Two doctrines in Company Law running anachronistic to each other are the Doctrine of Constructive Notice and the Doctrine of Indoor Management respectively. These are widely accepted principles evolved through common law judgments infusing reasonableness, fairness and equity to statutory enactments.
The former protects the company against ignorant or malicious contractors and bears semblance to the caveat emptor doctrine of Consumer Law. It preaches the third-party contractor to perform its due diligence before entering into an agreement. However, like all good measures, this too would come to be abused by its benefactors unless coated by a rider doctrine. That purpose is served by the Doctrine of Indoor Management which protects the third party’s rights against the company.
I. The Doctrine of Constructive Notice
The Memorandum of Association and Articles of a company are public documents available with the Registrar for perusal by any interested party upon payment of a nominal charge. The two documents, as detailed in previous articles, detail the entire nature, scope and limits of the powers and objects of a company, the extent of delegation of those powers on the Directors, and the limitations on such delegation. The company cannot perform any act outside the scope of the memorandum of association (Doctrine of Ultra Vires).
The Articles substantiate the powers mentioned in the Memorandum with regard to the procedural requirements and the regulations which govern all company affairs. Since the two documents are available for any interested person to go through, the Doctrine of Constructive Notice states that any person entering into a contract with the company will be presumed to have gone through and understood the documents in their true sense (Griffith v. Paget) [1]. In other words, he has been given “constructive notice” of all that is contained in the documents.
For instance, if a clause in the memorandum requires a bill of exchange to be signed by two directors, the person must make sure it is so signed, or there would arise no claim out of it.
The object of the doctrine is simple but significant. It protects the interests of the company and its subscribers against persons who remain ignorant to due diligence. As enumerated in Halsbury, with reference to the case of Jones v. Smith [2], where the conduct of the party shows that he had suspicions of a state of facts the knowledge of which would affect his legal rights, but deliberately failed to make an inquiry regarding the same, he would be deemed to have had notice.
Kotla Venkataswamy v. Rammurthy [3]
The facts are such that a mortgage deed for Rs. 1000 was made by the company in favour of a third party. Article 15 of its articles required that such deed must be signed by three people – the Managing Director, Working Director and the Secretary and that in absence of anyone signature it would be invalid. The deed was only signed by the latter two and not by the Managing Director. On the party’s claim to enforce the deed, the Court applied the Doctrine of Constructive Notice to hold against him.
Held that the person is presumed to know the contents of the Articles before entering into the deed and hence it was not maintainable.
II. The Doctrine of Indoor Management
A person may peruse the available documents and may even be presumed to understand it, but can he be expected to check himself and make sure whether the written regulations and procedures are actually being followed inside the company or not? The present doctrine answers it in the negative, and thus draws the line where the responsibility of the contractor to perform due diligence ends.
The doctrine says that what happens inside the doors of a company de facto are neither concerns of the third party nor in his ability to be checked and confirmed. Once he has perused the documents available, he may legally presume that their contents are being observed in totality by the company and its representatives, and he may claim his rights on that assumption.
For instance, if the memorandum requires a certain quorum to be present during the resolution by which the contract is made, the third party may assume that such quorum was present. Even if in fact the quorum was not present, the contract would still be valid and enforceable.
Royal British Bank v. Turquand [4]
This landmark case of 1856 gave rise to the Doctrine of Indoor Management. The facts of the case are such that in a banking company, the directors were authorized to borrow money on bond up to an amount decided by the members in general meeting. A resolution is supposed to be passed in the general meeting authorizing the Directors to borrow amount up to a limit. A director borrowed amounts on a bond without any such resolution.
It was held in favour of the creditor that it is not his obligation to make sure that the required internal resolution is passed. He may safely presume that as the memorandum has express provision authorizing a Director to borrow money, the required procedure must have been followed through.
“Outsiders are bound to know the external position of the company, but are not bound to know its indoor management.”
Thus, the doctrine of indoor management was born.
Lakshmi Ratan Cotton Mills Co. Ltd v. J. K. Jute Mitts Co. Ltd [5]
A loan was given to the defendant company by the plaintiff to the amount of Rs. 1,50,000 which it seeks in the case. The defendant company refuses on the ground that as no resolution to sanction the loan has been passed by the Board of Directors, the loan agreement is not binding on them.
This is a landmark case as it marks the dawn of the indoor management doctrine in Indian common law. The court applied the doctrine to hold that the fact whether a resolution was passed or not is not the creditor’s concern, and it can be safely assumed by him to have taken place. Thus, he is liable to be paid back.
