A. Lakshmana Swami Mudaliar and Ors. Vs.

Life Insurance Corporation of India and

Ors.

AIR 1963 SC 1185

Statement of Facts

The United India Life Assurance Company Ltd was a company incorporated under the Indian
Companies Act, 1882. Its principal object is carrying on life insurance business. The
Company was also a registered insurer under the Life Insurance Act,1938 for carrying on life
insurance business in India.

July 15, 1955: During an extraordinary General Meeting of the company shareholders a
resolution was passed that a donation of Rs. 2 lakhs were sanctioned from out of the
Shareholders' Dividend.

Account to a Trust proposed to be formed with the object, among other things, of promoting
knowledge in insurance and the Directors are authorised to pay the sum above to the Trustees
on its formation. On the date of resolution, appellants 2 & 4 were Directors of the Company,
appellant 4 being the Chairman of the Board of Directors.

December 6, 1955: Five settlers executed a deed stating that the settlers desired to establish a
charitable trust. Appellants 2, & 4 were the trustees nominated under the deed of Trust.

December 15, 1955: In pursuance of the resolution, the Directors paid Rs. 2 lakhs to the
Trust.

July 1, 1956: The Life Insurance Corporation (LIC) Act was brought into force. By section 7
of that Act on September 1, all assets and liabilities of controlled business of insurers were to
be transferred to and vested in Life Insurance Corporation of India.

Later the LIC asked the trustees to refund the Rs. 2 lakhs received from the Company. The
appellants denied liability to refund the amount. The Corporation applied to the Life
Insurance Tribunal for an order to the trustees to pay Rs. 2 lakhs with interest. The Tribunal
ordered in favour of LIC, and an appeal was filed in the Supreme Court. The Court agreed
with the order of the Tribunal and dismissed the petition.

Legal Issues

1. If the resolution and the payment made were ultra vires of the Company and void and had
no effect in law, in that the Memorandum of the Company did not authorise such payment?

2. What is the nature of Shareholders' Dividend Account? Can the shareholders utilise the
fund in the account in any way they want?

3. Does the resolution of the Company and the acceptance of appellants as trustees of the
Trust constitute a contract?

4. Whether the appellants are personally liable to refund the amount paid to them?
Arguments and Ratio

The appellants submitted that Directors of the Company were authorised by the Articles of
Association of the Company to donate for any charitable object or any public, or worthwhile
cause.

The Court made the following observations:

By Article 93(t) the Directors have the authority to "make payments towards any charitable
object, or for any general public, or useful object". However, this can be done if the
Memorandum of Association (MoA) allows achieving the object specified or for doing
anything incidental to or facilitative to objects specified. If the object is not within the
capacity of the Company, the Directors cannot rely on Art. 93(t) to spend the fund. MoA has
to be read together with the Articles of Association when the terms are vague or silent.

A Company is only competent to carry out its objects specified in the Memorandum of
Association. The objects of the Company are in Clause III. Sub- Clause (ii) allows the
Company to invest and trade with funds and assets of the Company on securities or
investments and in such manner fixed by the Articles of Association. Clause (ii) does not give
the Directors with power to deal with the funds in any manner. By sub-clause (v) the
Company can do "all such things as are incidental or conducive to the attainment of the above
objects." The Articles may explain the Memorandum, but they do not expand its scope. Acts
incidental to or conducive to the main object are those who have a reasonably close
connection with the object, an indirect or distant benefit which the Company may or may not
receive by doing an act is not authorised by this
extension.
The Trust has many objects, one of which is to promote knowledge in banking and insurance.
There is no commitment upon the trustees to utilise the fund for promoting education in
insurance, and even if the trustees utilised the fund for that purpose, it was not very likely
whether such trainees of insurance business were likely to take up employment with the
Company. Thus, the ultimate benefit which may result is too remote to be incidental or
conducive to the object of the Company.
Therefore, the Court held that the resolution donating the funds of the Company was not
within the objects mentioned in the MoA and hence it was ultra vires, void and cannot be
ratified even if all the shareholders agree. Where a Company does an ultra vires act, no legal
relationship ensues from it. The payment was therefore unauthorised, and the trustees
acquired no right to the amount
paid by the Directors to the Trust.

Cases relied on Ashbury Railway Carriages and Iron Company v. Riche "The covenant,
therefore, is not merely that every member will observe the conditions upon which the
company is established, but that no change shall be made in those conditions; and if there is
covenant that no change shall be made in the objects for which the company is established, I
apprehend that that includes within it the engagement that no object shall be pursued by the
company, or attempted to be attained by the company in practice, except an object which is
mentioned in the memorandum of association."

