Copy Corporate

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Articles of Association

1

Corporate Law-I


Submitted by :-

Suparna Sinha

Roll No. 68

3rd year, B.A.,LL.B.

(Hons)

Jamia Millia Islamia

Submitted to:-

Mr. Qazi Mohd. Usman

Assistant Professor,

Faculty of Law,



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Of a Company

Submitted to:-

Mr. Qazi Mohd. Usman

Assistant Professor,

Faculty of Law,


Submitted by :-

Suparna Sinha

Roll No. 68

3rd year, B.A.,LL.B.

(Hons)



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Acknowledgement

I would like to express my special thanks of gratitude to my professor,

Mr. Qazi Mohd. Usman, who gave me the golden opportunity to do

this wonderful project on the topic Articles of Association which alsohelped me in doing a lot of Research and I came to know about so

many new things. I am really thankful to him.

I would also like to thank the faculty members of Faculty of Law, Jamia

Millia Islamia for providing with the books, materials, prints etc

needed from time to time by me to make this project a reality.

I would also like to thank my parents and friends who helped me a lot

in finishing this project within the limited time.

I have gained immense knowledge about the topic while doing this

project.

THANKS AGAIN TO ALL WHO HELPED ME.

Suparna Sinha


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Table of Contents

Table of casesv-vi

Company1

Articles of association4

The obligation to register articles...................................................8

Contents of articles..........................................................................9

Alteration of articles.12

Limitations regarding alteration of articles..................................13

Binding force of memorandum and articles18

Company is bound to its members.................................................18

Each member is bound to the company........................................19

Each member is bound to other

member in exceptional case only..................................................20

Neither the company nor the members

are bound to outsiders....................................................................21

Constructive notice of memorandum and articles...23

The doctrine of indoor management....24

Origin of the doctrine..25


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Exceptions to the doctrine of indoor management..28

Application of the rule by the Indian courts.....34

Conclusion.37

Distinction between memorandum and articles...39

Bibliography...41


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Table of Cases

All India Railwaymens Benefit Fundsv. Bareshwar Nath, I.L.R. (1945) Nag 599. Allenv. The Gold Reefs of West Africa Ltd. (1900), Ch. 656. Anand Bihari Lalv. Dinshaw and Co., AIR 1942 Oudh 417. Andrewsv. Gas Meter Co., (1897) 1 Ch. 361. Ashbury Railway Carriage Co. v. Riche, (1875), L.R. 7 H.L. 653, p. 670 Beattiev. Beattie, (1938), Ch. 708. Boreland Trusteesv. Steel Brothers & Co. Ltd., (1901), 1 Ch. 279. Brownv. British Abrasive Wheel Co., (1919), Ch. 290. Burlandv. Earle, (1902), A.C. 83. C.Chettiarv. Krishna Aiyanger, ILR 33, Mad 36. County of Gloucester Bankv. Rudry Methyr & Co., (1895), 1 Ch. 629. Devi Ditta MalvThe Standard Bank of India, [1927] 101 IC 558 Duraiswamiv. UIL Association Co., AIR (1960) Mad. 316. Eleyv. Positive Government Life Insurance Co. Ltd., (1876), 1 Ex. D. 88. Guinenessv. Land Corporation of Ireland,(1882), 22 Ch. D. 349. Hari Chandrav. Hindustan Insurance Society, AIR (1925) Cal. 690 Hely-HutchinsonvBrayhead Ltd., [1968]38 comp.Cas 228m (CA). Houghton & Co. v. Nothard Lowe & Wills, (1928), A.C. 1. Howardv. Patent Ivory Manufacturing Co., [1888] 38 Ch. D. 156 Johnsonv. Lyttles Iron Agency, (1877), 6 Ch. 687. Lakshmi Ratan Cotton Mills Co. Ltd, v.J. K. Jute Mitts Co. Ltd, AIR 1957 All 311. Mahonyv. East Holyford Mining Co. East Holyford Mining Co., (1875) 7 HL 869. Menierv. Hooper Telegraph Works,(1874), 9 Ch. App. 350. MorrisvKansseen, [1946] 16 comp. Cas 186 ( HL) Official Liquidator, Manasube & Co. (P.) Ltd. V. Commissioner of police,

[1968]38 Comp. cas 884 (Mad)


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Pacific Coast Coal Mines Ltd. v. Arbuthnot, (1917) 1 Ch. 607. Penderv. Lushington, (1877), 6 Ch. D. 70. Re New British Iron Co., (1898) 1 Ch. 324. Re Perevil Gold Mines Ltd., (1889), 1 Ch. 122. Re Rotherham Alum & Co., (1883) 25 D. 103. Re Tavarone Mining Co. ,(1873), 8 Ch. App. 956. Royal British Bankv. Turquand, [1856] 6 E. & B. 327 Rubenv. Great Fingall Consolidates, [1906] A.C. 439 Shri Kishanv. Mondal Bros. & Co., AIR 1967 Cal 75. Sidebottomv. Kershaw, Leese & Co., (1920), 1 Ch. 154. The Dhakeshwari Cotton Mills Ltd. v. Nilkamal, AIR 1937 Cal 645. Varkey Souriarv. Keraleeya Banking Co. Ltd., AIR 1957 Ker 97. Weltonv. Saffery, (1897), A.C. 299, 315.


