Companies Act, 2008 - Doctrine of constructive notice and the Turquand rule

The South African government proposes substituting the Companies Act, 1973 (the "existing act") with the Companies Act, 2008 (the "new act") later this year.

The new act limits the application of the doctrine of constructive notice in the case of the founding documents of companies (i.e. the "Memorandum of Incorporation"). The doctrine of constructive notice is the legal assumption that when documents are lodged in a public office where they can be inspected by the public, members of the public are deemed to have notice and knowledge of the documents. Since the Memoranda of Incorporation of companies are lodged with the office of the Companies and Intellectual Property Commission (CIPRO) where they are available for inspection by the public, it follows that any member of the public dealing with a company is deemed to have knowledge of the provisions in the company's Memorandum of Incorporation.

It is possible for a company, both under the existing act and the new act (see sections 20(2) and 66(1) of the new act) to include in its Memorandum of Incorporation a provision that limits the authority of its directors. The limitation may be outright or conditional upon the fulfilment of internal conditions. An example of an outright limitation is one where a single director is not authorised to bind the company to any contract providing for payment by the company of an amount greater than a specified amount. An example of a conditional limitation is one where a contract concluded for the company by a single director is not binding upon the company unless it is approved by the company's procurement committee. Provisions of this nature can allow a company on whose behalf an agreement is purportedly concluded, to challenge the existence of the agreement on the basis that the director or other officer that acted for it was not in fact authorised to conclude the agreement. The other contracting party - being deemed to have knowledge about the lack of authority - may have no recourse.

The Turquand rule -originally established in the case of Royal British Bank v Turquand (1856) - goes some way towards mitigating the doctrine of constructive notice. It applies by attributing authority to company directors in cases where they have acted outside a conditional limitation on their authority in the Memorandum of Incorporation but have acted within the scope of the authority that is usually attributed to directors. The rule is explained thus in the case of Mahony v East Holyford Mining Co. Ltd (1875) LR 7 HL 869: "When there are present persons conducting the affairs of the company in a manner which is perfectly consonant with the [Memorandum of Incorporation] ... then those dealing with them externally are not to be affected by any irregularities which may take place in the internal management of the company". The Turquand rule does however not apply in cases where a limitation on authority is outright i.e. where it is clear from the Memorandum of Incorporation that the directors could not possibly have had authority to act. In those cases a third party can not rely on the Turquand rule even if the director acted in accordance with the authority usually attributed to directors.

Leading South African academics have long been in favour of a change in South African company law to curtain the operation of the doctrine of constructive notice in regard to limitations on directors' authority in the Memorandum of Incorporation. This was done in the United Kingdom in 1972 (see s40 of the UK Companies Act 2006) but not in South Africa. The existing act, in section 36, affords protection to a party contracting with a company against consequences of the doctrine of constructive notice only in cases where a contract is ultra vires i.e. where the act was beyond the capacity of the company and where, by virtue only of that fact, the directors could have had no authority.

The provisions in the new act relating to the doctrine of constructive notice in regard to limitations on directors' authority in the Memorandum of Incorporation are not clear. The following provisions of the new act are relevant:

1. Section 19(4):
"Subject to [section 19(5)], a person must not be regarded as having received notice or knowledge of the contents of any document relating to a company merely because it has been filed or is accessible for inspection at an office of the company".

2. Section 19(5)(a):
"A person must be regarded as having received notice and knowledge of any provision of a company's Memorandum of Incorporation contemplated in section 15(2)(b) if ....[notice of the provision has been given to CIPRO in the prescribed manner]"

3. Section 15(2):
"The Memorandum of Incorporation of any company may-
(a) include any provision-
(i) dealing with a matter that this Act does not address; or
(ii) altering the effect of any alterable provision of this Act;
(b) contain any special conditions applicable to the company, and any requirement for the amendment of any such condition in addition to the requirements set out in section 16; or
(c) prohibit the amendment of any particular provision of the Memorandum of Incorporation."

Thus, if a provision in a company's Memorandum of Incorporation that limits the authority of directors falls only within section 15(2)(a), third parties contracting with companies will be better off: They will not be exposed to being trapped into the legal assumption of being aware of the director's possible lack of authority. If however that provision also falls within 15(2)(b) and the notice of the provision has been given to CIPRO in the prescribed manner, the legal position would be the same as that under the existing act and the legal risk of third parties contracting with companies would remain unchanged. In order for a provision to fall within section 15(2)(b) it must be a "special provision" and it must be one that can not simply be amended by special resolution as set out in section 16: it must be subject to addition requirements. It is not clear what is meant by a "special provision" in section 15(2)(b) and it is possible that a provision limiting the authority of directors may well qualify as one. It seems possible that a provision relating to the limitation of authority of directors may be made to fit into section 15(2)(b) simply by increasing the shareholders' voting threshold by which it can be amended. This effectively gives companies the option to avail themselves of the protection afforded by the doctrine of constructive notice.

It is arguable that third parties will be better off under the dispensation set out in the new act not only because the new act makes the incorporation of limits of directors' authority more involved (and thus less likely to occur in practice) but also because better publicity is given to such limitations under the new act. A provision falling within section 15(2)(b) must be notified to CIPRO and flagged in CIPRO's records, thus making it easier for third parties to identify a limitation on authority. Section 11(3)(b) provides that if a company's Memorandum of Incorporation contains provisions envisaged in section 15(2)(b), the company must include the letters "RF" after its name. However, the new act does not provide that a failure by a company to include "RF" in its name will negate reliance by the company on the doctrine of constructive notice. A third party may however rely on section 218(2) which provides that any person who contravenes any provision of the new act is liable to any other person for any loss or damage suffered by that person as a result of that contravention.

The giving of notice to CIPRO of a provision contemplated in section 15(2)(b) is obligatory in the case of companies incorporated under the new act (see 13(3)) but optional for companies incorporated under the existing act (see schedule 5, paragraphs 7(9) and (10)).

Section 20(2) changes the common law by providing that that where the directors of a company have acted outside a limit on their authority in the company's Memorandum of Incorporation, the members of the company may by special resolution ratify that act.

Attempts are made in the new act to codify various provisions of common law relating to the capacity of companies and the authority of directors (see for example sections 20(7) and 20(8)).

For further information concerning any item in this publication please contact Jurgens Bezuidenhout on JB@JurgensB.co.za or telephone +27 82 922 3671

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