Indoor Management Rule and Contractual Authority

This assignment delves into the legal concept of the 'indoor management rule,' particularly its relevance within the context of corporate contracts. It examines how this rule allows third parties to assume an individual acting on behalf of a company has the authority to bind that company, even if their appointment or authority is later disputed. A case study involving Mary, a former director who purchased a car charging it to her company after resigning, illustrates the practical application of this rule and relevant legal provisions like Section 129 of the Corporations Act.

1a) Under what type of business structure are Mary, Fred and Chris running the business?
In this question, it has to be seen that Mary, Fred and Chris are learning the business under what
type of business structure. In this regard, a partnership can be described as a relationship that
exists between the persons who are carrying on business in common and with a view to earn
profit. This definition of the partnership can be found in the Partnership Act. In view of the
definition of partnership, there are three elements that are essential for the creation of a
partnership.
(i) Carrying on business
(ii) In common;
(iii) With a view to one profit.
In Smith v Anderson,1 the Court has stated that carrying on a business means the repetition of
acts. Therefore the case of an association that has been formed only for doing one act has been
excluded. There should be a series of acts that constitute a business. It was stated by the High
Court in United Dominions Corporation Ltd v Brian Pty Ltd.2 that a single adventure may
amount to carrying on business depending on its scope. The next requirement is that the business
should be carried on in common. This is also a key element of the definition of partnership.
However it is not necessary that and a control should be played by all the partners in managing
the affairs of the business. It simply means that the business should be carried on or on behalf of
all the partners.3 The third element that is necessary for the existence of a partnership is that the
business should be carried on with a view to earn profit. Therefore, the objective of the business
1 Smith v Anderson (1880) 15 Ch D 247
2 United Dominions Corporation Ltd v Brian Pty Ltd. (1985) 157 CLR 1
3 Duke Group Ltd v Pilmer (1999) 31 ACSR 213

should be to achieve financial gain. However it is immaterial if the venture proves to be
successful or not so long as there is an intention to make profit.
In the present case, Mary, Fred and Chris are running the business in common and with a view to
earn profit. As a result, in this case, it can be said that the business structure, adopted by them is
that of a partnership.
1b) Discuss whether Fred and/or his business partners are liable for the damages suffered by
the customer X?
According to the partnership law, all the partners are considered as the agents of the firm. This
principle was provided by the court in Re Baird’s case.4 Now this principle has also become a
part of the statutory law. As a result of this position of knowledge is considered that each partner
is an agent of the firm and also an agent of the other partners. Hence, if a transaction has taken
place in the usual or the normal course of business of the firm and a third-party is not aware of
any lack of authority on part of the partner, the law provides that the firm can be held liable as
principal of the transaction.5 As a result, liability can be imposed under contract or tort, on all the
partners. As a result in the present case, the liability for the negligent misrepresentation made by
Fred can be imposed on the partnership. Therefore all the partners can be held jointly and
severally liable.6
In this context, negligent misrepresentation can be described as the information or advice that
has been given honestly, but it is inaccurate or misleading. In Hedley Byrne & Co v Heller &
4 Re Baird’s case (1870) LR 5 Ch App 72
5 Sweeney, O’Reilly & Coleman, 2013, Law in Commerce, 5th Ed., LexisNexis
6 Stephen Graw, 2011, An Introduction to the Law of Contract, 7th Ed., Thomson Reuters

