Companies Capacity to Contract in European Civil Law and Common Law countries

The capacity of companies is often neglected. Experience shows that this negligence may have serious consequences on the efficiency of several legal acts such as guarantees. For instance, the French Cour de cassation ruled in 2014 that a company could not grant a guarantee to one of its shareholders if this could jeopardize the existence of that company.

A preliminary distinction must be made between the capacity of a company to enter into a contract and the power of its representatives. In the context of company law, capacity is the extent of a company's legal ability to exercise certain acts. Representation is the mechanism that allows a person to act on behalf of that company.

The content of legal rules relating to the capacity of companies

When it comes to the general rules governing the legal capacity of companies, it is possible to find numerous similarities between jurisdictions and legal systems. For instance, in both Common and Civil law jurisdictions, the corporate principle of separate legal personality of companies is recognized. As a distinct legal person, a company has the capacity to enter into agreements with other parties and to be held liable for those acts. Also, in order to establish whether a contract is valid and binding, the capacity of companies has to be verified.

The capacity of legal entities has been recently reformed by the Ordinance n°2016-131 dated February 10, 2016. The new article 1145 of the French Civil Code provides that the capacity of legal persons is limited to the acts that are useful for the realization of their purpose, as defined in their by-laws. Incidental acts to the ones allowing such an achievement are permitted as well. This new legal provision would therefore apply in all cases involving the capacity of companies.

Pursuant to article 1147 of the French Civil Code, the lack of capacity of a company is a ground of relative nullity. This specification serves the sole purpose of shielding either private or public interest. This means that it is a nullity that can only be invoked by the party that the law intended to protect, i.e., the company itself. This rule is somehow inconvenient as it allows a company to challenge its own signature. Moreover, the usefulness test could create some lack of certainty.

The new article 1148 of the French Civil Code provides that a company, which lacks the capacity to contract, is still able to enter into contracts that are day-to-day acts authorized by legislation or usage.

In addition, statutes relating to specific entities may provide for specific provisions on the corporate purpose of a company and consequently reduce their capacity. That is the case for some cooperative entities. Thus, article L124-1 of the French Commercial Code provides specific rules that frame the statutes of cooperative associations of retailers. It strictly lists the possible social objects that will "directly or indirectly" bind the company.

Article 37 of the Spanish Civil Code provides that companies enjoy "civil capacity." However, the extent of this capacity may vary depending on the company's legal nature, the law creating or recognizing the corporation, its statutes and its internal regulations.

Article 38 of the Spanish Civil Code goes further to deal with the exercise of this civil capacity of companies. It seems to suggest that there are no general obstacles to the exercise of rights, powers or duties by companies. However, this article indicates that a different regime may apply to certain legal persons. For instance, in Spain, the Church and the State have a special relationship and this is the reason why the Church is governed by the provisions of a particular concordat concluded with the State. In addition, the provisions of specific statutes govern educational and charitable establishments. It is possible to do a parallelism between the French and the Spanish reasoning. These two civil law countries seem to apply the ordinary law except when specific provisions target some legal persons.

Traditionally, the capacity of companies was defined and limited by an object clause provided in the company's memorandum of association. This clause usually provided the framework to determine the commercial activities that the company would be involved in, delineating, as a result, the company's capacity. The need to respect this object became the foundation of the doctrine of ultra vires. According to this doctrine, a company was incapable of doing anything that went beyond its statement of objects.

Initially, the ultra vires doctrine was seen as a necessary measure to protect shareholders and creditors. Given that shareholders and creditors rely on the by-laws of companies before investing, case law held that they would be protected if companies were unable to alter the direction of business as stated in their objects. The ultra vires doctrine led to the creation of the "constructive notice rule," which provided that any third party that contracted with a company was deemed to have knowledge of that company's objects clause. Given that, in common law, an ultra vires transaction was void ab initio, once it was determined that an act went beyond the company's object, it could not be ratified or authorized by the shareholders. Moreover, if any benefits had been transferred as a consequence of such act, restoration between parties was required.

