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Doctrine Of Constructive Notice And Indoor Management

Section 2 (20) of Companies Act, 2013 Company means a company incorporated under this Act or under any previous company law.

The word company has no strictly technical or legal meaning. A body corporate or corporation includes a company incorporated outside India, but does not include a co-operative society registered under the law relating to co-operative societies, and anybody corporate which the Central Government may, by notification, specify for this purpose. Company is derived from two words: com-group and companies-bread. Therefore, it means group that eat their bread together.

The company is given the status of an artificial person. The memorandum and articles of association, of a company, contemplates the documents, which sets out the objects and powers of a company. These documents are accessible to the people either without any costs or on payment of a nominal amount. Therefore, any person who enters into a contract with the company is thus presumed to have inspected such documents and thus to be aware of the powers that are being delegated to the directors.

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 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.

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
It means the memorandum of association of a company as originally framed or as altered from time to time in pursuance of any previous company's law or of this Act. According to Palmer, the memorandum of association is a document of great importance in relation to the proposed company. 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 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.

In the case of Oakbank Oil Co. v. Crum1
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.

Constructive Notice Of Memorandum And Articles Of Association

The memorandum and articles of association of every company are registered with the Registrar of the 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 the 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 same position as if he had read them. He will be presumed to know the contents of those documents. This kind of presumed notice is called constructive notice.

The 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 constructive notice not merely of the memorandum and articles, but also of all the documents, which are required by the Act to be registered with the Registrar. According to Palmer, the principle applies to documents which affect the powers of the company.

One of the suggested approaches is that all documents which are open to public inspection should be regarded as public documents. This is in keeping with the disclosure philosophy of company law and things which are required to be disclosed in a public office, should have public effects and should be usable as instruments of public accountability. In reference to the document containing particulars of directors it has been held that it becomes a public document. Persons dealing with the company would be deemed to have constructive notice as to who are the directors of the company.

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.

Effects:
The effect of the doctrine of constructive notice may be summed up as follows:
  1. Ultra Vires Acts

    According to doctrine of constructive notice, every person dealing with the company is presumed to have the knowledge of the contents of the memorandum and therefore if an act is ultra vires the company, he cannot claim relief on the ground that he was unaware of the fact that the act is beyond the memorandum (i.e., ultra vires the company). In India, the outsider dealing with the company is presumed to have the knowledge of the contents of the memorandum and therefore if an act is found to be ultra vires, he cannot claim relief on the ground that he had no knowledge that the act was beyond memorandum, and therefore, ultra vires.

  2. Acts Beyond The Authority Of Directors

    If there is lack of authority of the directors or other agents of the company, it is evident from the public documents like articles and other regulations, the person dealing with the company will be presumed to have the notice of the lack of authority and therefore he cannot hold company bound by the act of the directors or other agents. For example, if the articles require a bill to be signed by two directors, a person dealing with the company is under the duty to see that it has been signed by the two directors; otherwise he cannot enforce the bill against the company. But if the lack of authority of the directors or agents is not evident from the public documents, he cannot be presumed to have the notice of the lack of the authority and therefore he can held company bound by the act of the directors or other agents if he honestly thinks that the director or the agent with who he is negotiating is authorized to act on the behalf of the company. For example, where the articles require the directors to take the consent of the shareholders by ordinary resolution for exercising thereof the borrowing powers but they borrow money without taking such consent, the borrowing will be binding on the company if the creditor has no notice of the fact that the directors negotiating with him have not taken such consent.

  3. Inconsistent Agreements

    Person dealing with the company is presumed to have the notice of the contents of the articles and consequently he cannot make a contract with the company which purports to override any rights created by the articles. The doctrine of constructive notice protects the company but not the outsider dealing with the company. Sometimes the doctrine creates much hardship for the outsiders. They are presumed to have the knowledge of the public documents like the memorandum of the company but in practice it is very difficult and time taking to have the complete knowledge of them before making any contract with the company. Thus, the doctrine is inconvenient and unreal. It has failed to take the realities of business life. On account of its evil the doctrine has not been taken seriously both in India and UK. In England, the doctrine has been abrogated by the Europeans Communities Act, 1997.

  4. Doctrine Of Indoor Management

    Indoor Management restricts the operation of constructive notice to the public documents of the company. The role of the doctrine of indoor management is opposed to that of the rule of constructive notice. Accordingly, a person dealing with the company is bound to read only the public documents. If his contract is consistent with them, the company is bound. He will not be affected by any irregularity in the internal management of the company.

    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.

    The foundation of the rule was laid down in the case of Royal British Bank v. Turquand2 Turquand, a company, had a clause in its constitution that allowed the company to borrow money once it had been approved and passed by resolution (decision) of the shareholders at a general meeting. Turquand entered into a loan with the Royal British Bank and two of the co- directors signed and attached the company seal to the loan agreement. Loan had not been approved by the shareholders. Company defaulted on their payments and the bank sought restitution. Company refused to repay claiming that the directors had no right to enter into such an arrangement. It was held that the Turquand was entitled to assume that the resolution was passed. The Company was therefore bound by the rule. Doctrine is also popularly known as the Turquand rule'.