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COMPANY

Literally the word company means a group of persons associated

for any common object such as business, charity, sports and research,

etc. Almost every partnership firm having two or more partners may,

therefore, style itself a company. But in legal sense company means

which are incorporated or registered under the Companies Act, 1956.

Section 3(1)(i) and (ii) of the Companies Act, 1956 define a company

as a company former and registered under this Act or an existing

company. An existing company means a company formed and registered

under any of the former Companies Acts

The above definition does not reveal the distinctive characteristics

of a company. Perhaps the clearest description of a company is given by

Lord Justice Lindley: By a company is meant an association of many

persons who contribute money or moneys worth to a common stock

employ it in some trade or business, and who share the profit and loss

(as the case may be) arising there from. The common stock so

contributed is denoted in money and is the capital of the company. The

persons who contribute it, or to whom it belongs, are members. The

proportion of capital to which each member is entitled to is his share.

Shares are always transferable although the right to transfer them is

more often more or less restricted.

A more comprehensive legal definition of a company giving its main

essentials has been given by Haney: A company is an incorporated


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association, which is an artificial person created by law, having a

separated legal entity, with a perpetual succession and a common seal.

A company, thus, may be defined as an incorporated association

which is an artificial person, having separate legal entity, with a

perpetual succession, a common seal, a common capital comprised

of transferable shares and carrying limited liability.

Characteristics of a company are therefore:

1. Incorporated association.2. Artificial legal person.3. Separate legal entity.4. Perpetual existence.5. Common seal.6. Limited liability.7.Transferability of shares.

By convention, in India the documents ofcompanies into two separate

documents

the Memorandum of Association is the primary document, andwill generally regulate the company's activities with the outside

world, such as the company's objects and powers.

the Articles of Association is the secondary document, and willgenerally regulate the company's internal affairs and management,such as procedures for board meetings, dividend entitlements etc.
http://en.wikipedia.org/wiki/Company_%28law%29http://en.wikipedia.org/wiki/Memorandum_of_Associationhttp://en.wikipedia.org/wiki/Memorandum_of_Associationhttp://en.wikipedia.org/wiki/Articles_of_Association_%28law%29http://en.wikipedia.org/wiki/Articles_of_Association_%28law%29http://en.wikipedia.org/wiki/Board_of_directorshttp://en.wikipedia.org/wiki/Dividendhttp://en.wikipedia.org/wiki/Dividendhttp://en.wikipedia.org/wiki/Board_of_directorshttp://en.wikipedia.org/wiki/Articles_of_Association_%28law%29http://en.wikipedia.org/wiki/Memorandum_of_Associationhttp://en.wikipedia.org/wiki/Company_%28law%29


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In many countries, only the primary document is filed, and the

secondary document remains private. In other countries, both

documents are filed.

It is quite common for members of a company to supplement the

corporate constitution with additional arrangements, such as

shareholders' agreements, whereby they agree to exercise their

membership rights in a certain way. Conceptually a shareholders'

agreement fulfills many of the same functions as the corporate

constitution, but because it is a contract, it will not normally bind new

members of the company unless they accede to it somehow. One benefitof shareholders' agreement is that they will usually be confidential, as

most jurisdictions do not require shareholders' agreements to be publicly

filed.
http://en.wikipedia.org/wiki/Shareholders%27_agreementhttp://en.wikipedia.org/wiki/Shareholders%27_agreement


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Articles of Association are the internal regulations of the company and

are the benefit of the shareholder. To quote Lord Cairns again The

memorandum is, as it were, the area beyond which the actions of the

company cannot go; inside that area the shareholder may make suchregulations for their own management as they think fit in the form of the

Articles ofAssociation.

Therefore, it is an official document governing the running of a

company that is placed with the Registrar of Companies. The articles of

association constitute a contract between the company and its members,

set out the voting rights of stockholders and the conduct of stockholders'and directors' meetings, and detail the powers of management of the

company. A memorandum of association is a related document.

The Articles of Association contain, as per the law requires,

provisions on the company name, address and domicile, the purpose of

the company, the amount of share capital and the contributions made

thereto, the number, the par value and the type of shares, the calling of ageneral meeting of shareholders and the voting rights of them, the bodies

for the administration and the audit, and the form in which the company

shall publish notices. The Articles of Association contain the rules and

regulations of the internal management of the company. The articles of

association is nothing but a contract between the company and its

members and also between the members themselves that they shall

abide by the rules and regulations of internal management of the

company specified in the articles of association. It specifies the rights

and duties of the members and directors.


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The important items covered by the articles of association include:-

1. Powers, duties, rights and liabilities of Directors

2. Powers, duties, rights and liabilities of members

3. Rules for Meetings of the Company

4. Dividends

5. Borrowing powers of the company

6. Calls on shares

7. Transfer & transmission of shares

8. Forfeiture of shares

9. Voting powers of members, etc.


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The Obligation to Register Articles

Section 26 states that public company limited by shared may

register articles, while a company limited by guarantee or an unlimited

company or a private company limited by shares must register articles

along with the memorandum at the time of registration. In other words it

is optional for the public company limited by shares to register articles,

whereas other types of companies are required to do so compulsorily.

