Indoor Management Rule

A corporation acts through people, and its internal rules decide who may act for it and how. Those rules sit in its constating documents, its by-laws, any unanimous shareholder agreement and its board minutes. An outsider cannot see inside that "indoor" management. The indoor management rule, which traces back to the 1856 English case Royal British Bank v. Turquand, stops a corporation from escaping a deal by pointing to its own internal irregularity.

Ontario codified the rule in section 19 of the Business Corporations Act. It says a corporation, or a guarantor of a corporation's obligation, may not assert certain internal defects against a person dealing with the corporation or a person who has acquired rights from it. Section 18 of the federal Canada Business Corporations Act is almost word for word the same.

Three neighbouring OBCA provisions support it:

• No constructive notice (s.18). No one is deemed to know what a corporate document says just because it was filed with the government or is available at the corporation's office.
• Acts not invalid (s.17(3)). An act of the corporation, including a transfer of property, is not invalid by reason only that it breaches the articles, by-laws, a unanimous shareholder agreement or the Act.
• Defective appointments (s.128). An act of a director or officer is not invalid by reason only of a defect later discovered in their appointment, election or qualification.

Together these provisions put the burden of internal compliance on the corporation and its directors, not on the people they do business with. How the statute fits together is covered in our entry on the Ontario Business Corporations Act.

Under OBCA s.19, a corporation or its guarantor may not assert against a person dealing with the corporation that:

1. the articles, by-laws or any unanimous shareholder agreement have not been complied with;
2. the people named as directors in the most recent notice filed under the Corporations Information Act, or in the articles if more current, are not the directors;
3. the registered office shown in that notice or in the articles is not the registered office;
4. a person the corporation held out as a director, officer or agent was not duly appointed or lacks the authority customary in the corporation's business or usual for that role;
5. a document issued by a director, officer or agent with actual or usual authority to issue it is not valid or genuine; or
6. a sale, lease or exchange of all or substantially all of its property under s.184(3) was not authorized.

The last item matters in business sales. Selling all or substantially all of a corporation's property outside the ordinary course of business needs shareholder approval by special resolution. A buyer without inside knowledge is protected if that approval was skipped, though careful buyers still ask for it, as our guide to shareholder approval for asset sales explains.

The guarantor wording is also practical. A shareholder who personally guaranteed a corporate loan cannot escape the guarantee by arguing that the corporation's by-laws or board approval requirements were not followed, provided the lender had no inside knowledge of the defect.

Knowledge. Section 19 does not apply where the person has, or ought to have, knowledge of the defect by virtue of their position with or relationship to the corporation. Directors and officers are the clearest examples; shareholders involved in management, related companies and close advisers may also be caught, depending on what their role exposed them to. CBCA s.18(2) contains the same exception.

No holding out. Protection for a person's authority depends on the corporation having held that person out as a director, officer or agent. Someone who simply claims a title the corporation never gave them is not covered.

Unusual transactions. The authority protected is the authority customary in the corporation's business or usual for that director, officer or agent. A purchasing manager ordering supplies fits; the same manager selling the company's building does not. Outside that zone, the outsider must prove actual authority or rely on the general law of agency.

Forgery. Section 19 protects documents issued by someone with actual or usual authority to issue them. A document forged by a person with no authority at all is outside the rule.

Directors still answer internally. The rule protects the outsider, not the insiders. Directors and officers who ignore the articles, by-laws or a unanimous shareholder agreement breach their statutory duty to comply under s.134(2), which is part of directors' duties.

Section 19 is a defence in a dispute, not a substitute for diligence. A counterparty who relied on it still has to prove what it knew, and the knowledge exception turns on facts. For material contracts, loans and acquisitions, verify authority at the start:

1. Search the Ontario Business Registry to confirm the corporation is active and to see its current directors and officers. A certificate of status confirms the corporation exists.
2. Ask for a certified copy of the board resolution approving the transaction and naming the signing officers.
3. Get an officer's certificate, often called an incumbency certificate, confirming who holds each office, with specimen signatures.
4. Review the articles and by-laws for borrowing limits, two-signature requirements or restricted businesses.
5. Ask whether a unanimous shareholder agreement moves any board powers to the shareholders.
6. For an asset sale or other fundamental change, require evidence of the shareholder approval.

The corporation's side of the same exercise is a well-kept minute book, so it can produce these documents on request; our guide to corporate minute books covers what belongs in one.

Brightline Signs Inc., an Oakville sign maker owned by Amir Haddad, agrees to supply and install a $48,000 LED display for Halton Fitness Corp. The purchase order is signed by Halton's vice-president of operations, Sandra Mendes, whom Halton's website and emails present as the person responsible for equipment and facilities. Unknown to Brightline, Halton's by-laws require two signing officers for any contract over $25,000, and Halton's board never approved the purchase.

After installation, Halton refuses to pay, arguing the contract was never properly authorized. Section 19 blocks both of its arguments: Halton cannot assert that its by-laws were not complied with, and it cannot say that an officer it held out as running operations lacked the usual authority to buy equipment for its facilities. Amir had no inside knowledge, so Halton is very likely bound to pay the $48,000. Any complaint it has about Sandra's breach of the by-law is an internal matter between Halton and its officer.

The result would likely change if Amir also held shares in Halton and had received the board minutes refusing the purchase. He would then have knowledge of the defect through his relationship with the corporation, which takes Brightline outside the rule.