Business Organisations Law Guidebook [2 ed.] 0195593979, 9780195593976

Citation preview

Learn how to link the key concepts from your lectures, textbooks and tutorials to get the most from your study, improve your knowledge of law and develop legal problem-solving skills. This guidebook will help you navigate through the fundamental points of business organisations law using:

Business Organisations Law GUIDEBOOK

Your guide to the essentials of business organisations law.

• clear and concise explanations of what you need to know • cases, statutes and sections to remember • assessment preparation sections

• up-to-date cases and legislation.

Marina Nehme is a Senior Lecturer in the Faculty of Law, University of New South Wales.

adams nehme

Michael A Adams is Dean of the School of Law, University of Western Sydney.

Second Edition

• diagrams and tables to help explain difficult concepts and complex material

Business Organisations Law GUIDEBOOK

Second Edition

ISBN 978-0-19-559397-6

9 780195 593976

Michael A Adams Marina Nehme

Business Organisations Law Guidebook

Business Organisations Law Guidebook

Second Edition

Michael A Adams Marina Nehme



1 Oxford University Press is a department of the University of Oxford. It furthers the University’s objective of excellence in research, scholarship, and education by publishing worldwide. Oxford is a registered trademark of Oxford University Press in the UK and in certain other countries. Published in Australia by Oxford University Press 253 Normanby Road, South Melbourne, Victoria 3205, Australia © Michael A Adams and Marina Nehme 2015 The moral rights of the authors have been asserted. First published 2010 Second edition published 2015 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, without the prior permission in writing of Oxford University Press, or as expressly permitted by law, by licence, or under terms agreed with the appropriate reprographics rights organisation. Enquiries concerning reproduction outside the scope of the above should be sent to the Rights Department, Oxford University Press, at the address above. You must not circulate this work in any other form and you must impose this same condition on any acquirer. National Library of Australia Cataloguing-in-Publication data Adams, Michael A. (Michael Andrew), Author Business organisations law guidebook / Michael Adams, Marina Nehme. 2nd edition. ISBN  978 0 19 559397 6 (paperback) Includes index. Commercial law—Australia—Handbooks, manuals, etc Business enterprises—Law and legislation—Australia—Handbooks, manuals, etc Corporation law—Australia—Handbooks, manuals, etc. 346.9407 Reproduction and communication for educational purposes The Australian Copyright Act 1968 (the Act) allows a maximum of one chapter or 10% of the pages of this work, whichever is the greater, to be reproduced and/or communicated by any educational institution for its educational purposes provided that the educational institution (or the body that administers it) has given a remuneration notice to Copyright Agency Limited (CAL) under the Act. For details of the CAL licence for educational institutions contact: Copyright Agency Limited Level 15, 233 Castlereagh Street Sydney NSW 2000 Telephone: (02) 9394 7600 Facsimile: (02) 9394 7601 Email: [email protected] Edited by Joy Window Cover image by Shutterstock/Markovka Text design by Aisling Gallagher Typeset by diacriTech, Chennai, India Proofread by Liz Filleul Indexed by Julie King Printed by Sheck Wah Tong Printing Press Ltd Links to third party websites are provided by Oxford in good faith and for information only. Oxford disclaims any responsibility for the materials contained in any third party website referenced in this work.

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Contents List of Figures and Tables vii Preface viii Chapter 1: Partnerships, Trusts and Associations 1.1  Introduction 1.2  What are the legal requirements of a sole trader? 1.3  What are the legal issues for partnerships? 1.4  What is a joint venture? 1.5  What is a trust? 1.6  What is an association?

1 1 3 4 10 11 13

Chapter 2: Australian Corporate Law 18 2.1  Introduction 18 2.2  Corporations Act 2001 (Cth) (Corporations Act) 19 2.3  Australian Securities and Investments Commission and other bodies 27 2.4  How does the doctrine of precedent operate in corporate law? 31 2.5  Types of companies 32 2.6  Promoters 35 2.7  What are the consequences of registration (incorporation)? 39 2.8  Lifting the veil of incorporation 40 Chapter 3: Corporate Constitutions and Replaceable Rules 3.1  Introduction 3.2  Converting a memorandum and articles 3.3  Corporate constitutions and replaceable rules 3.4  Section 140(1) (statutory constitutional contract) 3.5  The objects clause and why it is a problem 3.6  Altering the company’s constitution

45 45 46 46 51 54 56

Chapter 4: Corporate Liabilities 4.1  Introduction 4.2  Primary and secondary (vicarious) liability 4.3  Can companies commit crimes? 4.4  Can companies be liable under tort law? 4.5  How are corporations held liable in contract law? 4.6  Are there any statutory protection rules for the protection of third parties? 4.7  Things to remember

60 60 61 61 66 67 69 72

Chapter 5: Capital and Fundraising 5.1  Introduction 5.2  Membership

74 74 75

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Contents

5.3  5.4  5.5  5.6  5.7  5.8 

Share (or equity) capital What types of shares are available? What are the liabilities of a shareholder? What is the basic rule of maintenance of share capital and its exceptions? Debt capital Fundraising

76 77 78 79 85 87

Chapter 6: Company Officers and Management 6.1  Introduction 6.2  Definition of officers 6.3  Role of the company secretary and directors 6.4  Organic theory and decision making

94 94 96 97 101

Chapter 7: Officers’ and Directors’ Duties 7.1  Introduction 7.2  Fundamental duties of officers 7.3  What duties are owed by an officer? 7.4  Insolvent trading 7.5  Insider trading 7.6  Sanctions and remedies

107 108 108 111 122 126 128

Chapter 8: Protection of Shareholders 136 8.1  Introduction 136 8.2  What are the key membership rights? 137 8.3  Majority rule in Foss v Harbottle 143 8.4  Statutory minority protection 145 Chapter 9: Companies in Financial Trouble 9.1  Introduction 9.2  Schemes of arrangement and receivership 9.3  Voluntary administration 9.4  Voluntary winding up 9.5  Compulsory liquidation 9.6  Powers and duties of liquidators 9.7  Voidable transactions 9.8  Things to remember

153 153 154 157 158 159 162 162 163

Table of Cases 166 Table of Statutes 171 Index 177

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List of Figures and tables Figures Figure 1.1: Division of power between state and federal levels  2 Figure 1.2: Elements of a partnership  7 Figure 1.3: Structure of an unincorporated association  14 Figure 1.4: Liability in an unincorporated association  16 Figure 2.1: Types of corporations in Australia  33 Figure 2.2: Liability for pre-registration contracts  39 Figure 2.3: The company as a separate legal entity  40 Figure 3.1: Gambotto case finding  58 Figure 4.1: How a company may enter into a contract  69 Figure 5.1: Raising secured capital  86 Figure 6.1: Organic theory of corporations  102 Figure 7.1: The duties owed by an officer  111 Figure 7.2: The enforcement pyramid  133 Figure 9.1: Types of voluntary winding up  158 Figure 9.2: Grounds for compulsory winding up  159 Figure 9.3: Voidable transactions  163

Tables Table 1.1: Advantages and disadvantages of sole trader structure  3 Table 1.2: Advantages and disadvantages of a partnership  10 Table 2.1: Corporations Act structure  22 Table 2.2: Corporate law reform key dates  24 Table 2.3: Classification of Australian corporate law cases by court, 1991–2009  31 Table 2.4: Classification of Australian companies 1991–2014  34 Table 3.1: Where internal governance rules can be found  47 Table 3.2: Provisions that apply as replaceable rules (s 141)  49 Table 5.1: General buy-back procedure: steps and applicable sections (s 257B)  81 Table 5.2: Number of prospectuses lodged with ASIC over the years  88 Table 7.1: Contraventions of the Corporations Act per defendant  118 Table 7.2: Quick summary of sanctions and remedies  129 Table 9.1: Different types of external administration  164

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Preface ‘Business organisations’ is a broader concept than that implied by the traditional name of ‘company law’ (the name of the first edition of this book in the Oxford Law Guidebook series). Business organisations include sole traders, partnerships and companies and are covered by a mixture of laws. The most common is ‘company law’ (the more traditional name); its more contemporary equivalent, corporate law, is a key area of law for all those studying business and commerce. In particular, if you want to be a qualified accountant it is mandatory to study company law. However, this subject is quite detailed and understanding doesn’t jump off the pages for students. This book—and in particular this new edition—is designed to make it easier to grasp the key concepts and to fly through the assessment tasks in the least stressful way. The authors have 30 years of experience of teaching company law to business students at a variety of universities, including the University of Technology Sydney, the University of Western Sydney and University of New South Wales, as well as in the United States, United Kingdom, Malaysia and China. The book has a focus on key principles, such as a corporation having a separate legal entity as established in Salomon v Salomon & Co Ltd [1897] AC 22, through to the High Court of Australia’s application of the principle in Wellington Capital Ltd v ASIC [2014] HCA 43 (5 November). Since the last edition some major cases have arisen, such as the James Hardie litigation ending in two significant High Court cases (ASIC v Hellicar [2012] HCA 17; Shafron v ASIC [2012] HCA 18). But for business and commerce students, it is cases such as Hadid v Lenfest Communications Inc [1999] FCA 1798 that are also of interest. In that case, a shareholder and director of a group of businesses sued a company for breach of contract, breach of fiduciary duty, deceit, misleading conduct under the old New South Wales and Commonwealth fair trading legislations (now called the Australian Consumer Law) and under the Corporations Law. In fact, the plaintiff did not win on any one of all the many grounds, but the case still demonstrates how the law can be used in the business world and why it is so important to understand the various legal issues surrounding business organisations. Professor Michael Adams wrote an earlier version of the book as part of the Cavendish Essential Series in 2002, followed by a second edition in 2005 called Essential Corporate Law. This latest edition of the book is still part of Oxford University Press’s Guidebook series, previously titled the Company Law Guidebook, and has been renamed the Business Organisations Law Guidebook. To give the book a more contemporary feel, Michael was joined as author by one of his top lecturers in corporate law and then doctoral student, Dr Marina Nehme. Marina has a lot of experience with teaching company law to both undergraduates and to Masters of Professional Accounting students.

Preface

On a personal note, Michael is very grateful for the support of his family and friends while completing planned legal writing while holding the position of the Head and then Dean of a School of Law and also coping with Hodgkin’s cancer (which is now in full remission). UWS has been amazingly supportive through this whole process. Also the team at OUP, in particular Michelle Head, Shari Serjeant and freelance editor Joy Window, have made the book production process as smooth as possible to meet all deadlines. Marina would like to sincerely thank Professor Michael Adams and her family, for their constant encouragement, patient guidance and generous support. Finally, we hope you enjoy the book and the study of company law—we certainly have. We first read of Mr Aaron Salomon in a case from 1897 establishing that a company is a separate legal person. That case is still relevant today, in 2015! We wish you well in your business and corporate law studies. Professor Michael A Adams, UWS, Sydney Dr Marina Nehme, UNSW, Sydney May 2015

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Chapter 1

Partnerships, Trusts and Associations Covered in this chapter • • • •

Identification of different business structures Explanation of the role of partnership Description of trusts and joint ventures Explanation of association

Cases to remember Bradley Egg Farm Ltd v Clifford and others (1943) 2 All ER 378 Carlton Cricket and Football Social Club v Joseph [1970] VR 487 Chan v Zacharia (1984) 154 CLR 178; [1984] HCA 36 Freeman v McManus [1958] VR 15 Peckham v Moore [1975] 1 NSWLR 353 Re Griffin Ex Parte Board of Trade (1890) 60 LJQB 235 Smith v Anderson (1880) 15 Ch D 247 United Dominions Corporation Ltd v Brian Pty Ltd (1985) 157 CLR 1; [1985] HCA 49

Statutes and sections to remember Partnership Acts in the different jurisdictions Trustee Acts in the different jurisdictions Associations Incorporation Acts in the different jurisdictions

1.1 Introduction Australia operates under a federal system of government, with specified powers granted to the central federal (Commonwealth) parliament and residual powers vested in the state and territory parliaments. The Australian Constitution splits the legal powers between the Commonwealth (the Federal Government) and the various states and territories of Australia. Further, Australia has a common law system, which relies upon case law being developed over time from both the common law and equity. These cases are binding through the hierarchy of the courts. Such a common law system has to be taken into account when dealing with business structures such as partnerships, trusts or companies.

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Figure 1.1 Division of power between state and federal levels Australian federal system with a Federal Parliament creating laws under the heads of power in s 51 of the Australian Constitution. One of the powers referred to the Federal Parliament by the states is the power to make Corporations Law legislation (see Chapter 2)

Each state (New South Wales, Victoria, South Australia, Western Australia, Queensland and Tasmania) and territory (Northern Territory and Australian Capital Territory) has its own parliament, which creates legislation on a variety of topics. Some examples of legislation at the state and territory level are Partnership Acts, Trustee Acts and Associations Incorporation Acts. Each state and territory will have a different Act regulating partnership, trust and incorporated associations.

As shown in Figure 1.1, the area regulating corporations is now a Commonwealth matter, while trust and partnership are covered as state matters. This chapter explains the different types of business enterprises. Although more than 2.1 million companies are registered in Australia, other types of business structure need to be evaluated. The major choices, other than companies, are: • sole trader; • joint venture; • partnership; • trust; • association; and • company (not discussed in this chapter: see chapters 2–8). Although businesses can also be established as co-operatives, mutuals and syndicates, these are beyond the scope of this book. The selection of the best type of business structure or enterprise will depend upon a variety of factors. The key questions in determining business structure are: • How easy is it to establish the business? • What is the cost of setting up the business? • Are there any minimum or maximum capital requirements? • What are the applicable laws, and who will control the management of the business? • What is the degree of business flexibility? • What taxation rate applies: personal (for the financial year 2014–15, the top rate for individuals is 45%) or company (for the financial year 2014–15, the tax rate for companies is 30%)? • What is the expected size of the business enterprise? • What is the process involved in any later sale of the business entity or part? • What is the process of termination of the business? Although there is in theory a great choice of business structures, a business will often end up being registered as a company because there is a general perception

Chapter 1: Partnerships, Trusts and Associations

that it is the most appropriate structure. The reason is that a company can be treated in the same way as an individual (s 124 of the Corporations Act: see 2.6).

1.2 What are the legal requirements of a sole trader? A sole trader is a one-person business. An individual is allowed to operate in business as a sole trader under Australian law, and that business structure is very easy to establish. However, unlike companies, the trader and the business are treated as one. The law does not distinguish between them. Further, no specific statute regulates sole traders (there is no particular sole trader legislation). Thus, the sole trader is governed by the ordinary commercial laws of Australia, which include contract, tort, crime, agency, and trust law and legislation, state Fair Trading Acts, and even the Competition and Consumer Act 2010 (Cth) (more specifically the Australian Consumer Law – Schedule 2 in the Competition and Consumer Act 2010). Table 1.1 Advantages and disadvantages of sole trader structure Advantages

Disadvantages

Minimal formalities and regulations There are very few formalities to be followed when a person is setting up a business as a sole trader. For instance, a person can set up a kiosk to sell newspapers with a sign reading ‘NEWSPAPERS SOLD HERE’. If a business name is being used, then registration of that name under the business names legislation of the appropriate state or territory will be essential.

Unlimited liability The sole trader is personally liable for all the debts of the company.

Total control The sole trader is in control of the business.

Limited capital and management resources The sole trader cannot raise capital on the market.

No sharing of management or profits The sole trader keeps all the profit made by the business.

Limited life The business will last as long as the owner wants it to. The structure is linked to the identity of the trader. Accordingly, the death of the trader will mean the end of the business in its current form.

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Sole traders have only limited taxation issues to take into account, and the individual will be personally liable for any debts the business incurs. A sole trader may obtain an ABN from the Australian Tax Office (ATO) and may be required to make annual or quarterly payments to the government based on the Business Activity Statement (BAS). The benefit of the sole trader structure is that the person has a lot of flexibility and is in control of the business. This has to be weighed up against the lack of capital for expansion, the shortage of skills and the potential for unlimited liability for debts. Unlimited liability simply means that the (human) sole trader is personally liable for all the debts of the business. Some professionals, such as barristers, are required to operate as sole traders and are prohibited from being in partnership or a corporate body.

1.3 What are the legal issues for partnerships? Partnerships require at least two people to come together with the intention to make a profit. Partnerships have a maximum number of 20 partners (s 115 of the Corporations Act). Exceptions are professional practices, such as law firms, which may have up to 400 partners, and accountancy firms, which may have 1000 partners. The most relevant laws governing partnerships are common law, equity and the codified state or territory Partnership Act: Partnership Act 1892 (NSW); 1891 (Qld); 1891 (SA); 1891 (Tas); 1895 (WA); 1958 (Vic); 1963 (ACT); 1997 (NT). These Acts have not changed much in the last 100 years. They are based on the UK Partnership Act of 1890. In 1991, the Partnership Act 1892 (NSW) was amended to allow some partners to have limited liability by virtue of the Partnership (Limited Partnership) Amendment Act 1991 (NSW). Similar provisions apply in other states and territories. However, every limited partnerships must be registered with the state government and have at least one unlimited liability partner. If a limited partner becomes involved in the management of the business, then their protection from financial liability is removed. The limited partners are intended to be silent investors only, not active or managing partners.

1.3.1 Definition of a partnership The Partnership Act in each jurisdiction provides a definition of a partnership and states that ‘partnership is the relation which subsists between persons carrying on a business in common with a view of profit’ (NSW s 1; Qld 5; SA s 1; Tas s 6; WA s 7; Vic s 5; ACT s 6; NT s 5).

Chapter 1: Partnerships, Trusts and Associations

Arising from this definition are three essential elements for a partnership to exist. They are: 1 Carrying on a business We need to consider two definitions when looking at this element: the meaning of ‘business’ and of ‘carry on’. The Partnership Acts provide that a business includes ‘every trade, occupation or profession’ (NSW s 1B; Qld s 3; SA s 45; Tas s 4; WA s 3; Vic s 3; ACT s 4; NT s 3). These statutes do not specify what is meant by ‘carry on’. In Smith v Anderson (1880) 15 Ch D 247 the court noted that ‘the expression “carrying on” implies a repetition of acts and excludes the case of an association formed for doing one particular act which is never to be repeated. That series of acts is to be a series of acts which constitute a business … The association, then, must be formed in order to carry on a series of acts having the acquisition of gain for their object’ (at 277–8). Accordingly, carrying on a business requires repetition of an act. But an isolated act can still satisfy the statutory requirement so long as it is accompanied with an intention to repeat an act, as noted in Re Griffin Ex Parte Board of Trade (1890) 60 LJQB 235 at 237: ‘If an isolated transaction, which if repeated would be a transaction in a business, is proved to have been undertaken with the intention that it should be the first of several transactions, that is with the intent of carrying on a business, then it is a first transaction in an existing business.’ However, it is important to note that there have been cases where a venture has been deemed a partnership even though it may have been regarded as a single venture. For example, in United Dominions Corporation Ltd v Brian Pty Ltd (1985), the High Court has noted that a ‘single adventure under our law may or may not, depending upon its scope, amount to the carrying on of a business … Whilst the phrase “carrying on a business” contains an element of continuity or repetition in contrast with an isolated transaction which is not to be repeated, the decision of this court in Canny Gabriel Castle Jackson Advertising Pty Ltd v Volume Sales (Finance) Pty Ltd (1974) 131 CLR 321, suggests that the emphasis which will be placed upon continuity may not be heavy’. 2 In common In the statutory definition of partnership, the word ‘in common’ is a key element of the definition of a partnership as it reflects the requirement that each partner is a principal in the business. This does not mean that all the partners must take an active role in the affairs of the business. It simply means that the business must be carried on by or on behalf of the partners. For example in Duke Group Ltd v Pilmer (1999) 31 ACSR 213, the court has noted that ‘[i]n order to meet this criterion, it is not necessary that each of the alleged partners should take an

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active part in the direction and management of the firm. The business may well be carried on by or on behalf of the partners by someone else. The person carrying on the business must be doing so as agent for all the other persons who are said to be partners’. The agency relationship has been highlighted as an important criterion when determining whether the element ‘in common’ is there. In Lang v James Morrison & Co Ltd (1911) 13 CLR 1, Griffith CJ said ‘now in order to establish that there was a partnership it is necessary to prove that JW McFarland carried on the business of Thomas McFarland & Co on behalf of himself, Lang and Keates, in this sense, that he was their agent in what he did under the contract with the plaintiffs—not that they would get the benefit, but that he was their agent’ (at 11). In addition to this agency relationship, a mutuality of rights and obligations must exist. In Smith v Anderson (1880) 15 Ch D 247, James LJ observed that ‘persons who have no mutual rights and obligations do not, according to my view, constitute an association because they happen to have a common interest or several interests in something which is to be divided between them’. Accordingly, whether the element ‘in common’ is present or not is a question of fact. Two key criteria should be considered: (1) does an agency relationship exist between the partners and (2) do the parties involved in the business have mutual rights and obligations? 3 View of profit The object of the business is the acquisition of financial gain. It does not matter whether the venture is successful or not, so long as the requisite intention is present. The three elements for a partnership is illustrated in Figure 1.2. Partnerships are quick and easy to establish—both informally and more formally with a partnership deed (contract)—but can run into difficulties with unlimited liability. Partners are personally liable for the debts of the partnership. A partnership, after all, is not a separate legal entity. (Recall that ‘separate legal entity’ means that the business entity is distinct from the identity of the people running the business.) The following relationships may look like partnerships but they are not deemed to be partnerships unless the three elements of a partnership are also there (NSW s 2; Qld 6; SA s 2; Tas s 7; WA s 8; Vic s 6; ACT s 7; NT s 6): • co-ownership; • sharing gross return. Sharing profit, while it creates a strong presumption that a partnership exists, is not conclusive evidence (see NSW s 2; Qld 6; SA s 2; Tas s 7; WA s 8; Vic s 6; ACT s 7; NT s 6).

Chapter 1: Partnerships, Trusts and Associations

Figure 1.2 Elements of a partnership For a partnership to exist we need: Emphasis is on the whole agreement, not just what the parties refer to as their business

Carrying on of a business

What is a business? Check s 1B of the Partnership Act

In common

View for profit

Carrying on of a business: is there repetition? Smith v Anderson If there is no repetition, check if the parties had intention to repeat the transaction: Re Griffin case If not, continuity not as important: United Dominion case

1.3.2  Liability of partners to outsiders Although the Partnership Acts recognise different types of partners—general or active partners and sleeping or silent partners—at common law they are all agents of the firm and may be involved in its management. This principle was laid down originally in Re Baird’s case (1870) LR 5 Ch App 725 and is now enshrined in the state Partnership Acts. This means that every partner is an agent of the firm and of the other partners. If a transaction arises in the usual or normal course of business and the third party dealing with the partner is unaware of any lack of authority, then the firm is still held liable as the principal of the transaction. Liability can be imposed either by contract or by tort, on all of the partners, by virtue of the Partnership Acts (NSW s 5; Qld 8; SA s 5; Tas s 6; WA s 26; Vic s 9; ACT s 9; NT s 9).

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For liability in contract, partners are deemed agents of each other. Accordingly, a partner has the power to bind the other partners in contract: • In cases of actual authority (express or implied) a partner will have the power to bind the rest of the partners: the relevant authority is the actual authority given by the firm to a particular partner. If a partner who is acting within their actual authority buys goods on behalf of the firm, then of course the firm is bound. Usually partners have implied powers to enter into any contract that relates to the partnership business. • In cases of apparent authority, a problem will arise where a partner exceeds their actual authority. The question will be: are the other partners liable? The partners will be liable only if four elements are there: • The kind of business carried on. Partners will be liable for the acts of any of the partners if those acts are of a kind of business the firm usually carries on. Determining whether a transaction is within the scope of a particular kind of business is a question of fact. • Whether the transaction was conducted in the usual way. Even if what a partner does is within the scope of the firm’s business, an outsider should normally be suspicious if the transaction is not being done ‘in the usual way’. For example in Goldberg v Jenkins (1889) 15 VLR 36 the court held that a partner borrowing funds on behalf of the firm at a rate of 60% interest was not acting in the usual way, and the rest of the partners were not bound, because the rate was far in excess of the normal commercial interest rate at that time. • The outsider must not know or suspect that the partner was exceeding their authority. • The outsider must have known, or at least believed, that the person with whom they were dealing was a partner. • Upon ratification: even if a particular transaction falls outside the scope of actual or apparent authority, the firm will be bound if it ratifies the action of the acting partner. Ratification can be express or implied. Partners are jointly liable for contracts incurred by the partnership (NSW s 9; Qld 12; SA s 9; Tas s 14; WA s 16; Vic s 13; ACT s 13; NT s 16). Joint liability means that the outsider who signed a contract with the partner can only initiate one legal action. An outsider who decides to sue one of the partners will not be able to initiate further legal action against the rest of the partners if the first action fails. Accordingly, it is best for the outsider to sue the firm (all the partners in the partnership) in the first place. Partners can also be liable for the wrongful act or omission of any partner who is acting in the ordinary course of the partnership business (NSW ss 10–13; Qld ss 13–16; SA ss 10–13; Tas ss 15–18; WA ss 17–20; Vic ss 14–17; ACT ss 14–17; NT ss 16). This was clearly illustrated in the case of Polkinghorne v Holland (1934)

Chapter 1: Partnerships, Trusts and Associations

51 CLR 143, where P was a client of the solicitors Holland and Whittington (H&W). H senior normally dealt with P, but on occasions H junior gave her advice on investments. P was advised on some questionable transactions and lost a considerable amount of money, and then H junior disappeared. The firm of solicitors was sued for the losses and the court held that the advice was in the usual course of H&W business as solicitors; the partners were therefore liable for H junior’s fraud. Under tort law the liability of partners is joint and several. This means the outsider can sue any or all the partners, and if they sue one partner but do not recover the amount from that partner, they can initiate legal action against the rest of the partners. This situation is very different from joint liability, where an outsider is only entitled to one legal action.

1.3.3 Relationship between partners Each partner owes a fiduciary duty to the partnership (usually called the ‘firm’, although it is important to remember that a partnership is not a separate legal entity) and to each partner. Thus, if one partner binds the partnership to a contract, all the partners are equally liable for the debt. If a partner becomes bankrupt, the other partners can be liable for that partner’s debt as well. All partners owe fiduciary duties: they are not to make secret profits or allow conflicts of interests to arise between their personal affairs and the partnership. The High Court had to consider the duties of a two-doctor partnership in Chan v Zacharia (1984) 154 CLR 178.

A case to remember Chan v Zacharia (1984) 154 CLR 178; [1984] HCA 36 Facts: Two doctors, Chan and Zacharia, were partners in a medical practice. They decided to dissolve their practice and Chan took the lease of the premises (one of the valuable assets of the partnership). Chan did not disclose his conduct to the other partner. Chan sought to continue the medical practice on his own by excluding the other partner. Held: The court held that the opportunity of the renewal of the lease belonged to the partnership and as such Chan could only hold it on a constructive trust for both of them, as beneficiaries. Principle of law: Partners owe a fiduciary duty to each other. The duty continues even after dissolution of the partnership, at least until all the debts of the partnership have been paid and all the assets have been divided.

This principle is now reinforced by statute (NSW ss 28–30; Qld ss 31–33; SA ss 28–30; Tas ss 33–35; WA ss 39–41; Vic ss 32–34; ACT ss 33–35; NT ss 32–34).

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Table 1.2 Advantages and disadvantages of a partnership Advantages

Disadvantages

Partnerships are simple and cheap to set up and to dismantle.

Partnerships have no separate legal entity.

Partnerships are very flexible. The partners decide the way the business is going to run.

A limited number of people can be involved in the partnership.

There is no formal requirement of disclosure to the public.

Continuity problem: The death of a partner may lead to dissolution of a partnership.

 

Capital may be difficult to get. Unlike public companies, the partnership cannot raise capital on the market.

 

Partners have unlimited liability.

 

Partnership interests are not freely transferable.

1.4 What is a joint venture? 1.4.1  Joint venture – definition Joint ventures are sometimes called syndicates or consortiums. All are terms employed for avoiding the legal relationship of a partnership. They are agreements by contract to engage in an ad hoc profit project by combining resources, but without binding the other venturers. Examples include exploration for minerals and exploitation of new technologies. No matter what they call the relationship, the joint venturers may still be deemed to be partners, as held by the High Court of Australia (HCA) in United Dominions Corporation Ltd v Brian Pty Ltd (1985) 59 ALJR 676. If the relationship is a partnership the parties will be held to be fiduciaries. In the United Dominions case the HCA examined the concept of joint ventures and the liabilities imposed upon deemed partners and joint venturers. An agreement existed between UDC, B and SPL to develop some land and to share the profits. UDC provided the finance and SPL owned the land. A substantial profit was made, but B did not receive any of it because a further loan had been taken out on the land by UDC and SPL. The HCA held that the three were acting as partners and thus there had been a breach of the fiduciary duties and B was entitled to some of the profits. However, if the joint venture is purely a commercial transaction dealt with at arm’s length, no presumption of partnership or fiduciary relationship will apply. This was held by the HCA in Hospital Products Ltd v United States Surgical Corporation (1984) 55 ALR 417. HP was the Australian distributor of US-made surgical appliances

Chapter 1: Partnerships, Trusts and Associations

during 1978–79. But it stopped its distribution and copied the products, selling them in Australia as their own. In 1980 the American designers gained an injunction to stop HP, and also claimed an account of profits for the period. The HCA held that there was no fiduciary relationship, so only damages for breach of contract were appropriate.

1.4.2 Things to remember It is important not to confuse partnership and joint venture. Some of the key differences between these two business structures are: • The joint venturers receive a share of the product of the joint venture. In a partnership, the partners receive a share of the profit. • The liability in a joint venture is individual rather than joint and several as in a partnership. • Subject to agreement, the joint venturers are free to dispose of their interest in the joint venture. This is not the case in a partnership as the change of parnters may result in the dissolution of the partnership. • In a joint venture, the parties are not necessarily in a fiduciary relationship. In a partnership, partners owe fiduciary duty to each other. • In a joint venture the joint venturers are not agents of each other. In a partnership, the partners are agents of each other.

1.5 What is a trust? 1.5.1  Elements of a trust A trust can be defined as an equitable obligation contained in a relationship in which person B (the trustee) holds property (the trust property) transferred to them by person A (the settlor) for the benefit of person C (the beneficiary). Accordingly, there are four elements that go to make up a trust. They are the following: • Settlor A settlor is the creator of the trust in cases of (1) an express trust (created by the intentional act of a person, the settlor, in a written document, the trust deed) or in certain instances (2) an implied trust (a type of non-express trust which can arise from circumstances when the intention to create the trust is not expressed). It is possible in such situations for the court to imply or infer that there was an intention to create a trust). The settlor transfers legal title of the trust property (or trust fund) to the trustee and establishes the trust conditions that are binding on the trustee. Where a trust is created unintentionally (as in the case of a constructive trust—a type of non-express trust that courts will create to remedy an injustice), there will not be any settlor. The settlor does not usually have any liability in relation to the trustee for fees or reimbursement for trust expenses. The settlor has no control over the trust after its establishment.

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•

•

•

•

•

•

Trustee The trustee is the person who will be in charge of the trust property. They will hold the legal title to the trust property (ownership will be ‘vested in’ the trustee) and they will manage it for the benefit of the beneficiaries. A trustee is the legal owner of the trust property. Beneficiary The beneficiary is the person who benefits from the trust. The beneficiary is the equitable owner of the trust property. Trust property The trust property is also called the ‘trust corpus’ or fund. To have a trust, it is essential that a trust property, or an interest in some specific property, exists. The trust property can be tangible or intangible, real or personal, a ‘chose in possession’ (something physical) or a ‘chose in action’ (a legal right, such as a debt that can be collected). The trust property ownership is divided between the trustee and the beneficiary. The trustee has the legal ownership of the trust property while the beneficiary has the equitable ownership. There are different types of trust: An express trust, as already mentioned, is created by the express and intentional declaration of the settlor. The declaration of intention is usually made in a trust deed. Express trusts may be also classified as discretionary or fixed. A discretionary trust is a trust under which the identity or interest of the beneficiary or beneficiaries is not determined at the creation of the trust. The trustee has discretion to decide on those matters. A fixed trust (or non-discretionary trust) is a trust under which the trustee is not required to exercise any continuing discretion. The trust deed will clearly state who the beneficiaries are and what interest they are entitled to.

1.5.2 Fiduciary relationship The cornerstone of the trust relationship is the fiduciary relationship—the relationship of trust and confidence that needs to exist between the trustee and the beneficiaries. The trustee has a duty to act in the best interest of the beneficiary. Trustees will be in breach of their duties if they act for their own benefit instead of the benefit of the beneficiaries. In brief, the trustee’s duties are: • the duty to obey the terms of the trust; • the duty to keep proper books and records and to provide information to beneficiaries about the performance of the trust—the beneficiaries also have the right to inspect the accounts and the other trust documents; • the duty to administer the trust personally—trust responsibilities usually cannot be delegated; • the duty of care. The standard of the duty that is imposed on the trustee is that of a ordinary prudent person looking after the person’s own affairs.

Chapter 1: Partnerships, Trusts and Associations

1.5.3 Things to remember A trust is not a separate legal entity. It operates through the trustee, who will be personally liable for all the activities of the trust. The main benefits of trusts are the following: • Property is conserved and protected. This is one of the main goals of the trust. Trusts can provide benefit to members of the family without loss of control over those assets. • There are tax advantages through ‘income splitting’. • A trust acts as protection for settlor and beneficiaries against liability to outsiders arising out of transactions of the trust. Trusts can protect assets against creditors. • Trusts can safeguard certain social security entitlements. • Trusts can also be a way to pass wealth from one generation to the next. • Trusts can arise to remedy injustice (in cases of constructive trust). The three special attributes of trusts are: 1 a split between legal and equitable ownership; 2 a fiduciary relationship between trustees and beneficiaries; 3 public policy limitations on trust that are governed both by common law and by statute (for instance, the rule against perpetuities). The main disadvantages of trusts are: • A trust has no separate legal entity. • There can be a considerable cost to establish and maintain the trust. • The trustee is personally liable for the debt of the trust. • In cases of discretionary trust, the beneficiaries might be put in a vulnerable position (be left out of distributions).

1.6 What is an association? There are various legal possibilities for the organisation of an association. The two main types are: 1 unincorporated associations; and 2 incorporated associations. Unincorporated associations and incorporated associations have one thing in common. They are not created to generate profit and financial gain to their members. They are non-profit organisations. They provide structure for a number of activities from recreational and social clubs and societies to religious and political associations.

1.6.1 Unincorporated association There is no specific legislation that deals with unincorporated associations. The general law will apply to the parties running the association. However, certain kinds of

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associations which raise money by requesting donations from the public may need to be registered under various state Acts. An unincorporated association is not a separate legal entity. Its usual structure is shown in Figure 1.3. Figure 1.3 Structure of an unincorporated association Unincorporated association Not a separate legal entity. Who is in charge? Committee members Make decisions in relation to the unincorporated association. They are in charge of management. Members Elect the committee members. Members of the unincorporated association are not involved in its management.

An issue that can arise for unincorporated associations is the question of liability for contracts entered into on behalf of the association. The committee members and those in a position of control run the risk of unlimited personal liability for their acts, and for short-term contracts taken in the name of the association, as was held in Bradley Egg Farm Ltd v Clifford and others (1943) 2 All ER 378. The situation is a little more complex regarding medium- and long-term contracts.

A case to remember Carlton Cricket and Football Social Club v Joseph [1970] VR 487 Facts: Carlton Cricket and Football Social Club (Carlton), a company limited by guarantee, entered into a 21-year lease with Fitzroy Football Club (Fitzroy), an unincorporated association. Carlton alleged that Fitzroy was in breach of the contract. Held: The court decided that Fitzroy, being an unincorporated association, had no power to enter into the long-term lease. Accordingly, there was no contract in this instance. Further, the committee members are not liable for the contract. Principle of law: Long-term contracts entered into by unincorporated associations are invalid.

Chapter 1: Partnerships, Trusts and Associations

Courts have taken a different view in cases of medium-term contracts.

A case to remember Peckham v Moore [1975] 1 NSWLR 353 Facts: In January 1970 Peckham signed a three-year contract to play rugby league football with the Canterbury Bankstown Rugby League Football Club, an unincorporated association. Peckham was injured in 1972 and applied for workers’ compensation on the basis that the association was his employer and he was injured during the course of his employment. The issue was: who was his employer? Held: The club was not the employer. But the club committee was. The question was: which committee would be liable, since each year the association elected a new committee? The court constructed a series of artificial contracts with each committee. There was a contract with the 1970 committee for that year, and similar contracts with the 1971 and 1972 committees. The court noted: Once he is put on the payroll by that committee for a given year, that committee becomes his employer for that year and it is to that committee that he must look if he wishes to enforce his rights as a workman.

Principle of law: This case is based on the creation of artificial contracts with every committee. This rule can lead to abuse, because it opens the way for one the parties to sever the agreement at the end of each year.

It is important to acknowledge that members of an unincorporated association are not liable for any contracts entered into on their behalf. The liability of the members of an unincorporated association is limited to the amount of their subscription or entrance fee. They do not have to compensate the committee for any payment it made. For example in Freeman v McManus [1958] VR 15 the court held that ‘[t]he fact that the members of a society have entrusted its affairs and management to a committee does not give the committee authority to make contracts binding on the members especially in a case where the members have no interest in the society funds’. The liabilities in an unincorporated association are illustrated in Figure 1.4.

1.6.1.1  Things to remember It is true that unincorporated associations are very easy to set up, but they have several disadvantages. These include: • The unincorporated association is not a separate legal entity. • There may be problems with donations. Gifts cannot be held in the name of an unincorporated association because these associations have no separate legal existence.

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Figure 1.4 Liability in an unincorporated association Who is liable?

Committee members? In contract: Liability varies depending on the length of the contract. In tort: Liable.

•

•

The unincorporated association?

Members of the association?

Since it is not a separate legal entity, it is not liable for debts.

Only liable for their own subscriptions. No agency relationship exists between committee and members.

There may be problems with the validity of long-term contracts: are such contracts entered into by unincorporated association valid? The committee is liable for the debt of the association.

1.6.2 Incorporated association To resolve the problems faced by unincorporated associations, such as issues with liability of committee members, an association can be incorporated. Only associations that do not generate profit for their members can be incorporated. Each state and territory has its own Associations Incorporation Act with different requirements. For example, in New South Wales, Victoria and the ACT, an association which applies for incorporation is required to have a minimum of five members. In Western Australia, it must have six members and in Queensland, seven. An incorporated association can have rules that will deal with its internal governance. The assets of an unincorporated association will usually be transferred to the incorporated association on registration. Since the incorporated association is a separate legal entity, it has all the powers of an individual. An incorporated association is generally managed by a committee whose powers and duties are specified in the association’s rules. As a separate legal entity it can receive gifts and own property. Further, it will be liable for any contract entered into on its behalf. The committee and the members of an incorporated association are not liable to contribute towards payment of the debts and liabilities of the incorporated association or the costs, charges and expenses of the winding up of the association.

Chapter 1: Partnerships, Trusts and Associations

Assessment preparation Revision questions 1 Name two advantages and two disadvantages of running a business in the form of a sole trader. 2 Define a partnership. 3 What is meant by ‘carrying on a business’? 4 When are partners bound by a contract signed on behalf of the partnership by a person who has apparent authority? 5 Is a partnership a separate legal entity? 6 What is the different between joint liability and joint and several liability? 7 Define a discretionary trust. How is it different from a fixed trust? 8 Who owns the trust property in a trust? 9 What is the major difference between an incorporated association and an unincorporated association? 10 Who is liable for short-term contracts signed on behalf of an unincorporated association?

Problem question Bob and Joshua are best friends, and they decide to run a flower shop together. They agree that they are agents of each other, and that Bob will be in charge of leasing suitable premises from which to run the business, and will hire the employees. Joshua is responsible for buying the equipment that they need to run the flower store. Both parties are very excited about the project. Joshua finds pots that he likes and that he believes will be great for the business. He buys fifty of them from Priya and sends the invoice and the merchandise to Bob, who takes delivery of them. However, before any other transaction takes place, Bob and Joshua have a big fight and they are no longer on speaking terms. Any idea of running the business together is scrapped. Priya has not yet been paid, and she would like to know if there is a partnership between Bob and Joshua. Advise Priya on this matter. For answers to problem questions, please refer to .

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Chapter 2

Australian Corporate Law Covered in this chapter • • •

• •

The Australian framework of corporate law The use of common law and statutory interpretation of the Corporations Act 2001 The concept of separate legal entity and lifting the veil of registration (incorporation) The various types of companies that may be registered and the role of promoters The role of the regulator, the Australian Securities and Investments Commission (ASIC)

Cases to remember Gilford Motor Ltd v Horne [1933] 1 Ch 935 Gluckstein v Barnes [1900] AC 240 Green v Bestobell Industries [1982] WAR 1 Morley v Statewide Tobacco Services Ltd (1992) 10 ACLC 1233; [1993] VR 423 Salomon v Salomon & Co Ltd [1897] AC 22 Smith Stone and Knight v Birmingham Corp [1939] 4 All ER 116 Tracy v Mandalay Pty Ltd (1953) 88 CLR 215; [1953] HCA 9

Statutes and sections to remember Commonwealth of Australia Constitution, s 51(xx) Corporations Act ss 9, 45A, 112, 113, 114, 119, 124, 131, 588G ASIC Act s 1.

2.1 Introduction The corporate law system has traditionally been based upon state laws. However, since 2001, the area of corporate law has been a Commonwealth matter, because the states and territories have referred their power to the federal level. This chapter explains the legal framework of Australian corporate law, including the role of the corporate financial services regulator, the Australian Securities and Investments Commission (ASIC).

Chapter 2: Australian Corporate Law

2.2  Corporations Act 2001 (Cth) (Corporations Act ) 2.2.1 What is the structure of Australian corporate law? The major legal control governing the functions of Australian companies, and in fact for all corporate officers, is the Corporations Act 2001 (Cth). However, as will be seen below, the regime regulating corporations has varied over the last century,

2.2.1.1  Position prior to 1989 Australian corporate law was heavily influenced by English corporations legislation even after Federation in 1901. It is important to note, though, that some innovation in Australian corporate law occurred even during the time when Australia was a British colony. For example, in the 1890s, the colony of Victoria introduced the ‘no liability’ company. With time, this new type of company became available in all Australian colonies and then was adopted in other countries. After Federation, Australian’s corporations laws varied from state to state. This lack of uniformity was the result of legal issues and complication arising from the Commonwealth Constitution, which did not clearly allow the Federal Parliament to regulate the formation of corporations (see s 51 of the Australian Constitution, especially s 51xx—this later provision in the Constitution specifies that the Commonwealth power to legislation extends to ‘foreign corporations, and trading or financial corporations formed within the limits of the Commonwealth’). For instance, in Huddart Parker & Co Pty Ltd v Moorehead (1909) 8 CLR 330, when considering s 51(xx), the High Court pre-empted serious consideration of enacting Commonwealth legislation to regulate companies. Company law was deemed as a state and not a federal matter. However, by the 1950s, the company law regimes in the different states and territories were starting to be problematic. Businesses that were operating across state borders had to deal with different regulatory regimes, which caused the rise in business cost and the increase in red tape. All this negatively affected the Australian economy. As a result, the Uniform Companies Acts were adopted in all states and territories from 1 July 1962. This attempt at uniformity did not last long as each state and territory had a different regulator with different expertise, budgets and priorities. The fragmentation of the regulatory system also enabled rogue businesses to exploit the inconsistency in standards being applied in the different states and territories. By the end of the 1970s, it was determined that a more uniform approach to regulation of corporations was needed to enhance the system and improve the Australian economy. Accordingly, in the early 1980s, a new set of uniform corporate legislation—the National Cooperative Scheme—was introduced.

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The Companies Code was passed by all states and led to the adoption of a more uniform approach to corporate regulation. For example, a new federal regulator, the National Companies and Securities Commission (NCSC) was established. The NCSC administered and enforced the corporations laws. While the cooperative scheme was designed to provide a national regulatory approach to corporate law, its operation was not ideal as the scheme lacked accountability structures. Additionally, the distribution of functions between the NCSC and its delegate led to duplication and red tape. Further, the scheme did not have a strong and consistent national direction: the framework did not involve the referral or surrender of state power to the Commonwealth. The system depended on the adoption by states and by the Northern Territory of legislation issued by the Commonwealth for the Australian Capital Territory. All of these factors have led to a discontent with the scheme and, in 1987, a Senate Committee recommended that the Commonwealth should assume responsibility for the regulation of companies and securities laws. This recommendation was accepted by the Hawke government, which passed the Corporations Act 1989 (Cth).