There arises a question as to what happens if a public company limited

by shares does not register any articles. The answer to this question is

provided in Section 28(2) which states that if a public company limited

by shares does not register any articles. Table A (the model set of 99

articles given in Schedule I) shall automatically apply to such company.

Even if such a company registers its own articles, Table A will still

apply automatically on all such points on which the said articles are

silent, unless its regulations have expressly been excluded by the

company in its articles. Companies, other than a public company have to

register articles compulsorily because they cannot adopt Table A in its

entirety but in this case also the regulations of Table A will, so far as

they are applicable, apply automatically on all such points on which their

own articles are silent, unless their own articles expressly exclude those

regulation.

The Articles of Association shall be:

(a)Printed(b)Divided into paragraphs numbered consecutively, and(c)Signed by each signatory of the memorandum in the presence of at

least one attesting witness (Section 30).


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Contents of Articles

Articles usually deal with the rules and bye-laws on matters like:

1.The extent to which Table A is applicable.2.Different classes of shares and their rights.3.Procedure of making an issue of share capital and allotment

thereof.

4.Procedure of issuing share certificates and share warrants.5.Forfeiture of shares and the procedure of their re-issue.6.Procedure for transfer and transmission of shares.7.

The time lag in between calls on shares.

8.Conversion of shares into stock.9.Lien on shares.10.Payment of commission on shares and debentures to

underwriters,

11.Rules for adoption for preliminary contracts if any.12.Re-organization and consolidation of share capital.13.Alteration of share capital.14.Borrowing powers of director.15.General meetings, proxies and polls.16.Voting rights of members.17.Payment of dividends and creation of reserves.18.Appointment, powers, duties, qualifications and remuneration of

directors.

19.Use of the Common Seal of the company.20.Keeping of books of accounts and their audit.21.Appointment, powers, duties, remuneration, etc. of auditors.22.Capitalization of profits.


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23.Board meetings and procedures thereof.24.Rules as to resolution.25.Appointment, powers, duties, remuneration, etc. of managing

director, manager and secretary, if any.26.Arbitrations provisions, if any.27.Provisions for such powers which cannot be exercised without the

authority of articles, for example,

a) the issue of redeemable preference shares;b) issuing shares warrants to bearers;c) refusing to register or transfer of shares;d) reducing share capital of the company;e) accepting payment of Calls in advance;f) the appointment of additional or alternate director(s).

28.Winding up.In addition to the above matters, the articles of an unlimited

company should state the number of members with which the

company is to be registered and if it has share capital, the amount of

share capital with which it is to be registered [Section 27(1)].

In the case of a company limited by guarantee, the articles must

state the number of members with which the company is to be

registered [Section 27(2)].

The articles of a private company having share capital must

contain the four restrictions as given by Section 3(1)(iii) under sub-

clauses (a), (b), (c) and (d), namely:

(a)Restriction on the right of members to transfer shares;


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(b)Limitation of the number of its member to fifty, excluding memberswho are or were in the employment of the company; joint holders of

shares to be treated as single members;

(c)Prohibition of any invitation to the public to subscribe for anyshares in, or debentures of, the company; and

(d)Prohibition of acceptance of deposits from the public.In the case of private company not having a share capital, the

articles must contain provisions relating to the matters specified in

the above mentioned sub-clauses (b), (c) and (d) only. [Section

27(3)].

It must, however, be remembered that articles should not contain

anything which is against the law of the land, the Companies Act,

the public policy and ultra vires the memorandum. Any such

clauses shall be inoperative and void.


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Limitations Regarding Alteration of Articles

(1)The alteration must not be inconsistent with the provisions ofthe Companies Act or any other statute (Section 31). Thus a

company cannot alter its articles so as to exclude or limit the rights

of its shareholders to present a petition for the winding up of the

company, because this right is conferred by Section 439. To cite

another example, the alteration cannot be made so as to increase

the liability of any member without his written consent, for, it shall

be contrary to Section 38 of the Act. However, it is possible that the

articles may impose on the company conditions stricter than those

provided under the law, for example, they may provide that a

resolution should be passed by a special majority when the Act

required to be passed by an ordinary majority. Similarly, the

articles may provide that all the directors would be liable to retire

by rotation when the Act provide that in case of a private company

all the directors can be permanent and in case of a public company

one-third of the total number of directors can be permanent.

(2)The alteration must not be inconsistent with the conditionscontained in the memorandum. (Section 31). The articles are

subject to the memorandum and so must not over-ride the

memorandum. As such they cannot be altered so as to give powers

which are not given by the memorandum.

(3)The alteration must not be inconsistent with the alterationordered by the Company Law Board. In the exercise of its powers

to remedy oppression and mismanagement under Sections 397


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and 398, the Company Law Board has power to alter the companys

memorandum and articles in any way it thinks fit. When the

company Law Board has amended the memorandum or articles,

the company can make no alteration which is inconsistent with theCompany Law Boards order without the permission of the

Company Law Board. (Section 404).

