BUSINESS LAW

TERM PAPER
ON

DOCTRINE OF INDOOR MANAGEMENT

Submitted to

Dr. R. ANITA RAO

Submitted by

SUBHASHISH RAY (1224109252)

SECTION-B

MBA (IB) - 2009-11

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 DOCTRINE OF INDOOR MANAGEMENT

AIM OF THE PAPER: The main objective of the paper is to study the scope of Indoor
management under Indian Companies Act, 1956

EXECUTIVE SUMMARY

Doctrine of Indoor Management also known as Turquand’s rule states the” Any outsider dealing
with the company is entitled to presume that internal requirements prescribed in memorandum
and articles have been properly observed.” The basic objective of this doctrine is to protect the
third party transacting with the Company in good faith and being unaware of the complex
internal management of the Company. There are certain exceptions where the outsider cannot
claim relief in name of the doctrine of Indoor Management.

They are as follows:

• Where the outsider has knowledge of Irregularity

• Suspicion of Irregularity
• Forgery
• Representation through Articles
• Acts outside apparent authority

The gist of the rule is that persons dealing with limited liability companies are not bound to
enquire into their indoor management and will not be affected by irregularities of which they had
no notice.

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REVIEW OF THE TOPIC

According to DOCTRINE OF INDOOR MANAGEMENT “persons dealing with the

company are entitled to presume that internal requirements prescribed in memorandum and
articles have been properly observed”. A transaction has two aspects, namely, substantive and
procedural. An outsider dealing with the company can only find out the substantive aspect by
reading the memorandum and articles. Even though he may find out the procedural aspect, he
cannot find out whether the procedure has been followed or not.

For example: A company may have borrowing powers by passing a resolution according to its
memorandum and articles. An outsider can only found out the borrowing powers of the
company. But he cannot find out whether the resolution has in fact been 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, but they are not
bound to do more; they need not inquire into the regularity of the internal proceedings as
required by the memorandum and articles. They can presume that all is being done regularly.

ORIGIN OF THE DOCTRINE

The rule had its genesis in the case of Royal Bank v Turquand. In this case the Directors of the
Company were authorized by the articles to borrow on bonds such sums of money as should
from time to time by a special resolution of the Company in a general meeting, be authorized to
be borrowed. A bond under the seal of the company, signed by two directors and the secretary
was given by the Directors to the plaintiff to secure the drawings on current account without the
authority of any such resolution. Then Turquand sought to bind the Company on the basis of that
bond. Thus the question arose whether the company was liable on that bond.

The Court of Exchequer Chamber overruled all objections and held that the bond was binding on
the company as Turquand was entitled to assume that the resolution of the Company in general
meeting had been passed. The relevant portion of the judgment of Jervis C. J. reads:

"The deed allows the directors to borrow on bond such sum or sums of money as shall from time
to time, by a resolution passed at a general meeting of the company, be authorized to be

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borrowed and the replication shows a resolution passed at a general meeting, authorizing the
directors to borrow on bond such sums for such periods and at such rates of interest as they
might deem expedient, in accordance with the deed of settlement and Act of Parliament; but the
resolution does not define the amount to be borrowed. That seems to me enough......We 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 bound to read the statute and the deed of
settlement. But they are not bound to do more. And the party here on reading the deed of
settlement, would find, not a prohibition from borrowing but a permission to do so on certain
conditions. Finding that the authority might be made complete by a resolution, he would have a
right to infer the fact of a resolution authorizing that which on the face of the document appear to
be legitimately done."

FURTHER EMBELLISHMENT OF THE RULE

The House of Lords further endeavored to explicate the Turquand Rule in the case of Mahony v.
East Holyford Mining Co. The case is an excellent example of Court drawing out qualifications
to the rule.

In this case the company's bank made payments based on a formal copy of a resolution of the
board authorizing payments of cheques signed by any two of three named "directors" and
countersigned by the named "secretary". The copy was itself signed by the secretary. It came out
subsequently that neither the directors nor the secretary had ever been formally appointed.
According to the articles, the directors were to be nominated by the subscribers to the
memorandum and the cheques were to be signed in such manner as the board might determine.

It was held by the House of Lords that since the bank had received formal notice in the ordinary
way of the board's decision, it was not bound to enquire further.

The Turquand's rule has also obtained statutory recognition in Section 9(1) of the European
Communities Act, 1972, which reads.

" 9. Companies.--(1) In favor of a person dealing with a company in good faith, any transaction
decided on by the directors shall be deemed to be one which it is within the capacity of the

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company to enter into, and the power of the directors to bind the company shall be deemed to be
free of any limitation under the memorandum or articles of association ; and a party to a
transaction so decided on shall not be bound 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 be presumed to have
acted in good faith unless the contrary is proved."

