Articles

Warning! Transaction authority affected by new Companies Act

Business Brief June/July 2010
By Goitse Pilane & Ross Forgan

The Companies Act, 2008, (the New Act) will change the way in which the internal procedures of South African companies are regulated, through the introduction of the Memorandum of Incorporation (MOI), which document will replace the Memorandum and Articles of Association (Memorandum and Articles) under the Companies Act, 1973 (the Old Act).

The Memorandum and Articles function to regulate the authority of individuals within a company, including the authority to bind that company when contracting with third parties. In terms of the New Act, it will become mandatory for all companies to adopt an MOI to replace the existing Memorandum and Articles. While they have the same function, there are differences regarding the way in which this document is constructed and interpreted.

Of particular interest to companies is the change to the Turquand Rule and the Doctrine of Constructive Notice (DOCN), two well established principles under the current regime.

The Turquand Rule and the DOCN
The Turquand Rule and the DOCN are tools that work hand-in-hand, having been applied by our courts for many years when deciding whether a company should be bound by a contract with a third party where the individual contracting for the company was not authorised to do so. According to Section 36 of the Old Act, such a contract is ultra vires. When deciding such an issue, a court applies the DOCN and the Turquand Rule.

According to the DOCN, a third party, when dealing with a company, is deemed to have knowledge of the contents of a company's public documents. Accordingly, the third party should appraise themselves with the contents of the documents of that company in order to confirm that the individual representing the company is authorised to do so.

The Turquand Rule, established in the case of Royal British Bank v Turquand (1865) 6 E&B 327, counteracts the DOCN. Where the Memorandum and Articles provide for an internal procedure authorising an individual to represent a company, (for instance, the passing of a resolution) this Rule states that it is permissible for the third party to presume that such internal procedures have been followed. Where this is not the case, and the person contracting on behalf of the company does not, in fact, have the authority to do so, such contract is capable of being cancelled only at the instance of the third party. The ability of the third party to exercise this right is contingent on the finding that the third party believed in good faith that the individual was properly authorised to act on behalf of the company.

Thus, under the current regime, both the company and the third party are afforded protection when contracting with each other. The company is protected by the DOCN, and the third party by the Turquand Rule.    

Under the new regime
Section 36 of the Old Act has been retained under Sections 20(1)(a) and 20(1)(b) of the New Act. As such, a contract entered into by an individual on behalf of a company, without the requisite authority is considered to be ultra vires. The DOCN, however, has been altered.

According to Section 19(4) of the New Act, a third party is not deemed to have knowledge of the contents of any documents relating to the company, including the MOI. Section 19(5) of the New Act contains an exception to this, in that a third party is deemed to have notice and knowledge of any provision of a company's MOI under section 15(2)(b) (which section deals with special conditions applicable to the company and requirements for the amendments thereof) if attention has been drawn to the provision. These provisions are known as "Ring Fenced" provisions and will be marked "RF". Thus, the applicability of the DOCN is limited. Further the Turquand Rule is legislated in Section 20(7) of the New Act.

Thus, under the new regime, the company will only enjoy the protection of the DOCN in respect of "RF" clauses, whereas the third party will always have the benefit of the Turquand Rule unless it can be demonstrated that the third party had knowledge, or ought to have had knowledge of the company's failure to comply with their internal processes.

A warning to company officers
It will become mandatory for all companies to adopt an MOI. This exercise should not be one that is considered a routine exercise.

Should a company blindly convert its Memorandum and Articles to an MOI, without carving out certain provisions as RF provisions, the company will effectively be depriving itself of a specific defence should it challenge an agreement entered into by an unauthorised individual, which may result in the company being bound to an onerous agreement.

This result, however, is not a foregone conclusion. It is imperative for the company to invest time, effort and expertise into this exercise. Should it adopt this stance there is no reason why the company should not enjoy just as wide a protection under the new regime as it did under the old.