Contract Law on Indoor Management - Essay Writing Assessment Answer

Contract Law on Indoor Management Assignment

Assignment Task

PART B: Problem Question

Joseph, Leon and Melanie are running a café as a partnership. Whilst out shopping with his wife one Saturday, Leon sees a coffee grinding machine which he believes would be perfect for the business. He is unable to contact the other two partners on the phone but proceeds with buying the coffee grinder anyway.

• Discuss whether the partnership is bound by the transaction that Leon entered into. Justify your answer.

1. The firm has two employees on a two-year employment contract. Due to a slowdown in business, the three partners decide that they need to fire their employees.

PART C: Essay Question

“After that… all that the directors do with reference to what I may call the indoor management of their own concern, is a thing known to them and known to them only ..”

Lord Hatherly in Mahony v East Holyford Mining Co (1874-75), LR 7 HL 869

Critically analyse and contrast the common law and statutory indoor management rule with reference to appropriate sections of the Corporations Act (2001) and case law. Students should also look at the limitations and exceptions to the use of the indoor management rule.

Part B:

Question (i)

Three partners; Joseph, Leon, and Melanie operates a coffee café, and one day Leon buys a grinding machine to serve in the business, and he could not conduct the other two partners. According to ordinary sense of section 5 of the Partnership Act 1892, every partner in a partnership is legally bound to be an agent of the partnership and every action he/she does binds the other partners and makes them liable to that action unless he has not right to act under the agreement (Keane & McKeown, 2014). Leon is among the three partners in their partnership, and this means that any action he takes will bind all the other two partners: Joseph and Melanie to be liable for that act. According to Deakin & Morris (2012), buying a grinding machine and not being able to contact the other two partners is just in line with the partnership act, and therefore, the transaction binds all the three partnership and if it might not work as expected, all the three partners are liable for that transaction. Mercantile Credit Co Ltd v Garrod 1962, ruling also supports the fact they all are bound to that transaction.

Question (ii)

Joseph, Leon, and Melanie want to fire their employees because the business has begun going slow. They made a two-year contract with their employees as per the law. Employees are only supposed to be fired by a partnership or any organisation as a result of their misconducts or if the organisation is dissolving or to the reasons stated in the employment contract. Following this contract law, it seems that the partnership agreement did not specify on firing the employees if the business starts going slow. As a result, it would be unlawful to fire the two employees since the contract will not have matured, and also they have no any misconducts acts to fire them.

Secondly, Peirson et al. (2014) observe that the Partnership Act 1892 also states that employees are only supposed to be fired according to the terms stated in the employment contract and not based on the interest of the partners. If the partnership was winding up, it could be lawful to fire them but firing them because the partnership is not making profits anymore is unfair. Employees need to be fired only according to terms in the contract or the law. Employees have their own job security which requires termination on neutral grounds. Under ordinary partnership agreements, employees are the most important people who carry out most of the partnership operation for its existence. Therefore, they deserve more than being fired just because the business is going slow.

Part C:

Indoor Management Rule

Introduction

Indoor management can come about during the Royal British Bank v Turquand whose discovery noticed that internal processes of selecting directors are the cause of defaults caused by their directors to the third parties. According to Schulz & Wasmeier (2012), the rule states that the innocent third party outsiders to the company acting in good faith have the right to assume that the internal processes of the company were followed during the deal unless they know otherwise. This rule helps the third parties to companies who are innocent to avoid making lose as a result of the company faults. However, the company directors are the ones who know what the internal procedures mean and no any.

Corporations Act 2001

Corporations Act 2001 is an Australian statutory law that talks and explains about the laws governing companies mostly. The law requires that the companies engage in any activity, deal, process, or procedures that comply with the law. They are supposed to be honest to other companies and outsiders. Iqbal, Saaiq, & Ali (2013) commend that the corporation’s law act protects the innocent outsiders of being humiliated and made to suffer a loss as a result of faults in internal processes of a company. They are also assured to recovering their money or any resources that they agreed to get from the companies in case something happens to those companies and they claim not to pay. Any company must follow certain processes and procedures according to the act which will enable it to employ qualified directors that will not put the company at risk. All the directors of the company must be well vetted and selected through the right and open channel so as to represent the company effectively. These directors are not supposed to make decisions especially those involving loans from outsiders without consulting the shareholders.

