Matters related to the Personal Protection in case of Corporate Contracting in Hong Kong Company Setup Service along with Common Law Indoor Management Rule


Corporate abuse is very apparent and prevalent in the corporate section after opening a business in Hong Kong and not everyone is doing business for right purpose because where there is the red apple, there is the rotten one too. So, probability exist that third party or outsider may suffer some damage or injury to their stakes by the unfortunate mechanism of corporate abuse on the part of agents. There is the possibility of the fact that, after opening a business in Hong Kong the person depicting of usual authority to contract on behalf of the company, does not holds the proper authority and this veil could let third parties or outsiders to get fool and they purportedly considers the person with usual authority. So, in this situation prima facie third party or outsider is innocent and thus their innocence should be compensated hence this is the reason there must be some protection to the third party, in case of such corporate abuse. One may sense the protection to third party, from the principles of apparent authority. However, to create a company in Hong Kong following are some of rules and provisions through which protection of third party can be ensured:

  • Indoor Management Rule as per Common Law.
  • Statutory Indoor Management Rule.
  • Property and Conveyancing Ordinance.
  • Ratification.
  • Validity of directors act and documents under seal.

Legal and commercial protection is what attracts the investment and boost the corporate sector of any country. So, all these rules and provisions are mandatory to be discussed in detail. However, we will first discuss the Indoor Management Rule, as it is the prime provision related to the protection of third parties and to prevail the authenticity of corporate contracting.

Common Law Indoor Management Rule

Outsiders are protected against any abuse or irregularity through the Common Law Indoor Management Rule. Its other names are; Internal Management or the rules set out in the case of Turquand. As per the general idea of these rules; any person who deals with the company in good faith and is affirmed he/she is acting in good faith and duly performing his/her responsibilities, then such person need not to enquire about the regularity of the matters within internal management of the company, he/she is dealing with. Now let’s go the case of Turquand and see what happened there and how these rules were made. The case of Turquand refers to the situation where a loan transaction was in question. The loan transaction was to be enforced against the company on the account of the argument that, board of the company authorised this transaction even thought this transaction was against the constitution of the company, as per which board’s prerogative to authorise the transaction is optional if members of the company have endorsed so in the general meeting. The outsider was supposed to be kept aside of this conflict in the internal management of the company, thus he was supposed to consider that approval had been given and hence on the account of this, the outsider was entitled to bind the company to the transaction.

Scope of Indoor Management Rule

We have generally discussed the Indoor Management Rule, now let’s ascertain its scope. To create a company in Hong Kong the scope of Indoor Management Rule is extended to the irregularities and defects in the way authority was conferred or in the way authority was exercised. The verdict of Australian High Court in the case of Northside Developments Pty Ltd can be well referred here to ascertain the scope of Indoor Management Rule. Justice Brennan in this case, communicated that:

Wherever indoor management rule is applied, it usually covers all the routes and links established between the constitution of the company and the act done by office or agent of the company, to which complaint was lodged or objection is raised. Following are some of acts or issues covered by the Indoor Management Rule:

  • Appointments of the directors, other officers of the company, agents of the company and any subsequent appointments of them.
  • Intensity and extent of any conferring of authority to the agents and officers of the company.
  • The extent of satisfaction regarding the way, authority was governed in the instant case.

So, only three are the categories upon which Indoor Management Rule can be applied or on basis of which it could be assessed such as; conferring of authority, matters related to the appointments and the extent of satisfaction of conditions.

Let’s move towards the situation where rules were set out in the case of Turquand and let’s find out that in what situation these rules could mark their impression. Rules of Turquand case can be held applicable in the situation where board passes the resolution to authorise the company to enter into contract or transaction, in question, and third party wants to seek the remedy or protection on account of the argument that there was some procedural irregularity in the way meeting was held. Such procedural irregularity can be the situation where certain directors were not given the notice of meeting and irregularity was of that extent, which can amount to the invalidity of the meeting. Other situations which can entitle the third party or outside, to the protection, includes:

  • Turquand case rules can be applied to the situation where director was found fail to disclose the conflict of interests, in the meeting in which transaction or contract was authorised.
  • Turquand case rules can be applied to the situation where transaction or contract was authorised in the meeting, but meeting does not have the minimum required quorum.
  • Turquand case rules can be applied to the situation where borrowing was made above of the limit, as specified and allowed by the constitution of the company.