(4)Approval of Central Government must also be taken in certaincases. Forexample, in the following cases alteration made in the

articles shall be valid and operative only if such alteration has also

been approved by the Central Government:

(a)If the alteration results in the conversion of a public companyinto private company (Section 31).

(b)In the case of a public company, if alteration related to anyprovision regarding the appointment or re-appointment of a

managing or whole-time director or of a director not liable to

retire by rotation, and the proposed alteration is not in

accordance with the conditions specified in Schedule XIII in that

regard. (Section 268 read with Schedule XIII).

(c)In the case of a public company, if alteration results in anincrease of remuneration to a director including a managing or

whole-time director beyond the limits prescribed in Schedule

XIII. (Section 310 read with Schedule XIII)

Where the alteration has been approved by the Government,

printed copy of the Articles altered shall be filed by the company

with the registrar within one month of the date of receipt of order of

approval.


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(5)The alteration must not deprive any person of his rights undera contract. Alteration should not destroy any of the rights

possessed by any person by virtue of a contract. In Allen v. The

Gold Reefs of West Africa Ltd.5

Lord Lindley observed Thusa person appointed in accordance with the provisions of the articles

as a director on a fixed remuneration of Rs. 2,000/- per month

under an independent contract of service, cannot be made to

accept lesser amount by altering the articles. It is to be observed,

however, that in case a person accepts the appointment purely on

the terms of the articles, the alteration shall be valid and binding

upon such a person. For example, in C.Chettiar v. Krishna

Aiyanger6, the articles provided `250 per month as pay for the

companys secretary. The post was accepted by the plaintiff and in

the specific agreement with him the articles were referred to show

the terms of the contract. Late on the company changed the articles

and reduced the secretarys pay to `25 per month. The alteration

was held to be valid and operative. It was stated that any one

accepting an appointment purely on the terms of the articles takes

the risk of those terms being altered.

The facts of Hari Chandra v. Hindustan Insurance Society7 also

involved a situation of this kind. In this case the plaintiff had taken

out a policy of life insurance in the defendants company. Under the

Policy the plaintiff was entitled to draw from the company certain

sum on a certain date. Later the company altered its articles to theeffect that such withdrawals of money could be made only out of

special fund. At the time the amount became payable to be

5(1900) 1 Ch. 656.

6ILR 33, Mad 36.

7AIR (1925) Cal. 690.


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assured, there was no money in the special fund. The plaintiff sued

for his payment under the original contract. Held that the

alteration of articles was not valid because it involved a

fundamental breach of contract which the company had previouslyentered into with the plaintiff.

(6)The alteration must not constitute fraud on the minority.Alteration would be liable to be impeached if the effect of it were to

defraud or oppress the minority shareholders, so as to give the

majority shareholders an advantage of which the minority

shareholders are deprived. This principle was laid down in Menier

v. Hooper Telegraph Works8. In this case the majority of the

members of the company A were also members of the Company B.

At a meeting of company A, they passed a resolution to compromise

an action again Company B in a manner alleged to be favourable to

company B but unfavourable to Company A. On an action by the

minority Company A, the resolution was held invalid and the

compromise was set aside. The Court observed, It would be a

shocking thing if that could be done because the majority have

out something into their pockets at the expense of the minority.

Similarly, the Court will certainly intervene if the majority pass a

resolution sanctioning a sale of companys property to themselves

at an undervalue.

(7)The alteration must be bona fide for the benefit of thecompany as a whole. Alteration shall not be valid if it has been

made for the benefit of an aggressive or fraudulent majority. Thus,

8(1874), 9 Ch. App. 350.


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BINDING FORCE OF MEMORANDUM AND ARTICLES

Regarding the binding force or legal effect of the memorandum and

articles, Section 36 of the Act provides that, subject to the provisions of

the Act, the memorandum and articles, when registered, bind the

company and the members thereof to the same extent as if they

respectively had been signed by the company and by each member, and

contained covenants (agreement) on its and his part to observe all

provisions of memorandum and of the articles. It follows from the

members, the members to the company, the members to each other in an

exceptional case, but they do not bind the company or its members to

outsiders.

1.Company is bound to its members.The articles and memorandum constitute a contract binding the

company to its members in their capacity as members, and as such

a company is bound to comply with the provisions of these

documents. As a result each member can restrain the company

from committing a breach of the articles or/and memorandum

which would affect his rights as a member, by bringing an

injunction against it (Re Perevil Gold Mines Ltd.11). Thus, an

individual member can enforce his membership rights such as his

right to vote or his right to recover dividend which has been

declared or his right to receive notice of any general meeting, etc., n

pursuance to the articles, if he is denied any of these rights by the

11(1889), 1 Ch. 122.


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company (Pender v. Lushington12). In Johnson v. Lyttles Iron

Agency13, a forfeiture of shares, irregularly affected by the

company, was set aside at the instance of the aggrieved member as

the company did not comply with the provisions of the articles.It must be noted that these documents bind the company to

members and vice versain respect of their membership rights only

and not contractual rights of other kinds. Even a member enjoying

certain rights in capacity other than a member cannot enforce

them against the company. Thus, where the articles provided that

the company should purchase certain property belonging to a

member, there was held to be no contract between the company

and the member to that effect (Re Tavarone Mining Co.)14.

