What is doctrine of “indoor management” ? Discuss with the help of decided cases.

What is doctrine of “indoor management” ? Discuss with the help of decided cases.

Category : Company Law

There are various principles in the corporate world that help determine the relationship which ensures the safety of various stakeholders in the company in the transactions that they undertake. The doctrine of indoor management is one such principle. The doctrine of indoor management was evolved 150 years ago. It is also known as Turquand’s rule. The other principle that is commonly referred to in this context is the principle of constructive notice.

The principle of constructive notice protects the company from frivolous claims by outsiders’. The third party cannot claim to not having been notified of the Company’s procedures or practices if they are a party to the MOA and the AOA. It is deemed to have been understood that a prudent person would have read the MOA and the AOA before agreeing to enter into an agreement with the company. The doctrine of constructive notice is limited to the external position of the company.

The role of doctrine of indoor management is opposed to of the role of doctrine of constructive notice.The doctrine of indoor management follows from the doctrine of ‘constructive notice’ laid down in various judicial decisions. The hardships caused to outsiders dealing with a company by the rule of‘constructive notice’ have been sought to be softened under the principle of ‘indoor management’. It affords some protection to the outsiders against the company.

The doctrine of constructive notice protects company against outsiders whereas the doctrine of indoor management protects outsiders against the actions of company. This doctrine also is a possible safeguard against the possibility of abusing the doctrine of constructive notice.

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.
Whereas the doctrine of constructive notice protects a company against outsiders, the doctrine of indoor management protects outsiders against the actions of a 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 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 obvious reason of convenience in business relations. Firstly, the articles of association and memorandum are public documents and they are open to 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.

INTRODUCTION

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

ORIGIN OF THE DOCTRINE

This doctrine was laid down in the case of Royal British Bank V. Turquand,

The directors of the company borrowed some money from the plaintiff. The article of 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 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 entitles 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 afterwards 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.”

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.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 that  whether 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 doctrine of indoor management

In 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 slight knowledge about the lack of authority of 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., the directors cannot borrow more than 1000 pound without the consent of the company’s annual general meeting. Directors borrowed 3500 pound without the consent of annual general meeting from another director who took debentures. Now as the plaintiff is director than 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 don’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., the X who was 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 company had never delegated their power to X. Held-  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 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,–  Here the secretary of the company forged the signature of two of the directors and issued the certificate without the authority. The issue of certificate requires the sign of two directors as given in the article. Held- here the holder of 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,– a bill of exchange signed by the manger 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 favour of a payee to whom the manger 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 enquiries and satisfy him as to the officer’s authority. If he fails to make an enquiry, he is estopped from relying in the rule.

In the case of  B. Anand Behari Lal v. Dinshaw & Co. (Bankers) Ltd.,an accountant of a company in favour 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 immoveable 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 of to the very existence of an agency.

In the case of Varkey Souriar V. Leraleeya Banking Co. Ltd the Kerala High Court held that the doctrine of Indoor management cannot apply where the question is not one as to 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 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.

How Indian judiciary has interpreted this doctrine

In the case of Lakshmi Ratan Cotton Mills Co. Ltd, v. J. K. Jute Mitts Co. Ltd,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 authorised 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.”

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

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 recent judgment Indian courts had broadened the scope of the doctrine. The object is still 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 the Supreme Court has first time analysed 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 per cent 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. Decision taken at ministers level without submitting it to council of misters or chief minister without obtaining concurrence of 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). Decision having financial implications, if taken by a minister without seeking concurrence of finance department as provided by with Rules of business, cannot be treated as 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 doctrine of constructive notice which is essentially a presumption operating in favour 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. Doctrine of indoor management is an exception to rule of constructive notice. It imposes an important limitation on doctrine of constructive notice. According to this doctrine, persons dealing with company are entitled to presume that internal requirements prescribed in the memorandum and articles have been properly observed. Therefore, doctrine of indoor management protects outsiders dealing with the company, whereas 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 doctrine of indoor management. Protection of doctrine is not available where the circumstance surrounding are suspicious and therefore invite inquiry.

Applying the exception to the present scenario, there is sufficient doubt with regard to conduct of power minister in issuing notifications. Therefore there is a definite suspicion of irregularity which render doctrine of indoor management inapplicable to the present case”

CONCLUSION

Doctrine of indoor management is evolved as a reaction of 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 arbitrary manner, there are some restriction imposed on it like forgery, third party having knowledge of irregularity, negligence, where third party don’t read memorandum and articles and the doctrine will not apply where the question is regard of to the very existence of the company. Act done by governmental authorities in the course of their activities comes under the doctrine of indoor management. In the case of MRF Ltd. v. Manohar Parrikar the doctrine of indoor management does not apply on 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.


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