The next question is itself very thought provoking and has the very sound ground. A very legitimate question is raised on the scope of Indoor Management Rule and the question asks; if to open company in HK, Indoor Management Rule shall be applicable in the situation where the absence of apparent and actual authority is apparent or where there was no attempt was made by the company to authorise any person or holding out the company to carry out the transaction. For example, consider the situation where office boy without any actual or apparent authority negotiates the term of transactions with the third party and ultimately enters into the transaction with the office, on behalf of the company. So, in this situation, will it be legitimate to hold this transaction as legitimate and will outsider be able to bind company to the transaction? This question is of sound technical extent and is of the intensity where it may be abused. So, answer or clarification of this technical point is very important.

Generally, if we try to assess this matter then general principle says that; any person who neither holds apparent authority nor holds the actual authority, any transaction or contract made by such person would not be a binding on a company nor it shall be called as a valid contract. However, legal perceptions are not made on the prepositions, so some legal reference is required. Justice Dawson stepped in to cope up with this technical issue and answered this in the case of Northside Developments Pty Ltd; Hon’ble Justice Dawson communicated that:

The Indoor Management Rule cannot be applied in the situation where none of authorities such as Apparent or Actual is not confirmed, thus in this situation outsider is entitled to put into inquiry the regularity in the internal affairs of the company, when person who apparently had the authority confronts the third person to transact. This can more be understood in simpler words as; Indoor Management Rule shall only be applied in the situation where the person who purportedly acted for the company, either holds the actual authority or the apparent authority. Therefore, this rule is solely dependent upon the operation of normal agency principles and thus such rule could only be operated if the alleged person is acting or acted in the capacity of actual or apparent authority.

This was however the foreign legal remarks, let’s find out what reference could Hong Kong legal history provide to smoothen the post open company in HK period. Lord Neuberger NPJ was found to be in favour of remarks of Justice Dawson in the case of Northside Developments Pty Ltd and same remarks were cited in the main judgement of Court of Final Appeal in the decision of Akai Holdings Ltd and same was made part of the verdict in the case of Albert Hwang.

You may now be thinking that what about the fate of documents where common or official seal of the company is affixed? So, there are some suggestions regarding the application of Indoor Management Rule in the situation where seal of the company is affixed on the document upon which contract or transaction, is relied. It is possible to apply Indoor Management Rule in this situation despite of absence of actual and apparent authority.

Mason CJ in the case of Northside Developments Pty Ltd casted the distinction about application of Indoor Management Rule in the situation seal of the company is used and his honorship considers that use of company seal in this regard has not been extensively described by the principles of agency law. Mason CJ say that;

If the person who is dealing with company, receives the document to which company seal is affixed and it is knowledge of this person that this seal is affixed in the presence of individuals designated by the constitution of the company to foresee such matter, then such person is entitled to perceive the validity of these documents.

He further communicated that:

Wherever the seal of the company is affixed to the document which ultimately gives rise to the assumption that this seal has been affixed with the usual authority of the directors. so, it must be considered valid and authentic.

We have heard a lot about case of Northside Developments Pty Ltd, let’s see what happened in this case so that reader could better be able to understand the circumstances and basis of our discussion. Case of Northside Developments Pty Ltd presents of the situation where director of the company named Mr. Sturgess acquired mortgage through the seal of the company. This use of company seal was against the provisions of company’s constitution because constitution of the company required seal to be used under the authority of the company’s directors and once the seal has been affixed, there should be the signature of one director, further counter-signed by any other director or the secretary of the company or any other person who has been appointed by the board for this purpose of authorisation. But, facts presented of the situation where Mr. Sturgees affixed the seal of the company on the mortgage documents and signed himself as the director of the company and his son signed as the secretary of the company. Australian High Court held this transaction to be not a binding on the company because neither this mortgage was authorised by the company’s directors nor Mr. Sturgees’s son was the secretary of the company.

Mason CJ was convinced to apply Indoor Management Rule in this case but later presented circumstances convinced him to look into the situation where neither Mr. Sturgees and his son does not have the actual authority to enter into mortgage as well as no apparent authority was visible from their position in the company. So, we can say that, use of company seal in these circumstances is of critical state especially where is neither apparent nor actual authority on the part of officials who purportedly acted for the company.

It must be remembered that rules entailed in the case of Turquand deems to protect only the third parties and not the company.

Pleading

Rules underlined in the case of Turquand is a plea of mixed facts and law so whenever the application is made relying on this rule, plaintiff is supposed to raise plea based on the rules of the pleadings and provision of substantial evidence and all relevant material facts, to support his/her application.