In this blog post, Tresa Ajay, a student of National University of Advanced Legal Studies, Kochi, who is currently pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, discusses in detail the Doctrine of Indoor Management in a Company. 

What is Doctrine of Indoor Management?

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. It is also popularly referred to 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 doctrine of indoor management protects the outsiders. If there is no notification as to a change in the internal dealings of the Company to the third party (usually subscribers) especially in the Memorandum and Articles of Association then the third party cannot be expected to know of such changes and any loss to such effect shall be made not be to the detriment if the business operates to protect the interests of the outsiders. This doctrine can be invoked by any person that is dealing with the company.

How Did The Doctrine Originate?

The rule gained recognition after it was mentioned in the case Royal Bank v. Turquand. The Articles of Association allowed the directors of the Company to borrow on bonds as the need be in a general meeting through a special resolution, only if they were authorized to do so. The Plaintiff was given a bond, with the seal of the company which was signed by two directors and the secretary to secure drawings on current account. This was however done without a resolution being passed to that effect. Turquand wanted to bind the company to the bond, and the question arose that if the company would be liable by that bond.

The Court of Exchequer Chamber held that the bond was binding as Turquand as an ordinarily prudent person would assume that the resolution had been passed in the general meeting and overruled all objections.

Jervis C.J. held in the decision:

“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 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 permission to do so under 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.”

One of the earliest cases that applied the Turquand’s Rule was Mahony v. East Holyford Mining Co.[1]The Company’s bank, in this case, made payments based on a formal resolution of the board that authorized payments of cheques if signed by any two of the three named ‘directors’ and includes the signature of the ‘secretary’ as well. In the instant case, the copy was signed by the secretary. It was later found out that neither the directors nor the secretary had been formally appointed. As per the Articles, the directors had to be nominated by the subscribers to the memorandum while the manner of the signing of the cheques in a manner determined by the board. The House of Lords held that the bank did not have to enquire further as the bank had received a formal notice in an ordinary way. The Turquand’s Rule has gained statutory recognition in Section 9 (1) of the European Communities Act, 1972.

Section 20(7) of the Companies Act, 2013 makes a mention of this. There are various Indian case laws that approved and followed the rule. In Lakshmi Ratan Cotton Mills Co. Ltd v. J.K Jute Mitts Co. Ltd[2], again the plaintiff sued the defendant company on a loan where the defendant pleaded that the transaction was not binding as no resolution had been passed to that effect by the Board of Directors. The court 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. 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.”

Application Of The Doctrine

There are several reasons why the doctrine continued to be applied and came to be accepted as one of the fundamental principles of Corporate Law. First, although the Articles of Association and Memorandum of Association are in public domain, all members of the public are not privy to the internal procedures that take place in the company and so cannot make informed decisions all the time. Second, there would be the great scope to abuse the doctrine of constructive notice if the doctrine of indoor management is not available. Thus, the courts of law continue to apply this theory.

There are certain exceptions to this rule, i.e. an outsider cannot claim protection under this in certain circumstances.

• Knowledge of irregularity: If the person contracting is a party himself to the inside procedure and had notice of it. In Morris v Kansseen[3], a director could not seek protection under the rule as he participated in the shareholder’s meeting that allotted the concerned shares.
• Suspicion of Irregularity: If circumstances surrounding the contract are suspicious and invite inquiry then, this rule cannot be applied. In Anand Bihari Lal v. Dinshaw& co[4], a transfer was held void in which the plaintiff accepted a transfer of a company’s property from its accountant. The defense supposed that the accountant had the authority to effect the transfer of the Company’s property.
• Forgery: In Ruben v Great Fingall Consolidates[5], the plaintiff’s contention was that whether the signature was forged or genuine came under the internal management of the company, and so the company should be stopped from denying the genuineness of the document. It was held that the rule could not be extended to cover a complete forgery.
• Acts outside apparent authority: If the officer acts beyond his scope of authority, then he cannot claim protection under the rule just because the articles allowed the delegation of power which authorized him to do the act. In the AnandBehari[6] The case, the plaintiff, was at fault as he accepted the transfer of the company’s property on the apparent authority of the accountant.

The doctrine of indoor management should not be used over extensively. A harmonious balance should try to be maintained to promote business transactions to third parties.

References

1. Doctrine of Indoor Management and its exceptions http://www.legalserviceindia.com/article/l203-Indoor-Management.html
2. Evolution to the Doctrine of Indoor Management, http://www.lawteacher.net/free-law-essays/company-law/evolution-of-the-doctrine-law-essays.php
3. Company Law Doctrines, Andrew R. Thompson http://www.jstor.org/stable/pdf/824437.pdf
4. Director’s Contracts. The rule in Turquand’s case, Kenneth Polack, http://www.jstor.org/stable/pdf/4505164.pdf?_=1469854783491

[1]1875] LR 7 HL 869.

[2]AIR 1957 All 311

[3][1946] 16 comp. Cas 186 ( HL)

[4]A.I.R. (1942) Oudh 417

[5][1906] A.C. 439

[6]A.I.R. (1942) Oudh 417