Doctrine Of Constructive Notice 

Introduction

Section 2(20) of the Companies act, 2013 defines a company as “a company incorporated under this act or under any previous company law”. Incorporation is a legal procedure by which a company comes into existence. After the company has been incorporated, it attains the character of a separate legal entity which gives it a distinct identity from its members, shareholders and other officers.

The procedure for incorporation of a company is provided under Section 7 of the Companies act, 2013. It indicates that certain specific documents are required to be filed with the Registrar of Companies in order to get a company incorporated. These documents include Memorandum of Association, Article of Association, list of directors of the company along with their consent, a statutory declaration, and such other documents as prescribed under this provision. Besides this, all of the conditions set forth in the Companies act of 2013 for the incorporation of a company must be complied with. The Registrar of Companies issues a certificate of incorporation after all of the documentation have been properly submitted and reviewed by the Registrar of Companies.

The Memorandum of Association (MOA) and the Article of Association (AOA) are the two most significant documents of a company. The powers of a company are described under its Memorandum and therefore it is also known as the charter of the company. According to Palmer, “the memorandum of association is a document of great importance in relation to the proposed company” as it describes the objects and the scope of work of a company. Article of Association, on the other hand, is the supplementary document that outlines the rules and regulations that must be observed by the company.

Following the incorporation of a company, these documents become public records under section 610 of the Companies act, 1956 that may be viewed by any person who is not a part of the company on the payment of a nominal fee. Each and every outsider interested in entering into a contract with the company or becoming a shareholder must read the company’s memorandum and article, as these documents contain all the information regarding what the company can and cannot do. If a person does not read these documents before signing a contract with the company, he or she will not be able to enforce the deal in order to obtain the benefits as promised. This principle is laid down in the Doctrine of Constructive Notice.

Doctrine Of Constructive Notice- Meaning And Provisions

The doctrine of constructive notice states that every outsider who enters into a contract with the company is presumed to be aware of all the contents of the Memorandum and Article of Association. Everyone has the right to examine these public documents in order to understand about the powers and requirements of the company for engaging into such a contract. Section 399(1) of the Companies act, 2013 states that upon registration of a company, all the documents which are registered with the registrar becomes public document and therefore they can be accessed by the people as and when required.

However, records filed with the registrar only as a matter of record, does not become public document. Only the documents which are submitted to carry out the registration procedure can be accessed by the public. This doctrine favors corporations over outsiders because if an outsider enters into a contract with a company without scrutinizing the memorandum and article of association and a discrepancy arises afterwards, the courts will not consider the contract as a valid contract and no liability would be imposed on the company. It would be presumed by the courts that the outsider entered into such a contract after reading the terms and conditions of the company.

This doctrine is based on the common law maxim of, “ignorantia juris non- excusat” which means that ignorance of the law is not an excuse. According to this maxim, it is presumed by the court of law that every party which enters into a contract is aware of the law and therefore, ignorance of the law cannot be used as a defense to avoid liability. This principle is also followed by the courts in India and therefore a company is not held liable for a contract which is entered into by the parties in ignorance of the rules and regulations of the company.

European Communities Act, 1972

The doctrine of Constructive notice was first mentioned under section 9 of the European Communities act, 1972 and it significantly altered the ultra vires principle which is extensively used in the company law. According to this provision, after a company’s certificate of incorporation is issued by the Registrar of Companies, it is presumed that any individual who deals with the company is deemed to have constructive notice of the components of its memorandum and articles of association and other relevant documents which are made available to the public for inspection. This has ceased to be the case since an amendment to the Companies act, 1985 was made in the year 1989 which provides that a person shall not be presumed to be informed of a matter simply because it is disclosed in a document submitted to the registrar and therefore stands available for public inspection.

However, this doctrine of constructive notice would mean that an individual would be presumed to know the contents of certain relevant documents of the company in which the company deals such as the scope of business of the company, its authorized share capital, shares issued and so on. Thus, a person entering into a contract with a company cannot object or claim if such a contract is declared invalid because it contradicts with the conditions, rules or bye- laws of the company. It is the duty of such person to carefully examine the relevant documents before entering into any contract.

Purpose and Effect of the Doctrine

The main rational behind the development of this doctrine is to protect the corporations from the outsiders or third parties. A company cannot be held liable for the ignorance of the other party and therefore, no claim of the other party arises against the company for their own fault. Furthermore, all the public documents of any company are easily available and therefore, it is the duty of the outsider or the third party to not only read them but also scrutinize them properly before entering into any contract with the company.

Thus, if any person enters into a contract which is in violation of the memorandum or article of association then such contract cannot be enforced in a court of law. The person cannot claim that he or she was not aware of the terms and conditions or guidelines of the company.

For instance: Suppose that a company, Stars Ltd. takes a loan of Rs. Five lacs from Mr. Ram. the company’s article of association, however, specify that the company cannot take a loan of more than Rs. Three lacs. Mr. Ram signs the loan agreement while being ignorant of such a rule. The loan agreement, in this case, would not be considered as a valid agreement since it is in violation of the company’s rules and guidelines which are provided under the article of association.

