Law and You > Corporate Laws > Companies Act, 2013 > The Doctrine of Indoor Management
The doctrine of constructive notice is very convenient and expedient for company management. It allows the company respite from explaining to each person separately their rules and regulations. This is a huge presumption in favour of the company and prejudicial for the person who is transacting with the company. The rule of constructive notice has proved too inconvenient for a business transaction, particularly where the directors or other officers of the company were empowered under the articles to exercise certain powers subject only to certain prior approvals or sanctions of the shareholders. The investors, vendors, creditors, and other outsiders have no available mechanism to check whether those sanctions and approvals had actually been obtained. Due to the business necessities, they do not dare to ask for such approved resolutions from the directors of the company. Hence the strict application of the doctrine of constructive notice is criticized. Thus it can be seen that the rule of constructive notice has drastic impacts on the corporate world and mainly investors. The courts are bound to apply the doctrine even if that equals to injustice for the persons involved. There are no means to ascertain whether necessary sanctions and approvals have been obtained before a certain officer exercises his powers which, as per articles, can only be exercised subject to certain approvals. Therefore, to mitigate such a situation, those dealing with the company can assume that if the directors or other officers are entering into those transactions, they would have obtained the necessary sanctions. This is known as the ‘doctrine of indoor management’ also known as Turquand’s Rule. It was first laid down in the case of Royal British Bank v. Turquand. The doctrine of Constructive Notice seeks to protect the company from the outsider whereas the Doctrine of Indoor Management seeks to protect the outsider from the company.
Doctrine of Indoor Management:
The ‘Doctrine of Indoor Management’ which is famously known as the ‘Turquand’s Rule’ is an old established principle that came to be recognized 150 years ago in the context of ‘Doctrine of Constructive Notice’ in Royal British Bank v. Turquand case.
In Royal British Bank v. Turquand, (1856) 119 ER 886 case, the director of the company had issued a bond to Turquand. They had power under the Articles to issue such bonds provided they, were authorized by resolution of the company. No such resolution was, however, passed by the company. The Court held that Turquand could recover the amount of the bond from the company on the ground that he was entitled to assume that the resolution had been passed. It was further observed that the duty of observing internal, managerial procedures such as regarding the constitution of the Board, quorum, voting, internal resolutions and regulations, etc. had been imposed upon those who are responsible for the management of affairs of the company.
In Premier Industrial Bank Ltd. v. Carlton Mfg. Co. Ltd., (1909) 1 KB 106 case, where it was observed that “if the directors have power and authority to bind the company but certain preliminaries are required to be gone through on the part of the company before that power can be duly exercised, then the person contracting with the directors is not bound- to see that all these preliminaries have been observed. He is entitled to presume that the directors are acting lawfully in what they do”.
In Haughton & Co. V. Nothard, Lowe & Wills Ltd., (1927) 1 K.B. 246 case, the Court held that a person who contracts with an individual director of a company knowing that the Board has the power to delegate its authority to such an individual can assume that the power of delegation has been exercised.
In P.V. Bamodar Ready V. Indian National Agencies Ltd.. 1946 Mad. 35 case, the articles provided that the directors could allot shares only to the existing members and that share could be allotted to outsiders only after the approval of shareholders in a general meeting. it was held that any allotment made to outsiders even without the approval of the company in general meeting, was valid. Outsiders were entitled to assume that the directors must have obtained the approval of the general meeting of the company.
In Morris v. Kanssen, (1946) A.C. 459 case, the Court observed: “the wheel of commerce would not go round smoothly if persons dealing with the company were compelled to investigate thoroughly the internal machinery of a company to see if something is not wrong.”
in Varkey Souriar v. Keraleeya Banking Co. Ltd, (1957) 27 Comp Cas 391 case, the Court held that a person dealing with the company need not enquire about the internal proceedings of the company in furtherance of an obligation put on them through a public document or otherwise.
In Lakshmi Ratan Cotton Mills Co. Ltd v. J.K. Jute Mills Co. Ltd, AIR 1957 All. 311 case, the plaintiff sued the defendant company for the non-payment of a loan of Rs. 1.5 Lakhs which was taken through a letter sanctioned by the Board of Directors. The Court held that the company cannot be expected to be in knowledge of an internal rule of the debtor company. If the negotiations are happening on behalf of the company, it shall be presumed that all the internal requirements for the same have been met by the officers of the company. The only aspect that a person needs to see is whether the person approaching on behalf of the company is the authorized person or not.
Exceptions to the Doctrine of Indoor Management:
Knowledge of Irregularity:
The doctrine of indoor management is based on the principle, that outsider dealing with the company is entitled to assure that so far as internal proceedings are concerned everything have been complied with. But a person cannot take the protection of the principle of indoor management if he has noticed, actual or constructive, that the prescribed procedure has not been complied with by the company.
In Devi Mal v. The Standard Bank of India, (1927) 101 I.C. 568 case, under the articles of the company, all transfers of shares to be approved by two directors of the company. A particular transfer of shares was approved by two directors, one of whom was, to the knowledge of the plaintiff, disqualified. The Court held that a person dealing with the company will not be entitled to the protection under the principle of indoor management if he has noticed, actual or constructive, that the prescribed procedure has not been complied with by the company and held the transfer of shares invalid.
In Pratt Ltd. V. Sasoon & Co. Ltd, 40 Bomb. L.R. 1109 P.C. case, where Company A lends money to company B on a mortgage of its assets and the procedure laid down in the articles for such a transaction was not complied with and the directors of the two companies were the same, it was held that the mortgage is not binding. It may be presumed that Company A had notice of irregularity through its directors.
