Doctrine of Indoor Management

According to Indian law, relating to companies, a public company is governed by decisions of the Board of Directors which is entrusted with the duty to manage the company in the most efficient and transparent manner possible. The recent scenario where business scams are everywhere prospective shareholders feel insecure about investing in a particular company. Over the period years, the shareholders have devised tools to keep a check on the methods and practices adopted by the directors of the company for its internal management.  But to what extent one can adopt these tools to find these methods and practices is where the Doctrine of indoor management comes into play. There is the only possible presumption of the good intention of a company but the outsider dealing with the company cannot know complete information of the company. There is also the possibility to abuse the doctrine of constructive notice for the favour of the company if the doctrine of indoor management is not present. If this doctrine is not present, the company can easily escape the creditors by denying the authority of officials acting on behalf of it.  Thus these two are the main reasons for the courts to apply this doctrine. This article will give an insight into how and when this doctrine is applicable, exceptions to the application of the doctrine of indoor management and how Indian courts have evolved over time in applying this doctrine.

Introduction

The Doctrine of Indoor Management also known as Turquand’s rule is just opposed to the doctrine of Constructive notice. It is 150 years old concept. When the doctrine of constructive notice protects the company from outsiders this doctrine protects outsiders from the actions of the company and protects from abuse of the doctrine of constructive notice. This doctrine protects the person from internal irregularities and if the person acted in the good faith without knowing the internal arrangement of the company. However, the condition pertaining to this rule is that the person entering into a transaction with the company needs to satisfy that his proposed transaction is not inconsistent with the articles and memorandum of the company.

This doctrine is one of the fundamental principles of Corporate Law. Although Articles of Association and Memorandum of Association are provided for public display all members of the public are not shared with internal procedures that take place in the company. But it compulsory that outsiders should be aware of the memorandum and articles of the company, in order to take this remedy. The government authorities can also be brought within the purview of this doctrine.

Origin

This doctrine was introduced in the case of Royal British Bank v.Turquand[1].

The Articles of the company provided for the borrowing of the money on bonds. It required a necessary condition that a resolution is passed in the General Meeting. After receiving the loan the directors failed to pass the resolution and defaulted in the repayment of the loan. The shareholders claim that as there is no resolution passed so the company is not bound to pay the money. The company was held liable. The shareholders did not accept the claim since the resolution was not passed. It was held that the company shall be liable and the person dealing with the company is entitled to assume that there has been necessary compliance with internal management. It was held that Turquand can sue the company on strength of the bond as he was entitled to assume the General Meeting resolutions had been passed.

It was rightly quoted by Lord Hatherly that “Outsiders are bound to know the external position of the company but not bound to know its indoor management.”

Section 290 provides for the validity of acts of directors – Acts done by a person as a director shall be valid, notwithstanding that it may afterward be discovered that his appointment was invalid by reason or any defect or disqualification or had terminated by virtue of any provisions contained in this act or in the articles.

Provided that nothing in this Section shall be deemed to give validity to acts done by a director after his appointment has been shown in the company to be invalid or to have terminated.

“The object of the Section is to protect persons dealing with the company outsiders as well as members by providing that the acts of a person acting as director will be treated as valid although it may afterward be discovered that his appointment was invalid or that it had terminated under any provision of this act or the articles of the company.” [2]

The rule was endorsed in Mahony v. East Holyford Mining Co.[3]

In the case, the cheque was signed by two directors and countersigned by the secretary where neither the directors nor the secretary was appointed properly. It was however held that the person who received the cheque is entitled to the amount since the appointment of the directors is a part of internal management where the company is responsible. Also held that it was not fair to expect the person dealing with the company to enquire about it. This view also has been included in the legal provision of Section 176 of the Companies Act,2013 that the defects in the appointment of the director shall not invalidate the acts done by the company.

Exceptions to the Doctrine

There are certain exceptions under which the person dealing with the company cannot claim the benefit of this doctrine of indoor management.

  • Knowledge of Irregularity: If the person dealing with the company faced circumstances under which he actual or constructive notice of irregularity then this rule will not apply.

