The Doctrine of Constructive Notice and Doctrine of Indoor Management

The doctrine of constructive liability is an important principle as it serves its purpose in easing business regulations. It provides security to the companies while they are dealing with the outsiders. However, this provision was seen to be doing more wrong than good, thereby, its credibility was getting reduced. For that, the doctrine of indoor management was evolved by the courts to restrict the application of this provision when the rule in dispute is internal.
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Introduction

The doctrine of Constructive Notice, the term company does not have a strict definition, even though it is defined in the Companies Act, 2013 (hereinafter referred to as ‘the Act’) under Section 2(20). It means a body corporate registered under the Act or any previous law. It includes all companies, whether they are public or private. A company is a public entity, to the extent that some of its documents are always available in the public domain, as soon as the company registers itself. It thereby becomes imperative that any person who transacts any business with the company is conversant with all the rules and regulations of the company which are available in the public domain. This apparent presumption is called the Doctrine of Constructive Notice.

The Memorandum of Association (hereinafter referred to as ‘MOA’) and the Articles of Association (hereinafter referred to as ‘AOA’) of every company are registered with the Registrar of Companies under the Ministry of Corporate Affairs, which is a public office. The two documents are the most important ones for a company and work as the constitution for the company. Furthermore, it is necessary to know that the MOA and AOA are public documents, accessible to all persons. Therefore, the law poses a duty on a person transacting with the company to be well-versant with the two documents of the company. It is the duty of a person making a contract with a company that his contract should conform to the AOA and MOA of the company. If not, the company cannot be made to fulfil the contract and no remedy lies for the contracting party due to this legal obligation put on him. This rule comes into help if a dispute arises regarding the regulation of the company which was a part of the AOA or the MOA of the company in violation of which, a contract has been signed between an outsider and a company representative, on behalf of the company.

History of the Doctrine of Constructive Notice

This is a common law doctrine and applicable in England as well as India, on same lines. The corporate law jurisprudence is somewhat similar throughout the globe, therefore, the principles of the corporate world are followed almost everywhere. This principle also has been adopted by the courts of many countries. The doctrine of constructive notice is one of the basic postulates of corporate law. The author shall be discussing the doctrine in detail in this article.

Doctrine of Constructive Notice

The term Constructive Notice is based on the term ‘constructive’ which means something which can be deduced by inference, a fact that was apparent and must have been known to the party. Therefore, a constructive notice shall mean such facts that are expected to be known to a person by virtue of some inference. This inference is drawn because of a legal duty that is put on a person to be aware of certain circumstances. In the corporate jurisprudence, it means such information which is expected to be known to a person who is transacting with a company because such information is available in public domain, irrespective of the fact whether it was known to him or not. The doctrine of constructive notice is a legal fiction that puts the liability on a person to have known any fact regarding the company which is available in the public domain.

The law providing for this presumption is provided under Section 399 of the Act which allows any person to inspect, take extracts from or make records of any document of any company which has been registered with the Registrar of Companies. The section provides for a fee, on payment of which, this right shall be provided to the applicant. The right extends to the inspection of any public document of any company. The MOA and AOA of the company are public documents and available for scrutiny at all times. Under this provision, the doctrine of constructive notice was instituted whereby a person is expected to be aware of the contents of any document which is available in the public domain. Before a person plans to transact with a company, he must inspect all the documents related to the company and ensure that the content of his transaction conforms to the rules of the company. This is an implied and a presumed notice given to the person who wishes to transact with the company notably called the ‘Doctrine of Constructive Notice’.

This doctrine applies to such provisions which are available in the public domain. In the case of Oakbank Oil Co. v. Crum[1] it was held that anyone who is dealing with the company shall be presumed to have read and understood the MOA and AOA of the company, thus presumes to be a notice to the public. Such a notice is called constructive notice.

Impact of Doctrine of Constructive Notice

The effect of the doctrine of constructive notice is harsh on a person who wishes to transact business with the company. It puts the liability on the person transacting any business with the company to inspect all the documents of the company available in the public domain to ensure that his contract conforms with the rules of the company. This matter was discussed in the case of Kotla Venkataswamy v. Rammurthy[2]. In this case, the plaintiff accepted a mortgage deed executed by the secretary who was a working director of the company only. The AOA of the company specified that such a deed needs to be executed by three specific officers of the company and it shall not be valid otherwise. Therefore, they were denied any protection by the application of this doctrine.

Another necessary implication of this rule is that a person transacting business with the company is considered to have read all the public documents of the company and understood them for what they mean. Such a person is also presumed to understand the powers that the company’s officers are authorised to execute. In the case of Re Jon Beauforte (London) Ltd case[3], an insolvent company’s objects were to manufacture dresses but the company was manufacturing veneered panels. The knowledge of this development was with the creditors. Therefore, in the insolvency proceedings, their claim was not carried out for being ultra vires.