PROVISIONS UNDER THE INDIAN COMPANIES ACT, 1956

The provision under the Indian Act which directly imbibes the Turquand rule is section 290,
which reads as under:

Section 290 - Validity of acts of directors:-Acts done by a person as a director shall be valid,
notwithstanding that it may afterwards be discovered that his appointment was invalid by reason
of any defect or disqualification or had terminated by virtue of any provision contained in this
Act or in the articles:

Provided that nothing in this section shall be deemed to give validity to acts done by a director
after his appointment has been shown to the company to be invalid or to have terminated:

Another Provision which directly follows the above stated rule is section 81 of the Indian
Companies Act, 1956 which bears the heading ‘further issue of shares’. Bona fide allottees of
shares are protected by the Doctrine of Indoor Management under s-81. Illustrating upon the
point the Punjab & Haryana High Court has avowed in the case of Diwan Singh v Minerva
Mills that

“The allottees of the shares were contracting in good faith with the Company and they were
entitled to assume that the acts of the Directors in making allotments of the shares to them are
within the scope of their powers conferred upon them by the shareholders of the Company. They
were not bound to enquire whether the acts of the Directors which as in this case related to
internal management had been properly and regularly performed. Even when the Directors
exceed their powers or infringe the restrictions imposed upon them, the company may be bound
for the outsider dealing with the company is only required to see that the transactions are

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consistent with the article. Strangers are justified in assuming that all matters of Indoor
management have been done regularly”.

APPLICATION OF THE RULE BY THE INDIAN COURTS

The Turquand's rule has been approved and followed by Varadaraja lyengar J., in Varkey
Souriar Vs Keraleeya Banking Co. Ltd. In the following way:
" Coming to the alternative ground, it is no doubt true that where a company is regulated by a
memorandum and articles registered in some public office, persons dealing with the company are
bound to read the registered documents and to see that the proposed dealing is not inconsistent
therewith but they are not bound to do more. They need not enquire into the regularity of the
internal proceedings what -Lord Hatherley called 'indoor management'. So 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. All he
has to see is that the managing director might have power to do what he purports to do. But the
rule cannot apply where the question, as here, is not one as to the scope of the power exercised
by an apparent agent of the company, but is in regard to the very existence of the agency."

In Lakshmi Ratan Cotton Mills Co. Ltd, v. J. K. Jute Mitts Co. Ltd,[the plaintiff company
sued the defendant company on a loan for Rs. 1,50,000. Among other things the defendant
company raised the plea that the transaction was not binding as no resolution sanctioning the
loan was passed by the board of directors. The court, after referring to Turquand's case and other
Indian cases, held :“If it is found that the transaction of loan into which the creditor is entering is
not barred by the charter of the company or its articles of association, and could be entered into
on behalf of the company by the person negotiating it, then he is entitled to presume that all the
formalities required in connection therewith have been complied with. If the transaction in
question could be authorized by the passing of a resolution, such an act is a mere formality. A
bona fide creditor, in the absence of any suspicious circumstances, is entitled to presume its
existence. A transaction entered into by the borrowing company under such circumstances
cannot be 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 absence, under
such circumstances, cannot be used to defeat the just claim of a bona fide creditor. A creditor

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being 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. Where the act is not ultra vires the statute or the company such a creditor would
be entitled to assume the apparent or ostensible authority of the agent to be a real or genuine one.
He 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 be protected by the doctrine of internal
management."

In case of Official Liquidator, Manasube & Co. (P.) Ltd. V. Commissioner of police the
learned judge observed that the lenders to a company should acquaint themselves with
memorandum and articles but they cannot be expected to embark upon an investigation as to
legality, propriety and regularity of acts of directors.

The rule is based upon obvious reasons of convenience in business relations. Firstly, the
memorandum and articles of associations are public documents, open to public inspection. Hence
an outsider “is presumed to know the constitution of a company; but 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.” People in business
would be very shy in dealing with such companies.

The rule is of great practical utility. It has been applied in a great variety of cases involving
rights and liabilities. It has been used to cover acts done on behalf of a company by de facto
directors who have never been appointed, or whose appointment is defective, or who, having
been regularly appointed, have exercised an authority which could have been delegated to them
under the company’s articles, but never has been 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
board; where the managing agents having the power to borrow with the approval of directors
borrowed without any such approval, the company was held bound.

