relationship between doctrines of indoor management and constuctive notice

7/25/2019 relationship between doctrines of indoor management and constuctive notice

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Relation between Doctrine of ConstructiveNotice and Indoor Management

HIDAYATULLAH NATIONAL LAW UNIVERSITY

CORPORATE LAW PROJECT

ON

RELATION BETWEEN DOCTRINE OF CONSTUCTIVE NOTICE AND

INDOOR MANAGEMENT

SUBMITTED TO

MS. APOORVI SHRIVASTAVA

SHASHWAT DUBEY

SEMESTER V

ROLL NO. 139

SUBMITTED ON 10THOCTOBER 2014

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ACKNOWLEDGEMENT

I would like to sincerely thank the Corporate Law Teacher Ms Apoorvi Shrivastava for giving

me this project on the elation !etween "octrine of Constructive #otice and Indoor

Management$ which has widened my knowledge on the "octrine under Corporate Law and

the relations !etween them% &er guidance and support has !een instrumental in the

completion of this project %Thank you Ma'am for your consistent support%

I'd also like to thank all the authors( writers and columnists whose ideas and works have !een

made use of in the completion of this project%

My sincere gratitude also goes out to the staff and administration )L*+ for the

infrastructure in the form of our li!rary and IT la! that was a source of great help in the

completion of this project%

I would also like to thank my friends who have lended me constant support through guidance

and inputs which has led to the completion of this project%

S&AS&,AT "*-./

S.M.ST. 0

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CONTENTS

CHAPTER 1

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CHAPTER 2 DOCTRINE OF CONSTRUCTIVE NOTICE AND

BACKGROUND

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CHAPTER 4 CONCLUSION

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BIBLIOGRAPHY AND WEB REFERENCES%%%%%%%%%%%%%%%%%%%%%%%%%%%%)=:+

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CHAPTER I INTRODUCTION AND OBJECTIVES OF THE

RESEARCH

1.1 I!"#$%&'"($!

The doctrines of constructive notice and indoor management are essentially rules of prudence

which facilitate !usiness transactions !etween a company and an outsider% The "octrine of

Constructive #otice provides that persons dealing with a company are deemed to have

knowledge of whatever is contained in the companyDs constitution and other pu!lic

documents of the company( especially as it relates to the powers( functions and duties of the

company's directors% The !asis of this imputation is that these are pu!lic documents and

therefore open to inspection !y any!ody% The doctrine operates on the assumption that people

doing !usiness with a company will !e sufficiently motivated to check the companyDs

constitution or other pu!lic documents to ensure that the transaction they are entering into is

not only allowed !ut to determine whether there are any internal formalities that must

!e complied with% The end result of the doctrine of constructive notice is that an individual or

juristic entity that deals with a company is presumed to !e informed of any reEuired internal

formalities or constraints prescri!ed !y the companyDs pu!lic documents( mainly the

constitution( relating to the transaction and the authority of the person representing the

company in the transaction% The individual or entity is thus prohi!ited from denying

knowledge of the formalities or constraints%

The doctrine of indoor management is an eFception to the rule of constructive notice% It

imposes an important limitation on the doctrine of constructive notice% According to this

doctrine Gpersons dealing with the company are entitled to presume that internal reEuirements

prescri!ed in memorandum and articles have !een properly o!servedG% A transaction has two

aspects( namely( su!stantive and procedural% An outsider dealing with the company can only

find out the su!stantive aspect !y reading the memorandum and articles% .ven though he may

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find out the procedural aspect( he cannot find out whether the procedure has !een followed or

not% 6or eFample( a company may have !orrowing powers !y passing a resolution according

to its memorandum and articles% An outsider can only found out the !orrowing powers of the

company% -ut he cannot find out whether the resolution has in fact !een 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(

!ut they are not !ound to do moreH they need not inEuire into the regularity of the

internal proceedings as reEuired !y the memorandum and articles% They can presume that allis !eing done regularly% The doctrine of indoor management is also known as the

