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Doctrine of Constructive Notice and Doctrine of Indoor Management in Company Law
Meaning of Company:
Section 2 (20) of Companies Act, 2013” “Company” means a company incorporated under this Act or under any previous company law.
The word “company” has no strictly technical or legal meaning. A body corporate or corporation includes a company incorporated outside India, but does not include a co-operative society registered under the law relating to co-operative societies, and any body corporate which the Central Government may, by notification, specify for this purpose.
“Company” is derived from two words: “com”- group and “panies”- bread. Therefore, it means group that eat their bread together.
A company is:
- an association or collection of individuals, whether natural persons, legal persons, or a mixture of both
- Company members share a common purpose and unite
- in order to focus their various talents and organize their collectively available skills or resources to achieve specific, declared goals
- not merely a legal institution
- a legal device for attainment of social (Section 25/8) or economic end and to a large extent publically and socially responsible
In common law, company is a “legal person” or “legal entity” separate from, and capable of surviving beyond the lives of, its members.
Characteristics of Company:
# Separate Legal Entity- Independent Legal Existence
# Limited Liability
# Perpetual Succession
# Separate Property
# Transferability of Shares
# Common Seal
# Capacity to sue and being sued
# Separate Management
Separate Legal Entity – Independent Legal Existence [S. 9]:
A company is, in law, a person. It is a distinct legal personaexisting independent of its members. By incorporation under the Act, the company is vested with a corporate personality which is distinct from the members who compose it. One of the effects of incorporation as stated in Section 9 is that upon the issue of the certificate of incorporation, the subscribers to memorandum and other persons, who may from time to time be members of the company, shall be body corporate capable forthwith of exercising all the functions of an incorporated company and having perpetual succession and common seal. Thus, the company becomes a body corporate which is capable immediately of functioning as an incorporated individual. The enterprise acquires its own entity. The entity of the enterprise becomes institutionalised.
Saloman v. Saloman & Co Ltd-
One Mr. Saloman was the owner of a business which he turned in to a limited liability company. The other members of the company were his wife and children. The total number of issued shares were 20,007 of which Saloman took 20,001 shares and his family members took the remaining six. Saloman also took mortgage debenture to the amount of pound 1000 in part payment for the business. Later on the company became insolvent. The trial judge and the court of appeal held that the creditors had the prior claim to the assets since the company was a mere sham. The House of Lords reversed this, holding that the company was in law a person distinct from Saloman and that, therefore, Saloman was preferentially entitled to the assets as the secured creditors. Saloman & Co Ltd was a real company fulfilling all the legal requirements. It must be treated as a company, as an entity consisting of certain corporators, but a distinct and independent corporation.
The principle has been recognized in India even before the Saloman Case. The decision of Calcutta High Court in Kondoli Tea Co Ltd seems to be the first on subject.
Kondoli Tea Co Ltd Case-
Certain persons transferred a tea estate to a company and claimed exemptions from ad valorem duty on the ground that they themselves were the share-holders in the company and therefore it was nothing but a transfer from them to themselves under another name. Rejecting this, the Court observed that “The Company was a separate person a separate body altogether from the shareholders and the transfer was as much a conveyance, a transfer of the property, as if the shareholders had been totally different persons”.
(1) Huge Financial Resources-
The company is the only medium of organizing business which is given the privilege of raising capital by public subscriptions either by way of shares or debentures. Further, public financial institutions lend their resources more willingly to companies than to other forms of business organization. The facility of borrowing and giving security by way of a floating charge is also an exclusive privilege of companies.
(2) Limited Liability-
The privilege of limiting liability for business debts is one of the principal advantages of doing business under the corporate form of organization. The company, being a separate person, is the owner of its assets and bound by its liabilities. Members, even as a whole, are neither the owners of the company’s undertaking, nor liable for its debt. Where the subscribers exercise the choice of registering the company with limited liability, the members’ liability becomes limited or restricted to the nominal value of the shares held by him.
(3) Perpetual Existence-
An incorporated company never dies. It is an entity with perpetual succession. A, B and C are the only members of a company, holding all its shares. Their shares may be transferred to, or inherited by X, Y and Z, who may, therefore, become the new members and managers of the company. But the company will remain the same entity.
Perpetual Existence means that the membership of a company may keep changing from time to time, but that does not affect the company’s continuity “in the like manner as the river Thames is still the same river, though the parts which compose it are changing every instant”. The death or insolvency of individual members does not, in any way, affect the corporate existence of the company. Such changes do not affect the continuity of the company or its commercial and contractual relations. Members may come and go but the company can go on forever.
(4) Transferability of Shares-
Section 44 of the Companies Act declares: “The shares or debentures or other interest of any member in a company shall be movable property, transferable in the manner provided by the articles of the company.” Thus, incorporation enables a member to sell his shares in the open market and to get back his investment without having to withdraw the money from the company. This provides liquidity to the investor and stability to the company.
(5) Professional Management-
The corporate sector is capable of attracting the growing cadre of professional managers. Young management graduates willingly join companies because of the feeling that they would thereby belong to a managerial class. Their independent functioning as managers is assured because of the fact that there is no human employer and the shareholders exercise only a formative control and that also for the sake of name only. Such an atmosphere of independence gives them an opportunity to develop extraordinary managerial capabilities.
