Corporations & Financial Markets Law. [7 ed.] 9780455237947, 0455237948

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CORPORATIONS AND FINANCIAL MARKETS LAW

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CORPORATIONS AND FINANCIAL MARKETS LAW

PAUL REDMOND AM Sir Gerard Brennan Professor Faculty of Law, University of Technology Sydney Emeritus Professor Faculty of Law, University of New South Wales

SEVENTH EDITION

LAWBOOK CO. 2017

Published in Sydney by Thomson Reuters (Professional) Australia Limited ABN 64 058 914 668 19 Harris Street, Pyrmont, NSW First edition Second edition Third edition Fourth edition Fifth edition Sixth edition

.................................................. 1988 .................................................. 1992 .................................................. 2000 .................................................. 2005 .................................................. 2009 .................................................. 2013

National Library of Australia Cataloguing-in-Publication entry Redmond, Paul. Corporations and financial markets law / Paul Redmond AM. 7th ed. Includes index. ISBN 978 0 455 23794 7 Corporation Law—Australia. © 2017 Paul Redmond This publication is copyright. Other than for the purposes of and subject to the conditions prescribed under the Copyright Act, no part of it may in any form or by any means (electronic, mechanical, microcopying, photocopying, recording or otherwise) be reproduced, stored in a retrieval system or transmitted without prior written permission. Inquiries should be addressed to the publishers. All legislative material herein is reproduced by permission but does not purport to be the official or authorised version. It is subject to Commonwealth of Australia copyright. The Copyright Act 1968 permits certain reproduction and publication of Commonwealth legislation. In particular, s 182A of the Act enables a complete copy to be made by or on behalf of a particular person. For reproduction or publication beyond that permitted by the Act, permission should be sought in writing. Requests should be submitted online at www.ag.gov.au/cca, faxed to (02) 6250 5989 or mailed to Commonwealth Copyright Administration, Attorney-General’s Department, Robert Garran Offices, National Circuit, Barton ACT 2600. Editor: Lara Weeks Product Developer: Elizabeth Gandy Publisher: Robert Wilson Typeset by Thomson Reuters (Professional) Australia Pty Ltd Printed by Ligare Pty Ltd, Riverwood, NSW

This book has been printed on paper certified by the Programme for the Endorsement of Forest Certification (PEFC). PEFC is committed to sustainable forest management through third party forest certification of responsibly managed forests. For more info: http://www.pefc.org

PREFACE The preface to the first edition of this book quoted Lord Wedderburn of Charlton, doyen of English company and labour law scholars, describing company law as “that part of our law which sets down conditions upon which personified aggregations of capital may operate in our society”. Those words emphasise that corporations law, in common with other legal ordering, derives its purpose and legitimacy from the social ends which it serves. This seventh edition is again animated by the belief that the study of the law governing corporations and financial markets involves not only close attention to the increasingly voluminous statute, case law and administrative and market regulation but also to underlying values, policies and theories, and the contexts in which law and regulation operate. Corporations law grants entity status to aggregations of capital and regulates relations between those who supply capital, those who manage the capital fund, the third parties with whom they deal and the societies and communities who support them and bear the impacts of their operations and activities. As the corporation has become the principal vehicle for economic relations, employment generation and wealth accumulation, corporations law has assumed a social significance to match its technical complexity. Adolph Berle’s claim over 60 years ago that corporations law would become the constitutional law of the new economic state no longer seems fanciful, if it ever did. This book considers not only the legal rules and structures created in response to the technical problems of large-scale enterprise but also the social issues posed by the rise of the corporation in this age of economic and cultural globalisation which it has so powerfully shaped. Financial markets have assumed a social significance to match their size and technical complexity. The growth of compulsory occupational superannuation and its investment through financial markets strengthens the social interest in, and financial dependency upon, their operation. Adapting Keynes, Peter Drucker claimed in the year before the Australian compulsory superannuation scheme was introduced that we are all pension fund socialists now. The financial crisis of 2008 and its lingering aftermath highlight the stake that so many Australians who think themselves remote and disconnected from financial markets have in their success and integrity. Of course, the book also recognises that most companies are engaged in small or medium enterprise in which those who supply or organize the operating capital also manage or direct the business and often work closely in its operations. They do not resort to public capital markets and their ownership interests may not be traded. This diversity of company types, with the distinct legal, financial and social issues that they raise, adds to the richness of the subject for those who study and work in the discipline. The title highlights the twin concerns of the book—the core principles of corporations law and the advanced treatment of corporate finance, corporate fundraising, financial market regulation and takeovers. This book is primarily addressed to law students. The book has at its core a personal communication born of deep affection for students, the fruit of so many happy years spent in legal education. I hope that they will sense in these pages both the concern for their learning and the love of the subject which have shaped the book. I am especially grateful to the generations of law students at the University of New South Wales and the University of Technology Sydney from whom I have learned so much. This book bears their stamp on almost every page. I am also deeply grateful to colleagues in the supportive community of Australian corporate law scholars; they have stimulated, inspired and encouraged me for well over a quarter-century.

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Corporations and Financial Markets Law

At Thomson Reuters, I am particularly grateful to have had Lara Weeks as editor. Lara’s editorial skills have been exemplary, with an eye for detail and advocacy for clear expression. She has been a gracious companion on the project and the final work bears her mark. Elizabeth Gandy, as academic product developer, has been singularly effective in ensuring that the project did not falter despite obstacles. I am grateful for her encouragement, support and sometime forbearance. I am also grateful to Luke Redmond for permission to use his photography on the book cover. Finally, the greatest debt in this and all previous editions is to my wife, Ann. Her support is the book’s cornerstone, as it is mine.

PAUL REDMOND 22 May 2017

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TABLE OF CONTENTS Preface .............................................................................................................................................. v Table of Cases .................................................................................................................................. ix Table of Statutes .......................................................................................................................... xxxv

1: Partnership ............................................................................................................ .. 1 2: The Historical, Institutional and Social Context of Corporations Law ......... 25 3: The Corporate Life Cycle .................................................................................... 101 4: Some Consequences of Corporate Personality ............................................. .. 161 5: Directors and Managers ..................................................................................... 227 6: Shareholders Acting Collectively: The Company in General Meeting ......... 347 7: The Duties and Liabilities of Directors and Managers ................................ .. 383 8: Shareholder Remedies ........................................................................................ 579 9: Corporate Finance ............................................................................................... 673 10: Corporate Fundraising ................................................................................... .. 771 11: Financial Market Regulation ......................................................................... .. 827 12: Takeovers ............................................................................................................ 913 Index .................................................................... .. ................................................................. 1009

vii

TABLE OF CASES [Where an extract from a case is reproduced the name of the case and the paragraph number on which the reproduction commences appears in bold type.] A .au Domain Administration Ltd v Domain Names Australia Pty Ltd [2004] FCA 424 ................ 10.230 A & BC Chewing Gum Ltd, Re [1975] 1 WLR 579 .......................................................... 5.195, 8.162 A Company, Re [1983] 1 WLR 927 ............................................................................................ 8.145 A Company, Re [1985] BCLC 333 ............................................................................................... 4.70 A Company, Re (1986) 2 BCC 99,191 ...................................................................................... 8.145 A Company, Re [1987] BCLC 133 ............................................................................................. 8.220 A Company, Re [1987] BCLC 82 ............................................................................................... 8.125 A F & M E Pty Ltd v Aveling (1994) 14 ACSR 499 ........................................................................ 3.11 A P Smith Mfg Co v Barlow 98 A 2d 581 ................................................................................... 2.200 AAPT v Cable & Wireless Optus Ltd (1999) 32 ACSR 63 .......................................................... 10.115 ABC Developmental Learning Centres Pty Ltd v Wallace [2007] VSCA 138 ................................ 4.182 ABC Plastik Pty Ltd, Re (1975) 1 ACLR 446 ............................................................................... 5.194 AC Acquisitions Corp v Anderson, Clayton & Co 519 A 2d 103 ................................................. 7.115 ACCC v Signature Security Group Pty Ltd [2003] FCA 3; (2003) ATPR 41-908 ........................ 10.230 ACCC v Universal Music Australia Pty Limited (No 2) [2002] FCA 192 ....................................... 5.235 ASC v Bank Leumi Le-Israel (Switzerland) (1996) 21 ACSR 474 ............................................... 12.220 ASC v AS Nominees Ltd (1995) 133 ALR 1; 18 ACSR 459 ...................................... 7.50, 8.145 ASC v Gallagher (1993) 10 ACSR 43 .................................................................................. 7.75, 7.95 ASC v Graco (1991) 5 ACSR 1 ................................................................................................... 11.95 ASC v Marlborough Gold Mines Ltd (1993) 10 ACSR 230 ........................................................... 2.85 ASC v Nomura International Plc (1998) 29 ACSR 473 ............................................................. 11.195 ASC v SIB Resources NL (1991) 5 ACSR 411 ................................................................................ 3.70 ASIC v Adler (2002) 168 FLR 253; 41 ACSR 72; [2002] NSWSC 171 ........ 5.30, 5.230, 5.235, 7.75, 7.82, 7.89, 7.95, 7.105, 7.130, 9.340, 9.345 ASIC v Axis International Management Pty Ltd (No 5) (2011) 81 ACSR 631 ...... 10.65, 10.70, 10.140 ASIC v Burke [2000] NSWSC 694 ........................................................................................... 11.120 ASIC v Burnard (2007) 64 ACSR 360 ....................................................................................... 11.120 ASIC v Carey (2006) 57 ACSR 307 .......................................................................................... 11.120 ASIC v Cassimatis (No 8) [2016] FCA 1023 ........................................................................ 7.75, 7.82 ASIC v Doyle (2001) 38 ACSR 606 .............................................................................................. 7.82 ASIC v Edensor Nominees Pty Ltd (2001) 177 ALR 329 ............................................................... 2.85 ASIC v Fortescue Metals Group Ltd (2011) 81 ACSR 563 ............................................... 7.105, 7.110 ASIC v Healey (2011) 83 ACSR 484 ................................................................. 5.30, 7.89, 7.100 ASIC v Healey (No 2) (2011) 196 FCR 430 ............................................................................... 7.100 ASIC v Ingleby (2013) 93 ACSR 274 ........................................................................................... 7.65 ASIC v Kingsley Brown Properties Pty Ltd [2005] VSC 506 ........................................................ 8.145 ASIC v Macdonald (No 11) (2009) 71 ACSR 368 ...................................................................... 7.100 ASIC v Mariner Corp Ltd (2015) 106 ACSR 343 ............................................................. 7.86, 12.135 ASIC v Mauer-Swisse Securities Ltd (2002) 42 ACSR 605 .......................................................... 8.135 ASIC v Maxwell (2007) 59 ACSR 373 ............................................................................... 7.86, 7.250 ASIC v Parkes [2001] 38 ACSR 355 ........................................................................................... 5.235 ASIC v Petsas [2005] FCA 88 ................................................................................................... 11.250 ASIC v Plymin (No 1) (2003) 175 FLR 124 ................................................................................ 7.150 ASIC v Reid (2005) 55 ACSR 152 .............................................................................................. 5.238 ASIC v Rich (2003) 44 ACSR 341 ................................................................................................ 7.82 ASIC v Rich (2009) 236 FLR 1; 75 ACSR 1 ............... 5.30, 7.75, 7.82, 7.86, 7.105, 7.110, 7.130 ASIC v Soust [2010] FCA 68 .................................................................................................... 11.195 ASIC v Southcorp Ltd (No 2) (2003) 130 FCR 406 .................................................................. 11.150 ASIC v Terra Industries Inc (1999) 163 ALR 122 ...................................................................... 12.105 ASIC v Vines (2007) 62 ACSR 1 ................................................................................................... 7.82 ASIC v Vizard (2005) 54 ACSR 394 ........................................................................................... 5.230 ix

Corporations and Financial Markets Law

ASIC v Warrenmang Ltd (2007) 63 ACSR 623 ............................................................................. 7.86 ASIC v v Green Pacific Energy Ltd [2006] FCA 1254 .................................................................. 8.177 AWA Ltd v Daniels t/as Deloitte Haskins & Sells (1992) 7 ACSR 759 .................................... 7.80, 7.90 AWB Ltd v ASIC [2008] FCA 1877 ............................................................................................. 11.90 AWB Ltd, Re (2008) 68 ACSR 374 ............................................................................................... 7.65 Aas v Benham [1891] 2 Ch 244 ................................................................................................ 7.480 Abbey Malvern Wells Ltd v Ministry of Local Government and Planning [1951] Ch 728 .............. 4.45 Aberdeen Railway Co v Blaikie Bros (1854) 1 Macq 461 ..................................... 1.150, 1.155, 7.360 Adams v ASIC (2003) 46 ACSR 68 ............................................................................................ 5.237 Adams v Adhesives Ltd (1932) 32 SR (NSW) 398 ........................................................................ 6.35 Adams v Cape Industries Plc [1990] 2 WLR 657 ............................................................. 4.105, 4.127 Adams v Yindjibarndi Aboriginal Corporation RNTBC [2014] WASC 467 ..................................... 6.35 Addlestone Linoleum Co Ltd, Re (1887) 37 Ch D 191 ................................................. 8.123, 10.225 Adler v ASIC (2003) 179 FLR 1; [2003] NSWCA 131 .................................. 5.235, 7.95, 7.440, 9.345 Adler v ASIC [2004] HCATrans 182 ........................................................................................... 5.235 Adler v DPP (Cth) (2004) 51 ACSR 1 ........................................................................................... 7.65 Adsteam Building Industries Pty Ltd v The Queensland Cement and Lime Co Ltd (No 4) (1984) 2 ACLC 829 ................................................................................................... 12.65, 12.75 Advance Bank, Re (1997) 22 ACSR 513 .................................................................................... 9.270 Advance Bank Australia Ltd v FAI Insurances Ltd (1987) 12 ACLR 118 ................................ 6.65, 6.85 Affleck v ASIC [2015] QSC 236 ................................................................................................. 5.237 Agriculturist Cattle Insurance Co, Re; Ex parte Spackman (1849) 1 Mac & G 170; 41 ER 1228 .................................................................................................................................... 8.145 Agriculturist Cattle Insurance Co (Baird’s Case), Re (1870) 5 Ch App 725 ................................... 2.45 Airpeak Pty Ltd v Jetstream Aircraft Ltd (1997) 23 ACSR 715 ..................................................... 8.135 Airservices Australia v Ferrier (1996) 185 CLR 483 ..................................................................... 3.210 Alati v Kruger (1955) 94 CLR 216 ........................................................................................... 10.225 Albazero, The [1977] AC 774 .................................................................................................... 4.105 Albert E Touchet Inc v Touchet 163 NE 184 (Mass 1928) ............................................................ 6.20 Albert Gardens (Manly) Pty Ltd v Mercantile Credits Ltd (1973) 131 CLR 60 ............................ 5.380 Albert Street Properties Ltd, Re (1997) 23 ACSR 318 ...................................................... 9.240, 9.255 Albion Insurance Co Ltd v Government Insurance Office (NSW) (1969) 121 CLR 342 ............... 3.120 Alexander v Automatic Telephone Co [1900] 2 Ch 56 .............................................................. 7.225 Alexander v Simpson (1889) 43 Ch D 139 ............................................................................... 6.105 Alexander Ward & Co Ltd v Samyang Navigation Co Ltd [1975] 1 WLR 673 ............................ 5.150 Allen v Atalay (1993) 11 ACSR 753 ........................................................................................... 8.135 Allen v Gold Reefs of West Africa [1900] 1 Ch 656 .............................. 5.245, 7.270, 8.15, 8.45, 8.63 Allen v Hyatt (1914) 30 TLR 444 ....................................................................... 7.540, 7.542, 11.260 Allied Mining and Processing ltd v Boldbow Pty Ltd (2002) 26 WAR 355 .................................. 5.240 Amalgamated Pest Control Pty Ltd v McCarron (1994) 12 ACLC 171 ....................................... 5.240 Ammonia Soda Co Ltd v Chamberlain [1918] 1 Ch 266 ............... 9.365, 9.380, 9.382, 9.395 Ananda Marga Pracaraka Samgha Ltd v Tomar (No 6) (2013) 94 ACSR 199 ............................. 8.210 Anderson v James Sutherland (Peterhead) Ltd [1941] SC 203 ................................................... 5.245 Anderson’s Case (1877) 7 Ch D 75 ........................................................................................... 9.220 Andrews v Mockford [1896] 1 QB 372 ................................................................................... 10.225 Anfrank Nominees Pty Ltd v Connell (1989) 1 ACSR 365 .......................................................... 3.200 Angas Law Services Pty Ltd (in liq) v Carabelas (2005) 226 CLR 507 ..................... 5.192, 7.75, 7.500 Anglo-French Co-operative Society; ex p Pelly (1882) 21 Ch D 492 .......................................... 7.225 Ansett v Butler Air Transport (No 1) (1958) 75 WN (NSW) 299 ................................................ 8.125 Ansett, Re (1990) 9 ACLC 277 .................................................................................................. 5.237 Antonio Gramsci Shipping Corp v Stepanovs [2011] EWHC 333 (Comm); [2011] 1 Lloyd’s Law Reports 647 .................................................................................................................. 4.105 Aqua-Max Pty Ltd v MT Associates Pty Ltd (2001) 3 VR 473 ..................................................... 5.270 Archibald Howie Pty Ltd v Commissioner of Stamp Duties (NSW) (1947) 77 CLR 143 ................ 3.95 Argentum Reductions (UK) Ltd, Re [1975] 1 WLR 186 .............................................................. 5.150 Ariadne Australia Ltd, Re (1990) 2 ACSR 791 .............................................................................. 6.35 Aronson v Lewis 473 A 2d 805 (Del 1984) ................................................................................ 7.120 Arthur Guinness, Son & Co (Dublin) Ltd v Owners of the Motor Vessel Freshfield (The Lady Gwendolen) [1965] P 294 ................................................................................................... 4.155 Ascot Investments Pty Ltd v Harper (1981) 148 CLR 337 ............................................................ 4.42 x

Table of Cases

Ashburton Oil NL v Alpha Minerals NL (1971) 123 CLR 614 ..................................................... 8.125 Atkins v St Barbara Mines Ltd (1997) 15 ACLC 800 .................................................................... 6.85 Attorney-General v Davey (1741) 2 Atk 212; 26 ER 531 ................................................... 3.150, 5.95 Attorney-General (Can) v Standard Trust Co of New York [1911] AC 498 .................................. 3.240 Attorney-General (Cth) v Alinta Ltd (2008) 64 ACSR 507 .......................................................... 12.30 Attorney General (Belize) v Belize Telecom Ltd [2009] 1 WLR 1485 .......................................... 5.327 Atwool v Merryweather (1867) LR 5 Eq 464 ............................................................................... 8.25 Augold NL, Re [1987] 2 Qd R 297 ............................................................................................ 5.295 August Investments Pty Ltd v Poseidon Ltd (1971) 2 SASR 71 .................................................. 9.305 Ausdoc Group Ltd [2002] ATP 9 .............................................................................................. 12.180 Australasian Centre for Corporate Responsibility v Commonwealth Bank of Australia [2016] FCAFC 80 .............................................................................................................................. 6.65 Australasian Memory Pty Ltd v Brien (2000) 200 CLR 270 ........................................................ 3.190 Australasian Oil Exploration Ltd v Lachberg (1958) 101 CLR 119 ................................... 9.387, 9.392 Australasian Temperance and General Life Assurance Society Ltd v Howe (1922) 31 CLR 290 ..... 4.20 Australia and New Zealand Banking Group Ltd v Frenmast Pty Ltd [2013] NSWCA 459 ............ 5.360 Australian Capital Television Pty Ltd v Commonwealth (1992) 177 CLR 106 ............................... 4.20 Australian Capital Television Pty Ltd v Minister for Transport and Communications (1989) 7 ACLC 525 ............................................................................................................................ 5.360 Australian Coal & Shale Employees’ Federation v Smith (1937) 38 SR (NSW) 48 ............... 2.10, 8.75 Australian Consolidated Investments Ltd v Rossington Holdings Pty Ltd (No 2) (1992) 7 ACSR 341 .......................................................................................................................... 12.200 Australian Fixed Trusts Pty Ltd v Clyde Industries Ltd (1959) 59 SR (NSW) 33 ......... 8.60, 8.63, 8.170 Australian Growth Resources Corp Pty Ltd v van Reesema (1988) 13 ACLR 261 ........................ 7.250 Australian Hydrocarbons NL v Green (1985) 10 ACLR 72 .......................................................... 9.275 Australian Innovation Ltd v Petrovsky (1996) 21 ACSR 218 ....................................... 6.15, 6.35, 7.95 Australian Institute of Fitness Pty Ltd v Australian Institute of Fitness (Vic/Tas) (No 3) (2016) 109 ACSR 369 .......................................................................................................... 8.195, 8.210 Australian Leisure & Hospitality Group Limited 01 [2004] ATP 19 ............................................ 12.195 Australian Metropolitan Life Assurance Co Ltd v Ure (1923) 33 CLR 199 ..... 7.235, 7.260, 8.125 Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame [1906] 2 Ch 34 .... 5.125, 5.135, 5.192, 7.10, 7.285, 8.75 Aztech Science Pty Ltd v Atlanta Aerospace (Woy Woy) Pty Ltd (2005) 55 ACSR 1 ....................... 3.75

B B v B (Matrimonial Proceedings: Discovery) [1978] Fam 18 ........................................................ 4.42 Back 2 Bay 6 Pty Ltd, Re (1994) 12 ACSR 614 ........................................................................... 8.210 Badeley v Consolidated Bank (1888) 38 Ch D 238 ......................................... 1.20, 1.40, 1.75 Bagnall v Carlton (1877) 6 Ch D 371 ....................................................................................... 3.220 Bailey v New South Wales Medical Defence Union Ltd (1995) 18 ACSR 521;132 ALR 1 ............ 5.245, 5.263 Baillie v Oriental Telephone and Electric Co Ltd [1899] 1 Ch 870 ............................................... 6.95 Baillie v Oriental Telephone and Electrical Co Ltd [1915] 1 Ch 503 ............................................. 8.85 Bain & Co Nominees Pty Ltd v Grace Bros Holdings Ltd (1983) 7 ACLR 777 .................... 6.90, 6.105 Baird v Henry Lees 1924 SC 83 ................................................................................................. 8.150 Baker v Palm Bay Island Resort Pty Ltd (No 2) [1970] Qd R 210 ................................................ 7.387 Ballantyne v Raphael (1889) 15 VLR 538 .................................................................................... 1.20 Ballarat Goldfields NL [2002] ATP 7 ......................................................................................... 12.180 Ballard v Multiplex Ltd (2008) 68 ACSR 208 ............................................................................. 8.110 Bamford v Bamford [1968] 2 All ER 655 .......................................................... 8.30, 8.35, 8.37 Bamford v Bamford [1970] Ch 212 ........................................................................ 5.190, 8.25, 8.30 Bancorp Investments Ltd v Primac Holdings Ltd (1984) 9 ACLR 263 ....................... 6.90, 6.95, 8.125 Bank of Tokyo Ltd v Karoon (Note) [1987] AC 45 ....................................................................... 4.65 Bank of Western Australia Ltd v Ocean Trawlers Pty Ltd (1995) 16 ACSR 501 ............................ 12.75 Banque Brussels Lambert SA v Australian National Industries Ltd (1989) 21 NSWLR 502 ........... 4.127 Barclays Finance Holdings Ltd v Sturgess (1985) 3 ACLC 662 ................................................... 5.360 Barnes v Addy (1874) LR 9 Ch App 244 ..................................................... 1.155, 7.30, 7.472, 9.350 xi

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Barnes & Co Ltd v Sharpe (1910) 11 CLR 462 ............................................................................ 4.20 Barrack Mines Ltd v Grants Patch Mining Ltd (No 2) [1988] 1 Qd R 606 .................................. 5.295 Barron v Potter [1914] 1 Ch 895 ................................................................................... 5.140, 5.275 Basic v Levinson 485 US 224 (1988) .......................................................................... 10.202, 12.200 Bateman v Newhaven Park Stud Ltd (2004) 48 ACSR 454; [2004] NSWSC 392 ........................ 11.65 Bateman v Newhaven Park Stud Ltd (2004) 49 ACSR 597; [2004] NSWSC 566 ........................ 12.75 Bay Marine Pty Ltd v Clayton Country Properties Pty Ltd (No 2) (1987) 5 ACLC 38 .................... 4.20 Beattie v E & F Beattie Ltd [1938] Ch 708 ................................................................................. 8.123 Beck v Weinstock (2013) 93 ACSR 251 ............................................................................ 9.75, 9.225 Beconwood Securities Pty Ltd v ANZ Banking Group Ltd (2008) 66 ACSR 116 ........................ 11.176 Beecham Group Ltd v Bristol Laboratories Pty Ltd (1968) 118 CLR 618 .................................... 8.105 Bell v Lever Bros Ltd [1932] AC 161 .......................................................................................... 7.527 Bell Group (in liq) Ltd v Westpac Banking Corp (2008) 70 ACSR 1 ............................................ 7.225 Bell Group Ltd (in liq) v Westpac Banking Corporation (No 10) (2009) 71 ACSR 300 .................. 7.70 Bellman and Western Approaches Ltd, Re (1981) 130 DLR (3d) 193 ......................................... 8.105 Belmont Finance Corp Ltd v Williams Furniture Ltd [1979] Ch 250 ........................................... 4.178 Belmont Finance Corp Ltd v Williams Furniture Ltd (No 2) [1980] 1 All ER 393 .............. 7.455, 9.350 Bennett, Ex parte (1805) 10 Ves Jun 381; 32 ER 893 ................................................................. 7.375 Bennetts v Board of Fire Commissioners of NSW (1967) 87 WN (Pt 1) (NSW) 307 ................... 7.337 Berkey v Third Ave Ry Co 155 NE 58 ........................................................................................... 4.45 Berlei Hestia (NZ) Ltd v Fernyhough [1980] 2 NZLR 150 ........................... 5.300, 7.50, 7.337, 7.527 Bernhardt v Beau Rivage Pty Ltd (1989) 15 ACLR 160 .............................................................. 8.145 Biala Pty Ltd v Mallina Holdings Ltd (1994) 15 ACSR 1 ............................................................... 7.95 Biggerstaff v Rowatt’s Wharf Ltd [1896] 2 Ch 93 ........................................................... 5.327, 5.355 Billabong International Ltd [2013] ATP 9 ................................................................................. 12.100 Birch v Cropper (1889) 14 App Cas 525 ................................................................. 9.80, 9.90, 9.100 Bird Precision Bellows Ltd, Re [1986] 2 WLR 158 ...................................................................... 8.215 Birmingham City District Council v O [1983] AC 578 ............................................................... 5.305 Birtchnell v Equity, Trustees, Executors and Agency Ltd (1929) 42 CLR 384 ............. 1.60, 1.135, 1.140, 1.150, 1.155 Bisgood v Henderson’s Transvaal Estates [1908] 1 Ch 759 ........................................................ 8.120 Bison Ltd v Cellante [2002] VSC 504 ........................................................................................ 5.240 Black v Smallwood (1966) 117 CLR 52 ....................................................................................... 3.75 Blackburn v Industrial Equity Ltd (1976) 2 ACLR 8 .................................................................... 9.392 Blackburn v Industrial Equity Ltd (1980) ACLC 40-604 ..................................................... 7.10, 9.395 Blacktown City Council v Macarthur Telecommunications Pty Ltd (2003) 47 ACSR 391 ............ 3.190 Blisset v Daniel (1853) 10 Hare 493; 68 ER 1022 ...................................................................... 8.155 Blue Arrow plc, Re (1987) 3 BCC 618 ....................................................................................... 8.162 Bluebird Investments Pty Ltd v Graf (1994) 13 ACSR 271 ........................................................... 4.90 Bluebottle UK Ltd v DCT (2007) 232 CLR 598 .......................................................................... 9.360 Bodikian v Sproule (2009) 72 ACSR 598; [2009] NSWSC 599 ................................................... 5.192 Bognor Regis UDC v Campion [1972] 2 QB 169 ......................................................................... 4.20 Bond v Barrow Haematite Steel Co [1902] 1 Ch 353 ..................................................... 9.360, 9.382 Borax Co, Re [1901] 1 Ch 326 .................................................................................................. 5.105 Boughey v R (1986) 161 CLR 10 ............................................................................................. 11.210 Boulting v Association of Cinematograph, Television and Allied Technicians [1963] 2 QB 606 .... 7.337, 7.387, 7.510 Bowman v Secular Society Ltd [1917] AC 406 ............................................................................ 3.70 Boyd Knight v Purdue [1999] 2 NZLR 278 .............................................................................. 10.202 Bradley Egg Farm Ltd v Clifford [1943] 2 All ER 378 ......................................................... 1.125, 3.25 Bray v Ford [1896] AC 44 ......................................................................................................... 1.155 Breen v Williams (1996) 186 CLR 1 ........................................................................................... 7.225 Brick and Pipe Industries Ltd v Occidental Life Nominees Pty Ltd (1990) 3 ACSR 649 ............... 5.265 Brick and Pipe Industries Ltd v Occidental Life Nominees Pty Ltd (1991) 6 ACSR 464 .................................................................................................................................... 5.365 Bridgewater Navigation Co, Re [1891] 2 Ch 317 ........................................................................ 9.90 Briess v Woolley [1954] AC 333 ................................................................................................ 7.542 Briggs v James Hardie & Co Pty Ltd (1989) 7 ACLC 841 ......................... 4.105, 4.120, 4.127 Briggs, Ex parte (1866) LR 1 Eq 483 ....................................................................................... 10.225 Bright Pine Mills Pty Ltd, Re [1969] VR 1002 .................................................................. 8.210, 8.215 xii

Table of Cases

Briginshaw v Briginshaw (1938) 60 CLR 336 .............................................................................. 7.65 British Murac Syndicate v Alperton Rubber Co [1915] 2 Ch 186 ............................................... 5.220 British Thomson-Houston Co v Federated European Bank Ltd [1932] 2 KB 176 ........................ 5.355 British and American Trustee and Finance Corp Ltd v Couper [1894] AC 399 ............................. 9.90 Broadcasting Station 2GB Pty Ltd, Re [1964-65] NSWR 1648 ................................................... 7.337 Broadway Motors Holdings Pty Ltd (in liquidation), re (1986) 6 NSWLR 45 .............................. 9.275 Broken Hill Proprietary Co Ltd v Bell Resources Ltd (1984) 8 ACLR 609 ..................................... 8.135 Brooker v Friend & Brooker Pty Ltd [2006] NSWCA 385 ........................................................... 8.145 Brookton Co-operative Society Ltd v Federal Commissioner of Taxation (1981) 147 CLR 441 .... 9.360 Browne v La Trinidad (1887) 37 Ch D 1 .................................................... 5.125, 5.270, 8.75, 8.120 Brunninghausen v Glavanics (1999) 32 ACSR 294 ............................................ 7.535, 7.542, 11.260 Brunswick NL, Re (1990) 3 ACSR 625 ....................................................................................... 8.135 Buenos Ayres Great Southern Railway Co Ltd, Re [1947] Ch 384 .............................................. 9.102 Bugle Press Ltd, Re [1961] Ch 270 .............................................................................................. 4.58 Bulawayo Market and Offices Co Ltd, Re [1907] 2 Ch 458 ............................................. 5.215, 5.225 Bulfin v Bebarfield’s Ltd (1938) 38 SR (NSW) 424 ................................................... 6.90, 6.95, 6.120 Burland v Earle [1902] AC 83 ................................................. 7.220, 7.460, 7.465, 8.75, 8.80, 8.125 Burton v Palmer [1980] 2 NSWLR 878 ...................................................................................... 9.340 Burton v Wookey (1822) 6 Madd 367; 56 ER 1131 ................................................................... 1.150 Bushell v Faith [1970] AC 1099 ...................................................................................... 5.240, 9.110 Buttonwood Nominees Pty Ltd v Sundowner Minerals NL (1986) 10 ACLR 360 .............. 6.95, 6.100 Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd (2010) 77 ACSR 410 ........ 7.40 Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd (2011) 82 ACSR 703 ......... 7.40 Byrnes v R (1995) 183 CLR 501 ................................................................................................ 7.500

C CAC v Drysdale (1978) 141 CLR 236 ................................................................................. 7.30, 7.32 CAC v Papoulias (1990) 20 NSWLR 503 ................................................................................... 7.250 CMI Ltd [2011] ATP 4 ............................................................................................................... 12.75 CMI Ltd 01R [2011] ATP 5 ........................................................................................................ 12.75 CSR Ltd v Wren (1997) 44 NSWLR 463 ..................................................................................... 4.127 Caason Investments Pty Ltd v Cao (2015) 108 ACSR 578 ....................................................... 10.202 Camden & Atlantic Railroad v Elkins 37 NJ Eq (10 Stew) 273 ...................................................... 6.20 Campaign Holdings Pty Ltd, Re (1989) 15 ACLR 762 ................................................................ 9.250 Campbell v Australian Mutual Provident Society (1908) LJPC 117 ............................................... 6.65 Campbell v Backoffice Investments Pty Ltd (2008) 66 ACSR 359 .............. 8.195, 8.210, 8.212, 8.215 Campbell v Backoffice Investments Pty Ltd (2009) 238 CLR 304 .................................. 8.145, 10.202 Campbell v Lowe’s Inc 134A (2d) 852 (Del Ch 1957) ................................................................. 6.20 Campbell v Rofe [1933] AC 91 ................................................................................................. 5.105 Campbell Printing Corp v Reid 392 US 286 (1968) ..................................................................... 4.20 Campomar Sociedad Limitada v Nike International Ltd (2000) 202 CLR 45 ............... 10.230, 11.143 Canadian Aero Service Ltd v O’Malley (1973) 40 DLR (3d) 371 ............. 1.155, 7.477, 7.490 Canadian Dredge and Dock Co Ltd v The Queen (1985) 19 DLR (4th) 314 ............... 4.160, 4.175, 4.178 Canadian Land Reclaiming and Colonizing Co, Re (1880) 14 Ch D 660 ..................................... 7.30 Cane v Jones [1980] 1 WLR 1451 ............................................................................................. 5.195 Canny Gabriel Castle Jackson Advertising Pty Ltd v Volume Sales (Finance) Pty Ltd (1974) 131 CLR 321 .......................................................................................................................... 1.20 Cape Breton Co v Fenn (1881) 17 Ch D 198 ............................................................................ 8.100 Cape Breton Co, Re (1885) 29 Ch D 795 ...................................................................... 7.385, 7.460 Capricorn Diamonds Investments Pty Ltd v Catto [2002] VSC 105 ......................................... 12.260 Capricornia Credit Union Ltd v ASIC (2007) 62 ACSR 671 .............................................. 5.110, 7.550 Caratti v Mammoth Investments Pty Ltd (2016) 113 ACSR 31 .................................................. 5.360 Caratti Holding Co Pty Ltd v Zampatti (1979) 52 ALJR 732 ............................................ 8.123, 8.160 Caratti Holdings Ltd, Re (1975) 1 ACLR 87 .................................................................... 8.123, 8.160 Cardiff Savings Bank (Marquis of Bute’s Case), Re [1892] 2 Ch 100 ............................................ 7.75 Cargill Inc v Hardin 452 F 2d 1154 (1971) .............................................................................. 11.235 Carlen v Drury (1812) 1 Ves & B 154; 35 ER 61 ........................................................................ 7.220 Carlton Cricket and Football Social Club v Joseph [1970] VR 487 .............................................. 1.125 xiii

Corporations and Financial Markets Law

Carpathian Resources Ltd v Highmoor Business Corp [2010] FCA 1294 ...................................... 6.25 Carpenter v Pioneer Park Pty Ltd (2008) 66 ACSR 564 .............................................................. 8.100 Carre v Owners Corporation Strata Plan–SP 53020 (2003) 58 NSWLR 302; [2003] NSWSC 397 ........................................................................................................................................ 8.75 Carrier Australasia Ltd v Hunt (1939) 61 CLR 534 ..................................................................... 5.263 Carruth v Imperial Chemical Industries Ltd [1937] AC 707 ....................................................... 6.105 Cashflow Finance Pty Ltd v Westpac Banking Corp [1999] NSWSC 671 ...................................... 7.95 Cassegrain v Gerard Cassegrain & Co Pty Ltd [2008] NSWSC 976 ............................................ 8.100 Cassegrain v Gerard Cassegrain & Co Pty Ltd (2012) 88 ACSR 358 ............................... 7.105, 8.210 Castlereagh Securities Ltd, Re [1973] 1 NSWLR 624 ...................................................... 6.105, 12.05 Catalano v Managing Australia Destinations Pty Ltd [2014] FCAFC 55 ...................................... 8.195 Catto v Ampol Ltd (1989) 16 NSWLR 342 ................................................................................ 9.255 Cawthorn v Keira Constructions Pty Ltd (1994) 33 NSWLR 607 ................................................ 3.190 Cayne v Global Natural Resources Plc [1984] 1 All ER 225 ........................................................ 7.290 Cayne v Global Natural Resources Plc (unreported, Chancery Division, 12 August 1982) ........................................................................................................ 7.235, 7.290 Central Piggery Co Ltd v McNicoll (1949) 78 CLR 594 .................................................... 3.95, 3.165 Chahwan v Euphoric Pty Ltd (2008) 65 ACSR 661 .................................................................... 8.100 Chan v Zacharia (1984) 154 CLR 178 ................................................ 1.60, 1.155, 7.225, 7.455 Chan Siew Lee v TYC Investment Pte Ltd [2015] 5 SLR 409 ...................................................... 5.140 Chandler v Cape plc [2012] EWCA Civ 525 .............................................................................. 4.127 Charitable Corporation, The v Sutton (1742) 2 Atk 400; 26 ER 642 .......................... 2.35, 5.95, 7.75 Charterbridge Corp Ltd v Lloyd’s Bank Ltd [1970] Ch 62 ......................................................... 4.105 Charterhouse Investment Trust Ltd v Tempest Diesels Ltd [1986] PCLC 1 ...................... 9.340, 9.345 Chequepoint Securities Ltd v Claremont Petroleum NL (1987) 11 ACLR 94 ............ 6.90, 6.95, 6.100 Chew v The Queen (1992) 173 CLR 626 ................................................................................ 11.255 Chime Corp Ltd, Re [2004] 7 HKCFA 546 ................................................................................. 8.215 Choc v Hudbay Minerals Inc 2013 ONSC 1414 ............................................................. 4.105, 4.127 Christensen v Scott [1996] 1 NZLR 273 .................................................................................... 8.110 Citizens United v Federal Election Commission 558 US 310 (2010) ............................................ 4.20 City Equitable Fire Insurance Co Ltd, Re [1925] Ch 407 ...................... 7.10, 7.75, 7.95, 7.102, 9.395 City Meat Co Pty Ltd, Re (1984) 8 ACLR 673 ...................................................... 8.145, 8.160, 9.365 Claremont Petroleum NL (No 2), Re [1990] 2 Qd R 310 ........................................................... 5.295 Clark v Dodge 269 NY 410; 199 NE 641 (1936) ....................................................................... 5.195 Clark v R (2004) 50 ACSR 592 .................................................................................................. 7.500 Clarkson Co Ltd v Zhelka (1967) 64 DLR (2d) 457 ...................................................................... 4.68 Clemens v Clemens Bros Ltd [1976] 2 All ER 268 ........................................................................ 8.63 Clements Marshall Consolidated Ltd v ENT Ltd (1988) 13 ACLR 90 .......................................... 12.90 Clifton v Mount Morgan Ltd (1940) 40 SR (NSW) 31 ................................ 5.100, 5.120, 5.135, 8.35 Coal Economising Gas Co (Gover’s Case), Re (1875) 1 Ch D 182 ............................................. 3.238 Coates v Classic Minerals Ltd [2016] WASC 371 ....................................................................... 5.295 Cobra Resources Ltd, Re [2003] ATP 23 ......................................................................... 12.230 Colarc Pty Ltd v Donarc Pty Ltd (1991) 4 ACSR 155 ................................................................... 8.37 Coleman v Myers [1977] 2 NZLR 225 ......... 7.350, 7.472, 7.535, 7.540, 7.542, 10.100, 11.260 Colhoun v Green [1919] 1 VLR 196 .......................................................................................... 6.100 Collie Power Co Pty Ltd, Re (1952) 54 WALR 44 ....................................................................... 9.102 Colorado Products Pty Ltd (in prov liq), Re (2014) 97 ACSR 581 ............................................... 8.100 Comberland Holdings, Re (1976) 1 ACLR 361 .......................................................................... 8.177 Commercial Bank of Australia Ltd v Amadio (1983) 151 CLR 447 ............................................. 5.270 Commonwealth Bank of Australia v Friedrich (1991) 5 ACSR 115 ...................................... 7.75, 7.95 Community Press Pty Ltd, Re (1980) 4 ACLR 782 ..................................................................... 8.152 Compaction Systems Pty Ltd, Re (1976) 2 ACLR 135; 2 NSWLR 477 ...... 5.175, 6.55, 9.275 Compagnie de Mayville v Whitley [1896] 1 Ch 788 ....................................................... 5.105, 5.270 Condraulics Pty Ltd v Barry and Roberts Ltd (1984) 8 ACLR 915 ............................................... 8.125 Connell v National Companies and Securities Commission (1990) 8 ACLC 70 ........................ 11.120 Connor v South Queensland Broadcasting Holdings Pty Ltd (1976) 1 ACLR 355 ....................... 5.300 Conservators of the River Tone v Ash (1829) 10 B & C 349; 109 ER 479 .......................... 3.150, 5.95 Const v Harris (1824) Tur & Rus 496; 37 ER 1191 ..................................................................... 8.155 Consul Development Pty Ltd v DPC Estates Pty Ltd (1975) 132 CLR 373 ....................... 1.155, 9.350 Continental Tyre and Rubber Co (GB) Ltd v Daimler Co Ltd [1915] 1 KB 893 .................. 3.150, 4.20 xiv

Table of Cases

Conway v Petronius Clothing Company Ltd [1978] 1 All ER 185; 1 WLR 72 ................... 5.300, 5.305 Cook v Deeks [1916] 1 AC 554 ........ 3.230, 7.387, 7.455, 7.465, 7.467, 7.472, 8.20, 8.25, 8.37 Cooke v Fairbairn [2003] NSWSC 232 ...................................................................................... 8.235 Coomber; Coomber v Coomber [1911] 1 Ch 723 .................................................................... 1.155 Coombs v Dynasty Pty Ltd (1994) 14 ACSR 60 ........................................................................... 6.20 Coopers Brewery Ltd 03R [2005] ATP 23 ................................................................................... 12.75 Coopers Brewery Ltd 04R [2005] ATP 24 ................................................................................... 12.75 Corbett v Corbett Court Pty Ltd (2016) 109 ACSR 296 ............................................................. 8.210 Coronation Syndicate Ltd v Lilienfeld [1903] TS 489 ................................................................. 5.195 Corporate Affairs, Commissioner for v Bracht (1989) 7 ACLC 40; [1989] VR 821 .............. 5.238, 7.40 Corporate Affairs, Commissioner for v Ekamper (1987) 12 ACLR 519 ........................................ 5.235 Corporate Affairs Commission v Glauber Co Ltd (1985) 3 ACLC 492 ....................................... 11.120 Corporate Affairs Commission (NSW) v Transphere Pty Ltd (No 2) (1985) 9 ACLR 1005 ........... 5.365 Corporate Affairs Commission (SA) v Australian Central Credit Union (1985) 157 CLR 201 ....... 10.35 Costa Rica Railway Co v Forwood (1901) 1 Ch 746 .................................................................. 1.150 Cotman v Brougham [1918] AC 514 ........................................................................................ 8.150 County Life Assurance Co, Re (1870) LR 5 Ch App 288 ............................................................. 5.355 Cowan v Scargill [1985] Ch 270 ............................................................................................... 2.207 Cox v Hickman (1860) 8 HLC 302 ................................................................... 1.40, 1.50, 1.75, 1.95 Crabtree-Vickers Pty Ltd v Australian Direct Mail Advertising and Addressing Co Pty Ltd (1975) 133 CLR 72 ..................................................... 5.335, 5.338, 5.365, 5.375 Craig v Lake Asbestos of Quebec Ltd 843 F (2d) 145 [3rd Circ (1988) ...................................... 4.120 Crichton’s Oil Co, Re [1902] 2 Ch 86 ....................................................................................... 9.102 Crumpton v Morrine Hall Pty Ltd (1965) 82 WN (Pt 1) (NSW) 456; [1965] NSWR 240 ........... 5.185, 8.15, 8.63, 9.117 Cumberland Holdings Ltd v Washington Soul Pattinson & Co Ltd (1977) 13 ALR 561 .............. 8.177 Cumberland Holdings Ltd, Re (1976) 1 ACLR 361 ......................................................... 8.170 Cumbrian Newspapers Group Ltd v Cumberland and Westmorland Herald Newspaper and Printing Co Ltd [1987] Ch 1 ....................................... 9.105, 9.100, 9.117 Cussen as Liquidator of Akai Pty Ltd (in liq) v Commissioner of Taxation (2004) 51 ACSR 530 ...................................................................................................................................... 3.210 Czerwinski v Syrena Royal Pty Ltd (No 1) (2000) 34 ACSR 245 ................................................. 5.295

D DCT v Austin (1998) 28 ACSR 565 .............................................................................................. 7.35 DHN Distributors Ltd v Tower Hamlets London Borough Council [1976] 1 WLR 852 .... 4.105, 4.120, 4.127 DPP v Kent and Sussex Contractors Ltd [1944] KB 146 .................................................. 4.160, 4.165 DPP (Cth) v JM (2013) 94 ACSR 1 .............................................................................. 11.190, 11.195 DPP Reference No 1 of 2000 [2001] NTSC 91 .......................................................................... 4.130 DR Chemicals Ltd, Re (1989) 5 BCC 39 .................................................................................... 8.212 Dafen Tinplate Co Ltd v Llanelly Steel Co (1907) Ltd [1920] 2 Ch 124 ....................................... 8.55 Daimler Co Ltd v Continental Tyre and Rubber Co Ltd [1916] 2 AC 307 ..................................... 4.20 Dairy Containers Ltd v NZI Bank Ltd (1995) 13 ACLC 3,211 ............................................ 4.127, 7.52 Dalkeith Investments Pty Ltd, Re (1985) 3 ACLC 74 ....................................................... 8.160, 8.210 Dalkeith Resources Pty Ltd v Regis Resources Ltd [2012] VSC 288 ............................................. 5.240 Daniels v Anderson; (1995) 37 NSWLR 438 ........................................ 7.75, 7.80, 7.95, 7.102, 7.135 Daniels v Daniels [1978] Ch 406 ................................................................................................ 8.80 Danish Mercantile Co Ltd v Beaumont [1951] Ch 680 .............................................................. 5.150 Darby, Re; Ex parte Brougham [1911] 1 KB 95 ....................................................... 3.242, 4.58, 4.65 Darvall v North Sydney Brick and Tile Co Ltd (No 2) (1989) 16 NSWLR 260 ............................. 7.313 Davies v Barlow (1881) 2 LR (NSW) 66 ..................................................................................... 1.105 Day v Mead [1987] 2 NZLR 443 ................................................................................................. 7.90 Dean v MacDowell (1878) 8 Ch D 345 ............................................................................. 1.145 Deangrove Pty Ltd (recs and mgrs apptd) v Buckby (2006) 56 ACSR 630; [2006] FCA 212 ....... 7.130 Delmenico v Brannelly [2008] QCA 74 ................................................................................... 10.225 Dempsey v CAC (1989) 7 ACLC 370 ........................................................................................ 5.237 Denham and Co, Re (1883) 25 Ch D 752 ................................................................................... 7.75 Dennis Willcox Pty Ltd v Federal Commissioner of Taxation (1988) 14 ACLR 156 ........................ 4.68 xv

Corporations and Financial Markets Law

Derry v Peek (1889) 14 App Cas 337 ...................................................................................... 10.225 Designbuild Australia Pty Ltd v Endeavour Resources Ltd (1980) 5 ACLR 610 ............................ 11.65 Devereaux Holdings Pty Ltd v Parry Corp Ltd (1985) 9 ACLR 837 ............................................... 6.90 Devereaux Holdings Pty Ltd v Pelsart Resources NL (unreported, Supreme Court of New South Wales, Equity Division, No Eq 4206/1985, Cohen J) ................................................... 7.350 Devereaux Holdings Pty Ltd v Pelsart Resources NL (No 2) (1985) 9 ACLR 956 ...... 6.90, 6.95, 6.105, 6.120 Dick v Convergent Telecommunications Ltd (2000) 46 ACSR 86 ............................................... 5.240 Dimbula Valley (Ceylon) Tea Co Ltd v Laurie [1961] 1 Ch 353 ............... 9.103, 9.118, 9.365, 9.390, 9.392 Dividend Fund Inc (in liq), Re [1974] VR 451 ............................................................... 8.123, 10.225 Dodge v Ford Motor Co 170 NW 668 ...................................................................................... 9.365 Dome Resources NL v Silver (2008) 68 ACSR 458 ..................................................................... 5.105 Donaldson v Natural Springs Australia Ltd [2015] FCA 498 ....................................................... 8.210 Donoghue v Stevenson [1932] AC 562 ....................................................................................... 7.70 Dorman Long & Co Ltd, Re [1934] 1 Ch 635 ....................................................... 6.85, 6.105, 6.120 Dovey v Cory [1901] AC 488 .................................................................................................... 9.380 Dowling v Colonial Mutual Life Assurance Society (1915) 20 CLR 509 ...................................... 8.105 Doyle v ASIC (2005) 227 CLR 18 .............................................................................................. 7.500 Dressy Frocks Pty Ltd v Bock (1951) 51 SR (NSW) 390 ............................................................. 9.350 Drillsearch Energy Ltd v McKerlie [2009] NSWSC 517 .............................................................. 7.350 Dromana Estate Ltd 01R [2006] ATP 8 ...................................................................................... 12.75 Drown v Gaumont-British Picture Corp Ltd [1937] Ch 402 ......................................................... 8.95 Duff’s Settlements, Re [1951] Ch 923 ....................................................................................... 9.390 Duke Group Ltd (in liq) v Pilmer (1998) 27 ACSR 1 .................................................................. 3.145 Dungowan Manly Pty Ltd v McLaughlin (2012) 90 ACSR 62 .................................................... 9.117 Dunn v Australian Society of Certified Practising Accountants (1998) 29 ACSR 1 ....................... 3.145 Dunn v Shapowloff [1978] 2 NSWLR 235 ................................................................................. 7.155 Duomatic Ltd, Re [1969] 2 Ch 365 ......................................... 5.170, 5.175, 5.185, 5.192, 6.55

E E H Dey Pty Ltd v Dey [1966] VR 464 ....................................................................................... 9.350 EBM Co Ltd v Dominion Bank [1937] 3 All ER 555 .................................................................... 5.355 ENT Pty Ltd v Sunraysia Television Ltd (2007) 61 ACSR 626 .................... 5.295, 6.90, 6.125 East v Bennett Bros Ltd [1911] 1 Ch 163 .................................................................................... 6.70 Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 ......... 8.63, 8.145, 8.155, 8.160, 8.162, 8.212 Eden Energy Ltd v Drivetrain USA Inc (2012) 90 ACSR 191 ....................................................... 5.360 Edensor Nominees Pty Ltd v ASIC (2002) 41 ACSR 325 ....................... 12.95, 12.105, 12.120 Edman v Ross (1922) 22 SR (NSW) 351 .............................................................. 5.295, 5.300, 5.305 Edwards v Halliwell [1950] 2 All ER 1064 ........................................................................... 8.75, 8.90 Ehsman v Nutectime International Pty Ltd (2006) 58 ACSR 705 ............................................... 8.100 El Ajou v Dollar Land Holdings plc [1994] 1 All ER 685 .............................................................. 4.178 El Sombrero Ltd, Re [1958] 3 All ER 1 ................................................................................ 6.50, 6.55 Elder v Elder and Watson Ltd 1952 SC 49 ................................................................................. 8.195 Elders IXL Ltd v NCSC [1987] VR 1 ................................................................................ 12.30, 12.75 Elders Trustee and Executor Co Ltd v Commonwealth Homes and Investment Co Ltd (1941) 65 CLR 603 ........................................................................................................................ 10.225 Elders Trustee and Executor Co Ltd v E G Reeves Pty Ltd (1987) 78 ALR 193 ............................. 3.238 Eley v Positive Government Security Life Assurance Co Ltd (1875) 1 Ex D 20 ..... 8.120, 8.123, 8.212, 9.110 Eley v Positive Life Assurance Co (1876) 1 Ex D 88 .................................................................... 8.120 Elkin & Co Pty Ltd v Specialised Television Installations Pty Ltd [1961] SR (NSW) 165 ................. 1.20 Elkington v CostaExchange Ltd [2011] VSC 501 ....................................................................... 9.355 Elliott v ASIC (2004) 48 ACSR 621 ............................................................................................ 7.140 Ellis v Joseph Ellis & Co [1905] 1 KB 324 ..................................................................................... 1.85 Emanuel Management Pty Ltd v Foster’s Brewing Group Ltd (2003) 178 FLR 1 ........................ 7.150 Emlen Pty Ltd v St Barbara Mines Ltd (1997) 24 ACSR 303 ....................................................... 8.135 Emma Silver Mining Co Ltd v Grant (1879) 11 Ch D 918 ......................................................... 3.220 xvi

Table of Cases

Emma Silver Mining Co Ltd v Lewis & Son (1879) 4 CPD 396 ....................................... 3.230, 3.238 English & Scottish Mercantile Investment Co Ltd v Brunton [1892] 2 QB 1 ................................ 9.55 Environmental Protection Authority v Caltex Refining Co Pty Ltd (1993) 178 CLR 477 ............... 4.20 Ephstathis v Greek Orthodox Community of St George (1988) 13 ACLR 691 ............................ 8.130 Equiticorp Finance Ltd (in liq) v Bank of New Zealand (1993) 32 NSWLR 50 ............................ 7.325 Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218 .............. 3.220, 3.230, 3.238, 4.30 Ernest v Nicholls (1857) 6 HLC 401; 10 ER 1351 ........................... 5.340, 5.345, 5.357, 5.360 Ernst & Young (Reg) v Tynski Pty Ltd (rec & mgrs apptd) (2004) 47 ACSR 433 ......................... 3.195 Errichetti Holdings Pty Ltd v Western Plaza Hotel Corporation Pty Ltd [2006] WASC 113 .......... 5.360 Escott v Barchris Construction Corp 283 F Supp 643 (1968) ................................................... 10.205 Esplanade Developments Ltd v Dinive Holdings Pty Ltd (1980) 4 ACLR 826 .................. 7.387, 7.542 European Assurance Society (Manistry’s Case), Re (1873) 17 Sol Jo 745 ................................... 7.225 European Assurance Society (Grain’s Case), Re (1875) 1 Ch D 307 ............................................. 2.45 Evling v Israel and Oppenheimer Ltd [1918] 1 Ch 101 .................................................. 9.102, 9.360 Exeter and Crediton Railway Co v Buller (1847) 16 LJ Ch 449 ................................................... 5.120 Expo International Pty Ltd (in liq) v Chant [1979] 2 NSWLR 820 .............................................. 7.207 Express Engineering Works Ltd, Re [1920] 1 Ch 466 .......... 5.95, 5.155, 5.160, 5.165, 5.175, 5.192, 5.194, 5.365

F F de Jong & Co Ltd, Re [1946] Ch 211 ..................................................................................... 9.102 FAI Insurances Ltd v Pioneer Concrete Services Ltd (No 2) (1986) 10 ACLR 801 ...... 11.65, 11.70 Fame Decorator Agencies Pty Ltd v Jeffries Industries Ltd (1998) 28 ACSR 58 ...... 11.200, 11.220, 11.235 Farrow’s Bank Ltd, Re [1921] 2 Ch 164 .................................................................................... 3.200 Fast Financial Services Pty Ltd v Crawford (2012) 88 ACSR 650 ................................................ 1.140 Faure Electric Accumulator Co, Re (1888) 40 CH D 141 ............................................................ 7.455 Featherstone v Cooke (1873) LR 16 Eq 298 .............................................................................. 5.140 Fexuto Pty Ltd v Bosnjak Holdings Pty Ltd [2001] NSWCA 97 ........................................ 8.145, 8.195 Firestone Tyre and Rubber Co Ltd v Lewellin [1957] 1 WLR 464 ............................................... 4.127 First National Bank of Boston v Bellotti 435 US 765 .................................................................... 4.20 Fitzsimmons v R (1997) 23 ACSR 355 ............................................................................ 7.250, 7.355 Five Minute Car Wash Service Ltd, Re [1966] 1 WLR 745 .......................................................... 8.212 Flavel v Roget (1990) 1 ACSR 595 ........................................................................................... 11.140 Flemying v Hector (1836) 2 M & W 172; 150 ER 716 ............................................................... 1.120 Flinders Diamonds Ltd v Tiger International Resources Ltd (2004) 88 SASR 281 .......... 12.35, 12.100, 12.105 Flitcroft’s Case (1882) 21 Ch D 519 .......................................................................................... 7.455 Florence Land and Public Works Co (Nicol’s Case), Re (1885) 19 Ch D 421 ................................ 3.95 Forest of Dean Mining Co, Re (1879) 10 Ch D 451 .................................................................... 7.10 Forge v ASIC (2004) 52 ACSR 1; [2004] NSWCA 448 .............................................. 7.75, 7.500, 8.37 Forrest v ASIC (2012) 247 CLR 486; [2012] HCA 39 ................ 10.215, 7.110, 11.141, 11.143 Foss v Harbottle (1843) 2 Hare 461; 67 ER 189 .... 5.95, 8.75, 8.80, 8.85, 8.90, 8.110, 8.125, 8.130, 8.132, 8.135, 8.215 Foster v Foster [1916] 1 Ch 532 .................................................................................... 5.105, 5.140 Foster v New Trinidad Lake Asphalt Co Ltd [1901] 1 Ch 208 .................................................... 9.387 Fowlers Vacola Manufacturing Co Ltd, Re [1966] VR 97 ................................................. 9.230, 9.240 Francis v United Jersey Bank 432 A 2d 814 (1981) ...................................................................... 7.80 Fraser v NRMA Holdings Ltd (1995) 15 ACSR 590; 127 ALR 543 .... 6.90, 6.95, 6.105, 6.120, 6.125, 10.200, 10.210, 10.215 Fraser v Whalley (1864) 2 H & M 10; 71 ER 361 ...................................... 7.220, 7.275, 7.285, 8.125 Freeman v Laventhol & Horwath 915 F 2d 193 (1990) ........................................................... 11.235 Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480 .................................................................................................. 5.320, 5.327, 5.330, 5.338 Funerals of Distinction Pty Ltd, Re [1963] NSWR 614 ................................................................ 5.300 Furs Ltd v Tomkies (1936) 54 CLR 583 .......... 1.155, 7.345, 7.455, 7.460, 7.472, 7.497, 7.527, 8.20 xvii

Corporations and Financial Markets Law

G G J Mannix Ltd, Re [1984] 1 NZLR 309 ....................................................................................... 4.20 G Jeffrey (Mens Store) Pty Ltd, Re (1984) 9 ACLR 193 ................................................... 8.160, 8.210 GIGA Investments Pty Ltd (in admin), Re (1995) 17 ACSR 472 .................................................. 5.275 GIO Australia Holdings Ltd v AMP Investment Insurance Ltd (1998) 29 ACSR 584 ................... 10.115 GPG (Australia Trading) Pty Ltd v GIO Australia Holdings Ltd (2001) 117 FCR 23 .................... 11.150 Gaiman v National Association for Mental Health [1971] Ch 317 .......................... 7.310, 7.312, 8.63 Galbraith v Merito Shipping Co 1947 SC 446 ........................................................................... 8.150 Galloway v Halle Concerts Society [1915] 2 Ch 233 ................................................................. 8.125 Gamble v Hoffman (1997) 24 ACSR 369 .................................................................................. 7.100 Gambotto v WCP Ltd (1995) 182 CLR 432 ........... 8.15, 8.65, 8.67, 8.68, 9.235, 9.250, 9.255, 12.275 Gamlestaden Fastigheter AB v Baltic Partners Ltd [2007] 4 All ER 164 ....................................... 8.215 Gantry Acquisition Corp v Parker & Parsley Petroleum Australia Pty Ltd (1994) 51 FCR 554 .... 12.200 Garcia v National Australia Bank Ltd (1998) 194 CLR 395 ......................................................... 5.270 Garden City, The [1982] 2 Lloyd’s Rep 382 ................................................................... 4.150, 4.155 Garvie v Axmith (1962) 31 DLR (2d) 65 .................................................................................... 6.120 Geller v Transamerica Corp 53 F Supp 625 ............................................................................... 4.120 Geneva Finance Ltd, Re; Quigley v Cook (1992) 7 ACSR 415 .................................................... 5.300 George Newman & Co, Re [1895] 1 Ch 674 ........................................... 5.155, 5.160, 5.165, 7.390 Gibbs and Webb’s Case (1870) LR 10 Eq 312 ........................................................................... 5.105 Gilford Motor Co Ltd v Horne [1933] 1 Ch 935 ....................................................... 4.50, 4.55 Gillfillan v ASIC (2013) 92 ACSR 460 ......................................................................................... 5.275 Gladstone Pacific Nickel Ltd, Re (2011) 86 ACSR 432 ............................................................... 8.100 Glandon Pty Ltd v Strata Consolidated Pty Ltd (1993) 11 ACSR 543 ......................................... 7.542 Glencore International AG v Takeovers Panel (2005) 54 ACSR 708 ................................. 12.30, 12.35 Glencore International AG v Takeovers Panel (2006) 56 ACSR 753 ............................................ 12.30 Glenville Pastoral Co Pty Ltd (in liq) v Commissioner of Taxation (Cth) (1963) 109 CLR 199 ..... 9.382 Gloucester Coal 01 [2009] ATP 6 .............................................................................................. 12.45 Gloucester Coal 01R [2009] ATP 9 ............................................................................................ 12.45 Gluckstein v Barnes [1900] AC 240 ................................................................................ 3.220, 3.240 Gold Ribbon (Accountants) Pty Ltd (in liq) v Sheers [2006] QCA 335 ....................................... 7.130 Golden Gate Petroleum Ltd, Re (2010) 77 ACSR 17 ....................................................... 10.65, 10.75 Goldex Mines Ltd v Revill (1974) 54 DLR (3d) 672 ..................................................................... 6.95 Goozee v Graphic World Group Holdings Pty Ltd (2002) 170 FLR 451; 42 ACSR 534 ..... 8.100, 8.195 Gorton v FCT (1965) 113 CLR 604 ............................................................................................. 4.68 Gothard v Fell (2012) 88 ACSR 328 .......................................................................................... 11.90 Goudberg v Herniman Associates Pty Ltd [2007] VSCA 12 .......................................................... 1.20 Goulburn Valley Butter Factory Co Pty Ltd v Bank of New South Wales (1900) 25 VLR 702 ....... 5.355 Gramophone and Typewriter Ltd v Stanley [1908] 2 KB 89 .................................. 4.60, 5.120, 5.135 Grant v John Grant & Sons Pty Ltd (1950) 82 CLR 1 ............. 5.380, 7.265, 7.295, 8.35, 8.90, 8.125, 8.132 Grant v United Kingdom Switchback Railway Co (1888) 40 Ch D 135 ..................................... 5.145 Grant-Taylor v Babcock & Brown Ltd (2016) 113 ACSR 362 ....................................... 11.135, 11.140 Gray v Lewis (1873) LR 8 Ch App 1035 ...................................................................................... 8.75 Gray v New Augarita Porcupine Mines Ltd [1952] 3 DLR (2d) 1 ................................. 7.380 Great Eastern Railway Co v Turner (1872) LR 8 Ch App 149 ....................................................... 7.10 Great Investments Ltd v Warner (2016) 114 ACSR 33 ............................................................... 5.360 Great Wheal Polgooth Co Ltd, Re (1883) 53 LJ Ch 42 ............................................................... 3.238 Greenhalgh v Arderne Cinemas Ltd [1946] 1 All ER 512 ............................................................ 9.118 Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286 ............ 7.240, 7.270, 7.300, 7.310, 8.55, 8.63, 8.170, 8.212 Greenwell v Porter [1902] 1 Ch 530 ......................................................................................... 5.195 Gregor v British-Israel-World Federation (2002) 41 ACSR 641 ................................................... 8.145 Griffin, Re; Ex parte Board of Trade (1890) 60 LJQB 235 ............................................................. 1.20 Grimaldi v Chameleon Mining NL (No 2) (2012) 87 ACSR 260; [2012] FCAFC 6 ......... 7.30, 7.37, 7.225 Grindley v Barker (1798) 1 Bos & Pul 229; 126 ER 875 ............................................................... 5.95 Grove v Flavel (1986) 43 SASR 410 ................................................................................ 7.312, 7.500 xviii

Table of Cases

H H A Stephenson & Son Ltd (in liq) v Gillanders Arbuthnot & Co (1931) 45 CLR 476 ........ 3.70, 8.150 H H Vivian & Co Ltd, Re [1900] 2 Ch 654 ................................................................................. 5.105 H L Bolton (Engineering) Co Ltd v T J Graham & Sons Ltd [1957] 1 QB 159 .................. 4.165, 5.355 H R Harmer Ltd, Re [1959] 1 WLR 62 ............................................................................. 8.185, 8.215 HIH Insurance Ltd, Re (2016) 113 ACSR 318 ........................................................................... 10.202 HNA Irish Nominee Ltd v Kinghorn (2010) 78 ACSR 553 ............................................................ 3.95 HNA Irish Nominee Ltd v Kinghorn (No 2) (2012) 88 ACSR 427; [2012] FCA 228 ......... 8.145, 9.392 Halifax Sugar Refining Co Ltd v Francklyn (1890) 59 LJ Ch 591 ................................................ 5.270 Hall v Poolman (2007) 65 ACSR 123 ..................................................................... 7.150, 7.207 Hallett v Dowdall (1852) 18 QB 2; 118 ER 1 ............................................................................... 2.50 Halliburton Co et al v Erica P John Fund Inc 134 S Ct 2398 (2014) ......................................... 10.202 Hamilton v Whitehead (1988) 65 ALJR 80 ........................................................................ 4.42, 4.185 Hamilton v Wright (1980) 5 ACLR 391 ..................................................................................... 7.145 Hamilton-Irvine, Re (1990) 2 ACSR 616 .................................................................................... 5.237 Hampson v Price’s Patent Candle Co (1876) 45 LJ Ch 437 ....................................................... 5.105 Hannes v MJH Pty Ltd (1992) 7 ACSR 8 .................................................................................... 7.245 Hanson Trust PLC v ML SCM Acquisition Inc 781 F 2d 264 (2d Cir 1986) ................................. 7.120 Hapytoz Pty Ltd (in liq), Re [1937] VLR 40 ................................................................................ 5.355 Harben v Phillips (1883) 23 Ch D 14 .................................................................... 5.120, 5.270, 6.85 Harkness v Commonwealth Bank of Australia (1993) 12 ACSR 165 ........................................... 7.387 Harlowe’s Nominees Pty Ltd v Woodside (Lakes Entrance) Oil Company NL (1968) 121 CLR 483 ............................................................ 7.215, 7.220, 7.230, 7.265, 8.125 Harris v Shepherd (1976) 2 ACLR 51 ........................................................................ 7.35, 7.40, 7.50 Hawkesbury Development Co Ltd v Landmark Finance Pty Ltd [1969] 2 NSWR 782 ................. 3.195 Hawkins v Bank of China (1992) 7 ACSR 349 ............................................................................ 7.145 Hayes v Bristol Plant Hire Ltd [1957] 1 WLR 499 ....................................................................... 5.275 Haywood v Roadknight [1927] VLR 512 ................................................................................... 7.385 He Kaw The v R (1985) 157 CLR 523 ........................................................................................ 4.182 Heide Pty Ltd (t/as Farmhouse Smallgoods) v Lester (1991) 3 ACSR 159 .................................. 7.150 Helmore v Smith (1890) 15 App Cas 223; (1886) 35 Ch D 436 ................................................ 1.150 Helwig v Jonas [1922] VLR 261 ................................................................................................... 6.90 Hely-Hutchinson v Brayhead Ltd [1968] 1 QB 549 ............ 5.315, 5.325, 5.327, 5.357, 5.365, 5.375 Heron v Port Huon Fruitgrowers Co-op (1922) 30 CLR 315 ...................................................... 8.123 Herrman v Simon (1990) 4 ACSR 81 ...................................................................... 5.185, 5.192 Heydon v NRMA [2000] NSWCA 374 ..................................................................................... 11.150 Hibblewhite v McMorine (1839) 5 M & W 462; 151 ER 195 ................................................... 11.170 Hickey v Axelford [2003] NSWSC 185 ...................................................................................... 5.270 Hickman v Kent or Romney Marsh Sheep-Breeders’ Association [1915] 1 Ch 881 .... 8.120, 8.123 Hill v Permanent Trustee Co of New South Wales Ltd [1930] AC 720 ........................................ 9.390 Hillhouse v Gold Copper Exploration NL (No 2) (1988) 6 ACLC 351 ......................................... 8.130 Hillhouse v Gold Copper Exploration NL (No 3) (1988) 14 ACLR 423 ....................................... 11.65 Hilton International Ltd v Hilton [1989] 1 NZLR 442 ................................................................ 9.395 Hilton International Ltd (in liq) v Hilton (1988) 4 NZCLC 64,721 ............................................. 9.365 Hindle v John Cotton Ltd (1919) 56 Sc LR 625 ......................................................................... 7.260 Hirsche v Sims [1894] AC 654 .................................................................................................. 7.270 Hivac Ltd v Park Royal Scientific Instruments Ltd [1946] Ch 169 ............................................... 7.527 Ho Tung v Man On Insurance Co Ltd [1902] AC 232 .......................................... 5.180, 5.192 Hoare & Co Ltd, Re [1904] 2 Ch 208 ....................................................................................... 9.382 Hogg v Cramphorn Ltd [1967] Ch 254 .............. 7.235, 7.275, 7.285, 7.295, 8.25, 8.37, 8.212 Holmes v Life Funds of Australia Ltd [1971] 1 NSWLR 860 .................................... 5.240, 6.90, 9.275 Holpitt Pty Ltd v Swaab (1992) 33 FCR 474 ................................................................................ 7.45 Homer District Consolidated Gold Mines, Re; Ex parte Smith (1888) 39 Ch D 546 ................... 5.270 Hooker Investments Pty Ltd v Baring Bros Halkerston & Partners Securities Ltd (1986) 5 NSWLR 157; 10 ACLR 462 ................................................................................................. 11.255 Hooker Investments Pty Ltd v Email Ltd (1986) 10 ACLR 443 .................................................... 8.125 Hordern v Hordern [1910] AC 465 ........................................................................................... 1.155 xix

Corporations and Financial Markets Law

Horn v Faulder & Co (1908) 99 LT 524 ..................................................................................... 5.275 Hosken v ASIC (1998) 28 ACSR 542 .......................................................................................... 5.237 Hospital Products Ltd v United States Surgical Corp (1984) 156 CLR 41 ........................ 1.140, 7.542 Host-Plus Pty Ltd v Australian Hotels Association [2003] VSC 145 .............................................. 8.145 Hotel Terrigal Pty Ltd v Latec Investments Ltd (No 2) [1969] 1 NSWR 676 ............................... 4.105 Houghton v Saunders [2014] NZHC 2229 .............................................................................. 10.225 Houghton-Le Touzel v Mecca Ltd [1950] 2 KB 612 ..................................................................... 4.20 Houghton & Co v Nothard Lowe and Wills [1927] 1 KB 246 .................................................... 5.355 House of Fraser Plc v ACGE Investments Ltd [1987] AC 387 ...................................................... 9.117 Howard v Mechtler (1999) 30 ACSR 434 ........................................................................... 6.15, 6.35 Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 ......... 7.235, 7.285, 7.312, 8.125 Huang v Wang [2016] NSWCA 164 .......................................................................................... 8.100 Huddart, Parker & Co Ltd v Moorehead (1909) 8 CLR 330 .............................................. 2.75, 2.105 Hudson Conway Ltd, Re (1993) 12 ACSR 668 .......................................................................... 9.230 Humes Ltd v Unity APA Ltd (1987) 11 ACLR 641 ......................................................................... 6.35 Hunter Resources Ltd, Re (1992) 7 ACSR 436 ........................................................................... 9.230 Hurley v BGH Nominees Pty Ltd (No 2) (1984) 2 ACLC 497 ..................................................... 7.542 Hussein v Good (1990) 1 ACSR 710 .......................................................................................... 7.145 Huth v Clarke (1890) 25 QBD 391 ........................................................................................... 5.275 Hutton v West Cork Railway Co (1883) 23 Ch D 654 ............................... 5.245, 7.240, 7.300, 7.390 Hydrodam (Corby) Ltd, Re [1994] 2 BCLC 180 ........................................................................... 7.40 Hymix Concrete Pty Ltd v Garrity (1977) 2 ACLR 559 .................................................... 7.150, 7.207

I ICAL Ltd v County Natwest Securities Aust Ltd (1988) 13 ACLR 129 ....................................... 12.200 IOC Australia Pty Ltd v Mobil Oil Australia Ltd (1975) 11 ALR 417 ............................................. 8.105 Idyllic Solutions Pty Ltd, Re (2013) 93 ACSR 421 ...................................................................... 8.135 Impact Datascape Pty Ltd v McIntosh (unreported, 3 October 1990) ....................................... 4.125 Imperial Chemical Industries Ltd, Re [1936] 1 Ch 587 .............................................................. 6.105 Imperial Hydropathic Hotel Co (Blackpool) v Hampson (1882) 23 Ch D 1 ..................... 5.240, 8.120 In Plus Group Ltd v Pyke [2002] EWCA Civ 370 ........................................................................ 7.527 Independent Steels Pty Ltd v Ryan (1989) 15 ACLR 518 ............................................................ 9.353 Industrial Development Consultant Ltd v Cooley [1972] 1 WLR 443 .............. 7.455, 7.482, 7.485 Industrial Equity Ltd v Blackburn (1977) 137 CLR 567 ............................. 4.105, 4.120, 9.360, 9.392 Inkerman Grazing Pty Ltd, Re (1972) 1 ACLR 102 ..................................................................... 5.105 Inland Revenue Commissioners v Thornton Kelley & Co Ltd [1957] 1 WLR 482 ........................ 9.390 Intercapital Holdings Ltd v MEH Ltd (1988) 13 ACLR 595 ......................................................... 5.295 International Hospitality Concepts Pty Ltd v National Marketing Concepts Inc (No 2) (1994) 13 ACSR 368 ....................................................................................................................... 8.145 Introductions Ltd, Re [1970] Ch 199 .......................................................................................... 3.75 Investment Trust Corp Ltd v Singapore Traction Co Ltd [1935] Ch 615 .................................... 5.200 Ireland v Retallack [2011] NSWSC 846 ..................................................................................... 8.210 Irvine v Union Bank of Australia (1887) 2 App Cas 366 ............................................................. 5.145 Isle of Thanet Electricity Supply Co Ltd, Re [1950] Ch 161 .......................................... 9.100 (1884) 25 Ch D 320 ...................................................................................................... 5.120, 5.125 Iso Lilodw’ Aliphumeleli Pty Ltd (in liq) v Commissioner of Taxation (2002) 42 ACSR 561 ......... 7.150

J J Spurling Ltd v Bradshaw [1956] 1 WLR 461 .......................................................................... 10.230 J W Broomhead (Vic) Pty Ltd (in liq) v J W Broomhead Pty Ltd [1985] VR 891 ........................... 5.365 Jackson v The Munster Bank Ltd (1884) 13 LR Ir 118 .................................................................. 6.95 Jacobus Marler Estates Ltd v Marler (1913) 85 LJPC 167n ......... 3.230, 3.250, 3.255, 7.385, 7.460 James v Buena Ventura Nitrate Grounds Syndicate Ltd [1896] 1 Ch 456 ..................................... 8.90 James, Ex parte (1803) 8 Ves Jun 337; 32 ER 385 ..................................... 1.155, 7.460, 7.470, 7.490 James Hardie Industries NV v ASIC [2010] NSWCA 332; (2011) 81 ACSR 1 .... 11.140, 11.195, 11.210 xx

Table of Cases

James Lumbers Ltd, Re (1925) 58 OLR 100 ............................................................................... 8.145 Jarrett, Re (1999) 32 ACSR 23 ................................................................................................... 5.237 Jeffree v National Companies and Securities Commission (1989) 15 ACLR 217 ......................... 7.500 Jenkins v Enterprise Gold Mines NL (1992) 6 ACSR 539 .......................... 8.108, 8.215, 8.225 Jervois Mining Ltd, Re; Campbell v Jervois Mining Ltd [2009] FCA 316 ..................................... 5.295 John Alexander’s Clubs Pty Ltd v White City Tennis Club Ltd (2010) 241 CLR 1 ........................ 1.140 John Henshall (Quarries) Ltd v Harvey [1965] 2 QB 233 ........................................................... 4.165 John J Starr (Real Estate) Pty Ltd v Robert R Andrew (A’Asia) Pty Ltd (1991) 6 ACSR 63 ............ 8.145, 8.210, 8.235 John Labatt Ltd, Re (1959) 20 DLR (2d) 159 ............................................................................... 8.65 John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113 ............ 5.110, 5.130, 5.135, 5.150 Johnny Oceans Restaurant Pty Ltd v Page [2003] NSWSC 952 .................................................. 8.163 Johns v Australian Securities Commission (1993)11 ACSR 467 .................................................. 11.90 Johnson v Gore Wood & Co [2001] 2 WLR 72 .......................................................................... 8.110 Johnson v Lyttle’s Iron Agency (1877) 5 Ch D 687 .................................................................... 8.120 Johnson Corp Ltd, Re (1980) 5 ACLR 227 ................................................................................. 8.152 Johnston v McGrath [2007] NSWCA 231 ................................................................................ 10.202 Joint Stock Discount Co v Brown (1869) LR 8 Eq 381 ................................................................. 7.90 Jones v Jones (2009) 27 ACLC 1,021 ........................................................................................ 7.542 Jones v Lipman [1962] 1 WLR 832 ...................................................................................... 4.55 Jubilee Mines NL v Riley (2009) 226 FLR 201 ...................................... 11.140, 11.141, 11.142

K KGD Investments Pty Ltd v Placard Holdings Pty Ltd (2016) 110 ACSR 399 .............................. 9.355 Kathleen Investments (Australia) Ltd v Australian Atomic Energy Commission (1978) 52 ALJR 45 ........................................................................................................................................ 8.125 Kaye v Croydon Tramways Co [1898] 1 Ch 358 ..................................................... 6.95, 6.100, 8.90 Keech v Sandford (1726) Sel Cas Ch 61; 25 ER 223 ...................... 7.470, 7.472, 7.475, 7.477, 7.480 Keith Henry & Co Pty Ltd v Stuart Walker & Co Pty Ltd (1958) 100 CLR 342 ............................ 1.155 Keith Smith East West Transport Pty Ltd (In liq) v Australian Taxation Office (2002) 42 ACSR 501 ...................................................................................................................................... 7.150 Keller v LED Technologies Pty Ltd [2010] FCAFC 55 .................................................................... 7.15 Kelner v Baxter (1866) LR 2 CP 174 ............................................................................................ 3.75 Keneally, Re (2015) 107 ACSR 172 ........................................................................................... 5.270 Kerry v Maori Dream Gold Mines Ltd (1898) 14 TLR 402 ......................................................... 7.225 Killen v Marra Developments Ltd (Kearney J ............................................................................. 6.105 Kingston Cotton Mill (No 2), Re [1896] 2 Ch 279 .................................................................... 9.185 Kinsela v Russell Kinsela Pty Ltd (In Liq) (1986) 4 NSWLR 722 .... 5.190, 5.192, 7.312, 8.37 Kinwat Holdings Pty Ltd v Platform Pty Ltd (1982) 6 ACLR 398 .............................................. 11.255 Kirby v Wilkins [1929] 2 Ch 444 ............................................................................................... 9.295 Kirton Investments Pty Ltd v CC Bottlers Ltd (1984) 10 ACLR 167 ............................................ 8.125 Kitson & Co Ltd, Re [1946] 1 All ER 435 ................................................................................... 8.150 Kleinwort Benson Ltd v Malaysia Mining Corp Berhad [1989] 1 WLR 379 ................................. 4.127 Knightswood Nominees Pty Ltd v Sherwin Pastoral Co Ltd (1989) 15 ACLR 151 ....................... 5.295 Kodak Ltd v Clark [1903] 1 KB 505 ............................................................................................. 4.68 Kokotovich Constructions Pty Ltd v Wallington (1995) 17 ACSR 478 .................. 7.245, 8.145, 8.160 Kornblums Furnishings Ltd, Re (1981) 6 ACLR 456 ................................................................... 5.200 Kornblums Furnishings Ltd, Re [1982] VR 123 .......................................................................... 12.80 Kounis v Kounis (1987) 11 ACLR 854 ........................................................................................ 8.160 Krakowski v Eurolynx Properties Ltd (1995) 183 CLR 563 ....................................................... 10.225 Kraus v J G Lloyd Pty Ltd [1965] VR 232 .......................................................................... 5.150, 8.90 Krecichwost v R [2012] NSWCCA 101 ...................................................................................... 9.392 Kreditbank Cassel GmbH v Schenkers [1927] 1 KB 826 ............................................................ 5.355 Krejci, Re (2006) 58 ACSR 403 .................................................................................................. 3.190 Kriewaldt v Independent Direction Ltd (1995) 14 ACLC 73 ...................................................... 5.300 Kuwait Asia Bank EC v National Mutual Life Nominees Ltd [1991] 1 AC 187 ...................... 7.45, 7.52 xxi

Corporations and Financial Markets Law

L L C O’Neil Enterprises Pty Ltd v Toxic Treatments Ltd (1986) 4 NSWLR 660 ............................... 6.25 Lady Gwendolen, The (Arthur Guinness, Son & Co (Dublin) Ltd v Owners of the Motor Vessel Freshfield [1965] P 294 .............................................................................................. 4.155 Lagunas Nitrate Co v Lagunas Syndicate [1899] 2 Ch 392 ......................... 3.225, 3.240, 3.245, 7.75 Lands Allotment Co, Re [1894] 1 Ch 616 ......................................................................... 7.10, 7.455 Ledir Enterprises Pty Ltd, Re (2014) 96 ACSR 1 ............................................................. 8.205 Lee v Lee’s Air Farming Ltd [1961] AC 12 ........................................... 4.35, 4.42, 4.185, 5.245 Lee v Neuchatel Asphalte Co (1889) 41 Ch D 1 ............................. 9.365, 9.370, 9.377, 9.380 Lee Behrens & Co Ltd, Re [1932] 2 Ch 46 ................................................................................ 5.245 Leeds and Hanley Theatres of Varieties Ltd, Re [1902] 2 Ch 809 .................................... 3.245, 3.255 Lees v Laforest (1851) 14 Beav 250; 51 ER 283 ......................................................................... 1.155 Lennard’s Carrying Co Ltd v Asiatic Petroleum Co Ltd [1915] AC 705 ........... 4.150, 4.160, 4.165 Levin v Clark [1962] NSWR 686 ..................................................................................... 7.335, 7.337 Lew v Coles Myer Ltd [2002] VSC 535 ........................................................................................ 6.85 Lewis v Daily Telegraph Ltd [1964] AC 234 ................................................................................. 4.20 Lewis (as liq of Doran Constructions Pty Ltd (in liq)) v Doran [2005] NSWCA 243 .................... 3.210 Link Agricultural Pty Ltd v Shanahan [1999] 1 VR 466; (1998) 28 ACSR 498 ........... 5.240, 6.80, 8.90 Links Golf Tasmania Pty Ltd v Sattler (2012) 90 ACSR 288 ........................................................ 7.527 Lion Nathan Australia Pty Ltd v Coopers Brewery Ltd (2005) 55 ACSR 583 ............................... 6.125 Lionsgate Australia Pty Ltd v Macquarie Private Portfolio Management Ltd (2007) 62 ACSR 178 ...................................................................................................................................... 12.35 Lionsgate Australia Pty Ltd v Macquarie Private Portfolio Management Ltd (2007) 62 ACSR 522 ...................................................................................................................................... 12.05 Liquidators of the Imperial Mercantile Credit Association, The v Coleman (1873) LR 6 HL 189 .............................................................................................. 3.242, 7.370 Lister v Romford Ice and Cold Storage Co Ltd [1957] AC 555 ..................................................... 7.75 Little v Australian Securities Commission (1996) 22 ACSR 226 .................................................... 3.70 Littlewoods Mail Order Stores Ltd v IRC [1969] 1 WLR 1241 ..................................................... 4.105 Littlewoods Organisation Ltd v Harris [1977] 1 WLR 1472 ........................................................ 4.105 Loch v John Blackwood Ltd [1924] AC 783 ............................................................................... 8.145 London & Mediterranean Bank, Wright’s Case, Re (1868) 37 LJ Ch 529 ..................................... 6.90 London City Equities Ltd v Penrice Soda Holdings Ltd (2011) 84 ACSR 573 .............................. 5.295 London and Mashonaland Exploration Co Ltd v New Mashonaland Exploration Co Ltd [1891] WN 165 ........................................................................................ 7.525, 7.527 Long Park v Trenton-New Brunswick Theatres Co 77 NE 2d 633 (1948) ................................... 5.195 Lonhro Ltd v Shell Petroleum Co Ltd [1980] 2 WLR 367 ....................................... 4.42, 4.105, 4.127 Lord Bruce’s Case (1728) 2 Strange 819; 93 ER 870 ................................................................. 5.240 Lubbock v British Bank of South America [1892] 2 Ch 198 .............................. 9.365, 9.385 Lucy v Lomas [2002] NSWSC 448 ............................................................................................ 8.210 Lyford v Media Portfolio Ltd (1989) 7 ACLC 271 ....................................................................... 5.360

M MIS Funding No 1 Pty Ltd v Buckley (2014) 96 ACSR 691 ........................................................ 10.85 MMAL Rentals Pty Ltd v Bruning [2004] NSWCA 451 ............................................................... 8.145 MacDougall v Gardiner (1875) 1 Ch D 13 ................................................... 8.75, 8.90, 8.120, 8.130 MacLeod v The Queen (2003) 214 CLR 230 ............................................................................... 4.42 MacarthurCook Limited [2008] ATP 20 ................................................................................... 12.247 Macarthurcook Ltd, Re (2008) 67 ACSR 345; [2008] ATP 20 ................................................... 12.240 Macaura v Northern Assurance Co [1925] AC 619 ...................................................................... 4.40 Macquarie Investments Pty Ltd, Re (1975) 1 ACLR 40 ............................................................... 5.237 Madrid Bank Ltd v Bayley (1866) LR 2 QB 37 ........................................................................... 3.200 Magna Alloys & Research Pty Ltd, Re (1975) 1 ACLR 203 .............................................. 5.235, 5.237 Magna Plant v Mitchell (unreported, 27 April 1966) ................................................................. 4.165 Maher v Honeysett & Maher Electrical Contractors Pty Ltd [2005] NSWSC 859 ........................ 8.100 Mahony v East Holyford Mining Co (1875) LR 7 HL 869 .......................... 5.330, 5.338, 5.355, 5.357 xxii

Table of Cases

Majestic Resources NL v Caveat Pty Ltd [2004] WASCA 201 ...................................................... 5.295 Mallan v Lee (1949) 80 CLR 198 .............................................................................................. 4.185 Maloney v New South Wales National Coursing Association Ltd (No 2) (1978) 3 ALCR 404 ...... 5.240 Manning River Co-operative Dairy Co Ltd v Shoesmith (1915) 19 CLR 714 .............................. 7.313 Manpac Industries Pty Ltd v Ceccattini [2002] NSWSC 330 ........................................... 7.150, 7.175 Mansfield v The Queen [2012] HCA 49 ................................................................................... 11.240 March v E & M H Stramare Pty Ltd (1991) 171 CLR 506 ............................................................ 7.90 Marchesi v Barnes [1970] VR 434 ............................................................................................. 7.250 Maritime Union of Australia v Patrick Stevedores No 1 Pty Ltd (1998) 27 ACSR 497 .................... 4.85 Maronis Holdings Pty Ltd v Nippon Credit Aust Pty Ltd (2001) 38 ACSR 404 ............................ 7.327 Marra Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616 ........................................... 9.360 Marra Developments Ltd, Re (1976) 1 ACLR 470 ............................................................. 6.95, 6.105 Marshall’s Valve Gear Co Ltd v Manning Wardle & Co Ltd [1909] 1 Ch 267 ............................. 5.135 Mason v Harris (1879) 11 Ch D 97 ............................................................................................. 8.37 Massey v Wales (2003) 57 NSWLR 718 .......................................................................... 5.140, 5.150 McCausland v Surfing Hardware International Holdings Pty Ltd [2013] NSWSC 902 ................ 8.210 McDougall v On Q Group Ltd (2007) 25 ACLC 910 ................................................................. 5.300 McGellin v Mount King Mining NL (1998) 144 FLR 288 ........................................................... 7.350 McKerlie v Drillsearch Energy Ltd (2009) 74 NSWLR 673 .......................................... 6.25, 6.70, 6.80 McLaren v Thompson [1917] 2 Ch 231 ...................................................................................... 6.85 McLellan v Carroll (2009) 76 ACSR 67 ...................................................................................... 7.175 McMillan v Toledo Enterprises International Pty Ltd (1995) 18 ACSR 603 ........... 8.145, 8.160, 8.210 McQuade v Stoneham 263 NY 323; 189 NE 234 (1936) .......................................................... 5.195 Measures Bros Ltd v Measures [1910] 2 Ch 248 ....................................................................... 7.527 Medefield Pty Ltd, Re (1977) 2 ACLR 406 ...................................................................... 5.195, 8.123 Medical Committee for Human Rights v Securities and Exchange Commission 432 F 2d 659 (1970) ................................................................................................................................. 5.138 Megevand, Re; Ex parte Delhasse (1878) 7 Ch D 511 ............................................. 1.20, 1.70 Meinhard v Salmon 249 NY 458; 164 NE 545 (1928) ......................................... 1.140, 1.135, 7.455 Melcann Ltd v Super John Pty Ltd (1995) 13 ACLC 92 ................................................... 9.240, 9.255 Melhado v Porto Alegre Railway Co (1874) LR 9 CP 503 ........................................................... 8.120 Mendes v Commissioner of Probate Duties (Vic) (1967) 122 CLR 152 ........................................ 5.95 Menier v Hooper’s Telegraph Works (1874) LR 9 Ch App 350 ................................. 7.465, 8.15, 8.20 Mercantile Trading Co, Stringer’s Case, Re (1869) LR 4 Ch App 475 ......................................... 9.355 Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC 500 ........................................................................................................ 4.160, 4.170, 4.178 Mesa Minerals Ltd v Mighty River International Ltd (2016) 111 ACSR 289 ................................ 5.295 Mesenberg v Cord Industrial Recruiters (Nos 1 & 2) (1996) 19 ACSR 483 ................................. 8.135 Metropolitan Fire Systems Ltd v Miller (1997) 23 ACSR 699 ..................................................... 7.140 Metropolitan Fire Systems Pty Ltd v Miller (1997) 23 ACSR 699 ..................................... 7.155, 7.170 Metyor Inc v Queensland Electronic Switching Pty Ltd (2002) 42 ACSR 398 ............................. 8.109 Mhanna v Sovereign Capital Ltd [2004] FCA 1040 ................................................................... 8.100 Midgley v Midgley [1893] 3 Ch 282 ........................................................................................... 7.50 Milburn v Pivot Ltd (1997) 78 FCR 472 .................................................................................... 9.340 Miles v Sydney Meat Preserving Co Ltd (1912) 12 SR (NSW) 98 ............................................... 9.365 Miller v Miller (1995) 16 ACSR 73 .................................................................................. 8.25, 12.245 Mills v Mills (1938) 60 CLR 150 ........................................................ 7.10, 7.235, 7.270, 7.285, 8.35 Mills v Northern Railway of Buenos Ayres Co (1870) LR 5 Ch App 621 ...................................... 9.355 Minnitt v Lord Talbot de Malahide (1881) 7 LR (Ir) 407 ............................................................ 1.125 Mirror Newspapers Ltd v Harrison (1982) 149 CLR 293 .............................................................. 4.20 Mistmorn Pty Ltd (in Liq) v Yasseen (1996) 21 ACSR 173 ............................................................ 7.35 Mollwo March & Co v Court of Wards (1872) LR 4 PC 419 ........................................................ 1.40 Molomby v Whitehead (1985) 63 ALR 282 .......................................................... 5.305, 7.337 Molopo Energy Ltd; Molopo Energy Ltd v Keybridge Capital Ltd (2015) 104 ACSR 46 ............. 9.250 Moore v I Bresler Ltd [1944] 2 All ER 515 ............................................................ 4.160, 4.170, 4.178 Morgan v 45 Fleurs Ave Pty Ltd (1986) 10 ACLR 692 ................................................................ 8.195 Morgan v Babcock and Wilcox Ltd (1929) 43 CLR 163 ............................................................. 4.142 Morgan v Flavel (1983) 1 ACLC 831 ......................................................................................... 7.250 Morley v ASIC (2010) 81 ACSR 285 ............................................................................................ 7.89 Morris v Kanssen [1946] AC 459 .................................................................................... 5.355, 5.380 xxiii

Corporations and Financial Markets Law

Moss v Elphick [1910] 1 KB 846 ............................................................................................... 1.115 Motel Marine Pty Ltd v IAC (Finance) Pty Ltd (1964) 110 CLR 9 ................................................. 4.20 Motherwell v Schoof [1949] 4 DLR 812 .................................................................................... 5.195 Mott v Mount Edon Gold Mines (Aust) Ltd (1994) 12 ACSR 658 ................................................ 6.95 Mount Edon Gold Mines (Aust) Ltd v Burmine Ltd (1994) 12 ACSR 727 ..................................... 4.90 Mousell Bros Ltd v London and Northwestern Railway Co [1917] 2 KB 836 ............. 4.135, 4.140, 4.142, 4.160 Movitex Ltd v Bulfield (1986) 2 BCC 99,403 ............................................................................ 7.550 Mozley v Alston (1847) 1 Ph 790; 41 ER 833 .............................................................................. 8.75 Mt Gibson Iron Ltd [2008] ATP 4 .............................................................................................. 12.75 Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services Ltd [1983] Ch 258 ..................................................................................................................... 4.105 Mutual Life and Citizen’s Assurance Co Ltd v Evatt [1971] AC 793 .................... 4.105, 7.540, 10.225

N N Slater Co Ltd, Re [1947] 2 DLR 311 ...................................................................................... 6.120 NCR Australia v Credit Connection [2004] NSWSC 1 ................................................................ 9.350 NCSC v Brierley Investments Ltd (1988) 14 NSWLR 273; 14 ACLR 177 ............. 4.90, 12.55, 12.105, 12.115 NCSC v Industrial Equity Ltd (1981) 6 ACLR 1 .......................................................................... 11.65 NCSC v Monarch Petroleum NL [1984] VR 733 ...................................................................... 11.225 NCSC v News Corp Ltd (1984) 156 CLR 296 ............................................................................ 11.85 NRMA v Bradley [2002] NSWSC 788 .......................................................................................... 6.40 NRMA v Morgan (1999) 31 ACSR 435 .................................................................................... 11.150 NRMA v Parker (1986) 6 NSWLR 517; 11 ACLR 1 ........................................................................ 6.40 NRMA v Snodgrass (2002) 42 ACSR 371; [2002] NSWSC 811 ........................................... 6.40, 6.65 NRMA Limited v Parkin [2004] NSWCA 153 ............................................................................... 6.40 NRMA Limited v Scandrett [2002] NSWSC 1123 ............................................................... 6.35, 6.40 NZ Flock and Textiles Ltd, Re [1976] 1 NZLR 192 ..................................................................... 9.392 Nassar v Innovative Precasters Group Pty Ltd [2009] NSWSC 342 ................................. 8.145, 8.195 National Australia Bank v Bond Brewing Holdings Ltd (1990) 169 CLR 271 ................................ 9.70 National Australia Bank Ltd v Bond Brewing Holdings Ltd [1991] 1 VR 386 ............................... 3.195 National Can Industries 01(R) [2003] ATP 40 .......................................................................... 12.180 National Discounts Ltd, Re (1951) 52 SR (NSW) 244 ................................................................ 8.170 National Dwellings Society Ltd, Re (1898) 78 LT 144 ................................................................ 9.117 National Exchange Pty Ltd (ACN 006 079 974) v ASIC (2004) 49 ACSR 369 ........... 10.200, 10.215, 10.230 National Foods Ltd [2005] ATP 8 .............................................................................................. 12.75 National Grocers Co Ltd, Re [1938] 3 DLR 106 ......................................................................... 6.120 National Portland Cement Co Ltd, Re [1930] NZLR 564 ........................................................... 8.150 National Provincial Marine Insurance Co, Re; Gilbert’s Case (1870) 5 Ch App 559 .................... 7.225 Nelson v Nelson (James) & Sons Ltd [1914] 2 KB 770 ........................................ 5.250, 5.255, 5.262 Nestegg Holdings Pty Ltd v Smith [2001] WASC 227 ................................................................ 8.110 Netbush Pty Ltd v Fascine Developments Pty Ltd [2005] WASC 73 ........................................... 8.177 New Brunswick & Canada Railway & Land Co v Muggeridge (1860) 1 Dr & Sm 363; 62 ER 418 .................................................................................................................................... 10.225 New Pinnacle Grove Silver Mining Co NL, Re (1897) 18 LR (NSW) Eq 168 ............................... 8.125 New South Wales v Commonwealth (1990) 169 CLR 482 ............................................... 2.85, 2.105 New South Wales Aboriginal Land Council v Jones (1998) 43NSWLR 300 ................................... 4.20 New South Wales Henry George Foundation Ltd v Booth (2002) 54 NSWLR 433 ........................ 6.85 New World Alliance Pty Ltd, Re; Sycotex Pty Ltd v Baseler (1994) 51 FCR 425 ............................ 7.45 New World Alliance Pty Ltd, Re; Sycotex Pty Ltd v Baseler (No 2) (1994) 122 ALR 531 .............. 7.312 New York Central and Hudson R v US 212 US 481 (1909) ........................................................ 4.175 New Zealand Netherlands Society “Oranje” Inc v Kuys [1973] 1 WLR 1126 .............................. 1.155 Newark Pty Ltd (in liq), Re; Taylor v Carroll (1991) 9 ACLC 1,592 .................................. 7.150, 7.207 Newspaper Proprietary Syndicate Ltd, Re [1900] 2 Ch 349 ....................................................... 5.245 Ngurli Ltd v McCann (1953) 90 CLR 425 .......................................................................................... ....... 5.300, 7.225, 7.235, 7.240, 7.270, 7.285, 7.312, 8.15, 8.20, 8.25, 8.35, 8.37, 8.125, 8.170 Nicholson v Permakraft (NZ) Ltd (in liq) (1985) 3 ACLC 453 .................................................... 5.190 xxiv

Table of Cases

Nicron Resources Ltd v Catto (1992) 8 ACSR 219 .......................................................... 9.240, 9.275 Nissho Iwai Australia Ltd v Malaysian International Shipping Corporation, Berhad (1989) 167 CLR 219 .......................................................................................................................... 7.45 Noble Investments Pty Ltd v Southern Cross Exploration NL [2008] FCA 1963 ......................... 8.215 Nokes v Doncaster Amalgamated Collieries Ltd [1940] AC 1014 ............................................... 1.125 Normandy v Ind Coope & Co Ltd [1908] 1 Ch 84 .................................................................... 5.245 North v Marra Developments Ltd (1981) 148 CLR 42; 37 ALR 341; 6 ACLR 386 ..... 11.200, 11.230, 11.235 North-West Transportation Co Ltd v Beatty (1887) 12 App Cas 589 ......... 7.375, 7.387, 7.465, 8.15, 8.20, 8.25 North Broken Hill Holdings Ltd, Re (1986) 10 ACLR 270 ......................................................... 12.220 North End Hotel (Huntley) Ltd, Re [1976] 1 NZLR 446 ............................................................. 8.162 North Sydney Brick and Tile Co Ltd v Darvall (1986) 5 NSWLR 681 .......................................... 12.90 Northern Counties Securities Ltd v Jackson and Steeple Ltd [1974] 2 All ER 625 ............ 5.195, 7.387 Northside Developments Pty Ltd v Registrar-General (1990) 170 CLR 146 .............. 5.265, 5.315, 5.338, 5.340, 5.355, 5.357, 5.375, 7.325 Nova Scotia Trust Co v Rudderham (1969) ................................................................................. 8.65

O O’Brien v Walker (1982) 1 ACLC 59 .......................................................................................... 7.455 O’Neill v Phillips [1999] 2 All ER 961; 1 WLR 1092 .............................................. 8.160, 8.195, 8.210 Oates v Consolidated Capital Services Ltd (2008) 66 ACSR 277 ................................................ 8.100 Oates v Consolidated Capital Services Pty Ltd (2009) 72 ACSR 506 ............................... 8.100, 8.109 Ogden’s Ltd v Weinberg (1906) 95 LT 567 ............................................................................... 7.145 Old Silkstone Collieries Ltd, Re [1954] Ch 169 ............................................................... 5.185, 9.117 On the Street Pty Ltd v Cott (1990) 3 ACSR 54 ......................................................................... 7.527 One.Tel Ltd (in liq) v Rich (2005) 53 ACSR 623 ........................................................................... 7.65 Online Advantage Ltd, Re [2002] ATP 14 ................................................................................ 12.100 Ooregum Gold Mining Company of India Ltd v Roper [1892] AC 125 ................ 9.205, 9.215, 9.220 Osborne v Amalgamated Society of Railway Servants [1909] 1 Ch 163 ..................................... 7.510 Osborne v Australian Mutual Growth Fund [1972] 1 NSWLR 100 ........................................... 11.170 Oswal v Yara Aust Pty Ltd (No 3) (2011) 86 ACSR 1 .................................................................. 5.195 Overend and Gurney Co v Gibb (1872) LR 5 HL 480 ......................................................... 7.10, 7.80 Overton Holdings Pty Ltd, Re (1984) 2 ACLC 777 ..................................................................... 8.215 Oxted Motor Co Ltd, Re [1921] 3 KB 32 .................................................................................. 5.175

P Pacific Carriers Ltd v BNP Paribas (2004) 218 CLR 451 ............................................................. 5.338 Palmer Leisure Coolum Pty Ltd v Takeovers Panel (2016) 110 ACSR 425 ................................... 12.30 Pancontinental Mining v Goldfields Ltd (1995) 16 ACSR 463 .................................................. 12.200 Panorama Developments v Fidelis Fabrics [1971] 2 QB 711 ...................................................... 5.355 Paradise Constructors Pty Ltd (admin apptd); Pong Property Development Pty Ltd v Sleiman (2004) 8 VR 171 ..................................................................................................... 3.190 Parkdale Custom Built Furniture Pty Ltd v Puxu Pty Ltd (1982) 149 CLR 191 .......................... 10.230 Parke v Daily News Ltd [1962] Ch 927 .................................................................. 7.240, 7.300 Parker v McKenna (1874) LR 10 Ch App 96 .......................................................... 7.10, 7.345, 7.455 Parker v NRMA (1992) 11 ACSR 370 ......................................................................................... 8.108 Parker and Cooper Ltd v Reading [1926] Ch 975 .......................................................... 5.165 Patrick Stevedores Operations No 2 Pty Ltd v Maritime Union of Australia (1998) 27 ACSR 521 ........................................................................................................................................ 4.85 Patrick Stevedores Operations No 2 Pty Ltd v Maritime Union of Australia (No 3) (1998) 27 ACSR 535 .............................................................................................................................. 4.85 Patterson v Humfrey (2015) 103 ACSR 152 .............................................................................. 8.210 Pavlides v Jensen [1956] Ch 565 ........................................................................................ 7.75, 8.25 Peate v Federal Commissioner of Taxation (1962-1964) 111 CLR 443 ......................................... 4.42 Peckham v Moore [1975] 1 NSWLR 353 ................................................................. 1.125, 3.25 Peek v Gurney (1873) LR 6 HL 377 ......................................................................................... 10.225 xxv

Corporations and Financial Markets Law

Peel v London & North Western Railway Co [1907] 1 Ch 5 ................................................ 6.65, 6.90 Pell v Marshall (1984) 8 ACLR 1015 .......................................................................................... 9.102 Pell’s Case (1869) LR 8 Eq 222 ................................................................................................. 9.220 Pender v Lushington (1877) 6 Ch D 70 ....................................................... 8.15, 8.90, 8.120, 8.125 Peninsular and Oriental Steam Navigation Co Ltd v Johnson (1938) 60 CLR 189 .... 3.255, 7.385, 7.387, 7.467, 7.497 People’s Department Store Inc v Wise [2004] 3 SCR 461 .......................................................... 7.130 Percival v Wright [1902] 2 Ch 421 ............................................................................................ 7.540 Pereira v DPP (1988) 63 ALJR 1 ................................................................................................. 9.345 Permanent Building Society (in liq) v Wheeler (1994) 11 WAR 187 .......... 7.70, 7.75, 7.90, 7.95, 7.355 Perpetual Custodians Ltd v IOOF Investment Management Ltd (2013) 91 ACSR 530; [2013] NSWCA 231 ............................................................................................................. 12.65, 12.75 Peruvian Railways Co, Re (1867) 2 Ch App 617 ........................................................................ 5.105 Peso Silver Mines Ltd (NPL) v Cropper (1966) 58 DLR (2d) 1 ..... 1.155, 7.475, 7.477, 7.482 Peter Buchanan Ltd v McVey [1955] AC 516n ........................................................................... 9.365 Peters v Australian Institute of Food Science and Technology (1986) 10 ACLR 547 ...................... 4.20 Peters’ American Delicacy Co Ltd v Heath (1939) 61 CLR 457 ......... 6.95, 7.225, 8.15, 8.37, 8.40, 8.50, 8.63, 8.68, 8.123, 8.200, 9.210 Petsch v Kennedy (1971) CLC 40-015; [1971] 1 NSWLR 494 ........................................ 5.270, 5.275 Phillips v Manufacturers’ Securities Ltd (1917) ............................................................................ 8.65 Phipps v Boardman [1967] 2 AC 46 ........................... 1.155, 7.455, 7.477, 7.480, 7.482, 7.485 Piercy v S Mills & Co Ltd [1920] 1 Ch 77 ................................................. 7.275, 7.285, 7.295, 8.125 Pilmer v The Duke Group Ltd (in liq) (2001) 207 CLR 165 ........................................................ 7.225 Pinnacle VRB Ltd (No 8), Re (2001) 39 ACSR 55 .................................. 12.30, 12.240, 12.245 Pioneer Concrete Services Ltd v Yelnah Pty Ltd (1987) 5 NSWLR 254 ....................................... 4.105 Playfair Development Corp Pty Ltd v Ryan [1969] 2 NSWR 661 .................................................. 1.20 Poliwka v Heven Holdings Pty Ltd (No 2) (1992) 8 ACSR 747 ........................................ 5.192, 5.275 Pooley v Driver (1876) 5 Ch D 458 ............................................................................................. 1.75 Portuguese Consolidated Copper Mines Ltd, Re (1889) 42 Ch D 160 ....................................... 5.270 Poseidon Ltd v Adelaide Petroleum NL (1994) 68 ALJR 313 ........................................................ 7.90 Pottie v Dunkley [2011] NSWSC 166 ........................................................................................ 8.100 Powell v Fryer (2001) 37 ACSR 589 .......................................................................................... 7.155 Power v Ekstein [2010] NSWSC 137 ......................................................................................... 8.100 PowerTel Ltd (No 1) [2003] ATP 25 ........................................................................................... 12.45 Praetorin Pty Ltd v TZ Ltd (2009) 76 ACSR 236;[2009] NSWSC 1237 ....................................... 5.295 Premier Gold NL v Ocean Resources NL (1994) 14 ACSR 695 ................................................... 8.135 Presidential Security Services of Australia Pty Ltd v Brilley (2008) 67 ACSR 692; [2008] NSWCA 204 .................................................................................................. 4.130, 4.135, 4.178 Prest v Petrodel Resources Ltd [2013] 2 AC 415 .............................................................. 4.65 Print Mail Logistics Ltd, Re [2012] NSWSC 792 .......................................................................... 6.80 Pritchard’s case (1873) LR 8 Ch 956 ......................................................................................... 8.120 Property Force Consultants Pty Ltd, Re (1995) 13 ACLC 1051 .................................................... 7.95 Prudential Assurance v Newman Industries [1982] Ch 204 ....................................................... 8.110 Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1981] Ch 257 .................. 8.80, 8.100 Puddephatt v Leith [1916] 1 Ch 200 ........................................................................................ 5.195 Pulbrook v Richmond Consolidated Mining Co (1878) 9 Ch D 610 ...... 5.275, 5.280, 8.123 Punt v Symons & Co Ltd [1903] 2 Ch 506 ......................................................... 7.275, 7.285, 8.125 Pyle Works, Re (1890) 44 Ch D 534 .......................................................................................... 3.110 Pyle Works (No 2), Re [1891] 1 Ch 173 .................................................................................... 5.105

Q QBE Insurance Group Ltd v ASC (1992) 8 ACSR 631 ........................................... 9.355, 9.365, 9.392 QIW Retailers Ltd v Davids Holdings Pty Ltd (No 1) (1992) 36 FCR 386; 8 ACSR 245 .............. 12.200 QIW Retailers Ltd v Davids Holdings Pty Ltd (No 2) (1992) 8 ACR 333 ..................................... 8.135 Qintex Australia Finance Ltd v Schroders Australia Ltd (1990) 3 ACSR 267 ............. 4.105, 4.125 Quancorp Pty Ltd v Macdonald (1999) 32 ACSR 50; [1999] WASCA 33 .................................... 11.65 Queensland Bacon Pty Ltd v Rees (1966) 115 CLR 266 .................................................. 5.360, 7.155 xxvi

Table of Cases

Queensland Mines Ltd v Hudson (1978) 52 ALJR 399 ................... 7.482, 7.495, 7.497, 7.545 Queensland Press Ltd v Academy Investments No 3 Pty Ltd (1987) 11 ACLR 419 ....................... 6.40 Quin and Axtens Ltd v Salmon [1909] AC 442 .......................................................................... 5.110

R R v Australasian Films Ltd (1921) 29 CLR 195 ........................................................................... 4.142 R v British Steel Plc [1995] 1 WLR 1356 .................................................................................... 4.182 R v Byrnes (1995) 183 CLR 501 ..................................................................................... 7.500, 7.527 R v Cawood (1724) 2 Ld Ray 1361; 92 ER 386 ........................................................................... 2.45 R v District Council of Victor Harbor; Ex parte Costain Australia Ltd (1983) 34 SASR 188 .......... 7.350 R v Dodd (1808) 9 East 516; 103 ER 670 .................................................................................... 2.45 R v Farris (2015) 107 ACSR 26 ................................................................................................ 11.240 R v Firns (2001) 38 ACSR 223 ................................................................ 11.135, 11.240, 11.255 R v Gateway Foodmarkets Ltd [1997] 2 All ER 78 ...................................................................... 4.182 R v Goodall (1975) 11 SASR 94 .................................................................................................. 4.42 R v H M Coroner for East Kent; Ex parte Spooner (1989) 88 Cr App R 10 ................................. 4.130 R v Hannes [2000] NSWCCA 503 ........................................................................................... 11.255 R v Holden [1974] 2 NSWLR 548 ............................................................................................ 11.255 R v Hughes (2000) 202 CLR 535 ..................................................................................... 2.85, 2.105 R v ICR Haulage Ltd [1944] KB 551 .................................................................... 4.130, 4.160, 4.165 R v J G Hammond & Co [1914] 2 KB 866 ................................................................................... 4.20 R v Kirby; Ex parte Boilermakers’ Society of Australia (1956) CLR 254 ......................................... 2.85 R v McDonnell [1966] 1 QB 233 ................................................................................................ 4.42 R v McMahon (1976) 2 ACLR 543 ............................................................................................ 4.105 R v Merchant Tailors’ Company (1831) 2 B & Ad 115; 109 ER 1086 ......................................... 5.295 R v Murray Wright Ltd [1970] NZLR 476 .................................................................................. 4.130 R v OC (2015) 108 ACSR 80 ..................................................................................................... 11.90 R v P & O European Ferries (Dover) Ltd (1991) 93 Cr App R 73 ................................................ 4.130 R v Registrar of Companies; Ex parte Attorney-General (unreported, Divisional Court, Queen’s Bench Division, 17 December 1980) ........................................................................ 3.70 R v Richardson (1758) 1 Burr 517; 97 ER 426 ........................................................................... 5.240 R v Varlo (1775) 1 Cowp 248; 98 ER 1068 ....................................................................... 3.150, 5.95 R v de Berenger (1814) 3 Maule & S 67; 105 ER 536 .............................................................. 11.190 R R Drury (1985) 48 MLR 644 .................................................................................................... 3.70 RCA Corporation v Custom Cleared Sales Pty Ltd (1978) 19 ALR 123 ....................................... 5.360 RJR Nabisco, Inc Shareholders Litigation, In re [1988-1989 Transfer Binder] Fed Sec L Rep (CCH) 94,194 ...................................................................................................................... 7.120 Ragless v IPA Holdings Pty Ltd (in liq) (2008) 65 ACSR 700 ....................................................... 8.100 Rainham Chemical Works Ltd v Belvedere Fish Guano Co Ltd [1921] 2 AC 465 .......................... 4.68 Rama Corp Ltd v Proved Tin and General Investments Ltd [1952] 2 QB 147 ............................. 5.355 Rathner in his capacity as Official Liquidator of Kalimand Pty Ltd (in liq) v Hawthorn [2014] FCA 1067 ............................................................................................................................. 3.210 Rayfield v Hands [1960] Ch 1 ............................................................................. 8.123, 9.110, 9.117 Re M Dalley & Co Pty Ltd v Sims (1968) 1 ACLR 489 ................................................................ 8.210 Read v Astoria Garage (Streatham) Ltd [1952] WN 185 ................................... 5.250, 5.260 Read v Astoria Garage (Streatham) Ltd [1952] Ch 637 .......................... 5.255, 5.260, 5.262 Refrigerated Express Lines (A/Asia) Pty Ltd v Australian Meat and Live-Stock Corporation (1979) 42 FLR 204 ................................................................................................................. 7.65 Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134n ............ 7.470, 7.472, 7.475, 7.477, 7.497, 7.527, 8.20, 8.25 Reid v Explosives Co Ltd (1887) LR 19 QBD 264 ....................................................................... 3.195 Reid House Pty Ltd v Beneke (1986) 5 ACLC 451 ...................................................................... 9.117 Reiffel v ACN 075 839 226 Ltd (2003) 45 ACSR 67 ................................................................. 10.205 Rejfek v McElroy (1965) 112 CLR 517 ....................................................................................... 7.140 Remrose Pty Ltd v Allsilver Holdings Pty Ltd [2005] WASC 251 ................................................. 8.195 Repco Ltd v Bartdon Pty Ltd [1981] VR 1; (1980) 4 ACLR 787 ........................................ 5.200, 11.65 Residues Treatment and Trading Co Ltd v Southern Resources Ltd (1988) 14 ACLR 569; 51 SASR 177 ................................................................................ 8.37, 8.75, 8.130 Resource Generation Ltd [2015] ATP 12 .................................................................................. 12.100 xxvii

Corporations and Financial Markets Law

Resource Generation Ltd 01R [2015] ATP 13 ........................................................................... 12.100 Reynolds Bros (Motors) Pty Ltd v Esanda Ltd (1983) 1 ACLC 1,333 ............................................. 9.50 Rich v ASIC (2004) 220 CLR 129; 50 ACSR 242 ............................................................... 5.230, 7.55 Richard Brady Franks Ltd v Price (1937) 58 CLR 112 ................................ 5.360, 7.215, 7.295, 8.200 Richfield Ltd, Re [2003] ATP 41 ................................................................................................. 12.35 Rilgar Nominees v BHA Holdings Pty Ltd [2014] VSC 632 ......................................................... 5.192 Ringuet v Bergeron (1960) 24 DLR (2d) 449; [1960] SCR 672 .................................................. 5.195 Rio Tinto Zinc Corp v Westinghouse Electric Corp [1978] AC 547 ............................................... 4.20 Riteway Express Pty Ltd v Clayton (1987) 10 NSWLR 238 ......................................................... 7.527 Roach v Winnote Pty Ltd (2006) 57 ACSR 138 .......................................................................... 8.100 Rochfort v Trade Practices Commission (1981) 53 FLR 364 ......................................................... 3.25 Rolloswin Investments Ltd v Chromolit Portugal Cutelaris E Produtos Metalicos SARL [1970] 1 WLR 912 ............................................................................................................................. 4.20 Roma Industries Ltd v Bliim (1983) 1 ACLC 1079 ...................................................................... 9.275 Ross v Caunters [1980] Ch 297 .............................................................................................. 10.225 Ross v GVC Homes Pty Ltd (admin appt) (2016) 110 ACSR 60 .................................................. 5.360 Rossfield Group Operations Pty Ltd, Re [1981] Qd R 372 .......................................................... 7.350 Rowland v Meudon Pty Ltd (2008) 66 ACSR 83 ........................................................................ 5.295 Royal British Bank v Turquand (1856) 6 E & B 327; 119 ER 886 ........... 5.340, 5.350, 5.355, 5.357 Ruben v Great Fingall Consolidated [1906] AC 439 .................................................................. 5.355 Ruddock, Re (1879) 5 VLR (IP & M) 51 ....................................................................................... 1.45 Rural Press Ltd v ACCC [2003] HCATrans 291 ........................................................................... 12.65 Russian Ironworks Co, Re (1867) LR 3 Eq 795 ......................................................................... 10.225 Ruut v Head (1996) 20 ACSR 160 ............................................................................................. 8.145 Ryan v Edna May Junction Goldmining Co NL (1916) 21 CLR 487 ................................... 6.90, 6.105