In re. South Durham Brewery Co - The two documents (MoA and AoA) must be read
together at all events as may be required to clarify any vagueness appearing in terms of the
Memorandum, or to supplement it on any matter regarding which it is silent.

In Tomkinson vs. South Eastern Railway - it was held that a resolution passed by the
shareholders of a Railway Company approving the Directors to use 1000 pound out of the
Company's funds towards a contribution to the Imperial Institute was ultra vires, even when
the creation of the Institute would aid the Company by generating a boost in passenger traffic
over their line.
Re. Birkback Permanent Benefit Building Society - When a Company does an act which is
ultra vires, no legal relationship or effect ensues from there. Such an act is void and can’t be
ratified even if all the shareholders agree.
The appellants argued that the amount of Rs. 2 lakhs were paid out of the Shareholders
Dividend Account (SDA), which was distinct from the general assets of the Company and is
the exclusive property of the shareholders, not the Company. They had the absolute right of
disposal over the said account. The donation was made in the exercise of absolute ownership
and power of disposal of the shareholders. Hence, the payment could not be called in
question by the Company or the Corporation since the powers of the Corporation were not
more extensive in scope than that of the Company.
The Court observed that the clauses of the AoA relating to the constitution of the
Shareholders' Dividend Account are Arts. 116, and 117. Articles 116 and 117 provide the
details of the fund to be set apart and be carried over to the SDA. By Art. 124 dividend is
made payable only out of the surplus, which is also in the SDA. Article 119 mandates
payment of dividend and bonus out of the SDA. The article states: "Dividend and bonus shall
be announced and disbursed to the shareholders in proportion to the paid-up capital out of the
total amount remaining in the SDA."
Article 123 provides that no larger dividend shall be declared than recommended by the
Directors, but the Company in a general meeting can declare a smaller dividend.
A separate SDA in Insurance Companies was necessary because of section 49 of the
Insurance Act which forbade insurers from using any part of the life insurance fund to declare
or pay any dividend or bonus to shareholders or policy-holders or of making any other
payment in favour of any debentures.
The donation of Rs. 2 lakhs were paid out of the SDA: but no dividend was declared in the
resolution. The Directors have to pass a resolution recommending payment of dividend at a
specific rate, for the shareholders to have authority to decide how to spend their share of SDA
fund. The resolution was one donating an amount to the Trust, not declaring dividend payable
on behalf of the shareholders to the Trust. Under Articles 116 and 117, the amounts so set
apart in SDA are to be the exclusive property of the shareholders. But it does not create a
proprietary interest in the SDA for the individual shareholders.'Exclusive property of the
shareholders' only means that in the SDA, the policy-holders have no interest and have no
right to participate therein.
However, until the dividend is declared, the shareholders do not become creditors of the
Company. The fund belongs to the Company and continues to do so until its destination is
decided by a resolution of the Company declaring a dividend. Unless in the general meeting,
a recommendation is made by the Directors and declares a dividend, the shareholders get no
right to the fund of SDA.
The meeting was convened explicitly for considering various resolutions, one of which was
to donate Rs. 2 lakhs out of the SDA. However, until the Company passes a resolution about
dividends in a general meeting, no part of the account belongs to the shareholders. It is
accepted by both parties that no resolution declaring Rs. 2 lakhs as dividend and paid over to
the shareholders was passed.

Cases relied on
Bacha F. Guzdar v. Commissioner of Income-tax, Bombay: "The true position of a
shareholder is that on buying shares an investor becomes entitled to participate in the profits
of the Company in which he holds the shares if and when the Company declares, subject to
the Articles of Association, that the profits or any portion thereof should be distributed by
way of dividends among the shareholders. He undoubtedly has a further right to participate in
the assets of the Company which would be left over after winding up but not in the assets as a
whole."
3. The Court declined the assertion that the resolution of the Company and the acceptance by
the trustees formed a contract. The SC said that there was no consideration from the trustees
for accepting the amount supposing that the resolution is indeed an offer. Mere readiness to
use the money for the Trust cannot be treated as consideration, for consideration to be valid it
must be of some value. Even before the Trust was formed, Directors desired to donate to it,
and hence the resolution was passed. By mere acceptance of the amount donated is no
consideration. Payment by the Company of the amount decided to be donated thus gratuitous:
its acceptance made it a gift and did not give rise to a contract.
4. The appellants also maintained that as trustees, they were not personally liable to
reimburse the two lakh rupees. The Court observed that Appellants 2 and 4 were at the
concerned time Directors of the Company, and they were part of the meeting convened under
the Chairmanship of the 4 th appellant. In the same meeting, the resolution, which is now
declared as ultra vires, was passed.
As the appellants were responsible for passing the resolution ultra vires, they will be
personally liable to make right the amount. Again by s. 15 of the LIC Act, the Corporation
has the right to demand back any payment made without consideration, and not necessary for
the controlled business of the insurer. By subsection (2) Tribunal has the power to make such
an order against any of the parties having respect to the degree to which those parties were
respectively liable for the transaction or profited from it. The Trust has benefited from the
payment, and the trustees represented the Trust.