2.2.1.2  Corporations Act 1989 (Cth) and the national scheme The introduction of the Corporations Act 1989 (Cth) led a number of states— New South Wales, South Australia and Western Australia—to challenge the constitutional validity of the Act. The High Court of Australia (HCA), in NSW v Commonwealth (1990) 169 CLR 482, determined (in a 6:1 majority judgment) that the Commonwealth did not have power to pass laws relating to companies under s 51(xx) of the Commonwealth of Australia Constitution. The court noted: The power conferred by s 51(xx) to make laws with respect to artificial legal persons is not a power to bring into existence the artificial legal persons upon which laws made under the power can operate (at 498).

This led to the establishment of a special arrangement between the states and territories and a national scheme took effect from 1 January 1991. The states and the Northern Territory agreed to apply the Commonwealth corporations legislation as if it were local company law. This was an unusual arrangement because, although it was technically state or territory based, the legislation actually operated as if it were federal legislation. Between 1991 and 2001, the relevant statute was called the ‘Corporations Law’. For most practical purposes, Australia had one system of corporate law. During its operation, the Corporations Law was subject to a range of reforms. For instance, in 1993, the reform process was commenced by the Commonwealth Labor Attorney-General and called the ‘Corporations Law Simplification Program’. With the change of federal government from Labor to the

Chapter 2: Australian Corporate Law

Coalition, this program of reform continued under the auspices of Treasury as the Corporate Law Economic Reform Program (CLERP). In the late 1990s, however, the national scheme started to unravel. A series of High Court cases followed, including Gould v Brown (1998) 151 ALR 395, Re Wakim (1999) 198 CLR 511, and R v Hughes (2000) 202 CLR 535, each of which challenged the constitutional validity of certain provisions in the Corporations Law. For example, as a result of Re Wakim (1999) 198 CLR 511, the High Court found that the Federal Court did not have jurisdiction to deal with matters that arise from the Corporations Law of a state. R v Hughes (2000) 202 CLR 535 cast doubt on the validity of the scheme especially regarding the power of the state to confer powers on Commonwealth officers.

2.2.1.3  Referral of powers and the Corporations Act 2001 (Cth) During 2000 and 2001, the Commonwealth Attorney-General and the Minister for Financial Services and Regulation pressured the states to refer their individual corporations powers to the Commonwealth for five years. All the states eventually passed legislation conferring their powers to the Federal Government. This enabled passage of the Corporations Act and the Australian Securities and Investments Commission Act 2001 (Cth) (the ASIC Act 2001), both of which commenced on 15 July 2001. On that date, the federal government was finally able to end a century of debate over whether Australia should have state or federal corporate laws. The constitutional basis of the Corporations Act is expressed in s 3 of Corporations Act, which provides that the states and territories referred their corporate powers under the Australian Constitution. The general administration of the Corporations Act is left to ASIC by s 5B of the Corporations Act. The Act includes its own Dictionary, in s 9, to aid interpretation of the complex law; however, there are still some sections with their own definitions scattered throughout the legislation. Section 5C of the Corporations Act provides that the federal Acts Interpretation Act 1901 (Cth) as amended is to be applied to the Corporations Act for consistency. The Corporations Act is divided into 28 chapters and two schedules. There were originally 1362 sections when the Act became operative on 1 January 1991. Now, with 1484 numbered sections, capital letters have been added to the section numbers when inserting new provisions in order to keep the structure logical. For example, the provision dealing with the appointment of a company secretary for a public company is numbered s 204A, as there were already existing sections numbered s 204 and s 205. These additions have taken the total number of sections in the Corporations Act to more than 5000. The Act is structured as shown in Table 2.1.

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Table 2.1 Corporations Act structure Chapter

Section

Topic

Ch 1

1 to 111Q

Introductory

Ch 2A

112 to 123

Registering a company

Ch 2B

124 to 167AA

Basic features of a company

Ch 2C

167A to 178D

Registers

Ch 2D

179 to 206M

Officers and employees

Ch 2E

207 to 230

Related party transactions

Ch 2F

231 to 247E

Members’ rights and remedies

Ch 2G

248A to 253N

Meetings

Ch 2H

254A to 254Y

Shares

Ch 2J

256A to 260E

Transactions affecting share capital

Ch 2L

283AA to 283I

Debentures

Ch 2M

285 to 344

Financial reports and audit

Ch 2N

345A to 349D

Updating ASIC information about companies and registered schemes

Ch 2P

350 to 354

Lodgments with ASIC

Ch 5

410 to 600H

External administration

Ch 5A

601 to 601AL

Deregistration and transfer of registration of companies

Ch 5B

601BA to 601DJ

Bodies corporate registered as companies and registrable bodies

Ch 5C

601EA to 601QB

Managed investment schemes

Ch 5D

601RAA to 601YAB

Licensed Trustee Companies

Ch 6

602 to 659C

Takeovers

Ch 6A

660A to 669

Compulsory acquisitions and buyouts

Ch 6B

670A to 670F

Rights and liabilities in relation to Chapters 6 and 6A matters

Ch 6C

671A to 673

Information about ownership of listed companies and managed investment schemes (Continued )

Chapter 2: Australian Corporate Law

Table 2.1 Corporations Act structure (Continued ) Chapter

Section

Topic

Ch 6CA

674 to 678

Continuous disclosure

Ch 6D

700 to 742

Fundraising

Ch 7

760A to 1101J

Financial services and markets

Ch 8

1200A to 1200U

Mutual recognition of securities offers

Ch 9

1274 to 1369A

Miscellaneous

Ch 10

1370 to 1541

Transitional provisions

Schedule

Topic

 

Schedule 3

Penalties

 

Schedule 4

Transfer of financial institutions and friendly societies

 

2.2.2  A decade of corporate law reform As previously mentioned, over the last decade there has been significant reform of the corporate law, prompting Mr Alan Cameron (former Chairman of ASIC), while speaking at the Corporate Law Teachers Association conference at the University of Technology Sydney in 1994, to muse, ‘you will need to keep buying legislation for some time yet’. Further, Justice Graham noted in Ku v Song and Others (2007) 63 ACSR 661 at 705: Whoever coined the expression ‘as clear as mud’ must have been slaving over the extraordinarily, and unnecessarily, complex provisions of the Corporations Act and the Corporations Regulations relating to share transfers at the time. Gaining an understanding of the relevant law on this subject back in 1961 involved a 5-minute exercise, reference being had to a couple of consecutive sections in the then Uniform Companies Act along with a couple of clauses in the relevant company’s articles of association or in a set of ‘Table A’ articles as recorded in the fourth schedule to that Act. Today, a like exercise requires hours of study, reference to numerous sections and regulations, which themselves make no sense without reference to numerous definitions, often shrouded in obfuscation, and, needless to say, strewn throughout the Corporations Act and the Corporations Regulations in various places such as ss 9 and 761A and regs 1.0.02 and 7.11.01. Why the law had to be expressed in such an obscure way beggars belief. Be that as it may, this case requires an understanding of the requirements for a valid transfer of shares in 2006.

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Some of the key dates of reform are noted below. The law is generally not retrospective, so companies and their officers can be held liable for breaches of the law only after the date of the commencement of any new law. Table 2.2 Corporate law reform key dates (the table includes some but not all amendments to Australia’s corporations legislation) Pre-1991

State Companies Code, Futures Industry Code, Securities Industry Code etc.

1 January 1991

Commencement of the Corporations Law consolidating the previous state codes and establishing the Australian Securities Commission as a national regulator.

1 February 1993

Commencement of new directors’ duties after passing the Corporate Law Reform Act 1992 (Cth).

23 June 1993

Commencement of new external administration provisions, such as voluntary administration and insolvent trading after passing the Corporate Law Reform Act 1992 (Cth).

9 December 1995

Commencement of the First Corporate Law Simplification Act 1995 (Cth), which rewrote the laws governing buy-backs, company registers and proprietary companies.

1 July 1998

Commencement of the Company Law Review Act 1998 (Cth) (originally the Second Corporate Law Simplification Bill), which rewrote the maintenance of capital laws, simplified registrations and corporate constitutions, reduced meetings, reduced annual returns and simplified the deregistration process. Commencement of the Financial Sector Reform (Consequential Amendments) Act 1998 (Cth) changed the name of the ASC to Australian Securities and Investments Commission (ASIC) and outlined its role for consumer protection. The government also established the Australian Prudential Regulatory Authority (APRA) with responsibility for the wholesale market in financial services.

13 March 2000

Commencement of the Corporate Law Economic Reform Program Act 1999 (Cth), which rewrote the fundraising provisions, officers’ duties, takeover laws and accounting standards.

15 July 2001

Commencement of the national Corporations Act 2001 (Cth) and the Australian Securities and Investments Commission Act 2001 (Cth).

15 December 2001

Commencement of the Criminal Code Act 1995 (Cth). (Continued )

Chapter 2: Australian Corporate Law

Table 2.2 Corporate law reform key dates (the table includes some but not all amendments to Australia’s corporations legislation) (Continued ) 11 March 2002

Commencement of the Financial Services Reform Act 2001 (Cth) (previously known as ‘CLERP6’ and now often referred to as ‘FSRA’), which repealed the existing chapters 7 and 8 of the Corporations Act dealing with securities and futures and replaced them with a completely new Chapter 7 entitled ‘Financial services and markets’. This FSRA reform had a twoyear transition period, which ended on 10 March 2004.

5 April 2002

Commencement of Financial Services Reform (Consequential Provisions) Act 2002 (Cth) to remedy a number of errors found in FSRA.

12 December 2002

CLERP 7 became the Corporations Legislation Amendment Act 2002 (Cth); it abolished the annual return and made provision for extracting of particulars connected to the date of corporate registration. Also streamlining of documentation and lodgments with ASIC.

11 April 2003

Commencement of the Corporations Amendment (Repayment of Directors’ Bonuses) Act 2003 (Cth).

1 July 2003

Commencement of the CLERP 7 provisions.

1 July 2004

Commencement of the Corporate Law Economic Reform (Audit Reform and Corporate Disclosure) Act 2004 (Cth), which is normally called CLERP 9. New liabilities are imposed on auditors, requiring greater independence and rotation of auditors, as well as new penalties for breaches of the continuous disclosure provisions and the directors’ remuneration report. Some of the provisions were delayed to commence after 1 January 2005.

18 November 2005

Commencement of the Corporations Amendment Act (No 1) 2005 (Cth), which made changes to s 197 (dealing with liability of directors of a company trustee).

28 June 2007

Commencement of the Corporations Legislation Amendment (Simpler Regulatory System Act) 2007 (Cth), which resulted in a number of changes in the Corporations Act such as changes to the definition of small and large proprietary companies and changes to the fundraising provisions under Chapter 6D.

20 August 2007

Commencement of the Corporations Amendment (Insolvency) Act 2007 (Cth), which fine-tuned the external administration provisions in the Corporations Act. (Continued )

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Table 2.2 Corporate law reform key dates (the table includes some but not all amendments to Australia’s corporations legislation) (Continued ) 11 December 2008

Commencement of the Corporations Amendment (Short Selling) Act 2008 (Cth), which addressed certain aspects of the regulation of short selling which became prominent as a result of the global financial crisis.

25 February 2009

Commencement of the Corporations Amendment (No 1) Act 2009 (Cth), which provided a mechanism in the Corporations Act for the recognition, in Australia, of the foreign jurisdictions disqualifications of people from managing corporations.

15 December 2009

Commencement of the National Consumer Credit Protection (Transitional and Consequential Provisions) Act 2009 (Cth), which set out the transitional and consequential arrangements to support the transfer of the regulation of credit from the states and territories to the Commonwealth.

25 March 2010

Commencement of the Corporations Amendment (Financial Market Supervision Act 2010 (Cth), which provided the Australian Securities and Investment Commission with the power to supervise trading on Australian financial markets.

28 June 2010

Commencement of the Corporations Amendment (Corporate Reporting Reform Act 2010 (Cth), which introduced changes to the dividend payment in Australia.

6 July 2010

Commencement of the Personal Property Securities (Corporations and Other Amendments) Act 2010 (Cth), which is the final set of amendments to the Personal Property Securities Act 2009 and includes consequential amendments to other Commonwealth legislation prior to the Personal Property Securities (PPS) regime coming into effect.

27 June 2011

Commencement of the Corporations Amendment (Improving Accountability on director and Executive Remuneration) Act 2011 (Cth), which introduced measures to strengthen Australia’s remuneration framework such as the ‘two strikes rule’.

27 June 2012

Commencement of the Corporations Amendment (Future of Financial Advice) Act 2012 (Cth), which led to changes in the way financial advice should be provided.

7 December 2014

David Murray releases the Financial System Inquiry: Final Report, which is likely to encourage significant changes to laws relating to financial services within the Corporations Act and ASIC Act in 2015.

Chapter 2: Australian Corporate Law

There have been nine CLERP Papers for reform and all nine have been enacted into legislation. The major proposals include: • Paper No 1—Reform of accounting standards (1997); • Paper No 2—Reforms of fundraising (1997); • Paper No 3—Reforms of directors’ duties and corporate governance (1997); • Paper No 4—Reform of takeovers (1997); • Paper No 5—Electronic commerce (1997); • Paper No 6—Financial markets and investment products (1997/1999); • Paper No 7—Simplified lodgments and compliance (2000); • Paper No 8—Cross-border insolvency (2002); • Paper No 9—Audit reform and corporate disclosure (2002). Details of the CLERP proposals are available at both the federal Treasury website www.treasury.gov.au and the ASIC website www.asic.gov.au. Corporate law reform has been led by the Corporations and Markets Advisory Committee (CAMAC) (see 2.3.3), which produces discussion papers and then makes its recommendation to the Commonwealth Treasury to amend the Corporations Act. More recently, the Commonwealth Treasury department has been issuing different consultation papers to initiate corporate law reforms and CAMAC may be dissolved in 2015.

2.3 Australian Securities and Investments Commission and other bodies The national agency responsible for enforcement and administration of the Corporations Act is the Australian Securities and Investments Commission (ASIC). As a consequence of the 1 July 1998 enactment of the Financial Services Sector Reform (Amendments and Transitional Provisions) Act 1998 (Cth), the Australian Securities Commission (ASC) was renamed ASIC. This change of name indicated to the public that the regulator now had broader responsibilities for investors’ protection in the financial sector. The day-to-day responsibility for administration and enforcement of corporations law rests with ASIC by virtue of s 11 of the ASIC Act 2001. The Corporations Act 2001 (Cth) itself does not specify ASIC’s objectives, but s 1 of the ASIC Act 2001 does provide that ASIC strives to: • maintain, facilitate and improve the financial system and entities within the system for commercial certainty, reducing business costs and efficiency of the market; • promote a confident and informed market for investors and consumers; • administer the laws with minimum procedural requirements;

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process and store all information provided to ASIC; and take whatever action is necessary to enforce and give effect to the laws of the Commonwealth that relate to corporations. ASIC has had six Chairs of the Commission so far: Tony Hartnell (1991–93); Alan Cameron (1993–2000); David Knott (2000–03); Jeffery Lucy (2003–07); Tony D’Aloisio (2007–11); Greg Medcraft (2011–current). As of the financial year 2013–14, ASIC has an annual budget of $346 802 million from the Federal Government. However, the Federal Government is cutting ASIC’s budget by $120.1 million over the next five years (initial reduction in financial year 2014–15 of 43.9 million, close to 12% of ASIC’s budget). This is despite the increasing responsibility of ASIC. The regulator is responsible for regulating over 2.1 million companies registered in Australia. Records of these are kept on the massive ASIC database called ASCOT. It further ensures that the provisions of the Corporations Act are being complied with by officers of the company and insolvency practitioners. ASIC also has responsibility for consumer protection in respect of financial services and the licensing of stockbrokers, insurance agents and other financial advisers. Further, ASIC now regulates trustee companies and consumer credit. It also supervises trading on financial markets and is in charge of the business register. In 2013–14, ASIC was successful in 90% of its cases (ASIC Annual Report 2013–2014, p 161). ASIC also has a number of administrative sanctions at its disposal such as banning orders and enforceable undertakings (an enforceable undertaking is a form of settlement between ASIC and the alleged offender which is enforceable in court). These administrative sanctions are commonly used by ASIC. For instance, the corporate regulator can use an enforceable undertaking as a sanction to ensure compliance with the rules and it has accepted 368 undertakings from 1998 to 2013. Similarly, in 2013–14, ASIC banned 60 directors from managing companies and 103 individuals or companies from providing financial services or credit services. In 2014, a Senate Economic Reference Committee conducted an inquiry into ASIC’s performance and made 61 recommendations to improve ASIC’s performance. A number of the recommendations were targeted towards improvement of the regulator’s supervision and monitoring of financial services, consumer credit and enforceable undertakings. Further, the committee recommended that the government consider increasing the penalties that may apply to breaches of the law and providing the regulator with alternatives other than court action to deal with certain breaches of the law. • •

Chapter 2: Australian Corporate Law

A number of other bodies involved in the investigation, reform and disciplinary measures of the Corporations Act were introduced or reconstituted under ASIC. They include the following.

2.3.1 The Takeovers Panel The Takeovers Panel was the new name adopted for the previous Corporations and Securities Panel (as at 11 March 2002) with the passing of the Financial Services Reform Act 2001 (Cth). This panel has primary responsibility for resolving disputes between parties involved in a takeover. Chapter 6 controls the legal procedures in respect of takeovers and Part 6.10 Division 2 provides for the Takeovers Panel. Specifically, s 659B limits who may apply to a court during a takeover, rather than applying to the panel: s 656A. The Takeovers Panel is the main forum for resolving disputes during a takeover: s 659AA. More details are available from www.takeovers. gov.au.

2.3.2 The Companies Auditors and Liquidators Disciplinary Board (CALDB) Originally, the Companies Auditors and Liquidators Disciplinary Board (CALDB) was established in 1990 to replace similar state-based boards at the time of the implementation of the Corporations Act 1989 (Cth) and the Australian Securities and Investments Commission Act 1989 (Cth). Following the referral of powers, CALDB is now established under the ASIC Act 2001, Part 11. This disciplinary board has responsibility for complaints made against auditors and liquidators who are registered with ASIC or the Australian Prudential Regulatory Authority (APRA). It can impose restrictions on, or remove the licence to practice of, an auditor or liquidator who is in breach of the Corporations Act. Any breach of the legal obligations contained in s 1292 of the Corporations Act can be referred to CALDB by ASIC. Under the CLERP 9 reforms the membership of CALDB was increased to include more accountants and provide for appointment of people who are not members of the Institute of Chartered Accountants in Australia or CPA Australia. The CALDB members are appointed by the federal Treasurer. Under s 203 of the ASIC Act 2001, they consist of: • a chairman; • a deputy chairman; • six members selected by the minister—these six people must reside in Australia and must be a member of a professional accounting body or any other body prescribed by regulation; and • six members selected by the minister having been satisfied that they are suitable persons for appointment as representatives of the business community. More details are available from www.caldb.gov.au.

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2.3.3 The Corporations and Markets Advisory Committee (CAMAC) The Corporations and Markets Advisory Committee (CAMAC) is established under Part 9 of the ASIC Act 2001. CAMAC is the official ‘think tank’ for corporate law reform. CAMAC provides the responsible minister with an independent source of advice on: • the amendment of the corporations’ legislation; • the operation and administration of that legislation; and • the enhancement of the financial services laws to ensure their efficiency. CAMAC has produced a number of quality consultative reports and discussion papers, such as The Social Responsibility of Corporations (2006), Issues in External Administration (2008), Diversity on Boards of Directors (2009), Aspects of Market Integrity (2009), Managed Investment Schemes (2012) and Crowd Sourced Equity Funding (2014). Prior to establishment of the Financial Services Reform Act 2001 (Cth) (for more information on this Act see Table 2.2) it was known as the Companies and Securities Advisory Committee (CASAC). Despite the central role CAMAC has played in implementing reforms that have cut red tape and enhanced business efficiency, the Abbott government has put forward an exposure draft Australian Securities and Investments Commission Amendment (Corporations and Markets Advisory Committee Abolition) Bill 2014, which aims to abolish CAMAC. Under the current proposal, its role will be taken over by the Treasury in the hope of reducing duplication and increasing efficiency in government. More details are at www.camac.gov.au.

2.3.4 The Australian Accounting Standards Board (AASB) and Financial Reporting Council (FRC) The AASB, in consultation with the accounting profession, the International Accounting Standards Committee and the Financial Reporting Council, makes appropriate accounting standards for Australia. Both these bodies are established under Part 12 of the ASIC Act 2001. There is also an Auditing and Assurance Standards Board (AUASB), which is overseen by the FRC, to implement auditing standards in Australia. On 1 January 2005 a Financial Reporting Panel, which helps to resolve disputes over accounts and financial reports between ASIC and the relevant company, was established. This was one of the many reforms included in CLERP 9. More details are at www.aasb.gov.au.

Chapter 2: Australian Corporate Law

2.4 How does the doctrine of precedent operate in corporate law? The doctrine of precedent (case law) is important in fully understanding the legal framework of corporate law. This is a key part of Australia’s status as a common law country, rather than relying totally upon statutes, as in civil code countries. A case heard before a superior court will bind the future decisions of lower courts on that point of law. Thus, a judgment of the HCA is binding on all other courts. A decision in a state Supreme Court (SSC) is binding on lower courts in the same state, but would only be persuasive to other judges in other states. This can cause ambiguities in the law, which can lead to appeals and legislative intervention. The development of Australian corporate law through case law can best be illustrated by the figures in Table 2.3. Table 2.3 illustrates five specific sets of years and a cumulative total for litigation commenced during the whole period of federal corporate law. All cases relate to superior court decisions reported in the LexisNexis:Butterworths Australian Current Law Reporter service. Corporate cases are classified in Category 120 of Halsbury’s Laws of Australia, LexisNexis Butterworths Editorial, Australian Current Law Reporter (LexisNexis:Butterworths, 2013) 490 (category 120–corporations, Halsbury’s Laws of Australia). This enables a consistent approach to analysis of corporate law cases by court. It can be seen that there are few HCA decisions relative both to state Supreme Court and to Federal Court (FCA) decisions. Furthermore, the Federal Court of Australia has been developing considerable expertise in the use of the Australian corporate legislation. However, in Gould v Brown (1998) 151 ALR 395, the High Court, in a very narrow decision (3:3 judgment), questioned the validity of the cross-vesting Table 2.3 Classification of Australian corporate law cases by court, 1991–2009 Year

All court cases

1991

4797

275

1995

7835

2000 2005   1991–2009

Total corporate cases

HCA

FCA

SSC

1

47

227

238

6

68

164

7397

250

5

10

235

6554

386

1

96

289

 

 

 

 

 

n/a

5852

46

1553

4252

Source: LexisNexis:Butterworths Australian Current Law Reporter

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legislation between the states and the Commonwealth. This cross-vesting scheme enabled civil cases to be heard in either the federal or state systems. The High Court subsequently ruled in Re Wakim (1999) 198 CLR 511 that the cross-vesting legislation was in fact unconstitutional and thus invalid. This meant that corporate law matters needed to be determined in the state Supreme Courts rather than the federal courts. The cross-vesting problem accounts for the significant fall in the number of cases heard by the Federal Court (see Table 2.3). Although the High Court’s interpretation of the Australian Constitution must be accepted, it is hard to understand how the states and the Commonwealth were able, for more than 10 years, to effectively and efficiently transfer legal powers to the Federal Court. However, in ASIC v Edensor Nominees Pty Ltd (2001) 177 ALR 329, ASIC won the right to bring litigation in the Federal Court as a Commonwealth agency. After the commencement of the Corporations Act and ASIC Act 2001, litigation may be brought in either the state or federal courts and the number of cases in the FCA is growing again.

2.5 Types of companies 2.5.1 What types of company may be registered? There are just two main types of company in Australia: public companies and proprietary companies, as highlighted in Figure 2.1. Section 112 of the Corporations Act allows these two main types to be subdivided into various categories: • proprietary companies limited by shares or unlimited in liability (with a share capital); or • public companies with liability: •

limited by shares; limited by guarantee; • unlimited with a share capital; or • no liability. •

In January 2013, the percentage of companies limited by shares was 99.2%—99.8% of these companies are proprietary companies (source: Paul Redmond, Corporations and Financial Markets Law (6th edn, 2013, LexisNexis). These statistics are not surprising as proprietary companies are cheaper to run than public companies. Further, limited liability by shares companies is a vehicle that encourages investments and entrepreneurialism as it limits investment risks to a certain extent. ‘Limited by shares’ means that the liability of members is limited to the unpaid amount (if any) for the shares held by them (s 9 of the Corporations Act). Effectively, the shareholder cannot be required to pay any more to the company, even in liquidation (hence the term ‘limited liability’). Such a company has ‘Ltd’ in its name.

Chapter 2: Australian Corporate Law

Figure 2.1 Types of corporations in Australia Companies

Public company

Company limited by shares (Ltd)

Proprietary company (Pty)

Company limited by shares (Pty Ltd)

Company limited by guarantee (Ltd)

Unlimited liability company

Unlimited liability company No liability company (NL)

A ‘guarantee’ company means that the members only pay the agreed amount (usually $50 per member) on a winding up of the company. Limited liability companies should generally have ‘Ltd’ in their name. ‘Unlimited’ companies are the same as a partnership regarding their liability and are only used for professional practices, such as those of lawyers or accountants. ‘No liability’ companies are mining companies that give the members extra protection from having to pay the full value of their shares on winding up. No liability companies have ‘NL’ in their name.

2.5.2 Proprietary and public companies Table 2.4 shows the various types of corporations that exist in Australia and their distribution over the last decade. Companies listed on the Australian Securities Exchange (ASX) are either public companies with shares or no liability mining companies. Proprietary companies make up 98.8% of all registered companies in Australia and vary from a $2 company to companies such as AustralianSuper Pty Ltd, which is worth billions of dollars. The category labelled ‘other public companies’ relates to public companies that do not have a limitation of liability by shares, such as charities, clubs and professional associations, which are limited by guarantee only.

2.5.2.1  What is a proprietary company? A proprietary company (usually shown as a name ending with Pty Ltd) is defined in a variety of sections in the Corporations Act, including ss 9, 45A and 112–114. As noted in Figure 2.1, a proprietary company may be limited by shares or

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Table 2.4 Classification of Australian companies 1991–2014 Year

Total Proprietary Other number of companies public companies companies

Public companies (limited by shares, including ASX Listed companies)

ASX listed companies

1991

8 92 749

8 71 648

10 699

10 402

1 096

1995

8 33 652

9 15 437

10 503

7 712

1 186

2000

1 173 709

1 154 044

11 559

8 106

1 295

2004

1 321 550

1 301 155

11 794

8 601

1 573

2006

1 411 421

1 392 458

11 105

7 858

1 873

2009

1 699 100

1 679 547

11 800

8 483

1 956

2011

1 840 839

1 818 915

13 689

8 235

2 012

2014

2 115 502

2 093 231

14 979

7 292

2 160

Source: ASIC, ASX annual reports and RP Austin and Ian Ramsay, Ford’s Principles of Corporations Law (16th ed, 2015, LexisNexis).

unlimited liability. The majority of proprietary companies are limited by shares. Examples of a proprietary company include Illawarra Coal Holdings Pty Ltd (coal mining) and Transfield Holdings Pty Ltd (major infrastructure construction). As highlighted by the name of the companies that are referred to above (they have Ltd in the name), these companies are limited liability companies. These companies are limited only by shares and thus have a share capital. The law requires only one member (shareholder) and there is a maximum limit of 50 non-employee shareholders. Also, the company must not engage in activity that would require a fundraising document (prospectus) to be lodged with ASIC (s 113(3)). Thus, the fundamental aspect of a proprietary company is that it is private and must not raise capital from the public. In 1995, as part of the Simplification Task Force, Part 1.5 Corporations Act (s 111J) was introduced as a ‘Small Business Guide’. This part of the Corporations Act is written in plain English and is a great starting point for understanding the law applicable to approximately 750 000 companies. At that same time, the government altered the Corporations Act to allow for proprietary companies to be classified as small proprietary or large proprietary companies (s 45A) for disclosure purposes.

Chapter 2: Australian Corporate Law

To be classified as a small proprietary company, two of the three following criteria must be satisfied in a financial year: 1 gross revenue of no more than $25 million; 2 gross assets of no more than $12.5 million; or 3 no more than 50 full-time employees. If these criteria are exceeded, the company will be deemed a large proprietary company. A small proprietary company is not required to lodge accounts or financial statements unless requested by a notice from ASIC or by shareholders representing 5% of the voting rights. A large proprietary company must lodge accounts with ASIC as if it were a public company. If a proprietary company wishes to convert to public, a simple process is laid down in the Corporations Act (for the process of converting a company see ss 162, 163 and 164).

2.5.2.2  What is a public company? Public companies are defined in s 9 as all companies that are not proprietary companies. Public company names usually end in ‘Limited’ or the abbreviation ‘Ltd’ if the company is a limited liability company (the company may be limited by shares or limited by guarantee). Examples include News Corporation Ltd and BHP Billiton Ltd. Public companies are not required to be listed on a securities exchange like the Australian Securities Exchange or the Chi X, yet may still raise capital from the public. Only one member (shareholder) is necessary (s 114) and there is no maximum number of shareholders. Every public company must have at least three directors and a company secretary (ss 201A and 204A).

2.6 Promoters A corporation must legally come into existence, and this process was previously called ‘incorporation’. Today the process of creating a company under the Corporations Act is known as registration. The person responsible for the process of registration is called a ‘promoter’.

2.6.1 Who is a promoter? There is no definition of a promoter in s 9. Thus, in most cases, there is a complete reliance on the common law case definition established by Lord Cockburn MR in Twycross v Grant (1877) 46 LJ CP 636, where he defined a promoter as: One who undertakes to form a company with reference to a given project and who takes the necessary steps to accomplish that purpose.

In Australia, this UK definition was accepted by the HCA in Tracy v Mandalay Pty Ltd (1953) 88 CLR 215, and was developed to include ‘deemed’ promoters. Deeming occurs where some of the people involved with the establishment of the company do

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not take an active role in the registration, but rather delegate this task to others. The court noted that the deemed promoter would benefit from the profits of the company, as well as initiating the principals to become involved with the business. Lawyers and accountants, in providing professional services, are not deemed to be promoters. If a person is held to be a promoter, they will automatically owe a fiduciary duty to the company. This can cause difficulties with conflicts of interest, in particular when entering into contracts on behalf of the company before it has been registered.

2.6.2 Can a promoter obtain a benefit from registering the company? The answer is ‘yes’, but there must be full and frank disclosure if a promoter is gaining a benefit from the creation of a company. Promoters have a fiduciary duty imposed on them. This is best illustrated in Gluckstein v Barnes [1900] AC 240, where the judge held that ‘honest disclosure’ is the key. If the company does not have an independent board of directors, disclosure of the profit made by the promoter has to be made to the existing or potential shareholders as held in Aequitas v AEFC (2001) 19 ACLC 1006. If there has been a breach of promoters’ duties the company may bring an action for compensation, rescission of the contract, and an order to make an account of profits.

A case to remember Gluckstein v Barnes [1900] AC 240 Facts: Gluckstein and three others purchased a property which they sold to a company they created. The secret profit they made from the sale was not disclosed. The company sought to recover the undisclosed profit made by the four promoters. Held: The House of Lords held that the four promoters had breached their fiduciary duty and were liable to account to the company for the secret profit that was made. Principle of law: Promoters have fiduciary duties imposed on them and they should not make secret profit. In case profit is made by promoters, they need to disclose their interests to an independent board of directors.

2.6.3 What steps must be taken to register a company? The first issue is whether you actually need to register a company (recall the other available structures). The choice of organisation needs to be made first. Australia does not require a minimum level of capital to establish a company and so it is easy and cheap to register a company. The process cost of establishing a company may vary between $1000 to $3000 depending on the complexity of

Chapter 2: Australian Corporate Law

the structure of the corporation. The steps that have to be followed to register a company are the following: 1 Choose a name for your company. There is an option available for the promoter to reserve a corporate name (Form 410). 2 Decide on the type of the company. 3 Obtain written consent of proposed members, directors and company secretary. 4 Select a registered office (its address). 5 Prepare a constitution if desired, or rely on replaceable rules. 6 Prepare register of members. 7 Lodge documents and forms with ASIC (Form 201). 8 Pay the scheduled fees to ASIC (the scheduled fee may be found on ASIC’s website: https://dv8nx270cl59a.cloudfront.net/media/1337510/Fees_for_ commonly_lodged_documents.pdf). ASIC will issue a certificate of registration and the corporation is deemed to have come into existence on that specified day (s 119).

2.6.4 What issues relate to the choice of corporate name? The promoter may select any name that has not already been registered (remembering that more than 2.1 million companies are already registered in Australia). There are some specific rules about names that are offensive or show a false connection to the government, royalty or certain charities, such as the Australian Red Cross. The chosen name may be similar, but not identical, to a name on the ASIC register or the database of Australian Business Names (which are registered at a state level). If there is potential for confusion, registration is likely to be refused. But registration does not offer protection. If registration succeeds but an existing company with a confusingly similar name objects to the new company trading under that name, it can bring an action in the state court for either the tort of passing-off, or in the Federal Court under s 18 of the Australian Consumer Law (for misleading or deceptive conduct). Each company is given an Australian Company Number of nine digits (usually called an ACN). This is different from the ATO requirement of an ABN, which has 11 digits. For convenience, the tax office inserts two digits in front of an existing nine-digit ACN for use as an ABN. (Say a company is registered as ACN 123-456789. The ATO will allocate ABN 00-123-456-789 for the sake of business efficacy.)

2.6.5 What are the necessary documents? Form 201 is the application form that contains the basic information that must be lodged with ASIC. The form is available from the ASIC website (www.asic.gov.au). The company may have a corporate constitution to be lodged (this is optional

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for most companies—for information on a company’s constitution see Chapter 3). There must be a certified list of directors who have consented to be directors and an address for the registered office. Proprietary companies require only one shareholder and one director (they can even be the same person) rather than the three directors required for public companies (s 201A of the Corporations Act).

2.6.6 What fees have to be paid? On the lodgment of the ASIC form and officers’ consent declarations, the regulated fee must be paid (the scheduled fee may be found on ASIC’s website). ASIC issues a certificate of registration and the company is deemed to come into existence at the beginning of the day the certificate is granted under s 119.

2.6.7 What happens if there is a pre-registration contract? The position at common law once was that a promoter would be liable for all contracts entered into prior to the company being registered (pre-registration contracts). The company could not be held liable for pre-registration contracts (Figure 2.2 shows who is liable for pre-registration contracts). This was stated in Kelner v Baxter (1886) LR 2 CP 174. Since 1981 this position has changed and the current position is set out in corporate statutes. Sections 131 to 133 of the Corporations Act provide that any contract made before the company is registered will be binding to the company, as long as: • •

the company is registered; and the contract is ratified within a reasonable time.

If this procedure is followed, the company is bound by the contract and the promoter is treated as an agent of the company. Alternatively, promoters can ask for a written release from liability, or use the concept of novation (renewal of the agreement in a new contract) for protection (ss 131 and 132). Reasonable expenses may be paid to the promoter out of the company’s assets by way of s 122.

Chapter 2: Australian Corporate Law

Figure 2.2 Liability for pre-registration contracts Promoter who signed the contract liable Promoter? The promoter is liable even if the company is liable. Who is liable for preregistration contracts?

There are certain instances when promoters will not be liable such as under s 132.

Company is liable if and only if: - the company is registered; and Company?

- the company ratifies the contract within a reasonable amount of time or within the agreed time.

2.7 What are the consequences of registration (incorporation)? The main consequence is that a company is a separate legal entity, as stated in Salomon’s case, which is one of the most significant cases in corporate law.

A case to remember Salomon v Salomon & Co Ltd [1897] AC 22 Facts: Salomon incorporated his family leather and boot business and sold it for cash, debentures and shares, which were held by family members. Salomon held both shares and debentures, but he sold the debentures, the value of which was owed to him by the company. The company went into liquidation and was unable to pay both the interest owed on the debenture and its unsecured creditors. The unsecured creditors argued that the business was run for the benefit of Salomon and that he should indemnify the company’s debts. Held: The court held indemnification was unnecessary. The company, although being conducted for profit by exactly the same individuals as before it was incorporated, was not in law an agent of the shareholders. Salomon was entitled to repayment of the debenture as a secured creditor. Principle of law: A company is an entity separate from the individuals associated with it, even if it has only one member (shareholder). A company is distinct from the directors and shareholders of the company.

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This principle has been confirmed in many cases including the UK Privy Council decision in Lee v Lee’s Airfarming Ltd (1961) [1961] AC 12 and NSW decision in ASIC and HIH Insurance v Adler, Williams and Fodera (2002) 42 ACSR 80. Other consequences include, in brief: • having perpetual succession (Lee v Lee’s Airfarming Ltd (1961) [1961] AC 12); • enjoying ownership of property (Macaura v Northern Assurance [1925] AC 619); • undertaking litigation in the company’s own name; • having its own signature (a common seal is optional under s 123); and • being a separate and independent person (ss 124 and 140).

2.8  Lifting the veil of incorporation Usually, in most circumstances, it is the company rather than the shareholders or the management that should sue or be sued. This is a direct consequence of the principle of separate legal entity. However, as can be seen in Figure 2.3, courts have power to see who is really in control of the business (either by applying the Corporations Act or under the common law jurisdiction), to ‘lift the corporate veil’—to look behind the protection of the company name. Figure 2.3 The company as a separate legal entity Principle of separate legal entity applies to companies: Salomon’s case and Corporations Act ss 119 and 124

Exceptions (Lifting the corporate veil) Common law exceptions Examples: • Avoidance of legal obligation • Agency • Involvement in breaches of directors’ duties

Statutory exceptions Examples: • Debts and other obligations incurred as trustee (Corporations Act s 197) • Insolvent trading (Corporations Act s 588G)

2.8.1 Example of lifting the corporate veil under statute The court may look behind the veil in the following circumstances: • where the group of companies have consolidated accounts; or • s 197 of the Corporations Act, which notes that directors may be liable for the debts of the company trustee if: • •

company trustee cannot pay the debt; and company trustee cannot be indemnified because it breached its duties.

Chapter 2: Australian Corporate Law

•

insolvent trading (s 588G). (For more detailed discussion on this topic see Chapter 7.) A director who allows a company to trade when it is insolvent will be personally liable for any debts of the company incurred when the company was insolvent. An example of this can be found in Morley v Statewide Tobacco Services (1992) [1993] VR 423.

A case to remember Morley v Statewide Tobacco Services Ltd (1992) [1993] VR 423 Facts: A family business was conducted by Mr and Mrs M until Mr M’s death. Mrs M asked her son to take over the running of the business, but never formally named him as managing director. After 10 years of trading the company became insolvent. M had had no active involvement in the business. A creditor brought an action under s 588G, insolvent trading, against the company. Held: As the wife was in breach of s 588G, the court lifted the corporate veil and held her liable for the debts of the company. Principle of law: A breach of s 588G may lead the directors to be personally liable for the debts of the company. In such instances the principle of separate legal entity does not apply.

2.8.2 Example of lifting the corporate veil under common law At common law courts have been prepared to lift the corporate veil in a range of circumstances. Some examples follow. Example 1: Avoiding contracts by using a corporate entity, known as a ‘sham’ company, as in Gilford Motor Ltd v Horne [1933] 1 Ch 935.

A case to remember Gilford Motor Ltd v Horne [1933] 1 Ch 935 Facts: Horne was the managing director of Gilford Motor Co Ltd. His employment contract included a clause that noted that Horne agreed that he would not solicit customers of the company during his employment and after he left the company, for a period of five years. After leaving the company, Horne registered a company with his wife and friend as shareholders. The newly formed company engaged in a similar business as Gilford Motor Co Ltd and the company, through Horne, targeted the customers of Gilford Motor Co Ltd. Gilford Motor Co Ltd sought an injunction to restrain Horne from breaching his contractual agreement. Held: The court found that the company created by Horne was incorporated to allow Horne to escape his legal obligation imposed by his employment contract. Accordingly, the court lifted the corporate veil and considered Horne and the company he registered as one. Principle of law: The court will lift the corporate veil if the company is created to avoid legal obligation.

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Example 2: Agency or groups of companies, which are closely connected, as in Smith Stone and Knight v Birmingham Corp [1939] 4 All ER 116.

A case to remember Smith Stone and Knight v Birmingham Corp [1939] 4 All ER 116 Facts: Smith, Stone and Knight Ltd was the holding company of Birmingham Waste Co Ltd. Birmingham Waste Co Ltd was conducting a business on the property owned by Smith, Stone and Knight. The goodwill of the business was never transferred to the subsidiary nor did the subsidiary have staff. It had no books of account and paid no rent for the premises. The person running the business was appointed by Smith, Stone and Knight. The local council compulsory acquired the land on which the business was running. However, the subsidiary was not able to claim compensation for the disturbance to its business. Instead, the parent company, Smith, Stone and Knight Ltd, sued the local council for compensation for the disturbance of the business. The local council argued that due to the principle of separate legal entity the holding company and the subsidiary were different companies and as a result the holding company could not sue for compensation. Held: The court determined that there was an agency relationship between the holding company and the subsidiary and as a consequence the court lifted the corporate veil and treated both companies as one. Atkinson J identified that an agency relationship existed, based on the answer to these six questions: 1 Were the profits treated as the profits of the parent? 2 Were the persons conducting the business appointed by the parent? 3 Was the parent the head and the brain of the trading venture? 4 Did the parent company govern the adventure, decide what should be done and what capital should be embarked on the venture? 5 Did the parent make the profits by its skills and directions? 6 Was the parent in effectual and constant control? Principle of law: The court may lift the corporate veil if there is agency between the holding company and the subsidiary.

Example 3: Where directors are involved in breaches of directors’ duties, the court will prevent abuses of power, as in Green v Bestobell Industries Ltd (1982). The Australian courts prefer not to lift the veil of incorporation, as the company is a separate legal entity, but the need for justice to prevail takes priority. Courts will therefore apply the concepts of equity rather than the strict letter of the law.

Chapter 2: Australian Corporate Law

A case to remember Green v Bestobell Industries [1982] WAR 1 Facts: Green was the Victorian branch manager of Bestobell Industries (BI). BI gained a tender to complete the construction of the first stage of a large project in Western Australia. While still employed by BI, Green personally submitted a tender for, and gained a contract to complete, the second stage of the project. BI submitted only the thirdcheapest proposal. BI claimed that Green owed it an account of profits for the project. Held: The court lifted the corporate veil. It was found that Green did owe BI an account of the profits. This liability stood even after Green’s termination, and despite no profit being made until after the termination. Principle of law: If directors form a company to allow them to breach their duties, the company and the directors will be considered as one. The corporate veil will be lifted.

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Assessment preparation Revision questions 1 2 3 4 5

6 7 8 9 10

Is the Corporations Law state or federal legislation? Who is the corporate regulator? When is a company considered a small proprietary company? Define a promoter. Eric is a promoter of Sales Pty Ltd. Prior to the registration of the company, Eric entered into contract with Will Ltd in the name of the company. After one month from the signature of the contract, the company is registered but the board are refusing to ratify the contract. Who will be liable for the contract with Will Ltd? Why? What are the steps that need to be followed to register a company? What was the principle established in Salomon v Salomon & Co Ltd? Identify four consequences of registering a company. Identify and discuss two instances in which courts will lift the corporate veil, based on the common law. Identify and discuss two instances in which courts will lift the corporate veil, based on statute law.

Problem question James was a senior manager of Gable Ltd. His contract of employment provided that, after he left the company, he could not compete with Gable Ltd for the first two years. In June 2013, James had a dispute with one of the directors of the company and resigned from his position. James was concerned that he would not find a job due to the financial crisis and he shared his concern with his friend, Emilie. Emilie brushed his concerns aside and informed him that he could run his own business in competition with Gable Ltd. When he told her about the restriction in his employment contract, she advised him that he could create a company that would run the competing business. In August 2013, James and Emilie decided to create such a company, Major Pty Ltd. It opened a competing business next door to Gable Ltd. Advise Gable Ltd on whether the company can seek a court injunction to prevent Major Pty Ltd from competing with its business. For answers to problem questions, please refer to .

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Chapter 3

Corporate Constitutions and Replaceable Rules Covered in this chapter • • • •

Explanation of the corporate constitution Explanation of the meaning of replaceable rules The ability to amend the constitution and also protect members The s 140(1) contract between the company and its members

Cases to remember Ashbury Railway Carriage and Iron Co v Riche Bros (1875) LR 7 HL 653 Eley v Positive Government Security Life Assurance Co (1875) 1 Ex D 20 Gambotto v WCP Ltd (1995) 182 CLR 432; [1995] HCA 12 Hickman v Kent or Romney Marsh Sheepbreeding Association [1915] 1 Ch 881 Lion Nathan Australia Pty Ltd v Coopers Brewery Ltd (2006) 236 ALR 561; [2006] FCAFC 144 Peter’s American Delicacy Ltd v Heath (1939) 61 CLR 457; [1939] HCA 2 Shuttleworth v Cox Bros & Co (Maidenhead) [1927] 2 KB 9 Southern Foundries (1926) Ltd v Shirlaw [1940] AC 701

Statutes and sections to remember Corporations Act ss 125, 130, 136, 140(1), 140(2), 141

3.1 Introduction As stated in Chapter 2, a company is deemed to be a separate legal person at common law (Salomon v Salomon & Co Ltd [1897] AC 22) and by ss 119 and 124 Corporations Act. The relationship between the company and its members is jointly regulated by the Corporations Act and the company’s constitution (where applicable), by way of s 134. A person, whether a human or a company, is referred to as a member, rather than a shareholder, under the Corporations Act, due to the fact that some types of companies do not have shares (that is, they are public companies limited by guarantee).