S SEC v Chenery Corp 318 US 80 .................................................................................................. 7.10 SEC v Ralston Purina Co 346 US 119 (1953) ............................................................................. 10.35 SGH Ltd v Commissioner of Taxation (2002) 210 CLR 51 ......................................................... 7.337 Sadler v Whiteman [1910] 1 KB 868 ........................................................................................... 1.85 St Barbara Mines Ltd v ASIC (2001) 37 ACSR 92 ....................................................................... 12.35 St James’ Court Estates Ltd, Re [1944] Ch 6 .............................................................................. 9.225 Salmon v Quin and Axtens Ltd [1909] 1 Ch 311 ............................................................ 8.120, 8.123 Salomon v Salomon & Co Ltd [1897] AC 22 .... 3.240, 4.25, 4.30, 4.42, 4.45, 4.65, 4.70, 4.95, 4.120, 4.185, 5.155, 5.215, 9.220 Salomons v Pender (1865) 3 H & C 639; 159 ER 682 ............................................................... 7.385 Saltdean Estate Co Ltd, Re [1968] 1 WLR 1844 ......................................................................... 9.103 Samic Ltd v Metals Exploration Ltd (1993) 60 SASR 300 ......................................................... 12.200 Sandell v Porter (1996) 115 CLR 666 ........................................................................................ 7.150 Sanford v Sanford Courier Service Pty Ltd (1986) 10 ACLR 549 ............................ 8.65, 8.210, 8.215 Sanford v Sanford Courier Service Pty Ltd (No 2) (1987) 11 ACLR 373 ..................................... 8.215 Santos Ltd v Pettingell (1979) 4 ACLR 110 ................................................................................ 5.220 Savoy Corp Ltd v Development Underwriting Ltd (1963) 80 WN (NSW) 1021 ......................... 8.125 Scarcel Pty Ltd v City Loan & Credit Corp Pty Ltd (1988) 12 ACLR 730 .................................... 8.100 Scarel Pty Ltd v City Loan & Credit Corp Pty Ltd (1988) 12 ACLR 730 ...................................... 8.135 Scholey v Central Railway Co of Venezuela (1868) LR 9 eq 266n ............................................ 10.225 Scott v Brown Doering McNab & Co [1892] 2 QB 724 .............................................. 11.230, 11.190 Scott v Frank Scott (London) Ltd [1940] Ch 794 ...................................................................... 8.123 Scott v Scott [1943] 1 All ER 582 .............................................................................................. 5.135 Scottish & Colonial Ltd v Australian Power & Gas Co Ltd (2007) 215 FLR 100 .......................... 5.240 Scottish Co-operative Wholesale Society Ltd v Meyer [1959] AC 324 ........ 7.50, 7.337, 7.527, 8.185, 8.215 Scottish Insurance Corp Ltd v Wilsons and Clyde Coal Co Ltd [1949] AC 462 ............ 9.80, 9.90, 9.100, 9.103, 9.117 Scottish Loan and Finance Co Ltd, Re (1944) 44 SR (NSW) 461 ................................................ 5.355 Seaton v Federal Hotels Ltd (1981) 6 ACLR 214 ........................................................................ 9.102 Secretary of State for Trade and Industry v Deverell [2001] Ch 340 ............................................ 7.40 xxviii

Table of Cases

Seddon v North Eastern Salt Co Ltd [1905] 1 Ch 326 ............................................................. 10.225 Selangor United Rubber Estates Ltd v Cradock (No 3) [1968] 1 WLR 1555 ................................. 7.50 Selig v Wealthsure Pty Ltd (2015) 105 ACSR 552 .................................................................... 10.215 Severn and Wye and Severn Bridge Railway Co, In re [1896] 1 Ch 559 ..................................... 9.360 Shafron v ASIC (2012) 88 ACSR 126 .................................................................................. 7.30, 7.88 Sharp v Dawes (1876) 2 QBD 26 ................................................................................................ 6.70 Sheahan (as liquidator of South Australian Service Stations) (In liq) v Verco (2001) 37 ACSR 117 ........................................................................................................................................ 7.95 Shearer Transport Co Pty Ltd v McGrath [1956] VLR 316 .......................................................... 9.350 Shears v Chisholm (1992) 9 ACSR 691 ....................................................................................... 6.95 Sheldon, Re; Re Whitcoulls Group Ltd (1987) 3 NZCLC 100,058 ................................................ 8.65 Shindler v Northern Raincoat Co Ltd [1960] 1 WLR 1038 ................................. 5.260, 5.262 Shum Yip Properties Development Ltd v Chatswood Investment & Development Co Pty Ltd (2002) 40 ACSR 619 ............................................................................................................ 8.210 Shuttleworth v Cox Bros & Co (Maidenhead) Ltd [1927] 2 KB 9 ............................ 5.262, 8.55, 8.63 Sidebottom v Kershaw Leese & Co Ltd [1920] 1 Ch 154 ........................................ 7.225, 8.55, 8.65 Sims v ABC Tissue Products Pty Ltd [2008] NSWSC 192 ............................................................ 3.210 Simto Resources Ltd v Normandy Capital Ltd (1993) 10 ACSR 776 ............................................. 4.20 Sino Australia Oil and Gas Ltd (in liq), Re [2016] FCA 934 ....................................................... 10.205 Skilled Group Ltd, Re (2016) 113 ACSR 525 ............................................................................. 9.340 Smith v Anderson (1880) 15 Ch D 247 .............................................................................. 1.20, 3.11 Smith v Butler [2012] EWCA Civ 314 ............................................................................... 5.327 Smith v Cock (1911) 12 CLR 30; [1911] AC 317 ....................................................................... 1.155 Smith v Hancock [1894] 2 Ch 377 ............................................................................................. 4.50 Smith v Kay (1859) 7 HLC 750; 11 ER 299 ............................................................................. 10.225 Smith v Sadler (1997) 25 ACSR 672 .................................................................................... 6.20 Smith v Van Gorkom 488 A 2d 858 (Del 1985) ......................................................................... 7.120 Smith v Yarnold [1969] 2 NSWR 410 .......................................................................................... 3.25 Smith Stone and Knight Ltd v Birmingham Corporation (1939) 161 LT 371 .... 4.60, 4.68, 4.120, 4.127 Smith and Fawcett Ltd, Re [1942] Ch 304 ..................................... 7.230, 7.255, 7.312, 8.125 Smolarek v Liwszyc [2006] WASCA 50 ...................................................................................... 8.195 Sodeman v R (1936) 55 CLR 192 .............................................................................................. 7.140 Sons of Gwalia Ltd v Margaretic (2007) 231 CLR 160 .................................................... 3.90, 10.195 South Hetton Coal Co Ltd v North Eastern News Assoc Ltd [1894] 1 QB 133 ............................. 4.20 Southard & Co Ltd, Re [1979] 1 WLR 1198 .............................................................................. 4.105 Southern v Watson [1940] 3 All ER 439 ....................................................................................... 4.68 Southern Cross Interiors Pty Ltd (in liq) v DCT (2001) 53 NSWLR 213 ...................................... 7.150 Southern Foundries (1926) Ltd v Shirlaw [1940] AC 701 .................................... 5.245, 5.250, 5.260 Southern Resources Ltd v Residues Treatment & Trading Co Ltd (1990) 3 ACSR 207 ................ 7.250 Southern Resources Ltd, Re; Residues Treatment & Trading Co Ltd v Southern Resources Ltd (1989) 15 ACLR 770 .............................................................................................................. 7.90 Sovereign Life Assurance Co v Dodd [1892] 2 QB 573 .............................................................. 9.235 Soyfer v Earlmaze Pty Ltd [20005] NSWSC 1068 ...................................................................... 5.360 Spackman v Evans (1868) LR 3 HL 171 ..................................................................................... 7.225 Spargos Mining NL, Re (1990) 3 ACSR 1 ............................................................... 8.215, 8.220 Spicer v Mytrent Pty Ltd (1984) 8 ACLR 711 ............................................................................. 5.270 Spies v R (2000) 201 CLR 603 .................................................................................................. 7.312 Standard Chartered Bank of Australia Ltd v Antico (1995) 131 ALR 1 .......................................... 7.50 Standard Chartered Bank of Australia Ltd v Antico (1995) 38 NSWLR 290 ....... 7.45, 7.52 Stanton v Drayton Commercial Investment Co Ltd [1983] 1 AC 501 ........................................ 9.222 Staples v Eastman Photographic Materials Co [1896] 2 Ch 303 ................................................ 9.102 State Bank of South Australia v Barrett (1995) 13 ACLC 1369 ................................................... 5.300 State Street Australia Ltd v Retirement Villages Group Management Pty Ltd (2016) 113 ACSR 483 ............................................................................................................................ 5.240 Statewide Tobacco Services Ltd v Morley (1990) 2 ACSR 405 ..................................................... 7.75 Steinfield v Gibbons [1925] WN 11 .......................................................................................... 5.140 Stekel v Ellice [1973] 1 WLR 191 ........................................................................................ 1.45, 1.55 Stena Line v Merchant Navy Ratings Pension Fund Trustees Ltd [2010] EWCA Civ 543 ............. 5.327 Stevens v Commonwealth General Assurance Corp Ltd (1938) 55 WN (NSW) 120 ................... 5.225 xxix

Corporations and Financial Markets Law

Stewart v Normandy NFM Ltd (2000) 18 ACLC 814 ................................................................. 5.300 Stirling v Maitland (1865) 5 B & S 840; 122 ER 1043 ............................................................... 5.260 Story v Advance Bank Australia Ltd (1993) 31 NSWLR 722 ........................................................ 5.360 Strickland v Rocla Concrete Pipes Ltd (1971) 124 CLR 468 ......................................................... 2.80 Strong v J Brough & Son (Strathfield) Pty Ltd (1991) 5 ACSR 296 .................................. 5.105, 8.152 Style Ltd, Re; Merim Pty Ltd v Style Ltd (2009) 255 ALR 63 ...................................................... 5.295 Sullivans Cove IXL Nominees Pty Ltd, Re (2011) 82 ACSR 224 ......................................... 5.195, 9.80 Summit Resources Pty Ltd, Re (2012) 261 FLR 365 ................................................................... 7.415 Sunburst Properties Pty Ltd (in liq) v Agwater Pty Ltd [2005] SASC 335 .................................... 5.360 Supply of Ready Mixed Concrete (No 2), In re [1995] 1 AC 456 ............................................... 4.170 Swansson v Pratt (2002) 42 ACSR 313 ....................................................... 8.100, 8.105, 8.108 Swiss Screens (Aust) Pty Ltd v Burgess (1987) 11 ACLR 756 ...................................................... 5.275 Sykes v Reserve Bank of Australia (1999) ATPR 41-699 ............................................................. 10.115

T TSC Industries Inc v Northway Inc 426 US 438 (1976) ........... 7.350, 7.540, 10.100, 10.155, 12.200 TVW Enterprises Ltd v Queensland Press Ltd [1983] 2 VR 529 ...................................... 12.80, 12.120 Taco Company of Australia Inc v Taco Bell Pty Ltd (1982) 42 ALR 177 ..................................... 10.230 Tai-Ao Aluminium (Aust) Pty Ltd, Re (2004) 51 ACSR 465 ......................................................... 5.300 Taipan Resources NL (No 9), Re [2001] APT 4; (2001) 38 ACSR 111 ............. 12.105, 12.125 Taldua Rubber Co Ltd, Re [1946] 2 All ER 763 .......................................................................... 8.150 Talisman Technologies Inc v Queensland Electronic Switching Pty Ltd [2001] QSC 324 ............ 8.105 Tanamerah Estates Pty Ltd v Tibra Capital Pty Ltd (2015) 110 ACSR 29 ....................................... 4.20 Taxation, Deputy Commissioner of v Clark (2003) 57 NSWLR 113 .................. 7.180, 7.210 Taxation, Federal Commissioner of v Sun Alliance Investments Pty Ltd (in liq) (2005) 225 CLR 488 ............................................................................................................................... 9.392 Taylor v Darke (1992) 10 ACLC 1516 ......................................................................................... 7.45 Taylor v Powell (1993) 10 ACSR 174 ......................................................................................... 7.150 Techflow (NZ) Ltd v Techflow Pty Ltd (1996) 7 NZCLC 261,138 .............................................. 8.105 Teck Corp Ltd v Millar (1973) 33 DLR (3d) 288 ................. 7.235, 7.240, 7.280, 7.305, 7.312 Teh v Ramsay Centauri Pty Ltd (2002) 42 ACLC 354; (2002) 42 ACSR 354 .............. 12.255, 12.260 Television New England Ltd v Northern Rivers Television Ltd (1971-3) CCH CLC 40-006 .......... 8.125 Tennent v City of Glasgow Bank (1879) 4 App Cas 795 .......................................................... 10.225 Tesco Supermarkets Ltd v Nattrass [1972] AC 153 .............. 4.160, 4.165, 4.170, 4.178, 7.45 Theophanous v Herald & Weekly Times Ltd (1994) 182 CLR 104 ................................................ 4.20 Theseus Exploration NL v Foyster (1972) 126 CLR 507 ............................................................. 3.125 Thomas v D’Arcy (2005) 52 ACSR 609 ...................................................................................... 8.110 Thomas v H W Thomas Ltd (1984) 2 ACLC 610; [1984] 1 NZLR 686 ............................. 8.195, 8.210 Thomas v Mackay Investments Pty Ltd (1996) 22 ACSR 294 ..................................................... 8.145 Thomas Marshall (Exports) Ltd v Guinle [1979] Ch 227 ............................................................ 7.527 Thompson v ASIC (2002) 41 ACSR 456 ............................................................. 10.185, 10.190 Thorby v Goldberg (1964) 112 CLR 597 .......................................................................... 7.515 Thornett v Federal Commissioner of Taxation (1938) 59 CLR 787 ............................................. 9.275 3M Australia Pty Ltd v Kemish (1986) 10 ACLR 371 .................................................................. 7.155 Tiessen v Henderson [1899] 1 Ch 861 ............................................................................. 6.90, 6.100 Tiger Investment Co Ltd, Re (1999) 158 FLR 321 .................................... 9.230, 9.250, 9.270 Tiger Investment Company Ltd, Re (2000) 33 ACSR 437 .......................................................... 9.275 Tiger Nominees Pty Ltd v State Pollution Control Commission (1992) 25 NSWLR 715 .............. 4.135 Tinkerbell Enterprises Pty Ltd v Takeovers Panel [2012] FCA 1272 ............................................. 12.40 Tintin Exploration Syndicate Ltd v Sandys (1947) 177 LT 412 ................................................... 9.222 Tivoli Freeholds Ltd, Re [1972] VR 445 ................................................................. 8.150, 8.152 Toal v Aquarius Platinum Ltd [2004] FCA 550 ........................................................................... 12.05 Tomanovic v Argyle HQ Pty Ltd [2010] NSWSC 152 ................................................................. 8.160 Tomanovic v Global Mortgage Equity Corporation Pty Ltd (2011) 84 ACSR 121 ........... 8.160, 8.195, 8.210 Tomczak v Morton Thiokol, Inc [1990 Transfer Binder] Fed Sec L Rep (CCH) 95,327 ................ 7.120 Topham v Duke of Portland (1869) 5 Ch App 40 ...................................................................... 7.270 Tosich Construction Pty Ltd (in liq) v Tosich (1997) 78 FCR 363 ............................................... 3.210 xxx

Table of Cases

Totally & Permanently Incapacitated Veterans’ Association of NSW Ltd v Gadd (1998) 28 ACSR 549 .............................................................................................................................. 6.40 Totex-Adon Pty Ltd, Re [1980] 1 NSWLR 605 .......................................................... 6.25, 6.55 Tourprint International Pty Ltd (in liq) v Bott (1999) 32 ACSR 201 ............................................ 7.170 Touzell v Cawthorn (1995) 18 ACSR 328 .................................................................................... 6.70 Tracy v Mandalay Pty Ltd (1953) 88 CLR 215 ......... 3.105, 3.230, 3.238, 3.240, 3.245, 3.255, 4.58 Trade Auxiliary Co v Vickers (1873) LR 16 Eq 303 ..................................................................... 5.140 Trafalgar West Investments Pty Ltd v Superior Lawns Aust Pty Ltd (No 6) (2014) 102 ACSR 130 ...................................................................................................................................... 8.210 Transvaal Lands Co v New Belgium (Transvaal) Land and Development Co [1914] 2 Ch 488 ........................................................................................ 7.350, 7.375, 7.387 Trevor v Whitworth (1887) 12 App Cas 409 .................................................................. 9.240, 9.280 Triplex Safety Glass Co Ltd v Lancegaye Safety Glass (1934) Ltd [1939] 2 KB 395 ....................... 4.20 Tritonia Ltd v Equity and Law Life Assurance Soc [1943] AC 584 ................................................. 4.20 Triulcio v Chase Property Investments Pty Ltd [2004] NSWSC 31 .................................. 8.145, 8.178 Truculent, The [1952] P 1 ......................................................................................................... 4.155 Trustor AB v Smallbone (No 2) [2001] 1 WLR 1177 .................................................................... 4.70 Tully Sugar Ltd [2009] ATP 26 ................................................................................................. 12.205 Tunstall v Steigmann [1962] 2 QB 593 ....................................................................................... 4.40 Turnbull v National Roads and Motorists’ Association Ltd (2004) 50 ACSR 44 ........................... 8.195 Turner v Berner (1978) 3 ACLR 272 ............................................................................................ 6.40 Turquand v Marshall (1869) LR 4 Ch App 376 ............................................................................ 7.75 Twycross v Grant (1877) 2 CPD 469 ...................................................................... 3.220, 3.235

U U Drive Pty Ltd, Re (1986) 5 ACLC 117 ..................................................................................... 5.192 Ultraframe (UK) Ltd v Fielding [2005] EWHC 1638 ..................................................................... 7.40 Unit Construction Co Ltd v Bullock [1960] AC 351 ..................................................................... 4.45 United Dominions Corporation Ltd v Brian Pty Ltd (1985) 157 CLR 1; 59 ALR 676 ........... 1.20, 1.25, 1.135, 7.542 United Medical Protection Ltd, Re (2002) 41 ACSR 623 ............................................................ 5.105 United States v Milwaukee Refrigerator Transit Co 142 F 247 (1905) ........................................ 4.120 Uniting Church of Australia Property Trust (NSW) v Macquarie Radio Network Pty Ltd (1997) 24 ACSR 721 .............................................................................................................. 6.20 Universal Telecasters (Qld) v Guthrie (1978) 32 FLR 360 ......................................................... 10.205

V V Brudney & R C Clark (1981) 94 Harv LR 997 ......................................................................... 7.455 VGM Holdings Ltd, Re [1942] Ch 235 ...................................................................................... 10.55 VPlus Holdings Pty Ltd v Bank of Western Australia Ltd (2012) 91 ACSR 545 ............................. 8.110 VTB Capital PLC v Nutritek International Corp [2012] EWCA Civ 808 ......................................... 4.70 VTB Capital plc v Nutritek International Corp [2012] EWCA Civ 808 ........................................... 4.65 Vadasz v Pioneer Concrete (SA) Pty Ltd (1995) 184 CLR 102 .................................................. 10.225 Van Reesema, Re (1975) 11 SASR 322 ....................................................................................... 5.237 Vanfox Pty Ltd, re [1995] 2 Qd R 445 ....................................................................................... 9.275 Vasudevan (as Joint and Several Liquidator of Wulguru Retail Investments Pty Ltd (in liq)) v Becon Constructions (Australia) Pty Ltd [2014] VSCA 14; (2014) 97 ACSR 627 ..................... 3.210 Verner v Commercial and General Investment Trust [1894] 2 Ch 239 .......... 9.365, 9.375, 9.377, 9.380 Versteeg v The Queen (1988) 14 ACLR 1 .................................................................................. 5.275 Viento Group Ltd [2011] ATP 1 ................................................................................................. 12.75 Village Roadshow Ltd v Boswell Film GmbH (2004) 8 VR 38 .......................................... 9.280, 9.285 Village Roadshow Ltd, Re [2004] ATP 4 ................................................................................... 12.220 Village Roadshow Ltd (No 3), Re (2005) 52 ACSR 238 .............................................................. 9.285 Vines v ASIC (2007) 62 ACSR 1 .......................................................................................... 7.65, 7.75 Vision Nominees Pty Ltd v Pangea Resources Ltd (1988) 14 NSWLR 38 ........................... 5.240, 6.25 Visnic v ASIC (2007) 231 CLR 381 ............................................................................................ 5.230 xxxi

Corporations and Financial Markets Law

Vrij v Boyle (1995) 3 NZLR 763 ................................................................................................ 8.105 Vrisakis v ASC (1993) 11 ACSR 162; 9 WAR 395 ........................................................ 7.75, 7.82, 7.90

W Wagner v International Health Promotions Pty Ltd (1994) 14 ACSR 466 ................................... 8.145 Wakim, Re; Ex parte McNally (1999) 198 CLR 511 ................................................ 2.85, 2.100, 2.105 Walker v Hirsh (1884) 27 Ch D 460 ............................................................................................ 1.55 Walker v Hungerfords (1987) 19 ATR 435 ................................................................................... 4.68 Walker v Johnson 17 DC App 14 ................................................................................................. 6.85 Walker v Wimborne (1976) 137 CLR 1 ...................... 4.75, 4.105, 4.120, 5.190, 7.312, 7.320, 7.500 Wallersteiner v Moir [1974] 1 WLR 991 .............................................................................. 4.58, 4.70 Wallersteiner v Moir (No 2) [1975] QB 373 ................................................................... 8.108, 8.125 Walt Disney Company Derivative Litigation, In re 907 A 2d 693 .................................................. 7.20 Walter Symons Ltd, Re [1934] Ch 308 ...................................................................................... 9.102 Wambo Mining Corporation Pty Ltd v Wall Street (Holdings) Pty Ltd (1998) 16 ACLR 1601 ...... 9.345 Wan Ze Property Development (Aust) Pty Ltd, Re (2012) 90 ACSR 593 ..................................... 8.210 Wayde v New South Wales Rugby League Ltd (1985) 180 CLR 459; 59 ALJR 798 ..... 8.195, 8.200, 8.210 Weaver v Harburn (2014) 103 ACSR 416 .................................................................................. 3.210 Webb v Earle (1875) LR 20 Eq 556 ........................................................................................... 9.102 Webster v Solloway Miles & Co [1931] 1 DLR 831 ...................................................................... 4.20 Weedmans Ltd, Re [1974] Qd R 377 ...................................................................... 8.170, 8.175 Weinberger v UOP Inc (1983) ..................................................................................................... 8.65 Weinstock v Beck (2013) 93 ACSR 251 ..................................................................................... 5.290 Welton v Saffery [1897] AC 299 ..................................................................................... 8.120, 8.123 Westburn Sugar Refineries Ltd v Inland Revenue Commissioners [1960] TR 105 ....................... 9.390 Westburn Sugar Refineries Ltd, Ex parte [1951] AC 625 ................................................. 9.230, 9.240 Westpac Banking Corporation v Bell Group Ltd (in liq) (No 3) (2012) 89 ACSR 1 .............. 7.10, 7.70, 7.105, 7.225 Whaley Bridge Calico Printing Co v Green (1879) 5 QBD 109 .................................................. 3.225 White v Bristol Aeroplane Co [1953] Ch 65 .............................................. 9.105, 9.115, 9.118 White Constructions (ACT) Pty Ltd (in liq) v White (2004) 49 ACSR 220 ................................... 7.150 White Star Line Ltd, Re [1938] Ch 458 ..................................................................................... 9.222 Whitehouse v Carlton Hotel Pty Ltd (1985) 10 ACLR 20 ........................................................... 5.265 Whitehouse v Carlton Hotel Pty Ltd (1987) 162 CLR 285 .......... 5.110, 7.235, 7.245, 7.295, 7.312, 12.245 Whitlam v ASIC (2003) 46 ACSR 1 .............................................................................................. 6.85 Wilkinson v Feldworth Financial Services Pty Ltd (1998) 29 ACSR 642 ........................................ 7.95 Will v United Lankat Plantations Co Ltd [1914] AC 11 ................................. 9.80, 9.85, 9.90 William Bedford Ltd (in liq), Re [1967] VR 490 .......................................................................... 9.102 William Metcalfe & Sons Ltd, Re [1933] Ch 142 ....................................................................... 9.100 Williams v NCSC (1990) 2 ACSR 131 ........................................................................................ 7.150 Williams v Spautz (1992) 174 CLR 509 ..................................................................................... 8.105 Wilson v London Midland and Scottish Railway [1940] Ch 393 ................................................ 7.387 Wilson v Lord Bury (1880) 5 QBD 518 ........................................................................................ 7.10 Wilson v Miers (1861) 10 CB (NS) 348; 142 ER 486 ................................................................. 5.105 Wiltshire v Kuenzli (1945) 63 WN 47 .......................................................................................... 1.35 Wily v Eastern Elevators Pty Ltd (2003) 175 FLR 344 ................................................................. 3.210 Wincham Shipbuilding, Boiler and Salt Co, Re (1878) 9 Ch D 322 .............................................. 7.10 Windsor v National Mutual Life Association of Australasia Ltd (1992) 7 ACSR 210 ....................... 6.40 Winepros Ltd [2002] ATP 18 ..................................................................................................... 12.75 Winlyn Investments Pty Ltd, Re (2011) 86 ACSR 197 .................................................................. 6.40 Winpar Holdings Ltd v Goldfields Kalgoorlie Ltd (2000) 34 ACSR 737 ..................................... 12.260 Winpar Holdings Ltd v Goldfields Kalgoorlie Ltd (2001) 166 FLR 144 ............ 9.230, 9.250, 9.255, 9.260, 9.275, 9.355 Winthrop Investments Ltd v Winns Ltd [1975] 2 NSWLR 666 ....... 5.190, 8.35, 8.37, 8.108, 8.132, 12.245 Wise v Perpetual Trustee Co Ltd [1903] AC 139 ............................................................. 1.120, 1.125 Wondoflex Textiles Pty Ltd, Re [1951] VLR 458 .............................................................. 8.150, 8.155 xxxii

Table of Cases

Wood v Odessa Waterworks Co (1889) 42 Ch D 636 ................................................................ 8.120 Woolfson v Strathclyde Regional Council 1978 SC (HL) 90 ....................................................... 4.105 Woolmington v DPP [1935] AC 462 ......................................................................................... 4.142 Woolworths Ltd v GetUp Ltd [2012] FCA 726 .................................................................... 6.30, 6.40 World Oil Resources Ltd [2013] ATP 1 ....................................................................................... 12.75 Wragg Ltd, Re [1897] 1 Ch 796 .................................................................. 9.215, 9.220, 9.222 Wyong Shire Council v Shirt (1980) 146 CLR 40 ......................................................................... 7.82

X X Bank Ltd v G [1985] Times LR 246 .......................................................................................... 4.58 XL Petroleum Ltd, Re [1971] VR 560 ......................................................................................... 8.145

Y Yara Australia Pty Ltd v Burrup Holdings Ltd (2010) 80 ACSR 641 ............................................. 5.295 Yenidje Tobacco Co, Re [1916] 2 Ch 426 .................................................................................. 8.145 Yianni v Edwin Evans & Sons [1982] QB 438 .......................................................................... 10.225 Yorke v Lucas (1985) 158 CLR 661 .................................................................. 9.345, 10.215, 11.150 Young v Ladies’ Imperial Club Ltd [1920] 2 KB 523 .................................................................. 5.270 Young v Sherman (2001) 40 ACSR 12 ....................................................................................... 3.190 Young Investments Group Pty Ltd v Mann (2013) 91 ACSR 89 ................................................... 7.15

Z Zubik v Zubik 384 F (2d) 267 (1967) ....................................................................................... 4.120 Zytan Nominees Pty Ltd v Laverton Gold NL (1988) 14 ACLR 524 ............................................ 12.90

xxxiii

TABLE OF STATUTES s 21(3): 11.90 s 22: 11.90 s 23(1): 11.95 s 24(2)(a): 11.90 s 24(2)(b): 11.90 s 25(1): 11.80, 11.90 s 25(2): 11.90 s 25(3): 11.90 ss 28(a) to (c): 11.90 s 28(d): 11.90 s 29: 11.90 ss 30 to 33: 11.90 s 35: 11.90 s 36: 11.90 s 37: 11.90 ss 40(a) to (c): 11.90 ss 41 to 43: 11.90 s 43(1): 11.90 s 43(4): 11.90 s 47: 11.90 s 48: 11.95 s 49: 11.115 s 49(1): 11.80 s 49(2): 11.80 s 49(3): 11.80 s 49(4): 11.80 s 50: 11.80, 11.120, 11.165 s 68(1): 11.100 s 68(3): 11.100 s 69(1): 11.105 s 69(2): 11.105 s 69(3): 11.105 s 76: 11.80, 11.100 ss 81 to 83: 11.80, 11.100 s 91: 11.165 s 93AA(1): 11.120 s 93AA(2): 11.120 s 93AA(3): 11.120 s 93AA(4): 11.120 s 95: 2.95 s 127(1): 11.90 s 127(1A) to (5A): 11.90 s 147(5): 2.130 s 148: 2.130 s 172: 12.25 s 174: 2.130 s 195(4): 12.40 s 204: 2.130 s 225: 2.130, 9.125 s 226: 2.130, 9.125 s 227(1): 9.125 s 227(3): 9.125 s 228: 9.125 s 233: 9.125 s 234A: 9.125

COMMONWEALTH Aboriginal Councils and Associations Act 1976: 3.13 Acts Interpretation Act 1901 s 2C: 12.55 s 15AA: 10.190 s 22: 4.20 Administrative Decisions (Judicial Review) Act 1977: 5.305, 12.35 s 5(1)(f): 5.305 Australian Charities and Not-for-profits Commission Act 2012: 3.110 Australian Securities and Investments Commission Act 2001: 2.90, 2.120, 2.130, 3.65, 11.80 s 1(2): 2.110 s 1(2)(g): 11.110 s 4(1): 2.90 s 5(1): 11.80, 11.90 ss 7 to 9: 2.120 s 9(2): 2.120 s 11(1B): 2.120 s 11(9A): 2.120 s 11(9B): 2.120 s 12(1): 2.120 s 12(2): 2.120 s 12(3): 2.120 s 12(4): 2.120 s 12(5): 2.120 s 12A: 2.125 s 12A(1): 2.125 s 12DA: 9.195, 10.185, 10.215 s 12DA(1A)(c): 10.210 s 12DA(1): 6.120, 10.210 s 13(1): 11.85 s 13(2): 11.85 s 14(1): 11.85 s 14(2): 11.85 s 14(3): 11.85 s 15: 11.85 s 16(1): 11.85 s 17(1): 11.85 s 17(2): 11.85 s 18(1): 11.85 s 18(2): 11.85 s 18(4): 11.85 s 19: 11.90 s 19(1): 11.90 s 19(2): 11.90, 11.95 s 19(3): 11.95 s 19(3)(a): 11.95 xxxv

Corporations and Financial Markets Law

Australian Securities and Investments Commission Act 2001 — cont s 235A: 9.125 s 236B(1): 9.125 s 241: 11.100 s 243: 2.120 Pt 2, Div 2: 2.125, 6.90 Pt 2, Div 2, subdiv G: 9.195 Pt 3: 11.80, 11.90, 11.95, 11.105 Pt 3, Div 1: 11.80, 11.85, 11.120 Pt 3, Div 2: 11.80, 11.90 Pt 3, Div 3: 11.90 Pt 3, Div 4: 11.90 Pt 9: 2.130 Pt 11: 2.130 Pt 12: 2.130 Pt 14: 2.120 Div 1: 11.90, 11.100 Div 2: 11.90 Div 3: 11.90 Div 4: 11.90, 11.95 Australian Securities and Investments Commission Regulations 2001: 3.65 reg 13: 12.40 reg 20: 12.40, 12.245 reg 21: 12.40 reg 35: 12.40 Banking Act 1959: 3.11 Bankruptcy Act 1966 Pt X: 5.230 Broadcasting Services Act 1992: 12.15 Business Names Registration Act 2011 s 5: 1.110 s 22: 1.110 Co-operatives (Adoption of National Law) Act 2012: 3.20 Co-operatives National Law: 3.20 s 10: 3.20 s 27(2)(c): 3.20 s 121: 3.20 Commonwealth of Australia Constitution Act 1901: 2.85, 2.90 s 5: 2.75 s 10: 2.75 s 51(xxix): 2.85 s 51(xxxvii): 2.90 s 51: 2.90 s 51(i): 2.85 s 51(xx): 2.75, 2.80, 2.85, 2.90, 2.105 s 75(iv): 4.20 s 77(iii): 2.85 s 109: 2.105 s 117: 4.20 s 122: 2.85, 2.90 Ch 3: 2.85

Companies Code: 5.365 s 68A: 5.355 Competition and Consumer Act 2010: 2.85, 2.125 s 18: 10.200, 10.210, 11.150, 11.235 s 50: 12.15 s 84: 4.180 s 86E: 5.230 s 131A: 6.90 Pt IV: 5.230 Sch 2: 2.125, 6.90 Corporate Law Economic Reform Program Act 1999: 8.205 Corporations (Aboriginal and Torres Strait Islander) Act 2006: 3.13 Corporations Act 1989: 2.85 Corporations Act 2001: 2.05, 2.85, 2.90, 2.95, 2.100, 2.110, 2.130, 2.155, 2.240, 3.05, 3.11, 3.13, 3.20, 3.25, 3.35, 3.50, 3.60, 3.65, 3.70, 3.100, 3.105, 3.150, 3.182, 4.20, 4.85, 4.90, 4.180, 4.185, 5.90, 5.95, 5.235, 5.305, 5.365, 6.05, 6.80, 7.15, 7.50, 7.75, 7.210, 8.65, 8.130, 8.170, 8.200, 8.215, 9.270, 10.45, 10.135, 11.80, 11.120, 11.125, 11.130 s (3): 6.80 s 3: 3.225 s 3(1): 2.90 s 3(2): 2.90 s 3(4): 2.90 ss 4(7) to (8): 2.95 s 5: 2.90 s 5(4): 2.240 s 5(8): 2.90 s 5E: 2.95 s 5E(4): 2.95 s 5F: 2.95 s 5G: 2.95 s 6(1): 7.32 s 9: 2.90, 3.45, 3.65, 3.70, 3.80, 3.105, 3.110, 3.120, 3.125, 3.135, 3.145, 3.195, 3.210, 4.90, 4.102, 5.100, 5.215, 5.230, 5.238, 5.295, 5.300, 7.30, 7.32, 7.37, 7.50, 7.140, 7.390, 7.400, 7.420, 8.100, 8.105, 8.140, 9.60, 9.120, 9.175, 9.185, 9.285, 10.85, 10.90, 10.110, 12.20, 12.30, 12.35, 12.55, 12.65, 12.130, 12.165, 12.220 s 9(b)(i): 7.35, 7.37 s 9(b)(ii): 7.40 s 9A: 10.92, 12.130 s 11: 4.90, 11.65, 11.176 s 12: 12.75 s 12(2): 12.75 s 12(2)(a): 12.75 s 12(2)(b): 12.75 xxxvi

Table of Statutes

s 119A(2): 3.70 s 119A(3): 3.70 s 119A(4): 3.70 s 120: 5.220 s 120(1): 3.70 s 120(2): 3.70, 9.200 s 124: 3.70, 3.75, 4.20, 5.145, 9.200 s 125: 5.145 s 125(1): 3.145 s 125(2): 3.145, 8.152 s 126: 5.310 s 127(1): 5.360 s 128: 5.360, 5.375, 5.380 s 128(1): 5.360, 5.365 s 128(3): 5.360 s 128(4): 5.360, 5.365, 5.375, 7.215, 7.387 ss 128 to 129: 5.310, 5.355, 5.375 s 129: 5.360, 5.375, 5.380, 7.387 s 129(1): 5.357, 5.360, 5.365 s 129(2): 5.360, 5.365 s 129(2)(b): 5.338 s 129(3): 5.360, 5.365 s 129(3)(b): 5.338 s 129(4): 5.360, 5.365, 7.215 s 129(5): 5.360 ss 129(5) to (6): 5.360 s 129(6): 5.360, 5.365 s 129(7): 5.360 s 130: 5.357 s 130(2): 5.360 s 131: 3.75 s 132: 3.75 s 133: 3.75 s 135: 3.145 s 135(3): 3.145 s 136: 3.145, 5.100, 5.245 ss 136(1) to (2): 3.145 s 136(3): 3.145, 6.40, 9.105 s 136(4): 3.145 s 136(5): 3.145 s 139: 3.145 s 140: 3.145, 8.132, 8.200 s 140(1): 5.245, 8.115, 8.123, 8.130 s 141: 3.145 s 147: 3.70 s 148(2): 3.70 s 148(4): 3.125 s 150: 3.110 s 152: 3.70 s 153: 3.110 s 157: 5.100 s 162(1): 5.100 s 165: 3.135 s 168: 3.165 ss 168 to 169: 5.295 s 169: 3.165, 8.125 s 169(3)(f): 9.200 s 169(5): 9.200 s 172(1): 2.90 s 173: 5.295

Corporations Act 2001 — cont s 12(2)(c): 12.75 s 15: 12.75 s 15(1)(c): 12.75 s 16: 12.75 s 21: 3.25 s 45A(2): 3.135 s 45B: 3.110 s 46: 4.90 s 46(a)(i): 4.90 s 46(a)(ii): 4.90 s 46(b): 4.90 s 47: 4.90 s 48: 4.90 s 50: 4.90 s 50AA: 4.90, 9.305, 10.60, 12.75, 12.80 s 50AA(1): 7.420 s 50AA(2): 7.420 s 50AA(3): 7.420 s 50AA(4): 7.420 s 53: 7.350, 8.195, 8.205, 10.170, 12.30, 12.75 s 58AA: 2.100, 3.190 s 64: 12.65, 12.120 s 64A: 9.305 s 79: 4.185, 7.65, 7.86, 9.225, 9.260, 9.330, 11.150, 11.250 s 82: 10.35 s 92(3): 10.50, 12.65 s 92(4): 10.50 s 95A: 7.150, 7.207 s 95A(1): 3.190, 7.150 s 95A(2): 3.190, 7.150 s 100: 9.370 s 103(2): 7.415 s 111AD: 11.130 s 111AE(1A): 11.130 s 111AE(1): 11.130 s 111AF: 11.130 s 111AG: 11.130 s 111AI: 11.130 s 111AL: 11.130 s 111AFA: 11.130 s 112: 3.80 s 112(1): 3.80, 3.90 s 112(2): 3.125 s 113: 3.135 s 113(3): 10.95 s 114: 3.70 s 114(1): 3.140 s 115: 3.11, 3.60 s 117: 3.70 s 117(2): 3.70 s 117(2)(f): 9.200 s 117(3): 3.145 s 118: 3.70 s 118(1)(v): 3.70 s 119: 3.70, 3.75 s 119A: 3.70 s 119A(1): 3.70 xxxvii

Corporations and Financial Markets Law

s 198A(2): 5.100, 5.105, 5.120 s 198C: 3.150, 5.215, 5.245 s 198D: 5.245, 5.275, 7.75, 7.95 s 198E: 3.145, 5.105 s 198F: 5.295, 5.300 s 198F(1): 5.300 s 198F(2): 5.300 s 198F(3): 5.300 s 198F(4): 5.300 s 199A: 7.550, 7.560 s 199A(1): 7.550 s 199A(2): 7.555 s 199A(3): 7.555 s 199B: 7.560 s 199C(1): 7.545 s 199C(2): 7.545 s 200B: 5.100 s 200B(1): 7.390 s 200C: 5.100 s 200F: 7.390 s 200AA: 7.390 s 201A: 5.95, 5.215 s 201A(2): 7.405 s 201B: 5.95, 7.37 s 201B(1): 5.225 s 201E(1): 5.220 ss 201E(2) to (3): 5.220 s 201F: 3.70, 3.145 s 201G: 5.100, 5.220 s 201H(1): 5.220 ss 201H(2) to (3): 5.220 s 201J: 3.150, 5.245, 5.263 s 201K(1): 5.215 s 201M: 5.380 s 201M(2): 5.380 ss 201N to 201U: 5.220 s 202A: 5.100, 5.105, 7.395 s 202A(1): 7.390 s 202B(1): 7.400 s 202C: 3.145 s 203A: 5.240 s 203B: 5.240 s 203C: 5.240, 5.245 ss 203C to 203D: 5.100 s 203D: 5.240, 5.263, 8.155 s 203D(1): 5.240, 7.330 ss 203D(2) to (6): 5.240 s 203E: 5.240, 5.300 s 203F: 5.245 s 203F(2): 5.263 s 204A: 3.150 s 204A(1): 5.215 s 204A(2): 5.215 s 204B(1): 5.215 s 204D: 5.215 s 204E: 5.380 s 204E(2): 5.380 s 205A: 5.360 s 205B: 5.360, 7.32 s 206A: 5.230, 5.238

Corporations Act 2001 — cont s 175: 3.165, 8.125, 8.130, 8.132, 11.70, 11.75 s 176: 3.165 s 179(2): 7.30, 7.32 s 180: 7.10, 7.30, 7.65, 7.86, 7.95, 7.100, 7.110, 7.130, 8.205, 10.205 s 180(1): 7.30, 7.60, 7.70, 7.75, 7.82, 7.84, 7.86, 7.88, 7.95, 7.100, 7.102, 7.105, 7.110, 7.130, 7.160, 7.500, 9.265, 9.395, 10.205, 11.143 s 180(2): 5.60, 7.70, 7.105, 7.110, 7.120, 7.125, 7.130, 7.220 s 180(2)(a): 7.105 ss 180(2)(a) to (d): 7.130 s 180(2)(b): 7.105 s 180(2)(c): 7.130 s 180(2)(d): 7.125, 7.130 s 180(3): 7.105, 7.130 ss 180 to 183: 5.235 s 181: 7.10, 7.30, 7.130, 7.250, 7.500, 8.135, 8.205 s 181(1): 7.50, 7.250, 9.265 s 181(1)(2): 7.60 s 182: 7.10, 7.30, 7.130, 7.500, 7.560, 8.37 s 182(1): 7.500 s 182(1)(2): 7.60 ss 182 to 183: 11.240 s 183: 7.10, 7.30, 7.130, 7.560 s 183(1): 7.500 s 183(1)(2): 7.60 s 184: 7.10, 7.65, 7.75 s 184(1): 7.250 s 184(2): 7.500 s 184(3): 7.500 s 185: 7.10, 7.70 s 187: 7.315, 7.330 s 189: 7.70, 7.75 s 189(c): 7.75 s 190: 7.75 s 190(1): 7.75 s 190(2): 7.75, 7.95 s 191: 7.65, 7.350, 7.387 s 191(1): 7.350 s 191(2): 7.350, 7.355 s 191(2)(a)(i): 7.350 s 191(3): 7.350 s 191(4): 7.350 s 192: 7.350 s 192(1): 7.350 s 193: 7.350 s 194: 7.345, 7.350 s 195: 7.65 s 195(1): 7.350, 7.355 s 195(2): 7.355 s 195(3): 7.355 s 197: 7.15 s 198A: 3.150, 5.30, 5.105, 5.120, 5.135, 5.150, 6.25, 6.65, 6.125 s 198A(1): 5.105, 5.115 xxxviii

Table of Statutes

s 228(3): 7.350 s 228(5): 7.430 s 228(6): 7.430 s 228(7): 7.430 s 229(1)(a): 7.425 s 229(1)(b): 7.425 s 229(1)(c): 7.425 s 229(2)(c): 7.425 s 229(3): 7.425 s 230: 7.415 s 232: 7.555, 8.195, 8.200, 8.205, 8.210, 8.212, 8.215, 8.225 s 232(4): 7.95 s 232(d): 8.195, 8.200, 8.205 s 232(e): 8.195, 8.205 s 233: 8.195, 8.200, 8.205, 8.210, 8.212, 8.215 s 233(1): 8.215, 8.220 s 233(1)(c): 8.220 s 233(1)(d): 8.178, 8.215 s 233(1)(e): 8.215 s 233(1)(h): 8.220 s 233(3): 8.220 s 233(g): 8.215 s 234: 8.195 s 234(e): 8.195, 11.120 s 236: 8.10, 8.75, 8.105, 8.110, 8.135 s 236(1): 8.100, 8.105, 8.108 s 236(1)(a): 8.105 s 236(2): 8.100 s 236(3): 8.100 s 237: 5.295, 8.100, 8.105 s 237(2): 8.100, 8.105 s 237(2)(a): 8.105 s 237(2)(a) to (e): 8.100 s 237(2)(b): 8.100, 8.105 s 237(2)(c): 8.105 s 237(2)(d): 8.105 s 237(2)(e): 8.100, 8.105 s 237(3): 5.60, 8.100 s 237(4): 8.100 s 238: 8.100 s 239: 8.100 s 239(1): 8.25, 8.100 s 239(2): 8.25, 8.100 s 240: 8.100 s 241(1): 8.100 s 241(2): 8.100 s 242: 8.100 s 243E: 4.90 s 245D(1): 9.210 s 245D(4): 3.95 s 246B: 9.110, 9.117 s 246B(1): 9.105 s 246B(2): 9.105, 9.117 s 246C(1): 9.105 s 246C(2): 9.105 s 246C(5): 9.105 s 246D: 9.105 s 247A: 5.300, 8.205, 8.210

Corporations Act 2001 — cont s 206B: 5.230, 5.235 s 206B(2): 5.230 s 206B(3): 5.230 s 206B(4): 5.230 s 206C: 5.235, 7.65, 7.555, 11.150 s 206C(1): 5.230 s 206C(2): 5.230 s 206D: 7.555 s 206D(1): 5.230 s 206D(2): 5.230 s 206E: 5.235, 7.555 s 206E(1): 5.230 s 206E(2): 5.230 s 206F: 5.230 s 206G: 5.230, 5.235 s 206J(1): 7.400 s 206K: 7.400 s 206L: 7.400 s 206BA: 5.230 s 206EA: 5.230 s 207: 7.415 s 208: 7.440, 7.445, 7.450 s 208(1): 7.415, 7.420 s 208(1)(a): 5.100 s 209(1): 7.415, 7.450 s 209(2): 7.60, 7.450 s 209(3): 7.65, 7.450 s 210: 7.425, 7.435, 7.440 s 211(1): 7.390, 7.435 s 211(2): 7.435 s 211(3): 7.435 s 212: 7.555 s 212(2): 7.435 s 212(3): 7.435 s 213: 7.435 s 214(1): 7.435 s 214(2): 7.435 s 215: 7.435 s 216: 7.435 s 217: 7.445 s 218(1): 7.445 s 219(1)(a): 7.445 s 219(1)(b): 7.445 s 219(1)(c): 7.445 s 219(1)(d): 7.445 s 219(1)(e): 7.445 s 219(2): 7.445 s 220(1): 7.445 s 221: 7.445 s 221(1): 3.140 s 223: 7.445 s 224(1): 7.445 s 224(8): 7.445 s 225(1): 7.445 ss 225(3) to (5): 7.445 s 226: 7.445 s 228: 8.100 ss 228(1) to (4): 7.430 s 228(2)(d): 7.350 xxxix

Corporations and Financial Markets Law

s 249R: 6.15 s 249S: 6.70 s 249T(1): 6.70 s 249T(2): 6.70 s 249T(3): 6.70 s 249T(4): 6.70 s 249U(1): 6.70 s 249U(2): 6.70 s 249U(3): 6.70 s 249U(4): 6.70 s 249V: 5.175, 6.55 s 249V(1): 6.70 s 249V(2): 6.70 s 249W(2): 6.70 s 249X(1A): 6.85 s 249X(1): 6.85 s 249X(2): 6.85 s 249Y(1): 6.85 s 249Y(2): 6.85 s 249Y(3): 6.85 s 249Z: 6.85 s 249CA: 6.15 s 249HA: 6.60 s 250(1): 6.85 s 250(2): 6.85 s 250A(1): 6.85 s 250A(2): 6.85 s 250B(3): 6.85 s 250C(2): 6.85 s 250D(1): 6.85 s 250D(1)(d): 6.85 s 250D(3): 6.85 s 250E: 3.145 s 250E(1): 6.80 s 250E(2): 6.80 s 250H: 6.80 s 250J(1): 6.80 s 250J(2): 6.80 s 250K(1): 6.80 s 250K(2): 6.80 s 250L(1): 6.80 s 250L(2): 6.80 s 250L(3): 6.80 s 250M: 6.80 s 250N: 3.140, 5.220 s 250N(2): 6.10 s 250R: 6.10 s 250R(2): 5.100, 6.65, 7.405 s 250R(3): 5.100, 6.65, 7.405 s 250R(4): 7.405 s 250R(5): 7.405 s 250R(5)(b): 6.85 s 250S: 6.70 s 250T: 6.70, 9.160 s 250T(1)(b): 6.70 s 250U: 7.405 s 250V: 7.405 s 250V(1): 7.405 s 250V(2): 7.405 s 250W(3): 7.405

Corporations Act 2001 — cont s 247A(1): 5.295 s 247A(3): 5.295 s 247B: 5.295 s 247D: 5.295 s 247E: 3.90, 10.195 s 248A: 5.155, 5.265 s 248B: 5.265 s 248C: 5.270 s 248D: 5.275 s 248E: 5.275 s 248F: 5.275 s 248G: 5.275 s 249A: 3.140 s 249A(1): 6.10 s 249A(2): 6.10 s 249A(5)(a): 6.10 s 249A(7): 6.10 s 249B(1): 6.10 s 249C: 6.15, 7.32 s 249D: 6.30, 8.205, 12.100 s 249D(1): 6.30 s 249D(2): 6.30 s 249D(5): 6.30 s 249E(1): 6.30 s 249E(2): 6.30 s 249E(3): 6.30 s 249E(4): 6.30 s 249E(5): 6.30 s 249F: 6.55 s 249F(1): 6.25 s 249F(2): 6.25 s 249G: 6.25, 6.50, 6.55 s 249G(1): 6.50 s 249G(2): 6.50 s 249H(1): 6.60 s 249H(2): 6.60 s 249H(3): 6.60 s 249H(4): 6.60 s 249J(1): 6.60 s 249K: 5.175, 6.55, 6.60 s 249L: 6.85, 6.125 s 249L(1): 6.60 s 249L(2): 6.60, 7.405 s 249L(2)(a): 7.405 s 249L(3): 6.60 s 249L(b): 6.90 s 249M: 6.60 s 249N: 6.65, 12.100 s 249O: 6.65 s 249O(1): 6.65 s 249O(2): 6.65 s 249O(3): 6.65 s 249O(4): 6.65 s 249O(5): 6.65 s 249P: 6.65 s 249P(7): 6.65 s 249P(8): 6.65 s 249P(9): 6.65 s 249Q: 6.15, 6.25, 6.35, 6.40 xl

Table of Statutes

s 254W(2): 9.355 s 254W(3): 3.125, 9.355 s 254W(4): 3.125, 9.355 s 254Y: 9.285 s 254SA: 3.110 s 256A: 9.240, 9.275 s 256B: 5.100, 9.250, 9.265, 9.355, 9.270, 9.275 s 256B(1): 9.250, 9.255, 9.260, 9.275,9.355 s 256B(1)(a): 9.260, 9.275 s 256B(1)(b): 9.260, 9.270, 9.275 s 256B(1)(c): 9.275 s 256B(2): 9.250 s 256B(3): 9.250 s 256C: 5.100, 9.250, 9.270, 9.275 s 256C(1): 9.250 s 256C(2): 5.192, 9.250, 9.270, 9.275 s 256C(2)(a): 9.250, 9.270 s 256C(2)(b): 9.250,9.270 s 256C(3): 9.250 s 256C(4): 9.250 s 256C(5): 9.250 s 256D: 9.285, 9.275 s 256D(1): 9.260, 9.395 s 256D(2): 9.250, 9.260, 9.275, 9.395 s 256D(3): 7.60, 9.260, 9.395 s 256D(4): 7.65, 9.260, 9.395 s 256E: 9.260, 9.285 s 257A: 5.100, 9.285, 9.295 s 257B(1): 9.285 s 257B(2): 9.285 s 257B(3): 9.285 s 257B(4): 9.285 s 257B(6): 9.285 s 257B(7): 9.285 s 257C: 5.100 s 257C(1): 9.285 s 257C(2): 9.285 s 257D: 5.100 s 257D(1): 9.285 s 257D(1)(a): 9.270 s 257E: 9.285 s 257F: 9.285 s 257G: 9.285 s 257H: 9.285 s 258A: 3.120, 9.245 s 258B: 9.245 s 258C: 9.245 s 258D: 9.245, 9.250 s 258E(1)(a): 9.245 s 258E(1)(b): 9.245 s 258E(2): 9.245 s 258E(a): 9.225 s 258F: 9.245 s 259A: 9.290, 9.295, 9.315 s 259A(a): 9.285 s 259B: 4.90, 9.310 s 259B(1): 9.290, 9.300, 9.315 s 259B(2): 9.300 s 259B(3): 9.300

Corporations Act 2001 — cont s 250W(4): 7.405 s 250W(5): 7.405 s 250W(6): 7.405 s 250W(9): 7.405 s 250X(3): 7.405 s 250BB(1)(c): 6.85 s 250BB(1)(d): 6.85 s 250BB(2): 6.85 s 250BC: 6.85 s 250BD: 6.85 s 250BD(1): 7.405 s 250BD(2): 7.405 s 250PA: 6.70, 9.160 s 250RA: 6.70, 9.160 s 250SA: 7.405 s 251A: 3.140, 7.95 s 251A(1): 5.285 s 251A(3): 7.32 s 251A(5): 5.285 s 251A(6): 5.285 s 251B: 5.285 s 251AA: 6.85 s 254A(1): 9.210 s 254A(1)(a): 9.210 s 254A(2): 3.170, 3.180, 9.75 s 254A(3): 9.225 s 254B(1): 9.200, 9.205 s 254B(2): 3.125 s 254B(3): 3.125 s 254C: 9.205 ss 254D(1) to (3): 3.95 s 254D(4): 9.210 s 254E(1): 9.210 s 254E(2): 9.210 s 254G(3): 9.225 s 254H: 5.100, 9.210 s 254J(1): 9.225 s 254J(2): 9.225 s 254K: 9.225 s 254L(1): 9.225 s 254L(2): 7.60, 9.225 s 254L(3): 7.65, 9.225 s 254M(1): 3.105, 9.200 s 254M(2): 3.125 s 254N(1): 9.200 ss 254P to 254Q: 3.125 ss 254P to 254R: 9.210 s 254S: 9.210 s 254T: 9.355, 9.395 s 254T(1): 9.355 s 254T(1)(a): 9.355 s 254T(1)(b): 9.355 s 254T(1)(c): 9.355 s 254T(2): 9.355 s 254U: 9.355, 9.360 s 254U(1): 9.360 s 254V(1): 9.360 s 254V(2): 9.360 s 254W(1): 9.355 xli

Corporations and Financial Markets Law

s 285(2): 2.90 s 285A: 3.110 s 286: 3.140, 9.130, 9.355 s 286(1): 9.120 s 290: 5.295, 5.300 s 290(1): 5.300 s 290(2): 5.300 s 292: 3.110, 3.140 s 292(1): 9.120 s 292(2): 9.120 s 293: 3.140 s 294: 3.110, 3.140 s 294A: 3.110 s 295: 3.140 s 295(1): 9.130 s 295(2): 9.130 s 295(4): 7.100, 9.130 s 295(4)(c): 7.100, 7.150 s 295(4)(d): 7.100 s 295(5): 9.130 s 295A(2): 9.130 s 296: 9.125, 9.130 s 297: 9.130 s 298: 3.110 s 298(2): 9.135 s 299: 7.100 s 299(1): 9.135 s 299(2): 9.135 s 299(2)(a): 7.425 s 299(2)(b): 7.425 s 299(3): 9.135 s 299A: 7.100, 9.140 s 300(1): 9.135 s 300(1)(d): 7.400 s 300(1)(g): 7.560 s 300(8): 7.560 s 300(9): 7.560 s 300(10): 7.75, 9.135 s 300(11): 9.140 s 300(11)(e): 5.90 ss 300(11B) to (11E): 9.140 s 300(12): 9.140 s 300(13): 9.140 ss 300(14) to (15): 9.135 s 300A(1A): 9.140 s 300A(1AA): 9.140 s 300A(1BB): 9.140 s 300A(1): 7.400, 9.140 s 300A(1)(g): 7.405 s 300A(1)(ba)(iv): 7.400 s 300A(2): 7.400, 9.140 s 300A(3): 7.400 s 300A(4): 7.400, 9.140 s 300B: 3.110 s 301: 3.110 s 301(1): 9.150 s 301(2): 9.150 s 302: 9.145, 9.150 s 302(b): 9.150 ss 302 to 306: 9.145

Corporations Act 2001 — cont s 259B(4): 9.300 s 259B(5): 9.300 s 259B(6): 9.300 s 259C: 4.90, 9.290, 9.310 s 259C(1): 9.305, 9.315 s 259C(1)(c): 9.305 s 259C(1)(d): 9.305 s 259C(2): 9.305 s 259D: 9.315 s 259D(1): 9.305 s 259D(2): 9.305 s 259D(3): 9.305 s 259D(4): 9.305, 9.315 s 259D(5): 9.305 s 259D(6): 9.305, 9.315 s 259E: 4.90, 9.300 s 259E(1): 9.310 s 259E(2): 9.310 s 259E(3): 9.310 s 259E(4): 9.310 s 259F(1): 9.315 s 259F(2): 7.60, 9.315 s 259F(3): 7.65, 9.315 s 260A: 4.90, 5.235, 9.330, 9.345, 9.353 s 260A(1): 9.330 s 260A(1)(a): 9.340, 9.345 s 260A(1)(b): 9.345 s 260A(1)(c): 9.345 s 260A(2): 9.330 s 260A(3): 9.330 s 260B: 5.192, 9.330 s 260B(1): 9.330 s 260B(2): 9.330 s 260B(3): 9.330 s 260C: 9.330 s 260C(1): 9.335 s 260C(2): 9.335 s 260C(3): 9.335 s 260C(4): 7.275 s 260C(5): 9.335 s 260C(5)(a): 9.335 s 260C(5)(b): 9.335 s 260C(5)(c): 9.335 s 260C(5)(d): 9.335 s 260D: 9.345 s 260D(1): 9.330 s 260D(2): 7.60, 9.330, 9.345 s 260D(3): 7.65, 9.330 s 260E: 9.240 s 264C(6): 9.105 s 283AA: 9.60 s 283AC: 9.60 s 283AD: 9.60 s 283BF: 9.60 s 283BH(1): 9.65 s 283BH(2): 9.65 s 283BH(3): 9.65 s 283DA: 9.60 s 283EB: 9.60 xlii

Table of Statutes

s 324CD(2): 9.170 s 324CE(1): 9.175 s 324CE(1A): 9.175 s 324CE(1B): 9.175 s 324CE(1C): 9.175 s 324CE(2): 9.175 s 324CE(3): 9.175 s 324CE(4): 9.175 s 324CE(5): 9.175 s 324CE(6): 9.175 s 324CE(7): 9.175 s 324CF(1): 9.175 s 324CF(1A): 9.175 s 324CF(1B): 9.175 s 324CF(1C): 9.175 s 324CF(2): 9.175 s 324CF(3): 9.175 s 324CF(4): 9.175 s 324CF(5): 9.175 s 324CF(6): 9.175 s 324CF(7): 9.175 s 324CG(1): 9.175 s 324CG(1A): 9.175 s 324CG(2): 9.175 s 324CG(3): 9.175 s 324CG(5): 9.175 s 324CG(5B): 9.175 s 324CG(5C): 9.175 s 324CG(8): 9.175 s 324CG(9): 9.175 s 324CG(10): 9.175 s 324CG(11): 9.175 s 324CH: 9.175 s 324CH(5A): 9.175 s 324CH(5B): 9.175 s 324CH(6A): 9.175 s 324CH(1): 9.175 s 324CH(5): 9.175 s 324CH(6): 9.175 s 324CH(8): 9.175 s 324CI: 9.180 s 324CJ: 9.180 s 324CK: 9.180 s 324DA: 9.185 s 324DA(3)(a): 9.185 s 324DB: 9.185 s 324DC: 9.185 s 324DD: 9.185 s 324DAA: 9.185 s 324DAB(2): 9.185 s 327(1A): 9.155 ss 327(1) to (4): 9.155 s 327A: 3.110, 5.100 s 327B: 5.100 s 327D(2): 9.155 s 327D(3): 9.155 s 327D(4): 9.155 s 327D(5): 9.155 s 327E: 9.155 s 329: 5.100, 6.10

Corporations Act 2001 — cont s 307: 9.150 s 307A: 9.150 s 307B: 9.150 s 307C: 9.180 s 307C(6): 9.180 s 307C(7): 9.180 s 308(1): 9.150 s 308(2): 9.150 s 308(3): 9.150 s 309(4): 9.150 s 309(5): 9.150 s 310: 9.150, 9.195 s 311: 9.150 s 311(4): 9.150 s 312: 9.150, 9.195 s 313: 9.150 s 314: 9.160 s 315: 9.160 s 316A: 3.110 s 317: 6.10, 9.160 s 318: 9.160 s 319(1): 9.160 s 319(2): 3.140, 9.160 s 319(3): 9.160 s 320: 9.160 s 323A: 9.150, 9.195 s 323B: 9.150, 9.195 s 323DA: 9.140 s 324: 9.155 s 324BA: 9.155 s 324BD: 9.155 s 324CA(1A): 9.170 s 324CA(1B): 9.170 s 324CA(1C): 9.170 s 324CA(1): 9.170 s 324CA(2): 9.170 s 324CA(3): 9.170 s 324CA(4): 9.170 s 324CA(5): 9.170 s 324CB(1A): 9.170 s 324CB(1B): 9.170 s 324CB(1C): 9.170 s 324CB(1): 9.170 s 324CB(2): 9.170 s 324CB(3): 9.170 s 324CB(4): 9.170 s 324CB(5): 9.170 s 324CB(6): 9.170 s 324CC(1A): 9.170 s 324CC(1B): 9.170 s 324CC(1C): 9.170 s 324CC(1): 9.170 s 324CC(2): 9.170 s 324CC(3): 9.170 s 324CC(4): 9.170 s 324CC(5): 9.170 s 324CC(6): 9.170 s 324CD: 9.185 s 324CD(1): 9.170 xliii

Corporations and Financial Markets Law

ss 444A to 444B: 3.190 s 444D: 3.190 s 444D(2): 3.190 s 444D(3): 3.190 s 444F: 3.190 s 444G: 3.190 s 444H: 3.190 s 444DA: 3.190 s 445D: 3.190 s 445G: 3.190 s 446A: 3.200 s 447A: 3.190 s 447A(1): 3.190 s 447A(2): 3.190 s 447E: 3.190 s 448B: 3.190 s 448C: 3.190 s 450A(3): 3.190 s 459A: 3.200 s 459B: 7.150 s 459C(2): 3.200 s 459E: 3.200 ss 459G to 459H: 3.200 s 459P: 3.200 s 459P(1)(f): 8.145 s 459P(2): 3.200 s 459P(2)(d): 8.145 s 459S: 3.200 s 461(1)(a): 5.100 s 461(e): 8.140, 8.165, 8.170, 8.177 s 461(f): 8.140, 8.165, 8.195 s 461(g): 8.140, 8.165, 8.195 s 461(k): 8.140, 8.145, 8.150, 8.155 s 462(2)(c): 8.140 s 464(1): 11.80 s 467(1)(c): 8.178 s 467(4): 8.145 s 468(1): 3.200 s 468(4): 3.200 s 468A: 3.200 s 471A: 3.200 s 471B: 3.200 s 471C: 3.200 s 477: 3.200 s 482: 3.190 s 486A(1): 2.90 s 491: 3.200, 5.100 s 491(1): 3.200 s 493A: 3.200 s 497: 3.200 s 499: 3.200 s 515: 3.110, 9.200 s 516: 3.105, 9.200 s 517: 3.110 s 519: 9.200 s 520: 3.120, 9.200 ss 520 to 523: 3.110 s 521: 3.120, 9.200 s 523: 9.200 s 533: 11.85

Corporations Act 2001 — cont s 329(1): 9.155 s 329(1A): 9.155 s 329(3): 9.155 s 329(4): 9.155 s 329(5): 9.155 s 329(7): 9.155 s 329(9): 9.155 s 334(1): 9.125 s 336(1): 9.125 s 340: 9.190 s 341: 4.127, 9.190 s 342: 3.140 s 342(1): 9.190 s 342A: 9.185 s 342DA: 9.185 s 344: 7.100 s 344(1): 7.60, 9.195 s 344(2): 9.195 s 344(3): 9.195 s 344M(2): 7.65 ss 347A to 347C: 7.150 s 411: 3.215, 9.275 s 411(1): 9.235 s 411(1A): 4.90 s 411(2): 9.235 s 411(4): 3.215 s 411(4)(a): 9.235 s 411(4)(b): 9.235 s 411(17): 9.235, 12.05 s 412: 3.215, 9.235 s 420: 3.195 s 422: 11.85 s 435A: 3.190 s 435C(1)(b): 3.190 s 435C(2)(a): 3.190 s 436A(1): 3.190, 7.135 s 436B: 3.190 s 436C: 3.190 s 436E(4): 3.190 ss 436E to 436F: 3.190 s 437A: 3.190 ss 437A to 437D: 3.190 s 437C(1): 3.190 s 437C(2): 3.190 s 438A: 3.190 s 439A: 3.190 s 439A(4): 3.190 s 439A(4)(a): 3.190 s 439C: 3.190 ss 440A to 440D: 3.190 s 440F: 3.190 s 440J: 3.190 s 441A: 3.190 s 441A(1)(b): 3.190 ss 441F to 441G: 3.190 s 442D(1): 3.190, 3.195 ss 443A to 443BA: 3.190 s 443D: 3.190 ss 443E to 443F: 3.190 xliv

Table of Statutes

s 588X(4): 7.205 s 588X(5): 7.205 s 588Y(1): 7.200 s 588Y(2): 7.200 s 588FA: 3.190 s 588FA(1): 3.210 s 588FA(3): 3.210 s 588FB: 3.210, 7.145 s 588FC: 3.210, 7.150 s 588FD: 3.210 s 588FE: 3.210, 7.390 s 588FE(6A): 3.210 s 588FE(2): 3.210 s 588FE(3): 3.210 s 588FE(4): 3.210 s 588FE(5): 3.210 s 588FF: 3.210 s 588FG(1): 3.210 s 588FG(2): 3.210 s 588FDA: 3.210, 7.390 s 588FDA(1): 7.390 s 588FGA: 7.210 s 588FGB: 7.210 s 588FGB(5): 7.210 s 596AB: 3.210 s 597: 11.80 s 598: 3.255, 7.70, 7.320 s 600A: 4.90 s 600B: 3.190 s 600C: 3.190 s 601CA: 2.90, 3.70 s 601FC(6): 7.65 s 601FD(4): 7.65 s 601FE(4): 7.65 s 601FG(3): 7.65 s 601JD(4): 7.65 s 602: 12.15, 12.30, 12.45, 12.90, 12.125, 12.130, 12.135, 12.180, 12.245 s 602(a): 12.45, 12.215, 12.230, 12.235 s 602(b)(iii): 12.215, 12.235 s 602(c): 12.30, 12.45, 12.245 s 602A(1): 12.30 s 604: 12.55 s 605(1): 12.135 s 605(2): 12.135 s 606: 12.45, 12.50, 12.60, 12.70, 12.75, 12.80, 12.90, 12.95, 12.100, 12.105, 12.120, 12.125, 12.130, 12.132, 12.180 s 606(1): 12.20, 12.50, 12.55, 12.60, 12.65, 12.70, 12.95, 12.100, 12.105, 12.115, 12.120, 12.125, 12.130 s 606(1)(a): 12.60, 12.250 s 606(1A): 12.50 s 606(2): 12.50, 12.55, 12.130 s 606(4): 12.50 s 606(6): 12.95 s 607: 12.105 s 608: 9.140, 12.120 s 608(1): 12.80, 12.90, 12.120

Corporations Act 2001 — cont s 533(1): 5.230 s 555: 3.205 s 556: 3.205 s 558: 3.205 s 558G(1)(b): 7.150 s 559: 3.205 s 561: 3.205 s 563A: 3.90, 10.195 s 571: 4.90 s 571(1): 4.90 s 571(2): 4.90 s 574: 4.90 s 579A(1)(e): 4.90 s 579E: 4.90 s 579E(1): 4.90 s 579E(2): 4.90 s 579E(10): 4.90 s 579E(12): 4.90 s 588E: 7.150 s 588G: 3.190, 3.210, 4.42, 4.45, 7.15, 7.45, 7.70, 7.175, 7.185, 7.210, 9.315, 9.355, 9.395 s 588G(1A): 7.145, 9.225, 9.260, 9.285, 9.330, 9.360, 9.365, 9.395 s 588G(1): 7.145, 7.160, 7.170, 9.285 s 588G(1)(a): 7.140 s 588G(1)(b): 7.140, 7.150 s 588G(1)(c): 7.140, 7.155 s 588G(1)(d): 7.140 s 588G(2): 7.60, 7.140, 7.160, 7.190, 9.260, 9.395 s 588G(2)(a): 7.160 s 588G(2)(b): 7.160 s 588G(3): 7.65, 7.140 s 588H: 3.210, 7.140, 7.165, 7.210 s 588H(2): 7.160, 7.170, 7.207 s 588H(3): 7.175 s 588H(4): 7.180, 7.210 s 588H(5): 7.140, 7.185, 7.205 s 588H(6): 7.185, 7.205 s 588J: 7.190, 9.260 s 588K: 7.190 s 588M: 7.190 s 588R: 7.190 s 588T: 7.190 s 588V: 3.210, 4.90 s 588V(1)(a): 7.195 s 588V(1)(b): 7.195 s 588V(1)(c): 7.195 s 588V(1)(d): 7.195 s 588V(1)(d)(i): 7.195, 7.205 ss 588V to 588X: 4.45 s 588W: 3.210, 7.195 s 588W(1): 7.200 s 588W(2): 7.200 s 588X: 3.210, 7.205 s 588X(2): 7.205 s 588X(3)(a): 7.205 s 588X(3)(b): 7.205 xlv

Corporations and Financial Markets Law

s 631(1A): 12.135 s 631(2): 12.135 s 632: 12.190 ss 632 to 635: 12.185 s 633: 12.190 s 633(1): 12.130 s 634: 12.190 s 635: 12.130, 12.190, 12.230 s 636: 12.190, 12.230 s 636(1): 12.45, 12.195 s 636(1)(m): 12.20 s 636(3): 12.45 s 636(5): 12.190 s 637(1): 12.195 s 638: 12.190 s 638(1): 12.45, 12.205 s 638(1A): 12.205 s 638(2): 12.205 s 638(3): 12.205 s 638(5): 12.45 s 639(1): 12.205 s 640: 12.270 s 640(1): 12.205 s 641(1): 12.205 s 642(1): 12.205 s 643: 12.45 s 643(1): 12.210 s 644: 12.45 s 644(1): 12.210 s 645: 12.210 s 647: 12.210 s 648A(2): 12.205 s 648A(3): 12.205 s 648B: 12.190 s 648C: 12.190 ss 648D to 648H: 12.145 s 649B: 12.160 s 649C: 12.160 s 650B(2): 12.165 s 650C(1): 12.165 s 650C(2): 12.165 s 650E(1): 12.165 s 650F(1): 12.165 s 650G: 12.165, 12.245 s 651A: 12.130 s 651A(1): 12.165 s 651A(2): 12.165 s 651A(3): 12.165 s 651A(4): 12.165 s 652B: 12.170 s 652C: 12.170, 12.245 s 652C(1): 12.130, 12.170, 12.237 s 652(C)(1): 12.165 s 652C(2): 12.130, 12.170, 12.237 s 652(C)(2): 12.165 s 654B: 12.220 s 654C(1): 12.220 s 654C(2): 12.220 s 654C(3): 12.220 s 656A(1): 12.25

Corporations Act 2001 — cont s 608(2): 12.80, 12.120 s 608(3): 12.95, 12.125, 12.255 s 608(3)(a): 12.80, 12.125, 12.130 s 608(3)(b): 12.80, 12.115, 12.130 s 608(4): 12.80, 12.115 s 608(5): 12.80, 12.115 s 608(6): 12.80 s 608(7): 12.80 s 608(8): 12.85, 12.90 s 608(9): 12.80 s 609: 9.140, 12.90 s 609(1): 12.90 s 609(2): 12.50, 12.90 s 609(3): 12.90 s 609(5): 12.90, 12.100 s 609(6): 12.90, 12.220 s 609(7): 12.45, 12.130, 12.220 s 609(8): 12.90 s 609(9): 12.90 s 610(1): 12.70 s 610(2): 12.70 s 610(3): 12.70 s 611: 12.45, 12.50, 12.125, 12.130, 12.180, 12.190, 12.245 s 612: 12.45, 12.130 s 613: 12.130 s 616(1): 12.135 s 617(2): 12.190 s 617(5): 12.190 s 617(6): 12.190 s 617(7): 12.190 s 618: 12.130, 12.145 s 618(3): 12.140 s 619: 12.130 s 619(1): 12.145 s 619(2): 12.145 s 620: 12.145 s 620(1): 12.190 s 621(1): 12.155 s 621(2): 12.140, 12.155 s 621(3): 12.130, 12.145, 12.155 s 622: 12.155 s 623: 12.145 s 623(1): 12.155 s 624(1): 12.130, 12.140 s 624(2): 12.245 s 625(1): 12.140 s 625(2): 12.150 s 625(3): 12.150 ss 625 to 630: 12.130 s 626: 12.150 s 627: 12.150 s 628: 12.150 s 629: 12.45, 12.150 s 630: 12.45 s 630(1): 12.150, 12.165, 12.248 s 630(3): 12.265 s 631: 12.247 s 631(1): 12.135 xlvi

Table of Statutes

s 664D(2): 12.275 s 664D(3): 12.275 s 664E(1): 12.275 s 664E(2): 12.275 s 664E(4): 12.275 s 664F: 8.67 ss 664F(1) to (3): 12.275 s 664F(4): 12.275 s 664AA: 8.67, 12.275 s 665A: 8.67 s 665A(1): 12.280 s 665A(2): 12.280 s 665B(1): 12.280 s 665C: 12.280 s 666B: 12.255 s 667A(1): 12.270, 12.275 s 667A(2): 12.275 s 667B(1): 12.270 s 667B(2): 12.270 s 667C: 12.260, 12.275, 12.280 s 667C(1): 12.255, 12.260 s 667C(1)(b): 12.260 s 667C(1)(c): 12.260 s 667C(2): 12.255, 12.260 s 667AA: 12.270 s 667AA(3): 12.270 s 670A(1): 12.215 s 670A(2): 12.215 s 670A(3): 12.215 s 670B(1): 12.215 s 671B: 12.125, 12.230 s 671B(1): 12.220 s 671B(3): 12.220 s 671B(6): 12.220 s 672B(1): 12.220 s 672B(2): 12.220 s 674: 11.130, 11.135, 11.140, 11.142, 11.143 s 674(1): 11.130 s 674(2): 11.130, 11.142, 11.145, 11.150, 11.155, 11.160, 11.165 s 674(2A): 11.150, 11.155 s 674(2B): 11.150 s 675: 11.140 s 675(1)(a): 11.130 s 675(1)(b): 11.130 s 675(2): 11.130, 11.145, 11.150, 11.155, 11.160, 11.165 s 675(2)(c): 11.130 s 675(2A): 11.150, 11.155 s 675(2B): 11.150 s 676: 11.135, 11.140 s 676(2)(a): 11.135 s 676(2)(b): 11.135, 11.140 s 676(3): 11.135 s 677: 11.140, 11.142 s 678: 11.145 s 700: 10.50, 10.190 s 700(1): 10.50 s 700(2): 10.55

Corporations Act 2001 — cont s 657A: 12.30, 12.45, 12.125, 12.180 s 657A(1): 12.30 s 657A(2): 9.260, 12.30 s 657A(2)(a): 12.30 s 657A(2)(b): 12.30 s 657A(2)(c): 12.30 s 657A(3): 12.30, 12.240 s 657B: 12.40 s 657B(2)(b): 12.30 s 657B(2)(c): 12.30 s 657C(2): 9.260, 12.30 s 657D: 12.125 s 657D(1): 12.30 s 657D(2): 12.30, 12.40 s 657EA: 12.245 s 657EA(4): 12.245 s 658C: 12.30 s 659A: 12.35 s 659B(1): 7.235, 12.35 s 659B(1)(c): 2.90 s 659B(2): 12.35 s 659B(3): 12.35 s 659B(4): 12.35 s 659C: 12.35, 12.245 s 659AA: 12.45 s 661A: 12.260 s 661A(1): 12.255, 12.260 s 661A(2): 12.255 s 661A(3): 12.255 s 661A(4): 12.255 s 661A(5): 12.255 s 661B: 12.255, 12.270, 12.280 s 661C: 12.255 s 661E: 12.255 s 661E(2): 12.260 s 662A: 12.265 s 662A(3): 12.265 s 662B: 12.270, 12.280 s 662B(1): 12.265 s 662C(1): 12.265 s 662C(2): 12.265 s 663(1): 12.270 s 663B(1): 12.270 s 663C(1): 12.270 s 663C(2): 12.270 s 663C(3): 12.270 s 664A: 8.67 s 664A(1): 12.275 s 664A(2): 12.275 s 664A(3): 12.275 s 664A(4): 12.275 s 664A(5): 12.275 s 664A(6): 12.275 s 664B: 12.275 s 664C: 12.280 s 664C(1): 12.275 s 664C(2): 12.275 s 664C(6): 12.275 s 664D(1): 12.275 xlvii

Corporations and Financial Markets Law

s 708AA(1)(b): 10.92 s 708AA(1)(f): 10.92 s 708AA(2): 10.92 s 708AA(3): 10.92 ss 708AA(7) to (11): 10.92 s 708AA(8)(e): 10.92 s 709: 10.95 s 709(1): 10.100 s 709(2): 10.125 s 709(3): 10.95, 10.125 s 709(4): 10.95, 10.100, 10.130 s 709(5): 10.95 s 710: 10.95, 10.100, 10.110, 10.115, 10.140 s 710(1): 10.100, 10.115 s 710(1)(b): 10.100 s 710(2)(c): 10.100 s 710(2)(d): 10.100 s 710(3): 10.100 ss 710 to 715: 10.150, 10.160, 10.200 s 711: 10.95, 10.140 s 711(1): 10.105 s 711(2): 10.105 s 711(3): 10.105 s 711(4): 10.105 s 711(5): 10.105 s 711(6): 10.105 s 711(7): 10.105 s 711(16): 10.95, 10.105 s 712: 10.95, 10.97, 10.140 s 712(1): 10.120 s 712(2): 10.120 s 712(3): 10.120 s 712(5): 10.120 s 713: 10.95, 10.97, 10.140 s 713(2): 10.110 s 713(3): 10.110 s 713(4): 10.110 s 713(5): 10.110 s 713(6): 10.110, 11.165 s 713A: 10.97 s 713B: 10.97 s 713C: 10.97 s 713D: 10.97 s 713E: 10.97 s 714: 10.95, 10.115, 10.125, 10.140 s 714(2): 10.95, 10.105 s 715: 10.95, 10.115, 10.130, 10.140 s 715(1): 10.130 s 715(3): 10.95, 10.105 s 715A: 10.150 s 715A(1): 10.105 s 716: 10.140 s 716(1): 10.105 s 717: 10.95, 10.140 s 718: 10.140 s 719: 10.140, 10.150, 10.155 s 719(1A): 10.155 s 719(2): 10.155 s 719(3): 10.155

Corporations Act 2001 — cont s 700(3): 10.55 s 700(4): 10.50 s 702(a): 10.55 s 702(b): 10.55 s 703: 10.50 s 705: 10.95, 10.100, 10.190 s 706: 10.55 s 707: 10.75 s 707(1): 10.55 s 707(2): 10.55, 10.60, 10.70, 10.145 s 707(3): 10.55, 10.65, 10.70, 10.100, 10.145 s 707(3)(b)(i): 10.65 s 707(3)(b)(ii): 10.65 s 707(4): 10.65 s 707(4)(b): 10.65 s 707(5): 10.55, 10.70, 10.100, 10.145 s 707(6): 10.70 s 708: 10.55, 10.60, 10.65, 10.70, 10.92, 10.170, 10.215, 10.235 s 708(1): 10.80 s 708(1A): 10.70 ss 708(1) to (7): 10.80 s 708(2): 10.80 s 708(5): 10.70 s 708(5)(a): 10.80 s 708(7): 10.80 s 708(8): 10.175 s 708(8)(a): 10.85 s 708(8)(b): 10.85 s 708(8)(c): 10.85 s 708(9): 10.85 s 708(10): 10.175 s 708(10)(a): 10.85 s 708(10)(b): 10.85 s 708(10)(c): 10.85 s 708(10)(d): 10.85 s 708(11): 10.85, 10.175 s 708(12): 10.90 s 708(13): 10.90 s 708(14): 10.90 s 708(15): 10.55, 10.90 s 708(16): 10.55, 10.90 s 708(17A): 3.190 ss 708(17) to (18): 10.90 ss 708(19) to (21): 10.90 s 708A: 10.65 s 708A(1A): 10.92 s 708A(1): 10.65, 10.92 s 708A(1)(c): 10.65 s 708A(2): 10.65, 11.165 s 708A(5): 10.65 s 708A(6): 10.65 s 708A(7): 10.65 s 708A(8): 10.65 s 708A(10): 10.65 s 708A(11): 10.65 s 708A(12): 10.65 s 708AA: 10.75 xlviii

Table of Statutes

s 734(5)(a): 10.175 s 734(5)(b): 10.175 s 734(5)(b)(iv): 10.175 s 734(6): 10.175 s 734(7): 10.175 s 734(8): 10.175 s 734(9): 10.175 s 736: 10.140, 10.180 s 736(1): 10.180 s 736(1A): 10.180 s 736(2): 10.180 s 737: 10.140 s 737(1): 10.160 s 737(2): 10.160 s 737(3): 10.160 s 738: 10.140, 10.180 s 739: 10.190 s 739(1): 10.150, 10.185, 10.190 s 739(1)(a): 10.105, 10.155 s 739(2): 10.185, 10.190 s 739(3): 10.150, 10.185, 10.190 s 739(4): 10.150, 10.185 ss 739(6) to (8): 10.185 s 740: 10.95, 10.185 s 741(1): 10.185 s 750: 12.200 s 760A: 11.30 s 761A: 10.50, 11.65 s 763A(1): 11.30 s 763B: 11.30 s 763C: 11.30 s 763D: 11.30 s 764A: 10.50, 11.30 s 765A: 11.30 s 766C: 10.215 s 767A: 11.35 s 767A(2)(a): 11.35 s 769A: 4.180 s 769B: 4.180 s 769C(1): 10.215 s 791A: 11.35 s 792A: 11.35 s 792A(a): 11.45 s 792B: 11.35 s 792B(2)(c): 11.130 s 793B: 11.45, 11.65 s 793B(1): 11.65 s 793B(2): 11.65 s 793C: 11.45, 11.60, 11.65, 11.70, 11.75, 11.125, 11.155, 11.165 s 793C(1): 11.65, 11.70 s 793C(2): 11.65, 11.70 s 793C(3): 11.65 s 793C(5): 11.65 s 793C(6): 11.65 s 793D: 11.65 s 793E: 11.65 s 795B(1): 11.35, 11.50 s 795B(2): 11.35 s 796A: 11.35

Corporations Act 2001 — cont s 719(4): 10.155 s 719(5): 10.155 s 720: 10.145 s 721: 10.95, 10.140 s 721(1A): 10.95 ss 721(1) to (4): 10.140 s 721(2): 10.95 s 721(3): 10.95 s 721(5): 10.140 s 722: 10.140 s 722(1): 10.160 s 722(2): 10.160 s 723: 10.140 s 723(1): 10.140 s 723(2): 10.160 s 723(3): 10.105, 10.160 s 724: 10.140, 10.160, 10.190 s 724(1)(a): 10.160 s 724(1)(b): 10.105, 10.160 s 724(1)(c): 10.155, 10.160 s 724(1)(d): 10.155 s 724(2): 10.155, 10.160 s 724(3): 10.160 s 725: 10.160 s 726: 10.140 s 727: 10.140 s 727(1): 10.65, 10.140 s 727(2): 10.140 s 727(3): 10.140, 10.150, 10.160 s 727(5): 10.65 s 728: 10.95, 10.140, 10.150, 10.185, 10.190, 10.200, 10.202, 10.205, 10.210, 10.215 s 728(1): 10.155, 10.200, 10.202, 10.205 s 728(2): 10.115, 10.200 s 728(3): 10.200, 10.205 s 729: 10.95, 10.140, 10.202, 10.205, 10.210 s 729(1): 10.200, 10.202, 10.205 s 729(2): 10.125, 10.200 s 729(3): 10.140 s 730: 10.140, 10.200 s 731: 10.95, 10.140, 10.205, 10.207, 11.150 s 731(1): 10.205 s 731(2): 10.205 ss 731 to 733: 10.210 s 732: 10.95, 10.130, 10.140, 10.205 s 733: 10.95, 10.140, 10.205, 10.207 s 733(1): 10.205 s 733(2): 10.205 s 733(3): 10.205 s 733(4): 10.205 s 734(1): 10.170 s 734(2): 10.170 s 734(2A): 10.175 s 734(3): 10.170 s 734(3)(d): 10.170 s 734(4): 10.170 xlix

Corporations and Financial Markets Law

s 1041I(1): 10.215, 11.225 s 1041J: 11.190 s 1041K: 10.210 s 1042A: 11.140, 11.240, 11.255 s 1042C: 11.135, 11.255 s 1042C(1): 11.255 s 1042C(1)(a): 11.240, 11.255 s 1042C(1)(b): 11.240, 11.255 s 1042C(1)(b)(i): 11.245, 11.250 s 1042C(1)(c): 11.240, 11.255 s 1042(D): 11.140 s 1042D: 11.240, 11.255 s 1042G: 11.240 s 1042G(1)(c): 11.250 s 1042G(1)(d): 11.245 s 1042H: 11.240 s 1042H(1)(d): 11.245 s 1043A: 11.240, 11.250 s 1043A(1): 11.240, 11.245, 11.250, 11.255 s 1043A(1)(b): 11.250 s 1043A(2): 11.240, 11.245, 11.250 ss 1043B to 1043K: 11.245, 11.250 s 1043C: 11.240 s 1043C(1): 11.250 s 1043C(3): 11.250 s 1043F: 11.240 s 1043G: 11.240 s 1043H: 11.240 s 1043K: 11.240 s 1043L: 11.250 s 1043L(1): 11.250 s 1043L(2): 11.250 s 1043L(3): 11.250 s 1043L(4): 11.250 s 1043L(5): 11.250 s 1043L(6): 11.250 s 1043L(7): 11.250 s 1043L(10): 11.250 s 1043M: 11.250 s 1043M(1): 11.245 s 1043M(2): 11.250 s 1043M(2)(a): 11.245 s 1043M(2)(b): 11.245 s 1043M(3): 11.245, 11.250 s 1043N: 11.250 s 1043N(a): 11.250 s 1043N(b): 11.250 s 1043N(c): 11.250 s 1043O: 11.250 s 1044B: 10.215, 11.225 s 1087: 3.165 s 1101B: 11.60, 11.65, 11.70, 11.75, 11.125, 11.155, 11.165, 11.180 s 1101B(1): 11.70 s 1101B(1)(b): 11.180 s 1101B(1)(d): 11.225 s 1101B(4)(h): 11.180, 11.225 s 1101H(1): 11.180, 11.225, 11.250 s 1274(7A): 3.70 s 1308: 10.220

Corporations Act 2001 — cont s 796B: 11.35 ss 797A to 797C: 11.35 s 797B: 11.35 s 798A: 11.35 s 798C(1): 11.35 s 798C(2): 11.35 s 798C(4): 11.35 s 798F: 11.35 s 798G: 11.35 s 798G(1): 11.35 s 798H: 11.35 s 798J: 11.35 s 798J(4): 11.35 s 798K: 11.35 s 945A: 7.82 s 995: 6.120, 10.210, 11.235 s 998: 11.235 s 1010A(1): 10.45, 11.30 s 1020B(2): 11.175, 11.176, 11.177, 11.180 s 1020B(4): 11.176 s 1020F: 11.178 s 1020AB: 11.177 s 1020AC: 11.177 s 1020AD: 11.177 s 1020AE: 11.177 s 1022: 6.120 s 1041A: 11.195, 11.205 ss 1041A to 1041D: 11.225 ss 1041A to 1041G: 11.225 s 1041B: 11.195, 11.205, 11.230 s 1041B(1): 11.200 s 1041B(2): 11.200 s 1041B(3): 11.200 s 1041C: 11.205 s 1041C(1): 11.200 s 1041C(2): 11.200 s 1041D: 11.205 s 1041E: 11.140, 11.145, 11.195, 11.205, 11.210 s 1041E(1): 11.210 ss 1041E to 1041H: 11.225 s 1041F: 11.145, 11.205 s 1041F(1): 11.215 s 1041F(2): 11.215 s 1041H: 6.90, 6.120, 10.185, 10.202, 10.210, 10.215, 10.230, 11.141, 11.143, 11.165, 11.210, 11.225, 11.235, 12.215 s 1041H(1): 10.220, 10.230, 11.155, 11.220, 12.215 s 1041H(2): 11.155, 11.220, 12.215 s 1041H(2)(a): 10.215 s 1041H(2)(b)(i): 10.215 s 1041H(2)(b)(ii): 10.215 s 1041H(2)(b)(iii): 12.215 s 1041H(3)(a): 10.210 s 1041H(3)(c): 10.210 s 1041I: 11.155 s 1041I(1B): 10.215, 11.225 l

Table of Statutes

s 1317DAF(7): 11.165 s 1317DAG(1): 11.165 s 1317DAG(2): 11.165 s 1317DAG(3): 11.165 s 1317DAG(4): 11.165 s 1317DAG(5): 11.165 s 1317DAH: 11.160 s 1317DAI: 11.160 ss 1317DAJ(1) to (3): 11.165 s 1317DAJ(2): 11.165 s 1317DAJ(4): 11.165 s 1318: 7.545 s 1322: 5.265, 5.290, 6.05, 9.275 s 1322(1): 6.60 s 1322(2): 5.290, 9.275 s 1322(3): 5.290, 6.60 s 1322(3B): 9.305 s 1322(4): 9.275, 10.65 s 1322(4)(a): 5.290, 9.275 s 1322(4)(b) to (d): 5.290 s 1322(4)(d): 6.40 s 1322(5): 5.290 s 1322(6): 5.290, 6.60 s 1322(6)(a): 5.290 s 1322(6)(c): 5.290 s 1323: 11.80, 11.120 s 1323(1)(h): 3.195 s 1324: 7.84, 7.555, 8.135, 9.275, 9.285, 9.315, 9.330, 10.185, 10.220, 11.120, 11.155, 11.180, 11.225 s 1324(1): 8.135, 9.260 s 1324(1A): 9.260 s 1324(1A)(b)(ia): 9.260 s 1324(1A)(b)(ii): 9.330 s 1324(1A)(c): 9.260 s 1324(1B): 9.260 s 1324(1B)(a): 9.275 s 1324(1B)(b)(iii): 9.330 s 1324(10): 8.135, 10.220, 11.120, 11.225 s 1324B: 11.155, 11.165 s 1325: 10.220, 11.120, 11.155 s 1325A: 12.105, 12.150, 12.220 s 1325A(1): 12.35 ss 1325A to 1326: 12.20 s 1325B: 12.135 s 1330: 11.120 s 1337B: 2.100 s 1337C: 2.100 s 1337F: 2.100 ss 1337H to 1337R: 2.100 s 1338B(1): 2.100 s 1338B(7): 2.100 s 1338B(8): 2.100 s 1338C: 2.100 s 1378: 3.70, 3.80, 3.115 Ch 2: 3.65, 6.90 Chs 2A to 2P: 3.65 Ch 2C: 8.125 Ch 2D: 7.10, 7.55, 7.115

Corporations Act 2001 — cont s 1308(2): 9.195 s 1308(4): 9.195 s 1308(5): 9.195 s 1308(6): 9.195 s 1308A: 4.180 s 1309: 9.195 s 1309(1): 11.145 s 1309(2): 11.145 s 1311: 9.195, 11.245, 12.215 s 1311(1): 9.195, 11.145, 11.180, 12.135 s 1311(1A): 9.195 s 1311(1A)(c): 9.195 s 1311(2): 11.145, 11.180 s 1315: 11.115 s 1316A: 4.20, 11.100 s 1317E: 5.235, 7.65, 7.500, 7.555, 9.225, 9.260, 9.315, 9.395, 11.35, 11.225 s 1317E(1): 7.60, 7.140, 11.150, 11.250 s 1317G: 7.65, 7.555 s 1317G(1A): 7.65, 11.150, 11.250 s 1317G(1B): 11.150 s 1317G(1): 7.65 s 1317H: 7.65, 7.70, 7.95, 7.555, 9.260 s 1317J: 11.120 s 1317J(3A): 7.65 s 1317J(1): 7.65 s 1317J(2): 7.65 s 1317J(4): 7.65 s 1317K: 7.65 s 1317L: 7.65 s 1317M: 7.65, 11.250 s 1317N(1): 7.65 s 1317P: 7.65 s 1317P(1): 11.250 s 1317P(2): 11.165 s 1317Q: 7.65 s 1317S: 7.100, 7.175, 7.545, 11.150 s 1317S(1): 7.65 s 1317S(1)(b): 7.65 s 1317S(2): 7.65 s 1317DA: 11.150 s 1317EA(2): 8.37 s 1317HA: 11.150, 11.165, 11.250 s 1317HA(1): 7.65, 11.250 s 1317HA(2): 7.65 s 1317HB(2): 11.35 s 1317DAA(1): 11.165 s 1317DAC(1): 11.160 s 1317DAD(1): 11.160 s 1317DAD(2): 11.160 s 1317DAD(4): 11.160 s 1317DAE(1): 11.160 s 1317DAE(1)(g): 11.160 s 1317DAE(2): 11.160 s 1317DAE(3): 11.160 s 1317DAE(6): 11.160 ss 1317DAF(1) to (4): 11.165 s 1317DAF(5): 11.165 s 1317DAF(6): 11.165 li

Corporations and Financial Markets Law

Pt 2M.4: 9.120, 9.195 Pt 2M.4, Div 2: 9.155 Pt 2M.5: 9.120 Pt 5.1: 9.230, 11.130, 12.05, 12.130 Pt 5.3A: 3.190, 7.135, 7.185 Pt 5.4A: 3.200 Pt 5.7B: 3.210, 7.140, 7.160, 7.210 Pt 5.7B, Div 3: 7.135, 7.150 Pt 5.7B, Div 4: 7.70, 7.190, 9.395 Pt 5.7B, Div 5: 4.105, 7.195, 7.200, 7.205 Pt 5.8A: 3.210, 4.85 Pt 5B.2: 2.90, 3.25, 3.70 Pt 5C.1: 9.120 Pt 6.2A: 12.130 Pt 6.10, Div 1: 12.20 Pt 6.10, Div 2: 12.20 Pt 6A.1: 12.15, 12.250, 12.255 Pt 6A.1, Div 1: 12.255, 12.270 Pt 6A.1, Div 2: 12.265, 12.270 Pt 6A.2: 12.250, 12.255 Pt 6A.2, Div 1: 8.67, 12.275, 12.280 Pt 6A.2, Div 2: 12.280 Pt 6A.3: 12.255 Pt 6D.2: 3.190, 9.40, 10.70, 10.95, 10.100, 10.140, 10.170 Pt 6D.2, Div 2: 10.55 Pt 6D.3: 10.225 Pt 6D.3, Div 1: 10.195, 10.210, 10.215 Pt 6D.3 Div 1: 10.210 Pt 6D.4: 10.185 Pt 7: 11.30 Pt 7.1, Div 3: 10.50 Pt 7.2: 11.30 Pt 7.3: 11.30 Pt 7.4: 11.30 Pt 7.5: 11.30 Pt 7.6: 11.30 Pt 7.7: 11.30 Pt 7.8: 11.30 Pt 7.9: 10.45, 10.50, 11.30 Pt 7.9, Div 5B: 11.177 Pt 7.10: 11.145 Pt 7.10, Div 2: 11.190 Pt 7.10, Div 2A: 10.215, 11.225 Pt 7.10, Div 3: 11.240 Pt 7.11: 11.30, 11.185 Pt 7.12: 11.30 Pt 9.2, Div 2: 9.155 Pt 9.4, Div 1: 9.195 Pt 9.4B: 7.55, 7.70, 7.95, 7.190, 7.450, 8.37, 9.330, 9.395, 11.150, 11.165, 11.250 Pt 9.4B, s 1317DAB(1): 11.160 Pt 9.4AA: 11.160 Div 3: 11.240, 11.255 Div 5B: 11.177 Sch 3: 9.195, 12.135, 12.215 Sch 3, item 229A: 11.145 Sch 3, item 229C: 11.145 Sch 3, item 300C: 11.180 Sch 3, Item 311C: 11.245

Corporations Act 2001 — cont Ch 2E: 3.140, 4.90, 5.235, 6.10, 7.415, 7.420, 7.445, 7.452, 12.245 Ch 2J: 9.235, 9.240, 9.280, 9.320, 9.330, 9.355 Ch 2K: 4.42 Ch 2L: 9.60 Ch 2N: 5.360 Ch 3: 3.65 Ch 4: 3.65 Ch 6: 6.125, 8.175, 9.235, 10.55, 10.90, 12.05, 12.15, 12.20, 12.25, 12.30, 12.35, 12.45, 12.100, 12.120, 12.125, 12.130, 12.135, 12.145, 12.240, 12.250, 12.270, 12.275, 12.280 Chs 6 to 6C: 10.50 Ch 6A: 12.15, 12.20, 12.30, 12.255 Ch 6B: 12.15, 12.30, 12.215 Ch 6C: 12.15, 12.20, 12.30, 12.45, 12.105, 12.130 Ch 6CA: 7.110, 10.50, 10.65, 10.110, 10.150, 11.125, 11.140, 11.145, 11.150 Ch 6D: 3.135, 9.25, 9.60, 10.45, 10.50, 10.55, 10.95, 10.97, 10.100, 10.125, 10.130, 10.155, 10.185, 10.200, 10.215, 10.220, 11.30, 11.150 Ch 7: 4.180, 10.45, 10.50, 10.125, 10.175, 11.30, 11.70, 11.80, 11.180, 11.185, 11.225, 11.250 Ch 8: 3.65 Pt 2.F1: 8.130 Pt 1.2: 3.65 Pt 1.2, Div 2: 7.445, 9.250, 11.176 Pt 1.2, Div 6: 4.90 Pt 1.5: 3.105 Pt 2 A.1: 3.65 Pt 2B.3: 3.75 Pt 2B.7: 3.130 Pt 2D.1: 7.75, 8.37, 8.135 Pt 2D.1, Div 1: 7.30, 7.32 Pt 2D.2, Div 1: 7.545 Pt 2E.1, Div 3: 7.445 Pt 2F.1: 5.270, 8.20, 8.25, 8.140, 8.163, 8.165, 8.170, 8.175, 8.195, 8.200, 8.215, 8.225, 9.117, 9.255 Pt 2F.1A: 5.300, 8.100, 8.105, 8.108, 8.109, 8.215 Pt 2F.2: 5.100, 8.67, 9.75, 9.105, 9.118 Pt 2G.2: 6.10 Pt 2J.1: 9.225, 9.260, 9.275, 9.335 Pt 2J.1, Div 1: 9.250, 9.270 Pt 2J.1, Div 2: 9.245 Pt 2J.2: 9.240, 9.290, 9.310, 9.315 Pt 2J.3: 9.320, 9.350 Pt 2L.8: 9.60 Pt 2M: 7.100 Pt 2M.2: 9.195 Pt 2M.3: 7.100, 9.120, 9.195 Pt 2M.3, Div 3: 9.150 lii

Table of Statutes

Corporations Act 2001 — cont Sch 3, Item 312A: 11.245 Sch 3, s 1311(1A): 11.180

Insurance Act 1973: 2.125

Corporations Amendment (Future of Financial Advice) Act 2012: 11.30

Insurance Contracts Act 1984: 2.125

Corporations Amendment (Phoenixing and Other Measures) Act 2012 (No 48, 2012): 4.45 s 489EA(1): 4.45

Mutual Assistance in Business Regulation Act 1992: 2.240

Insurance Act 1995: 3.11

Life Insurance Act 1995: 3.11

National Consumer Credit Protection Act 2009: 2.125

Corporations Regulations 2001: 3.65, 3.70, 11.35 reg 1.0.18: 12.30, 12.75 reg 2A.1.01: 3.11, 3.65 reg 2B.6.01: 3.70 reg 2M.3: 9.140 reg 2M.3.03: 7.400 reg 5.6.19: 3.190 reg 5.6.21: 3.190 reg 6D.2.03: 10.85 reg 6D.2.04: 10.97 reg 6D.2.05: 10.97 reg 6D.2.06: 10.97 Sch 2, Form 509H: 3.200 Sch 6: 3.70

Native Title Act 1993: 3.13 Ozone Protection and Synthetic Greenhouse Gas Management Act 1989 s 65: 4.180 Personal Properties Securities Act 2009: 3.45, 5.360, 9.50 Retirement Savings Accounts Act 1997: 2.125 Securities Exchange Act 1934: 7.540 Superannuation Industry (Supervision) Act 1993: 2.125 Superannuation (Resolution of Complaints) Act 1993: 2.125

Crimes Act 1914 s 4B(1): 4.130

Taxation Administration Act 1953 s 8Y: 4.45 s 8ZD: 4.180

Criminal Code Act 1995: 4.180, 9.150, 11.145, 11.150 s 5.4: 12.135 s 5.6: 11.145 s 5.6(1): 11.145 s 11.2: 11.145 s 12.1: 4.130 s 12.2: 4.180 s 12.3(1): 4.180, 11.145 s 12.3(2): 11.145 s 12.3(3): 4.180, 11.145 s 12.3(4): 4.180, 11.145 s 12.3(6): 4.180, 11.145 s 12.3(c): 4.180 s 12.3(d): 4.180 s 12.4(2): 4.180 s 12.4(3): 4.180

Taxation (Unpaid Company Tax) Assessment Act 1982 s 5: 4.45 Trade Practices Act 1974: 2.85, 2.125, 6.90, 10.205 s 52: 6.90, 6.120, 6.125, 10.210, 10.230, 11.150, 11.235 s 52(1): 9.345 s 79: 9.345 Uniform Companies Act 1961: 12.15 s 33(1): 8.115 Workplace Gender Equality Act 2012: 5.55

Family Law Act 1975: 8.105

AUSTRALIAN CAPITAL TERRITORY

Financial Sector (Shareholdings) Act 1998: 12.15

Partnership Act 1963: 1.10

Financial Services Reform Act 2001: 10.45, 11.30

NEW SOUTH WALES

Foreign Acquisitions and Takeovers Act 1975: 12.15

Associations Incorporation Act 1984: 3.25 s 7(2): 3.25 s 26: 3.25 ss 31 to 33: 3.25 s 34: 3.25 s 37: 3.25 s 40: 3.25 ss 42 to 45: 3.25

Foreign States Immunities Act 1985: 11.143 Income Tax Assessment Act 1936 s 80G: 4.90 Pt IVA: 4.45 Income Tax Assessment Act 1997: 3.110 liii

Corporations and Financial Markets Law

s 24(1): 1.115 s 24(1)(1): 1.45, 1.115 s 24(1)(3): 1.115 s 24(1)(5): 1.115 s 24(1)(7): 1.105, 1.115 s 24(1)(8): 1.115 s 24(1)(9): 1.115 s 25: 1.115 s 26: 1.85, 1.115 s 27: 1.115 s 28: 1.140 s 29: 1.140 s 29(2): 1.155 s 30: 1.140 s 31: 1.105 s 32(a): 1.115 s 32(b): 1.20 s 32(c): 1.115 ss 32 to 34: 1.85 s 33: 1.115 s 34: 1.110 s 35(f): 8.145 s 38: 1.155 s 39: 1.155 s 44: 1.115 s 45: 1.20 s 46: 1.10 s 54: 1.100 s 57: 1.100 s 67: 1.100 s 67(2): 1.100 s 75: 1.100

Associations Incorporation Act 1984 — cont ss 46 to 49: 3.25 ss 67 to 69: 3.25 s 75: 3.25 Associations Incorporation Act 2009: 3.25 Bank of New South Wales Act 1828: 2.75 Bank of New South Wales Act 1850 s 1: 2.75 s 2: 2.75 s 23: 2.75 Bank of New South Wales (Change of Name) Act 1982 s 4: 2.75 Companies Act 1936: 3.230, 8.165 Corporations (Commonwealth Powers) Act 2001 s 1(3): 2.90 s 5: 2.90 s 5(1): 2.90 s 6: 2.90 Crimes (Sentencing Procedure) Act 1999 s 16: 4.130 Employment Protection Act 1982 s 15: 4.185 Interpretation Act 1897 s 21(c): 4.20 Liquor Act 1982: 6.20 s 36(4): 3.11

Real Property Act 1900: 5.355 s 127: 5.355

Miscellaneous Acts Amendment (Directors’ Liability) Act 2012: 7.15

Securities Industry Act 1970 s 70: 11.235

Partnership Act 1892: 1.10, 1.15, 1.20, 1.25, 1.30, 1.40, 1.45, 1.50, 1.65, 1.85, 1.105, 1.110, 1.115, 1.140 s 1: 1.70 s 1(1): 1.15 s 1C: 1.100 s 2(1): 1.30, 1.65 s 2(1)(3): 1.40 ss 2(1)(3)(a) to (e): 1.40 s 2(1)(3)(d): 1.40, 1.70 s 2(2): 1.40 s 3: 1.40, 1.75 s 4: 1.15 s 5: 1.95 s 5(1): 1.95 ss 6 to 9: 1.95 ss 10 to 12: 1.95 s 13: 1.95 s 14: 1.50 ss 14 to 18: 1.95 s 20: 1.85 s 20(1): 1.85 s 23: 1.85

NORTHERN TERRITORY Criminal Code s 154(1): 4.130 Partnership Act: 1.10

QUEENSLAND Partnership Act 1891: 1.10

SOUTH AUSTRALIA Partnership Act 1891: 1.10 Statutes Amendment (Directors’ Liability) Amendment Act 2013: 7.15

TASMANIA Partnership Act 1891: 1.10 liv

Table of Statutes

Companies Act 1862: 2.60, 2.75, 3.110, 4.30, 5.125, 5.175, 9.385, 10.30

VICTORIA Associations Incorporation Reform Act 2012: 3.25

Companies Act 1900: 2.60 Companies Act 1908: 5.250, 5.330

Children’s Services Act 1996 s 27(1): 4.182

Companies Act 1929: 9.90 Art 68: 5.250, 5.255, 5.260 Art 91: 5.263

Mining Companies Act 1871: 2.75 Partnership Act 1915: 1.150 s 46: 1.150

Companies Act 1948: 5.240 s 162(4): 5.175 s 184: 8.155

Partnership Act 1958: 1.10

Companies Act 1985 s 9: 9.110 s 17(2)(b): 9.110 s 125: 9.110 s 125(1): 9.110 ss 125 to 129: 9.110 s 127: 9.110 Pt V, Ch II: 9.110

WESTERN AUSTRALIA Partnership Act 1895: 1.10

CANADA Canada Business Corporations Act 1974 s 97: 5.95 s 137(5)(b): 6.40 s 143(3)(c): 6.40

Companies Act 2006 s 172(1): 2.208 Companies Clauses Consolidation Act 1845 s 90: 5.125

GHANA Companies Code 1961: 7.337 s 203(3): 7.337

Financial Services Act 1986: 11.30 Industrial and Provident Societies Act 1852: 3.20, 3.110

NEW ZEALAND

Joint Stock Companies Act 1844: 2.55, 2.60, 3.11, 3.70, 3.120, 3.150, 3.225, 5.95 s 27: 3.150 Sch A: 3.150 s 27: 5.95 Sch A: 5.95

Companies Act 1955: 7.45 s 165(3): 8.105 s 209: 8.195, 8.200 Companies Amendment Act 1963: 7.540 Securities Amendment Act 1988: 4.170 s 20: 4.170 s 20(3): 4.170 s 20(4): 4.170 s 20(4)(e): 4.170

Joint Stock Companies Act 1856: 2.55, 3.145, 5.95, 8.115 s 10: 8.115 Limited Liability Act 1855: 2.55

Workers’ Compensation Act 1922: 4.35

Limited Liability Partnership Act 2000: 1.100 Merchant Shipping Act 1894 s 502: 4.150, 4.170 s 503: 4.150, 4.155

PAPUA NEW GUINEA Mining Act 1992: 11.255

Partnership Act 1890: 1.10

UNITED KINGDOM

Partnership Act 1892 s 25: 8.155

5 Geo IV, c 86: 2.75 6 Geo 1, c 18 s 20: 2.40 s 25: 2.40

Railway Clauses Consolidation Act 1845: 4.140 s 98: 4.140 s 99: 4.140 s 101: 4.140

Bubble Act 1720: 2.10, 2.40, 2.45, 2.55, 5.95, 11.20, 11.30 s 18: 11.30 s 26: 2.55

Restrictive Trade Practices Act 1976: 4.170 Sunday Observance Act 1677: 4.20 lv

Corporations and Financial Markets Law

Trade Descriptions Act 1968: 4.165 s 11(2): 4.165 s 24(1): 4.165 s 24(1)(a): 4.165 s 24(1)(b): 4.165 s 24(2): 4.165

Securities Act 1933: 10.10, 10.15 Securities Exchange Act 1934: 2.115, 10.10, 10.15 s 9(a)(i): 11.235 s 10(b): 11.235 s 23(a)(1): 2.115 r 14a-8: 6.65

Trading Companies Act 1834: 2.55

UNITED STATES

Social Security Act 1935: 2.160

Delaware General Corporation Law s 141(a): 5.30

TREATIES AND CONVENTIONS

Model Business Corporation Act s 35: 5.95

United Nations Guiding Principles on Business and Human Rights: 6.65, 12.100

lvi

CHAPTER 1 Partnership [1.10]

THE ORIGINS AND SOURCES OF PARTNERSHIP LAW ......................................................................... 2

[1.15]

THE DEFINITION OF PARTNERSHIP .................................................................................................... 2 [1.20] [1.30]

[1.80]

[1.110]

PRINCIPAL CHARACTERISTICS OF PARTNERSHIP ................................................................................ 9 [1.85]

A partnership is not recognised by Australian or English law as a distinct legal entity ........ 9

[1.90]

Partners bear unlimited liability for debts and obligations incurred by the partnership ............................................................................................ 10

[1.105]

Other characteristics of partnership ................................................................................ 12

CREATION OF PARTNERSHIP ........................................................................................................... 13 [1.110] [1.115]

[1.120]

Formation ...................................................................................................................... 13 Terms of the partnership agreement .............................................................................. 13

OTHER UNINCORPORATED FORMS OF ASSOCIATION COMPARED ................................................. 14 [1.120] [1.130]

[1.140]

The definition of partnership ............................................................................................ 2 Rules and indicia for determining the existence of partnership ......................................... 4

Unincorporated non-profit associations .......................................................................... 14 Unincorporated joint ventures ........................................................................................ 16

THE FIDUCIARY OBLIGATIONS OF PARTNERS .................................................................................. 17

[1.05] This book deals with the corporation or company, the dominant form of business

association for over a century. The corporation is not, however, the only form of business association; nor perhaps is it the most common. A form with a more ancient lineage – the partnership – might make a superior claim to that title. Discussion of the corporation commences with this business form, not least since its elements have had a shaping influence upon the structure of the modern corporation and the character of corporate law. This brief and selective account of partnership law looks first at its origins and sources, at the defining elements of partnership and finally at the fiduciary obligations of partners. Some partnership topics will be considered further in the treatment of corresponding doctrines in corporate law. Partnership is the simplest form of business association and perhaps the most common. Although income tax legislation requires the filing of a partnership return, this provides no clear guide to the incidence of partnership, since the definition of partnership for tax law does not follow precisely that of partnership law. There is great variety in size and formality of partnerships, ranging from an informal short-term business venture between two people to a large professional partnership with a complex management structure and an international operation. (The professional partnership is exempted from the general prohibition on partnerships formed with more than 20 members: see [3.10].) Much small business has been carried on in partnership, particularly in the retail sector, construction, tourism and agriculture. However, increasingly the corporate form is used for small business since, unlike the partnership, it permits the venturers to limit personal liability for losses of the business: see [3.35]. The partnership is accordingly much more lightly regulated than the corporation. The appeal of partnership is its informality, founded as it is simply upon the contract between the business associates; it requires no registration or other formality for its formation, conduct or dissolution. A partnership may be formed without its parties being aware that they are partners and despite declaring themselves not to be partners, if the relationship they have formed is nonetheless that which the law recognises as a partnership. There are undoubtedly [1.05]

1

Corporations and Financial Markets Law

more partnerships than can be known since they are in constant flux, forming and dissolving, sometimes under the partners’ false assumptions as to the legal relationship between them.

THE ORIGINS AND SOURCES OF PARTNERSHIP LAW [1.10] The modern forms of partnership are lineal descendants of two forms of business

association known to the medieval law merchant: the commenda and the societas. The commenda was a form under which one party supplied the capital for the venture but did not take an active role in its management. That function was performed by the operating partner who, unlike the financing party, assumed full personal responsibility for the success of the venture. The commenda partially survives in the modern form of the limited partnership: see [1.100]. 1 It was the societas, however, which became the central form in English partnership law. It is distinguished by common responsibilities and rights between the partners, including participation in net profits, sharing losses and joining in the management of the business. Partnership law was fashioned almost exclusively by court decisions from the Middle Ages until its codification in the Partnership Act 1890 (UK). That statute was reproduced in the Partnership Acts of the Australian States and Territories. 2 Like their 1890 model, the Australian legislation does not displace rules of equity and common law applying to partnership which are expressly saved unless inconsistent with express provisions of the legislation. 3 Because of their essential similarity to each other and to their British source, focus will be placed upon the Partnership Act 1892 (NSW) which is referred to as the Partnership Act in the text below. Statutory references are to that Act. 4

THE DEFINITION OF PARTNERSHIP [1.15] Partnership is defined by the Partnership Act as “the relation which exists between persons carrying on business in common with a view of profit”: s 1(1). Persons who have entered into partnership are collectively a “firm” for the purposes of the Act and the name under which their business is carried on is called the “firm name”: s 4. The section which immediately follows in each Act states a number of specific rules to which regard shall be had in determining whether a partnership does or does not exist. The following elements in the statutory definition are indicative of some of the principal matters relevant to the determination of whether a partnership exists and its legal character. The claim that a particular relationship is a partnership is often simply a foundational step to invoking some legal consequence that flows from this characterisation, for example, the agency authority of partners to bind the firm to third parties (see [1.95]) or the fiduciary relationship that is the “lifeblood” of partnership: see [1.140]-[1.155]. Other relationships based, for example, on contract may not be so readily productive of agency or fiduciary consequences: see [1.130].

The definition of partnership

Partnership as a relationship founded upon a business carried on in common [1.20] Partnership is a relationship founded upon the agreement of the parties, express or

implied. The partners may be either natural or corporate persons. To be in a relationship 1 2 3 4

2

C A Cooke, Corporation, Trust and Company (1950), p 45. See Partnership Act 1963 (ACT), Partnership Act (NT), Partnership Act 1891 (Qld), Partnership Act 1891 (SA), Partnership Act 1891 (Tas), Partnership Act 1958 (Vic) and Partnership Act 1895 (WA). See, eg, Partnership Act 1892 (NSW), s 46. For a fuller discussion of partnership law, see K L Fletcher, Higgins and Fletcher – The Law of Partnership in Australia and New Zealand (9th ed, 2007) and R C l’A Banks, Lindley & Banks on Partnership (19th ed, 2010). [1.10]

Partnership

CHAPTER 1

which attracts the status of partnership, the parties must, however, be carrying on business in common. The Partnership Act, s 45, provides that the expression “business” includes every trade, occupation, or profession. The concept of carrying on a business implies a repetition of acts and “excludes the case of an association formed for doing one particular act which is never to be repeated”. 5 Hence, in Ballantyne v Raphael, 6 where a syndicate was formed for the purpose of buying a block of land and subdividing it, the Supreme Court of Victoria held that there was “not such a series of acts contemplated being done by the syndicate as means a carrying on of business”. There have been, however, a number of cases where a partnership has been formed in respect of what may be regarded as a single venture, as distinct from commercial undertakings of more indefinite duration and wider range. 7 In the High Court decision in United Dominions Corporation Ltd v Brian Pty Ltd, Dawson J said 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 suggests that the emphasis which will be placed upon continuity may not be heavy. 8

The words “in common” in the statutory definition constitute the central defining element of partnership, reflecting the requirement that each partner must be a principal in the business and indicating the societas (or common bond) between the associates. It is not necessary, however, that each partner have the conduct of transactions or be active in the business since it is possible to be a dormant or sleeping partner. The element of commonality is determined not by reference to close linguistic analysis of those words in the statute but by reference to a cluster of considerations which were taken by courts prior to the 1890 codification to indicate the existence of a partnership, which factors are now compendiously captured by the statutory words “in common”. Those factors and the interplay between them – for none alone is decisive – are revealed in [1.70] Re Megevand; Ex parte Delhasse and [1.75] Badeley v Consolidated Bank.

