The Continued Role of the Common Law Indoor Management Rule Due Inquiry Exception

Introduction The Indoor Management Rule is a rule at company law which has had an interesting history of development within Australia. The rule allows outsiders dealing with a company to make assumptions about the internal consistency of decisions made by a company with its rules. The purpose of this paper is to consider the extent to which the common law Indoor Management Rule due inquiry exception applies in transactions ex post the introduction of s.l64(4)(b) of the Corporations Law. The paper will briefly outline the development of the indoor management rule within the Australian jurisdiction and consider the application of significant recent cases relevant to the due inquiry exception. The paper concludes with the view that the common law Indoor Management Rule operates in addition to the statutory Indoor Management Rule when considering transactions where an inquiry ought to have been made.


Introduction
The Indoor Management Rule is a rule at company law 1 which has had an interesting history of development 2 within Australia. The rule allows outsiders 3 dealing with a company to make assumptions about the internal consistency of decisions made by a company with its rules.
The purpose of this paper 4 is to consider the extent to which the common law Indoor Management Rule due inquiry exception applies in transactions ex post the introduction of s.l64(4)(b) of the Corporations Law. The paper will briefly outline the development of the indoor management rule within the Australian jurisdiction and consider the application of significant recent cases relevant to the due inquiry exception. The paper concludes with the view that the common law Indoor Management Rule operates in addition to the statutory Indoor Management Rule when considering transactions where an inquiry ought to have been made. 5 * Lecturer, Law School, University of Queensland. 1 Note the comments of Mason J in Northside Developments Pty Ltd v. Registrar General (1990) 64 ALJR 427 at 434 where he felt that it made little difference whether the Indoor Management Rule (in its common law form) was a subset of agency law or an organic principle of company law. 2 Commencing originally with English common law. 3 "Outsider" being a person who is neither a company officer nor a company member. 4 This paper was presented at the AAANZ Conference in Christchurch New Zealand in July 1996.. It relies upon the contents of work submitted for coursework assessment and draws substantially upon a paper presented to the Corporate Law Teachers' Conference (6-8 February 1994). 5 This paper seeks to provide a view on the possible outcome of the continued application of the common law. For a summary of points from the various cases see Law, LJ 'Security Transactions With Companies: Mitigating The Effect Of Defective Execution', The Queensland Law Society Journal, Volume 25, Number 5, October 1995, at 417.

The Indoor Management Rule
The Indoor Management Rule was established at common law in the case of Royal British Bank v. Turquand 6 . In Turquand the Court allowed the outsider to make the assumption that company officers had duly complied with the company's rules 7 . The directors of the company gave a guarantee to their bankers for borrowing without complying with their company's usual requirement of a shareholders' general resolution of approval. The company sought to rely on the absence of shareholder approval to avoid payment. The Court rejected this and found for the bank on the basis that the bank was entitled to assume that the borrowings were duly authorised. Accordingly the basis of this decision became known as the "rule in Turquand's case" and latterly as the "Indoor Management Rule". The exceptions to the common law Indoor Management Rule 8 were the Doctrine of Constructive Notice 9 , actual knowledge 10 , due inquiry 11 and forgery. 12 It is necessary to more fully consider the due inquiry exception at common law in order to understand its significance with respect to the current operation of the statutory exception contained in s.l64(4)(b).

The Due Inquiry Exception at Common Law
Due inquiry operated as an exception to the Indoor Management Rule at common law on the basis that an outsider was not entitled to make the presumption of regularity if the circumstances were such that the outsider should have inquired further, per Lord Simonds in Morris v. Kanssen 13 where he stated that an outsider: 6 (1856) 6 E&B 327. 7 At that time companies were incorporated by a specific Act of Parliament with a set of rules akin to articles called the Deed of Settlement. 8 The Doctrine of Ultra Vires is an aligned subject area which is beyond the scope of consideration in this paper. Briefly, Ultra Vires allowed a company to avoid being bound by a transaction which was "beyond its power"; see Re Haven Gold Mining Co (1882) 1996) "...cannot presume in his own favour that things are rightly done if inquiry that he ought to make would tell him that they were wrongly done". 14