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3.2  Converting a memorandum and articles All organisations are bound both by Australian laws and by their own constitutions (rule books). Before July 1998, every company was required to have a memorandum and articles of association. These documents had their origins in UK company law from 1844; they explained to the outside world what a company’s’ purpose and objectives were. The memorandum of association was the external document that set out the name of the company, who was responsible for its incorporation, the amount of capital that could be raised and the limit of liability of its members. Some memoranda of association even included a list of business activities, called the ‘objects clause’, which the company would or might engage in. The articles of association were the internal rules of a company, gathered together in an internal document that was made publicly available due to the requirement for all public companies to lodge their articles with the regulator, ASIC. The articles regulated the operation of the business in areas such as shareholders’ rights, regulation of meetings, appointment of directors, and other important issues. The previous corporate legislation did have a standard memorandum and articles, which were known as ‘Table A’. However, in practice very few companies adopted the standard articles, and those that did so generally changed them to suit their own purposes. This caused confusion between investors, creditors and regulators. A common problem would arise within groups of companies that had a different memorandum and articles for each entity within the group. The Simplification Task Force on corporate law reform proposed that the memorandum and articles be abolished. The Company Law Review Act 1998 (Cth) amended the legislation to automatically convert all existing memoranda and articles of association into a corporate constitution. By virtue of the previous s 1415 (now repealed), all companies’ documents were converted on 1 July 1998. Many of the important rules that were included in articles of association were imported into the Corporations Act, but gave a corporation a choice to opt out of the law by adopting a company constitution instead. These rules, called ‘replaceable rules’, are listed in a table found in s 141 (see 3.3.3). Accordingly, a company’s internal management is now governed by its constitution and/or the replaceable rules.

3.3 Corporate constitutions and replaceable rules The internal governance rules are the rules or arrangements made between the participants in a company that govern the internal administration of the company (see Table 3.1).

Chapter 3: Corporate Constitutions and Replaceable Rules

Table 3.1 Where internal governance rules can be found Before 1998

Since 1998 (s 134)

Memorandum of association and articles

•

Constitution (see 3.3.1) Replaceable rules (see 3.3.3) • A combination of both •

3.3.1 What is a corporate constitution? The 1998 amending Act of the Corporations Act dispensed with the requirement for companies to have separate constitutional documents—a memorandum of association and articles of association. Companies with a memorandum and articles can keep them, but they are now assembled into a constitution. Alternatively, a company can rely upon the replaceable rules that have been included in the Corporations Act. ASIC can request a copy of the company’s constitution from a company by s 138, as can a member (s 139). For companies that existed prior to 1 July 1998, there were three choices: 1 do nothing—so that the existing memorandum and articles are consolidated and become the company’s constitution; 2 repeal the constitution and accept the replaceable rules of the Corporations Act; or 3 retain their constitution in part and allow the replaceable rules to be applied. For companies registered after 1 July 1998, there are two choices: 1 do not register a constitution and allow the replaceable rules to apply; or 2 create a company constitution that will displace the replaceable rules in their entirety or in part. There are three types of company to whom the general rules above apply differently: 1 No liability companies These must have a constitution as there is still a requirement for an objects clause specifying mining as the sole purpose (s 112(2)). 2 Sole member/director proprietary companies If the same person is both director and member, then the replaceable rules do not apply (s 135(1)). 3 Listed companies As the ASX listing rules require certain provisions to be contained within a company’s constitution, these companies cannot rely solely upon the replaceable rules. A company may decide to adopt a constitution for a number of reasons such as: • To change some or all of the replaceable rules. This usually occurs when the replaceable rules are unsuitable for the company in question.

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•

•

•

•

To supplement the replaceable rules and address matters not covered by them. For example the company may wish to have different classes of shares. The company’s constitution will contain provisions that explain the rights that come with these shares. To collect all the internal governance rules into a single document for the convenience of the company’s members and officers. To ensure that any parliamentary amendment of the replaceable rules will not affect the company unless it is adopted by the company. To incorporate restrictions on the company’s business.

3.3.2 Interpretation of the constitution When interpreting the terms of the constitution, the principles that govern the construction of commercial contracts will be relied on. This was confirmed in Lion Nathan Australia Pty Ltd v Coopers Brewery Ltd (2006) 236 ALR 561, when the court stated: A corporate constitution is in the nature of a commercial contract, which, as Jenkins LJ said in Holmes v Keyes; [1959] Ch 199 at 215; [1958] 2 All ER 129 at 138, ‘should be construed so as to give [it] reasonable business efficacy, where a construction tending to that result is admissible on [its] language … in preference to a result which would or might prove unworkable’ (at [97]).

The Lion Nathan case further notes ‘that like other commercial documents, [the constitution] must be read as a whole and, where appropriate, having regard to the purpose that, from an objective perspective, they were intended to serve’ (at [97]). As such the meaning of the constitution is to be objectively assessed. Further, due to the changing membership of the company and the fact that the constitution may be altered by its members, the court has emphasised that it will not necessarily take into account other factors or surrounding circumstances if the objective intention of the terms of the constitution are clear. For instance in Sumiseki Materials Co Ltd v Wambo Coal Pty Ltd [2013] NSWSC 235, the court observed: If the words used [in the constitution] are unambiguous, the court must give effect to them. A court is not justified in disregarding unambiguous language simply because the contract would have a more commercial and businesslike operation if an interpretation different to that dictated by the language were adopted (at [137]).

3.3.3 What are replaceable rules? If a company decides not to have its own constitution, the replaceable rules under s 135 provide the basic standards required for a company to function. For example, the minimum number of members required to be present at a shareholders’ meeting (called a ‘quorum’) would be uncertain without a constitution. Section 249T states

Chapter 3: Corporate Constitutions and Replaceable Rules

that the minimum number is two members. But as this section is a replaceable rule a corporation could have its own provisions within its constitution to set the quorum to at least five members. The table in s 141 lists 42 replaceable rules covering officers, employees, inspection of books, directors’ meetings, members’ meetings and shares (see Table 3.2). Table 3.2 Provisions that apply as replaceable rules (s 141)  

Officers and employees

 

1

Voting and completion of transactions—directors of proprietary companies

194

2

Powers of directors

198A

3

Negotiable instruments

198B

4

Managing director

198C

5

Company may appoint a director

201G

6

Directors may appoint other directors

201H

7

Appointment of managing directors

201J

8

Alternate directors

201K

9

Remuneration of directors

202A

10

Director may resign by giving written notice to company

203A

11

Removal by members—proprietary company

203C

12

Termination of appointment of managing director

203F

13

Terms and conditions of office for secretaries

204F

 

Inspection of books

 

14

Company or directors may allow member to inspect books

247D

 

Director’s Meetings

 

15

Circulating resolutions of companies with more than 1 director

248A

16

Calling directors’ meetings

248C

17

Chairing directors’ meetings

248E

18

Quorum at directors’ meetings

248F

19

Passing of directors’ resolutions

248G (Continued )

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Table 3.2 Provisions that apply as replaceable rules (s 141) (Continued )  

Meetings of members

 

20

Calling of meetings of members by a director

249C

21

Notice to joint members

249J(2)

22

When notice by post or fax is given

249J(4)

22A

When notice under paragraph 249J(3)(cb) is given

249J(5)

23

Notice of adjourned meetings

249M

24

Quorum

249T

25

Chairing meetings of members

249U

26

Business at adjourned meetings

249W(2)

27

Who can appoint a proxy [replaceable rule for proprietary companies only]

249X

28

Proxy vote valid even if member dies, revokes appointment etc.

250C(2)

29

How many votes a member has

250E

30

Jointly held shares

250F

31

Objections to right to vote

250G

32

How voting is carried out

250J

33

When and how polls must be taken

250M

 

Shares

 

33A

Pre‑emption for existing shareholders on issue of shares in proprietary company

254D

33B

Other provisions about paying dividends

254U

34

Dividend rights for shares in proprietary companies

254W(2)

 

Transfer of shares

 

35

Transmission of shares on death

1072A

36

Transmission of shares on bankruptcy

1072B

37

Transmission of shares on mental incapacity

1072D

38

Registration of transfers

1072F

39

Additional general discretion for directors of proprietary companies to refuse to register transfers

1072G

Chapter 3: Corporate Constitutions and Replaceable Rules

It should be noted that s 141 merely offers a convenient summary of the replaceable rules, which are, in fact, located throughout the Corporations Act, depending upon their topic. For example, the replaceable rules relating to directors’ and members’ meetings are found scattered throughout Chapter 2G. These rules can apply to either proprietary or public companies and can be identified as replaceable by the particular section heading in the Corporations Act. The advantage of relying upon the replaceable rules is that the company will always be abreast of statutory change, as the current rules are consistent with the Act’s other requirements, and this will save many companies the difficulty and expense associated with constitutional amendment. However, the replaceable rules have a bias towards proprietary companies, rather than public companies. So it is unlikely that any public company would wish to rely upon those rules, and in any case they would be capable of funding the cost of ‘custom-made’ rules rather than adopting those found under s 141. One important replaceable rule is specified as mandatory for public companies but not for proprietary companies. The rule relates to the members’ right to appoint a proxy, and is found in s 249X. That section may be adapted or repealed by a proprietary company, but it is compulsory for all public companies (for more on proxies see 8.2.2.2).

3.4 Section 140(1) (statutory constitutional contract) Under s 140(1) the corporate constitution and the replaceable rules that apply to the company have the effect of a contract between: • the company and its members; • the company and its directors and company secretary; and • members and members. These various parties may enforce the rights contained in the constitution or replaceable rules.

3.4.1  A company and its members The constitution is a contract between a company and its members according to s 140(1). However, members cannot enforce clauses in the constitution that give them rights in some other capacity than that of members. The question that needs to be asked is: does the clause in the constitution give the members a right that comes with the shares, or not? If the answer is ‘yes’, the clause in the constitution will be a contract between a company and its members because it will affect the members in their capacity as members.

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Examples of rights that come with shares are voting rights, pre-emption rights (a right to be offered any company shares first, in the event they are offered for sale) or, as in the leading UK case of Hickman v Kent or Romney Marsh Sheepbreeding Association [1915] 1 Ch 881, the right to rely on a dispute resolution process rather than litigation. The company in that case was able to call a halt to legal proceedings against it until the parties had completed arbitration, as provided in the company’s constitution. This decision was followed in the decision of the Supreme Court of Western Australia in Carew-Reid v Public Trustee (1996) 20 ACSR 443. Another related case is Eley v Positive Government Security Life Assurance Co (1875) 1 Ex D 20.

A case to remember Eley v Positive Government Security Life Assurance Co (1875) 1 Ex D 20 Facts: Eley was a member of Positive Government Security Life Assurance Co. The company’s constitution provided that Eley was to be the company’s solicitor and could only be removed for misconduct. After some time, the company decided to stop employing Eley as a solicitor and he sued the company for breach of the contract securing his position as solicitor. Held: The clause of employment in the company’s constitution does not affect the member in their capacity as a member. The employment right does not come with the shares (buying shares in a company does not make the buyer an employee of the company). Accordingly the constitution is not a contract between Eley and Positive Government Security Life Assurance Co. Principle of law: The company’s constitution is a contract between a company and its members. However, the provisions in the constitution that affect members in their capacity as outsiders are not enforceable.

3.4.2 A company and its directors and company secretary A company’s constitution is a contract between the company and its directors and company secretary. Accordingly, the directors, company secretary and the company may enforce the terms of the constitution. An example can be found in Shuttleworth v Cox Bros & Co (Maidenhead) [1927] 2 KB 9. The case also illustrates the point that it is very important for parties to have an independent employment contract as per Southern Foundries (1926) Ltd v Shirlaw [1940] AC 701. The company’s constitution is a contract between the company and its directors and company secretary, thus if a director or company secretary is not complying with the terms of the constitution, the company may take action against the director or company secretary.

Chapter 3: Corporate Constitutions and Replaceable Rules

A case to remember Shuttleworth v Cox Bros & Co (Maidenhead) [1927] 2 KB 9 Facts: The company’s constitution contained a provision noting that Shuttleworth was a director of the company and that he could only be removed in certain instances (such as gross negligence). The company changed its constitution to add additional grounds of removal. Following that change, Shuttleworth was removed from his position. He took action against the company for breach of contract, based on the company’s constitution. Held: The court held that the constitution is a contract between a company and its directors. However, the clause appointing Shuttleworth as a director was subject to a statute-given power, and a company may have altered its constitution without the approval of directors who may be affected. Accordingly, the company could remove the director in this instance. This was not a breach of the constitution since the terms of the newly altered constitution had been complied with. Principle of law: The company’s constitution is a contract between a company and its directors, but it is a statutory contract, and it may be altered without the approval of the director.

Distinguishing between a person’s capacity, such as shareholder, director and employee, can be significant under the constitutional statutory contract.

A case to remember Southern Foundries (1926) Ltd v Shirlaw [1940] AC 701 Facts: Shirlaw was the managing director of Southern Foundries. He had an employment contract signed by the company guaranteeing his employment for the next 10 years. The company’s constitution also noted that he was a director of the company. The company voted for a change in the articles of association (corporate constitution) that allowed for the removal of Shirlaw by the shareholders. The shareholders then voted for Shirlaw to be removed from his position as managing director. Shirlaw disputed the validity of that action because of his employment contract with the company. Held: The House of Lords held that Shirlaw’s removal from his position as managing director was valid under the articles of association (corporate constitution) of the company. A clause in the constitution relating to directors may be altered without the approval of the directors. However, the employment contract between the company and Shirlaw (which was outside the company’s constitution) had been breached, so Shirlaw was entitled to damages for wrongful dismissal. Principle of law: A company may alter its corporate constitution, but in doing so, if it breaches any current contractual commitment between the company and its directors, the company will be liable for the breach. The alteration of a corporate constitution is a valid action that will not be invalidated on the basis of the breach of an employment contract. No other form of remedy is available to injured parties except for damages in this situation.

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3.4.3  Members and members The constitution is a contract between a company and its members. An example can be found in Pender v Lushington (1877) 6 Ch D 70.

A case to remember Pender v Lushington (1877) 6 Ch D 70 Facts: Pender was a shareholder who divided his votes between nominees to maximise his voting power (the company used a sliding scale of voting power). Pender proposed a resolution and the issue was voted upon. The chairman refused to count the votes of Pender in relation to this issue. Held: It was held that Pender’s votes were valid because the nominee votes were legally valid. Principle of law: Members have the right to enforce provisions of a corporate constitution which entitle them to have their votes counted at the general meeting. They are not trustees of the company and may vote as they like.

3.4.4 Things to remember The company’s constitution is a contract between certain people as noted in s 140(1). As such, when determining whether the constitution is a statutory contract, check if the person falls under any of the three categories present under this section. If the answer is ‘yes’, and the relevant category is ‘between company and members’, ask yourself the following question: do the rights present in the constitution come with the shares? If the answer is ‘yes’, that means that the constitution affects the member in their capacity as a member and this means that the constitution is a contract between the company and that person. If the answer is ‘no’, this means that the constitution affects that member in their capacity as an outsider and the constitution is not a contract.

3.5 The objects clause and why it is a problem The only remnant of the previous memorandum of association that may still be used is the objects clause. Apart from no liability companies (where this requirement is mandatory), any company has the right to decide whether to place an object clause in its constitution. An object clause is a clause in the constitution that describes the scope of business of the company. The idea was to help investors and creditors know if their financial commitment was being appropriately applied. The objects clause unfortunately suffered from a number of problems because of the concept of ultra vires. The legal meaning of ultra vires is ‘beyond power’

Chapter 3: Corporate Constitutions and Replaceable Rules

(exceeding the powers of the entity). In the context of company law, this meant that a company could only carry on the business activities that were stated in the objects clause in the memorandum. Companies with object clauses in their memorandum of association could not, in the past, enter into a contract that falls outside the object clause.

A case to remember Ashbury Railway Carriage and Iron Co v Riche Bros (1875) LR 7 HL 653 Facts: Ashbury Railway Carriage and Iron Company Ltd was incorporated under the Companies Act 1869 (UK) and its memorandum stated that the object of the company was ‘to make and sell, or lend on hire, railway-carriages’. However, the company entered into a contract with Riche and his brother to finance the construction of a railway in Belgium. Later, the company sought to repudiate the contract because it was outside the scope of the company’s object clause. Held: The House of Lords declared that the company did not have the capacity to enter into a contract because it was outside (ultra vires) its objects clause. Principle of law: This case established the ultra vires doctrine. If a company enters into contract outside its object clause, the contract is not binding to the company.

Moreover, under the doctrine of constructive notice, a person who is dealing with a company is deemed to know the full content of all the public documents of the company (including the company’s constitution). The combination of this rule and the ultra vires doctrine meant that a person entering into a contract with the company had to inspect the company’s constitution to ensure that it was acting within its objects. The ultra vires doctrine became very restrictive, especially in instances where new business opportunities that are not covered in the object clause became available to companies. To deal with such restrictions, many companies had objects clauses that continued for many pages, so as to cover virtually every conceivable business activity. The problem was originally resolved by making the need for an objects clause optional by amendments to the Companies Code 1981 in 1984. However, the application of the ultra vires doctrine and the doctrine of constructive notice were commercially unrealistic. As a consequence, provisions were introduced in the Corporations Act with the express object of abolishing the ultra vires doctrine (ss 124 and 125) and the doctrine of constructive notice (s 130). Today, under s 124 of the Corporations Act, the company is given the full capacity of an individual, which allows the corporation to engage in any lawful business activity. This effectively removes the whole concept of ultra vires for corporations, but some judges still use the phrase in respect of the capacity of the directors (Darvall v North Sydney Brick and Tile Co Ltd (1989) 16 NSWLR 260).

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A company is allowed to place a restriction in its corporate constitution by s 125. For example, this restriction could be used to prevent a cosmetics company from contracting with a business that uses animals for testing products. Notwithstanding s 125, the company, as a separate entity, retains its capacity to contract even though this activity may be in breach of the restriction. Although the company would be bound by the contract, the officers would probably be considered to be in breach of their duties for failing to comply with the corporate constitution. Further, under s 140(1), when the directors do not comply with an object clause, the directors may find themselves in breach of a contract that exists between them and the company as they have not complied with the terms of the constitution.

3.6 Altering the company’s constitution A corporate constitution can legally be amended by passing a special resolution and following a basic procedure (s 136(2)). As the constitution helps define the fundamental legal relationship between the company, the members and the corporate directors and company secretary (s 140(1)), it should not be easily changed or altered. The procedures to pass a special resolution are onerous for a corporation. For a change to be made, at least 75% of the votes cast in the meeting (not of the total number of members) is required (this is what is referred to as a special resolution). Votes cast include all the votes of members present and any proxy votes that have been given to the proxyholders (usually the chairman of the company or other member-nominated person). A public company must file the amended constitution with ASIC within 14 days of the resolution being passed (s 136(5)). The effective date of the constitutional amendment will be the date of the resolution or the date specified by the resolution (s 137). A sole member/director of a company wishing to amend its constitution need only sign a record, which will become the minutes of the deemed meeting (s 249B). Alterations are allowed, subject to a number of statutory and common law safeguards, so as to protect minority shareholders. The primary restrictions on the alteration of the constitution are discussed below.

3.6.1 Section 140(2) (prohibition on any imposition of further liability on members) Section 140(2) imposes a prohibition on any imposition of further liability on members. The section provides: Unless a member of a company agrees in writing to be bound, they are not bound by a modification of the constitution made after the date on which they became a member so far as the modification: (a) requires the member to take up additional shares; or

Chapter 3: Corporate Constitutions and Replaceable Rules

(b) increases the member’s liability to contribute to the share capital of, or otherwise to pay money to, the company; or (c) imposes or increases restrictions on the right to transfer the shares already held by the member, unless the modification is made: (i) in connection with the company’s change from a public company to a proprietary company under Part 2B.7; or (ii) to insert proportional takeover approval provisions into the company’s constitution.

3.6.2  Sections 232–234 (protection of minorities) Minority shareholders are protected from oppression by the Act (see 8.4.1). There is a general minority protection provision in ss 232–234. Those sections afford a variety of remedies to a member in the event that the affairs of the company or an act or omission are oppressive, unfairly prejudicial or are unfairly discriminatory, or operate against the interests of the company as a whole.

3.6.3  Common law protection (the Gambotto case) The need to protect minority shareholders from detrimental changes to the constitution was identified in Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656. The UK court laid down the ‘bona fide for the benefit of the company as a whole’ test to determine the validity of the amendment of the company’s constitution. That principle was followed in the HCA case of Peter’s American Delicacy Ltd v Heath (1939) 61 CLR 457. However, in 1995 the HCA’s decision in Gambotto v WCP Ltd (1995) 182 CLR 432; [1995] HCA 12 revisited this principle and stated that the appropriate standard for any amendment to a corporate constitution should be ‘the proper purpose’ test.

A case to remember Gambotto v WCP Ltd (1995) 182 CLR 432; [1995] HCA 12 Facts: WCP Ltd amended its constitution to allow its majority shareholder, Industrial Equity Ltd (who owned 99.7% of the shares in the WCP Ltd), to compulsorily acquire the shares of minority shareholders at fair value. Gambotto, a minority shareholder with a 0.1% interest in the defendant company, brought an action to prevent the amendment of the company’s constitution. Held: The HCA rejected the ‘bona fide for the best interest of the company as a whole’ test in Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656. The court held that

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amendment of the constitution to expropriate a proprietary right was valid as long as two elements were present: 1 the change of the constitution was for proper purpose; and 2 the change to the constitution was fair. This required full disclosure so that members could make an informed decision. Further, in case of an expropriation of shares, the compulsory acquisition needs to be done at fair value. In this case the court held that the amendment was not for a proper purpose, even though WCP Ltd could show a substantial saving in administrative costs. A proper purpose would have existed if the expropriation would have saved the company from significant harm. Principle of law: Any repeal or modification of a corporate constitution relating to expropriation of proprietary rights must be exercised for a proper purpose and must be fair.

The finding in the Gambotto case is illustrated in Figure 3.1. Figure 3.1 Gambotto case finding Proper purpose test

Gambotto case is only relevant in case of change of the constitution to expropriate members' shares or proprietary right

This is the proper purpose of everyone

Fair here relates to:

For such a change of the constitution to be allowed the court will consider two elements

- The company disclosed all relevant information to the members; and

The change of the constitution is fair

- If the change is in relation to expropriation of shares, that the members whose shares are being expropriated are paid the market value for the shares.

Chapter 3: Corporate Constitutions and Replaceable Rules

Assessment preparation Revision questions 1 2 3 4 5 6 7 8 9 10

What is meant by replaceable rules? Where can the replaceable rules be found? What is a company’s constitution? Does every company need to have a constitution? Does the ultra vires doctrine still apply today? When is a provision in a company’s constitution a contract between the company and the members? How can a company’s constitution be altered? Name two statutory protections available to members if a company’s constitution is altered. What is the significance of Gambotto v WCP Ltd (1995) 182 CLR 432; [1995] HCA 12? What is the ‘proper purpose’ test as imposed by Gambotto v WCP Ltd (1995) 182 CLR 432; [1995] HCA 12? Do no liability companies have to have a company’s constitution?

Problem question Architect Pty Ltd was registered in 2009. Mario, Lucas and Samantha are its only shareholders. Mario is the company director. Lucas is the company secretary. Samantha was married to Mario and when the company was created the three shareholders included a clause in the company’s constitution noting that Samantha was the company’s financial adviser. In 2014, after marriage difficulties, Mario and Samantha divorce. Samantha has just received a letter from Architect Pty Ltd stating that her services are no longer required. Advise Samantha on whether she can prevent the company from terminating her services as a financial adviser. She particularly wants to know if the company’s constitution will protect her. Answer this question by referring to company law rules and principles. For answers to problem questions, please refer to .

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Corporate Liabilities Covered in this chapter • • • •

How corporations can be held liable under the law Corporate liability under the law of tort Corporate liability under contract law Corporate liability under criminal law

Cases to remember HL Bolton (Engineering) & Co Ltd v TJ Graham & Sons Ltd [1957] 1 QB 159 Tesco Supermarkets v Nattrass [1971] 2 All ER 127 Lennard’s Carrying Ltd v Asiatic Petroleum Co Ltd [1915] AC 705 Lloyd v Grace, Smith & Co [1912] AC 716 Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 1 All ER 630 Royal British Bank v Turquand (1856) 119 ER 886 Northside Developments Pty Ltd v Registrar-General (NSW) (1990) 170 CLR 146; [1990] HCA 32

Statutes and sections to remember Corporations Act ss 124, 126, 127, 128, 129

4.1 Introduction The company is required to act through human agents, such as the company officers (as it will be seen in Chapter 6 of this book, the definition of officer includes directors, the company secretary, and senior managers who make significant decisions—s 9 of the Corporations Act), and its other employees or appointed agents. Even though this is the case, a company is deemed to be a separate legal person at common law (Salomon v Salomon & Co Ltd [1897] AC 22) and by ss 119 and 124 of the Corporations Act, which provides that ‘a company has the legal capacity and powers of an individual’ (see 2.7). Accordingly, a company may incur civil liability under contract law or under the law of tort, both through its own actions and through the actions of its officers, employees and agents. A company may also be guilty of a crime under the Corporations Act, which carries criminal sanctions for contravening the law, or another statute. Whereas an individual found guilty of an offence might be sent to jail, a company will be fined a greater amount (up to five times) than an individual in lieu of a prison sentence (s 1312). A company’s officers may be sent to jail for helping the company to commit a crime.

Chapter 4: Corporate Liabilities

When dealing with tort and criminal liability, it is important to distinguish between the primary liability of an individual (agent or employee of the company) and the liability of the company itself. A corporation can be held primarily (the company is deemed to have committed the wrong or offence itself) or secondarily (vicariously— the company is made liable for the conduct of its employees/agents) liable. Companies usually have insurance policies to cover the cost of litigation arising from the acts of their employees, officers and agents.

4.2 Primary and secondary (vicarious) liability There is a clear distinction between primary and secondary liability in contract, tort and criminal law. In respect of companies, the basic test is derived from Lord Denning in HL Bolton (Engineering) & Co Ltd v TJ Graham & Sons Ltd [1957] 1 QB 159 at 172: A company may in many ways be likened to a human body. It has a brain and nerve centre which controls what it does. It also has hands which hold the tools and act in accordance with directions from the centre. Some of the people in the company are mere servants and agents who are nothing more than hands to do the work and cannot be said to represent the mind or will. Others are directors and managers who represent the directing mind and will of the company, and control what it does. The state of mind of these managers is the state of mind of the company and is treated by the law as such.

There is a distinction, His Lordship said, between the mind of the company and its hands. This prompts a supplementary question: how can the mind of a company be determined? This is not an easy question to answer, except when there are few people involved in the company; then the will of the controlling directors is taken to be the will of the company. The board of directors can certainly bind the company (s 198A) or delegate to the managing director or CEO (s 198C). These provisions are replaceable rules, but most companies would have a similar authorisation in their corporate constitution. Section 198D specifically provides a delegation power from the board to directors’ committees to a specific director, to other specific agents and to employees. The constitution of the corporate body may restrict this statutory delegation power by the board of directors.

4.3  Can companies commit crimes? It is possible for the artificial entity of a company to be held criminally liable through the acts of humans: criminal liability may be the result of primary liability (the company is taken to have committed the crime itself). The test applied to determine the primary

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liability of the company is the ‘mind and will’ test as discussed above in HL Bolton (Engineering) & Co Ltd v TJ Graham & Sons Ltd [1957] 1 QB 159. The common law, however, has not recognised secondary (vicarious) liability of a company for criminal offences. In Tesco Supermarkets v Nattrass [1971] 2 All ER 127, the court noted: the concept [of secondary liability] has no general application in the field of criminal law. To constitute a criminal offence, a physical act done by any person must generally be done by him in some reprehensible state of mind. Save in cases of strict liability where a criminal statute, exceptionally, makes the doing of an act a crime irrespective of the state of mind in which it is done, criminal law regards a person as responsible for his own crimes only. It does not recognise the liability of a principal for the criminal acts of his agent: because it does not ascribe to him his agent’s state of mind (at 155).

In Australia, this position has been altered by statute and as such companies’ secondary liability is governed by statute law, which may specify that the company is responsible and liable for the conduct of its employees. An example of this may be found in s 769B of the Corporations Act. Today, there are a few crimes that a company is incapable of directly committing, such as bigamy and murder. But it is possible for a company to be held guilty of crimes such as manslaughter, insider trading and theft. The entire Corporations Act is in fact a criminal regime (s 1311), and a corporation will be required to pay up to five times the maximum fine that could be imposed on a human (s 1312). However, the rule in s 1312 does not apply in cases of market misconduct due to the seriousness of the nature of such contraventions. One such breach is insider trading (s 1043A). For an individual, the penalty is imprisonment for 10 years or a fine the greater of the following: • 4500 penalty units; • if the court can determine the total value of the benefits that have been obtained by one or more persons and are reasonably attributable to the commission of the offence—three times that total value; or • both. For a company, the penalty is a fine the greatest of the following: • 45 000 penalty units; • if the court can determine the total value of the benefits that have been obtained by one or more persons and are reasonably attributable to the commission of the offence—three times that total value; • if the court cannot determine the total value of those benefits—10% of the body corporate’s annual turnover during the 12-month period ending at the end of the month in which the body corporate committed, or began committing, the offence.

Chapter 4: Corporate Liabilities

After December 2001 all Commonwealth statutes that contain criminal offences must comply with the Criminal Code Act 1995 (Cth). The Criminal Code Act provides standard amounts for fines and standard defences to all crimes. All fines are expressed as penalty units, the value of which is set by s 4AA of the Crimes Act 1914 (Cth)—currently set at $170 per penalty unit. The prosecution is brought by ASIC or the Commonwealth Director of Public Prosecutions (DPP) with the help of the Australian Federal Police. Most crimes require the prosecution to prove the following: • criminal action (actus reus); • guilty mind (mens rea)

4.3.1  Criminal action (actus reus) Actus reus represents the physical element of an offence. As a result, the first element to be proven in any criminal prosecution is that a criminal act has taken place. There are difficulties in proving that an artificial entity, like a company, has actually committed a crime. However, the courts will take into account the actions of individuals associated with the company as tantamount to the company committing the crime itself. For example in R v Kite and Oll Ltd (Unreported, Winchester Crown Court, Bennett J, 8 December 1994), a UK court found both a company (fined £60 000) and its managing director (jailed for three years) guilty of the death of four teenagers on an adventure holiday. In contrast, in December 2001 the directors and managers of a Swiss adventure travel company, Adventure World, which had taken Australian tourists canyoning in Interlaken, were found guilty of manslaughter of three tour guides and 18 tourists through culpable negligence. The directors and managers were fined more than $200 000 and received suspended jail sentences. Modern forensic techniques are making it easier to provide the necessary evidence to a standard beyond reasonable doubt to prove that a company committed a particular crime.

4.3.2 Guilty intention (mens rea) Mens rea is roughly the equivalent of the fault element in criminal codes. This second element of a criminal act is even harder to prove against a company unless it is a strict liability offence. A company can be held primarily liable for a criminal offence, as was the case in Hamilton v Whitehead (1988) 166 CLR 121. It is difficult to prove the state of mind of the company, especially where the decision maker is not a senior executive or endorsed by the board of directors. This difficulty can be illustrated in Tesco Supermarkets v Nattrass [1971] 2 All ER 127.

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A case to remember Tesco Supermarkets v Nattrass [1971] 2 All ER 127 Facts: Tesco supermarkets advertised boxes of washing powder at a particular price. The boxes marked with this price ran out and were replaced by a night manager with boxes of the same washing powder at the regular (higher) price. Tesco had methods in place for managers to check that prices on special items were correct before opening the store each day. Natrass filed a claim against Tesco claiming it had engaged in false and bait advertising (equivalent under the Australian Consumer Law 2010 (Cth)). Held: Tesco was found not guilty because it had proper procedures in place and the individual store manager was not equivalent to the company. The manager was not deemed the mind and will of the company. Principle of law: A subordinate does not constitute the ‘directing mind and will’ of the company. If a company has set up methods for management to follow and these are not followed, the acts of the employee disobeying the prescribed methods do not constitute the intentions of the company. Note: The Commonwealth Criminal Code Act may impose other liabilities.

This case can be contrasted with Hartnell v Sharp Corp of Australia Pty Ltd (1975) 5 ALR 493, where a microwave manufacturer falsely advertised compliance with the Standards Association of Australia. The company was convicted under the previous Trade Practices Act 1974 (Cth) (now known as the Australian Consumer Law) and fined $100 000.

4.3.3 Other things to be aware of when dealing with criminal liability Under certain legislative provisions there is no need to prove a fault element. These crimes are known as ‘strict liability’ or ‘no fault liability’ offences. Examples include contraventions of the environmental laws, as in EPA (WA) v McMurtry and Gillfillan Holdings Pty Ltd (Unreported, Western Australian Court of Petty Sessions, 9 March 1995 no 343 14, as noted in Sharon Mascher, ‘Protecting Water Quality in Western Australia’ (1996) 26(2) University of Western Australia Law Review 401, 412), or breaches of the occupational health and safety legislation, as in Forrest v John Mills Himself Pty Ltd (1970) 121 CLR 149. Further, a number of sections in the Corporations Act are strict liability offences. For instance, under s 250N, a public company must hold an annual general meeting once per year. Non-compliance with such a provision may result in a strict liability offence (s 250N(3)). In 2004, the Australian Institute of Criminology estimated that corporate fraud in Australia was costing businesses approximately $5.8 billion per year. This indicates

Chapter 4: Corporate Liabilities

the importance of dealing and preventing white-collar crime in Australia. However, judges and regulators have been criticised in the way they handle white collar crime. For example, in 2012, former Federal Court Judge Ray Finkelstein, QC, observed that the judiciary is being soft and lenient in sentencing white-collar crime as most judges believe that ‘the humiliation, loss of job and loss of status experienced by ­ white-collar criminals when they are apprehended, brought to trial and punished is usually sufficient punishment’. This perception seems to be reflected in the statistics issued by ASIC on the number of prosecutions based on strict liability criminal offences this regulator has undertaken against directors between 2006 and 2010. In 2013, the Australian Institute of Criminology analysed this data and found that ‘[t]he average fine imposed for a summary insolvency offence decreased by 19 percent during the years 2006 to 2010. The reasons for this decline could be increased leniency by the courts, or due to the individual circumstances of the offence or the offender changing over time’. In addition, a corporation may be found liable if it can be shown that the corporate culture of the organisation (the combined belief, attitude, values, ethics, conduct of an organisation) ‘directed, encouraged, tolerated or led to non‑compliance with the relevant provision’ (s 12.3 of the Criminal Code Act 1995 (Cth)). A well-known and often cited example of the interrelationship between civil and criminal legal actions is the 2001 collapse of HIH Insurance, at a reported loss of $5 billion. This major corporate collapse of the second biggest insurance company in Australia resulted in a Royal Commission conducted by a judge of the Supreme Court of Western Australia, Justice Owen. His report was handed down in April 2003: ‘The failure of HIH: a corporate collapse and its lessons’ (available from www.hihroyalcom.gov.au). While the Royal Commission was being conducted, ASIC was investigating a specific $10 million transaction involving three officers of HIH Insurance. The case, ASIC and HIH Insurance v Adler, Williams and Fodera (2002) 41 ACSR 72, was a civil penalty case for various contraventions of the Corporations Act officers’ duties provisions (this case is discussed in detail in Chapter 7). Following this civil case, which led to the disqualification of Mr Adler as a manager of a company, a criminal prosecution was brought against Mr Adler for breaches of the criminal law arising out of the same conduct. Mr Adler claimed that this is in contravention of the principle of double jeopardy (a person should not be tried for the same event twice). However, in Adler v DPP (2004) 51 ACSR 1, the court accepted the prosecution’s argument that the criminal case should be heard, and that the criminal charges were not an abuse of process. Even though civil penalties may have a punitive nature, obtaining civil penalty orders was not deemed the equivalent to ‘prosecution’ of Mr Adler.

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4.4  Can companies be liable under tort law? It is possible for primary liability of the corporate mind to be found, but it is hard to prove. Most commonly the action would relate to the tort of negligence. An example of civil liability being imposed directly on a company is Lennard’s Carrying Ltd v Asiatic Petroleum Co Ltd [1915] AC 705.

A case to remember Lennard’s Carrying Ltd v Asiatic Petroleum Co Ltd [1915] AC 705 Facts: Lennard was a director of Lennard’s Carrying Co Ltd, which owned a ship. He was in charge of managing the vessel. Lennard knew that the ship has defects, but allowed it to transport cargo owned by Asiatic Petroleum Co Ltd. The ship caught fire due to unseaworthiness, thereby destroying its cargo. Held: The court determined that Lennard was the directing mind and will of the corporation and that the company was therefore primarily liable in negligence for the resulting damage. Principle of law: A company may incur primary liability for tort if the natural person who did the wrong is effectively the mind and will of the company.

It is more likely that a corporate body will be held liable for secondary liability, known as vicarious liability. This liability is incurred if an employee or agent is acting within the scope of their appointment when they breach the civil law. In such situations, the employer (in this case, a company) is responsible for the conduct of the employee. This was held to apply in the classic case of Lloyd v Grace, Smith & Co [1912] AC 716.

A case to remember Lloyd v Grace, Smith & Co [1912] AC 716 Facts: Mr Sandles was a clerk in a firm of solicitors, Grace, Smith and Co. He asked one of the clients of the firm, Mrs Lloyd, to sign two documents, which she did not read or understand. Mrs Lloyd assumed that these documents were needed to allow her to sell some of her assets. In reality, the documents transferred the ownership of the assets to Mr Sandles. When the fraud was uncovered, Mrs Lloyd sued the firm to be compensated for her loss. Held: The firm was held liable for the fraud committed by Mr Sandles in the course of his employment. Principle of law: It does not matter whether an employer authorised the conduct of the employee—the employer is secondarily liable for the actions or omission of its employees if they are done in the course of their employment.

Chapter 4: Corporate Liabilities

Companies in Australia may also be found to be vicariously liable for the actions of independent contractors whom they employ (such as bicycle couriers), following the High Court of Australia decision in Hollis v Vabu Pty Ltd (2001) 207 CLR 21. There have been some limits imposed upon such litigation in tort or contract law by state legislation, reducing compensation payments. One such example is the Civil Liability Act 2002 (NSW). In the other jurisdictions the corresponding enactments are the following: Civil Law Wrongs Act 2002 (ACT); Personal Injuries (Liability and Damages) Act (NT); Civil Liability Act 2003 (Qld); Civil Liability Act 2002 (Tas); Civil Liability Act 2002 (WA); and amendments to Wrongs Act 1936 (SA) and Wrongs Act 1958 (Vic).

4.5 How are corporations held liable in contract law? Once a company is registered, it is granted full contractual capacity under s 124. The company can enter into a contract directly either by: • attaching the company’s ‘common seal’ to the contract. The common seal is the company’s signature. It is applied with the signatures of usually two directors or one director and one company secretary: s 127(2). • executing a legal document (such as a contract) with two directors’ signatures or a director and company secretary: s 127(1). Further, the company can enter into contract indirectly through the use of agency. The company is the principal and the agent may be an employee, a representative of the company, a person appointed to be an agent, or an officer of the company. Different types of agent may have different types of legal authority to act on behalf of the company: • Actual authority (which can be express or implied) This is where the board of directors, either under the corporate constitution or relying upon statutory provisions such as s 198C or 198D, grants authority to some person to act as the company’s agent. The safest method for a corporation to use is a ‘power of attorney’ (a legal document executed by the company to grant the necessary authority to the agent). Actual authority can be given in writing or even orally, under some circumstances. It is possible for actual authority to be implied from the circumstances or from the position held by the agent. For example, a buyer for a fashion company would be expected to have the actual authority to buy products for the principal company to sell. For best business practice, the agent should have actual expressed authority in writing, but it could be implied from the buyer’s position in the company. Similarly, a managing director has implied authority to enter into contracts relating to management while a company secretary has implied authority to enter into contracts relating to administration. However, the company may limit the power of these people.

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•

•

Apparent authority (also called ostensible authority: see 7.3) This covers agents who have neither expressly stated authority nor implied actual authority (as discussed above). It arises when the person acting as an agent has been held out as an agent of the company in some way (for example, by the provision of a corporate credit card or a business card linked to a position that would normally be that of an agent). In such an event the company is estopped (prevented) from denying that person is an agent. Ratification If there is no actual or apparent authority, the company as the principal may have its approval of the transaction entered into by the purported agent on behalf of the company backdated by way of authority. This is called ‘ratification’. Once the

A case to remember Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 1 All ER 630 Facts: K and H both owned 50% of a company. The board consisted of K, H and a nominee of both of them. The company was developed in order to purchase land and with the idea of then developing it. The company’s memorandum of association (corporate constitution) included provisions that there should be no managing director. However, at all times K took the role of managing director, and at all times H was overseas. K engaged an architect to have some plans drawn up and the architect completed the work. The company then refused to pay, claiming that K had acted outside his authority by engaging the architect. Held: K always acted as the de facto managing director. It was within the power of the board to prevent this, but it did not. The court found in favour of the architect, and listed four conditions that are necessary to prove a binding representation: 1 A representation had been made by an agent of the company that the agent had authority to enter into the contract. 2 The contract was induced by the representation. 3 The representation came from a person with actual authority. 4 There were no articles that disallowed a representation to be made from such a party. Note: The fourth element is no longer relevant due to the abolition of the constructive notice and ultra vires doctrines. As such only three conditions need to be proved to determine if a company is liable for a contract based on apparent authority. Principle of law: Three conditions must be met to make a representation binding on the company. If the receiving party is induced by the representation, then the representing company is bound by the contract they enter. Managing directors and CEOs (chief executive officers) are normally expected to have authority to enter into commercial contracts on behalf of the company.

Chapter 4: Corporate Liabilities

transaction has been ratified, it is as if the person was properly appointed as an express agent with actual authority in the first place, and the company will be bound by the contract or transaction. Figure 4.1 illustrates the variety of methods by which a company may validly enter into a legally binding contract. Figure 4.1 How a company may enter into a contract How can a company enter into a contract?

Directly (in accordance with Corporations Act s 127)

s 127(1): Contract executed by two directors or one director and a company secretary (no common seal)

s 127(2): Common seal and signature of two directors (or one director and the company secretary)

Indirectly (through agency: Corporations Act s 126)

Actual authority, express or implied: Company is liable. No actual authority: Company may still be bound if the conditions of apparent authority are met (Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd). No actual or apparent authority: Company may be bound by a contract if the company ratified the contract.

4.6 Are there any statutory protection rules for the protection of third parties? Yes; the Corporations Act (in ss 128–129) states that an outsider dealing with a company can make a series of assumptions, even when no constructive notice is given, or where the dealings involve fraud or forged documents. These assumptions are listed below after a brief explanation of the common law principle that underpins the statutory assumptions found in the Corporations Act. It is important to note that the statutory assumptions overlap but do not displace the indoor management rule.

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4.6.1 What is the indoor management rule? In the old English case of Royal British Bank v Turquand (1856) 119 ER 886 the court held that an outsider could assume that all internal company procedures had been followed correctly, unless the outsider knew otherwise.

A case to remember Royal British Bank v Turquand (1856) 119 ER 886 Facts: Turquand was a mining company with deeds of settlement (similar to a corporate constitution) that included a clause that allowed the company to borrow money once the borrowing had been approved and passed by resolution of the shareholders at a general meeting. Turquand entered into a loan with the Royal British Bank and two of the company directors signed and attached the company seal to the loan agreement. The loan had not been approved by the shareholders. The company defaulted on the repayments and the bank sought restitution. The company refused to repay the loan, claiming that the directors had no right to enter into such an agreement. It claimed that the bank had constructive notice of the shareholder approval clause in its deeds of settlement. Held: Turquand was required to repay the loan to the bank and was permitted to assume that the loan document was legitimate. Principle of law: Parties dealing with companies have the right to assume that the internal processes of the companies have been properly carried out as stated in the corporate constitution. Parties need only be aware of the company’s public documents to be assured that the agreements between themselves and the company are authorised. The rule in this case is often known as the ‘indoor management rule’.