The requirement of profit [1.25] The objective of profit is an essential feature of partnership. That element distinguishes

partnerships from non-profit clubs or associations and from some other associations such as joint ventures. This may be done on two grounds. Non-profit clubs or associations often engage in profit-making or revenue earning activities which are then devoted to the purposes of the club or association, there being no distribution of surplus to members unless perhaps upon the dissolution of the association. The incidental or ancillary nature of the revenue 5

Smith v Anderson (1880) 15 Ch D 247 at 277-278 per Brett LJ. However, if a transaction is undertaken which, if repeated, would be one of a series of transactions of a business character and more transactions are intended at the time of the first, then the business exists from the time of the commencement of that transaction: Re Griffin; Ex parte Board of Trade (1890) 60 LJQB 235 at 237.

6

(1889) 15 VLR 538 at 557.

7

See, eg, Canny Gabriel Castle Jackson Advertising Pty Ltd v Volume Sales (Finance) Pty Ltd (1974) 131 CLR 321; Elkin & Co Pty Ltd v Specialised Television Installations Pty Ltd [1961] SR (NSW) 165; Playfair Development Corp Pty Ltd v Ryan [1969] 2 NSWR 661; see also the Partnership Act provision on dissolution of a partnership entered into for a single adventure: s 32(b).

8

(1985) 59 ALJR 676 at 681. A distinction is drawn between activities which are carried out preparatory to the commencement or setting up of a business, such as the investigation of the feasibility of a prospective business, and those which constitute the actual carrying on of the business itself: Goudberg v Herniman Associates Pty Ltd [2007] VSCA 12. Acts within the former do not constitute a partnership. [1.25]

3

Corporations and Financial Markets Law

earning activities may be treated as a significant point of distinction from partnership as well as the absence of provision for profit distribution during the life of the association. The Partnership Act concept of profit is relatively narrow, and this concept is a point of distinction between partnership and those contractual joint ventures which do not constitute a partnership between the venturers. (Some associations styled by their participants as joint ventures may also be partnerships: see [1.130].) In United Dominions Corporation Ltd v Brian Pty Ltd, Dawson J said that [p]erhaps in this country, the important distinction between a partnership and a joint venture is, for practical purposes, the distinction between an association of persons who engage in a common undertaking for profit and an association of those who do so in order to generate a product to be shared among the participants. Enterprises of the latter kind are common enough in the exploration for and exploitation of mineral resources and the feature which is most likely to distinguish them from partnerships is the sharing of product rather than profit. 9

Rules and indicia for determining the existence of partnership [1.30] The Partnership Act contains, in s 2(1), several specific rules to which regard must be had in determining whether a partnership exists. These rules are not for the most part conclusive but take their place along with other indicia which provide a guide to the existence of partnership. While the statutory rules have particular force, the case law has identified other features of relationships as being of particular significance in determining whether or not a partnership has been created. The body of these statutory and case law rules is explored in the following paragraphs and case extracts.

The parties’ characterisation of their relationship [1.35] The legal status which putative partners have sought to assign, or repudiate, for their

relationship is relevant but not necessarily decisive in determining the existence of partnership. In Wiltshire v Kuenzli, Roper J dealt with an argument that a partnership cannot be formed where the parties concur in saying that there shall not be a partnership between them: it having been ascertained that the parties intended to do all the things which would constitute them partners in law, no effect can be given to their declared intention not to become partners. Of course, if the facts are equivocal the expressed intention not to become partners is of the utmost importance as showing the proper inference to be drawn from the facts, but if the facts are unequivocal the same expressed intention is meaningless and useless. 10

Sharing net profits [1.40] The sharing of net profits is prima facie evidence of partnership. The Partnership Act

provides that “[t]he receipt by a person of a share of the profits is prima facie evidence that he is a partner in the business” but “does not of itself” make her or him a partner in the business: s 2(1)(3). By contrast, the Act provides that the sharing of gross returns does not of itself create a partnership, whether or not there is a joint or common interest in any property from which, or from the use of which, the returns are derived: s 2(2). The provision with respect to net profits in s 2(1)(3) reflects the common law rule settled by the House of Lords in 1860 in Cox v Hickman: It is often said that the test, or one of the tests, whether a person not ostensibly a partner, is nevertheless, in contemplation of law, a partner, is, whether he is entitled to participate in the profits. This, no doubt, is, in general, a sufficiently accurate test; for a right to participate in profits affords cogent, often conclusive evidence, that the trade in which the profits have been 9 10 4

(1985) 59 ALR 676 at 681. (1945) 63 WN 47 at 51. [1.30]

Partnership

CHAPTER 1

made, was carried on in part for or on behalf of the person setting up such a claim. But the real ground of the liability is, that the trade has been carried on by persons acting on his behalf. When that is the case, he is liable to the trade obligations, and entitled to its profits, or to a share of them. It is not strictly correct to say that his right to share in the profits makes him liable to the debts of the trade. The correct mode of stating the proposition is to say that the same thing which entitles him to the one makes him liable to the other, namely, the fact that the trade has been carried on on his behalf, that is, that he stood in the relation of principal towards the persons acting ostensibly as the traders, by whom the liabilities have been incurred, and under whose management the profits have been made. 11

The Partnership Act lists a number of specific instances where receipt of a share of profits does not of itself make the recipient a partner: s 2(1)(3). These provisions restate provisions introduced in response to the decision in Cox v Hickman, effectively displacing any inference of partnership from the receipt of a share of profits in the five instances set out in paras (a) to (e) of the subsection: (a) payment of a debt paid out of accruing profits of the partnership; (b) remuneration of servants or agents by a share of profits of the business; (c) (d)

annuities to the widow or children of a deceased former partner paid from partnership profits; the advance of money by way of loan to a person carrying on a business with interest varying with the profits or by a share of profits of the business provided that the contract is in writing and signed by the parties; and

(e) receipt of a portion of profits in consideration of the sale of goodwill of a business. Among the specific instances in the paragraphs, that in s 2(1)(3)(d), relating to a loan entitling the lender to a share of profits in lieu of interest, is arguably the most significant of the instances excluded from any presumption of partnership deriving from the section. Where a loan is made within that provision, the rights of the lender are postponed to other creditors in the event of the insolvency of the borrower: s 3. (What does [1.75] Badeley say about the effect of s 3 upon any security taken by the lender?) Of course, it may be that a purported loan under s 2(1)(3)(d) is, upon examination, found not to be a loan at all but an element of a partnership agreement because its terms create a relationship recognised by law as such, notwithstanding that its parties have sought to give it a different legal character. The cases extracted below at [1.70] and [1.75] provide instances of transactions that sought the protection of s 2(1)(3)(d). (The issue in each case was whether the putative lender was truly a partner liable for partnership debts.) An early instance of an arrangement held to be a true loan and not a partnership was that in Mollwo March & Co v Court of Wards 12 where the lender, as he was held to be, had significant powers of control in relation to the borrowing firm, but those powers were confined to limiting the scope of business activities, for example, while advances remained unpaid, and did not enable him to deal with the business as owner. They involved no initiative power and were held in effect to be a means of providing security in respect of the loan. In Mollwo the Privy Council acknowledged that there may be other cases where the substance of the arrangement is that the parties are really trading as principals and not as lender and borrower.

Sharing of losses [1.45] The sharing of losses as well as profits is also characteristic of partnership and the

Partnership Act provides for equal contribution to losses in the absence of agreement to the 11 12

(1860) 8 HLC 302 at 306. (1872) LR 4 PC 419. [1.45]

5

Corporations and Financial Markets Law

contrary: s 24(1)(1). There is, however, ample authority that the sharing of losses is not essential to a finding of partnership so that a partnership may exist although one or more partners agree to indemnify the others against loss, for example, in excess of their advances to capital. 13 Nevertheless, that indemnity will not alter the liability of each partner as principal for the debts and obligations of the firm in a suit by persons external to the partnership.

Status of principal [1.50] As noted, in Cox v Hickman the House of Lords expressed as the decisive test whether

the putative partner has the status of a principal in relation to dealings with others: see [1.40]. The reference in the Partnership Act to the carrying on of a business in common carries the implication that those acting in the partnership do so as agents of all the partners, who are the principals, even if “dormant” or “sleeping”. In Cox v Hickman the agency implications of the principal relationship between partners was elaborated in terms which are now expressed in the Act (see [1.40]): The liability of one partner for the acts of his co-partner is in truth the liability of a principal for the acts of his agent. Where two or more persons are engaged as partners in an ordinary trade, each of them has an implied authority from the others to bind all by contracts entered into according to the usual course of business in that trade. Every partner in trade is, for the ordinary purposes of the trade, the agent of his co-partners, and all are therefore liable for the ordinary trade contracts of the others. Partners may stipulate among themselves that some one of them only shall enter into particular contracts, or into any contracts, or that as to certain of their contracts none shall be liable except those by whom they are actually made; but with such private arrangements third persons, dealing with the firm without notice, have no concern. The public have a right to assume that every partner has authority from his co-partner to bind the whole firm in contracts made according to the ordinary usages of trade. This principle applies not only to persons acting openly and avowedly as partners, but to others who, though not so acting, are, by secret or private agreement, partners with those who appear ostensibly to the world as the persons carrying on the business. 14

The Partnership Act also provides for the like liability of persons who allow themselves to be held out as partners of a firm even though they are not partners: s 14.

Management participation [1.55] The role in management or decision making in the business taken by the putative

partner can be influential in indicating the existence of a partnership. The ways in which persons claimed to be partners deal with each other, are treated in the internal management of the business, participate in its control or management decisions and are held out to others are significant. 15 However, participation in management is not essential since there may be dormant or sleeping partners who remain principals in relation to external dealings but take no part in the management of the partnership. They have long been recognised as partners.

Mutual trust and confidence [1.60] A distinctive feature of partnership is the mutual confidence and trust between

partners. Dixon J in Birtchnell v Equity, Trustees, Executors and Agency Ltd 16 reasserted the old principle that the “mutual confidence of partners is the life blood of the concern”. The way in which persons deal with each other and the arrangements they create to make decisions or 13 14 15

See, eg, Re Ruddock (1879) 5 VLR (IP & M) 51; Stekel v Ellice [1973] 1 WLR 191. (1860) 8 HLC 302 at 304-305. See, eg, Stekel v Ellice [1973] 1 WLR 191; Walker v Hirsh (1884) 27 Ch D 460.

16

(1929) 42 CLR 384 at 407; see [1.150].

6

[1.50]

Partnership

CHAPTER 1

settle disputes may indicate the absence of such trust. However, this feature, and the fiduciary duties owed by partners to each other which flows from it, may be displaced by contrary provision in the particular partnership agreement, perhaps even to the point of excluding the fiduciary relationship. 17 Hence, mutual confidence and trust does not appear to be strictly essential for a finding of partnership.

Contribution to capital [1.65] Another feature of partnership that is sometimes referred to in the case law but again is not strictly essential is the contribution of capital, for example, in the form of money or property, made by a putative partner. It is quite common, however, to find no capital contribution by a partner but only a contribution of know-how or an agreement to work full-time in the business. Similarly, a partnership may involve no capital stock, but merely the sharing of expenses and profits, and not the property which is employed in the business which remains the separate property of one partner. Conversely, the Partnership Act states that joint or part ownership of property does not of itself create a partnership as to anything so owned, whether profits made by its use are shared or not: s 2(1).

Re Megevand; Ex parte Delhasse [1.70] Re Megevand; Ex parte Delhasse (1878) 7 Ch D 511 Court of Appeal, England and Wales [Delhasse agreed to advance a sum to M and S who were partners by a written agreement which referred to the then equivalent of s 2(1)(3)(d) and stated that it was by way of loan and was not to make Delhasse a partner. Under the agreement, Delhasse was to share in profits, and have the right to inspect partnership accounts and the option of dissolving the partnership in certain circumstances; the sum Delhasse advanced was not to be repayable until after dissolution. The advance was the only “capital” of the partnership.] JAMES LJ: [526] If ever there was a case of partnership this is it. There is every element of partnership in it. There is the right to control the property, the right to receive profits, and the liability to share in losses. But it is said that there are other provisions in the contract which prevent its having this operation, and which shew clearly that the parties meant the relation of lender and borrower, and not the relation of partners, to subsist between them. And for this purpose reliance is placed on the recital of s 1 of the Act – the recital of the agreement for a loan – and the declaration in cl 4, that “the £10,000 is advanced by Delhasse to the other two by way of loan under that section, and such advance does not and shall not be considered to render Delhasse a partner in the business”. Can those words really control the rest of the agreement? Do they really shew that the intention was not in truth that which it appears to be by all the other stipulations? To my mind it is quite clear that they do not. When you come to look at all the other stipulations, they are utterly inconsistent with the notion of a loan by the one to the two, so as to make the two personally liable in respect of it in any event or under any circumstances whatever. The loan is said to be made to the two, but, when you read the whole of the agreement together, it is impossible not to see that it was not a loan to the two upon their personal responsibility by the person who is said to be the lender but that it was a loan to the business which was to be carried on by the two for the benefit of themselves and him, and was to be repaid out of the business, and out of the business only, except in the case of loss, when the loss would have to be borne by the three in the proportions mentioned in the agreement. The use of the word “lend”, and the reference to the Act, are, in my opinion, mere sham – a mere contrivance to evade the law of partnership. The loan is a mere pretence, the object being to enable the so-called lender to be, not only a dormant partner, but the real and substantial owner of the business, for whom and [527] on whose

17

Chan v Zacharia (1984) 154 CLR 178 at 196 per Deane J; see [1.155]. [1.70]

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Re Megevand; Ex parte Delhasse cont. behalf it is to be carried on, and yet to provide that he shall not be liable for the loss, in case loss shall be incurred. … I am of opinion that the agreement was in truth and in substance an agreement for a real partnership between the parties.

Badeley v Consolidated Bank [1.75] Badeley v Consolidated Bank (1888) 38 Ch D 238 Court of Appeal, England and Wales [The plaintiff (Badeley) advanced money to a railway construction contractor (Smith). By deed, the contractor assigned to the plaintiff his plant, machinery and other items as security for the advance. The plaintiff was to receive 10% interest and 10% of the profits after allowance for some drawings by the contractor. The contractor covenanted to apply the moneys advanced in the carrying out of the work. The plaintiff could enter and complete them if the contractor became bankrupt.] LINDLEY LJ: [258] I take it that it is quite plain now, ever since Cox v Hickman (1860) 8 HLC 302 that what we have to get at is the real agreement between the parties. It is no longer right to infer either partnership or agency from the mere fact that one person shares the profits of another. … [259] Certain letters were alluded to in which the expression “capital” was used, and there is a rather remarkable document, a receipt … on 26 September 1878, which was a receipt for £1,000 advanced on account of working capital. I quite agree that if you take those documents alone they are consistent with either view. But they do not stand alone by any means, and when you do look at the whole of the evidence it appears to me that the formal document expresses the real truth, namely, that this was a contract of loan upon security. It was said that the capital was in the business, and risked in the business. It was in the business in a sense, that is to say, the money was advanced for the purpose of enabling Smith to carry on his contract with the railway company, and there was a stipulation that the money should be used for [260] that purpose. But there was not in this case what there was in Pooley v Driver (1876) 5 Ch D 458 and Ex parte Delhasse [1.70], a participation in loss on the part of the lender. The capital was not risked in the business in any such sense as it was in those two cases. If Smith had acquired funds in any other way Badeley could have recovered his money, the principal, interest and profits. There was a loan legally constituted and intended to be created, and the money which was advanced by Badeley to Smith was not made contingent as to its repayment upon the success of the undertaking. It appears to me that when you look at the transaction with a view to ascertain the real, true nature of it you are driven to the conclusion that it was a bona fide loan upon security, and not a participation in profits with a view to create a partnership either secret or open. Another point to which I will allude is … that even if that were so Badeley could not foreclose his securities upon the ground that he was thereby endeavouring to recover a portion of his principal or the profits or [261] interest payable on such a loan, and he could not do that in competition with Smith’s other creditors. Now there is obviously a fallacy at the bottom of that argument. Supposing that a person lends money upon mortgage of real estate, and stipulates that he is to have a share in the profits of some business, is it to be supposed that that mortgagee could not bring an ejectment to recover his security because of [s 3]? It is too absurd. That is not recovering his principal and interest. It is very true that unless he gets his security he may lose the fund out of which it is to be repaid; but such a case as that is not within the section at all. Neither is a case of foreclosure within the section. Foreclosure is realising the security. What the mortgagee says in the foreclosure is, “Redeem me or leave me alone.” … Here the lender is trying to enforce his security by foreclosure. It appears to me that he is not prevented so doing by [s 3], nor by any principle of ordinary law.

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PRINCIPAL CHARACTERISTICS OF PARTNERSHIP [1.80] Two legal characteristics of partnership in Australian and English law are fundamental:

the absence of distinct entity status for the partnership and the unlimited liability of partners for firm debts and other obligations. Other features are commonly associated with and characteristic of partnership but are alterable by private agreement. A partnership is not recognised by Australian or English law as a distinct legal entity [1.85] By contrast with Scots and civil law, in Australian and English law, the firm and its

members collectively are not endowed with a distinct entity status, that is, with any capacity of acquiring rights or obligations independent of those of the individual partners. The rights and liabilities of a partnership are no more than the aggregate of those of the individual partners. Accordingly, a firm as such cannot be convicted of a crime, commit torts or incur contractual obligations. Of course, its individual members may be personally liable in crime, tort and contract in respect of acts done for the partnership. A firm name may be used, eg, Smith & Co, although this is no more than a convenient shorthand expression. 18 Indeed, the common reference to the partners collectively as “the firm”, while convenient, is apt to confuse by suggesting that the firm is somehow distinct from its members as is the case with an incorporated company. Under taxation law a return of income is required for the partnership although each partner is liable to taxation on an individual basis only. The absence of separate legal status for the firm has a number of legal consequences. A partner, as a principal in the firm, cannot also be an employee of that firm. Thus, in Ellis v Joseph Ellis & Co 19 it was held that a partner who was in addition paid a fixed wage for doing specific work did not become a worker for the purposes of workers compensation legislation. Unlike a company, a partnership does not have perpetual succession; its duration is determined by the default rules in the Partnership Act (ss 26, 32 – 34) which are subject to any special agreement made by the partners. A partnership as such cannot own property; accordingly, the law on legal and equitable title to the property used in the partnership business is consequently somewhat complex: see s 20. There are some concessions to the logic of this principle which are made in the name of practical convenience. Thus, the inconvenience of suing a firm with numerous partners, or for them of bringing action, is overcome to a large extent by special rules of court which provide a mechanism for suing partners, or for suit by partners, in either case in the name of the firm of which the persons were partners at the time of the accruing of the cause of action. Nevertheless, the commercial reality is that partnerships are commonly thought of as having an existence distinct from their members. This is especially so for the large professional firms which endure despite many changes in their composition. (As already noted, only professional partnerships are permitted to have more than 20 members; other associations for gain must incorporate if they wish to go beyond this size.) A firm, as an association of particular persons, strictly comes to an end on the death or retirement of one of them. Provisions in partnership agreements of the larger professional firms not uncommonly provide for automatic novation of a partnership comprising the surviving partners where the old agreement is rescinded in such circumstances. Accounting practice also treats the firm as a body distinct from the members comprising it since partnership accounts commonly record the firm as debtor to each partner for contributions to the common stock. Further, the importance of the business carried on by the 18 19

Sadler v Whiteman [1910] 1 KB 868 at 889 per Farwell LJ. [1905] 1 KB 324. [1.85]

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partnership as a commercial entity calls for some special protection. Hence, the provisions of the Partnership Act that partnership property must be held and applied exclusively for the purposes of the partnership and in accordance with the partnership agreement (s 20(1)); there are also limitations on the rights of judgment creditors of partners in respect of nonpartnership obligations to levy execution against their interest in partnership property and profits: s 23. Partners bear unlimited liability for debts and obligations incurred by the partnership [1.90] As earlier noted, each partner has unlimited liability to the creditors of the partnership

expressed in some older cases as liability to their “last shilling and acre”. This rule is not affected by any agreement between the partners, even though their private agreement may establish obligations as between them to contribute in different proportions or may even indemnify some partners against personal liability. The unlimited liability of partners may be contrasted with the limitation on personal liability that is provided to shareholders with respect to the obligations of their companies. It must be contrasted also with the separate regime permitting registration of limited partnerships with a class of partners whose liability to contribute to the debts and other obligations of the partnership is limited to a publicly recorded sum: see [1.100]. Before considering that special form of partnership, we briefly consider the scope of the liability of partners in contract and tort for obligations assumed and wrongs committed by those for whom the firm is answerable.

Agency authority to bind fellow partners [1.95] The common law scope of the liability of partners for debts and obligations of those

who conduct the partnership business was noted above in the quoted words of the judgment of the House of Lords in Cox v Hickman: see [1.40]. That agency authority is restated (indeed, enlarged) in the Partnership Act, s 5, and complemented by provisions relating to firm contracts and instruments (ss 6 – 9, 14 – 18), civil wrongs (ss 10 – 12) and the improper use of trust property for partnership purposes: s 13. The most significant of these provisions, however, is that relating to the power of a partner to bind the firm under s 5 and the consequent scope of partner liability for firm debts. It applies doctrines of actual and ostensible authority which are examined more fully below in their application to corporate dealings: see [5.310]. The common law of agency distinguishes between the two main grounds of liability of a principal with respect to the dealings by an agent with an outsider. The first arises where the agent has actual authority from the principal and the second where the agent has ostensible (or apparent) authority. Actual authority involves an agency created by a consensual agreement between principal and agent, the scope of which includes any proper implications from the words used, usages of the trade or the course of dealings between the principal and agent. Actual authority is either express or implied. Express authority may be stated explicitly, orally or in writing. Implied actual authority may be inferred from the usual or customary authority involved in the relationship between principal and agent, or as incidental to express authority, but it may also arise from the special features of the relationship, or from an actual course of dealing between the parties which establishes an actual authority outside what is usual. Implied actual authority is often coextensive with apparent authority. Section 5(1) restates the scope of actual authority of a partner when it says that every partner is an agent of the firm. It identifies the major area of implied authority as extending to acts for carrying on the business of the kind carried on by the firm in the usual way. This section imposes no liability on partners for acts done by a partner who is acting, and is dealt with as acting, on their own behalf only, and not on behalf of the firm. 10

[1.90]

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Outsiders are not party to the agency agreement and therefore will not be in a position to know confidently the precise scope of the agent’s actual authority. Ostensible authority provides some protection for the outsider and scope for confident reliance upon the authority of a professing agent. It involves the authority of an agent as it appears or manifests itself to the outsider. It rests on the relationship between the principal and the outsider in that the principal is said to have represented to the third party that the agent is authorised to enter into the particular transaction with the outsider, even though the agent may have no actual authority, for example, because of specific reservations communicated by the principal to the agent but not to the third party. Ostensible authority is most clearly perceived in the case where the principal, through a specific representation, represents that the agent has authority to bind the principal in the transaction. However, the principal may have had no direct dealings with the third party and the representation or manifestation may also arise from the fact that the principal has put the agent in a position such that the agent appears to be authorised to act in the particular transaction on behalf of the principal. Thus, the principal may have armed the agent with the indicia of authority, or allowed such a situation to arise, and the third party has relied upon the representation as to the apparent authority of the agent. The scope of the ostensible authority may, as with implied authority, be affected by the usual powers of the position which the agent occupies or appears to occupy. Section 5(1) covers a major part of the ground of the ostensible authority doctrine. It provides that every partner is an agent of the firm and of the other partners for the purpose of the business of the partnership; the acts of every partner carrying on in the usual way the business of the kind carried on by the firm binds the firm and other partners. The section excludes liability, however, where the third party knows that the agent has no authority to act for the firm in the particular matter, or does not know or believe the agent to be a partner.

Limited partnerships allow for limitation of the liability of some partners [1.100] The limited partnership form represents a modern version of the medieval commenda which did not flourish in later English commercial practice. It was revived in England by statute in 1907 and the form was subsequently adopted in Australian jurisdictions, in some cases quite belatedly. The principal feature of limited partnerships is the creation of two classes of partner, general and limited partners. Limited partners contribute to capital and share profits but have no right to participate in management of the partnership; subject to the terms of the partnership agreement, the general partner or partners have unfettered control over the conduct of the partnership business. Indeed, if limited partners take part in the management of the business of the partnership, they thereby assume the unlimited liabilities of the general partners: s 67. Otherwise, their liability is limited to their capital contributions to the firm: s 67(2). This form is sometimes used for venture capital and private equity investments; its adoption usually reflects taxation advantages of the form for the passive investors. In contrast with ordinary partnerships, registration of limited partnerships is required and is a condition of the limitation on liability. A statement setting out details of the limited partnership is required including the firm’s name, address, the identity of the individual partners, their character as either general or limited partners, whether the firm is a limited partnership, and the limit of the liability of each limited partner to contribute to the firm’s debts and obligations: s 54. The Register of Limited Partnerships is available for public inspection: s 57. Limited partnership must be identified in any document issued by the partnership by the words “A Limited Partnership” immediately adjacent to its firm name: s 75. In 2004, the Partnership Acts of NSW, Victoria and Queensland were amended to create the category of incorporated limited partnership to further facilitate the use of the limited partnership form for some venture capital enterprises; venture capital is start-up capital at the [1.100]

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Corporations and Financial Markets Law

early, high risk, stage of the business cycle contributed by financially sophisticated investors who do not wish to participate in the management of the venture. This initiative followed the introduction of tax relief to specific venture capital forms, to promote the commercialisation within Australia of intellectual property innovation such as in biotechnology and medical technology. The Commonwealth tax relief required ventures to use the limited partnership form. Industry concerns about the effective limitation of limited partner liability led to the creation by the eastern seaboard States of complementary legislation providing for the creation of a new form of corporate entity, the incorporated legal partnership. The incorporated form is regulated by corporations legislation and partnership principles do not apply to such entities unless applied by the Act itself: see, eg, Partnership Act, s 1C. 20 In the United States and the United Kingdom, forms of limited partnership of wider application have been introduced using the corporate form and limiting the liability of members for obligations of the firm. In the United States, State legislation has created a new form of partnership, the limited liability partnership, which protects members of firms (in some States, professional partnerships only) against personal liability for the acts (including malpractice) of other members of the firm, but permits all members to take an active part in firm management. In the United Kingdom, the Limited Liability Partnership Act 2000 (UK) makes the form available to any two or more persons associated for carrying on a lawful business with a view to profit. This limited liabilty partnership is a body corporate, that is, an entity separate from its members; the partnership’s liabilities must be met from its assets alone unless members have agreed to make personal contributions. The limited liability partnership is regulated by provisions close to, and overlapping with, those governing the private company: see [3.135]. The form was introduced following lobbying by accountancy bodies concerned with the personal exposure of members with respect to negligent audits of client corporations. Other characteristics of partnership [1.105] The features to which reference is commonly made in determining whether a

particular business relationship is a partnership, such as the sharing of net profits, a relationship of principal and agent, participation in control and management, and contribution of capital and resources, are characteristic of many partnerships. Yet, as noted, none is regarded as absolutely essential to a finding of partnership and there are other legal relationships which may exhibit them in varying degrees. The mutual trust and confidence of partners in each other has, as mentioned earlier (see [1.60]), been said to be “the life blood of the concern”, yet may be highly attenuated or even excluded in some partnerships. Very large modern national or international professional partnerships can no longer be expected to exhibit the same personal and close working relationships as their smaller siblings do. Nevertheless, given that a partner may bind the other partners to unlimited liability, the contract of partnership is of a personal nature. Hence the presumption, subject to contrary agreement, is that no person may be introduced as a partner without the consent of all existing partners (s 24(1)(7)); if a partner dies, the deceased’s representatives or heirs have the right to become partners, in the absence of a contrary agreement. 21 It is thus a common feature of partnership that a partnership interest is not freely transferable in the absence of the consent of the other partners. The Partnership Act contemplates that an assignment of an interest in the partnership, either absolutely or by way of mortgage or redeemable charge, may entitle the assignee to receive the share of profits to which the assigning partner would otherwise be 20 21 12

See K Fletcher (2004) 17 Aust Jnl of Corp Law 157. Davies v Barlow (1881) 2 LR (NSW) 66. [1.105]

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entitled, but does not entitle the assignee to interfere in the management or administration of the partnership business or affairs, or to require any account or inspect the partnership books: s 31.

CREATION OF PARTNERSHIP Formation [1.110] As noted earlier (see [1.20]), partnership is a relationship resulting from contract and

therefore must be supported by consideration, which may be in the form of mutual promises. Prima facie, no writing or other formality is required to create a partnership; indeed, the partnership contract may be wholly oral or inferred from conduct. A partnership agreement is void if it is formed to carry on an illegal business or for an illegal purpose, or if it is to carry on a lawful business in an unlawful manner. The Partnership Act also provides that a partnership is dissolved by the happening of an event which makes it unlawful for the business to be carried on, or for the members to carry it on in partnership: s 34. Partnerships, other than limited partnerships, are not required to be registered and enjoy a high degree of privacy for their affairs. However, if the partners wish to carry on business under a name other than that of the individual partners, they must first apply to the Australian Securities and Investments Commission (ASIC) to register the business name on the Business Names Register: Business Names Registration Act 2011 (Cth), s 22. Registration applies nationally, permitting the partners to trade under the business name anywhere in Australia. The obligation to register a business name is not specific to partnerships and applies equally to a sole trader, registered company or other association or entity, unless the business name consists solely of the name of each person or the entity carrying on the business: Business Names Registration Act 2011 (Cth), s 5. Terms of the partnership agreement [1.115] While a written partnership agreement may not be essential to the enforceability of

the agreement, it is usually desirable to have a written document. At least it is essential that intending partners address themselves to the terms of their relationship and note their points of agreement since the Partnership Act establishes rules on a number of matters which the intending partners may consider inappropriate. Many of these provisions are displaced by the contrary agreement of the partners. The Act provides that the mutual rights and duties whether ascertained by agreement or defined by the Act may be varied by the consent of all the partners: s 24(1). Such consent may be expressed or inferred from a course of dealing, so that a written agreement is not proof against variation, although the parol evidence rule may render inadmissible evidence to vary or add to the terms originally agreed on and wholly reduced to writing. Some matters are not subject to the contrary agreement of the partners, for example, the provision that the partnership is dissolved by the happening of any event making it unlawful for the business to be carried on. The first rule is that all partners are entitled to share equally in the capital and profits of the business and must contribute equally towards losses: s 24(1)(1). The rule is subject to the agreement made by the partners that may deal with such matters as the sharing of profits and losses, time of division, drawings on account of profits and provisions to be retained before determining profits. Profit distribution in large professional partnerships has become a sophisticated exercise. The concept of capital requires careful attention. Agreed contributions to capital should be distinguished from advances beyond those capital contributions. The default rules provide for interest to be paid on such advances: s 24(1)(3). The principle flows from the essential nature [1.115]

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Corporations and Financial Markets Law

of partnership, namely, that a partner making such advances does not become a creditor of the firm. The rules for distribution of assets on final settlement of accounts direct the application of assets to pay partners’ advances beyond capital after payment of debts to third persons: s 44. Other default rules reinforce these provisions. In the absence of contrary provision, every partner may take part in the management of the partnership business (s 24(1)(5)); no person may be introduced as a partner without the consent of all existing partners (s 24(1)(7)); any differences arising as to ordinary matters connected with the partnership business may be decided by a majority but changes to the nature of the business require the consent of all partners: s 24(1)(8). Partners may inspect and copy the partnership books which must be kept at the partnership’s principal place of business: s 24(1)(9). A majority of partners cannot expel a partner unless the power to do so has been conferred by express agreement between the partners: s 25. Several provisions deal with the duration of partnerships. If a partnership is for an indefinite time, it may be determined at any time by one partner giving notice: ss 26, 32(c). If it is for a fixed term, it is dissolved by expiration of that term (s 32(a)) unless earlier dissolved by mutual consent, 22 or in one of the other ways prescribed by the Act. If a partnership for a term is continued over, continuance on the old terms is presumed: s 27. Subject to agreement, the partnership is also dissolved by death of a partner or if a partner charges their partnership share for a separate debt: s 33.

OTHER UNINCORPORATED FORMS OF ASSOCIATION COMPARED Unincorporated non-profit associations [1.120] A number of cases in England in the 19th century concerning the exclusive private

clubs of London’s West End drew distinctions between the liabilities of partners to third parties and those of members of non-profit clubs with respect to transactions undertaken by their committees, officers or employees of the club. To these latter transactions, it was said, the ordinary principles of agency law did not apply. 23 The effect of these cases was summarised in a leading statement of Lord Lindley for the Privy Council on appeal from New South Wales in Wise v Perpetual Trustee Co Ltd when his Lordship said that clubs are associations of a peculiar nature. They are societies the members of which are perpetually changing. They are not partnerships; they are not associations for gain; and the feature which distinguishes them from other societies is that no member as such becomes liable to pay to the funds of the society or to any one else any money beyond the subscriptions required by the rules of the club to be paid so long as he remains a member. It is upon this fundamental condition, not usually expressed but understood by everyone, that clubs are formed; and this distinguishing feature has been often judicially recognised. It has been so recognised in actions by creditors and in winding up proceedings. 24

A major issue is the extent of personal liability of members of the committee of the unincorporated association in whom the constitution of the association typically vests responsibility for management of group affairs. The scope of that liability is considered in the following case. 22

Moss v Elphick [1910] 1 KB 846.

23 24

For example, see Flemying v Hector (1836) 2 M & W 172; 150 ER 716. [1903] AC 139 at 149.

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Peckham v Moore [1.125] Peckham v Moore [1975] 1 NSWLR 353 Court of Appeal of the Supreme Court of New South Wales © Council of Law Reporting for New South Wales 2005 [A professional football player, Peckham, entered into a contract of employment to play rugby league football over three years for the Canterbury Bankstown Rugby League Football Club, an unincorporated association with over a thousand members. The contract, made in 1970, purported to be between “the player” and “the club” and was signed by the club secretary “pursuant to resolution and authority for and on behalf of” the club. The committee was elected annually and that of 1972 was not identical with the committee of 1970. The player applied for workers compensation in respect of an injury sustained in 1972 and named those on the committee in 1970 as respondents. His earlier action against the club failed on the ground that it was not a person recognised at law.] HUTLEY JA: [360] The inference that the members of a committee intend to assume liability is more readily drawn if what is to be done has to be done during their term of office than if afterwards. This is reinforced by a consideration of the consequences of the committee’s assumption of liability. … The committee had no recourse to the members, except such as had not paid their dues, in which cases they were entitled to collect the fees, and had a lien over the property of the club to enable them to reimburse themselves for the expenditure incurred in discharging the liability they had assumed on behalf of the club: Wise v Perpetual Trustee Co [1903] AC 139; Minnitt v Lord Talbot de Malahide (1881) 7 LR (Ir) 407. The committee would also have a right of indemnity. As it is put by Keeler, “Contractual Actions for Damages against Unincorporated Bodies” 34 MLR 615 at 619: “Although it is beyond doubt that the existence of a right of indemnity against the association fund is assumed by every person who undertakes the duties of a committee member of a voluntary society there is surprisingly little direct authority in its favour.” However, the authority to which he refers …, [361] … carry conviction. The two rights, lien and indemnity, are of little value in this case. The lien, derived by analogy from the position of trustees, is an equitable lien not lost by the retirement of the committee. Their loss of control over the assets of the club does not extinguish the lien, which does not depend upon possession: Halsbury’s Laws of England (3rd ed), Vol 24, p 155. The lien is enforced by judicial sale and there would be little to sell. The right to collect unpaid membership dues would have no real value. Their claims for a lien and for indemnity would be in competition with the claims of all other creditors of the club. However, the worthlessness of the rights of the committee is no reason for deducing that they did not intend to enter into legal relations. … [The trial judge] found that the committee employed the respondent, relying on the decision of the Court of Appeal in Bradley Egg Farm Ltd v Clifford [1943] 2 All ER 378. This case undoubtedly provides authority for the approach which his Honour took. In particular, the following passage from the judgment of Scott LJ, with which Goddard LJ (at 379, 386) agreed, represents the correct approach of a court when confronted with the kind of situation which has here arisen: That the plaintiffs intended to make a real contract with somebody is beyond doubt; but it is equally beyond doubt that they had never formed any intention in their own minds beyond the vague one of making a contract with the person or persons the law would hold responsible on the contract. They did not, of course, think about it at all; they merely assumed, with the confidence natural to a nation which normally carries out its contracts, that somebody would be responsible. They expected performance and not breach; but the rest was assumption which they never even began to think out. In these circumstances, what is the function of the law? Surely it is to imply an intention on the plaintiffs’ part to make their contract with the person or persons to whom alone in the circumstances of the case the law regards as the persons responsible. That cannot be the society, for it does not exist. The law, therefore, has to choose from the various persons associated together under the umbrella of the society’s name, those most concerned in the function of making contracts, those of the associated persons who were most directly [1.125]

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Peckham v Moore cont. concerned, and to discard those who were, for any reason, least directly concerned. In the latter category stand the mere members who, under the society’s rules, have no liability beyond their annual 7s 6d membership subscription, and have no right to participate, now or on winding up, in the funds of the society. But the body of members want to see the purposes of the society implemented, almost in the same way as in the case of a charity (in the popular sense); and they appoint an executive council to carry out those purposes. Making a contract, whether for employment of servants, for purchase of office furniture, for keeping a bank account, or for carrying [362] out tests to assist the branch of farming which produces utility poultry, is essentially a function which cannot be performed without somebody accepting personal responsibility to perform the contract and pay money; and the business men who accept the office of being on the executive council, seem to me to be the persons whom the law must regard as pledging their own credit in order to perform the duties which they voluntarily undertake for their so-called “society”; just as do the committee men of a club. The court in the Bradley Egg Farm case did not have to face the problem which has arisen here, namely, that the arrangement extended beyond the life of a committee. … references to “the club” in the contract have to be read as “the committee of the club”. In some cases “the committee of the club” means “the committee for the time being”. The arrangement is made with the committee of the club existing on 13 January 1970, but, for example, the obligation which Peckham assumed in the year 1972 was an obligation to play whenever he was called upon by the committee functioning as the committee of the club in that year, none of whom might have been members of the committee in the year 1970. In Carlton Cricket and Football Social Club v Joseph [1970] VR 487 Gowans J pointed out the theoretical problems in the assumption that the change in membership involved the transfer of rights. The difficulty in the case of contracts of employment is insoluble, as contracts of employment are unassignable: Nokes v Doncaster Amalgamated Collieries Ltd [1940] AC 1014. There is no way by which the contract of employment with the 1970 committee can be transferred to the 1972 committee; any apparent transfer is a novation. What Peckham agreed to do was to enter into an arrangement with the 1970 committee that he would play for the 1972 committee, if they engaged him for that year. When they did, that committee became his employers. This is a contract in the first instance with the committee for the year 1970. However, each successive committee can take up the offer on the part of Peckham to [363] play for the club and they did so at the latest when they put him on the payroll for that year. … Once he is put on the payroll by the 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. It is that committee which can dismiss him for misbehaviour. If this is the correct interpretation of the contract which was made, there is no question of the transfer of the right to employ from one committee to the other or of the transfer of burdens from one committee to the other. The possible situation under which the actual control of Peckham’s playing could be vested in a committee of members, all of whom had been ousted from executive responsibility by the members of the club, is therefore voided. … With great reluctance I, therefore, reach the conclusion that the appeal must be allowed and the award set aside. The relevant employers of the worker were not those persons who were functioning as the members of the 1970 committee, but would appear to be those who were functioning as members of the 1972 committee. As the case against these persons has not been litigated, the determination of the question who were the relevant employers of Peckham must await another round of litigation.

Unincorporated joint ventures [1.130] There are many arrangements involving several participants in an enterprise which

are not partnerships. Instances range from agreements for simple one-off acquisition of goods, or a single venture or activity not involving a “business”, to the large-scale contractual joint 16

[1.130]

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venture of modern times, such as exist in extractive industries. It is sometimes difficult to determine whether the relationship between these joint venturers makes them partners.

United Dominions Corporation Ltd v Brian Pty Ltd [1.135] United Dominions Corporation Ltd v Brian Pty Ltd (1985) 59 ALJR 676 High Court of Australia MASON, BRENNAN and DEANE JJ: [679] The term “joint venture” is not a technical one with a settled common law meaning. As a matter of ordinary language, it connotes an association of persons for the purposes of a particular trading, commercial, mining or other financial undertaking or endeavour with a view to mutual profit, with each participant usually (but not necessarily) contributing money, property or skill. Such a joint venture (or, under Scots law, “adventure”) will often be a partnership. The term is, however, apposite to refer to a joint undertaking or activity carried out through a medium other than a partnership: such as a company, a trust, an agency or joint ownership. The borderline between what can properly be described as a “joint venture” and what should more properly be seen as no more than a simple contractual relationship may on occasion be blurred. Thus, where one party contributes only money or other property, it may sometimes be difficult to determine whether a relationship is a joint venture in which both parties are entitled to a share of profits or a simple contract of loan or a lease under which the interest or rent payable to the party providing the money or property is determined by reference to the profits made by the other. One would need a more confined and precise notion of what constitutes a “joint venture” than that which the term bears as a matter of ordinary language before it could be said by way of general proposition that the relationship between joint venturers is necessarily a fiduciary one: but compare per Cardozo CJ, Meinhard v Salmon 164 NE 545 at 546 (1928). The most that can be said is that whether or not the relationship between joint venturers is fiduciary will depend upon the form which the particular joint venture takes and upon the content of the obligations which the parties to it have undertaken. If the joint venture takes the form of a partnership, the fact that it is confined to one joint undertaking as distinct from being a continuing relationship will not prevent the relationship between the joint venturers from being a fiduciary one. In such a case, the joint venturers will be under fiduciary duties to one another, including fiduciary duties in relation to property the subject of the joint venture, which are the ordinary incidents of the partnership relationship, though those fiduciary duties will be moulded to the character of the particular relationship: see generally, Birtchnell v Equity Trustees, Executors and Agency Co Ltd (1929) 42 CLR 384 at 407-409.

THE FIDUCIARY OBLIGATIONS OF PARTNERS [1.140] Some general statements of the law not only recognise that partners stand in a

fiduciary relationship to each other, but also appear to require very high standards of honour in the conduct of the partnership. Dixon J in Birtchnell’s case Birtchnell v Equity Trustees, Executors and Agency Co Ltd (1929) 42 CLR 384 (see [1.150]) notes that it has been said that “a stronger case of fiduciary relationship cannot be conceived than that which exists between partners”. A leading American statement of the standard of a partner’s fiduciary relationship, by Cardozo J in Meinhard v Salmon, is that: [n]ot honesty alone, but the punctilio of an honour the most sensitive, is then the standard of behaviour … [u]ncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the “disintegrating erosion” of particular exceptions … only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd. 25 25

249 NY 458; 164 NE 545 at 464 (NY), 546 (NE) (1928). [1.140]

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The Partnership Act restates these equitable obligations, requiring partners to render true accounts and full information concerning the partnership to other partners (s 28), and to account for • any benefit derived without the consent of the other partners from any transaction concerning the partnership, or for any use of the partnership property, name or business connection (s 29); and • profits derived without the consent of other partners from carrying on another business of the same nature as and competing with that of the partnership: s 30. These equitable obligations are examined in relation to partnership in the following cases and, in Chapter 7, in their like application to company directors and officers. Even if an association is determined not to be a partnership, the relation between the venturers may be fiduciary; whether it is so or not will be resolved by reference to the equitable rules governing fiduciary relationships generally. The key considerations will be: • the nature and incidents of the legal structure the parties have adopted (such as a contractual joint venture or an incorporated company); • whether there exists a special kind of vulnerability or reliance between the parties; and • whether there exists a strong degree of trust and custodianship between them. 26

Dean v MacDowell [1.145] Dean v MacDowell (1878) 8 Ch D 345 Court of Appeal, England and Wales [The plaintiffs, the two Dean brothers, and the defendant, MacDowell, agreed to carry on business as salt merchants and brokers as partners for seven years under the name “Dean Bros”. MacDowell and one of the Dean brothers covenanted not to engage in any trade or business except for the partnership, although the other brother could do so. The partnership expired and the plaintiffs discovered that the defendant had been engaged, through his son as nominee, as a partner in a firm of salt manufacturers, Ashton & Sons, for the last two years of the partnership. Ashton & Sons had made considerable profits and the plaintiffs sought to make the defendant account to them for his share. They also claimed a declaration that his interest in the firm belonged in equity to Dean Bros.] COTTON LJ: [353] [T]he business in which the defendant engaged was in no way within the scope of the partnership. No doubt it is dealing with the same article – salt, but it is dealing with it in a [354] totally different way, and I do not understand that the profit he made was made out of the firm in which he and the plaintiffs were engaged. The firm in which he, in violation of the partnership contract, engaged, were manufacturers of salt, selling their salt through the firm in which he was engaged with the plaintiffs. There are clear rules and principles which entitle one partner to share in the profits made by his co-partners. If profit is made by business within the scope of the partnership business, then the partner who is engaging in that secretly cannot say that it is not partnership business. It is that which he ought to have engaged in only for the purposes of the partnership. Again, if he makes any profit by the use of any property of the partnership, including, I may say, information which the partnership is entitled to, there the profit is made out of the partnership property, and therefore, of course, it must be brought into the partnership account. So, again, if from his position as partner he gets a business which is profitable, or if from his position as partner he gets an interest in partnership property, or in that which the partnership require for the purposes of the partnership, he 26

18

Fast Financial Services Pty Ltd v Crawford (2012) 88 ACSR 650 at [118], citing Hospital Products Ltd v United States Surgical Corp (1984) 156 CLR 41 and John Alexander’s Clubs Pty Ltd v White City Tennis Club Ltd (2010) 241 CLR 1. In Fast Financial Services, written agreements between two venturers and the incorporation of the venture did not displace the parties’ personal relationship in which one was vulnerable to and reliant upon the other, who occupied a position of ascendancy in the business. This imposed upon him a high degree of trust. The ascendant party was held to be under a fiduciary duty to promote and protect the joint interests of both parties and not his own exclusively (at [131]). [1.145]

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Partnership

Dean v MacDowell cont. cannot hold it for himself, because he acquires it by his position of partner, and acquiring it by means of that fiduciary position, he must bring it into the partnership account. That is the obligation arising from the fiduciary relation which partners bear one to another. But in the present case, notwithstanding there has been a breach of the contract (and I have dealt with it as a matter of contract), it does not give the plaintiffs the right they claim. These profits being derived from a trade not within the scope of the partnership business, not having been acquired by him by reason of his connection with the firm, or by any use of the firm’s property, in my opinion, the plaintiffs are not entitled to say, “We will have the profits which you made by engaging in the way in which you did in this entirely separate business.”

Birtchnell v Equity Trustees, Executors & Agency Co Ltd [1.150] Birtchnell v Equity Trustees, Executors & Agency Co Ltd (1929) 42 CLR 384 High Court of Australia [The appellants had been partners with Porter in a real estate agency. After Porter’s death, the surviving partners discovered that he had been sharing in the profits from speculative land deals with Spreckley, a client of the firm, who sold the land through the firm. Commission was paid to the firm, but Porter also received profits as principal with Spreckley. The firm had over the years invested in specific transactions in land as principal for profit. The appellants claimed an account of the profits Porter had derived from his partnership with Spreckley.] ISAACS J: [393] The Partnership Act 1915 (Vic) consolidates the law relating to partnership. Many of its provisions reduce to statutory form and force, rights and obligations that previously rested on doctrines of equity. But the Act is careful in [s 46] to preserve all rules of equity and common law applicable to partnership, where consistent with the express statutory provisions. [394] … Section [29] enacts that “(1) Every partner must account to the firm for any benefit derived by him without the consent of the other partners from any transaction concerning” the business of the firm, etc. The section is not new law. … The section plainly cannot be confined to matters within the scope of the partnership. The contrary view would open a wide door to fraud … If, for instance, A and B are in partnership as wholesale grocers, and B arranges with C, a retail grocer, to share C’s profits if B influences A to agree to supply C, I take it as clear that B’s arrangement with C is a “transaction concerning the partnership”, though C’s business itself is wholly outside its scope. The case would fall within the observations of Cotton LJ in Dean v MacDowell (see [1.145]), “acquired by him by reason of his connection with the firm”. The relevant proposition then, I apprehend, is this: If the Porter-Spreckley agreement was a “transaction concerning the business of the firm”, and if he derived benefit from that transaction “without the consent of the other partners”, he, and now his estate, must account to the firm for that benefit. … My only difficulty is to see how there can be the least doubt on the subject. The mere facts that the agency had not terminated, that it was in the process of performance that commission had yet to be earned and substantial services had yet to be rendered, that questions of adequate remuneration might still arise, that disputes might develop … and that in any case relative attention to the Spreckley land and to other affairs of the firm … remained to be [395] bestowed, seem to me to place beyond any possibility of hesitancy the question of whether the transaction was one “concerning the partnership”. Porter, by reason of that agreement, placed himself in the position that his interest conflicted, or might conflict, with his duty. On the one hand he had a distinct interest in devoting special attention to the difficulties of Spreckley’s land, and, to that extent, in disregarding other clients’ affairs and the general welfare of the firm in relation to those affairs, and he clearly had the greatest interest in not endeavouring to get the best commission he could, whether within the limits of 10% and 20%, or beyond the latter limit, whatever trouble, difficulty or even expense the firm should have in completing the Spreckley resales. It is also manifest that suppression of the fact that [1.150]

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Birtchnell v Equity Trustees, Executors & Agency Co Ltd cont. Porter was interested adversely to the firm might materially affect the decision of the majority upon any question whatever, dispute or otherwise, that arose between Spreckley and the firm. DIXON J: [407] The relation between partners is, of course, fiduciary. Indeed, it has been said that a stronger case of fiduciary relationship cannot be conceived than that which exists between partners. “Their mutual confidence is the life blood of the concern. It is because they trust one another that they are partners in the first instance; it is because they continue to trust one another that the business goes on” (per Bacon V-C in Helmore v Smith (1890) 15 App Cas 223; (1886) 35 Ch D 436 at 225 (App Cas), 444 (Ch D)). The relation is based, in some degree, upon a mutual confidence that the partners will engage in some particular kind of activity or transaction for the joint advantage only. In some degree it arises from the very fact that they are associated for such a common end and are agents for one another in its accomplishment. Lord Blackburn found in this consideration alone sufficient reason for the fiduciary character of the partnership relation: Cassels v Stewart. The subject matter over which the fiduciary obligations extend is determined by the character of the venture or undertaking for which the partnership exists, and this is to be ascertained, not merely from the express agreement of the parties, whether embodied in written instruments or not, but also from the course of dealing actually pursued by the firm. Once the subject matter of the mutual confidence is so determined, it ought not to be difficult to apply the clear and inflexible doctrines which determine the accountability of fiduciaries for gains obtained in dealings with third parties. Of the duties imposed by these doctrines, one which is material for the decision of this case is that which forbids a partner from withholding from the firm any opportunity of advantage which falls within the scope of its undertakings, and from using for his own exclusive benefit, information, knowledge or resources to which the firm is entitled. … Another duty of present materiality is that which requires a fiduciary to refrain from engagements which conflict, or which may possibly conflict, with the interests of those whom he is bound to protect: Aberdeen Railway Co v Blaikie Bros (1854) 1 Macq 461. Moreover, in considering such a matter it is important to remember that, in the language of James LJ, the general principle that … no agent in the course of his agency, in the matter of his agency, can be allowed to make any profit without the knowledge and consent of his principal … is an inflexible rule, and must be applied inexorably by the court, which is not entitled … to receive evidence, or suggestion, or argument as to whether the principal did or did not suffer any injury in fact by reason of the dealing of the [409] agent; for the safety of mankind requires that no agent shall be able to put his principal to the danger of such an inquiry as that (Parker v McKenna (1874) LR 10 Ch at 124). Further, and this, perhaps, is a necessary corollary, the partner is responsible to his firm for profits, although his firm could not itself have gained them. See Costa Rica Railway Co v Forwood (1901) 1 Ch 746 at 761, where Vaughan Williams LJ formulates the principles and concludes: As I understand, the rule is a rule to protect directors, trustees, and others against the fallibility of human nature by providing that, if they do choose to enter into contracts in cases in which they have or may have a conflicting interest, the law will denude them of all profits they may make thereby, and will do so notwithstanding the fact that there may not seem to be any reason of fairness why the profits should go into the pockets of their cestuis que trust, and although the profits may be such that their cestuis que trust could not have earned them [at] all. With reference to this last point, there is a recent and direct decision that the fact that the profits could not have been earned by the cestuis que trust is wholly immaterial; and that is a decision of the Court of Appeal in Boston Deep Sea Fishing & Ice Co v Ansell (1888) 39 Ch D 339. In considering the operation of these rules in this case, it is necessary to begin by ascertaining the subject matter over which the fiduciary obligations extend. … [410] A consideration of the course of business pursued by the firm, and of the written instruments which regulated the partnership, shows that for very many years a large part of the business conducted by the partnership consisted of subdividing and selling land and collecting the purchase money under arrangements which entitled them to a share of the profits in addition to a selling commission. … [I]t seems almost undeniable that they were part of the business. Indeed, together with the transaction now in question they came to be 20

[1.150]

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Birtchnell v Equity Trustees, Executors & Agency Co Ltd cont. a principal part of the business. … [412] There can be little doubt that in all such business the firm looked for opportunities to secure, in addition, a share of the proceeds, and it obtained such a share, sometimes as a further reward for services or as an incitement to additional exertion in realising the land, and sometimes as a result of investing capital in the speculation. If this view is right, it follows that the partnership was entitled to avail itself of any opportunity to embark upon such a transaction which came to the knowledge of the partners or any of them, and knowledge and information acquired by a partner as to the readiness of a client to share such profits, as to the conditions upon which he would do so, and generally as to every fact bearing upon the terms which the partnership might negotiate with him, were all matters which no partner could lawfully withhold from the firm and turn to his own account. The relation between such a client and the partnership is a matter affecting the joint interests which each member was bound to safeguard and protect, and no member could enter into dealings or engagements which conflicted or might conflict with those interests or which gave him a “bias against a fair discharge of his duty” in that respect: see per Leach V-C in Burton v Wookey (1822) 6 Madd 367; 56 ER 1131 at 368 (Madd), 1132 (ER).

Chan v Zacharia [1.155] Chan v Zacharia (1984) 154 CLR 178 High Court of Australia [Chan and Zacharia conducted a medical practice in partnership in leased premises. The lease contained an option for renewal for a further period of two years exercisable before September 1981. In May 1981, Chan gave Zacharia notice dissolving the partnership. Chan declined to join Zacharia in exercising the option for renewal. In November 1981, before the partnership’s affairs were wound up, the premises were leased to Chan. In an action in the Supreme Court of South Australia, Zacharia obtained a declaration that the interest acquired by Chan under the new lease was an asset of the former partnership and that it was held on constructive trust. Chan appealed.] DEANE J: [195] Fiduciary relationships may take a wide variety of forms and may give rise to a wide variety of obligations. Ordinarily, in determining whether a constructive trust of particular property has arisen as a consequence of the existence or breach of a fiduciary obligation, it is necessary to identify the nature of the particular fiduciary relationship and to define any relevant obligations which flowed from it: see, for example, per Fletcher Moulton LJ, Re Coomber; Coomber v Coomber [1911] 1 Ch 723 at 728-729. In the present case, Dr Chan and Dr Zacharia each occupied two related and overlapping roles as regards the legal rights (including the option) under the lease. The first role was as a trustee of those legal rights. The second was as a member of the former partnership of which the beneficial interest in those rights was an asset. The role of trustee was plainly a fiduciary one involving fiduciary obligations in relation to that trust property. It was, however, submitted on behalf of Dr Chan that, since the trust property was partnership property held for partnership purposes, the partnership relationship was, for present purposes, the dominant one and any fiduciary obligations of Dr Chan as a trustee were subject to, and liable to be displaced by, his rights and obligations as a partner in the dissolved partnership. Those overriding rights and obligations were not, it was submitted, fiduciary in their nature and neither their existence nor their breach could form a basis of a constructive trust of any right to a new lease which Dr Chan obtained for himself. It is convenient to turn immediately to consider the submission that Dr Chan’s role as a former partner was not a fiduciary one involving fiduciary obligations in respect of the property of the dissolved partnership. [196] A partnership can be confined to one joint activity or be a continuing relationship between its members. As between the partners, the rights and duties of the members of a partnership are primarily contractual, flowing from the express or implied terms of the particular partnership agreement. Questions of illegality aside, the implication, by statute or the general law, of general or particular obligations or standards is, as between the partners, ordinarily subject to any contrary provision in the agreement between them. It is conceivable that the effect of the provisions of a particular partnership [1.155]

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Chan v Zacharia cont. agreement, in the context of the nature of the particular partnership, could be that any fiduciary relationship between the partners was excluded. As a general rule, however, the relationship between partners is a fiduciary one. … [197] … The relationship between the partners was curtailed and altered by the dissolution of the partnership. It did not, however, cease. In particular, and with the exception of the “goodwill” of the practice … each doctor, by reason of his position as a former partner, remained under fiduciary obligations in respect of the partnership property which was to be realised and applied in paying or discharging partnership debts and liabilities and the expenses of and incidental to the winding up of the partnership affairs and, subject thereto, “in paying to each partner any unpaid profits which may be due to him and the balance (if any) … divided between the partners equally” (cl 26). Notwithstanding the dissolution of the partnership, “the good faith and honourable conduct due” from each partner to the other persisted for the purposes of winding up the affairs of the partnership and each partner remained under a fiduciary obligation to co-operate in an act consistently with the agreed procedure for the realisation, application and distribution of partnership property: see Lindley on Partnership (14th ed, 1979), p 654; Lees v Laforest (1851) 14 Beav 250; 51 ER 283; the Act, ss 29(2), 38 and 39. The partnership agreement reinforced those fiduciary obligations by expressly requiring that the partners respectively do or concur in anything necessary or proper to give full effect to that agreed procedure: cl 26. [198] … There is a wide variety of formulations, of the general principle of equity requiring a person in a fiduciary relationship to account for personal benefit or gain. The doctrine is often expressed in the form that a person “is not allowed to put himself in a position where his interest and duty conflict” (Bray v Ford [1896] AC 44 at 51) or “may conflict” (Phipps v Boardman [1967] 2 AC 46 at 123) or that a person is “not to allow a conflict to arise between duty and interest” (New Zealand Netherlands Society “Oranje” Inc v Kuys [1973] 1 WLR 1126 at 1129). As Sir Frederick Jordan pointed out, however, (see Chapters on Equity (6th ed, Stephen, 1947), p 115, reproduced in Jordan, Select Legal Papers (1983), p 115), this, read literally, represents “rather a counsel of prudence than a rule of equity”: indeed, even as an unqualified counsel of prudence, it may, in some circumstances, be inappropriate: see, for example, Hordern v Hordern [1910] AC 465 at 475; Smith v Cock (1911) 12 CLR 30; [1911] AC 317 at 36-37 (CLR), 325-326 (AC). The equitable principle governing the liability to account is concerned not so much with the mere existence of a conflict between personal interest and fiduciary duty as with the pursuit of personal interest by, for example, actually entering into a transaction or engagement “in which he has, or can have, a personal interest conflicting … with the interests of those whom he is bound to protect” (per Lord Cranworth LC, Aberdeen Railway Co v Blaikie Bros (1854) 1 Macq 461 at 471) or the actual receipt of personal benefit or gain in circumstances where such conflict exists or has existed. The variations between more precise formulations of the principle governing the liability to account are largely the result of the fact that what is conveniently regarded as the one “fundamental rule” embodies two themes. The first is that which appropriates for the benefit of the person to whom the fiduciary duty is owed any benefit or gain obtained or received by the fiduciary in circumstances where there existed a conflict of personal interest and fiduciary duty or a significant possibility of such conflict: the objective is to preclude the fiduciary from being swayed by considerations of personal interest. The second is that which requires the fiduciary to account for any benefit or gain obtained or received by reason of or by use of his fiduciary position or of opportunity or knowledge resulting from it: [199] the objective is to preclude the fiduciary from actually misusing his position for his personal advantage. Notwithstanding authoritative statements to the effect that the “use of fiduciary position” doctrine is but an illustration or part of a wider “conflict of interest and duty” doctrine (see, eg, Phipps v Boardman; NZ Netherlands Society “Oranje” Inc v Kuys), the two themes, while overlapping, are distinct. Neither theme fully comprehends the other and a formulation of the principle by reference to one only of them will be incomplete. Stated comprehensively in terms of the liability to account, the principle of equity is that a person who is under a fiduciary obligation must account to the person to whom the obligation is owed for any benefit or gain (i) which has been obtained or received in circumstances where a conflict or significant possibility of conflict existed between his fiduciary duty and his personal interest in the pursuit or possible receipt of such a benefit or gain or (ii) which was obtained or received by use or by reason of his fiduciary position or of opportunity or knowledge 22

[1.155]

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Chan v Zacharia cont. resulting from it. Any such benefit or gain is held by the fiduciary as constructive trustee: see Keith Henry & Co Pty Ltd v Stuart Walker & Co Pty Ltd (1958) 100 CLR 342 at 350. That constructive trust arises from the fact that a personal benefit or gain has been so obtained or received and it is immaterial that there was no absence of good faith or damage to the person to whom the fiduciary obligation was owed. In some, perhaps most, cases, the constructive trust will be consequent upon an actual breach of fiduciary duty: for example, an active pursuit of personal interest in disregard of fiduciary duty or a misuse of fiduciary power for personal gain. In other cases, however, there may be no breach of fiduciary duty unless and until there is an actual failure by the fiduciary to account for the relevant benefit or gain: for example, the receipt of an unsolicited personal payment from a third party as a consequence of what was an honest and conscientious performance of a fiduciary duty. The principle governing the liability to account for a benefit or gain as a constructive trustee is applicable to fiduciaries generally including partners and former partners in relation to their dealings with partnership property and the benefits and opportunities associated therewith or arising therefrom: see Birtchnell v Equity Trustees, Executors and Agency Co Ltd [(1929) 42 CLR 384]; Consul Development Pty Ltd v DPC Estates Pty Ltd (1975) 132 CLR 373 at 394. … [Deane J discussed the rule in Keech v Sandford.] [203] Prima facie, the rule in Keech v Sandford has a dual operation in the present case: there is an irrebuttable presumption that any rights in respect of a new lease of the Mansfield Park premises were obtained by Dr Chan by use of his position as a trustee of the previous tenancy and there is a rebuttable presumption of fact that any such rights were obtained by use of his position as a partner in the dissolved partnership whose assets were under receivership and in the course of realisation. … the facts of the present case are such as to make it strictly unnecessary to rely on either presumption: it is apparent that, as a matter of fact, Dr Chan was introduced to the premises through the partnership and that he obtained any rights in respect of a new lease of the premises through the use – or misuse – of his position as a trustee of the former tenancy and as a former partner. It follows that Dr Chan holds and will hold any rights to or under a new lease of the premises as a constructive trustee unless there be some reason for excluding the ordinary application of the general principle. [204] Many of the statements of the general principle requiring a fiduciary to account for a personal benefit or gain are framed in absolute terms – “inflexible”, “inexorably”, “however honest and well-intentioned”, “universal application” – which sound somewhat strangely in the ears of the student of equity and which are to be explained by judicial acceptance of the inability of the courts, “in much the greater number of cases”, to ascertain the precise effect which the existence of a conflict with personal interest has had upon the performance of fiduciary duty: see per Lord Eldon, Ex parte James (1803) 8 Ves Jun 337; 32 ER 385 at 345 (Ves Jun), 388 (ER); per Rich, Dixon and Evatt JJ, Furs Ltd v Tomkies (1936) 54 CLR 583 at 592-593. The principle is not, however, completely unqualified. The liability to account as a constructive trustee will not arise where the person under the fiduciary duty has been duly authorised, either by the instrument or agreement creating the fiduciary duty or by the circumstances of his appointment or by the informed and effective assent of the person to whom the obligation is owed, to act in the manner in which he has acted. The right to require an account from the fiduciary may be lost by reason of the operation of other doctrines of equity such as laches and equitable estoppel: see, for example, Clegg v Edmondson. It may still be arguable in this court that, notwithstanding general statements and perhaps even decisions to the contrary in cases such as Regal (Hastings) Ltd v Gulliver and Phipps v Boardman, the liability to account for a personal benefit or gain obtained or received by use or by reason of fiduciary position, opportunity or knowledge will not arise in circumstances where it would be unconscientious to assert it or in which, for [205] example, there is no possible conflict between personal interest and fiduciary duty and it is plainly in the interests of the person to whom the fiduciary duty is owed that the fiduciary obtain for himself rights or benefits which he is absolutely precluded from seeking or obtaining for the person to whom the fiduciary duty is owed: compare Peso Silver Mines Ltd (NPL) v Cropper (1966) 58 DLR (2d) 1 at 8. In that regard, one cannot but be conscious of the danger that the over-enthusiastic and unnecessary statement of broad general principles of equity in terms of inflexibility may destroy the vigour which it is intended to promote in that it will exclude the ordinary interplay of the doctrines of equity and the adjustment of general principles to particular facts and changing circumstances and convert equity into an [1.155]

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Chan v Zacharia cont. instrument of hardship and injustice in individual cases: see Canadian Aero Service Ltd v O’Malley (1973) 40 DLR (3d) 371 at 383 … There is “no better mode of undermining the sound doctrines of equity than to make unreasonable and inequitable applications of them” (per Lord Selborne LC, Barnes v Addy (1874) LR 9 Ch App 244 at 251). The circumstances of the present case have already been recounted in some detail. There is nothing in them to avoid or modify the application of the general principle under which a fiduciary holds any benefit or gain which he has obtained by use of his fiduciary position upon constructive trust for those to whom his fiduciary duty was owed. [Gibbs CJ, Murphy, Brennan and Dawson JJ agreed that the appeal should be dismissed. Brennan and Dawson JJ expressly agreed with Deane J.]

[1.160]

Review Problem

Carey, Summers & Co (a partnership commonly known as “Careys”) is one of the principal stock and station agency firms in Orange, in central New South Wales. Its business consists of acting as professional agent, broker, manager and adviser in connection with rural property, stock and produce. Oscar Summers, a member of Careys, lent $250,000 to his daughter Lucinda under a document entitled “Contract of Loan”. Being something of a bush lawyer, Oscar drafted the document himself. The purpose of the loan was to further the beef cattle stud which Lucinda conducts near Orange, called the “Canobolis Stud”. Oscar did not inform his partners in Careys about this. The contract says: WHEREAS Oscar Summers wishes to further the prosperity of the Canobolis Stud without breaching his own obligations to Careys, it is hereby agreed that: 1. Oscar and Lucinda are not partners and do not intend to be partners. 2. Lucinda hereby assigns to Oscar one-quarter of her interest in the Canobolis Stud, including the right to receive one-quarter of Lucinda’s profits from the Stud. 3. Lucinda shall keep Oscar informed as to the affairs of the Canobolis Stud and shall consult with Oscar before taking any major decisions concerning the Stud. 4. For the further avoidance of any conflict of interest, the Canobolis Stud shall transact no business with Careys and in particular shall not employ Careys as commission agent for the sale of cattle or other property.

The contract has operated for three years and Oscar has received considerable profits from it. 1. Would Oscar be liable to third parties for the debts of the Canobolis Stud? 2. Now assume that the contract of loan creates a partnership between Oscar and Lucinda concerning the Canobolis Stud. What redress (if any) will Careys have against Oscar with respect to his participation in the stud? Would it make any difference to your answer if the partnership agreement between the members of Careys included the following clause: “No member of the firm shall engage in any other business, or be a member of a firm which does so”?

24

[1.160]

CHAPTER 2 The Historical, Institutional and Social Context of Corporations Law [2.10]

[2.55]

[2.70]

[2.110]

[2.135]

[2.155]

[2.200]

[2.210]

THE DERIVATION OF THE MODERN COMPANY ............................................................................... 27 [2.10]

Introduction ................................................................................................................... 27

[2.15]

The recognition of corporate persons ............................................................................. 27

[2.25]

Boroughs and guilds ...................................................................................................... 29

[2.30]

Chartered corporations .................................................................................................. 30

[2.45]

The deed of settlement company ................................................................................... 34

THE GRANT OF GENERAL INCORPORATION ................................................................................... 37 [2.55]

The terms upon which incorporation was granted ......................................................... 37

[2.60]

The slow adoption of corporate form by large business .................................................. 39

[2.65]

Company law through the cases .................................................................................... 40

AUSTRALIAN STRUCTURES OF CORPORATE REGULATION ............................................................... 41 [2.75]

Early Australian companies and legislation ...................................................................... 41

[2.80]

State-based corporate regulation and its discontents ...................................................... 43

[2.85]

Seeking alternatives to Commonwealth legislation: 1982-2001 ...................................... 45

[2.90]

Commonwealth corporations legislation applying nationally .......................................... 47

[2.100]

The jurisdiction of courts under corporations legislation ................................................. 51

[2.105]

The future shape of corporate regulation within the Australian federal system ................................................................................................ 52

THE AUSTRALIAN SECURITIES AND INVESTMENTS COMMISSION .................................................. 55 [2.110]

Regulation through a specialist commission ................................................................... 55

[2.115]

A comparative perspective ............................................................................................. 56

[2.120]

Constitution and independence ..................................................................................... 56

[2.125]

ASIC’s role as consumer protection regulator for financial services ................................. 57

[2.130]

Satellite bodies ............................................................................................................... 58

THE AUSTRALIAN SECURITIES EXCHANGE ...................................................................................... 58 [2.140]

The genesis of the Australian Securities Exchange ........................................................... 59

[2.145]

The demutualisation and self-listing of the Australian Securities Exchange ...................... 59

[2.150]

Stock exchange listing ................................................................................................... 60

THE OWNERSHIP AND CONTROL OF CORPORATE AUSTRALIA ........................................................ 61 [2.155]

Continuing evolution of corporate form ......................................................................... 61

[2.165]

Share ownership patterns in listed companies ................................................................ 64

[2.180]

The locus of corporate control ....................................................................................... 66

CORPORATE GOALS AND SOCIAL RESPONSIBILITIES ...................................................................... 73 [2.200]

Positions and practices ................................................................................................... 73

[2.205]

What corporate social responsibility might mean (if it were really to matter) ............................................................................................................. 76

[2.209]

Two different conceptions of the corporation that affect conceptions of its purpose and objectives ...................................................................... 81

THEORIES OF THE CORPORATION .................................................................................................. 82 [2.215]

Managerialist theories of the corporation ....................................................................... 83 25

Corporations and Financial Markets Law

[2.240]

[2.220]

The corporation as contract ........................................................................................... 84

[2.225]

Other theories of the corporation ................................................................................... 86

GLOBAL DIMENSIONS OF CORPORATE ACTIVITY AND RESPONSIBILITY ......................................... 88 [2.247]

[2.250]

The United Nations framework for business and human rights ....................................... 92

CORPORATE CASE STUDY: THE FAIRFAX MEDIA GROUP OF COMPANIES ......................................... 93 [2.255]

The beginnings in family proprietorship: 1841-1930 ...................................................... 94

[2.260]

Corporate growth and family control: 1930-1987 .......................................................... 94

[2.265]

The son also rises: 1987-1990 ........................................................................................ 95

[2.280]

Sale of the company by the receivers: 1991-1992 .......................................................... 97

[2.285]

The search for ownership stability .................................................................................. 98

[2.05] The corporation is an organisational structure that facilitates the raising of finance for

business activity from those with capital for investment but no interest or capacity for management of that business. That latter function typically falls to professional managers with business or technical skills but inadequate personal wealth to fund the venture. The suppliers of long-term (or equity) capital (the shareholders) thus share in the financial gains of the enterprise without having to participate in its management. In this respect the corporation differs from many but not all partnerships. Of course, the corporate form is also widely used for private business activity in which the long-term capital suppliers may also participate in management of the venture in a manner typical of partnership. It was only in the early 20th century that the business corporation emerged as the dominant form of business association in Western societies. This status was belatedly achieved since English law had first adopted the notion of the corporate entity to solve problems of group relations in religious and social communities 800 years earlier. Elements of the medieval origins of the corporation endure in modern company law, albeit transformed by the application of the corporate idea to business enterprise from the late Middle Ages. This chapter deals first with the development of the doctrines and institutions of company law; it looks to that evolutionary process not only for its inherent interest but also because it introduces the constituent elements of the modern corporation and shows their relation with each other. 1 The chapter then considers the distinctive institutional arrangements for corporate regulation in the Australian federation, the respective roles of the corporate regulator and the Australian Securities Exchange, modern patterns of share ownership and control, theoretical models of the corporation, notions of corporate responsibility, and the global dimensions of enterprise. The chapter concludes with a case study of the evolution of one iconic Australian company which weaves into the narrative several of the themes introduced in the chapter.

1

26

In this book the terms “corporation” and “company” are used interchangeably. The latter is the older English usage, which has not been totally eclipsed in Australia by an emerging preference for the North American terminology of the corporation. The ambiguity of present usage is evident in the governing Australian statute whose title, the Corporations Act, belies the primary reference throughout its text to the “company” as the primary subject of its provisions. The significance of these differences in terminology is noted at [2.50]. [2.05]

The Historical, Institutional and Social Context of Corporations Law

CHAPTER 2

THE DERIVATION OF THE MODERN COMPANY Introduction [2.10] “The joint stock company”, wrote Sir Frederick Jordan in 1939 “is a hybrid growth …

a partnership which has been invested with the character of incorporation and the rules which are applicable [to it] are partly referable to both characters”. 2 The derivation of the modern company form is explored in the present section. One source of this derivation is the ancient body of learning on the corporate bodies recognised by the common law. This learning was applied to private business organisations when royal charters were granted to incorporate a company of traders which company subsequently conducted their business through a joint stock. However, the speculative excesses of the early 18th century, and the singularly inept parliamentary response in the form of the Bubble Act of 1720, stifled the growth of this form of business organisation. To avoid the strictures of the Bubble Act, resort was had to the partnership and the trust through the deed of settlement company. These bodies of doctrine are the principal influences in modern company law, since this deed of settlement company became the model of the registered company incorporated as of right, and not of privilege, under the general incorporation statutes from 1844. Later, members of this company were granted a limitation upon their liability for the debts of their company. These and other refinements expressed in the legislation of 1862 settled the structure of modern company law and its institutions. In briefest outline, these are the historical developments examined in this section. The treatment is relatively lengthy since a proper understanding of modern doctrines and institutions is impossible without an awareness of the complex process by which they have been forged. This process also reveals the principal actors in the modern corporation and the evolution of their distinct roles. The recognition of corporate persons [2.15] The registered company formed under companies legislation is the pre-eminent

modern form of the corporation. Corporations are legal persons, “right-and-duty-bearing” units, in Maitland’s apologetic phrase. 3 They are sometimes called differential legal persons to mark limitations upon the personality with which they have been invested. “Not all the legal propositions that are true of a man,” said Maitland “will be true of a corporation. For example, it can neither marry nor be given in marriage.” 4 There are other significant differences in the personalities ascribed to natural and corporate persons, for example, in the ascription of liabilities in contract, tort and crime: see [4.20]. The origins of the modern company lie with this group of corporate persons. 5 The corporate idea was, of course, familiar to societies more ancient than medieval England. 6 Our exploration of the origins of the modern company must, however, take a more proximate (if still distant) starting point. 2

Australian Coal & Shale Employees’ Federation v Smith (1937) 38 SR (NSW) 48 at 53.

3

H D Hazeltine et al (eds), Maitland: Selected Essays (1936), p 225.

4 5

Hazeltine et al, p 225. The variety of English group life from the medieval period to the turn of the 20th century is vividly described by Maitland in his Translator’s Introduction to O Gierke, Political Theories of the Middle Age (1900), p xxvi; see also C T Carr, “Early Forms of Corporations” in Select Essays in Anglo-American Legal History (1909), Vol III, p 161. A valuable account of the reception of the corporate idea by the English common law is contained in F Pollock & F W Maitland, The History of English Law (2nd ed, 1968), Vol 1, pp 486-511, 634-688; see also F Pollock (1911) 27 LQR 219. Jurisprudential and historical theories as to the nature and origins of corporate personality have been somewhat overtaken by the statutory grant of a general right of incorporation. The [2.15]

27

Corporations and Financial Markets Law

A History of English Law [2.20] W S Holdsworth, A History of English Law (Methuen: Sweet & Maxwell, 1908), Vol III [469] [W]e are left with the … class [of associations] which is the subject of this section – the class which became corporations. It was neither possible nor desirable to dissolve all these groups into their component parts. To use the words of Sir F Pollock, in a complex state of [470] civilisation, such as that of the Roman Empire, or still more of the modern Western nations, it constantly happens that legal transactions have to be undertaken, rights acquired and exercised, and duties incurred by a succession of sole or joint holders of an office of a public nature, involving the tenure and administration of property for public purposes, or by or on behalf of a number of persons who are for the time being interested in carrying out a common enterprise or object. This being the case, it is necessary from the point of view both of private and of public law to replace the old vague group by something more definite. The law knows the natural person. Its rules and its process are fitted to deal with him. They are not fitted to deal with indeterminate groups which exist, and yet show a tendency to crumble when an attempt is made to apply legal rules in detail to themselves and their activities. It is for this reason that the law adopts the device “of constituting the official character of the holders for the time being of the same office, or the common interest of the persons who for the time being are adventurers in the same undertaking, into an artificial person or ideal subject of legal capacities and duties”. Thus we get the division between “persons natural created by God”, and “persons incorporate or politick created by the policy of man … either sole or aggregate of many”. This conception of an “incorporate person” was becoming naturalised in our law at the end of this period [viz, late 15th century]. It is neither a primitive nor a native conception. When Bracton wrote [in mid 13th century] it had not been clearly perceived even by the canonists and civilians of his day. The first person to call a group of persons a persona ficta was, according to Gierke, Sinibald Fieschi, who in 1243 became Pope Innocent IV. … But, fictitious or not, it was to be regarded henceforth as a person and co-ordinated with natural men. This conception was received by the common lawyers because it supplied a useful explanation of certain associations which frequently appeared in the law courts as the owners of property or franchises, a useful theory for the regulation of their activities, and a useful mode of checking the too frequent multiplication of these bodies. [471] It was from the associations in which the property of the church was vested, and through which its various activities were exercised, that we get the earliest development in the direction of the establishment of this new law of incorporate persons. Nor is this fact surprising. The church had from the earliest times been a large property owner. This property belonged at the end of this period to archbishops, bishops, deans and chapters, monasteries, or rectors. Such persons were at the end of this period corporations sole or aggregate, and owned this property in their corporate capacity. [Holdsworth then examined the common law’s treatment of ecclesiastical groups in the medieval period, with particular reference to the holding of property and the identification of group action distinct from that of individual members.] [474] These rules show us very clearly the difficulties which arose from the want of a distinct conception of the nature of the personality of these ecclesiastical groups. In fact, these continuing theoretical lode on these questions is, however, particularly rich as the original fiction theory of the corporation gave way by the 15th century to the concession theory (viewing the grant of incorporation as within the exclusive gift of the state). Much later, European realist theories had some impact upon English legal thought and doctrine. Valuable discussions are contained in the several essays in Hazeltine et al; L C Webb (ed), Legal Personality and Political Pluralism (1958); S J Stoljar, Groups and Entities (1973); D H Bonham & D A Soberman, “The Nature of Corporate Personality” in J S Ziegel (ed), Studies in Canadian Company Law (1967), p 3; G W Paton, A Textbook of Jurisprudence (4th ed, 1972), pp 406-425; H J Laski (1915) 29 Harv L Rev 404 and (1917) 30 Harv L Rev 561; M Wolff (1938) 54 LQR 494. 6

28

See S Williston (1888) 2 Harv L Rev 105 at 106-107; A F Conard, Corporations in Perspective (1976), pp 126-134; M Radin, The Legislation of the Greeks and Romans on Corporations (1910). [2.20]

The Historical, Institutional and Social Context of Corporations Law

CHAPTER 2

A History of English Law cont. though somewhat passive entities badly needed to be embodied in some tangible form if they were to live and flourish in this transitory world of human beings and elaborate laws for human conduct. The theory that they were personae fictae gave them just that reality which they needed. Lawyers could speculate about their nature, and rules could be laid down for their conduct. They were no longer concealed by the activities of those who were, for the time being, their human representatives. They were persons created by the law, distinct from their human members. They were immortal and invisible. They could commit neither sin nor crime; and some said no tort – truly suitable representatives for saints and churches. When once this generalisation had become the accepted theory of the canon law, it was inevitable that it should affect the common law. These personae fictae were with ever increasing frequency litigants in the common law courts; and, when the common lawyers became familiar with them, and with the canonists’ theories concerning them, they naturally proceeded to apply these theories to other groups which had nothing to do with the church. The boroughs, the universities with their colleges, and the guilds, were groups to which this conception could easily and profitably be applied. Owing to their manifold activities, the boroughs were the group which, from the point of view of the development of legal doctrine, are the most important. Moreover, they were bodies composed of many members; and, that being so, the body itself stood out with greater distinctness from its individual members. … The recognition of this incorporate person as a subject of rights and duties raised many legal problems. Not the least was the problem of classifying, in a manner appropriate to this new idea, the incorporate persons recognised by the law. A century before Coke [that is, the 15th century] the law was coming to the conclusion that they could be divided into two main groups – corporations aggregate and corporations sole. This was the leading division adopted by Coke, and it became the leading division of the law of the 18th century. “Corporations aggregate”, says Blackstone, consist of many persons united together into one society, and are kept up by a perpetual succession of members, so as to continue for ever: of [480] which kind are the mayor and commonalty of a city, the head and fellows of a college, the dean and chapter of a cathedral church. Corporations sole consist of one person only and his successors, in some particular station, who are incorporated by law, in order to give them some legal capacities and advantages, particularly that of perpetuity, which in their natural persons they could not have had. In this sense the king is a sole corporation: so is a bishop: so are some deans and prebendaries, distinct from their several chapters: so is every parson and vicar. Corporations aggregate were destined to be by far the most important class of corporations. In the Middle Ages the boroughs were its most important members; and it was through the borough community that the notion of a corporation aggregate came to be distinctly realised by the common law. But the corporation sole or corporations analogous thereto were the oldest variety known to the law; and the conception of a corporation sole came into the common law by way of the church. … [482] The recognition of the existence of an incorporate person necessarily involves the recognition of the three following principles: (i) A corporation is a person distinct from its members; (ii) the property of the corporation is distinct from the property of its members; (iii) the property of its members cannot be taken in execution for the debt of the corporation, and vice versa.

Boroughs and guilds [2.25] After religious groups and offices, the second species of corporate person recognised by

the common law was the borough. Indeed, as Holdsworth said, in the Middle Ages the borough was the most important of the classes of corporations and rules fashioned for the boroughs in this period contributed greatly to the developing law of corporations. From the 13th century certain boroughs were granted franchises by royal charter, conferring “liberties” or privileges upon the municipal group. While the privileges varied from borough to borough, [2.25]

29

Corporations and Financial Markets Law

they commonly included jurisdictional privileges for the borough court (denying its burgesses the right to bring suit in another borough’s court), limited powers of self-government including the power to pass by-laws and impose taxes, and the right to elect governing officers of the borough. Other franchises commonly granted to boroughs are more typical attributes of the modern corporation – the right to perpetual succession, the right to sue and be sued in the group name, the power to hold lands and the right to use a common seal to identify acts on behalf of the borough. 7 The moving forces behind a borough’s drive for franchises and privileges were often its merchants. Indeed, the grant of such franchises was part of a wider struggle by the emergent merchant class to be free of the ties of feudalism. In the 13th and 14th centuries, groups of local merchants sought royal charters conferring like privileges on their own number, for example, to enjoy a monopoly of trade in the commodity produced by the borough, to sue and be sued in the group name, to use a common seal etc. These privileges also crystallised in the 15th century recognition of the group as an incorporate body. These merchant guilds (as they were known), with the protection of their charters, comprised an exclusive society of traders enjoying valuable rights. The guilds were not vehicles for collective trading activities, but were associations of individuals trading for private advantage only. Nonetheless, they exercised public regulatory functions in the trading sphere akin to those of the borough in municipal government. Guild ordinances prescribed the conditions upon which members might trade and the guildcourt exercised jurisdiction in all trade disputes. Outsiders were permitted to trade in the borough, if at all, only on terms dictated by the guild, terms which secured the trading advantage of its members. The merchant guilds were, in essence, fraternal societies deriving from the old Germanic brotherhoods, seeking for their members “material security in this life and salvation in the next”. 8 Consistently with these fraternal obligations, the guild’s ordinances commonly sought to secure economic security of the weaker members through the compulsory sharing of bargains and the limiting of returns to a median band. When trading took on a less provincial cast, the borough merchant guilds gave way to the craft or trade guilds which controlled, not a monopoly of trade in a particular borough, but the whole of a particular trade or craft in a wider geographical region. The link with local government (the borough) was now severed. The corporate form, however, continued to serve a public function through the trade guilds’ concern with the modes of production employed by members, the rates they charged, the wages paid to apprentices and journeymen, and the transmission of the craft lore and skill to apprentices. 9 Chartered corporations

The application of corporate notions to trading ventures [2.30] By the second half of the 16th century the guilds had broken down as a system for

regulating industry. Their fraternal and egalitarian values had been compromised by oligarchic tendencies among their governing bodies. Other forces were also at work in English trade. The navigational advances of the previous century had opened new vistas of fabulous trading opportunities in the New World. A fund of capital available for investment was also emerging 7

See C A Cooke, Corporation, Trust and Company (1950), p 21; see also Pollock & Maitland, Vol 1, pp 642-686.

8

H R Hahlo [1982] Jur Rev 139 at 148. Hahlo observes (at 148) that these fraternal obligations within the Germanic brotherhoods have left their mark on modern legal institutions. To this source may be traced the judicial custom of referring to fellow judges as “brothers” and the importance attached to formal dinners within the Inns of Court. While the word “company” is of uncertain etymology, one ascribed derivation is “cum pane” (literally, “with bread”) – your companion is one with whom you break bread.

9

See Cooke, pp 21-31.

30

[2.30]

The Historical, Institutional and Social Context of Corporations Law

CHAPTER 2

among a wealthy mercantile class. These forces together marked the demise of the essentially medieval social institution of the guild. A new form of corporation, the chartered (or charter) corporation, succeeded to the guilds’ function of regulating trade in the public interest. In time, however, as these corporations formed a joint stock to supplant the individual trading of members, the corporate form was turned to more explicitly private purposes. The early form of the chartered corporation was the regulated company, effectively a limited purpose guild 10 in which the member merchants engaged in foreign trade on their own account and risk, subject to regulations passed by the company. The risks of a particular voyage might be spread, however, by funding through a stock jointly subscribed or contributed by individual members. The movement from individual to joint stock trade was gradual. Thus, the East India Company was incorporated by royal charter in 1600 as “the Governor and Company of Merchants of London trading into the East Indies” under the direction of a governor, a deputy governor and 24 assistants, in the manner of the modern board of directors. The initial series of temporary joint stocks had by 1657 given way to a permanent capital fund although it was not until 1693 that private trading by members was forbidden. Originally, membership in the regulated company was extended also to the sons and apprentices of members; however, when the permanent joint stock was established, membership depended solely upon holding of shares in the joint stock which shares were freely transferable. 11 Chartered companies took their names from the regions in respect of which the company was given trading advantages, usually amounting to a monopoly. Prominent examples include the Eastland Company, the Levant Company, the Hudsons Bay Company, the Muscovy Company, the Morocco Company and, in a later period, the British South Africa Company. 12 10

Hahlo at 150. The guild organisation persists in idea, if not direct lineage, in a number of modern practices. Thus, the origins of modern Freemasonry, while somewhat obscure, may be traced to the medieval guild of stonemasons (or “free” masons). In the early 17th century the freemasons admitted honorary (or “accepted”) members to their society for instruction in the secret signs and passwords by which the mostly itinerant members of the guild had by tradition recognised each other, and in the lore and ritual of the guild. The Oxford English Dictionary says that the distinction of being an accepted member became “a fashionable object of ambition” in early 17th century England. Several London societies united to form a “grand lodge” in 1717 and the movement then spread more widely in Europe. The system of secret signs and other modern ritual of Freemasonry retain links with custom within the medieval guild. Further, the modern charge that the guilds’ successors, the professional and trade associations, are exhibiting a “guild mentality” on some issue carries a sting which would have bemused medieval guild members.

11

Cooke, pp 58-59. The term “joint stock company” was originally employed in the 16th and 17th centuries to distinguish the company with a common fund for members’ trading from the older regulated company. The term was, however, applied to successive forms of business organisation deriving from this joint stock company. The term has persisted well into the 20th century to refer to companies formed under legislation providing for general incorporation; see, eg, the language of Sir Frederick Jordan in 1939 quoted at [2.10].

12

The practice of incorporating business organisations by charter granted under royal prerogative declined long ago. The power of incorporation by charter persists, however, although its exercise is now confined to the incorporation of charitable, professional and scientific groups. Incorporation by charter is often thought to secure special status for the group and its activities. Incorporation of business ventures might also be achieved by special Act of Parliament although, as we shall shortly see, it was not until the second half of the 18th century that it became the practice for incorporation to be effected by legislation itself. The grant of general incorporation by legislation in 1844 diminished resort to this mode of incorporation. The principal account of the development of the joint stock company in this period is W R Scott, The Constitution and Finance of English, Scottish and Irish Joint Stock Companies to 1720 (1912, 3 vols) (see especially Vol 1, Chs XXI and XXII). Primary material on the constitutions of regulated and joint stock companies is contained in C T Carr (ed), Select Charters of Trading Companies 1530-1707 (Selden Society, 1913), Vol 28. The editor’s introduction to this volume contains an excellent introduction to developments in this period. An excellent general history of the joint stock company is contained in Gower’s Principles of Modern Company Law (6th ed, 1997; P L Davies (ed) (here called Gower)), Chs 2 and 3. Specialist accounts of value relating to this period are contained in S Williston (1888) 2 Harv L Rev 105 at 149; M Schmitthoff (1939-40) 3 U Toronto LJ 134 [2.30]

31

Corporations and Financial Markets Law

Similar charters were granted by the Crown to private groups of merchants in Holland and France. In contrast, in Spain and Portugal the Crown retained control over foreign trade and commerce which it pursued through the state bureaucracy. Charters typically ceded to the company not only trading privileges but extensive powers of self-government in the region such as power to make laws, raise taxes, establish a currency, conduct wars and settle the peace. In view of their distance from the metropolitan centre, these companies were effectively national governments in their own right. The Dutch East India Company established a trading empire extending from Java to Japan, Sri Lanka and South Africa which it relinquished to the Crown only at the end of the 18th century. The English East India Company governed the Indian subcontinent much as it pleased until the middle of the 19th century. Even a relatively minor charter company might leave an enduring political footprint. The Virginia Company settled the first English colony in America; in 1621, the company at general court adopted a constitution which granted powers of self-government to the people of the colony exercisable through an elected assembly. Thus was a measure of representative democracy introduced to the Americas a century and a half before the Declaration of Independence. 13 By the late 17th century, however, the commercial benefits of the corporate form which accompanied charter rights were prized in their own right. Holdsworth identifies the following corporate advantages which were well appreciated in this period: • the corporate group enjoyed perpetual existence; • it might more easily bring suit against strangers and even its own members; • by use of its common seal it might authenticate its acts and distinguish them from the acts of individual members; • incorporation facilitated continuity of management and the transferability of shares; and • it might facilitate the distinction between group liability and the personal liability of individual members. 14

The influence of corporate ideas [2.35] Charters were also granted to domestic trading concerns, usually large partnerships

alert to the benefits of incorporation. Thus, the Society of Mines Royal, founded in 1561, was incorporated in 1568 with membership based upon a holding of shares. In the same year the Society of Mineral and Battery Works was also incorporated. In the 17th century grants of incorporation were made to numerous mining and industrial companies, indicating the attainment of a common form and the elements of a general procedure. 15 Thus, grants were made to such groups as the Fishery Company, the Company of White Papermakers in England, the Royal Lutestring Company, the Tapestry Company and the Saltpetre Company. 16 Most of the companies enjoyed some degree of monopoly rights in domestic trade. As we shall see, other forms of association based on the partnership and the trust were to exert a greater influence on modern company law than the emerging law of these corporate (this article is particularly interesting for its treatment of the English history in the sweep of like developments in Continental Europe); Cooke, Chs III and IV; R R Formoy, The Historical Foundations of Modern Company Law (1923), pp 16-22; F Evans (1908) 8 Colum L Rev 339; L W Hein (1963-64) 15 U Toronto LJ 134. For a detailed account of the organisation and fortunes of one 16th century joint stock company, see C Shammas (1975) 17 Business History 95. 13 14

J P Davis, Corporations (1961), Vol 2, pp 167-169. W S Holdsworth, A History of English Law (1925), Vol VIII, pp 200-202.

15 16

Holdsworth, p 60. Holdsworth, p 60; see also Formoy, pp 18-22.

32

[2.35]

The Historical, Institutional and Social Context of Corporations Law

CHAPTER 2

bodies. Nevertheless, legal doctrines fashioned for, or applied to, the chartered joint stock company have had an enduring influence. Three examples might be chosen: • First, the chartered corporation adopted the principle that the voting power of members of the company should be based upon the size of their shareholding and not upon the “one person, one vote” principle of the guilds. This “one vote, one share” principle was not a legal prescription but a practice adopted in the drafting of the constitutions of many joint stock companies. In other companies it might be displaced in favour of a sliding scale of voting. • Second, governors and associates of the companies (“directors” in modern parlance) were held to the rigorous trustee standard of disinterested service. 17 The treatment of the managing body as fiduciaries is a central principle of modern company law. • Thirdly, the principle was recognised that the company possesses a personality distinct from that of its members, a concept of central importance to modern company law and underlying many of its doctrines. The South Sea Bubble [2.40] By the 17th century it had become common for the constitutions of joint stock

companies to contain provisions making shares in the joint stock freely transferable. By the last quarter of the century, there were numerous dealings in shares (or “stocks”) of joint stock companies. An organised stock market was established in London with stock jobbers (“stockbrokers” in modern language) and well settled mechanisms for dealings in shares. Periodic cycles of boom and bust were already evident in this market. The early years of the 18th century were a strong boom period. According to Cooke, “[i]t seemed suddenly to become a widely held belief that to subscribe to a capital fund was to become rich”. 18 Share prices rocketed and money seemed to be available for almost any kind of venture. Thus schemes were promoted “to make salt water fresh”, “for fatting of hogs”, “for a wheel for perpetual motion”, “for importing jackasses from Spain” and “for an undertaking which shall in due time be revealed”. 19 The public readily subscribed. Such was the demand for stocks that many scheme promoters did not trouble to seek charters from the Crown for their joint stock companies and unincorporated joint stock companies proliferated. Further, many companies seeking incorporation took the easier path of buying up the charter of a company which had ceased to trade and using it to conduct an unrelated business. 20 This boom – or bubble (for it was an inflated speculation) – now takes its name from the South Sea Company, The Company of Merchants of Great Britain Trading to the South Seas. The company was formed in 1711 to secure the trade, largely in slaves, to South America. It was granted monopoly rights with respect to trade to South America. The projected trade had a fanciful (and brutal) character: “We exchange our goods for nothing but gold and silver and the goods we traffick with them are onely wearing apparel and negroes for their mines”; to further stimulate the flow of bullion, the company would also dangle the lure of Cheshire cheese, pickles, sealing wax and silk handkerchiefs. 21 This at least was the project offered to investors. As a business proposition it was a sham; the logic for its promoters lay in the collateral benefits it gave them in national financial management. In 1719 the company 17

See Charitable Corp v Sutton (1742) 2 Atk 400; 26 ER 642.

18

Cooke, p 81.

19

These examples are taken from Cooke, p 81.

20

Holdsworth cites the instance of a banking partnership which took over the charter of a company formed to manufacture hollow sword blades. The banking business was conducted under the name of the Sword Blade Company which issued “sword blade notes” and “sword blade bonds”; see Holdsworth, Vol VIII, p 215. J Carswell, The South Sea Bubble (1993), pp 40 (quoting a proponent), 41.

21

[2.40]

33

Corporations and Financial Markets Law

acquired from the government the irredeemable portion of the national debt (nearly half of which was in the form of annuities) with a view to exchanging these debt claims for shares in the company. This scheme would succeed only if the company’s share price rose so that the cost of conversion of debt was reduced. In the period from February to August 1720 the market price of the company’s £100 shares rose from £129 to over £1,000. An annuity worth £10,000 might then be exchanged for 10 shares with a par (or face) value of £100 when those shares were trading for £1,000. However, to the company’s dismay the boom it had fanned extended well beyond the company’s stocks. In an attempt to capture its benefits, the directors persuaded the government (several of whose members had been corrupted in previous dealings with the company) to pass the Bubble Act. When the Act failed in this purpose, the directors began legal proceedings to forfeit the charters of rival companies. These proceedings, however, precipitated a panic in the market which burst the bubble to general dismay. Hogarth’s celebrated cartoon of the Bubble shows, as its caption explains, that “Honour and Honesty are Crimes that publickly are punished by Self-Interest and Villainy”. Indeed, Hogarth shows Honour being physically broken on a wheel by Self-Interest. What resulted from this misadventure was the Bubble Act, passed in June 1720 in a futile attempt to staunch irrational exuberance, at least beyond the South Sea Company’s own stock. Its proscriptions had an enduring impact upon company law. The Act prohibited “the acting or presuming to act as a corporate body” and “the raising or pretending to raise transferable stocks”, in either case “without legal authority, either by Act of Parliament, or by any charter from the Crown”: 6 Geo 1, c 18, s 20. The Act was expressed not to apply to bodies established before 24 June 1718 (s 20) and was subject to the further proviso that nothing “shall extend … to prohibit or restrain the carrying on of any home or foreign trade in partnership in such manner as hath been hitherto usually and may be lawfully done according to the laws of this Realm now in force”: s 25. “Henceforth,” Holdsworth writes “there was to be no confusion between a corporate and non-corporate commercial society. Henceforth the privilege of possessing a transferable stock, which brokers or jobbers could manipulate, was to belong only to a corporate society.” 22 The deed of settlement company

“Drawing the teeth” of the Bubble Act [2.45] The Bubble Act prohibited a company from acting or presuming to act as a corporation

and from raising a transferable stock without sanction of legislation or charter. These proscriptions were subject to provisos protecting existing companies and businesses carried on in partnership. When the “great catastrophe” of the Bubble was forgotten, Maitland wrote, lawyers began coldly to dissect the words of this terrible Act and to discover that after all it was not so terrible. For one thing, it threatened with punishment men who without lawful authority 22

34

Holdsworth, Vol VIII, p 220. More detailed accounts of the South Sea bubble, written primarily from a legal perspective, are found in Formoy, pp 21-30 and L C B Gower (1952) 68 LQR 214. The speculative mania evident in the South Sea bubble has recurred periodically in most Western countries, with repetition of similar techniques of abuse. In Australia, the boom in mining shares in the late 1960s disclosed many questionable practices and much outright abuse of the market. These practices and abuses are chronicled and analysed in Australian Securities Markets and their Regulation (Report from the Senate Select Committee on Securities and Exchange (Rae Report), 1974). Cycles of boom and bust have also been evident in the United States securities markets, as have repetition and refinement of abuses fashioned in the South Sea bubble; see, on the late 19th century speculations, L Loss, Securities Regulation (1961), Vol 1, p 7 and, on events preceding the Wall Street crash of 1929, F Pecora, Wall Street Under Oath (1939); J Flynn, Security Speculation (1934) and J K Galbraith, The Great Crash, 1929 (1955). The Wall Street crash of 1929 and the Australian mining boom of the late 1960s led in each country to a body of legislation to regulate the public markets for company securities, discussed in Chapter 11. [2.45]

The Historical, Institutional and Social Context of Corporations Law

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“presumed to act as a corporation”. But how could this crime be committed? … Before the Bubble Act was repealed in 1825 most of its teeth had been drawn. 23

In the 18th century there was, it appears, only one reported prosecution under the Act, in 1724, of a promoter “for setting up a bubble called the North Sea”. 24 To the consternation of business and the confusion of lawyers, the Act (long assumed by many to be dormant 25) was revived in a series of prosecutions in 1808-1812 and 1825. 26 With the repeal of the Bubble Act in 1825, there began a search for a form of association appropriate for contemporary business organisation, an inquiry which led to the introduction of the first general incorporation statute in 1844. That development is dealt with in the following section. There were strong economic factors in the 18th century making it imperative that a form of business association be available to facilitate the aggregation of investment capital. The expansion of foreign trade and, in the latter half of the century, industrialisation and the growth of the factory system made unprecedented demands. What was needed, if incorporation was not to be readily had as the gift of the state, was a form of association ensuring liquidity for members’ investment interests. While the Bubble Act at first blush appeared to hold the promise of readier grant of charters to business organisations, DuBois reports that in the first decade after the passage of the Act “an attitude of suspicion and scarcely veiled hostility [among Crown officials] placed such difficulties in the way of incorporation that projectors were ready to avail themselves of any loophole that would enable them to carry out their plans without subjecting themselves to the ponderous and almost immovable process of government”. 27 The invention born of this necessity, the deed of settlement, was fashioned by Chancery lawyers and secured de facto for its members the principal corporate advantages but without benefit of incorporation. By this device the prohibitions of the Bubble Act were effectively circumvented. DuBois describes its elements thus: Instead of a charter or act of incorporation, the basis of the unincorporated organisation has to be found in the articles of association which were, as a rule, in the form of a deed of settlement signed by those participating in the society. This instrument would make provision for the management of the business through a committee of management and an assembly of the subscribers. The articles of association stand as the constitution of the unincorporated society, and it was clearly understood in the 18th century that protests from members would be in order if committeemen sought to depart from its provisions. 28

23 24 25

26

27 28

F W Maitland, “Trust and Corporation” in Hazeltine et al, p 209. R v Cawood (1724) 2 Ld Ray 1361; 92 ER 386. In the first prosecution, in 1808, an application for a criminal information was dismissed, in exercise of discretion, because of “the lapse of 87 years since any authenticated proceeding has been had upon this branch of the Act”. The parties were warned, however, that the Act was not obsolete and that they should avoid “any other speculative project of a like nature, founded on joint stock and transferable shares”: R v Dodd (1808) 9 East 516; 103 ER 670 at 526-528 (East), 673-674 (ER) per Lord Ellenborough CJ. The litigation is described in Cooke, pp 96-106. This belated invocation of the Bubble Act marks the absence of any significant speculation in company shares until the early years of the 19th century. Gower writes that “the picture changes at the turn of the century, when first the exigencies of war and then the growth of the railways led to an outbreak of company promotion and of general speculation comparable to that of the Bubble period”: Gower, p 34. An interesting account of the interplay between legal and economic ideas in this period is contained in B C Hunt, The Development of the Business Corporation in England 1800-1867 (1936), Ch 2. A B DuBois, The English Business Company after the Bubble Act 1720-1800 (Octagon Books, New York, 1971 (1938)), pp 215-216. DuBois, p 217. [2.45]

35

Corporations and Financial Markets Law

To facilitate the holding of property and the bringing of suit – no small problems for a group with large and changing membership – its assets were placed in the name of trustees selected by members of the company. Paradoxically, the Bubble Act in the end brought about the rebirth of the very type of association which it had sought to destroy. 29 These companies remained in a nether world of uncertain legality until the introduction in 1844 of legislation which enabled them to secure de jure corporate status by formal registration with a state official. These large societies were well described, more than a century after they first appeared, in the following terms: [They] were large societies on which the sun of royal or legislative favour did not shine, and as to whom the whole desire of the associates, and the whole aim of the ablest legal assistance they could obtain was to make them as nearly a corporation as possible, with continuous existence, with transmissible and transferable stock, but without any individual right in any associate to bind the other associates, or to deal with the assets of the association. 30

The ascendancy of the deed of settlement company [2.50] The deed of settlement strictly bound only its subscribers. It became common,

however, to insert a provision in the deed that a transferee of a share should signify his assumption of the transferor’s rights and obligations under the deed as though he were an original subscriber. The limiting of members’ liability appears to have become a motive for seeking a grant of incorporation only towards the end of the 18th century. 31 Once conceded, however, limited liability was quickly seen as a corporate advantage of the first importance and a major spur for applications for grants of incorporation by private Act of Parliament. The first of such grants was made in this period. By the late 18th century, it was also not uncommon for deeds of settlement to include a provision that the liability of members was limited to the nominal value of their shares. The practice was particularly common among insurance companies whose policies were offered subject to this limitation. 32 Generally, the efficacy of such a limitation depended upon whether third parties had notice of the provision. In several respects the structure of the deed of settlement company anticipated that of the registered company under the mid 19th century legislation. Thus, distinct roles were ascribed to the managing committee and the collectivity of members duly assembled. Further, it was quite common for the deed of settlement to provide for the creation of a joint stock to be divided into a specified number of shares. (This practice, of course, derives from a much earlier period when the joint stock company was becoming distinct from the regulated company.) To evade the Bubble Act’s proscription of the raising of a transferable stock, it was common in the 18th century to impose some restriction, however formal and insubstantial, upon the free alienation of members’ interests. (Such restrictions upon transfer are of continuing significance in Australia where they were until recently a condition for incorporation as a proprietary (or private) company.) Finally, it was common in the deed of settlement to make provision for alteration of the deed of settlement by special majority falling short of the unanimity required for partnership. Long before the end of the 18th century a considerable proportion of certain types of commercial enterprise was organised as deed of settlement companies. This was so particularly 29

Gower, p 28.

30

Re Agriculturist Cattle Insurance Co (Baird’s Case) (1870) 5 Ch App 725 at 734 per James LJ; cf Re European Assurance Society (Grain’s Case) (1875) 1 Ch D 307 at 320; cf Cooke, pp 83-88; Stoljar, pp 91-98. See DuBois, pp 94-99.

31 32

36

See B Supple, The Royal Exchange Assurance: A History of British Insurance 1720-1970 (1970), pp 118-119. On the validity of such policies, see Hallett v Dowdall (1852) 18 QB 2; 118 ER 1; cf Cooke, pp 87-88, 108-109. [2.50]

The Historical, Institutional and Social Context of Corporations Law

CHAPTER 2

in the growing field of non-marine insurance, in the metal industries, the theatre and even in canal building where statutory incorporation was more common. Indeed, it was not until the end of the 18th century with the growth of canal building, which required the grant of powers of compulsory acquisition of land, that parliamentary incorporations by private Act became common. Over 100 statutory incorporations occurred during the last 40 years of the 18th century. 33 From the outset, incorporation by private statute was reserved for ventures of a public nature, albeit pursued for private profit (eg, railways, canals, gasworks and waterworks) or requiring extended financial responsibility (such as insurance) or attended by special risks (such as foreign mining ventures). 34 This policy of exclusivity in the grant of private incorporation continued in the following century until the grant of general incorporation rendered the procedure otiose. The early private statutes commonly granted a further concession, as noted, by limiting members’ liability for debts of the corporation. The standard statutory clause made the member liable for such debts to the extent only of the amount (if any) for the time being unpaid on the member’s shares in the company. This device survives as the limitation mechanism in modern corporations legislation: see [3.105]. But for the Crown’s illiberality with charters and the reluctance of Parliament to grant private incorporation, incorporated companies might well have become the dominant form of business organisation in 18th century England and the corpus of company law taken a different character. The deed of settlement company, the model of the later registered company, remained in essence a partnership and the principal rules applicable to it were derived from the law of partnership, contract and trusts. With the coming of general incorporation the ancient learning on corporations was also assimilated in a complex hybridisation. Gower described the resulting mix of corporation and partnership influences thus: Hence the modern English business corporation has evolved from the unincorporated partnership, based on mutual agreement, rather than from the corporation, based on a grant from the state, and owes more to partnership principles than to rules based on corporate personality. Thus we in England still do not talk about business corporations or about corporation law, but about companies and company law. In America, on the other hand, the Bubble Act seems, wisely, to have been ignored despite the fact that it had been extended to the colonies by statute in 1741. After the Declaration of Independence, incorporation by special Acts of the State legislatures was granted far more readily than in England, and the unincorporated joint stock company, though not unknown, was correspondingly less important. In a number of industrially important States incorporation by registration under a general Act came earlier than in England … and when it came, the model which the legislative draftsmen had in mind was the statutory or chartered corporation rather than the unincorporated company or partnership. Hence modern American corporation law owes less to partnership and contractual principles than does the British. 35

THE GRANT OF GENERAL INCORPORATION The terms upon which incorporation was granted [2.55] By the early years of the 19th century three forms of association were available for

business activity: the partnership, the unincorporated joint stock company formed upon a deed of settlement and the recent innovation of the company incorporated by private Act of Parliament. The partnership and unincorporated joint stock company were by far the most 33 34

On the incidence of deed of settlement companies and statutory corporations in this period, see Gower, pp 30-31. J H Clapham, An Economic History of Modern Britain (1932), Vol 2, p 136.

35

L C B Gower (1956) 69 Harv L Rev 1369 at 1371-1372. [2.55]

37

Corporations and Financial Markets Law

numerous forms. These two associations share a common legal form – the partnership – but the joint stock company was in substance a very different society from the “private” partnership. Thus, the joint stock company usually had a large and fluctuating membership – a membership of 2,000 was said to be no very extraordinary number. 36 Shares in the joint stock were transferable subject only to a formal (but usually insubstantial) restriction. Members of the joint stock company were denied by their deed of agency authority to bind one another or to participate in management except through the governing committee. There was little by way of societas – the personal ties of fellowship, mutual trust and confidence – typical of partnership. The only common feature was the personal liability of members. This liability, however, was sought to be limited by provisions in the deed and was in most cases impossible to enforce by reason of the large and constantly changing membership of the joint stock company. 37 Thus, by the early years of the 19th century the partnership form clothed two distinct species of association. As noted, prosecutions under the revived Bubble Act failed to establish a distinct legal regime for the joint stock company. With the repeal of the Bubble Act in 1825 the task of fashioning such a regime fell to the legislature. The period from 1825 to 1844 saw a series of tentative steps towards extending corporate privileges to joint stock companies. The Trading Companies Act 1834 (UK) empowered the Crown to confer by letters patent all or any of the corporate privileges, for example, the right to sue in the name of an officer, but without granting incorporation. (Incorporation might also be effected by royal prerogative but this power was still used only sparingly.) In the period 1837-1854 corporate privileges without incorporation were granted to more than 50 companies (or “quasi-corporations”). 38 Many, however, were fraudulent devices, promoted by the likes of Tigge Montague of the Anglo-Bengalee Disinterested Loan and Life Assurance Company whose activities were wryly observed by Dickens in Martin Chuzzlewit (1843). Several such scandals provided the impetus for the appointment in 1841 of a parliamentary committee “to inquire into the state of laws respecting joint stock companies, with a view to the greater security of the public”. 39 The committee’s prescriptions established the basic ideology of United Kingdom, and later Australian, regulatory policy towards companies. Incorporation might be had as of right by any group associated for a lawful purpose. As the price of registration, the state adopts a limited interventionism by requiring disclosure as to specified matters perceived to be material to the judgment of potential investors. Beyond that, the state does not attempt any merits review of the efficacy or equity of the proposed venture or of the interests in it which are being offered to investors. Brandeis’ phrase is the most eloquent justification of this disclosure policy of company regulation: “Sunlight is said to be the best of disinfectants, electric light the most efficient policeman.” 40 Further, as a prophylaxis against mismanagement, the first general incorporation statute, the Joint Stock Companies Act 1844 (UK), established accountability mechanisms through obligations with respect to the holding of company meetings and the audit and publication of company accounts. The 1844 Act adopted the constitutional structure of the deed of settlement company. The Act vested management powers in the directors, and directed that shareholders should not act “in the ordinary management of the concerns of the company 36

Formoy, p 33 quoting George on Companies (1825).

37

38 39

There was no requirement that deeds of settlement be registered or that lists of members be available to creditors and the public. On the formidable obstacles to legal suit against members of a joint stock company in this period, see Formoy, pp 33-36. Hunt, p 83. Quoted in Hunt, p 90.

40

L D Brandeis, Other People’s Money (1914), Ch 5.

38

[2.55]

The Historical, Institutional and Social Context of Corporations Law

CHAPTER 2

otherwise than by means of directors”: s 26. Other powers and functions were vested in the assembly of shareholders, termed the “general meeting”. Limited liability of shareholders in registered companies was granted in the Limited Liability Act 1855 (UK). This legislation followed a remarkable struggle. Hunt observes that “limitation of responsibility became the subject of repeated and voluminous legislative inquiry and heated debate”. 41 Much of the argument for limited liability was in terms of assisting the “humbler classes” to find an avenue for savings, an argument which had about it, Gower comments, a “whiff of Victorian humbug”. 42 Apart from the argument that limited liability should be introduced to enable the industrious and frugal to find a safe avenue for investment, the debate seemed to be between those who considered unlimited liability an appropriate incentive to caution and vigilance and those who regarded limited liability as an appropriate way of aiding industry by protecting those prepared to advance capital. 43 In 1856 a consolidated statute provided for incorporation on the application of seven persons. The deed of settlement gave way to two constitutional documents, the memorandum of association and the articles of association. A model set of articles of association was appended to the Act. The 1856 Act also dismantled some of the protective conditions introduced in 1844, including requirements for the registration of public offers of shares and debt interests in the company, the audit of company accounts and for a minimum paid up capital. The slow adoption of corporate form by large business [2.60] These changes marked a policy of legislative permissiveness that became the hallmark

of United Kingdom company law in the second half of the 19th century. It is likely that the removal of these barriers to company formation, and the freedom extended to company promoters, led to the registered company earning a bad name. In particular, manufacturing and other industrial enterprise continued to be predominantly organised on a partnership basis for several decades until reforms introduced later in the century created a more favourable legal environment. 44 As late as 1885 only one in 10 of significant business enterprises was conducted through registered companies. 45 Many registrations were by private partnerships seeking the protection of limited liability rather than the facility of public investment capital. In the late 19th century law reform secured wider legitimacy for the corporate form by reintroducing some of the protective measures of the 1844 legislation. In 1895 the Davey Committee adopted the following expression of the disclosure principle which has shaped government in relation to corporate law and regulation in the major common law jurisdictions to the present. The committee said: It must be generally acknowledged that a person who is invited to subscribe to a new undertaking has practically no opportunity of making any independent inquiry before coming to a decision. Indeed, the time usually allowed between the issue of the prospectus and the making of an application does not permit of any real investigation. The maxim of Caveat Emptor has in the opinion of your committee but a limited application in such cases. 41

Hunt, p 116.

42

Gower, p 41.

43

The arguments raised pro and anti limited liability are canvassed in detail in Hunt, Ch 6; see also Formoy, pp 114-130 and at [4.15].

44

Thus, in the period 1844–1856, of the 910 companies registered under the 1844 Act, only 106 were industrial: H A Shannon (1932) 7 Economic History 396 (Table A, at 420). All of the 910 companies were unlimited (limited liability was introduced from 1855). See generally P L Cotterell, Industrial Finance 1830-1914 (1980), pp 41-42, 44-45, 54, 75.

45

P L Payne, British Entrepreneurship in the Nineteenth Century (1974), p 19, cited in T Hadden, Company Law and Capitalism (2nd ed, 1977); see further Clapham, pp 133-143, 311-312, 357-360. [2.60]

39

Corporations and Financial Markets Law

It is therefore of the highest importance that the prospectus upon which the public are invited to subscribe shall not only not contain any misrepresentation but shall satisfy a high standard of good faith. It may be a counsel of perfection and impossible of attainment to say that a prospectus shall disclose everything which could reasonably influence the mind of an investor of average prudence. But this in the opinion of your committee is the ideal to be aimed at, and for this purpose to secure the utmost publicity is the end to which new legislation on the formation of companies should be directed. 46

Consequently, in 1900 companies legislation reimposed the requirement of the 1844 Act that prospectuses be registered before issue and prescribed their contents in detail. Similarly, the Companies Act 1900 restored the audit requirements to the statute, established auditors’ security of tenure and independence from directors, and specified their duties. Subsequently, public companies were required to put copies of their audited financial statements before shareholders in general meeting and then upon a public register. There is an interesting reflection of these developments in contemporary literature. In Little Dorritt, first published in instalments between 1855 and 1857, Dickens returned to themes earlier treated in Martin Chuzzlewit of the corporate form used as a vehicle for fraud with only slight opposition from the state. Trollope’s novel The Way We Live Now (1875) nicely captured the corruption of much corporate fundraising. Each member of the well titled board of directors of a company formed to construct a railway linking Mexico and the United States was given to understand by its fraudulent promoter that their fortune was to be made not by the construction of the railway but by the floating of the railway shares. The librettist W S Gilbert had a life-long, if sardonic, fascination with company law whose themes appear in several of his collaborations with Sir Arthur Sullivan, including The Gondoliers (1889), Utopia Limited (1893) and The Grand Duke (1896). In Utopia Limited a visionary society adopts a system of government founded upon the principles expressed in the Companies Act 1862 (UK). Gilbert’s scepticism is evident from the limited liability aria from that opera: Some seven men form an Association, (If possible, all Peers and Baronets) They start off with a public declaration To what extent they mean to pay their debts. That’s called their Capital: if they are wary They will not quote it at a sum immense. The figure’s immaterial – it may vary From eighteen million down to eighteen pence. I should put it rather low; The good sense of doing so Will be evident at once to any debtor When it’s left to you to say What amount you mean to pay, Why, the lower you can put it at, the better. They then proceed to trade with all who’ll trust ’em, Quite irrespective of their capital (It’s shady, but it’s sanctified by custom); Bank, Railway, Loan, or Panama Canal. 47

Company law through the cases [2.65] It should not be thought from this treatment of the development of companies

legislation that all or even the major doctrines of company law are expressed in statute. The 46 47 40

Report of the Departmental Committee (C7779, 1895), [5]-[6]. W S Gilbert, The Savoy Operas (1963 ed), Vol 2, pp 321-322. [2.65]

The Historical, Institutional and Social Context of Corporations Law

CHAPTER 2

companies statutes are not codes. From the middle of the 19th century major areas of company law were developed by the courts, including such fundamental matters as the duties of company directors, officers, promoters and majority shareholders, the limits on the capacity of the company under the ultra vires doctrine, and the law on the raising and maintenance of share capital. While judicial doctrines have been modified or supplemented by statute, many of the fundamental doctrines (and least tractable problems) of company law remain substantially expressed in a body of case law. This case law applies corporation, partnership, trust and contract principles, modified in their application to this particular form of business association.

