Evolution of the Doctrine of Indoor Management

Corporate Law-I Project

Table of Cases

Royal British Bank v. Turquand, [1843-1860] All ER 435 5

MRF Ltd. v. Manohar Parricker, 10

Mahony v. East Holyford Mining Co., [1875] LR 7 HL 869. 6

Morris v. Kanssen, [1946] 1 All ER 546. 6

County of Gloucester Bank v. Rudry Merthyr Steam and House Coal Colliery Co. [1895] 1 Ch. 629. ` 7

Re Bank of Syria, Own and Ashworth’s Claim [1901] 1 Ch. 115. 7

Re Bonelli’s Telegraph Co., Collie’s Claim [1871] LR 12 Eq 246. 7

Northside Developments Pry Ltd. v. Registrar-General, [1990] 170 CLR 146. 11

Anand Behari Lal v. Dinshaw and Co, AIR 1942 Oudh 417. 8

Ruben v. Great Fingall Consolidated, [1906] AC 439. 9

Lakshmi Ratan Cotton Mills v. J.K. Jute Mills Co., AIR 1957 All 311. 9

Rama Corporation v. Proved Tin and General Investment Co, [1952] 2 QB 147. 10

Introduction

The doctrines of constructive notice and indoor management are essentially rules of prudence which facilitate business transactions between a company and an outsider. The former favours the company in dealing with ordinary members of the public and provides that no outsider in dealing with the company may claim that he was unaware of certain provisions in the memorandum or articles of association. It seeks to estop such a person from ever pleading that he had not read these documents as the presumption is always that all such persons in their dealings have read these documents and understand their implications. While the doctrine of constructive notice thus greatly facilitates the business transactions from the company’s point of view, it has an important exception, namely, the doctrine of indoor management. Simply put, the doctrine of indoor management provides that an outsider is entitled to rely on the presumption that all procedures have been followed on the part of the company and the company cannot rely on any procedural irregularity after the deal with any outsider has been concluded. The doctrine of indoor management is founded on practical reasons of convenience in business relations [1] . First, even though articles and memorandum of association are public documents, any member of the public is not privy to all internal procedures in a company and thereby, cannot make an informed decision [2] . Second, and more importantly, the doctrine of constructive notice would be subject to great abuse by the companies if the doctrine of indoor management is not available. Therefore, to curb such malicious activity, the doctrine of indoor management has been used by courts of law. In this project, I deal with this doctrine in detail starting from its inception in Royal British Bank v. Turquand [3] and gradually tracing its evolution in subsequent decisions which have explained, clarified and limited the doctrine. In Part I, I briefly set out the facts and the decision in the Turquand case. In Part II, I trace the evolution of the doctrine along with the many limitations that have been incorporated by the Courts. In Part III, I draw a comparison between the Red Jaguar case in England and MRF Ltd. v. Manohar Parricker [4] in the Supreme Court of India, to see how the doctrine has been interpreted in the two most recent pronouncements on the law in these jurisdictions.

Part I: The Turquand decision

This case came up before the Court of Exchequer Chamber through an appeal filed by the defendant, Turquand, who was the official manager of Cameron’s Coalbrook, Steam, Coal and Swansea and London Rail Company. He was sued by the plaintiffs, the Royal British Bank, for the non-payment of a sum of 2000 pounds which the plaintiffs alleged that the company was bound to pay as they had acknowledged this debt through a bond bearing the common seal of the company and signed by two directors. The defendant pleaded that no such resolution had been adopted in authorising the making of the bond and any such bond was given without the authority and the consent of the shareholders of the company. The Court of Exchequer Chamber did not accept this contention. It held that since the deed of settlement registered under the Joint Stock Companies Act, 1844, allowed the directors to borrow on bond such bonds from time to time through a resolution passed at a general meeting of the company. The Court held that evidence showed that such a resolution had indeed been passed but the amount of money which the directors were authorised to borrow was never defined. The Court stated that dealings with companies were not dealings with ordinary partnerships and though the public should have known the contents of the documents that are published, they were not obligated to do more and any party reading the deed in instant matter would find that there was no prohibition from borrowing stated in the deed. Thus, any such party was entitled to assume that all internal procedural conditions not mentioned in the deed had been followed. Thus the Court ruled against the defendant directors and enunciated the rule that is now known as the Turquand rule or the Doctrine of Indoor Management.