In a case where the act is declared to be ultra vires the company’s AOA or MOA, a person cannot claim any relief on the ground that he was unaware of the said provision in the documents. The principle of common law jurisprudence of corporate law provides ample protection to an innocent person who is dealing with the company in good faith where the act concerned is not ultra vires to the company, but the protection cannot be extended in a case where the said act is beyond the authority of the company.

The doctrine of constructive notice was established by the House of Lords in the case of Ernest v. Nicholls[4] where it was held for the first time that any person who is dealing with the company is deemed to be familiar with the contents of all the public documents of the company. Further, in the case of Mahony v. East HolyFord Mining Co.[5] where it was held by the House of Lords that in the case of absence of the doctrine of constructive liability, the rules of the partnership will apply.

However, it was also categorically accepted by the British courts that the rule of constructive notice has drastic impacts on the corporate world and mainly investors. The courts are bound to apply them even if that equals to injustice for the persons involved. At times, the provision may be vague and subject to an internal procedure of the company. In such a scenario, the application of the Doctrine of Constructive Notice will amount to an injustice being met on persons. Therefore, to mitigate such a situation, the doctrine of Indoor Management, also known as Turquand’s Rule was established by the courts. It has been held to be an exception to the rule of constructive liability and is discussed in the following paragraph.

Doctrine of Indoor Management

The doctrine of constructive notice is very convenient and expedient for management. It allows the company respite from explaining to each person separately their rules and regulations. This is a huge presumption in favour of the company and prejudicial for the person who is transacting with the company, thereby, it becomes imperative that this rule is applied within very specific limits. One very important rule that restricts the doctrine of constructive notice is the Doctrine of Indoor Management. This rule protects the person contracting with the company in a situation when the application of the doctrine of constructive notice is being ruled out against an innocent contractor citing a rule which is privy to the management of the company i.e. not available in the public domain. Therefore, when certain information regarding the company is not available for inspection by the public, then, such a provision cannot be used to slap the doctrine of constructive notice on the person. In such a case, the company is not afforded any protection and must complete the agreement or face the repercussions. This rule balances out the previous rule and ensures that justice prevails for the innocent.

Origin

This doctrine of indoor management is also called Turquand’s Rule as it was generated in the case of Royal Bank v. Turquand[6]. In this case, the AOA of the company authorized its Directors to borrow any sum of money that is required after moving a special resolution in this regard in the general meeting of the company. The company borrowed the sum without the passing of the required resolution; therefore, the company denied the repayment of the sum to the bank. The company brought forward a bond with the seal of the company signed by two directors and the secretary which was given to the bank as the authority letter to fulfill the requirement. The company stated that the passing of the resolution is an internal matter and could not have been inquired upon by the bank. It forwarded the loan when adequate documents to prove the consent were provided to them. The Court of Exchequer Chamber ruled that the bond was binding on the company. It was held that Turquand was entitled to assume that the required resolution must have been passed by the company because of the bond that was presented to them. Therefore, Turquand was allowed to recover the payment. This was the first incident when the principle was officially established even though it was previously been made applicable in different forms in different cases.

Illustration

The rule of indoor management is an exception to the rule of constructive notice. In simplest terms, it means that the persons transacting any business with the company are entitled to assume that if there is any internal requirement prescribed in the public document; it has been met by the officers. It absolves any liability for any internal irregularity of the company as it cannot be reasonably expected from an outsider to inquire about such details.

Application

Any person dealing with the company is expected to be aware of any irregularity in the company’s public documents, without a doubt, but the same rule cannot be extended when the fact in dispute is an internal rule of the company. The Turquand’s rule was applied by the court in Varkey Souriar v. Keraleeya Banking Co. Ltd[7]. It was held that a person dealing with the company need not enquire about the internal proceedings of the company in furtherance of an obligation put on them through a public document or otherwise. All is expected from them is to ensure that the person transacting the business has the authority to do so. In the case of Lakshmi Ratan Cotton Mills Co. Ltd v. J.K. Jute Mills Co. Ltd[8], the plaintiff sued the defendant company for the non-payment of a loan of Rs. 1.5 Lakhs which was taken through a letter sanctioned by the Board of Directors. The stance of the court was similar to the Turquand case as it was held that the company cannot be expected to be in knowledge of an internal rule of the debtor company. If the negotiations are happening on behalf of the company, it shall be presumed that all the internal requirements for the same have been met by the officers of the company. The only aspect that a person needs to see is whether the person approaching on behalf of the company is the authorised person or not.