AUSTRALIAN STRUCTURES OF CORPORATE REGULATION [2.70] There have been distinct phases in the development of the Australian system of

corporate regulation. It has produced a legislative and regulatory structure different from that applying in the United States federal system and the United Kingdom unitary system of government. These constitutional differences are significant in that they shape both the powers of the regulators and the character and content of the substantive law. It is important to study this development, not only to appreciate the significance of constitutional framework upon corporate law, but also because it is not certain that the current structure of regulation represents the final stage of development. A chronological treatment is adopted here because each stage, including the present, represents a series of accretions shaped either by initiative or adverse events. Early Australian companies and legislation [2.75] The few business organisations in the infant colony of New South Wales followed the

contemporary English mixture of deed of settlement companies, chartered companies, companies incorporated by private statute and quasi-corporations. 48 The first native company was the Bank of New South Wales, formed by residents of the colony in 1817 as a partnership raising a joint stock of £20,000 divided into 200 shares of £100 each. 49 Governor Macquarie granted a charter purporting to confer limited liability upon shareholders but not corporate status. The charter was renewed in 1824 although by then Home authorities had declared it null and void as beyond the Governor’s powers. The company adopted a deed of settlement in 1828 in which year the Legislative Council of the colony passed legislation enabling the bank to sue and be sued in the name of its president. 50 The bank remained an unincorporated joint stock company with unlimited liability until 1850 when a new deed of settlement was adopted and legislation passed to incorporate the company, sanction its deed and limit the liability of its members to twice the amount of their subscribed capital. 51 The bank continues to operate under the deed and statute which accordingly required amendment when the bank changed its name in 1982 to the Westpac Banking Corporation. 52 48

49

On the origins of modern Australian company law and regulation, see P Lipton (2007) 31 Melbourne University L Rev 805; R McQueen (1995) 5 Aust Jnl of Corp Law 1; R McQueen (1991) 1 Aust Jnl of Corp Law 22; R McQueen (1992) 15 UNSWLJ 356. For a valuable chronology and collection of key documents in the history of Australian company law, see the website of the Centre for Corporate Law and Securities Regulation at the University of Melbourne at http://law.unimelb.edu.au/centres/cclsr/resources/ history-of-australian-corporate-law. The material in this paragraph relating to the origins of the bank is substantially based upon R F Holder, Bank of New South Wales: A History (1970), Vol 1, Chs 2, 4 and 11.

50 51

Bank of New South Wales Act 1828 (NSW), 9 Geo IV, No 3. Bank of New South Wales Act 1850 (NSW), 14 Vic, ss 1, 2, 23.

52

Bank of New South Wales (Change of Name) Act 1982 (NSW), s 4. [2.75]

41

Corporations and Financial Markets Law

The Bank of New South Wales was founded by colonial sons with little assistance from the state. The next two Australian companies were cast in a different mould – chartered companies incorporated by royal prerogative and clothed with privilege for the benefit of English capital. The Australian Agricultural Company was formed in 1824, incorporated by royal charter and supported by private statute conferring wide powers for “the cultivation and improvement of waste lands in the colony of New South Wales”. 53 The company was granted a million acres of land and considerable convict labour for its cultivation of fine wool for the expanding English market. 54 The company also engaged in gold and coal mining (much of Newcastle stands on land originally held by the company). With closer settlement, most of the company’s land was sold although it retains substantial pastoral and agricultural properties in New South Wales, Queensland and the Northern Territory. The company’s domicile was transferred by statute to New South Wales in 1976 and again, to Queensland, in 1989. The company is listed upon the Australian Securities Exchange (as to which see [2.135]). The third Australian company, the Van Diemen’s Land Company, was incorporated by royal charter in 1825 to enable an English syndicate to conduct pastoral activities in the north-west region of Tasmania, “beyond the ramparts of the unknown”. Like the Australian Agricultural Company, the Tasmanian company suffered from poor judgment in the selection of land and from English managers with little understanding of local conditions: “British dudes [who] threw away money with both hands, making roads from nowhere to a fallen tree, and building culverts on mountain tops.” 55 It is probable that the company’s tenant farmers suffered even more. 56 The company retains a fraction only of its original land grant, which is now employed in cattle breeding, sheep grazing and, increasingly, tourism. Despite their colour, and the prominence of the first two of their number, chartered companies were destined to play in the colony the diminished role they had assumed in the United Kingdom. The predominant early form was the joint stock company, perhaps incorporated or given some corporate incidents by private statute. 57 Apart from some minor legislation enabling joint stock companies to sue and be sued through an officer, there was no significant Australian companies legislation until the 1860s and 1870s when the United Kingdom Act of 1862 was adopted by each colony. 58 Later United Kingdom reforms and consolidations were faithfully transcribed although there was some interesting experimentation, mostly in Victoria. Thus, in the middle of the 19th century several colonies introduced legislation to adopt the limited partnership (a form not to be adopted in the United 53 54

5 Geo IV, c 86. The company’s early misfortunes – its exploitation by the Macarthur family and its disastrous initial selection of land – reveal the chartered company as a dim reflection of its Elizabethan glory: see J F Campbell, “The First Decade of the Australian Agricultural Company, 1824 to 1834” (1923) 9 (Pt 3) RAHSJ 113; J Robertson, “The Australian Agricultural Company and the Port Stephens Fiasco” (1965) 50 RAHSJ (Pt 3) 216. For an account of the later history see J Gregson, The Australian Agricultural Company 1824-1875 (1907).

55

R Bedford, Naught to Thirty-three (1976), p 171; a fuller account of the early activities of the Van Diemen’s Land Co is contained in K Pink & A Ebdon, Beyond the Ramparts: A Bicentennial History of Circular Head, Tasmania (1988).

56

See the wonderful account of an exchange between a resentful tenant farmer and the visiting Governor of the company (“a little pink old gentleman so soft in the skin that he seemed to be stuffed with moss”) in Bedford, pp 171-173.

57

Instances are too numerous for specific citation although a notable enduring institution is the Australian Gas Light Company which was given by private Act in 1837 (8 Wm IV) power to sue and be sued in the name of its secretary: s 5. The proprietors of the company were not incorporated by the Act (s 10) which contained detailed provisions for its management and wide powers “for lighting with gas the town of Sydney”.

58

A comprehensive list of legislation passed by the colonies (and, later, the States) relating to companies, partnerships and associations is contained in R Baxt, Second Australian Supplement to the Third Edition of Gower’s Modern Company Law (1974), pp 15-56; see also R W Gibson, Disclosure by Australian Companies (1971), Ch 5.

42

[2.75]

The Historical, Institutional and Social Context of Corporations Law

CHAPTER 2

Kingdom until 1907). In 1871 Victoria created the expedient of the no liability company form to defeat fraudulent practices arising out of the mining boom. 59 Unlike the United States, in Australia large scale industrial enterprise did not emerge in the last quarter of the 19th century: The new technologies revolutionising communications and production that were drivers of the rise of big business and the transition from “family capitalism” to “managerial capitalism” in the United States of America operated with less force in Australia… Merchants and agents linked the myriad of small scale producers ranging from the family farm to the corner shop… Moreover, up to the turn of the century nearly all businesses – except banking, the utilities and mining – were still sole proprietorship and partnerships. Few firms took the opportunity of incorporation offered by the British-inspired company acts, and of those who did, very few bothered to list their shares on the local stock exchanges. 60

Attempts were made, nonetheless, to establish a national scheme of company regulation in the period prior to Federation and in the early decades of the 20th century. 61 Indeed, the Commonwealth Constitution, s 51(xx), empowers the Commonwealth Parliament to make laws with respect to “foreign corporations, and trading and financial corporations formed within the limits of the Commonwealth”. However, the restrictive interpretation given to this grant of power by the High Court in its 1909 decision in Huddart, Parker & Co Ltd v Moorehead 62 pre-empted serious consideration of enacting Commonwealth legislation governing companies. Company law was a matter primarily for the States. State-based corporate regulation and its discontents [2.80] By the late 1950s 63 the substantial differences in companies legislation were proving

bothersome to companies operating in several States. The idea was gaining acceptance that the national economy which had emerged from the post-war recovery required uniform companies legislation. The Uniform Companies Acts were adopted in all States and Territories from 1 July 1962. Precise uniformity did not long endure, however, even before the dramatic events of 1969-1975, a watershed period in Australian company law. In September 1969 there began the most spectacular stock market boom in Australian history. The boom had its genesis in events associated with a small and relatively unknown mineral explorer called Poseidon NL (the letters NL indicate that the company was incorporated as a no liability company of the type created a century earlier in Victoria in the heat of another mining boom). On 1 October 1969, Poseidon announced to the Adelaide Stock Exchange assay results showing significant deposits of nickel and copper at its Windarra mine in Western Australia. Two weeks earlier the company’s shares had been trading at around $1.10 but by 30 September the price had risen to $7 and by the end of the year it exceeded $200. Daily market movements in Poseidon’s shares became the subject of national popular interest. The speculative activity spread rapidly to other mining and mineral 59

60 61 62 63

See Mining Companies Act 1871 (Vic). The background to this legislation is described in A R Hall, The Stock Exchange of Melbourne and the Victorian Economy 1852-1900 (1968), pp 75-77; see [3.125]. See further, on the adoption of English companies legislation in the Australian colonies and the scope of local innovation, R McQueen (1991) 1 Aust Jnl of Corp Law 22. D Merrett, “Business Institutions and Behaviour in Australia: A New Perspective” in D Merrett (ed), Business Institutions and Behaviour in Australia (2000), pp 5-6. See R McQueen (1990) 19 Fed L Rev 245. (1909) 8 CLR 330. On the evolution of the structures of Australian corporate regulation from the 1960s and the contemporary regulatory challenges faced at each stage, see B Mees & I M Ramsay, Corporate Regulators in Australia (1961-2000): From Companies’ Registrars to the Australian Securities and Investments Commission (Research Report, Centre for Corporate Law and Securities Regulation, University of Melbourne, 2008). [2.80]

43

Corporations and Financial Markets Law

exploration companies. Newspapers carried stories of fortunes gained or lost overnight. There was undoubtedly a great deal of abuse of the investing public through the flotation of nearly worthless new issues and manipulative activities in securities trading on stock exchanges. The Poseidon boom attracted parliamentary attention. In March 1970 the Senate established a committee to report upon the desirability and feasibility of establishing a national securities and exchange commission and the powers and functions necessary for it to act against share price manipulation and insider trading. The committee held its hearings amidst spectacular crashes of share traders, revelations of false and misleading statements to the market by public companies, and defaults by brokers. Its report in 1974 criticised Australian stock exchanges for their performance in regulating both securities markets generally and the market practices of their broker members. 64 The report also criticised lack of uniformity in State legislation and in the administrative practices and standards of the State corporate affairs offices which administered the Uniform Companies Acts. 65 Its principal recommendation was for the establishment of a national commission established by Commonwealth legislation to regulate Australian securities markets which, it concluded, had assumed a national character. 66 In a parallel development, in 1971 the High Court in Strickland v Rocla Concrete Pipes Ltd 67 held that its earlier decision in Huddart, Parker & Co Pty Ltd v Moorehead, which had placed a restrictive interpretation upon the corporations power under the Constitution, s 51(xx), was wrongly decided and should be overruled. The court did not elaborate upon the full scope of the Commonwealth’s legislative power with respect to corporations but held out the clear prospect of a much more expansive grant than had previously been assumed. In the following year, the first Commonwealth Labor government in 23 years assumed office committed to testing the scope of Commonwealth legislative power over corporations. The Whitlam Labor government introduced the Corporations and Securities Industry Bill 1974 (Cth) to establish a national regulatory commission with responsibility for securities markets. The Bill was influenced by United States experience with federal securities regulation under the New Deal legislation of the Roosevelt administration in 1933-1934. The Bill proposed financial reporting obligations upon those companies which solicited public investment in their securities, regulation of their fundraising and takeovers, the licensing of those who dealt in those securities or advised investors, and sought to prevent market abuse through manipulation and insider trading. A National Companies Bill was also prepared to replace the Uniform Companies Acts, relying solely upon Commonwealth legislative capacity; it was shortly to be introduced into Parliament when the Governor-General dismissed the Government in November 1975. The Corporations and Securities Industry Bill 1974 lapsed with that dismissal. The election of the Fraser Coalition government in the following month saw the development of corporate regulation take a different path. An understanding of the winding path of later developments is important if we are to appreciate the current legislative framework for corporate regulation and its underpinning forces.

64 65 66

See Australian Securities Markets and their Regulation (1974), Pt 1 (Report from the Senate Select Committee on Securities and Exchange). Australian Securities Markets and their Regulation, see generally Pt I, Vol 1, Chs 15-16. Australian Securities Markets and their Regulation, Pt I, Vol 1, p 16.1.

67

(1971) 124 CLR 468.

44

[2.80]

The Historical, Institutional and Social Context of Corporations Law

CHAPTER 2

Seeking alternatives to Commonwealth legislation: 1982-2001 [2.85] The Fraser Government acknowledged the need for regulation for national financial

markets but, reluctant to intrude upon settled areas of State responsibility, looked for an alternative to Commonwealth legislation. Its invention, the so-called co-operative scheme, effectively endured until the present scheme of Commonwealth legislation was introduced in 2001. A Formal Agreement between the Commonwealth and State governments established the co-operative scheme. The Agreement provided for a three-tiered hierarchy for regulation. At the apex was the Ministerial Council for Companies and Securities. Below the Ministerial Council there was the National Companies and Securities Commission (NCSC) with responsibility for the entire area of regulation but subject to the direction of the Ministerial Council. At the base, the State and Territory corporate affairs commissions continued to perform the great bulk of administration under the scheme, but acting now as delegates of the NCSC and subject to its direction. The Formal Agreement also provided the framework for securing legislative uniformity. This framework did not involve the referral or surrender of State powers but rather the adoption by the States of legislation enacted by the Commonwealth for the Australian Capital Territory, which adoption secured the automatic operation in the States of amendments made to that legislation. 68 Thus, the States and (from 1986) the Northern Territory enacted legislation applying, as law of each jurisdiction, the Commonwealth’s initial scheme legislation together with such amendments as might be made from time to time by the Commonwealth with Ministerial Council approval. Under the Formal Agreement the Commonwealth might introduce proposals to amend its scheme legislation only with the approval of the Ministerial Council. Following discontent with the limited role for the Commonwealth Parliament in the review of amendments to the co-operative scheme legislation, a Senate committee recommended in 1987 that the cooperative scheme had outlived its usefulness and that the Commonwealth should assume responsibility for companies and securities law. Its principal concerns were: (a) that the co-operative scheme’s collegiate decision-making structure dispersed, and thereby diminished, ministerial responsibility and accountability to Parliament; and (b)

that the distribution of functions between the NCSC and its delegates had resulted in administrative duplication and general operational inefficiency. 69

These recommendations were accepted by the Hawke Labor Government which in the following year introduced a comprehensive Corporations Bill relying solely upon Commonwealth legislative power. The Corporations Act 1989 (Cth) received assent on 14 July 1989 but was not proclaimed pending the outcome of a constitutional challenge concerning the scope of the Commonwealth’s power of general incorporation under s 51(xx). As noted, the placitum gives the Commonwealth power to legislate with respect to “foreign corporations, and trading or financial corporations formed within the limits of the Commonwealth”. On 8 February 1990 six judges of the High Court, in a single judgment, held that s 51(xx) did not confer power for the incorporation of companies: 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. 70 68 69 70

The Commonwealth legislation relied not upon the corporations power in the Constitution, s 51(xx) but upon the Territories power in s 122. The Role of the Parliament in Relation to the National Companies Scheme (1987), [6.7], [3.8] and [3.9]. New South Wales v Commonwealth (1990) 169 CLR 482 at 498 per Mason CJ, Brennan, Dawson, Toohey, Gaudron and McHugh JJ. [2.85]

45

Corporations and Financial Markets Law

Since the subject of a valid law with respect to trading and financial corporation is restricted by the participial phrase “formed within the limits of the Commonwealth”, the Court held that the phrase excludes the process of incorporation itself and limits the power to one with respect to corporations formed under some independent source of power. 71 The dissenting judge, Deane J, held that the word “formed” was intended to draw a contrast with foreign corporations and had no temporal significance. 72 The Commonwealth’s initial reaction to the decision was that it would proceed to proclaim the Corporations Act without the provisions relating to incorporation. It was evident, however, that with the absence of so fundamental a power as that of general incorporation, and the prospect of protracted constitutional challenge upon numerous other grounds, a new framework for corporate regulation needed to be negotiated with the States. What emerged was the so-called national scheme that took effect from 1 January 1991 and endured for a little more than 10 years. Under the scheme, Commonwealth law continued to be limited in its reach to the Australian Capital Territory and was applied as the local corporations law by each State and the Northern Territory. However, the scheme was constructed to appear as if the legislation were a single national law applying throughout Australia. Thus, there was created a truly uniform statutory text of the substantive law called the Corporations Law which was in reality eight distinct enactments, one for each State and Territory. The automatic amendment mechanism adopted under the co-operative scheme was retained. This “federalising” of State corporations law was strengthened in three ways. First, modes of citation referred to the Corporations Law as if it was a single body of law. Second, Commonwealth criminal and administrative law regimes were applied to the Corporations Law and Commonwealth agencies, such as the Director of Public Prosecutions, the Ombudsman and the Administrative Appeals Tribunal, were vested with authority under the Corporations Law. Third, civil jurisdiction under the Corporations Law was cross-vested in the Federal Court and the State and Territory Supreme Courts so that litigants had a choice of court system. However, despite its appearance as Commonwealth law applying nationally, the national scheme was essentially a scheme of uniform legislation not fundamentally different from the Uniform Companies Acts enacted in 1962. The resulting creation resembled a puppet show whose appearance as a single Commonwealth law applying nationally was achieved through intricate machinery provisions mostly invisible to users of the legislation. Two other principal changes were made to the co-operative scheme which have largely been retained in the current system. First, the unwieldy structure of a national regulator operating through State delegates was replaced with a single regulator, the Australian Securities and Investments Commission (“ASIC”), with sole responsibility for the administration and enforcement of corporations law, responsible only to the Commonwealth Minister and Parliament. Second, the role of the Ministerial Council was reduced under the new scheme and the Commonwealth’s independence with respect to it was increased. While the Council had to be consulted in relation to all amendments to legislation, the Commonwealth was given sole responsibility for legislative proposals relating to matters concerning national markets, viz, takeovers, public fundraising and financial markets. In relation to proposed amendments in these areas, the Commonwealth’s obligation was merely to consult the Council; it need not obtain Council approval for such changes. That approval was required, however, for proposals to amend other portions of the legislation although in respect of such proposals the Commonwealth was given weighted voting rights so that it required the support of two States only for amendments to non-market provisions. The States agreed that they would not repeal or amend a scheme law without Ministerial Council approval. 71 72 46

(1990) 169 CLR 482 at 498. (1990) 169 CLR 482 at 505-506. [2.85]

The Historical, Institutional and Social Context of Corporations Law

CHAPTER 2

In the late 1990s the federalised scheme began to unravel. In 1999 the High Court in Re Wakim; Ex parte McNally 73 held that Ch 3 of the Constitution exhaustively states the manner in which jurisdiction can be invested in federal courts. While the Constitution provides in s 77(iii) for the “autochthonous expedient” 74 of permitting the Commonwealth Parliament to invest State courts with federal jurisdiction, it contains no mirroring provision authorising federal courts to be invested with jurisdiction under State law. Accordingly, the State application legislation under the corporations scheme that purported to vest State judicial power in the Federal Court, even with express Commonwealth statutory mandate, was held to be constitutionally invalid. The effect of Re Wakim was that the Federal Court did not have jurisdiction to determine a matter arising under the Corporations Law of a State. 75 Shortly after Re Wakim, the States passed legislation to validate past decisions of the Federal Court in purported exercise of State jurisdiction under their Corporations Law by declaring them to be judgments of the relevant State Supreme Court. Nonetheless, some commentators lamented the loss of the unifying interpretative force the Federal Court had provided in the period after 1991 when it attracted a not insignificant proportion of corporations litigation. 76 These difficulties were compounded in 2000 when the High Court held in R v Hughes that State legislation might validly confer power and functions upon Commonwealth officers (such as the Commonwealth Director of Public Prosecutions) with respect to the prosecution of offences under State law only where the Commonwealth Constitution would permit the Commonwealth Parliament to create offences under Commonwealth law in relation to those matters. The decision cast doubt upon the reach of the Commonwealth prosecution capacity to particular areas of corporations law beyond its own legislative competence. 77 The co-operative scheme in its federal guise had effectively reached an impasse. Either it returned to its pre-1991 form with its evident weaknesses or another solution needed to be found. Negotiations for a new legal framework resumed between the Australian governments. Commonwealth corporations legislation applying nationally

Referral of powers [2.90] Several options were available in developing such a framework other than returning to

the co-operative scheme structure. First, an amendment to the Constitution might be sought to permit the Commonwealth Parliament to sanction the vesting of State jurisdiction in federal courts or expand the scope of the corporations power in s 51(xx); however, the dismal record 73

(1999) 198 CLR 511.

74

R v Kirby; Ex parte Boilermakers’ Society of Australia (1956) CLR 254 at 268.

75

The only exception arose when the matter also gave rise to a federal claim (typically, under the Trade Practices Act 1974, now called the Competition and Consumer Act 2010 (Cth)) and if the facts and transactions giving rise to the non-federal claim were sufficiently related to those that gave rise to the federal claim. These difficulties were compounded when the High Court held that, although the Federal Court had jurisdiction where ASIC sought injunctive and declaratory relief, there were potential constitutional problems where it sought other forms of relief: Australian Securities and Investments Commission v Edensor Nominees Pty Ltd (2001) 177 ALR 329. The High Court emphasised in 1993 the importance of uniformity in the interpretation of the enacted corporations law so that intermediate level appellate courts should follow the interpretation adopted by like courts in another Australian jurisdiction unless convinced that it was plainly wrong: Australian Securities Commission v Marlborough Gold Mines Ltd (1993) 10 ACSR 230 at 232.

76

77

(2000) 202 CLR 535. In Hughes, the fact that the funds which had been raised in a prohibited fundraising were invested overseas meant that the external affairs and overseas trade and commerce powers (Constitution s 51(xxix), (i)) would have cured constitutional deficiencies under s 51(xx) in criminalising the conduct under Commonwealth law. However, if the funds had been invested locally, the result would have been different since the defendant had not used a company for the local funds solicitation and accordingly the corporations power in the Constitution, s 51(xx) might not be called in aid. [2.90]

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Corporations and Financial Markets Law

of proposals for constitutional alteration by referendum discouraged close attention to this option. 78 Second, the Commonwealth might abandon the attempt to secure a single comprehensive corporations statute and instead enact its own legislation relying upon the corporations and trade and commerce heads of power. Complementary State legislation would then be required to deal with the incorporation of companies and other topics beyond Commonwealth legislative powers. 79 The Commonwealth and State statutes would create distinct systems and jurisdictional disputes between them would be likely. Third, the Commonwealth might seek referral of powers from the States under the Constitution, s 51(xxxvii), to expand Commonwealth legislative competence with respect to corporations. 80 Several States had refused to refer such powers in the late 1970s and indeed two States – Western Australia and South Australia – initially indicated unwillingness in 2000 to refer powers. Ultimately, however, all States agreed to refer powers to enable the Commonwealth Parliament to legislate with respect to corporations, corporate regulation and the regulation of financial products and services. The resulting Commonwealth legislation, the Corporations Act 2001 and the Australian Securities and Investments Commission Act 2001 81 (here together called “the corporations legislation”), commenced operation on 15 July 2001. These statutes re-enacted the substantive provisions of the then corporations legislation without significant amendment. Eight Corporations Laws then gave way to one Corporations Act 2001. In the centenary of Federation, Commonwealth legislation regulating companies applied nationally for the first time. State legislation referring powers covered not only the power to enact the two initial Commonwealth statutes but also to make express amendments of this legislation. The referral of powers is subject to two principal caveats. The first is that the referrals are not intended to enable the Commonwealth to amend the initial Acts with “the sole or main underlying purpose or object of regulating industrial relations matters”. 82 Second, the referral of powers is subject to a five-year sunset clause in that they are expressed to terminate on the fifth anniversary of the commencement of the Commonwealth legislation, viz, 15 July 2006. 83 The references may be extended by proclamation beyond this date and may be terminated earlier upon six months notice. 84 The States and Territories have extended the referral of powers until 2021. The Commonwealth legislation applies to referring States on the basis of the combined effect of the Commonwealth’s legislative powers under the Constitution, s 51, other than 78

79 80

81

Since Federation, 44 proposals for constitutional amendment have been put to 19 referendums with only eight being successful: I Govey & H Manson (2001) 12 Public L Rev 254 at 258-259. Bipartisan support for an amendment proposal provided no guarantee of success. Proposals to extend the Commonwealth’s powers over corporations failed in referenda in 1913 and 1919. Split systems operate in the United States and Canada: see [2.105]. Section 51(xxxvii) grants to the Commonwealth power to legislate with respect to “matters referred to the Parliament of the Commonwealth by the Parliament or Parliaments of any State or States”. Other options, including the creation of an integrated Australian court system and the dual registration of companies under State law and that of the Australian Capital Territory, are canvassed in S Riley (2000) 18 C&SLJ 455. The latter Act replaced a statute that had been enacted in 1989 under the same title and supported by State application legislation from 1991.

82

See, eg, Corporations (Commonwealth Powers) Act 2001 (NSW), s 1(3). This provision appears within the statement of the purposes of the Act.

83 84

See, eg, Corporations (Commonwealth Powers) Act 2001 (NSW), s 5(1). See, eg, Corporations (Commonwealth Powers) Act 2001 (NSW), ss 5, 6. Extension of the South Australian referral will require amendment to the referring statute. The Corporations Agreement 2002 between the Commonwealth, State and Northern Territory governments required the responsible Minister for each party to review the operation of the legislative framework of the scheme, and possible alternative constitutional bases for the scheme, shortly after the third anniversary of its commencement: cl 1005.

48

[2.90]

The Historical, Institutional and Social Context of Corporations Law

CHAPTER 2

s 51(xxxvii) and those powers that arise from the State referrals: CA s 3(1). (In this book the initials “CA” denote references to the Corporations Act 2001 (Cth) although they will generally only be used in contexts where reference is also being made to the Australian Securities and Investments Commission Act 2001 (Cth) (referred to as “ASICA”) so that an identifier is needed to avoid confusion between the two statutes.) The Commonwealth legislation applies in the Australian Capital Territory and the Northern Territory on the basis solely of the Commonwealth’s Territories power under the Constitution, s 122, and its legislative powers under s 51: CA s 3(2). If a State ceases to refer legislative power to the Commonwealth (either by the operation of the sunset clause or prior termination of the referral), the Commonwealth legislation would then apply in the State on the basis of the Commonwealth’s other legislative powers including that arising from the referral of powers by other States: CA s 3(4); ASICA s 4(1). 85 Companies incorporated in the non-referring State would be required to register with ASIC before carrying on business in a referring State or Territory. 86 These provisions indirectly provide cohesion to the national scheme since for many such companies it would be easier to transfer their domicile to a State that remained within the national scheme. Defection of a State from the scheme might therefore see the loss of local operations and employment generated by companies registered there, assuming that there is a link between a company’s domicile and the location of its headquarters. Of course, if a significant number of States were to withdraw their referrals, that would pose major difficulties for the scheme.

The Corporations Agreement underlying the national scheme [2.95] The Corporations Agreement 2002 provides the framework for the national scheme. It

does so by setting out supplementary obligations beyond those contained in the State referral legislation. The Agreement provides a framework whose provisions bind in political rather than legal obligation and operate independently of the national legislation although several of its provisions are given effect in the legislation. 87 At the centre of the scheme is the Ministerial Council, called the Ministerial Council for Corporations in the Corporations Agreement Corporations Agreement but renamed the Legislative and Governance Forum for Corporations in 2011 (here called the “ministerial council” for its descriptive clarity). The ministerial council consists of Ministers representing each of the Commonwealth, State and Northern Territory governments, the parties to the Agreement: cll 401, 402. The ministerial council becomes the vehicle for State participation in 85

The Corporations Act will not apply to an act or omission in a non-referring State to the extent that it is beyond the legislative powers of the Commonwealth Parliament: CA s 5(8).

86

This central cohering provision of the current national scheme is secured through the complex definitional structure of the Corporations Act. A company registered in a non-referring State, either before or after it ceases to be a referring State (as to registration of companies, see [3.70]), would fall within the definition of a “registrable Australian body” since it would cease to be a “company” when its State of registration ceased to refer powers: see definitions of these terms in the dictionary contained in CA s 9. If a registrable Australian body wished to carry on business in a State or Territory that remains within the national scheme, it must register with ASIC under Pt 5B.2 of the Corporations Act: s 601CA. Note the definition of the phrase “in the jurisdiction” used in s 601CA that is contained in CA s 9. As defined, the phrase marks out the geographical coverage of the corporations legislation as extending to each referring State and the Territories: CA s 5. Hence, a company registered in a State that ceases to be a referring State would presumably be regulated in relation to its activities within the State by that State’s own corporations law and, if it wished to carry on business in a referring State or a Territory, would need to register with ASIC. The use of the phrase “in the jurisdiction” throughout the Corporations Act creates numerous other (albeit minor) incentives to referring States to remain within the national scheme: see, eg, CA ss 172(1), 285(2), 486A(1), 659B(1)(c).

87

See The Role of Parliament in Relation to the National Companies Scheme (1987), [3.12], [3.16], [3.34]-[3.43] and the first edition of this book, p 39. [2.95]

49

Corporations and Financial Markets Law

policy formulation with respect to corporations, a greatly diminished policy role relative to the independent policy leadership role they had played in corporate regulation prior to the introduction of the co-operative scheme in 1982. The Corporations Agreement marks out the boundaries of the national scheme. First, the Agreement declares that the scheme legislation will not regulate State and Territory statutory authorities, corporations established under specific legislation or corporations established under State and Territory legislation that authorises forms of incorporation other than companies, such as co-operative societies and incorporated associations: cl 303(1). Commonwealth legislation may apply to these authorities and corporations only to the extent that the co-operative scheme legislation applied to them before 1991: cl 503(2). Further, while States and Territories may legislate for the formation and regulation of business entities other than companies, they have agreed that the company will continue to be the primary vehicle for corporate business enterprises: cl 504. Second, the Commonwealth undertakes in the Agreement that it will not introduce a Bill that depends in whole or part on a State referral of power for the purpose of regulating industrial relations, the environment or any other matter which the State representatives on the ministerial council unanimously determine: cl 505(1). Similarly, the Commonwealth undertakes not to use the referred powers to require natural persons or unincorporated bodies to conduct activities through a corporate structure: cl 505(2). 88 As with predecessor agreements, the Corporations Agreement provides machinery for the alteration of corporations legislation. The Commonwealth undertakes not to introduce a Bill to repeal or amend the corporations legislation without first consulting and, where required, obtaining the consent of the ministerial council: cl 506(1). Ministerial council approval is not required for amendments of those portions of the national legislation that relate to takeovers, fundraising, financial products and services and other market-related areas: cl 507(2). For amendments to other portions of the national law, such as core matters relating to corporate formation and general regulation of companies, the Commonwealth must obtain the approval of at least three State or Territory Ministers, an increase from the consent requirement of two Ministers under the post-1991 agreement: cl 507(2). (That consent is not always forthcoming: see [6.30].) Even where a proposal for amendment of the corporations legislation does not require ministerial council approval (but merely consultation with it), the Commonwealth must not proceed with the amendment if four State Ministers consider that it is for a purpose other than the formation of corporations, corporate regulation or the regulation of financial products or services: cl 508. Under the Agreement, States undertake not to introduce a Bill to amend their referral powers unless they first consult the ministerial council about their proposed amendments; ministerial council consent to the amendment is not, however, required: cl 519(1). A State may withdraw a referral of power with respect to amendments to the initial Commonwealth legislation only where four or more State Ministers consider that the Commonwealth has introduced or enacted legislation in breach of the consultation and approval obligations under the Agreement and the breach has not, in their view, been remedied within six months: cl 520(4). A State will remain part of the scheme (that is, remain a referring State) if it terminates its amendment reference and every other State does so also with effect from the same day: CA s 4(7) – (8). (It is assumed that, if four States withdraw a referral with respect to amendments, all States will do so.) By this measure, the States may “turn off” an amendment made to the corporations legislation without collapsing the scheme. Parties to the Agreement may withdraw from it upon giving six months notice: cl 901(1). 88

50

The undertaking does not apply to the longstanding prohibition upon partnerships and other unincorporated associations for gain having more than 20 members: cl 505(3) and see [3.10]. [2.95]

The Historical, Institutional and Social Context of Corporations Law

CHAPTER 2

The Corporations Agreement provides that the national law will itself provide for the continued operation of State and Territory legislation, existing or prospective, that is capable of operating concurrently with it: cl 512(1) and CA s 5E. The Corporations Agreement requires the national law to provide for the continued operation of inconsistent State and Territory legislation that was in force immediately before 15 July 2001 (when the Corporations Act commenced) and prevailed over the Corporations Law then, to the extent of the inconsistency, unless the State or Territory concerned has agreed to the displacement of their laws: cl 513. In relation to future inconsistent State or Territory legislation, a State and Territory may declare that the matter is an excluded matter prevailing over national law where the ministerial council has by simple majority approved the enactment of the inconsistent provision: cl 514. The Corporations Act gives effect to these undertakings by providing that the Commonwealth corporations legislation does not apply in a State and Territory in relation to a matter that the State and Territory which has declared to be an excluded matter, either in a specific provision or generally in the legislation: CA s 5F. The Act seeks to prevent direct inconsistencies arising in some cases by limiting the operation of the corporations legislation: CA ss 5G, 5E(4) (note). State or Territory legislation that existed at 15 July 2001 overrides Commonwealth legislation to the extent of the inconsistency unless a declaration has been made waiving displacement; State or Territory legislation enacted after 15 July 2001 overrides Commonwealth law where the State or Territory has declared the provision to be a “Corporations legislation displacement provision”: CA s 5G. The Corporations Act does not refer to the ministerial council consent provisions and its displacement provisions are not expressed to be subject to compliance with them. Indeed, the corporations legislation makes no reference to the Corporations Agreement although several of its provisions are given effect in the legislation. 89 The jurisdiction of courts under corporations legislation [2.100] The cross-vesting of jurisdiction under the earlier national scheme, from 1991 to

2001, was central to its assumed federal character. As noted, successful challenges to the cross-vesting of civil jurisdiction led to the scheme’s demise and its replacement with Commonwealth legislation applying nationally. The national law restores the jurisdictional arrangements applying prior to Re Wakim. 90 Since the Federal Court does not exercise criminal jurisdiction, separate provisions apply for civil and criminal jurisdiction. Jurisdiction to determine civil matters arising under the corporations legislation is vested in the Federal Court, in the Supreme Court of each State and Territory and, in relation to ancillary corporations matters arising in family proceedings, the Family Court of Australia: ss 1337B, 1337C. There are provisions for the transfer of civil proceedings between the courts having regards to the interests of justice and the hierarchy of courts: ss 1337H – 1337R. Appeals must generally be brought within the court system in which the original action was heard: s 1337F. The term “Court” where used in the Corporations Act is defined as any of the Federal Court, the Supreme Court of a State or Territory or the Family Court; where the term “court” is used, it refers to any court: s 58AA. Use of the term “Court” therefore limits the court in which proceedings may be brought but not choice as between the several court systems comprehended within that definition. This usage of the terms “Court” and “court” will be followed in this book so that “Court” will be used only when it is significant that the court referred to in the context is one of those named. 89

90

Other provisions of the Agreement given effect in the legislation are the requirements that ASIC establish a regional office with its own Regional Commissioner in each State and Territory and ensure that it serves adequately the needs of their business communities: ASICA s 95; cll 602, 603 (ASIC to maintain levels of service not lower than those formerly provided in each State and Territory under the co-operative scheme). (1999) 198 CLR 511. [2.100]

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As regards criminal jurisdiction, the several courts of the States and Territories exercising jurisdiction with respect to the summary conviction of offenders have equivalent jurisdiction with respect to offences against the corporations legislation: s 1338B(1). A court of summary jurisdiction may decline to exercise that jurisdiction in relation to an offence committed in another State or Territory if it is satisfied that it is appropriate to do so having regard to all the circumstances, including the public interest: s 1338B(7). 91 These rules have the advantage of enabling summary offenders to be tried in the jurisdiction in which they are found, subject to the court’s discretion to decline to exercise that jurisdiction in the public interest. However, in relation to indictable offences, the courts of a State or Territory have jurisdiction only with respect to offences committed outside Australia or offences committed, begun or completed in that jurisdiction: s 1338B(8). The laws of a State or Territory relating to arrest and custody, criminal procedure and rules of evidence apply in relation to persons charged in that jurisdiction with offences under the corporations legislation: s 1338C. The future shape of corporate regulation within the Australian federal system [2.105] The path to the present structure of corporate regulation and law making in Australia has been a tortuous one and its future is clearly mapped only until 2016 when the current referral expires although further five-yearly extensions are anticipated. The complexity and fragility of the present structure reflects the peculiarities of Australian federal constitutional law rather than its corporate law. The first peculiarity is the narrow construction placed upon the grant of power under the Constitution, s 51(xx), initially in 1909 in Huddart Parker v Moorehead 92 and in 1990 in New South Wales v The Commonwealth. 93 Second, the interpretative positions taken in Re Wakim 94 and R v Hughes 95 pose formidable obstacles to the pooling of powers under co-operative regulatory arrangements between the Commonwealth and the States such as that developed for corporate regulation from 1982 to 2001. In 2004 the Standing Committee of Attorneys General announced that it was giving consideration to constitutional amendments that would provide a sound basis for co-operative regulatory schemes. The present structure is born of the necessity of finding a workable solution that does not cede to the Commonwealth broad legislative power over corporations beyond that necessary for passage and amendment of the corporations legislation. The cost of the present arrangement is the breadth of the powers referred by the States and, in view of the central role played by corporations in commerce and social relations generally, their potential application in law making beyond the traditional sphere of corporate regulation. Certainly, there are protective measures in the present structure – in the Corporations Agreement, the statements of purpose in the referring statutes and the States’ power of revocation. However, these sanctions are not costless and fall well short of assurance against future use of referred powers with reach beyond the traditional scope of corporate law. Since corporations are such central actors in the modern economy and society generally, the future scope of corporate regulation might well expand (or contract) with implications for the breadth of the transfer of legislative power from the States. Indeed, some commentators presently argue for a wider social role for corporate regulation beyond the traditional goals of enterprise facilitation and investor protection. Of course, other solutions might be adopted including those that specifically address the constitutional weaknesses that brought down the uniform national scheme. Thus, 91

There is, however, no provision for transfer of proceedings to another court.

92

(1909) 8 CLR 330.

93

(1990) 169 CLR 482.

94

(1999) 198 CLR 511.

95

(2000) 202 CLR 535.

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constitutional amendment might be sought by referendum to extend the scope of the corporations power or to allow the States to consent to federal courts exercising jurisdiction with respect to matters arising under their laws and federal agencies administering and enforcing those laws. 96 The States might also decline to extend the referral of powers and initiate their own corporations legislation. A split system operates in North America. In the United States, State law governs the incorporation and management of companies and federal law is limited to regulation of public markets for corporate securities (eg, public fundraising, financial market regulation and takeovers). In Canada, there is both a federal corporations statute and separate corporate legislation in each of the Provinces; this provincial legislation, however, substantially follows federal corporations law. In further contrast to the United States, there is no federal securities market regulation in Canada and each Province has its own regulatory system, increasingly modelled upon and articulated with United States securities regulation. If Australian States were to choose such a split regulatory path, they would be vulnerable to pre-emption by Commonwealth legislation that is supported by one or more heads of legislative power by virtue of the Constitution, s 109. From the perspective of substantive company law, the Australian regulatory structure promotes uniformity over competition between the States for the development of superior law making. The substantive uniformity of Australian corporate law since 1962 is perhaps its most distinctive characteristic. It sets Australia apart from other federal systems such as the United States and Canada and, of course, regional systems such as the European Union. A single corporations law applying nationally has advantages. It prevents opportunistic State legislation which secures local benefits whose costs are substantially borne outside the jurisdiction. 97 There are also economies of scale in national law making and its enforcement through a single regulator. National regulation also reduces opportunities for evasion through exploitation of differences between State laws. On the other hand, State legislation has the advantage of allowing for different preferences in corporate law making and provides greater scope for local political and business influence. 98 The latter may not be an unambiguous good, of course. In the United States, many of the major corporations are incorporated in one of the smallest States, Delaware, to its significant fiscal advantage; New York and California are the other leading States for large corporation incorporation. In the United States the corporate law of the State in which a corporation is incorporated applies to the corporation even if it has no other connection with that State. There is no legal impediment, and only minor cost, in reincorporation in another State whose corporate law it finds more congenial. 99 The freedom to reincorporate creates competition between States for corporate charters (certificates of incorporation) and its associated revenue. This competition may act as a restraint upon substantive regulation of corporate conduct by the States whose corporations statutes accordingly are primarily facilitative or enabling. Some argue that Delaware has won “the race to the bottom” in providing standards of corporate regulation most accommodating to 96 97

98 99

As advocated in G Williams (2002) 20 C&SLJ 160. Thus, in Australia, 10 years after the Uniform Companies Acts, Victoria enacted special legislation to prevent the hostile takeover of the locally incorporated Ansett Transport Industries Ltd. In the United States, many States responded to a wave of hostile takeover bids in the 1980s by permitting target company directors to take account of non-shareholder interests such as those of employees and local communities in their response to those bids. See M J Whincop (1999) 27 Fed L Rev 77; M J Whincop (2001) 12 Public L Rev 263; I M Ramsay (1990) 19 Fed L Rev 169. Transfer of incorporation need not be internal within the United States. In 2004 the global News Corp Ltd announced its intention to seek shareholder approval to transfer its domicile from South Australia, where it was incorporated, to Delaware. [2.105]

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corporate management, the group which usually determines the place of incorporation. 100 Other scholars suggest instead that Delaware has simply produced superior corporate legislation, thereby winning “the race to the top”. They argue that investors and sophisticated lenders would discount the price of securities of a firm incorporated in a State which provided lax standards of management accountability. Such firms would face higher costs of capital raising and the prospect of management displacement through hostile takeover by another firm which might recoup part of the costs of acquisition simply through reincorporation in a State offering superior investor protection since its share price would thereby increase. 101 In the United States, competition between the States is not confined to the production of corporate law but extends also to its adjudication. Delaware’s competitive advantage is said to rest primarily in the quality and reliability of its specialist judges who hear corporations cases. 102 This form of jurisdictional competition in corporate law adjudication emerged in Australia with the introduction of cross-vesting of civil jurisdiction from 1991 and its restoration in 2001. 103 It links the constitutional and corporate law dimensions of choice as to the institutional options for the future of corporate regulation in Australia. [2.108]

Notes&Questions

1.

What are the strengths of the current scheme as a device for the federal regulation of companies and the securities industry? Consider relative to the merits of other structural options available.

2.

Prepare notes of advice separately for the Commonwealth and a State member of the ministerial council (now called the Legislative and Governance Forum for Corporations: see [2.95]) as to the optimal regulatory structure for corporate regulation and the necessary strategy for its realisation. Include in your notes the details of constitutional amendments necessary to enable a return to a functioning scheme for co-operative regulation and the merits of such a scheme relative to other models.

3.

What obligation – legal, political or moral – binds the national scheme participants together? May any party withdraw from the scheme at will? What sanctions might effectively be invoked against such a withdrawal?

100 101

W L Cary (1970) 83 Yale LJ 663; L A Bebchuk (1992) 105 Harv L Rev 1437. Even if State corporation law is management accommodating, US federal securities law is undoubtedly oriented to shareholder protection. R K Winter (1977) 6 J Legal Stud 251; W J Carney (1997) 26 J Legal Stud 303; R Romano, The Genius of American Corporate Law (1993); as to Canada, see R J Daniels (1991) 36 McGill LJ 130. Experience in the 1980s of State takeover regulation poses a particular challenge to “the race to the top” proponents: see R Romano (1993) 61 Fordham L Rev 843; L A Bebchuk & A Ferrell (1999) 99 Colum L Rev 1168.

102

B S Black (1990) 84 Nw U L Rev 542 at 589-590; I Ayres (1992) 59 U Chi L Rev 1391 at 1403-1406.

103

For a survey of the changes in the distribution of corporate law workload between the Federal Court and the State Supreme Courts in Australia see I Ramsay and A Watne, “Which Courts Deliver Most Corporate Law Judgments? A Research Note” (July 22, 2008). Available at SSRN: http://ssrn.com/abstract=1168057. The research shows that the flow of corporate law litigation to the Federal Court resumed strongly after the High Court decision in Re Wakim and other jurisdictional setbacks. By 2007-2008, 31.6% of corporate law judgments were delivered by the Federal Court and 42.4% by the Supreme Court of New South Wales. These proportions are much the same as they had been in 2004. New South Wales is the dominant State court in corporate law matters with 62.6% of the 479 judgments delivered by the State and Territory Supreme Courts in 2007-2008. Within the Federal Court, New South Wales, Victoria and Western Australia represented 81.7% of all corporate law judgments in 2007-2008. While there is a rough parity between Federal Court and Supreme Court decisions in Victoria and Western Australia, in New South Wales three-quarters of corporate law cases are decided by the Supreme Court.

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4.

Does the national scheme resolve difficulties with respect to ministerial and parliamentary accountability for the administration of scheme legislation? Do the scheme arrangements guard sufficiently against erosion of responsibility through excessive dispersal?

5.

If it were achievable, would less emphasis upon uniformity in corporate law, and greater competition between the Australian States in its production, be beneficial?

THE AUSTRALIAN SECURITIES AND INVESTMENTS COMMISSION Regulation through a specialist commission [2.110] The enactment of legislation is usually quite distinct from its implementation. 104For

many statutes, responsibility for implementation falls primarily upon the general institutions of civil and criminal administration – the courts, prosecution agencies and police. For other legislation, including that of business regulation, responsibility for implementing the policy statement contained in the statute is assigned to a regulatory agency dedicated to the purpose and enjoying some measure of independence from the general state bureaucracy. Of course, this delegation is rarely exclusive and a not insignificant role is played by courts and other state agencies. In mark of their diverse responsibilities, regulatory agencies are sometimes given powers of a quasi-legislative, executive and judicial character which, if combined in other state agencies, would affront accepted notions of the proper separation of powers. Indeed, concerns were evident in the United States even during the Roosevelt New Deal administration in the 1930s (which spawned the principal business regulatory agencies, including the Securities and Exchange Commission) about this “headless fourth branch of government” which some argued compounded concentration of power with irresponsibility in its exercise. 105 The Australian Securities and Investments Commission (ASIC) belongs to this species of independent regulatory agency. It is charged with legislative implementation and the routine administration of the Corporations Act which would otherwise be beyond the institutional capacities of government, Parliament and the courts. From its inception, ASIC was assigned goals of unusual breadth – to maintain the performance of companies, the markets in which their securities trade and the confidence of their investors, and to administer and enforce the corporations legislation. 106 ASIC also has extensive powers to investigate breaches of the national law, take civil enforcement action, initiate criminal prosecutions and exercise some adjudicative powers. These powers are coupled with discretions of a novel character and breadth, including the power to exempt persons and companies from compliance with particular provisions of the Corporations Act and to modify their operation. ASIC may apply for a declaration by the Takeovers Panel that an acquisition of shares or other conduct which, though not unlawful, is nonetheless unacceptable. (This declaration exposes its subject to a broad range of remedial orders including divestiture and disenfranchisement: see Chapter 12.) ASIC also has wide discretionary powers with respect to fundraising, takeovers and financial 104

105 106

For fuller treatment of ASIC’s powers of investigation and enforcement and wider responsibilities with respect to financial market regulation, see Chapter 11. The ASIC website contains much useful information, especially its regulatory documents (viz, Regulatory Guides, consultation papers, reports and information sheets) that explain its regulatory approach in specific areas: http://www.asic.gov.au. See P R Verkuil [1988] Duke LJ 257. Thus was the text of ASIC Law, s 1(2), prior to 1 July 1998 when it was amended to take account of the Commission’s added powers as a consumer protection regulator with respect to financial services. [2.110]

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Corporations and Financial Markets Law

market regulation. 107 ASIC may commence criminal prosecutions although in practice major prosecutions are undertaken by the Commonwealth Director of Public Prosecutions. A comparative perspective [2.115] Australian companies legislation has never adopted the United States practice, evident

since the New Deal era, of delegating a rule-making power to the regulatory agency. 108 Thus, the Securities and Exchange Commission (SEC) is empowered to make such rules and regulations as may be necessary to implement the provisions of the Securities Exchange Act 1934 (US) or for the execution of the functions vested in it by the Act: s 23(a)(1). The prohibition upon insider trading in United States federal securities law, the justly famous rule 10b-5, was promulgated by the SEC to provide an immediate and flexible remedy for the failure of the substantive statute to address purchases (as distinct from sales) by corporate insiders possessing price sensitive non-public information. 109 There is another significant difference between ASIC and the SEC. The SEC is a regulator whose responsibilities are limited to regulating the markets for corporate securities, the conduct of their participants and related transactions affecting those markets such as corporate takeovers and fundraising. As noted (at [2.105]), in the United States responsibility for ordinary corporate regulation – of standards of management conduct and compliance with non-market statutory requirements – rests with State regulators. Both functions – of corporate and financial market regulation – are vested in the Australian Commission so that ASIC is both an enforcement regulator and a disclosure regulator. ASIC has adopted distinct investigative and enforcement methodologies with respect to each. The corporate regulation function calls for a more traditional approach in which longer term goals are significant. Where ASIC acts as a market regulator, however, its overriding concern is with protection of the integrity of financial markets. This concern will often favour prompt intervention though civil enforcement seeking injunctive or administrative relief rather than resort to less timely but more punitive sanctions. The adjustment between these distinct goals sometimes presents difficult choices for ASIC since one set of remedies will often be pursued at some cost to the other. Constitution and independence [2.120] ASIC is a body corporate consisting of between three and eight members: ASICA

ss 7 – 9. (Statutory references in this section dealing with ASIC are to the Australian Securities and Investments Commission Act 2001 (Cth) without use of the identifier ASICA.) Members of ASIC are appointed by the Governor-General on the nomination of the Commonwealth Minister: s 9(2). ASIC is not subject to direction by the Legislative and Governance Forum for Corporations, the inter-governmental ministerial council (see [2.95]), and is accountable only to the Commonwealth Minister and Parliament: see [2.95]. The ASIC Act seeks to preserve ASIC’s independence. The Commonwealth Minister may give ASIC a written direction about policies and priorities but only after giving ASIC’s chairperson an adequate opportunity to discuss the need for the proposed direction: s 12(1), (2). Such a direction may not be given 107

Corporations legislation thus arguably falls within the category of “intransitive legislation” in that it is directed to regulators as well (or as much) as to the subjects of the legislation: see E L Rubin (1989) 89 Colum L Rev 369 at 372-385.

108

The Rae committee in 1974 envisaged that the independent securities commission which it proposed would need and should have a rule-making power: Australian Securities Markets and their Regulation (1974), Pt 1 (Report from the Senate Select Committee on Securities and Exchange), p 16.18: see [2.80]. Of course, as noted, ASIC publishes an extensive body of regulatory guides outlining its interpretation of the statute for administrative and enforcement purposes and its implementation program. These releases do not, however, enjoy the force of law of the rules made by the Securities and Exchange Commission.

109

L Loss, Fundamentals of Securities Regulation (2nd ed, 1988), pp 726-727.

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with respect to a particular case: s 12(3). The Minister is required to gazette a copy of the direction and to lay it before each House of Parliament: s 12(5). ASIC must comply with such a direction (s 12(4)) but is not otherwise subject to ministerial direction: s 11(1B). The power of direction has been exercised only once, in 1992, in relation to the division of prerogative between the Director of Public Prosecutions and ASIC for prosecution decisions under corporations legislation. The Minister may also direct ASIC to investigate suspected contraventions of the legislation. 110 Parliamentary scrutiny of ASIC’s work is strengthened by the creation of the standing Parliamentary Joint Committee on Corporations and Financial Services under Pt 14 of the ASIC Act. The committee is required to report to both Houses upon the activities of ASIC and the operation of corporations legislation: s 243. ASIC’s role as consumer protection regulator for financial services [2.125] ASIC’s extensive powers and functions under the corporations legislation range from

the registration of companies, maintenance of a public database of corporate information, regulation of financial markets and enforcement of myriad obligations under the legislation. In 1998, as part of a restructuring of the regulatory regime for the financial sector, ASIC’s role and powers were expanded with respect to consumer protection for financial services and products and it was renamed to reflect those added responsibilities (previously it had been the Australian Securities Commission). ASIC is also vested with powers under other statutes dealing with financial services, including insurance, superannuation and banking (excluding lending) with the broad function of monitoring and promoting market integrity and consumer protection in relation to the Australian financial system: s 12A. These changes implemented a recommendation of the inquiry into the Australian financial system that there be a single regulator responsible for consumer protection within the financial system rather than separate product- or industry-specific regulation. 111 ASIC’s consumer protection powers in relation to financial services replicate the consumer protection provisions of the Australian Consumer Law contained in the Competition and Consumer Act 2010 (Cth) (formerly called the Trade Practices Act 1974 (Cth)). ASIC’s regulatory tools with respect both to its consumer protection powers and market integrity functions are through disclosure requirements, the licensing of market intermediaries, the prevention of market abuse and unfair conduct, and the operation of complaints handling and resolution processes: see Chapter 11. The Australian Prudential Regulation Authority (APRA) has responsibility for prudential regulation (that is, oversight of capacity to honour financial commitments) of the financial sector (viz, banks, insurance companies and superannuation funds). The Reserve Bank of Australia is responsible for monetary policy and the stability of the financial system generally. The Australian Competition and Consumer Commission retains responsibility for the 110

111

ASIC may also have functions or powers conferred upon it under State and Territory laws with respect to financial services; however, ASIC is under no obligation to perform such functions or exercise such powers and is not subject to any direction of the Commonwealth Minister in relation to their performance or exercise: s 11(9A), (9B). Commonwealth of Australia, Financial System Inquiry Final Report (1997), pp 242-248 (Wallis Report). The report criticised the existing system for its substantially different disclosure requirements for functionally similar investment products (eg, public unit trusts and investment-linked life policies) and inconsistent approaches to the regulation of financial sales and advice in the securities and insurance industries. Accordingly, ASIC has powers and functions conferred upon it under the Insurance Contracts Act 1984 (Cth), Superannuation (Resolution of Complaints) Act 1993 (Cth), Insurance Act 1973 (Cth), Retirement Savings Accounts Act 1997 (Cth) and the Superannuation Industry (Supervision) Act 1993 (Cth). Under the National Consumer Credit Protection Act 2009 (Cth), ASIC is also the sole national regulator of credit and credit services. These powers and functions are in addition to those conferred upon it under Pt 2, Div 2 with respect to consumer protection in relation to financial services: s 12A(1). [2.125]

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Corporations and Financial Markets Law

competition laws as they affect financial services and products. The Council of Financial Regulators, the co-ordinating body for the principal financial regulatory agencies – the Reserve Bank, APRA, ASIC and Treasury – promotes co-operation and collaboration between them and advises government on the adequacy of the architecture of Australia’s financial system. Satellite bodies [2.130] The ASIC Act also creates other bodies to perform functions complementing those of

ASIC. The principal of these bodies is the Takeovers Panel which has such powers and functions as are conferred upon it by the Corporations Act or the ASIC Act: s 174. The only such powers presently conferred are those relating to declarations that an acquisition of shares or other conduct (generally but not exclusively made in the context of company takeovers) is unacceptable: see [12.25]-[12.30]. Those are essentially powers of a quasi-adjudicatory or policy-making character rather than administrative powers. 112 Other bodies perform specialised functions. The Companies Auditors and Liquidators Disciplinary Board is established under Pt 11 to perform such functions as are conferred by corporations legislation: s 204. The powers presently conferred are limited to the occupational regulation of those two groups. The Australian Accounting Standards Board is established under Pt 12 to make accounting standards subject to the oversight of the Financial Reporting Council: ss 225, 226. The Corporations and Markets Advisory Committee (CAMAC) is incorporated under Pt 9 to act as the principal source of law reform initiative and advice with respect to the corporations legislation and its administration: s 148. Members of CAMAC are appointed on a part-time basis. In making appointments, the Minister is directed to the desirability of the views of business communities being represented on CAMAC: s 147(5). The 2014-15 Commonwealth Budget announced CAMAC’s termination through the projected repeal of Pt 9 of the ASIC Act. The decision was made in the context of reforms designed to reduce the number of Australian Government bodies and streamline the shape of government. CAMAC’s advisory functions have been merged into Treasury although legislation for the repeal of Pt 9 is yet to be enacted.

THE AUSTRALIAN SECURITIES EXCHANGE [2.135] In the last quarter of the 17th century there emerged in England a market for shares in

joint stock companies and a group of people, stockbrokers, acting as commission agents or traders in that stock market: see [2.40]. This is but one element of the transformation that occurred when corporate securities took on a transferable character. 113 Stockbrokers formed stock exchanges to promote their markets and over time these stock exchanges became quasi-partners with securities commissions in the regulation of those markets.

112

This power of declaration was previously given to ASIC’s predecessor, the National Companies and Securities Commission but was transferred to an independent body because of concerns that a conflict of interest arose where the investigating authority also had responsibility for judging the propriety of market conduct.

113

The self-regulatory role of securities exchanges is examined more fully in Chapter 11. Useful material is available at http://www.asx.com.au.

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[2.130]

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The genesis of the Australian Securities Exchange [2.140] In Australia stockbroking began as early as 1829 114 and stock exchanges were

established in each of the capital cities in the period from 1870 to 1890. 115 Each exchange was later incorporated. By the rules of each exchange the right to trade upon the exchange was confined to stockbrokers who had been admitted to exchange membership or who were, subject to restrictions as to number and fitness, partners of such members. Until the late 1970s (1983 in the case of the Sydney Stock Exchange) exchange membership might be secured only by the purchase of the “seat” of a retiring member. The exchanges were governed by committees elected by members. The constitutions of the exchanges and their business rules restricted access to membership, excluded non-members from the trading floors, fixed brokerage rates and established a structure and process for exchange transactions. The exchanges had a long tradition of autonomy in the governance of their affairs and a jealous regard for their collective and individual independence. However, in 1985 the six capital city stock exchanges merged to form the Australian Stock Exchange Ltd (ASX) to conduct a single national stock exchange. ASX was granted approval under corporations legislation to conduct a stock market. It is the principal securities exchange operating in Australia. In 2006 it merged with the Sydney Futures Exchange and the merged group changed its name to the Australian Securities Exchange. The Sydney Futures Exchange, now a wholly-owned subsidiary of ASX, retains a separate licence to operate a futures market; its principal derivative markets are for interest rate products, equities and commodities. 116 The demutualisation and self-listing of the Australian Securities Exchange [2.145] In 1998 members of ASX voted to convert it from a mutual organisation of

stockbrokers to a public company limited by shares, that is, a company conducted as an ordinary commercial enterprise to earn profits for distribution as dividends to shareholders. ASX was simultaneously admitted to its own Official List so that shares in ASX might be purchased and traded upon the stock market conducted by ASX itself. ASX was the first stock exchange to simultaneously demutualise and self-list; others followed suit and the world’s major securities markets are now conducted by demutualised, for profit exchanges. 117 One contributing cause of the ASX demutualisation was the determination of the Trade Practices Commission in 1982 to withhold authorisation for longstanding stock exchange rules which had precluded corporate membership. Shortly after ASX modified its rules following this decision, the bulk of trading upon ASX was conducted through its new corporate members whose interests were by no means identical with those of the much larger group of individual members who were somewhat unevenly distributed among the corporate 114

When Matthew Gregson advertised that he had received permission from the Bank of New South Wales to trade in its shares: R F Holder, Bank of New South Wales: A History (1970). In 1835 William Barton established himself as an “agent for the transfer of shares”. His son Edmund became Australia’s first Prime Minister.

115

For institutional histories of the principal exchanges prior to their absorption into the Australian Stock Exchange, see: S Salisbury and K Sweeney, The Bull, the Bear and the Kangaroo: The History of the Sydney Stock Exchange (1988); G Adamson, A Century of Change: The First Hundred Years of the Stock Exchange of Melbourne (1984); R M Gibbs, Bulls, Bears and Wildcats: A Centenary History of the Stock Exchange of Adelaide (1988); A L Lougheed, The Brisbane Stock Exchange 1884-1984 (1984); G Adamson, Miners and Millionaires (1989) (Stock Exchange of Perth). For example, futures contracts are written with respect to major short and medium term interest rates (such as the 90 Day Australian Bank Accepted Bill Futures and Options and 3 Year and 10 Year Australian Treasury Bond Futures and Options); futures in fine wool, greasy wool and broad wool, in cattle and in coal enable producers to manage (hedge) their exposure to price volatility in those commodities.

116

117

Other exchanges listed on their own markets include the New York and London Stock Exchanges, the Deutsche Boerse, the Singapore and Hong Kong stock exchanges, and the Toronto Stock Exchange. [2.145]

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Corporations and Financial Markets Law

member organisations. The decision to demutualise was justified by reference to the want of identity, if not mutuality, in members’ interests and the undesirability for long-term control of the entity to reside with one group of members. The demutualisation decision broke the historic connection between membership of the stock exchange and access to the trading facilities that it provides. Any person or organisation possessing the qualifications specified in the ASX’s business rules is now entitled to access to those facilities. The self-listing decision was accompanied by amendments to the corporations legislation which strengthened the obligations of ASX to ensure oversight of the conduct and integrity of market participants and provided for supervision by ASIC of ASX’s own compliance with its listing rules, including possible conflicts between its commercial interests and its responsibilities to operate a market that is fair, orderly and transparent. Thus, until the transfer of ASX’s supervisory functions to ASIC in 2010, ASX had a dual character: as a body given statutory approval to conduct a stock market, it has extensive powers and obligations as a market regulator; and, as a commercial enterprise conducted for the benefit of its shareholders, it charged fees from listed entities for initial and continuing listing and for transactions effected upon its markets. 118 In 2010, the role conflict was resolved with ASIC assuming responsibility for the supervision of Australian financial markets and market participants, principally stockbrokers, as well as its longstanding statutory responsibility to enforce market misconduct laws relating to insider trading and market manipulation. ASX retains responsibility for ensuring that companies admitted to its list comply with the listing and operating rules it has promulgated: see [2.150] and [11.35]. Stock exchange listing [2.150] In March 2017, there were 2,224 entities listed on ASX, mostly comprising Australian entities (1,979) but also including some foreign entities (127); these entities are principally corporations but also include non-corporate entities, principally listed managed investments such as property trusts and infrastructure funds. 119 In addition to its market for corporate securities, ASX operates a number of markets for large, sophisticated (institutional) investors. These markets include markets for debt securities, futures and options markets, and warrants. 120 Trading and settlement of ASX transactions is effected through computerised systems which have replaced the traditional open outcry stock exchange trading floor. Companies wishing to have their securities traded on ASX apply for admission to the Official List and for quotation of their securities. ASX has promulgated listing rules governing the admission to the ASX Official List and the conduct of companies whose securities are granted quotation. ASX listing rules are designed to promote a fair, informed and efficient market for quoted securities. They specify prerequisites for admission of a company to the Official List and quotation of its securities, including minimum capital and spread requirements to ensure that the market for the company’s securities has sufficient depth and that prices are not de facto controlled by dominant investors. ASX has also promulgated business rules to regulate the machinery of exchange transactions and the conduct of market participants. ASX enforces its listing rules, particularly those relating to timely disclosure by listed companies of price-sensitive information, its business rules and the prudential risk standards it 118

In the interests of ensuring diverse ownership of ASX, shareholdings in ASX are limited to 15% of voting shares.

119

ASX Historical market statistics http://www.asx.com.au/about/historical-market-statistics.htm#No of Companies.

120

The exchange-traded options market lists put and call option contracts over securities of more than 50 leading companies. By purchase of a call contract the investor benefits from the higher price of the underlying security upon its expiry date or, in the case of a put option, the fall in price. The warrants market involves the issue of put and call options against a particular security, basket of securities or index. They are issued by banks and major investment institutions.

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[2.150]

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sets for industry participants such as stockbroking firms. As market regulator, ASIC conducts surveillance of market activity to identify unusual trades for investigation of possible insider trading or market manipulation. Listing and quotation upon a securities exchange secures particular advantages. First, it makes it easier for companies to raise funds through the new issue facilities of securities markets. Second, listing secures liquidity for corporate securities which enhances the appeal of the security to investors and thereby facilitates the raising of further funds. Third, listing enables proprietors whose capital has been effectively locked up in illiquid shareholdings to realise the value of their investment through the market for the shares once they are granted quotation by the stock exchange. Fourth, the securities exchange promotes investor confidence through monitoring of trading in securities and reduces transaction costs through its standard-form governance and transaction settlement rules. Finally, admission to the exchange list conveys a valuable reputational signal concerning the listed company which is of potential value in dealings with suppliers and financiers. However, with the growth of other information markets and alternative reputation assurance mechanisms, the stock exchanges no longer enjoy a natural monopoly with respect to these advantages. These advantages are also accompanied by some costs. The public market facility for the company’s securities exposes its erstwhile controllers to the threat of loss of control through takeover if they have used the listing to dispose of a significant portion of their holding. Listed companies also suffer loss of privacy through their continuous exposure to the stock exchange, market and press inquiry as to price-sensitive company developments. Listed companies are also subject to considerable expense for listing fees, share registry, annual reports to shareholders and general investor relations. They also face greater regulation of conduct through higher governance standards and trading restraints imposed through the listing rules.

THE OWNERSHIP AND CONTROL OF CORPORATE AUSTRALIA Continuing evolution of corporate form [2.155] In March 2017 there were 2.455 million companies registered under the Corporations

Act or its predecessor statutes; of these, only about 2,100 (less than 0.1%) were listed on ASX. 121 Of the rest, the great majority are small private companies with probably no more than one or two shareholders formed to provide limited liability for a business, to hold property or other assets, or as part of a tax planning structure: see [3.80]. The concern of this section, however, is with ownership and control of stock exchange listed companies which occupy the commanding heights of national and global economies. Over the past century the registered company has become the principal mechanism for aggregating private investment capital for large-scale commercial enterprise in most developed countries. The reasons are not difficult to find. The corporate form offers equity investors the enviable inducements of freedom from active participation in the management of the pooled fund (that task is assigned to a centralised management) and limited personal liability for losses arising from trading with the fund. Corporate personality clothes the fund to give it institutional continuity notwithstanding constant flux in its membership. Finally, organised securities markets offer liquidity for investments traded upon those markets. 122 Since share capital may not be redeemed at will, this liquidity through the market serves the invaluable social function of transforming what may be no more than a series of short-term credits into a 121

ASIC 2016 Company registration statistics, http://asic.gov.au/regulatory-resources/find-a-document/ statistics/company-registration-statistics/2017-company-registration-statistics/.

122

R C Clark, Corporate Law (1986), pp 2-3. [2.155]

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permanent capital fund. 123 The following article by Clark identifies distinct if overlapping stages in the evolution of the corporation and of related investment patterns and structures. Consider whether developments in the quarter century since the article was written have validated or undermined his thesis, especially his speculations as to a possible fourth stage. What recent social and economic developments bear upon this question? Do you think it possible to detect the outlines of a fifth stage? If so, what would be its character? Have the developments compendiously described within the term “globalisation” added fresh genetic material to the corporation’s evolutionary path? There is a discussion of global considerations at [2.245]. You will also find useful material that bears upon these questions in the treatment of patterns of share ownership and control that follow immediately. Indeed, the article provides a framework for analysing developments in corporate ownership and control.

The Four Stages of Capitalism: Reflections on Investment Management Treatises [2.160] Robert Charles Clark, “The Four Stages of Capitalism: Reflections on Investment Management Treatises” (1981) 94 Harvard Law Review 561 (footnotes omitted) [562] The history of capitalist enterprise in the United States over the last 200 years can be meaningfully organised into four distinct stages. … The four stages are like generations. They overlap with one another – indeed, none are dead, and all may continue indefinitely – but each in turn has had its own time of rapid growth. Each stage has its characteristic business entity and set of roles, and there is a clear overall trend to the changes between the stages. The first stage is the age of the entrepreneur, the fabled promoter-investor-manager who launched large scale business organisations in corporate form for the first time in history. (Depending on one’s perspective, he might also be called the “bourgeois capitalist” or the “robber baron”.) He was primarily a 19th century phenomenon. The objective correlate of his activity was the rise of the corporation as a form of business organisation. Its legal correlates were the increased enactment of general incorporation statutes and “enabling” laws. [563] The second stage, which reached adulthood in the first few decades of the 20th century, is the age of the professional business manager. He appeared when the entrepreneurial function was split into ownership and control, a development heralded in 1932 by Berle and Means in their classic work, The Modern Corporation and Private Property. The characteristic institution of the age was the modern publicly held corporation. The second stage required the legal system to develop stable relationships between professional managers and public investors, ostensibly aimed at keeping the former accountable to the latter, but also at placing full control of business decisions in the managers’ hands. A major legal correlate was the enactment of the federal securities laws during the Depression. The scholarly creation of the second stage [564] was the modern conception of corporation law, which focuses on the relationships of corporations and their fiduciaries to public security holders. Its golden period began with Louis Loss’ brilliant treatise on Securities Regulation. The third stage of capitalism has been growing since the beginning of this century, and probably reached young adulthood in the 1960s. It is the age of the portfolio manager, and its characteristic institution is the institutional investor, or financial intermediary. As the second stage split entrepreneurship into ownership and control, and professionalised the latter, so the third stage split ownership into capital supplying and investment, and professionalised the investment function. The phenomenal growth of professional investment management was identified, highlighted, and studied in the Securities and Exchange Commission’s monumental Institutional Investor Study, and it was subjected to legal analysis in the next decade by writers such as Bines, Clark, Frankel and Pozen. The increasing separation of the decision about how to invest from the decision to supply capital for investment is one of the most striking institutional developments in our century. Since 1900, the proportion of savings channelled through financial intermediaries has grown steadily, and about 123 62

W J Baumol, The Stock Market and Economic Efficiency (1965), pp 3-4. [2.160]

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The Four Stages of Capitalism: Reflections on Investment Management Treatises cont. 80 cents of every dollar saved now finds its way to some intermediary. Concomitantly, the role of financial intermediaries [565] in the major financial markets has increased. Consider all financial claims (stocks, bonds, and other debt instruments) against ultimate users of capital funds (governments, corporations, and home buyers). Since World War II, the proportion of such claims held directly by individual investors or “households” has significantly decreased, and the proportion held by financial intermediaries (banks, thrift institutions, insurance companies, pension plans, and investment companies) has increased. The relative volume of trading in financial claims by individuals and institutions shows a similar, even stronger, trend. The institutionalisation of the major American stock exchanges is only part of the phenomenon; equally important is the large role played by institutional investors in the other major kinds of capital markets – those for corporate bonds, governmental securities of various types, and home mortgages – and the growth of financial intermediation in the rest of the capitalist world. Can the fourth stage be predicted? It can, for it is already discernible in its infancy. One fumbles for an apt label, but perhaps it could be called the age of the savings planner. Just as the third stage split the capital ownership function into the decision to supply capital funds and active investment management, and professionalised the latter, so the fourth stage seems intent upon splitting capital supplying into the possession of beneficial claims and the decision to save, and profes- [566] sionalising the savings-decision function. Today, decisions about whether and how much to save are increasingly being made by group representatives on behalf of a large number of group members, rather than by each individual whose present consumption is being deferred in favour of future consumption. The objective signs of this change are the steadily increasing predominance of group over individual health and life insurance policies, and the rapid growth since World War II of employee pension plans, especially as compared to the relative stagnancy of the individual annuities business. Today, the decision to save is only indirectly controlled by many of the workers who are to benefit from these plans (which can no longer accurately be described as “fringe” benefits), just as the decision to invest in particular financial claims is only rarely controlled by public suppliers of capital to financial intermediaries. And those new professional savings planners – for example, the sponsors and administrators of large corporate pension plans – rarely perform the active investment function. Most pension plan sponsors and administrators contract with outside bank trust departments, insurance companies, and in- [567] vestment advisory firms for investment management services. The characteristic role players of the fourth stage are the corporate officers and union representatives who bargain over employee benefit plans. But crucial roles are also played by the financial intermediaries’ officers who market benefit packages to such plans (and who differ from the financial intermediaries’ portfolio managers), and the governmental decision makers who shape social security policy and devise legal subsidies to private employee benefit plans. The phenomenon of group saving decisions was foreshadowed by the Social Security Act 1935 (US), and its larger scope has been identified and analysed by Peter Drucker in his insightful book, The Unseen Revolution: How Pension Fund Socialism Came to America. (One can question the aptness of the term “socialism”, however.) … [E]ach shift from one stage to the next is marked by two features: increased division of labour, [568] and increased participation in the fruits of capitalist enterprise. Each later stage splits off and professionalises a certain analytically distinct aspect of the capital-mobilising process, and creates a set of institutional arrangements that make it practical for a significantly greater portion of the population to share in capital income. If by “capitalists” we mean only those who have a direct or indirect claim on capital income, then in the first stage the capitalists are a very small, elite group of wealthy persons. Stage two capitalists comprise a much larger, but still rather distinctly upper class group of public security holders: though there are, perhaps, about 25 million individual shareholders in the United States, over half in value of the corporate stocks and bonds owned by individuals (or trusts, estates, and so forth) are owned by the top 1% of such investors. Stage three capitalists include all bank and thrift institution depositors and insurance company policy holders, a vast group (many of whom, however, possess only very small claims). Stage four capitalists include all participants and beneficiaries in employee benefit plans. They now constitute a significant portion of the population and their investment claims are substantial. [2.160]

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The Four Stages of Capitalism: Reflections on Investment Management Treatises cont. But this sharing, or potential sharing, of the benefits of capitalist enterprise has been accompanied by an ever greater concentration of important discretionary powers in the hands of professional managers and group representatives. Increased sharing in benefits and decreased sharing in power: one wonders whether any of the early commentators on capitalist enterprise, from Adam Smith to Karl Marx, correctly anticipated that this would be the evolutionary pattern of the capitalist system.

Share ownership patterns in listed companies [2.165] Who are the owners of shares in Australian listed companies? What do we know about the distribution of control within these companies? These questions bear upon the issues posed by Clark as to the evolution of capitalist investment modes.

Individual participation in stock markets [2.170] A national survey of listed company share ownership in 2014 indicated that 36% of

adult Australians owned quoted shares directly (that is, personally held shares in stock exchange listed companies or through a self-managed superannuation fund) or indirectly through unlisted professionally managed investment funds such as equity trusts. 124 These figures do not include share ownership interests held through superannuation funds that are not self-managed funds; if these interests were included, the share ownership figure would be much higher in view of the Australian system of compulsory occupational superannuation. 125 The figure also takes no account of interests in the 99.9% of Australian companies that are not listed on a securities exchange. There was a pronounced increase in the extent of individual (or personal) share ownership in Australia during the 1990s, reflecting the then privatisation of government business enterprise which saw the Commonwealth Bank of Australia, Telstra and State government insurance offices transferred to private ownership, and the demutualisation of the Australian Mutual Provident Society. Many Australians acquired shares directly in this period for the first time. From 1999 to 2004 the aggregate figure for direct and indirect share ownership in listed companies was above 50% but has been declining since this peak. Again, this figure does not include indirect investment through the most common forms of occupational superannuation. Despite this recent decline, the incidence of direct personal share ownership in Australian companies remains high by international standards. 126

Distribution of share ownership in listed companies [2.175] How significant is this level of personal or individual shareholding in listed Australian

companies? Who holds shares in companies listed upon ASX and in what proportions? Statisticians sometimes divide shareholders into three investor classes: 124 125

Australian Securities Exchange, Australian Share Ownership Study (2015). The introduction of the Superannuation Guarantee Charge from 1992 stimulated the growth of occupational superannuation. The charge applies to employers who fail to contribute a prescribed level of contributions to complying superannuation funds on behalf of their employees. The charge is part of a complex of measures designed to ensure that a proportion of the salaries of Australian workers is invested in superannuation funds, whether under an industry-wide scheme involving a number of employers, a corporate scheme established by a company for its own staff, a retail fund offered by a large financial institution to the public, or a public sector scheme. Superannuation funds invest a significant portion of their funds in equities in view of the long-term nature of their members’ interests. Self-managed superannuation funds are the largest category by asset value (31%) followed by retail (27%), industry (19%) public sector (16%) and corporate funds (4%): Australian Prudential Regulation Authority, Statistics, Quarterly Superannuation Performance (June 2012), p 5.

126

Australian Securities Exchange, Australian Share Ownership Study (2015), p 49.

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[2.165]

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• households: direct individual investors including through self-managed superannuation funds; • domestic institutional investors: households’ indirect shareholdings through other superannuation and managed investment funds, and holdings by authorised deposit-taking institutions (principally banks) and insurance companies; and • foreign investors. In Australia, the principal category of domestic institutional investors, are professional investment managers (including insurance companies) and superannuation funds. Along with other financial institutions, institutional investors attract household savings, whether voluntary or as compulsory employment-related superannuation contributions, for investment under professional management. Investment may be undertaken by the funds management arm of the financial institution itself, as in the case of the large insurance companies and financial conglomerates such as AMP Capital, MLC, Westpac, AXA and ING. 127 Alternatively, it may be delegated to an external investment fund manager, including another investment institution. Most Australian superannuation funds outsource their investment decisions to external fund managers at least with respect to some portion of their funds. It is estimated that domestic institutional shareholders and foreign shareholders each hold around 40% of Australian quoted shares. 128 The balance is held by households. It is estimated that about two-thirds of foreign holdings are held by investment institutions such as United States pension (superannuation) funds or mutual funds (professionally managed investment funds) such as Fidelity Worldwide Investments and BlackRock Investment Management. 129 Accordingly, about two-thirds of quoted Australian shares are in institutional investor hands. The share ownership holdings by Australian institutions have traditionally been slightly lower than the proportions held by their counterparts in the United States and the United Kingdom. How do these holdings translate at the level of the individual company? Stapledon examined the disclosure of entitlements by substantial shareholders in Australian companies in ASX’s All Ordinaries Index in 1996. The index comprises the top quarter of listed Australian companies by market capitalisation and turnover. A substantial shareholder is one who is entitled together with their associates to rights in relation to voting or disposal of 5% of the voting shares in a listed company. Shareholdings in Australian listed companies were not evenly distributed between investors but concentrated in fewer hands: 130 1.

Ninety seven per cent of index companies had a substantial shareholder.

2.

Institutional investors were the largest or only substantial shareholder in 34% of the index companies in 1996 (up from 24% in 1993). The six largest institutions had the majority of substantial shareholdings.

127

The banks have external fund management arms which manage the investment of superannuation funds and funds of other investors as distinct from the proprietary investment and trading of the bank’s own financial assets.

128

S Black & J Kirkwood Reserve Bank of Australia Quarterly Bulletin(September Quarter 2010); G Stapledon, “The Development of Corporate Governance in Australia” in C Mallin (ed), Handbook on International Corporate Governance (2nd ed, 2011), p 330 (domestic institutional shareholders held 36% and foreign shareholders 42% in 2009).

129

Stapledon, p 336.

130

G P Stapledon, “Australian Sharemarket Ownership” in G R Walker, B Fisse & I M Ramsay (eds), Securities Regulation in Australia and New Zealand (2nd ed, 1998), pp 250 (Tables 5 & 7) and 253-254. [2.175]

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3.

Of the remaining 63% of companies, the substantial shareholders were either founding families, entrepreneurs, overseas companies or other Australian listed companies. In 33.5% of these companies, the largest or only substantial shareholder held 30% or more of the shares, in 11.5% it held between 20 and 30% and in 18% it held between 5 and 20%. In United States and United Kingdom listed companies, there are proportionately lower levels of inter-corporate and family holdings than those found in Australia and consequently more evenly dispersed, atomistic holdings: see [2.190]. The locus of corporate control [2.180] After looking at the pattern of share ownership in listed companies, it might seem

strange to ask separately where control of those companies lies. However, as we saw in Clark’s article, there is a complex relation between ownership and control of the corporation. Of course, to describe the bundle of rights that shareholders possess collectively as making them “owners” of the corporation is to beg an important question. This is so since the asserted status of shareholders as owners is sometimes used to ground normative claims to the primacy of their interests in the corporation. While the term “ownership” may be apt at the level of metaphor, it is important to be sensitive to whether the rights that shareholders enjoy are accurately described as making them owners of the corporation as distinct from owners of the shares themselves. With this caveat, the term “ownership” is used here to describe the position of shareholders as a group in relation to the corporation. We consider the aptness and content of the term at [2.220].

The managerialist hypothesis [2.185] In the United States, from the late 19th century technological developments enabled

great economies of scale to be achieved in business production and distribution, assisted by a single national market without internal barriers to competition. 131 The finance for this level of business operation was beyond the resources of all but the wealthiest entrepreneurs. Capital was raised through public markets from scattered investors typically with modest individual investments. In a related development, a new group of professional managers emerged to co-ordinate the internal processes necessary for these large-scale operations. These two elements produced the distinctive modern character of the large public corporation that emerged in England and Australia also, although not in Europe and other economies: see [2.190]. In 1932 Adolf Berle and Gardiner Means published The Modern Corporation and Private Property, arguably the most influential single work in corporate law. To this United States study is traced the insight that, for many large public corporations, those who own do not control the corporation and, conversely, those who control the corporation do not have significant ownership interests in it. 132 This thesis on the divorce of corporate ownership from control prompted a critical reassessment of the conventional wisdom on the nature of property 131 132

66

M J Roe, Strong Managers, Weak Owners: The Political Roots of American Corporate Finance (1994), pp 3–4. The insight did not spring newborn from Berle and Means but enjoyed a wide currency during the 1920s; see the still stimulating accounts in Thorstein Veblen, Absentee Ownership and Business Enterprise in Recent Times (1923), William Z Ripley, Main Street and Wall Street (1927) and Louis D Brandeis, Other People’s Money (1914). However, the statistical detail marshalled by Berle and Means and the force of their analysis have overshadowed these sources and identified the insight with The Modern Corporation and Private Property. For a critical analysis of the enthusiastic contemporary reception given to Berle and Means by “lawyers (and other amateurs)” and economists, see G J Stigler & C Friedland (1983) 26 J Law & Econ 237. For an Australian study employing similar methodology and producing broadly similar results, see M Lawriwsky, Ownership and Control of Australian Corporations (1978). [2.180]

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rights inhering in corporate share ownership, the social role and responsibilities of the large corporation, the legitimacy of corporate power and the accountability of those who wield it. Berle and Means examined the largest 200 non-financial corporations in the United States (primarily industrial corporations). They adopted the following definition of “control”: Since direction over the activities of a corporation is exercised through the board of directors, we may say for practical purposes that control lies in the hands of the individual or group who have the actual power to select the board of directors (or its majority) either by mobilising the legal right to choose them – “controlling” a majority of the votes directly or through some legal device – or by exerting pressure which influences their choice. Occasionally a measure of control is exercised not through the selection of directors, but through dictation to the management, as when a bank determines the policy of a corporation seriously indebted to it. 133

With this definition they identified five major control types. These types and their incidence within the sample were as follows: 1. Private ownership (that is, control through almost complete ownership): Corporations under this form of control represented 6% by number and 4% by wealth of the sample. 2.

Majority control (that is, control through ownership of a majority of issued capital): 5% by number and 2% by wealth of the sample.

3.

Control through a legal device: In 21% by number and 22% by wealth, control of the corporation was secured through a legal device without ownership of a majority of capital. The devices included pyramiding (corporation A holding a majority of the capital of B which holds a majority of C and so on), the use of non-voting shares and shares with weighted voting rights and the voting trust (trustees having full voting power with respect to shares committed to the trust). (The latter device is almost unknown in Australia but other devices such as a “pooling” agreement among shareholders may achieve a similar result.) 134 Each of these three control species (viz, (1), (2) and (3)) derives from the controllers’ ability to muster an ordinary resolution at a general meeting of the company although the proportion of voting power at the controllers’ command may vary significantly. In the two remaining control types – minority control and management control – the legal nexus between corporate ownership and control has been severed. Here “control is more often factual [that is, not resting upon legal right] depending upon the strategic position secured through a measure of ownership, a share in management or an external circumstance important to the conduct of the enterprise”. 135 It was these two modes of control, Berle and Means concluded, which characterised the large publicly held United States corporation. 4. Minority control: Such corporations represented 23% by number and 14% by wealth of the sample. 5.

Management control: Such corporations represented 44% by number and 58% by wealth of the sample. 136 Where does management derive power to select the board in this fifth type where shareholdings are so widely distributed that no individual or small group has an interest sufficient to dominate company affairs? Berle and Means offered this response: 133

A Berle & G Means, The Modern Corporation and Private Property (revised ed, New York, 1968), p 66.

134 135

For a fuller discussion of these control distribution devices see F H O’Neal, Close Corporations (1971), Ch 5; M A Pickering (1965) 81 LQR 248 and at [5.195]. Berle & Means, p 74.

136

For the incidence of the control types in the sample, see Berle & Means, pp 84-110. [2.185]

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To answer this question, it is necessary to examine in greater detail the conditions surrounding the electing of the board of directors. In the election of the board the stockholder ordinarily has three alternatives. He can refrain from voting, he can attend the annual meeting and personally vote his stock, or he can sign a proxy transferring his voting power to certain individuals selected by the management of the corporation, the proxy committee. As his personal vote will count for little or nothing at the meeting unless he has a very large block of stock, the stockholder is practically reduced to the alternative of not voting at all or else of handing over his vote to individuals over whom he has no control and in whose selection he did not participate. In neither case will he be able to exercise any measure of control. Rather, control will tend to be in the hands of those who select the proxy committee by whom, in turn, the election of directors for the ensuing period may be made. Since the proxy committee is appointed by the existing management, the latter can virtually dictate their own successors. Where ownership is sufficiently subdivided, the management can thus become a selfperpetuating body even though its share in the ownership is negligible. This form of control can properly be called “management control”. 137

Legal developments contributed to the centralisation of power within corporate management. The American legal historian James Willard Hurst has summarised these developments over the past two centuries: 138 Corporation law early favoured business arrangements which centralised decision making, gave it considerable assurance of tenure, and armed it for vigorous manoeuver. Shareholder decisions, it was soon established, should normally be by simple majority. Active management should be concentrated in a board of directors; stockholders did not have owners’ rights over the particular assets of a going corporate enterprise; unless exhibiting gross abuse of power or breach of faith, directors’ decisions governed the regular course of the business. Continuity was important to effective organisation. Insofar as law could contribute to an undisturbed flow of operations, it favoured strong central direction of pooled assets; capacity for indefinite life, uninterrupted by change of shareholders, was an enterprise-continuity value peculiar to the corporate form. A board of directors must do its business as a body, not as individuals. But – in significant departure from common law injunctions that agents might not delegate their roles – for ready dispatch of business a corporate board might designate officers and agents for the firm’s business and might even turn over interim decision making in the regular course of dealings to an executive committee of its membership.

The mixture of dispersed and concentrated share ownership systems [2.190] The United States model of widely dispersed share ownership is not the global norm;

on the contrary, outside North America it is the dominant ownership form only in the United Kingdom and, as noted at [2.175], to a lesser extent in Australia. In most other countries the dominant model of large business is one of concentrated ownership with non-financial corporations typically having a controlling shareholder or blockholder group. 139 These corporations are not so dependent upon public capital markets which are correspondingly less developed than in the United States and the United Kingdom; in blockholder systems, corporations look instead for finance to banks, other corporations or private capital sources. Corporate law’s project differs in each system. Under the dispersed ownership model, legal regulation seeks to assure investor confidence in securities market integrity; its enduring challenge is the problem of shareholder passivity and the absence of incentives to monitor management and hold it accountable. In concentrated ownership systems, law’s primary task 137

138

Berle & Means, pp 80, 82. Although Australian companies have not adopted the proxy committee referred to by Berle and Means, the operation of the proxy mechanism is not, however, radically different in the two countries: see [6.85]. The Legitimacy of the Business Corporation (1970), p 25.

139

R La Porta et al 54 J Fin 471 (1999); R La Porta et al 58 J Fin Econ 3 (2000).

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[2.190]

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is more the protection of minority shareholders against the temptation for the controller to run the corporation in its own interest at the expense of the minority. It seems that law matters and explains ownership structure even if its effects are only partially understood. Thus, the dispersed model produces, or permits, weak owners along with strong managers; weak regulation requires strong owners. There is a strong debate as to whether economic globalisation, particularly the integration of capital markets, is inevitably and rapidly producing convergence in ownership models, largely based upon the Anglo-American model. 140 In opposition, however, are the persistent forces in each country of its financial structure, its particular distribution of private capital and its politics, history and cultural tradition. The path dependency of law – law’s growth from, and debt to, the particular culture, history and institutions of a country – reflects the claims of social experience and shared values. Law matters, but so does society. 141

The control implications of institutional share ownership [2.195] These studies of the distribution of corporate ownership and control typically relate

to Clark’s second stage of capitalism’s evolution in the United States. To what extent are they overtaken by later stages marked by the rise of financial intermediaries? Do these stages displace the prerogatives of corporate management and the assumed functions of corporate law and regulation? From the Berle and Means study we derive the notion that dispersed shareholders in publicly traded companies lack adequate incentive to exercise ownership rights. This conclusion has spawned theories of the corporation which focus upon mechanisms whereby corporate managers may be made accountable to shareholders in substance and not merely form: see [2.210]. To what extent, however, has the increasing institutionalisation of share ownership affected the capacity and inclination of shareholders to play a monitoring role with respect to corporate management? Has institutionalisation restored equilibrium between corporate ownership and control? Since they are liquid assets, shares in publicly held corporations take on an impersonal character. These liquidity gains, however, may diminish shareholder controls over management, the loss reflecting the different logic of individual and collective action. 142 At the level of individual utility, for a dissatisfied shareholder exit through the stock market will usually be far easier than exercising the protective remedies of company law, the exercise of voice. 143 The logic of individual utility is sometimes expressed in the Wall Street rule under which it is assumed that a shareholder who is unhappy with a company’s performance will simply sell the shares. Its logic arises since the gains from shareholder agitation will be public goods, enjoyed by all shareholders. The individual shareholder derives benefits from 140

See H Hansmann & R Kraakman “The End of History for Corporate Law” (2001) 89 Geo LJ 439 (its title invokes Francis Fukuyama’s thesis that the contest between liberal democratic and other political governance systems has been conclusively resolved in favour of the former; the article’s thesis is not strengthened by the Enron and related collapses that followed shortly after its publication) and contra M Welsh et al, “The End of the ‘End of History for Corporate Law’” (2014) 29 Australian J Corporate Law 147; J C Coffee (1999) 93 Nw U L Rev 641; L A Cunningham (1999) 84 Cornell L Rev 1133; B R Cheffins (1999) 10 Duke J Comp & Int’l L Rev 5; E B Rock (1996) 74 Wash U LQ 367; for a more sceptical view see D M Branson (2001) 34 Cornell Int’l LJ 321.

141

142

L Bebchuk & M J Roe (1999) 52 Stanford L Rev 127; M J Roe, Political Determinants of Corporate Governance: Political Context, Corporate Impact (2003); J N Gordon & M J Roe (eds), Convergence and Persistence in Corporate Governance (2004). See generally M Olsen, The Logic of Collective Action: Public Goods and the Theory of Groups (1971).

143

See A O Hirschman, Exit, Voice and Loyalty (1970). [2.195]

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expenditures on monitoring and enforcement but only in proportion to her or his interest in the company. Other shareholders who bear none of the costs of monitoring and intervention also share the benefits. 144 Institutional share ownership puts enormous investment power in the hands of a relatively small number of fund managers. Where shares are held by a fund manager, the standard investment management agreement generally assigns voting rights attached to the shares to the fund manager. The calculus of advantage under the Wall Street rule appears profoundly different for them since the costs of organising collective action by institutional shareholders should be lower (bigger holdings and fewer holders with superior monitoring skills) and the benefits of exit diminished (institutions’ holdings are often large so that their disposal depresses the price for the security). This carries the prospect, therefore, that the institutions will be forced to monitor management in their own interest and indirectly to the advantage of shareholders generally, by informed voting in company meetings or through informal discussion with senior management. In practice, however, there are powerful disincentives against institutional shareholders monitoring investee companies. First, in most jurisdictions including Australia there is no explicit requirement upon institutional shareholders to vote shares which have been committed to their management. 145 Second, investment institutions are under intense performance review pressure from those (such as trustees of superannuation funds) who have committed funds to their management usually under an investment mandate of modest duration which the investment manager will wish to have renewed; short-term performance is, therefore, continuously on the line relative to that of competitor fund managers. Third, in a small investment community such as Australia there are numerous financial relationships with fund sponsors, clients and investee companies which may inhibit direct intervention for poor performance or too close an examination of portfolio company management. 146 Fourth, the gains from institutional monitoring and intervention are shared with other shareholders who bear none of the expenditure of effort and cost. While Australian institutions deny that this free-rider problem is a disincentive to activism, the infrequency of intervention belies this disavowal. 147 Trends in institutional investment theory and practice also militate against the impulse to improve portfolio company performance or governance. As in the United States, the efficient capital market hypothesis has considerable influence among Australian fund managers. This hypothesis assumes that stock markets work efficiently to impound quickly into the price of a security all available information affecting its value. The logic of the hypothesis is that over the medium and long-term fund managers cannot “beat” the market by active trading and that 144

This construction of the collective action problem is not without its critics: see, eg, B S Black (1990) 89 Mich L Rev 520. In private companies, where shareholders do not have such an exit, the protective structures and remedies of company law may assume far greater significance. (Company law addresses distinct problems for the different types of corporation.)

145

On the source and nature of the legal obligation, if any, of institutional shareholders to participate in corporate governance by exercising the voting rights attached to shares see J J Spigelman (2010) 28 C&SLJ 235. For evidence that such potential conflicts of interest discourage intervention see I Ramsay, G Stapledon & K Fong, Institutional Investors’ Views on Corporate Governance (Research Report, Centre for Corporate Law and Securities Regulation, University of Melbourne, 1998), pp 36–38; for United States analogues see A F Conard (1988) 22 U Mich J L Rev 117 at 143; M A Eisenberg (1989) 89 Colum L Rev 1461 at 1476; see also J A Brickley, R C Lease & C W Smith (1994) 1 J Corp Fin and (1988) 20 J Fin Econ 267, cited in Ramsay, Stapledon & Fong, p 37. In addition, fund managers are sometimes heard to complain, usually on a “not for attribution” basis, that the threat or prospect of being squeezed out of access to information is a powerful inhibitor of close monitoring and intervention in investee companies.

146

147 70

Ramsay, Stapledon & Fong, pp 34–36, 40–41. [2.195]

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comparable returns can be achieved, at lower cost, by simply “holding” the market, that is, by holding an investment portfolio whose composition matches that of the stock market as a whole or the desired subset of that market, usually the largest “blue chip” companies. Monitoring individual companies within such a broadly diversified portfolio, even if feasible, would squander the transaction cost savings of indexed investing. Hence, in the United States collective action by institutional investors has largely been directed towards improving the corporate governance system generally, rather than intervention in individual companies. Thus, action has often been directed to opposition to the adoption of defences against takeovers, encouraging the adoption by corporations of confidential proxy voting and measures to strengthen board independence from management, and to express concern at levels of executive remuneration or its lack of connection with performance. 148 Commonly, this system-level focus is justified on the ground that investment institutions lack the skills to second-guess firm-level decisions such as a company’s business strategy or its choice of senior management personnel. 149 There are fewer legal obstacles to joint activity by investment institutions in the United Kingdom although there are clearly economic and other barriers to institutional activism: [There is] a reluctance of even large shareholders to intervene, based on imperfect information, limited institutional capacities, substantial coordination costs, the misaligned incentives of money managers, a preference for liquidity, and the uncertain benefits of intervention. 150

While the incidence of institutional activism is generally higher in the United Kingdom, it is still relatively infrequent. 151 In the United Kingdom, as in the United States and Australia, it is extremely rare for an institution to propose its own candidates for election to the board of an investee company and not much more common to remove poorly performing directors. The UK Stewardship Code was introduced in 2010 in response to the 2008 financial crisis and the observation in an official review of the banking industry that institutional shareholders had failed to engage adequately with investee banks to address their excessive assumption of debt. 152 The Code operates, as many voluntary corporate governance codes do, on a “comply or explain” basis, that is, firms need not comply but at the cost of explaining departure from some or all of its provisions: see [5.25]. Its core principles include a commitment to monitor

148

149

R Romano (2001) 18 Yale J on Reg 174. In the United States, institutional investor activism varies with investment fund type. The most active investor group, at least as measured by shareholder proposals put to company general meetings, are religious groups and university endowment funds, followed by public pension funds, university staff pension funds and union pension funds. Mutual funds (the managed investment funds offered publicly to investors) are the least active institutional investors: at 175–176. Thus, as noted, institutions have been active in opposing the introduction into corporate constitutions of poison pills and other impediments to hostile takeovers (which are seen as threatening performance gains) and have proposed measures to improve the general structure of company boards such as mandatory requirements for independent directors: see R J Gilson & R Kraakman (1991) 43 Stan L Rev 863 at 867–876. The monitoring capacity and disposition of financial institutions is discussed in B S Black (1992) 39 UCLA L Rev 811; J C Coffee (1991) 91 Colum L Rev 1277; E B Rock (1991) 79 Geo L Rev 445; M J Roe (1991) 139 U Pa L Rev 1469; M J Roe (1991) 91 Colum L Rev 10; M J Roe (1990) 27 J Fin Econ 7.

150 151

B S Black & J C Coffee (1994) 92 Mich L Rev 1997 at 2086. Over several decades United Kingdom financial institutions have responded to unsatisfactory management performance or conduct by portfolio companies, by individual or collective action. Where it has occurred, management intervention is usually unobtrusive, private and marked by a preference for the velvet glove. For accounts of such interventions, see G P Stapledon, Institutional Shareholders and Corporate Governance (1996).

152

A Review of Corporate Governance in UK Banks and Other Financial Industry Entities (Walker Report) (2009), 5.10–5.13. [2.195]

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investee companies and to establish guidelines on how they will escalate activity to protect or enhance shareholder value. Most major UK investment institutions have subscribed to the Code. Industry best practice recommendations have also provided guidance on institutional shareholder responsibilities in Australia, from the Financial Services Council which represents funds management businesses and the Australian Council of Superannuation Investors (ACSI) representing superannuation funds. Both organisations call on superannuation funds and investment managers to vote equity holdings, engage with investee companies, and promote consideration of environmental, social, and governance (ESG) considerations in investment decisions. 153 Superannuation funds are increasingly pressing their external investment managers to vote shares and engage with investee companies more actively; some trustees say that they have regard to an investment manager’s corporate governance record when awarding investment mandates. Australian investment institutions are strongly represented among signatories to the United Nations Principles for Responsible Investment – in 2013, 125 out of 1169 signatories worldwide were Australian institutions. The UN Principles encourage institutional investors to incorporate ESG considerations into investment decisions and behave as active owners. On the other hand, superannuation trustees are necessarily concerned with investment performance relative to selected benchmarks; some Australian fund managers, it is claimed, rarely ask questions on long-term sustainability and corporate governance matters because their superannuation clients focus mostly on their near-term performance. 154 As noted, most superannuation funds delegate voting to external investment managers. 155 Although ACSI encourages its superannuation fund members to pressure their external investment managers to vote shares, it is not clear how many funds other than the larger ones have the resources to monitor the corporate governance practices of their mandate holders. Most investment firms rely on external proxy voting advisers when deciding how to vote: see [6.85]. The introduction of a requirement for an advisory vote on the remuneration report at the annual general meetings of listed companies has stimulated greater institutional shareholder engagement with investee company boards and management in this area at least: Australian investors have been among the most aggressive adopters of the “say on pay” mechanism introduced in the UK, US and Australia: see [7.405]. 156 Despite the recent surge of institution shareholder activism in engagement and voting, arguably the most dramatic instances of Australian institutional activism are in the not so recent past. Consider three examples. In 2002 Australian institutions supported the removal of a dominant shareholder from the then Coles board and its reconstitution to ensure a majority of members independent of management and without supply relationships with the firm. Second, in 2004 when the media conglomerate News Corporation announced its intention to 153

154 155

156 72

Australian Council of Super Investors, A Guide for Superannuation Trustees to Monitor Listed Australian Companies (2011); A Guide for Superannuation Trustees on the Consideration of Environmental, Social & Corporate Governance Risks in Listed Companies (2009); A Guide for Fund Managers and Consultants on the Consideration of Environmental, Social & Corporate Governance Risks in Listed Companies (2009); Financial Services Council, FSC No 20: Superannuation Governance Policy (March, 2013); see also the earlier Investment and Financial Services Association, Blue Book on Corporate Governance (2009) to be replaced by the successor Financial Services Council’s standards. OECD, The Role of Institutional Investors in Promoting Good Corporate Governance (2011), p 78. There is a complex division of labour in large superannuation funds. Investment of the funds is assigned to the fund managers, mostly external, whom the trustees appoint; ownership of equity and debt securities in trust funds is assigned to specialist custodians; an administration company usually handles routine fund administration; the trustees’ specific role (legal responsibilities and duties aside) might fairly be described as the governance of the fund. On the structure of superannuation funds and fund managers generally, see P Ali, G Stapledon & M Gold, Corporate Governance and Investment Fiduciaries (2003), pp 21–27. OECD, p 83. [2.195]

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transfer its domicile from South Australia to Delaware in the US, Australian institutional investors extracted agreement for enhanced shareholder rights beyond those granted under Delaware law as a condition of their support, and enforced the agreement two years later when News threatened to act in breach. 157 Third, institutions led the shareholder rejection of a heavily leveraged (debt funded) takeover bid for Qantas in late 2007 which, if successful, would have threatened the company’s solvency in the financial crisis that followed shortly after. However, in the United States, empirical evidence suggests that institutional intervention has not had a universally positive effect on firm performance; neither is there strong evidence of correlation between firm performance and the proportion of institutional ownership of the firm. 158 However, those initiatives that are clearly positive for shareholder value, such as the removal of defences against hostile takeovers, may be associated with share price increases. 159 Some argue that institutional investor activism has positive effects upon corporate culture and thereby improves corporate performance generally 160 although others take a more sceptical view as to such efficiency gains. 161 The extent of any such general effects is not easily susceptible to reliable assessment.

CORPORATE GOALS AND SOCIAL RESPONSIBILITIES Positions and practices [2.200] If the managerialist hypothesis of Berle and Means is sound (see [2.185]), and managers in many large corporations are effectively free of close shareholder control, how do they define corporate goals? Liberated from the claims of strong owners, do they substitute other priorities – of their personal interests, the corporate organisation or of society? This question is essentially empirical. A second question is normative – what goals ought corporate managers (if blessed with a discretion to do so) adopt in discharge of their and the corporation’s social responsibilities? Are those responsibilities best discharged by strict profit maximisation, unremitting social amelioration or some intermediate position between these two extremes? A third cluster of questions, of course, is doctrinal – what interests does the law enjoin directors to serve and what limits does it set to corporate altruism? We examine these doctrinal questions in Chapter 7, and simply note here in passing that corporate interests are identified with the collective interests of shareholders and only derivatively (if at all) with those of the community, consumers or employees. Although directors and managers have discretion as to the means by which the goals of profit maximisation and shareholder value are to be achieved, they are not free to act for fundamentally different ends and purposes. However, as a social as well as an economic institution, the corporation must comply with the law and may respect ethical considerations and public welfare claims within limits recognised for the responsible conduct of business.

157

See J G Hill (2010) 63 Vand L Rev 1.

158

B S Black, “Shareholder Activism and Corporate Governance in the United States” in P Newman (ed), The New Palgrave Dictionary of Economics and the Law (1998), pp 459, 462–464.

159

R Romano (2001) 18 Yale J of Reg 174 at 195–201. However, there is little or no evidence of positive performance effects from initiatives with respect to board composition, executive remuneration and confidential voting whose performance relevance is less direct: at 191–195, 201–209.

160 161

J N Gordon (1997) 31 U Richmond L Rev 1473. See, eg, Black & Coffee at 2086–2087. [2.200]

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The corporate social responsibility debate (as discussion of the second issue is often called) was, appropriately enough, stimulated by research for The Modern Corporation and Private Property. In 1931 Berle published a draft chapter in the Harvard Law Review. In this article he asserted: It is the thesis of this essay that all powers granted to a corporation or to the management of a corporation, or to any group within the corporation, whether derived from statute or charter or both, are necessarily and at all times exercisable only for the ratable benefit of all the shareholders as their interest appears. 162

E Merrick Dodd of Harvard Law School immediately took issue. His response is a classic statement of the managerialist ethic. He said: That the duty of the managers is to employ the funds of the corporate institution which they manage solely for the purposes of their institution is indisputable. That that purpose, both factually and legally, is maximum stockholder profit has commonly been assumed by lawyers. That such is factually the purpose of the stockholders in creating the association may be granted. Nevertheless, the association, once it becomes a going concern, takes its place in a business world with certain ethical standards which appear to be developing in the direction of increased social responsibility. If we think of it as an institution which differs in the nature of things from the individuals who compose it, we may then readily conceive of it as a person, which, like other persons engaged in business, is affected not only by the laws which regulate business but by the attitude of public and business opinion as to the social obligations of business. If business is tending to become a profession, then a corporate person engaged in business is a professional even though its stockholders, who take no active part in the conduct of the business, may not be. Those through whom it acts may therefore employ its funds in a manner appropriate to a person practising a profession and imbued with a sense of social responsibility without thereby being guilty of a breach of trust. 163

Berle’s immediate rejoinder was that “you cannot abandon emphasis on ‘the view that business corporations exist for the sole purpose of making profits for their stockholders’ until such time as you are prepared to offer a clear and reasonably enforceable scheme of responsibilities to someone else”. 164 In later years, however, he acknowledged a shift in public opinion towards recognition of community claims and came to believe that the argument had been settled in favour of Dodd’s contention. It is not clear, however, whether this reflects an accurate assessment of the then state of legal doctrine as distinct from social sentiment. 165 Indeed, by the 1950s Berle was arguing that American management had been “legitimated on the firing line” – that a corporate conscience had evolved among professional managers sustaining their role as disinterested arbiters of the various claims upon the corporation’s purse. 166 On the other hand, perhaps the pithiest and most enduring contrary statement on the issue is that of the economist Milton Friedman that “the social responsibility of business is to increase its profits”. 167

162

A A Berle (1931) 44 Harv L Rev 1049.

163 164 165

E M Dodd (1932) 45 Harv L Rev 1145 at 1161. A A Berle (1932) 45 Harv L Rev 1365 at 1367. The 20th Century Capitalist Revolution (1954), p 169. It has been suggested that Berle’s concession was motivated by the decision in A P Smith Mfg Co v Barlow 98 A 2d 581 (NJ), appeal dismissed, 346 US 861 (1953), in which the court’s approach was consistent with Dodd’s position although asserted to be in the minority of decided cases: S M Bainbridge, Corporation Law and Economics (2002), p 419. See The 20th Century Capitalist Revolution, Ch 5; see also A A Berle, Power Without Property (1959).

166 167

74

Originally published as M Friedman, “The Social Responsibility of Business Is to Increase Its Profits”, The New York Times, 13 September 1970, Sect 6 (Magazine), p 32. [2.200]

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While this business statesmanship or corporate good citizenship concept has not been without its critics, it has nonetheless received varying degrees of official expression in North America, Britain and Europe. Managerialism stresses that corporate management owes duties to interests beyond the corporation’s formal legal constituents, to “the four parties to industry” – labour, capital, management and the community. Other constituents to whom modern management has expressed a responsibility include government, suppliers and consumers. The managerialist model invests the corporate enterprise with an institutional personality and treats shareholders along with other constituent groups as an interest external to the firm. The management function under the model is the allocation of corporate resources between the competing interest groups to achieve corporate and public goals. Thus, in 1973 the Confederation of British Industry proposed “a general legislative encouragement” for companies “to recognise duties and obligations … arising from the company’s relationships with creditors, suppliers, customers, employees and society at large; and in so doing to strike a balance between the interests of the aforementioned groups and between the interests of those groups and the interests of the proprietors of the company”. 168 There is some expression of the social responsibility idea in the ASX Corporate Governance Principles and Recommendations (ASX Principles) which state that “[a] listed entity should act ethically and responsibly”: Principle 3. In elaborating that principle, the ASX Principles say: “[a]cting ethically and responsibly goes well beyond mere compliance with legal obligations and involves acting with honesty, integrity and in a manner that is consistent with the reasonable expectations of investors and the broader community. It includes being, and being seen to be, a ‘good corporate citizen’”. 169 Second, the ASX Principles address the potential loss of corporate value through loss of reputation and other non-financial capital. Thus, the ASX Principles provide that a listed company “should have a committee or committees to oversee risk” (Recommendation 7.1) and “should disclose whether it has any material exposure to economic, environmental and social sustainability risks and, if it does, how it manages or intends to manage those risks” (Recommendation 7.4). “Material exposure” is defined to mean “the real possibility that the risk in question could substantively impact the listed entity’s ability to create or preserve value for security holders over the short, medium or long term”: Recommendation 7.4 (Commentary). The ASX Principles are not mandatory. However, on the “if not, why not?” principle (equivalent to the UK “comply or explain” principle: see [2.195], [5.25]), the ASX Listing Rules require listed companies to disclose in each annual report the extent to which they have followed the ASX Principles during the reporting period and give reasons for not following them: ASX Listing Rule 4.10.3.

168

Confederation of British Industry, The Responsibilities of the British Public Company (1973), p 9.

169

ASX Corporate Governance Council, Corporate Governance Principles and Recommendations (3rd ed, 2014), Principle 3 (p 19). [2.200]

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What corporate social responsibility might mean (if it were really to matter) [2.205] While definitions abound, 170 including simple notions of corporate social

responsibility (CSR) as mere charitable giving, 171 CSR is generally understood as “the responsibility of enterprises for their impacts on society” 172 and refers to a range of voluntary measures undertaken by companies to integrate social, environmental and business concerns in their operations and their interaction with stakeholders. 173 In this sense, CSR represents a form of enlightened management practice, voluntarily adopted and extending beyond legal obligation because it is seen as being in the long-term interest of the corporation and its shareholders. A leading Australian practitioner describes CSR as “rational, enlightened and self-interested business behaviour”. 174 In its strongest form it is not an optional add-on but is fully integrated into and shapes all aspects of corporate operations. This dominant form of CSR has the advantage of enabling companies to manage the considerable non-financial risks of their operations; it also enables them to meet wider community expectations with respect to their conduct and to protect their “social licence to operate”. CSR initiatives protect firm goodwill or brand name – intangible assets that generally comprise a major part of the balance sheet of any corporation dealing in public product, services or investment markets. CSR also offers strategic social or ethical differentiation from competitors and broad legitimacy in consumer and investor markets and society generally. CSR initiatives have proliferated over the past two decades and it is unusual for a major corporation from a developed country not to have adopted a policy that addresses the negative social and environmental impacts of its operations and those of its supply chain. Most major firms and industries have now promulgated codes of responsible behaviour. It has been estimated that more than 3,000 global firms issue reports on their social and environment performance and that there are more than 300 industry or product codes. 175 Corporate social responsibility is “the tribute that capitalism everywhere pays to virtue.” 176 170

The wording of this heading is derived from the title of an article by C D Stone (1986) 71 Iowa L Rev 557. Stone’s analysis, however, takes a different path and is further developed in “Public Interest Representation: Economic and Social Policy within the Corporation” in K J Hopt & G Teubner (eds), Corporate Governance and Directors’ Liabilities (1985), p 122 and The Social Control of Corporate Behaviour (1976). The literature on corporate social responsibility is both rich and voluminous. Stimulating contributors include B Horrigan, Corporate Social Responsibility in the 21st Century: Debates, Models and Practices Across Government, Law and Business (2010); M A Eisenberg (1998) 28 Stetson L Rev 1 (examining the several guises in which apparently philanthropic conduct may indirectly advance corporate utility); M A Eisenberg (1983–84) 17 Creighton L Rev 1; H J Glasbeek (1988) 11 Dalhousie LJ 33; Lord Wedderburn, “The Legal Development of Corporate Responsibility” in K J Hopt & G Teubner (eds), p 3 (see also the other essays in Chs 1 and 2); (1985) 15 MULR 1 and (1985) 23 Osgoode Hall LJ 203; L S Sealy (1987) 13 Mon L Rev 164; C D Stone, Where the Law Ends (1976), Pt 3; N W Chamberlain, The Limits of Corporate Responsibility (1973). For a valuable bibliography of earlier material see P I Blumberg (1972) 28 Bus Law 1275.

171

A Dahlsrud, “How Corporate Social Responsibility is Defined: an Analysis of 37 Definitions” (2008) 15 Corporate Social Responsibility and Environmental Management 1.

172

European Commission, “A Renewed EU Strategy 2011–14 for Corporate Social Responsibility” (Communication No 681, European Commission, 25 October 2011), p 6.

173

See, eg, Commission of the European Communities, “Corporate Social Responsibility: A Business Contribution to Sustainable Development” (Communication No 347, Commission of the European Communities, 2 July 2002), pp 5–8. Westpac, Submission No 94 to Parliamentary Joint Committee on Corporations and Financial Services, Inquiry into Corporate Responsibility (September 2005), p 15. D Vogel, “The Private Regulation of Global Corporate Conduct” in W Mattli & N Woods (eds), The Politics of Global Regulation (2009), pp 151, 158.

174 175 176

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C Crook, “The Good Company”, The Economist (online), 20 January 2005: http://www.economist.com/ node/3555212; D McBarnet, “Corporate Social Responsibility Beyond Law, Through Law, For Law – The [2.205]

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In these codes, firms make voluntary commitments dealing with labour standards and working conditions, respect for human rights, social and environmental impacts and corruption avoidance. Codes range from initiatives by individual firms, industries and sectors, to those created with wider stakeholder input and some with the further legitimacy of government participation. Other voluntary instruments cover reporting, compliance and verification. These commitments go beyond the firm’s legal obligations; indeed, that is their ostensible purpose – to signify commitment to standards beyond those required by the legal systems of the countries in which they operate. They create a vast governance network of voluntary obligation or “soft law”, embracing most industries and sectors of global business. This is not CSR as philanthropy but rather CSR as avoidance of social and environmental harm and responsiveness to the expectations of stakeholders and the sanctions that may accompany their breach. 177 CSR’s origins were national but the movement has flourished under modern economic globalisation in response to instances of demonstrated governance failure in the global economy. 178 Although voluntary, CSR is socially and economically driven. The pressures to which firms respond are based on social or market-based sanctions, not legal. Code adoption reflects the advocacy capacity of civil society organisations, especially with the “naming and shaming” leverage of global communications technology, to hold firms to standards or societal expectations of conduct. They draw upon the sanctions of concerned consumers, socially responsible investors, and pension funds and other investors also concerned with non-financial risk in long-term investment. Civil society organisations are typically non-profit with a values-based agenda; often they form part of transnational advocacy networks, “activists beyond borders”, 179 partners in the “NGO-industrial complex”, 180 and occupy one corner of a “governance triangle” along with firms and states in this network of international civil regulation. 181 The limits of effective civil society advocacy define the contours of the reputational risk to which CSR responds. 182 While these sanctions are uneven and contingent, for most firms CSR is not a wholly voluntary add-on to business strategy. In response to these developments, one conception of CSR would permit directors to have regard to non-shareholder interests. Another would go further to impose a duty upon management towards parties other than shareholders such as creditors, employees, consumers and the community. 183 Should directors be permitted, or required, to use their powers and corporate funds to advance non-shareholder interests and, if so, within what limits and for what ends? The concern here is not with whether there should be specific legislation protecting

177

New Corporate Accountability” in D McBarnet, A Voiculescu & T Campbell (eds), The New Corporate Accountability: Corporate Social Responsibility and the Law (2007), pp 10–11 (“the institutionalisation of corporate social responsibility as a business issue”). D Vogel, The Market for Virtue: The Potential and Limits of Corporate Social Responsibility (2005), pp 17–24.

