The Turquand Rule and its importance in shaping corporate liability in South African company law

Abstract

The South African common law Turquand rule protects persons from suffering loss due to a company’s failure to comply with internal policies relating to the authority of its representatives. This rule safeguards bona fide third parties dealing with company representatives on the assumption that such representatives have the requisite authority to act on behalf of the company. The rule provides protection to third parties where a representative had authority to represent the company, even if certain internal procedures required for the transaction were not followed.

INTRODUCTION

The Turquand rule was created long ago as an exception to the doctrine of constructive notice—the principle that parties are deemed to have knowledge of publicly available information. The introduction of this rule was primarily aimed at mitigating the harsh consequences of the doctrine of constructive notice. Over the course of its development, the Turquand rule came to serve functions beyond merely mitigating the effect of the doctrine of constructive notice.¹

The Turquand rule, also known as the indoor management rule, was developed in the English case Royal British Bank v Turquand.² The main purpose of this rule was to protect third parties who enter into business transactions with a company from incurring liability resulting from non-compliance with the internal policies of that particular company by its representatives.

According to the Turquand rule, when a company concludes transactions with third parties, the third parties are entitled to assume that all internal prerequisites and requirements necessary to authorize the company to enter into such transactions have been complied with.³ The rule operates on the principle that outsiders should not be prejudiced by internal irregularities of which they have no knowledge.

It is important to note that, like every other rule, the Turquand rule has exceptions. Firstly, it does not apply to situations where the third party had actual knowledge that the company’s representative had not complied with the internal procedures of that company. Secondly, the rule is not applicable to forgeries. Thirdly, it does not apply to situations where there are suspicious circumstances that should put the third party on inquiry. Lastly, the rule does not apply where the representative acts beyond the powers that could be delegated to them.

The Turquand rule is sometimes criticized because it offers minimal protection to the company itself. Critics argue that the application of this rule may encourage a conflict of interest between the directors of the company and its shareholders, and that the rule’s application may lead to unpredictable results. The effect of the rule is that an individual entering into an agreement with a company is not expected to investigate whether the company’s internal prerequisites have been met, provided the individual acts in good faith.

THE PRINCIPLE OF THE TURQUAND RULE

The rule provides that outsiders dealing with a company in good faith may assume that internal formalities and procedural requirements have been properly executed, even if they were not. This protects third parties from hidden defects within the company’s internal governance, such as the absence of board resolutions, authorizations, quorum requirements, or voting procedures.

THE TURQUAND RULE IN SOUTH AFRICAN LAW

1. Common Law Position

The Turquand rule was expressed as follows in Mahoney v East Holyford Mining Co Ltd:⁴

“When there are persons conducting the affairs of a company in a manner that appears to be perfectly consonant with the articles of association, then those so dealing with them externally are not affected by any irregularities which may take place in the internal management of the company.”

The basis of the Turquand rule is that a bona fide individual transacting with a company representative whose power is subject to internal requirements may assume that such representative is authorized to act on behalf of the company and that all internal requirements relating to the authority of the company representative have been complied with.⁵ The Turquand rule will therefore provide protection to bona fide third parties dealing with the representative if the representative had authority to act on behalf of the company, even though some internal procedures necessary for the particular transaction were not followed.

The rule is intended to address a scenario in which a company fails to satisfy an internal requirement pertaining to the contractual authority of its agents. Put differently, the Turquand rule prevents a company from evading liability under a contract entered into by its representative by claiming that an internal requirement was not met.⁶

A third party cannot rely on the Turquand rule if that party knew that internal requirements were not being followed, or if there were circumstances that should have prompted the third party to inquire whether the aforementioned internal management requirements had been followed. However, it must be noted that the Turquand rule was purely developed to protect bona fide persons dealing with companies. Consequently, companies themselves cannot rely on the rule.

Oosthuizen argues that the Turquand rule will only find application where a specific relationship exists between the company and the apparent representative.⁷

2. Section 20(7) of the Companies Act 71 of 2008

Section 20 of the Companies Act deals with various situations and provides rights and protection to different stakeholders within the company, all under the heading “validity of company actions.”

Section 20(7) of the Act states:⁸

“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 any such requirement.”

Section 20(7) of the Companies Act 71 of 2008 introduces into South African law what appears to be a third-party protection mechanism similar to the Turquand rule.⁹ Section 20(8), on the other hand, confirms that the common law Turquand rule continues to apply alongside the statutory provision.

