Thursday, December 8, 2016

Is the Doctrine of Ultra Vires Applicable to LLPs?

[The following guest post is contributed by Saumya Kakkar, Associate and Govinda Toshniwal, Senior Associate, both with NovoJuris Legal.  They can be contacted at relationships@novojuris.com]

The objects clause of the Memorandum of Association (“MOA”) of a company enlists and defines the main and the ancillary aims and objects for which the company is incorporated. Any activity or business the company carries out, or intends to do so, should fall under the ambit of this object clause. The company is restricted from performing an activity which is outside the scope of this object clause. The Supreme Court of India recognized this “doctrine of ultra vires” in the case of Laxman Swami Mudaliar v. Life Insurance Corporation of India and stipulated that any act beyond the permitted activities as defined in the objects clause of the MOA of the company is considered void, irrespective of the fact that the shareholders or directors of the company have assented to it.

The MOA of the company clearly defines the objects for which it has been established, thereby permitting the use of funds of the company only for a particular range of activities. This rule was established to protect the interests of the creditors and investors and to keep a check on the manner of utilization of their monies. In order to avoid this rule being attracted, companies started framing a wide objects clause by including all possible business activities ancillary to the main object.

A limited liability partnership (“LLP”) is a relatively new business structure combining the features of a company and a partnership, and was introduced by the Limited Liability Partnership Act, 2008 (“LLP Act”). The liability of partners in an LLP is limited to their agreed contribution to the business. The prospective partners in an LLP enter into an agreement which includes a“business description” stating the business to be carried on by the LLP.

The question that arises is: Whether the doctrine of ultra vires applies to the business description/object stipulated in the LLP Agreement to safeguard the interests of the investors/creditors of the LLP, considering that the liability of the partners of an LLP is limited to their contribution?

Section 67(1) of the LLP Act stipulates that the Central Government may, by notification in the Official Gazette, direct that “any of the provisions of the Companies Act, 1956 (1 of 1956) specified in the notification— (a) shall apply to any limited liability partnership; or (b) shall apply to any limited liability partnership with such exception, modification and adaptation, as may be specified, in the notification.”

Section 366 of the Companies Act, 2013 (the “Companies Act”) defines “company” with reference to the Part 1 of Chapter XXI of the Companies Act dealing with “Companies Authorized to Register under this Act” as any partnership firm, limited liability partnership, cooperative society, society or any other business entity formed under any other law for the time being in force which applies for registration under this Part.

Section 371(2) of the Companies Act states that any instrument that constitutes or regulates an LLP, i.e, the incorporation document or the LLP Agreement is equivalent to a memorandum of association of a company that is incorporated under the Companies Act or under Companies Act, 1956 (corresponding Section 578). Such instrument shall be treated in the same manner, and similar incidents needs to be inserted in a LLP Agreement or an incorporation document of a LLP that are required to be inserted in a memorandum of association of the company. For the purpose of understanding, the “instrument” as per section 371(7) of the Companies Act includes deed of settlement, deed of partnership, or limited liability partnership.

To quote Section 371(2) of the Act–

All provisions contained in any Act of Parliament or any other law for the time being in force, or other instrument constituting or regulating the company, including, in the case of a company registered as a company limited by guarantee, the resolution declaring the amount of the guarantee, shall be deemed to be conditions and regulations of the company, in the same manner and with the same incidents as if so much thereof as would, if the company had been formed under this Act, have been required to be inserted in the memorandum, were contained in a registered memorandum, and the residue thereof were contained in registered articles.”

Hence, by virtue of section 371(2) of the Companies Act read with section 67(1) of the LLP Act, the doctrine of ultra vires shall be applicable on the “business description/Object” in the LLP Agreement/Incorporation Document and hence the LLP cannot perform a business activity that is not included in the scope of the “business description/Object” as provided in the LLP agreement/Incorporation Document. Further, rule 21(1) & (2) of the LLP Rules, 2009 read with sub-section (2) of Section 23 of the LLP Act, provide that any change in the LLP Agreement (in Form 3) shall be filed with the registering authority within 30 days of such change along with the prescribed fee.

Section 11 of the LLP Act mandates the partners to provide the description of the business of the LLP in the LLP Agreement, which forms a part of the incorporation documents, which are to be registered with the registering authority. Further, the LLP Act permits change of nature of business of the LLP in the manner or mode as prescribed in the LLP Agreement and if the partners do not agree on such mode/manner, the change of nature of business will require the consent of all the partners of the LLP, as provided in Schedule 1 of the LLP Act.

