RG Business

New wine in old bottles: commercial reality and the doctrine of ultra vires

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By Marshall, Diel and Meyers

Introduction

A corporation cannot enter into a contract if it does not have the legal capacity to do so.  The doctrine of “ultra vires”, with its Latin rubric, might perhaps be regarded as antiquated, and as mere “legalese”, but in Bermuda at least (and in many other parts of the Commonwealth) it can have wide ranging and severe commercial consequences, in particular in relation to persons dealing with statutory corporations. Such corporations include, in Bermuda, the Bermuda Gaming Commission, the Bermuda Monetary Authority, the Bermuda Tourism Authority, WEDCO, BDLC, BHC, the Hospitals Board and the Corporation of Hamilton.  The decisions of the Supreme Court and the Court of Appeal in the MIF litigation (Corporation of Hamilton v Mexico Infrastructure Finance LLC [2016] Bda LR 110 and Mexico Infrastructure Finance LLC v Corporation of Hamilton [2017] CA (BDA) 11 Civ, (2017) 90 WIR 232) serve as a poignant reminder of the fact that innocent third parties must take special care when dealing with statutory bodies.

The doctrine

The literal translation of “ultra vires” is “beyond the powers”.  In the context of a corporation whose powers are conferred by statute, it means that the corporation only has the powers expressed in the statute, as well as any other powers which may necessarily be implied from the terms of the statute, or which may be expressed or necessarily implied from other statutes.  The question is therefore one of interpretation, a process which can be complex.

Having determined that the statutory corporation has the requisite power, it is then necessary to determine whether the power has been exercised in a proper manner and for proper purposes, as a power not so exercised is equally ultra vires.

Broadly speaking, acts and omissions of statutory corporations which involve illegality, irrationality or procedural impropriety are treated as ultra vires.  Thus, if the corporation takes some action or decision for a purpose which is not one authorised by the statute in question; or takes a decision involving an error of reasoning depriving it of its logical integrity; or is guilty of unfairness, bias or the appearance of impropriety, the action or decision taken will be ultra vires. It is also ultra viresstatutory powers to act in bad faith, to ignore something legally relevant, to take into account something legally irrelevant, or to act in accordance with some rigid policy rule, or under the dictation of some other person or authority.  The range of potential errors which could render an action or decision ultra viresis considerable.

The consequences

If a statutory corporation purports to exercise a power which it does not have, or exercises a power which it does have unlawfully, the exercise of the power is ultra vires, with the result that it is void and of no legal effect whatsoever.  A contractual transaction which is ultra viresis therefore of no legal effect; and neither contracting party can enforce it or sue for damages for breach.  Further, the corporation can escape contractual liability entirely by raising its own ultra viresas a defence to an action based on the contract.  This is so even despite the passage of time, or the corporation acquiescing in the performance of the contract by the other side, or encouraging the other side to perform, or making representations that it had the power to enter into or perform the contract, or attempting to later ratify the contract, or delaying in raising the defence.  It is even so if the corporation accedes to a consent order of the court consenting to a judgment given against it on the contract and even if the corporation seeks to take the point some considerable time afterwards.

These principles, create an obvious risk, both legal and commercial, for those doing business with such corporations.  An innocent third party who has entered into a contract with a statutory corporation in good faith may find itself unable to sue to enforce the bargain if the transaction entered into with the corporation was outside the corporation’s powers.  This is even the case where the risk may not have been discoverable easily or at all.  Further, to make things more difficult, the innocent third party cannot rely on its own ignorance of the limitations of the corporation’s powers.  Nor would a warranty in the contract to the effect that the corporation had the relevant power assist, as that too would be equally ultra vires.

