The significance of the Indoor Management Rule

Autumn Tree decision highlights key factors when signing legal contracts

On an otherwise unremarkable winter’s morning in early August 2017 in Hobsonville, north-west of Auckland, Autumn Tree Limited (Autumn Tree) signed a sale and purchase agreement with Bishop Warden Property Holdings Limited (Bishop Warden).

That same day, at 1:10pm, Autumn Tree submitted documentation with the Companies Office which among other things added a new director, Anna. 

At around 6:00 pm, Tina entered into the Agreement on behalf of Autumn Tree to sell the property for approximately one-third of the valuation of the property. This turn of events set in motion a legal proceeding that brings to light the importance of ensuring that the person you are signing a contract with has the authority to do so.

Bishop Warden Property Holdings Ltd v Autumn Tree Ltd [2018] NZCA 285 (Autumn Tree decision) is a very important contract law decision. It effectively means that a party contracting with a company needs to take several precautions to make sure a director signing a contract has actual authority to do so.

When you enter a contract with a company and only one director of that company signs it, it is very important that:

1. you check the Companies Office register at the time you sign the contract to ensure that only one director is listed and keep evidence of that search; and
2. if the company has two or more directors, you either request that two directors sign it or obtain incontestable evidence that the whole board provided authority to that director to enter the contract. 

Indoor Management Rule

The "indoor management rule" is thought to have been established in Royal British Bank v Turquand 6 EI & BI 327, 119 ER 886 (Turquand's Case). The rule means that parties who deal with a company can presume that the company has complied with its own internal procedures before contracting with them. This generally meant that where an officer of a company (such as a named director) signed an agreement on behalf of the company, the other party could assume that officer had received the necessary authority to do so from shareholders or board members.

In New Zealand, the "indoor management rule" was codified in section 18 of the Companies Act 1993 (Act) and many considered (and were found to be wrong by the Autumn Tree decision) this fully incorporated the rule in Turquand’s Case. Under that section, third parties are offered protection when dealing with a company where a director, agent or employee of that company exercises powers that they would customarily have the authority to exercise. 

The Autumn Tree decision considered the exact wording of section 18 (1) and effectively held that the protection in section 18 was much narrower than the original rule in Turquand's Case. It confirmed that, in any section 18 enquiry, the emphasis is on what is customary for only one director (or other authorised person – usually an employee or agent) to have authority to sign on behalf of a company. Unfortunately, what is “customary” is often unclear and will vary from industry to industry. Put another way, what is “customary” may end up as something argued in and determined by a court. This means that it is best to take steps when contracting with a company to make sure the person signing the contract has actual authority, rather than having to rely on the uncertainty of section 18(1).

Outcome and background

The Autumn Tree decision dismissed an appeal from a High Court decision which had discharged a caveat over a property that was to be subdivided. The caveat had been lodged in reliance on a sale and purchase agreement (Agreement) signed by a vendor, Autumn Tree with its purchaser, Bishop Warden. The Agreement was signed and dated 3 August 2017 (Agreement Date).  The Court of Appeal held that Bishop Warden could not enforce the Agreement against Autumn Tree, and that the caveat could not therefore be sustained.

As recounted above, on the morning of the Agreement Date, Tina was the sole director of Autumn Tree. At 1:10pm, Autumn Tree submitted documentation with the Companies Office registering a change in director to add Anna as a new director and remove Tina.  Anna was added to the Companies Register - but Tina was not removed until two days later. 

The director of Bishop Warden gave evidence that on the evening that the Agreement was signed, he performed a search of the Companies Register which showed that Tina was the sole director of Autumn Tree. He did not keep any evidence or print-out of this search.  The Companies Office evidence was that the appointment of Anna as director was processed almost immediately after the 1.10pm filing and she would have been shown as a director on the register (as well as Tina) at that time.