Partners7, the court had stated that the ability exist in tort, negligent misrepresentation under the
circumstances where information or advise was sought from the person who has a special skill or
judgment and when such person knew or should have known that the other party is going to rely
on the information or advise given to it. Similarly in Mutual Life & Citizens’ Assurance Co Ltd
v Evatt,8 the High Court had stated that the duty arises when a person has given information are
advised to the other person and it was actively sought or merely accepted by such person
regarding a serious matter and the person giving advise knows or should have known that he is
being trusted and under the circumstances, it was reasonable for the other party to rely on such
information or advise.9 It is a success action for negligent misrepresentation can be initiated into
the below mentioned elements are present:-
There should be a legal duty under the circumstances, which needs a certain standard of conduct
to protect against a foreseeable risk.
There should be a breach of this duty as a result of the failure to meet the required standard of
care; and
A material injury should have been suffered by the plaintiff due to such breach.
In the present case, Fred had given advice to their client X regarding a property. It was a part of
the business of the firm to give advice to their clients. However in this case, while giving the
advice, Fred had made a mistake. As a result, X, suffers a loss of $15,000. Under these
circumstances, it is clear that the negligent misrepresentation has been made by Fred. The law
provides that in such cases all the partners are jointly and severally liable. Therefore in the
present case, Fred and his business partners are jointly liable for the damages suffered by X.
7 Hedley Byrne & Co v Heller & Partners [1964] AC 465
8 Mutual Life & Citizens’ Assurance Co Ltd v Evatt (1968) 122 CLR 556
9 Latimer, P, Australian Business Law CC, 2016 Edition

1c) Discuss whether Fred and/or his business partners are liable for the damages suffered by
Y?
The issue in the present case, is if Fred and his business partners can be held liable for the
damages suffered by Y as a result of relying on the negligent misrepresentation that was made by
Fred to X. Hence, it needs to be seen if Y as a cause of action against Fred for the loss of
$18,000 suffered by him as a result of relying on the negligent misrepresentation made by Fred.
For this purpose the requirements of negligent misrepresentation also need to be discussed. In
this regard, a successful claim for negligent misrepresentation can be brought by the plaintiff if
the below mentioned elements can be established.10
For this purpose, it needs to be established a representation was made by the defendant in the
course of his business or in a transaction in which the defendant had pecuniary interest;
False information was supplied by the defendant for the guidance of other persons in their
business transactions;
There was a failure on the part of the defendant to exercise reasonable care of competence while
providing the information;
It was justifiable for the plaintiff to rely on the representation; and
The negligent misrepresentation made by the defendant can be described as the proximate cause
of the injuries suffered by the plaintiff.
10 Vermeesch,R B, Lindgren, K E, Business Law of Australia Butterworths, 12th Edition, 2011

Therefore, the law provides that the action for negligent misrepresentation can be initiated only
by the party to whom the misrepresentation was made. The meaning of this legal position is that
only persons who were intended to receive the advise or information can bring an action for
negligent misrepresentation. This position has been explained by the court in Peek v Gurney.11 In
this case, the plaintiff sued the directors of the company for indemnity. However, the action of
the plaintiff failed. The court discovered that the plaintiff was not the party to whom the
representation was made. The law requires that in such cases, the representation should have
been received directly by such a party. However, it is sufficient that the representation has been
made to another party with the intention that the presentation could be made known to a
subsequent party, and ultimately acted upon by such party.
On the other hand, after going through the facts present in this question, it becomes clear that Y
was not the intended party to receive the representation. As a result, Y does not have a cause of
action against Fred and his partners for the loss suffered by him, because he had relied on the
advice given to X.
11 Peek v Gurney (1873) LR 6 HL 377

