DOCTRINE OF CONSTRUCTIVE NOTICE AND DOCTRINE OF INDOOR MANAGEMENT

DOCTRINE OF CONSTRUCTIVE NOTICE

The Doctrine of Constructive notice denotes that every outsider who deals with the company should have notice of the contents of the Memorandum of Association and Articles of Association of the company before entering into any transaction with the company. Section 399(1) of the Companies Act, 2013 provides that on registration with the Registrar both these documents of the company become public documents and thus can be inspected by any person who intends to deal with the company by paying a nominal fee. They are open and accessible to all. Thus, it can be assumed that such a person knows the contents of both these documents. This is known as the Constructive notice of Memorandum and Articles of the company.

Every outsider who deals with the company has to make sure that it is within the powers of the company to enter into the proposed contract with him. He should know the procedures to be followed by the company, powers of the Directors and other officers of the company, and all other details given in the Memorandum and Articles of the company.

Oak Bank Oil Company v/s Crum

In this case, the Court held that every outsider who enters into any transaction with the company is assumed to have read the Memorandum and Articles of the company and have understood both of them properly.

Thus, the Memorandum and Articles of the company are presumed to be notified of the constitution of the company to all the people transacting with the company.

 Mahony v/s East Holyford Mining Company

In this case, Lord Hatherley held that the Articles and Memorandum of a company are open to all dealing with the company and those outsiders who deal with the company must be affected with the notice of the contents of the two documents.  

Kotla Venkataswamy v/s Ram Murthy-

It was held that the mortgage deed signed in this case was actually not valid and thus could not be enforced.

The Articles of the company contained a clause that for deeds to be valid all the deeds and documents of the company shall be signed by the Managing Director, the Secretary, and a working Director on behalf of the company. In this case, the plaintiff had accepted a mortgage deed that was signed by the Secretary and a working Director only.

The Court held that the mortgage deed could not be enforced as it was invalid. The Court observed that if the plaintiff had gone through the articles of the company she would have not accepted the deed. Although the plaintiff had acted in good faith and her money was applied for the company, the deed was invalid.

                              DOCTRINE OF INDOOR MANAGEMENT

This doctrine is a limitation to the doctrine of constructive notice of the Memorandum and Articles of a company. The outsiders who are dealing with the company have a right to assume that the internal proceedings of a company have been regularly done. The outsiders dealing with the company are expected to take care that the proposed deal is not inconsistent therewith. The inquiry that the internal procedures of the company were carried out according to the procedure given in the Articles of the company was not required to be done by the outsiders. They can assume that all the internal proceedings are done as per the regular procedures. This limitation of the doctrine of Constructive notice is called the doctrine of Indoor Management. This doctrine is also called ‘the rule in the Royal British Bank v/s Turquand’ or the Turquand Rule.

ROYAL BRITISH BANK V/S TURQUAND:

The Directors of the company borrowed money on bond from Turquand who is the plaintiff in this case. The Articles of Association of the company ‘Royal British Bank’ provided that the Directors of the company might borrow money on bonds only on the condition that a resolution shall be passed by the company in its general meeting. The shareholders claimed that the company was not liable to pay the money as there was no such resolution passed by the company in its general meeting. 

The Court held that Turquand could recover the amount of bond from the company as he was entitled to assume that the required resolution had been passed by the company. Lord Hatherly observed in this case that the outsiders dealing with the company are bound to know the external position of the company, but they are not bound to know the indoor management of the company.

Thus, this case had established the rule of Indoor Management that the persons dealing with limited liability companies are not expected to inquire about the regularity of internal proceedings and they will not be affected by the internal irregularities of the company of which they had no notice.

PACIFIC COAST COAL MINES LTD V/S ARBUTHNOT:

In this case, it was held by the Court that the doctrine of Indoor Management was based on the principle of justice and public convenience. Although the Memorandum and Articles being public documents are open for inspection but the details of the internal proceedings of a company are not open to public inspection. Thus, the outsider entering into any transaction with the company is presumed to know the constitution of the company but not about the internal proceedings taking place in the company.

EXCEPTIONS TO THE DOCTRINE OF INDOOR MANAGEMENT:

  • Knowledge of internal irregularity-    

In cases where an outsider dealing with the company has actual or constructive notice of the irregularity taking place in the internal management of the company, he cannot claim the benefit under the doctrine of indoor management. At times, he may be a part of the internal procedure.

T.R. Pratt (Bombay) Ltd v/s E.D. Sassoon &Co. Ltd-

The company ‘E’ lent some money to the company ‘F’ on a mortgage of its assets. The procedure to carry out such transactions given in the Articles of company ‘E’ was not complied with. The Directors of both companies were the same. In this case, the question was whether the mortgage was binding or not. It was held by the Court that this mortgage was not valid and binding because the lender had notice of the irregularity. 

