Facts
- The dispute concerned a contract between the directors of the United Kingdom Switchback Railway Company and Mr. Grant for the construction of a railway.
- The company’s articles of association required shareholder approval for such contracts, which the directors did not obtain before entering the agreement.
- The relevant article operated as a clear procedural safeguard: no binding contract for capital works could be concluded unless and until the shareholders in general meeting passed an ordinary resolution authorising the board to proceed.
- The directors nevertheless executed the construction agreement and purported to bind the company without convening a meeting or circulating notice to the members.
- After Mr. Grant began performance, a general meeting was called. The shareholders, by ordinary resolution, purported to approve the contract retrospectively, believing that ratification would cure the procedural flaw.
- Mr. Grant relied on this later approval and sued for specific performance and damages when the company attempted to repudiate the agreement on the ground that it had been entered into ultra vires.
Issues
- Whether shareholders could retrospectively ratify a contract entered into by directors without the required prior shareholder approval stipulated in the company's articles.
- Whether shareholder ratification can make valid acts that exceed the directors’ or company’s powers under the articles of association.
Decision
- The High Court of Justice held that shareholder ratification could not retroactively validate the contract. The resolution passed after the fact was ineffective because the articles demanded prior consent as a condition precedent to the creation of a binding obligation.
- The court drew a distinction between (a) acts that are merely irregular and therefore capable of later confirmation, and (b) acts that the constitution itself forbids unless a specified procedure is followed. The contract fell into the latter category.
- It was further determined that the company could not be estopped from relying on its own articles. The contract was void ab initio in the sense that the company never had capacity to assume the obligation without compliance with the internal limitation.
- Consequently, Mr. Grant’s claim failed, and the agreement was declared unenforceable.
Legal Principles
- Shareholder ratification is only possible for acts shareholders could lawfully approve in advance; where the articles impose a procedural pre-condition, that condition must be satisfied before the transaction is concluded.
- The ultra vires doctrine, as developed in the nineteenth century, applied not only to acts beyond the objects clause of the memorandum but also to acts within the objects that were performed contrary to express constitutional limits. Such limits curtailed both the board’s capacity and the membership’s remedial power.
- Directors and shareholders are equally bound by the company’s internal governance rules. A general meeting cannot, by simple majority, waive or dispense with an entrenched procedural safeguard after the event.
- The case illustrates the policy rationale behind strict compliance: investors and creditors rely on the published constitution to assess risk; permitting ex post facto ratification would undermine certainty and invite abuse by interested majorities.
- Although later statutory reforms, most notably the Companies Act 1985 and Companies Act 2006, have mitigated the harshness of the ultra vires doctrine in relation to third parties acting in good faith, the principle that internal approval requirements must be observed remains important in disputes between the company and insiders.
Conclusion
Grant v Switchback Railway Co confirms that shareholder ratification cannot validate acts in breach of a company’s internal rules and affirms the role of the ultra vires doctrine in restricting both director and shareholder powers. The decision highlights the continued necessity for companies to observe their constitutional procedures meticulously; failure to obtain the requisite prior authority will render a contract void and unenforceable, even where a majority of shareholders later attempt to affirm it.