2a) Under what type of business structure should Mary, Fred and Chris operate now?
The main business structures that are available in Australia are sole trader, partnership, company
and a trust. In the present case, it appears that Fred, Mary and Chris had been running their
business as a partnership. However now it is advisable that they should run their business as the
company. For this purpose, they need to incorporated company. This decision has been made of
going through the advantages and disadvantages available in case of all the business structures. It
can be said that the business structure of company will be most suitable for the parties in the
present case. Although each business structure has its own advantages and disadvantages but in
the present case the business structure of the company will be most suitable for the parties. A
company is present as a distinct legal entity.12 Therefore it is separate from its owners
(shareholders) and those who have the responsibility to manage the affairs of the company
(directors). As a result of this legal position, generally the shareholders and directors of the
company are not considered as being personally liable for the deaths of company.13 The
exception present to the general rule, which provides that the directors cannot be held personally
liable for the debts of the corporation can be found in the provisions dealing with insolvent
trading as mentioned in the Corporations Act, 2001. Essentially, in case of insolvent trading, the
company a debt in incurred by the company at a time when reasonable grounds are present to
suspect that the company is no longer in a position to pay its debts as and when they become due.
The regulatory body in case of the companies in Australia is the Australian Securities and
Investments Commission. The ASIC also has the responsibility to administer the provisions of
the Corporations Act, 2001. Among other things, it is also the name of the ASIC to protect the
12 Graw, Parker, Whitford, Sangkuhl and Do, Understanding Business Law 7th ed LexisNexis Butterworths, 2015
13 Lipton P, Herzberg A and Welsh, M, Understanding Company Law, 18th edition 2016 Thomson Reuters

consumers and businesses while dealing with companies and to make sure that the companies in
Australia operate according to law, maintained proper records and report their activities. The
ASIC also has the responsibility to maintain the information database which contains the details
of all the companies in Australia.
As mentioned above, if business structure has its own advantages and disadvantages. In the same
way, there are certain advantages and disadvantages associated with the incorporation of a
company. However in the present case, the advantages of incorporating a company are
significant for Fred, Mary and Chris. Therefore it is advisable that they should form a company
for the purpose of running their business. The advantages that will be available to Fred, Mary
and Chris after the incorporation of a company can be described as follows:-
Limited liability: the law provides that a sole trader or a partnership is legally responsible for all
the aspects of the business which includes the debts and losses of the business. Similarly, if a
defective product is sold by the business or an error is made or a customer suffers an injury
during the course of business, in such a case the sole trader or the partners will be held
personally liable. This may even result in losing all the personal assets. On the other hand, in the
eyes of law company is a separate legal entity. Therefore the members of the company can
protect their personal assets from the liabilities of the business.
Minimize tax liability: the current rate of tax for companies in Australia is less as compared to
the rate of tax that is applicable in case of individuals. Therefore, the sole traders have to pay tax
at the same rate as the individuals. On the other hand, the tax burden may be reduced
significantly after registering a company. Similarly companies and small businesses have been
provided with a wide range of tax deductions for education and training, advertising,
maintenance and repairs that cannot be claimed by the individuals.

Avoiding conflict with founders: whenever there is a conflict between the founders, registering a
company can help significantly. After the registration of a company, the owners of the company
are limited to the number of shares purchased by them. In this way, the owners of the company
will clearly understand that their investment is decided on the basis of the number of shares
owned by them and not on the basis of any pre-registration agreement made verbally or in
writing.
Increases brand image: All the major brands in the world are registered companies. Therefore,
the registration of a company also increases the reputation and the perception of the business. At
the same time, the business structure of the company also establishes accountability.
Raising capital: After the registration of a company, the ability of the business to attract investors
and to raise money for business also improves. The registration of the company provides a
chance to borrow and to incur debt. But more significantly can sell shares and raise equity
capital. Raising money can be necessary for the expansion of the business. Moreover, investors
also prefer to invest in a register company instead of investing in a sole trader or a partnership.
The reason is that the investors are aware of the fact that a formal structure is present to accept
their investment.
Therefore, after going through, the benefits that are available in case of the evaporation of a
company, it can be devised that Chris, Mary and Fred should run their business as a company.

