Indoor Management

While a corporation is legal person, with its own assets, liabilities and legal rights, it does not have a mind of its own or opposable thumbs, which are certainly required, for example, in executing contracts.  As a result, corporate resolutions are passed or other authorizing procedures followed and signing officers physically sign a contract on behalf of a corporation.  It is not then overly surprising that the attempts have been made to argue that a corporation should not be bound by an agreement as certain corporate procedures authorizing the transaction were not properly followed or the person signing on the corporation’s behalf was not properly authorized to do so. The legal doctrine known as the indoor management rule was developed to deal with the issue.  

The law provides that it is not necessary for third parties to enquire into the corporation’s internal authorization requirements. One of the basic rationales is that the flow of commercial transactions, and the economy with it, would be brought to a screeching halt if the third parties, prior to signing any agreement with a corporate entity, were required to complete a thorough due diligence to ensure that such corporation is indeed properly authorized to sign.  This principle was first formulated in 1856 in England and became known as the “indoor management rule”.   The Canadian common law has adopted the rule which was also codified by our legislation.  The courts have held that a third party is entitled to rely on actions taken by officers of a corporation on the basis that they were within the authority usually granted to officers.  Such authority can either be actual or apparent authority. Actual authority, whether express (such as by a resolution) or implied (by a position held) is binding between a company and others.  Apparent authority creates a direct legal relationship between a company and a third party, based on the company’s representation to the third party that a certain employee or an officer has the authority to act on the corporation’s behalf.  In most of the cases considered by the courts, the actions were found to be in the ordinary course of the corporation’s business and therefore within at least the apparent authority of the employee or the officer in question. 

The courts held that a company is bound by the acts of persons who take it upon themselves, with the knowledge of the directors, to act for the company, provided such persons act within the limits of their present authority, and that strangers dealing bona fide with such persons have a right to assume that they have been duly appointed. The courts also held that it is not appropriate to ascribe an implied authority to a subordinate employees of a company in the way implied authority could be ascribed to a senior officer.

Action outside corporation business

The indoor management rule does not apply where an employee took action outside of the ordinary course of the corporation’s business and accordingly beyond the scope of authority an employee could be expected to have.  For example, in one case, an administrative manager with the defendant credit union had devised a scheme to defraud the credit union through the issuance of letters of guarantee.  The court found that the plaintiff (a party to whom the letter was issued) could not rely on the administrative manager’s ostensible authority since issuing such letters of guarantee was not part of the usual or ordinary business of the credit union and not part of the manager’s usual or ordinary duties.  The court held that although passive acquiescence on the part of a corporation may amount to holding out so as to create ostensible authority, that can only happen (in the absence of a direct representation) when an employee is in the course of his ordinary duties.  Therefore, if there is any evidence to demonstrate that signing officers of a corporation were acting outside of scope of their ordinary duties or outside of ordinary course of corporation’s business, in signing a particular agreement, the argument that their actions are not binding on the corporation could be made.

Also, a corporation will not be bound when a third party knew, or should have known, that something else was required before a particular action of the corporation was authorized.  For example, if it could be demonstrated that a thirty party knew that a particular form of corporate resolution authorizing a particular transaction was necessary, but no such resolution was passed, the argument could be made that the corporation is not to be bound by the resulting arrangement.  

Public Record

Placing certain documents relating to the corporation on the public record, does not amount to a constructive notice of the corporation’s authorizing requirements.  In other words, such filing does not charge third parties with the responsibility to ensure that their dealings with the corporation are not contrary to the provisions of those publically filed documents.  For example, in one case, a borrower argued that persons who signed a guarantee purportedly given to a bank by the company lacked the authority to do so and accordingly that the guarantee was not binding on the company.  There had been no board meeting held to approve the guarantee and the company argued that the bank knew (or should have known) based on the circumstances and on the company’s articles (which were publically filed) that no board meeting had been held.  The Court held that in signing the documents as they did, the signatories represented that the requisite board meeting had been held. The court held that a third party is not deemed to have knowledge of the company’s public documents and as a result there is no constructive notice.

Finally, where the board of directors of a corporation has failed to pass a resolution or there was some defect in the constitution of the board or in the meeting mechanics, the court may hold that the board has subsequently ratified the action.

For example, in one case it was the corporation’s president who recommended certain investment to the board of directors (purchase of shares of another corporation), but did not disclose certain information at that time, including that some of the financial information was inaccurate and that a material lease had been terminated.  After the investment was made, the minutes of a meeting of the board of directors showed that directors became aware of the information which was initially not disclosed by the president but treated the purchase as being effective and complete.  The court held that the board of directors had ratified the president’s actions and noted that ratification in law is based on approval or adoption of an act done by an agent without authority of the principal.

The court stated that those actions, including the lack of repudiation, constitute at least by implication a positive and unequivocal course of action which indicates ratification of the act of the president in making the purchase.   The only restriction to which the courts have referred is that ratification must take place within a “reasonable” period and have considered whether any person would be prejudiced if the resolution was subsequently ratified. 

In summary, the circumstances may exist where a corporation will be found not to be legally bound by an agreement, due to a lack of proper authorization.   However, such circumstances are quite specific and the indoor management rule is firmly in the way of corporations getting out deals which are no longer desirable, based on arguments that formalities were not followed. 

The content of this article is intended to provide general information for the reader and is not intended as advice or an opinion to be relied upon in relation to any particular circumstance.  For specific applications of the law to a particular set of circumstances, the reader should seek professional advice.

* Faruk Gafic practices in the areas of corporate law as well as commercial real estate and leasing with McLean & Kerr LLP, a law firm based in Toronto.