A COMPARITIVE STUDY ON DOCTRINE OF CONSTRUCTIVE NOTICE AND INDOOR MANAGEMENT

INTRODUCTION

In the Company law, it is important to understand Memorandum and Article of Association (MOA & AOA) if one wants to thoroughly want to understand Incorporation of a Company. MOA is the basic or root document of a company whereas AOA set the rule and regulation of the company and are covered under section 2(56)[1] & 2(5)[2] of the companies Act, 2013. Here, under Article Of Association  there are two important Doctrines, Doctrine of Constructive Notice and Doctrine of Indoor management. The former protects the company from the arbitrary actions of outsider and the latter protects outsiders from company’s arbitrary actions. Hence, these two doctrines work hand in hand to protect the interest of company and the person getting into a contract with the company. The doctrine keep a check and makes sure that none of the parties have unfair gains from a said contract. Therefore, it is sine qua non to study these two doctrine together to understand.

DOCTRINE OF CONSTRUCTIVE NOTICE

The Companies Act makes it necessary for the Memorandum and Article of Association to be registered with the Registrar of the Company within their jurisdiction. And as soon as they are registered they become “ Public Document” and can be inspected a person by paying a certain amount as fee under section 399[3]. As public document are open and accessible to whole of the public in general. Due to this it’s presumed that anyone dealing with the company has gone through these documents and has knowledge of the same and thus, it is the duty of the parties dealing with the company to through these documents before entering any contract. Therefore, whether someone read these documents or not will be treated as if he/she has read them and will be liable in the same sense.

Also, it presumed that the person under this doctrine has not only read the document but has also understood it properly not only the powers of the company but also the power of its officers.

It protects a company from being deceived by the other party, when the latter by citing their unawareness about the contents of MOA & AOA and evade their contractual liabilities arising out of a breach of contract.

In Oakbank Oil Co. V. Crum[4], it was decided that, “anyone dealing with the Company is presumed not only to have read the memorandum and Articles, but understood them properly. Thus, Memorandum and Articles of a company are presumed to be notice to the public. Such a notice is called Constructive notice”.

IMPACT OF DOCTRINE OF CONSTRUCTIVE NOTICE

The doctrine of constructive notice has a severe impact on the person who want to deal with a company. It put responsibility on the person on the person dealing or transacting with the company to go through all the public documents available. In Kotla Venkataswamy v. Rammurthy[5], In this case, A accepted a mortgage deed executed by B, a secretary who was a working director of the company. The Article of Association of the company specified that such a deed needs to be executed by three specific officers of the company and it shall not be valid otherwise. Therefore, they were denied any protection by the application of this doctrine.

Another implication of the said doctrine is that the person dealing with the company is presumed to have read all documents of the company available in the public domain and has understood them as well. Also, if an act of the company has been declared ultra-virus of the MOA and AOA, the person cannot take the defence of not being aware of the said provisions.

DOCTRINE OF INDOOR MANAGEMENT

To protect the third party from the Company using the Doctrine of Constructive Notice arbitrarily and evading their liabilities which it owes, the doctrine of indoor management was evolved. Where the Doctrine of Constructive notice protects the company when dealing with outsiders, the Doctrine of Indoor Management protects the third party dealing with the company from its illegal actions. The principle of Indoor management states that a person contracting with a company cannot be held liable or be compelled to gain knowledge of the internal functioning of the company and proceedings of the company in relation of the said contract.

“As the doctrine of constructive notice proved to be inconvenient for running company’s business, particularly where the directors or other officers of the company were empowered under the articles to exercise certain powers subject only to certain prior approvals or sanctions of the shareholders[6]”.

The stress on the notion that an outsider/ party who enters a contract in good faith and has presumed that there are no internal irregularities and all the procedural requirements have been observed by the company.

Once the Memorandum and Articles of Association become accessible to  public  and the person contracting with such a company must take a notice of these documents, but, this rule  is limited to the external position of the company and it can be inferred that, “the person will have no notice as to how the company’s internal machinery is handled by its officers”. Thus, the person  contracting with the company will not be held liable even when the transaction is inconsistent with the public documents, due to irregularities within the internal management of the company which render the transaction invalid.

**ORIGIN – The Doctrine of Indoor Management originated from the Famous English case of Royal British Bank V. Turquand[7], in the said case, “ the defendant Turquand, the official manager of the insolvent Cameron’s Coalbrook Steam, Coal and Swansea and Loughor Railway Company. The  directors of the borrowed some amount of money from the plaintiff (The Royal British Bank). Here, the directors of the company  were only authorised to borrow money from time to time as required, when a resolution of the company was passed in the general meeting. The defendants gave a bond to plaintiff without such authority. The issue emerged as to whether the company was liable on the bond ?”

