Copy Corporate

Articles of Association Association

Corporate Law-I Articles of Association

Submitted to:Submitted by :Mr. Qazi Mohd. Usman

Suparna Sinha

Assistant Professor,

Roll No. 68

Faculty of Law,

3rd year, B.A.,LL.B. (Hons)

Jamia Millia Islamia

Jamia Millia Islamia 1


Articles of Association Of a Company

Submitted by :-

Submitted to:-

Suparna Sinha

Mr. Qazi Mohd. Usman

Roll No. 68

Assistant Professor,

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

Faculty of Law,

(Hons)



2


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 “

which also

helped 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 cases…………………………………………………………v -vi -vi Company………………………………………………………………1 Articles of association…………………………………………………4 The obligation to register articles...................................................8 Contents of articles..........................................................................9 Alteration of articles………………………………………………….12 articles…………………………………………………. 12 Limitations regarding alteration of articles..................................13 Binding force of memorandum and articles…………………………18 articles………………………… 18 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 Constructiv e notice of memorandum and articles…………………...23 articles…………………... 23 The doctrine of indoor management………………………………....24 Origin of the doctrine…………………………………………..25

4

Articles of Association

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 Railwaymen’s Benefit Funds v. Bareshwar Nath, I.L.R. (1945) Nag 599.



Allen v. The Gold Reefs of West Africa Ltd. (1900), Ch. 656.



Anand Bihari Lal v. Dinshaw and Co., AIR 1942 Oudh 417.



Andrews v. Gas Meter Co., (1897) 1 Ch. 361.



Ashbury Railway Carriage Co. v. Riche, (1875), L.R. 7 H.L. 653, p. 670



Beattie v. Beattie, (1938), Ch. 708.



Boreland Trustees v. Steel Brothers & Co. Ltd., (1901), 1 Ch. 279.



Brown v. British Abrasive Wheel Co., (1919), Ch. 290.



Burland v. Earle, (1902), A.C. 83.



C.Chettiar v. Krishna Aiyanger, ILR 33, Mad 36.



County of Gloucester Bank v. Rudry Methyr & Co., (1895), 1 Ch. 629.



Devi Ditta Mal v The Standard Bank of India, [1927] 101 IC 558



Duraiswami v. UIL Association Co., AIR (1960) Mad. 316.



Eley v. Positive Government Life Insurance Co. Ltd., (1876), 1 Ex. D. 88.



Guineness v. Land Corporation of Ireland ,(1882), 22 Ch. D. 349.



Hari Chandra v. Hindustan Insurance Society, AIR (1925) Cal. 690



Hely-Hutchinson v Brayhead Ltd ., [1968]38 comp.Cas 228m (CA).



Houghton & Co. v. Nothard Lowe & Wills, (1928), A.C. 1.



Howard v. Patent Ivory Manufacturing Co ., [1888] 38 Ch. D. 156



Johnson v. Lyttle’s Iron Agency, (1877), 6 Ch. 687.



Lakshmi Ratan Cotton Mills Co. Ltd , v. J. K. Jute Mitts Co. Ltd, AIR 1957 All 311.



Mahony v. East Holyford Mining Co. East Holyford Mining Co., (1875) 7 HL 869.



Menier v. Hooper Telegraph Works,(1874), 9 Ch. App. 350.



Morris v Kansseen, [1946] 16 comp. Cas 186 ( HL)



Official Liquidator, Manasube & Co. (P.) Ltd . V. Commissioner of police , [1968]38 Comp. cas 884 (Mad) 6




Pacific Coast Coal Mines Ltd. v. Arbuthnot, (1917) 1 Ch. 607.



Pender v. 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 Bank v. Turquand, [1856] 6 E. & B. 327



Ruben v. Great Fingall Consolidates , [1906] A.C. 439



Shri Kishan v. Mondal Bros. & Co., AIR 1967 Cal 75.



Sidebottom v. Kershaw, Leese & Co., (1920), 1 Ch. 154.



The Dhakeshwari Cotton Mills Ltd. v. Nilkamal, AIR 1937 Cal 645.



Varkey Souriar v. Keraleeya Banking Co. Ltd., AIR 1957 Ker 97.



Welton v. 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 money‟s 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 of companies into two separate documents 

the Memorandum of Association is the primary document, and will 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 will generally regulate the company's internal affairs and management, such as procedures for board meetings, dividend entitlements etc.

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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

shareholders'

with

agreements,

additional

whereby

they

arrangements, agree

to

such

exercise

as 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 benefit of shareholders' agreement is that they will usually be confidential, as most jurisdictions do not require shareholders' agreements to be publicly filed.