(1) Lifting the corporate veil-
Circumstances may occur which compel the courts to identify a company with its members. There are situations where the court will lift the corporate veil of incorporation in order to examine the ‘realities’ which lay behind. Sometimes this may expressly authorised by statute and sometimes the court will lift of its own volition. A company cannot, for example, be convicted of conspiring with its sole director. Where the sole responsible person in the company is the defendant himself, it would not be right to say that there were two persons or two minds. The corporate veil is said to be lifted when the court ignores the company and concerns itself directly with the members or managers.
(2) Formality and expense-
Another disadvantage of incorporation is its expense and formality. Incorporation is a very expensive affair and requires a number of formalities to be compiled with. As compared with it, the formation of a partnership is very simple. Again, the administration of a company has to be carried on strictly in accordance with the provisions of the Act. General meetings must be held in time, accounts must be prepared and audited and then presented to the shareholders in general meetings; copies of accounts are to be filed with Registrar; mortgages and charges and certain resolutions have to be registered with the Registrar and in many other ways companies are under Government control and regulation.
(3) Company is not citizen-
Though company is a legal person, is not a citizen neither under the Constitution of India nor under the Citizenship Act.
State Trading Corpn of India Ltd v CTO-
It was held that neither the provisions of the Constitution of India, Part II, not of Citizenship Act, either confer the right of citizenship on, or recognize as citizen, any person other than a natural person.
If all the members are citizens of India the company does not become citizen of India.
Doctrine of Constructive Notice-
The memorandum and articles of association of every company are registered with the Registrar of Companies. The office of the Registrar is a public office and consequently the memorandum and articles become public documents. They are open and accessible to all. 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. But whether a person actually reads them or not, “he is to be in the same position as if he had read them”. He will be presumed to know the contents of those documents.
Another effect of this rule is that a person dealing with the company is “taken 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. Further, there is a constructive notice not merely of the memorandum and articles, but also of all the documents, such as special resolutions [S. 117] and particulars of charges [S. 77] which are required by the Act to be registered with the Registrar. But there is no notice of documents which are filed only for the sake of record, such as returns and accounts. According to Palmer, the principle applies only to the documents which affect the powers of the company.
The common law doctrine of constructive notice should apply to the form. To reiterate the form is a public document which contains particulars of directors who are the mind and will of a company, as well as managers and secretaries who are responsible for the day to day running of the company. It is a document which affects the powers of the company and its agents. Certainly, its purpose must be more than just to provide information about the company’s directors, managers and secretary. Therefore, persons dealing with company should check with the Registrar of Companies who its directors, mangers and secretaries are at given time.
Oakbank Oil Co. v. Crum
(1882 8 A.C.65)-
- It has been held that anyone dealing with the Company is presumed not only to have read the memorandum and Articles, but understood them properly.
- Thus, Memorandum and Articles of a company are presumed to be notice to the public.
- Such a notice is called ‘Constructive notice’.
MOA and AOA become public documents after registration of a Company.
It is taken for granted that everyone who deals with the company knows of these documents.
Legal effect: If a person’s deals with a company in a manner which is inconsistent with the provisions contained in MOA and AOA – own risk and cost and shall have to bear the consequences thereof.
Doctrine of Indoor Management-
The role of the doctrine of indoor management is opposed to that of the rule of constructive notice. The latter seeks to protect the company against the outsider; the former operates to protect outsiders against the company. The rule of constructive notice is confined to the external position of the company and, therefore, it follows that there is no notice as to how the company’s internal machinery is handled by its officers. If the contract is consistent with the public documents, the person contracting will not be prejudiced by irregularities that may beset the indoor working of the company.
Royal British Bank v. Turquand-
Turquand, a company, had a clause in its constitution that allowed the company to borrow money once it had been approved and passed by resolution (decision)of the shareholders at a general meeting. Turquand entered into a loan with the Royal British Bank and two of the co-directors signed and attached the company seal to the loan agreement. Loan had not been approved by the shareholders.
Company defaulted on their payments and the bank sought restitution. Company refused to repay claiming that the directors had no right to enter into such an arrangement
It was held that – the Turquand was entitled to assume that the resolution was passed.
The Company was therefore bound by the rule.
Doctrine is also popularly known as the ‘Turquand rule’.
Exceptions to the Doctrine of Indoor Management-
1. Knowledge of irregularity-
The first and the most obvious restriction is that the rule has no application where the party affected by an irregularity had actual notice of it. Knowledge of irregularity may arise from the fact that the person contracting was himself a party to the inside procedure.
Howard v Patent Ivory-
The directors could not defend the issue of debentures to themselves because they should have known that the extent to which they were lending money to the company required the assent of the general meeting which they had not obtained.
The principle is clear that a person who is himself a part of the internal machinery cannot take advantage of irregularities.
Doctrine of indoor management does not apply to forgery because forgery is void ab- initio.
Ruben v. Great Fingall Consolidated-
The plaintiff was the transferee of a share certificate issued under the seal of the defendant company. The certificate was issued by the company’s secretary, who had affixed the seal of the company and forged the signatures of two directors.
The plaintiff contended that whether the signatures were genuine or forged was a part of internal management and, therefore, the company should be estopped from denying genuineness of document. But it was held that the rule has never been extended to cover such a complete forgery.
Lord Loreburn said: “It is quite true that persons dealing with limited liability companies are not bound to inquire into their indoor management and will not be affected by irregularities of which they have no notice. But this doctrine, which is well established, applies to irregularities which otherwise might affect a genuine transaction. It cannot apply to a forgery.
3. Negligence on the part of the outsider-
Anand Bihari Lal vs. Dinshaw and Co
.- In this case the plaintiff accepted transfer of Company’s property from its accountant, the transfer was held void.