Doctrine of constructive notice
The memorandum and articles of association of every company are registered with Registrar of Companies. The Office of the Registrar is a public office and consequently the memorandum and articles become public documents. They are open and accessible to all.
It is, therefore, the duty of every person dealing with a company it inspect its public documents and make sure that his contract is in conformity with their provisions. But whether a person actually reads them or not, “he is to be in the same position as if he has read them.” He is presumed to know the contents of the documents.
This kind of presumed notice is called Constructive notice.
By this doctrine a company is protected from the outsiders. Company can avoid the claims of outsiders arising out of any irregularity which that outsider could have known from the memorandum of article of association. Another effect of this rule is that a person dealing with the company is taken not only to have read those documents but to have understood them according to their proper meaning.
Case Reference: Kotla Venkataswamy vs. Rammurthy – 1934
Doctrine of Indoor Management: Tarquand Rule
This rule of Indoor management is opposed to the doctrine of constructive notice. It operates to protect the outsiders against the company.
Constructive notice notifies the public about external position of the company or it simply informs how a thing should be done, but the internal machinery, how works or whether it is really handled in a proper way by the officers of the Company cannot be known by Constructive Notice. If the contract is consistent with the public document a man cannot be prejudiced by the irregularities happened within the closed doors. This is the Rule of Indoor Management.
The rule is established by a famous case – Royal British Bank vs. Turquand – 1856. For this it is also known as Turquand Rule.
The Directors of the Company borrowed money for the plaintiff. The Article of Association of the Company provided that the directors may borrow on bonds sums as may from time to time be authorized by a resolution passed at a general meeting. The shareholders claimed that no such meeting was held and the loan was unauthorized. But the court said that once it was found that directors could borrow subject to a resolution, the plaintiff had the right to infer that the necessary resolution must have been passed.
Thus the rule of indoor management was established. It is bases on the obvious reasons of convenience in business relations.
Firstly—the memorandum and articles are public documents open to public inspection. But the details of internal procedure are not open to public. Thus the outsider may know the constitution of the company but not what may or may not have taken place within the doors closed to him.
Secondly – The creditors will be really frustrated if the company is allowed to escape liability by denying the authority of the officials to act on its behalf.
Royal British Bank v Turquand (1856) 6 E&B 327, and the eponymous “Rule in Turquand’s Case” refer to the rule of English law that a third party dealing with a company is entitled to presume that a person held out by the company has the necessary authority to act on behalf of the company. The common law rule mitigated the perceived harshness of the doctrine of constructive notice with respect to the “public documents” of a company (including its Memorandum of Association and Articles of Association). In fact, the rule was not accepted as being firmly entrenched in law until it was endorsed by the House of Lords in Mahoney v East Holyford Mining Co. (1875) LR 7 HL 869.
In Mahoney Lord Hatherly phrased the law thus:
“When there are persons conducting the affairs of the company in a manner which appears to be perfectly consonant with the articles of association, those so dealing with them externally are not to be affected by irregularities which may take place in the internal management of the company.
So, in Mahoney, where the company’s articles provided that cheques should be signed by any two of the three named directors and by the secretary, the fact that the directors who had signed the cheques had never been properly appointed was held to be a matter of internal management, and the third parties who received those cheques were entitled to presume that the directors had been properly appointed, and cash the cheques.
According to the Turquand rule, each outsider contracting with a company in good faith is entitled to assume that the internal requirements and procedures have been complied with. Therefore the company will consequently be bound by the contract even if the internal requirements and procedures have not been complied with. The exceptions here are: if the outsider was aware of the fact that the internal requirements and procedures have not been complied with (acted in bad faith); or if the circumstances under which the contract was concluded on behalf of the company were suspicious.
So the rule is of great practical utility. Thus it has been applied in many cases like where something was done by the Directors, who were not properly appointed, or who has exercised authority without quorum, where directors could allot shares with the approval of general meting but meeting was not held.
However, it is sometimes possible for an outsider to ascertain whether an internal requirement or procedure has been complied with. If it is possible to ascertain this fact from the company’s public documents, the doctrine of disclosure and the doctrine of constructive notice will apply and not the Turquand rule. The Turquand rule was formulated to keep an outsider’s duty to inquire into the affairs of a company within reasonable bounds, but if the compliance or noncompliance with an internal requirement can be ascertained from the company’s public documents, the doctrine of disclosure and the doctrine of constructive notice will apply. If it is an internal requirement that a certain act should be approved by special resolution, the Turquand rule will therefore not apply in relation to that specific act, since a special resolution is registered with the Registrar of Companies (in Bangaldesh, i.e section 88 of the Companies Act 1994) or Companies House (in the United Kingdom), and is deemed to be public information
Section 88 of the Companies Act 1994
The doctrine of Indoor management is subject to some exceptions where this rule is not applicable and the company will not be liable to an outsider for its internal or indoor mismanagement.
- Knowledge of Irregularity:
Where the party affected by the irregularity has full knowledge of it, cannot bind the company relying on this doctrine.
Case Reference: Howard vs. Patent Ivory Manufacturing Co. 1888
- Suspicion of irregularity:
The rule cannot be applied where circumstances surrounding the contract are suspicious and invite enquiry. Suspicion could arise, for example from the fact that an officer, is purporting to act in a manner which is apparently outside the scope of his authority.
Case Reference: Anand Behari Lal vs. Dinshaw & Co. 1942
Forgery makes a transaction void ab initio. So Turquand rule cannot be used to legalize something which was forged and therefore is completely illegal.
Case Reference: Ruben vs. Great Fingal Consolidated 1906
- Ignorance of Contents of Article:
If the contracting party does not have any knowledge about the contents of the article, then Turquand rule cannot be applied as he cannot complain about something of which he does not have any knowledge.
Case reference: Rama Corp. vs. Proved Tin and General Investment Co. (1952)
- Acts outside apparent authority:
If the act of the officer is ordinarily beyond the power of such officer, the plaintiff cannot rely on Turquand rule.
Case Reference: Anand Behari Lal vs. Dinshaw & Co.( 1942)
Kreditbank Cassel vs. Schenkers Ltd (1927)
6. Representation through articles:
Case reference: Lakshmi Ratan Lal Cotton Mills vs. JK Jute Mills Co (1957)
Houghton & Co vs. Nothard, Lowe and Wills Ltd (1927)
British Thomson Houston Co vs. Federated European Bank Ltd. (1932)
Ford Motor Credit Co Ltd. vs. Harmack (1972)