The Doctrine of Indoor Management: UGC NET Commerce Notes & Material

The indoor management doctrine rests on grounds that are patent considerations of business convenience between third parties and a company. The Doctrine of Indoor Management is an essential legal principle that serves as a counterbalance to the Doctrine of Constructive Notice in company law. While the Doctrine of Constructive Notice holds that outsiders dealing with a company are presumed to know its constitution (i.e., its articles of association and memorandum of association), the Doctrine of Indoor Management provides protection to such outsiders when they rely on the internal management of the company. This doctrine ensures that individuals dealing with a company are not unfairly disadvantaged due to the company's internal irregularities or breaches of its internal rules.

The doctrine of indoor management is a vital topic to be studied for the commerce related exams such as the UGC-NET Commerce Examination.

In this article, the readers will be able to know about the following:

• What is The Doctrine of Indoor Management?
• The Doctrine of Constructive Notice
• Origin of the Doctrine of Indoor Management
• Exceptions to the Doctrine of Indoor Management
• Example of Doctrine of Indoor Management

The doctrine of indoor management, also known as the Turquand rule, is a concept that has been in existence for over 150 years. This principle provides a protective shield to external parties or outsiders against the actions carried out by a company.

When a person enters into a contract with a company, they must ensure that the transaction is sanctioned by the company's memorandum and articles of association. There's no requirement to delve into internal irregularities. Even if such irregularities exist, the company would be held accountable as the person acted in good faith or bona fide.

To fully understand this doctrine, it's important to first grasp the concept of the doctrine of constructive notice. Both the doctrine of indoor management and constructive notice will be discussed in detail below.

The doctrine originated from the landmark case "Jones v. Lipman" (1962). The facts of the case are as follows: The company's articles provided for the borrowing of money on bonds, which required a special resolution to be passed in the General Meeting. The management borrowed the loan but failed to pass the resolution. When the loan repayment defaulted, the company was held responsible. The shareholders refused to accept the claim without a trace of the resolution. They maintained that the company would be liable since the person dealing with the company is entitled to assume that there has been necessary compliance with the internal management.

This rule was also adopted by the Supreme Court in "Adams v. Cape Industries plc" (1990). In this case, the company's articles stated that the cheque would be signed by two Directors and countersigned by the Secretary. It later came to light that neither the Directors nor the Secretary who signed the cheque were properly appointed. It was held that the person receiving such a cheque would be entitled to the amount since the appointment of directors is a part of the internal management of the company, and a person dealing with the company is not required to enquire about it.

The above view held in the case of "Adams v. Cape Industries plc" is supported by Section 176 of the Companies Act, 2013, which states that the defects in the appointment of the director or directors will not invalidate the acts done.

The doctrine provides protection to outsiders who enter into a contract with the company against any irregularities in the internal procedure of the company. Outsiders can't discover internal irregularities that occur in a company, hence, the company will be held liable for any loss suffered by them due to these irregularities.

While the doctrine of constructive notice protects the company against the claims of outsiders, the doctrine of indoor management protects the outsiders against the company's procedures.

There are certain exceptions to the doctrine that have been judicially established, which provide circumstances under which the benefit of indoor management cannot be claimed by a person dealing with the company.

Knowledge of Irregularity

This rule does not apply to situations where the person affected has actual or constructive notice of the irregularity. In the case of "Rolled Steel Products (Holdings) Ltd v. British Steel Corporation" (1986), the company's articles allowed the directors to borrow up to a certain limit. The limit could be raised provided consent was given in the General Meeting. Without the resolution being passed, the directors borrowed a larger amount from one of the directors who took debentures. It was held that the company was liable only to the extent of the original limit. Since the directors knew the resolution was not passed, they couldn't claim protection under Turquand's rule.

Suspicion of Irregularity

If any person dealing with the company is suspicious about the circumstances surrounding a contract, then they should enquire into it. If they fail to enquire, they cannot rely on this rule.

In the case of "Bratton Seymour Service Co Ltd v. Oxborough" (1992), the plaintiff accepted the transfer of property from the accountant. The Court held that the plaintiff should have obtained a copy of the Power of Attorney to confirm the authority of the accountant. Therefore, the transfer was considered void.

Forgery

Transactions involving forgery are void ab initio (null and void) as it's not a case of absence of free consent; it's a situation of no consent at all. This was established in the "Ashbury Railway Carriage and Iron Co Ltd v. Riche" (1875) case. A person was issued a share certificate with a common seal of the company. The signature of two directors and the secretary was required for a valid certificate. The secretary signed the certificate in his name and also forged the signatures of the two directors. The holder argued that he was unaware of the forgery, and he isn't required to look into it. The Court held that the company is not liable for forgery committed by its officers.

Let's take an example to understand the Doctrine of Indoor Management:

Situation

Consider a company named ABC Ltd., and its manager, Mr. John, has the power to sign contracts in the name of the company. The company's Articles of Association state that any contract worth a specified amount of money needs to be approved by the company's board of directors.

Mr. John enters into a contract with a supplier for a bulk order without obtaining the approval of the board, which is against the internal rules of the company. The supplier, XYZ Suppliers, is unaware that the approval of the board was necessary.

Application of the Doctrine of Indoor Management

Under the ‘Doctrine of Indoor Management’, ‘XYZ Suppliers’ is safe. Although Mr. John did not comply with the internal rules of the company (the board's approval), ‘XYZ Suppliers’ can still look up to the contract as valid, since they were acting in good faith and did not have any knowledge about the internal procedure being disregarded.

Exception

If ‘XYZ Suppliers’ were aware that Mr. John was not authorized to sign such a contract without the approval of the board, they would not be covered by the Doctrine of Indoor Management. Here, they would need to make sure that Mr. John was duly authorized, or else the contract would be invalid.

This illustrates how the doctrine safeguards third parties (such as the supplier) who are not aware of a company's internal problems.

The Doctrine of Indoor Management acts as a safeguard for individuals transacting with companies by protecting them from the consequences of the company's internal irregularities. While the Doctrine of Constructive Notice places an onus on outsiders to acquaint themselves with a company's constitution, the Doctrine of Indoor Management recognizes the practical limitations of such knowledge and provides a level of protection to those who transact with companies in good faith.

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