Doctrine of Constructive Notice

INTRODUCTION

Section 610 of the Companies Act, 1956 provides the inspection, production and evidence of documents kept by Registrar. It provides that the memorandum and articles when registered with Registrar of Companies becomes public document and then they can be inspected by anyone on payment of a nominal fee. Therefore, any person who contemplates entering into a contract with the company has the means of ascertaining and is thus presumed to know the powers of the company has the means of ascertaining and is thus presumed to know the powers of the company and the extent to which they have been delegated to the directors. In other words, every person dealing with the company is presumed to have read these documents and understood them in their true perspective. This is known as doctrine of constructive notice. [1]

The memorandum of association and articles of association are two most important documents needed for registration and incorporation of a company. The memorandum of association of a company contains the fundamental conditions upon which alone the company has been incorporated. According to Section 2(28) of the Companies Act, 1956 defines the memorandum means the memorandum of association of a company as originally framed or as altered from time to time in pursuance of any previous companies law or of this Act. According to Palmer, the memorandum of association is a document of great importance in relation to the proposed company. [2] It contains the objects for which the company is formed and therefore identifies the possible scope of its operation scope of its operation beyond which its action cannot go.

The Articles of association of a company are its bye-laws or rules and regulations that govern the management of its internal affairs and the conduct of its business. According to section 2(2) of the Companies Act, 1956 ‘articles’ means the articles of association of a company as originally framed or as altered from time to time in pursuance of any previous companies laws or of the present Act.

Both memorandum of association and the articles of association are public documents according to section 610 of the Act. These documents become public documents as soon as they get registered and can be accessible by any members of the public under the provision of the Act. Therefore, notice about the contents of memorandum and articles is said to be within the knowledge of both members and non-members of the company. Such notice is a deemed notice in case of a members and a constructive notice in case of non-members.

The rule of constructive notice extends not merely to Memorandum and Articles but also to all such documents as are required to be registered with the Registrar of Companies. There is however no constructive notice of documents which are filed with the Registrar of Companies for the sake of record only. [3]

The effect of the doctrine of constructive notice is harsh on the outsider who does business with a company. An outsider who dealt with a company is deemed to have a constructive notice of the contents of the documents of the company. An outsider cannot claim relief on the ground that he was unaware of the powers of the company in case of ultra vires of the company.

The ‘doctrine of 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. [4] The courts in India do not seem to have taken it seriously though. For example, in Dehra Dun Mussorie Electric Tramway Co. v. Jagmandardas, the Allahabad high court allowed an overdraft incurred by the managing agent of a company when under the articles the directors had no power to delegate their borrowing power.

The European Communities Act, 1972 contained the provision of constructive notice, which has now abrogated. A person who dealt with a company was at common law deemed to have notice of the contents of its memorandum and articles of association when the company’s certificate of incorporation was issued by the Registrar of Companies and such a person also had constructive notice of the other documents which companies were required to deliver to the registrar of companies, provided they were open to public inspection and had been gazetted where necessary. This is no longer since an amendment was made in 1989 to the Companies Act 1985, providing that a person shall not be taken to have notice of any matter merely because it is disclosed in a document delivered to the Registrar of Companies and so is available to public inspection. The statutorily modified doctrine of constructive notice may therefore, according to the circumstances, mean that a person will be treated as being aware of the contents of certain documents filed in respect of the company with which he deals. These documents will tell the person who deals with the company what objects it may pursue, how much share capital it ahs issued and may issue in future, how its board of directors is constituted etc. In theory, therefore, a person who deals with a company cannot complain if a transaction which he enters into with the company is held to be invalid because it patently conflicts with the provisions or requirements of those documents which he could, and should in the circumstances, have inspected, at the companies registry.