T**A#" rule%

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1.2 OBJECTIVES OF RESEARCH

Critically eFamining the Corporate Law "octrines so as to comprehend the relationship !etween the

"octrine of Indoor Management and Constructive #otice%

1.3 RESEARCH METHODOLOGY

This project work is descriptive in approach and is !ased on the researches carried out to

study the "octrines under the Corporate Law and the relationship which eFists !etween them%

-ooks other references as guided !y faculty of Corporate Law have immensely helped in

the completion of the project%

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CHAPTER II DOCTINE OF CONSTRUCTIVE NOTICE AND

BACKGROUND

2.1 B)'*+#$&!% "$ ",- D$'"(!- $ C$!/"#&'"(- !$"('-

The "octrine of Constructive #otice to !e studied in depth reEuires a preliminary study of

various doctrines that have together !lended in to create the situation that in turn led to the

inception of the "octrine of Constructive notice% These doctrines are The doctrine of

Apparent authority of an agent on one hand and the doctrine of *ltra vires on the other% This

area of company law represents its !lend with the law of agency% The company( as is clear to

us( only acts through its agents%= &ence( the law of agency is applica!le to the acts of the

company's agents who enter into contractual relationships on !ehalf of the company%

An agent may possess two kinds of authorities( actual or apparent% ,hile actual authority

indicates factual conferment of authority on an individual( apparent authority should first !e

taken to mean that there is no real authority !ut a kind of presumed authority due tosuggestive circumstances% This principle was suita!ly defined in 6reeman and Lockyer's

case( !ut it is still often confused with implied authority% -ut it must !e remem!ered that

apparent authority is nothing !ut the impression in the mind of the third party% The crucial

distinction !etween the two lies in the fact whether there eFists a relationship !etween the

principal or the agent% The "octrine of Apparent authority was also ela!orated in Lockyer and

6reeman's Case !y "iplock L%5%7 The reEuirements that he puts forth for the eFistence of

actual authority clearly highlight that the !asis of such an authority is not the eFistence of any

1 Freeman and Lockyer v. Buckhurst Park Properties Ltd., [164! 2 "B 4#$.% Per &ip'ockL(% )*n *ctua' *uthority is a 'e+a' re'ationship et-een the principa' and the a+entcreated y a consensua' a+reement to-hich they a'one are parties. ts scope is to e ascertained y app'yin+ ordinaryprincipa's o/contracts0the usa+es o/ the trades, or the curse o/ usiness et-een the parties. o thia+reement theontractor [hird Party! is a stran+er0 everthe'ess, i/ the a+ent does enter into acontract, it does

create contractua' ri+hts and 'iai'ities et-een the principa' and the contractor.


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such authority !ut a representation !y the principle% This kind of authority is treated distinct

from the person and

depends on the representation made !y the principal to the world at large% This representation

may!e through eFpression or direct implication of the principal's conduct( or through the

principle's general treatment of the agent( say !y giving him a particular position( the

outcome of which would ordinarily include !estowal of such authority on the agent% Such

emphasis on representation then !rings apparent authority to !e further grounded in the rule

against estoppel% The former conduct of the principal is more easily linked to the rule of

estoppel !ut the latter( general( conduct of the principal is a link made more artificially% 1ften

the two categories overlap as every representation( as a matter of practice has some elements

of !oth generality and specificity% &owever( it must !e kept in mind that the representation

should have credi!ility to !e relia!le% Thus( for this purpose( the principle( who makes the

representation should have actual authority to do that act( otherwise( it may not !e tena!le toassume that one may create a chain of agents and su!3agents with no actual authority at the

root of such ostensi!le authority%

This rule was applied to company law as well in &ely3&utchinson case wherein it was held

that de facto discharge of duties of a position result in ostensi!le authority%?

