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Doctrine of Indoor Management

There are various principles in the corporate world that help determine the relationship which ensures the safety of various stakeholders in the company in the transactions that they undertake. The doctrine of indoor management is one such principle. The doctrine of indoor management was evolved 150 years ago. It is also known as Turquand’s rule. The other principle that is commonly referred to in this context is the principle of constructive notice.

The principle of constructive notice protects the company from frivolous claims by outsiders’. The third party cannot claim to not having been notified of the Company’s procedures or practices if they are a party to the MOA and the AOA. It is deemed to have been understood that a prudent person would have read the MOA and the AOA before agreeing to enter into an agreement with the company. The doctrine of constructive notice is limited to the external position of the company.

The role of doctrine of indoor management is opposed to of the role of doctrine of constructive notice.The doctrine of indoor management follows from the doctrine of ‘constructive notice’ laid down in various judicial decisions. The hardships caused to outsiders dealing with a company by the rule of‘constructive notice’ have been sought to be softened under the principle of ‘indoor management’. It affords some protection to the outsiders against the company.

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.

According to this doctrine, persons dealing with the company need not inquire whether internal proceedings relating to the contract are followed correctly, once they are satisfied that the transaction is in accordance with the memorandum and articles of association.

Shareholders, for example, need not enquire whether the necessary meeting was convened and held properly or whether necessary resolution was passed properly. They are entitled to take it for granted that the company had gone through all these proceedings in a regular manner.

The doctrine helps protect external members from the company and states that the people are entitled to presume that internal proceedings are as per documents submitted with the Registrar of Companies.
Whereas the doctrine of constructive notice protects a company against outsiders, the doctrine of indoor management protects outsiders against the actions of a 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 him.”[1]

Origin of The Doctrine
This doctrine was laid down in the case of Royal British Bank V. Turquand.[2]
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.”

Jervis C.J.held in the decision:
“The deed allows the directors to borrow on bond such sum or sums of money as shall from time to time, by a resolution passed at a general meeting of the company, be authorized to be borrowed and the replication shows a resolution passed at a general meeting, authorizing the directors to borrow on bond such sums for such periods and at such rates of interest as they might deem expedient, in accordance with the deed of settlement and Act of Parliament; but the resolution does not define the amount to be borrowed. That seems enough...We may now take for granted that the dealings with these companies are not like dealings with other partnerships, and the parties dealing with them are bound to read the statute and the deed of settlement. But they are not bound to do more. And the party here on reading the deed of settlement, would find, not a prohibition from borrowing but permission to do so under certain conditions. Finding that the authority might be made complete by a resolution, he would have a right to infer the fact of a resolution authorizing that which on the face of the document appear to be legitimately done.”

one of the earliest cases that applied the Turquand’s Rule was Mahony v. East Holyford Mining Co.[3]The Company’s bank, in this case, made payments based on a formal resolution of the board that authorized payments of cheques if signed by any two of the three named ‘directors’ and includes the signature of the ‘secretary’ as well. In the instant case, the copy was signed by the secretary. It was later found out that neither the directors nor the secretary had been formally appointed. As per the Articles, the directors had to be nominated by the subscribers to the memorandum while the manner of the signing of the cheques in a manner determined by the board. The House of Lords held that the bank did not have to enquire further as the bank had received a formal notice in an ordinary way. The Turquand’s Rule has gained statutory recognition in Section 9 (1) of the European Communities Act, 1972.

Section 20(7) of the Companies Act, 2013 makes a mention of this. There are various Indian case laws that approved and followed the rule. In Lakshmi Ratan Cotton Mills Co. Ltd v. J.K Jute Mitts Co. Ltd[4], again the plaintiff sued the defendant company on a loan where the defendant pleaded that the transaction was not binding as no resolution had been passed to that effect by the Board of Directors. The court held: “If it is found that the transaction of loan into which the creditor is entering is not barred by the charter of the company or its articles of association, and could be entered into on behalf of the company by the person negotiating it, then he is entitled to presume that all the formalities required in connection therewith have been complied with. If the transaction in question could be authorized by the passing of a resolution, such an act is a mere formality. A bona fide creditor, in the absence of any suspicious circumstances, is entitled to presume its existence. A transaction entered into by the borrowing company under such circumstances cannot be defeated merely on the ground that no such resolution was in fact passed. The passing of such a resolution is a mere matter of indoor or internal management and its absence, under such circumstances, cannot be used to defeat the just claim of a bona fide creditor. A creditor being an outsider or a third party and an innocent stranger is entitled to proceed on the assumption of its existence and is not expected to know what happens within the doors that are closed to him. Where the Act is not ultra vires the statute or the company such a creditor would be entitled to assume the apparent or ostensible authority of the agent to be a real or genuine one. He could assume that such a person had the power to represent the company, and if he, in fact, advanced the money on such assumption, he would be protected by the doctrine of internal management.”