2b) Does the business have to pay for the car under statutory rules?
The issue in this question is that Mary had entered a contract with a car dealership and has left
the country. At the time of entering into the contract, the car dealer was not aware that Mary had
left the business and resigned as the director of the company. As a result, the question arises if
the contract can be enforced against the company.
In this regard, the common law provides that when an outsider enters into a contract with the
person who purports to be acting on behalf of the company, but such person does not have the
necessary authority, the contract can be avoided by the company. However this was considered
as a harsh outcome. Therefore the court provided the indoor management rule in Royal British
Bank v Turquand.14 According to this rule, when an outsider is dealing with a company in good
faith and without having any knowledge on reasonable grounds to suspect regarding the presence
of any irregularity or impropriety, the outsider will not be affected by the presence of an actual
irregularity or impropriety in a matter of internal management of the company. This rule has also
been interpolated in the Corporations Act, 2001. As a result, section 129 of the Act provides
these statutory assumptions that can be made by the outsiders while dealing with the company.
A company can enter into contracts with a third-party either directly or through an agent. The
contract, created by the agent will be binding on the company unless the agent did not have the
authority to enter a binding contract on behalf of the company. Even if the agent has the
authority, section 129 can still be of assistance. According to section 128 of the Corporations
Act, the persons who are dealing with the company through an agent, are entitled to make certain
assumptions. It it is easier to rely on was held by the court in Lyford v Media Portfolio Ltd.15 that
14 Royal British Bank v Turquand (1856) 6 E&B 327
15 Lyford v Media Portfolio Ltd (1989) 7 ACLC 271

it is easier to rely on the statutory assumptions instead of using evidence regarding these matters.
Similarly, individual directors of the company, managing directors and company secretaries are
always treated as the agents of company. According to section 129 of the Corporations Act, the
law allows a person to assume that a person who has been held out by the company as an officer
or an agent of the company has been properly appointed and also has the authority to enter into a
contract on behalf of the company.
In the present case, Mary had decided to leave the business and resigned. However after
resigning from the company as its director, Mary decided to give ourselves a farewell present.
She goes to a car dealership and purchase is a new car. She asks the car dealer to charge the price
of the car from the company. Before entering into the contract, the car dealer checked the online
database of ASIC in which Mary had been mentioned as the director of the company. Therefore,
the car dealer gives the car to Mary. However, Mary has left the country, and the car dealer
wants is the contract against the company. On the other hand, the company wants to claim that
Mary was no longer a director of the company when she entered into the contract. But in view of
the indoor management rule, as well as the application of section 129 of the Corporations Act, it
is available to the car dealer to make an assumption that Mary had the authority to enter a
contract on behalf of the company. Moreover, representation has been made by the company to
the ASIC regarding the authority of Mary as the director of the company. Under these
circumstances, it is clear that it can be assumed by the car dealer that Mary had the authority to
enter the binding contract on behalf of the company. As a result, the contract created by Mary
purchase the car is binding on the company. As a result, the car dealer can pursue the company
for the debt. In view of the statutory assumptions mentioned in section 129, the company cannot

deny that Mary does not have the authority to create a binding contract on behalf of the
company. Hence, the business will have to pay for the car according to the statutory rules.

Bibliography
Graw, Parker, Whitford, Sangkuhl and Do, Understanding Business Law 7th ed LexisNexis
Butterworths, 2015
Latimer, P, Australian Business Law CC, 2016 Edition
Lipton P, Herzberg A and Welsh, M, Understanding Company Law, 18th edition 2016 Thomson
Reuters
Stephen Graw, 2011, An Introduction to the Law of Contract, 7th Ed., Thomson Reuters
Sweeney, O’Reilly & Coleman, 2013, Law in Commerce, 5th Ed., LexisNexis
Vermeesch,R B, Lindgren, K E, Business Law of Australia Butterworths, 12th Edition, 2011
Case Law
Duke Group Ltd v Pilmer (1999) 31 ACSR 213
Hedley Byrne & Co v Heller & Partners [1964] AC 465
Lyford v Media Portfolio Ltd (1989) 7 ACLC 271
Mutual Life & Citizens’ Assurance Co Ltd v Evatt (1968) 122 CLR 556
Peek v Gurney (1873) LR 6 HL 377
Re Baird’s case (1870) LR 5 Ch App 72
Royal British Bank v Turquand (1856) 6 E&B 327
Smith v Anderson (1880) 15 Ch D 247
United Dominions Corporation Ltd v Brian Pty Ltd. (1985) 157 CLR 1