Therefore, to perform any business activity beyond the scope of the “business description” of the LLP Agreement/Incorporation Document, the LLP needs to amend its “business description” stated in Form 2 while registering the LLP by filing Form 3 within 30 days of such change with the registering authority.  

Considering a penalty is imposed on providing false information in the incorporation documents, with a punishment of imprisonment for a term which may extend to two years and with fine which shall not be less than ten thousand rupees but which may extend to five lakh rupees, the business description and objects of the LLP provided in the incorporation document, shall be in sync with the business activity of the LLP. Also, if the partners of the LLP do not file any form, document, return, statement or do not comply with the provisions of the LLP Act, the LLP and its every partner shall be punishable with a fine which shall not be less than ten thousand rupees but which may extend to one lakh rupees.

To quote section 11 of the LLP Act -

“(1) For a limited liability partnership to be incorporated—

(a) two or more persons associated for carrying on a lawful business with a view to profit shall subscribe their names to an incorporation document;

(b) the incorporation document shall be filed in such manner and with such fees, as may be prescribed with the Registrar of the State in which the registered office of the limited liability partnership is to be situated; and

(c) there shall be filed along with the incorporation document, a statement in the prescribed form, made by either an advocate, or a Company Secretary or a Chartered Accountant or a Cost Accountant, who is engaged in the formation of the limited liability partnership and by any one who subscribed his name to the incorporation document, that all the requirements of this Act and the rules made thereunder have been complied with, in respect of incorporation and matters precedent and incidental thereto.

(2) The incorporation document shall—

(a) be in a form as may be prescribed;

(b) state the name of the limited liability partnership;

(c) state the proposed business of the limited liability partnership;

(d) state the address of the registered office of the limited liability partnership;

(e) state the name and address of each of the persons who are to be partners of the limited liability partnership on incorporation;

(f) state the name and address of the persons who are to be designated partners of the limited liability partnership on incorporation;

(g) contain such other information concerning the proposed limited liability partnership as may be prescribed.

(3) If a person makes a statement under clause (c) of sub-section (1) which he—

(a) knows to be false; or

(b) does not believe to be true,

shall be punishable with imprisonment for a term which may extend to two years and with fine which shall not be less than ten thousand rupees but which may extend to five lakh rupees.”

In light of the above, we argue that the doctrine of ultra vires applies to the “business description/object clause” included in the LLP Agreement and hence, this business description should be drafted in such a manner that it does not attract the rule. It would be interesting to hear a counter view on this.

- Saumya Kakkar & Govinda Toshniwal


2 comments:

Aishwarya Mohan Gahrana said...

Though I have same view but logic used to arrive to the conclusion does not seems correct.
Section 366 and 377 of the Companies Act, 2016 have no connection and have very limited use of conversion of business organisations to company.

This post correctly quoted Section 67(1) of the LLP Act which stipulates that the Central Government may, by notification in the Official Gazette, direct that “any of the provisions of the Companies Act, 1956 (1 of 1956) specified in the notification— (a) shall apply to any limited liability partnership; or (b) shall apply to any limited liability partnership with such exception, modification and adaptation, as may be specified, in the notification.” It seems there is no notification to the effect.

However, LLP agreement like partnership agreement and memorandum (both are in reality agreements) usually limits its objects and area of operation of LLP. Anything done beyond the objects defined in such agreement is violation of and ultra vires to the contract among the parties to it.

vswami said...

OFFHAND
The conclusion reads:
“In light of the above, we argue that the doctrine of ultra vires applies to the “business description/object clause” included in the LLP Agreement and hence,....”
On the first blush, in one’s independent perspective, a very crucial aspect of the law governing LLPs has been grossly over sighted.

To briefly pinpoint:
Section 11 of the LLP Act provides, -
(1) (a) two or more persons associated FOR CARRYING ON A LAWFUL BUSINESS with a view to profit shall subscribe their names to an incorporation document;
......
(2) The incorporation document shall—

(a) , (b), ...
(c) state the PROPOSED BUSINESS of the limited liability partnership;
(FONT supplied)
(d)..

In one’s firm conviction, while on the aspect of ‘ultra vires’, the legal significance and intricate implications of the above highlighted terms, as briefly set out in a couple of published articles -
HERE
LIMITED LIABILITY PARTNERSHIP – A New Concept (2005) 128 Comp. Cas

And HERE
CONCEPT OF LIMITED LIABILITY (2006) 65 SCL
PARTNERSHIP -A Study

might to have to be necessarily made a conscious note of / kept in lazer sharp focus. More so, for arguing before, - so also for the purpose of forming a righteous opinion by, - court, in any given case in which the ground of ‘lawful business’ arises / comes to be raised, for due consideration.