#16733 - Transactions With Outsiders

How do we know when a company has ‘done’ something? Where its primary decision-making bodies, ie the board and / or members when so authorised act, it makes sense to attribute their acts to the company. However, for the sake of commercial expediency, individual directors or employees may act on behalf of the company. In such situations, their acts should at least sometimes be attributable to the company. Aside from ethical arguments, one key policy argument is that companies are major economic actors and hence attributing criminal or tortious liability to companies in certain situations will spur the management of these companies on to control the behaviour of the company more closely, preventing such harm from occurring in future.

Lord Hoffmann per Meridian Global Funds Management Asia Ltd v Securities Commission [1994]: there are three layers of law applying to attribution in the context of companies:

Primary rules of attribution – where liability flows from the position of a body in the corporate constitution
General rules of attribution – based on the law of agency (not company-specific); the common law has come up with some company-specific rules such as vicarious liability although its use can be controversial – to what extent can a company be said to have authorised / been aware of or said to be responsible for an act of one of its agents?
Special rules of attribution – where company law and the common law appear to be inadequate so special rules such as legislation on corporate manslaughter is needed to fill a lacuna in the law

Two methods for a company to enter into a contract: first is when the board or members as a whole enter into the contract as the company; second is when an agent acts on behalf of the company. Usually, the result is the contract between the company and the third party; the individuals representing the company will not be personally liable under that contract. However, there are differences between the two methods in terms of legal implications.

Straightforwardly, where directors act as a board or where shareholders act collectively to enter into a contract which they are empowered to enter into by the constitution, this contract will bind the company. An issue arises where the board or shareholders purport to enter into a contract which is beyond their powers. Where the board has entered into a contract on a matter involving shareholders, or where a majority of shareholders have entered into a contract, the members or dissenting members may argue that the constitution of the company and its particular allocation of powers should be paramount, meaning those contracts should be void or voidable. However, while third parties would not expect the members to have general contracting powers, third parties would expect the board to have wide discretionary powers to enter into contracts as most AoAs, particularly the Model AoAs, are so structured. Thus, in recent years, company law now aims to give effect to the reasonable expectations of third parties although historically this was not the case.

In the 19^th century, the general norm was that the members had general powers to contract but the powers of the board were limited. As a result, if the board entered into a contract outside of its constitutional powers, the contract would be voidable in the sense that it would only bind the company if the members later decided to ratify the contract. The doctrine of constructive notice developed so a party which entered into a contract would be taken to have read and correctly understood the contracting powers of the board as reflected in the company constitution: Ernest v Nicholls (1857).

However, this position was tempered by Royal British Bank v Turquand (1856) through the inside management rule of benevolent interpretation. In that case, the board had the power to enter into loan agreements under certain conditions. In this case, the relevant resolution from the members had not been obtained. However, the lender was entitled to infer that, where the company was doing something that it could possibly do constitutionally (ie which was not clearly forbidden by the constitution), the relevant internal authorisations had been obtained.

This was applied in Mohoney v East Holyford Mining Co (1875) by HL: a bank honoured cheques of a company where those cheques had been signed by individuals who claimed to be directors and the secretary but had never actually been so appointed. The bank was entitled to assume that one who purported to be an officer of the company (and where such an officer would have been entitled to enter into such a transaction) could validly act on behalf of the company. In addition, S161 CA makes similar provision for officers of the company who had been invalidly appointed [Mohoney is about cases of no appointment], where the director in question was not entitled to vote on that particular matter, and where that director had been appointed in breach of the individual appointment rule.

The indoor management was helpful but inadequate: if the AoA limits the powers of the board in a certain way expressly, there will not be a way to get around it. Further, the Turquand rule will not apply where the contracting party has been put on notice or enquiry. This will be the case when some specific words or actions have occurred – B Liggett (Liverpool) Ltd v Barclays Bank [1928]: Director 1 told bank that cheques could only be cashed if signed by D1 and D2 as D2 was suspected of making improper withdrawals from company funds. However, D2 added new director D3 as a signatory using a form with only his signatory. The bank was held to have been put on notice and therefore liable to pay back the sums paid out on cheques which had only been signed by D2 and D3 but not D1.

The constructive notice rule, even tempered by the indoor management rule, is unattractive to third parties. Hence, to promote commercial certainty and to avoid due diligence transaction costs, statute has intervened to make certain transactions automatically binding on the company even where it is outside of the board’s AoA powers.

The company may still limit the powers of the board but a more obvious mechanism than the constitution must be used. S40 CA:

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, shall be deemed to be free of any limitations under the company’s constitution

This effectively repeals the constructive notice rule but is subject to certain limitations:

‘in favour of a person dealing with a company in good faith’: this provision is for the benefit of third parties – the company cannot use this to enforce a contract as against a third party where the agent of the third party was...

#16733 - Transactions With Outsiders - Company Law

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