The Turquand Rule was initially intended to mitigate the stark effects of the doctrine of constructive notice by entitling bona fide third parties who contract with a company, to assume that all of the company’s internal governance necessary for the conclusion of a valid contract has been properly carried out. An irrebuttable presumption is given in favour of such bona fide party, that the company has duly complied with its internal formalities and procedural requirements.
In order to illustrate the effects of the Turquand Rule on the authority of company directors, let us consider the following example:
Company A has a generally standard memorandum of incorporation, but has opted to include two additional provisions therein:
- firstly, that should the company be desirous of entering into a contract (the value of which being greater than 50% of the value of the issued share capital of the company), with any third party, then prior consent thereto need be given by way of the passing of a director’s resolution to that effect; and
- secondly, that under no circumstances shall the company enter into any contract with any third party, should the value thereof amount to more than 100% of the value of the issued share capital of the company.
A director of Company A nevertheless enters into a contract with a bona fide third party (“Third Party”) in contravention of the company’s above mentioned provision of its memorandum of incorporation. The contract entered into on behalf of the company was valued in excess of 50% of the value of issued share capital of the company.
The question now arises whether or not Company A is, through the unauthorised actions of its director, bound to the contract.
In the case of Ferguson v Wilson (1866) 2 Ch App 77: 15 LT 230, Cairns LJ held that a director is considered to be an agent for the company, and that the company itself cannot act in its own person, but only through its directors. In terms of agency law, if an agent contracts with a bona fide third party on behalf of the company, the contract will bind the third party and the company as if the contract was concluded personally between them. However, in order for a director to act on behalf of a company, he must have the authority to do so.
Section 66(1) of the Companies Act, No. 71 of 2008 (“Act”) provides that the business and affairs of a company must be managed by or under the direction of its board, which has the authority to exercise all of the powers and perform any of the functions of the company, except to the extent that the Act or the company’s memorandum of incorporation provides otherwise.
Section 20(7) of the Act however, states that a person dealing with a company in good faith may presume that the company has followed all formal and procedural requirements of the Act, its memorandum of incorporation, and its rules, in making a decision in the exercise of its powers.
Section 20(8) of the Act states that section 20(7) of the Act must be read together with, and not in substitution for, any relevant common law principle relating to the presumed validity of the actions of the company. Section 20(7) of the Act somewhat resembles and codifies the Turquand Rule.
Company A’s Standing
The confusion surrounding the position of Company A presents uncertainty and risks for both Company A and the Third Party.
The Third Party entering into the contract ordinarily has no knowledge of whether for example, at the time that Company A’s board passed a resolution to enter into the contract, a quorum was present. It would be unfair and damaging to business confidence and convenience if, in such a circumstance, the law were to hold that Company A is not to be bound to the contract because of the internal governance irregularity.
Notwithstanding section 66(1) of the Act, the Turquand Rule will be available for the Third Party to rely on. Even if the appointment of such director was made but Company A now disputes the validity of the appointment thereof, due to the fact that a quorum was not present at the board meeting where the appointment was made, the Turquand Rule will still apply, and the Third Party can irrebuttably presume the director’s appointment to be duly performed.
The only instance in which the Third Party will not be allowed to rely on the application of the Turquand Rule, is where the Third Party actually knew that the official acting on behalf of the company by the single director was against Company A’s memorandum of incorporation provision. Therefor Company A will only be protected from being bound by the contract with the Third Party, should the Third Party actually have knowledge of the fact that the director was acting beyond his authority.