178

See P Redmond, “International Corporate Responsibility” in T Clarke & D Branson (eds), The SAGE Handbook of Corporate Governance (2012), pp 588–590.

179

See generally M E Keck & K A Sikkink, Activists Beyond Borders: Advocacy Networks in International Politics (1998).

180 181

See generally G Gereffi, R Garcia-Johnson & E Sasser, “The NGO-Industrial Complex” (2001) 125 Foreign Policy 56. See generally K W Abbott & D Snidal (2009) 42 Vanderbilt Journal of Transnational Law 501.

182

Redmond in Clarke & Branson (eds), pp 595–600.

183

Such duties might be reinforced by mechanisms which secure board-level representation for nonshareholder interests. The German co-determination model for employee representation in company structure is perhaps the most familiar example: see E Bastone & P L Davies, Industrial Democracy: European Experience (1976). [2.205]

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non-shareholder interests. It is simply whether directors should have a licence or a duty to sacrifice shareholder interests for the common good (as directors see it) or for those of third parties when not required by law to do so. The answer to these questions will depend upon perceptions as to the efficiency and equity of markets for the satisfaction of social goals. The questions also expose issues as to the public or private character of corporations, especially publicly held corporations, and of company law itself. Is company law trivial? Why should anyone who is not professionally engaged with the subject care about it? Kent Greenfield offers this answer: The answer is that corporate law determines the rules governing the organisation, purposes, and limitations of some of the largest and most powerful institutions in the world. The largest corporations in the world have the economic power of nations. By establishing the obligations and priorities of companies and their management, corporate law affects everything from employees’ wage rates (whether in Silicon Valley or Bangladesh), to whether companies will try to skirt environmental laws, to whether they will tend to look the other way when doing business with governments that violate human rights. 184

Shareholder primacy [2.206] The commonly accepted purpose of corporate activity and measure of corporate

performance is the maximisation of shareholder value as expressed in the price of the corporation’s shares. Thus, in 1998 the Hampel Committee on corporate governance in the United Kingdom could say that [t]he single overriding objective shared by all listed companies, whatever their size or type of business, is the preservation and the greatest practical enhancement over time of their shareholders’ investment. The pursuit of this objective might require the company to develop relationships with a number of non-shareholder groups but in doing so they must have regard to the overriding objective just identified. 185

The assumption made under this shareholder primacy model is that the duty of management is to maximise the wealth of their principals, the shareholder “owners” of the firm, and that the function of corporate law is to promote that end. The claim for shareholders as owners is usually justified upon the grounds of • their role as ultimate risk bearers in the firm in that their financial claims as shareholders are generally postponed to those of creditors in the winding up of the company; • their entitlement to surplus income during the firm’s life within limits protective of creditors; this entitlement is said to give them a vested interest in ensuring that resources are used with maximum effectiveness to general societal advantage; and • their usual monopoly of voting rights within the corporation, of the right to sell control of the company through the disposal of their shares, and their monopoly of rights to bring suit for wrongs suffered by the company which it has not sought to vindicate. These and other justifications for shareholder primacy are disputed on several grounds, including the incentive that this model provides for the corporation to externalise (or avoid) the negative effects of its operations (eg, environmental degradation). 186 While some interests 184

K Greenfield, The Failure of Corporate Law: Fundamental Flaws and Progressive Possibilities (2006), pp 4–5.

185

Committee on Corporate Governance, Final Report (London, 1998), [1.16].

186

See, eg, G Kelly & J Parkinson, “The Conceptual Foundations of the Company: A Pluralist Approach” in J Parkinson, A Gamble & G Kelly, The Political Economy of the Company (2000), p 113 (non-shareholder stakeholders are also exposed to residual risk and should be represented in corporate governance structures); D Millon, “Communitarianism in Corporate Law: Foundations and Law Reform Strategies” in L E Mitchell (ed), Progressive Corporate Law (1995), p 4 (bargaining by non-shareholder stakeholders to protect rights is infeasible as a general norm and should not be the true measure of their entitlement under

78

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will be protected by contract or specific protection, it is fanciful to think that all of the costs of corporate operations will be imposed by legislation upon the corporation; there will inevitably be a time lag in legislation and gaps in its reach or enforcement. The incentive arises since, if a company voluntarily assumes social costs that it might effectively externalise, it risks its long-term survival against competitors who do otherwise.

Pluralist (or multifiduciary) models [2.207] One alternative to shareholder primacy is the proposal for a mandatory pluralist

model, creating a multifiduciary duty requiring directors and managers to run the company in the interest of all those with a stake in its success, balancing, one against the other, the claims of shareholders, employees, suppliers, the community and other stakeholders. (Stakeholders are variously defined as those with an interest in or dependence relationship with the company or, alternatively, as those upon whom it depends for its flourishing or survival.) The claims of each stakeholder are recognised as valuable in their own right and no priority is accorded shareholders in this adjustment; their interest may be sacrificed to that of other stakeholders. Pluralist models are sometimes based on a theory of the corporation as community that responds to the harm to which other stakeholders are exposed by a management focus solely upon shareholder interests. Communitarian theories were prompted by the hostile takeover boom of the 1980s in the United States that saw massive plant closure or relocation, in either case to extract higher post-acquisition returns for shareholders. To communitarians, these gains are often achieved through wealth transfers from non-shareholders, such as lenders whose security is weakened by the assumption of additional debt, employees who have made firm-specific human capital investments in the company over many years, and the local communities whose financial and social investments were made with the expectation of a continuing long-term relationship with the corporation. The pluralist model has been adopted in a majority of States in the United States (but not in Delaware, the seat of incorporation of most major United States corporations). These constituency statutes (as they are called) permit (but typically do not require) directors to take into account the interests of other stakeholder constituencies and community interests. Approximately, half of these constituency statutes grant the licence only in the context of a hostile takeover or other corporate control transaction; indeed, the licence has principally been invoked by directors in response to an unsolicited takeover bid. 187 The case for directors having a licence or a duty to sacrifice shareholder interests for those of third parties derives in some measure from the complexity of social and economic organisation and from assumptions as to regulatory overload upon the modern state. Thus, the argument is made that the state is unable to respond to the myriad instances of market failure by timely specific interventions and that management should therefore have either a duty or licence to allocate resources or forgo benefits in particular circumstances even at the expense of shareholder welfare. This would address the argument that the corporation’s legal mandate “to pursue its own self-interest, regardless of the often harmful consequences it might cause to others … [makes it] a pathological institution, a dangerous possessor of the great power it wields over people and societies”. 188

187 188

corporate law); M M Blair & L Stout (1999) 85 Va L Rev 247 at 278 (shareholder primacy is inadequate to secure the buy-in necessary for effective team production); L A Stout, The Shareholder Value Myth (2012); L A Stout, “New Thinking on “Shareholder Primacy”” (2011) UCLA School of Law, Law-Econ Research Paper No 11–04; available at SSRN: http://ssrn.com/abstract=1763944. Corporations and Markets Advisory Committee, Corporate Social Responsibility, Discussion Paper (2005) pp 66–69. J Bakan, The Corporation: The Pathological Pursuit of Profit and Power (2004), p 2. [2.207]

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Several problems, however, need to be addressed in the pluralist model. One concerns the problem of articulating corporate standards. In the absence of clearly defined and enforceable responsibilities, how is a proper allocation between the competing interests to be determined? Thus, it is argued: “Once the profit-maximising conception of the corporation is abandoned it is not easy to construct an attractive and logical new framework to guide and legitimate management.” 189 A second objection concerns the legitimacy of management power. Why are corporate managers better able to make these decisions than other individuals? Is it appropriate for a quasi-governmental role to be assumed by individuals standing outside the framework of representative government? Does such a licence weaken the accountability mechanisms, already tenuous, by which company law seeks to make management accountable for conduct? 190

Corporate social responsibility and directors’ duties [2.208] In Australia the question of the corporate purpose and of corporate responsibility was

highlighted by community concern with issues arising from the restructuring of the James Hardie group of companies and the inadequate resourcing of the asbestos subsidiaries that were severed from the group: see n 7 following [4.125]. James Hardie’s lawyers had advised the board of directors that their duties as directors precluded them from making voluntary payments to those suffering from the asbestos operations of the former subsidiaries unless it was for the benefit of the Hardie (parent company) shareholders. (A parent company is not liable as such for the debts of its insolvent subsidiary even if it holds the whole of its share capital: see [4.105].) Community concern prompted two inquiries into corporate social responsibility and directors’ duties, one by the Parliamentary Joint Committee on Corporations and Financial Services (PJC) and the second by the statutory advisory committee, the Corporations and Markets Advisory Committee (CAMAC). Both committees reported in 2006. The PJC opposed amending directors’ duties to expressly allow directors to have regard to the interests of stakeholders other than shareholders. The PJC considered that Australian corporate law already permits directors to have regard to those interests. The PJC expressed support for sustainability reporting but recommended against making such reporting mandatory. 191 CAMAC was of a similar view. It considered that the current formulation of directors’ duties was sufficiently flexible to allow directors to take non-shareholder stakeholder interests and broader community considerations into account. Companies may, in their own business 189

190

191

80

D Vagts (1966) 80 Harv L Rev 23 at 48. See also E Rostow, “To Whom and For What Ends is Corporate Management Responsible?” in E S Mason (ed), pp 59–71; M Friedman, Capitalism and Freedom (1962), p 120; E S Mason (1958) 31 J Bus 1; M Stokes, “Company Law and Legal Theory” in W Twining (ed), Legal Theory and Common Law (1986), p 155. Thus, it is said that “if managers are empowered to set constituency against constituency, in the end all power will fall into management’s hands”: R M Green (1993) 50 Wash & Lee L Rev 1409 at 1417. Parallel issues arise with respect to the investment of pension funds and other managed investment funds. To what extent may trustees and managers commit funds to socially desirable projects where the investment criteria are as much influenced by the perceived social utility of such projects as by their likely financial returns? How should pension fund managers vote shares held by the fund on social responsibility issues raised within portfolio companies? See J D Hutchinson & C G Cole (1980) 128 U Pa L Rev 1340; J H Langbein & R A Posner (1980) 79 Mich L Rev 72; M P Curzan & M L Pelesh (1980) 93 Harv L Rev 670; W A Lee, “Modern Portfolio Theory and the Investment of Pension Funds” in P D Finn (ed), Equity and Commercial Relationships (1987), pp 309–313 and see Cowan v Scargill [1985] Ch 270. Parliamentary Joint Committee on Corporations and Financial Services, Corporate Responsibility: Managing Risk and Creating Value (2006). [2.208]

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self-interest, respond to social concerns, but they should not be obliged to do so. CAMAC considered that changes to the law to require directors to consider social and environmental issues might introduce uncertainty as to the directors’ role and their accountability to shareholders. If any problems should arise with respect to social or environment impacts which the market is unable to resolve satisfactorily, they should be the subject of specific legislation. 192 In the United Kingdom a company law review committee had recently found evidence that “the obligation to look beyond the short term was not widely recognised by directors or members.” 193 Its solution to this issue and that of the proper place of stakeholder interests was to retain the shareholder primacy doctrine but to adopt an “inclusive” approach to the reformulation of directors’ duties that seeks to cultivate co-operative relationships with other participants in the enterprise. It rejected the pluralist model, preferring instead what it described as the notion of “enlightened shareholder value”. Its recommended provision is now contained in the Companies Act 2006 (UK), s 172(1) which is in these terms: A director of a company must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole, and in doing so have regard (amongst other matters) to – (a) the likely consequences of any decision in the long term, (b) the interests of the company’s employees, (c) the need to foster the company’s business relationships with suppliers, customers and others, (d) the impact of the company’s operations on the community and the environment, (e) the desirability of the company maintaining a reputation for high standards of business conduct, and (f) the need to act fairly as between members of the company.

This approach addresses the problem of indeterminate decision-making criteria by privileging the collective shareholder interest over that of other stakeholders, but only after directors consider the consequences of the decision for those stakeholder interests. However, under this approach consideration of non-shareholder interests is instrumental only in that those interests are to be considered not for their own sake but only to the extent that they promote shareholder interests. This approach proceeds from the insight that a company with poor relations with its employees, suppliers or consumers, or a poor reputation for its standards of business dealing, is unlikely to be maximising long term shareholder value. The explicit reference to the long term consequences of a decision is intended to address the problem of short-term focus. The enlightenment in this model of shareholder value lies in the forced scanning of stakeholder impacts for the purpose of extracting maximum shareholder advantage in corporate decision-making. Where the impact of a decision or strategy on stakeholders is negative it is not, as in pluralist models, weighed directly against its shareholder benefit; rather, that negative impact is to be taken into calculation in the calculus of shareholder advantage from the decision. Two different conceptions of the corporation that affect conceptions of its purpose and objectives [2.209] The answers to the questions posed above with respect to corporate purpose and

responsibility depend upon the underlying conception of the publicly held corporation that is 192

Corporations and Markets Advisory Committee, The Social Responsibility of Corporations, Report (2006).

193

Modern Company Law for a Competitive Economy: Completing the Structure, A consultation document from the Company Law Review Steering Group (2000), [3.18]. [2.209]

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adopted. Allen identifies two distinct conceptions of the corporation each representing “contrasting models of human action, each conditioned on a different view of what it means to be a human being in society”: The classical liberal paradigm describes the social world as populated by individuals rationally (if sometimes imperfectly so) pursuing their own vision of the good life. In this model – ideally – legal institutions keep the peace, define and protect property and contract and ameliorate problems that individuals cannot effectively resolve through bargaining. For classical liberals, the law is positivistic and should be utilitarian. Thus, ideally, the law should be a clear set of rules that facilitate the private ordering of human affairs. If the law comprised such a set of clear rules, individuals would have maximum control over their condition, and presumably free bargaining would lead towards better states of the world. An incidental cost of a system of clear rules will be that attempted transactions will occasionally fail to comply with the rules and will, as a result, collapse, causing unexpected disappointment or even injury. That fact is regrettable, of course, but classical liberals also see it as a necessary cost of a beneficial system of clear rules. Distribution of gains and losses is a secondary concern in this model. 194

Allen also identifies a social model which he sees as grounded in continental European thought of which he singles out Emile Durkheim as the exemplar: This alternative paradigm describes the world as populated not by atomistic rational maximizers, but by persons of limited rationality who lead lives embedded in a social context, in a community. … For those holding this perspective, individual autonomy and rationality are a part of the truth of human life, but their significance can easily be exaggerated. While proponents of the social model of human life would concede that property and contract law are useful in promoting productive social life, those holding this perspective see them as partial and assert that their utility rests in part on presupposition of shared norms including those of fairness and trust. Those holding this perspective are more willing to regulate and define the legal institutions of property and contract in service of social values. … While the liberal model seeks rules that are clear ex ante in order to facilitate future transactions, the social model of law can tolerate ambiguity in rules in order to promote outcomes that, when viewed ex post, are seen as fair. … The centuries-old law of fiduciary duty is the best example in our law of what I have called the social paradigm. In the law of fiduciary duties, the integrity of relationships of trust and the protection of dependents by a relatively open-ended, moralitybased fiduciary duty of loyalty have great importance. 195

These competing conceptions lead to a consideration of the theories of the corporation that might frame thinking about the purpose and function of corporate law and regulation. We return to the contest between property and social claims shortly in the context of communitarian theories of the corporation (at [2.235]) although this contest underlies most of corporate law.

THEORIES OF THE CORPORATION [2.210] We have briefly noted earlier theoretical debates about the nature of the corporation –

whether it should be regarded as an artificial entity whose recognition is dependent upon the concession of the sovereign or as a group whose juristic personality follows the reality of its group existence: see [2.15]. The grant of a general right to incorporate in England in 1844 diminished the significance of this debate although the implicit issue persisted as to the role of the state in the regulation of business association. (The basis for such intervention is clearer 194 195 82

W T Allen (1993) 50 Wash & Lee L Rev 1395 at 1396. Allen concedes that “[c]omplex and contradictory real life, of course, cannot be fully captured by either model”: at 1396. Allen at 1397–1398. [2.210]

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under the former concession theory than under realist theories that law does no more than recognise the social reality of the group.) It is this issue which lies at the heart of modern theoretical dispute as to the nature of the corporation, and the province and function of corporate law generally. Managerialist theories of the corporation [2.215] The principal theories contending as rival explanations of the modern corporation are

identified with particular stages in the evolutionary process identified by Clark: see [2.160]. The emergence in Clark’s second stage of the publicly held corporation in which ownership was separated from control prompted managerialist doctrines asserting the institutional personality of the corporation and an evolving corporate conscience to legitimate the power resting with management: see [2.200]. The economic historian Alfred Chandler described the ascendancy of management-controlled firms in terms of transaction cost economics. He pointed to the emergence of a management hierarchy which was able to monitor and co-ordinate the activities of a number of business units more efficiently than market mechanisms. 196 The internalisation of operating costs in place of external market mechanisms is an application of a theory of firms and markets developed by the economist Ronald Coase in 1937. Coase argued that the firm is simply a means of co-ordinating production functions which is efficient in so far as it has lower transaction costs relative to contracting for them through the market. 197 The balance between firm and market is reached when the firm has expanded to the point where “the costs of organising an extra transaction within the firm are equal to the costs involved in carrying out the transaction in the open market or to the costs of organising [in another firm]”. 198 In management-controlled corporations internal administrative controls became a miniature capital market. Chandler’s conclusion, briefly summarised, is that in many sectors of the economy the visible hand of management replaced what Adam Smith referred to as the invisible hand of market forces. The market remained the generator of demand for goods and services, but modern business enterprise took over the functions of coordinating flows of goods through existing processes of production and distribution, and of allocating funds and personnel for future production and distribution. As modern business enterprise acquired functions hitherto carried out by the market, it became the most powerful institution in the American economy and its managers the most influential group of economic decision makers. The rise of modern business enterprise in the United States, therefore, brought with it managerial capitalism. 199

This managerialist model views the corporation essentially as hierarchy and senior management, at the apex of the hierarchy, as the principal subject of legal regulation. The legitimacy of management power was sustained, in the apologetics of managerialism, by assertions of management professionalism, of an evolving corporate conscience (or statesmanship) and of business utility and expertise. 200 Since the formal disciplinary mechanisms through shareholder monitoring and reliance upon external capital markets were each diminished, the agenda of company law was directed to the insinuation of accountability 196

A D Chandler, The Visible Hand: The Managerial Revolution in American Business (Belknap Press, Cambridge, Mass, 1977), p 12.

197

R H Coase, “The Nature of the Firm” (1937) 4 Economica NS 388, reprinted in R A Posner and K E Scott, Economics of Corporation Law and Securities Regulation (1980), pp 3-7.

198 199 200

Chandler, p 6; see further O Williamson (1981) 19 J Econ Lit 1537. Chandler, p 1. W W Bratton (1989) 41 Stan L Rev 1471 at 1476. In so far as managerialism seeks to accord fair treatment to all with a stake in the corporation, and not merely shareholders, it expresses the social model of the corporation outlined at [2.225]. [2.215]

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mechanism to constrain management power and strengthen shareholder controls. Two key strategies have been the strengthening of legal duties imposed upon directors and senior management and the requirement of shareholder approval for a wider range of corporate transactions. 201 The strategy of strengthening shareholder democracy and establishing appropriate modalities for management accountability (and thereby legitimacy) provided the motive force for corporate law reform in North America, the United Kingdom and Australia for most of the 20th century. Its ascendancy was eclipsed only by the rise of an alternative conception of the corporation based upon the revival of neo-classical economic doctrines that stressed the contractual foundations of corporate association. The corporation as contract [2.220] The contractarian theories were stimulated by economic writing in the 1970s

developing Coase’s conception of the firm as an alternative to contracting for production through the market. 202 The corporation is deconstructed to reveal no more than a “nexus of contracting relationships” between shareholders, managers and other employees, lenders, suppliers and other stakeholders. 203 The corporate firm does not differ in the slightest degree from ordinary market contracting between parties. The firm is simply a “highly specialised surrogate market”. 204 The contracting relationships are not contracts in the sense that lawyers understand but rather the economist’s conception of “relationships characterised by reciprocal relations and behaviour.” 205 The choice between contracting alternatives is determined by that which secures the lowest agency costs. These are the costs inherent in any situation whereby one person employs another to perform some function which involves the delegation of decision-making authority. Inherent in all such arrangements is a divergence in interest between principal and agent since the agent’s personal utility will rarely be identical with that of the principal. The term “agency costs” is defined as the aggregate of 1. the monitoring expenditures by the principal to detect self-dealing or shirking by the agent; 2.

the expenditures by the agent (bonding costs) offered as an assurance of fidelity to the principal; and

201

The evolution of managerial theories of the corporation, and of complementary economic and legal doctrines, is perceptively traced in Bratton at 1475-6, 1482-1501.

202

203

An outstanding example of the application of contract analyses of the firm to problems in corporate regulation is to be found in the symposium on Contractual Freedom in Corporate Law in (1989) 89 Colum L Rev 1395-1774. Other influential analyses applying contract theory include F H Easterbrook & D R Fischel (1982) 91 Yale LJ 698 and (1983) 26 J L & Econ 395; B D Baysinger & H N Butler (1984) 52 Geo Wash L Rev 557 and (1985) 10 J Corp L 431; J R Macey (1984) 13 Hofstra L Rev 9; H N Butler (1989) 11 Geo Mason L Rev 99; L A Bebchuk (ed), Corporate Law and Economic Analysis (1990) and (1989) 102 Harv L Rev 1820. Contract-based analyses have influenced the bulk of United States academic writing on corporate law since the 1980s, whether as an application of its insights or a critical examination of its premises or its relevance to particular problems. For critical commentary on the contract model see M A Eisenberg (1989) 89 Colum L Rev 1461; M A Eisenberg (1990) 90 Colum L Rev 1321; W W Bratton (1989) 74 Cornell L Rev 407; W W Bratton (1989) 41 Stan L Rev 1471; J C Coffee (1988) 53 Brooklyn L Rev 919; V Brudney (1985) 85 Colum L Rev 1403; R C Clark, “Agency Costs Versus Fiduciary Duties” in J W Pratt & R J Zeckhauser (eds), Principals and Agents: The Structure of Business (1985), Ch 3; R M Buxbaum (1984) 45 Ohio St LJ 515. M C Jensen & W H Meckling (1976) 3 J Fin Econ 305, reprinted in Posner & Scott, p 39.

204 205

A A Alchian & H Demsetz (1972) 62 Am Econ Rev 777, reprinted in Posner & Scott, p 19. O Hart (1989) 89 Colum L Rev 1757, 1764.

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3.

the residual loss for the principal resulting from divergence between the agent’s decisions and those which would maximise the principal’s welfare. 206 The divergence in interest is apparent in the management-controlled corporation since management utility is more obviously secured by firm growth, job security, and enhanced prestige and power than by profit maximisation. 207 Under contract analyses, the corporation emerged from a process of natural selection of business forms as the optimal firm structure since it achieves the greatest reduction in agency costs. When managers and promoters offer corporate securities, a sceptical market will bid down the price of those securities upon capital markets, and make managers bear the risk of their shirking and disloyalty, unless managers offer sufficient monitoring and bonding structures to obviate this risk. Under contract theory, the optimum devices are those approved by the market and expressed in current practice, such as independent directors, audit committees, legal duties of care and loyalty, and audit and accounting requirements. This discipline through the capital market is reinforced by that of other markets, principally the market for corporate control, 208 the product market and the employment market for managers. 209 Under contract theory, since the firm is no more than a web or nexus of contracts, the view of corporation as hierarchy disappears and with it the so-called problem of management accountability and legitimacy. The optimal form of agency cost reduction is that determined by market exchanges between corporate issuers and investors. The role of corporate law and state regulation also declines since the contracting parties as rational utilitarians are entitled to structure their relations as they wish. The corporation being contract and not state concession, doctrinal constraints upon management should be left to the invisible hand of market forces although corporate law is useful to catch management fraud and as a standard form contract which reduces the transaction costs of negotiating an optimal contract afresh each time. In consequence, therefore, under contract theory corporate law is permissive and supplementary. It should not prevail over actual bargains and parties to the corporate contract should be entitled to opt out of the standard form contract. 210 Contract theory also rests upon the assumption that the duty of management is to maximise the wealth of their principals, the shareholder owners of the firm and that the function of corporate law is to promote that end. Insofar as the question arises under contract theory, the claim for shareholders as owners is usually justified upon three grounds: their role as ultimate risk bearers in the firm in that their financial claims as shareholders are postponed to those of creditors in the winding up of the company, their entitlement to surplus income during the 206

Jensen & Meckling in Posner & Scott, p 40.

207

Bratton (1989) 41 Stan L Rev 1471 at 1494-5.

208

The argument is that exit through the stock market by a dissatisfied shareholder is a signal as to value which may be more telling than a vote cast at a general meeting. The aggregate effect of such sales is to depress the share price so that it stands at a discount to the value which shares would bear under superior management. This discount provides the economic incentive for management displacement through a takeover bid. It is the threat of a hostile takeover, as much as the bid itself, which provides the discipline upon managers.

209

Contractarians also call in aid the efficient capital markets hypothesis which assumes that securities markets are efficient in that they accurately reflect all available information about a particular security. Under the hypothesis, share prices are determined by the judgment and trading of professional investors and small investors, being price takers, get a free ride in price determination. They also get a fair price that reflects professional judgment as to the value of the security offered. Professional investors whose trading sets market prices are better able to assess the value of contract terms of new securities offered than Parliament; accordingly, investor protection is best left to the market.

210

See, eg, F H Easterbrook & D R Fischel (1989) 89 Colum L Rev 1416; but see also M A Eisenberg (1989) 89 Colum L Rev 1461. [2.220]

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firm’s life (within limits protective of creditors) and their usual monopoly of voting rights. This normative claim is commonly called shareholder primacy: see [2.206]. It is not based upon shareholders’ assumed superior monitoring capacity or disposition or their legal right to direct the board and corporate management: see [5.40]. Contract theory has gained enormous influence in the United States and determined agendas for academic debate, if not policy prescription. The theory blossomed during the Reagan ascendancy and is, perhaps, the corporate theory most sympathetic to the deregulatory mood of that period. 211 Further, the hostile takeover boom of the 1980s lent support to the claims of management accountability through the market for corporate control. Indeed, the emergence of novel forms of bid financing and the “bust up” takeover financed through the sale of the target’s assets, the centre of influence shifted from corporate managers to investment bankers and other advisers. 212 The enduring currency and explanatory power of contract theory remains to be seen. Its influence in the United States legal academy reflects that of the law and economics movement generally whose academic influence itself is much stronger than in Europe, the United Kingdom and Australia. However, the influence of economic theory upon corporate law reform has arguably been stronger in Australia and, to a lesser extent, the United Kingdom, than in the United States. Flowers, whether of good or evil, may germinate and blossom at a distance from their source. Other theories of the corporation [2.225] Contract theory conceives of the corporation as no more than a vast network of

implicit contracts. Does this conception provide a credible explanation of the reality of publicly held corporations? The model is criticised since it does not recognise the large firm as having any institutional reality: To the philosophical realist, to call a corporation a network of contracts is to overlook an essential part of the empirical reality of social interactions “within” corporations. It implies that the circumstances that any participant in the enterprise may confront at any moment are fully accounted for by reference to one or more earlier negotiated (or implicit) bargains he or she made. This, to realists, is a palpably impoverished way to interpret much of what goes on within corporations. [C]onsider an instance in which employees work especially diligently in order that a team, department or division can reach a production goal. It very plausibly could be the case that contract would provide only a very partial and inadequate explanation of their behavior. On the realist view corporations can be, indeed inevitably are, more than contracts. Actual bargains, explicit or implicit, provide an incomplete account of the social order we find in organizations. That social order can exist only because contracts are embedded in a social context that permits trust and expectations of fair dealing. 213

More than a network of contracts, corporations are seen by realists as collective entities that have identities apart from those of the individuals who temporarily fill roles within them. The conception is expressed in competing theoretical models of the corporation.

The team production model [2.230] One variant seeks to address some of the social reality problems of contract theory,

especially those of trust and commitment within the firm. The contractual concept of the publicly held corporation as simply a bundle of assets creates a “sharp dichotomy” between 211 212

Thus, several of its principal exponents, including Professors R A Posner, F H Easterbrook and R K Winter, were appointed from academic posts to the federal appellate courts during the Reagan administration. Some of these developments were evident in the Tryart bid for John Fairfax Ltd in 1987: see [2.270].

213

Allen at 1401-1402.

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the claims of shareholder-owners and those whose inputs are merely hired. The team production model offers an explanation for the observed commitment of non-shareholders to corporate activities where multiple inputs are necessary for their success. It does so through the conception of the corporation and especially its board of directors as mediating hierarchy: [A] public corporation is a team of people who enter into a complex agreement to work together for their mutual gain. Participants – including shareholders, employees, and perhaps other stakeholders such as creditors or the local community – enter into a “pactum subjectionis” under which they yield control over outputs and key inputs (time, intellectual skills, or financial capital) to the hierarchy. They enter into this mutual agreement in an effort to reduce wasteful shirking and rent-seeking by relegating to the internal hierarchy the right to determine the division of duties and resources in the joint enterprise. They thus agree not to specific terms or outcomes (as in a traditional “contract”), but to participation in a process of internal goal setting and dispute resolution. Hence the mediating hierarchy of a corporation can be viewed as a substitute for explicit contracting. 214

The model suggests that those in the corporate hierarchy – the board of directors ultimately – work not for the shareholder owners but for the team members such as employees who actually “hire” them to control shirking and rent-seeking (looting, that is, self-dealing) among their number so as to provide the incentive to each to commit to the enterprise and the assurance that other team members will also do so: [T]he primary job of the board of directors of a public corporation is not to act as agents who ruthlessly pursue shareholders’ interests at the expense of employees, creditors, or other team members. Rather, the directors are trustees for the corporation itself – mediating hierarchs whose job is to balance team members’ competing interests in a fashion that keeps everyone happy enough that the productive coalition stays together. 215

Communitarian theory [2.235] Other critics of contract theory express concern at the “corrosive effect [of]

interpreting social life as a continuous, self-interested negotiation”. 216 A theory of the corporation as community addresses the threat of harm to non-shareholders from exclusive management focus upon shareholder interests. It was prompted by the hostile takeover boom of the 1980s in the United States which saw massive plants closure or relocation to extract higher post-acquisition returns for shareholders. To communitarians, these gains are often achieved through wealth transfers from non-shareholders such as lenders whose security is weakened by the assumption of additional debt, employees who have made firm-specific human capital investments over many years, and the local communities whose financial and social investments were made with the expectation of continuing long-term relationships with the corporation. There are several elements to communitarian critiques of contract theory: The first challenges key assumptions about the feasibility of non-shareholder self-protection through bargain. The second is more fundamental. It asserts that, even if self-protection through bargain were entirely feasible in a technological sense, disparities in bargaining power would prevent at least some non-shareholder constituencies from obtaining adequate protection from the costs of shareholder wealth maximization. This argument appeals to a conception of justice that insists that people are entitled to more than merely what they can bargain and pay 214

215

M M Blair & L Stout (1999) 85 Va L Rev 247 at 278; see also M M Blair & L Stout (2001) 79 Wash U LQ 403. Blair and Stout see their model as “consistent with the ‘nexus of contracts’ approach to understanding corporate law”: at 254. But see D Millon (2000) 86 Va L Rev 1001 (there is no reason to expect improvements in distributional outcomes since the model does nothing to improve the extra-legal status of non-shareholders in relation to shareholders). Blair & Stout at 280-281.

216

Allen at 1402. [2.235]

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for. Or, stating the same idea in terms of obligation rather than entitlement, community members owe each other duties of mutual regard and support. Finally, communitarians have offered a positive vision of corporate relationships … as a community rather than a mere aggregation of self-seeking individuals whose relationships are defined solely by contract. 217

Communitarian theory offers the concept of multifiduciary obligation, a duty owed by corporate managers to all stakeholders in the company and not merely to shareholders. One formulation of this duty would require shareholders to internalise (that is, bear) the cost that pursuit of profit maximisation imposes upon non-shareholders through “a duty to act reasonably to avoid injury to non-shareholder constituent groups in the process of corporate decision making.” 218 Another formulation would preclude management from making short-term shareholder gains (such as takeover premiums) if doing so would frustrate legitimate non-shareholder expectations. Instead, management should pursue profit-seeking strategies that harmonize shareholder and non-shareholder interests where possible. Where conflict between these interests is unavoidable (as in the case of a money-losing plant, for example), management should adopt solutions that fully compensate non-shareholders for their losses. 219

The multifiduciary standard is criticised on the basis of the indeterminacy of its standards and as ultimately concentrating power in management hands: “if managers are empowered to set constituency against constituency, in the end all power will fall into management’s hands.” 220 Of course, as noted at [2.207], a majority of jurisdictions in the United States has legislated to permit directors to promote stakeholder interests independently of shareholder benefit, in some cases when the directors are facing a hostile takeover for the company but, in other states, in any circumstances at all. These theories of the corporation are relevant throughout the study of corporate law, for their explanatory power concerning the state of legal doctrine, as competing criteria or frameworks for evaluating corporate law norms and as alternative visions of the enterprise of business and its regulation.

GLOBAL DIMENSIONS OF CORPORATE ACTIVITY AND RESPONSIBILITY [2.240] The regulation of corporate activity is primarily national in character; 221 corporate

operations, however, are increasingly global in their reach, whether in the offering of their securities to potential investors or in their manufacturing and other trading operations. Distinct questions are posed by the investment and trading aspects of international business each of which impose quite different strains upon global governance. There are established mechanisms for international co-operation in corporate law enforcement 222 and strong forces supporting the harmonisation of national systems of corporate and financial market regulation. 223 However, the limitations of national regulation and the weakness of global 217 218

D Millon, “Communitarianism in Corporate Law: Foundations and Law Reform Strategies” in L E Mitchell (ed), Progressive Corporate Law (Westview Press, Boulder, 1995), p 4. L E Mitchell (1992) 70 Tex L Rev 579 at 585.

219

Millon, p 12.

220

R M Green (1993) 50 Wash & Lee L Rev 1409 at 1417.

221

However, it is not uncommon for corporations legislation to assert an extraterritorial reach. Thus, the Corporations Act 2001 expresses each of its provisions to apply “according to its tenor” in relation to acts or omissions outside Australia: s 5(4). See Mutual Assistance in Business Regulation Act 1992 (Cth). Such as through the International Organization of Securities Commissions (IOSCO), as to which see http://www.iosco.org.

222 223

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standard-setting are more keenly felt in relation to the social effects of global business. Some background issues are introduced in the following extract.

Corporate Law and Human Rights in a Globalised Economy [2.245] P Redmond, “Corporate Law and Human Rights in a Globalised Economy: Some Implications for the Discipline of Corporate Law” (2016) 31 Australian Journal of Corporate Law 3 (footnotes omitted) [5] The causes and character of economic globalisation Ours is not the first global economy or the first globally integrated trading system. Those claims might plausibly be made for the global trading system under the hegemony of the British Empire from the 1870s. This was the era when John Maynard Keynes might boast that someone in London “could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep”. The Victorian era of globalisation collapsed with the closure of trade routes during the 1914-1918 war, the Great Depression and the ensuing protectionism that stifled global trade. Modern economic globalisation, however, is based not in empire but in revolutions in information and communications technology, lower transportation costs, and the international liberalisation of cross-border trade, investment and currency flows. Together these disparate developments have combined to allow the creation of modern global production and distribution networks and the global trading and investment system. Where economic activity was previously nationally constrained, it is now global in character, leaping national borders. The United Nations Conference on Trade and Development (UNCTAD) [6] estimates that by 1970 there were between 7,000-10,000 transnational corporations. By the early 1990s, this number had grown to 37,000 and in 2008 stood at over 80,000. Modern information and communications technology enables firms to operate globally through central coordination of business operations, facilitated by dramatic reduction in transportation costs. Enterprises operate through a network of subsidiaries, suppliers, sub-contractors, franchisees and distributors, often located in different states. Globalisation permits firms to organise production networks on a global scale by sourcing components and locating stages of production using multi-country sources and suppliers for individual components of production. For tradable goods and services, the issue is where to locate discrete production elements for lowest cost and compatible efficiency. That calculus of choice has seen manufacturing move from developed to emerging economies, often with contracting relationships substituting for direct investment through foreign branches and subsidiaries. Firms, including those whose markets are domestic rather than global, are now part of global supply chains operating as global networks crossing national boundaries; very few firms – or consumers – are disconnected from the global economy. The components of these international production networks are highly mobile and relatively easily transferable. Sourcing of supply and production is largely determined by cost so that the supply chain, now shaped by contractual relationships rather than investment in physical plant, is mobile with price competition putting downward pressure on host state labour conditions and other social protection. The threat of investment flight to a lower cost jurisdiction is a constant for developing countries. Capital’s ability to move freely across borders undermines the capacity and disposition of host states to enforce human rights protection since these impose costs for inbound capital – in the competitive auction for capital, hosts compete by lowering regulatory barriers including social protection. While globalisation does not formally negate state sovereignty, its effect is to subvert it since it negates the state’s monopoly of legitimate power over its territory: Governments, bound by territoriality, cannot project their power over the total space in which production and consumption organise themselves. Globalisation thus integrates along the economic dimension and simultaneously fragments along the political. And, of course, firms are now operating to a far greater extent in countries where there is little respect for human rights or where its protection is subordinated to national economic development or rent-seeking by political elites. [2.245]

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Corporate Law and Human Rights in a Globalised Economy cont. [7] Globalisation’s unwelcome progeny Manufacturing moves to low cost sites because of dire poverty and low labour costs accompanying the absence of economic opportunity. There are over 7,000 garment factories in Bangladesh producing for export; most are subcontracting factories, operating on the tightest margins, and with the least outside attention or support. Such conditions permit the violation of human rights in the workplace. The collapse of the Rana Plaza building in Bangladesh in 2013 with the loss of more than 1,100 lives of mostly young women garment workers is representative of a much wider problem. Recurrent labour violations in global production networks include denial of rights to free association, discrimination in hiring, the use of child and bonded labour, excessive working hours, insufficient wages, poor working conditions, forced overtime, health and safety risks, environmental pollution and the absence of grievance channels, in factories where laws are weak, labour inspectors rare, and unions repressed. In the extractives sector – oil, gas and mining, but also palm oil, a core incredient in so many products – exploration licences are rarely given over developed land but typically over remote areas occupied by indigenous peoples, threatening fragile cultures and ways of life; there are persistent documented complaints of displacement without consultation, consent or compensation, often enforced violently by public or private security forces. The International Labour Organization estimates that there are 150 million migrant workers around the world; migrant workers from south and south-east Asia typically leave their home country heavily in debt to a recruitment agency. In the Arabian Gulf where many workers endure life threatening heat and hazardous working conditions in construction, the hosts’ kafala system permits sponsors to confiscate the passports of migrant workers, enabling employers to threaten withholding of wages and deportation to prevent workers from escaping abusive workplace environments. Food and [8] beverage companies grapple with child labour in cocoa production in West Africa and electronics firms source precious metals from war-torn African states. Consumption across a broad spectrum of goods and services drives the global economy which modernity, technical ingenuity and political judgement have created. Network-based operating systems substitute negotiated relationships for the hierarchical structures of equity ownership. In consequence, the firm’s control over significant operations in its global supply chain is weakened, exposing it to downstream human rights abuses in that chain. These problems are not confined to large transnational firms. Few domestic companies today do not have a supply chain that extends extraterritorially; indeed, small and medium enterprises that typically focus on domestic markets will rarely have internal human rights expertise and so are likely to be less aware of their supply chain connection to human rights abuse. ... [9] Polycentric transnational governance of business Globally operating enterprises are not regulated globally. No global sovereign exercises authority over business; international law does not address itself directly to business but only to states and their conduct, and no international tribunal adjudicates grievances of irresponsible business conduct. Instead, the transnational corporation is subject to the regulatory authority of its jurisdiction of incorporation. That jurisdiction is territorially bounded in regulatory reach, even though company operations extend well beyond territorial boundaries. The off-shore jurisdictions in which the company does business are able to regulate only the conduct that occurs within their borders. Domestic regulation by host states also depends on their regulatory capacity. Especially for those host states with weak governance traditions and institutions, regulatory disposition is undermined both by the competitive [10] environment for foreign investment and the temptation for elites to subordinate the public good for private gain. Globalisation’s compact – free capital flows, trade and investment regimes – integrates upon the economic axis but fragments upon the political. Regulation of business conduct is now effected through distinct governance systems. Three principle systems can be identified. The first is grounded in public law, expressed at the domestic level in home and host state regulation of corporate activity, including through corporate and securities law. At the international level, public governance is effected through collective state decision-making and the action of international organisations such as the United Nations and the World Bank. The second, a 90

[2.245]

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Corporate Law and Human Rights in a Globalised Economy cont. transnational private governance system, involves a network of actors, instruments and mechanisms regulating transnational corporations independently of formally authoritative norms; its principal expression is soft law and its drivers are responsiveness to social expectations and the sanctions that globalisation gives to corporate stakeholders. The third governance system comprises the corporate governance and management systems needed for global enterprise, including the management of enterprise-wide risk as well as global strategy. Increasingly, the third system of corporate governance regulation also involves the integration into management systems of standards of responsible conduct deriving from the private governance system. These complementary systems together serve the regulatory functions performed by domestic corporate law systems pre-globalisation. The term “polycentric transnational regulation” is used here to describe the resulting regulatory mix. Polycentricity is a term more familiar in other disciplines – in international relations its post-Cold War usage refers to power structures where there is not a single hegemonic power or two hegemonic poles, and in urban planning to the organisation of a region around several political, social or financial centres. In the present context, it refers to the multiple sites and sources of corporate regulation. Polycentric regulatory regimes are “those in which the state is not the sole locus of authority, or indeed in which it plays no role at all. They are marked by fragmentation, complexity and interdependence between actors, in which state and non-state actors are both regulators and regulated, and their boundaries are marked by the issues or problems which they are concerned with, rather than necessarily by a common solution”. The term decentred regulation might also be used since it draws attention to the shift away from the centrality of state role. Polycentric regulation is more apt in this context, however, since it refers more positively to the multiple sites in which regulation is occuring and the diversity of actors, state and non-state. The public and private governance systems play mutually reinforcing roles that compensate for each other’s weaknesses and together produce “a more comprehensive and effective global regime”. ... [11] Public governance of corporate activity International law does not recognise the corporation; its subjects are states. Corporations are bound by those rules of international law applicable to natural persons although these are limited to grave crimes such as war crimes, genocide or crimes against humanity. International law applies vertically to states, and not horizontally to corporations by imposing obligations on them directly. While there is no conceptual or technical barrier to international instruments imposing direct obligations on corporations, state practice is otherwise. International law leaves the regulation of corporate actors to the domestic sphere. The corporation exists only as a locally incorporated entity subject to the domestic law of the state in which it is incorporated, rather than as a transnational entity or production network, closer to its organisational reality. Thus, when states ratify an international human rights treaty, the instrument obliges them to respect and fulfil the treaty rights in their own practice and to ensure observance of the protected rights by third parties such as corporations operating within their territory or jurisdiction. The state duty to respect, protect and fulfil rights under the treaty is discharged by enacting and enforcing legislation giving domestic effect to the treaty provisions and through appropriate policies, regulation and adjudication securing that effect. Protection of human rights lies, therefore, at the national level. Human rights standards might be applied to firms through the state in which they are incorporated (home state) or alternatively through the state in which they are operating (host state). International law imposes no clear obligations on states to regulate the extraterritorial conduct of their corporations and there is almost no home state regulation of offshore conduct except for bribery and corruption which have distinct histories. In 2000, a private member’s bill for regulation of off-shore conduct of large Australia companies failed to attract support and lapsed. In any event, globalisation undermines the ability of would be home state regulators to reach conduct beyond national borders. For off-shore activities and relationships, the state duty to protect falls to host states whose leverage over business in their territory is weakened by globalisation’s competitive auction for mobile capital. Even if it were not so constrained, host state regulation of global business is also geographically bound—enterprises operate globally; legal [2.245]

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Corporate Law and Human Rights in a Globalised Economy cont. regulation is national. Each nation sees and is seized of portion only of the elephant of global business. That limitation shapes perspective as much as capacity for action. The second domain of public governance comprises national systems of corporate law and regulation. International law is systemically linked to domestic corporate law systems through the state duty to protect. This duty requires that laws and policies governing business, such as corporate and securities law, do not constrain but rather enable business respect for human [12] rights. ... Social welfare is advanced by competition between enterprises but under frameworks that also secure responsible conduct. In national economies, corporate regulation falls to the political sovereign and lies within its capacity. The global economy knows no sovereign. Globalisation allows the triumph of markets; the gap it creates is the regulation of conduct in the transnational business activity that it permits. Private regulation initiatives respond to that challenge. [These initiatives are those discussed at [2.205] and [2.247].]

The United Nations framework for business and human rights [2.247] In 2008 the United Nations Human Rights Council unanimously adopted the

“Protect, Respect and Remedy” framework for business and human rights that had been proposed by the Secretary-General’s Special Representative on that subject. The framework includes the principle that all business firms of whatever size and origin have a responsibility to respect the human rights of those affected by the firm’s activities. 224 The framework is the most recent in a series of initiatives to identify standards of corporate responsibility for global business and, it seems, potentially the most influential. Its origins lie in recurrent human rights abuses arising in the liberalised trading and investment regimes of the modern global economy. Business operations or supply relationships confront situations where there is a divergence between the licence effectively available in host states and the social expectations of the firm’s consumers, investors and home state communities. These problems are ubiquitous and not confined to large international firms: see [2.245]. The corporate responsibility to respect human rights does not derive directly from international law but, it is contended, from the assumption of responsibility by business itself. 225 According to the principal architect of the framework and erstwhile Special Representative of the UN Secretary-General on Business and Human Rights, the responsibility is grounded in social norms and social expectations that have acquired “near-universal recognition by all stakeholders, including business” 226 so that “the notion that companies 224

225

226

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J Ruggie, Protect, Respect and Remedy: A Framework for Business and Human Rights, UN GAOR, 8 th sess, Agenda Item 3, UN Doc A/HRC/8/5 (7 April 2008) 9 [24] (Business and Human Rights Report). The other principles of the framework are the duty upon state parties to human rights instruments to protect against breaches by third parties (including business corporations) and the need for more effective access to remedies. The corporate responsibility is to respect internationally recognised human rights understood, “at a minimum”, as those expressed in the International Covenant on Civil and Political Rights, the International Covenant on Economic, Social and Cultural Rights and the International Labour Organisation’s Declaration on Fundamental Principles and Rights at Work: Business and Human Rights Report, UN Doc A/HRC/8/5, 15–6 [52]–[53]. The responsibility applies independently of the host State’s particular human rights commitments. Business and Human Rights Report, UN Doc A/HRC/8/5, p 8 [23]. Ruggie cites as examples the ILO’s Tripartite Declaration of Principles concerning Multinational Enterprises and Social Policy, the OECD Guidelines on Multinational Enterprise, the United Nations Global Compact and company codes as instances of firm collaboration in international voluntary standards that evidence acceptance of these norms of responsibility. J G Ruggie, Remarks by SRSG John G Ruggie Public Hearings on Business and Human Rights Sub-Committee on Human Rights European Parliament, (Remarks delivered at the European Parliament, Brussels, 16 April 2009) http://www.ohchr.org. [2.247]

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possess human rights responsibilities is not today seriously demurred from”. 227 The corporate responsibility is to respect the human rights of those affected by the firm’s activities: “[this] essentially means not to infringe on the rights of others – put simply, to do no harm”; 228 it applies to all companies in all situations. The responsibility includes both legal obligations and social norms and expectations: failure to meet this responsibility can subject companies to the courts of public opinion – comprising employees, communities, consumers, civil society, as well as investors – and occasionally to charges in actual courts. Whereas governments define the scope of legal compliance, the broader scope of the responsibility to respect is also defined by social expectations – as part of what is sometimes called a company’s social license to operate. 229

The responsibility to respect is a specific, non-discretionary norm to be distinguished from voluntary initiatives subsumed under the broad umbrella of CSR (see [2.205]); it has greater normative force as part of the international human rights system and sharper definition in the content of its norms. The two concepts share a foundation in sensitivity to social expectation and, from a firm and investor perspective, long-term risk management.

CORPORATE CASE STUDY: THE FAIRFAX MEDIA GROUP OF COMPANIES [2.250] This chapter has introduced the principal elements of the structure of the corporation

and some of the key participants (shareholders, directors, managers, employees, lenders, other stakeholders and regulators). 230 Their roles, rights and powers are explored in some detail in the chapters that follow. Before starting upon that examination, it may be helpful to see how these elements fit together in the experiences of one firm. This section has two purposes: not only to give an initial overview of the corporate actors and their roles in the drama of enterprise evolution and relations but also to provide a continuing contextual resource as you study those roles more closely in later chapters. The following case study of the Fairfax Media group of companies has themes that are common to many business corporations. One theme arises in family-controlled firms where family members seek to retain control while turning to public markets for the long-term capital that family members are unable or unwilling to supply. 231 Other themes concern the tensions between family proprietors and professional managers, the wider regulatory environment in which business is conducted and its impact upon corporate management and control, and the shaping influence of corporate culture. 227

228 229 230

231

J G Ruggie, Business and Human Rights: A Political Scientist’s Guide to Survival in a Domain where Lawyers and Activists Reign (Remarks delivered at the Annual Conference International Law Association (British Branch), London, 17 May 2008) http://www.ila-hq.org/en/branches/british-branch/british_branch_2008.cfm. Business and Human Rights Report, UN Doc A/HRC/8/5, p 9 [24]. J Ruggie, Mandate of the Special Representative on the Issue of Human Rights and Transnational Corporations and Other Business Enterprises (Preliminary Work Plan, UN Human Rights Council, 10 October 2008), p 3. This account of the Fairfax proprietorship draws heavily upon a rich body of published accounts of its history and recent upheavals, principally G Souter, Company of Heralds (1981) and its successor volume G Souter, Heralds and Angels: The House of Fairfax 1841-1990 (1991). Other valuable accounts which focus upon the events which brought the Fairfax proprietorship to an end are contained in V J Carroll, The Man Who Couldn’t Wait (1990) and T Sykes, Operation Dynasty (1989). A more personal account of these events is contained in J O Fairfax, My Regards to Broadway: A Memoir (1991). A detailed account of the contest to acquire the John Fairfax enterprise from its receivers in 1991 is contained in C Ryan & G Burge, Corporate Cannibals (1993). Another corporate group of Australian origin where this problem has been addressed more successfully to date is the News Corporation group under the effective control of the Murdoch family whose voting power exceeds its economic interest (referring to its proportionate right to financial participation in dividends etc) in the group. [2.250]

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The John Fairfax Group Pty Ltd and its subsidiary companies went into receivership on 10 December 1990, a mere two months short of the sesquicentenary of the Fairfax family’s proprietorship of the Sydney Morning Herald, the group’s oldest publication. The receivership brought to an end a proprietorship which had extended across five generations of the Fairfax family and had grown to include the principal Australian newspapers of quality and influence, and extensive interests in radio, television and magazine publishing. On 23 December 1991, after a competitive bidding process conducted by the receivers, Tourang Ltd acquired all of the issued capital of John Fairfax Group Pty Ltd. Tourang Ltd changed its name to John Fairfax Holdings Ltd on 7 January 1992 and on 13 March 1992 the company issued a prospectus offering its shares to the public and announcing its intention to apply to the Australian Stock Exchange (as it was then called) for admission to the Official List and the quotation (trading) of all its issued shares. Listing and quotation were subsequently granted by the Exchange. Until its entry into receivership the John Fairfax group represented an organisation under family control but, for a significant phase of its life, with public investment. The holding company was listed upon the Australian Stock Exchange (the immediate predecessor to the Australian Securities Exchange) until the appointment of the receivers and managers in 1990. A study of this group provides an introduction to issues in the evolution of firms as well as an engrossing human story. The beginnings in family proprietorship: 1841-1930 [2.255] John and Sarah Fairfax arrived in the colony of New South Wales with their infant

children in 1838. 232 John Fairfax was a printer by trade, liberal in political opinion and of deeply held dissenting Christian belief. He had left Warwickshire where, as publisher of a broadsheet newspaper, he had been reduced to bankruptcy by the successful defence of libel proceedings brought by a local solicitor. In 1841 John Fairfax purchased a half interest in the partnership publishing the Sydney Herald whose name was changed in the following year to the Sydney Morning Herald. In 1853 John Fairfax purchased his partner’s interest and three years later he took two of his sons into partnership under the name “John Fairfax & Sons”. After the death of John Fairfax in 1877 the role of senior proprietor fell to his son James Reading Fairfax who continued the partnership, principally with two of his sons, James Oswald Fairfax and Geoffrey Fairfax, until the firm’s conversion into a limited company, John Fairfax & Sons Ltd, in 1916. The shareholdings in the company were divided equally between the three men. The proprietorship of James Reading Fairfax, which began when he was taken into partnership in 1856, spanned 63 years. Like his father, he assumed a leading place in Sydney’s commercial and cultural affairs and those of the Congregational Church. Corporate growth and family control: 1930-1987 [2.260] If the proprietorship of James Reading Fairfax marks the consolidation of the

founding stage of the Fairfax proprietorship, that of his grandson Warwick marks its modern phase. In 1927 Warwick Fairfax, aged 25 years, joined his father and uncle as directors of John Fairfax & Sons Ltd, a position he was to relinquish only with his death in 1987. His accession was timely since James Oswald Fairfax and Geoffrey Fairfax died within three years. Their shareholdings remained, however, within the Fairfax family, with a majority shareholding in

232

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This and the next paragraph are substantially based upon the account in G Souter, Company of Heralds (1981), Chs 1-4 (hereafter Company of Heralds). [2.255]

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the hands of Warwick Fairfax and his mother. In 1937 the company was converted into a proprietary (or private) company freeing it from the obligation to publish its financial statements. 233 Several themes recur throughout Warwick Fairfax’s proprietorship. One is the desire to retain family control against the threat that death duties might force the outside disposal of shareholdings or even the dissolution of the company. This threat was largely met by personal persuasion which ensured that shareholdings were always concentrated in few hands despite the passing of the generations and the growing span of the dynasty. Another threat to family control came from the need to provide funds for growth, especially in the post-war period, when family shareholders were unwilling to contribute the necessary funds. In 1956 a new company, John Fairfax Ltd, was formed to acquire the whole of the issued capital of the proprietary company. The issued capital of John Fairfax Ltd was £4 million of which one half was issued to the erstwhile ordinary shareholders in the proprietary company in partial consideration for the transfer of their shares to it. The balance of the shares was offered for public subscription and the company was listed upon the Sydney Stock Exchange. At no time thereafter did Fairfax family shareholdings in the public company fall below 48%. Access to these funds stimulated a prodigious expansion of company activities. In 1949 the company launched a quality Sunday broadsheet which was later merged with another acquisition to become the Sun-Herald. Two years later it launched the Australian Financial Review which in 1963 became Australia’s first national daily; the National Times was launched in 1971. Publishing interests were also expanded by acquisitions in other capital cities, including the Melbourne Age. From 1953 the company acquired extensive broadcasting interests. The construction of this elaborate empire was largely achieved through professional managers who were financially and commercially astute, closer to the operations of the business than the family proprietors, and often stronger personalities. From 1930 Warwick Fairfax was successively managing director, governing director and chairman of the board of John Fairfax Ltd. In one general manager’s view, firmly expressed, the proprietor’s place was “at the top, and not in the hurly-burly of day-to-day business”. 234 By the 1960s directors and the general manager had grown to resent the directions which Sir Warwick Fairfax (as he now was) as chairman gave to senior management or editorial staff without consulting the general manager. In 1976 the directors appointed Sir Warwick’s son by his first marriage, James Fairfax, as chairman of the board. The decision was bitterly resented by Sir Warwick and Lady Fairfax. It was one, however, which Sir Warwick was unable to resist since his shareholding had been reduced by transfers to James Fairfax. Its echo can be detected in the final chapter of the family proprietorship – the takeover by Sir Warwick’s other son, W G O Fairfax, which precipitated the company’s receivership. The son also rises: 1987-1990 [2.265] Tensions between “Fairwater”, the home of Sir Warwick and Lady Fairfax, and

Broadway, the seat of company management, persisted throughout the 1980s. There was continuing resentment at Fairwater over Sir Warwick’s exclusion from management (other than as a non-executive chairman of the board) and the waxing influence of other Fairfax directors and senior management. Fairwater suspected that management was indifferent to the retention of family control, an anxiety aggravated by persistent concerns that an offer might be made for Fairfax shares that other family members might find attractive. 233 234

Company of Heralds, p 175. The proprietary company form was not introduced into New South Wales until 1936. Company of Heralds, p 368. [2.265]

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Going private: The takeover by Warwick Fairfax [2.270] The death of Sir Warwick Fairfax in January 1987 precipitated events. In the

following months, W G O Fairfax (hereafter “Warwick Fairfax”), the child of Sir Warwick’s third marriage, purchased 1.5 million shares in John Fairfax Ltd, increasing the Fairfax family’s aggregate holding from 48.6% to 50.1%. Warwick Fairfax was then aged 26 and had just completed graduate studies at the Harvard Business School. He had some modest United States experience in investment and commercial banking and, briefly, newspapers. On his return to Australia in April 1987 he worked in the Fairfax marketing department but declined an informal approach to join the board. On the evening of Sunday, 30 August 1987, he called upon the company’s chairman, his half-brother James Fairfax, and the deputy chairman, his cousin John B Fairfax, to inform them that a takeover bid would be announced on the following day for all the issued shares in the public company. The bid would be made through Tryart Pty Ltd, a dormant company acquired for the purpose, and would be funded by borrowings of $2.1 billion from the Australia and New Zealand Banking Group Ltd (hereafter “ANZ Bank”). It would be the largest takeover bid made for an Australian company, and the most highly geared (gearing refers to the relation between the size of a company’s interest bearing debt and its net assets). In its final form the Tryart bid offered $8.50 for each share in John Fairfax Ltd, a price which represented the very high multiple of 60 times annual earnings per share. The bid price was rendered even more attractive by the stock market collapse of October 1987 which saw share prices fall dramatically. Tryart did not seek regulatory approval to withdraw the bid or reduce the consideration offered in light of changed market conditions. James and John B Fairfax announced their early acceptance of the offers, confounding Warwick’s hopes that they would retain their investment in the company and not add to the cost of his bid. It appears that their decision to accept was as much influenced by the secrecy and unilateral character of the bid as by its financial attractiveness. In late October, the directors of John Fairfax Ltd, after receiving a report from an independent expert as to the fairness of the bid’s terms, recommended that shareholders accept the Tryart offer. By mid-November Tryart had acceptances in respect of all shares other than those held by or on behalf of Warwick Fairfax and his mother. On 7 December 1987 the directors of John Fairfax Ltd, including James and John B Fairfax, resigned their offices in favour of Warwick Fairfax and the advisers whom he had assembled around him. The company was removed from the Official List of the Australian Stock Exchange. In 1988 the new holding company (Tryart) changed its name to John Fairfax Group Pty Ltd.

Post-acquisition restructuring [2.275] From the outset the plan had been for John Fairfax Ltd to sell non-core assets and to distribute the proceeds as loans to John Fairfax Group Pty Ltd to be applied towards retiring the debt to the ANZ Bank. The task of negotiating asset sales commenced immediately but without early success. Operating revenues were insufficient to meet interest obligations. It soon became evident that comprehensive restructuring was inevitable. For this the group looked to the United States investment bank Drexel Burnham Lambert Inc which had pioneered the issue of high yield (or “junk”) bonds. The holders of junk bonds enjoy a higher interest rate than for loan funds backed by first ranking security, the yield reflecting the higher risk of non-payment to which their holders are exposed. 235 The restructuring which was 235

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The insight by Drexel which spawned the junk bond boom of the mid 1980s was that secondary markets excessively discounted the value of bonds issued by a corporation whose financial performance had declined after the issue of the bonds. Drexel applied this insight to develop a market for high yield bonds as a device for funding hostile takeovers. For a gripping account of the Drexel adventure in high finance, see C Bruck, [2.270]

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completed in January 1989 consisted of $1.1 billion in senior (that is, prior ranking secured) debt provided equally by the ANZ Bank and Citibank, with a term of seven years, secured over the assets of John Fairfax Group Pty Ltd and its main subsidiaries, and the issue of $450 million in bonds (or debentures, that is, debt interests) underwritten by Drexel. The claims of the bond holders were subordinated to those of the banks for which displacement the holders received a higher interest rate, rights of protection against depreciation of the Australian currency in which they were denominated and equity “sweeteners” enabling conversion of some portion of the debt claims into equity interests in the John Fairfax group of companies. Drexel sold the junk bonds in United States capital markets. The debt restructuring only delayed the inevitable. The cumulative burdens of retiring funding through asset sales in a depressed property market, of an economic recession which reduced newspaper advertising revenues, and of high interest rates, ultimately became intolerable. Three non-executive directors were added to the board in July 1989 from outside the Fairfax family and brought a heightened sense of the urgency of finding new equity capital. When these directors came to the view that the value of the proprietor’s equity had been effectively wiped out by the company’s debt burden and the decline of its asset values, a view which Warwick Fairfax would not accept, their position was untenable. 236 New directors were appointed in their place in August 1990 but they were no more successful than their predecessors in seeking further equity investment in the company even on terms that would have seen the proprietor’s equity reduced to a token 5%. On 10 December 1990 the banking syndicate refused to renew the 90-day bank bills through which they had provided loan funds or grant the directors’ request for a 14-day extension. 237 The directors immediately sought a court order for the appointment of a provisional liquidator to the subsidiary company through which the group’s borrowings were made upon the grounds that that company was unable to pay its debts. The appointment was made and, being in itself an event of default within the terms of the banks’ security, the banks immediately appointed two Sydney accountants to be receivers and managers of all the companies in the John Fairfax group to enforce the security and thereby obtain repayment of the sums due to the banks. Sale of the company by the receivers: 1991-1992 [2.280] The receivers and managers set in process a procedure leading to competitive bidding

for the sale of either the assets of the John Fairfax group of companies or the corporate structure. On 16 December 1991 the receivers and managers announced that the Tourang consortium’s offer for the group had been accepted. On the completion of the acquisition on 23 December, Tourang Ltd acquired all the issued capital of John Fairfax Group Pty Ltd from Citisecurities Ltd, as agent for the syndicate of bank lenders, for a consideration of $100,000. Tourang Ltd then raised $686.06 million in share and debt capital by the issue of The Predators’ Ball (1988) and, for an equally engaging account of the social ecology of the US hostile takeover boom of that period, see B Burrough & J Helyar, Barbarians at the Gate: The Fall of RJR Nabisco (1990). By 1989, however, Drexel was well past its apogee. Securities fraud investigations were underway which would lead to the imprisonment of its prime force, Michael Milken, for insider trading and the bankruptcy of the firm. The Fairfax capital raising was to be one of Drexel’s last significant junk bond financing projects. 236

Warwick Fairfax apparently hoped to reduce the group’s debt burden by persuading bond holders to redeem their bonds at a deep discount upon their face value. He was encouraged in this view, even though the bonds were not due for repayment until 2000, by the general collapse of the junk bond market in the United States in 1990. Bond holders were, however, reluctant to accept such a loss without a commensurate write down of the proprietor’s equity.

237

Indeed, renewal for the longer term may have exposed directors to personal liability for the debts since they had refused to certify to the banks that the group could meet its debts as and when they fell due. [2.280]

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398.25 million fully paid ordinary voting shares at $1.00 per share and 287,808 million non-voting debentures at $1.00 per debenture. On the completion of this fundraising, the John Fairfax group’s bank debt of $1.25 billion was discharged in part by a payment of $525 million and the balance of the debt reformulated into debt facilities in the amount of $700 million with a term of five years. These latter facilities enabled repayment of the unsecured debts of the group. Tourang’s name was changed to John Fairfax Holdings Ltd. Of the shares issued by Tourang, 59.5 million shares were subscribed for by The Daily Telegraph Plc (controlled by the Canadian Conrad Black) and the balance taken by Australian financial institutions. The size of the Telegraph’s equity investment was determined by the terms of the Treasurer’s foreign investment approval which limited Black’s investment to 15%. Half of the debentures were issued to the junk bond holders in exchange for their bonds and in full settlement of all their rights. In early 1992 appointments were made to the board of directors of John Fairfax Holdings Ltd and a chief executive officer appointed. In March 1992 John Fairfax Holdings Ltd issued a prospectus offering its shares to the public. The offer was fully subscribed. John Fairfax Holdings Ltd was listed upon the Australian Stock Exchange in May 1992 and its shares publicly traded. Since then about 60% of the holding company’s total issued capital has been held by Australian investment institutions and private investors. The search for ownership stability [2.285] An important theme in the recent history of Fairfax narrative remains that relating to

control of the company. It indicates, in ways that cannot be presently explored fully, the elusive, intangible and often protean character of corporate control, at least where, as in the case of Fairfax, it does not depend upon majority share ownership: see [2.185]. 238 By its conclusion, Conrad Black was the principal force in the Tourang bid. His influence in Fairfax – or de facto control – rested upon four distinct foundations: • his status as the company’s largest shareholder through The Daily Telegraph Inc’s 15% shareholding; • his effective power to select the board of directors, albeit within limits determined by the need for the support of the principal institutional shareholders; • his influence in the management restructure of Fairfax and the appointment of its chief executive; and • his personal newspaper management expertise and that of his organisation. This influence was vulnerable while his stake was limited by the need for the Treasurer’s approval under the foreign ownership law. Black signalled almost immediately after the stock exchange listing that he wished to raise his equity stake in Fairfax. In 1993 the Treasurer approved an increase in his interest to 25%. Black continued to press for approval to increase his equity stake in Fairfax as protection against the risk of displacement under a hostile takeover bid made for Fairfax. He canvassed publicly the option of disposing of his interest if approval were refused. The change of government in March 1996 encouraged some to expect that restrictions upon foreign investment would be relaxed. However, when it emerged that this was unlikely in the short term, Black disposed of the whole of its Fairfax holdings, principally, by the sale of a 19.9% to Brierley Investments Ltd. (Brierley subsequently increased its holding to 25% by on-market acquisitions permitted by corporations legislation.) Since Brierley was a New Zealand company with substantial foreign investors, the foreign ownership restrictions continued to apply to its investment in Fairfax. 238

98

A fuller account of the period after the float in 1992 is contained in the third edition of this book at pp 892-896. [2.285]

The Historical, Institutional and Social Context of Corporations Law

CHAPTER 2

The motive for Brierley’s investment was never clear. Possible explanations included: • a greater willingness to assume the risk that foreign ownership restrictions would be lifted; • the assumption that it would enjoy the same level of management influence in Fairfax that Black and his organisation had achieved; and • speculation that lifting of cross-media restrictions (which restrict companies with broadcasting interests controlling print media, and vice versa) would lead to a future contest for control of Fairfax in which the Brierley holding would play a crucial role. Over the next two years, any such expectations were disappointed as were the prospects of a loosening of foreign ownership restrictions. As regards management influence, Brierley’s lack of newspaper experience relative to that of Black’s group proved a disadvantage. In May 1998, one of Brierley’s two representatives on the Fairfax board of directors stood down as chairman of the board, although remaining as a director. In December 1998, Brierley disposed of its Fairfax stake: Fairfax made a buy-back (that is, a repurchase) of 9.9% of the share capital held by Brierley (see [9.285]) and the balance was sold to institutional investors. The most significant shareholding block in Fairfax, that taken by the principal surviving member of the Tourang consortium, had now been dissolved. Seven years of foreign control of Fairfax had ended, even if that control had become increasingly fragile. In 2007 Fairfax acquired all the shares in Rural Press Ltd in a friendly merger effected by a court-sanctioned scheme of arrangement. Rural Press was controlled by John B Fairfax, who had been deputy chairman of Fairfax when Warwick Fairfax made his surprise takeover offer in 1987. John B Fairfax had acquired his stake in Rural Press under the forced asset sale that Fairfax made in the attempted restructuring following the 1987 takeover. Under the 2007 merger in which shares in Rural Press were exchanged for shares in Fairfax, John B Fairfax through his family companies held 14.6% of the issued share capital of Fairfax, the largest single holding in the company. John B Fairfax and his son Nicholas were also appointed to the board of Fairfax. With the 2007 merger Fairfax family members had returned to the newspaper business in which their ancestor had acquired a half interest in 1841. The family’s return, however, proved short lived. By the end of 2011, after a collapse in the company’s share price and declining advertising and subscription revenues, the Fairfax family had disposed of its holding and left the board. It was reported that they suffered losses of $1 billion in the investment. The core Fairfax enterprise remains that upon which John Fairfax launched himself in 1841 –journalism of quality and influence within the Australian community. But few things stand still. King Croesus, washing his hands in the river Pactolus to rid himself of the touch that turned all to gold, turned its sands to “rivers of gold”; online technology did the opposite to Fairfax’s Pactolus, “washing away” its monopoly of classified advertising revenues. Although Fairfax’s online digital media enterprises make it Australia’s largest multi-platform media group, online revenue potential is nascent, uncertain and no immediate substitute for print revenue losses. In mid-2012, in the face of continuing drop in the share price and the acquisition of a hostile holding by mining magnate Gina Rinehart’s Hancock Prospecting, Fairfax announced cuts of one in five jobs, the closure of two major printing presses and a future digital priority. Print versions of newspapers would continue only so long as they were profitable. Many of the best known and most respected journalists were soon “tapped out” of the building by colleagues in a ritual of loss and solidarity. The river was silted, not golden. This restructuring was widely interpreted as a pre-emptive strike against a bid for control from Rinehart who had quickly assembled a holding of 19% in Fairfax although it was later reduced to 14.99% since Fairfax Media’s insurance policy denied cover for directors owning more than 15% of the company’s equity. It was assumed by many at the time that her interest in Fairfax was piqued by the platform it offered for louder advocacy of mining interests. Some [2.285]

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commentators spoke of a Sydney Mining Herald. A stand-off ensued with the Fairfax board which refused her request for two board seats and stipulated that she would need to abide by its governance principle that directors do not control editorial decisions before she was appointed to the board. (She refused to do so and was never appointed.) At the 2012 annual general meeting of shareholders, she unsuccessfully opposed the re-election of several directors but succeeded in her opposition to the company’s remuneration report, achieving with some other shareholders a first strike under the “two strikes” rule under which votes exceeding 25% for two consecutive years against a listed company’s remuneration report automatically trigger a resolution requiring all directors to stand for re-election within 90 days of the second vote: see [7.405]. She failed to reach that target at the 2013 AGM and sold her stake in 2015. At the apex of the Fairfax group of companies is the listed Fairfax Media Ltd. At 30 June 2016, there were 69 subsidiary companies in the group. 239 The board of directors of Fairfax Media Ltd then comprised seven non-executive directors (that is, directors who are not also employees of Fairfax group companies) and the chief executive officer who is, of course, an employee of Fairfax. Six of the eight directors were male; all directors had backgrounds in business, investment or professional services. Several are or had been chief executives of other corporations but none (apart from the chief executive officer) has been an employee of Fairfax. The company’s Annual Report 2012 records that the directors have determined that each of the directors, except the chief executive officer, is an independent director (that is, is independent of company management and free of a significant shareholding in or contractual relationship with the company). The Report stated that Fairfax generated 42% of group earnings from digital and non-print businesses, especially burgeoning property listings on Domain, its online real estate business, regaining lost revenue from its erstwhile print Pactolus; it projected that digital and non-print would deliver closer to 60% of earnings in 2017. 240 At 30 June 2016 the 20 largest shareholders in Fairfax held 86.4% of its ordinary share capital between them. These 20 shareholders were investment companies or custodian nominees for financial institutions holding their shares on behalf of a vast number of managed funds, superannuation funds and other collective investment vehicles as well as for individuals. Fairfax is important to the financial well-being of Australian citizens as well as to Australian society and culture generally. Company law is concerned with economy but also with society. The two are not easily separated. Why ever would they be?

239 240

Fairfax Media Limited Annual Report 2016, pp 98-101. Fairfax Media’s ownership interest in these companies is generally 100% but in no case falls below 51%. Fairfax Media Limited Annual Report 2016, p 7.

100

[2.285]

CHAPTER 3 The Corporate Life Cycle [3.10]

[3.65]

[3.80]

[3.135]

CHOICE OF FORM OF BUSINESS ASSOCIATION ............................................................................ 102 [3.10]

The diversity of business forms and functions ............................................................... 102

[3.13]

A special form of incorporation for Indigenous Australians ............................................ 105

[3.15]

Sole trader ................................................................................................................... 106

[3.20]

Co-operatives ............................................................................................................... 106

[3.25]

Incorporated associations ............................................................................................. 109

[3.30]

Factors affecting the decision to incorporate ................................................................ 111

THE PROCESS OF INCORPORATION UNDER THE CORPORATIONS ACT ........................................ 114 [3.65]

The structure of the Corporations Act ........................................................................... 114

[3.70]

Obtaining incorporation .............................................................................................. 114

[3.75]

Practical alternatives and formalities ............................................................................. 117

THE TYPES OF COMPANY UNDER THE CORPORATIONS ACT ........................................................ 118 [3.80]

Company types and their incidence ............................................................................. 118

[3.85]

The nature of share capital ........................................................................................... 119

[3.105]

Companies limited by shares ........................................................................................ 122

[3.110]

Companies limited by guarantee ................................................................................. 123

[3.115]

Companies limited both by shares and by guarantee ................................................... 125

[3.120]

Unlimited companies ................................................................................................... 125

[3.125]

No liability companies .................................................................................................. 126

[3.130]

Changing company type ............................................................................................. 127

PROPRIETARY COMPANIES ............................................................................................................ 127 [3.135]

Identifying the private company .................................................................................. 127

[3.140]

Privileges accorded the private company ..................................................................... 129

[3.145]

THE CORPORATE CONSTITUTION ................................................................................................ 130

[3.150]

THE CORPORATE ORGANS ............................................................................................................ 132

[3.155]

CORPORATE CAPITAL .................................................................................................................... 133

[3.185]

[3.220]

[3.160]

The distinction between equity and debt capital .......................................................... 133

[3.165]

The issue of share capital ............................................................................................. 134

[3.170]

The classes of share capital ........................................................................................... 134

[3.175]

Ordinary shares ............................................................................................................ 134

INSOLVENCY ................................................................................................................................ 136 [3.190]

Voluntary administration .............................................................................................. 137

[3.195]

Receivership ................................................................................................................. 141

[3.200]

Winding up the company ............................................................................................ 142

[3.215]

Schemes of arrangement ............................................................................................. 146

PROTECTING THE INCIPIENT COMPANY THROUGH PROMOTERS’ DUTIES ................................................................................................................... 147 [3.225]

Who is a promoter? ..................................................................................................... 147

[3.240]

The disclosure standard ................................................................................................ 155

[3.245]

Remedies of the company ............................................................................................ 156 101

Corporations and Financial Markets Law

[3.05] This chapter is concerned with the gestation and birth of the company, its principal

structural characteristics, and the processes and consequences of termination of its existence. The chapter discusses the choice of form of association, the design of constitutional and capital structures, the duties of company promoters, the making of pre-incorporation contracts for the company, the process of incorporation itself, the subsequent formalities necessary to set the company in motion and the consequences of its insolvency. Most companies, of course, will never become insolvent. They will be perpetual, mocking the suggestion in this chapter’s title. However, the darkness of insolvency sharpens understanding of corporate life lived in its shadow and of the principal corporate characteristics. For pedagogical reasons, the order of this treatment departs a little from the sequence of the developmental process. The first section looks at the range of forms of association (particularly corporate forms) and the factors affecting choice between them. The second examines the procedures necessary to effect the incorporation of a company under the Corporations Act. The third considers the classes of companies under the Corporations Act, their common features and distinguishing elements. The fourth is concerned with the search for a legal definition for the private company to be sheltered from the full rigours of regulation. The section examines the current formulation of the private company and the privileges extended to that company. The fifth to seventh sections introduce the organs, constitution and capital structure of the company, their principal features and the factors affecting their design. The eighth section looks at the consequences for a company of insolvency, including the order of application of its assets among those with claims against it. The chapter concludes with an examination of legal doctrines protecting the newborn or gestating company through the imposition of duties upon its promoters.

CHOICE OF FORM OF BUSINESS ASSOCIATION The diversity of business forms and functions [3.10] There is a wide variety of legal structures by which individuals may pursue

profit-making objectives in association with others. The plurality of these forms reflects the diversity of business association itself – the relation between partners, for example, is far removed from that between shareholders in a large public company or members of a credit union. Yet all participate to some degree in business activity for collective financial advantage. Several forms of business association may also be used for non-profit activities. Indeed, the boundaries between profit-making and non-profit activities are not always clear. Hence, the following table classifying the principal forms of business organisation includes some specifically non-profit forms.

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[3.05]

The Corporate Life Cycle

CHAPTER 3

Figure 3.1 The forms of business association

The forms of business association [3.11] The unincorporated forms of association were introduced in Chapter 1. Present

concern is with the incorporated forms, particularly the company and, to a lesser extent, the incorporated association and the co-operative. First, however, some general observations should be made about the relations between these legal forms and the various functions pursued through group activity. The diversity of the forms of association is accompanied by wide freedom of choice between them. The law imposes few fetters upon that freedom. The principal restriction derives from the 1844 Act (see [2.55]), that partnerships above a certain size should incorporate, the rationale for the restriction being “to prevent the mischief arising from large trading undertakings being carried on by large fluctuating bodies, so that persons dealing with them did not know with whom they were contracting, and so might be put to great difficulty and expense, which was a public mischief to be repressed”. 1 The current formulation of this prohibition is contained in the Corporations Act, s 115 which prohibits the formation with more than 20 members of a partnership or association having for its object the acquisition of gain by the association or individual members. An exception is made, however, for a profession or calling of a kind specified since the ethical rules or regulating statute of some 1

Smith v Anderson (1880) 15 Ch D 247 at 273 James LJ. It is a measure of the group’s freedom of choice of form that other constraints are highly specific, such as provisions under liquor licensing legislation precluding an unincorporated association from holding a liquor licence: see, eg, Liquor Act 1982 (NSW), s 36(4). These provisions explain the separation between the supporters and the licensed clubs associated with football teams in some States. [3.11]

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professions have traditionally restricted practice in incorporated form. Accordingly, the Corporations Regulations (reg 2A.1.01) specify upper size limits for particular partnerships, including • medical practitioners (50 members), • legal practitioners (400 members) and • accountants (1,000 members). While the principal forms of association have evolved or been fashioned to meet specific functions, there is no neat symmetry between the forms and functions of association. For any particular purpose for which individuals might wish to associate, there will generally be one or more incorporated and unincorporated forms available. The functions of association are, of course, as diverse as the forms. To indicate the flexibility in choice, four major functions are chosen to note the range of forms available for the pursuit of each. Much group activity is directed to the pursuit of non-profit goals. The term non-profit covers a spectrum of activities which at one end is closely related to business and profit purposes. The term may be thought to include: • activities having charitable objects (eg, philanthropic foundations, associations for political or community purposes); • educational and scientific activities (eg, private schools); • activities of a sporting, social or cultural nature (eg, football and RSL clubs, societies concerned with music); • activities intended to further professional or trade interests (eg, law societies, bar associations and retailers associations); and • activities carried on for the mutual benefit of members (eg, credit unions, rural cooperatives, mutual building societies, mutual insurance associations). Obviously these activities differ widely in the sense in which they are non-profit. Charities are effectively precluded by taxation and charitable collections legislation from giving material benefits to members of the association conducting them, at least so long as the member is not also an employee of the organisation. Professional and trade associations, on the other hand, may be an important adjunct to profitable business activity. Credit unions, mutual building societies and rural co-operatives clearly confer a material advantage on members, even though in some cases they may be non-profit in the sense of being not allowed to pay a dividend. The sporting and social clubs of Australia conduct activities which often are enormously profitable, and in some cases, of such magnitude that it seems curious to characterise them as non-profit or to say that their business activities are merely ancillary to non-profit social or sporting purposes. The unincorporated non-profit association (typically, a club) with all of its attendant legal obscurities is a legal form commonly adopted by non-profit groups: see [1.120]. Trusts are also widely used. Three corporate forms might also be used by the non-profit group. The incorporated association has been established by legislation in each jurisdiction to provide a relatively simple and inexpensive mode of incorporation for non-profit groups, thus avoiding the difficulties and uncertainties of the law on unincorporated non-profit associations. The incorporated association is considered at [3.25]. Second, State legislation provides for the incorporation of co-operative societies formed to promote the economic or social interests of their members. This form is considered at [3.20]. Finally, many non-profit groups have chosen to incorporate under corporations legislation as a company limited by guarantee: see [3.110]. The belated introduction of the incorporated association form in some States (especially New South Wales and Victoria) forced many social, cultural or scientific groups to adopt this mode of incorporation. 104

[3.11]

The Corporate Life Cycle

CHAPTER 3

A second function is private business activity. Private ventures (referring, imprecisely, to those ventures not employing publicly solicited funds) have historically been pursued through the partnership form and, more recently, the limited partnership, joint venture and syndicate. However, as we have seen, the registered company form was regularly used from the 19th century as a vehicle for private enterprises. Under the Corporations Act, the company limited by shares formed as a proprietary company is a standard form of organisation for small business and is by far the most numerous category of registered company. A third common purpose of association is to minimise tax imposts. For many years the company, particularly the proprietary company, has been employed in the design of more or less elaborate structures to minimise the incidence of taxation. Often the partnership was harnessed to this task, alone or in conjunction with other forms. One such form is the trust. Although the trustee is separate from the beneficiaries, the trust is not a distinct legal entity and the trustee bears personal responsibility for trust obligations. Since the trust is not taxed separately from beneficiaries, it is sometimes seen as having taxation advantages over other business forms. The trading trust, usually employing a limited company as trustee, has accordingly been used as a vehicle for conducting small (especially family) business. However, the ascription of personal liabilities to directors of the trust company, and taxation changes, has had a chastening effect upon this development. 2 A fourth function is the marshalling of public funds, or the aggregation of funds on a large scale, for trading or investment within the private sector. The company limited by shares, and necessarily a public company, is the principal form of association for such purposes. Other forms may also be used. Chartered corporations and corporations formed by a special Act of Parliament have played historically significant roles in such enterprises although their modern significance is greatly diminished. The co-operative form may also be employed within limits. Banking and insurance companies operate under special statutory regimes. 3 Credit unions, building societies and friendly societies are further, albeit specialised, forms of business organisation operating under specific statutory codes. Unit trusts have been important collective investment structures since the late 19th century when their immunity from the reach of the outsize associations provisions (s 115) was established. 4 This statutory provision, however, precludes most other forms of unincorporated association from being used for public ventures. A special form of incorporation for Indigenous Australians [3.13] The Corporations (Aboriginal and Torres Strait Islander) Act 2006 (Cth) provides a special form of incorporation for Aboriginal and Torres Strait Islander peoples that takes account of the specific character and requirements of Indigenous associations and activities. It replaces the Aboriginal Councils and Associations Act 1976 (Cth), an incorporation statute intended to provide a simple and flexible means for incorporating associations of Indigenous people. Approximately 2,800 Aboriginal and Torres Strait Islander corporations incorporated under the 1976 Act. Many were formed to hold land or deliver essential services, and 60% 2

3 4

To many minds, the use of the trust for trading purposes is a distortion of its proper function, and the trading trust is cherished only for its expediency. The use of a corporate trustee, usually with a low capitalisation, for trading activities has sometimes frustrated the expectations of creditors and other participants in the enterprise: the “fruit of this union of the law of trusts and the law of limited liability companies is a commercial monstrosity”: H A J Ford (1981) 13 MULR 1; see also H A J Ford & I J Hardingham, “Trading Trusts: Rights and Liabilities of Beneficiaries” in P D Finn (ed), Equity and Commercial Relationships (1987), p 48. See Banking Act 1959 (Cth); Insurance Act 1995 (Cth); Life Insurance Act 1995 (Cth). Smith v Anderson (1880) 15 Ch D 247; A F & M E Pty Ltd v Aveling (1994) 14 ACSR 499. [3.13]

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Corporations and Financial Markets Law

were located in areas classified as remote or very remote. 5 The 2006 Act corrects problems identified in the 1976 Act. Those flaws became more telling after the Native Title Act 1993 (Cth) introduced a requirement that, once a determination that native title exists has been made under the Act, the Federal Court must determine a prescribed body corporate to hold or manage the native title and fulfil the functions required by the Native Title Act. The 2006 Act permits Indigenous people to design corporate structures and rules which best suit their specific needs, whether by reference to cultural practices or otherwise. Incorporation under the 1976 Act was reserved for the use of Indigenous people. The 2006 Act, however, requires only that a majority of members and directors must be Indigenous. This licence for outside participation is to enable services to be provided to non-Indigenous people or adopted children especially as some corporations are the only providers of essential services in some Indigenous communities and non-Indigenous community members might otherwise be disadvantaged. 6 The 2006 Act is aligned with the Corporations Act where practicable. This is achieved through provisions relating to directors’ duties, external administration, the protection of members’ rights, disqualification from management, and technical matters such as the jurisdiction of courts and offences. One significant difference between the 2006 Act and the Corporations Act concerns the scope of the intervention powers of the Registrar of Aboriginal and Torres Strait Islander Corporations relative to those of ASIC. The Registrar is given an examination power that does not require grounds; it is intended to enable “healthy organisation checks” as a preventative measure. The power extends beyond financial management to support dispute resolution and improved organisational effectiveness. The Registrar may also appoint a special administrator to take control of the corporation’s affairs and may exempt the administrator from certain procedural requirements in the 2006 Act. Sole trader [3.15] A sole trader is not involved in business association. The term refers to an individual

conducting a business alone without the benefit of any legal structure or entity status distinct from that of the individual who conducts it. The sole trader is responsible for the management and financing of the business, perhaps with the assistance of one or more employees. The trader is personally liable for the debts and other liabilities of the business without any limitation, including those incurred by employees within the scope of their authority. There are no formalities accompanying the formation, conduct, transfer or termination of the business unless a business name is used requiring registration or the solvency of the trader is impaired in which latter case the general bankruptcy law applies. Taxation legislation imposes obligations of general application including the requirement for an Australian Business Number and returns of income and goods and services tax. All income received from the business by the sole trader is taxable on an individual basis and there are only modest opportunities for tax minimisation relative to business conducted in corporate form. The general statutory obligations with respect to workers’ compensation insurance, government licensing, industrial safety and employment protection apply equally to sole traders as to corporations. Limited liability and taxation considerations sometimes prompt sole traders to conduct the business through a corporation of which they may be the sole shareholder and director. Co-operatives [3.20] In all Australian States and Territories legislation provides for the incorporation of

registered co-operative societies, usually known as “co-operatives” or simply “co-ops”. These 5 6

Corporations (Aboriginal and Torres Strait Islander) Bill 2005, Explanatory Memorandum, [3.2]. Corporations (Aboriginal and Torres Strait Islander) Bill 2005, Explanatory Memorandum, [3.27].

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[3.15]

The Corporate Life Cycle

CHAPTER 3

co-operatives offer limited liability for their members and provide an alternative incorporated form for the pursuit of business as well as for non-profit goals. The co-operative is distinguished from the registered company by adherence to certain principles which govern both the formation and conduct of the co-operative and the distribution of surpluses. These principles derive from a group of Lancashire workmen, many of them weavers forced into poverty by the mechanisation of the Industrial Revolution, who in 1844 pooled their savings to form the Rochdale Society of Equitable Pioneers to provide staple food items to members. The principles upon which their society was formed express modern co-operative identity, values and principles: 1. voluntary and open membership, free from discrimination upon grounds of race, religion or politics; 2. democratic member control including the general principle of one vote per member regardless of shareholding; 3. returns upon share capital are limited with surpluses typically distributed to members in proportion to the volume of their transactions with the society; 4. commitment to the education of members and employees in co-operative principles; 5.

co-operation with other co-operative societies at local, national and international level; and

6.

concern for the sustainable development of their communities. 7

These principles distinguish the co-operative from the joint stock company which was first regulated by general statute in that same year: see [2.55]. Like registered companies, a co-operative may adopt a share capital and, if it does so, members of the co-operative are liable only for any amount unpaid upon their shares; members of a co-operative without a share capital are liable to the co-operative only for charges payable to the co-operative under its rules. 8 Co-operatives were initially developed under the guise of “friendly societies”. Friendly Societies Acts from 1834 had facilitated the formation of friendly societies which were little more than mutual insurance societies providing funeral and like benefits for the labouring classes. (Friendly societies had existed long before 1834. 9) Perhaps more by accident than design, trading societies were formed under the Friendly Societies Acts and the Industrial and Provident Societies Act 1852 (UK) extended the facility of incorporation to such bodies. Ten 7

8 9

This statement by the world organisation of the co-operative movement, the International Co-operative Alliance (http://ica.coop/en/whats-co-op/co-operative-identity-values-principles) and has been adopted as the authoritative statement of co-operative principles; a proposed co-operative must be designed to function under these principles: Co-operatives National Law, ss 10, 27(2)(c). For discussion of co-operative history and ideology, see B Potter, The Co-operative Movement in Great Britain (1987) and G D H Cole, A Century of Co-operation (1943). On recent Australasian applications, see Australian Information Service, The Co-operative Way: Victoria’s Third Sector (Ministerial Advisory Committee on Co-operation, 1986); V Hutchinson (1985) 5 (1) Social Alternatives 17. For discussion of worker co-operatives, see M Young & M Rigge, Revolution from Within: Co-operatives and Co-operation in British Industry (1983); R Oakeshott, The Case for Workers’ Co-ops (1978); A Campbell et al, Worker-Owners: The Mondragon Achievement (1977); C S Axworthy & D Perry (1989) 27 Osgoode Hall LJ 647; on consumer co-operatives see C S Axworthy (1977) 15 Osgoode Hall LJ 137. The legal aspects of co-operatives are examined in I Snaith, The Law of Co-operatives (1984). Co-operatives National Law, s 121. Thus, in verse form, the Town Porters Friendly Society of Edinburgh, instituted in 1688, declared: “To aid each other in distress, / to make want of old age less / or, should a member die, / his new made widow to assist / to lay his body in the dust. / These are the objects surely just / of our society.” Displayed in The People’s Story [museum], Edinburgh, 2012. [3.20]

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Corporations and Financial Markets Law

years later the legislation was amended to extend limited liability to members under a distinctive regime of protected capitalism for the working class. Co-operative societies having as their object the improvement of the conditions of working people or the community generally might incorporate under the Act subject to the benevolent paternalism of the registrar of friendly societies. 10 In Australia the co-operative was initially employed not (as in England) by the industrial proletariat but by primary producers seeking a vehicle for the collective marketing and distribution of their crops, etc. The dominance of rural co-operatives in Australia has persisted for over a century. 11 The co-operative form has also been employed by consumers to pool their buying power (the University Co-operative Bookshop Ltd will be a familiar example), in the provision of low-cost housing, in the credit union movement (consumer co-operatives in the financial sector), 12 in worker co-operatives and in numerous other trading and non-profit ventures. Some examples are indicative of the range of applications: the provision of sheltered workshops for aged and invalid pensioners; the provision of professional chambers, staff and library facilities for barristers; the provision of a service for bookmakers by giving guarantees and fidelity bonds to racing clubs; the establishment of Aboriginal hostels and training colleges; the conduct of an ice rink; providing communications services to taxi cab owners; the distribution of films made by members; and the provision of medical services to members. 13 While approximately three-quarters of Australian co-operatives are non-profit bodies operating in a local community, the larger agricultural co-operatives have a national and sometimes international footprint. 14 In 2012 there were approximately 1,700 registered co-operatives in Australia, compared with 2,350 in 2000; the decline reflects the very small number of new co-operatives being formed and perhaps the success of some of the larger for-profit co-operatives which have migrated to the registered company form to secure some of its peculiar benefits. 15 Although Australian co-operative legislation has generally followed common principles and nomenclature, uniformity broke down some time ago. In 2012, the International Year of Co-operatives, the Co-operatives National Law was introduced, removing barriers to cross-border business activity by co-operatives through uniform law and administration and the avoidance of multiple registrations. The inter-government agreement for the national law is similar in broad structure to that adopted for the co-operative companies regulation that operated between 1982 and 2001 in which the effect of a single national law was achieved through near identical State statutes: see [2.85]. New South Wales enacted the Co-operatives (Adoption of National Law) Act 2012 with the intent that it be mirrored by adopting legislation in the other participating States. (The Co-operatives National Law commenced in New South Wales and Victoria in 2014 and in South Australia, Tasmania and the Northern Territory in 2015.) The text of the Co-operatives National Law is contained in the Schedule to 10

The impetus for this legislation came from the Christian Socialists and their parliamentary representative: see P L Cottrell, Industrial Finance 1830-1914 (1980), pp 45, 83.

11

See Spaull & Kay, p 65. It is estimated that co-operatives produce the following proportions of rural produce: rice (100%); sugar (50%); tobacco (85%); cotton (70%); vegetables (40%); dairy products (50%) and fisheries (55%); see Australian Information Service, pp 8-10.

12

Co-operatives in the financial sector such as credit unions, mutual banks, mutual building societies and friendly societies are governed under separate legislation; as Authorised Deposit-taking Institutions, they are also prudentially regulated by the Australian Prudential Regulation Authority (APRA): see [2.125].

13 14

These examples are taken from Australian Information Service, pp 13-14. New South Wales, Legislative Assembly, Parliamentary Debates, 4 April 2012, p 10691 (Anthony Roberts MLA, Minister for Fair Trading).

15

Australian Bureau of Statistics, 1301.0 – Year Book Australia, 2012, Regulation of Co-operatives in Australia, http://www.abs.gov.au/ausstats/[email protected]/Lookup/by%20Subject/ 1301.0~2012~Main%20Features~Regulation%20of%20co-operatives%20in%20Australia~287.

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the NSW Act. The national law indicates which provisions of the Corporations Act 2001 are incorporated into the Co-operatives National Law; it modernises co-operative governance through provisions relating to director qualification and duties. Changes also simplify financial reporting by smaller co-operatives which relieve them of the obligation of public reporting of financial statements. The intention of the national law is that the co-operative will become closer to and competitive with the corporation as a form of business association while remaining faithful to the principles of co-operation maintained by the International Cooperative Alliance. 16 Incorporated associations [3.25] In each State and Territory there is a relatively simple and inexpensive mode of

incorporation for non-profit associations. Although the initial legislation was introduced in South Australia as long ago as 1858, 17 it was not until the 1980s that the Associations Incorporation Acts (as the legislation is intituled throughout Australia) were introduced in New South Wales and Victoria, and modernised in Queensland. The statutes vary in their detail: there is no national law for incorporated associations, as was achieved under the Co-operatives National Law: see [3.20]. Indeed, recent revisions of the legislation in Victoria and New South Wales enlarge rather than diminish those differences. Thus, the Associations Incorporation Reform Act 2012 (Vic) introduces many of the provisions of the Corporations Act relating to company meetings, directors’ duties and minority shareholder protection from oppressive conduct; in contrast, the Associations Incorporation Act 2009 (NSW) retains the traditional structure of lighter, largely facilitative, regulation. Both the New South Wales and Victorian revisions, however, impose size based differential financial reporting obligations, relieving smaller associations from the full requirement. The Associations Incorporation Act 2009 (NSW) is selected to exemplify principles generally shared by the legislation although, as noted, the Victorian legislation includes additional provisions drawn from the Corporations Act. The New South Wales Act permits an association of five or more persons formed for a lawful object to apply for incorporation. The Fair Trading Commissioner may incorporate an eligible association whose application is in the prescribed form unless satisfied that incorporation could be inappropriate or inconvenient by reason of the likely scale or nature of the association’s activities or property or the nature or extent of its dealings with the public: s 7(2). The incorporated association is subject to a number of continuing obligations which parallel those applying to companies. Thus, the committee of an incorporated association must appoint a public officer (s 34) who acts as a point of liaison between the association and the Commissioner. The committee must convene a general meeting of members each year: s 37. If an association’s receipts or assets exceed amounts prescribed in regulations, it is designated a Tier 1 association and must prepare and lay before the annual general meeting audited financial statements that comply with Australian Accounting Standards, and lodge them with the Commissioner: ss 42 – 45. For other associations (Tier 2 associations), the committee need only prepare and lay before the annual general meeting financial statements that give a true and fair view of the association’s affairs and lodge a summary with the Commissioner: ss 46 – 49. These statements need not comply with accounting standards, be audited or publicly disclosed beyond the required summary. The fees for incorporation and lodgment of annual statements for all associations are significantly lower than for companies registered under the Corporations Act. 16 17

See D Wiseman (2013) 31 C&SLJ 40 (Pt 1) and (2013) 31 C&SLJ 123 (Pt 2); A Apps (2016) 34 C&SLJ 6. On the history of the legislation, see K L Fletcher, The Law in Relation to Non-Profit Associations in Australia and New Zealand (1986), Ch 12 and generally on incorporated associations see Part C of that book and A S Sievers, Associations Legislation in Australia and New Zealand (1989). [3.25]

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Perhaps the principal deficiency of the unincorporated association is the exposure of its committee members to personal liability for the contracts and torts of the association. 18 In the incorporated association, however, the members of the association are not, by reason only of their membership, liable to contribute to the discharge of the association’s liabilities (that is, they enjoy what is called limited liability for corporate obligations): s 26. Committee members are also protected from personal liability for acts done as committee members although they may be made personally responsible for an insolvent association’s liabilities if the association incurred those liabilities while insolvent or with intent to defraud: ss 67 – 69. The Act imposes duties on committee members to disclose interests in matters being considered by the committee and makes it an offence for them to make dishonest use of their position or information obtained from it: ss 31 – 33. Of course, the rules of the association may impose additional liability but this is rare. As noted, the Victorian Act imposes a more elaborate set of duties on committee members that mirror those contained in the Corporations Act. An association must not conduct its affairs so as to provide pecuniary gain for its members: s 40. Since incorporated associations are dedicated to non-profit objects, any surplus property on the winding up of the association is not the property of individual members to be distributed among them. Rather, a distribution of surplus property must be approved by the Commissioner and may be vested in another non-profit association which has substantially similar objects: s 75. There is no national scheme for incorporated associations and incorporation in one jurisdiction secures no recognition or reciprocity in another. If an incorporated association wishes to operate outside the jurisdiction in which it is registered, it has two options. First, it may register a separate association in each further State or Territory in which it seeks to operate, obliging it to comply with multiple and disparate requirements. Alternatively, incorporated associations may register under Pt 5B.2 of the Corporations Act as registrable Australian bodies and thereby operate nationally. While the Corporations Act extends this limited facility, it does not otherwise regulate the activities of associations. 19 Neither option is administratively convenient since it requires at least dual sets of compliance obligations. A number of non-profit organisations have chosen the company limited by guarantee form under corporations legislation rather than the incorporated association or co-operative: as to the guarantee company see [3.110]. Legal and taxation/financial advice appear to be the principal drivers in choice of the guarantee company over the incorporated association. Other factors, in descending order of reported significance are, apprehended public perceptions as to the status of the organisation, its size, and need for a national or multi-State structure, the requirements of grant makers, and a preference for dealing with ASIC rather than a State regulator. 20 This research supports anecdotal evidence that “serious” or “more sophisticated” non-profit organisations generally prefer to register as a guarantee company. 21 In some instances this choice is explicable in terms of the unavailability of the incorporated association form in New South Wales and Victoria before the 1980s. However, this calculus of choice is now affected by the reforms to the not-for-profit sector introduced in 2012 which offer a dedicated national facility for not-for-profit entities including incorporated associations: see [3.110]. 18

See, eg, Peckham v Moore [1975] 1 NSWLR 353; Bradley Egg Farm v Clifford [1943] 2 All ER 378; Smith v Yarnold [1969] 2 NSWR 410; Rochfort v Trade Practices Commission (1981) 53 FLR 364.

19

Indeed, if the association carries on business (as broadly defined in Corporations Act, s 21) outside its jurisdiction of registration, it must register under Pt 5B.2. S Woodward & S Marshall, A Better Framework: Reforming Not-For-Profit Regulation (Centre for Corporate Law and Securities Regulation, University of Melbourne, 2004), p 58.

20 21

Woodward & Marshall, p 58.

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Factors affecting the decision to incorporate [3.30] Given the diversity of business forms and the freedom of choice between them, upon

what factors does the decision to incorporate depend? Generalisation here is impossible as much depends upon the individual circumstances of the associates – their objectives, the nature of the business sector in which they shall operate, their access to finance and their tax position. Such factors are infinitely variable. Even if the legal criteria are isolated, many lie outside corporate law. Yet some considerations relating to legal structure will usually affect the decision as to choice of form. The principal of these considerations are briefly noted below, together with that which is often the ultimate determinant – the taxation significance of choice of corporate form.

Limited liability [3.35] A primary motive for incorporating a business is often the desire to limit participants’

liability for the obligations of the enterprise. Partners are personally liable for the firm’s debts and their credit may be pledged by a partner acting within the ostensible scope of firm business. Incorporation insulates members’ other assets from claims against the company and protects against potentially crippling losses which may not always be avoided through insurance. For many small businesses, however, this corporate advantage will be illusory since sophisticated lenders, such as banks and other financial institutions, commonly require personal guarantees from directors or major shareholders. Even here, however, incorporation will insulate members from liability to trade creditors and involuntary creditors such as tort claimants. 22

Perpetual succession [3.40] “This unbroken personality,” wrote John Grant in 1850, “this beautiful combination

of the legal characters of the finite with essentials of infinity appears to have been the primary object of the invention of incorporations.” 23 The company enjoys perpetual succession since it is invested with the legal capacity and powers of an individual with none of the frailties that flesh is heir to. In law, the company is an entity distinct from the individuals comprising its membership. Its status, therefore, is unaffected by the death or bankruptcy of a member or the transfer of ownership interests. By contrast, such events will automatically dissolve a partnership and, although “continuation” provisions in the partnership agreement may provide for automatic novation by the surviving partners, property adjustments will usually be necessary.

Financing [3.45] Unincorporated forms of business organisation are denied the corporate advantages of the power to create a floating security over its assets (now called a circulating security interest under the Personal Properties Securities Act 2009 (Cth)) or to make a public issue of its shares or debt interests. (These debt claims issued by a corporation are called debentures: see s 9 of the Corporations Act and [9.55]–[9.65].) The circulating security interest is a particularly attractive financing instrument from a lender’s point of view. It is a security interest which “floats” over the subject property (often the whole of the company’s undertaking), allowing the company to deal with and dispose of the property in the ordinary course of business until some defined act of default. The appeal of this financing instrument, and the sources of finance 22

Certain provisions of the Corporations Act impose personal liability upon directors and officers for debts of, and distributions by, their company. Such imposition arises only upon proof of some default. Members as such are not generally exposed to such personal liability

23

Grant on Corporations (1850), p 4 quoted in J H Farrar et al, Farrar’s Company Law (3rd ed, 1991), p 81. [3.45]

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it may unlock, may be a telling factor in favour of incorporation, although security interests have been devised for unincorporated bodies which approximate its principal advantages.

Cost, formality and continuing obligations [3.50] Partnership is a remarkably flexible business form. No formality is required for its

creation. Internal structure is not constrained by statute and no registration or reporting obligations are imposed. Partners may freely withdraw their capital from the firm which may be dissolved without formality. In contrast, incorporation is an act of the state, attended with formality and expense. In addition to the formalities necessary to secure incorporation, the Corporations Act imposes continuing obligations to disclose information for the benefit of creditors, members and, in some cases, the wider community (eg, the situation of its registered office and particulars of its directors and secretary). Accounts disclosing the company’s financial position need to be maintained and, for some companies, audited and reported in summary form upon a public register. Registers disclosing particulars of matters such as its membership, directors and their shareholdings must be maintained and made available for inspection by members and, in some instances, the public. Procedures requiring meetings of shareholders or directors are imposed by the Act or the company’s constitution. The Act imposes penalties upon directors and officers for non-compliance with a myriad of obligations, including general duties of loyalty and diligence. In the interests of creditors, constraints are imposed upon the withdrawal of share capital from limited companies. Winding up the company is attended with legal complexity, delay and expense. This burden of formality is a major cost of incorporation against which the corporate advantages must be weighed.

Taxation [3.55] Historically, the double taxation consequence of incorporation was a disincentive for incorporation. As a distinct legal person, the company’s profits are taxable both in its own hands and in the hands of its members when they were distributed as dividends. To prevent tax avoidance through the “squirrelling” of corporate profits in private companies, undistributed profits tax was imposed at punitive rates upon inadequate distributions to members. Accordingly, the incorporation of small business ventures has often been at some cost in higher tax imposts, although it might also open up the possibility of tax deductions which are denied to those trading in unincorporated form. The resort during the 1970s to the trust for the pursuit of business activity is explicable as an attempt to secure corporate advantages without the price of double taxation. The dividend imputation provisions introduced in the 1980s eliminate the double taxation of company dividends. Companies which have paid tax on their profits at the company tax rate may pay dividends to shareholders which carry tax credits at this rate. The imputation measures (whose treatment lies outside the scope of this book) go far towards restoring tax neutrality to the choice of business form.

Overview of choice of form [3.60] There is, therefore, a complex calculus involved in the choice of form of association.

Generally, however, for large enterprises the advantages of incorporation, the transferability of corporate securities and the existence of organised securities markets will compel registration under the Corporations Act. The prohibition on outsize associations in s 115 will usually require incorporation of such enterprises in any event. For small business the choice will not be clear-cut and will turn upon a complex combination of factors, legal and personal, which defy easy prediction. The dividend imputation provisions have removed a burden not 112

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shared by other forms. The legal considerations affecting choice between partnership and incorporation are well exemplified in the following example provided by an experienced lawyer: If five engineers form a partnership, for example, they can choose any mix of entitlements to capital and income, and any decision-making processes, which they think appropriate for their business. As much of the business decision-making as they wish can be delegated to one of their number, or to some other person. They face no registration or reporting requirements over and above those associated with their professional activities and taxation obligations. They can decide whether to hold any meetings, what form of accounts to keep, and whether to have those accounts audited. One partner can be bought out by the others on any basis agreed at the time, or which is provided for in the partnership agreement. Similarly, they can take in a new partner on any basis agreed at the time, or provided for in the agreement. The advantages for those engineers of incorporating their business, rather than continuing as a partnership, would reflect the basic rationale for having limited liability companies: • reduced transaction costs on entry or exit of partners – there is no need to transfer assets or re-document leases, bank facilities, et cetera each time such an event occurs; • if they want to sell the business as a going concern, it will be much simpler to do so; • they will be able to contract with outsiders using a default limited recourse term, which limits their liability to clients to the assets of the business. 24

Taxation considerations will also weigh upon the minds of those advising the engineers, notwithstanding those provisions which seek to assure taxation neutrality in the choice of business form. [3.62]

Review Problems

Consider what forms of association you would recommend for the following groups who are considering a formal structure, incorporated or unincorporated, but in each case with a preference for a minimum of formality and expense. 1. A group of company law teachers form the Corporate Law Teachers Association with the broad objects of advancing the skills of members and the standards of corporate law teaching and research. Membership is open to law teachers in the Asia-Pacific region although a majority of members are likely to be from across Australia. The Association will conduct an annual conference. Members of its elected committee are concerned that these conferences involve a substantial financial commitment and that, if a particular conference is unsuccessful, the host institution might look to the Association or its governing committee for any shortfall. Some members of the committee are also anxious about any personal liability to which they might be exposed, for example, for defamatory comments made at a conference or in material published in the Association’s newsletter. 2. A national institute of the performing arts draws students from across Australia. It wants to form an alumni association to keep in touch with its graduates, assist their professional development and obtain a source of funds for its own development. 3. A student law society at an Australian law school provides the usual services to its membership, including support for student mooting, participation in student conferences and social activities. Its committee is elected annually by members. The current committee 24

D Goddard(1998) 16 C&SLJ 236 at 247-248. The limited recourse term referred to is the limited liability extended to members of a registered company for its debts and other obligations. Goddard argues that potential liability to involuntary creditors such as tort claimants is not a significant risk for small business: at 248, fn 38. The risk will, of course, depend upon the nature of its business. [3.62]

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believes that it can generate very considerable income if it is able to sell legal textbooks to its members in competition with the principal suppliers. 4. A group of women theologians wish to establish an association to advance feminist perspectives in theology and Australian church thinking. They are proposing to publish material the profits of which will finance the employment of office staff. Some members also propose to contribute long-term funds from which they expect to receive a continuing, albeit modest, financial return. Otherwise, it is not proposed that the association is “for profit” or that members take any financial return from the venture.

THE PROCESS OF INCORPORATION UNDER THE CORPORATIONS ACT The structure of the Corporations Act [3.65] A brief word about the structure of the Corporations Act may be useful here. The Act is divided into Chapters, each of which is divided into Parts which in turn are sometimes divided into Divisions and Subdivisions. “Part 7.6” therefore refers to the sixth Part of Chapter 7. Section 9, the dictionary provision, defines terms used throughout the Act; its definitions are, however, subject to displacement where a contrary intention appears in the particular context where a term is used. Expanded definitions of several of the terms in s 9 are given elsewhere in Pt 1.2. A deliberate effort has been made in the Act to retain as much as possible the chapter structure and section numbers of previous corporations legislation. In consequence, there are gaps in chapter and section numbers as the statutory material has been reorganised or repealed. Thus, there is no Chapter 2, 3, 4 or 8 although there are Chapters 2A to 2P, a total of 14 separate chapters with the number 2 in their title. The Corporations Regulations follow the chapter structure of the Act so that, for example, reg 2A.1.01 is the first regulation passed with respect to provisions contained in Pt 2 A.1 of the Act. The Australian Securities and Investments Commission Act and the Australian Securities and Investments Commission Regulations adopt the same structure. Both are less voluminous than their corporations counterparts. As noted in [2.85], from 1991 to 2001, the substantive corporations legislation was called the “Corporations Law”; since 2001 it is contained in the Corporations Act. In this book the terms “Corporations Act” and the “Act” are used to refer to the Corporations Act 2001 and, where the context calls for it, includes predecessor provisions. Generally, references will simply be made to sections of the Corporations Act without express reference to its title. However, where the section reference is to a provision of another statute, its title will be given.

Obtaining incorporation [3.70] Ever since the initial 1844 Act (see [2.55]), only persons associated for a lawful purpose

might obtain incorporation under companies legislation. The state incorporated the group by registering their constituting document, the memorandum of association, to which they had subscribed their names. The affairs of the group were governed by the terms of their constitution. From 1 July 1998, however, incorporation is effected simply by written application by a single person, natural or corporate. The proposed company need have only one member (s 114) and no constitution. Incorporation no longer clothes constitutional association, even if the traditional garment had become ragged through repeated use by sole traders obtaining corporate advantages for the price of merely formal compliance with the group requirement. 114

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A company is incorporated by ASIC following an application by a person containing a statement of the matters specified in s 117(2), principally: • the type of company that is proposed to be registered; • its proposed name, unless it is intended that its name will simply be “Australian Company Number” or “ACN” followed by the number assigned by ASIC upon registration; • the names and addresses of persons who consent to be members, directors or secretary of the company (the company need have only one member who may be its only director and secretary: ss 114 and 201F); • its proposed registered office and, if it is different, its proposed principal place of business; and • details of its proposed share capital or guarantee obligation, as applicable. If the company chooses to have a company name distinct from its Australian Company Number (ACN) it may reserve the proposed name prior to incorporation: s 152. It is usual to make availability searches before applying for reservation of a name because of a number of potential bars to reservation. A name is available for reservation unless it is identical to a name (a) reserved or registered in respect of another company; (b) registered on the Business Names Register in respect of another person; or (c)

is of a kind declared by regulation to be unacceptable: s 147.

In practice, (a) and (b) are the most serious barriers to availability as the volume of existing registrations has all but exhausted clichés and overtaxed many an imagination. Names declared by Corporations Regulations to be unacceptable include those which are likely to be offensive to a section of the public, names which include protected terms (eg, “Olympic”, “Building Society”, “Stock Exchange”, “Made in Australia” and “Trust”) and names which suggest a connection with the Crown, a government or the Royal family: reg 2B.6.01 and Sched 6. 25 If an application is lodged, ASIC may register the company, give it an Australian Company Number (ACN) and issue a certificate of registration stating its name, ACN and corporate type: s 118. When the company is registered, it comes into existence as a body corporate with the members, directors and company secretary named with their consent in the application: ss 119, 120(1). The share capital proposed for the company in the application is deemed to be issued to members: s 120(2). From registration, the company has the legal capacity and powers of an individual (viz, natural persons) together with the distinctive powers of a body corporate, for example, to issue shares or grant a floating charge: s 124. A limited company is required to include “Limited” or “Ltd” at the end of its name; a proprietary limited company must have “Proprietary Limited” or “Pty Ltd” at the end of its name: s 148(2). A company’s certificate of incorporation is conclusive evidence that all requirements for incorporation have been complied with, and that the company is duly incorporated: s 1274(7A). This presumption of conclusiveness absolves persons dealing with a company from inquiry as to whether the requirements for incorporation have been met. 26 The presumption does not, however, legalise objects which would otherwise be illegal, and 25

The regulation is not concerned with general community standards but with whether or not members of any section of the community are likely to be offended by a name or find it offensive: Little v Australian Securities Commission (1996) 22 ACSR 226. The Administrative Appeals Tribunal set aside the decision of ASIC to register a company with the name “Virgin Mary’s Pty Ltd” on the grounds that the name was likely to cause offence to members of the Christian and Islamic faiths.

26

H A Stephenson & Son Ltd v Gillanders Arbuthnot & Co (1931) 45 CLR 476 at 483 per Starke J and at 500 per Evatt J. [3.70]

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directors will be guilty of misfeasance if they apply the company’s funds for an illegal object. 27 In Bowman v Secular Society Ltd, Lord Parker expressed the obiter view that, while “all His Majesty’s lieges” were precluded by the equivalent section from going behind the certificate of incorporation, the section is not “so expressed as to bind the Crown, and the AttorneyGeneral, on behalf of the Crown, could institute proceedings by way of certiorari to cancel a registration which [has been] improperly or erroneously allowed”. 28 In appropriate instances where, for example, preconditions to incorporation were not satisfied, ASIC and the Attorney-General may also seek to have the company wound up; ASIC may not, however, cure the defect by seeking a court order for correction of the incorporating documents. 29 A company registered under the Act or a predecessor statute is referred to in the Act as a “company”: ss 9 (definition), 1378. Generally, the provisions of the Act are expressed to apply to companies. However, in particular contexts, especially those relating to financial market dealings, the Act uses the terms “corporation” and “body corporate” to extend the reach of its provisions to corporations formed under other statutes or sources of power and to unincorporated bodies with some corporate characteristics: s 9 (definition). Before 2001 companies were registered under the Corporations Law of a particular State or Territory; this registration was given de facto national recognition through the then scheme’s federalising characteristics: see [2.85]. Now a company registered under the Corporations Act is taken to be incorporated in “this jurisdiction”, a phrase defined as the geographical area of each referring State and Territories: ss 119A(1), 9 (definition). However, each company is registered in the particular State or Territory that it nominates in its application for registration and which is shown in its certificate of incorporation: ss 119A(2), 118(1)(v). The company’s legal capacity and powers are not affected by the choice of place of registration: s 119A (Note 2). However, the local registration requirement has two significant consequences. First, companies are amenable to regulation (other than corporate regulation) by the State or Territory in which they are registered, such as laws imposing stamp duty on transfers of shares: s 119A (Note 3). Second, deliberately or otherwise, the requirement protects against the possibility that one or more States might withdraw their referral of powers to the Commonwealth: see [2.90]. Companies registered in such a State might avoid the requirement of dual or multiple registrations that interstate business activity would involve by the simple expedient of transferring their place of registration to a State that continues to be part of the national scheme: s 119A(3), (4). 30 This measure indirectly provides additional cohesion to the national scheme by raising the prospect for each State that its defection from the scheme might see the relocation of its locally registered companies. 27

Bowman v Secular Society Ltd [1917] AC 406 at 439.

28

Bowman v Secular Society Ltd [1917] AC 406 at 439. An order was made on the application of the United Kingdom Attorney-General to quash the incorporation of a company (Lindi St Claire (Personal Services) Ltd) whose memorandum of association included as its first object: “To carry on the business of prostitution”. The application was brought on the ground that the company had not been formed for a lawful purpose as required by the predecessor provision to s 117. Following Bowman’s case, the order was made since “the association is for the purpose of carrying on a trade which involves illegal contracts because the purpose is a sexually immoral purpose and as such against public policy”: R v Registrar of Companies; Ex parte Attorney-General (unreported, Divisional Court, Queen’s Bench Division, 17 December 1980). This account of the decision is derived substantially from R R Drury (1985) 48 MLR 644 at 651. Australian Securities Commission v SIB Resources NL (1991) 5 ACSR 411. In that case, where a company had been incorporated as a no liability company notwithstanding that its objects were not dedicated solely to mining purposes (see [3.125]), the court adjourned proceedings to allow the company to expunge the non-mining objects from its constitution.

