This article, “Doctrine of Indoor Management” is written by Prerana Rajguru a 3rd year Law student at Savitribai Phule University.
Introduction
Various principles in the corporate world 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. The doctrine of indoor management was evolved 150 years ago. It is also known 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 have 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 agree with the company. The doctrine of constructive notice is limited to the external position of the company.
The role of the doctrine of indoor management is opposed to the role of the doctrine of constructive notice. The doctrine of indoor management follows from the doctrine of ‘constructive notice’ laid down in various judicial decisions. The hardships caused to outsiders dealing with a company by the rule of constructive notice’ have been sought to be softened under the principle of ‘indoor management’. It affords some protection to the outsiders against the company. The doctrine of constructive notice protects the company against outsiders whereas the doctrine of indoor management protects outsiders against the actions of the company. This doctrine also is a possible safeguard against the possibility of abusing the doctrine of constructive notice.
According to this doctrine, persons dealing with the company need not inquire whether internal proceedings relating to the contract are followed correctly, once they are satisfied that the transaction is under the memorandum and articles of association. Shareholders, for example, need not enquire whether the necessary meeting was convened and held properly or whether the necessary resolution was passed properly. They are entitled to take it for granted that the company had gone through all these proceedings in a regular manner. The doctrine helps protect external members from the company and states that the people are entitled to presume that internal proceedings are as per documents submitted with the Registrar of Companies. Whereas the doctrine of constructive notice protects a company against outsiders, the doctrine of indoor management protects outsiders against the actions of a company. This doctrine also is a possible safeguard against the possibility of abusing the doctrine of constructive notice.
The person entering into a transaction with the company only needed to satisfy that his proposed transaction was not inconsistent with the articles and memorandum of the company. He is not bound to see the internal irregularities of the company and if there are any internal irregularities then the company will be liable as the person has acted in good faith and he did not know about the internal arrangement of the company. The rule is based upon the obvious reason of convenience in business relations. Firstly, the articles of association and memorandum are public documents and they are open to the public for inspection. Hence an outsider “is presumed to know the constitution of a company, but what may or may not have taken place within the doors that are closed to him.”
Origin of the Doctrine
This doctrine was laid down in the case of Royal British Bank V. Turquand1. The directors of the company borrowed some money from the plaintiff. The article of the company provides for the borrowing of money on bonds but there was a necessary condition that a resolution should be passed in a general meeting. Now, in this case, the shareholders claim that as there was no such resolution passed in the general meeting the company is not bound to pay the money. It was held that the company was bound to pay back the loan. As directors could borrow but subjected to the resolution, the plaintiff had the right to infer that the necessary resolution must have been passed.
It was held that Turquand could sue the company on the strength of the bond. As he was entitled to assume that the necessary resolution had been passed. Lord Hatherly observed- “Outsiders are bound to know the external position of the company, but are not bound to know its indoor management.”
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.2The 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 ordinarily received a formal notice. 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. Various Indian case laws approved and followed the rule.
In Lakshmi Ratan Cotton Mills Co. Ltd v. J.K Jute Mitts Co. Ltd3, 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.”
Basis of Indoor Management
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 the 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 a 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.
- 1. What happens internally to a company is not a matter of public knowledge. An outsider can only presume the intentions of a company, but not know the information he/she is not privy to.
- 2. If not for the doctrine, the company could escape creditors by denying the authority of officials to act on its behalf.
Establishment of The Doctrine
The rule was not accepted as being firmly well established in law until it was approved by the House of Lords in Mahoney v East Holyford Mining Co. In this case; it was contained in the company’s article that a cheque should be signed by 2 of the 3 directors and also by the secretary. But in this case, the director who signed the cheque was not properly appointed. The court said that whether the director was properly appointed or not it comes under the internal management of the company and the third party who receives the cheque was entitled to presume that the directors had been properly appointed, and cash cheques.
Exceptions To Doctrine of Indoor Management
The circumstances where the relief of indoor management cannot be claimed by an outsider who is part of the company is Where the outsider knows of irregularity. The rule will not apply if the person dealing with the company has slight knowledge about the lack of authority of a person who is acting on behalf of the company in this situation the doctrine will not apply. In case this ‘outsider’ has actual knowledge of irregularity within the company, the benefit under the rule of indoor management would no longer be available. He/she may well be considered part of the irregularity.
How the Indian Judiciary Has Interpreted This Doctrine?
In the case of Lakshmi Ratan Cotton Mills Co. Ltd, v. J. K. Jute Mitts Co.Ltd, the company of the plaintiff sued the defendant’s company for the total amount of Rs.1, 50,000. The defendant’s company raised the argument that no such resolution sanctioning the loan was passed by the board of directors, thus it is not binding on the company. The court held that “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 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 a 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 genuine one. He could assume that such a person had the power to represent the company, and if he advanced the money on such assumption, he would be protected by the doctrine of internal management.”
Reference
https://cleartax.in/s/doctrine-indoor-management
https://byjus.com/commerce/the-doctrine-of-indoor-management/
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