Constructive Notice and Indoor Management
Chapter Twenty-One
Syllabus topic 1, "FORMATION OF COMPANY"
Pages 108 to 112 of 998
In one line
Because a company's constitution is public, an outsider is treated as having read it and cannot complain of a limit it contains; but because the internal workings are not public, he may assume that everything the constitution required to be done inside the company has been done.
In exam wording: the doctrine of constructive notice treats every person dealing with a company as having notice of its memorandum and articles, which are public documents open to inspection under section 399; the rule in Royal British Bank v. Turquand, 119 ER 474, is its counterweight, entitling an outsider dealing in good faith to assume that acts of internal management required by those documents have been regularly performed, as Kotla Venkataswamy v. Chinta Ramamurthy, AIR 1934 Madras 579, states before distinguishing it.
Why the law has this at all
The two rules are a matched pair, and neither makes sense alone.
Constructive notice exists because publicity would be pointless if it could be ignored. The company files its memorandum and articles; anyone may inspect them under s.399 on payment of the prescribed fee, and members are entitled to copies under s.17. Having made the constitution available, the law treats it as read. Otherwise a company that had honestly published a limit on its borrowing would be bound by every loan taken in breach of it, and the publicity requirement would protect nobody.
Indoor management exists because publicity has an edge. What is public is the constitution; what is not public is whether the board actually met, whether the quorum was present, whether the general meeting passed the resolution the articles required. An outsider cannot verify those things, and a rule requiring him to would make dealing with companies impossible: every counterparty would have to audit the company's internal compliance before contracting.
So the line is drawn exactly where information stops. Anything the outsider could have discovered from the public documents, he is fixed with. Anything he could not have discovered, he may assume was done. That single sentence answers most problems in this area.
Constructive notice, and what it fixes an outsider with
The doctrine attributes to the outsider knowledge of the contents of the memorandum and articles, and knowledge of their effect. He is taken to know that the objects clause limits the company's capacity, that the articles cap the directors' borrowing power, that a particular class of transaction requires a special resolution, and that a document must be executed in a stated manner.
Two consequences follow. A transaction ultra vires the memorandum is void and the outsider gets nothing, as [The Objects Clause and Ultra Vires] explains, and his supposed ignorance is irrelevant. And a transaction contrary to a limit in the articles cannot be enforced by an outsider who is fixed with notice of the limit, which is exactly what the Indian case below decides.
Constructive Notice and Indoor Management
The doctrine has been criticised, and an LL.M. answer should say so. It attributes knowledge nobody in commerce actually has; the modern reality is that counterparties rely on the person they deal with rather than on filed documents; and other jurisdictions have abolished it by statute for most purposes. India has not, so it remains part of the law, tempered by Turquand's rule.
The Indian case worked
Facts. Kotla Venkataswamy v. Chinta Ramamurthy, AIR 1934 Madras 579, concerned a mortgage of a company's property. Article 15 of the company's articles of association provided 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. The mortgage bond was signed by the Working Director and the Secretary only, the Managing Director having, it was said, been dismissed and prosecuted. The assignee of the mortgagee sued to enforce the security.
Held. The Madras High Court held the mortgage not binding on the company. The articles are public documents of which the mortgagee had constructive notice; a document executed otherwise than as the articles require confers no rights, and the unavailability of the Managing Director did not make execution by the remaining two officers any more valid. The Court also stated Turquand's rule, that an outsider dealing in good faith may assume that acts of internal management have been regularly done, and held it inapplicable, because the defect was not internal at all: it was apparent on the face of the public document the plaintiff was fixed with having read.
Why it matters here. It is the standard Indian illustration of constructive notice defeating an outsider, and it marks the boundary of Turquand's rule with unusual clarity. The plaintiff was honest and the company got the benefit of a bad point, which is the doctrine's cost; but the rule that saved the company also protects every shareholder whose company's articles impose a safeguard.
The rule in Turquand, and its exceptions
The rule, as stated in the judgment above, is that a person dealing with a company in good faith is entitled to assume that the acts of internal management required by the public documents have been regularly performed. If the articles permit the directors to borrow up to a limit on a resolution of the general meeting, the lender may assume the resolution was passed; he cannot be expected to know whether the meeting was held.
Constructive Notice and Indoor Management
Four exceptions are settled, and each is a case where the assumption is unreasonable.
Knowledge of the irregularity. A person who actually knows the internal requirement was not complied with cannot rely on the rule. His knowledge displaces the assumption.
Suspicion of irregularity. Where the circumstances put the outsider on inquiry, a transaction of obvious personal benefit to the officer, an unusual course of dealing, he must inquire, and the rule does not protect him if he does not.