2 7e'y 7utchinson v. Brayhead Ltd., [16#! 1 "B 54. 7ere, Lord Pearson he'd%)o-there is not usua''y any direct communication et-een the Board o/ &irectors and the8utsidecontractor. he actua' communication is made immediate'y and direct'y, -hether it ee9press or imp'ied,y the a+ent to the outside contactor. t is, there/ore, necessary in order to make a caseo/ ostensi'eauthority to sho- in some-ay that such communication -hich is made direct'y y thea+ent is made

u'timate'y y the responsi'e parties, the Board o/ &irectors0

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2.2 T,- D$'"#(!- $ C$!/"#&'"(- N$"('-

Section 7=J of the Companies Act( =


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The Articles of association of a company are its !ye3laws or rules and regulations that govern

the management of its internal affairs and the conduct of its !usiness% According to section

?)?+ of the Companies Act( =


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The .uropean Communities Act( =


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7*P:; % :**?:>: *& @ ;:L*8 A7 8@;=ana+ement

The rule of constructive notice has proved too inconvenient for !usiness transaction(

particularly where the directors or other officers of the company were empowered under the

articles to eFercise certain powers su!ject only to certain prior approvals or sanctions of the

shareholders% ,hether those sanctions and approvals had actually !een o!tained or not could

not !e ascertained !ecause in real situations( the investors( vendors( creditors and other

outsiders could not dare to ask the directors in so many words a!out those sanctions having

!een o!tained or to produce the relevant resolutions% Since( there are no means to ascertain

whether necessary sanctions and approvals have !een o!tained !efore a certain officer

eFercises his powers which( as per articles( can only !e eFercised su!ject to certain approvals(

those dealing with the company can assume that if the directors or other officers are entering

into those transactions( they would have o!tained the necessary sanctions% This is known as

the Bdoctrine of indoor management' and was first laid down in the case of oyal -ritish

-ank v% TurEuand%

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The doctrine of indoor management is an eFception to the rule of constructive notice% It

imposes an important limitation on the doctrine of constructive notice% According to this

doctrine Gpersons dealing with the company are entitled to presume that internal reEuirements

prescri!ed in memorandum and articles have !een properly o!servedG% A transaction has two

aspects( namely( su!stantive and procedural% An outsider dealing with the company can only

find out the su!stantive aspect !y reading the memorandum and articles% .ven though he may

find out the procedural aspect( he cannot find out whether the procedure has !een followed or

not% 6or eFample( a company may have !orrowing powers !y passing a resolution according

to its memorandum and articles% An outsider can only found out the !orrowing powers of the

company% -ut he cannot find out whether the resolution has in fact !een passed or not% Theoutsiders 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(

!ut they are not !ound to do moreH they need not inEuire into the regularity of the

internal proceedings as reEuired !y the memorandum and articles% They can presume that all

is !eing done regularly%

The doctrine of indoor management is also known as the T**A#" rule% The rule is

!ased on pu!lic convenience and justice and the following o!vious reasons>

=% The internal procedure is not a matter of pu!lic knowledge% An outsider is presumed to

know the constitution of a company( !ut not what may or may not have taken place within the

doors that are closed to him%

?% The lot of creditors of a limited company is not a particularly happy oneH it would !e

unhappier still if the company could escape lia!ility !y denying the authority of officials to

act on its !ehalf%

The Courts in India have also !een reluctant in applying the doctrine of constructive lia!ility%

The Allah!ada &igh Court inDehradun Mussoorie Electric Tramway Co. v.

Jagamanandaradas case rejected the doctrine of constructive lia!ility and the Company was

held lia!le to the party to the transaction even the directors of the company !orrowed the

money which was neither in compliance with the articles nor it was done after o!taining the

resolution in the general !ody%

The Madras &igh Court in the case of official LiEuidator(Manasube & Co. (P. !td. v.