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CONSEQUENCE OF THE RULE: RECENT DECISIONS

The Indian Courts in certain recent judgments have further broadened the scope of the Doctrine
of indoor management. The object being the same i.e. to protect the third party transacting with
the Company in good faith and being unaware of the complex internal management of the
Company.

In Monark Enterprises v Kishan Tulpule and Ors, the Company Board held -
“That the validity of the impugned transaction was not affected even if no resolution for entering
into it was actually passed by the board of the company as the company had entered into and
adopted the transaction throughout and implemented it after receiving consideration thereof In
YKM Holdings Private Limited v Prayag T-Pac Industries Limited and Others

Even amalgamation of two companies is one limb of indoor management. Therefore, notice
contemplated under Section 394A of the Act is required to be given only at the stage when
application under Section 394, of the Act is made to the Court for sanctioning the scheme and
not any time prior thereto.

EXCEPTIONS TO THE RULE

The rule of doctrine of indoor management is however subject to certain exceptions. In other
words, relief on the ground of ‘indoor management’ can’t be claimed by an outsider dealing with
the company in the following circumstances:
1. Where the outsider has knowledge of Irregularity
2. Suspicion of Irregularity
3. Forgery
4. Representation through Articles
5. Acts outside apparent authority

1. Knowledge of Irregularity: - The first and the most obvious restriction is that the rule has no
application where the party affected by an irregularity had actual notice of it. Knowledge of an
irregularity may arise from the fact that the person contracting was himself a party to the inside
procedure. As in Devi Ditta Mal v The Standard Bank of India, where a transfer of shares was

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approved by two directors, one of whom within the knowledge of the transferor was disqualified
by reason of being the transfer himself and the other was never validly appointed, the transfer
was held to be ineffective.

Similarly in Howard v. Patent Ivory Manufacturing Co. where the directors could not defend
the issue of debentures to themselves because 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 obtained. Likewise, in Morris v Kansseen , a director could not defend an allotment of
shares to him as he participated in the meeting, which made the allotment. His appointment as a
director also fell through because none of the directors appointed him was validly in office.

But after the Hely-Hutchinson v Brayhead Ltd., according to which the mere fact that a person
is a director does not mean that he shall be deemed to have knowledge of the irregularities
practiced by other directors. A newly appointed director does not mean that he shall be deemed
to have knowledge of the irregularities practiced by the other directors. A 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 liable.

2. Suspicion of Irregularity: - The protection of the “Turquand Rule” is also not available
where the circumstances surrounding the contract are suspicious and therefore invite inquiry.
Suspicion 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. Where, for example, as in the case of
Anand Bihari Lal v. Dinshaw & co., the plaintiff accepted a transfer of a company’s property
from its accountant, the transfer was held void. The plaintiff could not have supposed, in absence
of a power of attorney, that the accountant had authority to effect transfer of the company’s
property.

Similarly, in the case of Haughton & co v. Nothard, Lowe & Wills Ltd., where a person
holding directorship in two companies agreed to apply the money of one company in payment of
the debt 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

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it.” Any 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 behalf.”

3. Forgery: - Forgery may in circumstances exclude the ‘Turquand Rule’. The only clear
illustration is found in the Ruben v Great Fingall Consolidates; here in this case the plaintiff
was the transferee of a share certificate issued under the seal of the defendant’s company. The
company’s 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 be estopped from denying genuineness
of the document. But, it was held, that the rule has never been extended to cover such a complete
forgery.

Lord Loreburn said: “It is quite true that persons dealing with limited liability companies are not
bound to enquire into their indoor management and will not be affected by irregularities of which
they have no notice. But, this doctrine which is well established, applies to irregularities, which
otherwise might affect a genuine transaction. It cannot apply to Forgery.”

4. Representation through Articles: - The exception deals with the most controversial and
highly confusing aspect of the “Turquand Rule”. Articles of association generally contain what is
called ‘power of delegation’. Lakshmi Ratan Lal Cotton Mills v J.K. Jute Mills Co. explains
the meaning and effect of a “delegation clause”.

Here one G was director of the company. The company had managing agents of which also G
was a director. Articles authorized directors to borrow money and also empowered them to
delegate this power to any or more of them. G borrowed a sum of money from the plaintiffs. The
company refused to be bound by the loan on the ground that there was no resolution of the board
delegating the powers to borrow to G. Yet the company was held bound by the loans. “Even
supposing that there was no actual resolution authorizing G to enter into the transaction the
plaintiff could assume that a power which could have been delegated under the articles must
have been actually conferred. The actual delegation being a matter of internal management, the
plaintiff was not bound to enter into that.”

