code of 1807, which stated that the société was a contract, was repealed in 1966, but even then a provision was introduced which allowed the company to be declared a nullity on any of the grounds on which a contract may be annulled. Only as a result of the first EEC directive on company law was this provision modified in 1969.
'213. Many European countries have also followed the earlier French model (in this case the French Companies Act of 1867, which was repealed and replaced in France in 1966) and consider the directors to be mere agents (mandataires) of the company whose powers are governed by the rules of 'mandate' (mandat) -- a concept somewhat resembling, but not, strictly speaking, the exact equivalent of, the English concept of agency.
'214. On the Continent, however, there are two different concepts of mandate. One is that of the French Civil Code and of the legislations that have followed it, which conceive mandate (mandat) as a contract between the principal (mandant) and the agent (mandataire) which includes the granting of powers to the agent to represent the principal. Thus, basically, the authority of the agent to bind his principal in dealings with third parties depends on the mandate he has received.
(3) Germany
'215. The other approach is typified by the German Civil Code -- followed with some modifications by the Swiss and Italian Codes -- which distinguishes mandate (Auftrag; mandat; mandato) and representation (Vertretung; représentation; rappresentanza).
'216. Here, a further distinction is made between the power to represent the principal vis-à-vis third parties (German Vertretungsmacht) and the authority to represent that has actually been granted to the agent by the principal (Geschäftsführungsbefugnis) under a contract *15 of mandate or employment or under a partnership agreement between the principal and the agent.
'217. The power to represent (Vertretungsmacht) has two main sources. First, it may derive from an authority granted by the principal (Vollmacht) of which two varieties, as defined in the German Commercial Code, are relevant in the present context. One is the Prokura, which is the commercial authority, very broad in scope, which must be entered in the Commercial Register, and the other is the Handlungsvollmacht, narrower than the Prokura, which need not be registered. Secondly, in the case of the organs of a company, since their powers are defined by law and the company is considered to act through its organs, any limitation of these powers inserted in the articles would not be able to restrict them vis-à-vis third parties. Neither can the scope of the power of representation of the holder of a Prokura, the Prokurist, be limited vis-à-vis third parties and, if the authority actually granted (Geschäftsführungsbefugnis) is exceeded, this will only affect the internal relationship between principal and agent. The Prokura is also known in the Scandinavian countries.
'218. In Germany there is a clear distinction between the board of management's authority to manage the company (Geschäftsführungsbefugnis) and its power to represent the company vis-à-vis third parties (Vertretungsmacht). This power is given jointly to all the directors, but either the articles themselves or the supervisory board, if authorized by the articles, may, and usually do, provide that the power to represent the company will be exercised by two directors jointly or one jointly with a Prokurist. The appropriate entry in the Commercial Register is then required.
'219. The articles of association may impose restrictions only on the authority to manage, not on the power of representation. If the board exceeds its authority, the company will be bound but the board may be liable in damages to the company.
'220. This does not mean, however, that the board of management can exercise the powers expressly reserved by law to the general meeting of shareholders. In Germany, for instance, company mergers must be approved by the shareholders' meeting. This type of limitation is expressly recognized by the first EEC directive which provides that the company shall not be bound by acts of its organs which exceed the powers granted to them by law.'
Two Provisions Needed to Implement the Directive
Only two provisions have to be enacted and inserted into the Companies Act to implement the directive.
Powers to derive from the Companies Act
At present, the directors derive their powers from the articles of association. (Article 70 of Table A is usually adopted.) Instead, their powers should derive from the Companies Act. Art 9(1) of the first directive provides:
'Acts done by the organs of the company shall be binding upon it even if those acts are not within the objects of the company, unless such acts exceed the powers that the law confers or allows to be conferred on those organs.' (Emphasis added: here law means the Companies Act).
This requirement was clearly seen, back in 1973, not only by Dr Prentice (in his article in the LQR), but also by Professor André Tunc: Le Droit Anglais des Sociétés Anonymes (Paris:Dalloz, 1971), mise à jour au ler septembre 1973, p 6.
Persons authorised to represent the company: publicity
At present, a company must publicise the names of its directors with the Registrar of Companies (Companies Act 1985, ss288-289). To comply with Art 2(1)(d) of the directive, the company should also publicise the directors who 'are authorised to represent the company in dealings with third parties and in legal proceedings' and 'whether ... [they] may do so alone or must act jointly'. The need for this provision is shown by Haaga. See also the provision proposed below under the heading 'board with more than one member'.
Four Provisions Needed to Replace Section 35
Another four provisions are needed to replace s9(1) of the European Communities Act 1972, now s35 of the Companies Act 1985, but beware of the parliamentary draftsman: he tends to be verbose. His brief should be not to exceed the length of the corresponding provisions of the Italian Codice Civile, the French Loi Sur Les Sociétés Commerciales, or the German Aktiengesetz or GmbH-Gesetz.
Transactions outside objects
Ultra vires, in my view, should be entirely abolished in relation to third parties. The Act should provide:
'In dealing with third parties, the company is bound by transactions entered into by its board of directors, even if they fall outside the scope of the company's objects.'
Restrictions on powers of board
As the powers of the directors will now derive from a provision of the Act (see above); the Act should state:
'Any restriction placed on the powers of the board by the company's memorandum or articles or by a resolution of the board or of the shareholders may not be invoked against third parties.'
If it is felt that an exceptio doli is needed, the proviso found in Art 2384 in fine of the Italian Civil Code could be adopted.
Powers reserved to shareholders
Obviously, 'the powers reserved to the meeting of shareholders cannot be excercised by the board.' Also, *16 the Companies Act, not the articles, will have to enumerate the powers reserved to the shareholders.
Board with more than one member
Finally, the Act should provide:
'If the board of directors consists of more than one member, all members can only represent the company jointly, unless the articles decide otherwise.'
Conclusions
In my view, the main concern of the consultative document should have been 'the powers of directors to bind a company in transactions with third parties'. Also, ultra vires should have been abolished entirely and not reintroduced in the shape of 'the third party's actual knowledge that the transaction falls outside the company's objects'.
I believe that in transactions between the company and third parties, the concept of 'directors as agents' and 'powers delegated to the directors in the articles' should be replaced by 'directors as organs' and 'powers of the directors derived from the Companies Act'.
Finally, I submit the text of the six provisions that in my view ought to be enacted: two of them to implement the first EEC directive on company law; the other four to replace s35 of the Companies Act 1985.
FNa1. Reader in European Business Law, City of London Polytechnic.
COMPLAW 1987, 8(1), 11-16