Forgery. The rule presumes an act done irregularly; a forged document is not the company's act at all, so there is nothing to regularise. The classic instance is a share certificate issued under a forged seal or signature.
No knowledge of the articles at all. A person who never consulted the articles and did not rely on them cannot claim the benefit of an assumption the articles alone create, though the point is more contested than the other three.
To these is sometimes added the case where the document itself shows the defect, which is really Kotla Venkataswamy: if the public document says three signatures and the deed shows two, nothing internal is being assumed, and the defect is on the face of what the outsider is deemed to have read.
A worked example
Sahyadri Foods Private Limited's articles provide that the Board may borrow up to one crore rupees, and that borrowing beyond that requires an ordinary resolution of the general meeting; and that all instruments creating a charge shall be signed by two directors and countersigned by the Company Secretary.
Loan one. A bank lends one crore fifty lakh rupees against a charge signed by two directors and countersigned by the Secretary, on the strength of a board resolution and a copy of what purports to be a general meeting resolution. In fact no general meeting was ever held. The bank is protected: the requirement of a general meeting resolution is an act of internal management, and the bank, dealing in good faith without notice, may assume it was regularly done. The company is bound.
Loan two. The same bank lends fifty lakh rupees against a charge signed by one director only, with no countersignature. The bank is not protected. The manner of execution is stated in the articles, which the bank is deemed to have read, and the defect appears on the face of the instrument. This is Kotla Venkataswamy precisely, and no assumption about internal proceedings can supply what the public document requires.
Loan three. The same bank lends two crore rupees, and the branch manager who arranges it is the brother of the borrowing company's managing director and knows that the general meeting was never called. Knowledge of the irregularity defeats the rule, and the company is not bound.
Constructive Notice and Indoor Management
Loan four. A charge is executed under a forged signature of one of the two directors. Turquand's rule does not apply, because a forgery is not an irregular act of the company but no act of the company at all.
Notice how each answer turned on the same question: could the lender have found the defect in the public documents, or was it hidden inside the company? Structuring an answer around that question is worth more than a list of exceptions.
Distinctions
| Constructive notice | Indoor management, Turquand | |
|---|---|---|
| Whom it protects | The company, against outsiders | The outsider, against the company |
| Basis | Memorandum and articles are public: s.399 inspection, s.17 copies | Internal proceedings are not public and cannot be verified |
| What is assumed | That the outsider read and understood the constitution | That what the constitution required to be done internally was done |
| Defeated by | Nothing; it is an irrebuttable attribution | Knowledge, suspicion, forgery, and a defect apparent in the public documents |
| Indian illustration | Kotla Venkataswamy, AIR 1934 Madras 579 | The same judgment states the rule before distinguishing it |
What it does NOT mean
Not notice of everything the company files. The doctrine is usually confined to the memorandum and articles and documents of that character; it does not fix an outsider with knowledge of every return and resolution on the file.
Not a cure for ultra vires. Turquand's rule regularises internal irregularities; it cannot make a company capable of what its memorandum does not permit.
Not a licence to ignore suspicious circumstances. The rule is for the person dealing in good faith; suspicion that would put a reasonable person on inquiry destroys it.
Quick revision
Constructive notice: memorandum and articles are public, s.399 inspection, s.17 copies to members; every person dealing with the company is fixed with their contents and effect. Kotla Venkataswamy, AIR 1934 Madras 579: articles required three signatories, deed carried two, mortgage not binding; the defect was on the face of the public document, so Turquand did not save the lender. Turquand, 119 ER 474: an outsider in good faith may assume acts of internal management were regularly done. Exceptions: knowledge of the irregularity; circumstances arousing suspicion; forgery; absence of any reliance on the articles; and a defect apparent in the public documents.
Test yourself
1. State the dividing line between the two doctrines in one sentence. What an outsider could have learned from the public documents he is fixed with; what he could not have learned, being internal to the company, he may assume was regularly done.
2. Why did the mortgagee fail in Kotla Venkataswamy? Because the articles required execution by the Managing Director, the Secretary and the Working Director, and the deed bore only two signatures; the deficiency was apparent from a public document of which he had constructive notice, so it was not an internal irregularity Turquand could cure.
Constructive Notice and Indoor Management
3. A lender knows the required general meeting was never held but lends anyway. Result? The company is not bound: actual knowledge of the irregularity is the first exception to Turquand's rule.
4. Does Turquand's rule protect a person taking under a forged instrument? No. A forgery is not an irregular act of the company but no act of the company at all, so there is nothing for the rule to regularise.
5. Can indoor management save an ultra vires transaction? No. It addresses irregular internal procedure, not want of corporate capacity, which is void under Ashbury and cannot be cured.
The rest of this subject
These notes are cut from the University's printed syllabus. Open the syllabus itself, or the past papers, for the same subject.