What do you understand by 'doctrine of indoor management'? Explain the exceptions of this doctrine.
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Question: What do you understand by 'doctrine of indoor management'? Explain the exceptions of this doctrine. [BJS 2021]
Find the question and answer of Company Law only on Legal Bites. [What do you understand by 'doctrine of indoor management'? Explain the exceptions of this doctrine.]
Answer
In accordance with the doctrine of indoor management, if a company is said to enter into a contract, the member of the company, and not any party, who enters a contract with the company, is responsible for adhering to the company's policies. This protects outsiders who have entered into any contract with the company. The guideline is based on simple commercial convenience for all parties involved with a Company. Internal procedures are private, in contrast to the public documents that are available for public scrutiny, the memorandum of association and articles of association. The opaque nature of these procedures puts the internal affairs in a position of echoing, within the company and cannot be raised as any defence against its liability, from the act of the directors.
Origin of the concept
The Doctrine originated from an English precedent, Royal British Bank v. Turquand, (1856) 6 E&B 327. The "Turquand Rule" is the alternative name for this concept. In this instance, the company's directors had been given permission by the articles to borrow that amount of money on bonds as they should occasionally by passing a special resolution in a general meeting. The plaintiff received a bond with the company's seal signed by the secretary, and two directors, and was authorised to draw on the current account without the approval of any resolution.
On the basis of such a bond, Turquand tried to bind the company's activity. Therefore, the primary legal issue, in this case, was whether the firm could be held accountable for that bond. The court, in this case, held that the bond was binding on the company as Turquand was entitled to presume that the resolution of the company has been passed in the general meeting.
The rule was further endorsed by the House of Lords in Mahony v. East Holyford Mining Co., [1875] LR 7 HL 869, in this case, the company's articles stipulated that two directors must sign the cheque and the secretary must countersign it. Later it was discovered that neither the directors nor the secretary who signed the cheque had been given the required appointment. Holding that the appointment of directors is a component of the internal management of the company and that a person dealing with the firm is not compelled to inquire about it, the person receiving such a cheque shall be entitled to the amount.
The above view held in the case of the House of Lords in Mahony v. East Holyford Mining Co. is supported by Section 176 of the Companies Act, 2013, which states that the defects in the appointment of the director shall not invalidate the acts done. According to the doctrine, everybody who enters into a contract with a business is shielded against any abnormalities in the business' internal procedures. Because internal flaws in a corporation are hidden from third parties, the company will be responsible for any losses they incur as a result of these irregularities. While the idea of indoor management defends third parties against corporate policies, the doctrine of constructive notice defends the corporation from third-party claims.
In Pacific Coast Coal Mines Ltd v. Arbuthnot, 1917 AC 607, it was observed that 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.
Dewan Singh Hira Singh v. Minerva Mills Ltd., AIR 1959 Punj106., illustrates the exemption of this rule. A Company's Articles limited the directors' ability to distribute more than 5,000 "A" class shares. But they went considerably beyond and distributed more than 13,000 shares. According to the court's ruling, those who were allotted shares were doing business with the firm in good faith and had a right to believe that the directors' actions in allotting the shares to them fell within the purview of the authority granted to them by the company's shareholders. They were not required to investigate whether the directors' acts related to internal management had been carried out effectively and consistently.
Exceptions to the Doctrine of Indoor Management
1. Knowledge of Irregularity: The doctrine of indoor management does not apply when an outsider who is engaging in business with a corporation has actual or constructive knowledge of a problem with the internal management of the organisation. There may be instances where the outsider participates in the internal process themselves. In the case of T.R. Pratt (Bombay) Ltd. v. E.D. Sassoon & Co. Ltd., (1936) 6 Comp. Cas. 90., Company A had lent money to Company B for mortgaging its assets. The method for doing so, which was outlined in the Articles for transactions of this sort, was not followed. Both firms shared the same Directors. The lender knew about this irregularity, hence the court decided that the transaction was not valid.
2. Forgery: It is important to remember that the Doctrine of Indoor Management does not apply when a third party relies on a document that was falsely created in the company's name. A business is never accountable for forgeries carried out by its employees.
In the case of Ruben v. Great Fingall Ltd.,1906 AC 439, The transferee of the share certificate printed with the defendant company's seal was the plaintiff. The certificate was created by the company secretary, who faked the signatures of the two company directors and attached the business seal to the document. The plaintiff in this case argued that because the company's internal management is responsible for determining whether a signature is genuine or fake, the company should be held accountable for it. However, the court determined that the doctrine of indoor management has never been extended to cover a forgery. An outsider dealing with a company is not required to question their indoor administration and will not be impacted by any irregularities they are unaware of, according to Lord Loreburn's interpretation.
3. Negligence: If a third party engaging in business with a corporation could have learned about its management irregularities with proper diligence, they would not be eligible for relief under the doctrine of indoor management. When the conditions and situations surrounding the contract are so suspicious that they beg for investigation and the outsider of the firm fails to do any effective investigations for the same, the remedy under this concept is also not possible. In the case of Anand Bihari Lal v. Dinshaw & Co., A.I.R. (1942) Oudh 417, the company's accountant had offered to transfer some of the company's property to the plaintiff. The transfer was declared to be void by the court since such a transaction was outside the bounds of the accountant's power. The plaintiff had a duty to review the power of attorney that the business had executed in favour of the accountant.
4. Acts that are beyond the scope of apparent authority: The corporation will not be held responsible for any defaults caused by an officer's actions that go beyond the apparent limit of their authority. Because the Articles did not grant the officer the authority to perform such activities, the outsider in this situation is not eligible for any relief under the doctrine of Indoor Management. If the official has the authority to act on those reasons, only then can the outsider sue the corporation under the Indoor Management theory. In the case of Kreditbank Cassel v. Schenkers Ltd.,(1927) 1 KB 826. The company's branch manager had personally guaranteed a few bills of exchange in the name of the business in favour of a payee. He was not given any power to do so by the Company. The firm was determined by the court to be unbound. Additionally, it was stated that the firm would be held accountable for any fraud committed by an officer of the company acting on behalf of the company while acting with apparent authority.
5. Representation through Articles: This exception is the most confusing and highly controversial aspect of the Turquand Rule. Articles of Association generally contain a clause of power of delegation. In the case of Lakshmi Ratan Cotton Mills v. J.K. Jute Mills Co., AIR 1957 ALL 311, B was the Director of the company. The company comprised managing agents of which B was also a Director. The Articles of Association authorized the directors to borrow money and also empowered them to delegate this power to one or more of them. B borrowed a sum of money from the plaintiff. Further, the Company refused to be bound by the loan on the ground that there was no resolution passed directing to delegate the power to borrow given to B. Yet it was held in the case that the company was bound by the loan as the Articles of Association had authorized the director to borrow money and delegate the power for the same.