29

30

If such a company did not transfer its place of registration, it would fall within the definition of a “registrable Australian body” since it would then cease to be a “company”: see definitions in the dictionary contained in

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Practical alternatives and formalities [3.75] The incorporation of a company may take several weeks. A constitution will need to be

settled, even if it is not drafted from scratch, the proposed company name reserved and an application for incorporation lodged with ASIC. In consequence, a widespread practice has developed, particularly in small business, of using shelf companies which are incorporated in advance of need, and activated when instructions are received to form a company. The shelf mechanism also permits companies which have outlived their usefulness to lie dormant until reactivated for new ends and owners. In either case a new name will usually need to be adopted, constitutional changes made, existing shares transferred to the acquirers, and the offices of directors and secretary vacated in favour of their appointees. There are many potential slips here between cup and lip. The danger is even greater if the changes are not attempted. 31 In the meantime, those who are promoting the company (the term is used in a wider sense than its technical meaning discussed at [3.225]) may wish to secure rights for the proposed company or bind it to commitments which may not wait upon completion of incorporation formalities. The company comes into existence only from registration and derives powers and capacity only upon incorporation: ss 119, 124. The common law has created a complex body of rights and obligations applying when an agent professes to contract on behalf of or for the benefit of the gestating company (that is, in the period prior to its registration, a process that formerly might take several weeks). The practical significance of these doctrines has been eroded by the use of shelf companies and the rules themselves have been displaced by statutory provisions now contained in Pt 2B.3: s 133. Under the Act, a company may ratify a contract made on its behalf or for its benefit prior to its registration within an agreed or a reasonable time. 32 If, however, the company is not registered or does not ratify the contract, the person making the contract for the company is personally liable for damages; orders may also be made against the company where it has received benefits under the pre-registration contract but has not ratified it: s 131. 33 The professing agent may not be indemnified by the company from obligations under the contract: s 132. s 9. If a registrable Australian body carries on business in a State or Territory that remains within the scheme, it must register with ASIC under Pt 5B.2 of the Corporations Act: s 601CA. The company would also need to comply with the corporations legislation of the non-referring State or States in which it wishes to carry on business. 31

Thus, Introductions Ltd was formed in 1951 to provide hospitality services for overseas visitors to the Festival of Britain. From 1953 to 1958 it provided deckchairs and amusement machines at a holiday resort. Introductions Ltd was acquired by new owners in 1960 who turned it to pig breeding. No changes were made to its name or, more importantly, to its objects which were wholly inappropriate for pig breeding. Its borrowings from the bank were held to be beyond the company’s capacity under the now discarded ultra vires doctrine which limited corporate capacity to its objects: Re Introductions Ltd [1970] Ch 199.

32

Whether a contract has been ratified is determined by agency principles. Ratification may be express or implied; in either case what is required is the manifestation of the company’s intention to be bound by the contract. Express ratification occurs where the company acknowledges by unequivocal language or other conduct that it is bound by the contract. Ratification is implied where the company acts in such a way which can only be explained on the basis that it accepts the contract as its own. Where ratification is implied by conduct, that conduct will usually communicate the company’s acceptance to the other party. However, where ratification is express and occurs by act internal to the company, eg, by signing a board minute, it will be important to determine whether ratification is complete with that act or only with its communication to the other party: Aztech Science Pty Ltd v Atlanta Aerospace (Woy Woy) Pty Ltd (2005) 55 ACSR 1 at [81]-[82] per Basten JA, Handley JA concurring. At common law a contract made explicitly on behalf of a company yet to be registered does not bind the company upon its incorporation. The company is bound only upon the formation of a new contract and may not ratify the earlier contract since it was not in existence at the time when the agent professed to act on its behalf: Kelner v Baxter (1866) LR 2 CP 174. Where the contract is signed in the name of the company and the signature of directors attached merely to authenticate the company’s execution in the mistaken

33

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Certain post-incorporation formalities need to be completed before the company can commence its activities. The first directors and secretary take their appointments by virtue of the registration of the company. However, they will need to meet after incorporation to appoint a public officer as required under income tax legislation, appoint bankers and approve arrangements for signing cheques, and consider whether to adopt a common seal and appoint an auditor.

THE TYPES OF COMPANY UNDER THE CORPORATIONS ACT Company types and their incidence [3.80] The Act, s 112(1), provides for registration of six types of company:

TABLE 3.2 Section 112 types of companies Proprietary companies Public companies

Limited by shares Unlimited with share capital Limited by shares Limited by guarantee Unlimited with share capital No liability company

This graphic representation of the corporate types conceals the dual nature of the classification process to which every company is subject. First, a company is either a proprietary or a public company. A proprietary company may not have more than 50 non-employee shareholders and is constrained in the distribution of its securities: see [3.135]. If a company is not registered as a proprietary company, it falls within the residuary category of a public company: s 9 (definition of public company). Proprietary companies are subject to less rigorous regulation than public companies. Second, a company is either • a company limited by shares • a company limited by guarantee • an unlimited company with share capital or • a no liability company, a form available only to mining companies. Guarantee companies and no liability companies may not be registered as proprietary companies. Hence, the possible combinations are limited to the six types specified in s 112. Prior to 1 July 1998 companies might also be incorporated as a company limited both by shares and by guarantee or as an unlimited company without a share capital. Existing companies of these types – insignificant numerically and commercially – are unaffected by the closure of their category to new entrants: s 1378. In January 2013 there were 1.953 million registered companies whose proportions by company type were: • proprietary companies limited by shares (98.8%) • companies limited by guarantee (0.7%) • public companies limited by shares (0.4%) • no liability companies (0.01%) • companies limited both by shares and by guarantee (252 companies) and belief that the company has been registered, neither the company nor the agents personally are liable upon it: Black v Smallwood (1966) 117 CLR 52. These doctrines were once central to the study of company law. Their eclipse is unlamented. On the operation of the statutory solution to the problem of the failed (viz, non-ratified) pre-registration contract, see W Courtney (2007) 25 C&SLJ 226. 118

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• unlimited companies (181 companies). 34 At 30 June 2016, ASIC reported that 23,047 of approximately 2.37 million registered companies, were public companies. 35 The nature of share capital [3.85] Historically as we have seen ([2.30]), the idea of the corporation and the development

of share capital 36 (or the joint stock) fund were distinct, the corporation preceding the emergence of share capital by several centuries. Share capital is but a device to allocate certain risks, rights and functions among participants in the business venture, namely, the risk of loss, the distribution of profits and the control of the venture (eg, the right to elect directors). In those companies that do not have a share capital these functions are allocated by other means. In all companies whose members have limited liability there is the further function of fixing the minimum contribution by members to the liabilities of their company. In the following pages, consider how each of these functions is achieved through the share capital device and by other means in companies without it.

The share capital fund [3.90] Of the six types of registered company permitted under s 112(1), all except the

company limited by guarantee have a share capital; however, the holder’s commitments with respect to that capital vary between these five types. Share capital is that amount, in money or money’s worth, which members of the company agree to contribute permanently to the company in their capacity as members to fund the joint enterprise or activities. It also includes other accumulations made during the life of the company without contribution by members, such as through the issue of bonus shares: see [9.210]. On a winding up of a company the holders of share capital are the lowest ranked claimants upon the assets of the company; only after creditors of the company have been paid their debts in full are those who have contributed share capital entitled to have it returned to them. 37 They are also entitled to participate exclusively in any surplus of assets after creditors are paid and the share capital is returned to its holders. Thus, they are both the ultimate risk-bearers of the company and the residuary claimants upon the enterprise. These characteristics are said to account for their special status in company law, sometimes informally described as that of “proprietors” or owners of the company. These terms are, however, disputed as conclusory and overreaching: see [2.220]. The share capital fund partitions the assets of the company from those of its members. It creates a pool of assets that acts as a bonding device for those who extend credit to the company or otherwise trade with it. (In practice, creditors are at least as likely to look to a company’s assets, liabilities and future cash flow as to its paid up capital.) During the life of the company share capital may not be returned to its holders, and those holders may not be released from obligations they have undertaken to contribute it, without formal approval: see 34 35

Data provided by ASIC to the author on 11 January 2013. The figure for the number of public companies is taken from ASIC’s Annual Report 2015-2016, p 20; that for the total number of registered companies is available at http://asic.gov.au/regulatory-resources/find-adocument/statistics/company-registration-statistics/2016-company-registration-statistics/.

36

Share capital is treated fully in Chapter 9. This account is preliminary only so that the intervening material may be understood by readers. Under amendments to the Act made in 2010, shareholders may recover damages against a company, for example, for fraudulent misrepresentation that induced them to subscribe for the shares: s 247E. However, all claims by shareholders in relation to the buying, selling, holding or otherwise dealing with shares rank equally with each other but are postponed to other creditors’ claims: s 563A. These amendments reverse the effect of the High Court decision in Sons of Gwalia Ltd v Margaretic (2007) 231 CLR 160.

37

[3.90]

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[9.230]. The rules are designed to ensure that creditors have available to them the pool of capital contributed by members or so much of it as survives the company’s trading from time to time: Paid up capital may be diminished or lost in the course of the company’s trading: that is a result which no legislation can prevent: but persons who deal with, and give credit to a limited company, naturally rely upon the fact that the company is trading with a certain amount of capital already paid, as well as the responsibility of its members for the capital remaining at all, and they are entitled to assume that no part of the capital which has been paid into the coffers of the company has been subsequently paid out, except in the legitimate course of its business. 38

Creditors’ interests are protected through a complex of rules which protect the integrity of the obligations assumed by shareholders, at least in companies limited by shares. These capital maintenance rules define the financial distributions which a company may make to its shareholders and prohibit the acquisition by a company of interests in its own share capital. The utility of these capital maintenance rules is diminished, however, by the absence of any requirement of a minimum share capital. The phrase “$2 company” refers to the common form of proprietary company limited by shares, by far the most numerous of company types, whose incorporators have sought to minimise their personal commitment of risk-bearing capital to the minimum necessary for incorporation with two members. Since 1998, one member is sufficient.

Shares in the company [3.95] The term “share” refers to shares in the company. A share is simply a proportionate

interest in the net worth of the business or undertaking of the company. It confers an interest in the company through a bundle of rights to participate in the financial distributions made by the company and in group decisions. These rights are properly described as a chose in action since shareholders do not have any legal or equitable interest in the assets of the company. As Gower says, the word “share” is something of a misnomer, for shareholders no longer, since the times of the joint stock company formed on a deed of settlement (see [2.50]), share any property in common. 39 In Archibald Howie Pty Ltd v Commissioner of Stamp Duties (NSW) 40 Dixon J spoke of the “interest” or “share” of shareholders in a company as “an interest consisting of a congeries of rights in personam,” and that “these rights all arise out of the contract inter socios.” “It is a long hallowed usage in this field of discourse to speak of the bundle of rights conferred on a shareholder by the corporate compact between the members of a company as the ‘rights attached’ to that member’s share.” 41 The power to issue shares in a company is usually vested in directors: see [5.105]. The issue of shares is a two-step process. The intending member will usually submit to the board a form of application for a specified number of shares which, when accepted, results in a contract of allotment. The contract is completed by the issue of shares when the board enters the member’s name in the share register in respect of identified shares or delivers a share certificate in respect of those shares. 42 Directors will issue shares to members for an agreed consideration representing a judgment as to the worth of the rights acquired. In the case of public companies, in whose management 38 39 40

Trevor v Whitworth (1887) 12 App Cas 409 at 423-424 per Lord Watson. L C B Gower et al, Gower’s Principles of Modern Company Law (4th ed, 1979), p 397. (1947) 77 CLR 143 at 154, 152.

41

HNA Irish Nominee Ltd v Kinghorn (2010) 78 ACSR 553 at [37].

42

See further, on the meaning of the terms issue and allotment, Re Florence Land and Public Works Co (Nicol’s Case) (1885) 19 Ch D 421; Central Piggery Co Ltd v McNicoll (1949) 78 CLR 594. The distinction between the

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the shareholders will not usually play an active role, that worth is largely determined by the likely future dividend stream from the shares. Under a replaceable rule (as to which see [3.145]), directors of a proprietary company must first offer new shares to existing shareholders in proportion to their holdings; directors may issue any shares not taken up as they see fit: s 254D(1) – (3). The company in general meeting may by ordinary resolution authorise directors to make a particular issue of shares free of this pre-emptive right: s 245D(4). The full consideration agreed for the issue of shares may be paid upon application; alternatively, some or all of the consideration may be payable in the future, enforceable by calls made by the directors. The issued capital of a company is the aggregate of the amounts of money that members and those applying for membership have paid or agreed to pay as future calls for the shares for which they subscribe. Where shares are issued for a non-cash consideration, the agreed value of the consideration is the capital represented by those shares. Share capital is distinctive in that it is committed in consideration for the issue of shares and is therefore subscribed as a member and not in another capacity such as where a member lends money to the company. The aggregate amounts of money or its value (where shares are issued for a non-cash consideration) that has been received by the company for the issue of shares is called its paid up capital. The aggregate of issued capital for which payment has yet to be made is called its unpaid or uncalled capital. The latter terms are, however, not strictly synonymous since some unpaid capital may have been called up but not yet paid by its holder. An example demonstrates these concepts. Two persons form a company to establish a restaurant business. They each subscribe for 10,000 shares at $2 per share, paid to $1 per share. After two years profitable trading, they take in a third partner who agrees to subscribe for 10,000 shares at $3 per share, fully paid upon application. The increase in issue price reflects the shared judgment as to the then value of the one third of the business that the new member is acquiring. Number of shares issued Issued share capital Paid up share capital Uncalled capital

30,000 $70,000 $50,000 $20,000

The shares issued to the original shareholders are called partly paid shares; those of the third shareholder are fully paid shares. The nature of the outstanding obligation of each member of a company to contribute to the debts of the company will vary, depending upon whether the company is limited by shares or is an unlimited company. 43 It is immaterial to the liability issue, however, whether the company is proprietary or public. In practice, the hypothetical restaurant company would be formed as a proprietary company limited by shares.

The rights attached to shares [3.100] The rights attaching to shares in a company are those which are conferred by the

Corporations Act and general law doctrines of company law, the constitution of the company and the terms of issue of the shares. Shares are themselves a form of property, the more issue and allotment of shares has been diminished by the 1998 share capital amendments to the corporations legislation so that the terms may now be treated as synonymous for most practical purposes. However, the two-stage process for the issue of shares formally remains. 43

Of course, if the company were a no liability company, it would vary further. But this is impossible since a restaurant business is wholly foreign to the mining purposes to which a no liability company is dedicated. [3.100]

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valuable because of their transferability and, in the case of listed companies, their liquidity. The rights attaching to shares are of two broad species: to participate in financial distributions and in the governance of the company. Rights of financial participation generally involve an entitlement to receive dividend payments that the directors decide and the shareholders resolve will be paid from time to time out of current profits or profit reserves (viz, undistributed profits from prior years). Further, shares generally carry the rights in a winding up of the company to be repaid proportionately the capital their holders have paid up on the shares and to receive a proportionate share of any surplus assets of the company after that capital has been fully repaid (creditors would have first had their debts paid). The terms of issue of shares may assign one class of shares preferred rights over another in these distributions: see [3.180]. In private companies special arrangements may be made to distribute governance rights among shareholders disproportionately, reflecting the particular control distribution arrangement agreed between the participants: see [5.195]. Generally, however, governance rights attached to shares include provisions concerning the following matters: • the right to receive notice of meetings of members; • the right to attend, speak at and demand a poll (or ballot) at shareholder meetings; • the right to elect and remove directors; and • the right to vote, in some cases by proxy, at shareholder meetings on matters which are within the competence of that corporate organ to determine: see [6.40]. In stock exchange listed companies voting rights are generally distributed on the basis of “one share, one vote”; in proprietary companies, differential voting rights are more common. Since shareholders have a monopoly of voting rights, they have the power to sell control of the company and thereby displace its management. They also possess the right, subject to court approval, to litigate on the company’s behalf in respect of wrongs done to it: see [8.100]. The prerogatives that derive from their exclusive rights to vote, transfer control and sue derivatively secure shareholders’ privileged position in corporate law relative to others with a stake in the company. Of course, the rights of other stakeholders may be protected by contract and the taking of security. Companies limited by shares [3.105] A company limited by shares is a company formed on the principle of having the

liability of its members limited to the amount (if any) unpaid on the shares respectively held by them: s 9. If shares are issued as fully paid, their holder has no further obligation to contribute to the debts and liabilities of the company, at least in relation to those shares. If shares are partly paid shares, their holder’s obligation is simply to contribute to the company the amount which they have agreed to pay for them and which remains unpaid. In the restaurant example above, if the company is one limited by shares, the third shareholder has no further liability as shareholder to contribute to the company in the event of its financial failure. 44 The original shareholders, however, are liable to pay the amount unpaid upon their shares, viz, $10,000 each. This obligation may be enforced during the life of the company and, subject to the terms upon which the shares were issued, by calls made by the directors (s 254M(1)) or, in a winding up, by its liquidator: s 516. If calls are not paid within a specified time, the shares may be forfeited under provisions in the company’s constitution. Companies limited by shares may be incorporated either as a proprietary or public company. As noted in [3.80], proprietary companies limited by shares comprise 98.5% of all 44

All three members may, however, have liabilities in some other capacity, for example, as guarantors to the company’s bankers under independent financing arrangements.

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registered companies. Public companies limited by shares are the third largest company type but represent only about 0.65% of company registrations. The great majority of companies listed on the stock exchange are public companies limited by shares; however, only a small proportion of these public companies are listed companies: of the 8,715 public companies at 31 March 2004, only 1,273 were listed on the stock exchange. Prior to 1 July 1998, a company limited by shares was required to include in its memorandum of association, the incorporating constitutional document, a statement of the authorised or nominal capital with which the company was to be incorporated. That capital was divided into shares of a fixed amount called their par or nominal value. The par value fixed the amount which the holder of the share was obliged to pay to the company upon that share. 45 The par value was generally fixed throughout the life of the company; accordingly, a company would contract with subscribers to pay a premium above the par value as consideration for the issue of shares where their value was higher than the company’s par value. Thus, in the restaurant example above, the shares might be assigned a par value of $2 so that a premium of $1 per share would be paid by the third investor. The 1998 amendments abolished the concepts of par value and nominal (or authorised) capital for all companies whenever incorporated. They are referred to, however, in many cases extracted in this book. Tracy v Mandalay (see [3.230] at 234-235) provides a clear example of the concept of nominal capital and its relation to issued capital. Part 1.5 of the Act contains the Small Business Guide which summarises the main rules of the Act applying to the proprietary company limited by shares. It was introduced in 1995, partly in response to calls for a dedicated, simpler form of incorporation for small business, free of the complexity of much corporate regulation. The reform project that introduced the Guide also did much to simplify the Corporations Act in its application to all company types. Companies limited by guarantee [3.110] The company limited by shares is all but exclusively used as a vehicle for trading

activity. In contrast, the company limited by guarantee is in practice employed for non-profit activities. 46 The Act defines the company limited by guarantee as one “formed on the principle of having the liability of its members limited to the respective amounts that the members undertake to contribute to the property of the company if it is wound up”: s 9. On the winding up of a company limited by guarantee no contribution is required from a member exceeding the amount undertaken to be contributed in the event of winding up: s 517. The position of past members is similar to that for past members of companies limited by shares – it is primarily to members at the time of the winding up that the liquidator can look for contribution: ss 515, 520 – 523. Since members’ guarantees may only be enforced on the winding up of the company, they are not assets of the company which may be charged during its life. 47 The effect of these arrangements is to require contribution only in the event of winding up. A company limited by guarantee has no share capital. It may require fees to be paid by members or may raise loans but prima facie it is not a convenient vehicle for a business needing working capital. If the directors were to go ahead with business activities without 45

The requirement would commonly be satisfied by the statement: “The capital of the company is $100,000, divided into 100,000 shares of $1 each”.

46

Ninety-three per cent of companies limited by guarantee in January 2013 (data provided by ASIC to the author) were recorded by ASIC as non-profit companies: see [3.80]. The company limited by guarantee was introduced with the Companies Act 1862 (UK) and in the same year legislation was passed for the incorporation of co-operative societies: Industrial and Provident Societies Act 1852 (UK). These two forms represent the triumph of the limited liability principle beyond the sphere of trading relations for profit. Re Pyle Works (1890) 44 Ch D 534 at 574, 584.

47

[3.110]

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adequate funds they might incur personal liabilities under provisions that prohibit trading while insolvent: see [7.135] et seq. Because of these features companies limited by guarantee are often used for non-profit activities such as clubs and community or other associations that do not require significant funds but seek the protection of limited liability or the advantages of incorporation. The principal drawback in such situations is the expense and difficulty involved in drawing up a constitution, registering the company and continuing obligations. The alternatives of the incorporated association or registered co-operative sometimes commend themselves in comparison: see [3.25] and [3.20]. The constitution of a company limited by guarantee will contain provisions relating to voting, admission to and retirement from membership. Reflecting the usage of the form for not-for-profit purposes, from 2010 companies limited by guarantee are prohibited from paying dividends to members: s 254SA. Sometimes persons associated for non-profit purposes seek to avoid any suggestion, from their use of corporate form, that they are involved in business activity. The Act permits ASIC to authorise a guarantee company (such as Opera Australia) to dispense with the word “Limited” as part of its name. This concession is available only to companies limited by guarantee whose constitution requires the company to pursue charitable purposes exclusively and prohibits distributions to members and the payment of fees to directors: s 150. However, the requirement to display a company’s Australian Company Number on all its public documents introduced in the last decade (s 153) somewhat reduces the appeal of this facility. In 2010, as part of reforms to reduce complexity and compliance across the not-for-profit sector, a three tiered differential financial reporting framework for companies limited by guarantee was introduced. Guarantee companies with annual revenue of $1 million or more must prepare an audited financial report; guarantee companies with annual revenue in the range of $250,000 to $1 million (and those below $250,000 but with deductible gift recipient status under the Income Tax Assessment Act 1997 (Cth)) must prepare a financial report but may elect to have it reviewed rather than audited, a lower level of scrutiny; small companies limited by guarantee – those whose revenue is below $250,000 and do not have deductible gift recipient status – are not required to prepare a financial report unless directed to do so by members or ASIC: ss 45B, 285A, 292, 294, 294A, 298, 300B, 301, 316A, 327A. The Australian Charities and Not-for-profits Commission Act 2012 (Cth) completes this reform. The Act addresses regulatory fragmentation in the not-for-profit (NFP) sector, based as it has been on entity type rather than activity or outcomes. Apart from charitable trusts, the sector consists of 600,000 NFP associations, the majority of which (around 440,000) are unincorporated associations that fall largely outside any regulatory framework and have no reporting and other obligations apart from those arising from charities and tax legislation: see [1.120]. Incorporated associations are the next largest group (around 136,000) followed by companies limited by guarantee (around 11,700). 48 The Act established the Australian Charities and Not-for-profits Commission (ACNC), a dedicated national charity regulator. Under the new regime, ASIC continues to register companies limited by guarantee, but has limited oversight of financial reporting and governance arrangements of those guarantee companies that choose to register with ACNC – oversight of these arrangements is performed by ACNC although ASIC remains responsible for registering company auditors. ACNC offers NFP entities the facility of a “one stop shop” for registration, tax concessions, and access to other Australian Government services and concessions. 48

Australian Charities and Not-for-profits Commission Bill 2012, Revised Explanatory Memorandum, [16.16]–[16.18].

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Companies limited both by shares and by guarantee [3.115] Companies may no longer be registered as companies limited both by shares and by

guarantee although companies of this type formed under prior legislation continue to exist: s 1378. This hybrid form was apparently devised for the situation where a guarantee company required some initial capital to be contributed, for example, to acquire premises. 49 It is implicit that every member of the company is to assume a guarantee liability although shares may be held by less than the full membership. 50 Liability under shares and guarantee is cumulative. In England, the Jenkins Committee in 1962 recommended abolition of the form, saying that “if a company is formed with the intention of making pro rata distributions of profits to its members it seems inappropriate that it should be able to register as a company limited by guarantee”. 51 The 1998 amendments on the closure of the class gave effect to this recommendation. Unlimited companies [3.120] The unlimited company is the original form of the registered company, conceded

under the 1844 Act (see [2.55]) as the sole class of company until the grant of limited liability in 1855. Under the Act the unlimited company is defined as a company whose members have no limit placed on their individual liability to contribute to the debts of the company: s 9. In early 2013 ASIC recorded 181 unlimited companies registered in Australia ([3.80]); none are stock exchange listed. The unlimited liability of members of an unlimited company does not mean that they are directly liable to the company’s creditors. The company is still a separate legal entity with its own obligations. But there are not the restrictions on members’ liability to contribute to the property of the company amounts sufficient to discharge the company’s liabilities which are found in respect of the other types of company. If the company’s share capital when fully paid up is insufficient to discharge its liabilities, then calls may be made on members and, in some cases, on past members (but subject to ss 520 and 521). Calls will be made on the basis of equal contribution per share, but liability is several so that one member may be subjected to the full liability called and be left to exact contribution from other members. 52 Since the unlimited company patently fails to insulate members from the trading losses of the enterprise, it is not a widely adopted form of business organisation. 53 It does, however, have one singular advantage. Under the law on maintenance of a company’s share capital, a company may only reduce its share capital pursuant to a formal approval mechanism. 49 50

Of the 252 companies limited both by shares and guarantee in January 2013 only 64 were recorded by ASIC as non-profit companies (data provided by ASIC to the author). For more detailed analysis of this question, see R McQueen & M McGregor-Lowndes (1991) 9 C&SLJ 248 at 248-251.

51 52

Report of the Company Law Committee (Cmnd 1749, 1962), [70]. On the general doctrine of contribution, see Albion Insurance Co Ltd v Government Insurance Office (NSW) (1969) 121 CLR 342, especially at 350-352 per Kitto J.

53

Although in England, where companies legislation exempts unlimited companies from disclosure of financial reports, some major companies use the unlimited company form. They include Land Rover, the Equitable Life Assurance Society, Credit Suisse International (Credit Suisse’s UK investment banking arm) and even the novelist Ian McEwan whose company’s name is identical with his personal name. Hence, his 2012 novel Sweet Tooth shows Ian McEwan as copyright holder and adds “Ian McEwan is an unlimited company registered in England and Wales no. 7473219”. Corporate form has obvious advantages as a device for collecting royalty payments especially after the death of the human author; see [3.140] concerning Australian privileges from financial disclosure which are confined to those unlimited companies that also qualify as a small proprietary company. [3.120]

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However, since members of an unlimited company bear full responsibility for the company’s liabilities, this class of company is exempted from the prohibition upon unsanctioned capital reduction: s 258A. The power to reduce capital is valuable to companies which attract the funds of the investing public and invest them in corporate and government securities. They are structured so that investors may redeem their investments, which take the form of shares in the mutual fund company, simply by having the company buy back their shares. To provide this redemption feature the promoters of these funds might use the unlimited company form; however, their modest numbers suggest that this feature pales before the unlimited liability of their members. A regulatory problem presented by unlimited companies is the protection of those persons who invest in them without appreciating their unlimited personal liability. Unlike limited companies whose names signal their members’ limited commitments, unlimited companies are not required to refer to their members’ unlimited liability in their name. The unlimited proprietary company must partly show its colours by concluding its name simply with the word “Proprietary”. The unlimited public company bears no identifier notwithstanding that its membership and their individual liability for the company’s debts are unlimited. Accordingly, it may be inferred that compulsory identifiers in a company’s name are for the benefit of those dealing with the company rather than its members. No liability companies [3.125] A company may be registered as a no liability company only if

(a) (b)

the company has a share capital; the company’s constitution states that its sole objects are mining purposes (viz, prospecting for, extracting or selling ores, metals or minerals: s 9); and (c) the company has no contractual right under its constitution to recover calls made on its shares from a shareholder who fails to pay them: s 112(2). A no liability company is required to include the words “No Liability” or “NL” as part of and at the end of its name: s 148(4). A no liability company may only be registered as a public company. The no liability company form originated in Victoria as an arrangement to enable those investing in mining exploration companies to decide not to contribute further to exploration. In the mid 19th century it was the practice of Victorian mining companies (reflecting the contemporary English practice generally) to issue shares with a high issue value and only partly paid up. Funds might be secured, as they were needed from time to time, by calls upon the shares. Mining exploration is an inherently risky activity and the costs of enforcement against reluctant shareholders proved high with many shareholders resorting to evasion through the practice of dummying, that is, registering shares in fictitious names. In 1869 legislation was enacted to sanction provisions in company constitutions providing for the forfeiture of shares upon which calls were not paid. Two years later the forfeiture system was strengthened by enabling mining companies to be incorporated as no liability companies upon the principles now contained in the Act. 54 Of the 460 no liability companies registered as at 31 March 2004, 142 were recorded by ASIC as listed companies. (Later figures have not been published.) However, among the large mining companies, there appears to be a marked preference for the company limited by shares form: of companies listed on the Stock Exchange of Melbourne in 1986, none of the 20 largest 54

The background to this legislation is described by A R Hall, The Stock Exchange of Melbourne and the Victorian Economy 1852-1900 (1968), pp 75-77 and J C Waugh [1987] AMPLA Yearbook 30. For a more sceptical analysis of this legislation, see R McQueen (1991) 1 Aust Jnl of Corp Law 22 at 34-36.

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companies by turnover were no liability companies. 55 Its lack of appeal to larger listed mining firms may be explicable in terms of their disinclination to employ uncalled capital, their inability as no liability companies to charge this asset and, perhaps, speculative connotations attaching to the no liability form. 56 The no liability form is, however, of more appeal to smaller listed mining companies. The Act contains special provisions relating to no liability companies. Section 254M(2) embodies the defining feature of this class of company – that acceptance of a share by original allotment or transfer does not constitute a contract to pay calls or contribute to debts or liabilities of the company. The shareholder is not entitled to any dividend on a share on which a call is due and unpaid: s 254W(3). However, the shareholder may be bound to pay calls, not by mere acceptance of the share, but by independent agreement with the company. 57 Special rules apply in relation to financial participation of members in no liability companies. Their object is to secure equity of treatment between members inter se. Dividends payable to shareholders in such a company are payable in proportion to the number of shares held, irrespective of the amount paid up: s 254W(4). Similarly, any surplus on winding up is to be distributed among the parties entitled in proportion to shares held, irrespective of paid up value: s 254B(2). If a no liability company ceases to carry on business within 12 months of incorporation, shares issued for cash rank on a winding up to the extent of capital contributed in priority to those issued to vendors or promoters for consideration other than cash: s 254B(3). The Act also establishes procedures for the making of calls on shares in no liability companies and for forfeiture of shares on which calls have not been paid: ss 254P – 254Q. Changing company type [3.130] The choice of incorporation as a particular type of company need not bind

permanently and particular changes of corporate status may be made through specified procedures: Pt 2B.7.

PROPRIETARY COMPANIES Identifying the private company [3.135] Australian company law has long recognised a class of private companies which are

exempted from public disclosure of financial statements and given other valuable privileges representing a lower, less intrusive, form of regulation. The separate statutory treatment of the private company was inaugurated in 1896 in Victoria and in 1907 in England. The 1907 Act defined the private company as one whose articles of association (now part of its constitution (see [3.145])) restricted the transfer of its shares, limited membership to 50 persons and prohibited public offers of its securities. Companies which did not include these provisions in their articles formed a residual class of public companies. Only this residual class was required to file its financial statements upon the public register. The private company was given other minor privileges. In a relatively short time, however, many large enterprises secured de facto confidentiality for their financial statements by incorporating operating divisions as private (or proprietary) companies whose accounts were exempt from disclosure. The parent (or holding) company, being a public company, was entitled to no such privilege although its accounts might disclose little more than dividends received from its subsidiary companies (as to the terms holding and 55

Waugh at 52.

56 57

Waugh at 53. Theseus Exploration NL v Foyster (1972) 126 CLR 507 at 517. [3.135]

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subsidiary company see [4.90]). In Australia, the issue came to a head in the late 1950s when General Motors Corp acquired the preference shares of its Australian subsidiary, General Motors-Holden, thereby converting the Australian company into a wholly owned subsidiary of the American parent. Prior to their acquisition by General Motors Corp, preference shares in the subsidiary had been traded on Australian stock exchanges which had required the company’s accounts to be published for the benefit of investors. Once delisted, the Australian subsidiary would be free to withhold disclosure of its trading results, a sensitive matter politically in view of the success of the Holden car and strong public identification with it. 58 Companies legislation was amended to introduce a distinction between exempt and nonexempt proprietary companies and to limit the major privileges, including those of withholding financial statements from public disclosure, to the exempt proprietary company. This company was defined as a proprietary company no share in which was owned, directly or indirectly, by a public company or its subsidiaries. The underlying idea was that an exempt proprietary company was one in which there was no prospect, however indirect and insignificant, of public investment. In the early 1990s, 97.7% of all proprietary companies were treated as exempt. 59 In 1995 the definition of proprietary company was changed and the concepts of the exempt and non-exempt proprietary company were replaced with those of large and small proprietary companies. The reporting obligations of small proprietary companies were reduced below those applying to exempt proprietary companies and the reporting standards for large proprietary companies were strengthened. Only a company limited by shares or an unlimited company may be incorporated as a proprietary company. Both company types must have a share capital. If a company is not a proprietary company, it is a public company, the residuary class of companies: s 9. The formal conditions which once must have been satisfied for registration as, or conversion to, a proprietary company have now been replaced by two prohibitions: • a proprietary company must have no more than 50 members excluding employees of the company or its subsidiaries; and • a proprietary company must not engage in any activity that would require the lodgment of a prospectus or other disclosure document under Ch 6D although the company may offer its shares to existing shareholders and employees of the company or its subsidiaries: s 113. Accordingly, a proprietary company is limited as to the size of its membership and with respect to fundraising activities it can undertake through the distribution of its securities. The exemptions for offers to existing members and employees and under Ch 6D give proprietary companies some fundraising licence but without incurring the expense and obligations of prospectus preparation. If ASIC is satisfied that a company has contravened these prohibitions, ASIC may direct the proprietary company to change to a public company: s 165. The criteria for identifying the small proprietary company turn upon its assumed lesser economic significance relative to other proprietary companies. A proprietary company is a small proprietary company for a financial year if it satisfies at least two of the following criteria: (a) the consolidated revenue for the financial year of the company and the entities it controls is less than $25 million; (b) the value of the consolidated gross assets at the end of the financial year of the company and the entities it controls is less than $12.5 million; and 58 59

These developments are discussed in R W Gibson, Disclosure by Australian Companies (1971), pp 251-253. See second edition of this book, p 125.

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(c)

the company and the entities it controls have fewer than 50 employees at the end of the financial year: s 45A(2). These criteria applied not just to the individual proprietary company whose status is being examined but to the wider economic entity of which it is part: see [4.90]. The criteria may be altered by regulation. If a proprietary company is able to satisfy none or only one of these criteria in a particular financial year, then it falls into the default category of the large proprietary company. It is estimated that 99.4% of all proprietary companies are small proprietary companies. 60 Privileges accorded the private company [3.140] In 1995, when the concepts of the small and large proprietary company were introduced, the Corporations Law also adopted a revised system of relief from disclosure and other regulatory burdens. Some privileges remain common to all proprietary companies including • any proprietary company may register with a single shareholder and trade with a single director (ss 114(1), 221(1)); • the requirement to hold an annual general meeting applies only to public companies (s 250N); • all proprietary companies may use the facility of passing shareholder resolutions without holding a meeting (s 249A); indeed, a mechanism permits single director decisions to be taken by the recording of a decision to a particular effect which record also counts as minutes of the passing of the resolution (ss 249A and 251A); and • proprietary companies stand outside the prohibition upon participation by directors in deliberations of the board of directors in relation to matters in which they have a material personal interest and upon related party transactions under Ch 2E: see [7.415] et seq. Some privileges, however, are confined to small proprietary companies. The principal dispensation is in relation to the preparation and audit of financial statements. All companies must keep written financial records that correctly record and explain their transactions and financial position and enable true and fair financial statements to be prepared and audited: s 286. Companies other than a small proprietary company must also prepare financial statements for each financial year, have those statements audited and lodge them with ASIC so that they are publicly accessible. (These financial statements are a profit and loss statement for the year, a balance sheet at the end of the year and a statement of the cash flows for the year: s 295.) A small proprietary company is required to prepare financial statements and send them to members only if • shareholders with at least 5% of votes direct the company to do so (s 293); • the company is controlled by a foreign company and is not included in consolidated accounts lodged with ASIC by the foreign company (s 292); or • ASIC directs it to do so: s 294. These financial statements need not be lodged with ASIC so as to be publicly available: s 319(2). ASIC may relieve a company from financial reporting and audit obligations, including those arising by virtue of shareholder direction, by reference to criteria including whether these obligations would impose unreasonable burdens on the company: s 342. By legislative instrument, ASIC grandfathers an exemption from filing an annual report for those 60

This was the figure ASIC provided to the Parliamentary committee in 1998; in January 2013, ASIC confirmed to the author that it remained accurate although acknowledging that there is a degree of self-regulation in classification as a small proprietary company: Parliamentary Joint Statutory Committee on Corporations and Securities, Report on the Regulation of Proprietary Companies (2001), pp 9, 27. [3.140]

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large proprietary companies that were an exempt proprietary company on 30 June 1994 and which have continued to meet that (otherwise repealed) definition. 61 By this device some of the largest private businesses in Australia escape public disclosure of their financial position.

THE CORPORATE CONSTITUTION [3.145] As noted at [2.55], the English companies statute of 1856 introduced two distinct

constitutional documents, the memorandum of association and the articles of association, generally bound together in a single document. The memorandum was the incorporating document which contained fundamental matters such as the company’s capital structure. Companies statutes did not prescribe any particular content for the articles of association although since 1856 they have appended a model set of articles, called the Table A articles, which have been widely adopted by companies. In some cases the Table A articles were adopted with variations to effect a particular distribution of control rights in a private company. (There will be many references to Table A articles in the cases that follow in this book.) Table A articles and other articles adopted by companies usually contained detailed provisions relating to the internal organisation of the company, including • the division of corporate powers between the board of directors and the general meeting of shareholders • proceedings of the board and general meetings • the appointment and remuneration of directors • the transfer and transmission of shares • declaration of dividends and • the winding up of the company. From 1844 all registered companies were required to lodge their memorandum and articles of association with a state official so that they might be publicly accessible. From the early 1990s in Australia this obligation applied only to public companies. In 1998 the requirement to have a constitution was abolished. In place of the memorandum and articles of association, the Act introduced a series of provisions which any company may use to regulate its internal proceedings and management. These sections are identified by their headings in the Act as a “replaceable rule” or a “replaceable rule for proprietary companies and mandatory rule for public companies”: s 135. A table of replaceable rules is contained in s 141. If a company chooses to adopt its own constitution, that will displace the application to the company of any inconsistent rule except, in the case of a public company, a rule which is expressed to be mandatory and which operates therefore as an ordinary provision of the Act for the company. Companies therefore have three options in relation to the choice of rules to govern their internal management: • they may elect to function without a constitution, relying solely upon the replaceable rules • the company may adopt its own constitution to displace or modify the replaceable rules wholly or in part (s 136) or • if it was incorporated prior to 1 July 1998, it may retain its memorandum and articles of association as the constitution of the company to the exclusion of inconsistent replaceable rules; if the company is a public company, those provisions of the Act which contain a mandatory rule for public companies also apply to them: s 135. 62 61

ASIC Corporations (Exempt Proprietary Companies) Instrument 2015/840.

62

ASX requires listed companies to have a constitution since some replaceable rules are inconsistent with the listing rules with which listed companies must comply.

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The first option is available both to companies incorporated after 1 July 1998 and to prior registered companies if they choose to repeal their existing constitutions. This option has the virtue of simplicity since the replaceable rules are easily accessible in the Act and users get the automatic benefit of their revision from time to time. These advantages notwithstanding, most companies retain or adopt an individual constitution to replace or supplement the replaceable rules since they are seen as too basic in their scope. For example, if a company wishes to have the option of issuing partly paid shares, it will need provisions dealing with calls and forfeiture which are not to be found in the rules. The former Table A model set of articles of association for a company limited by shares contained a much more detailed governance structure than that provided by the replaceable rules. Indeed, it is too elaborate for some small companies which find a constitutional structure of intermediate scope and detail preferable. A company may adopt or vary the terms of a constitution by special resolution: s 136(1) – (2). (A special resolution is one passed with the support of at least 75% of the votes cast by members entitled to vote on the resolution who have notice of intention to propose the special resolution and of its terms: s 9. 63) There is scope for entrenchment of a constitutional provision against alteration by a special resolution, by specifying in the constitution a further requirement for its alteration which provision may not itself be repealed unless the further requirement is satisfied: s 136(3), (4). Such a further requirement might be one requiring • that the special resolution be passed with a greater majority than 75% of the votes cast • the consent of a particular person or • a particular condition to be fulfilled. Such provisions can be important as a control distribution device in private companies where individual members wish to preserve rights of veto or individual autonomy in relation to fundamental aspects of business operations: see [5.195]. The company’s constitution and any replaceable rules that apply to it have effect as a contract between • the company and each member • the company and each director and secretary and • the members themselves under which each person agrees to observe and perform the constitution and rules so far as they apply to that person: s 140. Failure to comply with a replaceable rule is not of itself a contravention of the Act (s 135(3)) and the intention is clear that the rules and constitution are on an equal footing in terms of their status and enforceability. 64 A public company which adopts a constitution must lodge a copy with ASIC together with a copy of any special resolution altering its provisions: ss 117(3), 136(5). It is then publicly available. A proprietary company which adopts a constitution need not lodge it with ASIC but must send a copy to a member of the company upon request: s 139. A company’s constitution may include a restriction or prohibition upon the exercise of any of the company’s powers. For example, it might limit borrowings or impose some restriction upon the transfer of shares (the latter provision is ubiquitous since until 1995 it was a pre-condition for registration as a proprietary company). The exercise of a power is not invalid, however, merely because it contravenes the restriction or prohibition: s 125(1). A company may also include objects in its constitution although acts beyond those objects are 63

64

The 75% test applies only to the votes actually cast, not this proportion of the total voting power in the company. The usual mode of members’ decision-making is by ordinary resolution which simply requires a majority of the votes cast: s 250E; as to notice requirements, see [6.60]. Under both types of resolution, votes may be cast in person or by proxy where allowed: see [6.85]. Company Law Reform Bill 1997, Explanatory Memorandum, [8.19]. [3.145]

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not thereby invalid: s 125(2). 65 Third parties dealing with companies are protected against limitations upon the powers and authority of the professing agents by assumptions which the Act permits them to make: see [5.310]. Replaceable rules do not apply to a proprietary company while the same person is both its sole shareholder and sole director. This exclusion is justified on the ground that such a company has little need for a formal set of rules governing its internal relationships. 66 The Act contains a number of special rules applying specifically to such companies. Their effect is to allow the company to function flexibly in its corporate character through the sole individual who constitutes and acts for it: ss 198E, 201F, 202C.

THE CORPORATE ORGANS [3.150] The corporation is an abstraction. It “has no physical existence [and] exists only in

contemplation of law”. 67 It requires the mediation of natural persons for the expression and execution of its will. Historically, two groups of individuals have been recognised as having authority to act for the corporation – its members assembled in general meeting and its board of directors or governing committee. For the early English corporations, the corporation “can only do corporate acts at a corporate meeting”. 68 Members assembled for a corporate purpose were the corporation which acted through the decision of a majority of those present, although special majorities might be prescribed by the constitution for particular decisions. 69 Such an unwieldy and democratic structure was seen as ill-suited to large trading associations. The direction of chartered companies was commonly given to the governor of the company and his assistants and in the 18th century the deed of settlement companies usually provided for a committee of management responsible to the assembly of subscribers: see [2.55]. Consistently, the 1844 Act (see [2.55]) imposed a rigid demarcation between membership and management functions. The 1844 Act conferred particular powers upon shareholders in general meeting but reserved the management of company affairs to the board of directors: shareholders were prohibited from acting in the ordinary management of the company “otherwise than by means of directors”. 70 While companies statutes in most North American jurisdictions continue to vest management powers in the board, English and Australian companies legislation has reverted to a facilitative model by constituting a board of directors and general meeting and leaving to the replaceable rules or the constitution the division of corporate powers between these organs. Management powers are, however, all but invariably vested in the board as in s 198A (replaceable rule) of the Corporations Act. This demarcation between ownership and management roles, although now placed upon a permissive basis, persisted with the use of corporate form for purely private trading ventures. The boundary between these roles is apt to become confused in those private companies in which the members are for all practical purposes partners and involved in company 65

The doctrine of ultra vires which limited a company’s capacity to the objects specified in its memorandum of association was abolished by statute in 1984: Duke Group Ltd (in liq) v Pilmer (1998) 27 ACSR 1. Where a company has an objects clause as part of its memorandum of association, the company has capacity to act outside those objects: Dunn v Australian Society of Certified Practising Accountants (1998) 29 ACSR 1; see S Woodward (1997) 15 C&SLJ 162.

66

Company Law Reform Bill 1997, Explanatory Memorandum, [8.22]. Such a company may, however, adopt a constitution, including one typical of a company with plural membership.

67 68

Continental Tyre & Rubber Co (Gt Brit) Ltd v Daimler Co Ltd [1915] 1 KB 893 at 916 per Buckley LJ. Conservators of the River Tone v Ash (1829) 10 B & C 349; 109 ER 479 at 378 (B & C), 490 (ER).

69 70

Attorney-General v Davey (1741) 2 Atk 212; 26 ER 531; R v Varlo (1775) 1 Cowp 248; 98 ER 1068. 7 & 8 Vict c 110, s 27 and Sch A.

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management. In such companies the formal distinction between shareholder and director roles, and the obligation to act through a particular organ for effective group action, is often at odds with the way the members view and conduct their affairs. Instances abound of members acting in disregard or ignorance of the formal obligations which the legal structure imposes: see [5.155]. In a smaller company the board may function as an organ to take the active direction of company affairs. However, in most companies of any significant size the day-to-day management and operations of the company are conducted by senior managers appointed by the board and employees appointed by those managers. Company constitutions commonly provide for the appointment of one or more managing (or executive) directors and for the delegation to them of the powers of the board: ss 201J and 198C. The Act also requires the company to appoint a secretary: s 204A. The powers, functions and prerogatives of the corporate organs and the senior officers are considered in Chapters 5 and 6.

CORPORATE CAPITAL [3.155] Chapter 9 of this book examines the capital of the company, especially share capital,

in some detail. Some further knowledge of the concepts and doctrines relating to capital will, however, be necessary for an understanding of the intervening material. The following notes are directed towards that limited end. The distinction between equity and debt capital [3.160] One major classification of the finance, or capital, of a company distinguishes

between equity and debt capital. Equity capital is that which is contributed by members (eg, paid up share capital) or in respect of which they have an interest (eg, retained earnings of the company which have not been distributed as dividends to members). It is important, however, to remember that the existence of a corporate entity means that this capital is not the property of the members in the way that partners have property rights in their partnership property. Debt capital is money which has been lent to the company or which is owed by it (eg, trade credit). The term capital is used in various ways which are calculated to confuse. It has just been used to refer to company finance. One other common usage refers to the net worth of the business – in effect, what members may expect to have left over if all of the assets are sold and liabilities are paid off. 71 Capital in this sense is the balancing item arrived at by deducting the liabilities of the business from its assets. A significant distinction between equity and debt is that debt capital involves a liability to a lender, commencing with a commitment to repay principal and interest on certain terms. Failure to repay on time may result in the company being sued and execution obtained against it. The interest on the debt must be paid whether the company has made profits or not. Equity capital, on the other hand, is more fully at risk in the business. Without special procedure for shareholder approval it may be repaid only on the winding up of the company: see [9.240]. Moreover, dividends – the functional equivalent of interest payments – may not be paid to shareholders unless the company has profits available for distribution. If no such profits are available, dividend payments must be forgone: see [9.355]. A further, perhaps more fundamental, distinction is that the suppliers of equity are members of the company and enjoy rights in as well as against the company. In contrast, debt holders are external to the company and merely possess claims against it. They stand outside the collectivity whose interests define those of the company: see [7.240]. 71

P L Davies (ed), Gower’s Principles of Modern Company Law (6th ed, 1997), p 234. [3.160]

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The issue of share capital [3.165] The corporate constitution normally confers upon directors the power to issue shares.

In some companies the constitution will give shareholders pre-emptive rights with respect to new share issues, entitling them to participate in proportion to their existing equity in the company. In all companies the board’s power to issue shares is a fiduciary one to be exercised bona fide in the interests of the company as a whole: see [7.230]. As noted at [3.95], there are distinct stages in the issue of shares: the executory allotment of shares followed by the formal issue effected by entering the allottee’s name in the company’s share register or issuing the allottee with a share certificate with respect to them. 72 The Act requires companies to keep a register of members and to enter into it the specified particulars: ss 168, 169. The register of members is prima facie evidence of matters contained within it: s 176. Entry on the register is thus prima facie evidence of membership, but subject to court orders for correction: s 175. The classes of share capital [3.170] The power to issue shares is usually conferred in terms empowering the board of

directors to attach preferred rights to shares. Company law adopts a permissive attitude towards the creation of different classes of shares, fettering the company’s freedom only by exacting a statement in the constitution or terms of issue of the rights of holders of preference shares with respect to the heads of entitlement enumerated in s 254A(2). The Act does not, therefore, fix the types or classes of shares which may be created and does not define exhaustively the rights which have been developed in practice. The types of shares encountered are determined substantially by commercial usage, a usage which is fluid and driven by taxation as much as by commercial considerations. New features and combinations of features appear from time to time. Within the loose categories of ordinary shares and preference shares, many significant variations are encountered. However, ordinary shares are the main general class of shares. Ordinary shares [3.175] The distinguishing characteristics of ordinary share capital are succinctly captured by

Gower: 73 Ordinary shares (as the name implies) constitute the residuary class in which is vested everything after the special rights of other classes, if any, have been satisfied. They confer a right to the “equity” in the company and, in so far as members can be said to own the company, the ordinary shareholders are its proprietors. It is they who bear the lion’s share of the risk and they who in good years take the lion’s share of the profits (after the directors and managers have been remunerated). If, as is often the case, the company’s shares are all of one class, then these are necessarily ordinary shares, and if a company has a share capital it must perforce have at least one ordinary share whether or not it also has preference shares or debentures. It is this class alone which is unmistakably distinguished from debentures both in law and fact.

In private companies it is not uncommon to create classes of ordinary shares with special rights with respect to voting where members wish to retain the individual autonomy and veto rights common to partnership. This may be achieved, for example, by creating classes of ordinary shares and requiring separate class consents to variation of particular rights confided to the holders of shares in that class. This mechanism draws upon the protection of provisions 72 73

See Central Piggery Co Ltd v McNicoll (1949) 78 CLR 594 at 599-600. A share certificate issued by the company is prima facie evidence of the member’s title to the share: s 1087. L C B Gower et al, Gower’s Principles of Modern Company Law (4th ed, 1979), p 423.

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which preserve the rights attached to a class of shares unless a specified proportion of holders of shares of that class consent to their variation: see [9.75]. There is a great deal of flexibility left to those in control to formulate constitutional provisions which create such protections.

Preference shares [3.180] The heads of preferential entitlement which may be attached to shares, listed in

s 254A(2), are not exhaustive. The standard preference share is one with a fixed dividend entitlement which must be satisfied before any dividend is paid on the ordinary shares. It may also have a right to return of capital on winding up in advance of a like return to ordinary shareholders although, of course, ranking after secured and ordinary creditors. It is possible to create a preference share with further distribution rights. Thus, it may have the right to participate equally with ordinary shareholders in dividend distributions beyond the fixed preferential entitlement. Such a preference share is said to be participating as to dividends. Further, the preference share might be given a right to participate equally with ordinary shares in distributions of a capital surplus on winding up after repayment of capital (repayment of preference capital would be in priority to repayment of other capital). Such shares have a greater interest in equity than the ordinary shares and are different from the standard preference share – they might fairly be called preferred ordinary shares. Such shares are less common. They are likely to be issued only when the company is having difficulty in attracting investors for its other share capital. Preference shares are, of course, an alternative means of obtaining finance for the company other than ordinary share capital and debt. Canons of construction have been developed by the courts to determine the rights of preference shares in situations where, despite s 254A(2), their terms of issue are silent or ambiguous as to a particular head of entitlement: see [9.80]. Under these canons the legal status of preference shares has come to approximate their financial character, as an intermediate or hybrid security bearing some of the characteristics of both equity and debt capital. The legal classification of preference capital is, however, as share capital. Its issue secures funds for the company upon terms which ordinarily do not interfere with existing voting control of the company since preference shares are usually given voting rights only when their holders’ dividend entitlements are in arrears. Second, the company need not pay a dividend to the holders of those shares if it has insufficient funds available; indeed, it may not do so if profits are not available for distribution. The company will need, however, to pay a higher coupon rate (or dividend entitlement) for this type of share. A complex calculus accompanies this funding choice, including crucial tax variables. [3.182]

Review Problem

Arthur and Betty wish to establish a restaurant. They will be equal partners in the business although Arthur will look after the kitchen and Betty will attend to the diners. They will need approximately $100,000 for equipment and fit out. In addition, they will need to enter into a lease that gives them some security of tenure and will have to meet staff and food supply expenses. They are conscious that there is a high degree of risk in such start-ups especially for those, like them, without established reputations. Arthur and Betty do not wish to have any more formalities than are necessary. Arthur’s sister, Franny, who is two weeks into a corporate law course at university, suggests that they should form a proprietary company limited by shares to run the business. Franny also says that the company does not need a constitution but should be able to rely on the replaceable rules in the Corporations Act. However, Franny is not sure as to how much equity Arthur and Betty should put into the company. Each of them has savings of $20,000. They will need financial support from Betty’s parents (who have agreed to put in $20,000) and from a bank. [3.182]

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1. Please help Franny advise Arthur and Betty with respect to the optimal capital structure and financing options for the company. 2. Do you agree with Franny that there is no benefit in adopting a constitution for the company in this situation? Or is there governance or other matters that are not addressed, or are inadequately addressed, in the replaceable rules applying to proprietary companies in the Corporations Act? 3. Are there any other matters that Arthur and Betty should consider?

INSOLVENCY [3.185] It may seem incongruous to deal with corporate insolvency in the context of the

formation process. Yet the consequences of insolvency shape the rights and obligations that apply throughout the life of a solvent company and the mix of claims between participants in relation to its assets. The threat of insolvency hangs over corporate life even if its shadow is barely visible for many companies in view of the strength of their business and the reserves accumulated from past operations. As we have seen, the adjustment between the rights of shareholders and creditors of a functioning company is partly effected by reference to distributions that would be made upon the winding up of the company. Of course, there are reasons other than insolvency why companies are wound up, for example, because the purpose for which they were formed no longer exists (this is especially the case within corporate groups (see [4.75]-[4.100]) where the need for a separate company for a particular function may change with time) or because of disputes between shareholders that make it just and equitable that the company be wound up at the suit of an aggrieved member: see [8.145]. It is, however, convenient to treat corporate insolvency at this juncture although it is important to bear in mind that winding up need not be for insolvency and that, as we shall shortly see here, winding up is not the inevitable outcome of insolvency. Winding up is just one of the forms of external administration of insolvent companies. (External administration indicates that the administration or control of company affairs is taken from the company’s directors and put into external hands.) It is the terminal mode that sees the extinction of the company and closure of its operations although portions of its business may be resurrected after sale by the liquidator. However, there are other forms of external administration for companies in financial difficulty which may avoid this finality of outcome: • voluntary administration; • receivership; and • a creditors’ scheme of arrangement (this form is not limited to insolvency or loan default). 74 The treatment of external administration in this section is introductory in nature, providing an overview of options, remedies and processes. Frequent reference will be made to these modes, especially winding up, in later chapters.

74

This list is not exhaustive. For example, an informal workout may be negotiated between a company and its creditors to restore it to a financially viable condition. The workout is usually effected by a voluntary contractual arrangement.

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Voluntary administration [3.190] Voluntary administration was introduced in 1993 as Pt 5.3A to provide an inexpensive procedure capable of being implemented swiftly and flexibly and offering alternative options for creditors for dealing with a financially troubled company. 75 The outcomes available under the procedure are: • the company will resume operations but with a deferred or reduced debt burden under a deed of company arrangement approved by its creditors; • a secured creditor will exercise its rights to appoint a receiver to obtain repayment of its debt by disposal of company assets and who will effectively displace the administrator while doing so; or • the creditors will vote to put the company into liquidation. Under either option, shareholders and directors will be displaced in favour of creditors and the receiver, administrator or liquidator (as the case may be). Depending upon the type of external administration and its outcome, this displacement may be permanent or temporary. Unlike winding up, voluntary administration does not require court approval for its initiation although the court exercises a supervisory jurisdiction over the conduct of the administration. Voluntary administration has proved a popular form of administration and has been adopted by some large companies in financial difficulties such as Ansett and Pasminco as well as the small to medium companies for whom it was primarily conceived. 76 The voluntary administration procedure seeks to maximise the chances of an insolvent company, or as much as possible of its business, surviving or, if it cannot be saved, to achieve a better return for creditors and members than would result from an immediate winding up of the company: s 435A. Voluntary administration is usually initiated by the company itself when directors resolve that: (a) in their opinion the company is insolvent or likely to become insolvent at some future time; and (b) an administrator of the company should be appointed: s 436A(1). While a company is under administration, the administrator has control of the company’s property and business: s 437A. The powers of other corporate officers, including directors, are suspended during the administration and may not be exercised except with the written approval of the administrator (s 437C(1)); company officers are not, however, removed from their offices by the appointment of the administrator: s 437C(2). The administrator must be a registered liquidator who is independent of the company: ss 448B, 448C. Under the Act, a company is solvent if, and only if, it is able to pay all of its debts as and when they become due and payable: s 95A(1). Otherwise it is insolvent: s 95A(2). The test of insolvency therefore looks to a company’s cash flow rather than the balance between its assets and liabilities although its capacity to obtain funds through asset disposals may enhance that cash flow; the test of insolvency is discussed at [7.150]. If directors of a company in financial difficulties allow it to continue to trade and incur debts while the company is insolvent, they may be personally liable for losses sustained by creditors: ss 588G, 588FA. Such potential liabilities therefore provide a strong incentive for 75

Australian Law Reform Commission, General Insolvency Inquiry (1988, ALRC 45), [54] (Harmer Report). The operation of Pt 5.3A has been reviewed by the statutory Advisory Committee: Companies and Securities Advisory Committee, Corporate Voluntary Administration (1998); Corporations and Markets Advisory Committee, Rehabilitating Large and Complex Enterprises in Financial Difficulties (Discussion Paper, 2003); see also Issues in External Administration (Discussion Paper, 2008).

76

Harmer Report, [57]. [3.190]

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directors to appoint an administrator if the company’s solvency is in doubt. The voluntary administration procedure offers them a safe harbour from future insolvent trading liability but with the loss of control of company affairs, property and operations to the administrator: ss 437A – 437D. (This loss may be temporary or permanent.) Less commonly, the administrator may be appointed by a liquidator of the company (s 436B) 77 or by a person who is entitled to enforce a security interest in the whole, or substantially the whole, of the company’s property (here called a substantial secured party): s 436C. As soon as practicable but no later than the next business day, the administrator must notify a substantial secured party of her or his appointment: s 450A(3). Within 13 business days of the administrator’s appointment, a substantial secured party may enforce its charge, usually by the appointment of a receiver or other agent: s 441A. If the substantial secured party opts to enforce its security, since the administrator’s powers are subject to those of that party and its receiver, it thereby effectively supplants the administration: s 442D(1). However, the substantial secured party must enforce its charge in relation to all the property of the company subject of it, and does not have the option of appointing the receiver to some part only of the company’s property, if they wish to override the powers of the administrator: s 441A(1)(b). This amounts to an “all or nothing” rule, justified on the basis that the company’s assets should be administered either by a receiver or administrator free of the problems arising in a system of divided or competing control of those assets. 78 If there is no substantial secured party, or if it does not opt to enforce its charge, there is a general moratorium upon actions or proceedings against the company and its property by creditors and owners or lessors of property used by the company: ss 440A – 440D, 440F. This moratorium provides a period for investigation and collective assessment of options without a general scramble for individual recovery. There are exceptions for proceedings commenced before the administration’s commencement or in respect of perishable property: ss 441F – 441G. During administration there is also a stay of enforcement of guarantees given by directors or their relatives of a liability of the company without the leave of the Court: s 440J. 79 The qualified stay addresses the disincentive to the appointment of an administrator if that event triggers directors’ personal guarantees. As soon as practicable, the administrator must investigate the company’s business, property and financial circumstances (s 438A) and, within strict but not inflexible time limits, convene two meetings of creditors to take decisions with respect to the administration. Within five business days of appointment, the administrator must convene a meeting of creditors to determine whether to appoint a committee of creditors to consult with (but not give directions to) the administrator: ss 436E – 436F. At this first meeting creditors may also replace the administrator with a qualified person of their choosing: s 436E(4). It is the second meeting of creditors that takes the major decisions. Within 21 days of appointment, the administrator must convene the second meeting of creditors (itself to be held 77

The liquidator may appoint himself or herself (or a partner, employee or associate in an incorporated practice) as administrator with the leave of the court or where the appointment is approved by a resolution at a meeting of creditors: s 436B. If the company then executes a deed of company arrangement, the Court may stay or terminate the winding-up. When considering an application to terminate, the Court must have regard to any misconduct by the company’s officers, the commercial decision of creditors accepting the deed and whether the company would remain insolvent after the termination of the winding up: s 482.

78

Harmer Report, [67].

79

Recall that the terms “Court” and “court” are used in this book with the same meaning as in the Act, viz, “Court” refers to the any of the Federal Court, the Supreme Court of a State or Territory or the Family Court; where the term “court” is used, it refers to any court: s 58AA and [2.100]. Use of the term “Court” therefore limits the court in which proceedings may be brought but not choice as between the several court systems comprehended within the definition. The term “Court” is used only when it is significant that the court referred to in the context is one of those named.

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within the next five business days) to decide on the company’s future: s 439A. (Time lines are extended to 28 days for the Christmas and Easter periods.) With the notice of meeting, the administrator must report to creditors about the company’s business, property, affairs and financial circumstances: s 439A(4)(a). At this meeting the creditors may resolve that: • the company execute a deed of company arrangement specified in the resolution; • the administration should end and the company be returned to the control of the directors; or • the company be wound up: s 439C. The administrator’s report must include a statement of her or his opinion upon each of these options and, if a deed of company arrangement is proposed, details of the proposed deed: s 439A(4). A resolution is passed at a meeting of creditors if it is decided on the voices unless a poll is demanded: reg 5.6.19. If a poll is demanded, the resolution is carried if a majority of creditors present in person or by proxy at the meeting vote for it and the value of the debts owed to them by the company is more than the debt held by those voting against the resolution; if the numbers and the weight of debt are not aligned, the chairperson of the meeting (usually the administrator) has a casting vote and so determines the outcome of the resolution: reg 5.6.21. 80 Deeds are sometimes referred to as moratorium deeds (in which the company is granted an extended period in which to repay its debts in full) or compromise deeds (under which creditors agree to receive less than their full debt) or may have some combination of these two features. 81 A deed of company arrangement might treat groups of creditors differentially; however, if it provides for distribution among creditors significantly different from the order of application of assets under a winding up, it is likely to prompt an application for its termination by the Court: s 445D. In particular, a deed of company arrangement must preserve the priority available to employee creditors in a winding up unless employees agree to waive their priority; the Court may approve an alteration of employee priorities in a deed if it is satisfied the alteration is likely to result in the same or better outcome for eligible employee creditors than what would have resulted from an immediate winding up of the company: s 444DA. If creditors resolve to accept a deed of company arrangement, the administrator draws up the deed for execution by the company and the deed administrator within 21 days of the resolution: ss 444A – 444B. The role of the administrator of the deed of company arrangement commences when the deed is executed by the company and the deed administrator. The deed will specify whether the company is to be administered by a deed administrator or by the company’s directors. The voluntary administration ends once the company becomes subject to the deed of company arrangement: s 435C(1)(b), (2)(a). Creditors’ rights under a guarantee or indemnity are unaffected where a debt is released by acceptance of the terms of a deed of company arrangement: s 444H. The deed binds all unsecured creditors, and secured creditors and owners and lessors of property used by the company who voted for the deed, the company and its officers and shareholders: ss 444D, 444G. The Court may order that secured creditors and owners and lessors who voted against the deed are nonetheless bound by it where enforcement of their rights would have a material adverse effect on the achievement of the deed’s purposes and 80

The power to exercise the casting vote is a fiduciary one which engages the obligation to avoid conflict between a duty to the creditors and the chairperson’s personal interest: Re Krejci (2006) 58 ACSR 403; see [7.340]. The court may review a resolution (or a proposed resolution) passed (or lost) on the chairperson’s casting vote: ss 600B, 600C.

81

Corporations and Markets Advisory Committee, [2.14]. The deed of company arrangement may also be used to achieve an orderly liquidation: Young v Sherman (2001) 40 ACSR 12 at [12]. [3.190]

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their interests will be adequately protected: ss 444D(2), (3), 444F. Where there is doubt on a specific ground whether a deed of company arrangement complies with Pt 5.3A, the Court may declare the deed or a provision of it to be void or may validate it despite a contravention of Pt 5.3A: s 445G. To facilitate offers to creditors to substitute equity for all or part of their debt in voluntary administrations, the fundraising provisions in Pt 6D.2 with their detailed disclosure obligations do not apply to such equity for debt swaps. An administrator making an equity for debt offer will only be required to provide a statement setting out all the information known to the administrator about the merits of the offer. The administrator’s statement must indicate that this statement is not a prospectus and therefore may contain less information than a prospectus; the exemption applies only where the offer does not require accepting creditors to contribute any further consideration: s 708(17A). The Court is given general powers to terminate the voluntary administration because, inter alia, the provisions of Pt 5.3A are being abused or the company is solvent: s 447A(2). It may alter the times fixed by Pt 5.3A under the power given to it to permit alterations to the way in which Pt 5.3A is to operate in relation to a particular company: s 447A(1). 82 These powers under s 447A are broad and plenary, to be exercised in the public interest. 83 They extend to ordering the winding up of the company for insolvency. 84 The Court also has a general power of supervision of a company under administration or under a deed of company administration: s 447E. The administrator is personally liable for debts incurred in the administration (ss 443A – 443BA) but has a right of indemnity out of company property for debts or liabilities incurred, in good faith and without negligence, in the performance of functions and powers as administrator: s 443D. The administrator’s right of indemnity ranks in priority over other debts except certain secured debts and is secured by a lien on the company’s property: ss 443E – 443F. The administrator does not have the power that a liquidator has to seek to set aside transactions and pursue remedies against directors and other officers: see [3.210]. The tightness of the time limits imposed upon an administrator also precludes the detailed investigations that a liquidator might undertake. Concerns have accordingly arisen that the voluntary administration process might be initiated by directors with a view to escaping the closer scrutiny and accountability under the winding up process. The directors’ choice, initially at least, of the administrator also may commend administration to them relative to the prospect of winding up. Of course, the two processes are not exclusive and, as noted, the second meeting of creditors may resolve that the company be wound up. As noted, the Court may exercise its powers to intervene in administration where the provisions of Pt 5.3A are being abused. 85

82 83

Australasian Memory Pty Ltd v Brien (2000) 200 CLR 270. Cawthorn v Keira Constructions Pty Ltd (1994) 33 NSWLR 607 at 611.

84

Paradise Constructors Pty Ltd (admin apptd); Pong Property Development Pty Ltd v Sleiman (2004) 8 VR 171.

85

Thus, in Blacktown City Council v Macarthur Telecommunications Pty Ltd (2003) 47 ACSR 391 it was judged to be likely that a meeting of creditors would determine matters “predominantly from the selfish point of view” of the sole director and shareholder and thereby forestall both the imminent hearing of legal action against the company and insolvent winding up. To prevent the company returning to the “mainstream of commercial life” and its director being spared the investigative eye of a liquidator, the court terminated the voluntary administration and wound up the company for insolvency.

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Receivership [3.195] Securities given by companies to lenders commonly grant the lender the right when a

defined act of default occurs 86 to appoint a person to take possession and control either of a particular asset or group of assets or the whole of the property and undertaking of the company. The receiver is empowered to deal with these assets in such a way (including by disposal) as may be necessary to obtain repayment of the debt that is the subject of the security. Although receivership need not result in winding up of the company, that is a common outcome since the remaining assets will usually be inadequate to discharge unsecured debts especially following the commercially traumatic circumstances of receivership and its negative effect upon the company’s business operations. Not infrequently, winding up will commence prior to completion of the receivership; in some cases (as with the John Fairfax Group Pty Ltd in 1990: see [2.275]), the appointment of the receiver is triggered by the appointment of a provisional liquidator although this is less common since the introduction of the voluntary administration procedure in 1993. The appointment of an administrator will usually be included among the defined acts of default in the charge instrument that trigger the right to appoint a receiver. As already noted, where an administrator is appointed her or his powers are subject to those of a receiver appointed by a substantial secured party (that is, a secured creditor who is entitled to enforce a security interest over the whole, or substantially the whole, of the company’s property: see [3.190]) if the latter elects within thirteen business days of the administrator’s appointment to enforce its charge over all the company’s property: s 442D(1). The appointment of a receiver by a substantial secured party therefore effectively suspends the administration; at the conclusion of the receivership, the administration is likely to proceed in different circumstances and with different prospects than those prevailing before the appointment of the receiver. It is common for security instruments to provide for the appointment by the lender of a receiver who has power to manage the business of the borrowing company upon its default. Such a person is called a receiver and manager; a receiver strictly has only power to receive property and income and not to undertake the management tasks such as asset disposal that may be necessary for this purpose. It is rare for a security instrument to provide for appointment of a receiver without powers of management although it is more common for a court-appointed receiver to be given power to receive and not to manage. The Court may appoint a receiver to protect particular property or funds of the company under s 1323(1)(h) or Rules of Court of wider application. “Particular caution” is required before a court appoints a receiver to the entire assets of a company. 87 In the Act the term “controller” is defined to refer compendiously to a receiver, a receiver and manager, and a mortgagee in possession or its agent: s 9. For convenience, the term receiver is used here in an abbreviated sense to refer to the common instance, the receiver appointed under a private instrument with powers of management. Where the receiver is appointed under powers contained in a private instrument, directors’ powers are displaced but only to the extent of inconsistency with the receiver’s powers. Thus, if the receiver has been appointed to a specific asset only, directors’ powers over other corporate property are unaffected. 88 Even if the charge purports to cover the whole of the company’s property, directors retain a limited power to sue in the company’s name to 86

87 88

These would be left to definition in the security instrument but would commonly include failure to make timely interest or other repayments, the company’s entry into external administration or ceasing to carry on business. National Australia Bank Ltd v Bond Brewing Holdings Ltd [1991] 1 VR 386 at 539 (receivership is a “drastic course allowed only under pressing circumstances and granted only with reluctance and caution”). Hawkesbury Development Co Ltd v Landmark Finance Pty Ltd [1969] 2 NSWR 782 at 790. [3.195]

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challenge the validity of the charge and the receiver’s appointment or to claim damages for wrongs done to the company by the holder of the charge. 89 Where a receiver is appointed by court order to company property, the directors’ powers over the property are thereby suspended and revive only upon termination of the receivership. 90 Receivers appointed under a private instrument need to be careful not to exceed their powers (or their statutory augmentation under s 420) lest they (and their appointer) be found to have dealt with company property beyond right and are exposed to tortious and other liabilities. Even though the receiver is appointed by and answerable to the secured party, private charge instruments usually provide that the receiver acts as agent of the company with the intention that it is responsible for the receiver’s acts, and not the secured party itself. Winding up the company

The appointment of a liquidator and its consequences [3.200] Winding up is the process leading to the liquidation of the company and termination of its registration and existence. Winding up is made either upon the order of the court (compulsory liquidation) or by voluntary decision of a company’s members or creditors. Since the company must be solvent before it may be wound up voluntarily by members (s 491(1)), this procedure is outside the present focus upon corporate insolvency. The creditors’ voluntary winding up procedure is available for insolvency although it is not commonly invoked. It requires resolutions at separate meetings of members and creditors (ss 491, 497); creditors appoint the liquidator and control the liquidator’s conduct: s 499. If the second creditors meeting of a company under voluntary administration resolves that the company be wound up, their resolution is deemed to be equivalent to the resolutions of meetings of members and creditors to wind up the company voluntarily so that the company moves into a creditors’ voluntary winding up procedure: s 446A. Future reference, however, will be to compulsory winding up exclusively. A winding up order may be made by the Court on the application of members of a solvent company complaining of unfairness or oppression in the conduct of its affairs or that it is just and equitable that the company be wound up: see Pt 5.4A. These applications are almost invariably made in the context of disputes between groups of shareholders or with those managing the company, and do not normally raise issues of insolvency: see [8.140]. In most instances, however, a compulsory winding up order is made upon the grounds of the company’s insolvency: s 459A. An application for winding up may be brought by a wide range of persons specified in s 459P (the term “contributory” used in the section refers to members of the company) although several groups require the leave of the Court: s 459P(2). These applications usually rely upon presumed insolvency arising from non-compliance with a statutory demand. A statutory demand is one made in the prescribed form requiring payment by the company of a debt of $2,000 minimum value that is presently due and payable to the creditor: s 459E and Corporations Regulations, Sch 2, Form 509H. The company is presumed to be insolvent if, within 21 days after service of the demand, the company fails either to pay the sum, make arrangements for payment which satisfy the creditor or apply to the Court to have the demand set aside: s 459C(2). If the winding up application is later made upon the basis of failure to comply with the statutory demand, the company is precluded from opposing the application by contesting the debt on a ground that it has previously relied upon or might have raised in other proceedings; if the company wishes to dispute the debt or raise an 89 90

Hawkesbury Development Co Ltd v Landmark Finance Pty Ltd [1969] 2 NSWR 782 at 782; Ernst & Young (Reg) v Tynski Pty Ltd (rec & mgrs apptd) (2004) 47 ACSR 433. Reid v Explosives Co Ltd (1887) LR 19 QBD 264.

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offsetting claim, it must apply to set aside the demand within 21 days of its service: ss 459G – 459H. If the company does not do so, it may oppose a winding up application based upon the debt only by proving its solvency at the hearing of the application: s 459S. Directors’ powers and offices are brought to an end by the making of a winding up order and they may no longer make decisions concerning company assets or the conduct of its business: s 471A. 91 After the commencement of winding up, any disposal of the company’s property made otherwise than by the liquidator or under earlier administration is void unless the Court orders otherwise: s 468(1). Powers with respect to the company and its property vest in the liquidator who may carry on the business of the company only so far as is necessary for its beneficial disposal or winding up: ss 471A, 477. A winding up order does not affect the rights of secured creditors (s 471C) although its effects upon unsecured creditors are profound since legal proceedings may thereafter be brought against the company only with the leave of the Court, and execution of any judgment obtained after the commencement of the winding up is void: ss 471B, 468(4). The making of a winding up order automatically terminates contracts of employment with the company. Transfers of shares in the company or alteration in the status of members made after the commencement of the winding up are also void without the liquidator’s consent: ss 468A, 493A.

The order of application of company assets [3.205] After the liquidator has realised the assets of the company, the funds are applied to

discharging the claims of creditors. The fundamental rule is the pari passu principle, viz, that all debts and claims in a winding up rank equally and, if the property of the company is insufficient to meet them in full, they must be paid proportionately: s 555. However, the principle is displaced in favour of certain claims. First, since the winding up order does not affect the rights of secured creditors, the fund available for distribution to creditors is determined after enforcement of their securities. However, where the property available for payment of creditors is insufficient for payment of certain of the unsecured claims that are given priority in fund distribution (relating to employee entitlements and superannuation contributions), payment of those particular preferential claims is given priority over the claims of a secured party in relation to a circulating security interest and those claims may be discharged out of property comprised in or subject to that security interest: s 561. Second, certain unsecured claims are given priority in that they must be paid sequentially and each in full before all other unsecured debts and claims; these priority payments are for the expenses of the liquidation and any earlier voluntary administration, and for employee entitlements for wages, superannuation contributions, claims for injury compensation and retrenchment: ss 556, 558. There are multiple nuanced differentiations made within these broad groupings, sometimes capped as to quantum of priority. Within the debts of each class or grouping the pari passu principle applies: s 559. Any surplus, of course, after all debts are paid is distributed to shareholders according to the rights conferred under the terms of issue of the shares and the constitution of the company: see [3.90].

Recovering property and compensation for the benefit of creditors [3.210] The liquidator may expand the fund available for distribution to creditors by

recovering property and funds passing under voidable transactions and seeking compensation from directors and other officers for losses sustained through breaches of duty. Part 5.7B contains an elaborate structure for the recovery of property or compensation for the benefit of 91

Anfrank Nominees Pty Ltd v Connell (1989) 1 ACSR 365 at 383-386; Madrid Bank Ltd v Bayley (1866) LR 2 QB 37 at 40; Re Farrow’s Bank Ltd [1921] 2 Ch 164 at 174. [3.210]

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creditors of an insolvent company. It is complemented by Pt 5.8A in relation to agreements or transactions to avoid the payment of employee entitlements. Under Pt 5.7B transactions within several categories are deemed to be voidable transactions if they were entered into within specified times before the deemed commencement of the winding up: s 588FE. If the transaction is deemed to be a voidable transaction, the liquidator may seek court orders concerning those transactions, including orders for the recovery of money and property by the company, disgorgement and tracing of benefits received under those transactions, orders releasing the company from debt and orders varying the terms of agreements or declaring them to be void or unenforceable: s 588FF. The first category of voidable transaction is insolvent transactions, comprising transactions by the company that give an unfair preference and uncommercial transactions of the company, in each case made within six months of the commencement of winding up and where the company becomes insolvent because of the transaction: ss 588FE(2), 588FC. 92 Whether a transaction is an uncommercial transaction is measured objectively by reference to the respective benefits and detriments of and to the parties to the transaction: s 588FB. 93 An unfair preference arises where a creditor receives from the company in respect of an unsecured debt a greater sum than they would receive if they had to prove for payment along with other unsecured creditors in the winding-up of the company: s 588FA(1). Section 588FA(3) provides a defence where a creditor has had regular dealings with the failed company and seeks to justify a preferential payment that it received on the basis that the payment was part of a continuing business relationship, or a “running account”, with the company under which supply was continued and payments made by the debtor from time to time. In this situation there will be a preference only if, during the prior six months period the creditor was paid more than the value of the goods or services it supplied, that is, only if there has been a net reduction in the amount of the debt during the period. 94 The quantum of any preference will generally be measured by the difference between the highest amount owing during the period and the amount owing on its last day. 95 An insolvent transaction which is also an uncommercial transaction is voidable if entered into within two years of the commencement of the winding-up: s 588FE(3). A four-year clawback period applies in two situations. The first is in respect of an insolvent transaction with a related entity to which the company is party: s 588FE(4). (The term “related entity” is expansively defined in s 9, effectively to embrace persons connected with the company or affiliated companies and their personal relations.) The second situation arises in 92

“In the context of an uncommercial transaction, an expansive notion of causation is not consistent with the purpose of these avoidance provisions”: Rathner in his capacity as Official Liquidator of Kalimand Pty Ltd (in liq) v Hawthorn [2014] FCA 1067 at [28] per Gordon J citing Giles JA in Lewis (as liq of Doran Constructions Pty Ltd (in liq)) v Doran [2005] NSWCA 243 at [138]: “[the insolvency] should be quite closely related to the entry into or giving effect to the transaction; if it were not so, the provisions would not guide conduct towards validity, but would avoid transactions because of the turn of later events”. Accordingly, an applicant must present clear evidence as to how a transaction affects a company’s solvency.

93

95

The question whether a transaction is uncommercial is answered by reference to “whether a reasonable person in the company’s circumstances would not have entered into the transaction. The company’s circumstances must include the state of its knowledge, that is, the knowledge of those who were relevantly its directing mind. Only if the court can conclude that a reasonable person in the company’s circumstances would not have entered into the transaction does the section make that transaction uncommercial”: Tosich Construction Pty Ltd (in liq) v Tosich (1997) 78 FCR 363 at 366-367 per the Full Court. Sims v ABC Tissue Products Pty Ltd [2008] NSWSC 192 at [13]; Airservices Australia v Ferrier (1996) 185 CLR 483 at 501-502 (“if the purpose of the payment is to induce the creditor to provide further goods or services as well as to discharge an existing indebtedness, the payment will not be a preference unless the payment exceeds the value of the goods or services acquired”). Wily v Eastern Elevators Pty Ltd (2003) 175 FLR 344.

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relation to an unreasonable director-related transaction of the company: ss 588FE(6A), 588FDA. Unreasonableness is measured objectively by reference to the respective benefits and detriments of the parties to the transaction: s 588FDA. 96 The section is designed to “catch director-related transactions of kinds not otherwise liable to avoidance as unfair preferences, uncommercial transactions or unfair loans”. 97 A ten-year clawback period applies in respect of an insolvent transaction of the company which is made with the purpose of defeating, delaying or interfering with the rights of creditors in a winding up: s 588FE(5). Finally, an unfair loan to the company is voidable whenever it is made (s 588FE(5)); a loan is unfair if the interest rate or loan charges are or have become extortionate by reference to specified considerations: s 588FD. An order may not be made materially prejudicing a creditor or other person in respect of a voidable transaction if it is proved that they received no benefit from the transaction or that they received the benefit in good faith and without reasonable grounds for suspecting that the company was insolvent: s 588FG(1). 98 Except in the case of an unfair loan to the company or an unreasonable director-related transaction, no such orders may be made against a person who became a party to the transaction in good faith, had no reasonable grounds for suspecting the company’s insolvency and provided valuable consideration under the transaction or changed its position in reliance on it: s 588FG(2). There are two broad additional remedies available to a liquidator that may expand the fund available for distribution to creditors. Part 5.8A gives the liquidator and employees compensatory remedies against persons who enter into transactions with the intention of preventing or inhibiting the recovery of employee entitlements or significantly reducing their amount: s 596AB. The remedy was introduced in response to the events following the restructure of the Patrick group of companies in 2000: see [4.85]. The more significant remedy, however, because of its wider application, arises where directors fail to prevent their company incurring debts while it was insolvent and either they were aware that there were reasonable grounds for suspecting the company’s insolvency or a reasonable person in their position would have done so; directors may be required to compensate the company’s creditors for losses suffered through the breach: s 588G. There is a counterpart remedy making a holding company liable for insolvent trading by a subsidiary: s 588V (as to these terms see [4.90]). Defences are available with respect to both remedies: ss 588H, 588X, 588W. These duties and the compensation remedies that they trigger are discussed at [7.135] et seq. 96

97 98

“The test of unreasonableness in s 588FDA of the Act is objective; it is what a reasonable person in the company’s circumstances may be expected not to do. The ‘company’s circumstances’ encompass all relevant matters, starting with its status as a company and what flows from that; its controllers, shareholders, business and other activities; and the facts and circumstances of, and surrounding, the transaction. … [93] The only insolvency related elements (ie necessary conditions) of a voidable unreasonable director-related transaction are that the company is being wound up and the transaction was entered into within four years of the relation-back day. Otherwise, the relevance and/or weight to be given to the fact, or risk, of insolvency depends on the facts. Indeed, a director-related transaction entered into when the company was insolvent would, without more, be caught by s 588FE(4). Further, a transaction may, like an unfair loan, be so objectively unreasonable that the financial position of the company at the time of entry into the transaction is not relevant. In other circumstances, the transaction may be unreasonable solely or primarily because of the financial condition of the company at the time of the transaction”: Weaver v Harburn (2014) 103 ACSR 416 at [91], [93] per McLure P. Vasudevan (as Joint and Several Liquidator of Wulguru Retail Investments Pty Ltd (in liq)) v Becon Constructions (Australia) Pty Ltd [2014] VSCA 14; (2014) 97 ACSR 627 at [28] per Nettle JA. The provision imposes an objective “reasonable business person” test and does not require the court to take into account the acumen, perspicacity and resources of the particular creditor: Cussen as Liquidator of Akai Pty Ltd (in liq) v Commissioner of Taxation (2004) 51 ACSR 530. [3.210]

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Schemes of arrangement [3.215] The scheme of arrangement is a further device that might be used by a company

facing the prospect of insolvency to restructure its debts, typically through a compromise of creditors’ claims similar to that which might be reached under a deed of company arrangement under voluntary administration. A creditors’ scheme of arrangement was never common but has now been eclipsed by the voluntary administration procedure with its lesser formality and expense and greater flexibility of outcome. The scheme of arrangement procedure is initiated by an application to the Court for an order that a meeting of creditors or classes of creditors be convened and for approval of an explanatory statement to be sent to creditors with the notice of meeting: ss 411, 412. The meeting (or separate meetings where creditor interests are different in relation to a proposed compromise or arrangement, as they almost invariably are) consider the proposed scheme; this binds creditors only if it is approved by a majority of creditors in each class who between them hold 75% of the total debt of those creditors who are present in person or by proxy at the meeting; the compromise must also be approved by the Court after application to it: s 411(4). The complexity, formality and delay inherent in this procedure explain both its erstwhile modest appeal and its present displacement in favour of voluntary administration. [3.217]

Review Problem

The Melick family has owned and managed the Country Stores Pty Ltd (“CS”) retail chain across regional New South Wales for over three generations. 99 The Melick family owns all of the shares, and holds all of the board positions in the company. Some of the CS stores are operated in buildings owned by the company, whilst others are in rented premises. With the drought and rural recession, the company’s operations have not prospered in recent years. Indeed, the company has sustained significant trading losses in each of the past five years. The State Bank has provided financial support through a constantly increasing overdraft limit. The bank is protected by a registered floating charge over the whole of the assets of the company. The floating charge instrument contains a negative pledge, which states that the company agrees not to grant any further securities over its assets without the bank’s prior written consent. The company has numerous other unsecured trade creditors, some of which provide goods subject to a retention of title clause. The poor trading results have meant that the company has had to rely upon substantial financial support from its main shareholder and chair of the board, George Melick. George Melick is an independently wealthy man with numerous investments, and has consistently bailed out the company in times of financial difficulty because of the pride he has in continuing on the family business. George has lent increasing sums to the company on an unsecured basis over the past six years. Over the past year the company has faced the possibility that it might not be able to see out the drought. The bank has indicated that the company should not assume its continuing financial support. On some occasions, the company has been forced to sell assets to pay overheads such as wages and trade invoices. George Melick has had to provide loan funds to the company, and has also agreed to provide personal guarantees to cover the company’s most recent overdraft extensions by the bank. CS’s board has taken other measures to secure its financial security. To induce George Melick to make his most recent loan to the company and to secure repayment of his earlier loans, the company gave him a floating charge over the historic building in Goulburn from 99

I am grateful to Jason Harris, Faculty of Law, University of Technology, Sydney for permission to use this review problem which he devised.

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which the company’s store operates. The security document gives him the option to call for the transfer to him of the Goulburn property at the value shown in the last Valuer-General’s valuation of the unimproved capital value of the land plus the sum for which the building is insured by the company. George may offset outstanding loan moneys against the purchase price upon the exercise of the option. Under the terms of her service contract as chief executive and managing director of the company, Gemma Melick, George’s daughter, was paid a bonus in 2008 for securing asset disposals and the continuing operation of the company. She had agreed to reduce the cash component of her salary package in exchange for the performance-based component of remuneration. Recently, however, trading has become worse and the board is concerned about the continuing solvency of the business. George has raised the idea of formulating a deed of company arrangement to give the business time to restructure. Advise the board of the options available to the company as well as the potential risks involved in continuing to trade the business in its current state.

PROTECTING THE INCIPIENT COMPANY THROUGH PROMOTERS’ DUTIES [3.220] The newborn or gestating company may need protection from its creators. 100

Legislation in the late 19th century imposed controls over prospectuses. Judicial doctrines identifying promoters and imposing upon them fiduciary obligations of good faith was the other response to the “profiteering trio” of promoter, lawyer and accountant to whom the high incidence of company failure in the 1860s and 1870s is attributed: see [2.60]. These doctrines were largely developed in case law in the last three decades of the 19th century. 101 Who is a promoter? [3.225] The term carries a range of meanings which have varied with context and historical

usage. Generally, promoters are the persons responsible for the formation of the company, the moving forces behind its gestation and birth. Farrar 102 neatly captures the evolution of the office of promoter in England: The small trader who takes steps to incorporate his business is engaged in promotion. From the 17th century onwards there have been men who have specialised in the promotion of public companies although in the early period they usually had a number of other interests as well. Thus Nicholas Barbone, son of Cromwell’s General Praise-God Barbone, was a physician, Member of Parliament and property developer as well as promoter of a fire insurance company and bank. Most professional promoters of public companies have been connected with the City of London and have been men of repute, but in the period 1860-1920 there were a number of company promoters who perpetrated frauds which the courts sought to combat by means of the development of specific fiduciary duties. In recent years, most leading companies have started off life as private companies or unlisted public companies and then “gone public” later after establishing a sound profit record. In this process they have been assisted by stockbrokers or 100

101

The concerns of this section with exploitation of the company that is in the process of incorporation were nicely captured in Gluckstein v Barnes [1900] AC 240 at 248 by Lord Macnaghten when he referred to it as “half-fledged and just struggling into life, bound hand and foot while still unborn”. See Bagnall v Carlton (1877) 6 Ch D 371; Twycross v Grant (1877) 2 CPD 469; Erlanger’s case (1878) 3 App Cas 1218; and Emma Silver Mining Co Ltd v Grant (1879) 11 Ch D 918. Each of these cases, except Erlanger, involved action for recovery of a secret profit derived by the same professional company promoter, Albert Grant.

102

J H Farrar et al, Farrar’s Company Law (3rd ed, Butterworths UK, 1991), pp 52-53. [3.225]

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specialist financial institutions known as issuing houses. An issuing house, which will usually be a merchant [or investment] bank, organises the raising of capital by new issues of securities. The stockbrokers and issuing houses are promoters if they perform more than mere ministerial acts.

The 1844 Act (see [2.55]) defined a promoter as “every person acting by whatever name in the forming and establishing of a company at any period prior to the company obtaining a certificate of complete registration”: s 3. The identification of promoters and the duration of the promotion have largely been left to the courts. In Whaley Bridge Calico Printing Co v Green, Bowen J said: The relief afforded by equity to companies against promoters, who have sought improperly to make concealed profits out of the promotion, is only an instance of the more general principle upon which equity prevents the abuse of undue influence and of fiduciary relations. The term promoter is a term not of law, but of business, usefully summing up in a single word a number of business operations familiar to the commercial world by which a company is generally brought into existence. In every case the relief granted must depend on the establishment of such relations between the promoter and the birth, formation and floating of the company, as render it contrary to good faith that the promoter should derive a secret profit from the promotion. 103

In Lagunas Nitrate Co v Lagunas Syndicate, Lindley MR considered the duration of the promotion: Here it was intended from the first to raise a large capital by appealing to the public. The promoters prepared a prospectus before the company was formed, and, although it was not issued until after the company was formed and until after the contract was executed, its issue must, as between the two companies, be treated as the act of the syndicate and of its directors, and not merely as the act of the nitrate company. The nitrate company, although, in one sense, formed when registered, was not completely formed, as contemplated by the promoters, until a prospectus had been issued and a large capital had been subscribed. The issue of the prospectus was the last act of promotion. 104

Tracy v Mandalay Pty Ltd [3.230] Tracy v Mandalay Pty Ltd (1953) 88 CLR 215 High Court of Australia [The underlying business problem facing the promoter in this case is now substantially addressed by the introduction of strata titles legislation. The case is, however, valuable both as the leading exposition of the law on company promotion and as a case study in the formation of a company and realisation of the objectives for which it was created. It also gives an interesting glimpse into post-War Sydney life and the enduring appetites of its residents for harbourside housing.] DIXON CJ, WILLIAMS and TAYLOR JJ: [234] These are appeals by each of the defendants from a decree of the Supreme Court of New South Wales in its equitable jurisdiction (Roper CJ in Eq) in which the plaintiff [Mandalay Pty Ltd] was granted relief on the basis that all the defendants were its promoters and that certain contracts which they had made with the plaintiff had been entered into without proper disclosure to the plaintiff and were voidable and should be rescinded. Before referring to the decree in more detail it will be convenient to refer to the material facts. They commence early in 1948. The defendant company [RSC Trading Co Pty Ltd] was then in existence having been incorporated on 14 September 1945. But it was not carrying on any business. It had first carried on the business of making and selling toys and later of selling bricks, but it had disposed of the latter business to the defendant Willard at the end of 1947. Its authorised capital was £2,500 divided into 2,500 shares of £1 each. But only 1,002 shares had been issued. The defendant Salon held [235] 668 of those shares and his wife, the defendant Mavis Lorraine Salon held 334. Salon had been a 103 104

(1879) 5 QBD 109 at 111. [1899] 2 Ch 392 at 428.

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Tracy v Mandalay Pty Ltd cont. director of the company from its commencement. Mrs Salon was appointed a director on 14 April 1948. Early in 1948 Salon had made a contract for the purchase of a block of land in Wylde Street, Potts Point, with a view to erecting thereon a modern building of ten storeys divided into a number of flats of different sizes. Salon made the purchase on behalf of the defendant company and intended to promote another company to which the defendant company would sell the land at a profit. The new company would then erect the building and sell the flats. In June 1948, Salon persuaded the defendants Griffith and Miss Withy, who were associated in other business transactions, to purchase 250 shares each in the defendant company from himself and Mrs Salon, at £10 per share, the inducement held out to them being that by so doing they would become in effect half owners of the land at Potts Point and would receive half the profit on the sale of that land to the new company. The price at which the land was purchased by Salon, according to the contract, was £6,000 but Griffith and Miss Withy said that he told them that he had paid £8,000, that he proposed to sell the land to the new company for £24,000, and that the profit would be £16,000 of which they would receive half, thereby making a profit of £3,000 on their investment of £5,000 in shares in the defendant company. Salon lent the £5,000 received from Griffith and Miss Withy to the defendant company and it was used towards payment of the purchase money for the land which was transferred to the defendant company towards the end of June 1948. Miss Withy received a minor post in the office of the defendant company at a salary of £5 a week less tax. The defendant Tracy was the secretary. Salon went ahead with the preparations for the new building. He obtained the general approval of the City Council to sketch plans prepared by an architect and commenced negotiations with the Maritime Services Board either to purchase or obtain rights of light over a small adjoining piece of land necessary to the success of the scheme. The board eventually agreed to sell this land for £250. Towards the end of 1948 Salon wanted to raise some money on the security of the land at Potts Point, but Griffith and Miss Withy objected. Salon and Mrs Salon then sold 250 of their shares in the defendant company to Willard for £10 each. Willard, like Griffith and Miss Withy, also knew of the proposed formation of the new company and bought his shares with a view to making a profit out of the sale of the land to the new company. [236] The plaintiff company was incorporated on 10 December 1948, as a proprietary company limited by shares under the provisions of the Companies Act 1936 (NSW). The land was not immediately sold to the new company. Salon conceived the idea that the profit on the sale might be taxable and proceeded to devise a new scheme by which the land would be sold by the defendant company to the plaintiff for £2,650, the amount required to discharge the debts of the defendant company, and the shareholders in the defendant company would sell their shares to the plaintiff at £8 12s 0d per share. Griffith and Miss Withy naturally objected to the new scheme, because under it they would not receive a profit on the transaction but would make a loss of £700. After some negotiations Griffith and Miss Withy said they would be satisfied if they got their money back, and Salon and Mrs Salon agreed to give Griffith and Miss Withy promissory notes for £700 to make good the loss. At a meeting of directors of the defendant company held on 29 December 1948, those present being Salon and Mrs Salon as directors and Tracy as secretary, applications were received and accepted from Mrs Salon, Willard and Tracy for the issue of the whole of the unissued capital of the defendant company, namely 1,498 shares. These shares were allotted to the respective applicants at a subsequent meeting of directors held on 4 January 1949, Willard receiving 342, Tracy 66 and Mrs Salon 1,090 shares. The share holdings in the defendant company were then as follows: Salon 218 shares, Mrs Salon 1,124 shares, Willard 592 shares, Griffith and Miss Withy 250 shares each and Tracy 66 shares. At a meeting of directors of the defendant company held on 31 December 1948, at which Salon and Mrs Salon were present as directors and Tracy as secretary, it was reported that all the members of the defendant company wished to offer their share holdings to the plaintiff at the price of £8 12s 0d per share in conjunction with the land at Potts Point at the price of £2,650 and the secretary was instructed to make that offer in writing to the plaintiff. Each of the shareholders about this time signed a letter offering his or her shares to the plaintiff at £8 12s 0d per share. [3.230]

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Tracy v Mandalay Pty Ltd cont. What purported to be a general meeting of the plaintiff was held on 7 January 1949. There were then only three shareholders, Willard, Salon, and Miss Withy, each of whom had signed the memorandum and articles of association of the plaintiff for one share. Willard and Salon were appointed directors and Tracy secretary of the company and the directors were instructed to negotiate for the purchase by the plaintiff of the whole of the shares [237] in the defendant company at £8 12s 0d per share and also for the purchase of the land at Potts Point. A meeting of directors of the plaintiff was held on 10 January 1949, Willard and Salon being present as directors and Tracy as secretary. At this meeting the directors resolved to accept the offer of the shares in the defendant company at £8 12s 0d per share and to accept the offer of the defendant company to sell the land at Potts Point for £2,650. On the same day, presumably at another but later meeting of directors, at which the same persons were present, an application by one Greene for 1,800 shares in the plaintiff accompanied by a cheque for £900 was accepted and the shares were allotted. The result of accepting the offers of the defendants was, as his Honour pointed out, that a company with a capital of £3 had agreed to pay £24,150 for the land and shares. Obviously the money to pay this sum and to finance the erection of the building, estimated to cost about £140,000, had to come from outside sources. The plaintiff soon got busy. It had already received the above application from Greene and it placed the business of selling the flats in the building which had not been commenced and for which final approval had not been obtained in the hands of a company, L J Hooker Ltd, which carries on the business of real estate agents. Mr Lightfoot, an associate director of that company, was in charge of the selling and he commenced operations early in January 1949. Inquirers were informed that the building was to be of ten storeys comprising basement, ground floor and eight upper floors each comprising seven self-contained home units of which the basement, ground floor and seven flats on the first floor would be let and the rent would pay the outgoings and running expenses of the building and the rest of the flats, 49 in all, would be sold as home units. It was said that it was expected that the building would be ready for occupation in January 1950, and that each unit would be sold separately and would be acquired by the purchase of £1 shares in the plaintiff company, payments to be 10s per share on application and the balance by four equal quarterly instalments. The public, no doubt owing to the housing shortage, rose to the bait. Applications for 52,102 shares were received by the plaintiff and the shares allotted in the next few months. The sum of £29,958 was raised by the issue of these shares and was used very largely to pay for the land and the shares in the defendant company sold to the plaintiff. The defendant company was paid £2,650, Salon £1,866 4s 0d, Mrs Salon £9,657 16s 0d, Willard £5,091 4s 0d, and Tracy £567 12s 0d. The dates these payments were made appear later. Griffith and Miss Withy were not so [238] fortunate. They received nothing at first and had to commence actions against the plaintiff after which Griffith received £500 and Miss Withy £2,150. All these payments total £22,482 16s 0d. The other shareholders have, but Griffith and Miss Withy have not, transferred their shares to the plaintiff. The contract of sale of the land to the new company was not signed until 23 December 1949, although the defendant company was paid for the land on 21 January of that year. The building has never been erected. An amendment of the law on 1 January 1949 made it impossible to carry out the intended plans. It was hoped that the law would be altered so that the project could proceed, but in October 1949 the plaintiff received advice that nothing could be done. In the statement of claim the plaintiff sought relief on four alternative bases: (1)

that the contracts of sale of the land and the shares were all part of one inseverable transaction, the whole of which was voidable and should be avoided, the contracts being cancelled and each of the defendants being held jointly and severally liable to repay the whole of the moneys paid by the plaintiff;

(2)

that the defendants should be ordered to pay the plaintiff £18,932 16s 0d alleged to be the difference between the price charged to the plaintiff for the land and shares and their real value;

(3)

that an account should be taken of the profits made by the sale to the plaintiff of the land and shares and that the defendants should be ordered to pay the amount of such profits to the plaintiff;

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Tracy v Mandalay Pty Ltd cont. (4)

that an inquiry should be had as to the damages suffered by the plaintiff by misfeasance, breach of trust, breach of duty or otherwise by reason of the act or default of the defendants as promoters, directors, officers or agents of the plaintiff and that the defendants should be ordered to pay to the plaintiff the amount of such damages when ascertained.

His Honour gave the plaintiff relief on the first of these bases and ordered that each of the contracts should be rescinded. [239] We are of opinion that the basis on which his Honour granted relief was the proper basis. The land and shares sold to the plaintiff were assets owned by the respective vendors at law and in equity. They were not assets which the vendors held on trust for the plaintiff. They were the absolute property of the defendants. The plaintiff could not affirm the contracts of sale and at the same time ask for an account of profits or for damages as this would be, in effect, asking the court to vary the contracts of sale and order the defendants to sell their assets at a lesser price. In Cook v Deeks [1916] 1 AC 554 Lord Buckmaster LC, delivering the judgment of the Privy Council said: In their Lordships’ opinion the Supreme Court has insufficiently recognised the distinction between two classes of case and has applied the principles applicable to the case of a director selling to his company property which was in equity as well as at law his own, and which he could dispose of as he thought fit, to the case of a director dealing with property which, though his own at law, in equity belonged to his company. The cases of North-West Transportation Co Ltd v Beatty (1887) 12 App Cas 589 and Burland v Earle [1902] AC 83 [240] both belonged to the former class. In each, directors had sold to the company property in which the company had no interest at law or in equity. If the company claimed any interest by reason of the transaction, it could only be by affirming the sale, in which case such sale, though initially voidable, would be validated by subsequent ratification. If the company refused to affirm the sale the transaction would be set aside and the parties restored to their former position, the directors getting the property and the company receiving back the purchase price. There would be no middle course. The company could not insist on retaining the property while paying less than the price agreed. This would be for the court to make a new contract between the parties. It would be quite another thing if the director had originally acquired the property which he sold to his company under circumstances which made it in equity the property of the company. The distinction to which their Lordships have drawn attention is expressly recognised by Lord Davey in Burland v Earle and is the foundation of the judgment in North-West Transportation Co Ltd v Beatty and is clearly explained in the case of Jacobus Marler Estates v Marler (1913) 114 LT 640n. … Promoters may sell their property to the new company but they are under a fiduciary duty to disclose to the new company that they are doing so and under a duty to place it in a proper position to decide whether to accept the offer or not by appointing an independent board and fully disclosing the whole position to that board. In Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218 at 1229 Lord Penzance said: It was the vendors, in their character of promoters, who had the power and the opportunity of creating and forming the company in such a manner that with adequate disclosures of fact, an independent judgment on the company’s behalf might have been formed. But instead of so doing they used that power and opportunity for the advancement of their own interests. Placed in this position of unfair advantage over the company which they were about to create, they were, as it seems to me, bound according to the principles constantly acted upon in the Courts of Equity, if they wished to make a valid contract of sale to the company, to nominate independent directors and fully disclose the material facts. Lord Cairns LC said: it is now necessary that I [241] should state to your Lordships in what position I understand the promoters to be placed with reference to the company which they proposed to form. They stand, in my opinion, undoubtedly in a fiduciary position. They have in their hands the creation and moulding of the company; they have the power of defining how, and when, and [3.230]

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Tracy v Mandalay Pty Ltd cont. in what shape, and under what supervision, it shall start into existence and begin to act as a trading corporation. If they are doing all this in order that the company may, as soon as it starts into life, become, through its managing directors, the purchaser of the property of themselves, the promoters, it is, in my opinion, incumbent upon the promoters to take care that in forming the company they provide it with an executive, that is to say, with a board of directors, who shall both be aware that the property which they are asked to buy is the property of the promoters, and who shall be competent and impartial judges as to whether the purchase ought or ought not to be made. It is clear from these passages, and there are many others to the same effect, that in the absence of approval by an independent board after full disclosure sales by a promoter of his property to the new company are in the same position as any other sales by a trustee of his property to a person towards whom he stands in a fiduciary relation. That is to say they are voidable at the mere option of the purchaser. But if the purchaser decides to affirm the transaction he must affirm it according to its terms. He cannot ask the court “to fix a proper price between vendor and purchaser, and estimate the damage with reference to such price. This the court cannot do” per Lord Parker of Waddington in Marler’s case. The word “promoter” has been said on many occasions to be a word which has no very definite meaning. It is sufficient to refer to the discussion of its meaning in Emma Silver Mining Co Ltd v Lewis & Son (1879) 4 CPD 396. There Lindley J, as he then was, said: With respect to the word “promoters”, we are of opinion that it has no very definite meaning: see Twycross v Grant (1877) 2 CPD 469. As used in connection with companies the term “promoter” involves the idea of exertion for the purpose of getting up and starting a company (of what is called “floating” it) and also the idea of some duty towards the company imposed by or arising from the position which the so-called promoter assumes towards it. It is now clearly settled that [242] persons who get up and form a company have duties towards it before it comes into existence: see Bagnall v Carlton (1877) 6 Ch D 371 and per Lord Cairns C, in Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218 at 1236. Moreover, it is in our opinion an entire mistake to suppose that after a company is registered its directors are the only persons who are in such a position towards it as to be under fiduciary relations to it. A person not a director may be a promoter of a company which is already incorporated, but the capital of which has not been taken up, and which is not yet in a position to perform the obligations imposed upon it by its creators. The defendants say they owed no duty to this company. But in our opinion this contention cannot be supported. In the first place, the defendants left Park to get up the company upon the understanding that they as well as he were to profit by the operation; they were behind him; they were in the position of undisclosed joint adventurers; and in respect of their interest his obligations and theirs are in our opinion undistinguishable. The defendants in fact were, partly by assisting Park and partly by leaving him to do the best he could for them as well as himself, in the position of promoters of the company (at 407-408). (The italics are ours.) In the present case Salon was admittedly a promoter of the plaintiff. He was directly responsible for its incorporation. It was on his instructions that the memorandum and articles of association were prepared and registered and incorporation effected. Some of the other defendants also took an active part in the promotion of the plaintiff, and we shall refer shortly to some of these activities. But it is not only the persons who take an active part in the formation of a company and the raising of the necessary share capital to enable it to carry on business who are promoters. It is apparent from the passage cited that persons who leave it to others to get up the company upon the understanding that they also will profit from the operation may become promoters. Salon, Griffith and Miss Withy gave evidence; Mrs Salon, Willard and Tracy did not do so. Willard, Tracy and Mrs Salon were, in our opinion, all promoters. Willard bought his original parcel of 250 shares from Salon and Mrs Salon with a view to sharing in the profit expected to be made out of the incorporation of the new company. On 29 December 1949, the balance of the capital of the defendant company was allotted at par, when Willard received 342 shares, Mrs Salon 1,078 shares and Tracy 66 shares. The whole purpose of this 152

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Tracy v Mandalay Pty Ltd cont. allotment was to enable the recipients to resell the shares [243] to the plaintiff at £8 12s 0d each. The meeting of directors of the defendant company followed on 4 January 1949, when it was resolved to offer all the shares to the plaintiff. The next step was the purported general meeting of the plaintiff on 7 January 1949, when Salon and Willard were appointed directors and Tracy secretary, Willard being appointed to the chair. The unanimous resolution was passed that the directors should be instructed to negotiate for the purchase of the share holdings in the defendant company and for the purchase of the land. But no negotiations were necessary because the shares and the land were already under offer at prices which had been fixed and the same persons who had fixed the prices at which these assets were to be sold intended to decide that these prices were acceptable to the new company. There followed the directors’ meeting of the plaintiff on 10 January 1949, Willard, Salon and Tracy being present, when it was resolved to purchase the land and the shares. The stage was then set for the intended profits to be made. The plaintiff had no real shareholders. Yet over £24,000 had to be subscribed to pay the total purchase moneys. An application had been received from Greene for 1,800 shares on 20 December 1948. His cheque had been received on 22 November 1948, but no allotment of shares was made to him until the directors of the plaintiff met for the second time on 10 January 1949. The only reasonable inference from these facts is that the persons floating the plaintiff were determined that the plan for the sale of the land and the shares to the plaintiff should be perfected and the plaintiff saddled with this huge obligation before the shareholders whose money was to be used to discharge it were introduced into the company. There followed the series of directors’ meetings of the plaintiff subsequent to 10 January 1949, at which applications from the general public anxious to acquire flats in the new building were disposed of; substantial parcels of shares were allotted and the allotment moneys applied not to pay for the new building or held in trust for that purpose but used to pay for the land and the shares in the defendant company. Willard, Salon and Tracy were the persons present at all these meetings. Salon was admittedly a promoter of the plaintiff, Willard took an active part in its promotion. By purchasing 250 shares from Mr and Mrs Salon at £10 each he paid a substantial sum to be let into the scheme. These shares were transferred to him at a meeting of directors of the defendant company on 29 December 1949, and at the same meeting he was allotted the 342 further shares. He became chairman of directors of the new company and played a leading part [244] in accepting the new capital and disposing of it. He saw to it that he was paid the purchase money for his own shares and made the intended profit. He was implicated in the scheme up to the hilt. Tracy assumed the role of secretary throughout, first of the defendant company and later of the plaintiff. As secretary it was his duty to give many instructions, such as the instructions to Mr Lightfoot about the manner in which the flats were to be sold, which could be attributable wholly to this office. But the inference was clearly open to his Honour that he was taking an active part in forming and floating the new company. He received 66 shares in the defendant company on 29 December 1948. It was suggested by his counsel that at that time his salary was in arrears to the extent of £624, and the profit he expected to make on the shares when they were sold to the plaintiff was to be the means of recouping his salary. On the other hand, it was contended for the respondent that he was paid these arrears. It is not clear from the evidence whether the arrears were paid or not. Assuming they were not, Tracy’s interest in the sale of the land and shares to the plaintiff was even greater than if they were. Undoubtedly he became a shareholder in the defendant company so that he would have an interest in the profit to be made out of the promotion and formation of the new company. If his activities were merely ministerial he was at least ministering to two boards the members of which were actively engaged on his behalf as well as their own in seeing that the scheme was carried through and he was fully aware and assisted in the means by which that purpose was achieved. Nor can there be any doubt that Salon was acting on behalf of his wife with her knowledge and consent. As for the defendant company, it was a mere puppet in the hands of Salon and Mrs Salon. It was bound by the steps they took on its behalf to sell the land to the new company. In our opinion his Honour was justified in holding that Mrs Salon and the defendant company were promoters of the plaintiff. The liability of Griffith and Miss Withy requires more consideration. Originally they purchased their shares in the defendant company from Salon and Mrs Salon with a view to making a large profit when [3.230]

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Tracy v Mandalay Pty Ltd cont. the land at Potts Point was sold to the new company. But this scheme was not carried out. A new scheme was substituted for it. Under the new scheme they would have sold their shares to the new company at a loss if they had not been recouped by the promissory notes. They were left out of the distribution of the balance of the capital of the defendant company on 29 December 1948. There is no evidence that either of them took any active [245] part in the formation of the plaintiff or in the attraction and disposition of the new capital. Miss Withy held a minor position in the office of the defendant company, but she only had a hazy idea of what was going on. She does not appear to have realised that she was taking part in a meeting of shareholders of the plaintiff on 7 January 1949. They were not paid for their shares or on the promissory notes until they resorted to litigation. Even then Griffith only received £500 of his £2,150. But it is clear that they agreed to participate in the scheme to promote the plaintiff and sell the land and the shares to it provided Mr and Mrs Salon gave them the promissory notes so that they would not lose on their investment by selling their shares at £8 12s 0d. In the end they had to be content to get their money back and the only way that they could do so was by accepting the new scheme and standing behind Salon in the operation. They were joint adventurers in the new scheme. As Salon and the other active promoters failed to discharge the fiduciary duties which that operation involved to make it legally binding on the new company, the transaction must be voidable not only against Salon but also on whose behalf he was acting. [Each of the defendants was ordered severally to repay, with interest, the purchase money received from the plaintiff.]

Twycross v Grant [3.235] Twycross v Grant (1877) 2 CPD 469 Court of Appeal, England and Wales COCKBURN CJ: [541] The question as to when one who in the outset was a promoter of a company continues or ceases to be so, becomes, therefore, as it seems to me, one of fact. A promoter, I apprehend, is one who undertakes to form a company with reference to a given project and to set it going, and who takes the necessary steps to accomplish that purpose. That the defendants were the promoters of the company from the beginning can admit of no doubt. They framed the scheme; they not only provisionally formed the company, but were, in fact, to the end its creators; they found the directors, and qualified them; they prepared the prospectus; they paid for printing and advertising, and the expenses incidental to bringing the undertaking before the world. In all these respects the directors were passive; without saying that they were in a legal sense the agents of the defendants, they were certainly their instruments. All the things I have just referred to were done with a view to the formation of the company, and so long as the work of formation continues, those who carry on that work must, I think, retain the character of promoters. Of course, if a governing body, in the shape of directors, has once been formed, and they take, as I need not say they may, what remains to be done in the way of forming the company, into their own hands, the functions of the promoter are at an end. But, so long as the promoters are permitted by the directors to carry on the work of formation, the latter remaining passive, so long, I think, would a jury be warranted in finding that what was done by them was done as promoters.

[3.238]

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Notes&Questions

In Elders Trustee and Executor Co Ltd v E G Reeves Pty Ltd (1987) 78 ALR 193 at 234 Gummow J addressed the question whether the defendant was a promoter by asking whether “the facts showed the establishment of such relations between the alleged promoter and the birth, formation and flotation of the business enterprise in question as to render it contrary to good faith that the alleged promoter should retain [3.235]

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from the promotion a secret profit or … that he should refuse restitution for loss inflicted by him by preferring his interest to his duty”. 2.

In Tracy v Mandalay Pty Ltd why was Willard held to be a promoter? Would he have been a promoter if (a) he had had no shareholding in the plaintiff company or (b) if his shareholding had been given in lieu of salary? Do you agree with the treatment of Griffith and Miss Withy? Do you think that the court would have imposed upon them the joint liability of a promoter if it was making an order for damages against the promoters and not merely rescinding the contract of sale?

3.

Consider the position of a stockbroker or investment banker who becomes involved in finding persons willing to contribute capital to a large new venture. Would such persons be treated as promoters? Would it be relevant that they were remunerated by a share of the funds raised or with a “success fee”? What is the position of the solicitor who procures the incorporation of the company, prepares the prospectus and other flotation documents and advises the promoters? See Re Great Wheal Polgooth Co Ltd (1883) 53 LJ Ch 42 and Emma Silver Mining Co Ltd v Lewis (1879) LR 4 CPD 396 at 408. Is a person who sells property to a newly formed company necessarily a promoter of the company? See Re Coal Economising Gas Co (Gover’s Case) (1875) 1 Ch D 182. Should it make any difference that the vendor acquired the property with the intention of resale to the company? See Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218.

4.

“Through all corporate history the promoter has desired to make a profit. He has considered that he took the chance of the business in its infancy, when there was no certainty that it would prove successful. He has devoted time and money and risked his reputation for business judgment and, out of a collection of disorganised ideas and economic material, has produced a going concern. Naturally he thinks he ought to be well recompensed, but he cannot even recover his expenses from the company. It is no surprise, therefore, that usually he has had to find his compensation in some hidden manner. The ‘logic’ of the law forces him to buy in his own right and then eventually to sell to the company. Having undertaken the entire risk, he might well think that along with it should go the power to make profit from the transaction”: J H Gross, Company Promoters (Israel Institute of Business Research, Tel-Aviv University, 1972), p 15. See further on the legal conception of the company promoter in J H Gross (1970) 86 LQR 493 and Company Promoters (1972), Chs 1-4.

The disclosure standard [3.240] In Tracy v Mandalay Pty Ltd (see [3.230]) the High Court referred to the duty upon

promoters selling their property to the company to make disclosure of their interest to an independent board of directors. Most cases on promoters – the case law is dominated by decisions of the last quarter of the 19th century – are concerned with sales of the promoter’s property to the company. Where the promoter derived a profit from the sale, not fully disclosed in the prospectus, the courts look sceptically at the promoter’s defence of disclosure to the board whom he has installed, particularly if he is one of their number. Thus, in Gluckstein v Barnes, where the House of Lords rejected such a plea, Lord Macnaghten said: “Disclosure” is not the most appropriate word to use when a person who plays many parts announces to himself in one character what he has done and is doing in another. To talk of

[3.240]

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disclosure to the thing called the company, when as yet there were no shareholders, is a mere farce. To the intended shareholders there was no disclosure at all. On them was practised an elaborate system of deception. 105

Lord Halsbury LC was even less tolerant: I decline to discuss the question of disclosure to the company. It is too absurd to suggest that a disclosure to the parties to this transaction is a disclosure to the company of which these directors were the proper guardians and trustees. They were there by the terms of the agreement to do the work of the syndicate, that is to say, to cheat the shareholders; and this, forsooth, is to be treated as a disclosure to the company, when they were really there to hoodwink the shareholders, and so far from protecting them were to obtain from them the money, the produce of their nefarious plans. 106

In 1897 the House of Lords in Salomon v Salomon & Co Ltd upheld a promoter’s sale to his company which was constituted without an independent board. 107 All members of the company had acquiesced in the sale and no share offering to others was in contemplation. Two years later, in Lagunas Nitrate Co v Lagunas Syndicate, Lindley MR said: After Salomon’s case I think it impossible to hold that it is the duty of the promoters of a company to provide it with an independent board of directors, if the real truth is disclosed to those who are induced by the promoters to join the company. 108

Thus, where the promoters held all the equity, and no further share issue was proposed, self-disclosure was held to be sufficient compliance, notwithstanding the promoter’s failure to disclose their profit to prospective debenture holders. 109 [3.242]

1.

