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Articles of Association
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Corporate Law-I
Articles of Association
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,
Jamia Millia Islamia
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Articles of Association
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Articles of Association
Of a Company
Submitted to:-
Mr. Qazi Mohd. Usman
Assistant Professor,
Faculty of Law,
Jamia Millia Islamia
Submitted by :-
Suparna Sinha
Roll No. 68
3rd year, B.A.,LL.B.
(Hons)
Jamia Millia Islamia
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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.
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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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