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
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 Co.[5]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.

Exceptions To Doctrine of Indoor Management
In following circumstances relief of indoor management cannot be claimed by an outsider who is dealing with the company.

Where the outsider had knowledge of irregularity– The rule will not apply if the person dealing with the company has slight knowledge about the lack of authority of person who is acting on behalf of the company in this situation the doctrine will not apply. In case this ‘outsider’ has actual knowledge of irregularity within the company, the benefit under the rule of indoor management would no longer be available. In fact, he/she may well be considered part of the irregularity.

In the case of Howard v. Patent Ivory Co.[6], the directors cannot borrow more than 1000 pound without the consent of the company’s annual general meeting. Directors borrowed 3500 pound without the consent of annual general meeting from another director who took debentures. Now as the plaintiff is director than he has the knowledge about the internal irregularity. Held- the debentures are good only for the 1000 pounds only because the plaintiff (director) has the knowledge of the internal irregularity.

No knowledge of memorandum and articles-Again, the rule cannot be invoked by a person on the ground that he doesn’t have the knowledge of memorandum and articles and thus he did rely on them.

In the case of Rama Corporation v. Proved Tin & General Investment Co.[7],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.

Forgery-The rule does not apply where a person relies upon a document that turns out to be forged since nothing can validate forgery. A company can never be held bound for forgeries committed by its officers. The rule does not apply to the transaction involving forgery or illegal or transactions which are void ab initio.In the case of the forged transaction there is lack of consent. Here the question of consent cannot arise as the person whose signature is forged he is not even aware of the transaction.

In the case of Rouben v. Great Fingal Consolidated,[8]–Here the secretary of the company forged the signature of two of the directors and issued the certificate without the authority. The issue of certificate requires the sign of two directors as given in the article. Held- here the holder of certificate cannot take the advantage of the doctrine as it was forged transaction which is void ab initio.

In the case of Kreditbank Cassel v. Schenkers Ltd,[9]–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.

Negligence-The doctrine of indoor management, in no way, rewards those who behave negligently. Thus, where an officer of a company does something which shall not ordinarily be within his authority, the person dealing with him must make proper enquiries and satisfy him as to the officer’s authority. If he fails to make an enquiry, he is estopped from relying in the rule.

If, with a minimum of effort, the irregularities within a company could be discovered, the benefit of the rule of indoor management would not apply. The protection of the rule is also not available where the circumstances surrounding the contract are so suspicious as to invite inquiry, and the outsider dealing with the company does not make proper inquiry.

In the case of B. Anand Behari Lal v. Dinshaw& Co. (Bankers) Ltd.,[10]an accountant of a company in favour of Anand Behari. on an action brought by him for breach of contract, the court held the transfer to be void. It was observed that the power of transferring immoveable property of the company could not be considered within the apparent authority of an accountant.
The doctrine will not apply where the question is in regard of to the very existence of an agency.
In the case of Varkey Souriar v. Leraleeya Banking Co. Ltd [11] the Kerala High Court held that the doctrine of Indoor management cannot apply where the question is not one as to scope of the power exercised by an apparent agent of a company but is in regard to the very existence of the agency.

This doctrine is also not applicable where a pre-condition is required to be fulfilled before company itself can exercise a particular power. In other words, the act done is not merelyultra viresthe directors/officers butultra viresthe company itself.[12]

How Indian Judiciary Has Interpreted This Doctrine?
In the case of Lakshmi Ratan Cotton Mills Co. Ltd, v. J. K. Jute Mitts Co.Ltd, [13]the company of plaintiff sued defendant’s company for the total amount of Rs.1, 50,000. The defendant company raised the argument that no such resolution sanctioning the loan was passed by the board of director, thus it is not binding on the company.

The court held that-“If it is found that the transaction of loan into which the creditor is entering is not barred by the charter of the company or its articles of association, and could be entered into on behalf of the company by the person negotiating it, then he is entitled to presume that all the formalities required in connection therewith have been complied with. If the transaction in question could be authorized by the passing of a resolution, such an act is a mere formality. A bona fide creditor, in the absence of any suspicious circumstances, is entitled to presume its existence. A transaction entered into by the borrowing company under such circumstances cannot be defeated merely on the ground that no such resolution was in fact passed. The passing of such a resolution is a mere matter of indoor or internal management and its absence, under such circumstances, cannot be used to defeat the just claim of a bona fide creditor. A creditor being an outsider or a third party and an innocent stranger is entitled to proceed on the assumption of its existence ; and is not expected to know what happens within the doors that are closed to him. Where the act is not ultra vires the statute or the company such a creditor would be entitled to assume the apparent or ostensible authority of the agent to be a real or genuine one. He could assume that such a person had the power to represent the company, and if he in fact advanced the money on such assumption, he would be protected by the doctrine of internal management.”[14]

In the case of official Liquidator, Manasube & Co. (P.) Ltd. V. Commissioner of Police,[15]
It is expected from the person that he will read the article and memorandum when he enters into a contract with the company but it is highly unlikely that he will also check the legality, propriety and regularity of acts of directors.

