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Doctrine of 'Indoor Management' and exceptions to this rule

The doctrine of Indoor management, popularly known as the Turquands rule initially
arose some 150 years ago in the context of the doctrine of constructive notice The rule of
!octrine of Indoor "anagement is conflicting to that of the principle of #onstructive
$otice The latter 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 &y its officers If the contract is
consistent with the pu&lic document, the person contracting will not &e pre'udiced &y
irregularities that may &eset the indoor work of the company
The !octrine of Indoor "anagement 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 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 o&served 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 &e invoked &y the
company and it does not operate against the company It operates against the person who
has failed to inquire &ut does not operate in his favour (ut the doctrine of )indoor
management* can &e invoked &y the person dealing with the company and cannot &e
invoked &y the company
Origin of the Doctrine
The rule had its genesis in the case of +oyal (ank v Turquand,1- In this case the
!irectors of the #ompany were authori.ed &y the articles to &orrow on &onds such sums
of money as should from time to time &y a special resolution of the #ompany in a general
meeting, &e authori.ed to &e &orrowed / &ond under the seal of the company, signed &y
two directors and the secretary was given &y the !irectors to the plaintiff to secure the
drawings on current account without the authority of any such resolution Then Turquand
sought to &ind the #ompany on the &asis of that &ond Thus the question arose whether
the company was lia&le on that &ond
The #ourt of 0xchequer #ham&er overruled all o&'ections and held that the &ond was
&inding on the company as Turquand was entitled to assume that the resolution of the
#ompany in general meeting had &een passed The relevant portion of the 'udgment of
1ervis # 1 reads2
3The deed allows the directors to &orrow on &ond such sum or sums of money as shall
from time to time, &y a resolution passed at a general meeting of the company, &e
authori.ed to &e &orrowed and the replication shows a resolution passed at a general
meeting, authori.ing the directors to &orrow on &ond such sums for such periods and at
such rates of interest as they might deem expedient, in accordance with the deed of
settlement and /ct of 4arliament% &ut the resolution does not define the amount to &e
&orrowed That seems to me enough5e may now take for granted that the dealings
with these companies are not like dealings with other partnerships, and the parties dealing
with them are &ound to read the statute and the deed of settlement (ut they are not &ound
to do more /nd the party here on reading the deed of settlement, would find, not a
prohi&ition from &orrowing &ut a permission to do so on certain conditions 6inding that
the authority might &e made complete &y a resolution, he would have a right to infer the
fact of a resolution authori.ing that which on the face of the document appear to &e
legitimately done3
Further embellishment of the rule
The 7ouse of 8ords further endeavored to explicate the Turquand +ule in the case of
"ahony v 0ast 7olyford "ining #o,9- The case is an excellent example of #ourt
drawing out qualifications to the rule
In this case the company:s &ank made payments &ased on a formal copy of a resolution of
the &oard authori.ing payments of cheques signed &y any two of three named 3directors3
and countersigned &y the named 3secretary3 The copy was itself signed &y the secretary
It came out su&sequently that neither the directors nor the secretary had ever &een
formally appointed /ccording to the articles, the directors were to &e nominated &y the
su&scri&ers to the memorandum and the cheques were to &e signed in such manner as the
&oard might determine
It was held &y the 7ouse of 8ords that since the &ank had received formal notice in the
ordinary way of the &oard:s decision, it was not &ound to enquire further
The Turquand:s rule has also o&tained statutory recognition in ;ection <=1> of the
0uropean #ommunities /ct, 1<?9, which reads
3 9. Companies.--(! In favour of a person dealing with a company in good faith, any
transaction decided on &y the directors shall &e deemed to &e one which it is within the
capacity of the company to enter into, and the power of the directors to &ind the company
shall &e deemed to &e free of any limitation under the memorandum or articles of
association % and a party to a transaction so decided on shall not &e &ound to enquire as to
the capacity of the company to enter into it or as to any such limitation on the powers of
the directors, and shall &e presumed to have acted in good faith unless the contrary is
proved3
