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 turquands 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 companys property from its accountant. Held, the transfer was
void as such a transaction was apparently beyond the scope of the
accountants authority. The plaintiff should have seen the power of attorney
executed in favour of the accountant by the company.
3. Forgery: the rule in turquands 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 companys 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.

Doctrine of Constructive Notice:

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.

High Court held that unless there is wilful or fraudulent turning away from
enquiry, the doctrine of constructive notice would not apply. The case Re
Bright's Trusts (1856) 21 Beav. 430 was also referred to. That relates to a
charge without notice on a chose in action, and it appears that except so far
as the actual notice was given, subsequent incumbrancers could have no
knowledge whatever of the existence of any prior charge. In that case the
charge was one on a fund in the hands of trustees, and notice was given only
of one of two charges created in the same deed, that for the life policy being
mentioned, and that the express notice given implied that no other charge
was alleged. It is clear that the principles of that case apply only to the duty
of enquiry arising in cases where, apart from constructive notice, there is
nothing to put the purchaser on enquiry.

The doctrine confined originally to cases of fraudulent turning away was

subsequently extended to cases of gross negligence and in West v. Reid
(1843) 2 Hare 249, the same learned Vice-Chancellor stated that there might
be a degree of negligence so gross (crassa negligentia) that a Court of
Justice might treat it as evidence of fraud though in fact as pointed out by
Romilly M.R. in Jones v. Williams (1857) 24 Beav. 47, no fraudulent intent
may be present. Lord Cranworth expressed the rule thus in Ware v. Lord
Egmont (1854) 4 De G. M. & G. 460 at page 473:

Where a person has actual notice of any matter of fact, there can be no
danger of doing injustice if he is held to be bound by all the consequences of
that which he knows to exist. But where he has not actual notice, he ought
not to be treated as if he had notice, unless the circumstances are such as
enable the Court to say, not only that he might have acquired, but also, that
he ought to have acquired, the notice with which it is sought to affect him-
that he would have acquired it but for his gross negligence in the conduct of
the business in question. The question, when it is sought to affect a
purchaser with constructive notice, is not whether he had the means of
obtaining, and might by prudent caution have obtained, the knowledge in
question, but whether the not obtaining it was an act of gross or culpable
negligence. It is obvious that no definite rule as to what will amount to gross
or culpable negligence, so as to meet every case, can possibly be laid down.

Though no definite rule defining what would constitute gross negligence

could by its very nature be laid down, the Courts of Equity held that if a
purchaser of property omits to make proper and usual inquiries into his
vendor's title, such omission, in the absence of reasonable explanation,
would amount to gross negligence and the purchaser must, therefore, be
fixed with constructive notice of facts which he would have known if he had
made such inquiries. This proposition was also in some cases rested on the
original theory of fraudulent turning away by saying that such omission on
the part of the purchaser, if not explained, may be evidence "of a design
inconsistent with bona fide dealing to avoid knowledge of the true state of
the title". But whatever be the legal theory on which the proposition may be
supported, the principle underlying the proposition was that a purchaser of
property, as an ordinary prudent man, is expected, for the protection of his
own interest, to make proper and usual inquiries into his vendor's title before
he purchases the property and if he omits to do so, without any reasonable
explanation, an inference can legitimately be drawn that either he has
wilfully abstained from making inquiries for the purpose of avoiding notice of
facts which he would have known had he made the inquiries or he is guilty of
gross negligence. This principle was explained by Lord Selborne, in Agra
Bank v. Barry (1874) L.R. 7 H.L. 135, where with reference to the duty of a
purchaser to investigate title the learned Law Lord said:

It has been said in argument that investigation of title and inquiry after
deeds is 'the duty' of a purchaser or a mortgagee; and, no doubt, there are
authorities which do use that language. But this, if it can properly be called a
duty, is not a duty owing to the possible holder of a latent title or security. It
is merely the course which a man dealing bona fide in the proper and usual
manner for his own interest, ought, by himself or his solicitor, to follow, with
a view to his own title and his own security. If he does not follow that course,
the omission of it may be a thing requiring to be accounted for or explained.
It may be evidence if it is not explained, of a design inconsistent with bona
fide dealing, to avoid knowledge of the true state of the title. What is a
sufficient explanation, must always be a question to be decided with
reference to the nature and circumstances of each particular case

Lord Lindley also said much to the same effect when after referring to the
passage from the judgment of Lord Cranworth in Ware v. Lord Egmont
(supra), he observed in Bailey v. Barnes (1894) 1 Ch. 25 at page 35:

Gross or culpable negligence" in this passage does not import any breach of
a legal duty, for a purchaser of property is under no legal obligation to
investigate his vendor's title. But in dealing with real property, as in other
matters of business, regard is had to the usual course of business; and a
purchaser who wilfully departs from it in order to avoid acquiring a
knowledge of his vendor's title is not allowed to derive any advantage from
his wilful ignorance of defects which would have come to his knowledge if he
had transacted his business in the ordinary way Can we say that Mr. Lilley or
his solicitors 'ought reasonably' to have made inquiries into the validity of
the sale by Barnes? 'Ought' here does not import a duty or obligation; for a
purchaser need make no inquiry. The expression 'ought reasonably' must
mean ought as a matter of prudence, having regard to what is usually done
by men of business under similar circumstances.

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. Therefore doctrine of indoor management protects outsiders
dealing or contracting with a company, whereas doctrine of
constructive notice protects the insiders of a company or corporation
against dealings with the outsiders. However suspicion of irregularity
has been widely recognized as an exception to the doctrine of indoor
management.

indoor management operates as an exception to constructive notice.

It must follow from this that indoor management does not have any
authority-granting power on its own. Even before invoking the rule, it
must be shown that the agent was acting within the scope of his
ostensible authority. Unless this is shown, the question of constructive
notice does not arise at all and if the question of constructive notice
does not arise, then there is no scope for invoking an exception to
constructive notice.

indoor management operates only when once authority is established

the company pleads it is not bound under the constructive notice
rule. In other words, the indoor management rule is a presumption that
ostensible authority has not been curtailed by the principals
instructions (this presumption can arise with constructive notice in
some cases) it is not a presumption that ostensible authority exists in
the first place.
 There are however some observations of some High Courts
in India holding that indoor management can be used for raising a
presumption as to the existence of authority itself. The remarks of the
Supreme Court could serve to clarify the position of law on this point;
that being an exception to constructive notice, indoor management
only gives back what constructive notice takes away. It cannot give
back more than what constructive notice took away.

The doctrine of Indoor management, popularly known as the Turquands rule

initially arose some 150 years ago in the context of the doctrine of
constructive notice. The rule of Doctrine of Indoor Management is conflicting
to that of the principle of Constructive Notice. The latter seeks to protect the
company against outsiders; the former operates to protect outsiders against
the company. The rule of constructive notice is confined to the external
position of the company and, therefore, it follows that there is no notice as to
how the companys internal machinery is handled by its officers. If the
contract is consistent with the public document, the person contracting will
not be prejudiced by irregularities that may beset the indoor work of the
company.

The Doctrine of Indoor Management 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. In other words, while
persons contracting with a company are presumed to know the provisions of
the contents of the memorandum and articles, they are entitled to assume
that the provisions of the articles, they are entitled to assume that the
officers of the company have observed the provisions of the articles. It is no
part of duty of any outsider to see that the company carries out its own
internal regulations.

It is important to note that the notice of constructive notice can be invoked

by the company and it does not operate against the company. It operates
against the person who has failed to inquire but does not operate in his
favour. But the doctrine of indoor management can be invoked by the
person dealing with the company and cannot be invoked by the company.