Company formation and constitution — SQE1 BLP question
A worked single-best-answer question on company formation and constitution, with why each wrong option is wrong — the way SQE1 traps candidates.
The articles of Hartley Tools Ltd provide that the directors must not enter into any contract worth more than £50,000 without the prior approval of the members by ordinary resolution. The board resolves to buy machinery for £80,000 from Ostler Supplies Ltd and the managing director signs the contract on the company's behalf. No members' approval is sought. Ostler's sales director had read Hartley's articles on the public register and knew of the restriction, but acted honestly throughout. Hartley Tools Ltd now wants to avoid the contract.
Can Hartley Tools Ltd avoid the contract with Ostler Supplies Ltd?
- AYes, because a contract made in breach of the articles is outside the company's capacity and is void.
- BYes, because Ostler knew of the restriction in the articles and so did not deal with the company in good faith.
- CYes, because Ostler is deemed to have notice of the contents of the articles filed at Companies House.
- DNo, because the directors' power to bind the company is deemed free of constitutional limitations in favour of a person dealing in good faith, and mere knowledge of the limitation is not bad faith.
- ENo, but the contract will only bind the company once the members ratify it by special resolution.
Show answer and reasoning
Rule: In favour of a person dealing in good faith, the directors' power to bind the company is deemed free of constitutional limitations, and knowledge of the limitation alone is not bad faith (CA 2006 s 40).
- A A company's capacity is not limited by anything in its constitution (s 39); this is a limit on the directors' authority, not capacity. (wrong rule)
- B Knowledge that the act exceeds the directors' powers is not, by itself, bad faith (s 40(2)(b)(iii)). (wrong rule)
- C A person dealing with a company is not bound to enquire into limits on the directors' powers (s 40(2)(b)(i)); constructive notice does not apply. (wrong rule)
- E The contract binds the company already under s 40; no ratification by special resolution is required. (wrong rule)
Source: Companies Act 2006, ss 39, 40(1)-(2)