In Custom Credit Holdings Ltd v. Creighton Investments Pty Ltd 15 a decision of
Clarke J in the Supreme Court of New South Wales, the question as to due sealing of leases by corporate execution arose for consideration. The leases were to be executed in accordance with the company's (Rohn Products Pty Ltd) articles which required a directors' resolution. The leases appeared to be duly executed and were accepted as such by the outsider (Custom Credit). Clarke J held that Custom Credit could not rely on the apparent validity of the execution because they had been put on notice. This was so because a resolution had not been passed by the company. Indeed one of the directors (whose signature was necessary) was clearly reluctant to execute the leases 16 due in part to advice given by his solicitor. Clarke J stated that: It is plain from... [the] facts that prior to the...[outsider] accepting the leases its officer was appraised of the fact that one of the two directors had not approved the execution and his solicitor was questioning its validity. In my opinion the outsider was put on notice of a probable irregularity and, having failed to make any further inquiry or taken any other steps to satisfy itself as to the validity of the execution, is unable to rely on the indoor management rule. 17 Because the leases were executed in 1983, before the introduction of the statutory Indoor Management Rule, the common law Indoor Management Rule due inquiry exception operated to preclude the outsider from relying on the apparent valid execution of the lease documents.
Thus where an outsider has knowledge which gives them reason to inquire as to the internal matters of the company and they seek to rely instead on the presumptions allowed by the Indoor Management Rule, then the outsider will not be able to so rely. This proposition was clearly supported by Kirby P in Registrar-General v. Northside Developments Pty Ltd & Ors 18 where he cited Wright L with approval 19 stating that:

The current form of the Indoor Management Rule in Australia is found within the Corporations Law in s.164. In Barclays Finance Holdings v. Sturgess & Ors 25
Wood J stated that the statutory provision was introduced to clarify the common law position rather than to make a new rule. 26 The statutory provisions were introduced to apply from 1 January 1984  Management Rule are contained in s. 164(4) which precludes reliance by an outsider in the circumstances of actual knowledge, and in limited circumstances of inquiry, particularly: 164(4)(a) "the person has actual knowledge that the matter that, but for this subsection, the person would be entitled to assume is not correct; or" 164(4)(b) "the person's connection or relationship with the company is such that the person ought to know that the matter that, but for this subsection, the person would be entitled to assume is not correct." The actual knowledge exception in s. 164(4)(a) is clearly a restatement of the actual knowledge exception to the Indoor Management Rule at common law. Section 164(4)(b) however, appears to be narrower than the due inquiry exception at common law requiring some sort of "connection or relationship" as a prerequisite for an outsider to be put on inquiry. Section 164(4)(b) is clearly critical for outsiders, particularly bankers in understanding the ambit of protection which borrowing companies are given by the statute. The Explanatory Memorandum to S.164(5) 28 does not provide assistance in seeking to determine a clear interpretation of the ambit of operation of the section. 29 It is therefore necessary to refer to the case decisions which have specifically considered the ambit of s.l64(4)(b).

Relevant Cases Considering the Statutory Indoor Management Rule
Unfortunately the cases considering the Statutory Indoor Management Rule have not been consistent in their application of s. 164(4)(b). This presents difficulty for those seeking to rely, 30 since there is uncertainty with respect to the ambit of inquiry which financial institutions are to make in taking security. 31 A consideration of these cases now follows. considered with respect to a transaction where funds were advanced by one company (Broadlands) to another (Media) in the absence of compliance with the latter's articles 33 .
When Media failed to make the required loan repayments it sought to preclude Broadlands' reliance on the statutory Indoor Management Rule 34 on the basis that the transaction in question was executed in a manner contrary to the usual way in which the two companies dealt.
Nicholson J. considered the meaning of "connection or relationship" stating that: Section [164(4)(b)] refers to knowledge a person ought to have by reason of his connection or relationship with the company and not to knowledge which he ought to have because something in the particular transaction would put a reasonable person on enquiry. The focus of para, (b) is on the nature of the "connection or relationship with the company". In my view, these words require reference to the facts which show the nature of that connection or relationship and an assessment of whether that connection or relationship was such as ought to have produced the state of knowledge referred to in para, (b). 35 Therefore because Media's reference to matters of the transaction were to wider circumstances and not to the "connection or relationship" with Media, Broadlands was allowed to rely on the statutory Indoor Management Rule. 36 Thus the interpretation of the statutory exception contained in s 164(4)(b) given by Nicholson J was narrower in application than the common law due inquiry exception, 37 finding that Broadlands had no "...legal or non-arm's length connection or relationship. Accordingly, the transferee company was precluded by s 164(4)(b) from relying upon the statutory Indoor Management Rule.

