The indoor management rule

The indoor management rule

The doctrine of Indoor Management is a legal doctrine or rule which was dwelt with to bring about convenience in business for third parties dealing with a company. In simple terms, it provides that an outside person dealing with a corporation ought to be able to make sure ‘obvious’ assumptions about the regularity in which the internal affairs of the company are run. The Indoor Management Rule was developed as a doctrine of the common law to bring about equity. The indoor management rule took center stage during the case between the Royal British bank against Turquand. To begin with, we take a glance at the meaning of the doctrine of indoor management. The doctrine states explicitly that an individual who is involved in a transaction with a company is not necessarily required to verify whether or not the procedure followed regarding the contract are correct as long as he or she is satisfied with the Memorandum of Understanding (MoU), and the Articles of Association (AoA). For example, shareholders entering into a contract with a company do not have to question whether the necessary meetings were held or whether there was proper passing of resolutions. The shareholders are at liberty to take for granted the assumption that the company had followed all the procedural steps in the right fashion. One of the most significant roles played by the doctrine is the provision of protection of the external members from the company, by ensuring that the company acts with integrity and that the foreign members or the general public have the right to presume that the company’s internal proceedings are in line with the information contained in the documents submitted to the registrar of companies.

The doctrine of indoor management was effectively implemented in the landmark case of the Royal British Bank against Turquand. In this case, the directors of the Royal British Bank had borrowed some money from the plaintiff. According to the article of the company, it was highlighted that borrowed money should be in the form of a bond. Still, in this scenario, it was resolved that a resolution would be passed when the members convene for the general meeting. Subsequently, there were disagreements as the shareholders argued that the said resolution was not agreed upon or moved during the general meeting, concluding that the transaction did not bind the company, hence the company could not pay the money borrowed.

Consequently, it was concluded that Turquand could sue the Royal British Bank on the strength of the bond since he had the right to presume that the necessary resolution had been passed in the general meeting of the company’s shareholders. During the case, Lord Hatherly established that “outsiders are bound to know the external position of the company, but they are not bound to know the indoor management.” This observation by Lord Hatherly would later form the core principle of the rule of indoor management. The provision of indoor management is further detailed in sections 290, which describes the validity of the acts of the directors of a company. The section states that the actions performed by a director of a given company shall be regarded as valid, not taking into account that his or her appointment may be later discovered to have been invalid by reason, or any defect or he or she may be disqualified or his or her contract terminated under the provisions entailed in the act or the articles. Further, sections expound that the rules in the section shall not be deemed to give validity to the actions carried out by a director of a company after the company has proven that his or her appointment is invalid or has been terminated by providing substantial information on the same. Sections 290 illustrates the main objective of the doctrine of indoor management as to protect persons who enter into contracts or carry out transactions with the companies from exploitation by the companies by holding that the actions taken or conducted by the director(s) of companies shall be deemed valid and shall reflect the stand of the company.

The history of the doctrine of indoor management dates back in the 1860s, about 150 years ago, when it was conceived from the context of the principle of constructive notice. The primary role of the doctrine of indoor management was to rectify or correct its predecessor, the doctrine of constructive notice. The doctrine of constructive notice sought to protect the company from the outside members. The doctrine of indoor management was formulated to ensure that the outsiders, too, were protected from the companies’ mishaps. Also, the doctrine of indoor management was aimed at ensuring that there were limited possibilities of abuse of the principle of constructive notice. The doctrine of indoor management was formed on two primary bases; first, the rule outlines that the internal activities of a company are not subject to public knowledge. This means that the external members or the general public do not have the right to know what happens in the proceedings of the company’s internal environment and that they (outsiders) can only presume that the intentions of the company are right. Also, the doctrine seeks to ensure that the company does not default or escape its creditors by refuting that the officials had the power to act on its behalf.

