The doctrine of Constructive Notice

The doctrine of Constructive Notice

Author : Gaurav Dua

 

The law recognises a company as an artificial person, which means it has been given some status of a legal person. It is governed by its own constitution and framework which lays down the powers, objectives and functions of the company along with the nature of its business. The set of these documents are called the memorandum and articles of association. Since a company needs to get these document registered to gets its incorporation certificate, they are public documents which are accessible to the people either without any costs or on payment of a nominal amount. A person dealing with the company is duty bound to read, understand and inspect these documents to ensure that its contract is in congruence with the provisions of the company. The person is deemed to have understood the documents as per the meaning in the manner they are to be interpreted. This includes an understanding of the powers of the company, its directors, officers and the extent of those powers. This assumption that the person dealing with the company has the notice of the contents of the Memorandum and Articles, is known as the doctrine of constructive Notice.

 

Consequently, if a person enters into a contract which was against the Memorandum, or beyond the powers which have been conferred on the directors in the Articles of Association, then the contract is void and cannot be enforced by the person even if he/she had acted in good faith and the money was utilised to achieve the objective of the company, as given in its Memorandum.

 

The doctrine of Constructive Notice The doctrine of Indoor Management
Provides protection to the company from outsiders Provides protection to outsiders from the internal affairs of a company
Confined to the external position and affairs of the company Confined to internal matters of the company
Memorandum and Articles of Association are public documents Internal affairs of a company are not public knowledge i.e. not registered anywhere
Is based on a negative concept Can be termed as a positive concept

 

Case Laws

The leading case on this is that of Kotla Venkataswamy v. China Ramamurthy.

In this, the Articles of Association of the company made it mandatory for all the deeds to be signed by the managing director, the secretary and a working director on behalf of the company. The secretary and the working directory of the company signed a mortgage deed which was executed in the favour of the plaintiff. At a later date, the company opted for voluntary liquidation and sold the mortgaged property to the defendant. The plaintiff then approached the court.

The court in its decision upheld the sale of the mortgaged property. The reason given by the court was that the Articles of Association of the company specifically asked for the signature of four officers of the company, and this was public knowledge. But since the plaintiff didn’t act prudently and dodged its duty to read the documents, the doctrine of constructive notice will apply and the mortgage deed will be considered as an incomplete document.

 

Rama Corporation v. Proved Tin and General Investment Co. (1952)

The director of the plaintiff company formed an agreement with the director defendant company which would enable them to subscribe funds which they can use to finance the sale of goods produced by a third company. The director of the plaintiff company gave a cheque to the defendant company. But as per the articles of association of the defendant company only a director to whom the power of the board has been delegated, can collect a cheque on the behalf of the company. The plaintiff hadn’t read the defendant’s articles and was unaware of this clause.
In the decision of the court applied the doctrine of constructive notice and the defendant company was held not bound by the agreement.

 

The doctrine of Indoor Management

The Doctrine of indoor management came from the case of Royal British Bank v Turquand.

Today the doctrine of indoor management has evolved into what can be referred to as a partial exception to the doctrine of constructive notice.

In the case of Royal British Bank v. Turquand (1856), the directors of the company had borrowed money by issuing a bond. The articles of association of the company, authorised them to do so subject a special resolution which had to be passed in this regard. But the company failed to pass such a resolution. The court held that though the company didn’t act as per its Articles of Association, it will still be held liable to pay off the debts incurred by it through previously issued bond and the bank will assume that the company had passed the special resolution as per its articles. This is because outsiders cannot be made to bear the burden of the company’s defiance.

 

In other words, if the articles of a company gives certain powers to its directors along with the power to bind the company through their authority, but certain formalities are to be completed first on the part of the company before the directors can duly exercise their power, then the person dealing with the directors will presume that all the formalities have been complied with and the directors have acted lawfully.

 

What was the reason for the emergence of this doctrine?

As the time changes so does the society, and a changing society attracts with it complexities in the domains of economy, development, infrastructure and law. The objective of framing a law is to solve the disputes which may arise in the future but no law can be foolproof, a lawmaker cannot be expected to be so far-sighted that they prepare for each and every problem which I am encountered in the future. It is because of this reason judicial law came into existence. In the case of Royal British Bank v. Turquand the judiciary saw the gap in the legislation, this gap was filled through the doctrine of indoor management. The judge in its verdict stated an outsider cannot be expected to know what happens behind the closed doors of the company, in such a case man no matter how prudent cannot have knowledge of information which hasn’t been public yet. An outsider will only come to know about the internal proceedings of a company when the same is delivered to him/her, but in the absence of such conveyance, the outsider cannot be made to suffer. The doctrine of indoor management thus provides protection to the outsiders from what happens in the internal proceedings of the company.

 

Case law

Freeman and Lockyer v. Buckhurst Park Properties Ltd. (1964)

The defendant company dealt with the purchase and sale of land. The company was founded by A & B who nominated a director each and together four of them formed the Board of Directors. As per the Articles of Association of the company the board was to nominate a name from the board itself, for the position of a Managing Director. The board failed to do so and A started acting as the Managing Director of the company. Subsequently, the company hired the plaintiff company for architectural and surveying services. Plaintiff firm after the completion of their services asked for their fees but the defendant firm denied because of its omission to appoint a Managing Director.
The court relied on the decision of Royal British Bank v. Turquand and held that the defendant company was liable to pay the plaintiff firm for their services as they cannot make to suffer because of the irregularity which took place in the management of the company.

 

Exceptions

However, there are certain exceptions to this doctrine; a person cannot be benefited from the doctrine of indoor management in the following circumstances:

 

  • when the person has actual knowledge or constructive notice of any irregularity in the internal proceedings of the company

 

  • when the person dealing with the company was negligent and,  the irregularities could have been discovered through enquiries had he acted in a prudent manner;

This can be better understood from the case of Anand Bihari Lal v. Dinshaw & Co. (1946) Here, the plaintiff bought a property from the defendant through their accountant without enquiring whether the accountant had power of attorney or not. The accountant had acted beyond the scope of its authority and the same could have come to the notice of the plaintiff if he had acted prudently. As a result, the court held that the transfer was void.

 

  • when the person dealing with the company banks upon a forged document or  when the company performs an act which is void;

 

  • when the person enters into a contract with an agent or officer of the company who acts beyond the power and authority granted to it.

 

Conclusion

Thus, I’d say that the doctrine of constructive notice and indoor management are complementary to each other. The importance of the doctrine of constructive notice is that it protects the company from the outsiders, and the importance of the doctrine of indoor management lies in the fact that it offers protection to the outsiders while dealing with the affairs of the company. The doctrine of constructive notice comes into the picture when an outsider fails to inquire about the company whereas the doctrine of indoor management can be invoked by any outsider dealing with the company.