The company is not liable as such a contract is itself invalid and therefore, no right of the other party arises. To sum up, it can be said that this theory has a negative and harsh impact on the other party.

Case Laws under the Common Law

The doctrine of Constructive notice was first laid down in the landmark case of Ernest v/s Nicholls, where a company entered into a contract with another company for acquiring their goodwill. The contract was signed and sealed by two directors of the company however, it needed to be signed by three out of the four directors of the company according to the rules of the company. The House of Lords was of the opinion that the article of association which limits or regulates the authority and powers of the company must be specified in a mandatory way for those engaging in a contract with the company. It was ruled that an outsider cannot compel a corporation to execute a contract on the basis of the contractor’s purported authority as forcing the entire corporation to adhere to the contracts signed by the contributors will result in utter chaos.

In another case of Knopp v/s Thane Investment Limited, the court was of the opinion that the director’s inability to follow the articles rendered a contract that was not in accordance with the article of association invalid. If the concept of constructive notice were properly followed, an outsider could not complain about a lack of power since they were presumed to know that the powers of the agent of the company is limited.

As the doctrine had a very strict and harsh impact on the other party, the courts, on the other hand, were very eager to reduce the impact of constructive notice. An action was taken in the case of Royal British bank v/s Turquand, for the payment of money borrowed by the firm from an outsider. The company’s contention was that no obligation of the company to repay the loan amount arises since the manager who arranged the loan should have been allowed to borrow by a resolution of the general meeting, which he did not have. The bank was presumed to have the knowledge about the same before providing any loan to the company. The public documents of the company only indicated that the resolution is necessary and not that it is mandatory that such a resolution has been passed. Because the bank was unaware that the resolution had not been passed, the borrowing did not appear to be invalid on the basis of the public documents.

Indian Case Laws

In India, too, the courts have been hesitant to apply the theory of constructive notice. The doctrine was first applied in the case of Charnock Collieries Co. Ltd. v/s Bholanath Dhar, where it was held that it is the duty of the outsider or any party to the company to read the article of association before entering into any contract and nothing more than that.

In Ram Buran Singh v/s Mufassil Bank Ltd., the Hon’ble High court of Allahabad held that the company is estopped from rejecting its duties under the contract in issue as long as the power of delegation exists in the articles and the act of the agent is not subject to the concept of ultra vires.

In Dehradun Mussoorie Electric Tramway Co. v/s Jagamanandaradas, the Hon’ble High Court of Allahabad rejected the doctrine of constructive notice and held the company responsible to the party to the contract, even though the company’s directors borrowed the money in violation of the article of association and without obtaining a resolution from the general body.

In another case of Official Liquidator, Manasube and Co. (P.) Ltd. v/s Commissioner of Police, the Hon’ble High Court of Madras held that while the lending institutions to a company should familiarize themselves with the memorandum and article of association, they cannot be intended to investigate thoroughly the legitimacy, propriety and regularity of the director’s acts.

From the above-mentioned judgments it can be inferred that the application of the doctrine of constructive notice is different in the Indian law as compared to the common law. The Indian Contract Act, 1872, which also deals with the law of agency in India, is one of the most fundamental reasons why the concept of constructive notice has not achieved a significant foothold in India.

Criticisms against the Doctrine

Due to its severe and punitive implications, the theory of constructive notice has posed several problems and challenges. It has been troublesome in business and commercial transactions, particularly when the article of association permitted the directors or other employees of the organization to use certain powers only if they have been prior approved by the shareholders.

As a result, it makes it difficult for the outsiders to learn about what is going on inside the company and whether their contract has been valid by the company’s shareholders or not. The theory of constructive notice was first used negatively in the case of Kotla Venkataswamy v/s Rammurthy, when the doctrine was applied in its ordinary interpretation by the Hon’ble High court of Madras and the third party mortgagee was denied relief due to the transaction’s irregular nature. Because of such strict interpretation, this doctrine is considered to be a far- fetched concept which is fictitious in nature and established only by the rulings of the court.

The criticism of this doctrine lead to the formation of another doctrine called; the ‘Doctrine of Indoor management’. It is also known as the ‘Turquand rule’ and is a one hundred and fifty year old notion that protects outsiders from the company’s activities. Any individual who enters into a contract with the company must make certain that the transaction is authorized by the company’s articles and memorandum. This doctrine was created to protect the outsiders who enters into a contract with the company from the company’s excessive powers.

Conclusion

The doctrine of constructive notice is a strict and fictitious concept which gives unnecessary and non- essential liberty to the corporate body against the outsiders or the third parties who enters into a contract with the company. The theory originated in the common law system and has not been widely utilized in Indian courts. By introducing Section 9 of the European Communities Act, which acknowledges the notion of good faith in economic transactions, the concept of constructive notice was also abolished. This provision corresponds to the reality of the commercial business, where people outside the company conclude the various contracts not on the basis of company documents but in good faith of the company. As a result, the doctrine has not gained much importance in the present day business transactions.