In Howard v. Patent Ivory Manufacturing Co, (1888) 38 Ch D 156 case, the Court held that the directors could not defend the issue of debentures because, being the directors, they should have been the extent to which they were lending the money and for that amount, the assent of the general meeting was necessary which was not obtained in this case.
In Morris v. Kanssen, (1946) A.C. 459 case, a director could not defend and allotment of shares to himself as a participant in the meeting which made the allotment and his appointment as director was also not in order because none of the directors appointing him was validly in office. Thus it is clear that where a person who is himself of part of the internal machinery of a company cannot be allowed to take advantage of irregularity.
Suspicion of Irregularity:
The protection under this provision shall not be given when the circumstances are such that they invite suspicion of a man of ordinary prudence. Not only actual knowledge, but even suspicion of irregularity may be sufficient in a given case to negate the application of the doctrine of indoor management.
In the case of Anand Behari Lal v. Dinshaw, AIR 1942 Oudh 417 case, the plaintiff accepted a transfer of property of the company concluded by the accountant of the company. In ordinary prudence, no company allows its accountant to transfer the properties of the company. Therefore, the plaintiff was asked to have been more cautious and the defence was not provided to him.
Forgery:
It may be noted here that the doctrine of indoor management does not protect a person where forgery is involved. A company cannot be held liable for forgeries committed by its officers. When a document is forged, it is total nullity in the eyes of law and the doctrine cannot be availed of in such a case.
In Ruben v. Great Fingall Consolidated Limited, 1906 AC 439 case, where the company secretary had sold the shares to the plaintiff by forging the signatures of two directors. The plaintiff 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. It was held that the company cannot be made liable in cases like this where there has been an apparent forgery and fraud.
Acts Falling Outside Apparent Authority:
An outsider will not be protected by the rule of indoor management if the act of the agent is one which would not ordinarily be within his powers simply because under the articles the power of making such a contract might have been entrusted to him. The outsider can hold the company liable only where the power had in fact been delegated notwithstanding a delegation clause to that effect in the articles.
In Kreditbank Cassel V. Schenkers, (1927) All E R 421 case, where the Branch Manager of a bank draw and endorsed bills on behalf of his company without having any authority from the company, it was held that drawing of bills was not within the ordinary ambit of powers of this branch manager and the company was not bound unless the authority was in fact delegated to him to this effect.
In Sri Krishna v. Mondal Bros. & Co., AIR 1967 Cal 75 case, the manager of the company had the apparent authority under the Memorandum and Articles of Associations of the company to borrow money. The manager borrowed money on a hundi but did not place the same in the strongbox of the company. It was held by the court that the company was bound to acknowledge the hundi, as the creditor had a bona fide claim for recovering the money on the grounds of fraudulent acts done by the officer of the company.
Negligence on the Part of the Outsider:
In E.B.M. Co. V. Dominion Bank, (1937) 3 All E.R. 555 case, a bank was put upon inquiry where the directors of the company secured their indebtedness by a charge upon the assets of the company. It was held that “the bank was not entitled to the benefit of the charge which had not in fact been authorized and Court further observed that where a person dealing with a company could discover the irregularity if he had made proper inquiries he cannot claim the benefit of the rule of indoor management.
The protection of this rule is also not available where the circumstances, surroundings the contract are so suspicious as to invite inquiry, and the outsider dealing with the company does not made proper inquiry.
In Underwood v. Bank of Liverpool, (1924) 1 K.B. 775 case, the sole director paid cheques drawn in the name of the company in his own account. It was held that “the Bank was put upon inquiry before crediting the cheques drawn in favour of the company in the account of the director. The Bank was not entitled to rely upon the ostensible authority of the director”.
In Houghton & Co. V. Nothard, Lowe & Wills (1927) 1 KB. 246 case, the Court held that even the unusual magnitude of the transaction may put a person dealing with the company upon inquiry as to its being authorized.
In Anand Bihari Lai V. Dinshaw & Co., AIR (1942) Oudh 417 case, the plaintiff accepted the transfer of the company’s property from its accountant, the transfer was held to be void because such a transaction is apparently beyond the scope of the accountant’s power. It puts the person dealing with the company into inquiry. The plaintiff should have insisted on seeing the power of attorney executed in favour of the accountant by the company. Even a delegation clause is not enough to make the transaction valid unless the accountant is in fact authorized.
Ignorance of Company’s Articles:
The doctrine of indoor management cannot be invoked in favour of a person who did not in fact read the company’s Memorandum and articles, and consequently did not act in reliance on those documents. In order to claim protection, under the doctrine of indoor management, knowledge or articles, is essential. This rule is based on the principle of estoppel and a person who did not consult the company’s Memorandum and articles cannot be protected under this rule.
In Rama Corporation Ltd. V. Proved Tin & General Investments Ltd, (1952) 2 Q.B. 147 case, Slade J. observed “The doctrine of constructive notice of a company’s registered documents such as its Memorandum and Articles and its Special Resolutions does not operate against a company, but only in its favour. The doctrine operates against the person who failed to inquire but does not operate in his favour”.
In Lakshmi Ratan Cotton Mills v. J.K. Jute Mills Co. AIR 1957 All. 311 case, 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. However, the Court held 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.
Conclusion:
The doctrine of Indoor Management which is used in accordance to the needs of the modern time. Its aim is to protect the interests and the rights of the third party who enter into transactions with the company in good faith and to whom the company stands indebted.