Introduction.docx

PROJECT REPORT ON TOPICDOCTRINE OF CONSTRUCTIVE NOTICE AND INDOOR MANAGEMENT

SUBMITTED TO:

SUBMITTED BY:

DR. ALAMDEEP KAUR

VIKAS DENIA

ASSISTANT PROFESSOR

236/15

UILS , PU

SECTION D

CHANDIGARH

B.COM LLB (HONS.) SEMESTER 8TH

ACKNOWLEDGMENT

Writing a project is one of the most significant academic challenges I have ever faced. Though this project has been presented by me but there are many people who remained in veil, who gave their all support and helped me to complete this project. First of all I am very grateful to my Subject Teacher Dr. Alamdeep Kaur without the kind support of whom and help the completion of project was a herculean task for me. I am very thankful to the Librarian who provided me several books on this topic. I acknowledge my friends who gave their valuable and meticulous advice which was very useful and could not be ignored in writing the project. I also owe special thanks to my parents for their selfless help which was very useful in preparing the project.

TABLE OF CONTENT

TABLE OF CASES

INTRODUCTION Under the Indian law relating to companies, a public company is managed by a Board of Directors which is entrusted with the responsibility of managing the company in the most efficient and transparent manner. However, in an era of recurring business scams, it would not be astonishing if the prospective shareholders feel insecure about investing in a particular company. Over the years, the shareholders have been given various tools to keep a check on the methods and practices adopted by the directors of a company for its internal management, but to what extent can one go in finding out about such methods and practices, is the question to which the answer remains ambiguous. Nevertheless, some explanation in this regard can be sought in the Turquand's Rule or the Doctrine of Indoor Management.1 The doctrine of indoor management was evolved 150 years ago. It is also known as Turquand’s rule. The role of doctrine of indoor management is opposed to of the role of doctrine of constructive notice. The doctrine of constructive notice protects company against outsiders whereas the doctrine of indoor management protects outsiders against the actions of company. This doctrine also is a possible safeguard against the possibility of abusing the doctrine of constructive notice. The person entering into a transaction with the company only needed to satisfy that his proposed transaction is not inconsistent with the articles and memorandum of the company. He is not bound to see the internal irregularities of the company and if there are any internal irregularities than company will be liable as the person has acted in the good faith and he did not know about the internal arrangement of the company. The rule is based upon obvious reason of convenience in business relations. Firstly, the articles of association and memorandum are public documents and they are open to public for inspection. Hence an outsider “is presumed to know the constitution of a company, but what may or may not have taken place within the doors that are closed to him2 Secondly, If not for the doctrine, the company could escape creditors by denying the authority of officials to act on its behalf. 1 2

http://www.legaleraonline.com/articles/doctrine-of-indoor-management-under-the-indian-company-law. Pacific Coast Coal Mines Ltd. V. Arbuthnot, 1917 AC 353.

DOCTRINE OF CONSTRUCTIVE NOTICE The memorandum and articles of association of every company are registered with the Registrar of Companies. The office of the Registrar is a public office and consequently the memorandum and articles become public documents. They are open and accessible to all.3 It is therefore, the duty of every person dealing with a company to inspect its public documents and

make

sure

that

his

contract

is

in

conformity

with

their

provisions.

But whether a person actually reads them or not, “he is to be in the same position as if he had read them”. He will be presumed to know the contents of those documents. This kind of presumed notice is called constructive notice. In Kotla Venkatswamy v. C. Rammurthi4 shows the practical effects of this rule. The Articles of Association of a company contained a clause that all deeds and documents of the company shall be signed by the managing director, the secretary and a working director on behalf of the company. A deed of mortgage was signed by the secretary and a working director only. It was held that “the mortgage could not be enforced as the illegality appeared on the face of the deed, and therefore, the deed was invalid notwithstanding that plaintiff acted in good faith and money was applied for the purposes of the company.” Another effect of this rule is that a person dealing with the company is “taken not only to have read those documents but to have understood them according to their proper meaning”. He is presumed to have understood not merely the company’s powers but also those of its officers. Further, there is a constructive notice not merely of the memorandum and articles, but also of all the documents, such as special resolutions [S. 117] and particulars of charges [S. 77] which are required by the Act to be registered with the Registrar. But there is no notice of documents which are filed only for the sake of record, such as returns and accounts. According to Palmer, the principle applies only to the documents which affect the powers of the company. The common law doctrine of constructive notice should apply to the form. To reiterate the form is a public document which contains particulars of directors who are the mind and will of a company, as well as managers and secretaries who are responsible for the day to day running of the company. It is a document which affects the powers of the company and its agents. Certainly, its purpose must be more than just to provide information about the 3 4