2.

Notes&Questions

Simply stated, to whom must the promoter make disclosure of her interest? If the promoter becomes a director of the company, how will she discharge the burden of disclosure? If a public offering is in contemplation but not immediately, may the promoter acquit herself in the meantime of the burden of disclosure? By parity of reasoning with the principles applicable to disclosure of directors’ interests, it will not be sufficient for a promoter merely to disclose that he is deriving a benefit. Rather, his disclosure should make the board or shareholders “fully informed as to the real state of things”: Imperial Mercantile Credit Assoc v Coleman (1873) LR 6 HL 189 at 201 per Lord Chelmsford. The onus of proving the adequacy of disclosure lies upon the promoter: Re Darby; Ex parte Brougham [1911] 1 KB 95 at 103.

Remedies of the company [3.245] The company’s primary remedy is rescission of the promoter’s contract. The remedy

is dependent upon the possibility of restitutio in integrum 110 and will be lost if third party rights have intervened. 111 Of course, the company constituted with an independent board must not have purported to ratify the contract. In Tracy v Mandalay Pty Ltd (see [3.230]), 105 106

[1900] AC 240 at 249. [1900] AC 240 at 247.

107 108 109 110 111

[1897] AC 22. [1899] 2 Ch 392 at 426. The judge did not, however, apply the dictum as the court found that the promoters there intended “from the first to raise a large capital by appealing to the public”: at 428. Attorney-General (Can) v Standard Trust Co of New York [1911] AC 498. Lagunas Nitrate Co v Lagunas Syndicate [1899] 2 Ch 392. As in Re Leeds and Hanley Theatres of Variety Ltd [1902] 2 Ch 809.

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where the subject of the contract was land, rescission was readily granted. However, in other contracts the subject matter may not be so durable. If rescission is not available (eg, because of the impossibility of restitutio), the company may have other remedies. Recall the alternative orders sought in Tracy v Mandalay Pty Ltd. Their doctrinal bases are considered below.

Jacobus Marler Estates Ltd v Marler [3.250] Jacobus Marler Estates Ltd v Marler (1913) 85 LJPC 167n Privy Council LORD PARKER delivered the judgment of THE PRIVY COUNCIL: [167] It is no doubt well settled that in equity an agent cannot, without the consent of his principal, given with full knowledge of the material facts and under circumstances which rebut any presumption of undue influence, retain any profit acquired by him in transactions within the scope of the agency. The principal can always in such a case treat the profit as acquired on his own behalf, and insist on its being accounted for to him. For the same reason an agent, whose duty it is to acquire property on behalf of his principal, cannot, without the like consent, acquire it on his own behalf and subsequently resell it to his principal at an enhanced price. In such a case the principal can treat the property as originally acquired for him and the resale as nugatory, and may, therefore, recover from the agent the money paid on such resale less the original price and the expenses incurred by the agent in acquiring the property. This, however, only applies where the relationship of principal and agent existed at the time when the agent acquired the property. If it did not then exist, the property acquired was, at the outset, the agent’s own property for all purposes, and the subsequent constitution of the relationship of principal and agent cannot deprive him of property already his own. … There is another principle of equity which ought to be distinguished from, but is sometimes confused with, that to which I have already referred. Equity treats all transactions between an agent and his principal, in matters in which it is the agent’s duty to advise his principal, as voidable unless and until the principal, with full knowledge of the material facts and under circumstances which rebut any presumption of undue influence, ratify and confirm the same. In such cases the interest of the agent is in conflict with his duty, and there can be no real bargain at all. It must be remembered, however, that if the transaction be one of sale by the agent to the principal, the latter must, in order to avoid it, be able to restore the agent to his original position. If he has resold the property, or cannot restore it to the agent in its original condition, the right to avoid the transaction will, as a general rule, have been lost. But, even so, it does not follow that the principal is without remedy. He may be able to recover damages from the agent for negligence in the performance of his duties. Thus, if the agent’s duty is to advise the principal as to the purchases of stocks or shares having a market value, and he sells to his principal stocks or shares of his own at prices in excess of their market value, he may be liable in damages for the excess of the prices received over the market value. It is a different matter if the property sold by the agent to the principal is a specific property having no market value, for the court will not fix a new price between the parties. In such a case the measure of damages will be the principal’s loss in the whole transaction. If he has suffered no such loss there can be no damages. The equities above referred to as governing the relationship between principal and agent apply also to other fiduciary relationships, and in particular to that which exists between a company promoter and the company which results from the promotion, and its shareholders. The facts of this particular case are comparatively simple. Sidney Marler and Jack Jacobus acquired the leasehold property in question on 14 March 1904 as a joint adventure. On 13 June 1905, after many disputes, they came to an agreement as to the terms on which they would endeavour to dispose of it. These terms involved the promotion of a company, [168] and the sale of the property to such company at an improved rental, and subject to an obligation to erect certain buildings and to subdemise part of the property, with the buildings thereon, to Jack Jacobus, at a rent of £1,500 per annum. Sidney Marler, who was an estate agent, having already done a considerable amount of work on behalf of the joint adventurers in trying to dispose of the property, it was further provided that he, or his firm, should receive from Jack Jacobus, as remuneration for such work, a commission of £1,000. It is reasonably clear, and indeed was in effect admitted by counsel for the appellant company, that neither on 14 March 1904, nor on 13 June 1905, was either Sidney Marler or Jack Jacobus in any [3.250]

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Jacobus Marler Estates Ltd v Marler cont. fiduciary relationship toward the appellant company, or any one whom the appellant company represents. It follows, therefore, that the appellant company can have no equity to treat the property itself or the £1,000 payable to Sidney Marler, or his firm, as property or profit acquired on its own behalf. It appears, however, that, after 13 June 1905, and pursuant to the terms agreed on that day, Messrs Jacobus and Marler entered into the agreement of 16 June 1905 for the sale of the property to one Phillips, as trustee for the intended company, and that the appellant company was thereafter promoted and registered; Sidney Marler, Seymour Hicks (who was interested in the property through Sidney Marler), and Alfred Beyfus being the first directors. On 29 June 1905, at a directors’ meeting, it was resolved that the agreement with Phillips should be adopted by the company, and that an agreement adopting the same and indorsed thereon should be sealed with the company’s seal. Obviously this resolution was not passed by any independent board, and was not binding on the company, and the agreement sealed pursuant thereto was voidable at the option of the appellant company. But the appellant company does not desire to avoid this agreement, even if it be in a position to restore the property to the vendors. Its remedy, if any, must therefore be in damages against Sidney Marler or Seymour Hicks for negligently allowing it to purchase the property on the terms specified. Such damages cannot be measured by the £1,000 commission payable to Sidney Marler or his firm. They can only be measured by the loss resulting to the appellant company from the whole transaction. It is not even alleged, much less proved, that there has been any such resulting loss. The allegation is that, by reason of the negligence of Sidney Marler, the terms on which the appellant company acquired the property were not so beneficial as Sidney Marler might with reasonable care have obtained for the appellant company. In other words, the appellant company is asking the court to fix a proper price between vendor and purchaser, and estimate the damage with reference to such price. This the court cannot do. I concur, therefore, in the opinion that the appeal fails.

[3.255]

Notes&Questions

1.

X buys property with the intention of transferring it to a company she is promoting. When the company is formed, she has a change of mind. May the company call for the property? On what doctrinal basis? Would it make any difference if X had originally bought the property for, or as trustee for, the unformed company? Alternatively, would X be liable if she had bought the property with the intention of selling it to best advantage (including the company among potential purchasers)? See Tracy v Mandalay Pty Ltd; Jacobus Marler Estates Ltd v Marler; Peninsular and Oriental Steam Navigation Co Ltd v Johnson (1938) 60 CLR 189 at 245-249 (see [7.385]).

2.

A promoter sells her own property to her company without making proper disclosure of her interest. Will she be liable to the company in damages if (a) the company elects not to exercise its option of rescission or (b) the company may not rescind because restitutio is no longer possible, but the company nonetheless seeks recovery of the promoter’s profit on the sale. What would be the measure of such damages? See Tracy v Mandalay Pty Ltd; Jacobus Marler Estates Ltd v Marler and Re Leeds and Hanley Theatres of Varieties Ltd [1902] 2 Ch 809 at 825-827 per Vaughan Williams LJ. For the like rule concerning directors, see Peninsular and Oriental Steam Navigation Co v Johnson (see [7.385]). In (a), might the situation arise where the promoter is amenable to account for the secret profit but not for damages? If so, is such a distinction between the remedies sound as a matter of law and of policy?

3.

The fourth order sought in Tracy v Mandalay Pty Ltd was for damages for misfeasance. The remedy is now expressed in s 598 and applies only to companies in extremis. The remedy is more frequently invoked against directors.

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4.

CHAPTER 3

The remedies outlined above lie at the suit of the company. Individual shareholders and creditors may also suffer loss at promoters’ hands. However, the fiduciary doctrines enjoin the promoters against abuse of the corporate person but not of its members or outsiders. (In exceptional cases the courts may, however, be expected in the future to impose fiduciary obligations in favour of individual members by analogy with a like exception drawn with respect to directors: see [7.540].) However, shareholders and creditors may have actions at common law for deceit, misrepresentation or negligence and investors may sue for false statements or material omissions in a prospectus upon which they have relied.

[3.255]

159

CHAPTER 4 Some Consequences of Corporate Personality [4.10]

[4.20]

[4.45]

[4.75]

[4.130]

LIMITED LIABILITY ......................................................................................................................... 162 [4.10]

The nexus between corporate personality and limited liability ...................................... 162

[4.15]

The merits and costs of limited liability ......................................................................... 162

CORPORATE PERSONALITY ........................................................................................................... 164 [4.20]

The special character of corporate personality .............................................................. 164

[4.25]

The separate personality of the corporation ................................................................. 166

PIERCING THE VEIL OF INCORPORATION ...................................................................................... 173 [4.45]

Introduction ................................................................................................................. 173

[4.50]

Fraud or improper conduct .......................................................................................... 175

[4.60]

Agency ........................................................................................................................ 177

[4.65]

Evasion of an existing obligation .................................................................................. 180

[4.70]

A residual category for the interests of justice? ............................................................. 185

CORPORATE GROUPS ................................................................................................................... 186 [4.75]

Legal recognition of corporate groups ......................................................................... 186

[4.105]

Corporate personality within corporate groups ............................................................ 194

CORPORATE CRIMINAL LIABILITY .................................................................................................. 206 [4.130]

What is the justification for imposing criminal liability upon corporations? ................... 206

[4.135]

Vicarious corporate criminal liability ............................................................................. 207

[4.145]

Primary corporate criminal liability ............................................................................... 209

[4.180]

Wider statutory bases of attributed liability ................................................................... 221

[4.182]

Strict or absolute corporate criminal liability ................................................................. 222

[4.185]

Personal liability of corporate officers ........................................................................... 224

[4.05] We have seen several references to the artificial personality with which our legal system

invests corporations. This chapter explores the special character of that personality and some consequences that flow from its recognition. One consequence lies in the separation between the personality of the group and those of its members. However, rigid formalistic insistence upon the distinction between the group and individual personalities may be at the expense of other policies and values cherished by the legal system. Hence, in particular situations the courts and legislature pierce the corporate veil, ignoring the corporate entity and looking instead to those who control it or its affairs to vindicate those policies or values. One important instance in which courts have to confront the consequences of formalism is in connection with the affairs of a corporate group (companies under common ownership or control). The concluding section of the chapter deals with a troublesome but important application of notions of corporate personality – the ascription to the corporation (as distinct from its officers or members) of criminal responsibility for activities undertaken by or on behalf of the organisation. Corporate personality is a human construct, created to solve human problems. As Holdsworth noted (at [2.20]), it was the medieval canonists who devised the concept of the persona ficta to provide legal recognition to groups of persons. The idea of the corporation preceded its application to business associations by several centuries: see [2.20], [2.30]. When it was applied, the business corporation was invested with an entity status, a personhood, distinct from that of its members. A legal person was recognised distinct from the collectivity [4.05]

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of members of the association. This sets the registered company and other corporations apart from unincorporated forms of business association such as the partnership. Arguably also, it has the consequence of distancing shareholders from the enterprise and weakening their responsibility for its affairs. The conception of “person” is a legal construction signifying what law makes it signify. The content of the notion of corporate personality and the uses to which it is put reflect legal tradition and, consciously or otherwise, an underlying conception of the corporation. The 1998 changes to the Act that permit incorporation by a single individual without any constitutional document clearly have significance for older conceptions based upon the corporation as association. Conceptions of the corporation simply as a fund of money to be applied for the purpose of the enterprise produce different requirements of personhood and entity recognition. They serve more instrumental goals and perhaps produce different notions of obligations of citizenship to which the entity is subject.

LIMITED LIABILITY The nexus between corporate personality and limited liability [4.10] Although corporate personality and limited liability are quite distinct conceptually and

in the timing of their application to the business corporation (see [2.55]), the two notions are closely linked functionally. In modern business, corporate personality serves the function of marking out an asset pool against which creditors of the enterprise have prior claims. Entity status partitions this asset pool from the personal assets of stakeholders. Piercing the veil typically involves breaking the partition to expose the personal assets of shareholders and directors to the claims of the firm’s creditors, although in some cases the veil is also pierced to relieve the company of the legal consequences of its separate entity status. Absent such special circumstances, shareholders and directors are not liable for the debts of the corporation. The recognition of corporate personality is therefore closely tied to limited liability doctrines; indeed, recognition of the corporation as an entity whose rights and duties are distinct from those of its members and directors is a precondition to the limited liability that members of most types of registered company enjoy. Since the liability of shareholders to contribute to this asset pool is limited to the amounts that are unpaid upon the shares that they hold – and no minimum level of capital subscription is prescribed – the risk of business failure may well fall upon creditors of the company. Hence the importance of financial reporting and the duties upon directors to pay proper regard to creditor interests and to prevent the company incurring debts while insolvent: see [7.135] et seq. The merits and costs of limited liability [4.15] The arguments for limited liability apply primarily to the publicly held company rather

than the private (or closely held) company. Several arguments may be advanced in favour of limited liability. 1 • Limited liability encourages investment by those who have no interest in or capacity for management participation; a system of unlimited joint and several liability for corporate obligations would be a powerful disincentive to investment by passive investors although that disincentive would be reduced under a regime of pro rata liability only. 1

See further on the cost and benefits of limited liability F H Easterbrook & D R Fischel, The Economic Structure of Corporate Law (1991), Ch 2; B R Cheffins, Company Law: Theory, Structure and Operation (1997), pp 496-508; P J Halpern, M J Trebilcock & S Turnbull (1980) 30 U Tor LJ 117; O E Williamson (1981) 19 J Econ Lit 1537; F H Easterbrook & D R Fischel (1985) 52 U Chi L Rev 89 and (1986) 38 Stan L Rev 271.

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• Limited liability relieves shareholders from the burden of monitoring fellow shareholders’ capacity to contribute proportionately to company failure under a regime of joint and several unlimited liability. • Limited liability thereby encourages free liquidity of share capital which not only reduces the cost of capital to the company but also insinuates an accountability mechanism for management through the threat that poor performance reflected in stock price decline will stimulate the acquisition of control by a party which believes it can achieve superior returns through management replacement. • The market pricing mechanism for shares is effective only if that price reflects the worth of the share itself and not in any degree its holder’s financial capacity to contribute to the company’s deficiency. By impersonalising the share, it may trade at a single price, at least on liquid markets. • Limited liability encourages entrepreneurial risk taking by companies since they may safely invest in projects with prospects of positive returns but also those with significant risk exposure. If projects with higher risk profiles are conducted through a separate entity, that further insulates members from losses. The force of these arguments is also affected by the structure of share ownership, particularly the growth of sophisticated investment intermediaries and the emergence of corporate group structures with capacity for internal monitoring of the risk of business failure of member companies: see [4.105]. The case for limited liability is weaker in these contexts. Limited liability is not without its critics; some argue that its benefits to shareholders are matched by risks to creditors not all of whom have greater monitoring and risk-bearing capacity. 2 Thus, tort claimants against a company may be more vulnerable than contract creditors who can bargain for desired protections and a rate of return commensurate with the risks they are assuming. Indeed, limited liability may create a moral hazard problem in the tort area with the opportunity it offers to externalise the risks of enterprise. 3 The logic of separate personality and limited liability doctrines favours the externalisation of the social costs of corporate behaviour, shifting the risk of enterprise operations away from shareholders and onto stakeholders or wider society, whether those with firm-specific investments such as employees, suppliers, local communities or the wider community. This arises since not all of the costs of corporate operations will be imposed by legislation upon the corporation: there will inevitably be a time lag in legislation and gaps in its coverage, and the effective barriers to private and public enforcement create opportunities to disregard obligations. This is particularly so in relation to transnational enterprise in host countries with weak governance and poor institutions for legal enforcement, in a climate of intense competition for investment capital: see [2.245]. 4 There are also legal limits upon the voluntary assumption by corporations of obligations that do not advance shareholder wealth: see [7.240]. Legal structure thus favours the externalisation of enterprise costs, reflected in the calculus of self-interest: limited liability encourages the corporation to locate risky activities 2

R E Meiners, J S Mofsky & R D Tollison (1979) 4 Del J Corp L 351.

3

H Hansmann & R Kraakman (1991) 103 Yale LJ 1879 (proposing the rule of pro rata unlimited shareholder liability for corporate torts to achieve internalisation of risk of harmful effects); D W Leebron (1992) 91 Colum L Rev 1565 at 1601-1602 (shareholders in a publicly held company may be better risk bearers than tort victims); N A Mendelson (2002) 102 Colum L Rev 1203 (proposing unlimited liability for controlling shareholders for corporate torts because of their special capacity to curb managerial risk externalisation); see, however, J Grundfest (1992) 102 Yale LJ 387 (avoidance mechanisms available in capital markets around a pro rata liability regime). See P Redmond (2016) 31 Aust Jnl of Corp Law 5 at 31-36 (discussing recent developments and reform options re parent company liability for off-shore human rights breaches of subsidiary companies and suppliers in its global value chain).

4

[4.15]

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into separate corporate structures and thereby insulate group assets from the risk of failure. The narrower moral compass of the corporation also favours externalisation of enterprise costs. For most individuals, the press of self-interest is moderated in varying degrees by the sense of personal responsibility for actions; in corporations, individual moral restraint is often blurred by the demands of the corporate role and lost in the anonymity of group decision and action.

CORPORATE PERSONALITY The special character of corporate personality [4.20] Recognition of the distinct personality of the company is a pre-condition to a legal

structure for the limited liability of members. It does not, however, determine the other privileges and treatment of the corporate entity in the wider dimensions of the legal attribution of personhood. We have seen that the corporation has a legal personality of a somewhat different character from that of natural persons. While a company registered under the Act is invested with the legal capacity and powers of an individual (s 124), its incorporeal nature ensures that it enjoys perpetual succession in the sense that there is no temporal limit upon its existence, which existence is unaffected by changes to its membership. Formerly, companies legislation expressly declared that registered companies were capable of suing and being sued and had the power to acquire, hold and dispose of property. The deletion of these express powers with the recasting of s 124 does not portend any change since these powers are comprehended within those possessed by a corporation by virtue of its equality of capacity with an individual. However, differences flowing from its artificial character remain: [A corporation] has neither body, parts nor passions. It cannot wear weapons nor serve in wars. It can be neither loyal nor disloyal. It cannot compass treason. It can be neither friend nor enemy. Apart from its corporators, it can have neither thoughts, wishes or intentions, for it has no other mind than the minds of the corporators. 5

Or, in words attributed to Lord Chancellor Thurlow in the 18th century: “Did you ever expect a corporation to have a conscience, when it has no soul to be damned, and no body to be kicked?” 6 We shall shortly see that, despite its soulless condition, a corporation may commit both crime and tort. Injury to the corporate reputation may be assuaged by an action for defamation, 7 although the corporation may recover only for injury to its pocket and not its feelings. 8 While the corporation may be in contempt of court, 9 it is incapable of personal

5 6

8

Continental Tyre and Rubber Co (GB) Ltd v Daimler Co Ltd [1915] 1 KB 893 at 916 per Buckley LJ. Accordingly, the company, having “no duties of piety and true religion”, is outside the category of persons enjoined by the Sunday Observance Act 1677 (UK) from trading on the Sabbath: Rolloswin Investments Ltd v Chromolit Portugal Cutelaris E Produtos Metalicos SARL [1970] 1 WLR 912; cf Houghton-Le Touzel v Mecca Ltd [1950] 2 KB 612. New South Wales Aboriginal Land Council v Jones (1998) 43NSWLR 300; South Hetton Coal Co Ltd v North Eastern News Assoc Ltd [1894] 1 QB 133; Barnes & Co Ltd v Sharpe (1910) 11 CLR 462. Non-profit corporations, no less than trading corporations, may sue for defamation: see, eg, Bognor Regis UDC v Campion [1972] 2 QB 169. See F Patfield (1988) 18 UWALR 203. Lewis v Daily Telegraph Ltd [1964] AC 234 at 262; Mirror Newspapers Ltd v Harrison (1982) 149 CLR 293.

9

R v J G Hammond & Co [1914] 2 KB 866.

164

[4.20]

7

Some Consequences of Corporate Personality

CHAPTER 4

appearance there and must appear through a representative. 10 In Australia the High Court has held by a narrow majority that a corporation is not entitled to invoke the common law privilege against self-incrimination in answer to a demand for the production of documents under statutory power. 11 In England 12 and Canada 13 the privilege has been extended by judicial decision to corporations, although in the United States it is confined to natural persons. 14 The general interpretation statutes of the Commonwealth and the States declare that a reference in legislation to a “person” includes a reference to a body corporate, subject only to a contrary intention appearing in a particular statute. 15 The High Court has held that the reference to “residents” in s 75(iv) of the Commonwealth Constitution (for purposes of conferring jurisdiction in disputes between residents of different States) does not embrace corporations. 16 Higgins J thought that the term connoted, in its ordinary meaning which was not displaced by the instant context, “a person of flesh and blood or, at the very least, an animal”. 17 Similarly, it seems probable that corporations will be denied the status of “a subject of the Queen” for the purposes of s 117 of the Commonwealth Constitution since they are incapable of personal allegiance. 18 Protective provisions in a money-lending statute have been interpreted as confined to the “protection of borrowers who are natural persons and subject to the possibility of being overreached in their indigence”. 19 On the other hand, in the United States, the First Amendment protection of free speech has been extended to corporations with the consequence that a law that banned corporations from sponsoring political advertisements in the period before elections infringed its prohibition. 20 Further, it is

10

11

Tanamerah Estates Pty Ltd v Tibra Capital Pty Ltd (2015) 110 ACSR 29; Tritonia Ltd v Equity and Law Life Assurance Soc [1943] AC 584; Bay Marine Pty Ltd v Clayton Country Properties Pty Ltd (No 2) (1987) 5 ACLC 38; Re G J Mannix Ltd [1984] 1 NZLR 309; but see Peters v Australian Institute of Food Science and Technology (1986) 10 ACLR 547; Simto Resources Ltd v Normandy Capital Ltd (1993) 10 ACSR 776; cf S Simmonds (1986) 7 Co Law 173 and R I Barrett (1987) 61 ALJ 421. Environmental Protection Authority v Caltex Refining Co Pty Ltd (1993) 178 CLR 477 per Mason CJ, Brennan, Toohey and McHugh JJ (Deane, Dawson and Gaudron JJ dissenting). Brennan J held that a corporation is, however, entitled to claim the privilege against self-exposure to a civil penalty, whether civil or criminal, unless the privilege is displaced by the clear terms of the statutory power; indeed, the Corporations Act itself excludes both forms of privilege from applying to criminal proceedings under its provisions: s 1316A. A company cannot be a witness in legal proceedings so that an officer of a corporation who is called as a witness speaks in her or his own right and is therefore entitled to the privilege against self-incrimination: Brennan J at 512-513; see V Waye (1997) 8 Aust Jnl of Corp Law 25.

12

Triplex Safety Glass Co Ltd v Lancegaye Safety Glass (1934) Ltd [1939] 2 KB 395; Rio Tinto Zinc Corp v Westinghouse Electric Corp [1978] AC 547.

13 14

See, eg, Webster v Solloway Miles & Co [1931] 1 DLR 831 at 833, 834. See Campbell Printing Corp v Reid 392 US 286 (1968). See I Freckleton (1985) 59 ALJ 204 at 207.

15 16

See Acts Interpretation Act 1901 (Cth), s 22 and, eg, Interpretation Act 1897 (NSW), s 21(c). Australasian Temperance and General Life Assurance Society Ltd v Howe (1922) 31 CLR 290.

17

Australasian Temperance and General Life Assurance Society Ltd v Howe (1922) 31 CLR 290 at 327; cf at 294-300 per Knox CJ and Gavan Duffy J. Taxation legislation commonly ascribes a residence to companies, usually identified with the place of their central management and control.

18

See C L Pannam (1967) 6 MULR 105 at 140.

19 20

Motel Marine Pty Ltd v IAC (Finance) Pty Ltd (1964) 110 CLR 9 at 12 per Dixon CJ. Citizens United v Federal Election Commission 558 US 310 (2010) (the constitutional rights that citizens hold are not lost when they gather in corporate form: “[i]f the First Amendment has any force it prohibits Congress from fining or jailing citizens, or associations of citizens, for simply engaging in political speech”: Kennedy J, delivering the opinion of the Court); First National Bank of Boston v Bellotti 435 US 765 at 777 (1978) (political speech is “indispensable to decision-making in a democracy, and this is no less true because [4.20]

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well established that a company may be an enemy alien, its status being determined by the nationality of those persons in control of its affairs. 21 The separate personality of the corporation [4.25] The separate personality doctrine and its consequences rest fundamentally upon

judicial decision. The starting point, although it is not the first decision to reveal the implications of the doctrine, is perhaps the most famous company law decision, that in Salomon’s case. In many respects it marks the beginning of modern company law. It has been described as an “unyielding rock” 22 on which company law is constructed although, as we shall shortly see, there is much controversy about whether and, if so, when that rock should yield: [4.45] et seq.

Salomon v Salomon & Co Ltd [4.30] Salomon v Salomon & Co Ltd [1897] AC 22 House of Lords [For many years Aron Salomon had traded on his own as a leather merchant and wholesale boot manufacturer. In 1892 he arranged for the incorporation under the Companies Act 1862 (UK) of a company called “Aron Salomon and Company Limited”. The Act required seven subscribers and Salomon, his wife, daughter and four sons each subscribed one share to satisfy the requirement. The company entered into an agreement to purchase Salomon’s business for £39,000 to be satisfied by the issue to Salomon of 20,000 fully paid £1 shares and debentures (that is, in this context a floating charge) with a face value of £10,000. The balance of the purchase price (viz, £9,000) remained as an unsecured debt. In the result, Salomon held 20,001 shares in the company and his family the remaining six shares. It was never intended that outsiders would take a financial stake in the company. Hard times quickly followed. A depression and a succession of strikes in the boot trade weakened the company. In the following year Salomon borrowed £5,000 from Broderip which he immediately advanced to the company. To obtain the advance from Broderip, Salomon had his debentures cancelled and reissued to Broderip, but upon terms that he should retain the residual beneficial interest in the debentures after Broderip’s debt was discharged. The injection of these funds did little to arrest the company’s misfortunes. When Salomon’s interest payments fell into arrears, Broderip enforced his security and the company’s liquidation ensued. After execution of Broderip’s security there remained a balance of indebtedness of £1,055 secured by the debentures. Salomon claimed his reversionary entitlement to this secured indebtedness which would have exhausted the funds in the liquidator’s hands to the total exclusion of the claims of the unsecured creditors. The liquidator resisted Salomon, initially by disputing the validity of the debentures, inter alia, on the ground of fraud. At the trial before Vaughan Williams J, the liquidator’s claim was amended, at the judge’s suggestion, to one for a declaration that the liquidator was entitled to be indemnified by Salomon for the unsecured debts of the company and for a lien on all sums payable by the company on the debentures. It was averred that the company was the “mere nominee and agent” for Salomon. Vaughan Williams J made the orders newly sought. The Court of Appeal dismissed the appeal. Lindley LJ thought that the certificate could not be impeached and that the company was created even if for an illegitimate purpose. He said that it was difficult to say that the company did not carry on business as principal and was merely an agent. He preferred to “liken the company to a trustee for Salomon”. “It is manifest here,” he said “that the other members of the company have practically no interest in it and their names have merely been used by

21

the speech comes from a corporation rather than an individual”); in Australia the implied right to freedom of political speech has been successfully invoked by corporations: Australian Capital Television Pty Ltd v Commonwealth (1992) 177 CLR 106; Theophanous v Herald & Weekly Times Ltd (1994) 182 CLR 104. See Daimler Co Ltd v Continental Tyre and Rubber Co Ltd [1916] 2 AC 307.

22

Lord Templeman (1990) 11 Company Lawyer 10.

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Salomon v Salomon & Co Ltd cont. Mr Aron Salomon to enable him to form a company, and to use its name in order to screen himself from liability”: [1895] 2 Ch 323 at 338. He considered that Salomon was liable to indemnify the company and that the creditors could only reach him through the company. On the use of the Act for this type of “one man” company, Lindley LJ said (at 339): If the legislature thinks it right to extend the principle of limited liability to sole traders it will no doubt do so, with such safeguards, if any, as it may think necessary. But until the law is changed such attempts as these ought to be defeated whenever they are brought to light. They do infinite mischief; they bring into disrepute one of the most useful statutes of modern times, by perverting its legitimate use, and by making it an instrument for cheating honest creditors. Lopes and Kay LJJ expressed similar sentiments. Thus, Lopes LJ said (at 340-341): It would be lamentable if a scheme like this could not be defeated. If we were to permit it to succeed, we should be authorising a perversion of the Joint Stock Companies Acts. We should be giving vitality to that which is a myth and a fiction. The transaction is a device to apply the machinery of the Joint Stock Companies Act 1856 (UK) to a state of things never contemplated by that Act – an ingenious device to obtain the protection of that Act in a way and for objects not authorised by that Act, and in my judgment in a way inconsistent with and opposed to its policy and provisions. It never was intended that the company to be constituted should consist of one substantial person and six mere dummies, the nominees of that person, without any real interest in the company. The Act contemplated the incorporation of seven independent bona fide members, who had a mind and a will of their own, and were not the mere puppets of an individual who, adopting the machinery of the Act, carried on his old business in the same way as before, when he was a sole trader. To legalise such a transaction would be a scandal. Salomon appealed to the House of Lords.] LORD HALSBURY LC: [29] My Lords, the important question in this case, I am not certain it is not the only question, is whether the respondent company was a company at all – whether in truth that artificial creation of the legislature had been validly constituted in this instance; and in order to determine that question it is necessary to look at what the statute itself has determined in that respect. I have no right to add to the requirements of the statute, nor to take from the requirements thus enacted. The sole guide must be the statute itself. Now, that there were seven actual living persons who held shares in the company has not been doubted. As to the proportionate amounts held by each I will deal presently; but it is important to observe that this first condition of the statute is satisfied, and it follows as a consequence that it would not [30] be competent to any one – and certainly not to these persons themselves – to deny that they were shareholders. I must pause here to point out that the statute enacts nothing as to the extent or degree of interest which may be held by each of the seven, or as to the proportion of interest or influence possessed by one or the majority of the shareholders over the others. One share is enough. Still less is it possible to contend that the motive of becoming shareholders or of making them shareholders is a field of inquiry which the statute itself recognises as legitimate. If they are shareholders, they are shareholders for all purposes; and even if the statute was silent as to the recognition of trusts, I should be prepared to hold that if six of them were the cestuis que trust of the seventh, whatever might be their rights inter se, the statute would have made them shareholders to all intents and purposes with their respective rights and liabilities, and, dealing with them in their relation to the company, the only relations which I believe the law would sanction would be that they were corporators of the corporate body. I am simply here dealing with the provisions of the statute, and it seems to me to be essential to the artificial creation that the law should recognise only that artificial existence – quite apart from the motives or conduct of individual corporators. … [33] My Lords, the learned judges appear to me not to have been absolutely certain in their own minds whether to treat the company as a real thing or not. If it was a real thing; if it had a legal existence, and [4.30]

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Salomon v Salomon & Co Ltd cont. if consequently the law attributed to it certain rights and liabilities in its constitution as a company, it appears to me to follow as a consequence that it is impossible to deny the validity of the transactions into which it has entered. Vaughan Williams J appears to me to have disposed of the argument that the company (which for this purpose he assumed to be a legal entity) was defrauded into the purchase of Aron Salomon’s business because, assuming that the price paid for the business was an exorbitant one, as to which I am myself not satisfied, but assuming that it was, the learned judge most cogently observes that when all the shareholders are perfectly cognisant of the conditions under which the company is formed and the conditions of the purchase, it is impossible to contend that the company is being defrauded. [The Lord Chancellor referred to Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218 relating to the fiduciary duties of promoters towards the company that they form.] But if every member of the company – every shareholder – knows exactly what is the true state of the facts (which for this purpose must be assumed to be the case here), Vaughan Williams J’s conclusion seems to me to be inevitable that no case of fraud upon the company could here be established. If there was no fraud and no agency, and if the company was a real one and not a fiction or a myth, every one of the grounds upon which it is sought to support the judgment is disposed of. LORD MACNAGHTEN: [47] My Lords, I cannot help thinking that the appellant, Aron Salomon, has been dealt with somewhat hardly in this case. Mr Salomon, who is now suing as a pauper, was a wealthy man in July 1892. He was a boot and shoe manufacturer trading on his own sole account under the firm of “A Salomon & Co,” in High Street, Whitechapel, where he had extensive warehouses and a large establishment. He had been in the trade over 30 years. He had lived in the same neighbourhood all along, and for many years past he had occupied the same premises. So far things had gone very well with him. Beginning with little or no capital, he had gradually built up a thriving business, and he was undoubtedly in good credit and repute. … [49] The company had a brief career: it fell upon evil days. Shortly after it was started there seems to have come a period of great depression in the boot and shoe trade. There were strikes of workmen too; and in view of that danger contracts with public bodies, which were the principal source of Mr Salomon’s profit, were split up and divided between different firms. The attempts made to push the business on behalf of the new company crammed its warehouses with unsaleable stock. Mr Salomon seems to have done what he could: both he and his wife lent the company money; and then he got his debentures cancelled and reissued to a Mr Broderip, who advanced him £5000, which he immediately handed over to the company on loan. … [50] The order of the learned judge appears to me to be founded on a misconception of the scope and effect of the Companies Act 1862. In order to form a company limited by shares, the Act requires that a memorandum of association should be signed by seven persons, who are each to take one share at least. If those conditions are complied with, what can it matter whether the signatories are relations or strangers? There is nothing in the Act requiring that the subscribers to the memorandum should be independent or unconnected, or [51] that they or any one of them should take a substantial interest in the undertaking, or that they should have a mind and will of their own, as one of the learned Lords Justices seems to think, or that there should be anything like a balance of power in the constitution of the company. In almost every company that is formed the statutory number is eked out by clerks or friends, who sign their names at the request of the promoter or promoters without intending to take any further part or interest in the matter. When the memorandum is duly signed and registered, though there be only seven shares taken, the subscribers are a body corporate “capable forthwith,” to use the words of the enactment, “of exercising all the functions of an incorporated company”. Those are strong words. The company attains maturity on its birth. There is no period of minority – no interval of incapacity. I cannot understand how a body corporate thus made “capable” by statute can lose its individuality by issuing the bulk of its capital to one person, whether he be a subscriber to the memorandum or not. The company is at law a different person altogether from the subscribers to the memorandum; and, 168

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Salomon v Salomon & Co Ltd cont. though it may be that after incorporation the business is precisely the same as it was before, and the same persons are managers, and the same hands receive the profits, the company is not in law the agent of the subscribers or trustee for them. Nor are the subscribers as members liable, in any shape or form, except to the extent and in the manner provided by the Act. That is, I think, the declared intention of the enactment. If the view of the learned judge were sound, it would follow that no common law partnership could register as a company limited by shares without remaining subject to unlimited liability. … [52] If … the declaration of the Court of Appeal means that Mr Salomon acted fraudulently or dishonestly, I must say I can find nothing in the evidence to support such an imputation. The purpose for which Mr Salomon and the other [53] subscribers to the memorandum were associated was “lawful”. The fact that Mr Salomon raised £5000 for the company on debentures that belonged to him seems to me strong evidence of his good faith and of his confidence in the company. The unsecured creditors of A Salomon and Company, Limited, may be entitled to sympathy, but they have only themselves to blame for their misfortunes. They trusted the company, I suppose, because they had long dealt with Mr Salomon, and he had always paid his way; but they had full notice that they were no longer dealing with an individual, and they must be taken to have been cognisant of the memorandum and of the articles of association. For such a catastrophe as has occurred in this case some would blame the law that allows the creation of a floating charge. But a floating charge is too convenient a form of security to be lightly abolished. I have long thought, and I believe some of your Lordships also think, that the ordinary trade creditors of a trading company ought to have a preferential claim on the assets in liquidation in respect of debts incurred within a certain limited time before the winding up. But that is not the law at present. Everybody knows that when there is a winding up debenture holders generally step in and sweep off everything; and a great scandal it is. It has become the fashion to call companies of this class “one man companies”. That is a taking nickname, but it does not help one much in the way of argument. If it is intended to convey the meaning that a company which is under the absolute control of one person is not a company legally incorporated, although the requirements of the Act of 1862 may have been complied with, it is inaccurate and misleading: if it merely means that there is a predominant partner possessing an overwhelming influence and entitled practically to the whole of the profits, there is nothing in that that I can see contrary to the true intention of the Act of 1862, or against public policy, or detrimental to the interests of creditors. If the shares are fully paid up, it cannot matter whether they are in the hands of one or many. If the shares are not fully paid, it is as easy to gauge the solvency of an individual as to estimate the financial ability of a crowd. LORD DAVEY: [57] [But the liquidator also claimed relief on the ground] that the contract for purchase of the appellant’s business ought to be set aside for fraud. The fraud seems to consist in the alleged exorbitance of the price and the fact that there was no independent board of directors with whom the appellant could contract. I am of opinion that the fraud was not made out. I do not think the price of the appellant’s business (which seems to have been a genuine one, and for some time a prosperous business) was so excessive as to afford grounds for rescission; and as regards the cash portion of the price, it must be observed that, as the appellant held the bulk of the shares, or (the respondents say) was the only shareholder, the money required, for the payment of it came from himself in the form either of calls on his shares or profits which would otherwise be divisible. Nor was the absence of any independent board material in a case like the present. I think it an inevitable inference from the circumstances of the case that every member of the company assented to the purchase, and the company is bound in a matter intra vires by the unanimous agreement of its members. In fact, it is impossible to say who was defrauded. [Lords Watson, Herschell and Morris delivered concurring judgments.]

[4.30]

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Lee v Lee’s Air Farming Ltd [4.35] Lee v Lee’s Air Farming Ltd [1961] AC 12 Privy Council [Lee formed a company to carry on a business of aerial top-dressing. He held the whole of the issued capital in the company except for one share held by his solicitor. Lee was appointed governing director of the company and employed at a salary as its chief pilot. By virtue of his powers as governing director and controlling shareholder, Lee enjoyed full and unrestricted control over the affairs of the company. Two years later Lee was killed while carrying out aerial top-dressing work for the company. Pursuant to statutory obligation, the company had taken out workers’ compensation cover on its employees. Lee’s widow sued the company for compensation as the widow of a “worker”, defined in the statute as “a person who works under a contract of service … with an employer”. The New Zealand Court of Appeal rejected the claim upon the basis that, since Lee was the governing director, in whom the full government and control of the company was vested, he could not also be its servant. His widow appealed to the Privy Council.] LORD MORRIS delivered the judgment of THE PRIVY COUNCIL: [24] The substantial question which arises is … whether the deceased was a “worker” within the meaning of the Workers’ Compensation Act 1922 (NZ), and its amendments. Was he a person who had entered into or worked under a contract of service with an employer? The Court of Appeal thought that his special position as governing director precluded him from being a servant of the company. On this view it is difficult to know what his status and position was when he was performing the arduous and skilful duties of piloting an aeroplane [25] which belonged to the company and when he was carrying out the operation of top-dressing farm lands from the air. He was paid wages for so doing. The company kept a wages book in which these were recorded. The work that was being done was being done at the request of farmers whose contractual rights and obligations were with the company alone. It cannot be suggested that when engaged in the activities above referred to the deceased was discharging his duties as governing director. Their Lordships find it impossible to resist the conclusion that the active aerial operations were performed because the deceased was in some contractual relationship with the company. That relationship came about because the deceased as one legal person was willing to work for and to make a contract with the company which was another legal entity. A contractual relationship could only exist on the basis that there was consensus between two contracting parties. It was never suggested (nor in their Lordships’ view could it reasonably have been suggested) that the company was a sham or a mere simulacrum. It is well established that the mere fact that someone is a director of a company is no impediment to his entering into a contract to serve the company. If, then, it be accepted that the respondent company was a legal entity their Lordships see no reason to challenge the validity of any contractual obligations which were created between the company and the deceased. … [26] Nor in their Lordships’ view were any contractual obligations invalidated by the circumstance that the deceased was sole governing director in whom was vested the full government and control of the company. Always assuming that the company was not a sham then the capacity of the company to make a contract with the deceased could not be impugned merely because the deceased was the agent of the company in its negotiation. The deceased might have made a firm contract to serve the company for a fixed period of years. If within such period he had retired from the office of governing director and other directors had been appointed his contract would not have been affected. The circumstance that in his capacity as a shareholder he could control the course of events would not in itself affect the validity of his contractual relationship with the company. When, therefore, it is said that “one of his first acts was to appoint himself the only pilot of the company,” it must be recognised that the appointment was made by the company, and that it was nonetheless a valid appointment because it was the deceased himself who acted as the agent of the company in arranging it. In their Lordships’ view it is a logical consequence of the decision in Salomon’s case that one person may function in dual capacities. There is no reason, therefore, to deny the possibility of a contractual relationship being created as between the deceased and the company. If this stage is reached then their Lordships see no reason why the range of possible contractual relationships should not include a contract for services, and if the deceased as agent for the company could negotiate a contract for services as between the company and himself there is no reason why a contract of service could not also be negotiated. It is said that therein lies the difficulty, because it is said that the deceased could not both be under the 170

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Lee v Lee’s Air Farming Ltd cont. duty of giving orders and also be under the duty of obeying them. But this approach does not give effect to the circumstance that it would be the company and not the deceased that would be giving the orders. Control would remain with the company whoever might be the agent of the company [27] to exercise it. The fact that so long as the deceased continued to be governing director, with amplitude of powers, it would be for him to act as the agent of the company to give the orders does not alter the fact that the company and the deceased were two separate and distinct legal persons. If the deceased had a contract of service with the company then the company had a right of control. The manner of its exercise would not affect or diminish the right to its exercise. But the existence of a right to control cannot be denied if once the reality of the legal existence of the company is recognised. Just as the company and the deceased were separate legal entities so as to permit of contractual relations being established between them, so also were they separate legal entities so as to enable the company to give an order to the deceased.

Gower’s Principles of Modern Company Law [4.40] L C B Gower et al, Gower’s Principles of Modern Company Law (4th ed, Stevens, 1979) [99] This decision [in Salomon’s case] opened up new vistas to company lawyers and the world of commerce. Not only did it finally establish the legality of the one man company and showed that incorporation was as readily available to the small private partnership and sole trader as to the large public company, but it also revealed that it was possible for a trader not merely to limit his liability to the money which he put into the enterprise but even to avoid any serious risk to the major part of that by subscribing for debentures rather than shares. This result seems shocking, and the decision has been much criticised. The only justification for it is that the public deal with a limited company at their peril and know, or should know, what to expect. In particular, a search of the company’s file at the Companies’ Registry will show whether there are any charges on the company’s assets, and its last balance sheet and profit and loss account. But the latter will probably be months out of date and not everyone will be capable of understanding them. Nor does everyone having dealings with a company have the time or knowledge needed to search the file. The experienced business man with his trade protection associations can take care of himself, but the little man, whom the law should particularly protect, rarely has any idea of the risks he runs when he grants credit to a company with a high-sounding name, impressive nominal capital (not paid up in cash), and with assets mortgaged up to the hilt. Nor is it practical for the unemployed workman, who is offered a job with [100] a limited company, to decline it until he has first searched the company’s file. Since the Salomon case, the complete separation of the company and its members has never been doubted. As we shall see later, there are cases in which the legislature, and to a very small extent the courts, have allowed the veil of incorporation to be lifted, but in general it is opaque and impassable. The consequences, however, are not necessarily wholly beneficial to the members. A landlord carrying on business through a one man company was formerly unable to resist the tenant’s application for a renewed tenancy or to obtain possession on the ground that he, the landlord, required possession for the purpose of a business to be carried on by him. (Tunstall v Steigmann [1962] 2 QB 593.) If a trader sells his business to a company he will cease to have an insurable interest in its assets even though he is the beneficial owner of all the shares. If therefore he forgets to assign the insurance policies, and to obtain any necessary consents of the insurers, nothing will be payable if the assets perish. (Macaura v Northern Assurance Co [1925] AC 619.) Similarly, a parent company will not have an insurable interest in the assets of its subsidiary companies even though wholly owned, for the rule that a company is distinct from its members applies equally to the separate companies of a group. In Professor Sir Otto Kahn-Freund’s striking phrase “sometimes corporate entity works like a boomerang and hits the man who was trying to use it”.

[4.40]

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[4.42]

Notes&Questions

1.

The High Court quoted with approval from the judgment in Lee v Lee’s Air Farming in Hamilton v Whitehead (see [4.190]). It also quoted with approval the reference of Bray CJ in R v Goodall, a propos Lee, to “some sort of metaphysical bifurcation or duplication of one act by one man so that it is in law both the act of the company and the separate act of himself as an individual”: (1975) 11 SASR 94 at 100.

2.

Upon what grounds did the judges in Salomon contemplate that it might be possible to pierce the veil of incorporation and expose Aron Salomon to the claims of the company’s creditors? Consider what relation these grounds bear to the exceptional cases noted at [4.45]. For an analysis of the remedies available to a modern company liquidator against someone in the position of Aron Salomon, see L S Sealy (1998) 16 C&SLJ 176. Sealy concludes that the only further remedy available against Salomon would be for a compensatory order based upon a breach of s 588G as a director of the company for failing to prevent it incurring the unsecured debts at a time when he must have known it was insolvent: see [7.135] et seq.

3.

In the important article referred to by Gower, Kahn-Freund described Salomon as a “calamitous decision”, inter alia, for the temptation to incorporate which it dangles before traders, even where their business is not risky and does not employ outside capital: see (1944) 7 MLR 54. What financing options does the case offer entrepreneurs and which does it favour? How might Aron Salomon have improved his priority in the liquidation of his company by other capitalisation arrangements? In consequence of Salomon’s case the English Companies Act was amended to require, upon penalty of invalidity, the registration of company charges with a view to protecting unsecured creditors from the prejudice of undisclosed floating (and other) securities: see W J Gough, Company Charges (1978), pp 208-210. The registration obligations are now contained in the Corporations Act, Ch 2K.

4.

What protection would Gower’s hypothetical unemployed workman enjoy in Australia if his potential employer were a small proprietary company?

5.

On the operation of the Salomon principle in another family context, see Ascot Investments Pty Ltd v Harper (1981) 148 CLR 337 where the High Court declined to treat as property of a party to a marriage assets held by a family company, notwithstanding that the husband had disposed of all his assets to the company and was not complying with orders made against him by the Family Court. But see B v B (Matrimonial Proceedings: Discovery) [1978] Fam 18 and Lonhro Ltd v Shell Petroleum Co Ltd [1980] 2 WLR 367 at 373 where it was envisaged that discovery might lie in proceedings involving an individual against her or his “one man” company.

6.

Since a company can act only through natural persons, there will always be problems in distinguishing between those acts of a corporate character and those in the actor’s individual capacity. Thus, may the sole beneficial shareholder be guilty of theft of the company’s property when they approve of the taking in their corporate character? See MacLeod v The Queen (2003) 214 CLR 230. May the sole beneficial shareholder be

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guilty of aiding and abetting an offence by her or his company? See R v Goodall (1975) 11 SASR 94 at 99-102 (quoted in Hamilton v Whitehead at [4.190]). Might the “one man” in a “one man company” be guilty of conspiracy with the company in the absence of any other human intervention? See R v McDonnell [1966] 1 QB 233. Are the differences reflected in these cases soundly based as a matter of legal policy? We shall consider at [4.130] the related difficulties of ascribing criminal liability to the company for acts necessarily performed by individuals. 7.

“A proprietary company, controlled by one man, has today taken the place of John Doe, William Roe and others who at an earlier time came out of ink wells in attorneys’ offices to do acts in the law of which law-abiding citizens might have the benefit while avoiding disadvantageous consequences. By incantations by typewriter, the obtaining of two signatures, payment of fees and compliance with formalities for registration, a company emerges. It is a new legal entity, a person in the eye of the law. Perhaps it were better in some cases to say a legal persona, for the Latin word in one of its senses means a mask: eriptur persona, manet res”: Peate v Federal Commissioner of Taxation (1962-1964) 111 CLR 443 at 478 per Windeyer J. “It has often struck me that morally there is most personality where legally there is none. A man thinks of his club as a living being, honourable as well as honest, while the joint stock company is only a sort of machine into which he puts money and out of which he draws dividends”: F W Maitland, “Trust and Corporation” in H D Hazeltine et al (eds), Maitland: Selected Essays (Cambridge University Press, 1936), p 201. Do you agree? Are these apt responses to Salomon and its derivatives?

PIERCING THE VEIL OF INCORPORATION Introduction [4.45] We have seen instances where the courts have pierced through the veil of

incorporation 23 to identify the company with its members or managers. Thus, for example, Lord Davey in Salomon was prepared to identify the company with the totality of its shareholders when they acted as a group (see [4.30]) and a company has been treated as an enemy alien because of the character of its controllers. Similarly, a company’s place of residence for tax purposes has been identified with that of its central management. 24 There are, however, other cases where the courts have ignored the separate personality of the company under the force of some conflicting principle or policy. In these situations it may be said that the otherwise opaque and impassable veil has been pierced. The principal cases indicative of the major categories are extracted below. The categories tentatively identified here relate to fraud or improper conduct, agency and the limited recognition accorded to the unity of the enterprise of a group of companies under common ownership. (Corporate groups are dealt with at [4.90].) These categories are treated serially along with a modern reformulation in terms of evasion of an existing obligation. The categories are not exclusive – 23

24

See further on the circumstances in which the courts have lifted the veil of incorporation H Anderson (2012) 22 Australian Accounting Rev 129; M J Whincop (1997) 15 C&SLJ 411; S Ottolenghi (1990) 53 MLR 338; A Beck, “The Two Sides of the Corporate Veil” in J H Farrar (ed), Contemporary Issues in Company Law (1987), p 69; M A Pickering (1968) 31 MLR 481; A Domanski (1986) 103 SALJ 224; D Jenkins [1975] CLJ 308; A Samuels [1964] JBL 107; E J Cohn & C Simitis (1963) 12 I CLQ 189; W O Douglas & C M Shanks (1929) 39 Yale LJ 193; I M Wormser (1912) 12 Colum L Rev 496. See, eg, Unit Construction Co Ltd v Bullock [1960] AC 351. In like vein, in Abbey Malvern Wells Ltd v Ministry of Local Government and Planning [1951] Ch 728, a company was given charitable status after examination of the trusts upon which its members held their shares. [4.45]

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a case may be assigned to more than one category. Neither are they exhaustive. Moreover, it may be deceptive even to speak of categories since that term suggests that the instances are principled or predictable. This is doubtful. Gower says of these instances, and of the like statutory directions, that “they reveal no consistent principle beyond a refusal by the legislature and the judiciary to apply the logic of the principle laid down in Salomon’s case where it is too flagrantly opposed to justice, convenience or the interests of the Revenue”. 25 When reading the following cases, consider whether this is a fair assessment of the exceptions made to Salomon or, alternatively, whether one can deduce from these cases a clear set of criteria by reference to which the veil has been, or will be, lifted. Also consider whether in these cases the language used by courts represents the factors that impel the judicial decision on veil piercing or whether it merely expresses in justificatory mode the decision made by the court. Eighty years ago a distinguished American judge described veil piercing as a doctrine “enveloped in the mists of metaphor”. 26 You might ask yourself whether the mist has lifted in the intervening years. Several statutory provisions contain directions to pierce the veil of incorporation. The principal exceptions in the Act itself arise when debts are incurred by the company when it is insolvent or its solvency is impaired by incurring that debt. Its directors are exposed to personal liability for those debts where they knew or ought have known of the insolvency: s 588G and [7.135]. Further, where the company is a subsidiary of another company, that holding company may also be made liable in relation to those debts where it knew or ought to have known of the state of its financial affairs: ss 588V – 588X and see [7.195]. Directors are also exposed to personal liability for the debts incurred by a corporate trustee where the trustee is not entitled to be fully indemnified by the beneficiaries of the trust, usually because the trustee has waived such indemnity rights. Further, because many groups of companies are in substance an integrated financial unit, the Act requires the preparation of consolidated accounts showing the financial position of the group as a whole: see [9.130]. Other statutes contain directions to like effect. 27 Perhaps the most familiar, although its direction is much less explicit, is Pt IVA of the Income Tax Assessment Act 1936 (Cth), the general anti-avoidance provision. The “bottom of the harbour” tax legislation which made vendors of shares responsible for the unpaid tax liabilities of their companies, involved a direct and retrospective repudiation of the Salomon doctrine. 28 Generally, the legislation only applied where the vendor shareholders received such a price for their shares as to make it probable that tax on the company’s profits would not be paid. In December 2011, the Commonwealth released the exposure draft Corporations Amendment (Similar Names Bill) 2012 which proposed amendments to the Act to impose personal liability upon directors of “phoenix” companies for company debts where company controllers and directors avoid payment of workers’ entitlements and other unsecured creditors by restarting a failed business using a new company with a similar name, often in the same premises with the same staff and clients. The Commonwealth has not proceeded with the proposal. The Commonwealth did, however, enact what it called “phoenixing” legislation in 2012 but with a narrower compass: ASIC is empowered to order the winding-up of companies that have been abandoned by their directors: s 489EA(1). A failed company must be wound up before its employees can access the 25

Gower’s Principles of Modern Company Law (P L Davies (ed), 6th ed, Stevens, 1997), p 112.

26

Berkey v Third Ave Ry Co 155 NE 58, 61 (NY, 1926) per Cardozo J.

27

Another important instance is the cluster of provisions imposing personal liabilities upon directors and managers for breaches by their company of obligations with respect to revenue collection, industrial regulation and environmental protection: see [7.15]. Among other instances is Taxation Administration Act 1953 (Cth), s 8Y (deeming persons managing a company liable for its taxation offences).

28

See Taxation (Unpaid Company Tax) Assessment Act 1982 (Cth), s 5; see A Freiberg (1988) 12 Crim LJ 137 and (1987) 10 UNSWLJ 67.

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General Employee Entitlements and Redundancy Scheme that protects workers’ entitlements. The measure relieves employees of the burden of commencing winding-up proceedings where ASIC is willing and has power to do so. The liquidator may then investigate any director misconduct and uncommercial transactions. 29 Fraud or improper conduct

Gilford Motor Co Ltd v Horne [4.50] Gilford Motor Co Ltd v Horne [1933] 1 Ch 935 Court of Appeal, England and Wales [The plaintiff company manufactured, sold and serviced Gilford motor cars and parts. In 1928 it appointed E B Horne as its managing director. By cl 9 of his service contract Horne covenanted that he would not, during or after his term of office, attempt to entice away any customers of the plaintiff. After Horne’s employment was terminated in November 1931, he opened a business under his own name selling spare parts for, and servicing, Gilford vehicles. On 29 March 1932, his solicitor wrote to the plaintiff seeking a copy of E B Horne’s service contract. Within a few days of its receipt, a company was incorporated under the name “J M Horne & Co Ltd” and took over E B Horne’s business. “J M Horne” was the name of E B Horne’s wife. The plaintiff sought an injunction restraining E B Horne, either directly or indirectly by means of J M Horne & Co Ltd, from attempting to entice away the plaintiff’s customers. E B Horne admitted to soliciting clients of the plaintiff, in breach of the agreement, in the period prior to the incorporation of the company. He argued that the covenant was void as an unreasonable restraint of trade; alternatively, he argued that it might not be enforced against the company. The Court of Appeal upheld the validity of the clause against E B Horne. It turned to the alternative submission.] LORD HANWORTH MR: [955] The registered office is at the private address of Mr Horne, 170 Hornsey Lane; the directors are Jessie May Horne, the wife of Mr E B Horne, and Mr Albert Victor Howard, a person who had been, as I understand, originally in the employ of Gilford Motors, but who was at that time associated with Mr E B Horne in the business which he carried on after November 1931. The nominal capital was £500 divided into 500 shares of £1 each, and the allotments that were made on 12 April were, as to 101 shares, to Mrs J M Horne, and 101 shares to Mr A V Howard [these were the only shares issued: ed]; the solicitor of the company was the writer of that letter of 29 March. … Farwell J [the trial judge] heard the evidence about that company and had these documents before him. He says this: The defendant company is a company which, on the evidence before me, is obviously carried on wholly by the defendant Horne. Mrs Horne, one of the directors, is not, so far as any evidence I have had before me, taking any part in the business or the management of the business. The son, whose initials are “J M”, is engaged in a subordinate position in that company, and the other director, Howard, is an employee of the company. As one of the witnesses said in the witness box, in all dealings which he had had with the defendant company the “boss” or the “guvnor”, whichever term is the appropriate one, was the defendant Horne, and I have not any doubt on the evidence I have had before me that the defendant company was the channel through which the defendant Horne was carrying on his business. Of course, in law the defendant company is a separate entity from the defendant Horne, but I cannot help feeling quite convinced that at any rate one [956] of the reasons for the creation of that company was the fear of Mr Horne that he might commit breaches of the covenant in carrying on the business, as, for instance, in sending out circulars as he was doing, and that he might possibly avoid that liability if he did it through the defendant company. There is no doubt that the defendant company has sent out circulars to persons who were at the crucial time customers of the plaintiff company. 29

Corporations Amendment (Phoenixing and Other Measures) Act 2012 (No 48, 2012); see H Anderson (2016) 34 C&SLJ 257; H Anderson et al (2015) 33 C&SLJ 133 and (2015) 33 C&SLJ 425; H Anderson (2012) 34 Syd Law Rev 411 and H Anderson (2011) 24 Aust J Labour Law 141. [4.50]

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Gilford Motor Co Ltd v Horne cont. Now I have recalled that portion of the judgment of Farwell J, and I wish in clear terms to say that I agree with every word of it. I am quite satisfied that this company was formed as a device, a stratagem, in order to mask the effective carrying on of a business of Mr E B Horne. The purpose of it was to try to enable him, under what is a cloak or a sham, to engage in business which, on consideration of the agreement which had been sent to him just about seven days before the company was incorporated, was a business in respect of which he had a fear that the plaintiffs might intervene and object. … [961] I think the injunction must go against the company. [Counsel for the defendants] admitted that if the company were such as is indicated by Lindley LJ in Smith v Hancock [1894] 2 Ch 377 at 385 it would not be possible to object to the injunction going against the company. Lindley LJ indicated the rule which ought to be followed by the court: “If the evidence admitted of the conclusion that what was being done was a mere cloak or sham, and that in truth the business was being carried on by the wife and Kerr for the defendant, or by the defendant through his wife for Kerr, I certainly should not hesitate to draw that conclusion, and to grant the plaintiff relief accordingly.” I do draw that conclusion; I do hold that the company was “a mere cloak or sham”; I do hold that it was a mere device for enabling Mr E B Horne to continue to commit breaches of cl 9 [962] and under those circumstances the injunction must go against both defendants. [Lawrence and Romer LJJ delivered concurring judgments.]

Jones v Lipman [4.55] Jones v Lipman [1962] 1 WLR 832 Chancery Division [Lipman contracted to sell land to the Joneses. Before completion of the contract, Lipman sold and transferred the land to a company which he had newly acquired. Lipman and a clerk employed by his solicitors were the only shareholders and directors of the company. The sale price to the company was for a significantly lesser sum than the Joneses had agreed to pay. The company borrowed part of the purchase price from a bank and the balance remained owing to Lipman. The Joneses brought an action for specific performance of the contract against both Lipman and the company.] RUSSELL J: [835] When the matter came on again in chambers the affidavit evidence by the first defendant made it plain (i) that the defendant company was, and at all material times had been, under the complete control of the first defendant, and (ii) that the acquisition of the defendant company by the first defendant and the transfer to it of the real property comprised in the contract with the plaintiffs … was carried through solely for the purpose of defeating the plaintiffs’ rights to specific performance and in order to leave them to claim such damages, if any, as they might establish. So much was, quite rightly, admitted by counsel for the defendants. For the plaintiffs the argument was twofold. First, that specific performance would be ordered against a party to a contract who has it in his power to compel another person to convey the property in question; and that admittedly the first defendant had this power over the defendant company. Second, that specific performance would also, in circumstances such as the present, be ordered against the defendant company. … [On the first point, it seems to me] that it necessarily follows that specific [836] performance cannot be resisted by a vendor who, by his absolute ownership and control of a limited company in which the property is vested, is in a position to cause the contract to be completed. [The judge referred to Gilford Motor Co Ltd v Horne.] Those comments on the relationship between the individual and the company apply even more forcibly to the present case. The defendant company is the creature of the first defendant, a device and a sham, a mask which he holds before his face in an attempt to avoid recognition by the eye of equity.

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Jones v Lipman cont. The case illustrates that an equitable remedy is rightly to be granted [837] directly against the creature in such circumstances. … The proper order to make is an order on both the defendants specifically to perform the agreement between the plaintiffs and the first defendant.

Notes&Questions

[4.58]

1.

Two undischarged bankrupts promoted a company which derived secret profits on the sale of grossly over-valued assets to another company which it had promoted. The liquidator of the second company recovered from the individuals the secret profit fraudulently derived by their company: “It was just an alias for themselves just as much as if they had announced in the Gazette that they were in future going to call themselves ‘Rothschild & Co’. It was merely a name under which they carried on business”: Re Darby; Ex parte Brougham [1911] 1 KB 95 at 101 per Phillimore J. See also Re Bugle Press Ltd [1961] Ch 270 at 276, 286.

2.

In an action for deceit and breach of fiduciary duty, the plaintiff alleged that the defendant had created an elaborate structure of corporations and trusts to put his assets beyond the plaintiff’s reach. Orders were made freezing the defendant’s assets and were affirmed by the English Court of Appeal on the ground that “the authorities revealed that the court would use its power to pierce the corporate veil if it was necessary to achieve justice irrespective of the legal efficacy of the corporate structure under consideration”: X Bank Ltd v G [1985] Times LR 246.

3.

In Wallersteiner v Moir [1974] 1 WLR 991 at 1013, Lord Denning MR (but not other members of the Court of Appeal) was prepared to treat a group of companies under the control of a notorious financier as his “puppets”: “He controlled their every movement. Each danced to his bidding. He pulled the strings. No one else got within reach of them. Transformed into legal language, they were his agents to do as he commanded. He was the principal behind them. I am of the opinion that the court should pull aside the corporate veil and treat these concerns as being his creatures – for whose doings he should be, and is, responsible.” See also Tracy v Mandalay Pty Ltd (see [3.230] at 244) (“the defendant company … was a mere puppet in the hands of Salon and Mrs Salon”).

Agency

Smith Stone and Knight Ltd v Birmingham Corporation [4.60] Smith Stone and Knight Ltd v Birmingham Corporation (1939) 161 LT 371 King’s Bench Division [Smith Stone and Knight Ltd was a paper manufacturer. It owned a factory in Birmingham which it let to a subsidiary, Birmingham Waste Co Ltd, on a yearly tenancy. The municipal authority wished to acquire the premises to build a technical college. It served a notice to treat upon Smith Stone and Knight which lodged a claim for compensation, inter alia, for removal costs and disturbance to the business. Initially Smith Stone and Knight made the claim for removal and disturbance on behalf of Birmingham Waste Co, but later amended the claim to one on its own behalf. In its amended claim it said: Factory and offices nominally let to the Birmingham Waste Co Ltd, which said company is a subsidiary company of Smith Stone and Knight Ltd, carrying on this business for and on behalf of Smith Stone and Knight Ltd, which said company owns the whole of the capital and takes the whole of the profits of the said subsidiary company. The subsidiary company [4.60]

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Smith Stone and Knight Ltd v Birmingham Corporation cont. occupies the said premises and carries on its trade as a separate department of and as agents for Smith Stone and Knight Ltd. The said rent was and is arranged as an inter-departmental charge and is merely a book-keeping entry. They added to that final note, or, at any rate, in its final form it read: These two items of damage will accrue to Smith Stone and Knight Ltd, who are the principals of the Birmingham Waste Co Ltd. The said loss will fall upon Smith Stone and Knight Ltd. The company and the authority were unable to agree to terms and the matter was referred to arbitration. A preliminary point was raised as to whether Smith Stone and Knight was entitled to claim compensation for disturbance to the business carried on on the premises, or whether such claim must be made by the Birmingham Waste Co. In the latter event, the authority would escape paying compensation for the disturbance since the statute denied compensation claims by occupiers with no greater interest than a tenancy not exceeding one year.] ATKINSON J: [372] The question has been put during the hearing in various ways. Was the loss which was incurred by the business which was being carried on on the premises the direct loss of the claimants, or was it, as the corporation says, a loss which they suffered merely in their capacity of shareholders in the waste company? Again, to whom did the business in truth belong? Again, was the waste company merely the agent of the claimants for the carrying on of the business? Were the claimants in fact carrying on the business, albeit in the name of the waste company? … In January 1913, a business was being carried on on these premises by the waste company (which was then not a limited company, but a partnership) and the business which was being carried on was that of dealers in waste. In that month the claimants bought from the waste company the premises and the business as a going concern, and there is no question about it that this business became vested in and became the property of the claimants. They altered and enlarged the factory and carried on the business. On 13 March, the claimants caused this new company, the Birmingham Waste Co Ltd, to be registered. It was a company with a subscribed capital of £502, the claimants holding 497 shares. They found all the money, and they had 497 shares registered in their own name, the other five being registered one in the name of each of the five directors. There were five directors of the waste company and they were all directors of the claimants, and they all executed a declaration of trust for the share which they held, stating they held them in trust for the claimants. At no time did the board get any remuneration from the waste company. The new company purported to carry on the waste business in this sense, that their name was placed upon the premises, and on the notepaper, invoices, etc. It was an apparent carrying on by the waste company. I think that these two facts are of the greatest importance. There was no agreement of any kind made between the two companies, and the business was never assigned to the waste company. There was no suggestion that anything was done to transfer the beneficial ownership of it to the waste company. A manager was appointed, doubtless by the company, but there was no staff. The books and accounts were all kept by the claimants; the waste company had no books at all and the manager, it is found, knew nothing at all about what was in the books, and had no access to them. There is no doubt that the claimants had complete control of the operations of the waste company. Then other businesses were bought by the claimants, but they were not assigned to the waste company; the waste company just carried them on. There was no tenancy agreement of any sort with the company; they were just there in name. No rent was paid. Apart from the name, it was really as if the manager was managing a department of the company. Six months after the incorporation there was a report to the shareholders that the business was under the supervision and control of the claimants and that the profits would be credited to that company in the books, as is very often done with departments. A proportion of the overheads was debited to the waste company and this rent, which has been referred to in the first claim of £90, was a book entry, debiting the company with that sum. There was a question as to why the company was ever formed. The functions of buying and sorting waste are different from the function of manufacturing paper, and, according to the evidence which is part of the case before me, it was thought better to have these different functions performed in a different name. … [373] At the end of each year the accounts were made up by the company, and if the accounts showed a profit, the claimants allocated the profit to the different mills belonging to the company, exhausting 178

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Smith Stone and Knight Ltd v Birmingham Corporation cont. the paper profit in that way and making the profit part of the company’s own profit, because allocating this profit to their different departments or different mills would have the effect of increasing their own profit by a precisely similar sum. The waste company never declared a dividend; they never thought of such a thing, and their profit was in fact treated as the claimants’ profit. Those being the facts, the corporation rest their contention on Salomon’s case and their argument is that the waste company was a distinct legal entity. It was in occupation of the premises, the business was being carried on in its name and the claimants’ only interest in law was that of holders of the shares. It is well settled that the mere fact that a man holds all the shares in a company does not make the business carried on by that company his business, nor does it make the company his agents for the carrying on of the business. That proposition is just as true if the shareholder is itself a limited company. It is also well settled that there may be such an arrangement between the shareholders and a company as will constitute the company the shareholders’ agent for the purpose of carrying on the business and make the business the business of the shareholders. In Gramophone and Typewriter Ltd v Stanley [1908] 2 KB 89 Cozens-Hardy MR, said at 95, 96: The fact that an individual by himself or his nominees holds practically all the shares in a company may give him the control of the company in the sense that it may enable him by exercising his voting powers to turn out the directors and to enforce his own views as to policy, but it does not in any way diminish the rights or powers of the directors, or make the property or assets of the company his, as distinct from the corporation’s. Nor does it make any difference if he acquires not practically the whole, but absolutely the whole, of the shares. The business of the company does not thereby become his business. He is still entitled to receive dividends on his shares, but no more. I do not doubt that a person in that position may cause such an arrangement to be entered into between himself and the company as will suffice to constitute the company his agent for the purpose of carrying on the business, and thereupon the business will become, for all taxing purposes, his business. Whether this consequence follows is in each case a matter of fact. In the present case I am unable to discover anything in addition to the holding of the shares which in any way supports this conclusion. … It seems therefore to be a question of fact in each case, and those cases indicate that the question is whether the subsidiary was carrying on the business as the company’s business or as its own. I have looked at a number of cases – they are all revenue cases – to see what the courts regarded as of importance for determining that question. … I find six points which were deemed relevant for the determination of the question: Who was really carrying on the business? In all the cases, the question was whether the company, an English company here, could be taxed in respect of all the profits made by some other company, a subsidiary company, being carried on elsewhere. The first point was: Were the profits treated as the profits of the company? – when I say “the company” I mean the parent company – second, were the persons conducting the business appointed by the parent company? Third, was the company the head and the brain of the trading venture? Fourth, did the company govern the adventure, decide what should be done and what capital should be embarked on the venture? Fifth, did the company make the profits by its skill and direction? Sixth, was the company in effectual and constant control? Now if the judgments in those cases are analysed, it will be found that all those matters were deemed relevant for consideration in determining the main question, and it seems to me that every one of those questions must be answered in favour of the claimants. Indeed, if ever one company can be said to be the agent or employee, or tool or simulacrum of another, I think the waste company was in this case a legal entity, because that is all it was. There was nothing to prevent the claimants at any moment saying: “We will carry on this business in our own name.” They had but to paint out the waste company’s name on the premises, change their business paper and form, and the thing would have been done. I am satisfied that the business belonged to the claimants; they were, in my view, the real occupiers of the premises. If either physically or technically the waste company was in occupation, it was for the purposes of the service it was rendering to the claimants, such occupation was necessary for that service, and I think that those facts would make that occupation in law the occupation of the claimants. An analogous position would be where servants [4.60]

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Smith Stone and Knight Ltd v Birmingham Corporation cont. occupy cottages or rooms for the purposes of their business, and it is well settled that if they have to occupy those premises for the purposes of the business, their occupation is the occupation of their principal. I have no doubt the business was the company’s business and was being carried on under their direction.

Evasion of an existing obligation

Prest v Petrodel Resources Ltd [4.65] Prest v Petrodel Resources Ltd [2013] 2 AC 415 Supreme Court of the United Kingdom [Orders for property transfers were made in matrimonial proceedings in favour of the wife against companies wholly owned and controlled by the husband. The trial judge held that he could not pierce the corporate veil under the general law without some relevant impropriety, and declined to find that there was any.] LORD SUMPTION: [8] … The separate personality and property of a company is sometimes described as a fiction, and in a sense it is. But the fiction is the whole foundation of English company and insolvency law. As Robert Goff LJ once observed, in this domain “we are concerned not with economics but with law. The distinction between the two is, in law, fundamental”: Bank of Tokyo Ltd v Karoon (Note) [1987] AC 45, 64. He could justly have added that it is not just legally but economically fundamental, since limited companies have been the principal unit of commercial life for more than a century. Their separate personality and property are the basis on which third parties are entitled to deal with them and commonly do deal with them. [16] I should first of all draw attention to the limited sense in which this issue arises at all. “Piercing the corporate veil” is an expression rather indiscriminately used to describe a number of different things. Properly speaking, it means disregarding the separate personality of the company. There is a range of situations in which the law attributes the acts or property of a company to those who control it, without disregarding its separate legal personality. The controller may be personally liable, generally in addition to the company, for something that he has done as its agent or as a joint actor. Property legally vested in a company may belong beneficially to the controller, if the arrangements in relation to the property are such as to make the company its controller’s nominee or trustee for that purpose. For specific statutory purposes, a company’s legal responsibility may be engaged by the acts or business of an associated company. Examples are the provisions of the Companies Acts governing group accounts or the rules governing infringements of competition law by “firms”, which may include groups of companies conducting the relevant business as an economic unit. Equitable remedies, such as an injunction or specific performance may be available to compel the controller whose personal legal responsibility is engaged to exercise his control in a particular way. But when we speak of piercing the corporate veil, we are not (or should not be) speaking of any of these situations, but only of those cases which are true exceptions to the rule in Salomon v A Salomon and Co Ltd [1897] AC 22, ie where a person who owns and controls a company is said in certain circumstances to be identified with it in law by virtue of that ownership and control. [27] In my view, the principle that the court may be justified in piercing the corporate veil if a company’s separate legal personality is being abused for the purpose of some relevant wrongdoing is well established in the authorities. It is true that most of the statements of principle in the authorities are obiter, because the corporate veil was not pierced. It is also true that most cases in which the corporate veil was pierced could have been decided on other grounds. But the consensus that there are circumstances in which the court may pierce the corporate veil is impressive. I would not for my part be willing to explain that consensus out of existence. This is because I think that the recognition of a limited power to pierce the corporate veil in carefully defined circumstances is necessary if the law is not to be disarmed in the face of abuse. I also think that provided the limits are recognised and respected, it is consistent with the general approach of English law to the problems raised by the use of legal concepts to defeat mandatory rules of law. 180

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Prest v Petrodel Resources Ltd cont. [28] The difficulty is to identify what is a relevant wrongdoing. References to a “facade” or “sham” beg too many questions to provide a satisfactory answer. It seems to me that two distinct principles lie behind these protean terms, and that much confusion has been caused by failing to distinguish between them. They can conveniently be called the concealment principle and the evasion principle. The concealment principle is legally banal and does not involve piercing the corporate veil at all. It is that the interposition of a company or perhaps several companies so as to conceal the identity of the real actors will not deter the courts from identifying them, assuming that their identity is legally relevant. In these cases the court is not disregarding the “facade”, but only looking behind it to discover the facts which the corporate structure is concealing. The evasion principle is different. It is that the court may disregard the corporate veil if there is a legal right against the person in control of it which exists independently of the company’s involvement, and a company is interposed so that the separate legal personality of the company will defeat the right or frustrate its enforcement. Many cases will fall into both categories, but in some circumstances the difference between them may be critical. This may be illustrated by reference to those cases in which the court has been thought, rightly or wrongly, to have pierced the corporate veil. [29] The first and most famous of them is Gilford Motor Co Ltd v Horne. Mr EB Horne had been the managing director of the Gilford Motor Co. His contract of employment precluded him being engaged in any competing business in a specified geographical area for five years after the end of his employment “either solely or jointly with or as agent for any other person, firm or company”. He left Gilford and carried on a competing business in the specified area, initially in his own name. He then formed a company, JM Horne & Co Ltd, named after his wife, in which she and a business associate were shareholders. The trial judge, Farwell J, found that the company had been set up in this way to enable the business to be carried on under his own control but without incurring liability for breach of the covenant. However the reality, in his view, was that the company was being used as “the channel through which the defendant Horne was carrying on his business”. In fact, he dismissed the claim on the ground that the restrictive covenant was void. But the Court of Appeal allowed the appeal on that point and granted an injunction against both Mr Horne and the company. As against Mr Horne, the injunction was granted on the concealment principle. Lord Hanworth MR said, at pp 961-962, that the company was a “mere cloak or sham” because the business was really being carried on by Mr Horne. Because the restrictive covenant prevented Mr Horne from competing with his former employers whether as principal or as agent for another, it did not matter whether the business belonged to him or to JM Horne & Co Ltd provided that he was carrying it on. The only relevance of the interposition of the company was to maintain the pretence that it was being carried on by others. Lord Hanworth did not explain why the injunction should issue against the company, but I think it is clear from the judgments of Lawrence and Romer LJJ, at pp 965 and 969, that they were applying the evasion principle. Lawrence LJ, who gave the fullest consideration to the point, based his view entirely on Mr Horne’s evasive motive for forming the company. This showed that it was ““a mere channel used by the defendant Horne for the purpose of enabling him, for his own benefit, to obtain the advantage of the customers of the plaintiff company, and that therefore the defendant company ought to be restrained as well as the defendant Horne”. In other words, the company was restrained in order to ensure that Horne was deprived of the benefit which he might otherwise have derived from the separate legal personality of the company. I agree with the view expressed by the Court of Appeal in VTB Capital plc v Nutritek International Corp [2012] EWCA Civ 808, at [63], that this is properly to be regarded as a decision to pierce the corporate veil. It is fair to say that the point may have been conceded by counsel, although in rather guarded terms (“if the evidence admitted of the conclusion that what was being done was a mere cloak or sham”). It is also true that the court in Gilford Motor Co might have justified the injunction against the company on the ground that Mr Horne’s knowledge was to be imputed to the company so as to make the latter’s conduct unconscionable or tortious, thereby justifying the grant of an equitable remedy against it. But the case is authority for what it decided, not for what it might have decided, and in my view the principle which the Court of Appeal applied was correct. It does not follow that JM Horne & Co Ltd was to be identified with Mr Horne for any other purpose. Mr Horne’s personal creditors would not, for example, have been entitled simply by virtue of the facts found by Farwell J, to enforce their claims against the assets of the company. [4.65]

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Prest v Petrodel Resources Ltd cont. [30] Jones v Lipman was a case of very much the same kind. The facts were that Mr Lipman sold a property to the plaintiffs for £5,250 and then, thinking better of the deal, sold it to a company called Alamed Ltd for £3,000, in order to make it impossible for the plaintiffs to get specific performance. The judge, Russell J, found that company was wholly owned and controlled by Mr Lipman, who had bought it off the shelf and had procured the property to be conveyed to it “solely for the purpose of defeating the plaintiffs’ rights to specific performance”. About half of the purchase price payable by Alamed was funded by borrowing from a bank, and the rest was left outstanding. The judge decreed specific performance against both Mr Lipman and Alamed Ltd. As against Mr Lipman this was done on the concealment principle. Because Mr Lipman owned and controlled Alamed Ltd, he was in a position specifically to perform his obligation to the plaintiffs by exercising his powers over the company. This did not involve piercing the corporate veil, but only identifying Mr Lipman as the man in control of the company. The company, said Russell J portentously at p 836, was “a device and a sham, a mask which [Mr Lipman] holds before his face in an attempt to avoid recognition by the eye of equity”. On the other hand, as against Alamed Ltd itself, the decision was justified on the evasion principle, by reference to the Court of Appeal’s decision in Gilford Motor Co. The judge must have thought that in the circumstances the company should be treated as having the same obligation to convey the property to the plaintiff as Mr Lipman had, even though it was not party to the contract of sale. It should be noted that he decreed specific performance against the company notwithstanding that as a result of the transaction, the company’s main creditor, namely the bank, was prejudiced by its loss of what appears from the report to have been its sole asset apart from a possible personal claim against Mr Lipman which he may or may not have been in a position to meet. This may be thought hard on the bank, but it is no harder than a finding that the company was not the beneficial owner at all. The bank could have protected itself by taking a charge or registering the contract of sale. [34] These considerations reflect the broader principle that the corporate veil may be pierced only to prevent the abuse of corporate legal personality. It may be an abuse of the separate legal personality of a company to use it to evade the law or to frustrate its enforcement. It is not an abuse to cause a legal liability to be incurred by the company in the first place. It is not an abuse to rely upon the fact (if it is a fact) that a liability is not the controller’s because it is the company’s. On the contrary, that is what incorporation is all about. Thus in a case like VTB Capital, where the argument was that the corporate veil should be pierced so as to make the controllers of a company jointly and severally liable on the company’s contract, the fundamental objection to the argument was that the principle was being invoked so as to create a new liability that would not otherwise exist. The objection to that argument is obvious in the case of a consensual liability under a contract, where the ostensible contracting parties never intended that any one else should be party to it. But the objection would have been just as strong if the liability in question had not been consensual. [35] I conclude that there is a limited principle of English law which applies when a person is under an existing legal obligation or liability or subject to an existing legal restriction which he deliberately evades or whose enforcement he deliberately frustrates by interposing a company under his control. The court may then pierce the corporate veil for the purpose, and only for the purpose, of depriving the company or its controller of the advantage that they would otherwise have obtained by the company’s separate legal personality. The principle is properly described as a limited one, because in almost every case where the test is satisfied, the facts will in practice disclose a legal relationship between the company and its controller which will make it unnecessary to pierce the corporate veil. … For all of these reasons, the principle has been recognised far more often than it has been applied. But the recognition of a small residual category of cases where the abuse of the corporate veil to evade or frustrate the law can be addressed only by disregarding the legal personality of the company is, I believe, consistent with authority and with long-standing principles of legal policy. LADY HALE: [90] Lord Sumption refers to the process compendiously as “disregarding the separate personality of the company” at [16]. When considering its scope, however, it may be helpful to consider what the purpose of doing this is. In Salomon v A Salomon and Co Ltd the purpose was to go behind the separate legal personality of the company in order to sue Aron Salomon personally for a liability that was legally that of the company which he had set up (with himself and members of his 182

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Prest v Petrodel Resources Ltd cont. family as shareholders) to conduct his leather and boot-making business. This succeeded at first instance and in the Court of Appeal, Lindley LJ going so far as to say that “Mr Aron Salomon’s scheme is a device to defraud creditors”: [1895] 2 Ch 323, 339. They did not think that Parliament had legislated for the setting up of limited liability companies in order that sole traders should be able to conduct their businesses on limited liability terms. But the House of Lords disagreed: the company was a separate person from Mr Salomon and he could not be made liable for the company’s debts. They did not think that there was any fraud involved simply in using a limited liability company as a vehicle for conducting a legitimate business. Thus was the legal structure of modern business born. [91] But there are a few cases where the courts have apparently been prepared to disregard the separate personality of a company in order to grant a remedy, not only against the company, but also against the individual who owns and/or controls it. Both Gilford Motor Co Ltd v Horne and Jones v Lipman are examples of this. In both those cases, it so happened that the controller had a pre-existing legal obligation which he was attempting to evade by setting up a company, in the one case a contractual obligation not to compete with his former employers, in the other case a contractual obligation to sell some land to the claimant. In In re Darby [1911] 1 KB 95, on the other hand, the liquidator of a creditor company was permitted to go behind the separate personality of a debtor company registered in Guernsey in order to obtain a remedy personally against its promoters who had fraudulently creamed off the profit from the sale by the Guernsey company to the creditor company of a worthless licence to run a slate quarry in Wales. [92] I am not sure whether it is possible to classify all of the cases in which the courts have been or should be prepared to disregard the separate legal personality of a company neatly into cases of either concealment or evasion. They may simply be examples of the principle that the individuals who operate limited companies should not be allowed to take unconscionable advantage of the people with whom they do business. But what the cases do have in common is that the separate legal personality is being disregarded in order to obtain a remedy against someone other than the company in respect of a liability which would otherwise be that of the company alone (if it existed at all). In the converse case, where it is sought to convert the personal liability of the owner or controller into a liability of the company, it is usually more appropriate to rely upon the concepts of agency and of the “directing mind” (discussed below at [4.145]). [Lord Sumption considered that the legal interest in the properties was vested in the companies and not in the husband and that there was no evidence that he was seeking to avoid any obligation which was relevant in the current proceedings. It followed that the piercing of the corporate veil could not be justified by reference to any general principle of law. But since the assets had been purchased by the company with funds lent by the husband, the company held them on trust for the him and they fell within the scope of the court’s power to make property transfer orders. Other members of the Court expressed agreement with Lord Sumption’s formulation save for Lord Clarke who considered that the distinction between concealment and evasion had not been discussed in the course of the argument and should not be definitively adopted “unless and until the court has heard detailed submissions upon it” (at [103]) and, in so far as Lady Hale differed from Lord Sumption, Lord Wilson who expressed agreement with her).]

[4.68]

1.

Notes&Questions For instances where an express agency was found between a company and its controlling shareholder, see Rainham Chemical Works Ltd v Belvedere Fish Guano Co Ltd [1921] 2 AC 465 and Southern v Watson [1940] 3 All ER 439. In Kodak Ltd v Clark [1903] 1 KB 505 no agency was inferred where 98% of the capital of a company was held by another company. The remaining capital was held by independent persons and there was no evidence that the parent company had ever sought to control the management of the subsidiary other than by voting as a shareholder. For cases where [4.68]

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the court declined to infer an agency between a company and a personal shareholder, see Gorton v FCT (1965) 113 CLR 604 at 624-625; but see Windeyer J (dissenting) at 627 and Clarkson Co Ltd v Zhelka (1967) 64 DLR (2d) 457. 2.

3.

4.

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Would the six factors identified by Atkinson J in Smith Stone and Knight apply where a company held all the capital of another, appointed all its directors, received distributions of its profits by way of dividends, approved budgets prepared by the subsidiary’s board and monitored progress in meeting them? Would they apply to every wholly-owned subsidiary or only when there is a requisite degree of financial and managerial integration between the entities? What other factors might influence the court to infer an agency? On Smith Stone and Knight see J Harris (2005) 23 C&SLJ 7 and, more generally on veil piercing, J Harris & A Hargovan (2011) 26 Aust Jnl of Corp Law 39. Ramsay and Noakes examined 104 Australian veil piercing cases. They found that the argument for veil piercing was accepted in 40 cases (38.5%), a lower proportion than that found in like studies in the United States (40%) and the United Kingdom (47%): see n 4 below. They found that the veil was more frequently pierced in proprietary companies (42%) than public companies (22%). The veil was most frequently pierced in companies with one shareholder (50%); for companies with two or three shareholders the figure fell to 37%. The veil was pierced in 43 per cent of cases where the shareholder was a natural person but only in 33% of cases where the shareholder is another (parent) company. (Can you explain this difference which might be thought counter intuitive (see [4.105]?) However, it replicates United States research outcomes (see n 4 below)). Veil piercing applications had their highest prospect of success in relation to private contracts, eg, to enforce a contractual remedy or seek an injunction (45%). The next most successful instances concerned specific statutes (43%) (the argument was most frequently made in this context, in 56 of the 104 cases), and tort cases (36% but only in 14 cases). Piercing arguments were most successful when expressed in terms of unfairness/injustice (60%) although argument was put in those terms only in 10 cases. Fraud was raised in 12 cases and had the next highest success rate (42%). Agency was raised, however, in 63 cases and succeeded in 40% of them. The piercing argument was made on the basis of group enterprise in 33 cases with a success rate of 24%. See I M Ramsay & D B Noakes (2001) 19 C&SLJ 250. The Australian study in n 3 followed a like empirical study by Thompson of 2,000 veil piercing cases in the United States to 1985 (mostly in the immediately preceding 30 years): R B Thompson (1991) 76 Cornell L Rev 1036. He found that in none of these cases was the veil pierced in a publicly held company. His findings are generally similar to those from Ramsay and Noakes’s Australian study (see n 3), in overall success rates (40%) and in the greater propensity to pierce in one shareholder companies (50%) and for two and three shareholder companies (46 and 35%, respectively). Courts were also more willing to pierce in contract (42%) contexts than in torts (31%). There were 779 contracts cases and only 226 torts cases. Although two-thirds of the tort cases involved a corporate defendant, courts pierced in less than one quarter of the parent-subsidiary cases where a tort claim was made. Thomson concludes that “piercing law is rooted in concerns of inequitable bargains” (at 1,068). The reasons most commonly associated with successful veil piercing were “instrumentality” (the company is no more than an instrument for its shareholders) (97% success rate when mentioned by the court), “alter ego” (96%), misrepresentation as to the company’s assets and/or as to the party responsible for payment (94%), agency (92%) and “dummy” (90%). Among the factors that led less often to a piercing [4.68]

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result were shareholder domination and control (57%), failure to follow corporate formalities (67%) and undercapitalisation (73%). Shareholder domination and control was by far the most frequently mentioned factor in the cases (551) followed by alter ego (181), officers (174) and misrepresentation (169). There was a total overlap of factors in 812 cases; undercapitalisation was mentioned in only 120 cases. For a similar study of United Kingdom cases see C Mitchell (1999) 3 Co Fin’l & Insol L Rev 15. 5.

From 1973 to 1983 A and B carried on a business in partnership; from 1983 the business was conducted by a private company as trustee of a family trust for the benefit of A’s and B’s families. C prepared the tax returns of the business from the outset and negligently understated the relevant depreciation allowance from 1974 onwards. May A and B recover damages for the full loss sustained after 1974 or only until incorporation in 1983? See Walker v Hungerfords (1987) 19 ATR 435: discussed in H A J Ford (1988) 5 ACLB 80.

6.

Acting upon misguided advice from his accountant as to the taxation advantages of doing so, D transfers a parcel of shares in Westpac which he has long held to a shelf company acquired from the accountant. D holds all the beneficial equity in the company. When the company is forced to sell the shares some months later, it makes a profit over its acquisition cost for which it is brought to tax. May D assert that no beneficial interest in the shares passed to the shelf company and that the latter’s acts should be attributed to D? See Dennis Willcox Pty Ltd v Federal Commissioner of Taxation (1988) 14 ACLR 156.

A residual category for the interests of justice? [4.70] In Prest v Petrodel Resources Ltd (see [4.65]) Lord Neuberger, after concluding that

the veil piercing doctrine “appears never to have been invoked successfully and appropriately in its 80 years of supposed existence”, considered whether it “should be given its quietus” (at [79]). He thought, however, that “it would be wrong to discard a doctrine which, while it has been criticised by judges and academics, has been generally assumed to exist in all common law jurisdictions, and represents a potentially valuable judicial tool to undo wrongdoing in some cases, where no other principle is available” (at [80]). Lady Hale considered that ostensible piercing cases “may simply be examples of the principle that the individuals who operate limited companies should not be allowed to take unconscionable advantage of the people with whom they do business” (at [92]). Does either formulation support the claim that courts will use their “powers to pierce the corporate veil if it is necessary to achieve justice irrespective of the legal efficacy of the corporate structure under consideration. … [since] the principles of Salomon v Salomon & Co Ltd [apply] only prima facie”? 30 Would it be feasible and desirable to fashion a general exception to Salomon in terms, for example, as where the interests of justice require it? Is there a preferable alternative formulation?

30

Re a Company [1985] BCLC 333 at 337-338 per Cumming-Bruce LJ, citing Lord Denning MR in Wallersteiner v Moir [1974] 1 WLR 991 at 1,013. The principle is not, however, universally accepted. In Trustor AB v Smallbone (No 2) [2001] 1 WLR 1177 at [21], Sir Andrew Morritt V-C declined to accept the proposition that the veil may be pierced where it is necessary to do so in the interests of justice and no unconnected third party was involved; the English Court of Appeal in VTB Capital PLC v Nutritek International Corp [2012] EWCA Civ 808 agreed (at [72]). See generally discussion at J H Farrar (2014) 29 Aust Jnl of Corp Law 23. [4.70]

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CORPORATE GROUPS Legal recognition of corporate groups [4.75] We have so far spoken of the company as though it were a single isolated entity

operating in a milieu of like nuclear units. This atomistic picture may be an apt description of much small business but, even here, a group of companies will often be employed to perform complementary functions within a single enterprise. Among large scale business, the group of companies is the dominant organisational structure. 31 Corporate group is not a term with a clear single meaning although it generally refers to “a number of companies which are associated by common or interlocking shareholdings, allied to unified control or capacity to control”. 32 There are two competing legal conceptions of the group: • as a family of subsidiary companies under a holding company which has majority ownership or voting control of the subsidiary companies; or • as an economic entity of a parent and its controlled entities under a broader and more generally expressed definition of corporate control. These two conceptions are examined shortly (at [4.90]), following an account of the incidence of corporate groups and some issues they pose for corporate law.

The incidence of corporate groups [4.80] Corporate groups are formed or gradually evolve for a variety of reasons:

• as the consequence of company takeovers following the acquisition of all or a majority of the shares of another company; taxation and stamp duty law favour this mode of acquisition over the purchase of the assets of the acquired business; • to achieve organisational efficiencies by segregating different businesses or functions into separate companies; • to maximise the benefits of limited liability by isolating the risk of business failure in a single entity; and • in the case of partly owned subsidiaries, to obtain control of another entity and access to its resources without the cost of acquiring all of its share capital. Some corporate groups may be primarily hierarchical or vertical in structure with layer upon layer of controlled companies. Others may be more horizontal, with a lesser number of corporate levels and a greater number of sibling entities at the same level, perhaps with some cross-ownership supporting control by the parent. 33 The motive for choice of group structure may be a preference for a particular financial and managerial structure; ownership structure is 31

For a detailed study of the growth of corporate group structure in the United States, Britain and Germany see A D Chandler, Scale and Scope: The Dynamics of Industrial Capitalism (1990). See generally Companies & Securities Advisory Committee, Corporate Groups: Discussion Paper (1998); I Ramsay & G Stapledon, Corporate Groups in Australia (Research Report, Centre for Corporate Law and Securities Regulation, University of Melbourne,1998); M Gillooly (ed), The Law Relating to Corporate Groups (1993); R P Austin, “Corporate Groups” in R B Grantham & C E F Rickett (eds), Corporate Personality in the 20th Century (1998); J McCahery, S Picciotto & C Scott (eds), Corporate Control and Accountability (1993), Pt IV; P Blumberg, K A Strasser, N L Georgakopoulos & E J Gouvin, Blumberg on Corporate Groups (2nd ed, 2005); P I Blumberg, The Multinational Challenge to Corporation Law (1993); P I Blumberg (1996) 28 Connecticut L R 295; T Hadden, The Control of Corporate Groups (1983) and (1984) 12 Int J Soc Law 346; D Sugarman and G Teubner (eds), Regulating Corporate Groups in Europe (1990); F Wooldridge, Groups of Companies: The Law and Practice in Britain, France and Germany (1981); K J Hopt (ed), Groups of Companies in European Laws (1982). For institutional histories of one leading modern group, see C Wilson, The History of Unilever (1954, 2 vols) and Unilever 1945-1965 (1968); D K Fieldhouse, Unilever Overseas (1978).

32 33

Walker v Wimborne (1976) 137 CLR 1 at 6 per Mason J. Companies and Securities Advisory Committee, Corporate Groups: Discussion Paper (1998), p 2.

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not, however, a sure guide to management structure since some groups with 100% ownership of subsidiaries nonetheless allow them high levels of financial and management autonomy. Some models are explored by Hadden et al at [4.100]. An empirical study of group structures within Australia’s largest listed companies in 1997 reported the following characteristics: • 89% of the sample had at least one controlled entity; • on average each listed company had 28 controlled entities (median of 11); • 90% of controlled entities were wholly owned; • 8.6% of controlled entities were controlled by a listed company holding (directly or through interposed companies) holding between 50 and 100% of their share capital; • only 1.3% were controlled by a listed company holding less than 50% of the shares; • as the size of the listed company decreased, so also did the number of its controlled entities; and • the average company in the sample had 11 first level controlled entities, 10.4 second level controlled entities and 5.5 on the third level. 34

The Patrick group restructure and its industrial aftermath [4.85] The dispute between the Patrick group of companies and the Maritime Union of

Australia during Easter 1998 attracted great public interest and exposed the concept of the corporate group to wider scrutiny. The Patrick group had long conducted stevedoring operations across Australia. In September 1997 the group was restructured so that several companies in the group (the employer companies) sold their businesses and assets to another company in the group (the stevedoring company) but continued to employ staff. The employer companies used the major part of the sale proceeds to buy back a large portion of their own shares and to repay debts. In order to secure the necessary labour for its operations, the stevedoring company entered into labour supply contracts with the employer companies, terminable without notice if there was any interruption in the supply of labour. When employees took industrial action early in 1998, 35 the stevedoring company terminated the labour supply agreements. The employer companies thereby lost their only significant income, became insolvent since they had no means to discharge continuing employment contracts, and had external administrators appointed to manage their affairs. The stevedoring company immediately entered into contracts for the provision of labour by a new workforce. The High Court upheld orders of the Federal Court restraining the employer and stevedoring companies from giving effect to the terminations of employment, subject to the statutory powers of the administrators. 36 The union did not invoke company law remedies. Had it done so, the directors of the employer companies might have been found in breach of their fiduciary duties and duties of care by stripping their companies of assets and thereby prejudicing their capacity to pay their employees’ entitlements. 37 When the Corporations Act was introduced in 2001 it contained new provisions in Pt 5.8A giving the liquidator and 34

Ramsay & Stapledon, pp 3-10.

35

The action was in protest at the leasing of dock space by Patricks to companies controlled by the National Farmers Federation. The union considered that these companies would seek to recruit non-union labour. Maritime Union of Australia v Patrick Stevedores No 1 Pty Ltd (1998) 27 ACSR 497 (Federal Court); Patrick Stevedores Operations No 2 Pty Ltd v Maritime Union of Australia (1998) 27 ACSR 521 (Full Federal Court); Patrick Stevedores Operations No 2 Pty Ltd v Maritime Union of Australia (No 3) (1998) 27 ACSR 535 (High Court). D A Kingsford-Smith, J Riley & L Aitken (1998) 10 BCLB 172.

36

37

[4.85]

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employees of a failed company remedies against persons who enter into transactions with the intention of preventing or inhibiting recovery of employee entitlements.

The evolving legal conception of the corporate group [4.90] The concept of the corporate group starts with that of the subsidiary company and its

correlative, the holding company. These terms and their cognates, the related company, the ultimate holding company and the wholly-owned subsidiary, are defined in Pt 1.2, Div 6. 38 A subsidiary company is one in which another company (the holding company or, colloquially, the parent company): • controls the composition of the board; • is in a position to cast, or control the casting of, more than half of the votes in a general meeting; or 38

The Act uses the term “body corporate” rather than “company”. Accordingly, its reach extends beyond registered companies to other incorporated forms such as statutory corporations and incorporated associations. However, for ease of reference and in view of the primary focus of the Act’s provisions, the term company is used here.

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• holds more than half of the share capital 39 of another company, the subsidiary company: s 46. Without limiting other modes of control of board composition, a company controls the composition of the board of a second company if it has the power to appoint or remove all or the majority of the directors of that company even if only with the consent of another person; a company is deemed to have that power if • no person can be appointed to the board of the second company without the exercise by the first company of the power in favour of that person (the power might derive from the company’s constitution or an agreement between members); or • the person’s appointment as director of the second company follows necessarily from the person being a director of the first (typically by provision in the constitution of the second company): s 47. Alternatively, a company will be a subsidiary of another if it is a subsidiary of a subsidiary of that other: s 46(b). Where the holding company owns the whole of the share capital of the subsidiary (either directly or through nominees or subsidiaries with no outside interests), it is called a wholly owned subsidiary: s 9. A holding company that is not itself the subsidiary of another company is the ultimate holding company: s 9. The ultimate holding company and its subsidiary companies are known commonly, but not exclusively, as a group of companies (s 9); each member of the group is said to be related to the others: s 50. The notions of control of voting and board composition in the definition of a subsidiary are inherently uncertain, an uncertainty exacerbated by the virtual absence of judicial interpretation of the provisions until recently; thus, basic questions such as whether de facto voting control which did not rest upon a legal right or power is sufficient for the section remained unresolved until the mid 1990s. In Mount Edon Gold Mines (Aust) Ltd v Burmine Ltd Europa held 38.5% of the voting shares in Burmine and its nominees were in a majority on its board. The other shareholdings in Burmine were widely dispersed. Europa and Burmine both regarded the latter as Europa’s subsidiary and Europa’s financial statements were drawn upon this basis. Burmine had consistently stated in its annual reports and returns lodged with ASIC that Europa was its ultimate holding company. The court held, however, that these facts alone did not create the subsidiary-holding company relationship which had been assumed to exist: [P]ractical or de facto control, in the absence of any such legally enforceable power, does not suffice to establish the relationship of holding company and subsidiary, pursuant to s 46(a)(i) [control of board composition] …, whatever other effect such measure of control might have. It is not sufficient … that, as a matter of commercial practice, possession of a substantial percentage of the shares of company, being less than 50%, will ordinarily be enough to determine the result of an ordinary resolution at a general meeting of the company. 40

In Bluebird Investments Pty Ltd v Graf this interpretation of s 46(a)(i) was adopted and applied. However, the argument was raised there that a 22% shareholding might in the circumstances satisfy the test in s 46(a)(ii), viz, the holder is in a position to cast, or control the casting of, more than half of the votes in a general meeting. The court interpreted the reference to the words “is in a position to cast” alongside the words “control of casting” the relevant votes as indicating that some arrangements falling short of control, may nonetheless suffice to bring about a subsidiary/holding company relationship, where the putative holding company is actually in a 39

A person holds shares if their name is entered in the company’s register of members in respect of those shares. The section is not confined to voting shares (NCSC v Brierley Investments Ltd (1988) 14 ACLR 177 at 184) although certain shareholdings are disregarded: s 48.

40

Mount Edon Gold Mines (Aust) Ltd v Burmine Ltd (1994) 12 ACSR 727 at 748. [4.90]

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position where it can vote more than 50% of the total votes capable of being cast. … In short, an actual power, revocable or not, legally enforceable or not, to cast more than 50% of the votes does suffice to satisfy the “present ability” alternative, so long as it does not depend on further action of support and is not under the control of another person. So too suffices actual enforceable control of that voting capacity. 41

By this time, however, wider concepts of control were progressively supplanting that of the related company as the legally relevant identifiers of affinity relationships. They are canvassed below in this paragraph. Australian company law does not provide a distinct legal regime dedicated to the corporate group. The Corporations Act makes frequent references to the concept of related companies, generally to extend the reach of its provisions in ways that acknowledge the realities of group structure and control. 42 The Income Tax Assessment Act 1936 (Cth), s 80G, makes a major concession to group enterprise by permitting the transfer of trading losses between resident companies within a group where there is 100% common ownership between the transferor and the transferee throughout the financial year. By this measure the losses of one company in a group may be offset against the profits of another company in the group. One of the first uses of the related company concept in companies legislation was to give effect to a concern that control of a company might be entrenched by shareholdings in the company held by other companies which are themselves under the control of the first company. Accordingly, legislation has long prohibited a company from being a member of its holding company and declared void any allotment or transfer to the subsidiary of shares in the holding company. The diagram in [4.85] shows in 1990 a shareholding by David Jones Ltd in the Adelaide Steamship Co Ltd which would breach this prohibition if David Jones was a subsidiary of Adelaide Steamship Co; if, however, David Jones was controlled by, without being a subsidiary of, the Adelaide Steamship Co, the prohibition would have been avoided. (The legality of this particular cross-holding was never tested.) Partly in response to such notorious instances of evasion of the spirit if not the letter of this prohibition, it was broadened in 1998 by prohibiting shareholding by a controlled entity in its controller (ss 259B, 259C); control is measured now by reference to a wider and more fluid standard through the capacity to determine the outcome of decisions about the financial and operating policies of the entity, a capacity marked by • the practical influence that the putative controller has rather than the rights it can enforce; and • any practice or pattern of behaviour affecting those policies: s 259E. 43 Similarly, companies legislation has for some time required the preparation of group accounts for the holding company and its subsidiaries and latterly their consolidation into a single set of accounts. By these measures the picture of the total group can be seen and the manipulative effect of intra-group transactions which distort the position of individual companies is eliminated. However, these group accounting requirements might be, and not infrequently 41

Bluebird Investments Pty Ltd v Graf (1994) 13 ACSR 271 at 282-283.

42

See, eg, s 11 (associates of a company include related companies and their directors and secretaries); s 411(1A) (facilitating shareholder meetings in schemes of reconstruction affecting large corporate groups); s 588V (the liability of a holding company for insolvent trading by a subsidiary); s 600A (power of the court to modify the outcome of decisions taken at creditors’ meetings which are controlled, inter alios, by related companies).

43

This control standard is also applied in the like prohibition upon a company taking security over shares in a company which controls it: s 259C. However, the prohibition upon giving financial assistance for the acquisition of shares is expressed to apply only with respect to shares in the company or its holding company: s 260A. See further on the identification of appropriate concepts of corporate control in this area P Edmundson (1997) 15 C&SLJ 264 and [9.130].

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were, evaded by “off-balance sheet” reporting of interests in entities effectively under the control of a group company but where the interests are structured so that the entity falls outside the definition of a subsidiary company. 44 In 1991 the group reporting obligation was recast to include the total economic entity constituted by the reporting company and all other entities, incorporated and unincorporated, which it controls. This is achieved by drawing upon the definition of a controlled entity contained in the accounting standard dealing with consolidated accounts. Under that definition control is the capacity of an entity to dominate decision-making, directly or indirectly, in relation to the financial and operating policies of another entity so as to enable that other entity to operate with it in pursuing the objectives of the controlling entity. 45

The commentary on the standard identifies factors normally indicating the existence of control of one entity by another. They include the existence of an arrangement which, in substance, gives an entity the capacity to enjoy the majority of the benefits and to be exposed to the majority of the risks of another entity notwithstanding that control may appear to be vested in another. The accounting standard definition of control was also adopted in another significant context of the Act, 46 which development marked a further step in the gradual eclipse of the related company as the measure of affinity relationships within corporate groups. The accounting definition is in similar, although not identical, terms with the control definition in s 259E applied in the prohibition upon cross-investment. In 1999 a general purpose definition of a controlled entity was introduced into the Act in identical terms to s 259E although it did not automatically supplant the other control standards in the Act and their existing spheres of application: s 50AA. Thus, corporate control relationships within groups are subject to two separate sets of definitions each with their own spheres of application – the related company and the controlled entity. The controlled entity itself has distinct formulations in accounting standards and in particular contexts of the Act. The definitions of subsidiary and controlled entity reflect profound differences in the drafting conventions of the professions from which they are derived: law and accounting, respectively. However, the willing adoption of the accounting conception in the Act also reflects a shift from the “black letter law” style to a “fuzzy law” approach which promotes interpretative freedom to secure policy goals. Denied the benefit of a single statutory definition, the notion of a corporate group is a plural and ambiguous one, taking its precise meaning from the context in which the term is used. That ambiguity is reflected also in the facility introduced into the Act in 2007 to allow the pooling of assets in a winding up of companies in a group so that the group is treated as a single enterprise for purposes of the liquidation. Pooling may be either by voluntary determination or Court order. A pooling determination is made by the liquidator with the approval of 75% of unsecured creditors by value and 50% by number of each of the companies in the group: ss 571, 574. Alternatively, the Court may order that a group of companies in liquidation is a pooled group if it is satisfied that it is just and equitable to do so:

44 45 46

See F L Clarke, G W Dean & K G Oliver, Corporate Collapse – Regulatory, Accounting and Ethical Failure (1997). Accounting Standard 1024: Consolidated Accounts, [9]. See now Accounting Standard 127: Consolidated and Separate Financial Statements; financial reporting obligations are discussed in Chapter 9. Chapter 2E dealing with the prohibition upon the giving of financial benefits to related parties of public companies. However, the accounting standard has since been replaced by the general definition of control contained in s 50AA: s 243E and [7.415]. [4.90]

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s 579E. 47 When a pooling determination or order is made, each company in the group is jointly and severally liable for each debt payable by, and each claim against, each other company in the group; further, debts and claims between group companies are extinguished: ss 571(2), 579E(2). Despite the central use of the term “group of companies” in these pooling provisions, it remains undefined in the Act. However, a pooling determination or order may be made only where all group companies are related companies or some group companies are jointly liable for one or more debts or jointly own or operate property used in connection with a business jointly conducted by group companies: ss 571(1), 579E(1). While these conditions limit the operation of the pooling provisions, they leave uncertain the reach of the provisions beyond related companies to those under de facto or broader notions of control. In practice, this uncertainty is addressed by provisions allowing individual creditors materially disadvantaged by pooling to seek judicial redress: ss 579A(1)(e), 579E(10).

Issues posed by corporate groups [4.95] The cases discussed or extracted at [4.105], [4.120] and [4.125] make it clear that each

company in a group retains its distinct entity status with its own separate liabilities and assets. The issues of legal policy which the corporate group raises range across company law. They include the following: • whether generally or in particular contexts company law should treat the group itself as the relevant legal entity by ignoring the separate entity status of individual members of the group; • what loyalty, if any, should directors of a member company of a group be entitled to extend to the interests of the group as a whole or of other companies in the group, at the expense of their own company’s interests; this issue assumes particular significance in the context of financial transactions between members of the group; • whether the group controllers owe a duty of good faith and fair dealing towards outside minority shareholders in the group companies and what the content of that duty might be; • when the controlling company in the group is liable for the debts of an insolvent member; and • whether there should be a pooling of assets and liabilities in the liquidation of a group of companies. A number of these issues arise in the context of examining whether and in what circumstances courts will ignore individual entity status within the group under an exception to the Salomon principle: see [4.105]. Others are examined elsewhere in the book. 48

47

48

192

The criteria by reference to which the pooling order is made include the extent to which a group company and its officers were involved in the management of other group companies, their conduct towards creditors of other group companies, any intermingling of the business of group companies, and whether the winding up of the pooled companies is attributable to the actions of any of the other group companies and their officers: s 579E(12). For tax law there is the enduring problem of the opportunities through financial integration for a multinational group to avoid taxation obligations in the countries in which its subsidiaries operate by using intra-group transfer pricing to locate profits in low tax countries. [4.95]

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Canadian Business Organisation Law [4.100] T Hadden et al, Canadian Business Organisation Law (Butterworths, 1984) [620] There is a very wide variation in managerial and financial practice within large groups of companies. In some groups, particularly those known as conglomerates, which operate in a variety of business spheres, the separate legal, managerial and financial identity at least of major operating subsidies is recognised and the holding company acts in much the same way as an external controlling shareholder in traditional legal theory, notably by intervening to replace the directors and officers of a subsidiary which is not meeting its targets for growth or profitability. In many other groups, particularly those in which the group’s operations are vertically or horizontally integrated and in which most subsidiaries are wholly owned, there is a tendency for central management at group headquarters to assert much greater control over the day to day activities of its subsidiaries. In such cases, the finances of the groups as a whole are likely to be centralised with banking and corporate finance functions being performed for the entire group through the parent company’s treasury operations. Management in operating subsidiaries is typically required to obtain the approval of group headquarters for all major investments and to report at specified intervals on their trading performance and prospects. They may also be required to price their products for intra-group trading, known as transfer pricing, in such a way as to produce a profit in whichever subsidiary or jurisdiction is most advantageous to the group as a whole. Wholly-owned subsidiaries may be required to make loans, either interest-free or at very low rates of interest, to other companies in the group. In some cases, an entirely distinct divisional structure is superimposed on the formal corporate structure, and the directors and officers of subsidiaries cease to perform any independent function as such. The major exception to this general trend toward the integration of management and finance within large groups is in respect of joint ventures. Because each corporate partner in a joint venture will naturally wish to protect itself against any practice which might affect the return on its investment, there is effective pressure on all sides to ensure that the finances of the joint venture company are kept strictly separate from those of the various parent groups.

[4.102]

1.

2.

3.

Notes&Questions

Assume that the shareholding structure described in the chart (at [4.85]) of shareholdings in and by Adelaide Steamship Co Ltd remains current. (a) Which company is Woolworths Ltd’s ultimate holding company? (This term is defined in s 9.) (b) Assume (again hypothetically) that over the past two decades no more than 50% by number or 70% by value of shareholders have been present, in person or by proxy, at a meeting of shareholders of David Jones Ltd. Would David Jones Ltd then be a subsidiary of Adelaide Steamship Co Ltd and, if so, with what consequences? What legal problems do you anticipate might arise from the widespread adoption of a corporate group structure for business enterprise? Does a distinct set of problems arise where the subsidiaries (a) are not wholly owned, (b) operate through a single treasury operation or (c) operate multinationally through a centralised financial structure? We shall look at such problems at several points in this book. Most common law and European countries treat companies in a corporate group as separate legal entities. However, Germany has three distinct group regimes – the integrated, contract and de facto groups – which public companies may adopt. In an integrated group the holding company may acquire minority interests in a subsidiary company where it holds 95% of its capital; thereafter, the holding company may exercise control over the subsidiary as though it were merely a department of the holding company. The holding company is jointly and severally liable for the debts of the subsidiary. A contract group is established by two companies each voting by 75% [4.102]

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majority to create an enterprise agreement between them giving one company (the parent company) the right to direct the other and to conduct its affairs in the interests of the parent or the group as a whole. In exchange, outside shareholders in the controlled company receive certain dividend rights and may seek to be bought out on fair terms. The parent company may be liable for the debts of the controlled company. A de facto group is recognised where a company exercises a dominant influence over another through the exercise of broad and systematic influence in its affairs. The controlling company is entitled to use its influence to the detriment of the other company only if it compensates that other and files an annual report identifying any detriment. Minority shareholders may also seek judicial review of intra-group transactions. This account of the German system is substantially derived from Companies and Securities Advisory Committee, Corporate Groups: Discussion Paper (1998), pp 21-23. See also T Hadden (1992) 15(1) UNSWLJ 61 at 81-85. Corporate personality within corporate groups [4.105] At numerous instances in this book we consider the particular application of

company law principles to a group of companies such as the duties of directors within corporate groups: see [7.315]. The treatment in this section is confined to doctrines relating to corporate personality. Subject to the legislative provisions which provide some limited recognition to the group as an economic entity (and to that extent blur distinctions between the personalities of constituent members), the norm formally persists that the separate personality of each company is not diminished by its membership of the group. Thus, directors of a company within a group are obliged to act by reference to their perception of its interests, and not those of the group generally. 49 Absent special contractual arrangements, statutory obligations or veil piercing, creditors of each company within the group are entitled to look only to the resources of that company for the discharge of their debts and obligations. Thus, it is said in two different sources: English company law possesses some curious features which may generate curious results. A parent company may spawn a number of subsidiary companies. … If one of the subsidiary companies, to change the metaphor, turns out to be the runt of the litter and declines into insolvency to the dismay of its creditors, the parent company and other subsidiary companies may prosper to the joy of the shareholders without any liability for the debts of the insolvent subsidiary. 50 Save in cases which turn on the wording of particular statutes or contracts, the court is not free to disregard the principle of Salomon v A Salomon & Co Ltd merely because it considers that justice so requires. Our law, for better or worse, recognises the creation of subsidiary companies which though in one sense the creatures of their parent companies, will nevertheless under the general law fall to be treated as separate legal entities with all the rights and liabilities which would normally attach to separate legal entities. 51

Yet, in this area UK courts have sometimes been less reluctant to pierce the veil. Thus, in DHN Distributors Ltd v Tower Hamlets London Borough Council the ownership of the business, land and operating vehicles used in a single business operation were divided between three companies in a wholly owned corporate group. The English Court of Appeal held that the separate group structure should not defeat the parent company’s claim for compensation for disturbance of the business that would otherwise be available if they were conducted under a unitary rather than a group structure. Lord Denning said: 49

Charterbridge Corp Ltd v Lloyd’s Bank Ltd [1970] Ch 62 at 74.

50 51

Re Southard & Co Ltd [1979] 1 WLR 1198 at 1208 per Templeman LJ. Adams v Cape Industries Plc [1990] 2 WLR 657 at 753.

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This group is virtually the same as a partnership in which all the three companies are partners. They should not be treated separately so as to be defeated on a technical point. … The three companies should, for present purposes, be treated as one, and the parent company DHN should be treated as that one. 52

Goff LJ added: I would not at this juncture accept that in every case where one has a group of companies one is entitled to pierce the veil, but in this case the two subsidiaries were both wholly owned; further, they had no separate business operations whatsoever; third, in my judgment, the nature of the question involved is highly relevant, namely, whether the owners of this business have been disturbed in their possession and enjoyment of it. 53

The DHN case is perhaps the most liberal, but by no means the only, instance of willingness to pierce the veil within a group of companies. 54 However, in the House of Lords in Woolfson v Strathclyde Regional Council, Lord Keith (with whom Lord Wilberforce, Lord Fraser and Lord Russell of Killowen agreed) said concerning DHN: I have some doubts whether …. the Court of Appeal properly applied the principle that it is appropriate to pierce the corporate veil only where special circumstances exist indicating that it is a mere façade concealing the true facts. 55

It may be doubted whether any modest English liberalism, whatever its scope and authority (as to which see also the discussion at [4.45]-[4.70]), is reflected in Australian jurisprudence; Australian courts have been less disposed to disregard form in favour of substance in this area. 56 Thus, the High Court in Walker v Wimborne asserted “the fundamental principles that each [company within a group is] a separate and independent legal entity, and that it was the duty of the directors of [each company] to consult its interests and its interests alone in deciding whether payments should be made to other companies.” 57 Similarly, in Industrial Equity Ltd v Blackburn the question arose as to whether in ascertaining the amount of profits available for distribution by a holding company by way of dividend it is correct to look at the profit of the holding company itself or to the group profit as disclosed by the consolidated accounts. Mason J (with whom the other members of the court agreed) said: it can scarcely be contended that the [consolidation] provisions of the [Companies] Act operate to deny the separate legal personality of each company in the group. Thus, in the absence of

52

[1976] 1 WLR 852 at 860.

