Indoor Management Rules - Essay Example

? Indoor Management Rule Under the English common laws, except for specific sta y repudiations, an individual cannot initiate litigation or in turn be prosecuted upon (as regards a contract), except when the individual is also a party to the contract.1In this context, Turquand rule is often used for representing the framework of how companies can form contractual alliances with third parties. Turquand rule (or the indoor management rule) is a company law (under common laws) in the UK, which held that people conducting transactions with business firms have the right to presume that company rules (internal) have been observed (even if the firm failed to do so).2 Currently the Companies Act 2006 (sections 39 to 41) in the UK complements this rule. In the UK, most commercial transactions are carried out under the statutory exception, which is the doctrine of agency. The agency of doctrine rule is based on the theory that if an agent signs a contract within his jurisdiction as by the principal, then all obligations and rights as acquired by the agent are passed on to the principal whereupon the latter can litigate and or be prosecuted upon, by on the terms as set within the contract. However, certain reservations3 within this doctrine brought the Turquand rule into existence, which helped in defining contractual alliances with third parties. The significance of Turquand rule was that this provision gave the third party a right to assume (while signing cheques) that the company directors with whom the contract is signed, has been rightfully appointed and they have the right to en-cash the cheque (matters of internal management). Turquand rule thus stated that a third party signing a contract with a company could view only the external position of the latter without going into issues of indoor management.  However, on close analysis it reveals that the rule does not provide any mechanism or route for the third party to bypass ‘privity of contract rule’ and prosecute the company. This basic shortcoming within the Turquand ruling translated into the fact that the rule held a role that was ancillary to that of the agent (directors), and playing a minor role in the overall legal principles, operating as regards company law, thus leading to the derivations that the Turquand rule does not add anything to concept of agency.  In cases of an internal obligation (in a situation where a ‘stranger’ or the third party is aware of the firm’s indoor management) where a given operation is permitted by a special declaration, the Turquand rule consequently becomes inapplicable. Currently the Companies Act 2006 (section 40)4 has now replaced Turquand rule in English law, where the general aim is to restrict the third party from being negatively affected owing to restrictions on authority as set within a company’s constitution. A closer look at section 40 reveals that the ?eld still remains complicated (the section being inadequately worded leaving scope for misinterpretation). The basic flaw is the wording, where it is seen that in section 40 (1) it is unclear as whether the third person or P is ‘a person dealing with a company’? It is evident that this individual is a ‘person,’ but it remains unclear whether he is ‘dealing with a company.’ There is delineation to this effect in section 40 (2), where it states that a person clearly ‘deals with’ a firm when he is part of any transaction or any other activity, where the firm ‘is a party’. Again the wording here is unclear, as the term ‘party’ is liable to be construed as a situation where the firm has signed a legal deal with the person. Here the primary difficulty is from the perspective of the person or individual (with whom the firm signs the deal). Unless the person can present as evidence that this section or another one is applicable that can remove the corollary of ‘constructive notice doctrine,’ it will be impossible with facts at hand to prove that the firm is a ‘party’ and hence can be prosecuted. Thus, the basic problem here is in trying to establish the fact that the firm is a party, and in this context the drafting of section 40 (1) is seen to be weak and not clearly defined. Similar problems are noticed in section 40(2), where the words ‘authorise others to do so’ are unclear. Presuming that problems can be resolved, then under section 40 b (i) the third party or P is not obliged to find out the power limitations of the company directors or even authorise some other person to do so. Therefore, not being a deeming provision, it functions by indirect removal of the constructive notice doctrine (the doctrine makes it mandatory for P to find out about ‘indoor management’ of the company it is dealing with, and failing which it would be understood that he/she must have noticed public file matters on  company registry). This provides P with a valid reason not to find about indoor management of the company concerned, as the statute gives him freedom to refrain from making ‘inquiries.’ Therefore section 40 (2) makes it evident that section 40 (1) will be important to a third person only where he or she did not ‘really’ possess information on company constitution before dealing with the company. However, section 40 (2) would fail to have an effect under conditions where P was ‘really’ aware of all terms, conditions and clauses before signing the deal contract. This leaves a large scope for a debate on how much knowledge about the company can be deemed as enough, to hold that the third party ‘really’ possessed information. This complex scenario, thus allows the provided UK legal intervention to have a hit and miss value. The statutory provision (the present legislation of section 40 under Companies act), which aims to restrain parts of the English common law under specific situations, is not well envisaged and not adequately drafted by its creators, thus keeping it as an accessory law, as was the case in Turquand rule. Therefore, it depends on the UK courts to make an appropriate decision when faced with third party issues in the context of company contract laws. Instead of depending on the section 40, the courts will have to translate correctly the actual objective of the legislation (as per the conditions in each case), in order to alleviate the harshness of the situation in which a third party is negatively affected by restrictions present within a company constitution. References Companies Act 2006 (c. 46) Part 4 — A company’s capacity and related matters [Online] Available at http://www.legislation.gov.uk/ukpga/2006/46/pdfs/ukpga_20060046_en.pdf [Accessed 31st May 2012] Contracts (Rights of Third Parties) Act 1999, [online] available at http://www.legislation.gov.uk/ukpga/1999/31/contents [accessed 31st May 2012] Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480, 500-510. Royal British Bank v Turquand [1856] 6 E&B 327. Sealy, L., and Worthington, S., 2007. Cases and Materials in Company Law. Hampshire: OUP. Read More