The right to inspection etc. is expressly granted by Section 399 of the Act. AIR 1934 Mad 579.

company’s directors, managers and secretary. Therefore, persons dealing with company should check with the Registrar of Companies who its directors, mangers and secretaries are at a given time. In Oakbank Oil Co. v. Crum5 it has been held that anyone dealing with the company is presumed not only to have read the memorandum and articles, but understood them properly. Thus, Memorandum and Articles of a company are presumed to be notice to the public. Such a notice is called ‘Constructive notice’. MOA and AOA become public document after registration of a Company. It is taken for granted that everyone who deals with the company knows of these documents Legal effect: If a person’s deals with a company in a manner which is inconsistent with the provisions contained in MOA and AOA – own risk and cost and shall have to bear the consequences thereof. In companies law, the doctrine of constructive notice is a doctrine where all persons dealing with a company are deemed (or "construed") to have knowledge of the company's articles of association and memorandum of association. The doctrine of indoor management is an exception to this rule. Statutory reform of Constructive Notice {Section 35-A, Companies Act of 1989 UK} Constructive notice is more or less an unreal doctrine. It does not take notice of the realities of business life. People know a company through its officers and not through its documents. Section 9 of the European Communities Act, 1972 has abrogated this doctrine. The provisions of Section 9 are now incorporated in Section 35 of the Companies Act, 1985 under the English law. An example of the impact of the new provisions has been provided by a famous English case6 (TCB Ltd v Gray,) where a debenture issued by a company was signed by a solicitor as attorney of a director of the company, but not by the director personally. The articles of the company provided that "every instrument to which the seal shall be affixed shall be signed by a director". Even so the company was held liable. Stating the effect of the new provision, the court said that before this enactment came into force a person dealing with the company was required to look at the memorandum and articles of the company to satisfy himself that the transaction was within the corporate capacity but that Section 9(1) has changed this.

5 6

(1882) LR 8 AC 65 1986 Ch 621.

The sub-section provides that good faith is to be presumed and that the person dealing with the company is not bound to inquire. The expression "a person dealing with a company" has not been held not to include a shareholder allottee. The court refused to validate an allotment of bonus shares by using the share premium account without authorisation.7 The courts in India also do not seem to have taken the rule of constructive notice seriously. For example, in Dehradun Mussoorie Electric Tramway v. Jagmandar Das8, the articles of a company expressly provided that the directors could delegate all their powers except the power to borrow. Even so an overdraft taken by the managing agents without approval of the board was held to be binding, the court saying that such temporary loans must be kept outside the purview of the relevant provision.

7 8

EIC Services Ltd v Phipps, 2004 EWCA (CIV) 1069. AIR 1932 All 141.

DOCTRINE OF INDOOR MANAGEMENT The role of the doctrine of indoor management is opposed to that of the rule of constructive notice. The latter seeks to prevent the company against the outsider; the former operates to protect the outsiders against the company. The rule of constructive notice is confined to the external position of the company and therefore, it follows that there is no notice as to how the company’s internal machinery is handled by its officers. If the contract is consistent with the public documents, the person contracting will not be prejudiced by irregularities that may beset the indoor working of the company. ORIGIN OF THE DOCTRINE This doctrine was laid down in the case of Royal British Bank V. Turquand,9 wherein “the directors of the company borrowed some money from the plaintiff. The article of company provides for the borrowing of money on bonds but there was a necessary condition that a resolution should be passed in general meeting. Now in this case shareholders claims that as there was no such resolution passed in general meeting so company is not bound to pay the money. It was held that the company is bound to pay back the loan. As directors could borrow but subjected to the resolution, so the plaintiff had the right to infer that the necessary resolution must have been passed. It was held that Turquand can sue the company on the strength of the bond. As he was entitles to assume that the necessary resolution had been passed. Lord Hatherly observed“Outsiders are bound to know the external position of the company, but are not bound to know its indoor management.” Position under the Indian Companies Act, 1956 The Doctrine of Indoor management can also be traced in the Indian Companies Act, 1956 under Section 290, (validity of the act of the director) which is explained as follows: Acts done by a person as the director shall/can be valid notwithstanding that later it may be discovered that his appointment was invalid due to any disqualification or defect or was terminated by any provision of the Act or the Articles.