As criticisms of the doctrine of constructive notice, the new theory called the doctrine of indoor management has been evolved by the courts. The doctrine of constructive notice seeks to protect the company against the outsider; the other doctrine operates to protect outsiders against the company. The rule of indoor management is based upon obvious reasons of convenience in business relations. Firstly, the memorandum and articles of association are public documents, open to public documents. But, the details of internal procedures are not thus open to public inspection. [5] Hence, an outsider is presumed to know the constitution of a company; but not what may or may not have taken place within the doors that are closed to him.

EFFECT OF THE DOCTRINE OF CONSTRUCTIVE LIABILITY

The effect of the doctrine of constructive liability is harsh on the other party. 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. The Madras High Court discussed the scope of the rule of constructive liability in kotla Venkataswamy v. Rammurthy. [6] The dispute in this case was whether the mortgage bond was validly executed as per the company’s articles of association so as to make the company liable. Article 15, of the Company’s Articles of Association provides that all deeds, hundies, cheques, certificates and other instruments hall be signed by the Managing director, the Secretary and the working Director on behalf of the Company, and shall be considered valid. In the instant case, the plaintiff accepted a deed of mortgage executed by the secretary and a working director only. The court held that the plaintiff could not claim under this deed. The Court further observed that if the plaintiff had consulted the articles she would have discovered that a deed such as she took required execution by three specified officers of the company and she would have refrained from accepting a deed inadequately signed. Notwithstanding, therefore, she may have acted in good faith and her money may have been applied to the purposes of the company, the bond is nevertheless invalid.

One of the effects of the rule of constructive liability is that a person dealing with the company is considered 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. [7]

In Re Jon Beauforte (London) Ltd case [8] , where the insolvent company’s stated objects were to manufacture dresses but it had for sometime instead been making veneered panels, a combination of actual knowledge of the business being carried on by the company and of constructive notice of its stated objects resulted in all but one of its creditors’ claim being ultra vires. The court said that the result of this rule of constructive notice was that where the business being carried on by the company were known to the third party and, whether he actually knew it or not, were ultra vires, he would be unable to sue the company.

In case of ultra vires acts of the company the other party cannot claim relief on the ground that he was unaware of the powers of the company. The rules of common law established over the years have already provided extensive protection for persons dealing with a company in good faith where the act or transaction concerning or involving such persons is not ultra vires and beyond the company’s powers. The Court in Royal British Bank v. Turquand [9] established a principal to provide the protection to other party who is dealing with a company. According to the rule propounded in this case, although those dealing with a company were deemed to have notice of the contents of memorandum and articles, they were not required to satisfy themselves that all the internal regulations se out therein had been complied with. This, however, was no help when the transaction was beyond the company’s capacity.

COMMON LAW CASES

The rule of constructive notice was laid down by the House of Lords in Ernest v. Nicholls [10] and was further explained by House of Lords in Mahony v. East Holyford Mining Co case. Lord Wensleydale in Ernest case took the view that the rules of partnership would apply in the absence of the doctrine of constructive liability. The objective was to hold the shareholders liable. The observation of Lord Wensleydale is not clear. However, it appears that he seems to have considered that it was to avoid this result that the legislature saw fit to require a company to register articles and so to make available the world information so as to make available to the world information as to who were the persons authorized to bind the shareholders. [11]

The British Courts in several cases observed that the doctrine of constructive notice has a potentially drastic effect on outsiders as they were deemed to know about any internal procedures in the constitution as it is a public document. So, sometimes, even though an action is within the capacity of the company, it may be outside the powers of the individual representing the company because an internal procedure was not complied with. For example in Knopp v. Thane Investment Limited (2003) the court found the director’s failure to observe the articles rendered a contract contrary to the articles unenforceable. If the doctrine of constructive notice was applied strictly the outsider could not complain about the lack of authority as they were deemed to know that there was a limit on the actual authority of the company’s agent. [12]

However, the Courts were often keen to mitigate the effect of constructive notice. In Royal British Bank v. Turquand (1856) an action was brought for the return of money borrowed by the company. The company argued that it was not required to pay back the money because the manager who negotiated the loan should have been authorized by a resolution of the general meeting to borrow but he had no such authorization. As a result of the doctrine of constructive notice the bank was deemed to know this. The Court held that the public documents only revealed that a resolution was required not whether the resolution had been passed. The bank had no knowledge the resolution had not been passed and thus it did not appear on the face of the public documents that the borrowing was invalid.