"ro#isions under the Indian Companies $ct% 9&'
The provision under the Indian /ct which directly im&i&es the Turquand rule is section
9<0, which reads as under2
(ection )9*+- ,alidit- of acts of directors2@/cts done &y a person as a director shall &e
valid, notwithstanding that it may afterwards &e discovered that his appointment was
invalid &y reason of any defect or disqualification or had terminated &y virtue of any
provision contained in this /ct or in the articles2
4rovided that nothing in this section shall &e deemed to give validity to acts done &y a
director after his appointment has &een shown to the company to &e invalid or to have
terminated2
/nother 4rovision which directly follows the a&ove stated rule is section A1 of the Indian
#ompanies /ct, 1<5B which &ears the heading Cfurther issue of shares (ona fide
allottees of shares are protected &y the !octrine of Indoor "anagement under s@A1
Illustrating upon the point the 4un'a& D 7aryana 7igh #ourt has avowed in the case of
!iwan ;ingh v "inerva "ills,E- that
*The allottees of the shares were contracting in good faith with the #ompany and they
were entitled to assume that the acts of the !irectors in making allotments of the shares to
them are within the scope of their powers conferred upon them &y the shareholders of the
#ompany They were not &ound to enquire whether the acts of the !irectors which as in
this case related to internal management had &een properly and regularly performed
0ven when the !irectors exceed their powers or infringe the restrictions imposed upon
them, the company may &e &ound for the outsider dealing with the company is only
required to see that the transactions are consistent with the article ;trangers are 'ustified
in assuming that all matters of Indoor management have &een done regularly*
$pplication of the .ule b- the Indian Courts
The Turquand:s rule has &een approved and followed &y Faradara'a lyengar 1, in Farkey
;ouriar v Geraleeya (anking #o 8td ,H- In the following way2
3 #oming to the alternative ground, it is no dou&t true that where a company is
regulated &y a memorandum and articles registered in some pu&lic office, persons dealing
with the company are &ound to read the registered documents and to see that the
proposed dealing is not inconsistent therewith &ut they are not &ound to do more They
need not enquire into the regularity of the internal proceedings what @8ord 7atherley
called :indoor management: ;o if there is a managing director and authority in the articles
for the directors to delegate their powers to him, a person dealing with him may assume
that it is within the ordinary duties of a managing director /ll he has to see is that the
managing director might have power to do what he purports to do (ut the rule cannot
apply where the question, as here, is not one as to the scope of the power exercised &y an
apparent agent of the company, &ut is in regard to the very existence of the agency3
In 8akshmi +atan #otton "ills #o 8td, v 1 G 1ute "itts #o 8td,,5-
The plaintiff company sued the defendant company on a loan for +s 1,50,000 /mong
other things the defendant company raised the plea that the transaction was not &inding as
no resolution sanctioning the loan was passed &y the &oard of directors The court, after
referring to Turquand:s case and other Indian cases, held 2)If it is found that the
transaction of loan into which the creditor is entering is not &arred &y the charter of the
company or its articles of association, and could &e entered into on &ehalf of the company
&y the person negotiating it, then he is entitled to presume that all the formalities required
in connection therewith have &een complied with If the transaction in question could &e
authorised &y the passing of a resolution, such an act is a mere formality / &ona fide
creditor, in the a&sence of any suspicious circumstances, is entitled to presume its
existence / transaction entered into &y the &orrowing company under such
circumstances cannot &e defeated merely on the ground that no such resolution was in
fact passed The passing of such a resolution is a mere matter of indoor or internal
management and its a&sence, under such circumstances, cannot &e used to defeat the 'ust
claim of a &ona fide creditor / creditor &eing an outsider or a third party and an innocent
stranger is entitled to proceed on the assumption of its existence % and is not expected to
know what happens within the doors that are closed to him 5here the act is not ultra
vires the statute or the company such a creditor would &e entitled to assume the apparent
or ostensi&le authority of the agent to &e a real or genuine one 7e could assume that such
a person had the power to represent the company, and if he in fact advanced the money
on such assumption, he would &e protected &y the doctrine of internal management3