9

(1856) 119 ER 886.

Provided that nothing in the section shall give validity to any of the acts done by a director after his appointment has been shown to the company to be invalid or terminated. “The object of the section is to protect persons dealing with the company outsiders as well as members by providing that the acts of a person acting as director will be treated as valid although it may afterward be discovered that his appointment was invalid or that it had terminated under any provision of this act or the articles of the company.” 10 Basis of Indoor Management There are several reasons why the doctrine continued to be applied and came to be accepted as one of the fundamental principles of Corporate Law. First, although the Articles of Association and Memorandum of Association are in public domain, all members of the public are not privy to the internal procedures that take place in the company and so cannot make informed decisions all the time. Second, there would be the great scope to abuse the doctrine of constructive notice if the doctrine of indoor management is not available. Thus, the courts of law continue to apply this theory. 1. What happens internal to a company is not a matter of public knowledge. An outsider can only presume the intentions of a company, but not know the information he/she is not privy to. 2.

If not for the doctrine, the company could escape creditors by denying the authority of officials to act on its behalf.

Establishment of the Doctrine of Indoor Management The rule was not accepted as being firmly well established in law until it was approved by the House of Lords in Mahoney v East Holyford Mining Co11. In this case; it was contained in the company’s article that a cheque should be signed by 2 of the 3 directors and also by the secretary. But in this case the director who signed the cheque was not properly appointed. The court said that that whether director was properly appointed or not it comes under the internal management of the company and the third party who receives cheque were entitled to presume that the directors had been properly appointed, and cash cheques.

10 11

Ram Raghubir Lal v. United Refineries (Burma) Ltd. (AIR 1931Rang 139). (1875) LR 7 HL 869.

Exceptions to the Doctrine of Indoor Management The Doctrine of Indoor Management is more than a century old. The companies in today’s time have come to occupy the centric position in economic and social life in the modern communities, it is important to widen the scope of this doctrine, else it stands narrow and in complete favour of the outsiders to the company and brings a lot of risk to the Companies. Eventually, in the modern time, the Doctrine of Indoor Management has been subjected to various exceptions which are as follows: 1. Knowledge of irregularity

The first and the most obvious restriction is that the rule has no application where the party affected by an irregularity had actual notice of it. “Thus where a transfer of shares was approved by two directors, one of whom within the knowledge of the transferor was disqualified by reason of being the transferee himself and the other was never validly appointed, the transfer was held to be ineffective. In Howard v Patent Ivory Mfg Co12, for example, the directors could not defend the issue of debentures to themselves because they should have known that the extent to which they were lending money to the company required the assent of the general meeting which they had not obtained. Similarly in Morris v Kanssen13, a director could not defend an allotment of shares to him as he participated in the meeting which made the allotment. His appointment as a director also fell through because none of the directors appointing him was validly in office. The principle is clear that a person who is himself a part of the internal machinery cannot take the advantage of irregularities. Any other rule would “encourage ignorance and condone dereliction from duty”. 2. Suspicion of irregularity

The protection of “the Turquand rule” is also not available where the circumstances surrounding the contract are suspicious and therefore, invite inquiry. Suspicion should also arise, for example from the fact that an officer is purporting to act in a manner which is apparently outside the scope of his authority. In Anand Behari Lal v Dinshaw & Co14, in this 12

(1888) LR 38 Ch D 156. 1946 AC 459. 14 AIR 1942 Oudh 417. 13

case plaintiff accepted a transfer of a company’s property from its accountant the transfer was held void. The plaintiff could not have supposed, in the absence of the power of attorney, that the accountant had authority to effect transfer of the company’s property. 3. Forgery

