Doctrine of Indoor Management

DOCTRINE OF INDOOR MANAGEMENT


Doctrine of Indoor Management also known as Turquand’s rule states the” Any

outsider dealing with the company is entitled to presume that internal requirements

prescribed in memorandum and articles have been properly observed.” The basic

objective of this doctrine is to protect the third party transacting with the Company in

good faith and being unaware of the complex internal management of the Company.

There are certain exceptions where the outsider cannot claim relief in name of the

doctrine of Indoor Management.

They are as follows:

• Where the outsider has knowledge of Irregularity

• Suspicion of Irregularity

• Forgery

• Representation through Articles

• Acts outside apparent authority

The gist of the rule is that persons dealing with limited liability companies are not

bound to enquire into their indoor management and will not be affected by

irregularities of which they had no notice.

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REVIEW OF THE TOPIC

According to DOCTRINE OF INDOOR MANAGEMENT “persons dealing with the

company are entitled to presume that internal requirements prescribed in

memorandum and articles have been properly observed”. A transaction has two

aspects, namely, substantive and procedural. An outsider dealing with the company

can only find out the substantive aspect by reading the memorandum and articles.

Even though he may find out the procedural aspect, he cannot find out whether the

procedure has been followed or not.

For example: A company may have borrowing powers by passing a resolution

according to its

memorandum and articles. An outsider can only found out the borrowing powers of

the company. But he cannot find out whether the resolution has in fact been passed or

not. The outsiders dealing with the company are presumed to have read and

understood the memorandum and articles and to see that the proposed dealing is not

inconsistent therewith, but they are not bound to do more; they need not inquire into

the regularity of the internal proceedings as required by the memorandum and articles.

They can presume that all is being done regularly.

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ORIGIN OF THE DOCTRINE

The rule had its genesis in the case of Royal Bank v Turquand. In this case the

Directors of the Company were authorized by the articles to borrow on bonds such

sums of money as should from time to time by a special resolution of the Company in

a general meeting, be authorized to be borrowed. A bond under the seal of the

company, signed by two directors and the secretary was given by the Directors to the

plaintiff to secure the drawings on current account without the authority of any such

resolution. Then Turquand sought to bind the Company on the basis of that bond.

Thus the question arose whether the company was liable on that bond.

The Court of Exchequer Chamber overruled all objections and held that the bond was

binding on the company as Turquand was entitled to assume that the resolution of the

Company in general meeting had been passed. The relevant portion of the judgment

of Jervis C. J. reads:

"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 to me 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 a permission to do so on 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."

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FURTHER EMBELLISHMENT OF THE RULE

The House of Lords further endeavored to explicate the Turquand Rule in the case of

Mahony v. East Hollyford Mining Co. The case is an excellent example of Court

drawing out qualifications to the rule.

In this case the company's bank made payments based on a formal copy of a

resolution of the board authorizing payments of cheques signed by any two of three

named "directors" and countersigned by the named "secretary". The copy was itself

signed by the secretary. It came out subsequently that neither the directors nor the

secretary had ever been formally appointed. According to the articles, the directors

were to be nominated by the subscribers to the memorandum and the cheques were to

be signed in such manner as the board might determine.

It was held by the House of Lords that since the bank had received formal notice in

the ordinary

Way of the board's decision, it was not bound to enquire further.

The Turquand's rule has also obtained statutory recognition in Section 9(1) of the

European

Communities Act, 1972, which reads.

“9. Companies.--(1) In favor of a person dealing with a company in good faith, any

transaction

decided on by the directors shall be deemed to be one which it is within the capacity

of the company to enter into, and the power of the directors to bind the company shall

be deemed to be free of any limitation under the memorandum or articles of

association; and a party to a transaction so decided on shall not be bound to enquire as

to the capacity of the company to enter into it or as to such any limitation on the

powers of the directors, and shall be presumed to have acted in good faith unless the

contrary is proved.”

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PROVISION UNDER THE INDIAN COMPANIES ACT,1956

The provision under the Indian Act which directly imbibes the Turquand rule is

section 290, which reads as under:

Section 290 – Validity of acts of directors: - Acts done by a person as a director shall

be valid, not withstanding that it may afterwards be discovered that this appointment

was invalid by reason of any defect or disqualification or had terminated by virtue of

any provision 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 to the company to be invalid or to have

terminated.