The court of Exchequer upheld the decision of the Queen Bench and held,

“ That the bank was entitled to sue the company for the execution of the bond. As the matter of resolution was an internal affair and the plaintiff has the right to presume that there had been a resolution at a general meeting, authorising the borrowing the money on bond. As the third party dealing with a company is bound to know what he can know as a public person and nothing beyond that. Therefore, the Bank Couldn’t have known whether any such resolution had been passed by the company and  in good faith could assume that acts were within the company’s constitution and powers had been properly and duly performed. Hence, they were not bound to enquire whether acts of internal management have been regular or irregular.”

This was the first case that set out the doctrine of indoor management and, thus, this doctrine is also known as the Turquand Rule.

APPLICATION – Any party or person contracting with the company is expected to know about the irregularities found in the public document of the company, but, when the issue in question is a matter of internal management and regulation of the company. Here the doctrine indoor management comes into play and protect the third party from any losses caused due to internal regulation of the company. In the case of  Varkey Souriar v. Keraleeya Banking Co. Ltd[8], It was held that “when a person is transacting with a company, it is not important or necessary to conduct an inquiry about the internal matters of the company in furtherance of responsibility put on them through a public document. All is expected from them is to make sure that the person negotiating the business has the authority to do so”.

In another case, Lakshmi Ratan Cotton Mills Co. Ltd v. J.K. Jute Mills Co. Ltd[9], the plaintiff sued the defendant company for the non-payment of a loan of Rs. 1.5 Lakhs which was taken through a letter sanctioned by the Board of Directors. The standing of the court was similar to the Turquand case as it was held that “the company cannot be expected to be in knowledge of an internal rule of the debtor company. If a bargain is happening on behalf of the company, it shall be assumed that all the internal obligations for the same have been met by the officers of the company. The only aspect that a person needs to observe is whether the person proceeding on behalf of the company is the authorised person or not”.

EXCEPTIONS : There are certain exceptions to the application of Doctrine of Indoor Management and under these certain cases relief cannot be claimed.

  1. Knowledge Of Irregularity – If a person transacting with a company has the knowledge of the internal irregularity, he/she cannot take up the defence of doctrine of indoor management as to claim protection against such company when there is a breach of contract. In Howard V. Patent Ivory Co.[10], the director of the company had authority to borrow loan only up to £1000 without requiring any sanction passed in general meeting. Here the Directors were lent £3,500 by one of the directors without any sanction being passed and who took debentures in return. The court held, “The company would be liable for only £1,000. The Doctrine of indoor management could not be applied because the directors must have had the knowledge of the provision of AOA stating that a sanction needs to be passed to borrow sum exceeding £1,000. Hence, cannot claim ignorance and protection of the said doctrine.”
  2. Negligence In Suspicion Of Irregularity – Where a person is suspicious or doubtful about the existence of an irregularity and yet he/she does not make a proper inquiry of the same. Later if such internal irregularity comes into picture, they cannot claim the benefit of the Doctrine of indoor management. Also, the protection of the said doctrine cannot be claimed if the conditions surrounding the contract with the company are dubious in nature and yet, the person does not conduct a proper inquiry for same to prevent any kind of fraud or loss. In Anand Bihari Lal V. Dinshaw & co.[11], here the plaintiff transfer of a company’s property from it’s accountant. The court held such a transfer void and it was beyond the scope of  the powers of an accountant because in ordinary course of business a company does not allow an accountant to transfer its properties. Hence, it was the duty of the plaintiff due be more vigilant and the protection under the Doctrine of indoor management was not provided to him.
  3. Forgery –  The protection under the doctrine of indoor management does not extend to dealings or contract that have taken place due to forgery or otherwise are void ab initio. Here, in the case of forgery there is no consent at all as the person whose signature are forged may not even be aware of any deal such being made. Here, the its not the title of the person that is defective but there no existence of any title at all. In Ruben V. Great Fingal Consolidated[12], in the said case a secretary of a company forged signatures of two directors of a company which is a necessary condition mentioned under AOA to issue a share certificate. The secretary issued share certificate under the name of the two directors without their knowledge to the applicants. Hence, the applicants were refused registration as members of company. The court held that “the certificate will have no effect and the certificate holder was not allowed to take advantage of the doctrine of indoor management”.
  4. No Knowledge Of Article-  To claim the protection of the doctrine of Indoor management it is essential to have the knowledge of the Articles as the rule is based on the principle of estoppel. A person who doesn’t have the actual knowledge of the company of MOA and AOA, he/she cannot claim protection of the turquand rule. In Rama Corporation V. Proved Tin And General Investment Company[13], In this case, T a director in the company entered into a contract with Rama Corp. (Plaintiff). While purporting to act on behalf of the company and he also took a cheque from the plaintiff. 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 AOA and MOA of the company. Later, it was found that the company had never delegated its power to T. It was held that “the plaintiff cannot take the remedy of the indoor management as they even don’t that power could be delegated.”