4.6.2  Statutory protection The indoor management rule has been broadened and incorporated in s 129 of the Corporations Act. The section provides that outsiders can assume that: • the constitution has been complied with by corporation; • persons in annual returns have been properly appointed; • officers held out by the company as someone who can sign the contract (this can be linked to apparent authority); • officers’ authority to issue documents is genuine; • documents appear to have been signed in accordance with s 127; and • officers, agents and employees perform their duties for the corporation for a proper purpose.

4.6.3  Exceptions to the rule Exceptions to the indoor management rule can be found in the common law in Northside Developments Pty Ltd v Registrar-General (NSW) (1990) 170 CLR 146; [1990] HCA 32 and BNZ v Fiberi Pty Ltd (1994) 12 ACLC 48.

Chapter 4: Corporate Liabilities

A case to remember Northside Developments Pty Ltd v Registrar-General (NSW) (1990) 170 CLR 146; [1990] HCA 32 Facts: The common seal of Northside Developments Pty Ltd was affixed to a mortgage document. The mortgage was over a piece of land owned by Northside that was its only major asset. The mortgage gave security for a loan from Barclays Bank to one of the directors of Northside; Northside itself would gain no advantage from entering into the mortgage. The document was signed and sealed by a director of the company and the director’s son, as company secretary. The other directors of the company did not know of or authorise the signing of the document. In addition, they were not aware that the director’s son was purporting to be company secretary. Held: This case is an exception to Turquand’s rule. The court held that when the loan was defaulted upon, Northside was not bound by the mortgage document. The use of the common seal had been invalid. The circumstances surrounding the signing should have put Barclays on inquiry. That is, when there was no commercial advantage for Northside to enter into the agreement, Barclays should have been suspicious about the validity of the document. Principle of law: An outsider can presume that the internal processes of a business have been conducted legally unless there are significant circumstances that suggest they should be put upon inquiry. If such warning circumstances occur, and the outsider makes no further inquiry, the unauthorised process will not be presumed to be valid.

Section 128(4) performs a similar role to the exceptions under the common law. This section imposes some limitations to the s 129 assumptions for third parties: • where there is actual knowledge of the true position, which is based upon a question of proof; or • there is imputed knowledge, where the person merely suspects the assumption is incorrect. There must be sufficient information for the person to be suspicious that the assumption should not be replied upon and further investigation of the facts is warranted. However, under s 128(4) the exception of ‘suspicion’ is narrower than ‘put on enquiry’ (one of the exceptions under Northside Developments v Registrar-General (NSW) (1990) 170 CLR 146; [1990] HCA 32). This common law exception can apply even when the outsider had no subjective suspicion, but was negligent. However, the wording of s 128(4) clearly requires that the outsider must actually suspect that the assumption was incorrect. (This means the person’s own subjective suspicion, not an objective standard of some other reasonable person.)

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4.7 Things to remember When dealing with a question about how a company entered into a contract, ask yourself the following two questions: 1 Check first whether the company entered directly into contract (s 127). If the answer is ‘yes’ you need to apply the assumptions under the indoor management rule and s 129 and check whether any of the exceptions under s 128(4) are there. 2 If the answer is ‘no’, check whether the company entered indirectly into the contract (s 126 ‘Express, implied, apparent authority’) or ratified the contract. If the answer is ‘yes’ you need to apply the assumptions under the indoor management rule and s 129 and check whether any of the exceptions under s 128(4) are there.

Chapter 4: Corporate Liabilities

Assessment preparation Revision questions Can a company commit manslaughter? Explain. When does a company have primary liability? What is meant by secondary liability? What is the difference between primary and secondary liability? How can a company enter into contract? What is the difference between actual and apparent authority? What is the significance of Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 1 All ER 630? 8 What is the indoor management rule? 9 What protections are available under the Corporations Act for the protection of third parties entering into contracts with companies? 10 Is there any limitation to the protection given by s 129? 1 2 3 4 5 6 7

Problem question Camilla and Henry are the only directors and shareholders of Vision Pty Ltd. Without Henry’s knowledge, Camilla has incurred personal debts that she is unable to pay because of her gambling problem. Camilla telephones Val Bank and request a loan of $100 000. She informs the bank that Vision Pty Ltd needs the money to expand its business. She asks the bank to pay the money into the company’s bank account. She plans to withdraw the money from the company’s account and transfer it to her own account later on. The bank agrees, and sends her the paperwork for the loan, which she fills out. Camilla fixes Vision Pty Ltd’s common seal to the loan documents, signs her own name, and forges Henry’s signature. Advise Val Bank. For answers to problem questions, please refer to .

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Chapter 5

Capital and Fundraising Covered in this chapter • • • • • •

The meaning of ‘share capital’ The basic rules of maintenance of capital The meaning of ‘debt capital’ Payment of dividend The rules relating to fundraising of capital (prospectuses) The potential civil and criminal liabilities for fundraising documents

Cases to remember Darvall v North Sydney Brick and Tile Co Ltd (1989) 16 NSWLR 260 Trevor v Whitworth [1886–90] All ER Rep 46

Statutes and sections to remember Corporations Act ss 113(3), 165, 176, 254A, 254J, 256A, 256B, 256C, 256D, 257A, 257B, 259A, 260A, 260B, 260C, 705, 706, 708, 727, 728, 729, 731, 732, 733

5.1 Introduction Business entities require funds to develop their businesses and help them make a profit. A wide choice of financing options is open to modern corporations. The focus of this chapter will be on how one becomes a member of a company and the choice of financing (debt and equity) options for corporate bodies. It is important to note that in law there is a clear distinction between share capital (known as equity) and debt (loan) capital. This is different in accounting, where there is a closer relationship between debt and equity. This difference can cause confusion, especially with hybrid financing options such as redeemable preference shares or convertible debentures. The choice of fundraising method and the category of finance utilised by the corporation will depend on the cost of capital and a range of other economic factors, rather than on any legal requirement.

Chapter 5: Capital and Fundraising

5.2 Membership Any person (whether a human or a corporation) may become a member of a company (s 231) and membership may be obtained in a number of different ways, including: • by agreement in the application for registration of the company; • by transfer (voluntary sale or gift) of shares from an existing member; • by transmission (operation of law) of shares (that is, on death or bankruptcy); and • by the conversion of debentures (debt) into shares. Where a company is limited by shares, the member is also called a shareholder. As more than 99.2% of companies are registered with shares, it has become more common to refer to people investing in a company as shareholders rather than members in a general business context. The membership details are confirmed on the company’s share register, known as the register of members. The register of members is very important because it is presumed that a person whose name is in the register is a member of the company (s 176). Shares are deemed to be the personal property of the member by virtue of s 1070A. The member or shareholder is also normally entitled to be issued with a share certificate as prima facie evidence of ownership (s 1070C). However, these membership provisions do not apply to ASX listed companies, which are governed by the ASX Listing Rules. On a practical level, it would be difficult for an individual company to maintain its register of members in a highly liquid market. This is because the company’s shares are being bought and sold and the members may be changing as regularly as every minute. As a result, shares listed on the ASX are subject to the Clearing House Electronic Sub-register System (known as CHESS). CHESS is operated by the ASX Settlement and Transfer Corporation, a wholly owned subsidiary of the ASX. CHESS creates a ‘virtual ownership’ whereby traded shares are held on trust for some period. This saves companies from having to issue share certificates upon every change in membership. Instead, a CHESS statement of their shareholdings, which they receive at regular intervals, updates the members as well as the company. Problems relating to the area of changes in share ownership were discussed in the complex case of Kokotovich Construction Pty Ltd v Wallington (1995) 17 ACSR 478. Listing rules are legally enforceable by s 793C. Since 11 March 2002 business rules and listing rules for securities exchanges have been known collectively as ‘operating rules’ under Chapter 7 of the Corporations Act. At the other end of the share ownership spectrum there are a number of different ways a shareholder may cease to be a member of a company. These include: • transfer of ownership of all shares to another investor; • non-payment of calls, resulting in the forfeiture of those partly paid shares;

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reduction in share capital by the company, such as a share buy-back; surrender of the shares through the member’s free will; • lien, where the company reclaims the shares as security for a personal loan; and • deregistration (dissolution) of the company. Membership rights are complex mixtures of terms and conditions laid out in the corporate constitution, replaceable rules and legislation (s 134). Many of the membership rights will be derived from the types and classes of shares each member owns. These rights can be legally enforced through the contract between the company and the shareholders under s 140(1) (see 3.4). • •

5.3 Share (or equity) capital The vast majority of registered companies have a share capital, so the importance of an understanding of equity capital is very clear. ‘Equity capital’ is a generic term encompassing a range of different share types. If a company has only a single type of share, those shares are called ‘equities’. There are specific rules in the Corporations Act for all companies, as well as ASX Listing Rules for publicly listed companies, which relate to the maintenance of share capital. The board of directors, on behalf of the company, will determine how many shares, and what types of shares, should be issued. Prior to 1998, there were a number of restrictions relating to the number of shares that could be issued and their nominal value. However, abolition of ‘par value’ of shares (s 254C) has enabled companies to focus on the actual share capital, based upon the issue price of each share. Proprietary companies, under s 254D, have a pre-emption right, which requires the company to offer existing shareholders a proportion of any new issues of shares. This is a replaceable rule, which may be removed or amended by a company’s own constitution. Although s 124 gives companies the power to issue shares and debentures, it is s 254A that further expands the choice of the different types of shares. A company must only issue shares for a proper purpose such as raising capital for the company. This principle was upheld in Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 832, where the company had attempted (unsuccessfully) to issue shares to defend itself against a hostile takeover bid (this case is discussed in more detail in Chapter 7). A company may also choose to issue bonus shares to existing shareholders as an alternative to paying a dividend. Companies will generally issue shares in return for consideration. The consideration paid by a shareholder is usually cash, or cash’s worth (an equivalent of cash such as goodwill, property or services). Where the investor is paying with cash’s worth there should be an independent valuation of the asset. For public companies, the independent valuation is lodged with ASIC.

Chapter 5: Capital and Fundraising

5.4 What types of shares are available? It is important to understand that there are different types of shares, as each type provides different membership rights. Many companies have only ordinary shares, and all members of those companies have the same rights. However, many other companies, especially public companies or those listed on the ASX, may have different types of shares, as well as different classes (or subsets) of a particular type of share. It is important to note that a company may have both a number of types of share (for example, ordinary or preference) and different classes of share within that share type (for example, class A ordinary voting shares and class B ordinary non-voting shares). The three main types of shares are: 1 ordinary shares; 2 preference shares; and 3 deferred shares (sometimes called ‘founders’ shares’). Ordinary shares are the most common type of share. Normally, ordinary shares have voting rights, based on one vote per share. It is possible for a class of ordinary share that offers either multiple votes per share or no voting rights at all to be created. If the requirements of s 254T have been met (see 5.6.6), these shareholders may be entitled to dividend. However, ordinary shareholders will only receive dividends after other priorities (such as creditors and preference shareholders) have been paid. Further, unlike preference shares, dividends from ordinary shares are not guaranteed to holders, and may vary from year to year. But ordinary shareholders have a ‘participation’ right, which is the right to a proportion of the surplus assets on a solvent winding up. Preference shares have two unique aspects. First, the dividend is a fixed percentage (for example, 5%, which would entitle the owner to a five-cent dividend for each one dollar preference share owned) and is paid in priority to ordinary shares. The dividend must be paid if the requirements of s 254T have been complied with. If a company is unable to pay a dividend in a particular financial year, the preference share dividends are normally cumulative, and thus will be paid in the following year, before payments to the ordinary shareholders. The second aspect of preference shares is that they have the benefit of a preferred return of capital on a winding up, although they generally do not have the participation right to surplus assets that is enjoyed by ordinary shareholders. However, preference shareholders have no claim on any surplus assets of the corporation. Preference shares may be issued to be redeemable at a fixed time or at the company’s or shareholder’s option (under s 254J). Deferred shares or, as they are more commonly known, founders’ shares are the ultimate ordinary shares. Such shares are normally issued to the people who form the company, who sacrifice their right to dividends in return for weighted voting rights.

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This means that members with deferred shares will accept that preference and ordinary shareholders will receive dividends before they do. However, although the owners of deferred shares are unlikely to receive a dividend, they will have greater voting rights, for example 100 votes per share, rather than the ordinary right of one vote per share. This enables the founders of the company to be appointed or remain as the directors and to maintain control over the other investors. Deferred shares are less common than ordinary shares, because ordinary shares may now be issued with any terms and rights attached as the directors deem fit (under s 254B). There are also many ‘hybrid’ types (or, more accurately, classes) of shares, which expand this basic list. Section 254A enables a company to issue shares, including bonus, preference and partly paid shares. Bonus shares are provided to an existing member without any consideration (value) being paid by that member. Partly paid shares enable a member to purchase shares, but pay the company less than the full amount at the time of purchase. At a later stage, the company will make a ‘call’ for the balance owing on the shares, at which time the shareholder must pay the balance or forfeit ownership of their shares. The various classes of shares have special features, with varying legal rights attached, and this tends to blend (or even blur) the defined roles of debt and equity capital. Examples of such hybrid shares include redeemable preference shares, cumulative preference shares, convertible preference shares, participating preference shares, non-voting ordinary shares and super-voting shares. It is beyond the scope of this book to provide an exhaustive explanation of each of the above types of shares; it is sufficient for a student of corporate law to acknowledge their existence and understand that they are different from the three main types of share. Alteration of the rights attached to the ownership of shares (class rights) may be made subject to terms contained in the corporate constitution or by passing a special resolution of the company and a special resolution of the particular class affected (s 246B). This is subject to an overriding test of ‘proper purpose’ (Gambotto v WCP Ltd (1995)182 CLR 432; [1995] HCA 12 (see 3.6.3)) and the minority protection provisions contained within ss 232–242 (see 8.4.1).

5.5 What are the liabilities of a shareholder? In a company limited by shares, if an investor owns shares that are fully paid up, they will have the protection of limited liability. What this means is that the investor will incur no further financial liability in the event that the company enters liquidation. When a company enters into liquidation, shareholders become known as ‘contributories’ because if their shares are partly paid, they will be required to pay the outstanding debt (a call will be made for payment).

Chapter 5: Capital and Fundraising

5.6 What is the basic rule of maintenance of share capital and its exceptions? 5.6.1 Principle of capital maintenance The basic rule of maintenance of share capital is that the company does not return the capital to its members. This was laid down in the classic case of Trevor v Whitworth [1886–90] All ER Rep 46, where the company had tried to purchase a shareholder’s interest in itself.

A case to remember Trevor v Whitworth [1886–90] All ER Rep 46 Facts: Whitworth was a shareholder in the company James Schofield and Sons Ltd. This company was in the business of producing flannel. The company’s articles allowed for the company to sell, dispose of or purchase its own shares. Whitworth sold his shares to the company and was to be paid in two instalments. Before the second instalment was paid the company went into liquidation. Whitworth applied to Trevor (the liquidator) to receive payment of the remaining funds owing on his shares. Held: The company’s purchase of its own shares for the purpose of reducing its capital was illegal and therefore void. Principle of law: Share capital must be maintained for the purpose of repayment of creditors and to allow creditors to monitor the degree of their risk. A company cannot purchase its own shares. This rule was adopted by the Corporations Act for limited liability companies, even if that is allowable within the company’s articles (it may be allowable under very restricted circumstances).

This principle was reaffirmed at common law in ANZ Executors & Trustee Co Ltd v Qintex Australia Ltd (1990) ACSR 676 and is also contained in Chapter 2J, especially s 259A. Before July 1998, there were few exceptions to the maintenance of capital rule. However, the Company Law Review Act 1998 (Cth) provided a major change in policy to facilitate a company’s ability to make reductions in capital and share buy-backs. Today there are a number of exceptions to the principle of capital maintenance. They are: • reduction of share capital (s 256B); • redemption of redeemable preference shares (ss 254A and 254J); • share buy-back (s 257A); and • financial assistance (s 260A).

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5.6.2 Reduction of share capital (s 256B) The Corporations Act contains specific procedures to protect creditors and shareholders from being disadvantaged by reductions in share capital. Section 256B provides that a reduction of capital is permitted only if a company satisfies three conditions: 1 that the reduction is fair and reasonable to the company’s shareholders as a whole; 2 that the reduction does not materially prejudice a company’s ability to pay its creditors; and 3 that (under s 256C) shareholders’ approval has been obtained through the passing of a resolution. For an equal reduction (where all shareholders are treated the same), only an ordinary resolution is required. Where there is a selective reduction (where only some shareholders are having their capital reduced), a special resolution must be passed. It is interesting to note that if the company contravenes s 256B, this does not invalidate the reduction. That is, the shareholders’ capital may still be reduced, but any persons involved in the contravention (that is, the directors) can be liable, both civilly and criminally (criminal liability applies only in cases of dishonesty), under s 256D.

5.6.3 Redemption of redeemable preference shares under ss 254A and 254J A company that makes a redemption of redeemable preference shares (calling issued shares back in and cancelling them) must follow a specific procedure. Under s 254A(3), the redemption may be at a fixed time or on the happening of a specified event. The decision to redeem may be made by the company or the shareholder, depending upon the terms of the issue. A company may only redeem redeemable preference shares if they are fully paid up and redeemed out of the profits or proceeds of a new issue of shares. Once the shares have been redeemed, they must be cancelled under s 254J, although failure to do so does not invalidate the redemption. However, the person involved in the contravention can be liable, both civilly and criminally, under s 254L.

5.6.4  Share buy-backs (s 257A) A company is allowed to buy back its own shares if: • the buy-back does not materially prejudice the company’s ability to pay creditors (the company is solvent); and

minimum holding

–

–

–

–

–

yes

yes

Procedures [and sections applied]

ordinary resolution [257C]

special/unanimous resolution [257D]

lodge offer documents with ASIC [257E]

14 days’ notice [257F]

disclose relevant information when offer made [257G]

cancel shares [257H]

notify cancellation to ASIC [254Y]

yes

yes

–

yes

–

–

–

yes

yes

–

yes

–

–

yes

yes

yes

–

yes

–

–

–

within 10/12 limit

within 10/12 limit

over 10/12 limit

on‑market

employee share scheme

Table 5.1 General buy-back procedure: steps and applicable sections (s 257B)

yes

yes

–

yes

–

–

yes

over 10/12 limit

yes

yes

yes

yes

yes

–

–

within 10/12 limit

yes

yes

yes

yes

yes

–

yes

over 10/12 limit

equal access scheme

yes

yes

yes

yes

yes

yes

–

selective buy‑back

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the company complies with the procedure set out in the Corporations Act. Section 257B sets out a clear table that demonstrates the five different procedures that must be followed (see Table 5.1). As noted in the Table 5.1, the procedure required to complete a buy-back varies with the type of buy-back: • A buy-back of minimum holdings (odd lots) allows a listed public company to buy back any parcel of its shares that is smaller than a marketable parcel under the trading rules of the relevant financial market (s 9). Such a buy-back only requires the company to cancel the shares and notify ASIC. These buy-backs are used to clean up the register of members where some shareholders have very small parcels of shares, previously referred to as ‘odd lots’. • Employee share schemes enable companies to buy back shares when an employee leaves the company. Section 9 defines this type of buy-back as one under a scheme that: • has as its purpose the acquisition of shares of employees of the company; and • has been approved by the company in a general meeting. When conducting such a buy-back, the company is required to give the member–employee 14 days’ notice, then cancel the shares and notify ASIC. If more than 10% of the voting shares of the company are purchased in a 12-month period, the members must pass an ordinary resolution authorising the company to reduce the shareholders’ capital by such an amount (s 257C). • On-market buy-backs are buy-backs of shares listed on a securities exchange. These types of buy-back are allowed for listed companies if members are given 14 days’ notice and the shares are cancelled with appropriate ASIC notification. If more than 10% of the voting shares of the company are purchased within 12 months the members must pass an ordinary resolution approving the buy-back (s 257C). • An equal access scheme is an offer to purchase shares from all members of the company. These buy-backs must satisfy the following conditions: • the offers under the scheme relate only to ordinary shares; • the offers are made to every person who holds ordinary shares to buy back the same percentage of their ordinary shares; • all of those persons have a reasonable opportunity to accept the offers made to them; • buy‑back agreements are not entered into until a specified time for acceptances of offers has closed; and • the terms of all the offers are the same. The offer document provided to members must be lodged with ASIC (s 257E). A selective buy-back will always be the most controversial because only some members are getting the benefit of selling their shares back to the company at a •

Chapter 5: Capital and Fundraising

fixed price. Section 257D therefore requires a special resolution to be passed by the members who are not having their shares bought. The offer document for the selective buy-back must be lodged with ASIC and all members given 14 days’ notice. There must be disclosure of all relevant information and the shares must be cancelled, and ASIC notification made, after the purchase. A number of consequences flow from a buy-back. These are carefully explained in a table headed ‘Signposts’ in s 257J.

5.6.5 Financial assistance under Part 2J.3 Generally, the Corporations Act prohibits self-acquisition and control of shares by a company (under s 259A). ‘Financial assistance’ is given if the company indirectly lends money to an investor who purchases shares in that same company. In Belmont Finance Corp v Williams Furniture Ltd (No 2) [1980] 1 All ER 393, financial assistance was broadly defined to include any corporate activity which diminishes the value of the company. If a contract or other transaction results in the company providing financial help, including release from debt, the company’s overall value decreases, which hurts all shareholders. A company is allowed to financially assist in the acquisition of shares if it complies with s 260A. That section requires that the financial assistance: • does not prejudice the interests of the company or its shareholders or the ability of the company to pay its creditors; or • is approved by shareholders under s 260B (a special resolution is needed); and • is exempt under s 260C (this is a broader exemption that applies when the loan is in the ordinary course of commercial dealing, or under an approved employee share scheme: s 260C).

A case to remember Darvall v North Sydney Brick and Tile Co Ltd (1989) 16 NSWLR 260 Facts: Darvall made a takeover offer to purchase a share of North Sydney Brick Co, which had a major asset of a piece of undeveloped land. The brick company refused the offer, believing that it grossly undervalued the land. North Sydney Brick Company then entered into an agreement with another company to develop the land. North Sydney Brick’s managing director was the main negotiator in obtaining the contract for the development with the third company. He did not disclose to any stakeholders that a provision of the negotiations involved obtaining a personal loan. With this the managing director was able to make his own takeover bid on North Sydney Brick, at a higher value than Darvall had offered. Darvalls applied to have the joint venture set aside on grounds that the managing directors had breached their fiduciary duties and that the financial assistance given to the managing director was illegal.

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Held: The financial assistance was illegal. However, the joint venture between North Sydney Brick Co and the third company was not set aside. Principle of law: A company may offer benefits for a takeover if it does not materially prejudice the interests of its shareholders and creditors, or if it is approved by the shareholders (s 260A).

If the company contravenes s 260A it does not invalidate the financial assistance. However, the person involved in the contravention can be liable, both civilly and criminally, under s 260D: see Darvall v North Sydney Brick and Tile Co Ltd (1989) 16 NSWLR 260.

5.6.6 Dividend The payment of dividend characterises the return on investment to shareholders of the company. Historically, dividends could only be paid out of the distribution of profit of the company. This was an application of the principle of capital maintenance as the profit and not the capital of the company could be used to pay the dividend. However, the profit test was heavily criticised. One of the major concerns related to the fact that the word ‘profit’ was not defined. Further, the guidance from the court decisions regarding the meaning of ‘profit’ was deemed outdated, complex and not in line with the current accounting standards. As a result, in June 2010, the Federal Government introduced an amendment to the Corporations Act that resulted in the replacement of the profit test. Under the current s 254T, payment of dividend can only be made if three conditions have been met: 1 the balance sheet test: the company’s assets exceed its liabilities immediately before the dividend is declared and the excess is sufficient for the payment of the dividend. It is worthwhile to note that the test is not a solvency test: a surplus of assets over liability does not mean that the company is solvent for the purpose of Australian law as s 95A notes that solvency is determined based on whether the company is able to pay its debts when they fall due; and 2 fair and reasonable to shareholders as a whole: the payment of the dividend is fair and reasonable to the company’s shareholders as a whole. This requirement is taken from the law of reduction of capital (see 5.6.2 for a comparison with the terms of s 256B). In the context of payment of dividends this requirement appears to be mainly aimed towards balancing the interest of the different classes of shareholders a company may have; and 3 no material prejudice to the company’s ability to pay its creditors: the payment of the dividend does not materially prejudice the company’s ability to pay its creditors. Once again, this requirement is taken from the law of reduction of capital (see 5.6.2 for a comparison with the terms of s 256B). The company’s ability to pay may be materially prejudiced if the company was insolvent, for example. Consequently, this

Chapter 5: Capital and Fundraising

requirement means that the directors should consider the financial condition of the company and how this condition may be affected by the payment of dividends. If and only if all these three elements are present, then the payment of dividends may be made. Further, the directors may determine how great the dividend will be, and when it is payable (s 254U). Directors who do not comply with s 254T may face the following consequences: • The directors may be found in breach of their common law and statutory duty of care (this duty is discussed in Chapter 7). • The directors may be found in breach of their duty to prevent insolvent trading (this duty is found under s 588G and is discussed in Chapter 7). Additionally, if the directors have decided to pay the dividend when the requirements of s 254T have not been met, then a person whose interests are negatively affected by the payment may apply for an injunction under s 1322 to prevent the payment of the dividend. It is interesting to note that s 254T does not overrule the principle of capital maintenance. A company is still not permitted to pay the dividend even if the requirements of s 254T have been met if the payment would amount to a reduction of capital. In such cases, the requirements of s 256B should also be met. At the time of writing of this book, an exposure draft Corporations Legislation Amendment (Deregulatory and Other Measures) Bill 2014 has been issued and one of the proposals put forward is a new amendment of s 254T as there is dissatisfaction with the current test. The proposed amendment suggests the introduction of a pure solvency test: it is argued that such a test should be the only consideration when a payment of dividend is considered.

5.7 Debt capital While share capital is fundamental to a corporation, it is also important to understand debt capital (borrowings). The relationship between debt and equity is often referred to as the gearing ratio, and this will vary depending upon a range of economic and financial factors such as the risk associated with the equity investment and the cost of debt capital.

5.7.1 What is debt finance? Debt finance plays a crucial part in the structure of most corporations, but the choices of debt and their relationship to equity are often not fully understood. The reasons for choosing debt rather than equity (or vice versa) are based on a number of commercial factors. These might include interest rates, tax implications, liquidity, cash flow, market conditions and the costs associated with raising capital, to name but a few.

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The borrowing power of the corporation must also be considered. Section 124(1)(b) gives express power to companies to issue debentures, which effectively means that a company can borrow just like an individual. Furthermore, s 198A provides the board of directors with the authority to raise debt capital. A company’s constitution can restrict borrowing, but as long as the third party (creditor) is unaware of the restriction, the loan remains valid (s 125), as occurred in Royal British Bank v Turquand (1856) 119 ER 886 (see 4.6.1). There are many reasons why the balance between debt and equity should be carefully considered. In creating debt a number of legal principles have to be taken into account. These relate to provisions in the corporation’s constitution, shareholders’ rights, directors’ duties, taxation, and the consequences of a number of the provisions of the Corporations Act. Thus, in reviewing a corporation’s gearing ratio, the following legal areas require prudent consideration: • insolvent trading (s 588G) (see 7.4); • voidable preferences of creditors (s 565) (see 9.7); • oppression of minority shareholders (ss 232–234) (see 8.4.1); and • financing dealing in the company’s own shares (s 260A). One of the most common forms of debt financing is the debenture. Only corporations are allowed to issue debentures (under s 124).

5.7.2 What is a debenture? A debenture, in its very simplest form, is merely a document issued by a corporation, which acknowledges that a debt is owed by the corporation (Edmonds v Blaina Furnaces Co (1887) 36 Ch D 215). The Corporations Act definition is found in s 9, and it is quite far-reaching, but not as wide as the common law. Figure 5.1 illustrates raising capital. Figure 5.1 Raising secured capital Security interest Company (grantor)

Lender (secured party) Debenture contract

The word ‘debenture’ is a general term covering many different types of debt financing. A corporation can issue different types of debenture, including secured or unsecured, convertible or not convertible, and redeemable or non-redeemable. Finally, a register of debenture holders must be kept by each corporation (s 171) and be open for inspection by the public (s 173). It is worth noting the definite distinction between a loan contract (debenture) and the security for the loan (security interest). The rules regulating security interests can be found in the Personal Property Securities Act 2009 (Cth).

Chapter 5: Capital and Fundraising

Thus it is possible for a court to declare that the security interest is invalid, but the loan contract (debenture) is still valid. In such instances, the debt is enforceable by the lender only as an unsecured creditor (see 9.6). That is, the lender will still be owed the money by the company, as the loan (debenture) contract is valid. But the lender becomes an unsecured creditor as the security interest (security offered by the company, which would have given the lender priority) is no longer valid.

5.8 Fundraising 5.8.1 What are the fundraising capital choices? The senior management of a company may decide that the business requires an injection of capital to develop its profitability. The corporation will naturally have to raise either share capital or loan (debt) capital at the time of incorporation or at some future time, as is commercially necessary. The cost of capital is an important calculation, which includes the prevailing interest rates, the company’s credit rating (for example, according to Standard & Poors) and the actual cost of raising capital. There are a number of direct and indirect costs associated with raising funds, such as legal fees, underwriting, management time and accounting services. Moreover, there are a number of different methods of raising share capital. The most common include rights issues, options, share purchase plans, dividend reinvestment plans and employee share schemes. A proprietary company cannot issue securities to investors under Chapter 6D except for share offers to existing shareholders or employees of the company or of a subsidiary of the company (s 113(3)). If it does, it is committing a strict liability offence (s 113(3A)). Further, ASIC can direct the company to convert into a public company (s 165(1)). A public company can issue securities to the public if it has issued a disclosure document. ‘Security’ for the purpose of Chapter 6D (‘Fundraising provisions’) is defined as: • shares; • debentures; • legal or equitable shares or debentures; or • disclosure documents (see 5.8.2).

5.8.2 Disclosure documents The most formal way to raise capital for a public company is with a ‘disclosure document’, more commonly known as a prospectus. Table 5.2 illustrates the popularity of the use of prospectuses. As a rule of thumb, based on commercial reality, if the amount of capital to be raised is above $10 million, a prospectus will be required. The government, as a

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priority of CLERP (see 2.2.1), actively encouraged a new set of laws to provide small and medium-sized entities (SMEs) with inexpensive channels through which additional funds could be raised. The Corporate Law Economic Reform Program Act 1999 (Cth), introduced, from March 2000, four separate types of disclosure documents. Three of these were specifically introduced to help SMEs and to clarify the exemptions to the issuance of a disclosure document. Table 5.2 Number of prospectuses lodged with ASIC over the years Year

Prospectus

1991

319

1995

503

2000

1033

2005

1064

2010

957

2014

1097 Source: ASIC annual reports

Sections 705 and 709 provide for four different types of disclosure document, which enable an offer of securities to be made to potential investors: 1 prospectus: the standard full disclosure document; 2 short-form prospectus: the document provided to investors that is an abridged version of all the material information lodged with ASIC; 3 profile statement: a brief statement of the offer, which is approved by ASIC, but does not replace the requirement to lodge a prospectus with ASIC; 4 offer information statement: a genuine alternative to a prospectus, where the amount raised through the issue of securities (combined with any previous equity capital raisings that have relied on an offer information statement) is $10 million or less. Each type of disclosure document has its own contents and liability requirements, as laid out in Part 6D.2. There are a number of exemptions that may enable a company to avoid preparing a disclosure document (a substantial saving to a company that is able to satisfy the requirements). Section 708 provides a list of offers that do not require a formal disclosure document. They include: • small-scale offerings of 20 issues in a 12-month period as a personal offer to raise up to $2 million; • the sophisticated investor exception (colloquially referred to as the ‘gold card’ exemption). This requires either a minimum investment of $500 000 per person,

Chapter 5: Capital and Fundraising

or a wealthy investor (the investor must prove that they have net assets of $2.5 million or a gross income for each of the previous two financial years of at least $250 000 a year) or an offer to a company or a trust controlled by a person who meets the requirement of a wealthy investor; • offers made through a licensed dealer or to professional investors (for example, life insurance companies or financial institutions); and • shares for no consideration. The essential information that must be contained in the four disclosure documents is laid out in ss 710–716 and varies depending on the type of disclosure document that is relied upon. Following the UK’s lead, in 1991 Australia adopted a general disclosure test for prospectuses in place of the previous checklists. The introduction of s 710 caused concern among many companies and professional advisers, as it requires the provision of all information that an investor (or the investor’s professional advisers) would reasonably expect to find in a prospectus. To this end, ASIC has issued Regulatory Guide 228 (Prospectuses: Effective Disclosure for Retail Investors) to guide issuers and advisers on how to word and present a prospectus in a ‘clear and concise manner’ (see s 715A) while still complying with the requirement of s 710. It is prudent to note that s 710 is an overarching provision that is supplemented by certain specific disclosure requirements for a prospectus contained within s 711. These include the terms and conditions of the offer; interests of, and fees paid to, certain persons; quotation of securities; expiry date; and lodgment with ASIC. More detailed prescribed information is set out in the corporate regulations. Short-form prospectuses have more limited content under s 712, which enables reference to be made to other material information that has already been lodged with ASIC. Section 713 provides special content rules for continuously quoted securities, as investors would already be aware of the company’s operations on the ASX. The contents of profile statements and offer information statements are specifically outlined in ss 714 and 715. One of the significant changes of policy made by ASIC has been the removal of the requirement that the regulator provide a detailed pre-vetting of the prospectus prior to its lodgment. There is now a more general requirement in s 718 that all disclosure documents that are to be used to offer securities must be lodged with ASIC. This change of policy reflects the fact that the company, its officers and its expert advisers, rather than the regulator, should be responsible for the disclosure document’s contents. However, if ASIC or the company discovers information that is materially adverse to the investor after the disclosure document is lodged, there is a requirement under s 719 for the company to issue a supplementary or replacement document. Examples of materially adverse information include misleading statements, omissions of information required by ss 710–715, or a new circumstance that has arisen after the lodgment date.

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Further, if a disclosure document is not complying with the statutory requirements, ASIC may issue an interim stop order under s 739 which would prevent the issue, sale or transfer of securities under the non-compliant disclosure document. Over the last five years ASIC has been actively monitoring compliance of prospectuses with the statutory requirements. For example, in the reporting period 2013–14, ASIC has improved the disclosure in 141 prospectuses. It also issued 26 interim stop orders and seven final stop orders to prevent fundraising when the statutory requirements regarding the prospectus have not been complied with (ASIC Annual Report 2013–2014, p 41). Given the complex web of legislative requirements governing capital fundraising, the need for professional advisers becomes abundantly clear. There are also a number of tax implications that have to be taken into careful consideration. The cost of raising share capital can be high, depending upon the amount being raised and the method being employed.

5.8.3  Liability for misleading statements A number of the parties who are involved in the production and issuing of a prospectus can be held liable under the civil law and criminal law for false or misleading statements or breaches of the Corporations Act. Part 6D.3 provides the prohibitions, liabilities and remedies for legal actions relating to disclosure documents. There are specific, and more serious, crimes in the fundraising chapter (Chapter 6D) of the Corporations Act. For example, it is an offence to offer securities in a corporation that does not exist (s 726) or to offer securities without a current disclosure document (s 727). Where a person commits an offence by making a misleading or deceptive statement that is materially adverse to the investor, it is a grave offence under s 728(3). These offences carry a maximum penalty of 200 penalty units ($34 000) and/or five years’ imprisonment. ASIC, with the Commonwealth Director of Public Prosecution, has the burden of proof in the prosecution of such an offence. This does not guarantee that the investors will be able to recover damages or their losses. Investors have a myriad civil actions available to them in order to recover any damage or losses arising from a misleading prospectus. Reforms in the Corporations Act have led to an increase in the liability of persons involved with the preparation and issuing of prospectuses, and other disclosure documents. At common law, it is possible to bring an action against the company and its directors in the tort of deceit, as in Derry v Peek (1889) 14 App Cas 337. However, the defence to deceit is ‘honest belief’, which makes any action in deceit extremely hard to prove. An investor may alternatively bring an action for the tort of negligence, based on the principles

Chapter 5: Capital and Fundraising

established by the HCA in Shaddock & Associates Pty Ltd v Parramatta City Council (1981) 150 CLR 255. The prohibition in the predecessor of the Australian Consumer Law against misleading and deceptive conduct (s 18) has been applied with spectacular success to prospectuses. This was illustrated in the controversial case of NRMA Holdings Ltd v Fraser and Talbot (1995) 127 ALR 577, where the majority of directors of the NRMA and its members wished to convert the mutual organisation into a publicly listed company. Two directors/members objected on the grounds that the prospectus was misleading under the previous s 52 of the Trade Practices Act 1974 (Cth) (now s 18 of the Australian Consumer Law), which is very similar to the old s 995 Corporations Law, which is now found in s 1041H of the Corporations Act. The Federal Court, in October 1994, prevented the $2.2 billion float from going ahead and the appellate court upheld that decision in 1995, holding that the prospectus was misleading. It was misleading because it said ‘free shares’ when the conversion was an exchange of legal rights rather than free of legal consideration (value, like money) and the ‘prospectus’ was really an information memorandum prior to the vote at a general meeting. The Corporations Act has been redrafted to remove the duplication of s 18 of the Australian Consumer Law and s 1041H of the Corporations Act. There are explicit ‘carve-out’ provisions in the Australian Consumer Law and in the Corporations Act that prevent the overlap in legislation for misleading conduct in relation to financial services and products (see National Exchange Pty Ltd v ASIC (2004) 49 ACSR 369 in connection with an offer to buy shares that was very misleading to the small investors). The section was also used in ASIC v Macdonald (No 11) [2009] NSWSC 287, known as the James Hardie case, where a media statement about the funds for asbestos victims was held to be misleading and deceptive. Section 728 provides that a person must not offer securities under a disclosure document that is misleading or deceptive, or if there is a material omission or new circumstance that should have been disclosed. If a person makes a forecast or forward-looking statement without reasonable grounds, this will be deemed to be a misleading statement under s 728(2). All persons who suffer a loss or damage due to misstatements in breach of s 728 may bring a civil action for recovery under s 729 against the following people: • the person making the offer (the company); • the directors; • the persons named in the disclosure document who gave consent (experts, who are only liable for their misleading statement or their omission); • the underwriter; and • any other person who contravenes s 728.

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5.8.4  Civil and criminal defences The Corporations Act provides a due diligence defence for the prospectus (s 731), a lack of knowledge defence for profile statement and offer information statement (s 732) and a more general defence for all disclosure documents (s 733). Due diligence for a prospectus requires that all reasonable inquiries have been made and, after doing so, reasonable belief that the statement was not misleading or deceptive. Further, s 732 notes that a person is not liable for a misleading or deceptive statement in an offer information statement or profile statement or for omissions if the person proves that they did not know that the statement was misleading or deceptive. Section 733 provides some general defences for all disclosure documents. A person does not commit a crime under s 728(3), and is not liable for a civil action under s 728(1), where there is reasonable reliance on information provided by another person. Also, if the person withdraws their consent to being named in the disclosure document, they will be able to avoid liability (s 733(3)). Finally, a person who is unaware of a new matter that should have been revealed after the disclosure document has been lodged will have a defence under s 733(4).

Chapter 5: Capital and Fundraising

Assessment preparation Revision questions 1 Identify two differences between ordinary shares and preference shares. 2 What is the significance of a register of members? 3 Explain the principle of maintenance of capital. Refer to the relevant case and section in the Corporations Act. 4 When is a reduction of capital allowed? 5 What are the consequences of breaching s 256B? 6 When is a share buy-back allowed? 7 What is a financial assistance? When is it allowed? 8 What is the difference between a floating charge and a fixed charge? 9 Explain two main consequences of registering a charge. 10 What is meant by ‘sophisticated investors’? 11 When is an offer considered a small-scale offer? 12 What different types of disclosure documents may be used for fundraising? 13 What is the consequence for a public company that issues securities to the public without a disclosure document? 14 What is the consequence of breaching s 728? 15 What are the defences available to people associated with a disclosure document that is misleading?

Problem question 1 Viva Game Ltd specialises in the creation of computer games. The company’s board of directors wanted to raise capital from the public through the issue of shares because it needed the capital to market a new game developed by the company called ‘Far Space’. The company asked Josephine, a renowned expert in the gaming community, to assess ‘Far Space’, and Viva Game Ltd received her consent to include her statements in the prospectus. Emily stated the following: ‘Far Space’ is a computer game that will create a new generation of player. The game has no glitches or faults. It runs smoothly and has excellent configuration and design.

In reality, Josephine was too busy to check the game. She actually wrote her statement based on past games produced by Viva Game Ltd. A number of investors bought shares based on her statement. When the game was launched, it was a total disaster. It was not designed properly and had a number of glitches and faults that prevented users from playing the game. The investors would like to take action against Josephine. Advise Josephine on her civil liability.

Problem question 2 Fame Ltd has 2500 shareholders who hold ordinary shares. The company has been successful for quite some time. However, in 2014, it became insolvent due to risky investments conducted by the directors. Further, rumours were spreading in the market that the company was in trouble. To stop these rumours, Hadler, one of the directors of Fame Ltd, started buying shares in the company with money provided to him by Fame Ltd. Has there been a breach to the principle of capital maintenance? For answers to problem questions, please refer to .

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Chapter 6

Company Officers and Management Covered in this chapter • • • • •

The definitional issues of officers, directors, secretaries and executives The role of the company secretary The organic theory The basic rules of how a company makes a decision Rules regarding directors’ meetings

Cases to remember Austin & Partners Pty Ltd v Spencer [1998] SCNSW 5680/63 Automatic Self-Cleansing Filter Syndicate Co v Cunninghame [1906] 2 Ch 34 Corporate Affairs Commission v Drysdale (1978) 141 CLR 236; [1978] HCA 52 Grimaldi v Chameleon Mining Ltd (No 2) [2012] FCAFC 6 John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113 Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd [1971] 3 All ER 16 Shafron v ASIC [2012] HCA 18 (2012) 247 CLR 465

Statutes and sections to remember Corporations Act ss 9, 198A–198D.

6.1 Introduction An artificial entity such as a corporation must be able to make legal decisions through certain organs of the company. In law the company is seen as a separate legal entity (s 124) and is the real ‘person’ employing managers and employees and transacting with third party suppliers or customers. Australian corporations have key officers to manage the corporations such as directors, secretaries and chief financial officer. As noted in Chapter 4, these officers may be seen as the mind and will of the corporations and as such the corporation would be primarily liable for their conduct. Since the publication of the Cadbury report in the United Kingdom in 1992, there has been an international diffusion of corporate governance codes and regulations around the world. The Cadbury report defined corporate governance as ‘the system by which companies are directed and controlled. The boards of directors are responsible for the governance of their companies. The shareholders’ role in governance is to appoint the directors and the auditors and to satisfy themselves

Chapter 6: Company Officers and Management

that an appropriate governance structure is in place. The responsibilities of the board include setting the company’s strategic aims, providing the leadership to put them into effect, supervising the management of the business and reporting to shareholders on their stewardship. The board’s actions are subject to laws, regulations and the shareholders in general meeting’ ([2.5]). Justice Owen, in his report on the HIH collapse observed that: I am becoming less and less comfortable with the phrase ‘corporate governance’—not because of its content but because it has been so widely used that it may become meaningless. There is a danger it will be recited as a mantra, without regard to its real import. If that happens, the tendency will be for those who have to pay regard to it to develop a ‘tick the box’ mentality. The attitude might be, ‘Yes, we have a stateof-the-art corporate governance model; yes, it is committed to writing; and, yes, the company secretary has checked that each item is in place and has included a statement to that effect in the annual report. Therefore there could be no problem in the corporation’.

Corporate governance—as properly understood—describes the framework of rules, relationships, systems and processes within and by which authority is exercised and controlled in corporations. Understood in this way, the expression ‘corporate governance’ embraces not only the models or systems themselves but also the practices by which that exercise and control of authority is in fact effected. HIH had a corporate governance model. The directors said so in the annual reports. But there is little, if any, evidence that the board periodically assessed the company’s corporate governance practices to ensure that they were, and continued to be, suited to the changing environment in which the company operated. For example, what might have been adequate for a group that was primarily Australian‑based, as it was in 1996, might not have been so as the overseas operations burgeoned in subsequent years. The danger of this practice is that, among other things, it can lead to the ‘tick the box’ approach just mentioned. There is little point in having a corporate governance model if the directors fail to examine periodically its practical effectiveness. The problem of poor corporate governance faced by HIH is not unique to Australia. In fact, in 2009, Walker found that the global financial crisis has reduced confidence in the quality of corporate governance (Walker, Walker Review of Corporate Governance of UK Banking Industry (2009, Financial Reporting Council)). To prevent corporate failures and corporate misconduct, understanding the way corporations are run is central to implementing good internal and external checks and balances to ensure good corporate governance. As such, the subject of corporate officers is one of the most important areas of corporate law and involves many complex and interlinked issues.

