The Turquand rule is founded in common law. It serves to protect bona fide third parties who are not aware of any internal irregularities of a company which may result in affecting the validity of a contract/transaction with the company.
The Turquand rule has been commonly referred to as the ‘indoor management rule’. A company entering into transactions with third parties has a duty to ensure that all its internal rules emanating from its Memorandum of Incorporation have been complied with.
The Turquand rule relieves third parties from enquiring whether the company it intends on contracting with has complied with all its internal rules. It serves to shield bona fide third parties from being prejudiced by the company’s failure to comply with its own internal requirements.
It is important to note that the common law Turquand rule only serves as protection to third parties acting in good faith. This means that a third party who knew or even suspects that internal formalities have not been complied with but deliberately turns a blind eye will not be protected.
The statutory interpretation of the Turquand rule extends to people who ought to have reasonably known that the company had not complied with its internal formalities. A third party may be put on an inquiry judging from the nature of the transaction, which includes an unusual or suspicious transaction. There must be absence of circumstances that put the third party on an inquiry. In addition, the Turquand rule does not protect a third party who relies on a forged document.
Though the Turquand rule is a common law rule, it has been incorporated in the Companies Act, 71 of 2008 (“the Act”). Section 20(7) of the Act provides that 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 the Act, its Memorandum of Incorporation and any rules of the company unless, in the circumstances, the person knew or ought to have reasonably known of any failure by the company to comply with such requirements.
The Turquand rule needs to be applied carefully since it may be interpreted in terms of common law and statutory law.
Author: Zilungile Stimela