As also outlined above, at around 6:00 pm, Tina entered into the Agreement on behalf of Autumn Tree to sell the property for approximately one-third of the valuation of the property. Bishop Warden immediately placed a caveat on the title. Autumn Tree then launched an application to the High Court to discharge the caveat asserting that the agreement was invalid.  It argued Tina did not have the authority to bind Autumn Tree at the time the Agreement was signed since there were two directors, one of whom (Anna) did not agree to the company’s entry into the Agreement. 

Tina was also subsequently removed as a director of Autumn Tree, but this change was not recorded on the Companies Register until two days after the Agreement was signed.

Key aspects of the decision 

The Autumn Tree decision turned on the Court’s factual finding (accepting the Companies Office evidence) that two directors were listed on the Companies Office register at the time the Agreement was signed. 

Practically speaking, this means that a party contracting with a company has to:

1. search the Companies Office Register at the time the contract is formed to check whether there are one or more directors; and
2. keep a copy of that search to prove what it showed at the time an agreement is formed.

Having found that there were two directors at the time the Agreement was signed, the Court of Appeal outlined that the authority to bind a company to an agreement is primarily reserved to the company's board.  Whether an agreement signed by a single director on behalf of a company is valid depends on whether the director had actual or apparent (also known as ostensible or implied) authority to enter into the agreement. These different types of authority were only briefly discussed in the decision.

It held that actual authority can be expressly given to a director (or agent) by the Company, or implied from the circumstances. Apparent authority is where an agent does not have actual authority, but those who do have actual authority hold out to a third party that this particular agent has authority and the third party reasonably relies on that representation.

Neither the High Court nor the Court of Appeal referred directly to section 180 of the Act, which sets out the authority required to bind a company to an agreement. A counterparty only needs to invoke section 18 (which was discussed at length in the case) to enforce an agreement if section 180 does not apply. Section 180(1)(a) provides that where a company has two or more directors, two directors are required to enter a deed (not an agreement). Section 180(1)(b) provides that a person acting under that company's express or implied authority can enter an obligation on behalf of a company.

Without referring to section 180 directly, the Court of Appeal held that where a company had more than one director, you could not reasonably assume that one director could sign an agreement on behalf of a company without more evidence that they had been granted authority by the company to do so.

Section 18 was discussed in much more detail. Section 18(1)(b) prevents a person from asserting that a person named as a director:

1. is not a director of a company;
2. has not been duly appointed; and
3. does not have authority to exercise a power which a director carrying on business of the kind carried on by the company customarily has authority to exercise.

Section 18(1)(c) is similar and extends to employees and agents of a company.

The Court held that it was not customary for a single director to be able to sign an agreement for sale and purchase of real estate on behalf of a property management company which had more than one director. In cases like this, the board would need to approve the company’s entry into the transaction.

Analysis  

The Autumn Tree decision unfortunately lacked detailed discussion on the interplay between sections 180 and 18 of the Act and "implied authority". There was also no general guidance on what types of contracts "customarily" entered into by one director could be relied upon by the other party.

The practical implication of the Autumn Tree decision is, therefore, that where a company has more than one director, unless a company's constitution allows one director to bind a company, you can never safely assume that one director (or any other person) has implied authority or can "customarily sign" a contract of any sort on behalf of that company.  Until this is clarified, it will be open to argument in a large variety of contexts that a contract is not something to which one director can bind a company without board approval.   

What does all this mean?

When signing a contract with a company, you should always perform and retain a copy of a Companies Office search of that company. If the company has more than one director, you should insist that two directors sign the Agreement. If you don’t, you risk being unable to enforce the contract.  By extension, if you cannot rely on one director signing, then you should seek a representation by at least two directors or the board that the person signing the contract has the authority to bind the company to the terms of the contract.

Haigh Lyon has widespread experience negotiating commercial contracts and providing expert advice on all aspects of business activity. Contact Anthony Kuran on 09 306 0611 or @email or Andrew Knight on 09 985 2531 or @email