The Memorandum and Articles has the function of, among other things, regulating the authority individuals within a company have to bind that company when contracting on its behalf with third parties. In terms of the New Act, it will become mandatory for all companies conducting business in terms of its Memorandum and Articles to adopt a MOI to replace the existing Memorandum and Articles. While the function of the MOI mirrors that of the Memorandum and Articles, there are significant changes regarding the way in which this document is constructed and interpreted. Of particular interest to companies, and something to keep in mind when conducting the exercise of converting the Memorandum and Articles to an MOI, is the way in which certain clauses in the MOI will be treated in respect of third parties contracting with the company, and in particular how the Turquand Rule and the Doctrine of Constructive Notice, two well established principles under the current regime, have been changed.
The Turquand Rule and the Doctrine of Constructive Notice under the current regime
The Turquand Rule and the Doctrine of Constructive Notice are two tools that work hand-in-hand and have been applied collectively by our courts for many years when deciding whether a company should be bound to a contract with a third party. This situation usually arises where the company will claim that they are not bound by a contract due to the fact that the party who contacted on the part of the company was not authorised to do so. As such, and according to Section 36 of the Old Act, such a contract would be considered to be ultra vires as the party entering the contract did not have the authority to do do. When deciding such an issue, a court will further apply the Doctrine of Constructive Notice and the Turquand Rule.
According to the Doctrine of Constructive Notice, a third party, when dealing with a company, is deemed to have knowledge of the contents of a company's public documents. As such, the third party, when contracting with the company, should appraise themselves with the contents of the Memorandum and Articles of that company in order to confirm that the individual representing the company in the contractual negotiations is, in fact, authorised to do so. Should that individual not be so authorised then the person would be acting beyond the scope of their authority, and as such the contract would be ultra vires the rules of the company and, as such, is not enforceable against the company.
The Turquand Rule, however, which rule was established in the case of Royal British Bank v Turquand (1865) 6 E&B 327, acts as a counter against the Doctrine of Constructive Notice. The Turquand Rule becomes applicable where the terms of the Memorandum and Articles provide for an internal procedure to be followed in order for an individual to have the authority to represent a company, for instance where a resolution needs to be passed by the company in order for the authority to be valid. In such instances, the Turquand Rule states that it is permissible for the third party contracting with the company to presume that such internal procedures have been complied with. Where such internal procedures have not been followed, and the person contracting on behalf of the company does not, in fact, have the authority to do so, such a contract is referred to as a limping contract and is enforceable, and capable of being cancelled, at the instance of the third party. The ability of the third party to exercise this right was contingent on the finding that the third party, when contracting with this individual, believed in good faith that the individual was properly authorised to act on behalf of the company.
Thus, under the current regime, both the company and the third party were afforded protection when contracting with each other. The company was protected by the Doctrine of Constructive Notice, and the third party by the Turquand Rule.
The Turquand Rule and the Doctrine of Constructive Notice under the new regime
The New Act has changed the way in which a court will approach such an issue. Section 36 of the Old Act has been retained in terms of Sections 20(1)(a) and 20(1)(b) of the New Act. As such, a contract entered into by an individual on behalf of a company, where that individual did not have the requisite authority to enter into such a contract is considered to be ultra vires. The startling change, however, comes about in the modified version of the Doctrine of Constructive Notice.
According to Section 19(4) of the New Act, a third party is not deemed to have notice or knowledge of the contents of any documents relating to the company. As such, it is no longer presumed that, when contracting with a company, the third party has appraised themselves with the MOI of that company. Section 19(5) of the New Act contains an exception to this, in that a third is deemed to have notice and knowledge of any provision of a company's MOI under section 15(2)(b) of the New Act (which section deals with special conditions applicable to the company and requirements for the amendments thereof) if the company's notice of incorporation or a notice of amendment has drawn attention to the provision. It may therefore be seen that the New Act abolishes the doctrine of constructive notice except in cases where attention is drawn to special conditions. These provisions are known as "Ring Fenced" provisions and in order to draw attention to such provisions they will be marked "RF". Therefore the doctrine of constructive notice is abolished to a certain degree.
Further, and in terms of clause 20(7) of the New Act, the Turquand Rule has been legislated in a slightly modified version. In terms of this provision, "A person dealing with a company in good faith, other than a director, prescribed officer or shareholder of the company, is entitled to presume that the company, in making any decision in the exercise of its powers, has complied with all the formal and procedural requirements in terms of this Act, its memorandum of incorporation and any rules of the company unless, in the circumstances, the person knew or reasonably ought to have known of any failure by the company to comply with such requirement".
Thus, under the new regime, the company will only enjoy the protection of the Doctrine of Constructive Notice in respect of RF clauses, whereas the third party will always have the benefit of the Turquand Rule unless it can be demonstrated that the third party had knowledge, or ought to have had knowledge of the company's failure to comply with their internal processes.
A warning to company officers
As has already been mentioned, it will become mandatory for all companies to adopt an MOI. This exercise should not be one that is taken lightly. As can be seen from the exposition above, the New Act has reduced the ability of a company to rely on the Doctrine of Constructive Notice as a defence unless the company's MOI is constructed with particular provisions. Should a company blindly convert it Memorandum and Articles to an MOI, without carving out certain provisions as RF provisions, the company will effectively be depriving itself of a specific defence should it challenge an agreement entered into by an unauthorised individual, which may result in the company being bound to an onerous agreement.
This result, however, is not a foregone conclusion. It is imperative for the company to invest time, effort and expertise into this exercise, and not view it as a routine administrative process. Should it adopt this stance there is no reason why the company should not enjoy just as wide a protection under the new regime as it did under the old.
