Professional Documents
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Doctrine of Indoor Management
Doctrine of Indoor Management
UNIVERSITY
VISAKHAPATNAM, A.P., INDIA
CORPORATE LAW I
ASHUTOSH KUMAR
201220, 7TH SEMESTER
ACKNOWLEDGEMENT
university
UNIVERSITY,
i.e.
DAMODARAM
VISAKHAPATNAM,
who
SANJIVIYYA
gave
us
NATIONAL
the
idea
LAW
and
to see is that the managing director might have power to do what he purports to do.
But the rule cannot apply where the question, as here, is not one as to the scope of the
power exercised by an apparent agent of the company, but is in regard to the very
existence of the agency."
In Lakshmi Ratan Cotton Mills Co. Ltd, v. J. K. Jute Mitts Co. Ltd 5, the plaintiff
company sued the defendant company on a loan for Rs. 1,50,000. Among other things
the defendant company raised the plea that the transaction was not binding as no
resolution sanctioning the loan was passed by the board of directors. The court, after
referring to Turquand's case and other Indian cases, 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 authorised 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."
In case of Official Liquidator, Manasube & Co. (P.) Ltd. V. Commissioner of police 6
5 AIR 1957 All 311
6 [1968]38 Comp. cas 884 (Mad)
7
the learned judge observed that the lenders to a company should acquaint themselves
with memorandum and articles but they cannot be expected to embark upon an
investigation as to legality, propriety and regularity of acts of directors.
The rule is based upon obvious reasons of convenience in business relations. Firstly,
the memorandum and articles of associations are public documents, open to public
inspection. Hence an outsider is presumed to know the constitution of a company;
but not what may or may not have taken place within the doors that are closed to
him. The wheels of commerce would not go round smoothly if persons dealing with
the company were compelled to investigate thoroughly the internal machinery of a
company to see if something is not wrong. People in business would be very shy in
dealing with such companies.
The rule is of great practical utility. It has been applied in a great variety of cases
involving rights and liabilities. It has been used to cover acts done on behalf of a
company by de facto directors who have never been appointed, or whose appointment
is defective, or who, having been regularly appointed, have exercised an authority
which could have been delegated to them under the companys articles, but never has
been so delegated, or who have exercised an authority without proper quorum. Thus,
where the directors of company having the power to allot shares only with the
consent, something which he could do only with the approval of the board; where the
managing agents having the power to borrow with the approval of directors borrowed
without any such approval, the company was held bound.
Consequence of the Rule: Recent Decisions
The Indian Courts in certain recent judgments have further broadened the scope of the
Doctrine of indoor management. The object being the same i.e. to protect the third
party transacting with the Company in good faith and being unaware of the complex
internal management of the Company.
In Monark Enterprises v Kishan Tulpule and Ors7, 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
7 [1992] Vol.74 CC 89
8
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 Others8
Even amalgamation of two companies is one limb of indoor management. Therefore,
notice contemplated under Section 394A of the Act is required to be given only at the
stage when application under Section 394, of the Act is made to the Court for
sanctioning the scheme and not any time prior thereto.
Exceptions To The Rule
The rule of doctrine of indoor management is however subject to certain exceptions.
In other words, relief on the ground of indoor management cant be claimed by an
outsider dealing with the company in the following circumstances:
1.
2.
3.
4.
5.
1. Knowledge of Irregularity: - The first and the most obvious restriction is that the
rule has no application where the party affected by an irregularity had actual notice of
it. Knowledge of an irregularity may arise from the fact that the person contracting
was himself a party to the inside procedure. As in Devi Ditta Mal v The Standard
Bank of India9, where a transfer of shares was approved by two directors, one of
whom within the knowledge of the transferor was disqualified by reason of being the
transfer himself and the other was never validly appointed, the transfer was held to be
ineffective.