Another Provision which directly follows the above stated rule is section 81 of the

Indian Companies Act, 1956 which bears the heading ‘further issue of shares’.

Bonafide allot tees of shares are protected by the Doctrine of Indoor Management

under s-81. Illustrating upon the point the Punjab & Haryana High Court has avowed

in the case of Diwan Singh v Minerva Mills that

“That allot tees of the shares were contracting in good faith with the company and

they were entitled to assumed that the acts of the Directors in making allotments of

the shares to them are within the scope of their powers conferred upon them by the

shareholders of the company. They were not bound to enquire whether the acts of the

Directors which as in the case related to internal management had been properly and

regularly performed. Even when the Directors exceed their powers or infringe the

restrictions imposed upon them, the company may be bound for the outsider dealing

with the company is only required to see that the transactions are consistent with the

article. Strangers are justified in assuming that all matters of Indoor management have

been done regularly”.

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APPLICATION OF THE RULE BY THE INDIAN COURTS

The Turquand's rule has been approved and followed by Varadaraja lyengar J., in Varkey

Souriar Vs Keraleeya Banking Co. Ltd. In the following way:

" Coming to the alternative ground, it is no doubt true that where a company is regulated by a

memorandum and articles registered in some public office, persons dealing with the company

are bound to read the registered documents and to see that the proposed dealing is not

inconsistent therewith but they are not bound to do more. They need not enquire into the

regularity of the internal proceedings what -Lord Hatherley called 'indoor management'. So if

there is a managing director and authority in the articles for the directors to delegate their

powers to him, a person dealing with him may assume that it is within the ordinary duties of a

managing director. All he has to see is that the managing director might have power to do

what he purports to do. But the rule cannot apply where the question, as here, is not one 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."

In Lakshmi Ratan Cotton Mills Co. Ltd, v. J. K. Jute Mitts Co. Ltd, in the plaintiff

company sued the defendant company on a loan for Rs. 1,50, 000. Among other

things the defendant company raised the plea that the transaction was not binding as

no resolution sanctioning the loan was passed by the board of directors. The court,

after referring to Turquand's case and other Indian cases, 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

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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."

In case of Official Liquidator, Manasube & Co. (P.) Ltd. V. Commissioner of police

the learned judge observed that the lenders to a company should acquaint themselves

with memorandum and articles but they cannot be expected to embark upon an

investigation as to legality, propriety and regularity of acts of directors.

The rule is based upon obvious reasons of convenience in business relations. Firstly,

the memorandum and articles of associations are public documents, 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.” The wheels of commerce would not go round smoothly if persons dealing with

the company were compelled to investigate thoroughly “the internal machinery of a

company to see if something is not wrong.” People in business would be very shy in

dealing with such companies.

The rule is of great practical utility. It has been applied in a great variety of cases

involving rights and liabilities. It has been used to cover acts done on behalf of a

company by de facto directors who have never been appointed, or whose appointment

is defective, or who, having been regularly appointed, have exercised an authority

which could have been delegated to them under the company’s articles, but never has

been so delegated, or who have exercised an authority without proper quorum. Thus,

where the directors of company having the power to allot shares only with the

consent, something which he could do only with the approval of the board; where the

managing agents having the power to borrow with the approval of directors borrowed

without any such approval, the company was held bound.

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CONSEQUENCE OF THE RULE: RECENT DECISIONS

The Indian Courts in certain recent judgments have further broadened the scope of the

Doctrine of indoor management. The object being the same i.e. to protect the third

party transacting with the company in good faith and being unaware of the complex

internal management of the company.

In Monark Enterprises v Kishan Tulpule and Ors the company Board held- “That the

validity of the impunged transaction was not affected even if no resolution for

entering into it was actually passed by the board of the company as the company had

entered into and adopted the transaction throughout and implemented it after

receiving consideration thereof In YKM Holding Private Limited v Prayag T-Pac

Industries Limited and others

Even amalgamation of two companies is one limb of Indoor management. Therefore,

notice contemplated under Section 394A of the Act is required to be given only at the

stage when application under Section 394, of the Act is made to the court for

sanctioning the scheme and not any time prior thereto.