In recent judgment Indian courts had broadened the scope of the doctrine. The object is still same, to protect the third party who acted in good faith with the company and is unaware of the internal management of the company.

Does The Doctrine of Indoor Management Apply To Government Authorities?
In the case of MRF Ltd. v. ManoharParrikar[16]the Supreme Court has first time analyzed the doctrine of indoor management in some detail. The case is related to the public law but a reference was made to the doctrine of indoor management to draw an analogy.

In this case notification issued by State Government for granting rebate of 25 per cent in Tariff in respect of the power supply to the Low Tension and High Tension Industrial Consumers was rescinded by another Notification issued at instance of Ministry of Power – Legality of the notifications challenged on grounds that they were not issued in compliance with the requirements of Article 154 read with Article 166 of the Constitution of India and the Business Rules of the Government of state framed by the Governor. Decision taken at ministers level without submitting it to council of misters or chief minister without obtaining concurrence of finance department, and notifications issued pursuant to ministers decision, so it was held that it is not sustainable in law.

A decision can be treated as the decision of the government only when decision satisfies requirements of with Rules of business framed under Art. 116(3)/77(3). Decision having financial implications, if taken by a minister without seeking concurrence of finance department as provided by with Rules of business, cannot be treated as decision of state government as a whole under article 154. So notifications issued pursuant to ministers decision so taken, are void ab initio and all actions consequent thereto are null and void.

“Doctrine of indoor management is in direct contrast to doctrine of constructive notice which is essentially a presumption operating in favour of the company against the outsider. It prevents the outsider from alleging that he did not know the constitution of the company rendered a particular delegation of authority ultra-vires. Doctrine of indoor management is an exception to rule of constructive notice. It imposes an important limitation on doctrine of constructive notice. According to this doctrine, persons dealing with company are entitled to presume that internal requirements prescribed in the memorandum and articles have been properly observed. Therefore, doctrine of indoor management protects outsiders dealing with the company, whereas doctrine of constructive notice protects the insiders of a company or corporation against dealings with outsiders. However, suspicion of irregularity has been widely recognized as an exception to doctrine of indoor management. Protection of doctrine is not available where the circumstance surrounding is suspicious and therefore invites inquiry.
Applying the exception to the present scenario, there is sufficient doubt with regard to conduct of power minister in issuing notifications. Therefore there is a definite suspicion of irregularity which renders doctrine of indoor management inapplicable to the present case”[17]

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. 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.

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 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 given time.
In Oakbank Oil Co. v. Crum[18],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.

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.[19]

The Courts in India have also been reluctant in applying the doctrine of constructive liability. The Allahabad High Court in Dehradun Mussoorie Electric Tramway Co. Jagamanandaradas [20]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.

Conclusion
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[21].

In the case of MRF Ltd. v. ManoharParrikar[22]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. But it compulsory that he should be aware of the memorandum and articles of the company, in order to take this remedy. The government authorities also come under the purview of this doctrine. As we have discussed in the case of MRF Ltd. v. Manohar Parrikar[23]there was a definite suspicion of irregularity which is also an exception of doctrine of indoor management.

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

Websites:
·https://www.scribd.com/doc/138206161/Doctrine-of-Indoor-Management-and-Ultra-Vires
·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-and-doctrine-of-indoor-management-2395-1.html

End-Notes
[1]Pacific Coast Coal Mines Ltd. V. Arbuthnot, 1917 AC 353
[2](1856) 119 E.R 886
[3][1875] LR 7 HL 869.
[4]AIR 1957 All 311
[5](1875) LR 7 HL 869
[6](1888) 38 Ch D 156
[7](1952) 1 All. ER 554
[8](1906) AC 439
[9](1927) 1 KB 826
[10]AIR 1942 Oudh 417
[11](1957) 27 Comp. Cas. 591 (Ker.)
[12]Pacific Coast Coal Mines Ltd. V. Arbuthnot, 1917 AC 353
[13]AIR 1957 All 311
[14]Ibid
[15][1968]38 Comp. cas 884 (Mad)
[16](2010) 11 SCC 374
[17]Ibid
[18]1882 8 A.C.65
[19](1856) 6 E&B 327
[20]AIR 1932 All. 141
[21]http://indiacorplaw.blogspot.in/2010/06/ostensible-authority-and-indoor.html
[22]( 2010 ) 11 SCC 374
[23]( 2010 ) 11 SCC 374

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