2.Each member is bound to the company.Member are bound to the company to observe and follow the

provisions of the memorandum and articles, just as if everyone of

them had contracted to conform to them. All money payable by any

member to the company under the memorandum or articles shall

be a debt due from him to the company (Sec. 36). Articles

constitute a contract between each member and the company.

This was held in Welton v. Saffery15. It follows, therefore, that a

company can sue its members for the enforcement of its articles as

well as for restraining their breach. Thus, if the articles provide to

refer any dispute between the company and its members toarbitration, the court will stay an action by the member, in such a

12(1877), 6 Ch. D. 70.

13(1877), 6 Ch. 687.

14(1873), 8 Ch. App. 956. Also see Duraiswamiv. UIL Association Co., AIR (1960) Mad. 316.

15(1897), A.C. 299, 315.


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dispute on an application made by the company. For the sake of

another illustration the facts ofBoreland Trusteesv. Steel Brothers

& Co. Ltd.,16 may be seen. The articles of the defendant company

provided that the shares of any member who became bankruptshould be sold to certain other persons at a certain price to be fixed

by the directors. B became bankrupt. His trustee in bankruptcy

claimed that he was not bound by the articles and he could dispose

of the shares as he liked. It was held that he was bound by the

terms of the articles and could not claim the shares against the

company.

But this binding force on the members is only in respect of their

rights and obligations as members. In Beattie v. Beattie17, the

articles provided that a dispute arising between the company and

any member would be referred to arbitration. A director, who was

also a member of the company, was sued for wrongs done in his

capacity as director. It was held that the arbitration clause was not

applicable to this dispute because it did not relate to the rights of

director as member but as director.

3.Each member is bound to other member in exceptional caseonly.

Articles or and memorandum do not create an express agreement

between the members of the company inter-se, because in usual

course a member is not allowed to sue another member directly forany wrong done to the company or to recover money alleged to be

due to the company. The action must be brought by the company

16(1901), 1 Ch. 279.

17(1938), Ch. 708.


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itself or if it is in liquidation, by the liquidator. This was held in the

case of Burland v. Earle18. If a shareholder defaults in making

payment of a call made, only the company may sue him because if

other members are allowed to sue him, there may be thousands ofsuits (if the number of members is that large) filed against him,

which shall be absurd.

The only exception, where articles form a contract between

individual members qua members and where an individual member

in his personal capacity, may sue other member or members

directly without joining the company as a party to the action, is

when the persons against whom relief is sought control the

majority shares and will not allow an action to be brought in the

name of the company and the acts complained of, are either

fraudulent or ultra vires. This was held in the case of The

Dhakeshwari Cotton Mills Ltd. v. Nilkamal19.

4.Neither the company nor the members are bound to outsiders.The articles and memorandum create no contract with outsiders

that is, vendors, solicitors, secretary, etc. A member is also an

outsider if the matter in question is not connected to his

membership rights and obligations. An outsider cannot take

advantage of these documents to found claim thereon against the

company or its members, even though his name may have been

mentioned in the articles, for, such a person is not a party to thecontract constituted by the articles and the memorandum. Thus,

for instance, where the articles provided for remuneration to be

18(1902), A.C. 83.

19AIR 1937 Cal 645.


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paid to promoters, it was held that the promoters had no right of

action against the company. This was decided in the case of Re

Rotherham Alum & Co.20.

Similarly in the case of Eleyv. Positive Government Life InsuranceCo. Ltd.21: The Articles provided that Eley should be the companys

solicitor for life. Eley was employed by the company and he also

purchased certain shares of the company. But the specific contract

with him did not contain the term that he shall be the companys

solicitor for life. After sometime the company dismissed him. He

then sued the company for damages for breach of contract. It was

held that he had no cause of action, because the articles did not

constitute any contract between the company and himself.

It may be noted that outsiders may acquire rights under the

articles and can enforce them against the company if articles have

been referred to show the terms of contract in the specific

agreement between the outsider and the company. Thus, where the

directors were appointed under the specific contract referring to

therein the provisions of the articles in that regard which provided

remuneration of ` 5,000 per month to a director, the terms of the

articles become a part of the contract which the directors could

enforce against the company. This was held in the case of Re New

British Iron Co.22.

20(1883) 25 D. 103.

21(1876), 1 Ex. D. 88.

22(1898) 1 Ch. 324.


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CONSTRUCTIVE NOTICE OF MEMORANDUM AND ARTICLES

In Mahonyv. East Holyford Mining Co. East Holyford Mining Co.23 it

was held that After registration memorandum and articles become

public document and it is taken for granted that everyone who deals

with the company is in the know of these documents. This is called the

Constructive notice of memorandum and Articles or the Doctrine of

Constructive Notice. The legal effect of this doctrine is that if a person

deals with a company in a manner which is inconsistent with the

provisions contained in the memorandum or article (i.e., enters into a

transaction which is beyond the powers of the company as set out in

those documents), he must be deemed to have dealt with the company at

his own risk and cost and shall have to bear the consequences thereof.

For example if the articles provide that a bill of exchange must be signed

by two directors, a person who has a bill signed by only one director

cannot claim payment upon such bill.