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ARTICLES OF ASSOCIATION

The articles of association of a company contain the rules relating to the management of its internal affairs. They are similar to the „partnership deed‟ in a partnership. They prescribe rules and regulations for the general management of the company and for the attainment of its objects as given in the memorandum. The general functions of Articles of Association were clearly stated by Lord Cairns in Ashbury Railway Carriage Co. v. Riche 1 where he observed that “the articles play a part subsidiary to the memorandum as the charter of incorporation of the company, and so accepting it, the articles proceed to define the duties, the rights and the powers of the governing body as between themselves and the company at large, and the mode and form of in which the business of the company is to be carried on, and the mode and form in which changes in the internal regulations if the company may from time to time be made.”

Being

subordinate to the memorandum, they cannot extend the objects as defined in the memorandum. Distinguishing between the functions of the memorandum and Articles of Association, Lord Justice Bowen observed in Guineness v. Land

Corporation

of

Ireland 2 :

“The

memorandum

contains

the

fundamental conditions upon which alone the company is allowed to be incorporated. They are conditions introduced for the benefit of the creditors, and the outside public, as well as of the shareholders. The 1 2

(1875), L.R. 7 H.L. 653, p. 670 (1882), 22 Ch. D. 349.

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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 such regulations for their own management as they think fit in the form of the Articles of Association.” 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 a general 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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Articles of association are simply the basic internal rules of operation for a business or non-profit organization that govern what tasks need to be done, what positions are required to perform the necessary functions, and how the processes in place are to be performed. Often articles of association deal with such operating issues as the calling of general meetings, the process for appointing and selecting directors and managers within the organizational structure, etc. Articles of association also address how the company will go about issuing shares of stock, paying dividends to investors, and how and when audits on the financial records will be conducted. The provisions of the articles of association must not be in conflict with the provisions of the Memorandum of Association. In case such a conflict arises, the Memorandum of Association will prevail. Normally, every company has its own articles of association. However, if a company does not have its own articles of association, the model articles of association specified in Schedule I - Table A will apply. A company may adopt any of the model forms of articles of association, with or without modifications. The articles of association should be in any of the one form specified in the tables B, C, D and E of Schedule 1 to the Companies Act, 1956. Form in Table B is applicable in case of companies limited by the shares, form in Table C is applicable to the companies limited by guarantee and not having share capital, form in Table D is applicable to company limited by guarantee and having a share capital whereas form in table E is applicable to unlimited companies. However, a private company must have its own articles of association. 13


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 subclauses (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 members who 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 any shares 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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ALTERATION OF ARTICLES

The articles, being the internal regulations of the company, can be freely altered by the company. The right to later or add to the articles is expressly conferred by Section 31 which states that a company may alter its articles, as often required, by passing a special resolution only. A copy of special resolution authorizing the alteration together with the printed copy of the alter Articles must be filed with the Registrar within 30 days of passing the said resolution. The alteration will be effective from the date of registration by the Registrar. It is to be observed that this power to alter articles is a statutory power and cannot be negative in any way. A company cannot deprive itself of this statutory right either by inserting a clause in the articles or by a contract with any one (Andrews v. Gas Meter Co. 3 ). Further, articles can be re-altered by passing a special resolution and they can also be altered with the retrospective effect (Allen v. The Gold Reefs of West Africa Ltd.4 ). The freedom of a company to alter its articles is, however, subject to certain limitations.

3 4

(1897) 1 Ch. 361. (1900), Ch. 656. Also see All India Railwaymen’s Benefit Funds v. Bareshwar Nath, I.L.R. (1945) Nag 599.

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Limitations Regarding Alteration of Articles (1) The alteration must not be inconsistent with the provisions of the 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 conditions contained 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 alteration ordered by the Company Law Board. In the exercise of its powers to remedy “oppression” and “mismanagement” under Sections 397 20


and 398, the Company Law Board has power to alter the company‟s 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 the Company Law Board‟s order without the permission of the Company Law Board. (Section 404).

(4) Approval of Central Government must also be taken in certain cases. For example, 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 company into private company (Section 31). (b) In the case of a public company, if alteration related to any provision 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 an increase 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 under a 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 “……… Thus a 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

Aiyanger 6 , the articles provided 250 per month as pay for the `

company‟s 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 secretary‟s 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 Society 7 also involved a situation of this kind. In this case the plaintiff had taken out a policy of life insurance in the defendant‟s 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 the effect 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. ILR 33, Mad 36. 7 AIR (1925) Cal. 690. 6

22


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 previously entered 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 Works 8 . 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 company‟s property to themselves at an undervalue.