Analysis
The Court held that a company’s funds cannot be redirected to every type of charity even
though the company's memorandum gives power to that effect. Secondly, objects must be
distinguished from powers. The power to borrow or to make a charity is not an object.
Objects have to be stated in the memorandum. The powers stated can only be used to
effectuate objects of the company. They do not become independent objects by themselves;
This case can be held to be good law and an authority on these points of law. The judgement
is also referred to on other points of law, including personal liability of directors and value of
consideration.
Any other Supreme Court judgements have not cited the case. Since 1963 it has been cited in
26 reported High Court cases. The latest one on March 21, 2020, by the Delhi High Court.
In Ajay Surendra Patel vs Deputy Commissioner of Income Tax the Gujarat High Court
relied on this case to show that the corporate veil can be lifted if the act of the Company is
found to be ultra vires, The Court said that “There is another well-known principle which
indicates that corporate veil can be lifted if the Act of the Company found to be ultra vires
and as stated above, the Memorandum of Association is the yardstick for which only the
Company is incorporated or formulated and therefore, the directors of the Company shall be
personally liable for all such acts which are beyond the scope for which the Company was set
up. The corporate veil under the circumstance is necessarily to be pierced and the members
cannot be allowed to take shelter behind the corporate veil of the Company. This proposition
is fortified by a decision of the Supreme Court in case of Dr. A. Lakshmanaswami Mudaliar
& Ors. v. Life Insurance Corporation of India & Anr.

In MoolChand Khairati Ram Trust vs Director of Income Tax the Delhi High Court
extended its applicability. The Court said that “Although the above observations were made
in the context of interpretation of the Object Clause of a Memorandum of Association of a
Company, the principle would also be applicable to determine whether any activity is ultra
vires the purpose of a Trust."
The doctrine of ultra vires confines corporate action within fixed limits in the memorandum.
While it handicaps the enthusiastic manager, it lays a trap for the heedless creditor. That is
why there has been protests against this doctrine ever since its creation. The businessman has
always endeavoured to evade the limitations imposed by the doctrine on their freedom of
action. A method of bypassing ultra vires is the practice of registering memoranda containing
a profusion of objects and powers. For example, in Cotman v Brougham the House of Lords
had to consider a memorandum which has an objects clause with thirty sub-clauses enabling
the company to carry on almost every conceivable type of business which it can adopt. This
type of object clause defeats the very purpose for which it is there. In order to prevent this
from happening the courts created the " main objects rule” of construction. The rule has its
origin in the decision of Ashbury case8 where the court declared that the words “general
contractors” must be read in connection with the company’s main business.
Several English case laws subsequent to Mudaliar also agreed with the various points in
Mudaliar. In Introductions Ltd (No 2), re: A company had an independent clause in its
memorandum empowering it to borrow money from debentures. Yet its act of loan for a
purpose known to the lender to be outside the scope of its object was held to be ultra
vires.
Similarly, where the directors of a company proposed to distribute the money received on the
sale of its assets as compensation to the employees who had lost their jobs, the court
restrained the scheme.
Their motives may be laudable from the point of view of industrial relations, but the law does
not recognise them as a sufficient justification to enable the majority to spend the money of
the company. Therefore, the interests of the company cannot be disregarded. Charity is
allowed only to the degree to which it is absolutely necessary in the reasonable management
of the business of the company.
There must be a close connection between the gift and the company’s business interests.
But the question whether the limit has been exceeded has to be considered by keeping in
mind the fact that the image of the business corporation is evolving from the nineteenth
century one of a heartless
exploiter of a wage slave labour, single mindedly bent upon the maximisation of profits to
that of the corporate good citizenship of today. Corporations are coming to focus their
attention upon their duty
to serve mankind. The Companies Act of 2013 makes compulsory provisions for charitable
dispensation under the heading Corporate Social Responsibility.
After the application of the European Community (EC) Act in England, the doctrine of ultra
vires stands restricted to a certain extent. S.9(1) of the EC Act provides that "in favour of a
person dealing with a company in good faith, any transaction decided on by the directors
shall be deemed to be one which is within the capacity of the company". Thus, as against a
third person acting in good faith, the company can no longer plead that the act was ultra vires.