23(1875) 7 HL 869.


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THE DOCTRINE OF INDOOR MANAGEMENT

As observed above, the Doctrine of Constructive Notice will estop

a person dealing with a company from pleading ignorance of the

provisions contained in its memorandum or articles. But where these

documents prescribe some conditions or procedure to be fulfilled or

adopted before a transaction is entered into, a perusal of these public

documents will give no indication whether the required condition or

procedure has been complied with. Also, the outsider cannot be deemed

to have constructive notice of any procedural failure which he has no

means of discovering. It is for this reason that the courts have allowed an

exception to the doctrine of constructive notice and have enunciated a

rule for the protection of persons dealing with companies. The rule is

that persons dealing with the company in good faith have a right to

assume that the internal requirements prescribed in public

documents have been observed. They are not bound to enquire into

the regularity of the internal proceedings.

Thus, where the articles give power to borrow with the sanction of

an ordinary resolution of a general meeting, a lender need not enquire

whether the general meeting was convened on proper notice, or whether

a proper quoram was present at the meeting, or whether the necessary

resolution was properly passed thereat. He is entitled to assume that

what has been done has been regularly done by the company and can

hold the company liable even if the internal formalities are found, not to

have been completed.

This rule is known as the Doctrine of Indoor Management.


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Origin of the Doctrine

The rule had its genesis in the case of Royal British Bank v.

Turquand24. In this case the Directors of the Company were authorized

by the articles to borrow on bonds such sums of money as should from

time to time by a special resolution of the Company in a general meeting,

be authorized to be borrowed. A bond under the seal of the company,

signed by two directors and the secretary was given by the Directors to

the plaintiff to secure the drawings on current account without the

authority of any such resolution. Then Turquand sought to bind the

Company on the basis of that bond. Thus the question arose whether the

company was liable on that bond.

The Court of Exchequer Chamber overruled all objections and held

that the bond was binding on the company as Turquand was entitled to

assume that the resolution of the Company in general meeting had been

passed. The relevant portion of the judgment ofJervis C. J. reads:

"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 Act of Parliament; but the resolution does not

define the amount to be borrowed. That seems to me enough......We may

now take for granted that the dealings with these companies are not like

24[1856] 6 E. & B. 327


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dealings with other partnerships, and 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 soon 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 appear to be

legitimately done."

The company alleged that no such resolution had been passed,

and, the loan was taken without its authority. The Court held that thecompany was bound by the contract since the plaintiff was entitled to

assume that the necessary resolution must have been passed. The

observations made byV. Haldane in the case ofPacific Coast Coal Mines

Ltd. v. Arbuthnot25is worth noting in this connection : A person can be

presumed to know the constitution of the company, but not what may or

may not have taken place within the doors that are closed to him.

The facts of County of Gloucester Bank v. Rudry Methyr & Co.26,

case provide another good illustration on this point. In that case a person

was issued a mortgage deed to which the seal of the company had been

affixed at a Board meeting at which no quoram was present. Is was held

that mortgage deed was valid because the mortgagee had no means of

knowing the internal irregularity in the management

Briefly stated the doctrine of indoor management lays down that

persons dealing with the company are only required to see that the

proposed dealings are apparently regular and consistent with the

25(1917) 1 Ch. 607.

26(1895), 1 Ch. 629.


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Exceptions to the Doctrine of Indoor Management

In the following cases protection under this doctrine cannot be

claimed;

1.Knowledge of irregularityThe first and the most obvious exception is that the rule has no

application where the party affected by an irregularity had

actual notice of it. Knowledge of an irregularity may arise from

the fact that the person contracting was himself a party to the

inside procedure. As in Devi Ditta Mal v The Standard Bank of

India27, where a transfer of shares was approved by two

directors, one of whom within the knowledge of the transferor

was disqualified by reason of being the transfer himself and the

other was never validly appointed, the transfer was held to be

ineffective.

Similarly in Howard v. Patent Ivory Manufacturing Co28., where

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.

Likewise, in Morrisv Kansseen29, a director could not defend an

allotment of shares to him as he participated in the meeting,

which made the allotment. His appointment as a director alsofell through because none of the directors appointed him was

validly in office.

27[1927] 101 IC 558

28[1888] 38 Ch. D. 156

29[1946] 16 comp. Cas 186 ( HL)


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But after the Hely-Hutchinson v Brayhead Ltd.30, according to

which the mere fact that a person is a director does not mean

that he shall be deemed to have knowledge of the irregularities

practiced by other directors. A newly appointed director does notmean that he shall be deemed to have knowledge of the

irregularities practiced by the other directors. A newly appointed

director entered into contracts of indemnity and guarantee with

the company through a director whom the company had

knowingly allowed to hold himself out as having the authority to

enter into such transaction, although in fact he had no such

authority. The company was held liable

A person who has actual or constructive notice of the internal

irregularity cannot obviously claim the protection to this rule.

Thus in Howard v. Patent Ivory Co.31, the directors, under the

articles, had no authority to borrow more than 1,000 without

the sanction of a resolution of the company in general meeting.

Without such consent they borrowed 3,500 from themselves

and took debentures. It was held that as they had notice of the

internal irregularity, their debentures were good only to the

extent of 1,000.