Indoor management rule was established majorly to protect the outsiders such as banks, microfinance institutions, housing finances, and any other financial lending institutions. So many financial institutions have been made to suffer just because they engaged in a deal with a company, and when they come to discover later that the directors acted without the consent of the shareholders. Northside Developments Pty Ltd v Registrant – General (1990) case ruling shows that indoor management rule is essential to outsiders. The corporation’s act 2001 came about with several amendments to ensure that the third party outsiders are well protected through the indoor management rule. The outsiders are only made to assume that by the time they are entering into a contract with the company through director’s signatures, they assume that the directors have followed all the internal procedures. It is very hard for the lending outsiders to just conclude with information from the company that the deal is genuine. Therefore, the rule is meant to protect the outsiders and hold companies accountable in case they breach the contract.

Common Law

Common law was the one which came about with the Indoor management rule after Royal British Bank v Turquand case. The law states that a person, who acts as a company’s agent to a contract with a financial lending outsider, should have followed a certain procedure that approves him to do that. De Pont (2013) says that an outsider who acted in good faith might not know whether the agent who might be a director has followed the right company procedures so that in case the company fails to pay the debt, it will be held accountable as a whole. The directors who are involved in an action with an outsider must have been approved first through their appointment. They should also inform the other board members about the action prior to engaging in it, and then agree as a committee first. Therefore, the common law ensures that the outsider who does not know whether the directors were approved effectively is not affected in case of any irregularities that might be committed by these outsiders.

Indoor management rule was established to assure the outsider that the deal he is entering into with the company through the agent is clean and transparent. In also saves the time of making the contract since the outsider is only meant to assume that the company has complied with all the procedures involved in appointing that agent. According to Ridley, (2011), it ensures that the appropriate board meetings to approve this agent have been done perfectly and that the company is ready for the loan. However, the outsider is not supposed to relax about the whole matter and enter into the contract blindly; he is supposed to make efforts on his own to know if the agent he/she is dealing with is a satisfied person by the organisation, and has the necessary legal documents to do so. He should also produce personal documents that show he is working with the company and is allowed to enter into that deal on behalf of the company. With will help the outsider to be on the safe side in case of irregularities since he would confirm that the agent was approved at the time they were making the contract.

Exceptions to Indoor Management Rule

Having prior knowledge about irregularities

The rule of indoor management is an exception to those outsiders who have some information about unapproved directors or any irregularities on the side of the company. Watson (2011) observes that should the court investigate and discover that by the time the outsider was entering into a contract with the company had any information about irregularities and had kept quiet, the rule will not apply. The outsider will have to suffer that lose should the company default in paying the debt it had borrowed. This is ignorance, and both the outsider and the agent of the company who was responsible for the irregularities might even face the full force of the law.

Outsiders’ failures

The indoor management rule is also an exception to an outsider who has failed to act all the responsibilities under his position. For instance, an outsider who priory discovered irregularities in the agent acting on behalf of the company and failed to perform investigations required under his/her position. Macpherson (2011) commends that an outsider who also does a shallow investigation about the irregularities he might have discovered before making a deal with an agent will have to suffer the loss. This rule also does not apply on an outsider who is put on inquiry to determine what another reasonable person acting in his position would have done in the case of irregularities, yet he has not done that yet. Therefore, Delport (2011) says that it is the responsibility of any outsider to ensure that any discoverable irregularities from an agent acting on behalf of the organisation are researched, established, and well-addressed according to the law. An outsider should make sure that he has done his duties and responsibilities to ensure that he has exhausted the information required for him to know the law to make him innocent and act in good faith.

Limitations of Indoor Management Rule

It is based on assumptions

Despite the fact that indoor management protects the outsiders from being conned and suffers a loss from a deal with the companies, it is all about assumptions. First, the rule requires the outsider to assure himself that the agent acting on behalf of the company has been effectively approved by only looking at the memorandum of the company. Secondly, De Pont (2013) says that the rule assumes that by providing an internal process for companies, every company would have approved its agents according to the law always before entering into a contract with an outsider. It does not provide extensions on how they should follow these procedures and thus why we have so many cases arising since the rule is not clear.

It is self-contradicting

The indoor management rule also contradicts itself on the assumptions that it makes. It states that the outsider should assume that the company would have followed the right procedure of appointing the agent was dealing with (Baiketlile, 2014). However, the rule contradicts itself by again stating that it is the duty of the outsider to make necessary investigations by going through the memorandum signed and governing the company or else it will become an exception. So, how should the outsider assume the procedures at the same time make investigations over the same matter? This makes the rule not effectively appropriate to all cases.

Conclusion

In summary, the indoor rule was established during the case of Royal British Bank v Turquand. The rule was supposed to protect the outsiders from suffering the loss as a result of irregularities from the agent of the company they entered a contract with. According to Harris (2015) the Corporations Act 2001 highlights regulations through common law to guide the operations of the rule. There are several exceptions to the rule where it does not apply. They include failures of the outsiders, and outsider having prior knowledge of irregularities. There are also limitations about the rule because it is self-contradicting and is based on assumptions only.