Analyzing the Common Law and Statutory Indoor Management Rule with Reference to Corporations Act and Case Law

Indoor management rule and Constructive notice

Critically Analyse and Contrast the Common Law and Statutory Indoor Management Rule with Reference to Appropriate Sections of the Corporations Act (2001) and Case Law.

The indoor management rule was discussed for the first time by the court in Turquand's case (Royal British Bank v Turquand, 1856) and it deals with the doctrine of constructive notice. It can be said that the indoor management rule conflicts with the doctrine of constructive notice. The doctrine of constructive notice makes an attempt to protect the corporation from the outsiders (Baxt, 1991). On the other hand, the purpose behind the introduction of the indoor management rule was to protect the outsiders while they enter into the contracts with the corporations. For this purpose, it has been mentioned by the indoor management rule that when a person is dealing with a corporation, and has made sure that the proposed transaction is not in any way inconsistent with the memorandum/articles of incorporation, such a person does not have the legal obligation of making inquiries that the internal procedures of the corporations have been followed in such a case. In this way, the effect of the indoor management rule is that while translating with a corporation, it can be assumed by the outsiders, that the officers of the corporation have fulfilled the requirements prescribed by the articles of incorporation (Baxt, 1997). The result is that it is not the obligation of the outsiders to make inquiries if the internal rules of procedure have been fulfilled by the corporation while transacting with the outsiders (Baxt, 1991). 

As mentioned above, the indoor management rule was applied by the court for the first time in Royal Bank v Turquand (1856). Before proceeding further, it will be helpful to briefly describe the facts of this case. In this case, according to the articles of incorporation, the directors have been authorized to borrow on bonds, the sums that have been authorized by passing a special resolution by the corporation in its meetings. In this case, a bond that has been signed by two directors and the secretary of the corporation, under the seal of the corporation, was given by the directors, to the plaintiff for the purpose of securing the drawings on current account but in this case, the above-mentioned special resolution has not been passed by the corporation. These were the circumstances when Turquand tried to bind the company in accordance with his bond. The issue that had to be decided by the court in this case was in the corporation can be held liable for the bond. However in its decision, all the objections were set aside by the court and according to the decision delivered by the court, the bond was binding on the corporation. In support of its decision, the court stated that it can be assumed by Turquand that the resolution has been passed by the general meeting of the company, as required. 

Application of Indoor management rule

In view of this decision, it can be said that the effect of the indoor management rule is that when the outsiders are entering into transactions with a corporation in good faith, it can be assumed by then that such an act falls within the powers and the Constitution of the corporation and it can also be assumed that it has been properly and duly performed (Austin, 1988). Therefore, in such a case, there is no legal obligation on the outsiders to make inquiries in all the acts required by the internal procedures of the company has been validly executed or not. This is the principle that has been provided in the indoor management rule. As mentioned above, the purpose behind the introduction of the indoor management rule is to provide protection to the outsiders while transacting with the corporation as in such a case, they are entitled to assume that the person with whom they are transacting, enjoys the authority as claimed by such a person as it is not possible for the outsiders to know (Cain, 1990). 

However there are certain exceptions present to the application of the indoor management rule. For instances, the indoor management rule will not be applicable in the cases where the outsider knows that there are certain regularities related with the internal procedure of the corporation (Carroll, 1995). Similarly, the protection provided by the indoor management rule will not be available if the circumstances of the transaction are such that the outsider would have been put to inquiry. Such circumstances are considered to be present when any of the reasonable person would have become suspicious that there may be some irregularity related with the internal procedure of the corporation and therefore, further inquiries would have been made by such a person. It has also been provided by the law that a corporation cannot use the indoor management rule for its own benefit as rule only provides protection to the outsiders while transacting with the corporation (Austin R, 1985).