(7) The alteration must be bona fide for the benefit of the company 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.

23


in Brown v. British Abrasive Wheel Co., 9 certain shareholders held 98% of the company‟s shares.

The company passed a special

resolution that a shareholder, upon the request of the holders of 90% of the issued shares, shall be bound to sell and transfer his shares to the nominee of such holders at a fair value. It was held that the alteration was not for the benefit of the company as a whole but for the benefit of the majority and an injunction was granted restraining the company from carrying out the resolution. On the other hand, alteration made bona fide in the interests of the company shall be valid even if it likely to affect adversely the personal interests of some of the members of the company. Thus, in Sidebottom v. Kershaw, Leese & Co. 10 ,the Court upheld an alteration of the articles of a private company, which authorized the directors to order any shareholder, carrying on a competitive trade to that of the company, to transfer his shares at a fair value to the persons nominated by the directors, on the ground that the alteration was for the benefit of the company as a whole, individual hardship being irrelevant. The distinction between these two cases must, however, be noted. Whereas in the former case the alteration was clearly for the benefit of an aggressive majority, in the latter it was not, because under the given circumstances it would likewise have operated against the majority.

9

(1919), Ch. 290. (1920), 1 Ch. 154.

10

24


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.

25


company (Pender v. Lushington 12). In Johnson v. Lyttle’s Iron Agency 13 , 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 versa in 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. Saffery 15 . 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 to arbitration, the court will stay an action by the member, in such a 12

(1877), 6 Ch. D. 70. (1877), 6 Ch. 687. 14 (1873), 8 Ch. App. 956. Also see Duraiswami v. UIL Association Co., AIR (1960) Mad. 316. 15 (1897), A.C. 299, 315. 13

26


dispute on an application made by the company. For the sake of another illustration the facts of Boreland Trustees v. Steel Brothers & Co. Ltd., 16 may be seen. The articles of the defendant company provided that the shares of any member who became bankrupt should 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. Beattie 17 , 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 case only. 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 for any 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 17

(1901), 1 Ch. 279. (1938), Ch. 708.

27


itself or if it is in liquidation, by the liquidator. This was held in the case of Burland v. Earle 18 . 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 of suits (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. Nilkamal 19 .

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 the contract constituted by the articles and the memorandum. Thus, for instance, where the articles provided for remuneration to be

18 19

(1902), A.C. 83. AIR 1937 Cal 645.

28


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 Eley v. Positive Government Life Insurance Co. Ltd.21: The Articles provided that Eley should be the company‟s 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 company‟s 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. (1876), 1 Ex. D. 88. 22 (1898) 1 Ch. 324. 21

29


CONSTRUCTIVE NOTICE OF MEMORANDUM AND ARTICLES

In Mahony v. 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 c alled the “Constructive notice of memorandum and Articles” or the Constructive Notice”.

“Doctrine of

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.

30


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 t he 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.” 31


Origin of the Doctrine

The rule had its genesis in the case of Royal British Bank v. Turquand 24 . 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 of Jervis 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

32


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 so on 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 the company was bound by the contract since the plaintiff was entitled to assume that the necessary resolution must have been passed. The observations made by V. Haldane in the case of Pacific Coast Coal Mines Ltd. v. Arbuthnot 25 is 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 tha t the proposed dealings are apparently regular and consistent with the 25 26

(1917) 1 Ch. 607. (1895), 1 Ch. 629.

33


memorandum and articles. They need not enquire into the regularity of the internal proceedings of the company. They are entitled to presume that the directors are acting lawfully in what they do, and can hold the company liable even if the internal formalities are found not to have been completed.‟ The doctrine is of great importance in the world of commerce, because in its absence the general plight of the persons dealing with companies would have been miserable, for, the company, very often, could have escaped liability denying the authority of the officials to act on its behalf.

34


Exceptions to the Doctrine of Indoor Management In the following cases protection under this doctrine cannot be claimed; 1. Knowledge of irregularity The 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 India 27 , 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 Co 28., 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 Morris v Kansseen 29 , 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 also fell through because none of the directors appointed him was validly in office. 27

[1927] 101 IC 558 [1888] 38 Ch. D. 156 29 [1946] 16 comp. Cas 186 ( HL) 28

35


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 not mean 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 outsider If 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 31

[1968]38 comp.Cas 228m (CA) (1888), 38 Ch. D. 156. Also see Devi Ditta Mal v. The Standard Bank of India (1972) I.C. 568.

