March 4, 2021

Doctrine of Constructive Notice: Concept, Effect and Exceptions

Companies Act

Introduction

A company has separate legal entity which can be formed by an association of individuals to with the intention to carry commercial activities to generate profit. The formation and functioning of the company are governed by certain laws, rule and regulations. The intention to behind the enactment of such laws is to provide protection to company, its management as well as the outsider person who is contractually engaging with the company. There are certain set of laws and the principles which provide safeguard to the company from the outsider person and vice versa. Companies use to resources in the country and generate revenues. So, companies constitute important role in the growth of the economy and hence, it becomes necessary to create the laws governing them. These laws operate as prevention to curb the unfair and wrong practices in the corporate world.

Doctrine Constructive Notice

When we study Company Law, one of the most important doctrines that come our way is the doctrine of Constructive Notice. The doctrine of Constructive Notice implies that the Article of Association is well-known by the outsider who seeks to hold any relation with the company in the near future because the Article of Association of the Company is a public document and is available to everyone according to Section 399 of the Companies Act, 2013.

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From the time when the company is registered, the Article of Association and the Memorandum of Association are considered as the ‘public document.’ They are open for inspection by anyone from the general public. It is therefore presumed that any person who is dealing with the company is well equipped by its rules and regulations.

The rule of constructive notice extends not merely to Memorandum and Articles but also to all the other documents which are required to be registered with the Registrar of Companies. But for the documents that are filed with the registrar of companies for the sake of records only, the doctrine of constructive notice doesn’t apply.

This English doctrine was initially applied to only cases of fraud but was soon thereafter extended to cases of gross negligence also.[1]

Constructive Notice and Actual Notice

Many times there is confusion between the two terms- Constructive Notice and Actual Notice. A person although may not have actual notice, but he may still have constructive notice. Actual notice is when knowledge of the incident or of any matter was in actually given to that particular person. Whereas on the other hand, constructive notice implies legal notice although an actual notice was never given. But it should be possible that the person would reasonably know about the proceeding under the given circumstance. For example, we often see legal notice being posted in newspapers, etc.

In a case, it was held that anyone who deals with the company is presumed to have not only read its Memorandum of Association and Artice of Association but also properly understood the real meaning of the provisions. Such notice is called Constructive Notice.[2]

Effect of the Doctrine of Constructive Notice

Under the doctrine of Constructive Notice, it is the outsider. It is burdened with a responsibility to know the documents that guide the company. He should be well aware of all the legal documents before he signs any deal with the company. It is also the responsibility of the third party to understand the real meaning of the provision and terms therein. The doctrine favours corporate bodies.

The Madras High Court discussed the scope of the rule of constructive liability in the case of Kotla Venkataswamy vs. Rammurthy [3].  The dispute in this case was whether the mortgage bonds was validly executed according to the company’s articles of association so as to make the company liable. Article 15, of the Company’s Articles of Association provides that all deeds, hundies, cheques, certificates and other instruments hall be signed by the Managing director, the Secretary and the working Director acting on behalf of the Company, and shall be considered valid.

In the instant case, the plaintiff accepted a deed of mortgage executed only by the secretary and an executive director. The court held that the plaintiff cannot claim under this deed. The Court further observed that if the plaintiff had consulted the articles, they would have discovered that a deed to carry out the work required by the three specified officers of the company such as they would have refrained from accepting a deed inadequately signed. Notwithstanding, therefore, she may have acted in good faith and her money have been applied to the purposes of the company, yet the bond is invalid.

However, the court had also developed a doctrine subsequently and held that although the third party should have notice of all the contents of the Memorandum and Article, they are not required to inspect the internal matters and see whether the company had complied with all the internal procedure.[4]

An Exception to The Doctrine of Constructive Notice: Doctrine of Indoor Management

The doctrine of indoor management is an exception to the doctrine of constructive notice and It is important to note that the doctrine of constructive notice does not allow outsiders to have report or notice of the internal affairs of the company. Therefore, if an act is authorized by a Memorandum or Articles of Association, then the outsider can assume that all detailed formalities are observed in carrying out the act and this is known as the Doctrine of Indoor Management or the Turquand Rule. This is based on a landmark case between The Royal British Bank vs Turquand. [5]

In simple terms, the doctrine of indoor management means that the company’s indoor affairs are the company’s problem. Therefore, this rule of indoor management is important for those people who are working with a company through its directors or other persons. They can assume that the members of the company are performing their acts or functions within the scope of their explicit authority. Hence, if an act which is valid under the Articles is done in a particular way, then the outsiders working with the company can assume that the director or other officers have worked under their authority.

PURPOSE OF THIS DOCTRINE- The business is a field which requires the protection of all the contracting parties and good business can only make sure the good development of the economy and commerce.  Though, apparently this doctrine is for the protection of the persons dealing with the company but it’s more important purpose it to promote the investments in business in order to keep the business and the economy going well.