It is pertinent to note that the Doctrine of Indoor Management does not apply in cases where an outsider relies on a document which is forged in the name of the company. A company can never be held liable for the forgeries committed by its officers. In case Ruben v. Great Fingall Consolidated15 the Plaintiff was a transferee of the share certificate issued under the seal of the defendant company. The certificate was issued by the Company’s secretary who has forged the signature of the two directors of the company and had affixed the seal of the Company. The plaintiff, in this case, had contended that whether the signature was forged or genuine comes under the purview of the internal management of the company, therefore the company shall be held liable for the same, but it was held by the court that the doctrine of Indoor Management has never extended to cover a forgery. Lord Loreburn had interpreted that “an outsider dealing with companies are not bound to inquire into their indoor management and will not be affected by any irregularities of which they are unaware of. But this doctrine, which is well established, applies to irregularities which otherwise might affect a genuine transaction. It cannot apply to a forgery.” In the case of Kreditbank Cassel v. Schenkers Ltd,16 – a bill of exchange signed by the manger of a company with his own signature under the words stating that he signed on behalf of the company, was held to be forgery when the bill was drawn in favour of a payee to whom the manger was personally indebted. The bill in this case was held to be forged because it purported to be a different document from what it was in fact; it purported to be issued on behalf of the company in payment of its debt when in fact it was issued in payment of the manager’s own debt. 4. Representation through Articles

This aspect deals with the most controversial and highly confusing aspect of “The Turquand Rule”. Article of Association generally contain what is called the power of delegation. 15 16

(1906) AC 439. (1927) 1 KB 826.

In the case of Lakshmi Ratan Cotton Mills v. J.K. Jute Mills Co. Ltd. the meaning and the effect of the delegation clause was explained“One B was the Director of the company. The company comprised of managing agents of which B was also a Director. The Articles of Association authorized the directors to borrow money and also empowered them to delegate this power to one or more of them. B borrowed a sum of money from the plaintiff. Further, the Company refused to be bound by the loan on the ground that there was no resolution passed directing to delegate the power to borrow given to B. Yet it was held in the case that the company was bound by the loan as the Articles of Association had authorized the director to borrow money and delegate the power for the same. Even supposing that there was no actual resolution authorising G to enter into the transaction, the plaintiff could assume that a power which could have been delegated under the articles must have been actually conferred. The actual delegation being a matter of internal management, the plaintiff was not bound to enter into that.” 

Power of delegation in articles-

In Houghton & Co. v. Nothard, Lowe and Wills Ltd.,17 in this case the defendant company and one P & Co. was engaged in fruit trade. One ML was a director of both companies. By the articles of the defendant company the director could “delegate any of their powers to committees consisting of such members as they think fit. ML borrowed advance from the plaintiff a fruit broker on the pretext that plaintiff will be allowed to sell the fruit imported by the defendant company and to retain proceed as security for advance. The agreement was confirmed by the secretary but later on it was challenged by the defendants as being without their authority. The plaintiff were not entitled to assume that any authority to make the contract had been delegated to them by the board for the simple reason – that the plaintiff are not entitled to rely on the supposed exercised and of the existence of which they were in ignorance on the date when they contracted.

17

(1927) 1 KB 246.



Ostensible position allowed to directors.-

Thus the ostensible position allowed to an officer is the most crucial factor. The decision of the court of appeal in Ford Motor Credit Co. Ltd v. Harmack18 is a further evidence of this. In this case Lord Denning said that when there was a group of companies all controlled by the same person who was in full control of everything- it had to be supposed that the he was the chairman and managing director of each. It seemed that he had not only actual but also ostensible authority”. 

Contracting party knowledge of articles.-

In the case of Rama Corporation v. Proved Tin & General Investment Co19 the X who was director in the company entered into a contract with Rama Corporation while purporting to act on behalf of the company and he also took a cheque from them. The articles of the company did provide that the director may delegate their power but Rama Corporation did not have knowledge of this as they did not read the articles and memorandum of the company. Now later on it was found that company had never delegated their power to X. Held- plaintiff cannot take the remedy of the indoor management as they even don’t that power could be delegated. 

Scope of authority –

In other words, “if the act is one which is ordinarily within the powers of such an officer, then the company cannot dispute the officer’s authority to do the act, whether the directors have or have not actually invested him with authority to do it. In Freeman & Lockyer v. Buckhurst Park Properties (Mangal) Ltd.20, William LJ attempted to reconcile all the previous authorities. The facts of the case may be noted first- K who carried on business as a property developer entered into a contract to purchase an estate. He had not enough money to pay for it and obtained financial assistance from H. They formed a limited company with certain