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6.2 Definition of officers 6.2.1 Who are corporate officers? An officer is defined in the definition section of the Corporations Act, s 9. There was previously an alternative definition for matters that arose prior to 13 March 2000, when the Corporate Law Economic Reform Program Act 1999 (Cth), came into force. This definition was repealed as part of the CLERP 9 amendments that commenced in July 2004. The main definition contained in s 9 is more functional, stating that an officer is: (a) a director or secretary of the corporation; or (b) a person: (i) who makes, or participates in making, decisions that affect the whole, or a substantial part, of the business of the corporation; or (ii) who has the capacity to affect significantly the corporation’s financial standing; or (iii) in accordance with whose instructions or wishes the directors of the corporation are accustomed to act (excluding advice given by the person in the proper performance of functions attaching to the person’s professional capacity or their business relationship with the directors or the corporation) … (c) a receiver, or receiver and manager, of the property of the corporation; or (d) an administrator of the corporation; or (e) an administrator of a deed of company arrangement executed by the corporation; or (f) a liquidator of the corporation; or (g) a trustee or other person administering a compromise or arrangement made between the corporation and someone else.

This definition of an officer should be compared with the definition of a director as it is drafted to be deliberately much wider. The definition of a director is also found in s 9 and are discussed in 6.3.2.

6.2.2 Who are employees? The term ‘employee’ does not refer to each and every employee of a company, only to senior managers of the corporation. It relates to managers under a contract of employment which carries with it a common law duty of fidelity (faithfulness) owed by the employee to the company. In Jesseron v Middle East Trading (1994) 13 ACSR 455 Justice Young said: I do not, however, consider that every employee of the company is an officer of the company. I think one must look at the way in which the term was defined at common law and under earlier statutes and note that from the mid-19th century it was only those persons who were connected with the making or the implementation of policy

Chapter 6: Company Officers and Management

or management decisions in the company that came within the purview of the term ‘officer’.

This principle was applied in the case of Timber Engineering Co Pty Ltd v Anderson [1908] 2 NSWLR 488, where the defendant set up a company competing with his employer and passed business from his employer to the new company.

6.2.3 Who are executive officers? An executive officer is often the most senior employee in the organisation, and may be called the CEO or managing director. In very large companies it is also common to have a small team of executives, such as the chief financial officer, chief information officer and general counsel. The law imposes a vast array of duties on such executives because of their unusual position and their ability to influence and damage employees, shareholders, creditors and the community. An executive officer assumes three different capacities, and is therefore subject to the duties owed by all three positions within the company. An executive is simultaneously: • an employee of the company, and therefore owes a duty of fidelity; • a director of the company (due almost always to occupying a position on the board), and therefore subject to all directors’ duties; and • an agent of the company, with the ability to legally bind the company. This can be contrasted with the role of the non-executive director, who is a member of the board, but not an employee nor an agent of the company. Non-executive directors will attend meetings of the board of directors and meetings of the committees of the board to which they are appointed. Their job is to monitor the performance of the executive directors and to help shape the long-term policies of the company. The CLERP 9 Act (Corporate Law Economic Reform (Audit Reform and Corporate Disclosure) Act 2004 (Cth)), after July 2004, specifically defined ‘senior manager’ to include those that make decisions that affect the whole business or have the capacity to significantly affect the corporation’s financial standing (s 9 of the Corporations Act). This was in direct response to some of the recommendations made by Justice Owen in his 2003 report, after the Royal Commission into the HIH Insurance collapse (www.hihroyalcom.gov.au).

6.3 Role of the company secretary and directors 6.3.1 Who is the company secretary? Under s 204A, every public company is required to have a company secretary. Approximately 100 years ago, the position of company secretary was seen as merely

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A case to remember Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd [1971] 3 All ER 16 Facts: B was a company secretary with extensive administrative duties and a great deal of authority over the affairs of Fidelis, which dealt in luxury cars. B fraudulently ordered hire cars on behalf of the business, stating they were for business purposes. The cars were delivered but not paid for. When Panorama demanded payment Fidelis denied having granted authority to B and refused to accept any subsequent liability. Held: On appeal, it was held that B was not liable for his own debts. As a company secretary, he had acted with ostensible authority and the company was liable for the debt incurred. Principle of law: A company secretary has ostensible (apparent) authority to sign contracts connected with administrative affairs of the company. Companies are liable for the actions of agents acting with ostensible or direct authority.

a ‘servant of the board’ or as a ‘mere clerk’. However, that position changed after Lord Denning’s judgment in Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd [1971] 3 All ER 16. Accordingly, Lord Denning recognised that the secretary could bind the company as he held the ‘key administrative position’. This UK case was subsequently followed by the NSW Supreme Court in Club Flotilla (Pacific Palms) Ltd v Isherwood (1987) 5 ACLC 1027. It is important to note that the authority of a company secretary applies only to administrative contracts, not to commercial contracts. Thus if a company secretary purchases a photocopier, it would be an administrative contract which they have the implied power to sign. But to arrange the bank overdraft would be deemed commercial, and the company secretary would not have power to complete such a contract. The board or CEO could always give the secretary the express authority to enter a commercial contract, but it is not implied. The company secretary, as an officer of the company, is bound by the same statutory duties as directors (other than s 588G) and is actually appointed by the board of directors (s 204D). Although the only qualification is that the secretary must be over 18 years old (s 204B), the duties of care expected (as one example) are the same as a director. The terms and conditions of the appointment of the secretary, including remuneration, are determined by the board of directors under s 204F. The name and address of the company secretary are kept on the public record by ASIC under s 205B. If there is a change of details, including a new secretary, ASIC must be informed within seven days (s 205C). The company secretary may be held personally criminally liable for offences outlined in s 188. These include failing to maintain the registered office and lodging annual returns and notices with ASIC. Approximately 20 000 secretaries are held

Chapter 6: Company Officers and Management

liable each year for breaching this law in respect of the lodgment of annual returns. As officers of the company, secretaries are also subject to the broader officers’ duties under common law, equity and statute (ss 180–185 Corporations Act). Officers’ duties will be discussed in Chapter 7. This is highlighted in Shafron v ASIC [2012] HCA 18 (2012) 247 CLR 465.

A case to remember Shafron v ASIC [2012] HCA 18 (2012) 247 CLR 465 Facts: Shafron worked for James Hardie as a company secretary and a general counsel from 1998. From 1999, he shared the role of company secretary with Mr Cameron. As will be explained in Chapter 7 when the James Hardie cases are discussed, Shafron was sued for breaching his duty of care when he failed to advise the board of James Hardie about: •

the amount of information that need to be disclosed to the ASX by the company; and

• the

actuarial report upon which the board based their beliefs not being appropriate for the board to base their decision on.

Shafron tried to argue that his duties as a company secretary were limited to company secretarial functions and did not include his general counsel functions. Held: The court found that Shafron could not delimit his role of a company secretary from his role as a general counsel. Since both matters fell within his responsibility, he was found in breach of his duty of care. Principle of law: If a company secretary has specialised skill, training or knowledge then it is expected for them to bring such skill, training or knowledge to their role. The precise role of the company secretary will depend upon the size and type of the corporate entity. Previously, all companies were required to have a company secretary; however, proprietary companies are now exempt from this requirement. In practice, many proprietary companies still retain a company secretary, who also has a financial/accounting or legal compliance role.

6.3.2 Who are the directors? By law, public companies must appoint a minimum of three directors, while proprietary companies need only appoint one (s 201A). The directors must ordinarily reside in Australia, but overseas directors may be appointed to the board. Section 9 defines a director as: (a) a person who: (i) is appointed to the position of a director; or (ii) is appointed to the position of an alternate director and is acting in that capacity; regardless of the name that is given to their position; and

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(b) unless the contrary intention appears, a person who is not validly appointed as a director if: (i) they act in the position of a director; or (ii) the directors of the company or body are accustomed to act in accordance with the person’s instructions or wishes …

This definition indicates that the courts will look at the function of the person rather than their job title. This is particularly important in light of the US corporate collapses, such as Enron, WorldComm and Lehman Brothers, and the Australian collapses of HIH Insurance, One.Tel and Opes Prime. Therefore, a governor or trustee of a company could be a director for corporate law purposes. The question is whether the person can make significant decisions which will affect the whole of the business or have a significant financial impact. In Austin & Partners Pty Ltd v Spencer [1998] SCNSW 5680/63, the court held that a senior person who attended all the board meetings and was crucial to the decision-making process, even though not appointed to the board, was still a de facto director. Similarly a person who is not appointed to the board of directors but is in control of the board (for example, the board is used to acting in accordance with the person’s instruction and wishes) will be deemed a shadow director.

A case to remember Corporate Affairs Commission v Drysdale (1978) 141 CLR 236; [1978] HCA 52 Fact: Drysdale was appointed as a director of a company. However, he was not re-elected as a director at the next annual general meeting. As a consequence he stopped being a director. While this may have been the case, Drysdale continued to act as a director for the next two years by attending meetings and voting at the meeting and making decisions with the rest of the directors. Drysdale was then sued for breaching directors’ duties. Held: While Drysdale was not appointed as a director, he was a de facto director as he was acting as a director. Consequently, he was bound by the duties that apply to directors. Principle of law: Just because a person is not appointed as a director does not mean that the person may not be deemed as a director and found in breach of directors’ duties. Mason J stated that a de facto director is a person ‘who acts in the position [of director] with or without lawful authority’.

6.3.3 How can a director be appointed and be removed from office? 6.3.3.1  Appointment of directors Under s 201G, directors are appointed at a member meeting through the passage of an ordinary resolution. However, s 201G is a replaceable rule and as such may be changed by the company’s constitution.

Chapter 6: Company Officers and Management

A case to remember Grimaldi v Chameleon Mining Ltd (No 2) [2012] FCAFC 6 Fact: Grimaldi was a consultant of Chameleon Mining Ltd. He was sued by Chameleon Mining Ltd, who claimed that Grimaldi was acting as a director of the company and had received extensive private benefits as a result of his position. Grimaldi had in fact assisted the board of directors of Chameleon Mining Ltd in a number of decisions, which caused the company to give benefits to Grimaldi and his associates for little or no benefit to the company. Held: Grimaldi was deemed as a de facto director. Principle of law: A person who has been appointed as a consultant may be deemed as a de facto director if the person acted as a director. When assessing whether the person is a de facto director, it is important to assess the role such a person has played within the company.

Any person who is 18 years or over may be appointed as a director as long as they are not disqualified from acting as a director (s 201B). Companies cannot be appointed as directors (a company may be a shadow director). Under s 201A, in a proprietary company, the minimum number of directors is one and the person must ordinarily reside in Australia. In a public company, the minimum number of directors is three and two of them must ordinarily reside in Australia.

6.3.3.2  Removal of directors A director can be made to vacate their position by satisfying either certain statutory conditions or conditions under the company’s constitution. Statutory conditions include the failure to obtain qualification shares, being an insolvent person, being convicted of fraud, by court order for dishonesty, and by shareholders passing an ordinary resolution (ss 203C for proprietary company (this is a replaceable rule) and 203D for public companies (this is not a replaceable rule)). Historically there was an age limit of 72 years for public companies, but this age discrimination barrier has been removed. Corporate constitutional conditions may include being of unsound mind, being absent for more than six months, and discovery of any conflicts of interest.

6.4  Organic theory and decision making 6.4.1 Organic theory The key concept in this area of law is the political science topic often referred to as the ‘organic theory’. This theory applies the analogy above: that governments can only make decisions on behalf of their voting citizens with their decision-making organs. In the Australian Parliament, adult voters select members of parliament, the majority of whom make up the government of the day. From this pool (house)

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of representatives is selected a cabinet, which may delegate to an inner group or person (for example, the prime minister) the authority for making day-to-day decisions. Thus, a government cannot make a decision without the involvement of its decision-making arm. Furthermore, individual voters, or ministers, are usually unable to change such decisions. Applying this organic theory to the corporate law paradigm in Figure 6.1, it can be seen that the board of directors is the elected decision-making arm of the corporation. However, when considering the theory in light of shareholders’ rights, a fundamental question arises: can an ordinary shareholder or group of shareholders force the directors to change one of their decisions by passing a resolution at a members’ meeting? Figure 6.1 Organic theory of corporations CEO/MD

Company secretary

Board of Directors Managers Company (separate legal entity)

Shareholders

This question has been examined by the courts in the UK in John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113 and, more recently, in Australia in NRMA Holdings Ltd v Parker (1986) 6 NSWLR 517. The resulting common law principle is in keeping with the organic theory of the corporation: shareholders are not the decision-making organ and generally cannot interfere with management decisions. The simple diagram in Figure 6.1 illustrates the fact that various legal decisions can only be made by certain organs of the company. In law, the company is seen as both a separate legal entity (s 124) and as the real ‘person’ employing staff and transacting with third party suppliers and customers. The two main decision-making organs are the board of directors and the members at a general meeting. Each organ has specific and general powers to make decisions, as well as authority to delegate their powers to other parties. Decisions need to be made at meetings, which must be

Chapter 6: Company Officers and Management

A case to remember John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113 Facts: Several brothers owned and controlled a company. The brothers took advantage of the company and wrongfully utilised company property for their own purposes in order to reduce their individual tax liabilities. The brothers decided that they would appoint three principal directors and the brothers would become ordinary directors of the company without voting rights. The principal directors then drew up a repayment schedule for the brothers to repay their debts and they signed this. Two brothers wilfully ignored their repayment undertaking and the company took legal action. The shareholders held an extraordinary general meeting and passed a resolution to discontinue the legal proceedings. Article 95 of the articles of association (constitution) of the company included provisions to the effect that the management of the business was under the control of the directors, subject to the constitution and legislation. Held: The shareholders were acting outside their authority, and the legal action could continue. The only options available to the shareholders were to refuse to vote the same directors back onto the board in future elections, or to vote for an alteration of the constitution. Principle of law: Shareholders cannot usurp the authority given to directors in the company’s constitution.

validly held and recorded in minutes at board level or at the shareholders’ meetings. Section 198E provides special rules for proprietary companies that have a sole director/shareholder, with respect to decision making. As a general rule, the members delegate management powers to the board of directors. Section 198A notes that the board of directors is in charge of the management of the company. Although s 198A is a replaceable rule, virtually every company would have a similar provision in its corporate constitution. However, under the Corporations Act, certain decisions are reserved purely for the general meeting and cannot be made by the board of directors. Examples include removal of directors in public companies (s 203D), amendment of the corporate constitution (s 136) and reduction of capital (ss 256B and 256C). The board of directors, as a decision-making organ of the company, has broad powers to manage the business of the company. As noted previously, s 198A provides that the directors may exercise all powers except those required by the Corporations Act or the company’s constitution to be exercised by the general meeting. The board may confer its powers to a managing director (more commonly known as the CEO), by virtue of the replaceable rule in s 198C. As with any delegation, this may be revoked at any time by the board, but does not operate retrospectively. The Corporations Act provides an express power in s 198D for the board to delegate its authority, subject only to the corporate constitution. The delegation of power may be made to a committee of directors, an individual director,

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an employee of the company, or any other named person. The delegation must be recorded in the company’s minutes book (under s 251A). The law clearly states that if the Corporations Act or the corporate constitution so provides, it is the board of directors, not the shareholders or the managers, who have power to make certain decisions. This was established in Australia in NRMA Holdings Ltd v Parker (1986) 6 NSWLR 517. If the shareholders disagree with the board, they may convene a general meeting, but are unable to pass a resolution to change decisions that have already been made by the board of directors.

A case to remember Automatic Self-Cleansing Filter Syndicate Co v Cunninghame [1906] 2 Ch 34 Facts: A members’ meeting passed a resolution directing the directors to sell the company’s property. The board of directors refused to do so, relying on a provision in the constitution similar to s 198A. The members argued that the directors are agents of the members and as such should comply with the members’ wishes. Held: The Court of Appeal rejected this argument and held that the members could not interfere in the management of the company. Principle of law: The members cannot overrule the decision of a board of directors.

6.4.2 Directors’ meeting Decisions need to be made at meetings, which must be validly held, and those decisions recorded in minutes at a board level or at the shareholders’ meetings (for discussion on members’ meetings see 8.2.2). If the directors pass a motion, it is known as a resolution and becomes immediately binding upon the company. Unlike members’ meetings, which require compliance with strict notice requirements, directors’ meetings only require reasonable notice to be given (s 248C). At the meeting of the board, there is one vote per director and only a simple majority of votes (more than 50%) is required to pass the motion as a resolution. Any resolutions decided must be recorded in the board’s minutes book. Alternatively, directors may pass a resolution without a meeting, provided the motion is circulated to all the directors to sign (s 248A). This alternative method is available under a replaceable rule (s 135). The quorum for a board meeting is normally two directors, but again this is a replaceable rule (s 248F). The James Hardie case in 2009 (ASIC v Macdonald (No 11) [2009] NSWSC 287) dealt with, in detail, the issue of minutes in board meetings. The focus of the case was on the board meeting of 15 February 2001 and whether the infamous media statement to the ASX contained the phrase ‘fully funded’ for the compensation of asbestos victims. The minutes of the board meeting were not signed until the next

Chapter 6: Company Officers and Management

board meeting on 4 April 2001. ASIC argued that there was a statutory assumption under s 251A that the minutes and resolutions were recorded unless the contrary was proved. The definition of ‘books’ includes documents such as draft minutes, which had been circulated to all the directors soon after the February meeting under s 1305. But the court held that the specific requirements of s 251A (entering the minutes book within one month and signing by the chair) must be complied with, and took priority over a general provision such as s 1305. James Hardie Industries’s failure to enter the minutes meant that the evidential value of the documents was diminished to the status of any other document in evidence. Normally the correct signed minutes and all the resolutions contained within them would be presumed to be the accurate determination of the meeting.

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Assessment preparation Revision questions 1 2 3 4 5 6 7 8 9 10

Define corporate governance. Can shareholders usually force the directors to sell the assets of the company? Who is in charge of the management of the company? What is meant by senior manager in a company? How are directors appointed? Who may be appointed as a director? What is the role of a company secretary? How is a company secretary appointed? What is meant by a shadow director? How is voting conducted at board of directors meeting?

Problem question James was elected as a director of ‘Super Pty Ltd’ at the annual general meeting. His appointment was invalid because the procedure in the constitution (which was in relation to appointments of directors) was not complied with. James continued to attend board meetings. He voted on resolutions with other directors and he participated in the management of the company. ASIC suspected that the board of directors of Super Ltd were breaching their duties and decided to take action. Could James be sued for breach of directors’ duties? Why or why not? For answers to problem questions, please refer to .

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Officers’ and Directors’ Duties Covered in this chapter • • • •

Officers’ statutory duties under the Corporations Act Officers’ common law and equitable fiduciary duties The impact of civil actions and remedies The impact of criminal prosecutions and sanctions

Cases to remember ASIC and HIH Insurance v Adler, Williams and Fodera (2002) 42 ACSR 80 ASIC v Healy (2011) 196 FCR 291 Brunninghausen v Glavanics (1999) 46 NSWLR 538 Commonwealth Bank of Australia v Eise and Friedrich (1991) 9 ACLC 946 Daniels v Anderson Ltd (1995) 16 ACSR 607 DCT v Clark (2003) 57 NSWLR 113 Fysh v The Queen [2013] NSWCCA 284 Green v Bestobell Industries Pty Ltd (1982) 1 ACLC 1 Howard Smith v Ampol Petroleum [1974] AC 821 Hutton v West Cork Railway (1883) 23 Ch D 654 Kinsela v Russell Kinsela Pty Ltd (In Liq) (1986) 4 NSWLR 722 Metropolitan Fire Systems v Miller [1997] 23 ACSR 699 Percival v Wright [1902] 2 Ch 421 R v Byrnes and Hopwood (1995) 183 CLR 501; [1995] HCA 1 Re Smith and Fawcett Ltd [1942] 1 All ER 542 Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134 Spies v R (2000) 201 CLR 603; [2000] HCA 43 State of South Australia v Marcus Clark (1996) 19 ACSR 606; [1995] SASC 4956 Statewide Tobacco Services v Morley (1990) 2 ACSR 405 Tourprint International Pty Ltd v Bott (1999) 32 ACSR 201 Walker v Wimborne (1976) 137 CLR 1; [1976] HCA 7 Whitehouse v Carlton Hotel Pty Ltd (1987) 162 CLR 285; [1987] HCA 11

Statutes and sections to remember Corporations Act ss 9, 180(1), 182, 183, 184, 189, 190(2), 204A, 208, 588G, 588H

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7.1 Introduction Officers of a company have a range of duties imposed on them. It is essential that all lawyers and accountants have a solid understanding of the interrelationship between the common law duties, equitable fiduciary duties and statutory duties. Each one of these duties has different remedies that may apply if the duty has been breached. There are also some laws that apply to all corporate officers and some that apply only to directors; thus, the definitions of the terms ‘officers’ and ‘directors’ hold the key to the application of the law.

7.2 Fundamental duties of officers The fundamental duties of officers are of paramount importance to all students of corporate law. A clear understanding of the basic concepts underlying these duties is essential before delving into the finer detail of each duty. In attempting to achieve this understanding, it would be prudent to formulate answers to three central questions, which will be discussed below: • Who can bring legal action against an officer? • To whom to directors and officers owe a duty? • What remedies may be sought it breaches of duties occur?

7.2.1 Who can bring a legal action against an officer? Four parties may bring a legal action against a company’s officers. These are: • the company itself (s 124); • ASIC, as the corporate and financial services regulator (s 50 ASIC Act); • a shareholder, through the use of statutory derivative action (s 236) – it is important to remember that a shareholder cannot sue the directors in their own name. They have to do it in the name of the company (see 8.4.7); and • a liquidator acting on behalf of the company. If the officers or directors are being sued criminally, the case will be brought by ASIC and the Commonwealth Director of Public Prosecutions (DPP). ASIC usually deals with minor criminal breaches. For example, from 2006 to 2010, ASIC investigated and prosecuted before the local and magistrates’ courts across Australia almost exclusively insolvency crimes committed by directors of failed or insolvent companies where they had failed to assist the liquidator (Peter Keenan, Convictions for Summary Insolvency Offences Committed by Company Directors (2013, Australian Institute of Criminology)). The DPP will be prosecuting more serious contraventions such as breaches of s 184 of the Corporations Act.

Chapter 7: Officers’ and Directors’ Duties

7.2.2 To whom do the directors owe a duty? 7.2.2.1  Duty owed to the company It should be remembered that a century ago, in the leading UK case of Percival v Wright [1902] 2 Ch 421, it was held that the officer’s duty is owed to the company, not individual shareholders.

A case to remember Percival v Wright [1902] 2 Ch 421 Facts: A shareholder of a company approached one of the directors and offered to sell his shares for a particular price. The directors agreed to the price and purchased the shares. However, the directors did not disclose that they were currently in negotiations for a takeover of the company to a third party at a considerably higher price. The takeover did not occur, but when the negotiations were aired the shareholders wanted to set aside the sale, claiming a breach of fiduciary duty by the directors of the company. Held: The sale was not set aside. It was a valid sale of shares by the shareholders to the directors. Principle of law: Directors do not owe fiduciary duties to individual shareholders. Duties are owed by directors to the company as a whole.

However, in some cases, the courts may deem a special duty to be owed to the shareholders because of the quasi-partnership nature of the company. This exception was put forward in the New Zealand case of Coleman v Myers [1977] 2 NZLR 225 and approved by the New South Wales Court of Appeal in Brunninghausen v Glavanics (1999) 46 NSWLR 538. Where the company, through its board of directors, decides not to bring a legal action against a director, ASIC or a member may be able to bring the case (see 8.4.7). The principle that an officer’s duty is owed to the company was taken even further by the High Court of Australia in Walker v Wimborne (1976) 137 CLR 1; [1976] HCA 7, where the court held that, in a group of companies, the director owes a duty to the company to which they are appointed, not the ultimate holding company (this confirms the principle of separate legal entity). The rule in Walker v Wimborne (1976) has been modified (by s 187) for wholly owned subsidiaries acting in the best interests of the company (if the conditions of s 187 have been complied with). It is natural for courts to have developed some exceptions to this general rule. For example, where the company is insolvent, or even nearing insolvency, the directors owe a duty to the creditors as in Kinsela v Russell Kinsela Pty Ltd (In Liq) (1986) 4 NSWLR 722 and Spies v R (2000) 201 CLR 603. Where a director is acting in

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A case to remember Brunninghausen v Glavanics (1999) 46 NSWLR 538 Facts: B and G were the directors and shareholders of their business as well as brothers-in-law. G was not an active director, and he did not interfere in the activities of the business. After a falling out, G organised to sell his share in the business to B. However, while these negotiations were occurring, B received an offer for the shares of the whole company at a much higher price. B did not disclose this to G. G sold for a price substantially below the offer B had received. G later found out and applied to the court for equitable compensation. Held: B had breached fiduciary duties owed by him to G by not disclosing the offer he had received. G was granted the difference in price of the shares, plus a further payment for goodwill. Principle of law: The case outlines the exception to the rule developed in Percival v Wright [1902] 2 Ch 421. In this matter the judge ruled that some situations will give rise to a fiduciary duty being owed to a shareholder by a director, as in a quasi-partnership. This is the case when there is a personal relationship of trust, confidence and reliance between the director and the shareholder.

another capacity, for example as an agent on behalf of a shareholder, the duty will be owed to that shareholder (Allen v Hyatt (1914) 30 TLR 444).

7.2.2.2  What about corporate social responsibility? As seen from the above paragraph, directors and officers owe their duty to the company and, except in limited instances such as insolvency, they do not need to balance the interest of the corporations with the interest of different stakeholders. Such a position may be viewed as unacceptable today with Bell stating that ‘to think of the business corporation simply as an economic instrument is to fail totally to understand the meaning of the social changes of the last half century’ (Daniel Bell, The Coming of Post-Industrial Society: A Venture in Social Forecasting (1999), Basic Books, p 289). As a result, there are numerous mandatory and voluntary national and international standards and guidelines that exist nowadays for companies to demonstrate good corporate citizenship. However, in 2006, CAMAC issued a report on corporate social responsibility that decided that no reforms are needed to expand directors’/officers’ duties. CAMAC observed: The Committee considers that the current common law and statutory requirements on directors and others to act in the interests of their companies … are sufficiently broad to enable corporate decision-makers to take into account the environmental and other social impacts of their decisions, including changes in societal expectations about the role of companies and how they should conduct their affairs (p. 111).

Chapter 7: Officers’ and Directors’ Duties

7.2.3 What remedies or sanctions may be sought? It should be noted from the outset that the terms ‘remedies’ and ‘sanctions’ are not interchangeable; rather, they have their own distinct meanings and applications. The most common remedies sought and awarded by the courts for breach of a civil duty owed by an officer are damages and injunctions. However, sanctions handed down for criminal breach of a duty owed by an officer may include fines and imprisonment. This has become even more complex with the introduction of civil penalty provisions in 1993 that are a hybrid of civil remedies and criminal sanctions. See Figure 7.2. Both of these concepts are explored in greater depth in 7.6.

7.3 What duties are owed by an officer? Officers’ duties are governed by a complex interrelationship between case law and legislation, which gives rise to duties under the common law, equity and statute. Figure 7.1 best illustrates this web of duty in which officers are enmeshed. Figure 7.1 The duties owed by an officer Corporations Act s 184 s 588G(1) s 1043A s 180 s 181 s 588G(1)

s 181 s 182 s 183 s 185

Common law duties

Equitable fiduciary duties

Source: Adams (1992, revised in 2009, published with Chartered Secretaries Australia, now Governance Institute of Australia, in the Applied Corporate Law course)

In Figure 7.1 the overlapping areas represent the way the Corporations Act in Part 2D.1 reflects parts of the common law and equitable principles. Some duties are specifically laid out in statute, such as insider trading in s 1043A (before the Financial Services Reform Act 2001 (Cth), this provision was known as s 1002G). Other duties, such as those that arise when directors have interests in contracts entered into by the company, are both statutory (s 182) and fiduciary. Directors must not allow the company to trade while insolvent (s 588G) and they have a fiduciary

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duty to consider creditors in times of financial trouble. Probably one of the most important overlaps is the tort of negligence under the common law and s 180(1) of the Corporations Act. It should be noted that, in a single legal proceeding, an officer can be sued for breaches of all three, by virtue of s 185, as occurred in State of South Australia v Marcus Clark (1996) 19 ACSR 606.

A case to remember State of South Australia v Marcus Clark (1996) 19 ACSR 606 Facts: The managing director of the State Bank, Timothy Marcus Clark, was sued by the South Australian Government for damages arising from a purchase by the bank of the whole issued share capital of a life assurance company. The value paid was $59 million, when fair value of the company was $27 million. Marcus Clark did not disclose to the board of directors that the life assurance company was in debt to the value of $27 million, and that he was a director of the holding company. It was also not disclosed that his wife owned a shareholding in the company. Held: Marcus Clark was negligent at common law and was required to pay the difference in value plus interest, the total amounting to $81 million. He was also in breach of his equitable fiduciary duty. Marcus Clark was a trustee of the property of the bank and there was a sufficient relationship of proximity between the Crown and Marcus Clark to require him to disclose his personal interests in the purchased property. Principle of law: Directors may be sued at the same time for breaches of directors’ duties under common law, equity and statute.

7.3.1 Officers’ common law and equitable duties The common law on the duties of corporate officers has evolved over the last 150 years. The main common law duty imposed on directors is the duty of care. But because officers did not require any special training or qualifications, the general standard expected has been very low (a standard similar to that of the reasonable person in negligence, but with a greater element of subjectivity). Since the 1990s the courts have started to impose and expect a higher duty of care, a trend also apparent in the changing statutory environment. Under equity, the main duties that are imposed on directors are: • to act in good faith; • to act for a proper purpose; and • to avoid conflict of interest. It is necessary to analyse the case law under the common law and equity to fully appreciate the impact of the judicial developments, as well as to understand the interrelationship with the post-March 2000 legislative amendments. One can say that the basic concepts have not really changed and these need to be well understood.

Chapter 7: Officers’ and Directors’ Duties

7.3.1.1  Common law duties: duty of care, skill and diligence The main duty imposed by the courts is the duty of care, skill and diligence. The common law duty of care, skill and diligence expected by the courts has traditionally been set at an amazingly low standard. The basic test of whether this duty had been fulfilled was originally laid down in Re City Equitable Fire Insurance Co Ltd (1925) [1925] Ch 407, where it was simply stated that the officers should take ‘reasonable care’. This was a subjective test that relied upon the individual officer’s level of skill, knowledge and experience in determining what was ‘reasonable’. This can be compared with the attempted new objective standard of care introduced by the Australian Parliament in February 1993. This amendment was originally known as (old) s 232(4); it has now been refined in s 180(1). Before 1990, the common law duty for directors was set at the lowest standard for any professional person. For the modern business community such a standard was clearly unacceptable. As a result of the inadequacy of the required standard, both the courts and parliament acted to change the traditional position. In a number of important cases the courts have lifted the common law standard expected. A very clear statement was made to that effect in Commonwealth Bank of Australia v Eise and Friedrich (1991) 9 ACLC 946, where the honorary chairman was held liable for $97 million for insolvent trading, even though there was no question of dishonesty and he was not receiving any remuneration. Even more important was the 1992 decision of AWA Ltd v Daniels t/a Deloitte Haskins & Sells (1992) 7 ACSR 759, where Rogers CJ held that an objective test of directors’ duty of care must be imposed on them. However, non-executive officers were not expected to adhere to the same standard of care as executive officers. On appeal in Daniels v Anderson Ltd (1995) 16 ACSR 607, it was held that all officers should apply the necessary standard of care and diligence. The test to determine whether there has been a breach of duty of care is an objective one for both executive and non-executive directors, and directors’ ignorance is not a defence. The actual FOREX trader involved in this case, who escaped to New York, USA in 1986, actually returned to Australia and was imprisoned in 2013. Three defences are available to directors who breach their duty of care: the business judgment rule, the reliance defence, and the delegation defence. These defences are discussed in 7.3.2.

7.3.1.2 Equitable duties All officers are expected to act honestly and reasonably in their activities. The equitable duties go further by requiring officers to comply with their fiduciary duty. Those people in a position to harm others are required by equity to exercise a

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fiduciary duty. In the High Court of Australia decision of Hospital Products Ltd v United States Surgical Corporation (1984) 156 CLR 41; [1984] HCA 64 the fiduciary duty was defined. Directors, like partners, trustees and agents, always owe a fiduciary duty to those they could easily harm. For a fiduciary, three central tenets govern corporate behaviour: to avoid conflicts of interest; not to make a secret profit; and to act for a proper purpose and for the best interest of the company. All officers must avoid breaches of these equitable fiduciary duties. A breach may result in the officer becoming a constructive trustee; this would mean that all the financial benefit the officer obtained would be held on trust and returned to the company. This was formally established in Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134, where the directors took advantage of a business opportunity for their own benefit rather than on behalf of the company. The ironic point in that case was that the company was incapable of exploiting the commercial advantage. However, the court still held that the directors were in breach of their fiduciary duties.

A case to remember Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134 Facts: Regal (Hastings) Ltd created a subsidiary to take up leases on two cinemas and the capital was fully paid. The directors, chairman and company solicitor were not prepared to guarantee the leases personally, but took up 500 shares each. When the shares were sold to a third party for a substantial profit, Regal (Hastings) Ltd brought an action against the former directors, chairman and solicitor to recover the profit made by them. Held: The directors were liable for breaching their fiduciary duties. It was irrelevant that the company was not in a position to take up the shares. They should have obtained shareholder approval. Principle of law: It is a conflict of interest for directors to profit from their position. The directors may protect themselves if they get the members’ approval.

The fiduciary duty may be split into a variety of component parts, each with its own cases and judicial interpretations. These different aspects include: • Confidentiality Officers should maintain confidentiality in respect of information gained in their role as either a director or secretary of the company. In Industrial Development Consultants v Cooley [1972] 1 WLR 443 the CEO breached confidentiality to take advantage of a corporate contract. • Conflicts of interest Officers should avoid seeking personal benefits that could give rise to conflicts of interest. This principle was established in Aberdeen Railway Co v Blaikie Bros

Chapter 7: Officers’ and Directors’ Duties

•

(1854) 1 Macq 461 and was illustrated in Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134 and Green v Bestobell Industries Pty Ltd (1982) 1 ACLC 1, where a senior executive passed confidential tender bid information to his own family company. It is possible for a director to be released from the duty on the basis of full and frank disclosure and after getting members’ approval as noted in Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134 or by an application to the court for relief under s 1318. Duty to act for proper purpose The High Court of Australia has held that officers must comply with a general proper purpose test in carrying out their duties. Thus the powers they are given must be utilised for a proper purpose. This was illustrated in Whitehouse v Carlton Hotel Pty Ltd (1987) 162 CLR 285; [1987] HCA 11, where Mr Whitehouse made significant changes to voting rights which impacted on a group of shareholders (his former wife and daughters). The High Court of Australia held that although Mr Whitehouse believed it was in the best interests of the company, it was, in fact, in breach of his fiduciary duty to act for a proper purpose because the shares were issued for an improper purpose (to exclude his former wife and daughters from taking control of the company). However, in cases where a company issues shares for a mixed purpose (one purpose being proper and another being improper) the court applies the ‘but for’ test to determine whether a breach of the duty to act for a proper purpose has occurred. An example of this can be found in Howard Smith v Ampol Petroleum [1974] AC 821.

A case to remember Howard Smith v Ampol Petroleum [1974] AC 821 Facts: RW Miller Ltd (Miller) received takeover bids from Ampol and Howard Smith. Miller issued shares to Howard Smith to the value of $4.5 million, claiming it needed the money to invest in capital. This reduced Ampol’s majority holding from 55% to 33.5%. Ampol took the complaint to court, claiming that this action had been taken for the sole purpose of changing the majority holdings and as such the directors of the business had acted with an improper purpose (to defeat the takeover). The directors noted that the reason behind the issuing of shares was to raise capital, which is a proper purpose. Held: The court applied the ‘but for’ test and asked whether the directors would issue the shares if the proper purpose (raising capital) was not there. The court found that even if the company did not want to raise capital it would have issued the shares to dilute the majority (Ampol) and create a new majority. As a consequence, Miller had acted with an improper purpose issuing the shares to Howard Smith. Principle of law: Directors must act for a proper purpose. Share issues cannot be made simply for the purpose of altering the voting powers within a company.

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•

Duty to act in good faith The directors owe a duty to act in the best interest of the company. Lord Greene MR, in Re Smith and Fawcett Ltd [1942] 1 All ER 542, defined the duty as the requirement: ‘To act bona fide for the benefit of the company as a whole and not for any collateral purpose.’

A case to remember Re Smith and Fawcett Ltd [1942] 1 All ER 542 Facts: Smith and Fawcett each held 50% of the shares in the company and were both directors. Article 10 of the corporate constitution stated that as directors they had absolute uncontrolled discretion to register a transfer of shares in their company. Fawcett died and left his shares to his son and daughter. Smith appointed his solicitor as the other director of the business and refused to register the transfer of the son’s shares in the shareholder register. Fawcett’s son applied to have the shareholders’ register altered. Held: Article 10 conveyed complete and utter discretion to the directors of the company to act in what they believed to be the best interests of the company. In refusing to register the son as a member there was no evidence that this was for any reason apart from what the remaining director believed to be the best interests of the company. There was no proof that Smith acted in anything but good faith. The son failed in his attempt to have the shareholder register altered and to become a member of the company. Principle of law: Directors must act in good faith and act for the good of the company. They have a fiduciary duty to behave in a manner they believe is in the best interests of the company and not for any collateral purpose.

The test that is applied to determine if there is a breach of duty to act in good faith is an objective test, as noted in Hutton v West Cork Railway (1883) 23 Ch D 654: Bona fide cannot be the sole test, otherwise you might have a lunatic conducting the affairs of the company, and paying away its money with both hands in a manner perfectly bona fide yet perfectly irrational …

‘Bona fide’ is Latin for ‘good faith’, meaning complete honesty.

7.3.2 Officers’ statutory duties Since the implementation of the national corporate legislation, attempts have been made to codify the common law duties and impose harsher penalties. In 1993 there was an attempt to decriminalise the statutory provisions by adopting a new idea called civil penalty provisions. Each of these provisions is a hybrid of civil and criminal penalties for breaching the statutory officers’ duties, although the High Court of Australia held in 2004 that civil penalties from a procedural aspect are akin to criminal sanctions (in Rich v ASIC (2004) 78 ALJR 1354). The CLERP Act 1999 (Cth) rewrote

Chapter 7: Officers’ and Directors’ Duties

the entire officers’ duties provisions in order to clearly distinguish between the civil, criminal and civil penalty provisions. It is important to note that an officer may be sued for breaches of the common law, equity or the statutory duties under s 185. The most important duties are as follows: • The duty to act in good faith (s 181) requires all officers to exercise their duties and powers in good faith in the best interests of the company and for a proper purpose. A breach of this section is a civil penalty provision. This section is an extension of the fiduciary duty to act in good faith for the best interest of the company. The severity of the penalty depends upon whether there was any intention to deceive or defraud the company, members or creditors. If there is an attempt to be reckless or intentionally dishonest, a separate criminal offence may be committed under s 184(1). • The duty to exercise care and diligence (s 180(1)) is similar to the common law standard of care, except that it has different consequences in that it is a civil penalty provision. Section 180(1) was re-drafted from its predecessors so that the director or officer must exercise their duties and powers with the degree of care and diligence of a reasonable person if: • they are a director or officer in the corporation’s circumstances; and • they occupy the position and hold the same responsibilities within a corporation as an officer. This objective test is the same test that applies to the common law duty of care. The new statutory standard only applies to conduct that occurred after 13 March 2000 and is treated as a purely civil penalty provision, with no equivalent criminal provision.

A case to remember ASIC v Macdonald (No 11) [2009] NSWSC 287 Facts: In 2001, the management and the board of directors of James Hardie Industries Group (JHI) had decided to reorganise themselves to be a Netherlands-based company named JHI NV. This was an extremely complex matter for any company to organise as there were so many subsidiary companies spread throughout the world. The only legal methodology available under corporate law is known as a scheme of arrangement, and this requires the court’s permission as well as the shareholders’ consent to the changes. A variety of reasons was given for this reorganisation, including taxation and business costs (savings) and that the appropriate level of funding for future asbestos victim claims would be met through a trust (Medical Research and Compensation Foundation— MRCF). The true motive behind the reorganisation has never been publicly stated and still remains quite unclear, apart from the fact that it was agreed by the board of directors on a business case. However, the general community appeared to be sceptical as to the

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corporate body’s intention, thinking there was reason to believe that the company was relocating to escape its asbestos liability. In 2001 JHI transferred the value of $293 million to establish the MRCF and made a very clear statement that this trust was ‘fully funded’ to meet the future Hardie asbestos claims. By the end of 2001 the actuaries estimated that MRCF would in fact need $574 million; by 2002 liability had grown to $752 million; and by the end of 2003 the estimates sat at an amazing $1.573 billion. The civil action was commenced in February 2007 by the corporate regulator, ASIC, against the original listed entity (JHI) and its former directors. The major focus of the case was on the media release (as an announcement) to the Australian Securities Exchange (ASX) that JHI had fully funded the MRCF. The media release, which one might call the ‘smoking gun’ in a criminal case, was a single page drafted by a public relations firm, which passed through internal and external lawyers, the senior management and the whole board itself. ASIC alleged, among other things, that the directors breached their duty of care when they allowed the release of the misleading media release. Held: ASIC was successful in proving 33 of the contraventions, covering officers’ duties (24), misleading and deceptive conduct (4), false statements in relation to securities (3) and breaches of continuous disclosure rules (2). Table 7.1 summarises the court’s finding.

Table 7.1 Contraventions of the Corporations Act per defendant Position/capacity

Corporations Act

Contraventions

Old JHI (now ANB 60 Pty Ltd)

Misleading conduct (s 995) False statement to securities (s 999) Continuous disclosure (s 1001A)

Three Two One

Current JHI NV company

Section 1041H (misleading conduct) Section 1041E (false statement in financial products) Section 674 (continuous disclosure)

One One One

CEO (Peter Macdonald)

Section 180 (duty of care)

Ten

General counsel (Peter Shafron)

Section 180 (duty of care)

Six

CFO (Phillip Morley)

Section 180 (duty of care)

One

Chapter 7: Officers’ and Directors’ Duties

Position/capacity

Corporations Act

Contraventions

Seven non-executive directors (including the chairperson Meredith Hellicar)

Section 180 (duty of care)

One each

12 defendants

Corporations Law and Corporations Act 2001

33 contraventions in total

Principle of law: The heart of the action, and the distinctive feature of this case, is that all the directors and in particular the CEO were held to have breached the most basic of officers’ duties. All 10 directors, without exception, were found to have contravened s 180(1) Corporations Act. The directors failed to meet the objective standard set out by Parliament in the legislation. In making the original draft ASX announcement (media release) on 15 February 2001 they did not take the necessary care that would have been expected by directors of a publicly listed company at that time and in those circumstances.

A case to remember ASIC v Healy (2011) 196 FCR 291 Facts and decision: The directors were found to be in breach of their duty of care under s 180(1) because they approved the inaccurate financial accounts of the company. The court stated: It is not envisaged by the [Corporations Act] that the directors can simply put the discharge of those functions [approving the financial accounts of the company] in the hands of apparently competent and reliable persons, for directors are a part of the process themselves by undertaking the task of approving and adopting the financial statements and reports. Principle of law: This case illustrates that the board of directors must be aware of and review the financial position of the company. This is not something they can just delegate to other people. The directors need to fulfil their obligation with due care.



• •

To counterbalance the more stringent test of care and diligence a statutory business judgment rule was introduced in s 180(2). This is a defence for all officers, who are to be taken as complying with the duties in s 180(1) and their common law equivalents if the director made a business decision and all the following conditions applied: the business judgment was made in good faith for a proper purpose; the officer did not have a material personal interest in the events;

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they informed themselves about the subject matter; and they rationally believe that the judgment is in the best interests of the corporation. Other defences are also available, such as the reliance defence under s 189 and the delegation defence under s 190(2). Under s 189, directors have the power to delegate their power under s 189D. However, they are responsible for the actions of the delegate. Section 190(2) provides that directors are not responsible if they believe, based on reasonable grounds, that: • the delegate would exercise the power properly; and • the delegate was reliable and competent. Under s 189, directors can use the reliance defence if they relied on: • employees; • professional advisers or experts; • other directors; or • a committee of directors. Reliance on these people can be a defence if the reliance was in good faith and the other person’s advice was only accepted after the person trying to rely on this defence had made an independent assessment of the information or advice. Duty to avoid conflict of interest: The duty not to misuse the officer’s position (s 182) reflects the equitable fiduciary duty that an officer could easily take advantage of an opportunity that really belongs to the company. This provision is widely drafted to catch any officer or employee who is in breach. This is a civil penalty provision, but could also be criminal under s 184(2), depending upon the presence of intent. The High Court of Australia reviewed the concept of improper use of an officer’s position in R v Byrnes and Hopwood (1995) 183 CLR 501. The directors could not defend themselves on the basis that their actions were in the company’s interest, while motivated by an ulterior motive (their own benefit). • •

•

A case to remember ASIC v Adler [2002] NSWSC 510; Adler v ASIC [2002] NSWCA 303 Facts: Rodney Adler, as a non-executive director of HIH Insurance, had $10 million transferred to a company he controlled. Some of the money was used to buy shares in HIH Insurance. ASIC was able to isolate a single $10 million transaction so as to bring a civil penalty action focusing on ‘officers’ duties’ against Adler, Williams (the chairman) and Fodera (the chief financial officer).