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Thus 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 question of knowledge of Articles came up in the case of Rama Corporation v Proved Tin
and General Investment Co, here; one T was the active director of the defendant company. He,
purporting to act on behalf of his company, entered into a contract with the plaintiff company
under which he took a cheque from the plaintiffs. The company’s article contained a clause
providing that “the directors may delegate any of their powers, other than the power to borrow
and make calls to committees, consisting of such members of their body as they think fit”. The
board 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 bound by the agreement. Slade J’, was of the
opinion that knowledge of articles was essential. “A person who at the time of entering into a
contract with a company has no knowledge of the company’s articles of association, cannot rely
on those articles as conferring ostensible or apparent authority on the agent of the company with
whom he dealt.” He could have relied on the power of delegation only if he knew that it existed
and had acted on the belief that it must have been duly exercised.

Knowledge of articles is considered essential because in the opinion of Slade J; the rule of
‘indoor management’ is based upon the principle of estoppel. Articles of association contain a
representation that a particular officer can be invested with certain of the powers of the company.
An outsider, with knowledge of articles, finds that an officer is openly exercising an authority of
that kind. He, therefore, contracts with the officer. The company is estoppel from alleging that
the officer was not in fact authorized.

This view that knowledge of the contents of articles is essential to create an estopped against the
company has been subjected to great criticism. One point is that everybody is deemed to have
constructive notice of the articles. But Slade J brushed aside this suggestion stating constructive
notice to be a negative one. It operates against the outsider who has not inquired. It cannot be
used against interests of the company. The principle point of criticism, however, is that even if

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the directors had the power to delegate their authority. They would not yet be able to know
whether the director had actually delegated their authority. Moreover, 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. A person believes upon that representation and contract with
him. The company shall naturally be estopped from denying that authority of that officer for
dealing on its behalf, irrespective of what the articles provide. Articles would be relevant only if
they had contained a restriction on the apparent authority of the officer contained.

5. Acts outside apparent authority: - Lastly, if he act of an officer of a company is one which
would ordinarily be beyond the power of such an officer, the plaintiff cannot claim the protection
of the “Turquand rule” simply because under the articles power to do the act could have been
delegated to him. In such a case the plaintiff cannot sue the company unless the power has, in
fact, been delegated to the officer with whom he dealt. A clear illustration is Anand Behari Lal
v Dinshaw here the plaintiff accepted a transfer of a company’s property from its accountant.
Since such a transaction is apparently beyond the scope of an accountant’s authority’ it was void.
Not even a ‘delegation clause’ in the articles could have validated it, unless he was, in fact,
authorized.

CONCLUSION

The case of Royal British Bank v Turquand , refined the basic Common law of Agency to
articulate the Doctrine of Indoor Management. The rule was enunciated by the Court to mitigate
the rigors of the Constructive Notice Doctrine. Its importance arises in situations in which the
third party’s dealings are with some officer or agent other than the Board. The rule protects the
interest of the third party who transacts with the Company in good faith and to whom the
Company is indebted. The rule enunciated in the decision is often referred to as "Turquand's
rule" and "indoor management rule". The gist of the rule is that persons dealing with limited
liability companies are not bound to enquire into their indoor management and will not be
affected by irregularities of which they had no notice The rule enunciated in Turquand has been
applied in many cases subsequently and generally in order to protect the interests of the party
transacting with the Directors of the Company. Applying the rule, now it can not be argued that a
person having dealings with a Company is deemed to have notice of who the true Directors are,

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and this being shown by public documents i.e. the registers of the directors required to be
maintained by the Company and the and the notices of changes.

With the due course of time several exceptions have also emerged out of the rule like Forgery,
negligence, third party having knowledge of irregularity etc. If we analyze the cases it is revealed
that the Turquand rule did not operate in a completely unrestricted manner. Firstly, it is inherent
in the rule that if the transaction in question could not in the circumstances have been validly
entered into by the company, then the third party could not enforce it. Secondly, the rule only
protected 'outsiders', that is persons dealing 'externally' with the company; directors, obviously,
were the very people who would be expected to know if internal procedures had been duly
followed. Thirdly, actual notice of the failure to comply fully with internal procedures precluded
reliance upon the rule. Fourthly, an outsider could not rely upon Turquand's Case where the
nature of the transaction was suspicious; for example, where the company's borrowing powers
were exercised for purposes which were wholly unconnected with the company's business and of
no benefit to the company.

SOURCES

• Paul L Davies, Gower's Principles of modern Company law

• http://www.law.uvic.ca/mgillen/315/documents/Ch20-ultravires_000.pdf
• Cowan de Groot Properties Ltd v. Eagle Trust plc [1991] BCLC 1045
• Indian Companies Act, 1956.

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