The indoor management rule is a common principle, codified in Ugandan law. However, recent decisions from courts have applied the rule inconsistently, and have been a cause of concern as to what reliance can be placed on a company resolution by a party contracting with a company.
What is the indoor management rule?
The indoor management rule implies that a person dealing with a company in good faith is entitled to assume that the corporate acts provided for in the company’s documents have been properly and duly performed in compliance with articles and bylaws. The person is not bound to inquire whether such acts were duly supported by internal management.
However, sufficient inquiries have to be with the company’s constitutive documents before such presumption can be made. The law also requires that if power is given to the directors by an article of association of the company the decision of the directors to exercise it should be in accordance with the true construction of the article of association.
The indoor management rule has been codified under the Ugandan Companies Act 2012, which entitles directors to bind a company without limitation and further relieves a party dealing with the company from making any inquiries whether the transaction is permitted by the company’s memorandum or articles or any limitation on their powers of the board of directors to bind the company.
An opposing view is that this provision in the Companies Act only does away with the ultra vires doctrine rather than codifying the indoor management rule which then remains a common law rule.
There have been a number of recent Ugandan rulings dealing with the indoor management rule, and the significance of company resolutions.
- Necta (U) Ltd v Crane Bank
The borrowing powers of the company were vested in the company’s board of directors. The company passed a special resolution offering the company’s property to secure a borrowing. The resolution stated that the directors had resolved to offer their property as security for the requested overdraft. The resolution did not state:
- whether it was passed at a meeting of the company or by circulation;
- the amount to be borrowed;
- nor the date and place at which it was signed.
The resolution was signed by one director and the secretary of the company. However, the company itself contested that the resolution was not passed at a formal sitting of any organ of the company. This went against the company’s articles, which required that resolutions of the board of directors passed without a formal meeting had to be signed under the hand of all the directors. The company therefore contended that because the resolution was not signed by all the directors, it was invalid.
The bank contended it was protected by the indoor management rule. Having received a signed and registered resolution from the company, the bank was entitled to rely on it without need for further investigation of the circumstances in which the resolution was signed.
The High Court ruled that a meeting was not necessary before a resolution of the company could be signed by the directors and was comfortable that the only two directors were the signatories to the resolution and the security documentation with the bank. The court also found that since the resolution was on the letter head of the company, the place of signing of the resolution could be resolved by reference to the company’s stated address.
The Court of Appeal required that the bank prove that the resolution had either been signed following a meeting or had been signed by all the directors of the company at the time. In the absence of this evidence, the court quickly found that the special resolution was not valid.
The court made no comment at all on the title of the resolution as a “special resolution”. Under the Companies Act, a special resolution is one passed by 75% of the shareholders at a general meeting. The court had already established that under the articles of association of the company, the borrowing powers of the company were vested in the board of directors. The court should therefore have found that the resolution to borrow was invalid to authorise a borrowing as it was passed contrary to the articles of association of the company. This would perhaps have been a stronger ground to rely on.
- CTM v Allmuss
The Necta decision however directly contradicts the CTM decision, which was decided a few months prior.
Here, the contest was over a board resolution used to change of name of the company. The resolution had been accepted by the Companies Registry and a certificate of change of name issued. However, the company contended that its managing director had fraudulently presented the board resolution well knowing, that by law, a special resolution (by the shareholders) was required to change the name of the company.
The court, upon a review of the law on the indoor management rule and the Companies Act, stated that it would make business very difficult if persons dealing with the company in good faith would have to ascertain for themselves that the internal procedures of the company have been complied with before they conclude a transaction.
The court, while acknowledging that the Companies Act required a special resolution (and not a board resolution) to support a change of name, swept this distinction under the carpet on the basis of the indoor management rule and refused to hold against the third parties dealing with the company in good faith.
- Charles Harry Twagira v dfcu Bank
In Charles Harry Twagira v dfcu Bank, the plaintiff (borrower) denied ever giving the bank a resolution to authorise its borrowing and challenged the lending as illegal, void and therefore non-payable. This is despite having signed the facility agreement and taken the bank’s monies. Interestingly, the defence by the bank was that there was no law prohibiting them from advancing a loan to a borrower who has not provided a resolution.
The High Court quickly swept these objections away at threshold of the indoor management rule. The court also called in the aid of the Companies Act. The court refused to accept that the plaintiff, having taken the loan sums, could not delay on its own delinquency in not passing a resolution to escape the repayment obligation.
The Companies Act empowers the directors of a company to bind the company. Under the Act, a document executed by a director and the secretary of the company or by two directors of a company and expressed to be executed by the company, has the same effect as if executed under the seal of the company. Documents requiring authentication by a company may be signed by a director, secretary or other authorised officer of the company and need not be under its common seal.
We are inclined to agree with the CTM decision that it would be too onerous a burden for persons relying on company documents to be required to make further inquiries to establish the bona fides of the documents. How would, for instance, a prospective lender determine that the resolution in the Necta decision was passed without a formal meeting? Should the prospective lender ask for minutes of the board meeting? Should the prospective lender verify the signatures of the directors attending? Where does it stop?
A recipient of a company document signed as prescribed by law and the company articles of association should be entitled to place full reliance upon it. This would be good for the law and good for business.
Bright lights for banks
Regardless of how this contest over the indoor management rule ends, the good news for banks is that none of the borrowers in the above cases got away without payment of the loans. In all cases, the borrowers were ordered to repay the bank on the footing of a mix between principles of unjust enrichment and estoppel. The clear signal from the courts is that the finer points of the law and procedure may well be argued but a loan once taken must be repaid.
Read the original publication at ENSafrica