Doctrine of constructive notice

(C) Arun Verma

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DOCTRINE OF CONSTRUCTIVE NOTICE/KNOWLEDGEDOCTRINE OF INDOOR MANAGEMENTDOCTRINE OF ULTRA VIRESARUN VERMA ©

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DOCTRINE OF CONSTRUCTIVE NOTICE / KNOWLEDGE• Every outsider dealing with a company is

deemed to have notice of the contents of the Memorandum and the Articles of Association. These documents, on registration with the Registrar, assume the character of public documents. This is known as 'constructive notice' of Memorandum and Articles.

• The Memorandum and the Articles are open and accessible to all. It is the duty of every person dealing with a company to inspect these documents and see that it is within the powers of the company to enter into the proposed contract.

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• Section 399 (1) of the Companies Act, 2013 provides the inspection, production and evidence of documents kept by Registrar. It provides that the memorandum and articles when registered with Registrar of Companies becomes public document and then they can be inspected by anyone on payment of a nominal fee. Therefore, any person who contemplates entering into a contract with the company has the means of ascertaining and is thus presumed to know the powers of the company has the means of ascertaining and is thus presumed to know the powers of the company and the extent to which they have been delegated to the directors. In other words, every person dealing with the company is presumed to have read these documents and understood them in their true perspective. This is known as doctrine of constructive notice.

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• The memorandum of association and articles of association are two most important documents needed for registration and incorporation of a company. The memorandum of association of a company contains the fundamental conditions upon which alone the company has been incorporated.

• According to Section 2(56) of the Companies Act, 2013 defines the memorandum means the memorandum of association of a company as originally framed or as altered from time to time in pursuance of any previous companies law or of this Act.

• According to Palmer, the memorandum of association is a document of great importance in relation to the proposed company.

• It contains the objects for which the company is formed and therefore identifies the possible scope of its operation scope of its operation beyond which its action cannot go.

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• The Articles of association of a company are its bye-laws or rules and regulations that govern the management of its internal affairs and the conduct of its business. According to section 2(5) of the Companies Act, 2013 ‘articles’ means the articles of association of a company as originally framed or as altered from time to time in pursuance of any previous companies laws or of the present Act.

• Both memorandum of association and the articles of association are public documents according to section 610 of the Act. These documents become public documents as soon as they get registered and can be accessible by any members of the public under the provision of the Act.

• The rule of constructive notice extends not merely to Memorandum and Articles but also to all such documents as are required to be registered with the Registrar of Companies. There is however no constructive notice of documents which are filed with the Registrar of Companies for the sake of record only.

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• The effect of the doctrine of constructive notice is harsh on the outsider who does business with a company. An outsider who dealt with a company is deemed to have a constructive notice of the contents of the documents of the company. An outsider cannot claim relief on the ground that he was unaware of the powers of the company in case of ultra vires of the company.

• The ‘doctrine of constructive notice’ is more or less an unreal doctrine. It does not take notice of the realities of business life. People know a company through its officers and not through its documents. 

• The courts in India do not seem to have taken it seriously though. For example, in Dehra Dun Mussorie Electric Tramway Co. v. Jagmandardas, the Allahabad high court allowed an overdraft incurred by the managing agent of a company when under the articles the directors had no power to delegate their borrowing power.

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• The European Communities Act, 1972 contained the provision of constructive notice, which has now abrogated. A person who dealt with a company was at common law deemed to have notice of the contents of its memorandum and articles of association when the company’s certificate of incorporation was issued by the Registrar of Companies and such a person also had constructive notice of the other documents which companies were required to deliver to the registrar of companies, provided they were open to public inspection and had been gazetted where necessary. This is no longer since an amendment was made in 1989 to the Companies Act 1985, providing that a person shall not be taken to have notice of any matter merely because it is disclosed in a document delivered to the Registrar of Companies and so is available to public inspection. The statutorily modified doctrine of constructive notice may therefore, according to the circumstances, mean that a person will be treated as being aware of the contents of certain documents filed in respect of the company with which he deals. These documents will tell the person who deals with the company what objects it may pursue, how much share capital it has issued and may issue in future, how its board of directors is constituted etc. In theory, therefore, a person who deals with a company cannot complain if a transaction which he enters into with the company is held to be invalid because it patently conflicts with the provisions or requirements of those documents which he could, and should in the circumstances, have inspected, at the companies registry.

