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Introduction
The Article of Association (hereinafter, ‘AoA’) of each company is the preamble of the management of its daily affairs. Shares and dividends are the two concepts whose meanings were highly debated earlier. The need to settle the law on this point has sometimes not been equitable for some people. However, courts have resolved the dilemma in various ways and through multiple reasoning. But the impact of such contextual meanings needs to be scrutinized in order to facilitate the development of company law and bring some clarity. However, the main aspect to be discussed is the significance of constructive notice. The famous judgment of Oakbank Oil Company v. Crum,[1], which was decided by the UK Privy Council in the year 1882, is the appropriate case to analyze the law on this aspect. The 5-judge bench was unanimous in its opinion on the interpretation of dividends. Its interpretation has been followed in Indian courts which makes it more important to understand.
Facts of the case
The Oakbank Oil Company was incorporated under the Companies Act 1862 and 1867. The nominal capital of the company was 20,000 pounds in 400 shares of 50 pounds each. On 16th Nov 1869 the capital was increased by 20,000 pounds by addition of 400 shares of 50 pounds each. Through special resolution dated 21st Feb 1873 it was decided that the capital should be divided into 40,000 shares of 1 pound each. However, in 1875 the capital was again increased by 20,000 pounds with new shares of 1 pound. It was called up only to the extent of 5shillings each. Thus, out of 60000 shares of 1 pound each, of which 40000 were fully paid-up whereas 20000 were paid to the extent of 5shillings. each. But the company decided to sanction the payment of dividend at the rate of so much percent on the paid-up capital.[2]
Devastated by the decision, the respondent notified the company that he being the recent purchaser should not be prejudiced and asked them to pay the dividend equally irrespective of the paid up capital. He emphasized that the directors are bound by AOA of the company. The respondent, not being a registered shareholder, could not participate in the customary resolution passed on 17th May, 1881. However, later a special case was arranged between the company and the respondent. [3]
The 5-judge bench of Privy Council unanimously dismissed the appeal and affirmed the order issued by the learned Judge of First division which ruled in favour of respondent.
Issues in the case
The crucial issue involved in the case was: – whether the dividendis payable on the paid-up capital or in proportion to the number of shares held by members irrespective of the amount paid upon them.[4] Also, it throws light on the scope of power of director to undertake such measure while paying dividends which will be come to known as constructive notice.
Contentions in the case from both the Sides
The appellants rested their arguments on two main grounds:
a) The judgment by the First Division court was inequitable as the one who had fully paid up was receiving only dividend whereas the other without full payment got dividend and interest
b) The natural construction of article 71 of AoA guaranteed the director with the power to recommend payment of dividend on basis of paid-up shares. They based it on interpretation of “may” in Article 71 which granted the power to director to pay dividend on basis of amount paid-up.[5]
On the other hand, the respondent argued that on sound construction of AoA the dividend should be paid according to the proportion of shares held by each member rather than on the amount paid-up.
Court’s Decision and Judgment
The learned Judge of First division Court (Lord Shand and Inglis) ruled in favour of respondent. It directed the appellant to pay the dividend according to the proportion of the shares of the member without giving regard to the amount paid-up by them. However, the court admitted to the inequitable manner in this interpretation but it didn’t impact the decision as it was based on true construction of the AoA.[6]
On appeal, the matter was heard by 5-judge bench of Privy Council. It unanimously decided in favour of respondent and thus affirmed the decision of the lower court. Each judge wrote their opinion. It is pertinent to go through each one of them for a better understanding.
Lord Selborne- TheJudge thoroughly analyzed the articles of association to interpret the meaning of “a dividend to be paid to the members in proportion to their shares” which is mentioned in Article 71 of AoA. He also rejected the claim of appellant that word “may” grants such power to the director of company. According to him, it was an enormous power which cannot be guaranteed implicitly; it had to be in express terms and governed by law. Thus, the whole question revolved around the meaning of “in proportion to their shares”. He further went on to interpret the word “shares” as mentioned in articles of association. He concluded that it means shares into which capital is divided and it depends on aggregate amount held by each shareholder. Hence, he confirmed the judgment of the court below in accordance with the Act of 1867 and dismissed the appeal.[7]
Lord Blackburn- The judge agreed with the opinions of Lord Selbourne and held that there is no need to go into the question of equity as the matter at hand was about true interpretation of articles of association. He stated that the reading of the Act of 1867 further strengthened his belief. Thus, he concurred with the judgment of lower court.[8]
Lord Watson- the Judge agreed with the conclusion reached by other judges and thus affirmed the decision of the lower court. However, he warned that in reaching this conclusion he had left out the consideration of comparative injustice or inconvenience in adopting one mode over another.[9]
Lord Bramwell- He also concurred with the opinion of the other judges and affirmed the decision of lower court by ruling in favour of respondent.[10]
Lord FitzGerald- Although entertaining doubts regarding the justness of the interpretation by his learned brothers, he concurred with their opinion. According to him, if the company wanted to do this then it should have expressly declared under Section 24 of the Act of 1867[11] since it failed to do so, the judgment had adopted the reasonable interpretation of Article 71. Hence, the appeal was dismissed.[12]
Analysis
This landmark judgment strengthened the doctrine of constructive notice. Lord Selbourne stated, while giving the decision, that- “Each party must be taken to have made himself acquainted with the terms of the written contract contained in the articles of association, and the Acts of Parliament, so far as they are important. He must also in law be taken to have understood the terms of the contract according to their proper meaning; and that being so he must take consequences, whatever they may be, of the contract which he has made.”[13]
Over time, this doctrine became so significant that it was extensively used by the companies to gain advantage against any outsider. The term ‘constructive’ means something which can be deduced by an inference or something which was so obvious that it must be known.[14] It was first laid down in the case of Ernest v. Nicholls[15] where the House of Lords ruled that any person dealing with the company ought to be familiar with its public document. This doctrine was followed in many cases such as Kotla Venkataswamy v. Rammurthy[16] where appellant was denied the relief as the disputed proposition was explained in Article of Association of company. Hence, it was constructive notice so he should have known.The judgment was extensively relied In Re Jon Beauforte Ltd.[17] where knowledge of development of wheels was held to be known by the creditors and hence no claim.