EXCEPTIONS TO THE RULE

The rule of Doctrine of indoor management is however subject to certain exceptions.

In other words, relief on the ground of ‘indoor management’ can’t be claimed but an

outsider dealing with the company in the following circumstances:

1. Where the outsider has knowledge of Irregularity

2. Suspicion of Irregularity

3. Forgery

4. Representation through Articles

5. Acts outside apparent authority

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1. Knowledge of Irregularity: - The first and most obvious restriction is that the rule

has no application where the party affected by an irregularity had actual notice of it.

Knowledge of an irregularity may arise from the fact that the person contracting was

himself a party to the inside procedure. As in Devi Ditta Mal v The Standard Bank

of India, where a transfer of shares was approved by two directors, one of whom

within the knowledge of the transferor was disqualified by reason of being the transfer

himself and the other was never validly appointed, the transfer was held to be

ineffective.

Similarly in Howard v. Patent Ivory Manufacturing Co. Where the directors could

not defend the issue of debentures to themselves because they should have known that

the extent to which they are lending money to the company required the assent of the

general meeting which they had not obtained. Likewise, in Morris v Kansseen, a

director could not defend an allotment of shares to him as he participated in the

meeting, which made the allotment. His appointment as a director also fell through

because none of the directors appointed him was validly in office.

But the Hely-Hutchinson v Brayhead Ltd., according to which the mere fact that a

person is a director does not mean that he shall be deemed to have knowledge of the

irregularities practiced by other directors. A newly appointed director does not mean

that he shall be deemed to have knowledge of the irregularities practice by other

directors. A newly appointed director entered into contracts of indemnity and

guarantee with the company through a director whom the company had knowingly

allowed to hold himself out as having the authority to enter into such transaction,

although in fact he had no such authority. The company was held liable.

2. Suspicion of Irregularity: - The protection of the Turquand Rule is also not available

where the circumstances surrounding the contract are suspicious and therefore invite

inquiry. Suspicion should arise, for example, from the act that an officer is purporting

to act in matter, which is apparently outside the scope of his authority. Where, for

example, as in case of Anand Bihari lal v. Dinshaw & Co., the plaintiff accepted a

transfer of a company’s property from its accountant, the transfer was held void. The

plaintiff could not have supposed, in absence of a power of attorney, that the

accountant had authority to effect transfer of the company’s property.

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3. Forgery: - Forgery may in circumstances exclude the Turquand Rule. The only clear

illustration is found in the Roben v Great Fingall Consolidate; here in this case the

plaintiff was the transferee of a share certificate issued under the seal of the

defendant’s company. The company’s secretary, who had affixed the seal of the

company and forged the signature of the two directors issued the certificate.

The plaintiff contended that whether the signature were genuine or forged was apart

of the internal management, and therefore, the company should be stopped from

denying genuineness of the document But, it was held, that the rule has never been

extended to cover such a complete forgery.

4. Representation through Articles:- The exception deals with the most controversial

and highly confusing aspect of the Turquand Rule. Articles of the association

generally contain what is called ‘power of delegation’. Lakshmi Ratan Lal Cotton

Mills v J.K. Mills Co. Explains the meaning and effect of a “delegation clause”.

Here one G was director of the company. The company had managing agents of

which also G was a director. Articles authorize directors to borrow money ans also

empowered them to delegate this power to any or more of them. G borrowed a sum of

money from the plaintiffs. The company refused to be bound by the loan on the

ground that there was no resolution of the board delegating the powers to borrow to

G. Yet the company was held bound by the loan. “even supposing that there was no

actual resolution authorizing G to enter into the transaction the plaintiff could

assumed that a power which could have been delegated under the articles must have

been actually conferred. The actual delegation being a matter of internal

management, the plaintiff was not bound to enter into that.”

Thus the effect of a “delegation clause” is “that a person who contracts with an

individual director of a company, knowing that the board has power to delegate its

authority to such an individual, may assume that the power of delegation has been

exercised.”