Compared to the common law Turquand rule, section 20(7) is more comprehensive and has additional components. This section requires both subjective and objective knowledge that will disqualify a third party from using this protection.¹⁰ The section provides that if a person knew, or reasonably ought to have known, of the company’s failure to comply with requirements, they cannot rely on the presumption.

This section may not be invoked by directors, prescribed officers, or shareholders. In addition, the section permits a third party to assume that the company has complied with its Memorandum of Incorporation and the requirements of the Act.¹¹

The significant feature of section 20(8)¹² is that it expressly preserves the common law Turquand rule and stipulates that it must be interpreted concurrently with, and not in replacement of, the Turquand rule. This means that both the statutory and common law protections are available to third parties.

Case Law Applications

Mine Workers’ Union v Prinsloo¹³

The Turquand rule safeguards innocent third parties from internal policies that could affect the validity of a contract they have entered into with the company. This rule protects third parties if they act in good faith, which gives them the right to presume that the internal protocols necessary for a contract have been met. When entering into a contract, a third party that is genuinely acting in good faith is not required to verify that all internal policies and procedures of the company have been followed.

Morris v Kansen¹⁴

The court held that the Turquand rule is a rule designed for the protection of those who are entitled to assume, precisely because they cannot know, that the person with whom they deal has the authority that person claims to have. The court further stated that the Turquand rule “cannot be invoked if he who would invoke it ought to be put upon his inquiry.” This means that if circumstances exist that should raise suspicion, the third party must investigate before relying on the rule.

Merifon (Pty) Limited v Greater Letaba Municipality and Another¹⁵

This matter pertained to an application for leave to appeal, which was dismissed by the Constitutional Court. The applicant’s appeal was against the judgment and order of the High Court of South Africa, Limpopo Division, Polokwane.¹⁶ The main issue was whether the property sale agreement was valid and enforceable in accordance with section 33 of the Local Government: Municipal Finance Management Act 56 of 2003.¹⁷

The applicant attempted to invoke the Turquand rule to uphold the agreement reached with the Municipality regarding the sale of property and to compel the Municipality to abide by it. The Constitutional Court confirmed that the rule is not applicable because void acts cannot be validated under the Turquand rule. As a result, Merifon was denied leave to appeal by the Constitutional Court.

3. Practical Application

The Turquand rule applies to situations such as the following:

A director executing a contract without evidence that the required board resolution has been passed. In such circumstances, a third party dealing with the director in good faith may presume that the necessary board approval was obtained.

A company issuing documents without the third party having sight of internal authorization. The third party is entitled to assume that proper authorization exists.

A manager finalizing a loan agreement without documented shareholder consent being provided to the lender. The lender may rely on the Turquand rule if acting in good faith and without knowledge of the defect.

4. Exceptions to the Turquand Rule

The Turquand rule does not apply in the following circumstances:

First, where the third party had actual knowledge of the internal irregularity or non-compliance with internal requirements.

Second, where suspicious or unusual circumstances were present that should have put the third party on inquiry as to whether internal requirements had been met.

Third, where the transaction involved a forged document or signature.

Fourth, where the representative of the company acted beyond any authority that could have been delegated to them by the company (ultra vires the company’s capacity or beyond delegable authority).

5. Importance of the Turquand Rule in Shaping Corporate Liability in South Africa

The Turquand rule plays a crucial role in shaping corporate liability in South Africa in several important ways.

First, it promotes commercial certainty by allowing third parties to transact with companies without having to investigate internal corporate processes. This facilitates business transactions and reduces transaction costs.

Second, it protects outsiders and encourages economic activity by ensuring that bona fide third parties are not prejudiced by internal corporate irregularities of which they have no knowledge. This protection encourages persons to engage in commercial dealings with companies.

Third, the rule allocates responsibility to the company for ensuring compliance with its own internal requirements. This places the burden on the company, which is in the best position to ensure compliance, rather than on outside parties.

Fourth, the rule works in conjunction with the doctrine of apparent authority to provide comprehensive protection to third parties. Together, these doctrines create a framework that balances the interests of companies and those dealing with them.

Fifth, the codification of the rule in section 20(7) of the Companies Act 71 of 2008 strengthens legal certainty and accountability. The statutory provision, read together with the common law rule preserved in section 20(8), provides robust protection to third parties while maintaining the company’s responsibility for internal governance.

