The Indoor Management Rule Analysis

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The “Indoor Management Rule” apparently developed as a means of mitigating the harshness and burdens of the doctrine of constructive notice in relation to outsiders dealing with companies; the doctrine of constructive notice states that persons dealing with a company are deemed to have notice of the contents of its registered documents. The reason for this was stated by, Lord Wensleydale in Ernest v Nicholls to be the fact of the public nature of registration: All persons therefore, must take notice of the deed (of settlement) and the Provisions of the Act.

If they do not choose to acquaint themselves with the powers of the directors, it is their own fault, and if they give credit to any unauthorized persons they must be contented to look to them only, and not to the company at large. The stipulations of the deed, which restrict and regulate their authority, are obligatory on those who deal with the company. However, a qualification to the rule of constructive notice developed, which favoured third parties as against companies.

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This rule, known as the indoor management rule may be relied on by a third party where the company’s public documents contain nothing which indicates that the contract in question may not be made. If the documents confer power on the company’s officers to bind the company, but provide that certain preliminary conditions or formalities must be complied with before the power may be exercised, then the contractor or the third party is not obliged to ensure that those conditions or formalities have been fulfilled. He is entitled to assume that the company’s officers are acting lawfully.

This means that, third parties or people dealing with a company are not supposed to found out if the directors of the company have the authority to perform, all procedures of the corporation have been complied with, and that all the terms and conditions in the company’s regulation have been fulfilled. To do so will not encourage smooth running of business. When this happen, it will impose a serious burden on third parties in their dealings with companies, in this case people transacting with companies are entitled to assume that internal company rules are complied with, even if they are not.

This rule, also known as the “Rule in Royal British Bank v. Turquand” states that outsiders dealing with a company are not bound to ensure that all the internal regulations of the company have in fact been complied with as regards the exercise and delegation of authority: but they are entitled to assume that all acts of internal management have been properly carried out in accordance with the maxim “omnia praesumuntur rite et solemniter esse acta” – “all things have been done properly and solemnly which ought to have been done”.

In other words, a person dealing with an incorporated company is not expected to peep into the internal affairs of the company or to investigate the locus standi of the officers before transacting any business of a normal every-day nature with the company. The case of Royal British Bank v. Turquand, was the case in which the rule was first enunciated and therefore, the locus classicus on this point. In that case, the Royal British Bank sued Turquand as the liquidator of the Coal brook Steam, Coal, and Swansea and London Railway Co. on a bond signed by two directors, whereby the latter company acknowledged itself to be bound to the Royal British Bank in an amount of ? 2,000. Under the constitution of the company the directors, might borrow on bond such sums as should, from time to time, by a general resolution of the company, be authorized to be borrowed, and the defendant pleaded that there had been no such resolution. The Court held that the defendant was bound.

Jervis CJ gave the judgment of the Court. I am of opinion that the judgment of the Court of Queen’s Bench ought to be affirmed. I incline to think that the question which has been principally argued both here and in that Court does not necessarily arise, and need not be determined. My impression is (though I will not state it as a fixed opinion) that the resolution set forth in the replication goes far enough to satisfy the requisites of the deed of settlement.

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 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 the Act of Parliament; but the resolution does not otherwise define the amount to be borrowed. That seems to me enough.

If that be so, the other question does not arise. But whether it is so or not we need not decide; for it seems to us that the plea, whether we consider it as a confession and avoidance or a special Non est factum, does not raise any objection to this advance as against the Company. Jervis C. J. gave the rationale for the decision thus: “We may now take for granted that the dealings with these companies are not like dealings with other partnerships, and that 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 appeared to be legitimately done”. In Mahony v. East Holyford Mining Co. dealing with the ostensible authority of de facto directors, Lord Hatherley explained the application of this rule clearly as follows: “when there are persons conducting the affairs of the company in a manner which appears to be perfectly consonant with the articles of association then those dealing with them, externally, are not to be affected by any irregularities which may take place in the internal management of the company” Thus, it was held in that case that a bank dealing with the company was entitled to accept cheques drawn and signed by the directors of the company in the manner authorized by the articles and the bank was not obliged to enquire whether the individuals signing the cheques were validly appointed as directors. This was further applied in the case of Freeman and Lockyer v. Burkhurst Park Properties (Mangal) Ltd. Here, the articles of the company contained power to appoint a managing director, but none was appointed. K, one of the directors, though never appointed as such, acted as managing director. He instructed the plaintiffs, a firm of architects, to do certain work for the company, which they did. The Court held that the company was bound to pay the architects’ fees even though K, was not formally appointed managing director.

