"Indoor management and its application to finance raising by companies"

Constructive Notice
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 not knowing
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.

Kotla Venkatswamy v. C. Rammurthi

The Articles of Association of a company contained a clause that all deeds and
documents of the company shall be signed by the managing director, the
secretary and a working director on behalf of the company. A deed of mortgage
was signed by the secretary and a working director only.
It was held that the mortgage could not be enforced as the illegality appeared on
the face of the deed, and therefore, the deed was invalid notwithstanding that
plaintiff acted in good faith and money was applied for the purposes of the
company.
The doctrine of constructive notice of the Memorandum and Articles, however,
is not a positive doctrine but a negative one. It is like doctrine of estoppels. It
does not operate against the company. It operates only against an outsider
dealing with the company. It prevents him from alleging that he did not know
that the Memorandum and Articles rendered a particular act ultra vires the
company.

Indoor Management
The role of Doctrine of Indoor Management is opposed to that of the principle of
Constructive Notice. Constructive notice 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.
Genesis of the Doctrine: - The rule had its genesis in the case of Royal Bank v Turquand.
In this case, the directors of a banking company were authorised by the articles to borrow
on bonds such sums of money as should from time to time, by resolution of the company
in the general meeting, be authorised to borrow. The directors gave a bond to Turquand
without the authority of any such resolution.
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.
A c c o r d i n g t o t h i s doctrine, a person dealing with a company is bound to read
only the public documents. He will not be affected by any irregularity in the
internal management of the company. The rule of indoor management had its
genesis in Royal British Bank v. Turquand.

T h e directors of the company borrowed a sum of money from the plaintiff. The
companys articles p r o v i d e d t h a t t h e d i r e c t o r s m i g h t b o r r o w o n b o n d s s u c h
s u m s a s m a y f r o m t i m e t o t i m e b e authorized by a resolution passed at a general
meeting of a company. The shareholders claimed that there was no such resolution
authorizing the loan and, therefore, it was taken without their authority.
The company was however held bound for the loan. Once it was found that
the directors could borrow subject to a resolution, the plaintiff had the right
to assume that the necessary resolution must have been passed.
The rule is based on public convenience and justice and the following obvious
reasons:
1

The

internal

procedure

is

not

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. T h e l o t o f c r ed i t o r s o f a l i m i t e d c o m p a n y i s n o t a p a r t i c u l a r l y
h a p p y o n e ; i t w o u l d b e unhappier still if the company could escape
liability by denying the authority of officials to act on its behalf. The
rule/doctrine is applied to protect persons contracting with companies from all kinds
of internal irregularities.
It has been applied to cover the acts of de facto directors , who have not been
appointed but have only assumed office at the acquiescence of the shareholders or
whose appointment is defective, or have exercised authority which could have
been delegated to them under the Act but actually not delegated, or who has acted without
quorum.
Provisions under the Indian Companies Act, 1956
The provision under the Indian Act which directly imbibes the Turquand rule is section
290, which reads as under:
Section 290:- Validity of acts of directors:-

Acts done by a person as a director shall be valid, notwithstanding that it may afterwards be
discovered that his appointment was invalid by reason of any defect or disqualification or had
terminated by virtue of any provision contained in this Act or in the articles:
Provided that nothing in this section shall be deemed to give validity to acts done by a
director after his appointment has been shown to the company to be invalid or to have
terminated.
Another Provision which directly follows the above stated rule is section 81 of the Indian
Companies Act, 1956 which bears the heading further issue of shares. Bona fide
allottees of shares are protected by the Doctrine of Indoor Management under s-81.
Illustrating upon the point the Punjab & Haryana High Court has avowed in the case of
Diwan Singh v Minerva Mills that The allottees of the shares were contracting in good faith
with the Company and they were entitled to assume that the acts of the Directors in making
allotments of the shares to them are within the scope of their powers conferred upon them by
the shareholders of the Company.
They were not bound to enquire whether the acts of the Directors which as in this case related
to internal management had been properly and regularly performed. Even when the Directors
exceed their powers or infringe the restrictions imposed upon them, the company may be
bound for the outsider dealing with the company is only required to see that the transactions
are consistent with the article. Strangers are justified in assuming that all matters of Indoor
management have been done regularly.
Exceptions to the rule of indoor management
Knowledge of irregularity
A p e r s o n w h o h a s a c t u a l k n o w l e d g e o f t h e i n t e r n a l irregularity cannot
claim the protection of this rule, because he could have taken steps for
self- protection. A person who himself is a party to the inside procedure, such as a director is
deemed to know the irregularities, if any.
T.R Pratt (Bombay) Ltd. V. E.D. Sassoon & Co. Ltd
Company A lent money to Company 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.
Negligence and suspicion of irregularity
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.
Forgery
T h e r u l e i n Turquands case d o e s n o t a p p l y w h e r e a p e r s o n r e l i e s u p o n
document that turns out to be forged since nothing can validate forgery. In Ruben v.
Great Fingall Ltd, a co was not held bound by a certificate issued by tit secretary by forging
the signature of two directions. However, in Official Liquidator v. Commr of Police, the
Madras High Court held the company liable where the Managing Director had forged the
signature of two other directors.

Representation through Articles

This exception deals with the most controversial and highly confusing aspect of
the Turquand Rule. Articles of association generally contain what is called the
power of delegation.
Lakshmi Ratan Cotton Mills v. J.K. Jute Mills Co.
This case explains the meaning and effect of a delegation clause.
One G was a director of a company. The company had managing agents of
which also G was a director. Articles authorized directors to borrow money and
also empowered them to delegate this power to any one 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 power to borrow to G. Yet the company was held bound by the
loan.
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.