With time and as their company law developed, different common law jurisdictions adopted variations to the traditional ultra vires doctrine, weakening its strict application. It was found that the ultra vires doctrine, together with the constructive notice rule, was not favourable to commercial practice. As a result, some common law jurisdictions have amended and restricted its application. However, its downfall is not absolute and there can be exceptions in different jurisdictions. For example, in Ireland, it is recognized that special purpose vehicles (SPVs) shall not enter into other transactions than those in accordance with the objects behind their formation; therefore, the ultra vires doctrine should apply to these companies.

Section 39 of the United Kingdom Companies Act states that "the validity of an act done by a company shall not be called into question on the grounds of lack of capacity by reason of anything in the company's constitution." This means that the objects clause in the articles of association can no longer limit the company's ability to enter into valid and enforceable contracts. Currently, companies are not required to include an objects clause, but if they do, the objects are unrestricted unless the articles of association provide otherwise (section 31 of the Act). Moreover, even in the case where a company has objects in its articles, this cannot affect the company's capacity to bind itself. It is then safe to conclude that at the current time, the ultra vires doctrine has lost a significant part of its relevance in the United Kingdom due to the inability of objects clauses to restrict the capacity of companies. It is relevant to point out that some nuances can be identified. For instance, Section 42 provides for special rules of capacity governing charities.

The European Directive 2009/101/EC of September 2009 addresses the issue of the capacity of commercial companies. Its article 10-1 states that a company is bound by the acts done by its organs even if they are not within the objects of the company. However, that same article mentions that Member States may provide that a company will not be bound where such acts are outside of the objects of the company, but only if it proves that the third party knew that the act was outside those objects or could not have been unaware of them. The directive specifies that the party does not consider a simple disclosure of the by-laws as sufficient proof of knowledge.

The modifications to the legal rules relating to the capacity of companies A) The judicial modification

The praetorian creation of ostensible authority gives effect to an act concluded with a third party who truly believed that the co-contractor was empowered to conclude. In French law, it would probably not be possible to apply the ostensible authority rule to a case where the capacity to contract of a company and not the power of its representatives would be questioned.

A) The judicial modification The praetorian creation of ostensible authority gives effect to an act concluded with a third party who truly believed that the co-contractor was empowered to conclude. In French law, it would probably not be possible to apply the ostensible authority rule to a case where the capacity to contract of a company and not the power of its representatives would be questioned. B) The contractual modification

What would be the legal effect of a statement declaring that a company has the capacity to enter into a contract? The French Civil Code does not answer this question. However, regarding natural persons, article 1149 of the French Civil Code provides that "The mere fact that a minor has made a declaration of majority does not constitute an obstacle to annulment." By analogy, the scope of this article could be extended to the capacity to contract of companies. Therefore, with regard to its uncertainty, one may doubt the efficiency of such a statement for a company.

Article 1158 of the French Civil Code grants the possibility for a third party to ask the person who is being represented to confirm that its representative is empowered to conclude a contract. One may consider applying this article where the third party wishes to get a confirmation that the company itself is not only duly represented but is also capable of contracting. The issue of representation would indeed be meaningless without clarifying the underlying issue of capacity.

Conclusion

The review of the law governing the capacity of companies across jurisdictions shows a somehow incoherent evolution. Some civil law jurisdictions adopt regimes that extend the protection given to companies, while certain common law countries appear more concerned with facilitating commercial activity and safeguarding the interest of third parties.

Additional Resources

FRANCE Bruno Dondero, "Le droit des sociétés et la réforme du droit des contrats », Bulletin Joly Sociétés, p. 510

Stéphanie Roy, Marie Gabiano, "L'objet social seul gardien de la validité des actes conclus par des sociétés ?":

SPAIN Article 37 and 38 of the Spanish Civil Code

UK