2.Negligence on part of outsiderIf the circumstances are so suspicious as to invite further

enquiry and the outsider had not made proper enquiries which

would have revealed the irregularities, he would not be entitled

to the protection of the doctrine of indoor management. For

30[1968]38 comp.Cas 228m (CA)

31(1888), 38 Ch. D. 156. Also see Devi Ditta Malv. The Standard Bank of India (1972) I.C. 568.


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example, if an officer acts outside his apparent authority, the

outsider cannot claim the protection under this rule under the

pretext that he presumed that the relevant power might have

been delegated to the officer, as per the articles. In such a casehe must make further enquiries otherwise he is taking a risk. A

clear illustration of the case ofAnand Bihari Lalv. Dinshaw and

Co.32, where the plaintiff accepted a transfer of companys

property from its accountant, the transfer was held void. The

plaintiff should have insisted on seeing the power of attorney

executed in favour of the accountant by the company before

accepting the transfer, as the transaction is apparently beyond

the scope of an accountants authority. Even the unusual

magnitude of the transaction may put a person dealing with the

company upon enquiry as to its being authorized. This was also

held in the case ofHoughton & Co. v. Nothard Lowe & Wills33.

The question of knowledge of Articles came up in the case of

Rama Corporation v Proved Tin and General Investment Co.34,

here; one T was the active director of the defendant company.

He, purporting to act on behalf of his company, entered into a

contract with the plaintiff company under which he took a

cheque from the plaintiffs. The companys article contained a

clause providing that the directors may delegate any of their

powers, other than the power to borrow and make calls to

committees, consisting of such members of their body as they

think fit. The board had not in fact delegated any of their

32AIR 1942 Oudh 417.

33(1928), A.C. 1.

34(1952) 2 KB 147, 152.


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powers to T and the plaintiffs had not inspected the defendants

articles and, therefore, did not know of the existence of power to

delegate.

It was held that the defendant company was not bound by the

agreement. Slade J, was of the opinion that knowledge of

articles was essential. A person who at the time of entering into

a contract with a company has no knowledge of the companys

articles of association, cannot rely on those articles as conferring

ostensible or apparent authority on the agent of the company

with whom he dealt. He could have relied on the power ofdelegation only if he knew that it existed and had acted on the

belief that it must have been duly exercised.

Knowledge of articles is considered essential because in the

opinion of Slade J; the rule of indoor management is based

upon the principle of estoppel. Articles of association contain a

representation that a particular officer can be invested withcertain of the powers of the company. An outsider, with

knowledge of articles, finds that an officer is openly exercising

an authority of that kind. He, therefore, contracts with the

officer. The company is estoppel from alleging that the officer

was not in fact authorised.

This view that knowledge of the contents of articles is essential

to create an estopped against the company has been subjected

to great criticism. One point is that everybody is deemed to have

constructive notice of the articles. But Slade J brushed aside

this suggestion stating constructive notice to be a negative one.


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the document. But, it was held, that the rule has never been

extended to cover such a complete forgery.

Lord Loreburnsaid: It is quite true that persons dealing with

limited liability companies are not bound to enquire 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 Forgery.

The rule is of no avail where the outsider is found to have relied

upon a document which is a forged one, for, a forgery is a

nullity, that is, void ab initio. The signatures of two of the

directors, as required under the articles, on a share certificate

and issued the same to the plaintiff. The company refused to

accept him as a shareholder. The plaintiff pleaded that whether

the signatures were genuine or forged was part of internal

management, and therefore, the company should be estoppedfrom denying genuineness of the document. But it was held that

the plaintiff was not a shareholder and the certificate was a

nullity because this doctrine only applies to irregularities which

otherwise might effect a genuine transaction and it cannot apply

to a forgery which is void ab initio.

It must, however, be observed that although the company is not

liable for forgeries committed by its officers, yet it may be held

liable for fraudulent acts of its officers acting under their

ostensible authority on its behalf. Thus, where a director or a

manager of a company with ostensible authority under the

company by not placing the money borrowed by him on a hundi


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or a bill of exchange in the coffer of the company, the company

is bound to honour the hundi or bill of exchange, as the case

may be, and cannot defeat a bona fide creditors claim for

recovery of the money on the ground of fraud of its own officers.This was held in the case ofShri Kishanv. Mondal Bros. & Co.36.

Application of the Rule by the Indian Courts

The Turquand's rule has been approved and followed by

Varadaraja lyengar J., in Varkey Souriarv. Keraleeya Banking Co. Ltd.37

In the following way:

" Coming to the alternative ground, it is no doubt true that where a

company is regulated by a memorandum and articles registered in some

public office, persons dealing with the company are bound to read the

registered documents and to see that the proposed dealing is not

inconsistent therewith but they are not bound to do more. They need not

enquire into the regularity of the internal proceedings what -Lord

Hatherley called 'indoor management'. So if there is a managing director

and authority in the articles for the directors to delegate their powers to

him, a person dealing with him may assume that it is within the ordinary

duties of a managing director. All he has to see is that the managing

director might have power to do what he purports to do. But the rule

cannot apply where the question, as here, is not one as to the scope of

36AIR 1967 Cal 75.