Exceptions

The rule of indoor management is also not absolute and remains subject to certain exceptions. Relief under the doctrine of indoor management cannot be claimed by a person transacting business with the company in the following cases-

  1. Knowledge of irregularity: Firstly, is a case when the party affected knew of the irregularity already. It may happen in a case when the person contracting himself was a party to the inside procedure of the company. In the case of Howard v. Patent Ivory Manufacturing Co[9], it was held that the directors could not defend the issue of debentures because, being the directors, they should have been the extent to which they were lending the money and for that amount, the assent of the general meeting was necessary which was not obtained in this case.
  2. Suspicion of irregularity: The protection under this provision shall not be given also when the circumstances are such that they invite suspicion of a man of ordinary prudence. In the case of Anand Behari Lal v. Dinshaw[10], the plaintiff accepted a transfer of property of the company concluded by the accountant of the company. In ordinary prudence, no company allows its accountant to transfer properties of the company. Therefore, the plaintiff was asked to have been more cautious and the defence was not provided to him.
  3. Forgery: Forgery may, in some cases, be an exception to this rule. An example of this is the case of Ruben v. Great Fingall Consolidated[11]where the company secretary had sold the shares to the plaintiff by forging the signatures of two directors. It was held that the company cannot be made liable in cases like this where there has been an apparent forgery and fraud.
  4. Representation through articles:When the AOA of the company allow for delegation of any power, the person transacting business with the company may assume that the person purporting to conclude the transaction must have been delegated the said power. The issue regarding this rose in the case of Rama Corporation v. Proved Tin and General Investment Co[12], where a director entered into an agreement on behalf of the company without any delegation of power in that regards. It was found out that the person did not have the knowledge that there existed a power of delegation; therefore, the benefit was not given to him. Although it was observed by the court that had he been aware of the power of delegation, the assumption would have been in his favour.

The ‘Turquand Case’ laid down the basic principles of common law which later on culminated into the Doctrine of Indoor Management which exists to mitigate the excesses which might be caused by doctrine of constructive notice.

Criticism

The rule of constructive liability is an inconvenience for the business world. It puts the liability on the other party to such a great extent that becomes restrictive in nature. It creates apprehension in the minds of the people before investing in a company, thereby, restricting the growth potentials of the business world. The Indian courts have always been reluctant in applying the doctrine of constructive liability in India. The Allahabad High Court in the case of Dehradun Mussoorie Electric Tramway Co. v. Jagmandar Das[13]did not allow the company to take the benefit of this doctrine even when the transaction for borrowing money was not concluded in the manner provided for in the AOA of the company. Another important observation of Madras High Court in the case of Official Liquidator, Manasube & Co. (P) Ltd. v. Commissioner of Police[14] where it was stated that the lender can be expected to be aware of the MOA and AOA, but an unlimited liability cannot be embarked upon him to investigate the legality, propriety and regularity in each action of the officers of the company.

This doctrine, therefore, needs to be scrutinised to ensure that it is not being made applicable in infraction of the rule of law and the basic postulates of justice. Additionally, it needs to be assured that the company is not provided with an opportunity to take advantage of its wrong.

Conclusion

The doctrine of constructive liability is an important principle as serves its purpose in easing the business regulations. It provides security to the companies while they are dealing with the outsiders. Yet, this seems to be an unrealistic provision on most times. It is a judicial fiction created through the pronouncement of the courts. There are innumerable contracts that take place in companies daily. The company cannot be expected to explain its stand and its rules to people as that will become a cumbersome process. The fiction of law is created in favour of the company as this allows the process to be smooth. Thereby, if an outsider is dealing with the company, he is burdened with the duty to know all the rules of the company that are available in the public domain.  This provision was seen to be doing more wrong than good, thereby; its credibility was getting reduced. For that, the doctrine of indoor management was evolved by the courts to restrict the application of this provision when the rule in dispute is internal. The freedom to make assumptions regarding the company’s rules can be made when they are reasonable to be deduced from the point of view of a prudent man. To conclude, the author is of the view that this provision is important, and has been assisting in bringing justice to the people.


[1] 1882 8 AC 65.

[2]AIR 1934 Mad 579.

[3](1953) 1 Ch. 131.

[4] (1857) 6 HL Cas 401.

[5](1875) LR 7 HL 869. 6.

[6] (1856) 6 E&B 327.

[7] (1957) 27 Comp Cas 391.

[8] AIR 1957 All. 311.

[9] (1888) 38 Ch D 156.

[10] AIR 1942 Oudh 417.

[11] (1906) AC 439.

[12] (1952) 1 All. ER 554.

[13]AIR 1932 All 141.

[14](1968) Comp Cas 884 (Mad)

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