The doctrine (as interpreted by the Courts) renders the due diligence exercise, in short, something of a minefield. Finding, reading and correctly interpreting the governing statute (as well as any other applicable statutes), as difficult as that may be, is not be sufficient.  The innocent third party also need to be in a position to assess the rationality and procedural propriety of the decision to make the contract.  That involves making a judgment on such matters as: whether all relevant factors had been taken into account and all irrelevant ones excluded from consideration; or whether or not the corporation may be acting in bad faith, for example, in order to make some sort of unauthorized profit rather than to further its statutory purposes.

From the perspective of legal policy, this seems an odd position for the law to adopt.  The notion that the enforceability of statutory corporations’ contracts should be subject to the ultra viresdoctrine with these results has been described as “harmful and irrational”. Commentators have further pointed to the potential impact of the ultra viresrisk on commercial decisions in relation to entering into contracts with public corporations and the possible consequence that, in order to compensate for this risk, businesses contracting with public corporations may increase prices, thus leading to the undesirable consequence of increasing the cost of public contracting.

On the other hand, it has been argued that the ultra viresdoctrine, despite its apparently troublesome consequences, is justifiable on the basis that it upholds, supports and promotes the rule of law, which is possibly the most important of constitutional and political values.  The rule of law in this context means that the corporation must act in accordance with the law as enacted or framed by the legislature and with the constitution.  This is a fundamental constitutional principle, the purpose of which is to protect individual citizens from illegal action by the government.  In relation to municipalities, this rationale (it has been said) is further buttressed by the related doctrine that municipalities owe their ratepayers a duty in the nature of a fiduciary duty in relation to the use to which they put their rates.  To permit a municipality to use rates otherwise than for statutorily authorised purposes would be a breach of this duty; and for the council of a municipality not to raise the ultra viresdefence to an action for monetary recovery on a contract in order to protect ratepayers’ funds would likely similarly be a breach of duty.

Thus, although applying the consequence of absolute invalidity or voidness may be a particularly strict approach, it has the advantage of being an unambiguous declaration by the courts of their concern to protect the rule of law, constitutional principle and ultimately, individual citizens from illegal action by the government. Accordingly, it is said, this strict approach is justifiable.  Public accountability, it is asserted, ought to outweigh commercial convenience, especially given that the ultra viresrisk is a known one and can be addressed by careful legal advice, which then passes the risk on; as does transaction insurance, which is also an available option.

The MIF litigation

Facts

The facts of the MIF litigation and the legal arguments made perfectly illustrate the various policy issues arising from these competing approaches.  Successive Councils of the Corporation of Hamilton thought that it would be a good idea to promote the development of a St. Regis hotel in the city of Hamilton.  The Corporation therefore took the view that it should assist a private company, Par-la-Ville Hotel and Residences Estates Limited (“PLV”), to do so.  The eventual mechanism for such assistance was the provision of a secured guarantee by the Corporation of a bridging loan of $18 million to PLV from Mexico Infrastructure Finance LLC (“MIF”).  The security for the guarantee was a mortgage on the retained freehold interest of the development land leased to PLV pursuant to a development and lease agreement between the Corporation and PLV.  The purpose of the loan was not to fund the development project itself, but to put PLV in funds to discharge certain debts by way of anticipated expenses to be incurred in securing the equity and senior lending that would fund the development project.

The Government of the day supported the development project, proposing and ensuring the passage of motions in both Houses of the Legislature approving the issuance of the guarantee and the guarantee and mortgage documents themselves, and granting the requisite Ministerial permissions under the companies and immigration legislation, as well as under the Municipalities Act 1923.  In addition, as there had been some disquiet as to the Corporation’s capacity to issue the guarantee, the Government sought to dispel it by procuring the enactment of the Municipalities Amendment Act 2013, which contained provisions thought to address that issue.

PLV defaulted on the loan and, having issued a demand for the entire balance in December 2014, MIF accordingly sought to enforce the Corporation’s guarantee.  MIF applied for summary judgment and acting on advice that there was no defence, the Corporation acceded to a consent order, which was granted in May 2015.  Having obtained fresh legal advice, the Corporation commenced proceedings in late June 2016, over a year later, seeking to set aside the consent order, on the ground that it had no power to provide the guarantee, which it accordingly asserted to be null, void and of no effect, and the further ground that it therefore had no power to consent to its enforcement.