Another early Indian case is the Official Liquidator, Manasube & Co. (P.) Ltd. v. Commissioner of Police [6] where the court reiterated that the person is expected to read the memorandum and articles but it remains highly unlikely and unreasonable that he will check the propriety, legality and regularity of the acts of the directors.
III. Irregular Acts of Directors, Statutory Recognition and Ratification
Situations arise where Directors, though acting intra vires the memorandum and articles have no authority to perform those acts as their appointment as directors itself suffers from infirmity or has ended. In these situations, the acts of the directors so disqualified (or retired) done before such infirmity comes to knowledge, have been saved by the Companies Act, 2013.
Section 176 states that acts done by directors remain valid, regarding whom it is subsequently found that their appointment suffers from defect, disqualification or termination under any provision of the Act or the articles. It is pertinent to note that the infirmity must have come to notice before such acts were done, and any act after the defect is known will not be validated.
The court has upheld the provision’s stand in Ram Raghubir Lal v. United Refineries (Burma) Ltd [7], saying that it seeks to protect outsiders and members dealing with the company from suffering just because the Director’s appointment suffered from defect.
The provision runs both as an aspect of indoor management specifically recognized by the Act, as well as an addition to the doctrine. It is an addition in the sense that even if the public documents and facts make it clear that the appointment of the concerned director is faulty, it will still not render the acts done invalid. This was held in the landmark case of British Asbestos Co. Ltd. v. Boyd [8].
IV. Exceptions to the Doctrine
To protect this doctrine from being abused as well, certain situations have arisen by common law jurisprudence where this defence would not be applicable:
- Where the outsider had knowledge of irregularity – No person who has been given express or implied notice of the irregularity and still enters into the agreement will be protected by the doctrine. If a person knows the director does not have the authority to undergo the transaction and continues with the transaction then he cannot claim this defence. (Howard v. Patent Ivory Co. [9]
- No knowledge of memorandum and articles – If the person seeks to rely on the doctrine of indoor management as defence, the requirement set on him to have read the memorandum and articles needs to be discharged first. In a case where it was shown that the defendant company did not read the articles where it was stated that certain powers could be delegated to a Director, then they cannot claim indoor management on the basis that the delegation was not actually done. They did not know it could be done in the first place. (Rama Corporation v. Proved Tin & General Investment Co [10])
- Forgery – It is well settled that where the acts themselves are illegal, or void ab initio the doctrine does not come into play at all. Thus, where a transaction involves forgery, say of the required signatures on a certificate, then the certificate itself is a nullity and renders no title to its holder. It cannot be claimed by the third party that the forgery was an internal act and they could not be expected to have known it. (Rouben v. Great Fingal Consolidated [11]).
- Negligence – The defence begins with reprimanding ignorance, it is clear that it will not come to the aid of the negligent. The person entering in an agreement still needs to exercise caution and make reasonable enquiries whether the person has the authority to execute the concerned agreement or not. In Underwood v. Bank of Liverpool [12], the sole director and principal shareholder of the company deposited in his own account some cheques drawn in favour of the company. Held, that, the bank ought to have made inquiries as to the powers of the director.
- Again, the doctrine has no application where the question challenges the very existence of an agency. In Varkey Souriar v. Keraleeya Banking Co. Ltd [13]., the Kerala High Court held that the doctrine is applicable where the scope of an agent’s power is under consideration, not where the fact of his agency itself is being challenged.
V. Conclusion
The dichotomy of the constructive notice and indoor management is a finely balanced protection to each party in any corporate transaction. The former is a defence applied only by the company against third parties, and the latter can only be used by the third parties. Due diligence is always the obligation of the person entering into a contract. However, once the obligation is discharged, he is free to assume that the internal regulations were followed and claim based on that assumption. Finally, the exceptions evolved by the courts to this doctrine remove mala fide attempts to abuse it.
References
[1] (1877) Ch. D. 517.
[2] (1841) 1 Hare 43.
[3] AIR 1934 Mad 579.
[4] (1856) 119 E.R. 886.
[5] AIR 1957 All 311
[6] [1968] 38 Comp. cas 884 (Mad)
[7] AIR 1931 Rang 13.
[8] (1903) 2 Ch 439.
[9] 38 Ch. D 156
[10] (1952) 1All. ER 554
[11] (1906) AC 439
[12] (1924) 1 KB 775.
[13] (1957) 27 Com Cases 591 (Ker.)
