In this blogpost, Sudhi Ranjan Bagri, Student, National Law Institute University, Bhopal, writes about what is the doctrine of indoor management, what is the doctrine of constructive notice and  the exceptions to the doctrine of indoor management.

Doctrine of constructive notice

The company is given the status of an artificial person. The memorandum and articles of association, of a company, contemplates the documents, which sets out the objects and powers of a company. These documents are accessible to the people either without any costs or on payment of a nominal amount. Therefore, any person who enters into a contract with the company is thus presumed to have inspected such documents and thus to be aware of the powers that are being delegated to the directors. In other words, every person dealing with the company is presumed to have read these documents and understood them in their true perspective.[1]

This doctrine operates on the assumption that people entering into contracts with the company will be sufficiently motivated to check the company’s constitution or other public documents to ensure that the transaction they are entering into is not only allowed but to determine whether there are any internal formalities that must be complied with.[2]

Indoor Management: an antithesis to constructive notice principle

The foundation of the rule of indoor management was laid down in the case of Royal British Bank v Turquand,[3] and the doctrine of ‘indoor management’ evolved as a partial exception to the doctrine of ‘constructive notice’.

In this case, the directors of a company borrowed money by issuing a bond. As per the articles of association of the company, they were authorized to do so subject to a special resolution in that behalf. But no such resolution was passed by the company. The court held that the company would still be liable to pay off the debts incurred, and the bank was entitled to assume that before borrowing money, the resolution was passed.

Professor Gower, summarizing the doctrine stated, “If the directors have the power and authority to bind the company but certain preliminaries are required to be gone through on the part of the company before that power can be duly exercised, and then the person contracting with the directors is not bound to see that all these preliminaries have been observed. He is entitled to presume that the directors are acting lawfully in what they do.”[4]

The doctrine of indoor management is based on the policy of public convenience and justice. The reason as to why such doctrine is needed[5] is that the internal procedure, which happens within the company, is not a matter of public knowledge. Therefore, though any outsider is presumed to be aware of the documents which are publically accessible, but not of the internal proceedings of which he cannot be reasonably aware of because those are not accessible to the public.

Thus, the doctrine of constructive notice and indoor management go hand in hand. On one hand, the doctrine of constructive notice protects the company from the outsiders; on the other hand, the principal of indoor management offers protection to the outsiders while dealing with the affairs of the company. The doctrine of constructive notice comes into picture when an outsider fails to inquire about the company. However, the doctrine of indoor management can be invoked by any outsider dealing with the company and cannot be invoked by the company.

Exceptions to the doctrine of indoor management

The doctrine of indoor management has been used for almost a century now. Since in the modern world, the companies extended their roles to various social and political spheres, therefore the scope of this doctrine was widened. Since the scope was widened, the chances of its misuse also increased, so the courts came up with following exceptions to this rule:

Knowledge of Irregularity

This exception covers situations where the person dealing with a company is aware of the irregularities which are present in internal management. Such knowledge can be either by actual or constructive notice, and the person thus cannot claim the benefit under the rule of indoor management.[6]

This exemption can be better understood, by considering the case of T.R. Pratt (Bombay) Ltd. v. E.D. Sassoon & Co. Ltd.[7], wherein one company lent some money to another company on a mortgage of its assets. However, the procedure which was necessary to comply before such transaction, was not complied with. The directors of the two companies were the same. The court thus held that since the lender had notice of the irregularity, the doctrine could not be invoked and hence the mortgage was not binding. The transfer was approved by two directors, and the transferor was aware of the fact that one of the directors was not validly appointed, and the other was disqualified being the transferee himself. Hence, the court held that the transfer was ineffective.

Negligence

The person cannot invoke this doctrine if the person, who is entering into a contract with the company, has not enquired prudently and has not made proper inquiries, because of which he is not aware of the irregularity. If he would have conducted proper inquiries, then would have known that irregularity exists, and hence it is because of his own fault that he is unaware of the irregularity. This exception also covers the situation where the situations surrounding the contract were so suspicious that a prudent person would have made an inquiry, but the concerned person has not done so and hence is not entitled to claim the benefit of the doctrine.

This exception could be better understood while referring to the case of Anand Bihari Lal v. Dinshaw & Co.[8]. In this case, the plaintiff accepted a transfer of a company’s property from its accountant. The court held that the transaction entered by the accountant was clearly beyond the scope of his authority, and hence the transfer was void. The plaintiff was reasonably expected to see the power of attorney executed in favour of the accountant before accepting such transfer by the accountant on behalf of the company.

