Is a contract valid if the content does not correspond to a company’s scope of business? | In Principle

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Is a contract valid if the content does not correspond to a company’s scope of business?

The consequences of a transaction falling outside the scope of business specified in the articles of association.

It is fairly common to find a long list of items in a company’s articles of association describing the company’s scope of business. The founders of the company do this to ensure the greatest possible flexibility in business operations. In some cases however a company which has specified its business in the articles of association as manufacture of certain goods, for example, might begin activities of a totally new kind (e.g. trading in other goods) without updating its scope of business. Such situations raise concern as to the effectiveness and validity of transactions effected by the company in areas not covered by the articles of association.

What is the scope of business?

First, some basic terms. There is no legal definition of the scope of business, but it can be understood as the manner, agreed upon by the shareholders and accordingly stipulated, in which the company’s objective is realised.

The method whereby the company’s objective is realised is of fundamental importance, and this is demonstrated both by the fact that it should be stipulated in the company’s main organisational document (articles of association) and that major changes to the scope of business require the articles of association to be amended in the form of a resolution adopted by a qualified majority of votes. In the case of a limited-liability company (sp. z o.o.), under Art. 246 §1 of the Commercial Companies Code, this is ¾ of the votes, and in the case of a joint-stock company (SA), under Art. 416 of the Commercial Companies Code, ⅔ of the votes, with a range of other restrictions such as certain privileges given by certain shares, limitations, etc not applying during the ballot).

Scope of business adopted by a company

As a company can be incorporated for almost any lawful purpose, as a rule the scope of business can be selected freely provided it does not list illegal activities. It is correctly stated in the legal literature that the scope of activity should be appropriately broad. While some writers say that the company’s scope of business can even be “any business,” according to the Supreme Court (for instance the resolution of 21 April 1989, Case III CZP 24/89, which is still relevant despite being issued on the basis of the Commercial Code, which is no longer in effect) and some commentators, this scope should be described specifically at least by stating the type of business conducted. To use the Supreme Court’s example, it is possible to state that the scope of business is manufacture or services and trade in the form of small-scale production (Supreme Court resolution of 9 November 1988, Case III CZP 92/88—in this case as well the resolution issued on the basis of old laws remains relevant).

In articles of association a practice has emerged of specifying the scope of business by reference to the descriptions and codes in the Polish Classification of Activities (PKD). This is not compulsory, however (see “Specification of the subject of the company’s business in the register”). Sometimes (especially if the envisaged area of business is innovative) there may not be a suitable description in the PKD.

Effectiveness towards third parties

Let us return to the issue of the legal implications of a transaction (for example conclusion of an agreement) that does not fall within the scope of the company’s business.

Assuming that the management board has the power only to conduct transactions listed in the articles of association, this would lead to a great deal of uncertainty when trading. How can a third party doing business with the company be sure whether the transaction is included in the list?

A company’s scope of business is listed in the commercial register, but not the entire scope. There are no legal restrictions on the number of entries that can be listed or categories of business that can be listed, but the number of entries that can be made in the register is limited. Under Art. 40 of the National Court Register Act, no more than ten entries of the scope of business, including one core area of activity, can be specified in the commercial register.

Therefore, the information listed in the register may not fully represent the actual scope of business described in the articles of association.

In such a case, does the other party in a transaction have to analyse the articles of association each time, and if the articles of association state for example that the company’s scope of business is “manufacture of rubber seals,” how can it be sure that an agreement concluded by the company for purchase of metal parts is covered by the list?

If an analysis of this kind had to be conducted this would certainly gravely undermine principles of trade safety and certainty.

Polish lawmakers have resolved this issue by stating definitively that it is not possible to restrict the right of a management board member to represent the company with legal effect towards third parties (Art. 204 §2 and 372 §2 of the Commercial Companies Code). This rule is complemented by the rule in Art. 17 of the National Court Register Act of presumed accuracy of entries in the register, which means that a third party does not need to review the articles of association and there is no need for analysis of whether a particular transaction performed by a company is covered by the list in the company’s articles of association.

It follows therefore that the management board (acting in accordance with the representation policy in place at the company and taking into consideration special limitations on transactions which by law require the prior consent of the meeting of shareholders or general meeting) can perform any transactions on the company’s behalf relating to the company’s affairs.

Liability towards the company

Does the scope of business specified in the articles of association actually mean anything in practice?

Leaving aside arguments relating for example to the tax implications of particular transactions, the main consequence of transactions of this kind performed by the management board is organisational liability of the members of the management board. Nevertheless, if actions of a management board member which are not in line with the articles of association and for which the member is culpable (because they fall outside of the scope of business specified in that document) cause damage to the company, there may be grounds for compensatory liability of that member towards the company (Art. 293 §1 and 483 §1 of the Commercial Companies Code).

Accordingly, a company’s scope of business is more important to members of the management board than to counterparties.

Maciej Szewczyk, legal adviser, M&A and Corporate practice, Wardyński & Partners