18

The Times, 7-7-1972; noted 1972 JBL 226. (1952) 2 QB 147. 20 (1964) 2 Comp LJ 36 (CA). 19

capital subscribed equally by K and H to buy the estate with a view to selling it for development. K and H with a nominee of each, comprised the board. The quorum of director was by the article of association, four. H was at all material times abroad. There was power under the articles to appoint managing director, but the board did not in fact do so. K to the knowledge of the board acted as if he were managing director of the company in relation to finding a purchaser for estate, and again without express authority of the Board, employed on behalf of the company, a firm of architects and surveyors for the submission of an application for planning permission etc., The firm claimed from the companies their own fees for work done. It was held that the company was liable for the fees claimed because K throughout acted as MD to the knowledge of the company and thus was held out by company as being MD, and the ostensible authority thus conferred could bind the company since its article of association in fact provided for there being a managing director of the company. K’s act in employing the plaintiff was within the ordinary ambit of the authority of such a managing director. In India it does not seem to have been insisted in any of the cases on the subject that knowledge of articles is essential. But as late as 1966, MUKHARJI J. observed obiter in a decision of the Calcutta High Court21 that “if a person has not, in fact, knowledge of the existence of the power of delegation contained in the company’s articles he cannot rely upon its suggested exercise.” The net conclusion that we can draw from the stage of this authorities is that what matters is not the plaintiff’s knowledge of the company’s articles, but whether the act in question is within the ostensible authority of the officer through whom he contracted with the company.” 5. Acts outside apparent authority.-

Lastly, if the act of an officer of a company is one which ordinarily be beyond the power of such an officer, the plaintiff cannot claim the protection of the “Turquand Rule” simply because under the articles power to do the act could have been delegated to him. In such a case the plaintiff cannot sue the company unless the power has, in fact, been delegated to the officer with whom he dealt. A clear illustration is Anand Behari Lal v. Dinshaw & Co.22 21 22

Kishan Rathi v. Mandal Bros & Co, (1996) 1 Comp LJ 19. AIR 1942 Oudh 417.

wherein the plaintiff accepted a transfer of a company’s property from its accountant. Since such a transaction is apparently beyond the scope of an accountant’s authority, it was void. Not even a “delegation clause” in the articles could have validated it, unless he was in fact authorised.

CONCLUSION

The case of Royal British Bank v. Turquand refined the common law of agency to articulate the Doctrine of Indoor Management. The rule was enunciated by the Court to mitigate the rigors of the Doctrine of Constructive Notice. The rule protects the interest of the third party who transacts with the company in good faith and to whom the company is indebted. The gist of the rule is that persons dealing with a public company are not bound to enquire into their indoor management and will not be affected by irregularities of which they had no notice. The Turquand Rule has been applied in many cases subsequently and generally in order to protect the interests of the party transacting with the directors of the company. With the due course of time several exceptions have also emerged out of the rule like forgery, negligence, acts done outside the scope of apparent authority and third party having knowledge of irregularity etc. If we analyse the cases it is revealed that the Turquand Rule did not operate in a completely unrestricted manner. Doctrine of indoor management is evolved as a reaction of the doctrine of constructive notice. It puts a Bar on the doctrine of constructive notice and it protects the third party who acted in the act in the good faith. This doctrine protects outsiders dealing or contracting with a company, It was analyzed that the doctrine does not operate in arbitrary manner, there are some restriction imposed on it like forgery, third party having knowledge of irregularity, negligence, where third party don’t read memorandum and articles and the doctrine will not apply where the question is regard of to the very existence of the company. Act done by governmental authorities in the course of their activities comes under the doctrine of indoor management. In the case of MRF Ltd. v. Manohar Parrikar23 the doctrine of indoor management does not apply on state of Goa because of the fact that there was an internal irregularity which should be taken care of and it is one of the exceptions of the doctrine. The doctrine of indoor management should not be used over extensively. A harmonious balance should try to be maintained

to

promote

business

transactions

to

third

parties.

The doctrine of indoor management is available to the outsider who had acted in the good faith and entered into a transaction with the company, he can presume that there were no internal irregularities and all the procedural requirements are satisfied. 23

(2010) 11 SCC 374.

BIBLIOGRAPHY

Books:  Dr. G.K. Kapoor, Taxman’s Company Law and Practice 22nded. 2017.  Avtar Singh, Company Law 15th ed., 2009.

Websites:  https://www.pdfcoke.com/doc/138206161/Doctrine-of-Indoor-Management-and-UltraVires  http://www.legalserviceindia.com/article/l203-Indoor-Management.html  https://www.lawctopus.com/academike/%EF%BB%BFdoctrine-indoor-management/  http://www.legalservicesindia.com/article/article/doctrine-of-constructive-notice-anddoctrine-of-indoor-management-2395-1.html