Doctrine of Indoor Management

Shruti S Sareen, Associate Partner & Bhavya Guliani, Trainee Associate

The Doctrine of Indoor Management  famously known as Turquand’s Law is a 150 year old rule which protects outsiders against the actions done by the company. To understand the concept of this doctrine, it is important to understand the concept of the doctrine of constructive notice as both these doctrines are inter-related.

Meaning & Concept of Doctrine of Constructive Notice

Memorandum of Association (MOA) is a legal document that specifies the scope of business activities of the company and information about, inter alia, the object of the company and shareholding of the company while  the Articles of Association (AOA) is a document that specifies the  internal regulations for a company’s operations. Being  the constitutional documents of the company AOA and MOA are public documents and are therefore filed with Registrar of Companies. These are available in the public domain and Section 399 of Companies Act, 2013 (Act) allows any person to electronically inspect, make a record, or get copy/extracts of any document of any company which the Registrar maintains on payment of requisite fee.

The doctrine of constructive notice presumes that every person dealing with a company has knowledge of the contents of the Memorandum of Association, Articles of Association and every other document such as resolutions as these are filed with the Registrar and available for inspection on payment of nominal fees. Thus, any person dealing with the company must inspect these documents and establish conformity with the provisions. Even if a person doesn’t have knowledge about it or if he fails to read them, in the eyes of law it is assumed that he was aware of the contents of the same.

To explain it simply, if any person enters into a contract, which is inconsistent with the company’s Memorandum and Article, he shall not get any rights against the company and shall bear the consequences himself.

Concept of Doctrine of Indoor Management

The Doctrine of Constructive Notice protects the company from outsiders, however, there needs to be a check to keep its application in control and to avoid misuse. The Doctrine of Indoor Management emerged as a counter to the Doctrine of Constructive Notice to protect the outsiders from the acts of the company.

The doctrine of Indoor Management ensures that third parties who enter into a contract with the company are protected against any irregularities in the internal procedure and functioning of the company. It is based on the presumption that the third parties cannot find out internal irregularities that take place in a company, hence the company will be liable for any loss suffered by them due to these irregularities. The doctrine protects third parties by following the principle that if a company is said to enter into a contract, the obligations of following the internal company policies falls on the member of the Company and not on any party, who enters a contract with the company.

In simple words, the doctrine of indoor management elucidates that а company’s internal affairs are the company’s affairs only. Though there is no specific provision to the doctrine of indoor management under the Act. However, the courts in India have recognized this doctrine and followed the same in various cases in India under Section 176 of the Act. (Defects in appointment of directors not to invalidate actions taken ).

Judicial Review :  Indian Case Laws

• Raja Bahadur and Others v The Tricumdas Mills Co. Ltd.

  The appellant and his legal counsel were unaware that the Board of Directors were deficient in making such a contract valid due to the lack of minimum numbers of directors they needed to have on the Board. This was the first case in India where Doctrine of Indoor Management was applied The court in this case held that both the appellant and his legal counsel had a right to believe that the acts of the respondent company during the execution of a contract were right and valid before the execution of that document.

• Hi-tech Gears Ltd. v. Yogi Pharmacy Ltd. & Ors

  The Doctrine of Indoor Management was further recognised in this case wherein the court determined that the complainant who was a borrower acted in good faith and borrowed money through an inter corporate deposit and had a perfect right to believe and presume, that all the compliances were made by the respondent company and all the conditions for such an inter corporate deposit had been met, required motions on the books were brought into routine and that the Directors had contracted in accordance with the protocol decided in the board meeting. The court in this case observed that an outsider cannot have knowledge of such internal affairs of the company.

• Premier Industrial Bank Limited vs. Carlton Manufacturing Company Limited & Crabtree

  The court laid down that an outsider cannot be expected to know any other internal details other than what has been mentioned in the articles and memorandum of association of a company, and he has all the reasons to believe that the acts of the directors are in accordance with the constitutional documents of the company and any act performed by the directors is a valid act.

• P.V. Damodara Reddy vs. Indian National Agencies Limited

  In this case, according to the AOA of the respondent company, the directors of the company had the power only to allot shares to the current members of the company and any allotment to outsiders could only be done after taking consent at the general meeting of the company. The directors allotted shares to outsiders without complying with the conditions and taking consent. The court ruled that outsiders cannot be expected to know if all the conditions were compiled before the allotment of such shares and as such a process will slow down the wheels of the business.

Exceptions to The Doctrine of Indoor Management

There are  few exceptions to this doctrine that have been judicially established. The circumstances under which the benefit of indoor management cannot be claimed by a person dealing with the company are as follows: –

• The outsider has an actual or constructive knowledge of an irregularity.

  The first exception to this rule is that it does not apply to a situation where the person who has been affected had an actual or constructive notice of the irregularity. As this doctrine is based on the principle that a person entering into a contract is entitled to assume that all the internal proceedings of the company have been complied with but if there’s any irregularity and it was in the knowledge of the outsider then in such circumstances this doctrine will not hold any relevance.

• Forgery.

  This doctrine does not apply in circumstances where an outsider has relied on a document which is forged in the company’s name. A company is never held liable for the forgeries committed by its officers. Transactions including forgery are void ab initio (invalid and void) since in this situation it’s not just that there is no free consent; it is a situation of no consent by any means.

• Negligence.

  The remedy under this doctrine is not available where the situations and circumstances surrounding the transaction are so suspicious that it invites inquiry, and the outsider of the company does not make any inquiry for the same efficiently. This is a situation where an outsider if he/she would have made proper inquiries, could have easily discovered the irregularities in the management of the company before entering into a transaction, then he/she cannot seek doctrine of Indoor Management as a remedy.

• Acts beyond the apparent scope of the authority.

  This exception deals with a situation where an officer of a corporation exceeds its authority and apparent power through the acts performed by him; in such a case those acts of the officer will not hold the company accountable as it’s the act of the officer and his failure to perform such acts within the apparent scope of authority. In such a case, the outsider cannot seek any remedy or redress under the doctrine of indoor management since the Articles clearly did not grant the officer the authority to perform such activities.

• Representation through articles.

  This exception addresses the ‘delegation’ clause. The AOA generally  provides for a clause that deals with the ‘power to delegate’. For eg. there may be a clause in the articles of the company that authorize the director of a company to borrow money and to delegate this power to any or more of its  managing agents. In a case, one of the director’s borrowed a sum of money from a third party, however the company refused to repay the loan borrowed by the director of the Company stating that there was no actual resolution authorizing the director to enter into such a transaction. In such a situation the effect of a “delegation clause” is “that a person who contracts with an individual director of a company, knowing that the board has power to delegate its authority to such an individual, may assume that the power of delegation has been exercised.” The actual delegation being a matter of internal management, the third party will not be bound to have knowledge of the same.

Conclusion

The relevance of the doctrine of Indoor management has reduced overtime as the with new Act and emergence of  corporate governance a lot of transparency and accountability has gained momentum. Almost all requisite filings under the law are available in public domain which makes undertaking due diligence seriously even more important but still this doctrine holds some relevance as there may be some acts of the company that are still not in the public domain. It is therefore of utmost importance to understand that we need to thoroughly and diligently conduct legal due diligence as if we miss out anything by being negligent, we cannot take the protection for the same under the doctrine of Indoor Management.

Legal updates by Ms. Shruti Sareen, Associate Partner
 

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