Criticism of Doctrine of Constructive Liability: Evolution of Doctrine of Indoor Management

The rule of constructive notice has proved too inconvenient for 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. Whether those sanctions and approvals had actually been obtained or not could not be ascertained because in real situations, the investors, vendors, creditors and other outsiders could not dare to ask the directors in so many words about those sanctions having been obtained or to produce the relevant resolutions. Since, 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, 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’ and was first laid down in the case of Royal British Bank v. Turquand. [13]

The Courts in India have also been reluctant in applying the doctrine of constructive liability. The Allahbada High Court in Dehradun Mussoorie Electric Tramway Co. v. Jagamanandaradas [14] case rejected the doctrine of constructive liability and the Company was held liable to the party to the transaction even the directors of the company borrowed the money which was neither in compliance with the articles nor it was done after obtaining the resolution in the general body.

The Madras High Court in the case of official Liquidator, Manasube & Co. (P.) Ltd. v. Commissioner of Police [15] observed that the lenders to a company should acquaint themselves with memorandum and articles, but they cannot be expected to embark upon an investigation as to legality, propriety and regularity of acts of directors.

STATUTORY REFORM OF CONSTRUCTIVE NOTICE

Section 9 of the European Communities Act, 1972 has abrogated the doctrine of constructive notice. The provision of Section 9 is now incorporated in Section 35 of the Companies Act, 1985. Additionally the Companies Act, 1989 introduced two further sections into the 1985 Act to deal with the constructive notice. Section 35B of the Companies Act satted:

“A party to a transaction with the company is not bound to enquire as to whether it is permitted by the company’s memorandum or as to any limitation on the powers of the board of directors to bind the company or authorize others to do so.”

This was supposed to be introduced by Companies Act, 1985, S.711A which was to abolish the concept of constructive notice for corporations. However, S.711A has never been implemented and so only section 35 B dealt with constructive notice. [16]

An example of the impact of this provision was seen in the case of TCB Limited v. Gray, [17] where the debenture issued by the company was signed by solicitor but not by the director himself. The articles of the company required the signature of the director for this purpose. 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 into the memorandum and articles of the company to satisfy himself that the transaction was within the corporate capacity but that section 9(1) had changed this. The sub-section says that good faith is to be presumed and that the person dealing with the company is not bound to inquire. [18]

CONCLUSION

The rule of constructive liability is a unrealistic doctrine. It is an imaginary doctrine and is a fiction created by the judicial pronouncement of the Courts. Innumerable parties enter into a number of contracts in everyday business of the company. This doctrine expects each and every outsider not only to know the documents of the company but also presume to understand the exact nature of documents, which is practically not possible. In reality, the company is not known by the documents but by the people who represent it and deal with an outsider. The outsiders do the business and enter into contracts not always on the basis of documents of the company but the goodwill and the reputation of the directors or officers who are representing the company.

This is the reason why the British Courts and Indian Courts have shifted its approach in dealing with the cases relating to the outsider of the company. The Indian Courts have not given much importance to this doctrine. The European Communities Act has also abrogated the concept of constructive notice by bringing Section 9 of the Act which recognizes the concept of good faith in business transaction. This provision is in the tune of the reality of the business transaction, where the outsiders of the company enter into the various contracts not on the basis of the documents of the company but on the good faith of the company.

This is the reason why the courts have evolved the doctrine of indoor management as an opposite to the doctrine of constructive notice in order to protect the interests of the outsiders.

The researcher on the basis of the various commentaries on the subject and the cases decided by the British Courts and Indian Courts is of view that merely registration of a company should not constitute the notice of the documents submitted to the registrar. Also, an outsider should always have the freedom to make some assumption which a reasonable person may infer into the particular circumstances.