Chapter 7: Officers’ and Directors’ Duties

Held: The court found that the majority of the funds used to acquire HIH shares were actually provided by the company. The New South Wales Supreme Court (and subsequently the New South Wales Court of Appeal) found that the defendants had collectively contravened 197 provisions. The use of the $10 million led to a number of breaches of directors’ duties, including the duty to avoid any conflict of interest present under s 182. Principle of law: Directors should not misuse their position.

The duty not to misuse information (s 183) is a refinement of the general duty not to take advantage of the officer’s position. All officers naturally handle the company’s most sensitive information and it should not be used for personal gain. The section is applied to all companies and is not limited to securities (unlike the insider trading provision in s 1043A). An example of this provision being used is Green v Bestobell Industries Pty Ltd (1982) 1 ACLC 1. This is a civil penalty provision, which may lead to criminal consequences under s 184(3). In a recent case, ASIC v Vizard (2005) 145 FCR 57, Vizard used his position as a director of Telstra to gain confidential information to purchase shares in companies that Telstra was planning on taking over. He was found in breach of his duty under s 183. Vizard was fined $390 000 for his involvement in three illegal transactions and was disqualified from being a director for 10 years. A number of other statutory provisions within the Corporations Act have a direct impact on officers of a company. A public company must comply with Chapter 2E, titled ‘Financial benefits to related parties’. Additional criminal provisions within the Corporations Act are aimed at enforcing disclosure. Sections 191–194 require directors of proprietary companies to disclose to the board their holding of any another office; s 195 prohibits voting as an interested public director; ss 200A and 200B require disclosure of directors’ benefits in connection with a person’s loss or retirement of office or position; and s 202B requires disclosure of all directors’ remuneration. This has been further enhanced by the CLERP 9 requirements in the directors’ report to include a separate remuneration report, with more details, as stated in s 300A. ASIC maintains a register of disqualified directors and will prevent a dishonest director from being appointed as an officer of another company. ASIC can prosecute for additional offences, such as fraud by officers (s 596); falsification of books (s 1307); making false statements (s 1308); lodging false reports (s 1309); and even obstructing the regulator (s 1310). The Corporations Act also contains two specific statutory duties that commonly arise as important issues. These are insolvent trading (s 588G) and insider trading (s 1043A).

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7.4 Insolvent trading Corporations are prohibited from trading while insolvent, as doing so unfairly places creditors at risk. The Corporations Act allows for the ‘veil of incorporation’ to be lifted where insolvent trading occurs. The company is always liable for the debts it incurs. However, parliament has imposed an extra duty if the company is unable to pay its debts: the directors are personally liable for debts incurred after the date of insolvency. The company and the directors are jointly liable for those debts that have arisen after the specified date. Originally, subject to a number of defences, all officers who took part in the management of an insolvent company could be held personally liable for the corporate debts. This old section (s 592) has been reformed and replaced with a narrower focus on directors, rather than on all officers, and is contained in s 588G. This section commenced operation on 23 June 1993. This insolvent trading provision received media attention because of a number of cases in which non-executive directors have been held liable, despite not being actively involved in the management of the company. In the leading case of Morley v Statewide Tobacco Services Ltd (1992) 10 ACLC 1233 the court decided that a non-executive director (the mother of the company’s managing director) should pay $165 290 towards the corporate debt of $300 000 incurred by her son, as director. The largest amount imposed for insolvent trading occurred in Commonwealth Bank of Australia v Eise and Friedrich (1991) 9 ACLC 946, which came about as a result of the problems of John Friedrich and the Victorian branch of the National Safety Council. The honorary chairman, Max Eise, was found liable for nearly $97 million. The elements of this duty are: • The person is a director of the company when the company incurs a debt. A company secretary was sued for a breach of the earlier provision in Holpitt Pty Ltd v Swaab (1992), but he was able to avoid liability through use of the defence that he was not part of the company’s management (he was only an administrator). Under the reformed section of s 588G, the company secretary would not be liable unless also holding the office of director. • The company incurs a debt. Incurring a debt is an essential element in establishing a contravention of s 588G. In Powell and Another (as joint liquidators of Noelex Yachts Australia Pty Ltd (in liq)) v Fryer and Another (2001) 37 ACSR 589, the court held that ‘the words “incur” and “debt” are to be applied in a practical and common sense manner, consistent with the context in which they appear and the purposes of the legislation. “Debt”, as used in CL s 588G, should be given its natural and ordinary meaning; it is an obligation of one party to pay a sum of money to the other, and may be present and absolute, or contingent’.

Chapter 7: Officers’ and Directors’ Duties

A case to remember Russell Halpern Nominees Pty Ltd v Martin (1986) 10 ACLR 539 Facts: Russell Halpern Nominees Pty Ltd (Russell) was a solvent company when it signed a lease on premises from which it would operate its business. The business ran into financial problems and began incurring debts. Martin was the landlord for the company and brought an action under s 588G, as he believed that Russell was engaging in insolvent trading by incurring debts even after it had begun winding-up proceedings. Held: The company was not guilty of insolvent trading. In this case the positive act (the signing of the lease) took place prior to the business becoming insolvent. Rent must be paid whether the premises are in occupation or not. Thus the debt could not be avoided and a liability was only accrued after the business became insolvent. Principle of law: To engage in insolvent trading a debt needs to be commenced by a positive act. When signing leases, the debt is incurred when the lease is signed and the liability falls when the rent falls due.

•

The company incurs a debt when it is insolvent Insolvency is an important part of s 588G. Under s 95A a company is insolvent if it cannot pay its debts when they are due. However, this is hard to prove in the context of s 588G. For this reason there are certain rebuttable presumptions of insolvency under s 588E. They are: • continuous insolvency; or • not keeping proper financial records (these presumptions only apply for the duty to prevent insolvent trading); and • when the debt is incurred there were reasonable grounds to suspect that the company was insolvent or would become insolvent, and the director was aware, or should have been aware, of this. Under s 588G a director, including non-executive directors and alternate directors, will be personally liable for the debts incurred by the company if there are reasonable grounds for suspecting that the company is insolvent while continuing to trade (for example at One.Tel Ltd and HIH Insurance Ltd during 2001, or in the case of Elliott v Water Wheel Holdings Pty Ltd [2004] FMCA 37).

A case to remember Elliott v Water Wheel Holdings Pty Ltd [2004] FMCA 37 Facts: Elliott was a non-executive member of the companies collectively known as Water Wheel. Water Wheel traded under the advisory of an ANZ advisory board. The board claimed that between September 1999 and 17 February 2000 Water Wheel traded while insolvent. Evidence existed that they had been insolvent but still trading for some time.

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Held: The court held that Elliott and the two other directors were liable for the debts the business accrued during this period. Elliott was banned from being a company director for four years and was liable for exemplary and punitive damages. Principle of law: Even non-executive members are liable to obtain information from management on a regular basis, including lists of debtors, profit and loss statements, cash-flow reports and reports about negotiations with creditors about outstanding debts. A director’s failure to cease trading during an insolvent period is enough to constitute ‘failing to prevent the company from incurring a debt’ under s 588G.

This is an objective test and the judge will decide whether a reasonable person in a like position would continue to trade, as stated in Metropolitan Fire Systems v Miller (1997) 23 ACSR 699.

A case to remember Metropolitan Fire Systems v Miller (1997) 23 ACSR 699 Facts: Miller was the director of Raydor. Raydor enagaged Metropolitan Fire Systems as a subcontractor to install some fire equipment. Raydor then entered into winding-up activities and, with permission from the liquidator, Metropolitan commenced legal proceedings under s 588G against Miller. Their claim was that Miller had entered into a contract when it was insolvent. Held: The debt was incurred for the subcontract work on the day on which the contract was signed. On that day, it was held, Raydor was insolvent and reasonable grounds existed on which to base suspicions that it was. The company’s belief that the business was solvent was based upon optimism about future business transactions. Principle of law: When determining whether a company is insolvent, as defined by s 95A, an objective test must be used and a decision must be made to the standard of that of a competent director. A director has the responsibility to enquire about the financial fitness of a company and they must not rely upon the judgment of others.

•

The company keeps trading A director contravenes s 588G if they failed to prevent the company from incurring a debt. In ASIC v Elliott (2004) 205 ALR 594, the Court of Appeal stated that (at 625): [I]t is in our view clear that the effect of s 588G(2) is that a director contravenes the section ‘by not preventing’ or ‘by failing to prevent’ a company from incurring a debt, and that a director will be taken to have so failed if debts are incurred by a company at a time when there are reasonable grounds for suspecting that the company is insolvent.

Chapter 7: Officers’ and Directors’ Duties

There are a number of defences to insolvent trading, and they are contained in s 588H. These defences are: • Reasonable expectation of solvency (s 588H(2)) The court in Tourprint International Pty Ltd v Bott (1999) 32 ACSR 201 found that: Expectation, as required by s 588H(2), means a higher degree of certainty than mere hope or possibility of suspecting … The defence requires an actual expectation that the company was and would continue to be solvent, and that the grounds for so expecting are reasonable. A director cannot rely on complete ignorance of or neglect of duty … and cannot hide behind ignorance of the company’s affairs which is of their own making or, if not …, has been contributed to by their own failure to make further necessary inquiries.

Similarly, in Metropolitan Fire Systems v Miller [1997] 23 ACSR 699 the court held that an expectation requires something more than hope and it implies a measure of confidence in the company’s solvency. Hall v Poolman (2007) 65 ACSR 123 makes it clear that directors must take a proactive stance in maintaining their expectation of solvency. • Reasonable reliance on others (s 588H(3)) For reliance to be a defence two elements need to be there: 1 the director relied on information provided by another competent and reliable person; and 2 the information provided allowed the director to expect that the company was solvent and would remain solvent even if it incurs a debt.

Absence from management (s 588H(4)) This is a defence if the directors had a good excuse to be absent from management, such as illness. Two important cases regarding this defence are DCT v Clark (2003) 57 NSWLR 113 and Statewide Tobacco Services v Morley (1990) 2 ACSR 405, which confirmed that the days of ‘sleeping directors’ were over. • Reasonable steps to prevent the company from incurring the debt (s 588H(5)) This defence may be used if the directors put the company under voluntary administration (see 9.3). It is worth noting that a breach of s 588G is a civil penalty provision under Part 9.4B. However, as per s 588G(3) where the insolvent trading occurs due to dishonesty, there is a separate criminal offence under Schedule 3 to the Corporations Act, which may incur a fine of up to $340 000 and/or five years of imprisonment. This law has also been extended to holding and subsidiary companies under s 588V. However, there has been very little litigation using the insolvent trading provisions against holding companies. During 2001 the corporate collapses of HIH Insurance •

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Ltd and One.Tel Ltd raised a broader public awareness of the impact of insolvent trading on their directors.

7.5 Insider trading Another crucial area of officers’ duties that must be considered is insider trading. The media and Hollywood have continued to keep the subject of insider trading alive and kicking, the latter through films such as Wall Street. Everyone appears to agree that insider trading occurs, but no one seems to be caught actually doing it. Academic research reports that approximately 5% of all trades on the Australian Securities Exchange are tainted by insider information. The previous laws were significantly altered in 1991 with the repeal of s 1002 and its replacement with ss 1002A–1002U. Once again, in March 2002, through the Financial Services Reform Act 2001 (Cth), insider trading laws were reformatted under s 1043A. The current provisions in s 1043A redefined the meaning of insider trading and increased the penalty for individuals and for corporations. As noted in 4.3, for an individual, the penalty is imprisonment for 10 years or a fine the greater of the following: • 4500 penalty units; • if the court can determine the total value of the benefits that have been obtained by one or more persons and are reasonably attributable to the commission of the offence—three times that total value; or • both. For a company, the penalty is a fine the greatest of the following: • 45 000 penalty units; • if the court can determine the total value of the benefits that have been obtained by one or more persons and are reasonably attributable to the commission of the offence—three times that total value; • if the court cannot determine the total value of those benefits—10% of the body corporate’s annual turnover during the 12-month period ending at the end of the month in which the body corporate committed, or began committing, the offence. There is a natural overlap with s 183 (misuse of information by an officer), but insider trading is limited to dealing in securities and therefore usually only applies in relation to listed companies. The 2002 amendments also introduced the fact that a contravention that was not dishonest could be tried as a civil penalty action and thus attract a lower penalty. The contravention of a civil penalty for insider trading would have a maximum penalty of $200 000 and a disqualification of the officers, as well as a compensation order. The FSRA changed the wording of insider trading from ‘securities’ (which mostly meant shares/equities) to ‘financial products’. The term ‘financial products’ is defined in the Corporations Act and has a much wider meaning and range of financial instruments than securities.

Chapter 7: Officers’ and Directors’ Duties

Three main contraventions of the Act relating to insider trading are found in s 1043A: • actually trading in (acquiring, buying or selling) the financial products; • procuring (actively encouraging another) to buy or sell the financial products; and • communicating the confidential inside information to someone who is likely to use the secrets to trade in the financial products. The regulator’s first success was against one of its own officers, Mr Teh, who passed information to his brother about companies the regulator was investigating. Corporations were not capable of insider trading in their own right until the legislation was changed in 1991 due to Hooker Investments Pty Ltd v Baring Bros (1986) 10 ACLR 525. Australia’s first criminal conviction for insider trading occurred in July 1996, relating to Murray Williams trading in Australis Media shares. Williams pleaded guilty to purchasing 200 000 shares just before a confidential announcement was made about Pay TV licences. One year later, the 52-cent shares were sold for $1.25, making Williams a secret profit of $90 000. Williams was fined $50 000 and sentenced to 18 months’ periodic detention for contravening the insider trading laws. The ‘Mark Booth and TNT options scandal’ in September 1996 involved claims of insider trading and failed financial transaction reporting. The character Mark Booth was allegedly invented by Simon Hannes, a director of Macquarie Bank who was advising TNT on a proposed takeover by KPN. Subsequently, Mark Booth purchased five million TNT options (worth $90 000), which produced a profit of $2 million. Charges were laid against Mr Hannes for the TNT transaction, finally leading to his conviction in August 1999 for both insider trading and failed financial transaction reporting. On appeal, Hannes obtained a court order for a retrial in 2002 (R v Hannes (2000) 158 FLR 359). Mr Hannes was then convicted again of insider trading. Other high-profile cases involving insider trading, such as Australian Coachlines and Mt Kersey Mining NL, were dropped for technical reasons. The most important recent case has been R v Rivkin (2003) 198 ALR 400, where the infamous stockbroker was convicted of insider trading in Qantas airlines shares. It is important to remember that not all uses of company information will be deemed to be insider trading. In a takeover situation, or during prospective fundraising, some confidential information may pass without necessarily breaching s 1043A. The courts are willing to look at the purpose of the section and the definition of ‘securities’ does not include future shares (which as yet do not exist). This was discussed in detail in Exicom Pty Ltd v Futuris Corp Ltd (1995) 18 ACSR 404. Today, insider trading can also be the subject of civil penalty action. An example can be found in Australian Securities and Investment Commission v Petsas [2005] FCA 88. In that case, Mr Petsas came into possession of information concerning a proposed merger between BRL Hardy Ltd and Constellation Brands Inc during the course of his employment with ANZ Ltd. ANZ Ltd had been engaged by BRL Hardy to perform a confidential assessment of the merger. Upon discovery of the proposed

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merger, Mr Petsas communicated the information to the second defendant, Mr Miot. The pair then purchased call options over BRL Hardy shares in Miot’s name. When the proposed merger was publicly announced the following day, the BRL Hardy share price rose, and the options were exercised for a profit of $121 495. ASIC instigated civil proceedings against the pair under s 1043A of the Corporations Act. Mr Petsas pleaded guilty and specifically admitted that he was aware that at the time he received the information he knew it was not generally available and that it was market-sensitive. He was subsequently fined $75 000 taking into account his guilty plea, his inability to find alternative work, and his disgorgment of the profit obtained. Mr Miot, as the recipient of information, knew that the Mr Petsas was not entitled to information regarding the merger discussions and was subsequently found guilty and fined $65 000. ASIC does not win all its insider trading cases due to the difficulty of enforcing s 1043A. For example, ASIC initiated civil proceedings against Citigroup Global Markets Australia Pty Ltd for breaching, among other things, the insider trading provisions in the Corporations Act. ASIC lost the case and its costs relating to the litigation in Citigroup Global Markets Australia Pty Ltd were around $1.5 million. From 2009 until mid-2014, ASIC announced 29 separate insider trading matters to be prosecuted, of which 20 have been successful and five unsuccessful, with the others yet to be completed. One of the most significant is Fysh v The Queen [2013] NSWCCA 284, where the importance of possession and materiality of information was examined in detail. The court originally convicted Dr Fysh of having inside information in respect of a UK company (BG Group) purchasing shares in Queensland Gas Company for its liquefied natural gas deposits. Although Dr Fysh had been at a meeting where there was a print-out of PowerPoint slides with the information contained on them, it was not drawn to his attention nor did it seem material to the value of the company. This case sets a high standard of proof for insiders actually having possession of information and the likelihood of it having a material impact on the share price.

7.6 Sanctions and remedies As seen in previous paragraphs, the common law and equitable duties are reinforced by the statute. However, different remedies will apply depending on the type of duty breached. Under the Corporations Act a range of civil remedies and criminal sanctions is available where there has been a contravention of corporate law. It is important to understand that different types of legal causes of action result in different outcomes. For example, a company suing a director will wish to recover damages (civil action), while ASIC may wish to prosecute, resulting in a custodial sentence as a punishment (criminal action).

Chapter 7: Officers’ and Directors’ Duties

7.6.1  Action based on common law or equity A legal action brought against the officers under the common law or for a breach of equitable fiduciary duty may only result in a civil remedy. As illustrated in Table 7.2, the main remedy under common law is damages. A breach of fiduciary duty will lead to a range of equitable remedies such as: • equitable compensation; • account of profits; • injunctions (interim and final); • rescission; • creation of constructive trust. Table 7.2 Quick summary of sanctions and remedies Common law duties

Equitable duties

Statutory duties

Possible sanction/ remedies as a result of civil action

Duty of care: Daniels v Anderson (1995) 16 ACSR 607: imposes an objective test for both executive and non-executive directors

–

Duty of care under s 180(1): imposes an objective test for both executive and non-executive directors. It is the same objective test imposed by common law (ASIC and HIH Insurance v Adler, Williams and Fodera (2002) 42 ACSR 80

Remedy for breach of common law duty: damages sanctions for breaching statutory duty: civil penalties provision: • compensation; • declaration; • pecuniary penalties; • disqualification.

–

Duty to act in good faith

Duty to act in good faith (s 180(1)(a))

Remedies for breaching equitable duties: • equitable compensation; • account of profits; • injunctions (interim and final); • rescission; • creation of constructive trust. Sanctions for breaching statutory duty: civil penalties provision (Continued )

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Table 7.2 Quick summary of sanctions and remedies (Continued ) Common law duties

Equitable duties

Statutory duties

Possible sanction/ remedies as a result of civil action

–

Duty to act for a proper purpose

Duty to act for a proper purpose (s 181(1)(b))

Remedies for breaching equitable duties: • equitable compensation; • account of profits; • injunctions (interim and final); • rescission; • creation of constructive trust. Sanctions for breaching statutory duty: civil penalties provision

 

Duty to avoid conflict of interest

Duty to avoid conflict of interest (s 182 and 183)

Remedies for breaching equitable duties: • equitable compensation; • account of profits; • injunctions (interim and final); • rescission; • creation of constructive trust Sanctions for breaching statutory duty: civil penalties provision

–

–

Section 588G

Sanctions for breaching statutory duty: sivil penalties provision plus s 588M

In calculating damages, the court will apply the ordinary principles of contract or tort. For example in State of South Australia v Marcus Clark (1996) 19 ACSR 606 the court found Marcus Clark to have caused a loss of $38 million, plus interest, totalling $81 million. A court may order civil compensatory damages for a breach of the Corporations Act under Part 9.5.

Chapter 7: Officers’ and Directors’ Duties

7.6.2  Criminal action Where ASIC or the Commonwealth Director of Public Prosecutions commences a criminal prosecution, the sanctions are prescribed in the Corporations Act. It should be noted that the majority of provisions in the Corporations Act are criminal by virtue of s 1311, the general penalty provision. This imposes a maximum fine of five penalty units (currently $850) for a contravention of the Corporations Act. All the penalties for ‘serious’ criminal offences are listed in Schedule 3 to the Corporations Act, and may prescribe fines of up to 2000 penalty units (currently $340 000) and/or five years’ imprisonment. Where a company is held liable under s 1312, the corporation must pay a fine of up to five times the equivalent maximum individual fine. In calculating penalties under the Corporations Act one must refer to s 4AA of the Crimes Act 1914 (Cth), which currently defines penalty units as $170. The criminal provisions of all Commonwealth statutes have been amended as a result of the implementation of the Criminal Code Act 1995. This Act provides default provisions designed to govern all criminal offences, including defences, fault and strict liability, and the involvement of human agents on behalf of corporate entities. In the last decade of federal jurisdiction over corporate law, the regulator, ASIC, with the Director of Public Prosecutions, has sent over 200 officers to jail for periods of more than six months’ imprisonment. The Corporations Act does contain some specific sections whose contravention is not a breach of the criminal law. For example s 180(1) (duty of care) creates a civil contract which, if broken, does not incur a criminal sanction. Similarly, failure to comply with the replaceable rules is not a contravention of the law by s 135(3), and misleading conduct (s 1041H) is purely a civil action.

7.6.3  Civil action initiated by ASIC ASIC may bring a civil action on behalf of the company or shareholders if it is deemed to be of public interest by s 50 of the ASIC Act. In recent years ASIC has been successful in negotiating civil remedies on behalf of investors and creditors. In July 1993 the government introduced a new form of remedy/sanction into the corporate legislation, which is a hybrid of civil and criminal law. These new provisions are called civil penalty orders. Part 9.4B outlines 15 different sections of the Corporations Act that are dealt with as civil penalty provisions (CPPs) rather than criminal sanctions. CPPs are brought in a civil court, but can result in an unlimited compensation order (damages), a pecuniary penalty (up to $200 000) paid to the government, a declaration, and an officer’s disqualification order. The FSRA 2001 further adds financial services civil penalties to the existing list of corporations civil penalties in s 1317E. The High Court of Australia has ruled that the procedures to be

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applied in bringing a civil penalty case are more akin to a criminal case than to a civil case (in Rich v ASIC (2004)). Where there is a serious contravention of a CPP, ASIC can bring criminal proceedings. As illustrated in Table 7.2, CPPs are applied to the following selected areas of the Corporations Act: • officers’ duties (ss 180–183); • related parties’ rules (s 209); • financial reporting (s 344); and • insolvent trading (s 588G(2)). An excellent illustration of the use and application of corporate civil penalties arose in one of the many HIH Insurance collapse cases. In ASIC and HIH Insurance v Adler, Williams and Fodera (2002) 42 ACSR 80 the court declared that the three defendants had contravened more than 180 provisions of the Corporations Act. Mr Adler was ordered to pay a penalty of $900 000, was disqualified for 20 years and had to pay a share of the $8 million damages order. Mr William was ordered to pay a penalty of $250 000, was disqualified for 10 years and was made to share the compensation order. Mr Fodera was only ordered to pay a $5000 pecuniary penalty. In the majority of cases where officers are in breach of their duties the parties will reach a negotiable settlement, which removes the need for litigation. However, in commencing litigation, the shareholders must consider the costs and the potential outcomes of pursuing such action. Similarly, the regulator must take into account the strain on resources associated with investigating and commencing civil actions or criminal prosecutions. For the last decade ASIC has been consistently successful in over 70% of its major cases. However, in 2009, ASIC lost a number of high-profile cases such as the One.Tel case (ASIC v Rich [2009] NSWSC 1229).

7.6.4  Certain regulatory policies Some consideration should also be given to the consequences that fall outside the normal list of civil, criminal and civil penalty matters. Many disputes are resolved by a mixture of dispute resolution, negotiation, arbitration and clarification between corporations, their officers and the various regulators involved, including the Australian Competition and Consumer Commission (www.accc.gov.au), the Australian Prudential Regulation Authority (www.apra.gov.au), the Australian Taxation Office (www.ato.gov.au) and ASIC. A broader influence on regulatory policies of enforcement by ASIC is known as the ‘enforcement pyramid’; this is illustrated in Figure 7.2. This provides a range of enforcement strategies from low-level warnings and education practices to the most severe, licence revocation.

Chapter 7: Officers’ and Directors’ Duties

Figure 7.2 The enforcement pyramid

Licence revocation Licence suspension

Criminal penalty

Civil penalty

Enforceable undertaking

Persuasion/Warning letter/Education

Source: Based on the enforcement pyramid of Ian Ayres and John Braithwaite Responsive Regulation: Transcending the Deregulation Debate (1992, Oxford University Press).

The width of the pyramid at each layer represents the proportion of enforcement activities at that level. The explanation for the varying size is simple. If the regulator can plausibly threaten to match any non-compliance by moving successfully up the pyramid, then most of the regulator’s work will be done effectively at the bottom layers of the pyramid. The lighter sanctions will dissuade the regulated entity from continuing its illegal activities because it will not want the regulator to use its stronger sanctions. Put another way, when there is equilibrium between harsh and soft sanctions, the regulator attains the result needed by speaking softly. One of the most important enforcement strategies, which can be used as an alternative to civil or criminal proceedings, is the use of enforceable undertakings in s 93AA of the ASIC Act 2001 (Cth). Enforceable undertakings may even change the way a regulator wishes to proceed with either a criminal or civil penalty action. Enforceable undertakings are legally binding agreements that are voluntarily entered into by the parties (a company and its officers with the regulators). All enforceable

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undertakings are published on the ASIC website for transparency of the legal process. The making of an undertaking does not imply an admission of liability, but the parties voluntary enter into an agreement to refrain from being an officer for a period of time, or to appoint an independent expert to review the corporate compliance program, or to achieve some other practical outcome that will provide a commercial solution to a potential breach of the law. If the company and its officers ignore the enforceable undertaking, ASIC may take the agreement to court, where it can be enforced or a type of action akin to contempt may be brought. Since the introduction of the ASIC Act in 1998 more than 368 enforceable undertakings have been made to ASIC by parties (from 1998 to 2013).

Chapter 7: Officers’ and Directors’ Duties

Assessment preparation Revision questions 1 What are the sources of directors’ duties? 2 Do directors usually have a duty to individual shareholders of their company? Is there any exception? Explain. 3 What test is applied to determine whether a director is in breach of a common law duty of care? Is the test identical to the one under the statute? 4 What is the business judgment rule? Is it a general defence? 5 What test is applied if directors issue shares for both proper and improper purpose? 6 When is a company presumed insolvent for the purpose of s 588G? 7 What are the defences for breaching s 588G? 8 What is the significance of s 588V? 9 Can directors be sued criminally for breaching their duty of care? 10 What remedies apply if there is a breach of s 182? Would these remedies be different if there were a breach of the fiduciary duty to avoid conflict of interest?

Problem question Marc, Charlie and Jennifer are the directors of Online Invest Pty Ltd. Marc is a plumber without prior experience in conducting a business and managing a company. He is married to Jennifer. Like Marc, Jennifer has never been a director in any other company, nor does she have any business experience. She accepts the position at her husband’s request. Because of the trust and confidence she has in him, she does not participate in the management of Online Invest Pty Ltd. Charlie is a highly qualified businessman appointed as a non-executive director. He believes that his appointment is largely ceremonial since he is not receiving any fees. He relies on Marc to advise him if the company gets into financial difficulty. Online Invest Pty Ltd’s business is not going well. Proper financial records have not been maintained. Marc is aware that the company is in financial trouble but he thinks that the company will be all right if it continues trading. He keeps allowing the company to enter into more debt. Both Jennifer and Charlie are unaware of the company’s financial position. The company goes into liquidation on 10 October 2009. The liquidator takes action against the directors for breaching their duties to prevent insolvent trading. 1 What is the consequence of not keeping proper financial records in relation to s 588G? 2 Assuming that s 588G has been breached, do the directors of the Online Invest Pty Ltd have any defences to escape liability under s 588G? For answers to problem questions, please refer to .

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Protection of Shareholders Covered in this chapter • • • •

Members’ meetings The majority rule in Foss v Harbottle Statutory protections for minority shareholders Case law exceptions to the majority rule principle

Cases to remember Direct Share Purchasing Corporation Pty Ltd v AXA Asia Pacific Holdings Ltd (2008) 67 ACSR 99 Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 Gambotto v WCP Ltd (1995) 182 CLR 432; [1995] HCA 12 Humes Ltd v Unity APA Ltd (1987) 5 ACLC 15 Morgan v 45 Flers Avenue Pty Ltd (1986) 5 ACLC 222 Re Yenidje Tobacco Co Ltd [1916] 2 Ch 426 Rossington Pty Ltd v Lion Nathan Ltd (1992) 7 ACSR 509 Swansson v RA Pratt Properties Pty Ltd (2002) 42 ACSR 313 Wayde v NSW Rugby League Ltd (1985) 180 CLR 459; [1985] HCA 68

Statutes and sections to remember Corporations Act ss 169, 232–234, 236–242, 247A, 247D, 249D, 249Q, 461. Australian Securities and Investments Commission Act 2001 (Cth) (ASIC Act) ss 13–15

8.1 Introduction As noted in Chapter 6, the board of directors is in charge of the management of the company. Members of a company have three simple choices if they disagree with the direction of the board: • The general meeting has the power to remove the directors of a proprietary company by an ordinary resolution (greater than 50% of the votes cast) under replaceable rule s 203C. For a public company, a longer notice period is required,

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but still an ordinary resolution has to be passed under s 203D. The removal of directors does not change decisions already made by the board. • The general meeting may pass a special resolution to modify the corporate constitution to restrict the broad powers in ss 198A and 198C. This is possible because ss 198A and 198C are replaceable rules. • The ‘Wall Street Walk’: a shareholder who is dissatisfied with the board of directors can sell their shares and invest in another company with philosophies closer to those of the investor. Additionally, ownership of shares bestows upon members certain key rights under the Corporations Act and the terms contained in the contract between the company and the members. While the members do not usually have a say in the management of a company, a number of rights and remedies are available to them. These rights and remedies vary from calling for a members’ meeting to initiating court action against a range of people.

8.2 What are the key membership rights? The key membership rights are often expressed as terms of the contract established by s 140(1) (see 3.4). The actual terms and conditions between the shareholder and the company are determined by the company at the time of issue, including any rights and restrictions attached to the class of share (s 254B). For a public company, any document that provides rights to shares must be lodged with ASIC (s 246F). The most common key membership rights are: • voting rights; • the right to attend members’ meetings; • the right to appoint directors (see Chapter 6 regarding the rules about the appointment of directors); and • the right to a dividend out of profits. Notwithstanding these fundamental rights, the actual power to manage the company’s business is left to the board of directors. It is important that people understand their rights as members, especially given the the number of ‘mum and dad’ shareholders, resulting from the spate of privatisations, floats and demutualisations such as Medibank Private, Commonwealth Bank, GIO, Qantas, Telstra, TAB, Woolworths, NRMA and AMP. In 2012, 38% of the adult Australia population owned shares and other listed securities (either directly through shares or other listed investments (34% of the adult population) or indirectly through unlisted managed funds (4% of the adult population). This level of investment was higher in previous years. For example in 2010, 43% of adult Australians owned shares and other listed securities (see ASX, Australia Share Ownership Study 2013 (2013, ASX) pp 3–4).

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One of the practical problems that arises for companies with more than one million members is keeping corporate registers up to date. This must be done for members to be able to claim their rights.

8.2.1 What are the corporate registers? Disclosure is a common theme of corporate regulation and registers are one way of providing the public with information. For a member to benefit from their key membership rights, they must be entered on the register of members, or at least be entitled to be entered (s 231). Prior to 1995 companies were required to maintain at least 10 different registers. The First Corporate Law Simplification Act 1995 (Cth) created a new Chapter 2C, which contains all the information previously held on the essential registers. According to the Attorney-General the chapter was intended to facilitate ‘rapid and easy access’ by members of the public to a company’s register ‘at reasonable cost’. Section 168 requires a company to maintain three registers: • the register of members (s 169); • the register of option holders (s 170); and • the register of debenture holders (s 171). Every company is required to have a register of members (s 169), and it is for this reason that it is the most important register under the Corporations Act. A corporation’s register of members must contain the following minimum information: • names and addresses of members; • details of shares held by each member, including class of shares; • date of entry into the register; • date of each allotment and forfeiture of shares; and • amount paid or agreed to be paid on the shares. Where a company has more than 50 members, an index must be kept in addition to the register, unless the register is already maintained in alphabetical order (s 169(2)). A share register service (for example, Computershare Investor Centre and Link Market Services) may be utilised for convenience, subject to the appropriate notification to ASIC under s 72(2). The registers should be located at the company’s registered office, principle place of business or another place approved by ASIC. The company can alter the register of members at any time so as to comply with the Corporations Act. This need may arise from the admission of a new member, a change of name or address, an error in registration or some other reason (for example, a buy-back or a call on shares). In certain circumstances, the register can be altered by a court order, particularly when the company displays an unwillingness to alter the register (for example, where there is a disputed title to the shares). The court order, authorised by s 175, is called a ‘correction of registers’; an example can be found in Peninsula Gold Pty Ltd v Sunbeam Victa (1996) 20 ACSR 553.

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The members and the general public have a limited right of inspection of the corporate registers (s 173), which can be exercised at no cost to members and at a small fee to members of the public. The use of information in the registers is now restricted by s 177; it cannot be used to send unsolicited material. In Rossington Pty Ltd v Lion Nathan Ltd (1992) 7 ACSR 509 the court identified the rights of the public to inspect company records.

A case to remember Rossington Pty Ltd v Lion Nathan Ltd (1992) 7 ACSR 509 Facts: A prospectus was lodged in 1991 with the regulator regarding a renounceable rights issue of stock units in Lion Nathan. Verified copies of three agreements relating to the proposed merger between the parties were deposited at the registry office. Six months after the lodgment of a prospectus any person can inspect the copies of every material contract referred to in the documents without a fee. An employee of Rossington Pty Ltd’s solicitors was denied access to the documents; Lion Nathan Ltd’s solicitors claimed a reason should be given for denial of access to the documents. Held: Lion Nathan Ltd’s conduct contravened the Corporations Act. The judge refused to read down a section of the law so as to avoid an obligation to disclose commercially sensitive material on the basis that any information relied upon was justified as it could be obtained from the regulator. Principle of law: Material that should be available to the public by law may be inspected by the public without charge at any stage.

Section 173 notes that regarding registers of members, option holders or debenture holders, the register may be accessed by members free of charge. Outsiders may access it for a fee.

A case to remember Direct Share Purchasing Corporation Pty Ltd v AXA Asia Pacific Holdings Ltd (2008) 67 ACSR 99 Facts: Direct Share Purchasing Corporation Pty Ltd (Direct Share) requested a copy of the list of members of AXA Asia Pacific Holdings Ltd (a public listed company on the ASX). They included with their request a cheque for $20 000 and asked for the difference between the actual fee and the fee they paid to be returned to them. AXA Asia Pacific Holdings Ltd charged Direct Share a fee of $17 195.39 because it had to obtain its register of members on a CD-ROM from Computershare Investor Services Pty Ltd. The issue in the case was whether this fee was excessive.

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Held: The court held that the marginal cost of providing the information on a CD-ROM was $250 and it ordered AXA Pacific Holdings Ltd to refund the difference to Direct Share. An appeal by AXA Asia Pacific Holdings Ltd was dismissed (AXA Asia Pacific Holdings Ltd v Direct Share Purchasing Corp Pty Ltd (2009) 173 FCR 434).

The Direct Share case led to the amendment of the legislation through the passage of the Corporations Amendment (No 1) Act 2010 (Cth). The Corporations Regulations in Schedule 4 now state that the fee payable for a copy of the register is a flat fee of $250. In addition to this: • It can charge $0.05 for each member in excess of 5000 and up to 19 999 members. • If the company has 20 000 members or more, it may also charge an additional $0.01 for each member. This means that if a company has 30 000 members, the fee for a copy of its register would be $1099.95. The following registers are no longer required to be kept: the directors’ register; directors’ shareholdings register; register of share buy-backs; substantial shareholders’ register; and register of notices of beneficial interests. However, for commercial reasons, this information may still be kept on the company’s own system for the convenience of the board. The registers that are required to be kept under s 168 may be kept on a computer (s 1306). A common register to be maintained for practical purposes is the ‘seal register’. This was never a requirement in the Corporations Act and is now less relevant due to use of a corporate common seal being purely optional (s 123). In Kriewaldt v Independent Direction Ltd (1995) 14 ACLC 73 the court held that directors can have access to all board papers even after they cease to be a director. It was held that the secretary should keep a full set of board papers for inspection by former company directors. The directors’ inspection rights are now contained in s 198F for a current director. The right continues for up to seven years after the director ceases to be a member of the board. Section 290 provides directors with access to the company’s financial records during their appointment. If the company refuses access, the court may order the records to be made available (s 290(4)). The company or its directors may allow a member to inspect the company books, under replaceable rule s 247D. Alternatively, a court may order the inspection of all company books under s 247A. Section 247A contains the main provision covering members’ application to the court for access to the company’s books. ‘Books’ are broadly defined in s 9 as including registers, any other record of information, financial reports or records, and documents. The court is granted wide discretion when handing down its

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orders (s 247B), including power to restrict disclosure of the information to ASIC and the members who requested the order (s 247C). Section 1305 provides that the books are prima facie evidence of the matters stated or recorded in the books, and may be used as evidence in legal proceedings. Probably the most important books that will be requested by either directors or members are the minutes books. These formally record the proceedings and the decisions made at both board and members’ meetings.

8.2.2  Company meetings 8.2.2.1  Annual general meetings According to s 250N, every public company has to hold an annual general meeting (AGM) once per year. Such a company has to hold an AGM within 18 months after its registration. After that it needs to hold such an AGM each year and within five months after the end of its financial year. Non-compliance with this requirement will result in a strict liability offence. According to s 250R, the business of the AGM may include any of the following (even if the matter is not referred to in the notice of the meeting): • consideration of the annual financial report, directors’ report and auditor’s report; • election of directors and the appointment of the auditor; • remuneration of auditor. CAMAC has issued a discussion paper on the AGM, covering the analyses of the role of an AGM and its future use. No decisions or reforms, as yet, have been proposed by parliament.

8.2.2.2 Extraordinary general meetings There are a number of ways in which an extraordinary general meeting can occur: • A director can call for a members’ meeting (s 249C). • The directors have to call for a members’ meeting at the request of shareholders holding at least 5% of the voting shares in a company, or of at least 100 members (the 100 member rule) who are entitled to vote at the general meeting (s 249D). At the time of writing this book, the Corporations Legislation Amendment (Deregulatory and Other Measures) Bill 2015 (Cth) has been passed in both houses of the Parliament. As such, the 100 member rule will be abolished. This will mean that under a new s 249D only members with at least 5% of the voting shares in a company may request a members’ meeting. • Members with at least 5% of the voting shares can also call for a general meeting without first requesting the directors to call for a meeting (based on s 249F). This right is rarely used because the shareholder calling for the meeting has to pay the expenses of the meeting.

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The court may order the company to call for a meeting (s 249G), but this power is rarely exercised as the court does not like to interfere in the affairs of the company. Section 249Q notes that members’ meetings must be held for a proper purpose. If the purpose of the request is proper the meeting can be held. The proposed resolution will usually be for a proper purpose if it involves shareholders’ rights (for example, members have the right to change the constitution, so a member can call for a meeting with a view to changing the constitution. Such a meeting is for proper purpose). There are two examples of improper purpose in relation to s 249Q. They are: 1 calling a meeting to harass the company or the directors: Humes Ltd v Unity APA Ltd (1987) 5 ACLC 15; and 2 calling a meeting to interfere with the directors’ power to manage the company’s business (except when the company’s constitution allows it). In NRMA v Parker (1986) 4 ACLC 609 a member requested the calling of a general meeting. The proposed resolution purported to direct the board over a matter that the NRMA’s constitution exclusively vested in the directors. As this resolution was in relation to management, the court held that the directors were entitled to refuse to call for the meeting. However, it is not relevant if the shareholder calling for the meeting is motivated by ill will or self-interest: NRMA v Scandrett [2002] NSWSC 1123. Further, in Humes Ltd v Unity APA Ltd (1987) 5 ACLC 15 the court held that a meeting is not called for an improper purpose just because a proposed resolution is likely to be defeated, thus causing inconvenience and expense to the company, its directors and majority shareholders. All meetings require notice to be given of their occurrence and the opportunity for members to put forward a motion. If the shareholders pass a motion, it is known as a resolution and becomes immediately binding upon the company. If a special resolution has to be passed, then the motion must be included in the notice, and be in writing. The notice period is set at 21 days for a members’ meeting (s 249H), and is extended to 28 days for ASX listed companies (s 249HA). At the shareholders’ meeting, each member may vote according to the number of shares they own and the voting rights attached. Ordinary shares generally have one vote per share. A member who is unable to attend a meeting may appoint a proxy to exercise their voting rights. These votes are known as proxies. Proxies may be voted in advance, specifying whether they are for or against the motion (similar to a postal vote in a political election). Alternatively, the proxy holder (who is often the chairman of the meeting) may be given discretion over when to vote and in which direction to cast the votes. Proxies were mentioned briefly at 3.3.3 and 3.6. The votes used to calculate whether a motion has been passed are always the votes actually cast—that is, the actual people present at the meeting and voting, •

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plus any proxies that have been lodged prior to the meeting. The total number of members eligible to vote is irrelevant. In theory, a company with 1000 shareholders and 1 000 000 votes could make a decision if 10 members, with a total of 500 votes, turned up. In such a situation, a motion would be passed if 251 votes were cast in favour of the motion (rather than 500 001, being half the eligible votes). An ordinary resolution requires a simple majority, which means more than 50% of the votes cast. A special resolution, as required to change the corporate constitution, requires a majority of at least 75% of the votes cast. The quorum for a members’ meeting is only two, which is also a replaceable rule (s 249T). Voting can occur in one of two ways. The most common is by a show of hands, with one vote allocated per member, irrespective of the member’s shareholding. The second method is called a poll, which is an actual count of all votes cast. The poll is becoming more popular for public companies, due to the inaccuracy of a show of hands and the ASX requirement to record the number of proxy votes. Each member has the right to appoint a proxy under s 249X. This right is mandatory for public companies, but a replaceable rule for proprietary companies. A company that owns shares may appoint either a proxy or a ‘corporate representative’ under s 250D. A corporate representative has the same powers as a natural member. All meetings must have minutes as a record, and public companies must file with ASIC, within 14 days of the meeting, details of special resolutions that have been passed. The minutes of a general meeting must be entered into the minutes book within one month, and can be signed by the chair at the next meeting (s 251A).

8.3 Majority rule in Foss v Harbottle Foss v Harbottle (1843) 67 ER 189 is the leading case on majority rule and minority protection.

A case to remember Foss v Harbottle (1843) 67 ER 189 Facts: Shareholders felt that the company had lost financially through a sale of its land to a director. Two of the shareholders brought an action in the name of the entire shareholder body against the directors, the solicitors, the architect and the five recipients of the property). Held: The court found that the shareholders could not sue based on an injury to their own returns; it was in fact an injury to the company. If monies were to be recovered, the company would have to bring an action in its own name.

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Principle of law: The ‘proper plaintiff rule’: injury or damage to a company must be recovered by the company (who should bring the legal action) and not by the individual shareholder.