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 acthas in fact been delegated to the officer with whom he
entered into the contract.
Kredit bank 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.
Government not keen on defining what ordinary course of business means:
The corporate affairs ministry has ruled out defining the term 'ordinary course of
business', used several times in the Companies Act, 2013. This, experts say, might lead
to confusion and litigation. "We are not going to define the 'ordinary course of
business'. Companies will have to do it themselves," said a senior ministry official, asking
not

to

be

named.

Though the term has been used at various places in the new companies law, it has primarily
drawn attention because of its significance in cases of related-party transactions.
While the Companies Act of 1956 used the term in reference to very few situations, the law
of 2013 uses it in conjunction with situations that are far more common, Sharma adds. "For
example, it is used as a reference to specify restrictions in related-party transactions. Even a
slight misinterpretation might result in non-compliance." Besides related-party transactions,
the term is used in the context of loans to directors, powers of the board, insider-trading
provisions, etc. The fact that the phrase has been used at different places and in reference to a
variety of transactions in the Act might lead to contextual interpretations and inconsistency in

application. As a result, there could ultimately be increased compliance cost for Indian
companies," says Sharma.
"There is no definition for what is ordinary and what is not. So, there will be confusion
over whether a particular related-party transaction, such as royalty payment, requires
approval from the board of directors or minority shareholders," says Dolphy D'Souza, partner
at

member

firm

of

EY

Global.

According to an expert, the memorandum and articles of association of the company

concerned will be used to interpret an 'ordinary course of business' in the event of
litigation.

This,

in

some

cases,

might

lead

to

subjectivity.

Yogesh Sharma, partner (assurance) at Grant Thornton India LLP, says while it will be easy
to identify what is 'ordinary course of business' in most cases, it will remain subjective
and require judgement in situations where it is not so obvious. "Consider royalty
payments, for example. It can be taken as ordinary course of business for a company
like Maruti Suzuki but one might view it differently in the case of, say, a Tata Group
company."
Which types of transactions will be regarded as ordinary course of business?
The phrase ordinary course of business is not defined under the Companies Act 2013 or
rules made thereunder. It seems that the ordinary course of business will cover the usual
transactions, customs and practices of a business and of a company. In its guidance to
auditors, the Institute of Chartered Accountants of India has included following few examples
of transactions that are considered outside the entitys normal (or ordinary) course of
business:
1. Complex equity transactions, such as corporate restructurings or acquisitions.
2. Transactions with offshore entities in jurisdictions with weak corporate laws. ? The
leasing of premises or the rendering of management services by the entity to another
party if no consideration is exchanged.
3. Sales transactions with unusually large discounts or returns.
4. Transactions with circular arrangements, for example, sales with a commitment to
repurchase.
5. Transactions under contracts whose terms are changed before expiry.
The assessment of whether a transaction is in ordinary course of business is very
subjective, judgemental and can vary on case-to-case basis giving consideration to

nature of business and objects of the entity. The purpose of making such assessment is
to determine whether the transaction is usual or customary to the company and/ or its
line of business. Companies should consider variety of factors like size and volume of
transactions, arms-length, frequency, purpose, etc, to make this assessment.
Position in India
The courts in India do not seem to have taken the doctrine of contructive
n o t i c e s e r i o u s l y. F o r e x a m p l e , t h e Calcutta High Court in
Charnock Collieries Co Ltd. v. Bholanath enforced a security which was not signed in
accordance with the companys articles.
Application of the Rule by the Indian Courts
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 Ors, 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 had
entered into and adopted the transaction throughout and implemented it after receiving
consideration thereof

In MRF Ltd. v. Manohar Parrikar (Civil Appeals No. 4219 and 4220 of 2010, decided on May 3, 2010),
the Supreme Court of India highlighted some aspects of the operation of the indoor management rule
(or the rule in Turquands case). While the issue before the Court was a matter of public law and
reference was made to indoor management only as an analogy, the decision is noteworthy as it is
perhaps the first time that the Supreme Court has analysed the rule in some detail.
The case before the Supreme Court arose from an appeal against a decision of Panaji Bench of the Bombay
High Court, which involved a public interest petition questioning the legality of two notifications issued by
Government of Goa in respect of grant of 25% rebate u/s 23 of the Electricity Act, 1910 to certain industrial
consumers of electricity. The indoor management rule became relevant because of a contention taken that the

conduct of some governmental authorities in the course of their activities is within the indoor management of
the authorities; and the procedure must be taken to have been properly complied with. The analogy is
somewhat far-fetched; and in fact, the Court cited its previous judgment in S. Dhawan v. Shaw Bros., (1992)
1 SCC 534, on the dangers of private law analogies before commencing its discussion on the point. The
Court did go ahead and examine the nature of the indoor management rule to conclude that the analogy was
in any case inapplicable.
On facts, the Court held that the suspicion of irregularity threshold was satisfied in the case; and reliance on
analogies of the indoor management rule was inapplicable.
What is significant about the decision from a company law perspective is that it recognizes explicitly
that 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.
Consequently, 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, 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.
Conclusion
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 cannot 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.
1. 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.
2. 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.
3. Thirdly, actual notice of the failure to comply fully with internal procedures precluded
reliance upon the rule.
4. 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.
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.