This rule was reinforced in the case of Howard v. Patent Ivory Manufacturing Company[4] where the articles of the company empowered the directors to borrow up to 1000 pounds and further power to raise the limit was given to General Meeting discussions. Without any resolution being passed the directors took 3500 pounds from one of the directors. Since the directors are expected to know that resolution has not yet been passed they cannot claim protection under the Turquand’s rule.

  • Suspicion of Irregularity: If any person dealing with the company is suspicious about the circumstances of the contract then he shall inquire into it. If no enquiry is made he cannot rely on this rule.

In the case of Anand Bihari Lal v. Dinshaw& Co[5]

When the plaintiff accepted a transfer of property from accountant the Court held that the plaintiff should have acquired a copy of the Power of Attorney to confirm the authority of the accountant & held transfer void.

  • Forgery: Transactions involving forgery are void ab initio since it is not the absence of free consent but no consent at all.

In Ruben v. Great Fingall Consolidated case[6]

The signature of the two directors and the secretary was required for a valid certificate. A person was issued a share certificate with a common seal of the company but the secretary signed his name and forged the signatures of the two directors. The person who was issued the share certificate contended that he was not aware of these happenings of forgery. Court held that the company is not liable for forgery done by its officers.

In another case of Kreditbank Cassel v. Schenkers Ltd.[7]

A bill of exchange signed by the manager of a company with his own signature under the words stated that he signed on behalf of the company. It was held to be forgery when the bill was drawn in favor of a payee to whom the manager was personally indebted. The bill was considered to be forged because it appeared to be falsely issued on behalf of the company in payment of its debt but actually was issued in payment of the manager’s own debt.

The articles of association and memorandum are public documents that are open to the public for inspection and hence an outsider is expected and presumed to have known the constitution of a company but what may or may not have taken place within the doors that are closed to him.[8]

  • No knowledge of memorandum of association and article of association – This rule cannot be invoked on the ground that the outsider did not have knowledge of memorandum and articles.

In the case of Rama Corporation v. Proved Tin & General Investment Co. [9]

The X who was the director of the company entered into a contract with Rama Corporation and took a cheque while appearing to act on behalf of the company. 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. Later it was found that the company had never delegated its power to X. It was held that the Rama Corporation cannot take remedy of the indoor management as they even don’t know that power could be delegated.

  • Negligence:  The doctrine of indoor management does not apply to persons acting negligently. Where an officer of a company does something which shall not ordinarily be within his authority the person dealing with the officer should take proper inquiries and satisfy him as to the officer’s authority. If not he is estopped from relying on the rule.

B.AnandBehari Lal v. Dinshaw& Co. (Bankers) Ltd., [10]

A transfer was made by an accountant of a company in favor of AnandBehari. When the action was brought by for breach of contract, the court held the transfer void. It was observed that the power of transferring immovable property of the company cannot be held within the apparent authority of an accountant.

  • This doctrine will not apply where the question is in regard to the very existence of an agency.

In the case of VarkeySouriar v. Leraleeya Banking Co. Ltd[11]The Kerala High Court held that the doctrine of Indoor management cannot apply when there arises a question as to the scope of the power exercised by an apparent agent of the company but is in regard to the very existence of the agency.

  • This doctrine will not be applicable if pre-condition is required to be fulfilled before the company itself can exercise a particular power. The act done is not merely ultra vires the directors or officers of the company but ultra vires of the company itself.[12]

Doctrine of Indoor Management and Indian Judiciary

Initially when this rule was brought about it was not accepted until approved by the House of Lords in Mahoney v. East Holyford Mining Co.[13].

In this case, it was contained in the company’s article that a cheque should be signed by 2 out of 3 directors along with the secretary. But the directors, in this case, were not properly appointed. The court held that whether the director was properly appointed or not does not affect the third party’s entitlement to receive the cheque as an outsider will presume that directors had been properly appointed.

In the case of Lakshmi Ratan Cotton Mills Co. Ltd v. J.K.Jute Mitts Co. Ltd.[14]

The company of the plaintiff sued the defendant’s company for a total amount of Rs. 1,50,000. The defendant company raised the argument that no such resolution of loan sanction was passed by the board of directors and the company cannot be binding on a contractual basis. However, 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 an assumption, he would be protected by the doctrine of internal management.”[15]

In the case of Official Liquidator, Manasube & Co. (P.) Ltd. V. Commissioner of Police[16]

It is expected by the courts from the outsider person that he will read the article and memorandum of association when he enters into a contract with the company but it is highly unlikely and not possible to expect that he will also check the legality, propriety, and regularity of acts of directors.