Law

Both the Supreme Court and the Court of Appeal agreed that the Corporation had to exercise its power to enter into a contract of guarantee in a manner that was consistent with the statutory purposes, and that the Municipalities Act 1923 properly construed in relation to the facts of the case meant that the Corporation had to act for municipal purposes.  The Court went on to say that this involved provision of services to ratepayers as part of the Corporation’s function of the local government of the City of Hamilton.  The purpose of the guarantee was to facilitate a hotel development by a commercial developer and this purpose was held not to involve the provision of services to ratepayers and therefore not to be a municipal purpose.  Accordingly, the Court found, in giving or purporting to give the guarantee, the Corporation had acted ultra viresits powers.

This was so despite the fact that successive Councils of the Corporation, as well as the Government of the day, supported the development project because it was thought it would benefit the City and Bermuda as a whole; despite the Corporation consenting to a judgment against it, having not at the time raised the ultra viresdefence; and despite the passage of time since the consent judgment had been entered.

On this point, it was argued that, given the ultra viresdefence was available at the time of the consent judgment, it ought to have been raised, and for that reason to subsequently attempt to raise it as a ground for setting aside the order was an abuse of process of the Court.  The Court of Appeal, however, held that the abuse of process rule was displaced by the ultra viresdoctrine.  The Court of Appeal followed the logic of the ultra viresdoctrine to its ultimate conclusion, holding that the consequence was that the consent judgment (being ultra vires) could not be effective or binding in any way and accepting that in any event, in principle, such a consent judgment could not in law be an adjudication to which the abuse of process rule could attach.

Although the Court of Appeal did not need to apply the test for abuse to the facts, it agreed with the Supreme Court that there was no abuse.  The Court of Appeal emphasized that MIF had been made aware of the risk at an earlier stage of the transaction by the Corporation’s lawyers at the time, that the risks of transactions with entities such as the Corporation were well known in the marketplace, that MIF seemed to have relied on the advice of the Corporation’s attorneys rather than taking their own advice, that MIF’s attitude towards effecting recovery did not appear urgent, and that MIF were sophisticated lenders who had entered into the transaction voluntarily and with a view to profit.

There is an appeal to the Privy Council pending in relation to the question whether the guarantee was ultra viresthe Corporation’s powers, but there is no appeal in relation to the abuse issue, hence the decision of the Court of Appeal stands in relation to that issue.

The position now

The case re-affirms the relevance of the ultra viresdoctrine in the modern commercial context (on the particular facts, commercial lending to a municipality or public authority).  It demonstrates that the Bermuda court will apply not merely the simple version of the doctrine, involving an analysis of the relevant statutes in order to determine whether there is power to make a particular contract, but also the more far reaching principles, requiring that the third party ask and answer a wide range of additional questions, such as whether the particular corporation:

  • has acted in good faith,
  • reasonably and rationally,
  • taking everything relevant into account and excluding from consideration everything irrelevant,
  • for proper purposes,
  • in accordance with relevant procedures, and
  • has not permitted itself to slavishly follow a rigid a priori policy without proper consideration of the individual merits of the particular decision.

It also demonstrates the court’s commitment to fundamental constitutional principle and the rule of law, even in the face of competing commercial considerations.  The consequences of this approach will no doubt unfold as time goes by.  But what is clear is that, even if the impact on commercial dealings with public corporations turns out to be deleterious, given the court’s demonstrable commitment to the concept, legislative intervention will likely be necessary to deal with any perceived difficulties.  Bermuda may have to follow the UK in this regard.  In the meantime, those contracting with public corporations ought to take particular care that a proper and comprehensive process of due diligence is undertaken.  Time will tell whether the Privy Council agrees.

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