Courts are reluctant to interfere with the internal management of a company and generally the majority opinion within a corporation will prevail. A corporation should sue in its own name against the directors and others based on the separate legal identity of the company from the individuals. This case provides two basic principles of corporate law. The first is that the majority of members make decisions that bind minority shareholders. The second is that the company is the proper plaintiff in civil actions. If directors are in breach of their duties, the company – not the shareholders – should bring the legal action. The problem with a strict interpretation of these principles is that the board of directors, which has responsibility for bringing litigation on behalf of the company, may not wish to sue one of its own directors. This reluctance would naturally cause frustration to a minority shareholder who honestly believed a director to be in breach of their common law, equitable or statutory duties. Even in Foss v Harbottle it was recognised that, under exceptional circumstances, a minority shareholder should be permitted to bring a case, instead of the company. Clearly, the majority of members, especially when they are also the company officers, could take an unfair advantage over the minority shareholders, and thus some degree of protection is necessary. As with any rule of law, there are a number of exceptions. The rule in Foss v Harbottle has a number of statutory and common law exceptions. These developed over time, but in March 2000 they were rewritten with the introduction of a statutory derivative action in Australia (see 8.4.2). The courts have generally been sympathetic to minority shareholders, but clearly believe in majority rule. In providing the necessary minority shareholder protection, the courts have had to apply their inherent equitable jurisdiction in order to make the law work as it was intended. The Australian Parliament has also found it necessary to add further minority protection provisions (or what may be described as exceptions to the basic rule). There are some legal hurdles that a minority shareholder must jump in order to be able to bring litigation instead of the company. The law requires a person who brings a civil case to have locus standi (legal standing). As a corporation is a separate legal entity, it is deemed to have the appropriate locus standi to bring the case. However, if a member wishes to bring a case on behalf of the company, the member must obtain from the court the necessary legal standing. There are four ways this may occur: • derivative actions (bringing the case on behalf of the company, where the legal rights are derived directly from the company), which were abolished through the introduction of s 236 of the Corporations Act;

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personal claims (where a member has suffered a greater loss than any other member); or • Federal Court class actions (representative actions, where a group of minority shareholders bring a case collectively); or • special rights denied: where the shareholder has a special right, this cannot be denied. This principle was followed by the HCA in Gambotto v WCP Ltd (1995) 182 CLR 432, a case relating to protection of shareholders when a company was changing its constitution to expropriate proprietary rights of members (see 3.6.3). There are clear limitations on common law actions after the introduction of the statutory derivative action, because of the impact of s 236(3). Once a member is granted locus standi, they still have to prove the breach of duty they are claiming. •

8.4 Statutory minority protection Parliament has provided, in the Corporations Act, a number of provisions to protect minority shareholders. These statutory rules enable individual members, or a class of shareholder, to bring a legal action either on behalf of the company or in their own right. Some of the provisions are broad, but many relate to very specific circumstances. There are seven major statutory protection provisions.

8.4.1  Section 232 (oppressive conduct) Since 1948 the Corporations Act (and its predecessors) has included a provision that deals with ‘oppressive conduct’. Part 2F.1 is titled ‘Oppressive conduct of affairs’ and is made up of three key sections, ss 232–234. In the last decade these same provisions were labelled as s 260 and as s 246AA. In many academic writings on this topic, you will see the old numbers referred to. They should be interpreted as ss 232–234. Under those sections the court has a wide discretion if the plaintiff can establish that the majority of members have been oppressive, unfairly prejudicial or discriminatory to the minority under s 232. Section 234 lists those who can bring an action. The list includes members, people who ceased to be members due to oppressive conduct, and persons authorised by ASIC. Unfortunately, the courts’ attitude towards these provisions has generally required a high level of ‘oppression’ to be proved before a minority shareholder can be successful. The addition of the words ‘unfairly prejudicial or unfairly discriminatory’ to the oppression provision under s 232 has provided greater flexibility. The case law for these provisions is derived from both the UK and Australia. The term ‘oppressive’ is defined in Scottish Co-operative Wholesale Society Ltd v Meyer [1959] AC 324 to mean ‘burdensome, harsh and wrongful’. Further, Young J

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noted that the words ‘oppressive to, unfairly prejudicial to, discriminatory against’ should be viewed as a ‘composite whole and the individual elements mentioned in the section should be considered merely as different aspects of the essential criterion, namely commercial unfairness’ (Morgan v 45 Flers Avenue Pty Ltd (1986) 5 ACLC 222, at 223). When looking at the unfairness of a decision, the High Court noted in Wayde v NSW Rugby League Ltd (1985) 180 CLR 459 (at 272) that ‘the test of unfairness is objective and it is necessary, though difficult, to postulate a standard of reasonable directors possessed of any special skill, knowledge or acumen possessed by the directors.’ Accordingly, the test applied in determining the unfairness of the decision is an objective test. Section 232 is more often used by small, closely held companies where a domestic or family dispute arises, rather than by large public companies. For example, a company secretary refused to enter an employee’s name on the register of members. The employee was not a member at the time of the proceedings and was denied access to relief under s 232 (Titlow v Intercapital Group (1996) 144 ALR 203). Section 233 provides a long, but non-exhaustive, list of court orders that may be granted, and offers a wide discretion to courts with the words ‘as it considers appropriate in relation to the company’. An illustration of the court’s use of imagination arises in the case of Re HR Harmer Ltd [1958] 3 All ER 689, where a governing director had his powers transferred to his sons and amendments were made to the corporate constitution (now s 233(1)(b)). A common remedy for such domestic corporate disputes is for the minority shareholder to be ordered to sell the shares either to the majority member or to the actual company (a buy-back). Section 233 court orders (orders to buy the minority’s shares) will also require an expert report on the valuation of the shares to be fair and reasonable between the parties. The final valuation of the shares can cause its own legal problems, particularly in relation to acceptance of expert accounting evidence, as in Rankine v Rankine (1995) 18 ACSR 725. Sometimes the court may simply order the whole company to be wound up under either s 233 or s 461(k) (the just and equitable winding up provision). This provision has generated a number of important cases, such as Wayde v NSW Rugby League Ltd (1985) 180 CLR 459 and Morgan v 45 Flers Avenue Pty Ltd (1986) 5 ACLC 222.

A case to remember Wayde v NSW Rugby League Ltd (1985) 180 CLR 459 Facts: NSW Rugby League decided to remove a club, Western Suburbs (Wests), from its competition to lower the number of clubs allowed to play in the competition to 12,

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because it had determined that the current number of teams was uneconomical. Wests took an action against NSW Rugby League, based on the equivalent to s 232, to stop the league from proceeding with its decision to exclude the club. Held: The league was entitled to exclude Wests. The decision made by the directors to exclude Wests was made honestly, in pursuit to improving the game of rugby league. Even though the decision was harsh on Wests, it was one a reasonable board could have made. Principle of law: Mere prejudice or discimination is not enough to determine that conduct is oppressive. To determine whether there is oppression, conduct will be assessed objectively.

8.4.2  Section 461 (winding up) The ultimate sanction for any disgruntled shareholder is to apply to the court to wind up the company (s 462). The grounds for seeking such an order are well defined in s 461(1)(e)–(g), which deals with oppression and unfairly prejudicial conduct. However, wider discretion is derived from s 461(1)(k), which allows a court to order a winding up where ‘the court is of the opinion that it is just and equitable’ to do so. Some examples of just and equitable ground are: • Breakdown of mutual trust This ground will be considered as a just and equitable ground for winding up of a company in situations where the company is a ‘quasi-partnership’.

A case to remember Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 Facts: Two partners, Nazar and Ebrahimi, ran a carpet shop in a partnership. The partners decided to incorporate the business and agreed that they would be the sole directors and shareholders of the company. Shortly after incorporation Nazar’s son was made a director and shareholder of the company. Ebrahimi and Nazar had a falling out, and through an ordinary resolution at the general meeting Ebrahimi was voted out of his position as director by the majority votes of Nazar and his son. Ebrahimi claimed that the company should be wound up, on equitable grounds, and that his shares should be purchased from him at a reasonable price. Held: The House of Lords held that the company should be wound up on equitable grounds. It found that the management of the company, being partly in the hands of Nazar’s son, ‘was in contravention to the nature of the personal agreement’ between the partners at the time of incorporation. Principle of law: Under s 461(k) a court can wind a company up on just and equitable grounds. In a ‘quasi-partnership’, when objectives for the running of a company are agreed upon at the time of incorporation, if the actuality is different, the court may order that the company be wound up on just and equitable grounds.

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This was confirmed in Australia in Re Wondoflex Textiles [1951] VLR 379, where Smith J noted (at 458: ‘The “just and equitable” provision does not, as the respondents suggest, entitle one party to disregard the obligation he assumes by entering a company, nor the court to dispense him from it. It does, as equity always does, enable the court to subject the exercise of legal rights to equitable considerations; considerations, that is, of a personal character arising between one individual and another, which may make it unjust, or inequitable, to insist on legal rights, or to exercise them in a particular way.’ • Deadlock It will be a just and equitable ground to wind up a company where the shareholders are in a deadlock and as a consequence the company can no longer function properly.

A case to remember Re Yenidje Tobacco Co Ltd [1916] 2 Ch 426 Facts: A company was formed with two shareholders who were also the two directors of the company. They had equal amount of power and each held 50% of the shares in the company. The company made considerable profit but hostility arose between the two shareholders, making them unable to communicate. Held: The company was ordered to be wound up because there was a deadlock between the shareholders. Principle of law: The court may wind up a company on just and equitable grounds if there is a deadlock in management where there are fundamental disagreements, or it becomes impossible for resolutions to be passed (a quorum of two is needed).

8.4.3  Section 1324 (injunctions) Where there is a contravention of the Corporations Act a shareholder can lobby ASIC to bring an action under s 1324 for a statutory injunction, as was attempted in Broken Hill Proprietary Co Ltd v Bell Resources Ltd (1984) 8 ACLR 609. A creditor (landlord), who had not had rent paid by a company, sued the directors for breach of duty under the Corporations Act and claimed an injunction to stop them from breaching their duty. The court awarded a creditor compensatory damages rather than an injunction. An injunction was granted in Allen v Atalay (1993) 11 ACSR 753.

8.4.4  Sections 247A–247D (inspections of books) Section 247D notes that ‘[t]he directors of a company, or the company by a resolution passed at a general meeting, may authorise a member to inspect the

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books of the company’. However, if this is not possible, the member who would like access to the books of the company may apply to the court for an order authorising the member to inspect the books. The court will make such an order if it is satisfied that the member is acting in good faith and the inspection is for a proper purpose (s 247A). However, the court also has discretion to restrict the books to which a shareholder is given access, as held in Majestic Resources NL v Caveat Pty Ltd [2004] WASCA 201.

8.4.5  Sections 13–15 of the ASIC Act ASIC has specific powers of investigation following a request from the company, a liquidator, a shareholder or the minister. It should be noted that before ASIC can begin an investigation it must have reason to suspect that a contravention of the corporations legislation has occurred (Little River Goldfields NL v Moulds (1992) 10 ACLC 121).

8.4.6  Sections 249D, 249E (meeting requisitions) As noted in 8.2.2.2, shareholders who represent 5% of the voting power can make a written demand that a shareholders’ meeting be held and are able to put forward various motions (usually to remove the directors). An example of this procedure can be found in Humes Ltd v Unity APA Ltd [1987] VR 467. In practice, these actions are very rarely successful because of the power of proxies lodged (usually with the directors) in advance of the meeting. The NRMA has been subject to many of these actions, at a great cost (purportedly costing up to $1 million per meeting), but with little change in management decision making on any of the issues raised.

8.4.7  Section 236 (statutory derivative actions) The Corporations Act provides a number of specific provisions that attempt to protect minority shareholders. In 2000 these were expanded to include the statutory derivative action. Officially, the action is known as ‘Proceedings on behalf of a company by members and others’, and is found in Part 2F.1A. Australia has followed Canada and New Zealand in introducing such an action. Parliament has prevented the overlap with the common law derivative action (known as the fraud on the minority) by enacting s 236(3), which abolishes the general law provision that enabled shareholders to bring proceedings on behalf of the company. Section 237 facilitates an application for leave of the court to launch such proceedings, which may be brought by a member, former member or company officer. The legal action must be brought in the company’s name, rather than the member’s name. Permission to bring an action or to intervene in existing proceedings should be granted by the court if it is satisfied that: • the company will probably not bring the action; • the applicant acts in good faith;

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• • •

it is in the best interests of the company; there is a serious question to be tried (prima facie case); and at least 14 days before the application, written notice was given to the company of the intention to apply for a statutory derivative action (or the court may waive the need for notice to be given).

A case to remember Swansson v RA Pratt Properties Pty Ltd (2002) 42 ACSR 313 Facts: Swansson was a member and a director of RA Pratt Properties Pty Ltd. She sought to bring a derivative action against one of the directors of the company for alleged breaches of directors’ duties. The director being sued was also her ex-husband. Held: The court refused to grant leave under s 237 as Swansson was not able to prove that she was acting in good faith. Principle of law: When assessing whether the applicant was acting in good faith the court will consider two interrelated factors: 1 Does the applicant honestly believe that a good cause of action exists and has a reasonable prospect of success? 2 Does the applicant have a collateral purpose when they are bring the derivative action (such as abuse of process)?

Proceedings under s 236 are relatively few. Between March 2000 and 12 August 2005 there were only 31 cases relating to derivative action (Ian Ramsay and Benjamin Saunders, Litigation by Shareholders and directors: An Empirical Study of the Statutory Derivative Action, 2006, Centre for Corporate Law and Securities Regulation, University of Melbourne). One such case was Talisman Technologies Inc v Queensland Electronic Switching Pty Ltd [2001] QSC 324, which discussed the need for the application to be brought in good faith and in the best interests of the company. It was held that the applicants did not meet these two conditions, and therefore the Supreme Court of Queensland did not grant leave. The case involved a joint venture enterprise and one of the parties brought the action in their own interests. The court may appoint an independent investigator to report on the affairs of the company with respect to the facts or circumstances giving rise to the proceedings and the likely costs to be incurred. Section 240 requires the company to seek permission from the court to settle or discontinue the proceedings. This provision is designed to prevent a minority shareholder from ‘greenmailing’ the company and its officers. In the event that all of the members ratify the breach that is the basis of the legal action, the minority shareholder bringing the statutory derivative action is not prohibited from continuing the s 236 proceedings. However, under s 239 the court

Chapter 8: Protection of Shareholders

would take this ratification or approval by the members into account in making its orders. The court has a wide power under s 242 to make orders in respect of costs, which are crucial in these cases. In Keyrate Pty Ltd v Hamarc Pty Ltd [2001] NSWSC 491 the Supreme Court of New South Wales reaffirmed the need for the action to be brought in the company’s name, and granted leave for the statutory derivative action to be brought so as to avoid multiplicity of legal actions. A minority shareholder will usually rely upon both common law (see 6.5) and statutory provisions to bring litigation.

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Assessment preparation Revision questions 1 Does a proprietary company have to hold an annual general meeting once every year? 2 What limitation is imposed on members’ power to call for a members’ meeting? 3 If the members disagree with the decision of the board of directors, what options are available to them? 4 Define an ordinary resolution. How is it different from a special resolution? 5 What are the principles established in Foss v Harbottle? 6 What remedies are available to members in case of a breach of a company’s constitution? 7 When will the court consider that conduct is oppressive? 8 Discuss one member’s remedy under common law. 9 Can the members automatically take action against the directors on behalf of a company? Explain. 10 Give an example of a just and equitable ground.

Problem question Bernadette and Jim are the two directors of ‘Insured Pty Ltd’. They are also two of the members of the company, and each holds 40% of the shares. The rest of the shares are divided between Jane and Dominique, who each hold 10%. Jane wishes to call for a members’ meeting to: • remove Bernadette from her position, because Jane had a dispute with her; and • force the board of directors to sell certain assets that are causing the company to lose money. The directors would like to call for a meeting to pass a resolution to change the company’s constitution to allow shareholders holding more than 30% of the shares of the company to expropriate the shares of minority shareholders. 1 Can Jane call for a members’ meeting? 2 What two remedies will be available to Jane and Dominique to invalidate a change of the constitution to expropriate their shares? For answers to problem questions, please refer to .

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Companies in Financial Trouble Covered in this chapter • • • • • •

The meaning of ‘external administration’ The differences between schemes of arrangement and receivership The application of the voluntary administration system The differences between a winding up and liquidation The duties associated with liquidators The impact of insolvent trading on directors and companies

Cases to remember Commonwealth Bank of Australia v Eise and Friedrich (1991) 9 ACLC 946 David Grant & Co Pty Ltd v Westpac Banking Corp (1995) 184 CLR 265; [1995] HCA 43 Elliott v Water Wheel Holdings Pty Ltd [2004] FMCA 37 Russell Halpern Nominees Pty Ltd v Martin (1986) 10 ACLR 539

Statutes and sections to remember Corporations Act ss 411, 420A, 435A, 436A, 436B, 436C, 459A, 459E, 461, 462, 556, 588G, 588H, 588FE

9.1 Introduction Under the Corporations Act, a company comes into existence when it registers with ASIC and a certificate of registration is issued (see Chapter 2). In the same way, after a company ‘dies’, ASIC will deregister it following an application by the company, members, directors of the company or a liquidator (s 601AA). The process that usually leads to deregistration of a company is known as ‘external administration’. This area of law is complex and is undertaken by specialist lawyers and accountants called insolvency practitioners. Such professionals have to be specifically registered with ASIC, in the same way that auditors must be registered. In 1988 the Australian Law Reform Commission (ALRC) reviewed this area of law and produced the Harmer Report. Many of the recommendations made by the ALRC were incorporated into the legislation by the Corporate Law Reform Act 1992 (Cth) and became effective from 23 June 1993. More recently, the Corporations

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Amendment (Insolvency) Act 2007 (Cth) fine-tuned the process of voluntary administration. The law relating to external administration is contained concurrently within Chapter 5 of the Corporations Act and the extensive case law that has developed around these matters. In fact, two-thirds of all corporate law litigation (approximately 3000 cases) in the last decade has involved some aspect of external administration. Four major types of external administration need to be studied: 1 schemes of arrangement; 2 receivership; 3 voluntary administration; and 4 winding up/liquidations.

9.2 Schemes of arrangement and receivership 9.2.1 What are schemes of arrangement and receivership? With changes in economic circumstances such as a recession and the global financial crisis, many companies have to change their structures, amalgamate or pass control to creditors rather than to the investing shareholders. For example, the board of directors may decide to engage in schemes of arrangement in order to facilitate complex changes to the corporate structure. Such schemes tend to be both expensive and time-consuming. Receivership, on the other hand, comes into operation at the insistence of a secured creditor, rather than at the wish of the directors. The systems have in common the concept that an external person takes control of the management of either the whole company or a particular asset of the company. After a period of external management the control may pass back to the board of directors of the company. However, if the company remains insolvent, liquidation may occur.

9.2.2  Arrangements and reconstructions 9.2.2.1  What is a scheme of arrangement or reconstruction? A scheme of arrangement is a process whereby a number of difficult problems can be resolved at one time. It is an alternative to a voluntary administration or liquidation of the company, and is carefully controlled by ss 410–415 (Part 5.1 of the Corporations Act). It can be used for two distinct purposes. First, a scheme of arrangement is a special agreement with creditors to enter a compromise that is binding on all parties. Second, a scheme may be used as part of a financial reconstruction of the company. Schemes may be put forward as either creditors’ or members’ schemes, depending upon the solvency of the company and the proposed outcomes.

Chapter 9: Companies in Financial Trouble

Under a creditors’ scheme of arrangement, a creditor may be given the opportunity to accept a proposed scheme of arrangement and compromise their existing claims, rather than wait for a liquidator to wind up the whole entity. For example a creditor may be more willing to accept a $750 000 payment immediately, rather than having to wait for an unknown proportion of a million-dollar loan to be repaid at the direction of a liquidator at some uncertain time in the future. A scheme of arrangement that is to be used for a reconstruction by members may involve a variation of the company’s share capital, such as conversion of debt and preference shares into ordinary shares. A members’ scheme may also be used for the transfer of one entity’s assets for the issue of new shares in another entity. This is particularly beneficial to amalgamate a group of companies into a single entity.

9.2.2.2 Procedure ASIC will examine a proposed scheme prior to the application that must be made to the court. The court must order a creditors’ meeting at which the scheme is to be fully explained. Furthermore, the scheme must be approved by a double majority (a resolution of creditors with a majority constituting 75% of the value of the debt owed by the company, who also comprise at least 50% of the creditors of the company who are entitled to vote). Once a double majority is passed, the scheme must still be submitted to the court for approval. The scheme of arrangement, upon approval by the court, binds all the creditors and members. It is this fact which makes it of use to companies with debt problems, as it will bind all the creditors and members to a compromise or an arrangement. Schemes of arrangement are relatively slow and costly to implement. A lot of detailed documentation must be provided and the scheme is always subject to court approval under s 411. After the failed attempt to demutualise the NRMA in 1995 the court and many commentators observed that the NRMA should have used the scheme of arrangement system. In light of the costly nature of schemes of arrangement, in 1993 the government introduced an alternative to the creditors’ scheme of arrangement in the form of voluntary administration. Schemes of arrangement are now rarely being used for companies in an insolvent state. An example of a case on schemes and their use is Re Theatre Freeholds Ltd [1996] 132 FLR 235. Another example is the James Hardie reconstruction.

9.2.3 Receivership 9.2.3.1  Appointment of a receiver A receiver may be appointed by a court or secured creditor to take control of specific corporate property. Receivership, which includes both the appointment of a receiver

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for a specific asset and a ‘receiver and manager’ who has control over all assets, is governed by ss 416–434G (known as Part 5.2 of the Corporations Act). The company entering receivership must be served with notice of the appointment of a receiver and ASIC must be notified by lodging an ASIC Form 504. The receivership is also published in the Commonwealth of Australia Business Gazette. The directors and company secretary must also make a report on the affairs of the company to the receivers within 14 days of the notice of receivership being served. There is a difference between the appointment of a receiver and the appointment of a receiver and manager. Receivers are responsible only to the creditor who has appointed them, to realise the value of an asset over which that creditor has a security, whereas a receiver and manager must be aware of all creditors and be extremely careful not to damage any of the assets that are not covered by the security. The appointment of a receiver may be made either by the court, on an application from creditors, or privately, where a creditor directly appoints a receiver under a security document. This document is the contract that makes up the security interest given by the company. A practical example of the process of receivership was where receivers were appointed by secured creditors in the cases of Opes Prime (2008) and ABC Learning Centres (2008).

9.2.3.2  Powers and duties of receivers Receivers have a number of powers and duties, outlined in s 420. These include the power to: • enter into possession and take control of property; • lease, let, hire or dispose of property; • borrow money on security of property; • convert property to money; • execute any document and bring or defend any legal proceedings in the name of the company; and • make an application for the winding up of the company. Additionally, under s 422 the receiver has an obligation to report to ASIC any misconduct by the company in receivership. Moreover, at common law the receiver has a duty to act in good faith (Downsview Nominees Ltd v First City Corp Ltd [1993] 2 WLR 86). The deed of appointment of a receiver is crucial. It contains what action a receiver may and may not take while in possession and legal control of the relevant assets. In situations where a receiver and manager replaces the company’s existing management, the receiver and manager owes a duty to inform ASIC if the previous

Chapter 9: Companies in Financial Trouble

management is suspected of any form of misconduct. If a receiver is unsure what decisions to make, they may apply to the court for specific directions under s 424.

9.3 Voluntary administration The introduction of Part 5.3A (ss 435A–451D) on 23 June 1993 established a new procedure for companies in financial difficulty. The law enables the appointment of an administrator (who is a registered liquidator with ASIC) to determine whether a deed of company arrangement can be executed or whether the company should be wound up. Voluntary administration (known as ‘VA’) replaced the previous concept of an ‘official manager’, which was not very successful.

9.3.1  Appointment of an administrator An administrator may be appointed by the directors (s 436A) who think that the company is insolvent, by a company’s liquidator or provisional liquidator (s 436B), or by a substantial secured creditor (s 436C). A substantial secured creditor is a creditor who has a security over the whole, or substantial part, of the company’s property. The administrator is deemed to be the company’s agent and thus has a wide range of powers in order to carry on the company’s business. Examples of administration include the Brashes Group in 1993, Osborne Computers (later Gateway) in 1995, Ansett Airlines in 2001 (prior to its final liquidation) and ABC Learning Centres in 2008.

9.3.2  Effect of appointment In order to give the administrator time to devise a plan to restructure a company in difficulty, s 440A grants a moratorium period for the enforcement of debts. That is, during the voluntary administration (usually 25 business days), the company cannot commence a voluntary winding up and the court will not accept a petition to liquidate if it is not in the creditors’ interests. The intention of the VA is to enable an insolvent company to maximise its chances of trading out of financial difficulties and to maintain itself as a going concern as provided in s 435A. The Federal Court, in Dallinger v Halcha Holdings Pty Ltd (1996) 14 ACLC 263, held that there does not have to be some prospect of saving the company from liquidation when the administration commences. A secured creditor will not be able to enforce a security or take possession of assets without the court’s leave or the written consent of the administrator (ss 440B–440D, and 440F). However, a substantial secured creditor may enforce its security within 13 business days after the appointment of the administrator (s 441A). Additionally, the moratorium period does not apply to secured creditors who have enforced their securities before the commencement of the administration (s 441B).

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9.3.3  Conclusion of administration Within 25 business days of the administration commencing the administrator must hold a company creditors’ meeting to pass a resolution (pursuant to s 439C) to the effect that: • the company executes a deed of arrangement; • a winding up commences; or • control has been returned to the board of directors. If a deed of company arrangement is to be executed, all the company’s unsecured creditors, officers, and members, along with the administrator, are bound by it (s 444D). A secured creditor is only bound by the terms of the deed to the extent that the court orders or the secured creditor voted in favour of the deed. If the creditors decide to wind up the company after the administration, a voluntary winding up will take place.

9.4 Voluntary winding up ‘Winding up’ and ‘liquidation’ are terms used to describe a process or procedure. The terms are synonymous, but, as a matter of convenience, ‘winding up’ is a voluntary process (that is, at the choice of the company) and ‘liquidation’ is a compulsory process (that is, as the result of a court order). Approximately 10 000 companies are wound up or deregistered each year by ASIC (ASIC statistics on external administration are available at www.asic.gov.au/regulatory-resources/finda-document/statistics/insolvency-statistics/insolvency-statistics-series-3-externaladministrator-reports). A voluntary winding up may be classified as in Figure 9.1. Figure 9.1 Types of voluntary winding up Voluntary winding up Does not involve any court intervention.

By creditors Only possible when company is insolvent.

By members Only possible when company is solvent.

9.4.1  Members’ voluntary winding up The difference between the two types of winding up (members’ and creditors’) lies in whether or not the directors are able to make a declaration of solvency. A members’

Chapter 9: Companies in Financial Trouble

voluntary winding up is commenced by a special resolution passed by the company under s 491. The members at a general meeting appoint the liquidator under s 495 if the company is solvent. The necessary declaration of solvency is made after an inquiry into the affairs of the company, and the directors form the opinion that all debts will be paid in full within 12 months of the resolution. Section 494 imposes severe penalties on directors who make a declaration of solvency without reasonable grounds. The deemed time of commencement of a winding up is the date of the company resolution (s 495).

9.4.2  Creditors’ voluntary winding up There will be a creditors’ winding up if the directors cannot make a declaration of solvency or if, during the members’ winding up, the liquidator discovers that the company cannot in fact pay all the debts. In such a situation the liquidator must immediately call a creditors’ meeting. The creditors vote (on the basis of one vote per dollar of debt) on whether to change the liquidator from the person appointed by the members or to continue with the member-appointed liquidator (s 496). Another example of voluntary winding up by creditors is the result of voluntary administration. In a voluntary administration, if the creditors vote to wind up the company it will be voluntarily wound up.

9.5  Compulsory liquidation There are different types of compulsory liquidation as characterised in Figure 9.2. Figure 9.2 Grounds for compulsory winding up Compulsory winding up Court has discretion when deciding whether or not to order liquidation of the company.

Reasons other than insolvency Who can apply for liquidation of the company based on this ground? (See s 462) What are the grounds on which the company can be liquidated? (See s 461)

Upon insolvency Who can apply for liquidation of the company based on this ground? (See ss 459A and 459P) What are the grounds on which the company can be liquidated? (Company must be insolvent)

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9.5.1 Compulsory liquidation for reasons other than insolvency The court-ordered compulsory liquidation requires a petitioner (person who applies to the court) to specify a ground (reason) for placing the company into liquidation. The persons who can apply to the court for a compulsory liquidation order are listed in s 462 as being: • the company; • a creditor; • a contributory (name of a member on a winding up); • a liquidator (such as a provisional liquidator); • ASIC; or • APRA (Australian Prudential Regulatory Authority). The grounds for applying to the court for such an order are stated in s 461 as follows: • the company passes a special resolution; • the company did not commence business within one year of registration; • the company has no members; • the directors have acted in their own interests or oppressively, unfairly prejudicially or unfairly discriminatory to the members as a whole; • ASIC has prepared a report that the company should be wound up; • APRA has prepared a report that the company should be wound up; or • the court is of the opinion that it is just and equitable that the company should be wound up (see 6.6.2). Under s 461(1)(k) the court retains a residual discretion to order the winding up of any company on the ground that it is ‘just and equitable’ to do so. Take, for example, the case of Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 (see 8.4.2), where the House of Lords held on equitable grounds that the proper course was to wind up the company, even though it was solvent. This principle was followed in Australia in Re Dalkeith Investments Pty Ltd (1984) 9 ACLR 247, where there was an atmosphere of animosity following the marital separation of the chairman (Mr Smith) from his director-wife. Smith was late for a general meeting, at which various resolutions were passed in his absence; these had the effect of either diluting his shareholding or forcing him to invest more money in a company whose shareholders were hostile to his interests. The court decided not to wind up the company, but the unfairly prejudicial conduct against Smith entitled him to have his shares purchased at an appropriate value.

Chapter 9: Companies in Financial Trouble

9.5.2  Liquidation for insolvency Another ground for petitioning to wind up a company is insolvency, as laid down in its own section, s 459C. Most compulsory liquidations arise under the insolvency petition. The meaning of insolvency has been controversial, but it is generally taken to mean that the corporation cannot pay its debts as they fall due (s 95A). However, being unable to pay debts does not automatically mean that a company will be wound up. The Corporations Act provides that once a statutory demand has been made for the debt, if it is not paid, then a rebuttable presumption of insolvency is created, as stated in s 459A. The minimum amount for an outstanding debt to give rise to a statutory demand is $2000. The form of the statutory demand for an outstanding debt has been altered from the previous law and its contents are now specified in s 459E. The prescribed form (Form 509H, which can be found in Schedule 2 of the Corporations Regulations 2001 (Cth)) should be used. Further reforms of the laws governing insolvency have meant that the ability to dispute a debt and have a demand set aside for technical errors has been limited. A company still has 21 days to pay the debt or to apply to the court to have the demand set aside if the substantiated amount is less than $2000 or if, by allowing the demand to continue, there would be a ‘substantial injustice’. There have been many cases in this area, the most significant being David Grant & Co Pty Ltd v Westpac Banking Corp (1995) 184 CLR 265; [1995] HCA 43 in the High Court of Australia.

A case to remember David Grant & Co Pty Ltd v Westpac Banking Corp (1995) 184 CLR 265; [1995] HCA 43 Facts: Westpac served a statutory demand on David Grant & Co, which then applied to the court to have the statutory demand set aside. However, its application was outside the 21 days allowed by s 459G in which to make application to set aside a statutory demand. David Grant & Co sought to extend the time limit imposed by s 459G. Held: The High Court held that the time limit in s 459G was an essential condition of s 459G and could not be extended. Principle of law: Any application to extend the period in which to challenge a statutory demand must be brought within the 21-day time limit.

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9.6  Powers and duties of liquidators A liquidator is an agent of the company. This agency relationship imposes upon the liquidator fiduciary duties and duties of care. These duties are similar to the duties of directors discussed in Chapter 7, since a liquidator falls within the definition of an officer of the company (see the definition of ‘officer’ under s 9). When a liquidator is appointed, they replace the board of directors as an organ of the company and assume all the powers of the board (s 417A). The liquidator’s powers can be found under s 477. For example, the section provides that the liquidator has to carry on the business of the company so far as is necessary for the beneficial disposal or winding up of that business. One of the most difficult areas for the liquidator of an insolvent company is the priority order of payments to creditors. As long ago as 1897, in Salomon v Salomon & Co Ltd [1897] AC 22, the question as to who should be paid in what order was of crucial importance. Section 556 states that the priority ranking of payments between secured, preferred unsecured and unsecured creditors is a set order. Except as otherwise provided by the Corporations Act, all creditors rank equally due to s 555. This is the result of the pari passu rule, which provides that unsecured creditors participate equally in the distribution of the company’s assets on the winding up of the company. Such a principle acknowledges the fact that liquidation due to insolvency has a collective nature and aims to benefit all the creditors as a general body. Thus, if there are insufficient assets for a particular class, each creditor must be paid proportionally, which is expressed as ‘cents in the dollar’ of debt. The government has passed special provisions (Part 5.8A) to deal with employee rights, especially where the company and its officers have attempted to avoid paying their employees’ entitlements (s 596AA).

9.7 Voidable transactions A number of other changes to the liquidation provisions which clearly distinguish between a solvent and insolvent winding up, and give liquidators greater powers to avoid certain types of transactions, have been made. The voidable transactions are illustrated in Figure 9.3. These powers are contained in s 588FE and allow certain transactions to be declared voidable if: • the insolvent transaction was an unfair preference transaction that occurred within the six months prior to the winding up commencing (s 588FA); • the insolvent transaction was an ‘uncommercial transaction’ (that is, a reasonable person in the company’s circumstances would not have entered into such a transaction) occurring within the two years prior to the winding up commencing (s 588FB);

Chapter 9: Companies in Financial Trouble

the insolvent transaction was an unreasonable director-related transaction, within the four years prior to the commencement of the company being wound up (s 588FDA); or • it was an unfair loan (extortionate interest or security) to the company prior to the winding up (s 588FD). Insolvent transactions are defined (in s 588FC) as unfair preferences or uncommercial transactions that cause the company to become insolvent, or that occur while the company is insolvent. •

Figure 9.3 Voidable transactions Voidable transactions

Unfair preference transactions (s 588FA)

Uncommercial transactions (s 588FB)

Unfair loans (s 588FD)

Unreasonable related transactions (s 588FDA)

To be voidable, transaction must be an insolvent transaction entered into during the period of 6 months ending on the relation back day (s 588FE(2)).

To be voidable, transaction must be an insolvent transaction entered into during the period of 2 years ending on the relation back day (s 588FE(3)).

To be voidable, transaction must have been entered into before the winding up began.

To be voidable, transaction must have been entered into during the period of 4 years ending on the relation back day (s 588FE(6A)).

9.8 Things to remember The variety of external administrations available to a company are complex and the different names – winding up, liquidations, receivership and so on – are very confusing. Table 8.1 provides a clear overview of the different types of external administration.

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Table 9.1 Different types of external administration  

Scheme of Voluntary Receivership Winding up arrangement administration

Initiation

Creditors and company

Directors, liquidator Secured creditor Members, and substantial and court creditors, secured creditor ASIC

Outcome

Possible compromise

If a deed of arrangement is the result of VA, the unsecured creditor is bound by the deed

Preservation of asset or sale of asset

Distribution of company’s asset and deregistration

Main Advantages

Reach a compromise that is flexible

Quick, moratorium period, no court involvement, maximising the chances of saving the company

Payment of secured creditor who appointed him

Power of liquidator, voidable transaction

Administrator has a very short time to deal with complex issues in an organisation

No moratorium

Lengthy and expensive and may offer lower returns to creditors than VA

Main Expensive, disadvantages lengthy, and involves going to court twice

Chapter 9: Companies in Financial Trouble

Assessment preparation Revision questions 1 Name three differences between a scheme of arrangement and a voluntary administration. 2 Who can appoint a receiver? 3 Who can put a company under voluntary administration? 4 What are the possible outcomes of a voluntary administration? 5 What are the rights of a substantial secured creditor during and after the voluntary administration? 6 When is a members’ voluntary winding up possible? 7 Provide one example of a creditors’ voluntary winding up. 8 What is the significance of a statutory demand? 9 What is the significance of David Grant & Co Pty Ltd v Westpac Banking Corp (1995) 184 CLR 265; [1995] HCA 43? 10 When will a transaction be considered a voidable transaction?

Problem question Bone Pty Ltd is experiencing some financial difficulty. It has several creditors and the directors are worried that the company is not able to pay its debt when they are due. The creditors are the following: • Avalon Ltd is a secured creditor with a security over all the assets of Bone Pty Ltd. • Trade Ltd is an unsecured creditor. • Apollo Pty Ltd is a secured creditor. It has a security over one of the minor assets of Bone Pty Ltd. (a) Who can put Bone Pty Ltd under voluntary administration (VA)? (b) What are the rights of the creditors during and after the VA assuming that the result of the VA was a deed of arrangement? For answers to problem questions, please refer to .

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Table of Cases Aberdeen Railway Co v Blaikie Bros (1854) 1 Macq 461  114–15 Adler v ASIC [2002] NSWCA 303  120 Adler v DPP (2004) 51 ACSR 1  65 Aequitas v AEFC (2001) 19 ACLC 1006  36 Allen v Atalay (1993) 11 ACSR 753  148 Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656  57 Allen v Hyatt (1914) 30 TLR 444  110 ANZ Executors & Trustee Co Ltd v Qintex Australia Ltd (1990) ACSR 676  79 Ashbury Railway Carriage and Iron Co v Riche Bros (1875) LR 7 HL 653  45, 55 ASIC and HIH Insurance v Adler, Williams and Fodera (2002) 42 ACSR 80  40, 65, 107, 129, 132 ASIC v Adler [2002] NSWSC 510  120 ASIC v Edensor Nominees Pty Ltd (2001) 177 ALR  32 ASIC v Elliott (2004) 205 ALR 594  124 ASIC v Healy (2011) 196 FCR 291  107, 119 ASIC v Macdonald (No 11) [2009] NSWSC 287  91, 104, 117 ASIC v Rich [2009] NSWSC 1229  132 ASIC v Vizard (2005) 145 FCR 57  121 Austin & Partners Pty Ltd v Spencer [1998] SCNSW 5680/63  94, 100 Australian Securities and Investment Commission v Petsas [2005] FCA 88  127 Automatic Self-Cleansing Filter Syndicate Co v Cunninghame [1906] 2 Ch 34  94, 104 AWA Ltd v Daniels t/a Deloitte Haskins & Sells (1992) 7 ACSR 759  113 AXA Asia Pacific Holdings Ltd v Direct Share Purchasing Corp Pty Ltd (2009) 173 FCR 434 140 Belmont Finance Corp v Williams Furniture Ltd (No 2) [1980] 1 All ER 393  83 BNZ v Fiberi Pty Ltd (1994) 12 ACLC 48  70 Bradley Egg Farm Ltd v Clifford and others (1943) 2 All ER 378  1, 14 Broken Hill Proprietary Co Ltd v Bell Resources Ltd (1984) 8 ACLR 609  148 Brunninghausen v Glavanics (1999) 46 NSWLR 538  107, 109, 110 Canny Gabriel Castle Jackson Advertising Pty Ltd v Volume Sales (Finance) Pty Ltd (1974) 131 CLR  5 Carew-Reid v Public Trustee (1996) 20 ACSR 443  52 Carlton Cricket and Football Social Club v Joseph [1970] VR 487  1, 14 Chan v Zacharia (1984) 154 CLR 178  1, 9 City Equitable Fire Insurance Co Ltd, Re (1925) [1925] Ch 407  113 Club Flotilla (Pacific Palms) Ltd v Isherwood (1987) 5 ACLC 1027  98 Coleman v Myers [1977] 2 NZLR 225  109 Commonwealth Bank of Australia v Eise and Friedrich (1991) 9 ACLC 946  107, 113, 122, 153 Corporate Affairs Commission v Drysdale (1978) 141 CLR 236  94, 100

Table of Cases

Dalkeith Investments Pty Ltd Re (1984) 9 ACLR 247  160 Dallinger v Halcha Holdings Pty Ltd (1996) 14 ACLC 263  157 Daniels v Anderson (1995) 16 ACSR 607  107, 113, 129 Darvall v North Sydney Brick and Tile Co Ltd (1989) 16 NSWLR 260  55, 74, 83, 84 David Grant & Co Pty Ltd v Westpac Banking Corp (1995) 184 CLR 265  153, 161 DCT v Clark (2003) 57 NSWLR 113  107, 125 Derry v Peek (1889) 14 App Cas 337  90 Direct Share Purchasing Corporation Pty Ltd v AXA Asia Pacific Holdings Ltd (2008) 67 ACSR 99  136, 139 Downsview Nominees Ltd v First City Corp Ltd [1993] 2 WLR 86  156 Duke Group Ltd v Pilmer (1999) 31 ACSR 213  5 Ebrahimi v Westbourne Galleries Ltd [1973] AC 360  136, 147, 148, 160 Edmonds v Blaina Furnaces Co (1887) 36 Ch D 215  86 Eley v Positive Government Security Life Assurance Co (1875) 1 Ex D 20  45, 52 Elliott v Water Wheel Holdings Pty Ltd [2004] FMCA 37  123, 153 EPA (WA) v McMurtry and Gillfillan Holdings Pty Ltd (Unreported, 9 March 1995)  64 Exicom Pty Ltd v Futuris Corp Ltd (1995) 18 ACSR 404  127 Forrest v John Mills Himself Pty Ltd (1970) 121 CLR 149  64 Foss v Harbottle (1843) 67 ER 189  136, 143, 144 Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 1 All ER 630  60, 68, 69 Freeman v McManus [1958] VR 15  1, 14, 15 Fysh v The Queen [2013] NSWCCA 284  107, 128 Gambotto v WCP Ltd (1995) 182 CLR 432  45, 57, 58, 59, 78, 136, 145 Gilford Motor Ltd v Horne [1933] 1 Ch 935  18, 41 Gluckstein v Barnes [1900] AC 240  18, 36 Goldberg v Jenkins (1889) 15 VLR 36  8 Gould v Brown (1998) 151 ALR 395  21, 31 Green v Bestobell Industries Pty Ltd (1982) 1 ACLC 1  18, 42, 43, 107, 115, 121 Griffin Ex Parte Board of Trade, Re (1890) 60 LJQB 235  1, 5, 7 Grimaldi v Chameleon Mining Ltd (No 2) [2012] FCAFC 6  94, 101 Hall v Poolman (2007) 65 ACSR 123  125 Hamilton v Whitehead (1988) 166 CLR 121  63 Hartnell v Sharp Corp of Australia Pty Ltd (1975) 5 ALR 493  64 Hickman v Kent or Romney Marsh Sheepbreeding Association [1915] 1 Ch 881  45 HL Bolton (Engineering) & Co Ltd v TJ Graham & Sons Ltd [1957] 1 QB 159  60, 61, 62 Hollis v Vabu Pty Ltd (2001) 207 CLR 21  67 Holmes v Keyes [1958] 2 All ER 129  48 Holpitt Pty Ltd v Swaab (1992) 6 ACSR 488  122 Hooker Investments Pty Ltd v Baring Bros (1986) 10 ACLR 525  127

167

168

Table of Cases

Hospital Products Ltd v United States Surgical Corporation (1984) 55 ALR 417  10, 114 Howard Smith v Ampol Petroleum [1974] AC 821  76, 107, 115 HR Harmer Ltd, Re [1958] 3 All ER 689  146 Huddart Parker & Co Pty Ltd v Moorehead (1909) 8 CLR 330  19 Humes Ltd v Unity APA Ltd (1987) 5 ACLC 15  136, 142, 149 Hutton v West Cork Railway (1883) 23 Ch D 654  107, 116 Industrial Development Consultants v Cooley [1972] 1 WLR 443  114 Jesseron v Middle East Trading (1994) 13 ACSR 455  96 John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113  94, 102, 103 Kelner v Baxter (1886) LR 2 CP 174  38 Keyrate Pty Ltd v Hamarc Pty Ltd [2001] NSWSC 491  153 Kinsela v Russell Kinsela Pty Ltd (In Liq) (1986) 4 NSWLR 722  107, 109 Kokotovich Construction Pty Ltd v Wallington (1995) 17 ACSR 478  75 Kriewaldt v Independent Direction Ltd (1995) 14 ACLC 73  140 Ku v Song and Others (2007) 63 ACSR 661  23 Lang v James Morrison & Co Ltd (1911) 13 CLR 1  6 Lee v Lee’s Airfarming Ltd (1961) [1961] AC 12  40 Lennard’s Carrying Ltd v Asiatic Petroleum Co Ltd [1915] AC 705  60, 66 Lion Nathan Australia Pty Ltd v Coopers Brewery Ltd (2006) 236 ALR 561  45, 48 Little River Goldfields NL v Moulds (1992) 10 ACLC 121  149 Lloyd v Grace, Smith & Co [1912] AC 716  60, 66 Macaura v Northern Assurance [1925] AC 619  40 Majestic Resources NL v Caveat Pty Ltd [2004] WASCA 201  149 Metropolitan Fire Systems v Miller (1997) 23 ACSR 699  107, 124, 125 Morgan v 45 Flers Avenue Pty Ltd (1986) 5 ACLC 222  136, 146 Morley v Statewide Tobacco Services Ltd (1992) 10 ACLC 1233  18, 41, 122 National Exchange Pty Ltd v ASIC (2004) 49 ACSR 369  91 Northside Developments Pty Ltd v Registrar-General (NSW) (1990) 170 CLR 146 60, 70, 71 NRMA Holdings Ltd v Fraser and Talbot (1995) 127 ALR 577  91 NRMA Holdings Ltd v Parker (1986) 6 NSWLR 517  102, 104 NRMA v Parker (1986) 4 ACLC 609  142 NRMA v Scandrett [2002] N SWSC 1123  142 NSW v Commonwealth (1990) 169 CLR 482  20 Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd [1971] 3 All ER 16  94, 98 Peckham v Moore [1975] 1 NSWLR 353  1, 15