Another peculiar aspect of this judgment is its interpretation of the word ‘may’ in the AoA of the company. The reasoning is quoted as- “It appears to me that directors and general meetings of companies of this sort can have no powers by implication except such as are incident to, or properly to be inferred from, the powers expressed in the memorandum ad articles of association. Their powers are entirely created by the law and by the contract founded upon the law which enables such companies to be constituted.”[18] Thus, it limited the use of implied powers to very specific uses. However, the judgment fails to provide any instances of such implied power. It made the express powers the ultimate law. In recent years, this aspect has been relied on by Indian courts. The DRA tribunal Delhi in the case Mangal Singh v. IFCI and others[19] ruled that for the shareholder to borrow money it should be expressly stated in the memoranda of company. Thus, the rule against implied power has emerged as law in certain cases.
However, the judgment lags behind the development of law because of its conventional usage. The judges as stated above had despite knowing that the decision is inequitable ruled in favor of respondent. The interpretation of the word “shares” according to which dividend is to be paid in the proportion of shares and not actual paid-up amount is unjust to the shareholder who had paid the full amount. The judges in Oakbank oil could have evoked equity and thus set a precedent for subsequent cases. They failed to do so. This unjust interpretation was heavily relied on in the case of Birch v. Cropper.[20]
Conclusion
The judgment in Oakbank oil is a landmark for a reason that it has been extensively relied on and affirmed by judges across courts in India as well as in other jurisdictions. However, it fails on certain grounds such as- not able to provide equitable remedy, following the doctrine of constructive notice disregarding the misuse of it by companies and not providing instances of implied powers. This led to criticism of the judgment in Oakbank oil. In order to deal with the inherent abuse of doctrine of constructive notice another doctrine of indoor management was developed to provide relief to the outsiders while dealing with companies. The doctrine of indoor management was first laid down in the case of Royal Bank v. Torquand[21] (popularly known as Torquand’s rule) that provides protection to outsiders against companies’ documents which are not available in public domain. The Indian court in Varkey Souriar v. Keraleeya Banking Co. Ltd[22] relied on the aforementioned doctrine. However, there are exceptions to its application such as- knowledge of irregularity (Howard v. Patent Ivory Manufacturing Co.[23]), forgery (Ruben v. Great Fingall Consolidated[24]) and representation through articles (Rama Corporation v. Proved Tin and General Investment Co.[25]).
The doctrine of constructive notice, howsoever appealing it looks, is flawed. It cannot be denied that it has certainly helped the companies in managing their relations with outsiders. This has facilitated the business for companies at an enormous rate. But it has also affected the contracting power of outsiders by making them vulnerable even in cases where they are innocent. Thus, there was need to reform this policy so the doctrine of indoor management was invoked as counter-measure. It relieved the outsider as it lessens his burden by sharing some liabilities with the company.
The judgment in Oakbank Oil although not against the law at that time was inequitable as it failed to appreciate the balance of inconveniences which was greater on the part of shareholders who have fully paid the amount. It made no exception for them thus making it mandatory for each party to know the documents even if it is internal. This reduces the authority of the judgment in Oakbank oil to be used in present circumstances. By and large, it also increased the work of companies by requiring express powers to be provided in articles of association even if they are obvious to conclude. Such absolute provisions are not good for fair dealings in the business transactions Though the judgment in Oakbank oil was not equitable as it didn’t mitigate the plight of outsiders in a company, it was valid according to law. It directed the attention of scholars to find a balance of liability between the company and outsiders. Thus it generated the need for a reformative approach towards the development of company law.
References:
[1]Oakbank Oil Company v. Crum,1882 8 AC 65.
[2]Id.
[3]Id.
[4]Id para 6.
[5]Id.
[6] 9 Ct. Sess. Cas., 4th Series, 198.
[7]Supra 1, para 18.
[8]Supra 1.
[9]Supra 1, para 23.
[10]Supra 1, para 25.
[11]Companies Act 1867, Section 24 (UK).
[12]Supra 1, para 26-28.
[13]Id.
[14]Merriam Webster, The Merriam-Webster Dictionary, (Revised Edition, Merriam-Webster US, 2009).
[15]Ernest v. Nicholls,(1953) 1 Ch. 131.
[16]KotlaVenkataswamy v. Rammurthy, AIR 1934 Mad 579.
[17]In Re Jon Beauforte Ltd, (1857) 6 HL Cas 401.
[18]Supra 1.
[19]Mangal Singh v. IFCI and others, (2010) 2 BC 1 (DRAT).
[20]Birch v. Cropper, (1889) 14 App Cas 525 (HL).
[21]Royal Bank v. Torquand, (1856) 6 E&B 327.
[22]VarkeySouriar v. Keraleeya Banking Co. Ltd, (1957) 27 Comp Cas 391.
[23]Howard v. Patent Ivory Manufacturing Co, (1888) 38 Ch D 156.
[24]Ruben v. Great Fingall Consolidated, (1906) AC 439.
[25]Rama Corporation v. Proved Tin and General Investment Co., (1952) 1 All. ER 554.