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• As criticisms of the doctrine of constructive notice, the new theory called the doctrine of indoor management has been evolved by the courts. The doctrine of constructive notice seeks to protect the company against the outsider; the other doctrine operates to protect outsiders against the company. The rule of indoor management is based upon obvious reasons of convenience in business relations. Firstly, the memorandum and articles of association are public documents, open to public documents. But, the details of internal procedures are not thus 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.

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EFFECT OF THE DOCTRINE OF CONSTRUCTIVE LIABILITY• The effect of the doctrine of constructive liability is harsh on the other party. It is, therefore, the duty of every person dealing with a company to inspect its public documents and make sure that his contract is in conformity with their provisions. The Madras High Court discussed the scope of the rule of constructive liability in kotla Venkataswamy v. Rammurthy.  The dispute in this case was whether the mortgage bond was validly executed as per the company’s articles of association so as to make the company liable. Article 15, of the Company's Articles of Association provides that all deeds, hundies, cheques, certificates and other instruments shall be signed by the Managing director, the Secretary and the working Director on behalf of the Company, and shall be considered valid. In the instant case, the plaintiff accepted a deed of mortgage executed by the secretary and a working director only. The court held that the plaintiff could not claim under this deed. The Court further observed that if the plaintiff had consulted the articles she would have discovered that a deed such as she took required execution by three specified officers of the company and she would have refrained from accepting a deed inadequately signed. Notwithstanding, therefore, she may have acted in good faith and her money may have been applied to the purposes of the company, the bond is nevertheless invalid.

• One of the effects of the rule of constructive liability is that a person dealing with the company is considered not only to have read those documents but to have understood them according to their proper meaning. He is presumed to have understood not merely the company’s powers but also those of its officers. 

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• Re Jon Beauforte (London) Ltd case  , where the insolvent company’s stated objects were to manufacture dresses but it had for sometime instead been making veneered panels, a combination of actual knowledge of the business being carried on by the company and of constructive notice of its stated objects resulted in all but one of its creditors’ claim being ultra vires. The court said that the result of this rule of constructive notice was that where the business being carried on by the company were known to the third party and, whether he actually knew it or not, were ultra vires, he would be unable to sue the company.

• In case of ultra vires acts of the company the other party cannot claim relief on the ground that he was unaware of the powers of the company. The rules of common law established over the years have already provided extensive protection for persons dealing with a company in good faith where the act or transaction concerning or involving such persons is not ultra vires and beyond the company’s powers. The Court in Royal British Bank v. Turquand established a principal to provide the protection to other party who is dealing with a company. According to the rule propounded in this case, although those dealing with a company were deemed to have notice of the contents of memorandum and articles, they were not required to satisfy themselves that all the internal regulations se out therein had been complied with. This, however, was no help when the transaction was beyond the company’s capacity.

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• COMMON LAW CASES• The rule of constructive notice was laid down by the

House of Lords in Ernest v. Nicholls and was further explained by House of Lords in Mahony v. East Holyford Mining Co case. Lord Wensleydale in Ernest case took the view that the rules of partnership would apply in the absence of the doctrine of constructive liability.

• the legislature saw fit to require a company to register articles and so to make available the world information so as to make available to the world information as to who were the persons authorized to bind the shareholders. 

• The British Courts in several cases observed that the doctrine of constructive notice has a potentially drastic effect on outsiders as they were deemed to know about any internal procedures in the constitution as it is a public document.

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• In Knopp v. Thane Investment Limited (2003) the court found the director’s failure to observe the articles rendered a contract contrary to the articles unenforceable. If the doctrine of constructive notice was applied strictly the outsider could not complain about the lack of authority as they were deemed to know that there was a limit on the actual authority of the company’s agent.

• However, the Courts were often keen to mitigate the effect of constructive notice.

• In Royal British Bank v. Turquand (1856) an action was brought for the return of money borrowed by the company. The company argued that it was not required to pay back the money because the manager who negotiated the loan should have been authorized by a resolution of the general meeting to borrow but he had no such authorization. As a result of the doctrine of constructive notice the bank was deemed to know this. The Court held that the public documents only revealed that a resolution was required not whether the resolution had been passed. The bank had no knowledge the resolution had not been passed and thus it did not appear on the face of the public documents that the borrowing was invalid.