Brick and Pipe Industries Ltd v. Occidental Life Nominees Pty Ltd
In Brick and Pipe Industries Ltd v. Occidental Life Nominees Pty Ltd 43 the plaintiff (Brick and Pipe) was acquired by the Goldberg group with the Brick and Pipe's shares held by a Goldberg subsidiary (Arnsberg Pty Ltd). Brick and Pipe was subsequently used to guarantee funds advanced to another Goldberg group company, Spersea Pty Ltd. Brick and Pipe did not receive any benefit from giving the guarantee. After the failure of the Goldberg group Brick and Pipe asserted that the outsider financier (Occidental) was precluded from relying on the Indoor Management Rule. The court found in favour of the financier. 44 Interestingly, in Brick and Pipe the court felt that s.l64(4)(b) did not include

the common law exception of being put on inquiry stating that:
Although [s.164] was undoubtedly inspired by the rule in Turquand's case and is in a sense a codification of it, the section does not incorporate the concept of being "put on enquiry" and we are obliged to have regard to the assumptions, as defined by the section, which the respondents were entitled to make subject to the exceptions in subs.4. 45 Therefore the court in Brick and Pipe supported the view of the statutory exception given in Lyford.

Advance Bank Australia Ltd v. Fleetwood Star Pty Ltd & Anor
In Advance Bank Australia Ltd v. Fleetwood Star Pty Ltd & Anor 46 the company, Fleetwood Star Pty Ltd held the director's (and his wife's) family home. The director fraudulently forged his wife's signature in order to give the family property as third party security for an unrelated transaction. In this case the court cited Brick and Pipe with approval stating that: Whilst [s.164] was derived from the rule in Turquand's case, it seems to me that the codification is broader in the protection it extends to a person dealing with a company. The codified rule does not attract consideration of those matters which prior to the codification might have been considered to have put a person dealing with the company upon inquiry. 47 On appeal 48 however, Gleeson CJ felt that Parliament probably had not intended to limit the operation of s.l64(4)(b) stating that: In Lyford...Nicholson J observed that the focus of [s.l64(4)(b)] is on the nature of the third party's "connection or relationship with the company". Indeed to ignore that would be to render the first ten words of the paragraph otiose. The inquiry is whether that connection or relationship was such as ought to have produced the relevant state of knowledge. It is impossible exhaustively to state the facts or circumstances that might give rise to or involve a relevant connection or relationship. Obvious examples would be dealings between a company and a person who is a director or shareholder or employee...However, the provision is not limited to such cases, and whilst it is necessary to attend to the language of the statute, it is unlikely that Parliament intended a radical narrowing of the qualification to the common law rule. 49 The appeal decision of Advance Bank represents the turning point in judicial opinion as to the ambit of the statutory due inquiry exception.