DIFFERENCE BETWEEN DOCTRINE OF CONSRTRUCTIVE NOTICE AND INDOOR MANAGEMENT

DOCTRINE OF CONSTRUCTIVE NOTICEDOCTRINE OF INDOOR MANAGEMENT
It protects company against outsiders.It protects outsiders transacting with the company.
It’s confined to external position and affairs  of the company.It’s confined to internal position and affairs of the company.
The memorandum and articles of association of the company are public documents. They need to be registered with the Registrar of Companies. These are open to public and third parties to access.  The internal affairs need not be registered They are not open to public and third parties.
It is important for the third party to read and understand AOA & MOA (as these are public document available to them on payment of certain fee) fully to claim protection under the said doctrine. Here, the third persons, who have no notice of an irregularity or want of authority, if they try they could know about that irregularity or want of authority, will not be protected on the principle of ‘constructive notice’.Third persons, who have no notice to any irregularity or want of authority, will be protected on the principle called the ‘Turquand Rule’. As it is presumed that there is no internal irregularity and that the third party cannot inquire into the private matters of the company.
Operates as an estoppel against outsiders.It mitigates the effect of ‘Doctrine of Constructive Notice’.

CONCLUSION

Now, when we look at the two doctrines and compare their usage, it is clear that the Doctrine of Constructive Notice has caused a lot of inconvenience in the corporate world and is detrimental towards the third party’s interest, putting a huge burden on their shoulders,  creating apprehension in the minds of investor. Hence, it can be said that it is restrictive in nature. This is also a why the Indian courts are reluctant to apply this doctrine and have scrutinised it to ensure that it is not being made applicable in infraction of the rule of law and the basic postulates of justice. In Allahabad High court case, Dehradun Mussoorie Electric Tramway Co. v. Jagmandar Das [14], “rejected the doctrine of constructive liability and the Company was held liable to the party to the transaction even the directors of the company borrowed the money which was neither in compliance with the articles nor it was done after obtaining the resolution in the general body”.

The Doctrine of Indoor management was therefore created as an exception to the Doctrine of constructive Notice so as to counter its effect and protect the third party against any arbitrary action of the company and prevents the latter from evading their liability.

As companies enter into several kinds of contracts and it is not possible for the law to cover each and every aspect and as a result these two doctrines have evolved to look after the interest of both sides.


[1] THE COMPANIES ACT, 2013, S. 2(56)

[2] THE COMPANIES ACT, 2013, S. 2(5)

[3] THE COMPANIES ACT, 2013, S.399

[4] (1882) 8 AC 65,71

[5]  AIR 1934 Mad 579

[6][6] Dr. G.K Kapoor & Dr. Sanjay Dhamija, Company Law and Practice, 180 (Taxmann’s, 24th Edition, August 2019)

[7] (1856) 6 E&B 327

[8] S. A. No. 109 of 1955 (B)

[9] AIR 1957 All 311

[10] (1888) 38 Ch D 156

[11]  AIR (1942) Oudh 417

[12] [1906] AC 439

[13] [1952] 2 QB 147

[14] AIR 1932 All 141.

Aishwarya Says:

I have always been against Glorifying Over Work and therefore, in the year 2021, I have decided to launch this campaign “Balancing Life”and talk about this wrong practice, that we have been following since last few years. I will be talking to and interviewing around 1 lakh people in the coming 2021 and publish their interview regarding their opinion on glamourising Over Work.

If you are interested in participating in the same, do let me know.

Do follow me on FacebookTwitter  Youtube and Instagram.

The copyright of this Article belongs exclusively to Ms. Aishwarya Sandeep. Reproduction of the same, without permission will amount to Copyright Infringement. Appropriate Legal Action under the Indian Laws will be taken.

If you would also like to contribute to my website, then do share your articles or poems at secondinnings.hr@gmail.com

We also have a Facebook Group Restarter Moms for Mothers or Women who would like to rejoin their careers post a career break or women who are enterpreneurs.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.