The Turquand Rule

The Turquand Rule otherwise known as the internal management rule was first developed in Royal British Bank v Turquand (1856) 6 E & B 327, 119 ER 886. It is argued by many that it was formulated as a means of counteracting the rigid doctrine of constructive notice by protecting ‘bona fide third parties’ dealing with a company, by entitling them to assume that all internal management and procedures have been complied with. The Turquand rule was accepted as part of South African law in Legg& Co v Premier Tobacco Co (1926 AD 132).

To understand the effect of theTurquand rule, it is important to examine the doctrine of constructive notice.The Doctrine of Constructive Notice which was developed in Ernest v Nicholls (1857)6 HL Cas 401, was to the effect that all persons dealing with a company are deemed to be familiar with the content of its public documents of the company the most important of which were the Memorandum of Association and the Articles of Association, because they were available for public inspection. This doctrine protected the company at the expense of third parties, thus, there was a need to even things out, hence the formulation of the Turquand rule.

The effect of the Turquand rule is that a third party dealing with a company has constructive notice of the internal formalities of a company required by its constitution but does not have notice of whether or not they have been complied with and is not obliged to enquire. Internal formalities include, quorum requirements,limitations on the authority of persons representing the company, voting procedures among others. The rationale for this rule as put forward by Cassim is that companies cannot escape liability from an otherwise valid contract solely on the grounds that an internal formality was not complied with. An inspection of the public documents willnot reveal that these internal formalities have been followed so, bona fide third parties should not suffer from the company’s failure to comply with its internal management rules.Having discussed what the Turquand rule is, the next issue up for discussion is when the Turquand rule can apply under the common law.

It is trite that the Turquand rule applies only when the third party is acting in good faith. So a person cannot be protected by the Turquand rule if the person knows or ought to have known that internal management requirements have not been complied with. The 2008 Companies Act abolished the doctrine of constructive notice in Section14(4) except for ring-fenced companies but creates a statutory Turquand rule and retains the common law Turquand rule.Section 20(7) provides that: a person dealing with a company in good faith, other than a director, prescribed officer or shareholder of the company, is entitled to presume that the company, in making any decision in the exercise of its powers, has complied with all of the formal and procedural requirements in terms of this act, its Memorandum of Incorporation and any rules of the company unless, in the circumstances, the person knew or reasonably ought to have known of any failure by the company to comply with any such requirement.

Section 20(8) retains the common law Turquand rule by providing that subsection 7 above should be construed concurrently with and not in substitution for any relevant related common law principle. The wording of this section is to the effect that the ‘statutory Turquand rule’ and the common law Turquand rule will co-exist. This of course implies that the statutory Turquand rule encapsulates some but not all of the common law provisions, an overlap which Cassim stipulates may prove to be a source of difficulties in practice. The differences between the common law Turquandrule and the statutory Turquand rule are stated as follows.Section 20(7) protects third parties excluding directors, prescribed officers andshareholders and so if a person is a director, the rule doesn’t apply. However, under the common law as stated inHely-Hutchinson v Brayhead Ltd [1967] 3 A11 ER 98(CA), a director acting in his/her capacity as a director is different from one acting notas a director but as an outsider contracting with the company. The latter will be able to seek the application of the Turquand rule. So the common law Turquand rule is not entirely outside of an insider’s reach.

In Monark Enterprises v Kishan Tulpule and Ors, the Company Board held :- “That the validity of the impugned transaction was not affected even if no resolution for entering into it was actually passed by the board of the company as the company had entered into and adopted the transaction throughout and implemented it after receiving consideration thereof In YKM Holdings Private Limited v Prayag T-Pac Industries Limited and Others .Even amalgamation of two companies is one limb of indoor management. The rule of doctrine of indoor management is however subject to certain exceptions. In other words, relief on the ground of ‘indoor management’ cannot be claimed by an outsider dealing with the company in the following circumstances: Ø Where the outsider has knowledge of Irregularity Ø Suspicion of Irregularity Ø Forgery Ø Representation through Articles Ø Acts outside apparent authority The case of Royal British Bank v Turquand, refined the basic Common law of Agency to articulate the Doctrine of Indoor Management.

The rule was enunciated by the Court to mitigate the rigors of the Constructive Notice Doctrine. Its importance arises in situations in which the third party’s dealings are with some officer or agent other than the Board. The rule protects the interest of the third party who transacts with the Company in good faith and to whom the Company is indebted. The rule enunciated in the decision is often referred to as “Turquand’s rule” and “indoor management rule”. The gist of the rule is that persons dealing with limited liability companies are not bound to enquire into their indoor management and will not be affected by irregularities of which they had no notice The rule enunciated in Turquand has been applied in many cases subsequently and generally in order to protect the interests of the party transacting with the Directors of the Company. Applying the rule, now it can not be argued that a person having dealings with a Company is deemed to have notice of who the true Directors are, and this being shown by public documents i.e. the registers of the directors required to be maintained by the Company and the and the notices of changes.

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