In case of Ifficial 8iquidator, "anasu&e D #o =4> 8td F #ommissioner of police,B-
The learned 'udge o&served that the lenders to a company should acquaint themselves
with memorandum and articles &ut they cannot &e expected to em&ark upon an
investigation as to legality, propriety and regularity of acts of directors
The rule is &ased upon o&vious reasons of convenience in &usiness relations 6irstly, the
memorandum and articles of associations are pu&lic documents, open to pu&lic
inspection 7ence 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
wheels of commerce would not go round smoothly if persons dealing with the company
were compelled to investigate thoroughly )the internal machinery of a company to see if
something is not wrong* 4eople in &usiness would &e very shy in dealing with such
companies
The rule is of great practical utility It has &een applied in a great variety of cases
involving rights and lia&ilities It has &een used to cover acts done on &ehalf of a
company &y de facto directors who have never &een appointed, or whose appointment is
defective, or who, having &een regularly appointed, have exercised an authority which
could have &een delegated to them under the companys articles, &ut never has &een so
delegated, or who have exercised an authority without proper quorum Thus, where the
directors of company having the power to allot shares only with the consent, something
which he could do only with the approval of the &oard% where the managing agents
having the power to &orrow with the approval of directors &orrowed without any such
approval, the company was held &ound
Conse/uence of the .ule+ .ecent Decisions
The Indian #ourts in certain recent 'udgments have further &roadened the scope of the
!octrine of indoor management The o&'ect &eing the same ie to protect the third party
transacting with the #ompany in good faith and &eing unaware of the complex internal
management of the #ompany
In "onark 0nterprises v Gishan Tulpule and Irs,?-, the #ompany (oard held 2@
)That the validity of the impugned transaction was not affected even if no
resolution for entering into it was actually passed &y the &oard of the company as the
company had entered into and adopted the transaction throughout and implemented it
after receiving consideration thereof In JG" 7oldings 4rivate 8imited v 4rayag T@4ac
Industries 8imited and Ithers,A-
0ven amalgamation of two companies is one lim& of indoor management Therefore,
notice contemplated under ;ection E<H/ of the /ct is required to &e given only at the
stage when application under ;ection E<H, of the /ct is made to the #ourt for sanctioning
the scheme and not any time prior thereto
0xceptions 1o 1he .ule
The rule of doctrine of indoor management is however su&'ect to certain exceptions In
other words, relief on the ground of Cindoor management cannt &e claimed &y an
outsider dealing with the company in the following circumstances2
K 5here the outsider has knowledge of Irregularity
K ;uspicion of Irregularity
K 6orgery
K +epresentation through /rticles
K /cts outside apparent authority
. 2no3ledge of Irregularit-2 @ The first and the most o&vious restriction is that the rule
has no application where the party affected &y an irregularity had actual notice of it
Gnowledge of an irregularity may arise from the fact that the person contracting was
himself a party to the inside procedure /s in !evi !itta "al v The ;tandard (ank of
India,<-, where a transfer of shares was approved &y two directors, one of whom within
the knowledge of the transferor was disqualified &y reason of &eing the transfer himself
and the other was never validly appointed, the transfer was held to &e ineffective
;imilarly in 7oward v 4atent Ivory "anufacturing #o,10- where the directors could not
defend the issue of de&entures to themselves &ecause they should have known that the
extent to which they were lending money to the company required the assent of the
general meeting which they had not o&tained 8ikewise, in "orris v Gansseen,11-, a
director could not defend an allotment of shares to him as he participated in the meeting,
which made the allotment 7is appointment as a director also fell through &ecause none
of the directors appointed him was validly in office
(ut after the 7ely@7utchinson v (rayhead 8td,19-, according to which the mere fact that
a person is a director does not mean that he shall &e deemed to have knowledge of the
irregularities practiced &y other directors / newly appointed director does not mean that
he shall &e deemed to have knowledge of the irregularities practiced &y the other
directors / newly appointed director entered into contracts of indemnity and guarantee
with the company through a director whom the company had knowingly allowed to hold
himself out as having the authority to enter into such transaction, although in fact he had
no such authority The company was held lia&le