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Kotla Venkatswamy v. C. Rammurthi

• The Articles of Association of a company contained a clause that all deeds and documents of the company shall be signed by the managing director, the secretary and a working director on behalf of the company. A deed of mortgage was signed by the secretary and a working director only.

It was held that the mortgage could not be enforced as the illegality appeared on the face of the deed, and therefore, the deed was invalid notwithstanding that plaintiff acted in good faith and money was applied for the purposes of the company.

The doctrine of constructive notice of the Memorandum and Articles, however, is not a positive doctrine but a negative one. It is like doctrine of estoppels. It does not operate against the company. It operates only against an outsider dealing with the company. It prevents him from alleging that he did not know that the Memorandum and Articles rendered a particular act ultra vires the company.

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• Criticism Of Doctrine Of Constructive Liability: Evolution Of Doctrine Of Indoor Management

• The rule of constructive notice has proved too inconvenient for business transaction, particularly where the directors or other officers of the company were empowered under the articles to exercise certain powers subject only to certain prior approvals or sanctions of the shareholders. Whether those sanctions and approvals had actually been obtained or not could not be ascertained because in real situations, the investors, vendors, creditors and other outsiders could not dare to ask the directors in so many words about those sanctions having been obtained or to produce the relevant resolutions. Since, there are no means to ascertain whether necessary sanctions and approvals have been obtained before a certain officer exercises his powers which, as per articles, can only be exercised subject to certain approvals, those dealing with the company can assume that if the directors or other officers are entering into those transactions, they would have obtained the necessary sanctions. This is known as the ‘doctrine of indoor management’ and was first laid down in the case of Royal British Bank v. Turquand. 

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• The Courts in India have also been reluctant in applying the doctrine of constructive liability. The Allahbada High Court in Dehradun Mussoorie Electric Tramway Co. v. Jagamanandaradas case rejected the doctrine of constructive liability and the Company was held liable to the party to the transaction even the directors of the company borrowed the money which was neither in compliance with the articles nor it was done after obtaining the resolution in the general body.

• The Madras High Court in the case of official Liquidator, Manasube & Co. (P.) Ltd. v. Commissioner of Police 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.

STATUTORY REFORM OF CONSTRUCTIVE NOTICE• Section 9 of the European Communities Act, 1972 has abrogated the doctrine

of constructive notice. The provision of Section 9 is now incorporated in Section 35 of the Companies Act, 1985. Additionally the Companies Act, 1989 introduced two further sections into the 1985 Act to deal with the constructive notice. Section 35B of the Companies Act settled: “A party to a transaction with the company is not bound to enquire as to whether it is permitted by the company’s memorandum or as to any limitation on the powers of the board of directors to bind the company or authorize others to do so.”

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• This was supposed to be introduced by Companies Act, 1985, S.711A which was to abolish the concept of constructive notice for corporations. However, S.711A has never been implemented and so only section 35 B dealt with constructive notice. 

• An example of the impact of this provision was seen in the case of TCB Limited v. Gray, where the debenture issued by the company was signed by solicitor but not by the director himself. The articles of the company required the signature of the director for this purpose. Even so, the company was held liable. Stating the effect of the new provision, the Court said that before this enactment came into force a person dealing with the company was required to look into the memorandum and articles of the company to satisfy himself that the transaction was within the corporate capacity but that section 9(1) had changed this. The sub-section says that good faith is to be presumed and that the person dealing with the company is not bound to inquire. 

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CONCLUSION• The rule of constructive liability is a unrealistic doctrine. It is an imaginary doctrine and

is a fiction created by the judicial pronouncement of the Courts. Innumerable parties enter into a number of contracts in everyday business of the company. This doctrine expects each and every outsider not only to know the documents of the company but also presume to understand the exact nature of documents, which is practically not possible. In reality, the company is not known by the documents but by the people who represent it and deal with an outsider. The outsiders do the business and enter into contracts not always on the basis of documents of the company but the goodwill and the reputation of the directors or officers who are representing the company.

• This is the reason why the British Courts and Indian Courts have shifted its approach in dealing with the cases relating to the outsider of the company. The Indian Courts have not given much importance to this doctrine. The European Communities Act has also abrogated the concept of constructive notice by bringing Section 9 of the Act which recognizes the concept of good faith in business transaction. This provision is in the tune of the reality of the business transaction, where the outsiders of the company enter into the various contracts not on the basis of the documents of the company but on the good faith of the company.

