Doctrine of Indoor Management

By Aman Sachan, RMLNLU, Lucknow

Editor’s Note: The paper is on the topic of Indoor Management, which is a concept protecting good faith action on behalf of a person contracting with a company. The analysis is furthered by looking at how the Indian Judiciary has looked at the concept.

INTRODUCTION

The doctrine of indoor management was evolved 150 years ago. It is also known as Turquand’s rule. The role of the doctrine of indoor management is opposed to the role of the doctrine of constructive notice.  The doctrine of constructive notice protects the company against outsiders whereas the doctrine of indoor management protects outsiders against the actions of the 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 the 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 the obvious reason of convenience in business relations. Firstly, the articles of association and memorandum are public documents and they are open to the 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 the 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 the 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 entitled 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.”  

Sections 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.” [3]

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.[4] 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 whether the 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 the doctrine of indoor management

In the following circumstances, relief of indoor management cannot be claimed by an outsider who is dealing with the company.

  1. Where the outsider had knowledge of irregularity – The rule will not apply if the person dealing with the company has a slight knowledge about the lack of authority of the person who is acting on behalf of the company in this situation the doctrine will not apply.

    In the case of Howard v. Patent Ivory Co.[5], the directors cannot borrow more than 1000 pound without the consent of the company’s annual general meeting. Directors borrowed 3500 pounds without the consent of annual general meeting from another director who took debentures. Now as the plaintiff is a director that 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

  1. 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.[6], the X who was the 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 the company had never delegated its power to X.

    Held– the plaintiff cannot take the remedy of the indoor management as they even don’t that power could be delegated.

  1. Forgery- 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 a 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,[7]–  Here the secretary of the company forged the signature of two of the directors and issued the certificate without the authority. The issue of the certificate requires the signatures of two directors as given in the article. Held- here the holder of the 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,[8]– a bill of exchange signed by the manager 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 favor of a payee to whom the manager 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.

  1. 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 inquiries and satisfy him as to the officer’s authority. If he fails to make an inquiry, he is estopped from relying on the rule.

    In the case of  B. Anand Behari Lal v. Dinshaw & Co. (Bankers) Ltd.,[9] an accountant of a company in favor 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 immovable property of the company could not be considered within the apparent authority of an accountant.

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

    In the case of Varkey Souriar v. Leraleeya Banking Co. Ltd[10] the Kerala High Court held that the doctrine of Indoor management cannot apply where the question is not one as to the scope of the power exercised by an apparent agent of a company but is in regard to the very existence of the agency.

  1. This doctrine is also not applicable where a pre-condition is required to be fulfilled before the company itself can exercise a particular power. In other words, the act done is not merely ultra vires the directors/officers but ultra vires the company itself.[11]

How Indian judiciary has interpreted this doctrine:

In the case of Lakshmi Ratan Cotton Mills Co. Ltd, v. J. K. Jute Mitts Co. Ltd,[12]  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.”[13]

In the case of Official Liquidator, Manasube & Co. (P.) Ltd. V. Commissioner of Police:[14]

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 a recent judgment, Indian courts had broadened the scope of the doctrine. The object is still the 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. Manohar Parrikar [15]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 percent 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.

A decision was taken at ministers level without submitting it to the council of misters or chief minister without obtaining the concurrence of the 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).

The decision having financial implications, if taken by a minister without seeking the concurrence of finance department as provided by with Rules of business, cannot be treated as the 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 the doctrine of constructive notice which is essentially a presumption operating in favor 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. The doctrine of indoor management is an exception to the rule of constructive notice.

It imposes an important limitation on the doctrine of constructive notice. According to this doctrine, persons dealing with the company are entitled to presume that the internal requirements prescribed in the memorandum and articles have been properly observed. Therefore, the doctrine of indoor management protects outsiders dealing with the company, whereas the 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 the doctrine of indoor management. Protection of doctrine is not available where the circumstance surrounding is suspicious and therefore invite inquiry.

Applying the exception to the present scenario, there is sufficient doubt with regard to the 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”[16]

CONCLUSION

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 are some restriction imposed on it like forgery, third party having knowledge of irregularity, negligence, where the third party don’t read memorandum and articles and the doctrine will not apply where the question is regarding of to the very existence of the company.

The act done by governmental authorities in the course of their activities comes under the doctrine of indoor management[17]. In the case of MRF Ltd. v. Manohar Parrikar [18]the doctrine of indoor management does not apply on the 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.

CONTRIBUTION OF THE RESEARCHER

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[19] there was a definite suspicion of irregularity which is also an exception to the doctrine of indoor management.

Formatted on March 16th, 2019.

REFERENCES:

[1] Pacific Coast Coal Mines Ltd. V. Arbuthnot, 1917 AC 353

[2] (1856) 119 E.R 886

[3] Ram raghubir lal v. united refineries (Burma) Ltd. {AIR 1931 Rang 139}

[4] (1875) LR 7 HL 869

[5] (1888) 38 Ch  D 156

[6] (1952) 1All. ER 554

[7] (1906) AC 439

[8] (1927) 1 KB 826

[9] AIR 1942 Oudh 417

[10] (1957) 27 Comp. Cas. 591 (Ker.)

[11] Pacific Coast Coal Mines Ltd. V. Arbuthnot, 1917 AC 353

[12] AIR 1957 All 311

[13] Ibid

[14] [1968]38 Comp. cas 884 (Mad)

[15] ( 2010 ) 11 SCC 374

[16] Ibid

[17] http://indiacorplaw.blogspot.in/2010/06/ostensible-authority-and-indoor.html

[18] ibid

[19] ( 2010 ) 11 SCC 374

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