). (uspicion of Irregularit-2 @ The protection of the )Turquand +ule* is also not
availa&le where the circumstances surrounding the contract are suspicious and therefore
invite inquiry ;uspicion should arise, for example, from the fact that an officer is
purporting to act in matter, which is apparently outside the scope of his authority 5here,
for example, as in the case of /nand (ihari 8al v !inshaw D co,1E-, the plaintiff
accepted a transfer of a companys property from its accountant, the transfer was held
void The plaintiff could not have supposed, in a&sence of a power of attorney, that the
accountant had authority to effect transfer of the companys property
;imilarly, in the case of 7aughton D co v $othard, 8owe D 5ills 8td,1H-, where a
person holding directorship in two companies agreed to apply the money of one company
in payment of the de&t to other, the court said that it was something so unusual )that the
plaintiff were put upon inquiry to ascertain whether the persons making the contract had
any authority in fact to make it* /ny other rule would )place limited companies without
any sufficient reasons for so doing, at the mercy of any servant or agent who should
purport to contract on their &ehalf*
4. Forger-2 @ 6orgery may in circumstances exclude the CTurquand +ule The only clear
illustration is found in the +u&en v Lreat 6ingall #onsolidates,15-% here in this case the
plaintiff was the transferee of a share certificate issued under the seal of the defendants
company The companys secretary, who had affixed the seal of the company and forged
the signature of the two directors, issued the certificate
The plaintiff contended that whether the signature were genuine or forged was apart of
the internal management, and therefore, the company should &e estopped from denying
genuineness of the document (ut, it was held, that the rule has never &een extended to
cover such a complete forgery
8ord 8ore&urn said2 )It is quite true that persons dealing with limited lia&ility companies
are not &ound to enquire into their indoor management and will not &e affected &y
irregularities of which they have no notice (ut, this doctrine which is well esta&lished,
applies to irregularities, which otherwise might affect a genuine transaction It cannot
apply to 6orgery*
5. .epresentation through $rticles2 @ The exception deals with the most controversial
and highly confusing aspect of the )Turquand +ule* /rticles of association generally
contain what is called Cpower of delegation 8akshmi +atan 8al #otton "ills v 1G 1ute
"ills #o,1B- explains the meaning and effect of a )delegation clause*
7ere one L was director of the company The company had managing agents of which
also L was a director /rticles authorised directors to &orrow money and also empowered
them to delegate this power to any or more of them L &orrowed a sum of money from
the plaintiffs The company refused to &e &ound &y the loan on the ground that there was
no resolution of the &oard delegating the powers to &orrow to L Jet the company was
held &ound &y the loans )0ven supposing that there was no actual resolution authori.ing
L to enter into the transaction the plaintiff could assume that a power which could have
&een delegated under the articles must have &een actually conferred The actual
delegation &eing a matter of internal management, the plaintiff was not &ound to enter
into that*
Thus the effect of a )delegation clause* is )that a person who contracts with an individual
director of a company, knowing that the &oard has power to delegate its authority to such
an individual, may assume that the power of delegation has &een exercised*
The question of knowledge of /rticles came up in the case of +ama #orporation v
4roved Tin and Leneral Investment #o,1?-, here% one T was the active director of the
defendant company 7e, purporting to act on &ehalf of his company, entered into a
contract with the plaintiff company under which he took a cheque from the plaintiffs The
companys article contained a clause providing that )the directors may delegate any of
their powers, other than the power to &orrow and make calls to committees, consisting of
such mem&ers of their &ody as they think fit* The &oard had not in fact delegated any of
their powers to T and the plaintiffs had not inspected the defendants articles and,
therefore, did not know of the existence of power to delegate
It was held that the defendant company was not &ound &y the agreement ;lade 1, was of
the opinion that knowledge of articles was essential )/ person who at the time of
entering into a contract with a company has no knowledge of the companys articles of
association, cannot rely on those articles as conferring ostensi&le or apparent authority on
the agent of the company with whom he dealt* 7e could have relied on the power of
delegation only if he knew that it existed and had acted on the &elief that it must have