Recently the Indian courts have broadened the scope of the doctrine. Though the object is still the same i.e.to protect the third party acting in good faith from the company’s deceptive ways to hide the internal management of the company.

Conclusion

Thus at this point, we know this doctrine of indoor management was evolved as a counter-reaction to deal with the doctrine of constructive notice. By putting a bar on the doctrine of constructive notice protects the third party who acted in good faith towards the company. This doctrine is contrary to the doctrine of constructive notice acts to protect outsiders from the act of the company.

The doctrine of indoor management is evolved as a reaction to the doctrine of constructive notice. It puts a Barr 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 an arbitrary manner, there is some restriction imposed on it like forgery, the third party having knowledge of irregularity, negligence, where the third party doesn’t read memorandum and articles and the doctrine will not apply where the question is regarding of to the very existence of the company. Not only does it punish private companies but even the government authorities can be brought under its ambit. This doctrine protects the public in general from company directors’ misuse of power and authority. This doctrine has been applied to various cases subsequent to the Royal British bank case and generally in order to protect the parties transacting with the directors of the company. This doctrine cannot be applied in cases where actual notice of failure to comply with the internal procedures is issued.

Hence by analyzing the various aspects, its origin and exceptions we can understand how and where this doctrine can be applied to contracts entered with companies.

[1] (1856) 6 E & B 327.

[2]Ram Raghubirlal v. United refineries (Burma) Ltd, AIR 1931 Rang 139.

[3] (1875) LR 7 HL 869.6.

[4] (1888) 38 Ch D 156

[5] (1946) 48 BOMLR 293

[6] (1906) 1 AC 439.

[7](1927) 1 KB 826.

[8] Pacific Coast Coal Mines Ltd v. Arbuthnot, 1917 AC 353.

[9](1952) 1All. ER 554.

[10]AIR 1942 Oudh 417.

[11] (1957) 27 Comp. Cas. 591 (Ker.)

[12] Pacific Coast Coal Mines Ltd. v. Arbuthnot, 1917 AC 353.

[13](1875) LR 7 HL 869.

[14] AIR 1957 All 311

[15] Ibid.

[16](1968) 38 Comp cas 884 (Mad).

[17](2010) 11 SCC 374.

Questions

Q1. Does the doctrine of Indoor Management apply to government authorities?

In the case of MRF Ltd. Manohar Parrikar[17], the Supreme Court has for the first time analyzed the doctrine of indoor management in some detail. In this case, a notification issued by the State Government for granting a rebate of 25 percent in tariff for power supply to the low tension and high tension industrial consumers was rescinded by another notification issued by the Ministry of Power. When the legality of notifications was challenged, the exceptions of suspicion of irregularity to the doctrine rule were applied and the case was dismissed.

Q2. Can this doctrine be applicable if the MOA and AOA are not read?

This rule cannot be invoked on the ground that the outsider did not have knowledge of memorandum and articles.

Q3. Why Article of Association is called the doctrine of indoor management?

This 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.

Q4. What is the relevant provision for this doctrine in the Indian legal system?

Section 399 of the Companies Act, 2013 gives the legal foundation and frame to this doctrine.

Q5. Difference between Doctrine of constructive notice and indoor management?

The basic difference between both is the doctrine of constructive notice protects the company against outsiders and operates as an estoppel against the outsider whereas the doctrine of indoor management protects outsiders against the company.

References

  1. https://www.legaleraonline.com/articles/doctrine-of-indoor-management-under-the-indian-company-law
  2. https://indiankanoon.org/search/?formInput=doctrine%20of%20indoor%20management
  3. https://thefactfactor.com/facts/law/civil_law/company-law/exceptions-to-doctrine-of-indoor-management/13397/
  4. https://www.lexology.com/library/detail.aspx?g=469212cf-f6d8-458d-8a5d-2722c5d4ba99

Leave a Reply

Your email address will not be published. Required fields are marked *