INTRODUCTION
The Doctrine of Constructive Notice and the Doctrine of Indoor Management regarded as the most significant principles of Company law regarding the documents of the company publicly available and the third parties’ rights conducting business with a company. The latter doctrine operates to safeguard the outsider against the company, and the former doctrine safeguards the company from the outsider. The Doctrine of Constructive Notice is based on the Presumption that every person conducting business with the company has read thoroughly the public documents of the company which are memorandum of and articles of association. The Doctrine of Indoor Management safeguards the rights of the third parties who are conducting business with the company supposing that its internal machinery has been handled fairly and consistently and not opposed to the company’s regulations. This blog delves into the doctrines through its case laws. This blog also critically analyses the doctrines.
DOCTRINE OF CONSTRUCTIVE NOTICE
MOA and AOA are the most important documents of the company which are considered as charter and constitution of the company. Section 399 of the Companies Act, 2013 declared it as a document that is available to the public to make the public aware of the company. As per the Doctrine of Constructive Notice, it is the duty of the person conducting business with a company to inspect its public documents and confirm that the dealing conforms with their provisions. Whether a person inspects them or not, it will presume to be read those documents by a person. Such a kind of presumption is known as Constructive notice. The doctrine provides transparency and safeguards the interest of the third parties. It guarantees that publicly available information about the company must be reliable. It makes sure that everyone is beware of the company’s fundamental functions. Any restriction can be enforceable against the party conducting business with the company, irrespective of the knowledge or intent of the parties or not.
CASE LAWS
- Kotla Venkataswamy v Chinta Ramamurthy[1]
In this case, articles of association bound the officials of the company to sign deeds, etc. on behalf of the company. The plaintiff accepted a mortgage deed which is executed by the secretary and a working director only not by the managing director. The court held that the plaintiff’s claim under the mortgage deed is not maintainable.
The court held that “If the plaintiff had consulted the articles, she would have discovered that a deed such as she took required execution by three specific officers of the company and she would have refrained from accepting a deed which was inadequately signed. Notwithstanding, therefore she may have acted in good faith and her money may have been applied to the purpose of the company, the bond is nevertheless invalid.”
- Oakbank Oil Co v Crum[2]
In this case, the court observed that a person conducting business with the company is not only bound to have read the memorandum of association and article of association but to have comprehended them according to their proper meaning.
- Mahony v. East Holyford Mining Co.[3]
The court observed in this case that,
“Every joint-stock company has its memorandum and articles of association…open to all who are minded to have any dealings whatsoever with the company, and those who so deal with them must be affected with notice of all that ‘is contained in these documents.”
CRITICAL ANALYSIS
Its critics believe that the doctrine is unreal. The Doctrine does not take into consideration of realities of business or life as it is based upon a fiction of law. As per Palmer, the doctrine of constructive notice will apply to all documents that affect the powers of the Company, However, the Company is known through its officials, not through its documents. Hence, Section 9 of the European Communities Act, of 1972 abrogated this doctrine. The Doctrine is also inapplicable for business transactions, where directors or other officials are bound under the documents to exercise certain power on sanctions and approval of shareholders. In a case, where a third person acted inconsistent with the MOA and AOA, a person will not be eligible to claim relief based on being unaware of the said provision of the document.
DOCTRINE OF INDOOR MANAGEMENT
The doctrine of Indoor Management is opposite to that of the Doctrine of constructive notice. It implies that there is no obligation to have notice of the company’s internal machinery which is handled by its officials. If a contract is according to the MOA and AOA of the company, the person will not be prosecuted because of mismanagement of the internal machinery of the Company. The doctrine originated in the landmark English case of Royal British Bank v Turquand[4] in the year 1856. In this case, the directors of the company taken a sum of money from Turquand on bonds. However, the article of association provided that the director might take money on bonds on a condition to pass the resolution at the general meeting of the company. The court held that the company would be bound to pay off the debts. In the summarized words of Professor Gower, “If the directors have the power and authority to bind the company but certain preliminaries are required to be gone through on the part of the company before that power can be duly exercised, and then the person contracting with the directors is not bound to see that all these preliminaries have been observed. He is entitled to presume that the directors are acting lawfully in what they do.” However, the doctrine is subject to a few exceptions that limit its application. The situation where a third party has actual knowledge of internal irregularity. It may happen in a situation where a contracting party himself is a party to the internal machinery of the company. The doctrine is also not applicable under such circumstances which involve suspicion. In a situation where the plaintiff accepted the transfer of the company’s property from its accountant. The doctrine restricts its applicability in circumstances of forgery where the company secretary forged the signature of directors and issued the share certificate.
CASE LAWS
- Dewan Singh Hira Singh v Minerva Films Ltd[5]
In this case, directors are bound to allot only 5000 “A” class shares. They acting ultra virus allotted 13000. The court held that the third parties were acting in good faith with the company. They were not obliged to be aware of the internal machinery of the company.
- PV Damodara Reddy v Indian National Agencies Ltd[6]
In this case, the directors can not allot a share without the consent of the general meeting. Directors allotted the shares without the consent of the general meeting. The court held that the contracting party will not be prosecuted for the mismanagement of the internal machinery of the company.
- Khulna Loan Co Ltd v Jahir Goldar[7]
In this case, the director of the company is obliged to grant a lease only by the prior approval of the Board. Violating the articles and memorandum of association, they granted with such. It was held that the third party would not be liable for the internal mismanagement of the company.
CRITICAL ANALYSIS
The most common Criticism is that the doctrine encourages a conflict of interest between directors and the shareholders of the company. Directors act beyond the power which is granted by the article of association and memorandum of association as the third parties believe that they have the power to bind the company. Shareholders suffer in the end because of the inability to oversee the director’s actions. The doctrine is criticized for its limited protection for the company as the company has a minimal defence against ultra vires conduct of their directors and third parties can enforce the transaction which results in fraud and unauthorized transaction. Its critics believe that the application of the theory is subject to uncertain outcomes. Demerits of the doctrine were observed by the court in the case of Mahony v. East Holyford Mining Co[8], in which the director issued the share certificate to the plaintiff. The court held that the act of the director was forgery. Hence, it will not be remedied by the doctrine.
CONCLUSION
The doctrine of Constructive notice and Indoor management are regarded as the most significant concepts of company law. Constructive notice obliged the contracting party to be aware of the public documents of the company. Indoor management safeguards third parties who deal in good faith on the occasion of internal mismanagement of the company. Although, the theory has invited criticism for its abuse. Critics raised concerns about the misuse and abuse of the doctrines. In my opinion, while considering the critics, some revisions and alterations could have a positive impact on corporate governance and the harmony between accountability and efficiency.
Author(s) Name: Muzakkir Khan (Mumbai University, Mumbai)
References:
[1] Kotla Venkataswamy v Chinta Ramamurthy, [1934] AIR 579.
[2] Oakbank Oil Co. v Crum, [1882] 8 AC 65
[3] Mahony v. East Holyford Mining Co, [1875] LR 7 HL 869.
[4] Royal British Bank v Turquand, [1856] 119 ER 886.
[5] Dewan Singh Hira Singh v Minerva Films Ltd, [1959] AIR 106 (PH).
[6] PV Damodara Reddy v Indian National Agencies Ltd, [1946] AIR 35 (Mad).
[7] Khulna Loan Co Ltd v Jahir Goldar, [1914] IC 24 (Cal).
[8] Mahony v. East Holyford Mining Co, [1875] LR 7 HL 869.