Commissioner o" Police#o!served that the lenders to a company should acEuaint themselves

5 [1968] 38 Com Cases 884. (Mad)

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with memorandum and articles( !ut they cannot !e eFpected to em!ark upon an investigation

as to legality( propriety and regularity of acts of directors%

3.2 RELATIONSHIP BETWEEN THE DOCTRINE OF

CONSTRUCTIVE NOTICE AND INDOOR MANAGEMENT

As criticisms of the doctrine of constructive notice( the new theory called the doctrine of

indoor management has !een evolved !y the courts% The doctrine of constructive notice seeks

to protect the company against the outsiderH the other doctrine operates to protect outsiders

against the company% The rule of indoor management is !ased upon o!vious reasons of

convenience in !usiness relations% 6irstly( the memorandum and articles of association are

pu!lic documents( open to pu!lic documents% -ut( the details of internal procedures are not

thus open to pu!lic inspection% &ence( an outsider is presumed to know the constitution of a

companyH !ut not what may or may not have taken place within the doors that are closed to

him%

The doctrines of constructive notice and indoor management are essentially rules of prudence

which facilitate !usiness transactions !etween a company and an outsider% The former favours

the company in dealing with ordinary mem!ers of the pu!lic and provides that no outsider in

dealing with the company may claim that he was unaware of certain provisions in the

memorandum or articles of association% It seeks to estop such a person from ever pleading

that he had not read these documents as the presumption is always that all such persons in

their dealings have read these documents and understand their implications% ,hile the

doctrine of constructive notice thus greatly facilitates the !usiness transactions from the

company's point of view( it has an important eFception( namely( the doctrine of indoor

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management% Simply put( the doctrine of indoor management provides that an outsider is

entitled to rely on the presumption that all procedures have !een followed on the part of the

company and the company cannot rely on any procedural irregularity after the deal with any

outsider has !een concluded%

The doctrine of indoor management is founded on practical reasons of convenience in

!usiness relations%

6irst( even though articles and memorandum of association are pu!lic documents( any

mem!er of the pu!lic is not privy to all internal procedures in a company and there!y( cannot

make an informed decision %

Second( and more importantly( the doctrine of constructive notice would !e su!ject to great

a!use !y the companies if the doctrine of indoor management is not availa!le% Therefore( to

cur! such malicious activity( the doctrine of indoor management has !een used !y courts of

law%

Thus( there eFists a very close relation !etween the two doctrines%

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CHAPTER IV CONCLUSION

In this project( I have analysed the "octrine of Constructive #otice and the rule laid down in

the TurEuand case which gave rise to the "octrine of indoor Management% The rule which

later came to !e known as the doctrine of indoor management was carved out so as to preventthe doctrine of constructive notice( used !y companies to their advantage( from !ecoming an

impediment to trade and commerce as otherwise third parties would !e seriously affected if

constructive notice was applica!le in all cases%

The doctrine of indoor management seeks to protect the interest of the shareholders who are

in minority or who remains in dark a!out whether the working of the internal affairs of the

company are !eing 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 !ound

to inEuire the regularity of any internal proceeding%

&owever( the doctrine of indoor management cannot also !e applied over3eFtensively% In

essence( a harmonious !alance has to !e maintained so as to promote !usiness transactions

!etween the company and third parties% Thus the doctrine of indoor management cannot give

validity to a transaction where there is no authorityH it can only apply as an eFception to the

doctrine of constructive notice%

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Thus so as to prevent gross injustice to the third party which cannot !e eFpected to have

knowledge of the internal affairs of the Company( the "octrine of Indoor Management was

introduced%

It emerged as a criticism to the doctrine of Constructive #otice and has a close relationship with it as was

discussed in the project%

BIBLIOGRAPHY

MC !handari( 8uide to Company Law rocedures$( ?=st edition( LeFis #eFis

u!lication( #ew "elhi( ?J=?%

Ashok 9 -agnal( Company Law$( =Jthedition( Indian u!lishing Company( ?J=@%

WEB REFERENCES

http>www%lawnotes%in"octrineofIndoorManagement

http>www%llphelpline%comdocumentsApplica!ility3"octrine3Indoor3

Management%pdf

http>www%lawteacher%net!usiness3lawessaysdoctrine3of3constructive3notice3

!usiness3law3essay%php

http>ravneetarora%!logspot%in?J=@J;doctrine3of3constructive3notice3and%html

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Documents

relationship between doctrines of indoor management and constuctive notice