LAB Assignment on Doctrine of Indoor Management_10202123

8/8/2019 LAB Assignment on Doctrine of Indoor Management_10202123

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The satisfaction and euphoria that accompany the successful completion of any task would

be incomplete without mentioning the name of the people whose constant guidance and

encouragement has crowned all my efforts with success.

I would like to thank Prof. (Dr.) Prabir Kumar Pattnaik for giving me this opportunity

and guidance to prepare this report who have extended his co-operation and help for

completion of the report.

DOCTRINE OF INDOOR MANAGEMENT

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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.

ORIGIN OF THE DOCTRINE

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The rule had its genesis in the case ofRoyal 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."

FURTHER EMBELLISHMENT OF THE RULE

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

East Holyford 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 any such limitation on the powers of the directors, and shall be presumed to have

acted in good faith unless the contrary is proved."

PROVISIONS UNDER THE INDIAN COMPANIES ACT, 1956

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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,

notwithstanding that it may afterwards be discovered that his 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. Bona fide allottees 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 ofDiwan Singh v Minerva

Mills that

The allottees of the shares were contracting in good faith with the Company and they were

entitled to assume 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 this 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.

APPLICATION OF THE RULE BY THE INDIAN COURTS

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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,[ 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 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.

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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, havingbeen regularly appointed, have exercised an authority which could have been delegated to them

under the companys 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 impugned 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 Holdings 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.

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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 cant be claimed by 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

1. Knowledge of Irregularity: - The first and the 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 defendthe issue of debentures to themselves because they should have known that the extent to which

they were 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 afterthe 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 practiced by the other directors. A newly appointed

director entered into contracts of indemnity and guarantee with the company through a director

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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 fact that an officer is purporting to act in matter,

which is apparently outside the scope of his authority. Where, for example, as in the case of

Anand Bihari Lal v. Dinshaw & co., the plaintiff accepted a transfer of a companys 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 companys

property.

Similarly, in the case of Haughton & co v. Nothard, Lowe & Wills Ltd., where a person

holding directorship in two companies agreed to apply the money of one company in payment of

the debt to other, the court said that it was something so unusual that the plaintiff were put upon

inquiry to ascertain whether the persons making the contract had any authority in fact to make

it. Any other rule would place limited companies without any sufficient reasons for so doing,

at the mercy of any servant or agent who should purport to contract on their behalf.

3. Forgery: - Forgery may in circumstances exclude the Turquand Rule. The only clearillustration is found in the Ruben v Great Fingall Consolidates; here in this case the plaintiff

was the transferee of a share certificate issued under the seal of the defendants company. The

companys 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 estopped from denying genuineness

of the document. But, it was held, that the rule has never been extended to cover such a complete

forgery.

Lord Loreburn said: It is quite true 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

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they have no notice. But, this doctrine which is well established, applies to irregularities, which

otherwise might affect a genuine transaction. It cannot apply to Forgery.

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

highly confusing aspect of the Turquand Rule. Articles of association generally contain what is

called power of delegation. Lakshmi Ratan Lal Cotton Mills v J.K. Jute 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 authorized directors to borrow money and 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 loans. Even

supposing that there was no actual resolution authorizing G to enter into the transaction the

plaintiff could assume 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 anindividual, may assume that the power of delegation has been exercised.

The question of knowledge of Articles came up in the case ofRama 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 contract with the plaintiff company

under which he took a cheque from the plaintiffs. The companys 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

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contract with a company has no knowledge of the companys 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 estoppel. 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 estoppel 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

officer as possessing an authority. A person 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 articles provide. Articles 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 officer, 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 companys property from its accountant.

Since such a transaction is apparently beyond the scope of an accountants authority it was void.

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CONCLUSION

The case ofRoyal 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

the rigors of the Constructive Notice Doctrine. Its importance arises in situations in which the

third partys dealings are with some officer or agent other than the Board. The rule protects the

interest of the third party who transacts with the Company in good faith and to whom the

Company is indebted. The rule enunciated in the decision is often referred to as "Turquand's

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 interests of the partytransacting with the Directors of the Company. Applying the rule, now it can not 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 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. If we analyze the cases it is revealed

that the Turquand rule did not operate in a completely unrestricted manner. Firstly, it is inherent

in the rule that if the transaction in question could not in the circumstances have been validly

entered into by the company, then the third party could not enforce it. Secondly, the rule only

protected 'outsiders', that is persons dealing 'externally' with the company; directors, obviously,

were the very people who would be expected to know if internal procedures had been duly

followed. Thirdly, actual notice of the failure to comply fully with internal procedures precluded

reliance upon the rule. Fourthly, an outsider could not rely upon Turquand's Case where the

nature of the transaction was suspicious; for example, where the company's borrowing powers

were exercised for purposes which were wholly unconnected with the company's business and of

no benefit to the company.

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SOURCES/Bibliography

Paul L Davies, Gower's Principles 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 Companies Act, 1956.

MERCANTILE LAW by S.S Gulsan

MERCANTILE LAW by Sen & Mitra

www.wikipedia.com

www.google.com

www.ask.com

www.answers.com

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LAB Assignment on Doctrine of Indoor Management_10202123

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