Similarly in Howard v. Patent Ivory Manufacturing Co10. where the directors could
not defend the issue of debentures to themselves because they should have known that
the extent to which they were lending money to the company required the assent of
the general meeting which they had not obtained. Likewise, in Morris v Kansseen11, a
8 Decided On: 20.12.2000
9 [1927] 101 IC 558
10 [1888] 38 Ch. D. 156
11 [1946] 16 comp. Cas 186 ( HL)
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clear illustration is found in the Ruben v Great Fingall Consolidates15; here in this
case the plaintiff was the transferee of a share certificate issued under the seal of the
defendants company. The companys secretary, who had affixed the seal of the
company and forged the signature of the two directors, issued the certificate.
The plaintiff contended that whether the signature were genuine or forged was apart
of the internal management, and therefore, the company should be estopped from
denying genuineness of the document. But, it was held, that the rule has never been
extended to cover such a complete forgery.
Lord Loreburn said: It is quite true 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 have no notice. But, this doctrine which is
well established, applies to irregularities, which otherwise might affect a genuine
transaction. It cannot apply to Forgery.
4. Representation through Articles: - The exception deals with the most controversial
and highly confusing aspect of the Turquand Rule. Articles of association generally
contain what is called power of delegation. Lakshmi Ratan Lal Cotton Mills v J.K.
Jute Mills Co16. explains the meaning and effect of a delegation clause.
Here one G was director of the company. The company had managing agents of which
also G was a director. Articles authorised directors to borrow money and also
empowered them to delegate this power to any or more of them. G borrowed a sum of
money from the plaintiffs. The company refused to be bound by the loan on the
ground that there was no resolution of the board delegating the powers to borrow to
G. Yet the company was held bound by the loans. Even supposing that there was no
actual resolution authorizing G to enter into the transaction the plaintiff could assume
that a power which could have been delegated under the articles must have been
actually conferred. The actual delegation being a matter of internal management, the
plaintiff was not bound to enter into that.
Thus the effect of a delegation clause is that a person who contracts with an
individual director of a company, knowing that the board has power to delegate its
authority to such an individual, may assume that the power of delegation has been
exercised.
15 [1906] A.C. 439
16 AIR 1957 All 311
11
actually delegated their authority. Moreover, the company can make a representation
of authority even apart from its articles. The company may have held out an officer as
possessing an authority. A person believes upon that representation and contract with
him. The company shall naturally be estopped from denying that authority of that
officer for dealing on its behalf, irrespective of what the articles provide. Articles
would be relevant only if they had contained a restriction on the apparent authority of
the officer contained.
5. Acts outside apparent authority: - Lastly, if he act of an officer of a company is
one which would ordinarily be beyond the power of such an officer, the plaintiff
cannot claim the protection of the Turquand rule simply because under the articles
power to do the act could have been delegated to him. In such a case the plaintiff
cannot sue the company unless the power has, in fact, been delegated to the officer
with whom he dealt. A clear illustration is Anand Behari Lal v Dinshaw 18 here the
plaintiff accepted a transfer of a companys property from its accountant. Since such a
transaction is apparently beyond the scope of an accountants authority it was void.
Not even a delegation clause in the articles could have validated it, unless he was, in
fact, authorized.
Conclusion
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 partys 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
18 A.I.R. (1942) Oudh 417
13
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.
With the due course of time several exceptions have also emerged out of the rule like
Forgery, negligence, third party having knowledge of irregularity etc. If we analyze
the cases it is revealed that the Turquand rule did not operate in a completely
unrestricted manner. Firstly, it is inherent in the rule that if the transaction in question
could not in the circumstances have been validly entered into by the company, then
the third party could not enforce it. Secondly, the rule only protected 'outsiders', that is
persons dealing 'externally' with the company; directors, obviously, were the very
people who would be expected to know if internal procedures had been duly followed.
Thirdly, actual notice of the failure to comply fully with internal procedures precluded
reliance upon the rule. Fourthly, an outsider could not rely upon Turquand's Case
where the nature of the transaction was suspicious; for example, where the company's
borrowing powers were exercised for purposes which were wholly unconnected with
the company's business and of no benefit to the company.
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