The rule of indoor management has been further clarified by the court in Mahony v. East Holyford Mining Co (1874) where the court made efforts to further explain the Turquand's rule. In this way, this case also acts as an example of the case where qualifications to the general rule have been prescribed by the court. In this case, the payments were given by Bank of the company on the supply of the formal resolution passed by the board of the company according to which, the bank was authorized to pay the cheques that have been signed by two out of the three directors of the corporation and also countersigned by the company secretary. In this case, the copy was signed by the company secretary. But later on it was discovered that the director and the company secretary have not been formally appointed to their posts. It has been mentioned in the articles of incorporation that the directors are required to be nominated by the subscribers to the memorandum and the cheques were also required to be signed in a way that has been decided by the board of the company. In view of the circumstances, it was the decision of the House of Lords that a formal notice has been received by the bank in the ordinary way related with the decision of the board and there was no obligation on the part of the bank to make further inquiries.

Exceptions to Indoor management rule

The role of indoor management has also been incorporated in the Corporations Act, 2001 although certain modifications have been made to the rule. Therefore even if the coverage of the provisions of the Corporation Act overlaps with the principles of general law, however they are not the same in their effect and the coverage. The result is that the provisions of the Corporations Act do not replace the provisions of general law in this regard. In order to deal with such a situation, a number of assumptions have been provided by the Corporation Act that the outsiders are entitled to make when they are transacting with the corporation (Duong, 1996). The statutory provisions that are equivalent to the role of indoor management are present in section 128, 129 of the Corporation Act. At this point, it is also worth mentioning that certain exceptions also to the application of this rule. Therefore, when a person is transacting with a corporation and those regarding the irregularity concerning the procedure of internal management of the corporation, the assumptions provided by the indoor management tool are not available to such a person.

Therefore, when a person has knowledge that the internal rules of procedure have not been followed, the protection provided by this rule is not available to such a person. The reason is that inside is it is the responsibility of the person to take steps for protecting himself. In this regard, if the person is a party to the internal procedure, for example a director of the corporation it is considered that the person has knowledge regarding the irregularity. Another limitation that has been imposed on the application of this rule is related with the negligence of the outsiders. The protection is not available to the outsiders if the outsider could have easily discovered the irregularity in the internal procedure by making reasonable inquiries. In this way, if the circumstances that are related with the transaction are suspicious, and consequently, further inquiries have to be made, the protection of the indoor management rule is not available to the outsiders. Similarly, the outsiders cannot take the benefit of indoor management tool if the document on which they are going to rely upon is forged. The reason behind this position is that the rule is applicable only where there has been any irregularity regarding the internal procedures of the corporation and which will have an impact on a genuine transaction. Therefore, in case of a forgery, indoor management rule will not be applicable.

References

Austin R, (1985) ‘Constructive Trusts’ in P Finn (ed) Essays in Equity, Sydney: Law Book Company

Austin RP, (1988) ‘The Melting Down of the Remedial Trust’, 11 New South Wales Law Journal 66

Baxt R, (1991) ‘Company Law Reform – The Future and Fixing Up the Past – The Doctrine of Ultra Vires’, 19 Australian Business Law Review 147

Baxt R, (1991) ‘Ultra Vires – Has it Been Revived?’, 1 Company and Securities Law Journal 101

Baxt R, (1997) ‘Should Third Parties Have to Inquire About the Ability of Directors to bind Their Company?’ 15 Company and Securities Law Journal 434

Cain T, (1990) ‘The Rule in Royal British Bank v Turquand in 1990’, 2 Bond Law Review 152

Carroll R, (1995) ‘Proper Performance of Duties by Company Officers: The Statutory Assumption in s 164(3)(f)’ 69 Australian Law Journal 200

Duong J, (1996) ‘Ought to Have Known it Was Put on Inquiry: Section 164(4)(b) of the Corporations Law’ 7 Journal of Banking and Finance Law and Practice 245

Case Law

Royal British Bank v Turquand (1856) 6 EL & BL 327

Mahony v East Holyford Mining Co (1874-75), LR 7 HL 869