Table of Cases

Pender v Lushington (1877) 6 Ch D 70  54 Peninsula Gold Pty Ltd v Sunbeam Victa (1996) 20 ACSR 553  138 Percival v Wright [1902] 2 Ch 421  107, 109, 110 Peter’s American Delicacy Ltd v Heath (1939) 61 CLR 457  45, 57 Polkinghorne v Holland (1934) 51 CLR 143  8–9 Powell and Another (as joint liquidators of Noelex Yachts Australia Pty Ltd (in liq)) v Fryer and Another (2001) 37 ACSR 589  122 R v Byrnes and Hopwood (1995) 183 CLR 501  107, 120 R v Hannes (2000) 158 FLR 359  127 R v Hughes (2000) 202 CLR 535  21 R v Kite and Oll Ltd (Unreported 8 December 1994)  63 R v Rivkin (2003) 198 ALR 400  127 Rankine v Rankine (1995) 18 ACSR 725  146 Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134  107, 114, 115 Rich v ASIC (2004) 78 ALJR 1354  116, 132 Rossington Pty Ltd v Lion Nathan Ltd (1992) 7 ACSR 509  136, 139 Royal British Bank v Turquand (1856) 119 ER 886  60, 70, 86 Russell Halpern Nominees Pty Ltd v Martin (1986) 10 ACLR 539  123, 153 Salomon v Salomon & Co Ltd [1897] AC 22  18, 39, 44, 45, 60, 162 Scottish Co-operative Wholesale Society Ltd v Meyer [1959] AC 324  145 Shaddock & Associates Pty Ltd v Parramatta City Council (1981) 150 CLR 255  91 Shafron v ASIC (2012) 86 ALJR 584  94, 99 Shuttleworth v Cox Bros & Co (Maidenhead) [1927] 2 KB 9  45, 52, 53 Smith and Fawcett Ltd, Re [1942] 1 All ER 542  107, 116 Smith Stone and Knight v Birmingham Corp [1939] 4 All ER 116  18, 42 Smith v Anderson (1880) 15 Ch D 247  5, 6, 7 Southern Foundries (1926) Ltd v Shirlaw [1940] AC 701  45, 52, 53 Spies v R (2000) 201 CLR 603  107, 109 State of South Australia v Marcus Clark (1996) 19 ACSR 606  107, 112, 130 Statewide Tobacco Services v Morley (1990) 2 ACSR 405  107, 125 Sumiseki Materials Co Ltd v Wambo Coal Pty Ltd [2013] NSWSC 235  48 Swansson v RA Pratt Properties Pty Ltd (2002) 42 ACSR 313  136, 150 Talisman Technologies Inc v Queensland Electronic Switching Pty Ltd [2001] QSC 324 150 Tesco Supermarkets v Nattrass [1971] 2 All ER 127  60, 62, 63, 64 Theatre Freeholds Ltd, Re [1996] 132 FLR 235  155 Timber Engineering Co Pty Ltd v Anderson [1908] 2 NSWLR 488  97 Titlow v Intercapital Group (1996) 144 ALR 203  146 Tourprint International Pty Ltd v Bott (1999) 32 ACSR 201  107, 125 Tracy v Mandalay Pty Ltd (1953) 88 CLR 215  35

169

170

Table of Cases

Trevor v Whitworth [1886–90] All ER Rep 46  74, 79 Twycross v Grant (1877) 46 LJ CP 636  35 United Dominions Corporation Ltd v Brian Pty Ltd (1985) 157 CLR 1  1, 5, 7, 10 Walker v Wimborne (1976) 137 CLR 1  107, 109 Wayde v NSW Rugby League Ltd (1985) 180 CLR 459  136, 146 Whitehouse v Carlton Hotel Pty Ltd (1987) 162 CLR 285  107, 115 Wondoflex Textiles, Re [1951] VLR 379  148 Yenidje Tobacco Co Ltd, Re [1916] 2 Ch 426  136, 148

171

Table of Statutes Commonwealth Acts Interpretation Act 1901  21 Australian Consumer Law 2010  64 s 18  91 Australian Securities and Investments Commission Act 1989  29 Australian Securities and Investments Commission Act 2001  21, 24, 26, 32 Part 9  30 Part 11  29 Part 12  30 s 1  18, 27 s 11  27 ss 13–15  136, 149 s 50  108, 131 s 93AA  133–4 s 203  29 Company Law Review Act 1998  24, 46, 79 Competition and Consumer Act 2010  3 Sch 2  3 Constitution  1, 32 s 51  2 s 51(xx)  18, 19, 20 Corporate Law Economic Reform (Audit Reform and Corporate Disclosure) Act 2004  25, 97 Corporate Law Economic Reform Program Act 1999  24, 96, 116–17 Corporate Law Reform Act 1992  24, 153 Corporations Act 1989  20–1, 29 s 1292  29 Corporations Act 2001  19–27, 28, 29, 32, 35, 40, 47, 51, 55, 88, 119 Ch 1  22 Ch 2A  22 Ch 2B  22 Ch 2C  22, 138 Ch 2D  22 Ch 2E  22, 121 Ch 2F  22 Ch 2G  22, 51 Ch 2H  22 Ch 2J  22, 79

Ch 2L  22 Ch 2M  22 Ch 2N  22 Ch 2P  22 Ch 5  22, 154 Ch 5A  22 Ch 5B  22 Ch 5C  22 Ch 5D  22 Ch 6  22 Ch 6A  22 Ch 6B  22 Ch 6C  22 Ch 6CA  23 Ch 6D  23, 25, 87, 90 Ch 7  23, 25, 75 Ch 8  23, 25 Ch 9  23 Ch 10  23 Part 1.5  34 Part 2B.7  57 Part 2D.1  111 Part 2F.1  145 Part 2J.3  83–4 Part 5  154 Part 5.2  156 Part 5.3A  157 Part 5.8A  162 Part 6D  90 Part 6D.2  88 Part 6D.3  90 Part 9.4B  131 Part 9.5  130 ss 1–111Q  22 s 3  21 s 5B  21 s 5C  21 s 9  18, 21, 23, 32, 33, 35, 60, 82, 86, 94, 95–7, 107, 140, 162 s 19  60 s 45A  18, 33, 34 s 72(2)  138 s 95A  84, 123–4, 161 s 111J  34 s 112  18, 32, 33 ss 112–123  22 s 112(2)  47

172

Table of Statutes

s 113  18, 33 s 113(3)  74, 87 s 113(3A)  87 s 114  18, 33, 35 s 115  4 s 119  18, 37, 38, 40, 45 s 122  38 s 123  40, 140 s 124  3, 18, 40, 45, 55, 60, 67, 76, 86, 94, 102, 108 ss 124–167AA  22 s 124(1)(b)  86 s 125  45, 55–6, 86 s 126  60, 69, 72 s 127  60, 69, 70, 72 s 127(1)  67, 69 s 127(2)  67, 69 s 128  60, 69 s 128(4)  71, 72 s 129  60, 69–70, 72 s 130  45, 55 s 131  18, 38 s 132  38, 39 s 133  38 s 134  47, 76 s 135  48, 104 s 135(1)  47 s 136  45 s 136(2)  56 s 136(5)  56 s 137  56 s 138  47 s 139  47 s 140  40 s 140(1)  45, 51–4, 56, 76, 137 s 140(2)  45, 56–7 s 141  45, 46, 49–51 s 162  35 s 163  35 s 164  35 s 165  74 s 165(1)  87 ss 167A–178D  22 s 168  138, 140 s 169  136, 138 s 169(2)  138 s 170  138 s 171  86, 138 s 173  86, 139 s 175  138

s 176  74, 75 s 177  139 ss 179–206M  22 s 180  111, 118, 119 ss 180–185  99 s 180(1)  107, 112, 113, 119, 129, 131 s 180(1)(a)  129 s 180(1)(b)  130 s 180(2)  119 s 181  111, 117, 132 s 182  107, 111, 120–1, 130, 132 s 183  107, 111, 121, 126, 130, 132 s 184  107, 108, 111 s 184(1)  117 s 184(2)  120 s 185  111, 112, 117 s 185(3)  131 s 187  109 s 188  98–9 s 189  107, 120 s 189D  120 s 190(2)  107, 120 s 190A  103 s 190E  103 s 191  121 s 192  121 s 193  121 s 194  49, 121 s 195  121 s 197  25, 40 s 198A  49, 61, 86, 104, 137 ss 198A–198D  94 s 198B  49 s 198C  49, 61, 67, 103, 137 s 198D  61, 67, 103 s 198F  140 s 200A  121 s 200B  121 s 201A  35, 38, 99–100, 101 s 201B  101 s 201G  49, 100 s 201H  49 s 201J  49 s 201K  49 s 202A  49 s 202B  121 s 203A  49 s 203C  49, 101, 136 s 203D  101, 103, 137 s 203F  49

Table of Statutes

s 204  21 s 204A  21, 35, 97–8, 107 s 204B  98 s 204D  98 s 204F  49, 98 s 205  21 s 205B  98 s 205C  98 ss 207–230  22 s 208  107 s 209  132 s 231  75, 138 ss 231–247E  22 s 232  136, 145–7 ss 232–234  57, 86, 145–6 ss 232–242  78 s 232(4)  113 s 233  136 s 233(1)(b)  146 s 234  136 s 236  108, 144–5, 149–50, 150 ss 236–242  136 s 236(3)  145, 149 s 237  149–50 s 239  150–1 s 240  150 s 242  151 s 246AA  146 s 246B  78 s 246F  137 s 247A  136, 140 ss 247A–247D  148–9 s 247B  141 s 247C  141 s 247D  49, 136, 140 s 248A  49, 104 ss 248A–253N  22 s 248C  49, 104 s 248E  49 s 248F  49, 104 s 248G  49 s 249B  56 s 249C  50, 141 s 249D  136, 141, 149 s 249E  149 s 249F  141 s 249G  142 s 249H  142 s 249HA  142 s 249J(2)  50

s 249J(4)  50 s 249J(5)  50 s 249M  50 s 249Q  136, 142 s 249T  48–9, 50, 143 s 249U  50 s 249W(2)  50 s 249X  50, 143 s 250C(2)  50 s 250D  143 s 250E  50 s 250F  50 s 250G  50 s 250J  50 s 250M  50 s 250N  64, 141 s 250N(3)  64 s 250R  141 s 251A  104–5, 143 s 254A  74, 76, 78, 79, 80 ss 254A–254Y  22 s 254A(3)  80 s 254B  137 s 254C  76 s 254D  50, 76 s 254J  74, 77, 79, 80 s 254L  80 s 254T  77, 84, 85 s 254U  50, 85 s 254W(2)  50 s 256A  74 ss 256A–260E  22 s 256B  74, 79, 80, 84, 103 s 256C  74, 80, 103 s 256D  74, 80 s 257A  74, 79, 80 s 257B  74, 81, 82 s 257C  82 s 257D  83 s 257E  82 s 257J  83 s 259A  74, 79 s 260  146 s 260A  74, 79, 83, 84, 86 s 260B  74, 83 s 260C  74, 83 s 260D  84 ss 283AA–283I  22 ss 285–344  22 s 290  140

173

174

Table of Statutes

s 290(4)  140 s 300A  121 s 344  132 ss 345A–349D  22 ss 350–354  22 ss 410–415  154 ss 410–600H  22 s 411  153, 155 ss 416–434G  156 s 417A  162 s 420  156 s 420A  153 s 422  156 s 424  157 s 435A  153 ss 435A–451D  157 s 436A  153 s 436B  153 s 436C  153 s 439C  158 s 444D  158 s 459A  153, 159 s 459C  161 s 459E  153 s 459G  161 s 459P  159 s 461  136, 146–8, 153, 159 s 461(1)(e)–(g)  146 s 461(1)(k)  146, 160 s 461(k)  146–7 s 462  153, 159, 160 s 477  162 s 495  159 s 495A  161 s 495E  161 s 496  159 s 555  162 s 556  153, 162 s 565  86 s 588E  123 s 588FA  162 s 588FB  163 s 588FC  163 s 588FD  163 s 588FDA  163 s 588FE  153, 162 s 588FE(2)  163 s 588FE(3)  163 s 588FE(6A)  163

s 588G  18, 40, 41, 86, 98, 107, 111, 121–5, 130, 153 s 588G(1)  111 s 588G(2)  132 s 588G2  124 s 588H  107, 125, 153 s 588H(2)  125 s 588H(3)  125 s 588H(4)  125 s 588M  130 s 588V  125 s 592  122 s 596  121 s 596AA  162 s 601AA  153 ss 601–601AL  22 ss 601BA–601DJ  22 ss 601EA–601QB  22 ss 601RAA–601YAB  22 ss 602–659C  22 ss 660A–669  22 ss 670A–670F  22 ss 671A–673  22 s 674  118 ss 674–678  23 ss 700–742  23 s 704  88 s 705  74 s 706  74 s 708  74, 88 s 709  88 ss 710–716  89 s 715A  89 s 718  89 s 726  90 s 727  74, 90 s 728  74, 91 s 728(1)  92 s 728(2)  91 s 728(3)  90, 92 s 729  74, 91 s 731  74, 92 s 732  74, 92 s 733  74, 92 s 733(3)  92 s 733(4)  92 s 739  90 ss 760A–1101J  23 s 761A  23

Table of Statutes

s 769B  62 s 793C  75 s 995  118 s 999  118 s 1001A  118 s 1041E  118 s 1041H  91, 118, 131 s 1043A  62, 111, 121, 126–8 s 1070A  75 s 1070C  75 s 1072A  50 s 1072B  50 s 1072D  50 s 1072F  50 s 1072G  50 ss 1200A–1200U  23 ss 1274–1369A  23 s 1305  105, 141 s 1306  140 s 1307  121 s 1308  121 s 1309  121 s 1310  121 s 1311  62, 131 s 1312  60, 62, 131 s 1317E  131–2 s 1324  148 ss 1370–1541  23 Sch 3  23, 131 Sch 4  23 Corporations Amendment Act (No 1) 2005 25 Corporations Amendment (Corporate Reporting Reform) Act 2010  26 Corporations Amendment (Financial Market Supervision) Act 2010  26 Corporations Amendment (Future of Financial Advice) Act 2012  26 Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Act 2011  26 Corporations Amendment (Insolvency) Act 2007  25, 154 Corporations Amendment (No 1) Act 2009 26 Corporations Amendment (No 1) Act 2010 140

Corporations Amendment (Repayment of Directors’ Bonuses) Act 2003  25 Corporations Amendment (Short Selling) Act 2008  26 Corporations Legislation Amendment Act 2002 25 Corporations Legislation Amendment (Simpler Regulatory System Act) 2007 25 Crimes Act 1914 s 4AA  131 s 4AA  63 Criminal Code Act 1995  24, 63, 64, 131 s 12.3  65 Financial Sector Reform (Consequential Amendments) Act 1998  24 Financial Services Reform Act 2001  25, 29, 30, 126 Ch 6  29 Part 6.10  29 s 656A  29 s 659AA  29 s 659B  29 Financial Services Reform (Consequential Provisions) Act 2002  25 Financial Services Sector Reform (Amendments and Transitional Provisions) Act 1998  27 First Corporate Law Simplification Act 1995  24, 138 National Consumer Credit Protection (Transitional and Consequential Provisions) Act 2009  26 Personal Property Securities Act 2009  86 Personal Property Securities (Corporations and Other Amendments) Act 2010  26 Trade Practices Act 1974  64 s 52  91

Australian Capital Territory Civil Law Wrongs Act 2002  67 Partnership Act 1963  1, 2, 4 s 4  5 s 6  4

175

176

Table of Statutes

s 7  6 s 9  7 ss 14–17  8 ss 33–35  9

New South Wales

s 5  7 ss 10–13  8 ss 28–30  9 s 45  5 Wrongs Act 1936  67

Civil Liability Act 2002  67

Tasmania

Partnership (Limited Partnership) Amendment Act 1991  4

Civil Liability Act 2002  67

Partnership Act 1892  1, 2, 4 s 1  4 s 1B  5, 7 s 2  6 s 5  7 s 9  8 ss 14–17  8 ss 28–30  9

Northern Territory Partnership Act 1997  1, 2, 4 s 3  5 s 5  4 s 6  6 s 9  7 ss 32—34  9 s 16  8 Personal Injuries (Liability and Damages) Act 67

Queensland Civil Liability Act 2003  67 Partnership Act 1891  1, 2, 4 s 3  5 s 5  4 s 6  6 s 8  7 ss 13–16  8 ss 31–33  9

South Australia Partnership Act 1891  1, 2, 4 s 1  4 s 2  6

Partnership Act 1891  1, 2, 4 s 4  5 s 6  4, 7 s 7  6 ss 15–18  8 ss 33–35  9

Victoria Partnership Act 1958  1, 2, 4 s 3  5 s 5  4 s 6  6 s 9  7 ss 14–17  8 ss 32–34  9 Wrongs Act 1958  67

Western Australia Civil Liability Act 2002  67 Partnership Act 1895  1, 2, 4 s 3  5 s 7  4 s 8  6 ss 17–20  8 ss 39–41  9 s 26  7

United Kingdom Companies Act 1869  55 Partnership Act 1890  4

177

INDEX actus reus (criminal action) 63 administration 157–8 agency relationship 6, 42, 60 actual authority (express or implied) 67 apparent authority (ostensible authority) 68 common law principle—partners 7 companies, indirect contract entry 67, 69 ratification 68 see also ‘in common’ requirement arrangement, schemes of 154–7 articles of association 46–7 ASIC Act 2001 27–8 AASB and FRC establishment 30 CALDB establishment 29 CAMAC establishment 30 assets transfer of 155 trusts—conserved and protected property 12 associations definition 13–16 incorporated associations 16 unincorporated associations 13–16 auditors, CALDB discipline 29 Australian Accounting Standards Board (AASB) 30 Australian Business Names 37 Australian Business Number (ABN) 4, 37 Australian Company Number (ACN) 37 Australian Constitution see Constitution Australian Law Reform Commission (ALRC), external administration review 153–4 Australian Securities and Investments Commission (ASIC) annual returns/lodgements 99 case success and sanctions/bans 28 Chairs 28 civil action initiated by 131–2 companies deregistration 153, 158 registration 22–5, 35–9 corporation process 37 Corporations Act administration 21

enforcement and administration 27–9 enforcement pyramid 132–3 insolvency practitioners, registration 153 introduction/reconstitution of bodies 29–30 prosecutions 63, 65, 108, 121, 131 enforcement difficulties 128 receivership company misconduct during 156–7 notification of 156 regulatory policies 132–4 s 13–15—investigative powers 149 Australian Securities Exchange (ASX) ASX Listing Rules 47, 75, 76 companies listed on 33, 35 replaceable rules application 47 Australian Tax Office (ATO) 4, 37 authority actual authority (express or implied) 8, 67 apparent authority (ostensible ­authority) 8, 68 of partners 8 ratification (no authority) 68–9 balance sheet test 84 bonus shares 78 business ‘business’; ‘carry on,’ partner liability and 8 statutory requirements ‘business’; ‘carry on’ 5 ‘in common’ 5–6 view of profit intention 6 structure, determining factors 2–3 structures 2 taxation, Australian Business Number 4, 37 transaction, ‘in the usual way’ 8 Business Activity Statement (BAS) 4 ‘but for’ test, Howard Smith v Ampol Petroleum 115 buy-backs (shares) 80–3 general procedure 81 types 82–3

178

INDEX

Cadbury report, corporate governance definition 94–5 capital debt capital 85–7 debt capital, equity, distinction 74 preferred return of capital on winding up (shares aspect) 77 share capital 76, 155 debt capital, equity, distinction 74 maintenance 79–85 capital maintenance, principle of application profit (not capital) dividend payment 84 s 254T non-overrule 85 exceptions 79–84 Trevor v Whitworth 79 ‘carry on’ requirement 5 case law common law–equity development 1 corporate law development though case law 31–2 operation in 31–2 civil defence, fundraising disclosure documentation 92 civil duty, breach 111 civil penalty provisions (CPPs) 116–17, 121, 126, 131–3 Clearing House Electronic Sub-register System (CHESS), shares, clearing and ‘virtual ownership’ 75 colonisation 19 commercial law, sole trader governance 3 committees 14, 16 artificial contracts with 15 common law action based on 129–30 Australia’s common law country status 31 case law development 1 Corporations Act/equitable principles/ common law overlap 111–12 duty of care, skill and diligence, officers’ duties 113 duty of fidelity (faithfulness) 96–7 duty to act in good faith 156 exception to indoor management rule— suspicion 71 lifting the corporate veil Gilford Motor Ltd v Horne 41 Green v Bestobell Industries Ltd 42–3

Smith Stone and Knight v Birmingham Corp 42 protection—Gambotto case 57–8 recognition of partners as agents 7 Commonwealth, legislative power extent 19 Commonwealth Director of Public Prosecutions (DPP ), prosecutions 63, 108, 131 companies amalgamation 155 assets, surplus of assets over liability 84 ASX listed companies 75 replaceable rules application 47 shares types and classification 77 board of directors 76 arrangement schemes initiation 154 decision making arm 102, 103–4 delegation of power 103–4 governance 94–5 management power 137 borrowing power, constitutional restrictions 86 classification 34–5 ‘common seal’ 67 Companies Code regulation 20 company meetings 140–3 annual general meetings 140 extraordinary general meetings 141–3 company officers 94–105 company secretary 52–3, 97–9 as contractual principals 67 creditors binding agreement—scheme of arrangement 154 no material prejudice to payment 84–5 pari passu rule 162 receivership initiation 154 criminal liability 61–5 deregistration (ASIC) see external administration directors see directors entering liquidation 78 exclusion from director appointment 101 external documents and internal rules 46–7 in financial trouble 153–64 arrangement and receivership 154–7 compulsory liquidation 159–61

INDEX

liquidators, powers and duties 162 voidable transactions 162–3 voluntary administration 157–8 voluntary winding up 158–9 fundraising capital choices 87 ‘guarantee’ companies 33 for insolvency 161 internal governance rules 46–7 and its directors and company secretary 52–3 and its members 51–2 limited liability companies 32–5, 78 management 94–105 membership 75–6 as most appropriate business structure 2–3 ‘no liability’ companies 19, 33 replaceable rules application 47 pre-Federation ‘no liability’ company 19 profit distribution, profit test 84 proprietary companies 76 replaceable rules application 47 as real ‘person’ 102–3 registration (ASIC) 35 documentation 37–8 fees 38 full contractual capacity 67 pre-registration contracts 38–9 promoters and 36 separate legal entity—Salomon’s case 39–40, 45, 60, 102–3 steps 36–7 ‘sham’ companies 41 shares companies limited by 32, 75, 78 issue according to proper ­ purpose 76, 78 types of 32–5 unlimited companies 33 see also corporations Companies Auditors and Liquidators Disciplinary Board (CALDB) 29 Companies Code 20 company law state matter, not federal 19 state/territory regimes 19 Company Law Review Act 1998 (Cth) capital maintenance exception provisions

Part 2J.3—financial assistance 83–4 s 256B—reduction of share capital 80, 84 s 257A—share buy-backs 80–3 ss 254A, 254J—redemption of ­redeemable preference shares 80 conversion of memorandum/articles into constitutions 46 provisions, capital maintenance exception provisions 79–84 company secretary administrative contracts authority 98 appointment and duties 98 changed position—Panorama Developments (Guildford) Ltd v Fidelis Furnishing Fabrics Ltd 98 contract with company–secretary– directors 52–3 criminal liability 98–9 role 97–9 compulsory liquidation 159–61 application grounds 160 for insolvency 161 insolvency, for reasons other than 160 liquidators, powers and duties 162 petitioners 160 types of 159 confidentiality 114 conflicts of interest 114–15 ASIC v Adler 120–1 consortiums see joint ventures Constitution division of powers 1 High Court interpretation 32 s 51—Commonwealth legislative power 19 see also corporate constitutions constructive notice doctrine, ultra vires concept and 55 contract law, corporate liability in 67–9 contracts breach of contract 56 commercial contracts 98 ‘common seal’ 67 companies direct and indirect entry 67, 69 full contractual capacity of 67

179

180

INDEX

contracts cont. contractual agreements—joint ventures 10–11 medium/long-term contracts contractual liability—­associations 14–15 validity 16 partners’ liability, binding power 8 pre-registration contracts 38–9 contractual liability 38–9 secretaries, administrative contracts authority of 98 statutory constitutional contract, s 140(1) 51–4 convertible preference shares 78 corporate collapses 65, 95, 97, 100 corporate constitutions amendments 56–8 a contract with company–members, Pender v Lushington 54 a contract with company–secretary– directors 52–3 case examples 53 definition 47–8 interpretation 48 Lion Nathan case 48 replaceable rules and 46–51 decision to adopt 47–8 corporate governance 94–5 poor corporate governance 95 corporate law Australian framework 18–43 corporate regulation, NCSC regulation 20 Corporations Act national scheme and 20–1 referral of powers and 21–3 development though case law 31–2 external administration litigation 154 inter-state variations 19 pre-1989 position 19–20 English legislative influence 19 reform 23–7 CAMAC ‘think tank’ 30 Simplification Task Force 46 structure 19–23 Corporate Law Economic Reform (Audit Reform and Corporate Disclosure) Act 2004 (Cth) (CLERP 9 Act), ‘senior manager’ definition 97

Corporate Law Economic Reform Program Act 1999 (Cth), CLERP 9 amendments 96 Corporate Law Economic Reform Program (CLERP) 21 CLERP Papers for reform 27 corporate registers 138–41 access to Direct Share case 139–40 Kriewaldt v Independent Direction Ltd 140 altering 138 index 138 right of inspection 139 corporate social responsibility 110 corporations borrowing power 86 corporate constitutions 37–8, 46–51 adoption of 47–8 amendments 56–8 rule books 46 corporate fraud 64–5 corporate governance 94–5 see also Corporations Act 2001 (Cth) corporate liability 60–72 in contract law 67–9 versus individual primary liability 61 under tort law 66–7 corporate name choice issues 37 debenture holders register 86 debts, statutory demand for 161 lifting the corporate veil, case examples 40–3 organic theory 102–4 types of 33 see also companies Corporations Act 2001 (Cth) (Corporations Act) 19–27 ASIC enforcement and ­administration 21, 27–30 compliance with Act 28 companies 153 company secretary requirement 97–9 contract entry 69 delegation of power 61 legal capacity/powers of an ­individual 39–40, 45, 60 subdivisions of 32 contraventions 118–19, 127 sanctions and remedies 111, 128–34

INDEX

corporate officers definition 96 Corporations Act/equitable principles/ common law overlap 111–12 South Australia v Marcus Clark 112 a criminal regime 62 decision making, reserved for general meetings 103 director appointment and removal 100–1 liquidation provisions—voidable transactions 162–3 national scheme and 20–1 Part 1.5 ‘Small Business Guide’ 34–5 provisions 144–5 applicable as replaceable rules 49–50 civil penalty provisions 116–17, 121, 126, 131–2 referral of powers and 21–3 replaceable rules 46 s 140(1) statutory constitutional contract 51–4 s 140(2) prohibition on member liability 56–7 s 197—lifting corporate veil 40–1, 122–6 Morley v Statewide Tobacco Services Ltd 41 s 232—oppressive conduct 145–7 s 236—statutory derivative actions 149–51 s 245T conditional dividend payment 84–5 director non-compliance 85 s 461—winding up 147–8 s 1324—injunctions 148 schemes of arrangement control 154 ss 232–234—protection of minorities 57 ss 247A–247D—inspection of books 148–9 ss 249D, 249D—meeting requisitions 149 statutory minority protection 145–51 structure 21–3 third party protection rules 69–71 knowledge and imputed knowledge 71 ultra vires and constructive notice abolition 55 voluntary administration 157–8 Corporations Amendment (No 1) Act 2010 (Cth) 140

Corporations and Markets Advisory Committee (CAMAC) 30 AGM discussion paper 141 Corporations Law 20–1 constitutional validity 21 creditors insolvency, priority order of payments to creditors 162 no material prejudice to payment 84–5 receivership initiation 154 schemes of arrangement creditors’ schemes 154–5 double majority approval 155 voluntary administration meeting for resolution 158 crime 61–5 ASIC and DPP prosecutions 63, 131 actus reus 63 mens rea 63–4 insolvency crimes 108 white-collar crime 65 Crimes Act 1914 (Cth) 63, 131 criminal action 131 Criminal Code Act 1995 (Cth) 63 fault element 63–4 criminal defence, fundraising disclosure documentation 92 criminal liability 61–5 fault element 64 cross-vesting legislation, HCA invalidity ruling 31–2 cumulative preference shares 78 deadlock, Re Yenidje Tobacco Co Ltd 148 debentures debenture holders register 86 definition 86–7 debt, equity–debt balance 85 debt (loan) capital 85–7 debenture, definition 86–7 debt finance, definition 85–6 incurring debt 122–3 reasonable steps to prevent 125–6 debt finance, definition 86–7 decision making 101–5 deferred shares 77–8 derivative actions 144, 149–51 Swansson v RA Pratt Properties Pty Ltd 150

181

182

INDEX

directors appointment and duties 99–101 authority, non-usurping from shareholders 102–3 board of directors 76, 94–5, 154 decision making arm 102, 103–4 delegation of power 103–4 management power 137 contract with company–secretary–­ directors 52–3 de facto directors, case ­examples 100, 101 definition 96 directors’ list 38 directors’ meetings 104–5 duties common law duty 85 duty owed to company 109 fiduciary duty 109 Percival v Wright 109 to shareholders 109–10 statutory duty of care 85 function versus job title 100 non-executive directors 97, 122 Commonwealth Bank of Australia v Eise and Friedrich 122 duty elements 122–6 Morley v Statewide Tobacco Services Ltd 122 removal from office—statutory conditions 101 s 254T non-compliance 85 dividend payment 85 disclosure 121 corporate registers 138–41 disclosure documents—fundraising 87–90 ‘honest disclosure’—promoters 36 dispute resolute, takeover dispute resolution—Takeovers Panel 29 dividends 77 fixed percentage dividend (shares aspect) 77 payment 84–5 by profit (not capital) 84 sacrifice for weighted voting rights 77–8 duty not to misuse information 121 duty of care, skill and diligence all officers, AWA Ltd v Daniels t/a Deloitte Haskins & Sells 113

breach defences business judgment rule 113 delegation defence 113 the reliance defence 113 Re City Equitable Fire Insurance Co Ltd 113 duty to act for proper purpose 115 duty to act in good faith 116, 117 objective test for breach 116 Re Smith and Fawcett Ltd 116 duty to avoid conflicts of interest 120–1 duty to exercise care and diligence 117, 120 ASIC v Healy 119 economy, effect of problematic company law regimes on 19 employees common law duty of fidelity 96–7 definition 96–7 employee share schemes 82 vicarious liability of companies for 67 equal access scheme 82 equity 74, 76 action based on 129–30 case law development 1 Corporations Act/equitable principles/ common law overlap 111–12 equity–debt balance 85 officers’ duties, equitable duties 113–16 executive officers, definition 97 external administration 153–4 types of 164 Federal Court class actions 145 Federal Government ASIC budget 28 state referral of powers to 21–3 Federal Parliament Commonwealth legislative power 19 division of powers 2 Federation (1901) 19 fiduciary duty 9–10, 113–14 Hospital Products Ltd v United States Surgical Corp 114 joint venturers deemed partners 10 parts 114–15 of promoters 36 statutory reinforcement 9 finance debt finance, definition 85–6 financial assistance 83–4

INDEX

financial assistance, Darvall v North Sydney Brick and Tile Co Ltd 83–4 Financial Reporting Council (FRC) 30 Financial Services Reform Act 2001 (Cth) 126 First Corporate Law Simplification Act 1995 (Cth) 138 founders’ shares see deferred shares fraud 64–5 fundraising civil and criminal defences 92 disclosure documents 87–90 fundraising capital choices 87 misleading statements, liability for 90–1 governance corporate governance 94–5 internal governance 46–7 sole trader governance 3 government decision making 101–5 decision making arm 101–5 Federal Government 21–3, 28 federal system, division of powers 1 High Court of Australia (HCA) cross-vesting legislation invalidity ruling, Re Wakim 31–2 directors’ duty owed to company, Walker v Wimborne 109 United Dominions case—joint ventures 10 HIH collapse 97, 100 Adler v DPP (2004) 51 ACSR 1 65 poor corporate governance 95 ‘hybrid’ share classes 78 ‘in common’ requirement 5–6 agency/mutuality criterion 6 incorporated associations 16 incorporation 16 Corporations Act company creation see registration lifting the corporate veil 40–3, 122–6 under common law [examples] 41–3 under statute [example] 40–1 individuals 3 operating as sole traders 3–4 indoor management rule 70 exceptions 70–1 Northside Developments Pty Ltd v Registrar General 71

non-replacement 69 Royal British Bank v Turquand 70 statutory protection 70 injunction 148 insider trading 62, 121, 126–8 ASIC cases 128 Hooker Investments Pty Ltd v Baring Bros 127 increased penalty for 126 ‘Mark Booth and TNT options scandal’ 127 R v Rivkin 127 insolvency 159–61 Commonwealth Bank of Australia v Eise and Friedrich 113 compulsory liquidation for reasons other than 160 directors’ duty owed to creditors 109–10 Kinsela v Russell Kinsela Pty Ltd 109 disputing debt—David Grant & Co Pty Ltd v Westpac Banking Corp 161 insolvency crimes 108 insolvency presumption 161 liquidation for 161 insolvency practitioners 153 insolvent trading 121–6 incurring debt when insolvent 123–4 continuing trading 124–5 Elliott v Water Wheel Holdings Pty Ltd 123–4 Metropolitan Fire Systems v Miller 124 James Hardie case board meeting minutes 104–5 James Hardie reconstruction 155 joint ventures definition 10–11 partnership–joint venture distinction 11 venturers deemed partners fiduciary relationship 10 no fiduciary relationship 10–11 just and equitable 148, 160 liability of companies 32–5 company secretaries, criminal liability of 98–9 corporate liability 60–72 criminal liability 61–5

183

184

INDEX

liability cont. joint and several versus joint 9 limited liability 32–5, 78 misleading statements—­fundraising 90–1 ‘no liability’ 19, 33 primary and secondary (vicarious) liability, HL Bolton (Engineering) & Co Ltd v TJ Graham & Sons Ltd 61–2 of shareholders 78 trusts, liability protection of 12 unlimited liability partnerships/partners 6, 7–9, 33 sole traders 4 liquidation 78, 159–62 a compulsory process 158 ground, ‘just and equitable’ to do so 160 for insolvency 161 liquidators CALDB discipline 29 priority order of payments to creditors 162 loan capital see debt (loan) capital loan contracts (debentures), loan contracts versus security interest 86–7 majority rule, Foss v Harbottle 143–5 management 94–105 absence from management 125 management power of boards of directors 137 meetings directors’ meetings 104–5 entering minutes, timeframe 105 resolutions motion 104 general meetings, decision making and 103 voluntary administration meeting for resolution 158 members/membership a company and its members 51–2 key membership rights 137–43 members’ schemes 155 members’ voluntary winding up 158–9 membership rights 76 register of members 75 s 140(2) prohibition on further member liability 56–7 memorandum of association 46–7 ‘objects clause’ 46, 47, 54–6

mens rea (guilty intention) 63–4 Tesco Supermarkets v Nattrass 63–4 ‘mind and will’ test 61–2, 94 minimum holdings buy-backs 82 minorities (protection) 57, 145–51 mutuality concept 6 National Companies and Securities Commission (NCSC) 20 National Cooperative Scheme 19 national scheme, Corporations Act and 20–1 negligence tort 112 Lennard’s Carrying Ltd v Asiatic Petroleum Co Ltd 66 non-profit organisations, associations 13–16 non-voting ordinary shares 78 ‘objects clause’ 46, 47 non-compliance and breach of contract 56 ultra vires concept 54–6 why it is a problem 54–6 officers 94–105 becoming constructive trustees, Regal (Hastings) Ltd v Gulliver 114 definition 60, 96–7 duties common law and equitable duties 112–16 duties owed by 111–21 fiduciary duty 113–14 fundamental duties 108–11 Shafron v ASIC 99 statutory duties 116–21 mind and will of corporations 94 What remedies may be sought it breaches of duties occur? 111 Who can bring legal action against an officer? 108 To whom to directors and officers owe a duty? 109–10 on-market buy-backs 82 oppressive conduct 145–7 Wayde v NSW Rugby League 146–7 ordinary shares, voting rights 77 organic theory 101–4 decision making and 101–5 pari passu rule 162 parliament

INDEX

Federal Parliament see Federal Parliament specified powers 1 participating preference shares 78 partly paid shares 78 Partnership Acts ‘business’; ‘carry on’ statutory requirements 5 ‘in common’ statutory requirements 5–6 ‘partnerships’ definitions, essential ­existence elements 4–6 recognition of partners 7 requisite view of profit intention 6 partnerships 1–16 agency relationship 6 essential elements for partnerships carrying on a business 5, 7 ‘in common’ 5–6, 7 profit, view of 6, 7 establishment 6 knowledge of 8 legal issues 4–10 liability contractual 8–9 of partners to outsiders 7–9 torts 9 unlimited liability 6, 33 partners advantages/disadvantages 10 authority 8 continuing fiduciary duty—Chan v Zacharia 10 express/implied ratification 8 as principals 5 relationships between 9–10 Partnership Acts definitions 4–6 partnership–joint venture distinction 11 rights and obligations mutuality 6 personal claims 145 power abuse of 42–3 board of directors, delegation of power 103–4 borrowing power 86 Commonwealth legislative power 19 division of powers 1–2 management power of boards of directors 137 partners, binding power of 8 partners’ liability, binding power 8

powers and duties, receivers 156–7 referral of powers, Corporations Act and 21–3 residual powers 1 specified powers 1 ultra vires concept 54–6 precedent, doctrine of (case law) 31–2 preference shares aspects fixed percentage dividend 77 preferred return of capital on winding up 77 primary liability, primary and secondary (vicarious) liability, distinction 61 profit ad hoc profit 10 disclosure 36 non-profit organisations 13–16 secret profit—Gluckstein v Barnes 36 view of profit intention— partnerships 6 promoters company registration a benefit? 36 contractual liability 39 corporate name choice issues 37 definition 35–6 fiduciary duty 36 proper purpose 76, 78, 115, 142 proprietary companies 32 classification criteria 35 decision making 103 definition 33–4 replaceable rules bias towards 51 proxy appointment 51 protection common law protection—Gambotto case 57–8 indoor management rule/statutory protection 70 of minorities 57 Foss v Harbottle 143–5 statutory minority protection 145–51 of shareholders 136–51 ss 232—234 protection of minorities 57 third party protection rules 69–71 trusts, liability protection of 12 public companies 32 company secretary requirement 97–9 definition 35

185

186

INDEX

ratification 8, 68–9 see also contracts receivership 154–7, 164 ASIC notification 156 definition 154 examples 156 receiver and managers, appointment and responsibility 156 receivers appointment and responsibility 155–6 common law duty to act in good faith 156 powers and duties 156–7 reconstructions definition 154–5 example—James Hardie reconstruction 155 procedure 155 see also voluntary administration redeemable preference shares 78 redemption of redeemable preference shares 80 registration 35–9 consequences 39–40 pre-registration contracts 38–9 see also promoters regulation, corporate regulation, National Companies and Securities Commission 20 reliance defence 125 remedies 111, 128–34 replaceable rules 46, 61, 76, 100, 103, 104 bias towards proprietary companies 51 corporate constitutions and 46–51 definition 48–51 differing applications (to companies) 47 proxy appointment 51 resolutions (director) 104 rights key membership rights 137–43 membership rights 76 ordinary shares, voting rights of 77–8 right of inspection—company records, Rossington Pty Ltd v Lion Nathan Ltd 139

that come with shares 51–2 Eley v Positive Government Security Life Assurance Co 52 rule books (constitutions) 46 sanctions 111, 128–34 schemes of arrangement 154–7, 164 approval 155 binding all creditors/members 155 board of directors initiation 154 case example—Re Theatre Freeholds Ltd 155 definition 154–5 procedure 155 double majority (creditor) approval 155 purposes binding agreement with creditors 154 financial reconstruction part 154 secondary (vicarious) liability 66–7 Lloyd v Grace, Smith & Co 66 primary and secondary (vicarious) liability, distinction 61 security interests, loan contracts versus security interest 86–7 selective buy-backs 82–3 separate legal entity principle 39–40, 45, 60, 94, 102–3 share capital (equity) 74, 76 dividend 84–5 financial assistance 83–4 maintenance and exceptions 79–85 principle of capital maintenance 79 redemption of redeemable preference shares 80 reduction of share capital 80, 84 variation—scheme of arrangement 155 shareholders cannot usurp director authority Automatic Self-Cleansing Filter Syndicate Co v Cunninghame 104 boards, disagreement with 104 John Shaw & Sons (Salford) Ltd v Shaw 102–3 company members 75 ceasing membership 75–6

INDEX

‘contributories’ on company liquidation 78 in deadlock 148 directors’ duties to 109–10 Brunninghausen v Glavanics 110 dividends ‘fair and reasonable’ condition 84 receipt of 77 return on investment 84–5 liabilities of, limited liability protection 78 ‘mum and dad’ shareholders 137 protection 136–51 self-interest 142 special rights cannot be denied 145 shares CHESS ‘virtual ownership’ 75 problems—Kokotovich 75 issue for proper purpose 76 limited shares companies 32, 75 ownership 75, 78 rights that come with 51–2 share buy-backs 80–3 types ‘hybrid’ classes 78 ordinary, preference and deferred 77–8 valid transfer—Ku v Song and Others 23 value of, ‘par value’ 76 Simplification Task Force, abolition of memorandum and articles 46 sole traders governance/regulation 3 legal requirements 3–4 structure, advantages/ disadvantages 3 taxation issues (limited) 4 unlimited liability 4 trader–business non-distinction 3 solvency declaration of 158–9 reasonable expectation of solvency 125 stare decisis see precedent, doctrine of state parliaments, residual powers 1 states Companies Code 20 division of powers 2 Uniform Companies Acts 19

super-voting shares 78 suspicion 71 syndicates see joint ventures Takeovers Panel, role in takeover dispute resolution 29 taxation ‘income splitting’ 12 unlimited liability partnerships 6 sole traders 4 territories Companies Code 20 division of powers 2 Uniform Companies Acts 19 territory parliaments, residual powers 1 third party protection 69–71 indoor management rule 70 statutory protection 70 tort law corporate liability under 66–7 litigation limits 67 negligence tort 66, 112 partners’ joint and several liability 9 transactions, voidable transactions 162–3 transparency 133–4 trusts benefits, disadvantages and attributes 12 definition 11–13 elements 11–12 fiduciary relationship 12 ultra vires doctrine 54–6 restrictive nature 55 Uniform Companies Acts 19 unincorporated associations 13–16 contractual liability long-term contract invalidity 15 medium/long-term contracts 14 limited member liability 15 non-separate legal entity 16 structure 14 unlegislated—general law regulation 13 vicarious liability 61 voidable transactions 162–3 voluntary administration (VA) 157–8, 164 administrator appointment and effect 157

187

188

INDEX

voluntary administration (VA) cont. conclusion of 158 examples 157 intention—trading out of difficulty 157 voluntary winding up 158–9 creditors’ voluntary winding up 159 members’ voluntary winding up 158–9 voting corporate constitutions, amendments 56 voting rights 77–8, 142–3

white-collar crime 65 winding up 147–8, 158–9, 164 Ebrahimi v Westbourne Galleries Ltd 147 grounds 161 members’ voluntary winding up 158–9 a voluntary process 158

Learn how to link the key concepts from your lectures, textbooks and tutorials to get the most from your study, improve your knowledge of law and develop legal problem-solving skills. This guidebook will help you navigate through the fundamental points of business organisations law using:

Business Organisations Law GUIDEBOOK

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Marina Nehme is a Senior Lecturer in the Faculty of Law, University of New South Wales.

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Michael A Adams is Dean of the School of Law, University of Western Sydney.

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Business Organisations Law GUIDEBOOK

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Michael A Adams Marina Nehme