The question of knowledge of Articles came up in the case of Rama Corporation v

Proved Tin and General Investment Co, here; one T was the active director of the

defendant company. He, purporting to act on behalf of his company, entered into a

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contract with the plaintiff company under which he took a cheque from the plaintiffs.

The company’s article contained a clause providing that “the directors may delegate

any of their powers, other than the power to borrow and make calls to committees,

consisting of such members of their body as they think fit”. The board had not in fact

delegated any of their powers to T and the plaintiffs had not inspected the defendants

articles and, therefore, did not know of the existence of power to delegate. It was held

that the defendant company was not bound by the agreement. Slade J’, was of the

opinion that knowledge of articles was essential. “A person who at the time of

entering into a contract with a company has no knowledge of the company’s articles

of association, cannot rely on those articles as conferring ostensible or apparent

authority on the agent of the company with whom he dealt.” He could have relied on

the power of delegation only if he knew that it existed and had acted on the belief that

it must have been duly exercised.

Knowledge of articles is considered essential because in the opinion of Slade J; the

rule of ‘indoor management’ is based upon the principle of estoppels. Articles of

association contain a representation that a particular officer can be invested with

certain of the powers of the company. An outsider, with knowledge of articles, finds

that an officer is openly exercising an authority of that kind. He, therefore, contracts

with the officer. The company is estoppels from alleging that the officer was not in

fact authorized.

This view that knowledge of the contents of articles is essential to create an estopped

against the company has been subjected to great criticism. One point is that everybody

is deemed to have constructive notice of the articles. But Slade J brushed aside this

suggestion stating constructive notice to be a negative one. It operates against the

outsider who has not inquired. It cannot be used against interests of the company. The

principle point of criticism, however, is that even if the directors had the power to

delegate their authority. They would not yet be able to know whether the director had

actually delegated their authority. Moreover, the company can make a representation

of authority even apart from its articles. The company may have held out an officers

as possessing an authority. A persons believes upon that representation and contract

with him. The company shall naturally be estopped from denying that authority of that

officer for dealing on its behalf, irrespective of what the article provides. Articles

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would be relevant only if they had contained a restriction on the apparent authority of

the officer contained.

5. Acts outside apparent authority:- Lastly, if he act of an officer of a company is one

which would ordinarily be beyond the power of such an offer, the plaintiff cannot

claim the protection of the “Turquand rule” simply because under the articles power

to do the act could have been delegated to him. In such a case the plaintiff cannot sue

the company unless the power has, in fact been delegated to the officer with whom he

dealt. A clear illustration is Anand Behari Lal v Dinshaw here the plaintiff accepted a

transfer of a company’s property from its accountant. Since such a transaction is

apparently beyond the scope of an accountant’s authority’ it was void. Not even a

‘delegation clause’ in the articles could have validated it, unless he was, in fact,

authorize.

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The case of Royal British Bank v Turquand, refined the basic common law of

agency to articulate the Doctrine of Indoor Management. the rule was enunciated by

the court to mitigate to rigors of the constructive notice doctrine. its importance arises

in situation in which the third party's dealing are with some officer or agent other than

the board. the rule protects the third party who transact with the company in good

faith and to whom the company is indebted. The rule enunciated in the decision is

often referred to as "Tunquand Rule" and "Indoor management rule". the gist of the

rule is that persons dealing with limited liability companies are not bound to enquire

into their indoor management and will not be affected by irregularities of which they

had no notice. the rule enunciated in Turquand has been applied in many cases

subsequently and generally in order to protect the interest of the party transacting with

the Directors of the company. Applying the rule, now it cannot be argued that a

person having dealings with a company is deemed to have notice of who the true

Directors are, and this being shown by public documents i.e. the registers of the

directors required to be maintained by the company and the notices of changes.

With the due course of time several exceptions have also emerged out of the rule like

Forgery, negligence, third party having knowledge of irregularity etc.

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SOURCES:-

Paul L Davies, Grower's principle of modern company law

http://www.law.uvic..ca/mgillen/315/documents/ch20-ultravires_000.pdf

Cowan de Groot Properties ltd. v. Eagle Trust Plc(1991) BCLC 1045

Indian company Act, 1956

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Documents

Doctrine of Indoor Management