Part II: Evolution of the Doctrine in English and Indian jurisdictions

The Rule in Turquand’s case was a special rule in guiding the transactions made by third parties with companies. In this part, I give a brief evolution of how the Rule was treated by later Courts in England and how it came to be incorporated into the Indian Companies Act of 1956. Furthermore, I also provide the host of qualifications which were formulated in due course and had to be satisfied before application of the Rule could be made. One of the earliest significant decisions in which the Turquand Rule was discussed was the case of Mahony v. East Holyford Mining Co. [5] A company was formed by one Wadge to purchase a mine belonging to him at a price in excess of its real value. The memorandum and articles of association of the company were subscribed by two persons, Hoare and Wall who subsequently joined Wadge in directing the company’s affairs, together with four clerks employed by Wadge and one independent person, McNally. The articles stated that the subscribers would have to appoint the directors of the company but in reality no one was appointed. However, Wadge, Hoare and Wall managed the company’s affairs from its registered office and issued a prospectus inviting ordinary members of the public to subscribe to the shares. The money received from these applicants was deposited in the company’s account at the appellant bank. Afterwards, Wadge communicated the bank that as ‘secretary’, though he was never appointed to the post, he was asking the bank to honour cheques signed on the company’s behalf by any two of the three ‘directors’. The bank made no attempt to inquire whether such directors were actually appointed or whether Wadge had the authority to write to them as secretary and consequently, honoured the cheques. After the company went into liquidation, the liquidator sued the bank for the amount thus paid and the bank claimed that on the basis of the Turquand Rule it was not liable as it had no knowledge of the company’s lack of authority. The House of Lords held that the bank was not required to enquire about the appointment procedure and of its fulfilment. It held that the bank was only obligated to look into the memorandum of association and the articles of association and on so doing, it would have found that there was a specified procedure of appointing directors and from this, the bank could reasonably have deduced that the directors had actually been appointed. This case lists out an important distinction between the Turquand Rule and the Rule of Apparent Authority of a company’s agents [6] . In the former, unlike the latter, a party does not need to rely on the representation and act on it [7] . If this were the case, the bank would have been held to the standard of the reasonable man in such situations and would have had to duty to at least inquire whether all the procedures had been followed. Thus, even acceptance of the authority on its face can absolve a party of all liability.

However, a question arises whether such leniency can be accorded to parties who formed a part of the company but were alien to the procedures in question. This question was decided in Morris v. Kanssen [8] where the facts were such that the appellant at the date of the transfer of share was appointed to the board of directors. It was not within the appellant’s knowledge that the procedural requirements of appointing the other directors had not been followed. The House of Lords held that the appellant could not rely on this rule as he had assumed the position of a director on the date of the transaction and was thus under an obligation to inquire about the procedural requirements of such transfer and whether the requisite authority had been vested with the other directors. The House of Lords did not question the Turquand Rule itself, merely the application of it in the instant matter [9] . It held that had the appellant not become a director at the time of the transfer, he would have able to rely on the Turquand Rule. Therefore, it appears that the rule is not applicable in internal procedural matters.

The Turquand Rule has been followed in many other English cases and some of the principles that emerge are that the Rule will defeat any contention by a company that the board meeting was inquorate, that is, there were an insufficient number of members to pass the said resolution [10] or that there was no board meeting at all to pass any such resolution [11] . Nowadays, the Turquand’s Rule is covered by §40 of the Companies Act, 2006 of the United Kingdom which renders ineffective any limitation in a company’s constitution on the power of its directors to bind the company. Thus it would seem that the Turquand Rule has been totally replaced by §40 of the Act [12] . In India, however, the Turquand Rule is firmly entrenched as can be seen by §290 of the Indian Companies Act, 1956, which provides that acts done by a person as director shall be valid notwithstanding that it may afterwards be discovered that his appointment was invalid by reason of any defect or disqualification or had been terminated by virtue of any provision contained in this Act or in the articles [13] . Even on a prima facie examination of the provision, it becomes clear that it does not apply to any person associated with the company other than a person in the position of the director of the company [14] . Thus, when a person had ceased to hold the office of a director, any subsequent act of his will not be held valid as it is not an irregular exercise of power but exercise of power where none existed. [15] In the following paragraphs, I deal with the exceptions to the Turquand Rule in general and as embodied under §290 of the Act with the help of Indian and English case law.

Exceptions to the Doctrine of Indoor Management

Over the years, the Turquand Rule has been read down to incorporate many exceptions which limit the application of the Rule. Such a need was also articulated by CJ Mason in Northside Developments Pry Ltd. v. Registrar-General [16] where the Learned Judge cautioned that an over-extensive application of the Rule might facilitate fraud and unjustly favour those who dealt with companies at the expense of innocent creditors and shareholders who would be the victims of unscrupulous persons acting or purporting to act on behalf of companies [17] .

As has been mentioned, the Rule does not usually apply to favour internal parties of the company. [18] This is because knowledge of internal procedural matters is presumed in such cases. Apart from knowledge, even if there is an iota of suspicion on the part of a third party against a company, then the doctrine of indoor management will not have any application as it would be against principles of good faith to protect the third party. This principle is exemplified by the case of Anand Behari Lal v. Dinshaw and Co. [19] , where transfer of a company’s property from its account to the plaintiff was held to be void. Here, the plaintiff argued that whether the accountant had the requisite authority or not was not something that plaintiff could have known. However, the Court held that the accountant had no power of attorney and thus the plaintiff could not have supposed as a reasonable man that his authority was unquestionable. [20]

It has been opined that forgery may sometimes serve as an exception to the Turquand Rule. This interpretation flows from the dictum of Lord Loreburn in Ruben v. Great Fingall Consolidated [21] , where the plaintiff who was the transferee of a share certificate was aggrieved when the company contended that though the certificate was issued under the seal of the company, the secretary had forged the seal as well as the signatures of two directors of the company. The plaintiff contended that whether the documents were forged or not was the internal matter of the company but the Court invalidated this argument by holding that such an argument will not apply to gross irregularities which affect genuine transactions [22] . However, this statement of the Learned Judge has been taken to be obiter dictum since the case was decided on the basis that the secretary had no actual or implied authority to represent that a forged document was genuine [23] and therefore, no established rule of using forgery as an exception has arisen.

