The “Indoor Management Rule” is well established in Canadian law. This common law rule holds that parties dealing with a corporation, acting in good faith and without knowledge of any irregularity, are entitled to assume that a corporation’s internal policies and proceedings have been followed and complied with. Some elements of the rule are codified in the various provincial business corporations statutes.
In Accra Wood Products,1 the trustee in bankruptcy (Trustee) used the Indoor Management Rule as the basis for disallowing the secured claim made by Formations Inc. (Formations) in the bankruptcy proposal process of Accra Wood Product Ltd. (Accra). Formations had supplied raw wood materials to Accra for use in Accra’s wood moulding manufacturing business. Their arrangements were documented in a credit application which Formations had provided to Accra, which application included a clause granting a security interest to Formations. That security interest covered all of Accra’s present and after-acquired personal property. The credit application was completed and signed by Accra’s office manager, Lisa Golding. After the execution of the credit application, the parties operated under the contract for two years without there being any hint of a problem with the granting of that security interest to Formations.2
The Trustee disallowed Formations’ secured claim on two grounds: (1) Golding, as the Office Manager of Accra, did not have the authority to execute the credit application granting Formations a security interest over Accra’s property and Formations knew or ought to have known that she did not have such authorization; and (2) the term of the credit application was inconspicuously included in the fine print and was not drawn to the attention of the person signing. The Trustee further argued that (a) it is not typical for a supply credit application to contain a clause granting the supplier a security interest, (b) it is not typical for an “office manager” or “accounts payable contact” to have the authority to grant such a security interest, and (c) in lending practice it is standard to obtain directors’ resolutions from a company when obtaining a security interest to ensure that the security interest has been duly authorized and granted.3 In support of the Trustee, Accra contended that it had no intention of granting Formations a security interest.4
In considering Formations’ appeal, Justice Masuhara of the British Columbia Supreme Court reviewed prior case law to determine the scope of the Indoor Management Rule designed to protect innocent third parties who rely on authority of the agent.
In Justice Masuhara’s view, the Trustee had placed undue reliance upon Golding’s limited authority. There was no internal documentation produced to substantiate the limits on her authority. It was also apparent that credit applications were normal transactions for Accra and that it was standard procedure for Golding to execute such documents on behalf of Accra. Indeed, security had been granted to other creditors with similar credit applications. Further to this, Golding had been the office manager of Accra for approximately 23 years. For this reason, the Court noted that it was fair to assume that she was knowledgeable of the internal processes of Accra.5 Another important factor in the Court’s determination was that Golding had clearly read the credit application as she had crossed out those sections that would have imposed joint and several liability upon her as the signatory of the document, yet she did not strike out the clause that read, “the undersigned individual is authorized to execute this application on behalf of the Customer”.
Justice Masuhara noted that while in many cases it is standard practice to require directors’ resolutions when security is granted, this is not always the case. Additionally, no case law was presented by the parties to support the proposition that further steps were required to determine the proper authority of Accra. There was no evidence of law supporting the proposition that an employee who is an office manager and who is responsible for accounts payable and other administrative duties, is presumed not to have authority to execute an agreement on behalf of his/her employer, including the granting of security. The Court determined therefore that the Trustee was not justified in departing from the Indoor Management Rule and disallowing the claim of Formations.6 The Trustee’s alternative arguments regarding the prominence of the placement of the security granting clause within the credit application were also dismissed by the Court.
The important point to note in this case is that it is still the best practice to obtain certified directors’ resolutions authorizing significant transactions entered into by a company or authorizing a person to enter into material documents on behalf of the company whenever possible. However, in those situations where a resolution was not obtained, the Indoor Management Rule may be available as a mechanism to protect parties dealing with companies and appropriate signing authorities. In the right circumstances, lenders may rely on upon documents signed by those that appear to have the authority to do so. The “right circumstances” can vary, depending upon anything from the number of years the person signing the document has worked at the company, how often a particular type of transaction is entered into, and the level of knowledge of the lender as to the internal processes of the relevant corporation.