&een duly exercised
Gnowledge of articles is considered essential &ecause in the opinion of ;lade 1% the rule
of Cindoor management is &ased upon the principle of estoppel /rticles of association
contain a representation that a particular officer can &e invested with certain of the
powers of the company /n outsider, with knowledge of articles, finds that an officer is
openly exercising an authority of that kind 7e, therefore, contracts with the officer The
company is estoppel from alleging that the officer was not in fact authorised
This view that knowledge of the contents of articles is essential to create an estopped
against the company has &een su&'ected to great criticism Ine point is that every&ody is
deemed to have constructive notice of the articles (ut ;lade 1 &rushed aside this
suggestion stating constructive notice to &e a negative one It operates against the outsider
who has not inquired It cannot &e used against interests of the company The principle
point of criticism, however, is that even if the directors had the power to delegate their
authority They would not yet &e a&le to know whether the director had actually delegated
their authority "oreover, the company can make a representation of authority even apart
from its articles The company may have held out an officer as possessing an authority /
person &elieves upon that representation and contract with him The company shall
naturally &e estopped from denying that authority of that officer for dealing on its &ehalf,
irrespective of what the articles provide /rticles would &e relevant only if they had
contained a restriction on the apparent authority of the officer contained
&. $cts outside apparent authorit-2 @ 8astly, if he act of an officer of a company is one
which would ordinarily &e &eyond the power of such an officer, the plaintiff cannot claim
the protection of the )Turquand rule* simply &ecause under the articles power to do the
act could have &een delegated to him In such a case the plaintiff cannot sue the company
unless the power has, in fact, &een delegated to the officer with whom he dealt / clear
illustration is /nand (ehari 8al v !inshaw,1A- here the plaintiff accepted a transfer of a
companys property from its accountant ;ince such a transaction is apparently &eyond
the scope of an accountants authority it was void $ot even a Cdelegation clause in the
articles could have validated it, unless he was, in fact, authori.ed
Conclusion
The case of +oyal (ritish (ank v Turquand , refined the &asic #ommon law of /gency to
articulate the !octrine of Indoor "anagement The rule was enunciated &y the #ourt to
mitigate the rigors of the #onstructive $otice !octrine Its importance arises in situations
in which the third partys dealings are with some officer or agent other than the (oard
The rule protects the interest of the third party who transacts with the #ompany in good
faith and to whom the #ompany is inde&ted The rule enunciated in the decision is often
referred to as 3Turquand:s rule3 and 3indoor management rule3 The gist of the rule is that
persons dealing with limited lia&ility companies are not &ound to enquire into their
indoor management and will not &e affected &y irregularities of which they had no notice
The rule enunciated in Turquand has &een applied in many cases su&sequently and
generally in order to protect the interests of the party transacting with the !irectors of the
#ompany /pplying the rule, now it can not &e argued that a person having dealings with
a #ompany is deemed to have notice of who the true !irectors are, and this &eing shown
&y pu&lic documents ie the registers of the directors required to &e maintained &y the
#ompany and the and the notices of changes
5ith the due course of time several exceptions have also emerged out of the rule like
6orgery, negligence, third party having knowledge of irregularity etc If we analy.e the
cases it is revealed that the Turquand rule did not operate in a completely unrestricted
manner 6irstly, it is inherent in the rule that if the transaction in question could not in the
circumstances have &een validly entered into &y the company, then the third party could
not enforce it ;econdly, the rule only protected :outsiders:, that is persons dealing
:externally: with the company% directors, o&viously, were the very people who would &e
expected to know if internal procedures had &een duly followed Thirdly, actual notice of
the failure to comply fully with internal procedures precluded reliance upon the rule
6ourthly, an outsider could not rely upon Turquand:s #ase where the nature of the
transaction was suspicious% for example, where the company:s &orrowing powers were
exercised for purposes which were wholly unconnected with the company:s &usiness and
of no &enefit to the company
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