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Relation between Doctrine of Constructive Notice 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 10 TH OCTOBER 2014
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Relation between Doctrine of Constructive Notice and Indoor Management
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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Relation between Doctrine of Constructive Notice and Indoor Management
B #1TIC. I#"11 MA#A8.M.#T%%%%%%%%%%%%%%%%%%%%%%%%%%%%)=23=4+ CHAPTER 4 CONCLUSION C1#CL*SI1#%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%)=7+ BIBLIOGRAPHY AND WEB REFERENCES %%%%%%%%%%%%%%%%%%%%%%%%%%%%)=:+
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Relation between Doctrine of Constructive Notice and Indoor Management 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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Relation between Doctrine of Constructive Notice and Indoor Management 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 all is !eing done regularly% The doctrine of indoor management is also known as the T**A#" rule%
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Relation between Doctrine of Constructive Notice and Indoor Management
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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Relation between Doctrine of Constructive Notice and Indoor Management
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 to suggestive 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'ock L(% )*n *ctua' *uthority is a 'e+a' re'ationship et-een the principa' and the a+ent created y a consensua' a+reement to -hich they a'one are parties. ts scope is to e ascertained y app'yin+ ordinary principa's o/ contracts0the usa+es o/ the trades, or the curse o/ usiness et-een the parties. o thi a+reement the ontractor [hird Party! is a stran+er0 everthe'ess, i/ the a+ent does enter into a contract, it does create contractua' ri+hts and 'iai'ities et-een the principa' and the contractor.
Relation between Doctrine of Constructive Notice and Indoor Management 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 to assume 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%)othere is not usua''y any direct communication et-een the Board o/ &irectors and the 8utside contractor. he actua' communication is made immediate'y and direct'y, -hether it e e9press or imp'ied, y the a+ent to the outside contactor. t is, there/ore, necessary in order to make a case o/ ostensi'e authority to sho- in some-ay that such communication -hich is made direct'y y the a+ent is made u'timate'y y the responsi'e parties, the Board o/ &irectors0
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Relation between Doctrine of Constructive Notice and Indoor Management
2.2 T,- D$'"#(!- $ C$!/"#&'"(- N$"('Section 7=J of the Companies Act( =<47 provides the inspection( production and evidence of documents kept !y egistrar% It provides that the memorandum and articles when registered with egistrar of Companies !ecomes pu!lic document and then they can !e inspected !y anyone on payment of a nominal fee% Therefore( any person who contemplates entering into a contract with the company has the means of ascertaining and is thus presumed to know the powers of the company has the means of ascertaining and is thus presumed to know the powers of the company and the eFtent to which they have !een delegated to the directors% In other words( every person dealing with the company is presumed to have read these documents and understood them in their true perspective% This is known as doctrine of constructive notice%
The memorandum of association and articles of association are two most important documents needed for registration and incorporation of a company% The memorandum of association of a company contains the fundamental conditions upon which alone the company has !een incorporated% The Companies Act( =<47 defines the me morandum as memorandum means the memorandum of association of a company as originally framed or as altered from time to time in pursuance of any previous companies law or of this Act% @ According to almer( the memorandum of association is a document of great importance in relation to the proposed company% It contains the o!jects for which the company is formed and therefore identifies the possi!le scope of its operation scope of its operation !eyond which its action cannot go%
3 Section ?)?;+ of Companies Act =<47
Relation between Doctrine of Constructive Notice and Indoor Management 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( =<47 Barticles' means the articles of association of a company as originally framed or as altered from time to time in pursuance of any previous companies laws or of the present Act% -oth memorandum of association and the articles of association are pu!lic documents according to section 7=J of the Act% These documents !ecome pu!lic documents as soon as they get registered and can !e accessi!le !y any mem!ers of the pu!lic under the provision of the Act% Therefore( notice a!out the contents of memorandum and articles is said to !e within the knowledge of !oth mem!ers and non3mem!ers of the company% Such notice is a deemed notice in case of a mem!ers and a constructive notice in case of non3mem!ers% The rule of constructive notice eFtends not merely to Memorandum and Articles !ut also to all such documents as are reEuired to !e registered with the egistrar of Companies% There is however no constructive notice of documents which are filed with the egistrar of Companies for the sake of record only% The effect of the doctrine of constructive notice is harsh on the outsider who does !usiness with a company% An outsider who dealt with a company is deemed to have a constructive notice of the contents of the documents of the company% An outsider cannot claim relief on the ground that he was unaware of the powers of the company in case of ultra vires of the company% The Bdoctrine of constructive notice' is more or less an unreal doctrine% It does not take notice of the realities of !usiness life% eople know a company through its officers and not through its documents% The courts in India do not seem to have taken it seriously though% 6or eFample( in Dehra Dun Mussorie Electric Tramway Co. v. Jagmandardas 4( the Allaha!ad high court allowed an overdraft incurred !y the managing agent of a company when under the articles the directors had no power to delegate their !orrowing power%
4 AIR 1932 All 141 1$
Relation between Doctrine of Constructive Notice and Indoor Management The .uropean Communities Act( =<:? contained the provision of constructive notice( which has now a!rogated% A person who dealt with a company was at common law deemed to have notice of the contents of its memorandum and articles of association when the company's certificate of incorporation was issued !y the egistrar of Companies and such a person also had constructive notice of the other documents which companies were reEuired to deliver to the registrar of companies( provided they were open to pu!lic inspection and had !een gaKetted where necessary% This is no longer since an amendment was made in =<;< to the Companies Act =<;4( providing that a person shall not !e taken to have notice of any matter merely !ecause it is disclosed in a document delivered to the egistrar of Companies and so is availa!le to pu!lic inspection% The statutorily modified doctrine of constructive notice may therefore( according to the circumstances( mean that a person will !e treated as !eing aware of the contents of certain documents filed in respect of the company with which he deals% These documents will tell the person who deals with the company what o!jects it may pursue( how much share capital it has issued and may issue in future( how its !oard of directors is constituted etc% In theory( therefore( a person who deals with a company cannot complain if a transaction which he enters into with the company is held to !e invalid !ecause it patently conflicts with the provisions or reEuirements of those documents which he could( and should in the circumstances( have inspected( at the companies registry%
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Relation between Doctrine of Constructive Notice and Indoor Management
7*P:; % :<8L=8 8F &8;: 8F &88; >**?:>: *& @ ;:L*8 A7 8@;=<: 8: 3.1 riticism o/ &octrine o/ onstructive Liai'ity% :vo'ution o/ &octrine o/ ndoor >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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Relation between Doctrine of Constructive Notice and Indoor Management 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% 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 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 in Dehradun 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) 13
Relation between Doctrine of Constructive Notice and Indoor Management 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 14
Relation between Doctrine of Constructive Notice and Indoor Management 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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Relation between Doctrine of Constructive Notice and Indoor Management
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 prevent the 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% 16
Relation between Doctrine of Constructive Notice and Indoor Management
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