36


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 case he must make further enquiries otherwise he is taking a risk. A clear illustration of the case of Anand Bihari Lal v. Dinshaw and Co.32 , where the plaintiff accepted a transfer of company‟s 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 accountant‟s 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 of Houghton & Co. v. Nothard Lowe & Wills 33 . 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 company‟s 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 32

AIR 1942 Oudh 417. (1928), A.C. 1. 34 (1952) 2 KB 147, 152. 33

37


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 comp any‟s 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 of delegation 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 with certain 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. 38


It operates against the outsider who has not inquired. It cannot be used against interests of the company. The principle point of criticism, however, is that even if the directors had the power to delegate their authority. They would not yet be able to know whether the director had actually delegated their authority. Moreover, the company can make a representation of authority even apart from its articles. The company may have held out an officer as possessing an authority. A person believes upon that representation and contract with him. The company shall naturally be estopped from denying that authority of that officer for dealing on its behalf, irrespective of what the articles provide. Articles would be relevant only if they had contained a restriction on the apparent authority of the officer contained.

3. Forgery Forgery may in circumstances exclude the „Turquand Rule‟. The only clear illustration is found in the Ruben v. Great Fingall Consolidates 35; here in this case the plaintiff was the transferee of a share certificate issued under the seal of the defendant‟s company. The company‟s secretary, who had affixed the seal of the company and forged the signature of the two directors, issued the certificate. The plaintiff contended that whether the signature were genuine or forged was a part of the internal management, and therefore, the company should be estopped from denying genuineness of 35

[1906] A.C. 439

39


the 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 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 estopped from 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 40


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 creditor‟s claim for recovery of the money on the ground of fraud of its own officers. This was held in the case of Shri Kishan v. 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 Souriar v. 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 36 37

AIR 1967 Cal 75. AIR 1957 Ker 97

41


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. Ltd 38, 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 be entered 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 38

AIR 1957 All 311

42


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 police 39 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 internal machinery 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 company‟s articles, but never has been so delegated, or who have exercised an authority without proper quorum. 39

[1968]38 Comp. cas 884 (Mad)

43


Thus, where the directors of company having the power to allot shares only with the consent, something which he could do only with the approval of the board; where the managing agents having the power to borrow with the approval of directors borrowed without any such approval, the company was held bound.

Conclusion

The case of Royal British Bank v. Turquand 40 , refined the basic Common law of Agency to articulate the Doctrine of Indoor Management. The rule was enunciated by the Court to mitigate the rigors of the Constructive Notice Doctrine. Its importance arises in situations in which the third party‟s dealings are with some officer or agent other than the Board. The rule protects the interest of the third party who transacts with the Company in good faith and to whom the Company is indebted. The rule enunciated in the decision is often referred to as "Turquand's rule" and "indoor management rule". The gist of the rule is 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 had no notice The rule enunciated in Turquand has been applied in many cases subsequently and generally in order to protect the interests of the party transacting with the Directors of the Company. Applying the rule, now it cannot be argued that a person having dealings with a Company is deemed to have notice of who the true Directors are, and this being shown by public documents i.e. the registers of the 40

(1856) 6 E. & B. 327

44


directors required to be maintained by the Company and the and the notices of changes. With the due course of time several exceptions have also emerged out of the rule like Forgery, negligence, third party having knowledge of irregularity etc. If we analyze the cases it is revealed that the Turquand rule did not operate in a completely unrestricted manner. Firstly, it is inherent in the rule that if the transaction in question could not in the circumstances have been validly entered into by the company, then the third party could not enforce it. Secondly, the rule only protected 'outsiders', that is persons dealing 'externally' with the company; directors, obviously, were the very people who would be expected to know if internal procedures had been duly followed. Thirdly, actual notice of the failure to comply fully with internal procedures precluded reliance upon the rule. Fourthly, an outsider could not rely upon Turquand's Case where the nature of the transaction was suspicious; for example, where the company's borrowing powers were exercised for purposes which were wholly unconnected with the company's business and of no benefit to the company.

45


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 upon which 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 the articles are not only subordinate to the Act but also to the memorandum. 3) The memorandum must compulsorily be filed with the Registrar by 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 A‟— the model set of articles. 4) The memorandum defines the relation between the company and the 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 are easily alterable by passing a special resolution only.

46


6) Acts done by a company ultra vires the memorandum are void and cannot be ratified by the shareholders. But acts done by a company ultra vires the articles but intra vires the memorandum are

simply

irregular

and

not

void

and

can

be

ratified

subsequently by the shareholders. 7) Outsiders have no remedy against the company for contracts entered into ultra vires the memorandum, while they can enforce contract against the company even if it is ultra vires the 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.

47

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