Bank of New Zealand v. Fiberi Pty Ltd
The case of Bank of New Zealand v. Fiberi Pty Ltd 50 considered circumstances similar to those in Advance Bank. As for Advance Bank, in Fiberi the company held a residential property asset occupied by its directors. This residential asset was used by one of the directors (Doyle) to give guarantees and a third party mortgage to the bank as security for advances made to other companies of which Doyle was a director. Allen J held that the bank was not able to rely on the statutory Indoor Management Rule for similar reasons as those given by the High Court in its consideration of the common law position in Northside, namely that: The bank knew that Fiberi was not a trading company... [and] that there was no apparent benefit from the transactions to Fiberi, the company, as distinct from the benefits to the man...indeed the material before the bank suggested the contrary. On the reasoning of every one of the judges who constituted the bench in Northside...the bank was put upon inquiry. 51 On appeal 52 Kirby P strengthened the possibility of using the common law due inquiry exception in addition to s.l64(4)(b). With reference to Northside, His Honour noted the folly of jumping to extreme conclusions about the ambit of the statute without having regard to its practical consequences. 53 Kirby P then made an analysis oí Northside drawing parallels with the facts of the case before him with respect to the due inquiry exception. 54 Kirby P considered the ambit of s.l64(4)(b) rejecting the view of both Studdert J in Advance Bank and the Court in Brick and Pipe that the statute does not include the "common law concepts of being put upon inquiry". 55 Kirby P clearly stated that the common law Indoor Management Rule due inquiry exception can be read as included within the operation of the statutory Indoor Management Rule: ...the [section] is expressed in sufficiently broad terms to indicate that a person dealing with a company will be taken to know that certain assumptions are not correct where the circumstances of the "connection or relationship with the company" put that person upon inquiry.
The question of what activates the requirement of an inquiry is..best answered by the common law... on inquiry... [and] does not involve a test more restrictive than that which exists under the common law. 56

Comment
It therefore seems that the later cases point towards the continued operation of the common law due inquiry exception within the ambit of s.l64(4)(b). This will ensure that the apparent poor drafting of s.l64(4)(b) does not hamper the practical realities of being put on notice by a transaction. Whilst the courts have been careful to apply the common law due inquiry exception within the ambit of the statute, it is suggested that the common law Indoor Management Rule might simply be able to operate in addition to s.l64(4)(b).
The idea that the common law Indoor Management rule due inquiry exception might apply in addition to s.l64(4)(b) has not been wholeheartedly embraced by other commentators. Horrigan 57 has suggested that the cases of Northside and Brick and Pipe suggest that s.164 "largely subsumes the common law on indoor management, so that there probably scant room for common law notions of being put on inquiry". 58 Although he does consider it appropriate to "import" the common law due inquiry exception 59 (a concept similar to the view of Kirby P in the Fiberi appeal) at times where it is impossible to separate the operation of s.l64(4)(b) from circumstances putting the outsider on notice where a reasonable person would make further inquiry. It is suggested that Kirby P placed a wider interpretation on the operation of the common law due inquiry exception, such that if the circumstances of due inquiry arise in a case to which the statute applies, then the common law is to be considered. Two recent case decisions support this wider view that the common law due inquiry exception operates in addition to s.l64(4)(b).

Recent decisions
Two recent decisions of the Victorian Supreme Court, 60 Sixty-Fourth Throne Pty Ltd v Macquarie Bank 61 and Pyramid Building Society v Scorpion Hotels Pty Ltd, 62 assist in determining the role of the common law Indoor Management Rule due inquiry exception.
Both cases involved circumstances which were similar to Fiberi. In each case

Conclusion
This paper has examined the extent to which the common law Indoor Management Rule due inquiry exception applies to modify the operation and ambit of s.l64(4)(b) of the Corporations Law.
Until the High Court hears a statutory Indoor Management Rule case in circumstances requiring consideration of s.l64(4)(b), the precise ambit of the application of common law due inquiry will remain unsettled. Notwithstanding this, the current trend injudicial opinion is that the s.l64(4)(b) exception is sufficiently wide to incorporate an application of the common law indoor management rule due inquiry exception. Whether s.l64(4)(b) incorporates the common law or whether the common law applies in addition to s.l64(4)(b) is a moot point.
The continued application of the common law will facilitate reasonable and practical outcomes in the use of s.l64(4)(b). No commentary, including this paper, has suggested that the statutory provisions will be less effective or indeed taken over by this recognition of the role of the common law.
Therefore it is suggested that the common law due inquiry exception operates in addition to the statutory exceptions contained in s.l64(4)(b) and both the common law and the statute are necessary considerations for those seeking to rely on the S.164(3) assumptions.