    The doctrine of indoor management is based on the policy of public convenience and justice. The reason as to why such doctrine is needed is that the internal procedure, which happens within the company, is not a matter of public knowledge. Therefore, though any outsider is presumed to be aware of the documents which are publically accessible, but not of the internal proceedings of which he cannot be reasonably aware of because those are not accessible to the public.

    The rule is based upon obvious reasons of convenience in business relations. The memorandum and articles of association are public documents. But the details of internal procedure are not thus open to public inspection. 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. Thus, the doctrine of constructive notice and indoor management go hand in hand. On one hand, the doctrine of constructive notice protects the company from the outsiders; on the other hand, the principal of indoor management offers protection to the outsiders while dealing with the affairs of the company. The doctrine of constructive notice comes into picture when an outsider fails to inquire about the company. However, the doctrine of indoor management can be invoked by any outsider dealing with the company and cannot be invoked by the company.

Exceptions To The Rule

The doctrine of indoor management has been used for almost a century now. Since in the modern world, the companies extended their roles to various social and political spheres, therefore the scope of this doctrine was widened.

Since the scope was widened, the chances of its misuse also increased, so the courts came up with following exceptions to this rule:
  1. Knowledge Of Irregularity:

    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. This exception covers situations where the person dealing with a company is aware of the irregularities which are present in internal management.

    Such knowledge can be either by actual or constructive notice, and the person thus cannot claim the benefit under the rule of indoor management. This exemption can be better understood, by considering the case of T.R. Pratt (Bombay) Ltd. v. E.D. Sassoon & Co. Ltd wherein one company lent some money to another company on a mortgage of its assets. However, the procedure which was necessary to comply before such transaction, was not complied with.

    The directors of the two companies were the same. The court thus held that since the lender had notice of the irregularity, the doctrine could not be invoked and hence the mortgage was not binding. The transfer was approved by two directors, and the transferor was aware of the fact that one of the directors was not validly appointed, and the other was disqualified being the transferee himself. Hence, the court held that the transfer was ineffective.

  2. Negligence:

    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.

    The person cannot invoke this doctrine if the person, who is entering into a contract with the company, has not enquired prudently and has not made proper inquiries, because of which he is not aware of the irregularity. If he would have conducted proper inquiries, then would have known that irregularity exists, and hence it is because of his own fault that he is unaware of the irregularity.

    This exception also covers the situation where the situations surrounding the contract were so suspicious that a prudent person would have made an inquiry, but the concerned person has not done so and hence is not entitled to claim the benefit of the doctrine.

    This exception could be better understood while referring to the case of Anand Bihari

    Lal v. Dinshaw & Co
    In this case, the plaintiff accepted a transfer of a company's property from its accountant. The court held that the transaction entered by the accountant was clearly beyond the scope of his authority, and hence the transfer was void. The plaintiff was reasonably expected to see the power of attorney executed in favour of the accountant before accepting such transfer by the accountant on behalf of the company.

  3. Forgery:

    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. The doctrine of internal management cannot be used to validate transactions in which the person relies on a document which has been forged. The leading case on this point is of Shri Kishan Rathi v. Mondal Brothers and Co. (P.) Ltd.

    In this case, the plaintiff was the transferee of a share certificate issued under the seal of the defendant company. The certificate which was issued contained the seal of the company and forged signatures of two directors, and such forgery was done by the company's secretary.

    It was being argued by the plaintiff that the matter regarding the genuineness of the signature is a part of internal management, and thus, such forgery of the signature cannot be contended by the company. But the court held that the doctrine of indoor management cannot be extended to validate and cover forgery cases. The court also said that this doctrine applies to irregularities which might affect a genuine transaction and not to forgery.

  4. Representation Through Articles:

    This exception deals with the most controversial and highly confusing aspect of the doctrine of indoor management. Articles of association generally contains what is called the power of delegation. The case in which the meaning and effect of a delegation clause has been explained is the case of Lakshmi Ratan Cotton Mills v. J.K. Jute Mills was a director of a company. The company had managing agents of which also G was a director.

    The article of association, empowered the directors to borrow money and to further delegate this power to any of them. G borrowed a sum of money from the plaintiffs. The company argued that since there was no resolution of the board delegating the power to borrow to G, he was not authorized to borrow money and hence refused to be bound by the loan. But the court held that the company is bound to repay the loan.

Conclusion
The rule of constructive liability is an unrealistic doctrine. It expects each and every outsider not only to know the documents of the company but also presumes to understand the exact nature of documents, which is practically not possible, and thus, in my opinion, is a little unfavorable to the outsiders dealing with the company. However, in reality, the company is not known by the documents but by the people who represent it and deal with an outsider. Those who enter into contracts with the company usually do so, on the basis of goodwill and reputation of the persons representing the company rather than the documents of the company.

Hence, 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. In my opinion, the doctrine of indoor management is absolutely necessary for protecting the outsiders and forcing the company to fulfill their part of obligation in genuine transactions. This also needs to be implemented subject to certain exceptions and the same have been evolved by the courts. 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.

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