Devi Ditta Mal v/s Standard Bank of India-

A transfer of shares in a company was approved by two directors of the company. One of these directors was not validly appointed and the other director was disqualified to do so as he was the transferee himself. The Court held that as information about this material fact was known to the transferor, the transfer of shares was ineffective.

  • Negligence-  In cases where an outsider dealing with the company by being vigilant or by making proper inquiry could discover the internal irregularity, he cannot claim the benefit of the rule of indoor management. This rule’s protection also cannot be taken when the circumstances surrounding the contract are so suspicious that they invite inquiry. For example, if an officer of a corporation acts outside the scope of his evident authority, suspicion should arise in the mind of the outsider and thus he should make a correct inquiry before going into a contract with the corporation.

Anand Bihari Lal v/s Dinshaw & Company-

The plaintiff accepted a transfer of a company’s property from the company’s accountant. The Court held that the transfer was void per se as the accountant was not having the authority to enter into such a transaction. Thus, as the transaction was apparently beyond the scope of the accountant’s authority the plaintiff should have asked him to produce before him the power of attorney executed in favor of the accountant by the company.

  • Forgery– 

The rule of Indoor Management doesn’t apply where an outsider dealing with the company relies on a document that is found out to be forged because nothing can validate forgery. A corporation cannot be held accountable for forgeries committed by its officers. The illegal transactions or transactions involving forgery are void and thus cannot be protected under this doctrine.

Ruben v/s Great Fingall Consolidated Co-

A share certificate was issued by the Secretary of a company under the common seal of the company with his signature and a signature of a director that was forged by him. The Court held that as the doctrine of Indoor Management does not cover any kind of forgery, the share certificate was not binding on the company. The person who gave money on the strength of this certificate was not entitled to be registered as a holder of the shares. Thus, the holder of the share certificate cannot be protected by this doctrine as the transaction was void ab initio because of being forged.

  • Acts outside the scope of apparent authority-

When an official of a corporation enters into a contract with an outsider and if the act of the officer is beyond the scope of his authority, the corporation is not bound by his actions. Thus, in such a case, the plaintiff cannot claim the protection of this doctrine because the Articles of the company did not delegate the officer the power to do such acts. The plaintiff can sue the company only when the power to act has been delegated to the officer with whom he entered into the contract. If an officer of the company acts fraudulently under his ostensible authority on behalf of the company, the company is liable for his fraudulent act.

Sri Krishna v/s Mondal Bros. & Co.-

The Manager of a company had the authority under the Memorandum and Articles of the company to borrow money. Although the manager borrowed money on hundi he did not place the money in the strongbox of the company. The Court held that the company was bound to honor the hundi. It could not defeat the bonafide claim of the creditor for the recovery of the money. 

  • Representation through articles

The Articles of Association usually contains a clause of the power of delegation known as the “delegation clause.” An outsider entering into contracts with an individual director of a company, knowing that the board can delegate its authority to such an individual, may assume that the power of delegation provided in the articles of the company has been exercised.

Lakshmi Ratan Cotton Mills v. J.K. Jute Mills Co-

 One D was the Director of the company. The company comprised of managing agents of which D was also a Director. The Articles of Association of the company not only authorized the directors to borrow money but also empowered them to delegate this power to one or more of them. D borrowed a sum of money from the plaintiff. The Company refused to be bound by the loan as no resolution was passed directing to delegate the power to borrow given to D. The Court held that as the Articles of Association had authorized the director to borrow money and delegate this ability the company was bound by the loan.

  • No knowledge of Memorandum and Articles

A plaintiff cannot seek remedy under the doctrine of indoor management who relies completely on the company for not knowing the Memorandum and Articles of the company. Thus, every person who enters into a contract with a company must go through the Memorandum and Articles of the company.

 Rama Corporation v/s Proved Tin & General Investment Co-

In this case, the Articles of the company mentioned that the directors may delegate their powers. Rama Corporation without reading the Memorandum and Articles of the company entered into a contract with Director X of the company. Later it was found out that the company had not delegated the power to Director X.

The court held that the plaintiff could not take benefit under the rule of indoor management for not knowing the Memorandum or Articles of the company.

CONCLUSION:

From the above discussion, we can conclude that the doctrine of Indoor Management evolved as a limitation of the doctrine of Constructive Notice. The doctrine of Indoor Management protects the interests and rights of the outsiders dealing with the company who acted in good faith and the doctrine of constructive notice protects the company against the outsiders. The Courts have applied the rule of Indoor management to various cases. However, the application of this rule is not arbitrary as the doctrine is subject to many exceptions like knowledge of internal irregularity, negligence of the third party dealing with the company, forgery committed by an officer of a company, the officer acting outside the scope of his authority, etc.

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