Forgery

The doctrine of internal management cannot be used to validate transactions in which the person relies on a document which has been forged. The leading case on this point is of Shri Kishan Rathi v. Mondal Brothers and Co. (P.) Ltd.[9]. In this case, the plaintiff was the transferee of a share certificate issued under the seal of the defendant company. The certificate which was issued contained the seal of the company and forged signatures of two directors, and such forgery was done by the company’s secretary. It was being argued by the plaintiff that the matter regarding the genuineness of the signature is a part of internal management, and thus, such forgery of the signature cannot be contended by the company. But the court held that the doctrine of indoor management cannot be extended to validate and cover forgery cases. The court also said that this doctrine applies to irregularities which might affect a genuine transaction and not to forgery.

Representation through Articles

This exception deals with the most controversial and highly confusing aspect of the doctrine of indoor management. Articles of association generally contains what is called the “power of delegation”. The case in which the meaning and effect of a delegation clause has been explained is the case of Lakshmi Ratan Cotton Mills v. J.K. Jute Mills Co.[10]. One G was a director of a company. The company had managing agents of which also G was a director. The article of association, empowered the directors to borrow money and to further delegate this power to any of them. G borrowed a sum of money from the plaintiffs. The company argued that since there was no resolution of the board delegating the power to borrow to G, he was not authorized to borrow money and hence refused to be bound by the loan. But the court held that the company is bound to repay the loan.

Thus it can be said that the effect of a delegation clause is that a person who enters into a contract with an individual director of a company, with the knowledge that the board has power to delegate its authority to such an individual, he may assume that the power of delegation has been exercised, and thus can claim the benefit under this doctrine.

Acts outside the scope of apparent authority

This exception covers situations wherein, if an officer of a company enters into a contract with a third party and if the act of the officer is beyond the scope of his authority, the company is not bound by such act of the officer. So in these situations, the plaintiff cannot claim the protection of the doctrine of indoor management merely because under the Articles the power to do the act could have been delegated to him. The plaintiff can sue the company only if the power to act has in fact been delegated to the officer with whom he has entered into the contract.[11]

Conclusion

The doctrine of constructive notice doctrine expects each and every outsider not only to know the documents of the company but also presumes to understand the exact nature of documents, which is practically not possible, and thus, in my opinion, is a little unfavorable to the outsiders dealing with the company. However, in reality, the company is not known by the documents but by the people who represent it and deal with an outsider. Those who enter into contracts with the company usually do so, on the basis of goodwill and reputation of the persons representing the company rather than the documents of the company.

Hence, the courts have evolved the doctrine of indoor management as an opposite to the doctrine of constructive notice in order to protect the interests of the outsiders. In my opinion, the doctrine of indoor management is absolutely necessary for protecting the outsiders and forcing the company to fulfill their part of obligation in genuine transactions. This also needs to be implemented subject to certain exceptions and the same have been evolved by the courts.

[1] Narayana, ‘The Companies Act, 1956-Company Rules & Allied Laws’, First Ed., 2006, Alt Publications, Hyderabad.

[2] Lumb, R., ‘Corporate Personality’, 4 University of Queensland Law Journal 418 (1961-64).

[3] Royal British Bank v Turquand, (1856) 6 E&B 327.

[4] Paul L Davies, Gower’s Principles of modern Company law, p-222.

[5] Sealy & Hooley, ‘Commercial Law-Text, Cases and Materials’, Fourth Ed., 2009, Oxford University Press.

[6] Koessler, M. ‘The Person in Imagination or Persona Ficta of the Corporation’, 9 Louisiana Law Review 435 (1948-490.

[7] T.R. Pratt (Bombay) Ltd. v. E.D. Sassoon & Co. Ltd. ,AIR 1936 Bom 62.

[8] Anand Bihari Lal v. Dinshaw & Co., (1946) 48 BOMLR 293.

[9] Shri Kishan Rathi v. Mondal Brothers and Co. (P.) Ltd., AIR 1967 Cal 75.

[10]  Lakshmi Ratan Cotton Mills v. J.K. Jute Mills Co., AIR 1957 All 311.

[11] Koessler, M. ‘The Person in Imagination or Persona Ficta of the Corporation’, 9 Louisiana Law Review 435 (1948-490.