Doctrine of indoor management 

Memorandum of Association and articles of association are two most important documents
needed for the incorporation

of a company. The memorandum of a company is the constitution of that company. It sets out the
(a) object clause, (b) name clause, (c) registered office clause, (d) liability clause and (e) capital
clause; whereas the articles of association enumerate the internal rules of the company under
which it will be governed. 

Undoubtedly, both memorandum of association and the articles of association are public
documents in the sense that any person under section 610 of Indian company act, 1956 may
inspect any document which will include the memorandum and articles of the company kept by
the registrar of companies in accordance with the rules made under the destruction of records act,
1917 being documents filed and registered in pursuance of the act. As a consequence, the
knowledge about the contents of the memorandum and articles of a company is not necessarily
restricted to the members of the company alone. Once these documents are registered with the
registrar of companies, these become public documents and are accessible by any members of
the public by paying the requisite fees. Therefore, notice about the contents of memorandum and
articles is said to be within the knowledge of both members and non-members of the company.
Such notice is a deemed notice in case of a members and a constructive notice in case of non-
members. Thus every person dealing with the company is deemed to have a constructive notice
of the contents of the memorandum and articles of the company. An outsider dealing with the
company is presumed to have read the contents of the registered documents of the company. The
further presumption is that he has not only read and perused the documents but has also
understood them fully in the proper sense. This is known as the rule of constructive notice. So,
the doctrine or rule of constructive notice is a presumption operating in favour of the company
against the outsider. It prevents the outsider from alleging that he did not know that the
constitution of the company rendered a particular act or a particular delegation of authority ultra
vires. 

The ‘doctrine of constructive notice’ is more or less an unreal doctrine. It does not take notice of
the realities of business life. People know a company through its officers and not through its
documents. The courts in India do not seem to have taken it seriously though. For example, in
Dehra Dun Mussorie Electric Tramway Co. v. Jagmandardas, the Allahabad high court allowed
an overdraft incurred by the managing agent of a company when under the articles the directors
had no power to delegate their borrowing power. 

The doctrine of indoor management is an exception to the rule of constructive notice. It imposes
an important limitation on the doctrine of constructive notice. According to this doctrine
“persons dealing with the company are entitled to presume that internal requirements prescribed
in memorandum and articles have been properly observed”. A transaction has two aspects,
namely, substantive and procedural. An outsider dealing with the company can only find out the
substantive aspect by reading the memorandum and articles. Even though he may find out the
procedural aspect, he cannot find out whether the procedure has been followed or not. For
example, a company may have borrowing powers by passing a resolution according to its
memorandum and articles. An outsider can only found out the borrowing powers of the
company. But he cannot find out whether the resolution has in fact been passed or not. The
outsiders dealing with the company are presumed to have read and understood the memorandum
and articles and to see that the proposed dealing is not inconsistent therewith, but they are not
bound to do more; they need not inquire into the regularity of the internal proceedings as
required by the memorandum and articles. They can presume that all is being done regularly.

The doctrine of indoor management is also known as the TURQUAND rule after Royal British
Bank v. Turquand. In this case, the directors of a company had issued a bond to Turquand. They
had the power under the articles to issue such bond provided they were authorized by a
resolution passed by the shareholders at a general meeting of the company. But no such
resolution was passed by the company. It was held that Turquand could recover the amount of
the bond from the company on the ground that he was entitled to assume that the resolution was
passed.

In one of the case the rule was stated thus: “If the directors have the power and authority to bind
the company but certain preliminaries are required to be gone through on the part of the company
before that power can be duly exercised, and then the person contracting with the directors is not
bound to see that all these preliminaries have been observed. He is entitled to presume that the
directors are acting lawfully in what they do.”

In another case where the plaintiff sued the defendant company on a loan of Rs.1,50,000, it was
held that where the act done by a person, acting on behalf of the company, is within the scope of
his apparent or ostensible authority, it binds the company no matter whether the plaintiff has read
the document or not. In this case 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 that 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.