The next and most important embodiment to the doctrine of indoor management is the power of delegation in the article of association. This theory states that if there exists a power of delegation and a third party has knowledge of this power, then a person purporting to act in consequence of this delegation will bind the company irrespective of whether such power was actually delegated or not. Such a scenario was exemplified by the case of Lakshmi Ratan Cotton Mills v. J.K. Jute Mills Co. [24] . In this case, the directors of the company were authorised by the articles of association to borrow money from third parties and were empowered to delegate this power of borrowing to any one director or more. The company contended that no resolution was passed to actually delegate this power to the director who borrowed the money. This contention was not favoured by the court which held that the mere existence of the delegation clause and the third party’s knowledge of it was enough to bind the company. Therefore, two important criteria have to be satisfied before the Turquand Rule can apply. First, there must be ostensible authority vested in the person. This criterion will get satisfied if the person is in a position of ostensible authority, for example, a director. But no such presumption may lie in case of, say, an accountant as has been shown by the Dinshaw [25] case. The other criterion is that such power of delegation was within the knowledge of the third party and if the third party did not have any idea about such power then that party cannot rely on this power. Thus in Rama Corporation v. Proved Tin and General Investment Co. [26] , the director of a company was empowered by the articles of association to delegate any of his powers but not the power to borrow or make calls. In any event, the third party did not know of the power to delegate at all and the Court was of the opinion that no reliance could be placed on the clauses whose existence was unknown to the third party. However, such a decision relates the doctrine of indoor management to the principle of estoppel and has been criticised.

Part III: Does the Doctrine of Indoor Management stand alone? The Supreme Court clarifies.

The impression that one gets after reading some of the authorities listed above is that the doctrine of indoor management may often stand alone and grant legality to a transaction which is ultra vires the powers of the company. The Supreme Court in MRF Ltd. v. Manohar Parikkar [27] had an occasion to clarify this stand. The case dealt with the legality of two government notifications with respect to grant of rebate to certain industrial consumers of electricity and thus the questions in the court were essentially of public law. However, counsel for the government took the argument that here the government was itself empowered under the doctrine of indoor management to carry a presumption that all procedures within the governmental authorities were complied with [28] . This was an unusual case of taking advantage of the doctrine by a party who may otherwise be prejudicially affected by it. The Court first cautioned against an analogy between public law and private law concepts but nevertheless held that the doctrine of indoor management operated as an exception to the doctrine of constructive notice. As mentioned above, the doctrine of constructive notice would help a company to escape liability on the presumption that third parties are bound by the clauses in the articles and memorandum of association even if they are aware of them. So, the doctrine of indoor management’s sole purpose is to stop a company from taking this protection of constructive notice too far so as to not jeopardise third parties. Therefore, the doctrine of indoor management did not have any authority granting power and could only apply even if the opposite rule of constructive notice was applicable. Ostensible authority cannot exist merely by pleading the doctrine of indoor management; the doctrine can merely help courts draw a presumption that ostensible authority, which did exist, did not curtail the agent’s power to perform the impugned act. This position is supported by the Northsides [29] case discussed earlier. In that case, a bank sought to sue the company over a loan given to the director but where the loan had nothing to do with the company’s business and was meant purely for the benefit of the director. However, the director sought to affix the common seal of the company on the transacting document. The Court held that in this case there was no authority (ostensible or otherwise) at all to affix the seal and the doctrine of indoor management unless ostensible authority had been proved to exist. [30] This case lends credence to the proposition that the doctrine of indoor management cannot be used as a positive assertion so as to validate an otherwise ultra vires act but can only act as an exception when the benefit of constructive notice is claimed.

Conclusion

In this project, I have analysed the rule laid down in the Turquand case and its evolution through English and Indian case law. The rule which later came to be known as the doctrine of indoor management was carved out so as to prevent the doctrine of constructive notice, used by companies to their advantage, from becoming an impediment to trade and commerce as otherwise third parties would be seriously affected if constructive notice was applicable in all cases. However, the doctrine of indoor management cannot also be applied over-extensively. In essence, a harmonious balance has to be maintained so as to promote business transactions between the company and third parties. Thus the doctrine of indoor management cannot give validity to a transaction where there is no authority; it can only apply as an exception to the doctrine of constructive notice as mentioned above.