As Justic Bray said in Dey v. Pullinger Engg Co.[6]:-

“The wheels of commerce would not go around smoothly if persons dealing with companies were compelled to investigate thoroughly the internal machinery of a company to see if something is not wrong.”

Exceptions To The Doctrine Of Indoor Management: –

The doctrine of indoor management is not unexceptionable in all the circumstance, rather, there are certain circumstances where this doctrine cannot and should not be applied. Like the establishment of the doctrine, these exceptions are also judicially established, which are as follows:-

1-Knowledge of Irregularity

The doctrine of indoor management can be no defense where the person dealing had the knowledge of the irregularity. This is the first and foremost restriction on the application of this doctrine. Meaning thereby that the presumption of irregularity cannot be relied upon by the “insiders” ie the persons who by virtue of there position in the company are in position to know whether or not internal regulation has been observed.

2-Suspicion of irregularity

As the words “in the absence of circumstances putting him on inquiry “were used in the Turquand case, so the advantages of this doctrine are not available to the person who had suspicion of irregularity as in this case he is obligated to satisfy himself of the legality of the transaction and all matters relating to it.

As in Anand Bihari Lal V. Dinshaw & Co, Air [7]the plaintiff accepted the transfer of company’s property from its accountant. The transfer was held to be void. The plaintiff could not have supposed, in the absence of power of attorney, that the accountant held power to transfer company’s property.

3-Forgery:-  Turquand’s rule does not to apply to forgery. It was clearly said in Ruben v. Great Fingall Consolidated [8]that 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 it cannot apply to a forgery. In this case the plaintiff was the transfree of a share certificate issued the defendant company. But this was issued by companay secretary who affixed the seal of company and froged the signature of two of the directors.

4-Representataion through articles

The Articles of association generally contain what is called the “power of delegation” In order to claim protection under this rule and under this kind of exception knowledge of Memorandam and Articles of Association is essential. A person who did not consult or act according to its provisions cannot be protected.

5-Act apperently out of the power of the officer of company:-

This exception of the “Turquand rule “is the one which can very easily be invoked. It is very clear that if the act of the officer of the company is such as is apparently out of his power it should not be relied upon and if relied upon the company cannot be held to be bound by the act.

A very clear description of this rule was given in Anand Behari Lal v. Dinshaw and Co. AIR where “the plaintiff accepted the transfer of company’s property by an accountant of the company which was apparently beyond the powers of an accountant and company was held not to be bound.[9]

Conclusion

The doctrine of Constructive notice is often quoted as an unreal doctrine. The reason behind this is that the doctrine is created by courts through judicial pronouncements and is an imaginary doctrine. A number of contracts take place between the outsider and the company in a day. The doctrine lays a duty on each and every outsider to have a notice of all the legal documents of the company. This is done for the smooth and effective functioning of the corporate world.

From the time the doctrine was established, it has been evolved greatly, and we saw the emergence of another important doctrine, that is the doctrine of Indoor Management. It implies that all the internal functioning of the company remains its private matter, and the outsider need not inquire as to whether the company is functioning according to its Memorandum and Article.

The doctrine of Constructive notice is often quoted as an unreal doctrine and the reason behind this is that the doctrine is created by the courts through judicial pronouncements and it is an imaginary doctrine. The outsider and the company have several contracts a day. The doctrine lays a duty on each and every outsider to have a notice of all the legal documents of the company and this is done for the smooth and effective functioning of the corporate world.

The rule of constructive liability is an unrealistic doctrine and this doctrine requires each and every outsider not only to know the company’s documents but also presume to understand the exact nature of documents, which is practically not possible. And In reality, the company is not known by the documents but by the people who represent it and deal with an outsider.

The outsiders do the business and enter into contracts not always on the basis of company documents but on the goodwill and the reputation of the directors or officers who are representing the company. This is the reason why the courts have developed the doctrine of indoor management as an opposite to the doctrine of constructive notice in order to protect the interests of the outsiders.

Companies enter into several kinds of contracts and transactions with different persons.  The laws regulating the companies have never been able to cover each and every aspect of the companies workings and the judiciary has always helped through precedents, examples of this help by the courts of law are the creation of the “Doctrine of Constructive Notice” and the “Doctrine of Indoor management.”

The former one is for the protection of the companies from outside stakeholders and has always been very helpful for the companies while as the interests of the investors are also necessary to be protected the “doctrine of indoor management” was introduced. These two doctrines act to balance the protection of company as well as outside stakeholders.

                                                                                                 


[1] West v. Reid (1843) 2 Hare 249

[2] Oakbank Oil Co. v. Crum (1882) 8 A.C. 65.

[3] AIR 1934 Mad 579

[4] Royal British bank v. Turquand (1856) 6 E&B 327

[5] (1856) 6 E&B 327

[6] (1921) 1 KB 77

[7] 1942 Oudh 417

[8] (1906) AC 439

[9] 1942 Oudh 417


Author Details: Harshita Raj

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