The rule is based on public convenience and justice and the following obvious reasons:

1.     the internal procedure is not a matter of public knowledge. 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.

2.     the lot of creditors of a limited company is not a particularly happy one; it would be
unhappier still if the company could escape liability by denying the authority of officials to act
on its behalf. 

Exceptions to the doctrine of indoor management:

The exceptions to the doctrine of indoor management are as under:

1.     Knowledge of irregularity: when a person dealing with a company has actual or
constructive notice of the irregularity as regards internal management, he cannot claim benefit
under the rule of indoor management. He may in some cases, be himself a part of the internal
procedure. The rule is based on common sense and any other rule would encourage ignorance
and condone dereliction of duty.

T.R Pratt (Bombay) Ltd. V. E.D. Sassoon & Co. Ltd., Company A lent money to Company B on
a mortgage of its assets. The procedure laid down in the articles for such transactions was not
complied with. The directors of the two companies were the same. Held, the lender had notice of
the irregularity and hence the mortgage was not binding.

In Howard v. Patent Ivory Co, the directors had the authority under the articles to borrow only up
to £1000 without the resolution of general meeting. For any amount beyond £1000, they needed
the consent of general meeting. But the directors borrowed £3500 from themselves without the
consent of general meeting or shareholders and accepted debentures. It was held that they had
knowledge of internal irregularity and debentures were good only up to £1000.

2.     Negligence: where a person dealing with a company could discover the irregularity if he had
made proper inquiries, he cannot claim the benefit of the rule of indoor management. The
protection of the rule is also not available where the circumstances surrounding the contract are
so suspicious as to invite inquiry, and the outsider dealing with the company does not make
proper inquiry. If, for example, an officer of a company purports to act outside the scope of his
apparent authority, suspicion should arise and the outsider should make proper inquiry before
entering into a contract with the company.

Anand Bihari Lal v. Dinshaw & Co, the plaintiff, in this case, accepted a transfer of a company’s
property from its accountant. Held, the transfer was void as such a transaction was apparently
beyond the scope of the accountant’s authority. The plaintiff should have seen the power of
attorney executed in favour of the accountant by the company.

3.     Forgery: the rule in turquand’s case does not apply where a person relies upon a document
that turns out to be forged since nothing can validate forgery. A company can never be held
bound for forgeries committed by its officers. The leading case on the point is :

Ruben v. Great Fingall Consolidated Co., the secretary of a company issued a share certificate
under the company’s seal with his own signature and the signature of a director forged by him.
Held, the share certificate was not binding on the company. The person who advanced money on
the strength of this certificate was not entitled to be registered as holder of the shares.

 
4.     Acts outside the scope of apparent authority: if an officer of a company enters into a
contract   with a third party and if the act of the officer is beyond the scope of his authority, the
company is not bound. In such a case, the plaintiff cannot claim the protection of the rule of
indoor management simply because under the articles the power to do the act could have been
delegated to him. The plaintiff can sue the company only if the power to act has in fact been
delegated to the officer with whom he entered into the contract.

Kreditbank Cassel v. Schenkers Ltd,a branch manager of a company drew and endorsed bills of
exchange on behalf of the company in favour of a payee to whom he was personally indebted.
He had no authority from the company to do so. Held, the company was not bound. But if an
officer of a company acts fraudulently under his ostensible authority on behalf of the company,
the company is liable for his fraudulent act. 

Conclusion: Thus the doctrine of indoor management seeks to protect the interest of the
shareholders who are in minority or who remains in dark about whether the working of the
internal affairs of the company are being carried out in accordance with the memorandum and
articles. It lays down that persons dealing with a company having satisfied themselves that the
proposed transaction is not in its nature inconsistent with the memorandum and articles, are not
bound to inquire the regularity of any internal proceeding.