• This is the reason why the courts have evolved the doctrine of indoor management as an opposite to the doctrine of constructive notice in order to protect the interests of the outsiders.

• The researcher on the basis of the various commentaries on the subject and the cases decided by the British Courts and Indian Courts is of view that merely registration of a company should not constitute the notice of the documents submitted to the registrar. Also, an outsider should always have the freedom to make some assumption which a reasonable person may infer into the particular circumstances.

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DOCTRINE OF INDOOR MANAGEMENT• Under the Indian law relating to companies, a public company

is managed by a Board of Directors which is entrusted with the responsibility of managing the company in the most efficient and transparent manner.

• 'Doctrine of Indoor Management', popularly known as the Turquand’s Rule initially arose from 150 years ago in the context of the 'Doctrine of Constructive Notice'.

• The rule of the doctrine of indoor management is opposed to the rule of constructive notice. The latter seeks to protect the company against the outsider while the former seeks to protect the outsiders against the company.

• It is no part of duty of any outsider to see that the company carries out the requisite internal proceedings.

• It is important to note that the rule of constructive notice can be invoked by the company and it does not operate against the company. It operates against the person who has failed to inquire but does not operate in his favour.

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• The Rule of Doctrine of Indoor Management had its genesis in the English case Royal British 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 the 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.

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EXCEPTIONS TO THE DOCTRINE OF INDOOR MANAGEMENT1. KNOWLEDGE OF IRREGULARITY

2. NEGLIGENCE ON THE PART OF THE OUTSIDER

3. FORGERY

4. NO KNOWLEDGE OF ARTICLES

5. ACTS OUTSIDE APPARENT AUTHORITY

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KNOWLEDGE OF IRREGULARITY

• Where a person dealing with a company has actual or constructive notice of the irregularity as regards internal management, he cannot claim the benefit under the rule of indoor management.

T.R. Pratt (Bombay) Ltd. v. E.D. Sassoon & Co. Ltd.• Company A lent money to Company B on a mortgage of its

assets. The procedure laid down in the Articles for such transactions was not complied with. The directors of the two companies were the same. It was held in this case that the lender had notice of the irregularity and hence the mortgage was not binding.

A transfer of shares in a company was approved by two directors. One of these directors was not validly appointed. The other was disqualified by reason of being the transferee himself. These facts were known to the transferor. It was held in this case that the transfer was ineffective.

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NEGLIGENCE ON THE PART OF THE OUTSIDER• Where a person dealing with a company could discover the

irregularity if he had made proper inquiries, he cannot claim the benefit of the rule of indoor management. The protection of the rule is also not available where the circumstances surrounding the contract are so suspicious as to invite inquiry, and the outsider dealing with the company does not make proper inquiry. If, for example, an officer of a company purports to act outside the scope of his apparent authority, suspicion should arise and the outsider should make proper inquiry before entering into a contract with the company.

Anand Bihari Lal v. Dinshaw & Co.• The plaintiff, in this case, accepted a transfer of a company's

property from its accountant. It was held in this case that the transfer was void as such a transaction was apparently beyond the scope of the accountant's authority. The plaintiff should have seen the power of attorney executed in favour of the accountant by the company.

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FORGERY

•The rule in Turquand's case does not apply where a person relies upon a document that turns out to be forged since nothing can validate forgery. A company can never be held bound for forgeries committed by its officers.

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NO KNOWLEDGE OF ARTICLES • This exception deals with the most controversial and highly confusing

aspect of the Turquand Rule. Articles of association generally contain what is called the "power of delegation".

Lakshmi Ratan Cotton Mills v. J.K. Jute Mills Co.• This case explains the meaning and effect of a delegation clause.• One G was a director of a 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 one 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 power to borrow to G. Yet the company was held bound by the loan.

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.

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ACTS OUTSIDE APPARENT AUTHORITY•If an officer of a company enters into a

contract with a third party and if the act of the officer is beyond the scope of his authority, the company is not bound. In such a case, the plaintiff cannot claim the protection of the rule of indoor management simply because under the Articles the power to do the act could have been delegated to him. The plaintiff can sue the company only if the power to act has in fact been delegated to the officer with whom he has entered into the contract.