37AIR 1957 Ker 97


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the power exercised by an apparent agent of the company, but is in

regard to the very existence of the agency."

In Lakshmi Ratan Cotton Mills Co. Ltd, v. J. K. Jute Mitts Co. Ltd38,

the plaintiff company sued the defendant company on a loan for `

1,50,000. Among other things the defendant company raised the plea

that the transaction was not binding as no resolution sanctioning the

loan was passed by the board of directors. The court, after referring to

Turquand's case and other Indian cases, held :If it is found that the

transaction of loan into which the creditor is entering is not barred by

the charter of the company or its articles of association, and could beentered into on behalf of the company by the person negotiating it, then

he is entitled to presume that all the formalities required in connection

therewith have been complied with. If the transaction in question could

be authorised by the passing of a resolution, such an act is a mere

formality. A bona fide creditor, in the absence of any suspicious

circumstances, is entitled to presume its existence. A transaction entered

into by the borrowing company under such circumstances cannot be

defeated merely on the ground that no such resolution was in fact

passed. The passing of such a resolution is a mere matter of indoor or

internal management and its absence, under such circumstances,

cannot be used to defeat the just claim of a bona fide creditor. A creditor

being an outsider or a third party and an innocent stranger is entitled to

proceed on the assumption of its existence ; and is not expected to know

what happens within the doors that are closed to him. Where the act is

not ultra vires the statute or the company such a creditor would be

entitled to assume the apparent or ostensible authority of the agent to be

38AIR 1957 All 311


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a real or genuine one. He could assume that such a person had the

power to represent the company, and if he in fact advanced the money on

such assumption, he would be protected by the doctrine of internal

management."

In case of Official Liquidator, Manasube & Co. (P.) Ltd. V.

Commissioner of police39 the learned judge observed that the lenders to a

company should acquaint themselves with memorandum and articles

but they cannot be expected to embark upon an investigation as to

legality, propriety and regularity of acts of directors.

The rule is based upon obvious reasons of convenience in business

relations. Firstly, the memorandum and articles of associations are

public documents, open to public inspection. Hence an outsider is

presumed to know the constitution of a company; but not what may or

may not have taken place within the doors that are closed to him. The

wheels of commerce would not go round smoothly if persons dealing with

the company were compelled to investigate thoroughly the internalmachinery of a company to see if something is not wrong. People in

business would be very shy in dealing with such companies.

The rule is of great practical utility. It has been applied in a great

variety of cases involving rights and liabilities. It has been used to cover

acts done on behalf of a company by de facto directors who have never

been appointed, or whose appointment is defective, or who, having been

regularly appointed, have exercised an authority which could have been

delegated to them under the companys articles, but never has been so

delegated, or who have exercised an authority without proper quorum.

39[1968]38 Comp. cas 884 (Mad)


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DISTINCTION BETWEEN MEMORANDUM AND ARTICLES

The fundamental points of distinction between these two important

documents are as follows:

1)The memorandum contains the fundamental conditions uponwhich alone the company is allowed to be incorporated. It

defines and limits the objects of the company beyond which the

actions of the company cannot go. The articles are the internal

regulations of the company and are subsidiary to the

memorandum.

2)The memorandum is subordinate to the Act only, while thearticles are not only subordinate to the Act but also to the

memorandum.

3)The memorandum must compulsorily be filed with the Registrarby all types of company at the time of incorporation while a

public company limited by shares need not file a separate set of

articles at the time of incorporation as it may choose to adopt

Table Athe model set of articles.

4)The memorandum defines the relation between the company andthe outsiders, i.e., creditors, buyers, sellers, debtors and

members, etc. Articles govern internal relationship between the

company and the members and generally have nothing to do

with the outsiders.

5)The memorandum cannot be easily altered while articles areeasily alterable by passing a special resolution only.


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6) Acts done by a company ultra vires the memorandum are voidand cannot be ratified by the shareholders. But acts done by a

companyultra viresthe articles but intra viresthe memorandum

are simply irregular and not void and can be ratifiedsubsequently by the shareholders.

7) Outsiders have no remedy against the company for contractsentered into ultra viresthe memorandum, while they can enforce

contract against the company even if it is ultra viresthe articles,

i.e., where some formality relating to internal regulation like

passing of the required resolution, might have not been

performed, provided they act carefully and had no notice of the

irregularity.

Memorandum of Association is also called the charter of an

organization and is a useful document for the investors to know

how their money is being invested and utilized by the company. On

the other hand, Articles of Association is also important as it lets

one get a look into the internal structuring of the company and how

the power flows down. It tells about the laws governing internal

management of the company. It also reflects the roles,

responsibilities and functions of various people in the management

of the company.


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BIBLIOGRAPHY

M.C. Kuchhal: Corporate Laws, A Mahavir Publication, 4th Ed.,2012-13.

Avtar Singh: Company Law, Eastern Book Agency, Lucknow, 15thEd., 2007.

The Companies Act, 1956http://www.lexvidhi.com/article-details/articles-of-association-of-

a-company-105.html

http://www.lexvidhi.com/article-details/alteration-of-articles-guidelines-461.html
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