The act of engaging architects was within the usual authority of a managing director of a property company and the plaintiffs did not have to inquire whether the person with whom they were dealing was properly appointed, it was sufficient for them that under the articles there was in fact power to appoint him and that the board of directors had allowed him to act as such. The rule in Turquand’s case has received statutory approval in Ghana, according to section 202 (6) of the companies code. The code provides that: “No person dealing with the company in good faith or registering any disposition of, or title to, property shall be concerned to see whether the conditions of section 202 (6) have been fulfilled and the provisions or sections 139 to 143 of this code shall apply to any transaction of the type referred to in this section notwithstanding that such conditions have not been fulfilled.

In pursuant to section 142, and subject to a couple of provision in limited instances, people dealing with a company or with anyone deriving title under the company shall be entitled to assume that, the company’s regulations have been duly complied with and for that matter every person described in the particulars filed with the registrar as director, managing director or secretary of the company, or represented by the company , acting through its members in general meeting, board of directors, or managing director, as an officer or agent of the company has been duly appointed and has authority to exercise the powers and performs the duties customarily exercised or perform in those capacities. Nevertheless, the rule in the turquand’s case cannot apply or rely upon in certain instances, that is, there are some exceptions to this case.

The exceptions includes Insiders (persons holding responsible positions within the company) cannot rely on the rule because they must be taken to know of the irregularity, where the person seeking to rely on the rule is himself aware, or has knowledge, of the irregularities, where the transaction is of such an unusual nature or by reason of some suspicious circumstances, that a person dealing with the officers of a company might reasonably be expected to make inquiries to assure himself that those with whom he is dealing are acting regularly and within the authority of the company, where the person seeking to rely on it was not aware of the contents of the memorandum and articles of association of the company, Where the transaction involves forgery or is a “non-genuine” transaction. The first instance or exception to the rule which will be considered under this discussion is when the matter involves insiders of the company. In this situation the insiders cannot rely on the rule for judgment.

Under this exception, a director or a purported director or someone so closely related to the company as to have been taken to know of the internal irregularity would not be allowed to rely on the rule. In Howard v. Patent Ivory Manufacturing Co. , debentures had been issued for an amount which under the articles required authorization by resolution of the general meeting. No such resolution had been passed. All the debenture holders who were directors of the company were not allowed to rely on the rule by the Court since they must be taken to have known that the internal requirements of the company had not been observed and the debentures were invalid. In Morris v.

Kanssen, C. whose appointment as director had ceased, and S. , who had never been appointed a director, purported to hold a board meeting and appoint M. a director. Then all three purported to allot shares to M. In this case M. sought to rely on the rule to validate his appointment and the allotment of shares to him. It was held that the rule would not apply since M. purported to act as a director in the transaction. Giving the rationale for this decision, Lord Simonds said: “It is a rule designed for the protection of those who are entitled to assume, just because they cannot know, that the person with whom they deal has the authority which he claims.

It is the duty of directors, and equally of those who purport to act as directors, to look after the affairs of the company, to see that it acts within its powers and that its transactions are regular and orderly. To admit in their favour a presumption that, that is rightly done which they have themselves wrongly done is to encourage ignorance and condone dereliction from duty” In a nutshell, we can see that, the rule of constructive notice was too harsh for third parties or people dealing with a company and imposes impossible burdens on them making business difficult to transact. For this reason, the indoor management rule was brought in to reduce the harshness of the rule of constructive notice.

The indoor management rule, also known as the rule in Royal British Bank vrs Turquand however has some exception to serve as a check and balances on some people who want to cover their bad conduct by relying on the rule for a favour in terms of judgment, especially in the case of matters involving insiders who are supposed to know what is going on within the internal affairs of the company. REFERENCES: Company and partnership Law by Ebenezer Osei Darko (Esq) Modern Practice Journal of Finance and Investment Law, Vol. 9 nos. 1-2, p. 70-87 Final Report of the Commission of Enquiry into the Working and Administration of the present Company Law of Ghana, p. l I

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