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Kreditbank Cassel v. Schenkers Ltd.• A branch manager of a company drew and endorsed bills of

exchange on behalf of the company in favor of a payee to whom he was personally indebted. He had no authority from the company to do so. It was held that the company was not bound. But if an officer of a company acts fraudulently under his ostensible authority on behalf of the company, the company is liable for his fraudulent act.

Sri Krishna v. Mondal Bros. & Co.• The manager of a company had the authority under the

Memorandum and the Articles of the company to borrow money. He borrowed money on a hundi but did not place the money in the coffers of the company. It was held that the company was bound to honour the hundi. It could not defeat the bona fide claim of the creditor for recovery of the money on the ground of fraud of its own officer.

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POSITION UNDER THE INDIAN COMPANIES ACT

The provision under the Indian Companies Act, 2013 which directly imbibes the Turquand’s Rule is Section 176, which reads as follows:

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.

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CONCLUSION• The case of Royal British Bank v. Turquand refined the common law of agency

to articulate the Doctrine of Indoor Management. The rule was enunciated by the Court to mitigate the rigors of the Doctrine of Constructive Notice. 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 gist of the rule is that persons dealing with a public company are not bound to enquire into their indoor management and will not be affected by irregularities of which they had no notice.

• The Turquand Rule 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. With the due course of time several exceptions have also emerged out of the rule like forgery, negligence, acts done outside the scope of apparent authority and 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 protects 'outsiders', that is persons dealing with the company externally; directors, obviously were the very people who would be expected to know if the internal procedures had been duly followed.

• Thirdly, actual notice of the failure to comply fully with the internal procedures precluded reliance upon the rule. Lastly, an outsider could not rely upon the Turquand's Rule 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.

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DOCTRINE OF ULTRA VIRES• ‘Ultra’ means beyond and ‘vires’ means powers. The term ultra

vires a company means that the doing of the act is beyond the legal power and authority of the company. The doctrine of ultra vires is important in defining the limits of the powers conferred on the company by its Memorandum of Association. According to this doctrine, the vires (power) of a company to enter into a contract or transaction is limited by the ambit of the Objects Clause of the Memorandum and the provisions of the Companies Act. Whatever is not permitted by the Objects Clause and the Act, is prohibited by the doctrine of ultra vires. If a company engages in any activity or enters into any contract which is ultra vires (outside the power conferred by) the Memorandum or Act, it will be null and void so far as the company is concerned and it cannot be subsequently ratified or validated even if all the shareholders give their consent. Thus under this doctrine, a company has powers to engage in only such activities or enter into such transactions:

• Which are essential to the attainment of the objects specified in the Memorandum;

• Which are reasonably and fairly incidental to the main objects; and• Which are permitted by the provisions of the Companies Act.

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• The doctrine of ultra vires was first enunciated in the celebrated case Ashbury Railway Carriage and Iron Co. Ltd., vs Riche. The company was registered with the following objects:

• 1. to make, and sell, or lend on hire, railway carriages and wagons;

• 2. to carry on the business of mechanical engineers and general contractors;

• 3. to purchase, lease, work and sell mines, minerals, land and buildings.

• The directors contracted with M/s. Riche to purchase a concession for laying a railway line in Belgium. The contract was ratified by a special resolution. Later, the contract was repudiated by the company on the ground of its being ultra vires and Riche brought an action on the ground of breach of contract. It was held by the House of Lords that the contract was ultra vires the company so void ab initio. It was also held that, not even the assent of the whole body of shareholders can ratify such a contract, as the contract was ultra vires the objects clause.

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Effects of Ultra Vires Transactions:

• If a company enters into transactions, which are ultra vires, it will have the following effects:

• 1.Injunction: Whenever a company goes beyond the scope of the object clause, any of its members can get an injunction from the court to restrain the company from undertaking the ultra vires act.

• 2.Personal Liability of Directors: If the transaction is ultra vires, for instance, if the funds of the company are misapplied, the directors will be held personally liable.

• 3.Ultra Vires Contracts: Contracts entered into by a company, which are ultra vires, are void ab initio and unenforceable.

• 4.Property Acquired Ultra Vires: If a company acquires any property under an ultra vires transaction, it has the right to hold the property and protect it against damage by other persons.

• 5.Ultra Vires Torts: A company is not liable for torts committed by its agents or employees in the course of ultra vires transactions.

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