Worth to note, the doctrine of indoor management has some exceptions that include:

Knowledge of irregularity

Knowledge irregularity explains that in the event that an external member obtains actual knowledge about any form of irregularities in the company’s internal operations, then the benefits provided by the rule of indoor management would cease to apply. Subsequently, the outsider might as well be termed as part of the irregularity. An excellent example of the implementation of this exception is the case of Howard vs. Patent Ivory Company. In this case, the directors of Patent Ivory Company are not allowed to borrow more than 1000 pounds of ivory from the external member, Howard, without the consent of the shareholders, which can only be granted by passing a resolution during the company’s annual general meeting. However, in the events leading to the case, the directors borrowed 3500 pounds of ivory from another director who took debentures, without obtaining the authorization of the company’s shareholders in the annual general meeting. Now, taking to account that the plaintiff in this matter is a director of the company, who had perfect knowledge about the existence of the internal irregularities during the transaction, but he failed to make the appropriate inquiries about the deal, the benefits of the doctrine of indoor management will not be available to protect him. The ruling, in this case, held that the debenture is only valid for the 1000 pound only since the plaintiff (director/creditor) had the knowledge of the ongoing internal irregularities but chose to presume that the appropriate steps were taken.

Negligence

The other exception is negligence, which outlines that the benefit of the indoor management rule may also fail to apply if the irregularities within the company are uncovered with little or no effort. Also, the protection of the outsider by the rule of indoor management is sabotaged or altered if the conditions that surround the contract are suspicious enough to invite inquiry. Still, the external member fails to make the appropriate probing. Take, for instance, the case of B. Anand Behari Lal aginst Dinshaw & Co (Bankers) Ltd., which involved an accountant attached to the Dinshaw & Co. (Bankers) Ltd., and the case was decided in favour of Anand Behari as the court ruled that the transfer was void as it involved a breach of contract. The court observed that the accountant of a company does not have the authority to effect the transfer of immovable property of a company. Hence, the transaction was void. In another case that involved Varkey Souriar and Leraleeya Banking Co. Ltd., the Kerala High Court based its judgment on the observation that the doctrine of indoor management is inapplicable in a situation where the existence of the agency entering into a contract is questionable. That is, the question is not one about the authority granted to the apparent agent to represent the agency in a transaction, but the actual existence of the agency.

Forgery

Last but not least, the doctrine of indoor management creates an exception for forgery, which dictates that the rule of indoor management cannot be effected in the event that the external member and the company signed an agreement or entered into a contract with forged documents. The rule stresses that forgeries performed by its official members cannot bind a company. For example, the exception of the rule of indoor management was adequately explored in the case that involved Rouben and Great Fingal Consolidated, where the secretary of the company forged the signature of two of the company’s directors in a bid to give the certificate without following the proper procedure. As it is provided in the Article of Association (AoA) of the said company, the issuance of the certificate must be authorized by two of the directors of the company in signing. Therefore, the holder of the certificate could not benefit from the protection guaranteed by the rule of indoor management due to the fact that the transaction involved forgery, which is void ab ignition.

No knowledge of articles

The exception outlines that the external member who, at the time of he or she enters into contract with a company is not aware of the existence of the memorandum or association and the articles of association, and has not read both documents to understand the contents of the memorandum and articles, cannot be guaranteed of the protection provided by the doctrine of indoor management. The central principle that governs the rule of indoor management is the principle of estoppels, which cannot be applied in favor of an outsider who has not familiarized himself with the company’s memorandum and articles prior to the engagement in contract with the said company. The doctrine fails to protect a person who acts in complete ignorance by not consulting the relevant documents of the company to establish the contents of the documents and their relationship to his or her contract with the company. For example, in the case of Ram Corporation against Proved Tin and General Investment Co., the plaintiffs entered into an agreement with the defendant company. They issued a cheque under the same contract. However, the director involved in the transaction was not authorized to engage in such an activity. The plaintiffs could have benefited from the outsider protection that is provided by the rule of indoor management, but the plaintiffs had not read the company’s articles. The director misappropriated the cheques, and the plaintiffs filed a lawsuit against the company. However, the court held that the director was not liable for the misconduct, or the breach of contract, as the plaintiffs acted with absolute ignorance.

Acts outside apparent authority

The rule of Turquand cannot be used to protect an individual during a transaction with a company if the representative of the company involved in the transaction goes above and beyond their actual ostensible authority. A case example relevant to this exception is the Anand Lal vs. Dinshaw & Co in 1942, where the accountant was involved in the transfer of the company’s immovable property, an act that was beyond the designated authority of the accountant. The transaction was ruled as void since the accountant went above and beyond the scope of his power.

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