CONCLUSION

The Turquand doctrine safeguards individuals from loss that they would otherwise suffer as a result of a company’s failure to comply with its internal procedures relating to the authority of its representatives. Provided that the contract is not void and that the contracting party did not know, and had no reason to suspect, that the company had not complied with its internal requirements, the rule may be invoked as a defense to claims by the company that an agreement cannot be enforced due to non-compliance with the company’s internal prerequisites. However, the Turquand rule cannot be used to validate transactions that are void or to excuse conduct that is unlawful. Since the Turquand rule operates within both common law and statutory frameworks, it should be applied with careful consideration of its scope and limitations. The rule remains a vital component of South African company law, balancing the need to protect third parties with the requirement that companies maintain proper internal governance.

BIBLIOGRAPHY

Case Law

Mahoney v East Holyford Mining Co Ltd (1875) LR 7 HL 869

Merifon (Pty) Limited v Greater Letaba Municipality and Another (CCT 159/21) [2022] ZACC 25; 2022 (9) BCLR 1090

Mine Workers’ Union v Prinsloo 1948 (3) SA 831 (A)

Morris v Kansen 1946 AD 459

Royal British Bank v Turquand (1856) 119 ER 886

Legislation

Companies Act 71 of 2008

Local Government: Municipal Finance Management Act 56 of 2003

Books

Cassim FHI and others, The Law of Business Structures (3rd ed, Juta 2012)

Journal Articles

Mujulizi J, “The Continued Relevance of the Turquand Rule Under the Current Company Law Regime in South Africa” (2020) 6 Journal of Corporate and Commercial Law and Practice 47

Olivier EA, “The Turquand Rule in South African Company Law: Another Suggested Solution” (2019) 2 Journal of Corporate and Commercial Law and Practice 1

Oosthuizen MJ, “Aanpassing van die Verteenwoordigingsreg in Maatskappyverband” (1979) TSAR 1

Swart and Lombard, “Representatives of Companies Under the Companies Act 71 of 2008” (2017) 80 Journal of Contemporary Roman-Dutch Law 672

Online Resources

Da Costa B, “The Turquand Rule and Litigation in Courts” (Fasken, 10 August 2022) https://www.fasken.com/en/knowledge/2022/08/10-the-turquand-rule-and-litigation-in-courts accessed 10 September 2023

FOOTNOTES

¹ FHI Cassim and others, The Law of Business Structures (3rd ed, Juta 2012) 232.

² Royal British Bank v Turquand (1856) 119 ER 886.

³ Da Costa B, “The Turquand Rule and Litigation in Courts” (Fasken, 10 August 2022) https://www.fasken.com/en/knowledge/2022/08/10-the-turquand-rule-and-litigation-in-courts accessed 10 September 2023.

⁴ Mahoney v East Holyford Mining Co Ltd (1875) LR 7 HL 869.

⁵ Swart and Lombard, “Representatives of Companies Under the Companies Act 71 of 2008” (2017) 80 Journal of Contemporary Roman-Dutch Law 672.

⁶ EA Olivier, “The Turquand Rule in South African Company Law: Another Suggested Solution” (2019) 2 Journal of Corporate and Commercial Law and Practice 1, 2.

⁷ Oosthuizen MJ, “Aanpassing van die Verteenwoordigingsreg in Maatskappyverband” (1979) TSAR 1, 11.

⁸ Companies Act 71 of 2008, s 20(7).

⁹ EA Olivier, “The Turquand Rule in South African Company Law: Another Suggested Solution” (n 6) 2.

¹⁰ Mujulizi J, “The Continued Relevance of the Turquand Rule Under the Current Company Law Regime in South Africa” (2020) 6 Journal of Corporate and Commercial Law and Practice 47, 54.

¹¹ ibid.

¹² Companies Act 71 of 2008, s 20(8).

¹³ Mine Workers’ Union v Prinsloo 1948 (3) SA 831 (A).

¹⁴ Morris v Kansen 1946 AD 459.

¹⁵ Merifon (Pty) Limited v Greater Letaba Municipality and Another (CCT 159/21) [2022] ZACC 25; 2022 (9) BCLR 1090.

¹⁶ ibid [3].

¹⁷ ibid.