53 54

DHN Distributors Ltd v Tower Hamlets London Borough Council [1976] 1 WLR 852 at 861. See also Antonio Gramsci Shipping Corp v Stepanovs [2011] EWHC 333 (Comm); [2011] 1 Lloyd’s Law Reports 647; Littlewoods Mail Order Stores Ltd v IRC [1969] 1 WLR 1241 at 1254; Littlewoods Organisation Ltd v Harris [1977] 1 WLR 1472 at 1482-3; The Albazero [1977] AC 774; Lonhro Ltd v Shell Petroleum Co Ltd [1980] 2 WLR 367 at 373-376, 377-378 (CA); [1980] 1 WLR 627 at 634-646 (HL); but see contra Woolfson v Strathclyde Regional Council 1978 SC (HL) 90 and Multinational Gas and Petrochemical Co v Multinational Gas and Petrochemical Services Ltd [1983] Ch 258. Where the veil has been lifted in English decisions, it has usually assisted, not imposed obligations upon, the members concealed behind it.

55

1978 SC (HL) 90 at 161.

56

In practice, in Australia parent companies do walk away from insolvent runts of the group litter. Modern instances include H G Palmer Consolidated Ltd whose collapse in the early 1960s led to well-known economic tort litigation against its parent (Mutual Life and Citizen’s Assurance Co Ltd v Evatt [1971] AC 793) and the failure in 1979 of Associated Securities Ltd, a subsidiary of Ansett Transport Industries Ltd. Their ability to do so now is affected by possible liabilities as a holding company under Pt 5.7B, Div 5. A significant exception, reflecting an unusually well organised and hostile public response, concerned the James Hardie Industries group, discussed at [4.127], n 7. (1976) 137 CLR 1 at 6-7.

57

[4.105]

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contract creating some additional right, the creditors of company A, a subsidiary company within a group, can look only to that company for payment of their debts. 58

The following judgments in Briggs v Hardie [4.120] and Qintex v Schroders [4.125] reveal tensions between commercial and legal norms in this area. The legal issue arising in Qintex might be thought to be partly addressed by the new statutory pooling facility; however, doubt persists as to whether the new procedure addresses the problem arising in Qintex, namely, where the affairs of the group are so intertwined that creditors do not know which company they dealt with. 59 The case for limited liability appears weaker in the context of a corporate group. Blumberg has argued for the fundamentally different force of the claimed economic advantages of limited liability in a group rather than a unitary context: 60 • shareholders in a group are not atomistic, unequal contributors of capital but a cohesive group small in number with a capacity and disposition for active participation in management of the enterprise; • limited liability in a corporate group operates to provide multiple layers of insulation from liability; piercing one layer does not expose the “ultimate” shareholders to personal liability; and • there are commonly sophisticated information flows between management and shareholders within a corporate group which generally have no counterpart in unitary structures. It cannot be said, however, that economic analysis has played an explicit part in those decisions which have blurred the distinct entity status of a group member. As noted at [4.15], the rationale for limited liability is weaker in relation to tort claims since victims have no choice in relation to the identity and financial capacity of their tortfeasor; accordingly, limited liability permits the externalisation of risk and creates a moral hazard problem for claimants. These policy weaknesses are multiplied in the context of global business operations where production and extractive industries (such as mining, oil and gas extraction) shift to high-risk, less regulated environments with greatly expanded scope for adverse human rights impacts: see [2.245]. In a negligence claim against a Canadian parent for alleged human rights abuses by employees of a Guatemalan subsidiary, the policy argument was accepted as relevant to a strike-out motion that “tort law should be evolving to accord with globalization, and local communities should not have to suffer without redress when adversely impacted by the business activity of a Canadian corporation operating in their country. … Ordinary tort doctrine would call for the losses to be allocated to the ultimate cost of the products and borne by the consumers who benefit from them, not disproportionately by the farmers and peasants of the Third World”. 61 These words reflect concerns expressed by Rogers AJA in Briggs v James Hardie & Co Pty Ltd [4.120].

58

Industrial Equity Ltd v Blackburn (1977) 137 CLR 567 at 577. See also Pioneer Concrete Services Ltd v Yelnah Pty Ltd (1987) 5 NSWLR 254; R v McMahon (1976) 2 ACLR 543; for an instance of lifting the veil, see Hotel Terrigal Pty Ltd v Latec Investments Ltd (No 2) [1969] 1 NSWR 676.

59 60

See J Harris (2007) 19 AIJ 28 at 30. P I Blumberg, The Multinational Challenge to Corporation Law (1993), pp 138-147; P I Blumberg (1986) 11 J Corp L 573.

61

Choc v Hudbay Minerals Inc 2013 ONSC 1414 at [73]; the motion to strike the action was dismissed and the suit allowed to proceed to trial.

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Briggs v James Hardie & Co Pty Ltd [4.120] Briggs v James Hardie & Co Pty Ltd (1989) 7 ACLC 841 Court of Appeal of the Supreme Court of New South Wales [The plaintiff is described thus by Rogers AJA: “Mr Briggs is 71 years old. He is a member of the Kumbaingeri tribe. He can sign his name but cannot read or write. In 1946 he moved to Baryulgil and obtained employment at the asbestos mine and mill. When he commenced this employment, he was healthy. He worked at the mine altogether for about six years, between 1946 and 1966. All the time he worked at the mine, he was in contact with asbestos dust and fibre. Since some time in the 1970s, he has been suffering from asbestosis.” Mr Briggs commenced an action in the District Court, claiming damages for the asbestosis which he alleged he contracted whilst working at the mine at Baryulgil. He sued not only Asbestos Mines Pty Ltd (Asbestos), his former employer, but also its holding company, Hardies, and Wunderlich which had a 50% equity in Asbestos until its sale to Hardies in 1953. The action against Hardies and Wunderlich was brought on the basis that Asbestos was acting as agent for Hardies or, alternatively, that, for the purposes of the proceedings, the plaintiff was entitled to pierce the corporate veil. The plaintiff’s application for extension of time in which to sue was granted only against Asbestos.] ROGERS AJA: [848] This undoubtedly afflicted 71-year-old man was therefore confronted with the barriers of the entrenched principles of limited liability, firmly enshrined in the law since the decision of the House of Lords in Salomon v Salomon & Co Ltd [1897] AC 22. With all due humility, I am bound to say that there seems to me to be something wrong with the state of the law when, in order to recover compensation for his apparent asbestosis, a person in the position of this plaintiff has to mount a challenge to fundamental principles of company law. … [854] The plaintiff submitted that the material I have attempted to summarise proves the existence of evidence to show that, initially, the mining operation was conducted by a partnership of Wunderlich and Hardies which determined, inter alia, the destination of output, the price of the product, the decisions to be made by the board of directors of Asbestos and the identity of future shareholders. It was said that the inference may be drawn that there was no room left for a truly independent, separately functioning, corporate entity. It is, of course, clear that in these respects, the relationship between Asbestos, Hardies and Wunderlich was no different from the everyday situation of a holding company and its fully-owned subsidiary. In everything but name, the two are as one. The holding company customarily exercises complete dominion and control over [855] the subsidiary. There is little difference in the situation when, instead of a holding company and a fully-owned subsidiary, there are two shareholders who utilise a third company as the joint venture vehicle. In essence, then, the submission for Hardies and Wunderlich was simple. If it were to be held that during the period of joint shareholding by Hardies and Wunderlich, and later by Hardies by itself, they were the principal, and Asbestos, the agent, then that conclusion could apply in relation to just about every holding company and fully-owned subsidiary and the principle of limited liability in relation to the activities of subsidiaries would be left in tatters. … No settled principle for piercing the corporate veil The threshold problem arises from the fact there is no common, unifying principle, which underlies the occasional decision of courts to pierce the corporate veil. Although an ad hoc explanation may be offered by a court which so decides, there is no principled approach to be derived from the authorities. … In the result, it is a matter of extreme difficulty to say whether the evidence adduced meets even the less than exacting requirements of the section. The rule in Salomon was laid down at a time when economic circumstances were vastly different. The principle of laissez faire ruled supreme and the fostering of business enterprise demanded that the principle of limited liability be rigidly maintained. To date, the effect of incorporation has remained the same, notwithstanding the proliferation of conglomerates, holding companies and subsidiaries. … [861] There are some propositions that may safely be accepted. Thus, the potential only to exercise control over the subsidiary is insufficient. The exercise in fact of some control over the subsidiary is insufficient. Thereafter one enters the uncertain. As was said in the United States in 1905 in United States v Milwaukee Refrigerator Transit Co 142 F 247 (1905), 255: [4.120]

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Briggs v James Hardie & Co Pty Ltd cont. If any general rule can be laid down, … it is that a corporation will be looked upon as a legal entity as a general rule, and until sufficient reason to the contrary appears; but, when the notion of legal entity is used to defeat public convenience, justify wrong, protect fraud, or defend crime, the law will regard the corporation as an association of persons. This amorphous test has not been clarified in the years since for, as is pointed out by Pennington: It is impossible in the present state of the law to determine when the court will imply such an agency or trusteeship. It is noteworthy, however, that the court is more ready to do so when the strict application of the principle of separate personality would result in an anomaly or an injustice, but it is far from true to say that an anomaly or injustice will always induce the court to depart from the strict rule, as the examples given earlier in this chapter show. If exercise of dominance be at least part of the test, what degree of domination is required? (Cf Craig v Lake Asbestos of Quebec Ltd 843 F (2d) 145 [3rd Circ (1988)].) If so, what is the extent of reliance on the parent that is required to be shown? Is undercapitalisation a relevant factor? The law in Australia has not yet fully worked out answers to these and like questions. Unity of enterprise theory The proposition that a company has a separate legal personality from its corporators survived the coming into existence of the large numbers of fully-owned subsidiaries of companies and their complete domination by their holding company: Pennington’s Company Law (5th ed), p 806. There was continued adherence to the principle recognised by Salomon, notwithstanding that for a number of purposes, legislation recognised the existence of a group of companies as a single entity. Adolf A Berle Jnr pointed out in “The Theory of Enterprise Entity” (1947) 47 Col LR 343 that the conglomerate is a long way from the original concept of a corporation. In his view (at 344): The so-called “artificial personality” was designed to be the enterpriser of a project. Multiplicity of artificial personalities within an enterprise unit would probably have been impossible under most early corporation laws. He continued (at 345): The corporation is emerging as an enterprise bounded by economics, rather than as an artificial mystic personality bounded by forms of words in a charter, minute books, and books of account. The consequence of the theory, in circumstances such as the present, are summarised by him (at 348): [862] This category of cases stands still more squarely on the foundation of economic enterprise-fact. The courts disregard the corporate fiction specifically because it has parted company with the enterprise-fact, for whose furtherance the corporation was created; and, having got that far, they then take the further step of ascertaining what is the actual enterprise-fact and attach the consequences of the acts of the component individuals or corporations to that enterprise entity, to the extent that the economic outlines of the situation warrant or require. Such an approach finds a reflection in the passage from Professor Gower quoted by Lord Denning in DHN (see [4.105]). Whilst this approach would solve many problems which are increasingly troubling the courts, its adoption may be foreclosed to Australian courts, below the High Court, as a result of the decision in Industrial Equity Ltd v Blackburn (1977) 137 CLR 567. [The judge referred also to the statements of Mason J in Walker v Wimborne quoted above.] In the result, as the law presently stands, in my view the proposition advanced by the plaintiff that the corporate veil may be pierced where one company exercises complete dominion and control over another is entirely too simplistic. The law pays scant regard to the commercial reality that every holding company has the potential and, more often than not, in fact, does, exercise complete control over a subsidiary. If the test were as absolute as the submission would suggest, then the corporate veil should have been pierced in the case of both Industrial Equity and Walker v Wimborne. It remains to be seen whether the time has come for the development of a more principled approach than the authorities provide at present. 198

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Briggs v James Hardie & Co Pty Ltd cont. The incorrect test applied In my opinion, on the present application, it should not have been held that the plaintiff had failed to prove the availability of evidence which may make out a cause of action against Hardies and Wunderlich. This is for a number of reasons. First, so to hold was to come to a conclusion as to the final outcome of the trial. … [863] Even assuming that the appropriate test in the present case for determining whether the corporate veil should be pierced be the test of agency, his Honour dealt with the question as though he was disposing of the issue finally at a trial rather than at the much less demanding level demanded by s 58(2)(b) of the Limitation Act. In the present state of the law, it is not possible to say what the evidence would ultimately suffice to make out a case. The law on the topic appears to be in a state of flux. It may be that only the High Court and perhaps not even it, can alleviate the consequences of the decision in Salomon so as to adapt the principle of limited liability to the economic realities of today. … Second, the judge fell into error when he said: Having carefully considered the authorities I do not infer agency on behalf of any of the defendants. To begin with the doctrine of lifting the corporate veil has never been invoked in negligence cases. It has been invoked in tax and registration cases and in compensation cases not being compensation for personal injury. His Honour was not referred to, as indeed we were not referred to, decisions in the United States where, in the context of claims in negligence, attempts were made to pierce the corporate veil. Much academic writing … points out how inappropriate are the tests of the kind mentioned by Atkinson J in Smith Stone (supra) to actions in negligence to determine whether or not to pierce the corporate veil. Generally speaking, a person suffering injury as a result of the tortious act of a corporation has no choice in the selection of the tortfeasor. The victim of the negligent act has no choice as to the corporation which will do him harm. In contrast, a contracting party may readily choose not to enter into a contract with a subsidiary of a wealthy parent. The contracting entity may enquire as to the amount of paid-up capital and, generally speaking, as to the capacity of the other party to pay the proposed contract debt and may guard against the possibility that the subsidiary may be unable to pay: cf G L Davies QC The Law of Corporations, unpublished. It seems to me reasonable, as indeed Goff LJ suggested in DHN Food Distributors, that different considerations should apply in deciding whether to pierce the corporate veil in actions in tort from the criteria applied in actions in contract or, for that matter, revenue or compensation cases. Control and dominance by a holding company of a subsidiary do not in themselves increase the risk of injury to tort victims: cf Gillespie, “The Thin Corporate Line; Loss of Limited Liability Protection” (1969) 45 ND Law Rev 363 at 369 et seq. The failure of a corporation to comply with usual corporate formalities, such as shareholders’ and directors’ [864] meetings, useful as it may be as an indicator in an action for debt, has nothing to do with a claim by a pedestrian who has been hit by a motor vehicle owned by an insolvent subsidiary and either uninsured or inadequately insured. The factors of shareholder control and dominance by a parent corporation may be equally irrelevant in determining in actions in tort whether the parent should be held liable. It has been said by Professor Downs in “Piercing the Corporate Veil – Do Corporations Provide Limited Personal Liability?” (1985) 53 UMKC Law Review 95 that “such control and dominance does not increase the risk of injury to tort victims, and, of course, had no connection with the particular negligence alleged.” Even though the proposition may be too broad, there is substance in it. It may be too broad because it may be the exercise of dominance that results in inadequate safety precautions being taken. Again, it may be exercise of control that results in underinsurance. Professor Downs suggested that the real determinant in tort cases should be whether a corporation “should be permitted to shift the risk and responsibility for such occurrences to the victims or the general public by operating the business as a corporation without sufficient capital or insurance to cover foreseeable risks”. I recognise that it is possible to argue that the proposed general tort considerations should not be applicable in cases where the injured person is an employee. It would be argued that such a person has equal opportunity with a contracting party in determining whether or not to enter into the employer/employee relationship out of which the injury arises. [4.120]

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Briggs v James Hardie & Co Pty Ltd cont. However, whilst the employee may be able to choose whether or not to be employed by the particular employer, generally speaking, he has no real input in determining how the business will be conducted and whether reasonable care will be taken for his safety. For the sake of completeness, I should perhaps add that, in Lake Asbestos of Quebec, a claim for personal injury by an employee by reason of exposure to asbestos, the Court of Appeals for the Third Circuit, applying New Jersey law, stated one of the requirements for piercing the corporate veil to be that “the parent so dominated the subsidiary that it had no separate existence but was merely a conduit for the parent”. Lest it be thought that it is only academic writing and the obiter statement of Goff LJ that support the proposition that different considerations need to be applied according to the nature of the case in determining whether to pierce the corporate veil, I should mention the decision of the Court of Appeals for the Third Circuit in Zubik v Zubik 384 F (2d) 267 (1967). The court said (at 273): Cases in bankruptcy or in taxation call for an entirely different evaluation of “fraud” or “injustice” than cases of controlled corporate subsidiaries, or as in this instance, a case of corporate tort. (14) The defrauded creditor or “victim” of a business transaction with an undercapitalised corporation, for instance, often has a strong case for piercing the veil of a “sham” corporation. See 63 ALR 2d 1051. The controversy in such cases invariably involves some degree of reliance by the plaintiff, contributing to the fraud, or undue advantage or trick accenting the injustice. But the injured tort claimant stands on a different footing. It is not contended that the claimants here relied upon Zubik Corp’s being more than a “mere operating company”. Limiting one’s personal liability is a traditional reason for a corporation. Unless done deliberately, with specific intent to escape liability for a specific tort or class of torts, the cause of justice does not require disregarding the corporate entity. The corporate form itself works no fraud on a person harmed in an accident who has never elected to deal with the corporation. Once fraud or injustice demand piercing the corporate veil, then the intertwining of personal affairs with a family corporation can provide additional grounds for arguing that the defendant cannot be heard to complain. In such cases, the failure of various corporate formalities either contributes to the fraud involved or strengthens the argument for injustice by holding the individual in effect estopped. FOOTNOTE (14) Counsel have been unable to cite a case where the corporate entity was disregarded to make an individual liable for tort. As it was stated in Geller v Transamerica Corp 53 F Supp 625 at 631 (D Del 1943): “In the absence of extraordinary circumstances, a court will not disregard the corporate fiction and hold a stockholder liable for the torts of the corporation”. [Hope JA agreed with Rogers AJA that the application should be returned to the District Court for determination according to law. Meagher JA dissented on the ground that the plaintiff was unable to point to any evidence from which the inference might be drawn as to an agency relationship or other basis for lifting the corporate veil.]

Qintex Australia Finance Ltd v Schroders Australia Ltd [4.125] Qintex Australia Finance Ltd v Schroders Australia Ltd (1990) 3 ACSR 267 Supreme Court of New South Wales ROGERS CJ in COMM DIV: [268] On 1 August 1989, the defendant, on behalf of a member of the Qintex group of companies, sold ¥1.2bn, realising $11,560,693.64. The defendant drew a cheque in favour of Qintex Television Ltd, (hereinafter referred to as QTL), a member of the Qintex group of companies. It paid the cheque not into the account of QTL but into the account of the plaintiff with the Commonwealth Bank of Australia, 240 Queen Street, Brisbane. At the same time as receiving directions to effect the sale of the Japanese yen, Mr Hunt, a senior corporate advisor employed by the 200

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Qintex Australia Finance Ltd v Schroders Australia Ltd cont. defendant, received instructions to purchase a forward contract for ¥1.2bn for delivery on 4 December 1989. The exercise price for the contract was $12,054,244.12. On 4 December 1989 the defendant closed out the forward exchange contract at a loss. In the result, an amount of $1,377,137.60 became payable to the defendant by the member of the Qintex group of companies on whose behalf the forward exchange contract had been obtained. On the same day, in purported reduction of the amount payable in respect of the loss on the forward contract, the defendant appropriated $916,206.81 standing to the credit of the plaintiff in a domestic account. On 7 December 1989, the defendant appropriated $153,761.40 from funds standing to the credit of the plaintiff in the “QAFL – Domestic Account No 2304” in further reduction of the amount payable to it. On 4 December US$46,243.41 was appropriated from the defendant’s Euro account. The contest in the present proceedings is to identify the member of the Qintex group of companies on whose behalf the futures exchange contract had been purchased by the defendant on 4 August 1989. Was it the plaintiff, was it QTL, or perhaps another member of the Qintex group? As I see it, there is today a tension between the realities of commercial life and the applicable law in circumstances such as those in this case. In the everyday rush and bustle of commercial life in the last decade it was seldom that participants to transactions involving conglomerates with a large number of subsidiaries paused to consider which of the subsidiaries should become the contracting party. A graphic example of such an attitude appears in the evidence of Ms Ferreira, a dealer in the treasury operations department of the defendant. In her written statement (Ex 3, [26]) she said: In my discussion with either Craig Pratt or Paul Lewis when I confirmed deals undertaken for Qintex, it was not my practice to ask which of the Qintex companies was responsible for the deal. I always treated the client as Qintex and did not differentiate between companies in the group. Paul Lewis and Craig Pratt always talked as being from “Qintex” without reference to any specific company. To record foreign exchange transactions Schroders needed a client code. I was only aware of one client coding for Qintex which was the coding “QTLBR1”. Mr Craig Pratt and Mr Paul Lewis were respectively assistant treasurer and treasury dealer, under the direction of Mr Capps, the group treasurer of Qintex. [269] Again, according to Mr Hunt, the manager of futures of the defendant when, in mid December 1988, he said to Mr Pratt, that “We are looking at the establishment of credit limits for other treasury products for you, we will need to know which company we are looking at”, the response was “It does not matter to us. Choose whichever company you feel the most comfortable with” (Ex 6, [11]). This attitude may have been more extreme than was the norm, but is none the less a reflection of general commercial attitudes. … It may be desirable for Parliament to consider whether this distinction between the law and commercial practice should be maintained. This is especially the case today when the many collapses of conglomerates occasion many disputes. Regularly, liquidators of subsidiaries, or of the holding company, come to court to argue as to which of their charges bears the liability. If an illustration were needed of the futility and inappropriateness of arguments of this kind, it may be found in the facts which ground my decision in Impact Datascape Pty Ltd v McIntosh (unreported, 3 October 1990). As well, creditors of failed companies encounter difficulty when they have to select from among the moving targets the company with which they consider they concluded a contract. The result has been unproductive expenditure on legal costs, a reduction in the amount available to creditors, a windfall for some, and an unfair loss to others. Fairness or equity seems to have little role to play. This may be illustrated by the argument in the present case. The plaintiff had received the proceeds of the sale of ¥1.2bn into its account. Its submission was that the liability, for the forward contract for ¥1.2bn fell on QTL, which it said was the contracting party and that accordingly, the defendant was not entitled to make the set off against moneys standing to the plaintiff’s credit in the books of the defendant. Attractively as the plaintiff’s case was presented, its intrinsic merits were not readily apparent. If I may venture the observation, there is a great deal to be said for the suggestion advanced by those in charge of the demised Hooker group of companies that assets and liabilities of the parent and the subsidiaries should be aggregated. It may be argued that there is justification for preserving the same attitude in relation to the demised companies as was displayed during their active commercial life. [4.125]

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Qintex Australia Finance Ltd v Schroders Australia Ltd cont. [The judge concluded that the facts and documentation pointed to QTL being the party to the contract rather than the plaintiff.]

[4.127]

1.

Notes&Questions

Mr Wren was awarded damages in the Dust Diseases Tribunal for mesothelioma found to have been caused by inhaling asbestos fibres while employed by a wholly owned subsidiary of CSR Ltd. The subsidiary was described as part of CSR’s Building Materials Division and its board of directors and management staff were all employees of CSR. CSR board meetings regularly made routine decisions concerning the subsidiary’s operations and working conditions of the subsidiary’s employees were often determined by policies and directives of the parent. The award against CSR was upheld upon appeal when CSR was held to owe a duty of care to employees of the subsidiary directly and not on a secondary basis by lifting the corporate veil (the latter argument was not made): CSR Ltd v Wren (1997) 44 NSWLR 463 (NSW Court of Appeal) (discussed by R I Barrett (1998) 72 ALJ 286). Given the fact that “the whole of the management staff who had responsibility for the operational aspects of [the subsidiary], and therefore the conditions in which Mr Wren worked, were CSR staff, CSR had a duty directly to Mr Wren and that duty was co-extensive with that owed by an employer to an employee”: at 485 per Beazley and Stein JJA. Similarly, in Chandler v Cape plc [2012] EWCA Civ 525, without advertence to Wren, the English Court of Appeal upheld a decision that a parent company has breached a duty of care owed to an employee of its wholly-owned subsidiary. The court noted that until its decision “there is no reported case of a direct duty of care on the part of a parent company”. The Court held that the parent company owed a duty of care because of the responsibility it had assumed towards the subsidiary’s employees: “this case demonstrates that in appropriate circumstances the law may impose on a parent company responsibility for the health and safety of its subsidiary’s employees. Those circumstances include a situation where, as in the present case, (1) the businesses of the parent and subsidiary are in a relevant respect the same; (2) the parent has, or ought to have, superior knowledge on some relevant aspect of health and safety in the particular industry; (3) the subsidiary’s system of work is unsafe as the parent company knew, or ought to have known; and (4) the parent knew or ought to have foreseen that the subsidiary or its employees would rely on its using that superior knowledge for the employees’ protection. For the purposes of (4) it is not necessary to show that the parent is in the practice of intervening in the health and safety policies of the subsidiary. The court will look at the relationship between the companies more widely. The court may find that element (4) is established where the evidence shows that the parent has a practice of intervening in the trading operations of the subsidiary, for example production and funding issues” (at [80] per Lady Justice Arden). The Court “emphatically” rejected that the decision in any way concerned veil piercing (at [69]). Similar principles were invoked in Ontario in Choc v Hudbay Minerals Inc 2013 ONSC 1414 to dismiss a strike-out motion and allow a claim against a parent company to proceed to trial. See further on the potential tortious liability of holding companies and their directors R J Turner (2015) 33 C&SLJ 45; H Anderson (2011) 31(4) Legal Studies: The Journal of the Society of Legal Scholars 547; R Carroll, “Shadow Directors and Other Third Party Liability for Corporate Activity” in I M Ramsay (ed),

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Corporate Governance and the Duties of Company Directors (1997), p 162 at 163-169; P Redmond (2016) 31 Aust Jnl of Corp Law 5 at 31-36. 2.

In Dairy Containers Ltd v NZI Bank Ltd (1995) 13 ACLC 3211, DCL brought civil proceedings against its auditor for losses suffered through misappropriation of its funds by staff below board level. DCL was a wholly owned subsidiary of NZDB and the relationship between them was described by the trial judge as “symbiotic”. The directors of DCL were all employees of NZDB nominated as such. The auditor joined NZDB to the proceedings as a joint tortfeasor although its claim for contribution against NZDB was ultimately unsuccessful. The auditor relied upon NZDB’s almost total control over DCL. Thomas J said (at 3237): [C]ontrol of this kind, exercised through employees who have been appointed directors to the subsidiary’s board, does not negate the duty of those directors to the company. The interference, and the action on the part of NZDB which would give rise to the duty, is not its ability to control the company, but the actual act or acts which override the directors’ duty to their company so that the parent can be said to have interfered in the affairs of the company. I do not consider, therefore, that the general or usual control exerted by a parent company over its subsidiary can be the basis for a duty of care to the subsidiary relating to the way in which the company conducts its business. To my mind, not even total control of NZDB over its subsidiary could give rise to that duty. The parent may hold its subsidiary accountable if it does not perform as required, but it is going too far to suggest that it must undertake monitoring functions reposed in the directors of DCL which it has appointed to look after its interests.

What conduct or intervention by NZDB might expose it to liability in tort? If it directed the directors of DCL to act in a particular way either without reference to DCL’s interests or at their expense, would the position be different? See [7.330] and E W Thomas, “The Role of Nominee Directors and the Liability of their Appointors” in I M Ramsay (ed), Corporate Governance and the Duties of Company Directors (1997), pp 148-161. 3.

In DHN (see [4.105]), might the court have reached the same result by applying Smith Stone and Knight? Are there considerations which justify a greater willingness to lift the corporate veil within a group of companies than with a company with a dominant individual shareholder? Recall the empirical data at [4.68], nn 4, 5.

4.

Would the outcome of the decisions in DHN and Smith Stone and Knight be different if the boards of the subsidiaries, although appointed by the parent, nonetheless enjoyed autonomy in their management of the company’s business? See Lonhro Ltd v Shell Petroleum Co Ltd [1980] 2 WLR 367 at 373-376, 377-378 (CA); [1980] 1 WLR 627 at 634-646 (HL) and Firestone Tyre and Rubber Co Ltd v Lewellin [1957] 1 WLR 464.

5.

What principles are expressed in Briggs v Hardie as to the circumstances in which a parent company will be liable because of its status as such (and not for any actions of its own organs and agents) to those who suffer tortious harms for which its wholly owned subsidiary is responsible? What does the case indicate is the significance of the following considerations: • the potentiality for control over the subsidiary; • the tortious context in which the question arises; • whether the parent dominates the subsidiary; and • the risk shifting intent with which the subsidiary was formed?

[4.127]

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Recall the arguments briefly noted at [4.15] as to policy considerations peculiar to veil piercing for torts and the data on their relative incidence: see [4.68], nn 4, 5. 6.

In Briggs v Hardie the case was remitted for “determination according to law”. How would you frame arguments for Mr Briggs at the trial of his action as to the responsibility of the holding companies for any tortious injury which he has suffered from his employment by the subsidiary? For a further instance of an attempt to make a parent company responsible for injuries arising out of a subsidiary’s asbestos mining operations, see Adams v Cape Industry Plc [1990] 2 WLR 657.

7.

In 2004 the New South Wales Government appointed a senior barrister to inquire into the circumstances in which the James Hardie Industries group had been restructured so that the subsidiaries formerly concerned with asbestos manufacture and distribution were transferred out of the group into the ownership of a foundation which the group had established. The group was then restructured so that the domicile of the ultimate holding company of the group was located in the Netherlands. Later, the potential for claims upon the ultimate holding company by the principal Australian operating company were later greatly reduced with the cancellation of a significant tranche of partly paid shares that it had issued to the parent prior to the court approval for the restructure. There was considerable public concern as to whether the subsidiaries and the foundation were adequately resourced to meet compensation claims that might be made.

8.

The Commissioner found that the net present value of the likely shortfall in assets of the operating subsidiaries against likely claims was approximately $1.5 bn. The Commissioner considered that there was no legal obligation upon the parent company to provide greater funding to meet these claims but that if it was aware that “it were perceived as not having made adequate provision for the future asbestos liabilities of its former subsidiaries there would be a wave of adverse public opinion which might well result in action being taken by the Commonwealth or State governments (on whom much of the cost of such asbestos victims would be thrown) to legislate to make other companies in the Group liable in addition [to the subsidiaries]”: Report of the Special Commission of Inquiry into the Medical Research and Compensation Foundation (D F Jackson QC Commissioner, 2004), [1.8]. (The report made no reference to Briggs v Hardie.) But for the separation of the subsidiaries from the group, the Commissioner concluded, “it seems likely that, for the indefinite future, the asbestos liabilities would have been treated, as they had been for years, as one of the annual expenses of the Group”: [1.21]. Following protracted negotiations conducted in late 2004 in the shadow of threatened legislation to set aside the corporate restructuring and impose direct responsibility upon the holding company for the asbestos related claims, the company announced that it would submit to shareholders a proposal for the creation of a fund to meet all claims regardless of whether it is legally responsible for them. See H J Glasbeek (2012) 27 Aust Jnl of Corp Law 132 for critical appraisal of the James Hardie action and its implications. The Cork Committee posed the following hypothetical question: A wholly-owned subsidiary company is undercapitalised. It relies virtually wholly on moneys lent by the parent. Its affairs are conducted by and in the interest of the parent and they are mismanaged. There is a history of transactions between subsidiary and parent which, although not individually or collectively susceptible to attack at law, have, cumulatively, advantaged the parent and disadvantaged the subsidiary. All profits earned by the subsidiary have been paid up to the parent by way of dividend and the

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moneys needed by the subsidiary to conduct its business lent back by the parent (Insolvency Law and Practice: Report of the Review Committee (Cmnd 8558, 1982), [1931]).

Under present case law, would it be likely that the corporate veil might be lifted here, for example, by making the parent liable for the subsidiary’s debts or displacing its claims in the subsidiary’s liquidation? 9.

ASIC has issued Class Order 98/1418 under s 341 relieving wholly owned subsidiaries from statutory obligations with respect to financial reporting and audit. Relief is granted on the condition that the holding company and the affected subsidiaries enter into a deed of cross-guarantee under which the holding company and subsidiaries covenant to meet any deficiencies of each other. The covenants enure for the benefit of the liquidators of each company. The holding company must prepare consolidated accounts for the group. Almost one third of companies in the top 500 listed companies take advantage of the relief: I Ramsay & G Stapledon, Corporate Groups in Australia (Research Report, Centre for Corporate Law and Securities Regulation, University of Melbourne, 1998), p 26. On the incidence of and managers’ attitudes to such cross-guarantees see G Dean & F Clarke (2005) 23 C&SLJ 299.

10.

A holding company issues to a bank which is making an advance to a subsidiary a letter of comfort stating that “it is our policy to ensure that the business of [the subsidiary] is at all times in a position to meet its liabilities to you under the [loan] agreements”. In the letter the parent also confirmed that “we will not reduce our current financial interest in [the subsidiary] until the [loan] facilities have been repaid or until you have confirmed that you are prepared to continue the facilities with new shareholders.” May the bank seek payment from the holding company if the subsidiary defaults? See Kleinwort Benson Ltd v Malaysia Mining Corp Berhad [1989] 1 WLR 379. Would it make any difference if the parent’s comfort letter had stated instead that “it is our practice to ensure that our [subsidiary] will at all times be in a position to meet its financial obligations as they fall due [including] repayment of all loans made by your bank”? See Banque Brussels Lambert SA v Australian National Industries Ltd (1989) 21 NSWLR 502.

[4.128]

Review Problem

For some years Aussie Fun Park Pty Ltd (“AFP”) has conducted an amusement park in Sydney for which it has recently acquired a state of the art amusement ride with ultra-sophisticated technology. However, in its first year of operation, there is a serious malfunction of this ride and two AFP workers operating it are badly injured. The workers sue AFP for breach of their contract of employment by failing to ensure a safe system of work. They join AFP’s parent company Australian Entertainment Ltd (“Entertainment”) in the action. Entertainment is listed on the ASX. AFP is a wholly owned subsidiary of Entertainment. Other Entertainment subsidiaries (most of which are wholly owned) conduct amusement parks in capital cities and operate amusement arcades in cinemas where patrons play video games, pin ball machines and simulated racing cars. The AFP board comprises senior managers of Entertainment although AFP has its own sub-board management and staff. AFP has an issued capital of $2 and its working capital comes from Entertainment by way of loans and profits retained from past operations. Advise the injured workers with respect to their rights of recovery against Entertainment. [4.128]

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CORPORATE CRIMINAL LIABILITY What is the justification for imposing criminal liability upon corporations? [4.130] If the corporation is a separate person in law, should it be amenable to the criminal

law in the manner of natural persons? 62 If the corporation has “no soul to be damned, and no body to be kicked” (see [4.20]), what purpose is served by applying sanctions that are intended to sound in moral retribution and the possibility of physical punishment? Since the company’s criminal liability will generally be in addition to that of its human agents, there is also a duplication of criminal sanctions. The corporate offender will suffer only a fine and not the more punitive sanctions to which natural persons are exposed by the criminal law. That fine might penalise shareholders for acts which might be beyond their knowledge and effective control. There is also research evidence that when corporations are criminally sanctioned there is little assurance that internal disciplinary mechanisms will transfer the sanction to officials responsible for the deficiency in system operation or design that caused the breach; 63 indeed, corporate law does nothing specifically to secure this outcome. There is also the argument that it is simply easier to prosecute corporations than individuals which choice has the effect of undermining the system of individual responsibility upon which social control ultimately depends. 64 Yet, there are powerful considerations in favour of criminal sanctions against corporations. Corporations are powerful and pervasive social actors, providing the bulk of mass produced goods and dominating many areas of services, transport, communications and distribution. Further, in recent decades corporations have assumed a number of sensitive functions previously assumed to be core state responsibilities, ranging from the operation of prisons to general infrastructure provision. The waxing of the corporate role has been accompanied by a corresponding waning of state function in some domains. The process of globalisation extends corporate reach globally under exaggerated power differentials and diminished governmental constraint: see [2.245]. The threat of social harm posed by corporate misconduct grows accordingly as the dimensions of corporate power expand under social and economic developments. The case for imposing criminal liability upon corporations rests upon its function in expressing social repugnance for the sanctioned conduct and its presumed deterrent effect. For those corporations with a reputational stake in product or capital markets, the stigma attached to criminal liability, and its damage to brand value, will greatly outweigh direct monetary impact of a fine. Further, since corporate operations have a group character with multiple participants, it is sometimes difficult to attribute responsibility to one or more individuals personally; this is particularly the case where the breach arises from neglect or failure to act. Accordingly, sanctioning the corporation may provide the only feasible option. There are very few crimes which may not be committed by corporations. Perjury is an instance since a company is incapable of testifying personally. Bigamy and suicide are other 62

63

See further, on corporate criminal liability generally, J Hill [2003] JBL 1; R Edwards (2001) 13 Aust Jnl of Corp Law 231; L H Leigh, The Criminal Liability of Corporations in English Law (1969); L H Leigh (1977) 9 Ottawa L Rev 247 and (1982) 80 Mich L Rev 1508; R S Welsh (1946) 72 LQR 345; W B Fisse (1973) 5 NZULR 250 and (1978) 6 Adel L Rev 361; I A Muir (1973) 5 NZULR 357; B Fisse & P A French (eds), Corrigible Corporations and Unruly Law (1985); K Wheelwright (2006) 19 Aust Jnl of Corp Law 287; K Wheelwright (2004) 32 ABLR 239. B Fisse & J Braithwaite, Corporations, Crime and Accountability (1993), pp 1-16.

64

Fisse & Braithwaite, pp 5-6 (of the 96 major business regulatory agencies surveyed, only 20 reported a preference for targeting the responsible individuals; these agencies were mostly concerned with mine safety (where legislation focuses upon managers and supervisors) and maritime safety and pollution where there is a long tradition of locating responsibility in the ship’s captain).

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examples. 65 Otherwise, a company will generally be amenable to the criminal law to the same degree as natural persons, except for those offences (such as murder, treason and piracy) which are punishable exclusively by the personal penalties of imprisonment or capital punishment. 66 However, this field of excluded offences has now been largely eliminated through legislation converting physical sentences and punishments into fines. 67 A company may be punished by fine or, in appropriate cases, expropriation of property or withdrawal of a licence. A company may be convicted of manslaughter 68 although not in jurisdictions where the offence is defined by statute in terms of a killing by a natural person. 69 There are several distinct bases for subjecting corporations to criminal liability. First, the corporation may be liable upon the basis of vicarious liability doctrines drawn from the general law of civil obligation. A second basis of liability, attributed primary corporate liability, has been developed peculiarly for corporations although its roots also lie in the civil law. Under this doctrine the acts or omissions of key individuals or groups, the directing mind and will of the company, are attributed to the company for the purpose of criminal responsibility. These bases are augmented by statutory and court made rules of attributed criminal liability applying in particular contexts. Finally, some statutory offences are interpreted as creating strict or absolute criminal liability arising from the mere fact of failure to meet a certain standard of conduct; the level in the corporate hierarchy of the employees, or external agents, who were responsible for the failure is irrelevant to corporate liability as is the absence of any intention to breach the standard. These several bases of criminal liability are examined below. Vicarious corporate criminal liability [4.135] Since the company is an abstraction, if it is to act or form an intention it must do so

through human agents. A company may be vicariously liable under contract and tort law for the defaults of its agents. However, unlike in contract or tort, 70 the common law set its face against imposing criminal liability upon corporations on the ground of vicarious liability. Vicarious criminal liability arises only in three instances – the common law offences of public nuisance and criminal libel (both of which bear close affinity with counterpart civil doctrines) and those statutory offences which impose criminal liability upon a company for the acts of its servants whether authorised or not. This third category is by far the most important and numerous of the three. Some modern legislation may be so cast as to contemplate that the prohibited conduct will in the ordinary course be committed by employees or agents acting within their employment or authority. In such cases the intention may be inferred from the statute that criminal liability is imposed upon the principal even without any other organisational knowledge of the breach, fault or benefit derived from the employee or agent’s conduct. Whether this is so is essentially a question of construction of the particular provision 65

Presidential Security Services of Australia Pty Ltd v Brilley (2008) 67 ACSR 692; [2008] NSWCA 204 at [141] (ACSR).

66 67

R v ICR Haulage Co Ltd [1944] KB 551 at 556. See, eg, Crimes (Sentencing Procedure) Act 1999 (NSW), s 16; Crimes Act 1914 (Cth), s 4B(1); Criminal Code Act 1995 (Cth), s 12.1; DPP Reference No 1 of 2000 [2001] NTSC 91 (a company may be charged with a dangerous omission pursuant to Criminal Code (NT), s 154(1)).

68

R v P & O European Ferries (Dover) Ltd (1991) 93 Cr App R 73; R v ICR Haulage Co Ltd [1944] KB 551 at 556; R v H M Coroner for East Kent; Ex parte Spooner (1989) 88 Cr App R 10. R v Murray Wright Ltd [1970] NZLR 476; see C Wells [1988] Crim LR 788.

69 70

Tort liability has been imposed upon companies under both vicarious and primary liability doctrines. However, since vicarious liability has been much more readily imposed in tort than in crime, even in the intentional torts and those involving malice, resort to doctrines of primary corporate liability has been of incidental importance only. [4.135]

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creating the offence. Generally, however, a company will not be exposed to vicarious criminal liability for a criminal offence having mens rea as an element. 71 Instances where mens rea will not be inferred are more likely to arise in relation to offences characterised as “public welfare offences”, that is, offences regulatory in substance although criminal in form, for example, in fair trading, consumer protection or environmental fields. 72 The circumstances in which vicarious criminal liability might be inferred from a statute are considered in Mousell’s case.

Mousell Bros Ltd v London and Northwestern Railway Co [4.140] Mousell Bros Ltd v London and Northwestern Railway Co [1917] 2 KB 836 Court of Appeal, England and Wales [The Railway Clauses Consolidation Act 1845 (UK) required the owners of goods conveyed by rail (or any persons having their care) to give to the collector of tolls, upon demand, an account of the number and quantity of those goods: s 98. If any such person should fail to give an account, or give a false account, to the collector or officer of the railway company, with intent to avoid the payment of tolls on the goods, he should be liable to pay a monetary penalty to the railway company: s 99. Upon complaint preferred by the railway company, a magistrate found that goods consigned had been misdescribed by servants of the appellant company with intent to avoid payment of toll. The appellant urged, however, that it was not criminally liable for acts of its servants.] ATKIN J: [845] I think that the authorities … make it plain that while prima facie a principal is not to be made criminally responsible for the acts of his servants, yet the legislature may prohibit an act or enforce a duty in such words as to make the prohibition or the duty absolute; in which case the principal is liable if the act is in fact done by his servants. To ascertain whether a particular Act of Parliament has that effect or not regard must be had to the object of the statute, the words used, the nature of the duty laid down, the person upon whom it is imposed, the person by whom it would in ordinary circumstances be performed, and the person upon whom the penalty is imposed. [846] … Now in this case the duty is imposed upon “every person being the owner or having the care of any goods” to “give to the collector of tolls … an exact account.” I share with my Lord the doubt as to whether “the person having the care of the goods” does not mean a bailee who is entrusted by the true owner of the goods with the care of them for the purpose of himself contracting with the railway company, and I think that view is supported by a consideration of s 101, and especially the provision as to disputes therein mentioned. But the duty which is imposed upon an owner or a person having care of the carriage of goods was a duty which even in 1845 would ordinarily be performed by a servant of the owner or the person having care. The account would in those days, as it certainly would in these days, be prepared by some clerk, servant, or manager. When a penalty is imposed for the breach of the duty, it is reasonable to infer that the penalty is imposed for a default of the person by whom the duty would ordinarily be performed. If the servant is to prepare the account, then it is the fault of the servant in not preparing the account that makes the owner liable to the penalty. This is borne out by s 99, which imposes the penalty for breach of the duties imposed by s 98 – namely, for failure to give the account or for giving a false account. It is true it proceeds to provide a penalty for other offences, such as unloading and withholding a way-bill or bill of lading. I see no difficulty in the fact that an intent to avoid payment is necessary to constitute the offence. That is an intent which the servant might well have, inasmuch as he is the person who has to deal with the particular matter. The penalty is imposed upon the owner for the act of the servant if the servant commits the default provided for in the statute in the state of mind provided for by the statute. Once it is decided that this is one of those cases where a principal may be held liable criminally for the act of his servant, there is no difficulty in

71 72

Presidential Security Services of Australia Pty Ltd v Brilley (2008) 67 ACSR 692; [2008] NSWCA 204 at [147] (ACSR). Tiger Nominees Pty Ltd v State Pollution Control Commission (1992) 25 NSWLR 715 at 718.

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Mousell Bros Ltd v London and Northwestern Railway Co cont. holding that a corporation may be the principal. No mens rea being necessary to make the principal liable, a corporation is in exactly the same position as a principal who is not a corporation. [Viscount Reading CJ and Ridley J concurred.]

Notes&Questions

[4.142]

1.

2.

In Mousell. Atkin J said that “[o]nce it is decided that this is one of those cases where a principal may be held liable criminally for the act of his servant, there is no difficulty in holding that a corporation may be the principal”: at 846. Since the instant offence was construed as not involving mens rea, the imposition of vicarious criminal liability was more readily made. However, Mousell pre-dates Woolmington v DPP [1935] AC 462 and it might be doubted whether the particular offence would now be interpreted as free of any requirement of mens rea. In this respect, Glanville Williams describes Mousell as “out of the current of [English] authority”: Textbook of Criminal Law (2nd ed, 1983), p 967; cf Criminal Law: The General Part (2nd ed 1961), p 274; see also L H Leigh, Strict and Vicarious Liability (1982), pp 44-45. With the reluctance of English courts to interpret statutes as dispensing with mens rea and to visit vicarious criminal liability upon principals, the development of this head of liability has been overtaken there by doctrines of primary liability. In Australia, however, there are numerous instances of criminal liability vicariously imposed upon corporations for acts of their subordinate employees: see, eg, the cases cited by W B Fisse (1967) 41 ALJ 203 in fn 2 and C Howard, Criminal Law (4th ed, 1982), pp 379-381. Howard says (at 380 in fn 62): “There must be hundreds of cases, both reported and unreported, in which the same point has passed sub silentio against a defendant corporation.” For a leading case applying Mousell, see R v Australasian Films Ltd (1921) 29 CLR 195. However, Australian courts have not always clearly distinguished between the bases of corporate criminal liability; for an instance of confusion as to the basis upon which criminal liability was imposed, see Morgan v Babcock and Wilcox Ltd (1929) 43 CLR 163 at 173-174, discussed in W B Fisse (1967) 41 ALJ 203 at 204-205.

Primary corporate criminal liability [4.145] Where mens rea is an element of the offence, it may be supplied by the doctrine of

primary (or direct) corporate criminal liability which attributes to a company the mental state and physical acts of the person whom the law regards as its “directing mind and will”. (In some instances, wider rules of attribution are supplied by particular statutes: see [4.180].) The human actors whose acts and intentions are attributed to the company for purposes of primary criminal liability are identified by the organic theory of corporate personality, a doctrine originally developed in relation to civil liability for merchant shipping losses. The organic theory derives its name from the anthropomorphic metaphor which it expresses.

Lennard’s Carrying Co Ltd v Asiatic Petroleum Co Ltd [4.150] Lennard’s Carrying Co Ltd v Asiatic Petroleum Co Ltd [1915] AC 705 House of Lords [A ship’s cargo was lost at sea, a loss attributable to the vessel’s unseaworthy condition. The ship’s owners were a limited company as were its managing owners. Lennard, the managing director of the latter company, managed the ship on behalf of the owners. He knew, or ought to have known of the [4.150]

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Lennard’s Carrying Co Ltd v Asiatic Petroleum Co Ltd cont. ship’s unseaworthiness but took no steps to prevent it from putting to sea. The cargo owners sued the shipowners for recovery of their loss. The latter invoked s 502 of the Merchant Shipping Act 1894 (UK) by virtue of which the owner of a British ship is exempted from liability for “any loss or damage [to cargo] happening without his actual fault or privity”. 73 The ship’s owners argued that they were not personally liable for Lennard’s default. Verdict was given for the plaintiffs at first instance and affirmed by the Court of Appeal. The shipowners appealed.] VISCOUNT HALDANE LC: [713] Now, my Lords, did what happened take place without the actual fault or privity of the owners of the ship who were the appellants? My Lords, a corporation is an abstraction. It has no mind of its own any more than it has a body of its own; its active and directing will must consequently be sought in the person of somebody who for some purposes may be called an agent, but who is really the directing mind and will of the corporation, the very ego and centre of the personality of the corporation. That person may be under the direction of the shareholders in general meeting; that person may be the board of directors itself, or it may be, and in some companies it is so, that that person has an authority co-ordinate with the board of directors given to him under the articles of association, and is appointed by the general meeting of the company, and can only be removed by the general meeting of the company. My Lords, whatever is not known about Mr Lennard’s position, this is known for certain, Mr Lennard took the active part in the management of this ship on behalf of the owners, and Mr Lennard, as I have said, was registered as the person designated for this purpose in the ship’s register. Mr Lennard therefore was the natural person to come on behalf of the owners and give full evidence not only about the events of which I have spoken, and which related to the seaworthiness of the ship, but about his own position and as to whether or not he was the life and soul of the company. For if Mr Lennard was the directing mind of the company, then his action must, unless a corporation is not to be liable at all, have been an action which was the action of the company itself within the meaning of s 502. It has not been contended at the Bar, and it could not have been successfully contended, that s 502 is so worded as to exempt a corporation altogether which happens to be the owner of a ship, merely because it happens to be a corporation. It must be upon the true construction of that section in such a case as the present one that the fault or privity is the fault or privity of somebody who is not merely a servant or agent for whom the company is liable upon the footing respondeat superior, but somebody [714] for whom the company is liable because his action is the very action of the company itself. It is not enough that the fault should be the fault of a servant in order to exonerate the owner, the fault must also be one which is not the fault of the owner, or a fault to which the owner is privy: and I take the view that when anybody sets up that section to excuse himself from the normal consequences of the maxim respondeat superior the burden lies upon him to do so. [The Lord Chancellor concluded that, in the absence of evidence from Lennard or others rebutting the presumption of liability, the company might not rely upon the section. Lords Dunedin, Atkinson, Parker and Parmoor concurred.]

Civil applications of organic theory [4.155] The organic theory has been further applied in relation to the attribution of liability

for losses from merchant shipping as well as for corporate criminal responsibility. Thus, in The Lady Gwendolen 74 a collision was caused by the failure of a ship’s master to observe proper navigational safeguards in fog. The marine superintendent of the shipowner, a brewing company, had failed to monitor the master’s navigation records which revealed a practice of 73

74

Section 502 and the like provision in s 503 limiting liability for damage to other vessels express “the simple notion that a shipowner should not be exposed to ruin in respect of a liability incurred without any fault on his part, in order that British ships may compete equally with others”: The Garden City [1982] 2 Lloyd’s Rep 382 at 398. [1965] P 294, discussed by L H Leigh (1965) 28 MLR 584.

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using excessive speed in fog. The superintendent was not a director of the company but had been clothed by its assistant managing director with all relevant powers of control over navigation of the company’s vessels. (In turn, the board had charged the assistant managing director with responsibility for the company’s transport department.) The superintendent was held to be the “alter ego” of the company for purposes of s 503 of the Merchant Shipping Act 1894 (UK) and his default was accordingly attributed to the company which was denied the protection of the section. In The Garden City 75 another marine collision was caused by the failure of the shipping company’s chief navigator and his staff to monitor the navigational practices of the ship’s master. However, this default by the chief navigator and his staff was not attributed to the company (the Polish state-owned shipping company 76) since they were not the company’s directing mind and will, either in practice or under its constitution. The judge considered that, both in practice and under the company’s constitution, control of the company’s affairs lay with its director of technical and investment affairs (whose default accordingly would have been that of the company). However, through no fault of his own, but of his subordinates, the director was not aware of the defaults of the chief navigator and his staff. Further, he had acted in the manner reasonably appropriate for the owner of a large number of ships, inter alia, by taking reasonable steps to ensure that vessels were safely navigated. The company might, therefore, rely upon the limitation despite the failure of its subordinate staff.

Application to corporate criminal responsibility [4.160] The distinction drawn in Lennard’s case between primary and vicarious bases of corporate liability has been of particular importance in the application of the criminal law to companies. In Mousell the Court of Appeal treated the instant offence as one not involving mens rea. However, in three remarkable decisions in 1944 the English courts, without explicit reference to Lennard’s case, fashioned a doctrine of criminal liability for mens rea offences by adopting notions of primary corporate liability to identify the company with those persons who were its directing mind and will. The three decisions concerned offences clearly requiring a guilty state of mind. This mental state was found in senior managers and attributed to their companies. 77 Subsequent decisions, for example, Tesco Supermarkets Ltd v Nattrass [4.165], have invoked Lennard’s case to rationalise this judicially created doctrine of corporate criminal responsibility. (In Tesco, the inquiry as to whether the company officer in question represented its directing mind arose in the context of determining the availability of a statutory defence to liability.) Two cases are extracted with Tesco. In Meridian Global Funds Management Asia Ltd v Securities Commission [4.170] the Privy Council interpreted Tesco as establishing special rules of attribution that ultimately depend upon the interpretation of the relevant statutory provision and its policy objectives. In Canadian Dredge and Dock Co Ltd v The Queen [4.175], the Supreme Court of Canada outlined an identification theory of criminal liability developed out of the organic theory but with distinct elements. The court also canvassed the wider role of doctrines of vicarious liability under federal law in the United States.

75

[1982] 2 Lloyd’s Rep 382; see also The Truculent [1952] P 1.

76

The Polish shipping company was not disqualified by its foreign character from invoking the limitation of the section.

77

DPP v Kent and Sussex Contractors Ltd [1944] KB 146; R v ICR Haulage Ltd [1944] KB 551; Moore v I Bresler Ltd [1944] 2 All ER 515. [4.160]

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Tesco Supermarkets Ltd v Nattrass [4.165] Tesco Supermarkets Ltd v Nattrass [1972] AC 153 House of Lords [The facts of this case are outlined in the judgment of Lord Reid.] LORD REID: [167] My Lords, the appellants own a large number of supermarkets in which they sell a wide variety of goods. The goods are put out for sale on shelves or stands, each article being marked with the price at which it is offered for sale. The customer selects the articles he wants, takes them to the cashier, and pays the price. From time to time the appellants, apparently by way of advertisement, sell “flash packs” at prices lower than the normal price. In September 1969 they were selling Radiant washing powder in this way. The normal price was 3s 11d but these packs were marked and sold at 2s 11d. Posters were displayed in the shops drawing attention to this reduction in price. [168] These prices were displayed in the appellants’ shop at Northwich on 26 September. Mr Coane, an old age pensioner, saw this and went to buy a pack. He could only find packs marked 3s 11d. He took one to the cashier who told him that there were none in stock for sale at 2s 11d. He paid 3s 11d and complained to an inspector of weights and measures. This resulted in a prosecution under the Trade Descriptions Act 1968 (UK) and the appellants were fined £25 and costs. Section 11(2) provides: If any person offering to supply any goods gives, by whatever means, any indication likely to be taken as an indication that the goods are being offered at a price less than that at which they are in fact being offered he shall, subject to the provisions of this Act, be guilty of an offence. It is not disputed that that section applies to this case. The appellants relied on section 24(1) which provides: In any proceedings for an offence under this Act it shall, subject to subsection (2) of this section, be a defence for the person charged to prove – (a) that the commission of the offence was due to a mistake or to reliance on information supplied to him or to the act or default of another person, an accident or some other cause beyond his control; and (b) that he took all reasonable precautions and exercised all due diligence to avoid the commission of such an offence by himself or any person under his control. The relevant facts as found by the magistrates were that on the previous evening a shop assistant, Miss Rogers, whose duty it was to put out fresh stock found that there were no more of the specially marked packs in stock. There were a number of packs marked with the ordinary price so she put them out. She ought to have told the shop manager, Mr Clement, about this, but she failed to do so. Mr Clement was responsible for seeing that the proper packs were on sale, but he failed to see to this although he marked his daily return “all special offers OK”. The magistrates found that if he had known about this he would either have removed the poster advertising the reduced price or given instructions that only 2s 11d was to be charged for the packs marked 3s 11d. Section 24(2) requires notice to be given to the prosecutor if the accused is blaming another person and such notice was duly given naming Mr Clement. In order to avoid conviction the appellants had to prove facts sufficient to satisfy both parts of s 24(1) of the Act of 1968. The magistrates held that they had exercised all due diligence in devising a proper system for the operation of the said store and by securing so far as was reasonably practicable that it was fully implemented and thus had fulfilled the requirements of s 24(1)(b). But they convicted the appellants because in their view the requirements of s 24(1)(a) had not been fulfilled: they held that Clement was not “another person” within the meaning of that provision. [169] The Divisional Court held that the magistrates were wrong in holding that Clement was not “another person”. The respondent did not challenge this finding of the Divisional Court so I need say no more about it than that I think that on this matter the Divisional Court was plainly right. But that court sustained the conviction on the ground that the magistrates had applied the wrong test in deciding that the requirements of s 24(1)(b) had been fulfilled. In effect that court held that the words 212

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Tesco Supermarkets Ltd v Nattrass cont. “he took all reasonable precautions …” do not mean what they say: “he” does not mean the accused, it means the accused and all his servants who were acting in a managerial or supervisory capacity. I think that earlier authorities virtually compelled the Divisional Court to reach this strange construction. So the real question in this appeal is whether these earlier authorities were rightly decided. … [170] Where a limited company is the employer difficult questions do arise in a wide variety of circumstances in deciding which of its officers or servants is to be identified with the company so that his guilt is the guilt of the company. I must start by considering the nature of the personality which by a fiction the law attributes to a corporation. A living person has a mind which can have knowledge or intention or be negligent and he has hands to carry out his intentions. A corporation has none of these: it must act through living persons, though not always one or the same person. Then the person who acts is not speaking or acting for the company. He is acting as the company and his mind which directs his acts is the mind of the company. There is no question of the company being vicariously liable. He is not acting as a servant, representative, agent or delegate. He is an embodiment of the company or, one could say, he hears and speaks through the persona of the company, within his appropriate sphere, and his mind is the mind of the company. If it is a guilty mind then that guilt is the guilt of the company. It must be a question of law whether, once the facts have been ascertained, a person in doing particular things is to be regarded as the company or merely as the company’s servant or agent. In that case any liability of the company can only be a statutory or vicarious liability. … [The judge quoted from the judgment of Viscount Haldane in Lennard’s case dealing with the “directing mind” of the company with whom the company is identified.] [171] Reference is frequently made to the judgment of Denning LJ in H L Bolton (Engineering) Co Ltd v T J Graham & Sons Ltd [1957] 1 QB 159. He said 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. In that case the directors of the company only met once a year: they left the management of the business to others, and it was the intention of those managers which was imputed to the company. I think that was right. There have been attempts to apply Lord Denning’s words to all servants of a company whose work is brain work, or who exercise some managerial discretion under the direction of superior officers of the company. I do not think that Lord Denning intended to refer to them. He only referred to those who “represent the directing mind and will of the company, and control what it does”. I think that is right for this reason. Normally the board of directors, the managing director and perhaps other superior officers of a company carry out the functions of management and speak and act as the company. Their subordinates do not. They carry out orders from above and it can make no difference that they are given some measure of discretion. But the board of directors may delegate some part of their functions of management giving to their delegate full discretion to act independently of instructions from them. I see no difficulty in holding that they have thereby put such a delegate in their place so that within the scope of the delegation he can act as the company. It may not always be easy to draw the line but there are cases in which the line must be drawn. Lennard’s case [1915] AC 705 was one of them. In some cases the phrase alter ego has been used. I think it is misleading. When dealing with a company the word alter is I think misleading. The person who speaks and acts as the company is not alter. He is identified with the company. And when dealing with an individual no other individual can [4.165]

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Tesco Supermarkets Ltd v Nattrass cont. be his alter ego. The other individual can be a servant, agent, delegate or representative but I know of neither principle [172] nor authority which warrants the confusion (in the literal or original sense) of two separate individuals. … [173] In the next two cases a company was accused and it was held liable for the fault of a superior officer. In Director of Public Prosecutions v Kent and Sussex Contractors Ltd [1944] KB 146 he was the transport manager. In R v ICR Haulage Ltd [1944] KB 551 it was held that a company can be guilty of common law conspiracy. The act of the managing director was held to be the act of the company. … In John Henshall (Quarries) Ltd v Harvey [1965] 2 QB 233 a company was held not criminally responsible for the negligence of a servant in charge of a weighbridge. In Magna Plant v Mitchell (unreported, 27 April 1966) the fault was that of a depot engineer and again the company was held not criminally responsible. I think these decisions were right. In the Magna Plant case Lord Parker CJ said: knowledge of a servant cannot be imputed to the company unless he is a servant for whose actions the company are criminally responsible, and as the cases show, that only arises in the case of a company where one is considering the acts of responsible officers forming the brain. [174] What good purpose could be served by making an employer criminally responsible for the misdeeds of some of his servants but not for those of others? It is sometimes argued – it was argued in the present case – that making an employer criminally responsible, even when he has done all that he could to prevent an offence, affords some additional protection to the public because this will induce him to do more. But if he has done all he can how can he do more? I think that what lies behind this argument is a suspicion that magistrates too readily accept evidence that an employer has done all he can to prevent offences. But if magistrates were to accept as sufficient a paper scheme and perfunctory efforts to enforce it they would not be doing their duty – that would not be “due diligence” on the part of the employer. Then it is said that this would involve discrimination in favour of a large employer like the appellants against a small shopkeeper. But that is not so. Mr Clement was the “opposite number” of the small shopkeeper and he was liable to prosecution in this case. The purpose of this Act must have been to penalise those at fault, not those who were in no way to blame. The Divisional Court decided this case on a theory of delegation. [See Lord Morris at 180.] In that they were following some earlier authorities. But they gave far too wide a meaning to delegation. I have said that a board of directors can delegate part of their functions of management so as to make their delegate an [175] embodiment of the company within the sphere of the delegation. But here the board never delegated any part of their functions. They set up a chain of command through regional and district supervisors, but they remained in control. The shop managers had to obey their general directions and also take orders from their superiors. The acts or omissions of shop managers were not acts of the company itself. In my judgment the appellants established the statutory defence. I would therefore allow this appeal. LORD MORRIS OF BORTH-Y-GEST: [180] The question in the present case becomes a question whether the company as a company took all reasonable precautions and exercised all due diligence. The magistrates so found and so held. The magistrates found and held that “they” (that is, the company) had satisfied the provisions of s 24(1)(b). The reason why the Divisional Court felt that they could not accept that finding was that they considered that the company had delegated its duty to the manager of the shop. The manager was, they thought, “a person whom the appellants had delegated in respect of that particular shop their duty to take all reasonable precautions and exercise all due diligence to avoid the commission” of an offence. Though the magistrates were satisfied that the company had set up an efficient system there had been “a failure by someone to whom the duty of carrying out the system was delegated properly to carry out that function”. My Lords, with respect I do not think that there was any feature of delegation in the present case. The company had its responsibilities in regard to taking all reasonable precautions and exercising all due diligence. The careful and effective discharge of those responsibilities required the directing mind and will of the company. A system had to be created which could rationally be said to be so designed that 214

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Tesco Supermarkets Ltd v Nattrass cont. the commission of offences would be avoided. There was no delegation of the duty of taking precautions and exercising diligence. There was no such delegation to the manager of a particular store. He did not function as the directing mind or will of the company. His duties as the manager of one store did not involve managing the company. He was one who was being directed. He was one who was employed but he was not a delegate to whom the company passed on its responsibilities. He had certain duties which were the result of the taking by the company of all reasonable precautions and of the exercising by the company of all due diligence. He was a person under the control of the company and on the assumption that there could be proceedings against him, the company would by s 24(1)(b) be absolved if the company had taken all proper steps to avoid the commission of an offence by him. To make the company automatically liable [181] for an offence committed by him would be to ignore the subsection. He was, so to speak, a cog in the machine which was devised: it was not left to him to devise it. Nor was he within what has been called the “brain area” of the company. If the company had taken all reasonable precautions and exercised all due diligence to ensure that the machine could and should run effectively then some breakdown due to some action or failure on the part of “another person” ought not to be attributed to the company or to be regarded as the action or failure of the company itself for which the company was to be criminally responsible. The defence provided by s 24(1) would otherwise be illusory. [Viscount Dilhorne, Lord Pearson and Lord Diplock also delivered judgments allowing the appeal.]

Meridian Global Funds Management Asia Ltd v Securities Commission [4.170] Meridian Global Funds Management Asia Ltd v Securities Commission [1995] 2 AC 500 Privy Council on appeal from New Zealand [Koo was the chief investment manager of Meridian, an investment management company, and reported to its managing director. With other persons outside Meridian, Koo sought to gain control of a New Zealand listed company, ENC. As part of this initiative, Koo misused his authority and Meridian funds to acquire a substantial shareholding in ENC, in Meridian’s name but really for the benefit of his private group. The New Zealand Securities Amendment Act 1988 requires disclosure by a “substantial security holder” in a listed company (s 20(3)) “as soon as the person knows, or ought to know,” that the person has such an interest: s 20(4). The size of the ENC acquisition engaged s 20(3). Koo did not report the interest to Meridian which accordingly did not disclose it to the New Zealand Securities Commission. When the interest became known, the Commission prosecuted Meridian for nondisclosure. The New Zealand Court of Appeal upheld the conviction on the basis that Koo was the directing mind and will of Meridian. Meridian appealed to the Privy Council.] LORD HOFFMANN delivered the judgment of THEIR LORDSHIPS: [506] Any proposition about a company necessarily involves a reference to a set of rules. A company exists because there is a rule (usually in a statute) which says that a persona ficta shall be deemed to exist and to have certain of the powers, rights and duties of a natural person. But there would be little sense in deeming such a persona ficta to exist unless there were also rules to tell one what acts were to count as acts of the company. It is therefore a necessary part of corporate personality that there should be rules by which acts are attributed to the company. These may be called “the rules of attribution.” The company’s primary rules of attribution will generally be found in its constitution, typically the articles of association, and will say things such as “for the purpose of appointing members of the board, a majority vote of the shareholders shall be a decision of the company” or “the decisions of the board in managing the company’s business shall be the decisions of the company.” There are also primary rules of attribution which are not expressly stated in the articles but implied by company law, such as [the informal corporate doctrine as to which see [5.155]] … These primary rules of attribution are obviously not enough to enable a company to go out into the world and do business. Not every act on behalf of the company could be expected to be the subject of a resolution of the board or a unanimous decision of the shareholders. The company therefore builds [4.170]

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Meridian Global Funds Management Asia Ltd v Securities Commission cont. upon the primary rules of attribution by using general rules of attribution which are equally available to natural persons, namely, the principles of agency. It will appoint servants and agents whose acts, by a combination of the general principles of agency and the company’s primary rules of attribution, count as the acts of the company. And having done so, it will also make itself subject to the general rules by which liability for the acts of others can be attributed to natural persons, such as estoppel or ostensible authority in contract and vicarious liability in tort. … [507] The company’s primary rules of attribution together with the general principles of agency, vicarious liability and so forth are usually sufficient to enable one to determine its rights and obligations. In exceptional cases, however, they will not provide an answer. This will be the case when a rule of law, either expressly or by implication, excludes attribution on the basis of the general principles of agency or vicarious liability. For example, a rule may be stated in language primarily applicable to a natural person and require some act or state of mind on the part of that person “himself,” as opposed to his servants or agents. This is generally true of rules of the criminal law, which ordinarily impose liability only for the actus reus and mens rea of the defendant himself. How is such a rule to be applied to a company? One possibility is that the court may come to the conclusion that the rule was not intended to apply to companies at all; for example, a law which created an offence for which the only penalty was community service. Another possibility is that the court might interpret the law as meaning that it could apply to a company only on the basis of its primary rules of attribution, ie if the act giving rise to liability was specifically authorised by a resolution of the board or a unanimous agreement of the shareholders. But there will be many cases in which neither of these solutions is satisfactory; in which the court considers that the law was intended to apply to companies and that, although it excludes ordinary vicarious liability, insistence on the primary rules of attribution would in practice defeat that intention. In such a case, the court must fashion a special rule of attribution for the particular substantive rule. This is always a matter of interpretation: given that it was intended to apply to a company, how was it intended to apply? Whose act (or knowledge, or state of mind) was for this purpose intended to count as the act etc of the company? One finds the answer to this question by applying the usual canons of interpretation, taking into account the language of the rule (if it is a statute) and its content and policy. The fact that the rule of attribution is a matter of interpretation or construction of the relevant substantive rule is shown by the contrast between two decisions of the House of Lords, Tesco Supermarkets Ltd v Nattrass and In re Supply of Ready Mixed Concrete (No 2) [He discussed the decision in Tesco.] … [508] On the other hand, in In re Supply of Ready Mixed Concrete (No 2) [1995] 1 AC 456, a restrictive arrangement in breach of an undertaking by a company to the Restrictive Practices Court was made by executives of the company acting within the scope of their employment. The board knew nothing of the arrangement; it had in fact given instructions to the company’s employees that they were not to make such arrangements. But the House of Lords held that for the purposes of deciding whether the company was in contempt, the act and state of mind of an employee who entered into an arrangement in the course of his employment should be attributed to the company. This attribution rule was derived from a construction of the undertaking against the background of the Restrictive Trade Practices Act 1976: such undertakings by corporations would be worth little if the company could avoid liability for what its employees had actually done on the ground that the board did not know about it. As Lord Templeman said, at p 465, an uncritical transposition of the construction in: would allow a company to enjoy the benefit of restrictions outlawed by Parliament and the benefit of arrangements prohibited by the [509] courts provided that the restrictions were accepted and implemented and the arrangements were negotiated by one or more employees who had been forbidden to do so by some superior employee identified in argument as a member of the “higher management” of the company or by one or more directors of the company identified in argument as “the guiding will” of the company. 216

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Meridian Global Funds Management Asia Ltd v Securities Commission cont. Against this background of general principle, their Lordships can return to Viscount Haldane LC in Lennard’s Carrying Co Ltd v Asiatic Petroleum Co Ltd the substantive provision for which an attribution rule had to be devised was section 502 of the Merchant Shipping Act 1894 (57 & 58 Vict c 60), which provided a shipowner with a defence to a claim for the loss of cargo put on board his ship if he could show that the casualty happened “without his actual fault or privity.” The cargo had been destroyed by a fire caused by the unseaworthy condition of the ship’s boilers. The language of section 502 excludes vicarious liability; it is clear that in the case of an individual owner, only his own fault or privity can defeat the statutory protection. How is this rule to be applied to a company? Viscount Haldane LC rejected the possibility that it did not apply to companies at all or (which would have come to the same thing) that it required fault or privity attributable under the company’s primary rules. Instead, guided by the language and purpose of the section, he looked for the person whose functions in the company, in relation to the cause of the casualty, were the same as those to be expected of the individual shipowner to whom the language primarily applied. Who in the company was responsible for monitoring the condition of the ship, receiving the reports of the master and ship’s agents, authorising repairs etc? This person was Mr Lennard, whom Viscount Haldane LC, at pp 713-714, described as the “directing mind and will” of the company. It was therefore his fault or privity which section 502 attributed to the company. … [Lord Hoffmann also referred to H L Bolton (Engineering) Co Ltd v T J Graham & Sons Ltd (see in Tesco at 171) where Denning LJ likened a company to a human body.] But this anthropomorphism, by the very power of the image, distracts attention from the purpose for which Viscount Haldane LC said, at p 713, he was using the notion of directing mind and will, namely to apply the attribution rule derived from section 502 to the particular defendant in the case: For if Mr Lennard was the directing mind of the company, then his action must, unless a corporation is not to be liable at all, have been [510] an action which was the action of the company itself within the meaning of section 502. (Emphasis supplied.) [511] Once it is appreciated that the question is one of construction rather than metaphysics, the answer in this case seems to their Lordships to be … straightforward …. The policy of section 20 of the Securities Amendment Act 1988 is to compel, in fast-moving markets, the immediate disclosure of the identity of persons who become substantial security holders in public issuers. Notice must be given as soon as that person knows that he has become a substantial security holder. In the case of a corporate security holder, what rule should be implied as to the person whose knowledge for this purpose is to count as the knowledge of the company? Surely the person who, with the authority of the company, acquired the relevant interest. Otherwise the policy of the Act would be defeated. Companies would be able to allow employees to acquire interests on their behalf which made them substantial security holders but would not have to report them until the board or someone else in senior management got to know about it. This would put a premium on the board paying as little attention as possible to what its investment managers were doing. Their Lordships would therefore hold that upon the true construction of section 20(4)(e), the company knows that it has become a substantial security holder when that is known to the person who had authority to do the deal. It is then obliged to give notice under section 20(3). The fact that Koo did the deal for a corrupt purpose and did not give such notice because he did not want his employers to find out cannot in their Lordships’ view affect the attribution of knowledge and the consequent duty to notify. It was therefore not necessary in this case to inquire into whether Koo could have been described in some more general sense as the “directing mind and will” of the company. But their Lordships would wish to guard themselves against being understood to mean that whenever a servant of a company has authority to do an act on its behalf, knowledge of that act will for all purposes be attributed to the company. It is a question of construction in each case as to whether the particular rule requires that the knowledge that an act has been done, or the state of mind with which it was done, should be attributed to the company. Sometimes, as in In re Supply of Ready Mixed Concrete (No 2) and this case, it will be appropriate. Likewise in a case in which a company was required to make a return for revenue purposes and the statute made it an offence [512] to make a false return with intent to deceive, the [4.170]

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Meridian Global Funds Management Asia Ltd v Securities Commission cont. Divisional Court held that the mens rea of the servant authorised to discharge the duty to make the return should be attributed to the company: see Moore v I Bresler Ltd [1944] 2 All ER 515. On the other hand, the fact that a company’s employee is authorised to drive a lorry does not in itself lead to the conclusion that if he kills someone by reckless driving, the company will be guilty of manslaughter. There is no inconsistency. Each is an example of an attribution rule for a particular purpose, tailored as it always must be to the terms and policies of the substantive rule. [Meridian’s appeal against its conviction was dismissed.]

Canadian Dredge and Dock Co Ltd v The Queen [4.175] Canadian Dredge and Dock Co Ltd v The Queen (1985) 19 DLR (4th) 314 Supreme Court of Canada [The accused corporations were charged with conspiracy to defraud arising out of the bid-rigging of dredging contracts. There was evidence that the bid-rigging was performed by the officer of each corporation in charge of its dredging operations, enjoying the title (as the case may be) of president, vice-president or general manager of the corporation. These individuals devised an elaborate system of compensation for the co-operating high bidders (or non-bidders) in a particular tender. There was evidence that in some cases the compensation “due” to one of the corporate accused was diverted to individual officers. The corporations were convicted and their appeals to the Ontario Court of Appeal dismissed. They appealed to the Supreme Court of Canada.] ESTEY J delivered the judgment of THE COURT: [328] This rule of law was seen as a result of the removal of the officer or managerial level employee from the general class of “inferior servants or agents” for whose acts the corporate employer continued (as in the case of the human employer) to be immune from vicarious liability in criminal law. This result is generally referred to as the “identification” theory. It produces the element of mens rea in the corporate entity, otherwise absent from the legal entity but present in the natural person, the directing mind. This establishes the “identity” between the directing mind and the corporation which results in the corporation being found guilty for the act of the natural person, the employee. Such is the power of legal reasoning. It is the direct descendant of Blackstone’s famous theorem: “The husband and the wife in law are one and that one is the husband.” … [329] The principle of attribution of criminal actions of agents to the employing corporate principal in order to find criminal liability in [330] the corporation only operates where the directing mind is acting within the scope of his authority. … The essence of the test is that the identity of the directing mind and the company coincide so long as the actions of the former are performed by the manager within the sector of corporation operation assigned to him by the corporation. The sector may be functional, or geographic, or may embrace the entire undertaking of the corporation. The requirement is better stated when it is said that the act in question must be done by the [331] directing force of the company when carrying out his assigned function in the corporation. It is no defence to the application of this doctrine that a criminal act by a corporate employee cannot be within the scope of his authority unless expressly ordered to do the act in question. Such a condition would reduce the rule to virtually nothing. Acts of the ego of a corporation taken within the assigned managerial area may give rise to corporate criminal responsibility, whether or not there be formal delegation; whether or not there be awareness of the activity in the board of directors or the officers of the company, and, as discussed below, whether or not there be express prohibition. … The route which was taken in this country and in the United Kingdom is not that which has been followed by the federal courts of the United States. Criminal responsibility in the corporation has for many years, in those courts, been placed upon the basis of the doctrine of respondeat superior. The resultant vicarious liability seems to arise in the corporation out of the criminal acts of any employee, supervisory, menial or otherwise. The United States Supreme Court expounded this principle as far 218

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Canadian Dredge and Dock Co Ltd v The Queen cont. back as New York Central and Hudson R v US 212 US 481 (1909). Although the statute there before the court specifically imposed liability in the corporation for the acts of its employees (without limitation), the courts have construed the case as establishing vicarious criminal liability in a corporation for the wrongful acts of its employees of all grades and classes. … [335] The criticisms of the United States federal court doctrine are manifold. The net is flung too widely, it is said. Corporations are punished in instances where there is neither moral turpitude nor negligence. No public policy is served by punishing shareholders where the corporate governing body has been guilty of no unlawful act. The disparity between the treatment of the corporate employer and the natural employer is wide and wholly without a basis in justice or political science. The test as applied in the United States federal courts may be on the broad basis above indicated because so many of the federal statutory crimes are regulatory in nature. … In the criminal law, a natural person is responsible only for those crimes in which he is the primary actor either actually or by express or implied authorisation. There is no vicarious liability in the pure sense in the case of the natural person. That is to say that the doctrine of respondeat superior is unknown in the criminal law where the defendant is an individual. [336] On the other hand, the corporate vehicle now occupies such a large portion of the industrial, commercial and sociological sectors that amenability of the corporation to our criminal law is as essential in the case of the corporation as in the case of the natural person. Thus where the defendant is corporate the common law has become pragmatic, as we have seen, and a modified and limited “vicarious liability” through the identification doctrine has emerged. … The corporation is but a creature of statute, general or special, and none of the provincial corporation statutes and business corporations statutes, or the federal equivalents, contain any discussion of criminal liability or liability in the common law generally by reason of the doctrine of identification. It is a court-adopted principle put in place for the purpose of including the corporation in the pattern of criminal law in a rational relationship to that of the natural person. The identity doctrine merges the board of directors, the managing director, the superintendent, the manager or anyone else delegated by the board of directors to whom is delegated the governing executive authority of the [337] corporation, and the conduct of any of the merged entities is thereby attributed to the corporation. … [A] corporation may, by this means, have more than one directing mind. This must be particularly so in a country such as Canada where corporate operations are frequently geographically widespread. The transportation companies, for example, must of necessity operate by the delegation and subdelegation of authority from the corporate centre; by the division and subdivision of the corporate brain, and by decentralising by delegation the guiding forces in the corporate undertaking. The application of the identification rule in Tesco may not accord with the realities of life in our country, however appropriate we may find to be the enunciation of the abstract principles of law there made. … [340] The third defence, acts carried out in the face of express instructions to the contrary, is susceptible to easy disposition. … [341] If the law recognised such a defence, a corporation might absolve itself from criminal consequence by the simple device of adopting and communicating to its staff a general instruction prohibiting illegal conduct and directing conformity at all times with the law. That is not to say that such an element is without relevance when considering corporate liability with reference to offences of strict liability. Where, however, the court is concerned with those mens rea offences which can in law be committed by a corporation, the presence of general or specific instructions prohibiting the conduct in question is irrelevant. The corporation and its directing mind became one and the prohibition directed by the corporation to others is of no effect in law on the determination of criminal liability of either the directing mind or the corporation itself by reason of the actions of the directing mind. This accords with the result reached in other courts. … [351] Where the criminal act is totally in fraud of the corporate employer and where the act is intended to and does result in benefit exclusively to the employee-manager, the employee-directing mind, from the outset of the design and execution of the criminal plan, ceases to be a directing mind of the [4.175]

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Canadian Dredge and Dock Co Ltd v The Queen cont. corporation and consequently his acts could not be attributed to the corporation under the identification doctrine. … [T]he identification doctrine only operates where the Crown demonstrates that the action taken by the directing mind (a) was within the field of operation assigned to him; (b) was not totally in fraud of the corporation, and (c) was by design or result partly for the benefit of the company. … [355] The identification theory … loses its basis in rationality when it is applied to condemn a corporation under the criminal law for the conduct of its manager when that manager is acting not in any real sense as its directing mind but rather as its arch enemy. On the facts before the jury in this case in these proceedings, as the Court of Appeal has pointed out, the directing minds were acting partly for their own benefit and partly for the benefit of the corporation, and not wholly in fraud of the employer corporation. Consequently, it is unnecessary, technically, for this court to [356] define the limits in our law of the [theory] … In my view, the very pragmatic origins of the identification rule militate against its extension to the situation which would have existed here had one or more of the directing minds acted entirely for his own benefit and directed his principal efforts to defrauding the company. Where the corporation benefited or was intended to be benefited from the fraudulent and criminal activities of the directing mind, the rationale of the identification rule holds. Where the delegate of the corporation has turned against his principal, the rationale fades away. [The court considered that there was ample evidence to support the jury’s finding that each of the individuals was a directing mind of one of the accused corporations.]

[4.178]

1.

2.

3.

4.

220

Notes&Questions

Who are the organs and officers identified with the company under the primary basis of criminal liability? In Tesco Lord Diplock thought that this question might be answered by “identifying those natural persons who by the memorandum and articles of association or as a result of action taken by the directors, or by the company in general meeting pursuant to the articles, are entrusted with the exercise of the powers of the company”: at 200. Viscount Dilhorne identified with the company “a person who is in actual control of the operations of a company or part of them and who is not responsible to another person in the company for the manner in which he discharges his duties in the sense of being under his orders”: at 187. Further, in the third of the 1944 decisions invoking the notion of primary liability, Moore v I Bresler Ltd [1944] 2 All ER 515, the acts and intention attributed to the company were those of its secretary who was also the manager of one of its branches. The directing mind and will of a company is not to be found exclusively in those who have the general control of a company’s affairs but extends to those who have control of a particular sphere of activity. In El Ajou v Dollar Land Holdings plc [1994] 1 All ER 685 at 706, Hoffman LJ said “the authorities show clearly that different persons may for different purposes satisfy the requirements of being the company’s directing mind and will”. Does Meridian offer a fundamentally different process for identifying the directing mind and will of a company to that applied in Tesco and Canadian Dredge? If so, what are those differences and the comparative merits of Meridian’s rules of special attribution? See S Worthington (2017) 133 LQR 118. Do the judgments in Tesco, Meridian and Canadian Dredge give a clear indication of the range of persons who will be identified with the company? Would a different result have ensued in Tesco if the company had operated not hundreds of stores but only one or two? If so, is the supermarket chain therefore placed in a privileged position relative [4.178]

Some Consequences of Corporate Personality

5.

6.

CHAPTER 4

to the corner grocer (whether incorporated or unincorporated)? More particularly, does Tesco impose too restricted a notion of the persons whose acts will be identified with the company? Should a branch manager, at the coalface of the company’s operations and arguably its representative in a particular locality, be identified with it, and not just those on its commanding heights? What considerations should determine the scope of identification? The managing director and sales manager of a company, acting in collusion, sell some of the company’s stock to themselves, without any payment to the company or note in its accounts. Would the company be criminally liable for their fraud? Would it make any difference whether the company was a small private company controlled by the wrongdoers or one whose shares were widely and publicly held? See Moore v I Bresler Ltd [1944] 2 All ER 515 and Canadian Dredge at 340-341. Would a corporation in the Canadian Dredge case have escaped liability if its board had expressly repudiated a proposal from its president that the corporation enter into the bid-rigging but the president had nonetheless proceeded, in stealth and in defiance of its direction? For a civil decision reaching a like result to that in the Canadian Dredge case, see Belmont Finance Corp Ltd v Williams Furniture Ltd [1979] Ch 250. Suppose that the managing director of a company whose operations are based in the suburbs of Brisbane is suddenly summonsed to attend a board meeting in the city. In her haste to meet the appointed time she drives recklessly through a crowded street and kills an innocent pedestrian. There is no doubt that the company would be liable in tort. Would it also be criminally liable? See R S Welsh (1946) 72 LQR 345 at 360; and Presidential Security Services of Australia Pty Ltd v Brilley (2008) 67 ACSR 692; [2008] NSWCA 204 at [6]-[7] (ACSR).

Wider statutory bases of attributed liability [4.180] Several statutory provisions specify the corporate officers whose intention or conduct

will be attributed to the company for purposes of liability under the statute. Thus, for the purposes of certain proceedings under the Competition and Consumer Act 2010 (Cth), s 84 of the Act attributes to the company the conduct and state of mind of corporate officers acting within the scope of their actual or apparent authority. 78 The Criminal Code Act 1995 (Cth) (Criminal Code) contains an extensive statutory scheme of attribution which goes well beyond that developed under the attribution rules created by the courts. The Criminal Code applies for the purpose of offences created under Commonwealth legislation, including the Corporations Act itself. 79 If the physical element of an offence is committed by a company employee acting within the actual or apparent scope to their employment, or by an agent of the company acting within the scope of their actual or apparent authority, that element is attributed to the company: s 12.2. If intention, knowledge or recklessness is a fault element of an offence, that fault element is attributed to a company if it “expressly, tacitly or impliedly” authorises or permits the commission of the offence: s 12.3(1). That authorisation or permission may be established by proof that the board of directors or a high managerial agent of the company intentionally, knowingly or recklessly carried out the relevant conduct or authorised the commission of the 78

See also, eg, Taxation Administration Act 1953 (Cth), s 8ZD (attributing to a company for purposes of a taxation offence the intention of the servant or agent by whom the act was done or omitted to be done); Ozone Protection and Synthetic Greenhouse Gas Management Act 1989 (Cth), s 65 (attributing conduct by director, servant or agent within the scope of their actual or apparent authority).

79

Corporations Act, s 1308A, but not to offences under Ch 7 which deals with financial services and markets: s 769A. A dedicated regime of corporate responsibility for offences under Ch 7 is contained in s 769B. [4.180]

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offence. A high managerial agent is a company employee, agent or officer with duties of such responsibility that their conduct may fairly be assumed to represent the company’s policy: s 12.3(6). The presumed authorisation from the high managerial agent’s conduct or authorisation is, however, displaced by proof that the company exercised due diligence to prevent such conduct or authorisation: s 12.3(3). The fault element is also attributed to the company where it is established that a corporate culture existed within the company that directed, encouraged, tolerated or led to noncompliance with the relevant provision or that the company failed to create and maintain a corporate culture that required compliance with the provision: s 12.3(c), (d). Among the factors relevant in establishing a corporate culture are whether a high managerial agent has authorised the commission of an offence of a similar character and whether the person who committed the offence reasonably believed or expected that a high managerial agent would have authorised the commission of the offence: s 12.3(4). The wider attribution provided by the notion of a corporate culture therefore looks to the living norms of the company, “the way we do things around here”, rather than its formal rules and policies if, with the authority or reasonably assumed support of a high managerial agent, they are commonly ignored. Norms in action rather than those merely in the books govern attribution of fault for offences requiring intention, knowledge recklessness. Where negligence is the fault element of an offence, it may be satisfied even when no individual employee, agent or officer is negligent but the company’s conduct is negligent when viewed as a whole (that is, by aggregating the conduct of any number of its employees, agents or officers): s 12.4(2). Such negligence may be evidenced by the fact that the prohibited conduct was substantially attributable to: • inadequate corporate management, control or supervision of the conduct of one or more of its employees, agents or officers; or • failure to provide adequate systems for conveying relevant information to relevant persons in the company: s 12.4(3). The broad attribution rules under the Criminal Code represent an attempt at careful translation from the individual to organisational setting of notions of fault and responsibility that engage the criminal law. However, the rules apply only for offences under Commonwealth legislation. Strict or absolute corporate criminal liability [4.182] There is a species of modern regulatory offence that creates a strict or absolute

liability in that proof of mens rea (or guilty mind) is not an element of the offence and liability arises from the mere fact of failure to meet a certain standard of conduct or to do a particular act. The level in the corporate hierarchy of the employees, or even the external agents, responsible for the failure is irrelevant to liability as is the absence of any intention to breach the standard. In some statutory provisions the criminal liability might be described as absolute since it is complete upon proof of failure to meet the particular standard; other provisions are more accurately described as creating strict liability since a defence is provided such as for honest and reasonable mistake or the exercise of due diligence 80 although this is a matter of nomenclature more than of substance. Thus, in some provisions the statutory duty to ensure safety standards, etc, will be expressed to be subject to some qualifier such as “so far as reasonably practicable”. 81 While such a practicability qualification means that the obligation 80

See He Kaw The v R (1985) 157 CLR 523, 590 per Dawson J.

81

In this case, it may not be relevant to consider the level in the corporate hierarchy of the employees whose conduct may or may not satisfy the reasonableness test: “if the test is whether all reasonable precautions

222

[4.182]

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to ensure safety is not absolute, the liability for breach is nonetheless absolute. 82 Smith explains the basis for absolute liability and distinguishes it from vicarious liability in the context of discussing a decision where the statute required an employer to ensure a safe working environment for workers: Where a statutory duty to do something is imposed on a particular person (here, an “employer”) and he does not do it, he commits the actus reus of an offence. It may be that he has failed to fulfil his duty because his employee or agent has failed to carry out his duties properly but this is not a case of vicarious liability. If the employer is held liable, it is because he, personally, has failed to do what the law requires him to do and he is personally, not vicariously, liable. There is no need to find someone – in the case of a company, the “brains” and not merely the “hands” – for whose acts the person with the duty can be held liable. The duty on the company in this case was “to ensure” – ie to make certain – that persons are not exposed to risk. They did not make certain. It does not matter how; they were in breach of their statutory duty and, in the absence of any requirement of mens rea, that is the end of the matter. 83

The statutory duty was thus interpreted to impose liability on the employer whenever the relevant event occurred, namely, a failure to ensure the health and safety of an employee. In ABC Developmental Learning Centres Pty Ltd v Wallace, ABC, the proprietor of a childcare centre, was prosecuted for breach of s 27(1) of the Children’s Services Act 1996 (Vic): (1) The proprietor of a children’s service must ensure that all children being cared for or educated by the service are adequately supervised at all times that children are on the premises where the service operates or in the care of that service. (2) A staff member of the children’s service must ensure that any child in the care of that staff member is adequately supervised.

Due to inadequate supervision by staff employed in the centre, a child climbed over the fence and left the centre. In the Magistrates Court and on appeal to a single judge of the Supreme Court, the failures of the “low-level” employees were attributed to the company on the basis that the terms of the offence and the achievement of the policy objectives of the statute required it. The Victorian Court of Appeal, however, considered that s 27(1) did not call for any rules of attribution. 84 The statutory duty on the proprietor of a children’s service under s 27(1) is to ensure that children within its care are adequately supervised at all times: Under s 27(1), the proprietor has a duty to ensure – that is, make certain – that a certain state of affairs exists viz adequate supervision of all children. … [Section] 27(1) is framed to achieve a result. Unless there is adequate supervision, the company is in breach. Liability under the section does not depend upon any failure by the company itself, meaning by those persons who “embody the company”. If it is proved that there was not adequate supervision, it is immaterial where in the organisation the failure occurred. 85

Absolute criminal liability is imposed upon the corporation on the basis that the duty imposed by the statute is not one that can be delegated to another person. Liability does not depend on proof of mens rea: the offences are committed by the objective failure of the company to meet

82

have been taken by the company or on its behalf, then it would not seem to be material to consider whether the individual concerned, who acted or was authorised to act on behalf of the company, was a senior or a junior employee” (R v Gateway Foodmarkets Ltd [1997] 2 All ER 78 at 83-84, cited in ABC Developmental Learning Centres Pty Ltd v Wallace [2007] VSCA 138 at [17]). ABC Developmental Learning Centres Pty Ltd v Wallace [2007] VSCA 138 at [14].

83 84

J C Smith [1995] Crim L R 654 at 655, referring to R v British Steel Plc [1995] 1 WLR 1356. The Court of Appeal, however, said that, if it were necessary to consider the question of attribution, it would uphold it in this case for these reasons given (at [29]).

85

ABC Developmental Learning Centres Pty Ltd v Wallace [2007] VSCA 138 at [19]. [4.182]

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the specified standard, whether the failure is deliberate or inadvertent and at what level of the company hierarchy it occurs. This is, of course, a matter of interpretation of the particular provision. Another provision may attract vicarious or primary liability only. Personal liability of corporate officers [4.185] So far we have considered when criminal responsibility for the defaults of human

actors should be ascribed to a corporation. However, in a number of statutes, particularly in the fields of industrial regulation and revenue collection, liability has been extended from the corporation to its directors. For example, the Employment Protection Act 1982 (NSW), s 22 provides that where a corporation contravenes a provision of the Act, each director and other person concerned in its management is deemed to have contravened the same provision unless they establish that (a) the contravention was without their knowledge; (b)

they were not in a position to influence the conduct of the corporation in relation to its contravention or

(c)

if they were in such a position, they used all due diligence to prevent the contravention. 86

Company officers may also be liable as ancillary participants in the company’s crime. Section 79 defines the scope of secondary party involvement in a contravention of the Corporations Act and includes those who aid, abet or induce the offence or who are knowingly concerned in or party to the offence. The ancillary liability of corporate officers presents the occasional difficulty of disentangling the spheres of corporate and individual action. In Mallan v Lee, the statutory offence was interpreted as imposing primary liability upon the public officer of a company who lodges a tax return for the company that knowingly understates its income; the company was made responsible vicariously under the section. The prosecution of the public officer as an accessory to the company’s breach failed since [i]t would be an inversion of the conceptions on which the degrees of offending are founded to make the person actually committing the forbidden acts an accessory to the offence consisting in the vicarious responsibility for his acts. 87

However, in Hamilton v Whitehead the company was charged with advertising offers of an investment interest in breach of the companies legislation. Whitehead, its managing director, was charged with being knowingly concerned in the commission of the offences alleged against the company. In the High Court, Mason CJ, Wilson and Toohey JJ said: There can be no doubt, on the facts of the present case, that [Whitehead], in placing the advertisement and in dealing with those who replied to it, was the company. He was its managing director and his mind was the mind of the company. The company therefore was liable as a principal for the breaches of [the Act]. The liability was direct, not vicarious. … Since [Whitehead] was the actor in the conduct constituting the offences and had knowledge of all the

86

The automatic extension of liability and similar grounds of exculpation have appeared in numerous other statutes especially relating to occupational safety, revenue collection and environmental protection. Considerations going to the equity and efficiency of this positional or status-based regulation have prompted a comprehensive overhaul of legislation imposing personal liability upon corporate officers for corporate breaches by reference to principles formulated by the Council of Australian Governments: see [7.15].

87

(1949) 80 CLR 198 at 215.

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[4.185]

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material circumstances, it must follow … that [he] was “knowingly concerned” in the commission of the offences committed by the company. 88

Whitehead invoked Mallan v Lee to argue that it was “wrong and oppressive” to prosecute him as an accessory to an offence where the primary liability arose solely from the attribution to the company of his own conduct. This argument was rejected by the High Court: the inversion of which [Dixon J in Mallan v Lee] spoke has no application here. The company is not vicariously liable for the actions of [Whitehead]. The company is the principal offender and the respondent is charged as an accessory. [The primary judge] thought that it was “wrong and oppressive” to prosecute [Whitehead] for the identical acts and decisions as were relied on as the acts of the company. There is nothing conceptually wrong in such a course since “it is a logical consequence of the decision in Salomon’s case that one person may function in dual capacities” (Lee v Lee’s Air Farming Ltd). In R v Goodall (1975) 11 SASR 94, Bray CJ discussed what his Honour described as: some sort of metaphysical bifurcation or duplication of one act by one man so that it is in law both the act of the company and the separate act of himself as an individual (at 100) and expressed his conclusion as follows (at 101): my view is that the logical consequence of Salomon’s case … is that the company, being a legal entity apart from its members, is also a legal person apart from the legal personality of the individual controller of the company, and that he in his personal capacity can aid and abet what the company speaking through his mouth or acting through his hand may have done. We agree with this view. 89

It appears therefore, following Mallan v Lee, that the result in Hamilton v Whitehead would have been different if the company had been liable on the basis of vicarious and not primary (or direct) liability. As Kahn-Freund noted (see [4.40]), corporate form can sometimes operate as a boomerang, rebounding against its user in adverse, unintended and unforeseen ways. [4.190]

Review Problem

Recall the facts of the Review Problem in [4.128] concerning Aussie Fun Park Pty Ltd (“AFP”) – a wholly owned subsidiary of Australian Entertainment Ltd (“Entertainment”) – which operated an amusement ride that malfunctioned, injuring two AFP workers. The (hypothetical) Amusement Park Safety Act 2000 (Cth), s 25 provides that: The operator of an amusement park shall commit an offence for knowingly, intentionally or recklessly exposing its workers and users to foreseeable risks in the operation of amusements.

The Entertainment board has set out guidelines for the safe operation of its subsidiaries’ amusement parks. However, there has been little policing of their enforcement and AFP managers have largely ignored them. The Head of Safety at AFP regarded them as “unrealistic and unsuitable” for the Sydney operation. AFP fears prosecution under this section. It seeks your advice with respect to its prospects of success in defending any criminal prosecution. Limit your advice to the fault element of the offence and do not address the physical element.

88 89

(1988) 65 ALJR 80 at 82. (1988) 65 ALJR 80 at 82. [4.190]

225

CHAPTER 5 Directors and Managers [5.10]

[5.30]

[5.95]

[5.120]

CORPORATE GOVERNANCE .......................................................................................................... 228 [5.10]

The moral hazard in shareholder–manager relations .................................................... 228

[5.15]

The range of corporate governance measures .............................................................. 229

[5.20]

Diversity and commonality in corporate governance systems ....................................... 230

[5.25]

The range and role of corporate governance codes and standards ............................... 231

THE EFFECTIVE BOARD ................................................................................................................. 233 [5.30]

The formal primacy of the board .................................................................................. 233

[5.35]

The collapse of Enron: a case study in board failure ...................................................... 235

[5.40]

What is the proper role of the board? .......................................................................... 238

[5.55]

Board composition: the role of independent directors .................................................. 242

[5.85]

Empowering the independent directors ....................................................................... 251

THE DISTRIBUTION OF CORPORATE POWERS BETWEEN SHAREHOLDERS AND DIRECTORS .......... 254 [5.95] [5.100]

The derivation of the corporate organs ........................................................................ 254 Original powers of the general meeting ....................................................................... 256

[5.105]

The powers of the board .............................................................................................. 257

DIRECTORS’ INDEPENDENCE IN THE EXERCISE OF THEIR POWERS ............................................... 259 [5.120] [5.140] [5.150] [5.155]

[5.195]

[5.265]

[5.310]

259 264 265 266

PLANNING FOR CONTROL IN THE PRIVATE COMPANY ................................................................. 277 [5.195] [5.200]

[5.210]

General principles of interpretation of constitutional provisions .................................... Residual control in the general meeting ....................................................................... Dual initiative to litigate in the company’s name? ........................................................ Informal corporate acts ................................................................................................

Shareholder agreements .............................................................................................. 277 Other control distribution devices ................................................................................ 280

APPOINTING AND REMOVING DIRECTORS .................................................................................. 281 [5.215]

The personnel of company management ..................................................................... 281

[5.220] [5.225] [5.230]

Appointment of directors ............................................................................................. 283 Restrictions upon appointment as director ................................................................... 284 Disqualification from office and from managing companies ......................................... 285

[5.240]

Termination of office .................................................................................................... 295

[5.245]

Executive directors’ service contracts ............................................................................ 298

FUNCTIONING OF THE BOARD OF DIRECTORS ............................................................................ 305 [5.265]

The board as collective ................................................................................................. 305

[5.270]

Convening directors’ meetings .................................................................................... 306

[5.275] [5.285] [5.290]

The conduct of directors’ meetings .............................................................................. 307 Minutes of directors’ meetings ..................................................................................... 310 Validation of irregularities ............................................................................................. 310

[5.295]

Director and shareholder access to corporate information ............................................ 311

THE AUTHORITY OF CORPORATE AGENTS TO BIND THE COMPANY ............................................. 316 [5.310] [5.315]

Problems facing those who deal with companies ......................................................... 316 Actual authority ........................................................................................................... 317

[5.330]

Ostensible authority ..................................................................................................... 320 227

Corporations and Financial Markets Law

[5.340] [5.360]

Indoor management rule ............................................................................................. 327 The statutory assumptions protecting those dealing with companies ........................... 336

[5.375]

Validation of directors’ acts under defective appointment ............................................. 343

Structure of the chapter [5.05] The corporation is an abstraction devoid of physical form, existing only in

contemplation of the law. It is, therefore, incapable of expressing its will except through the mediation of natural persons. Modern company law recognises two groups of individuals as the primary organs through which the corporate will may be known and given effect – the shareholders in general meeting and the board of directors. This chapter is concerned with the relationship between these two groups, the principal incidents of the office of director, the functioning of company boards, and the directors’ relationship with senior management. Thus, the chapter deals successively with • the evolution of the corporate organs and of their relative status; • the division of corporate powers between shareholders and directors; • directors’ independence from shareholders in the exercise of their powers; • other mechanisms for distributing control between the participants in the enterprise; • key incidents of the office of director and the functioning of the board as a group whose powers are collective rather than individual; and • the rules governing the authority of corporate officers to bind the company to transactions purportedly made on its behalf. The chapter commences with an examination of the elements of corporate governance systems and the purposes that they broadly serve. The following section looks particularly at the place of the board of directors within governance systems and how the functions that the board performs are made most effective.

CORPORATE GOVERNANCE The moral hazard in shareholder–manager relations [5.10] Corporate governance lies at the heart of corporate law and the idea of the corporation

itself. What is corporate governance? Not surprisingly, it might be described as the structures and processes by which the corporation is governed. However, this is simply a tautological definition and sheds little light. At one level, corporate governance refers to the complex of legal rules and constitutional provisions that regulate the internal affairs of the company as distinct from the external regulation of corporate behaviour by the state and its agencies. In this sense, corporate governance is concerned with the relations between the shareholders themselves and with the directors and the senior managers whom the directors appoint to manage the enterprise. These rules are to be found in the replaceable rules and their augmenting constitutional provisions (if any), in doctrines fashioned by the courts to guard against abuse by corporate managers and controllers, and in statutory provisions that complement general law doctrines. Thus, these corporate governance rules distribute the corporate powers between the several organs and officers, define the legitimate prerogatives of each, impose duties and constraints upon those exercising corporate powers, and create remedies for their violation. Corporate governance can, however, be viewed more broadly. At its core is the inherent conflict of interest and preference between company management (including directors) and shareholders. This is a moral hazard in the manager–shareholder relation, that arising whenever one person employs another to perform some function in the other’s interest which 228

[5.05]

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involves the delegation of decision-making authority. The divergence in interest between principal and agent arises in such arrangements since the agent’s personal utility will rarely be identical with that of the principal. The degree of moral hazard varies with the opacity and specialised nature of the agent’s functions. In a corporate context the risk is that directors and managers may take imperfectly observable actions in their own interest rather than in shareholders’ interests. These dangers principally comprise those of looting (self-dealing and diversion of corporate opportunity), shirking (failure to apply themselves diligently to the job) and empire building that secures executive vanity or indirect personal gain rather than advances the collective shareholder benefit. Thus, the agent captures the whole of the benefit of shirking but some portion only of the benefit from hard work in the company’s interest. These dangers are difficult to protect against and to detect through monitoring of directors, senior managers and lower level employees. Accordingly, corporate governance systems typically provide for a number of measures that seek to make management accountable to shareholders (adopting the language of managerialist models of the corporation and corporate law) or which seek to reduce the agency costs that arise from the delegation of authority to managers to run the business in the interests of shareholders (using the language of transaction cost economics). This concern is captured in the conception of corporate governance as “the framework of rules, relationships, systems and processes within and by which authority is exercised and controlled within corporations. It encompasses the mechanisms by which companies, and those in control, are held to account”. 1 A second element of corporate governance systems responds to the purpose question: what is the corporate objective – in whose interests should the corporation be operated and managed (see [2.200])? This element stresses its function in responding to “external” stakeholder claims, “in holding the balance between economic and social goals and between individual and communal goals”; in these formulations, its function is to “align as nearly as possible the interests of individuals, corporations and society”. 2 Whether framed in terms of shareholder or stakeholder interests, the quest for enhanced accountability is necessarily pursued at the expense of management authority and the vigour and initiative that the broad grant of authority secures. The adjustment between these competing goals lies at the heart of corporate governance systems. The range of corporate governance measures [5.15] There is a variety of legal, market and social forces that seek to align the interests of

managers and shareholders, if not so clearly those of other stakeholders. Some emphasise legal rules, albeit in varying degree – • the imposition of legal duties upon directors and managers; • shareholder voting rights; • shareholder litigation rights; • the system for reporting and verification of corporate financial information; • the design of executive compensation packages to provide performance incentives; • oversight and enforcement by regulatory agencies; and 1

This is the definition adopted in the ASX Corporate Governance Council, Corporate Governance Principles and Recommendations (3rd ed, 2014), p 3, adapting the formulation contained in HIH Royal Commission, The Failure of HIH Insurance, Volume 1: A Corporate Collapse and its Lessons (2003), p xxxiii.

2

The words quoted in this sentence are from Sir Adrian Cadbury, Corporate Governance Overview, 1999 World Bank Report, quoted in Executive Summary of the King Report on Corporate Governance 2002, p 6. [5.15]

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• measures affecting board composition (the appointment of independent outside directors), structure (committees dominated by independent outsiders to deal with sensitive areas including those marked by management conflicts of interest) and function (explicit role for the board in monitoring management). Since each of these measures has its own peculiar limitations, they need to be overlapping with each other and with others that are not so heavily reliant upon legal norms and their enforcement. 3 Measures concerning board structure and function are discussed at [5.30][5.90]. Other legal measures are discussed in later chapters: shareholder voting rights at [6.75]-[6.85], the imposition of fiduciary and other duties upon directors in Chapter 7, shareholder litigation rights at [8.70] et seq, and corporate financial reporting at [9.120] et seq. Other instruments of corporate governance range well beyond legal rules. They include market disciplines – • financial markets whose pricing sanctions reward good performance with lower capital raising costs for the corporation; • the executive employment markets, both within and external to the corporation, which determine the reputational capital of managers and thereby their remuneration; • the market for corporate control which may displace directors and managers of a corporation whose stock price reflects, among other things, the negative judgment of traders and investors as to the quality of its management; and • the markets for a corporation’s products or services; failure in those markets powerfully affects business performance with a cascading negative effect upon stock price and like consequences in other markets. Finally, there are also the personal moderators of conduct through the ethical and moral sense of directors, managers and employees, and the social norms that operate within a corporation to reinforce, or undermine, the wellsprings of personal integrity and responsibility. Diversity and commonality in corporate governance systems [5.20] Corporate governance involves some elements of choice for each company along with

some characteristics that are generally distinctive of corporate type and national system and tradition. Thus, in Australia the partnership model requiring consensus for major decisions is often adopted by private companies where directors are actively involved in management and have broadly comparable, or complementary, knowledge of business operations. The model is inappropriate for the publicly held corporation where a model based upon a structure of decisional hierarchy and command is more common. Even within publicly held corporations, models of corporate governance differ widely. The differences are most pronounced at the national level. Thus, in the United States, the United Kingdom and Australia, the shareholder suit and the hostile takeover bid have some purchase as disciplinary measures to secure governance objectives; the scope and function of each varies between the three systems and over time within each. However, until recently, shareholder litigation has been largely unknown outside these three systems. Other governance systems might, as in most European systems, rely upon monitoring of corporate management by controlling shareholders, by financial intermediaries (such as by banks in Germany) or interlocking ownership structures as in Japan. In the United States, the United Kingdom and Australia, the unitary board is the legal norm; many European systems adopt a two-tier board structure with a supervisory board above a separate management board. In the Anglo-American model, the board of directors in 3

American Law Institute, Principles of Corporate Governance: Analysis and Recommendations (Vol 1, 1994), pp 4-9.

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publicly held corporations acts as a monitor of corporate management, a function increasingly pursued through the appointment of non-executive directors formally independent of management and the adoption of a board committee structure designed to maximise independence from management in relation to key functions. These measures are not mandatory although some might be required as a condition of stock exchange listing. Generally, however, the United States, Australian and, to a lesser extent, the United Kingdom systems of corporate governance rely upon legal protection of investors to a greater degree than other national systems, supporting and perhaps explaining their distinctive patterns of dispersed share ownership and liquid markets. 4 For all systems of corporate governance, however, there are some common axes of choice. One relates to the balance struck between the goals of assuring the vigour of corporate management through the grant of broad authority and security of tenure and, on the other hand, management accountability for business performance and standards of conduct. Thus, directors are given broad powers and enjoy a substantial degree of autonomy in their exercise; their business judgments are subject to judicial review only in exceptional circumstances, and their tenure in office is protected through a mixture of constitutional and contractual provisions that are examined in this chapter. Accountability is addressed through powers given to shareholders collectively with respect to board composition, the imposition of legal duties and rights to seek their enforcement through the courts. A second axis of choice common to corporate governance systems asks whose interest ultimately shapes the corporate purpose. Is the corporation ultimately conducted for the collective benefit of shareholders so that their claims trump those of other stakeholders in situations where, in the absence of legal obligation, a discretion lies as to whose interests shall prevail or shape the outcome of a decision as to the allocation of corporate resources? The accommodation permitted for non-stakeholder interests where they are in conflict with those of shareholders varies between national systems of corporate law and the wider social, financial and cultural systems in which they are embedded. A significant difference between European and common law corporate governance systems is in the role accorded to corporate constituencies beyond shareholders. This is most evident in European co-determination structures which provide for labour representation upon the supervisory board of a corporation sitting above and exercising control functions over the management board. It is evident also in a more pronounced stakeholder orientation generally in European corporate governance. None of these systems is resistant to internal and external forces for change; that change is evident: see [2.200]. The range and role of corporate governance codes and standards [5.25] In addition, there is emerging a plethora of corporate governance standards that rest

upon a mixture of legal obligation, market pressure and individual corporate initiative. These standards are primarily addressed to publicly held corporations and expressed in formal corporate governance codes. They seek to strike a balance between efficiency in business operations and accountability for performance against business and wider criteria. In varying degrees they seek to advance a mixture of cognate or instrumental goals, such as transparency of conduct, fairness in the treatment of stakeholders, and the assumption of responsibility for corporate conduct including its social impacts. The international corporate governance code movement is a response to the desire of governments and securities exchanges to attract foreign investment with investor-friendly codes and corresponding investor pressure, from 4

H Hannsman and R Kraakman (2001) 89 Geo L J 439; J C Coffee (1999) 93 Nw U L Rev 641; in the United Kingdom there has been greater reliance upon functional equivalents and complements to legal rules rather than upon those rules themselves: B Cheffins (2001) 30 J Leg Studs 459: see [2.190]. [5.25]

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institutional investors especially, for an international benchmark model of good corporate governance. This competition for investment results in a tendency towards convergence in code provisions in matters such as board structure, composition and functioning, the separation of chair and CEO roles, board committee structure, executive remuneration, the management of conflicts of interest, and a pro-shareholder disposition generally. This convergence is expressed more in national corporate governance codes than in statute law. 5 The formal character of corporate governance codes and standards varies widely. Thus, the corporate governance standards established by independent professional committees and adopted by the Australian Securities Exchange 6 and the London Stock Exchange 7 establish norms which their listed companies must either comply with or explain why they choose not to do so. (In the United Kingdom and Europe, the term “comply or explain” is generally used; the Australian usage is “if not, why not”). These standards recommend that listed companies create their own codes of conduct with respect to matters such as ethical conduct and compliance with obligations to stakeholders. 8 On the other hand, it is also common for unlisted companies, including modestly sized private companies, to create codes of conduct on their own initiative, particularly with respect to areas of potential liability or perceived vulnerability to consumer sentiment, for example, as measures to protect brand or product reputation. In between are a wide range of other corporate governance standards. They include standards of recommended practice with an intended global application such as the G20/OECD Principles of Corporate Governance. 9 In Australia, apart from the ASX Corporate Governance Principles and Recommendations (here called the ASX Principles), statements of recommended corporate governance practices and conduct have been adopted by professional associations 10 and associations representing superannuation funds 11 and investment and fund managers. 12 The UK Corporate Governance Code issued by the independent regulator, the Financial Reporting Council, is the body of principles from which companies listed on the London Stock Excange must justify their departure under the comply or explain principle. The UK Code is a summation of principles 5

6

The European Corporate Governance Codes Network collects and shares information on European national corporate governance codes: see http://www.ecgcn.org/Corporate-Governance-Reports.aspx. The codes are not mandatory and generally adopt the “comply or explain” mechanism introduced in the UK Cadbury Report in 1992: The Financial Aspects of Corporate Governance. In that respect they share characteristics of other non-binding conduct standards: as Captain Barbossa explains to a naïve Elizabeth in Pirates of the Caribbean: The Curse of the Black Pearl, rejecting her claim to protection under the pirate code, the code “is more what you’d call ‘guidelines’ than actual rules”. (I am grateful to Dr Suzanne Le Mire for drawing my attention to this parallel.) ASX Corporate Governance Council, Corporate Governance Principles and Recommendations (3rd ed) (here called the “ASX Principles”). ASX Listing Rule 4.10.3 requires listed entities to provide in their annual report or website a corporate governance statement disclosing the extent to which the entity has followed the recommendations set by the ASX Corporate Governance Council. If the entity has not followed a recommendation for any part of the reporting period, the statement must identify that recommendation and state the reasons for not following it and what (if any) alternative governance practices it adopted in lieu of the recommendation during that period.

7

Financial Reporting Council, UK Corporate Governance Code (2016).

8 9

See, eg, ASX Principles, Principle 3. OECD, G20/OECD Principles of Corporate Governance (2015).

10

Working Party of the Australian Institute of Company Directors etc, Corporate Practices and Conduct (3rd ed, 1995) (Bosch Report).

11

Australian Council of Superannuation Investors, ACSI Governance Guidelines: A Guide to Investor Expectations of Australian Listed Companies (2015).

12

Investment and Financial Services Association, Corporate Governance: A Guide for Fund Managers and Corporations: IFSA Guidance Note No 2.00 (2009) (Blue Book). In 2010 the association changed its name to the Financial Services Council.

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derived from earlier general foundational statements 13 and specialised statements with respect to the role of non-executive directors, 14 director and executive remuneration, 15 audit committees, 16 and director recruitment and professional development. 17 The responsibilities of investors, especially institutional investors, have been separately examined in the United Kingdom and are now expressed in the UK Stewardship Code issued by the Financial Reporting Council. 18 In the United States, the American Law Institute (an academy of senior lawyers) has prepared an influential statement of corporate governance principles that extends beyond analysis and restatement of existing law to recommend governance models and legal reform. 19 A number of US industry organisations have also issued guidelines on recommended practice, including the Council of Institutional Investors (a proxy advisory service), 20 the peak labour organisation 21 and leading pension funds. 22 The King Review of Corporate Governance in South Africa has attracted international attention for its Code of Corporate Practices and Conduct. 23 Other national and regional level reviews have also recommended corporate governance standards. 24

THE EFFECTIVE BOARD The formal primacy of the board [5.30] The board of directors is central to corporate governance, if only because the bulk of

corporate powers are vested in directors, placing them, formally at least, at the apex of its power system. One important element of corporate governance systems therefore relates to board function, composition and committee structure. This component is examined here, in advance of the treatment of the legal rules governing board and shareholder powers and the director’s office. Many companies have provisions in their constitutions that simply declare that the business of the company shall be managed by the directors; this standard clause is based upon the Table A model that was appended to companies statutes for a century and a half until the introduction of replaceable rules in 1998. The replaceable rule in s 198A states that the business of a company is to be managed by or under the direction of the directors. (The added 13

The Financial Aspects of Corporate Governance (Cadbury Report, 1992); Hampel Report: Committee on Corporate Governance (Final) (1998).

14 15

D Higgs, Review of the Role and Effectiveness of Non-Executive Directors (2003). Directors’ Remuneration (Greenbury Report, 1995).

16 17

Audit Committees, Combined Code Guidance (Smith Report, 2003). The Tyson Report on the Recruitment and Development of Non-Executive Directors (2003).

18

The UK Stewardship Code (2012) builds upon Institutional Investment in the United Kingdom: A Review (Myners Report, 2001); Institutional Shareholders’ Committee, The Responsibilities of Institutional Shareholders and Their Agents – Statement of Principles (2002); Association of Unit Trusts and Investment Funds, Code of Good Practice: Institutional Investors and Corporate Governance (2001).

19 20

American Law Institute, Principles of Corporate Governance: Analysis and Recommendations (1994). Council of Institutional Investors, Corporate Governance Guidelines.

21

American Federation of Labor and Congress of Industrial Organisations, Investing in Our Future: Proxy Voting Guidelines.

22

See, eg, California Public Employees’ Retirement System (CalPERS), US Corporate Governance Core Principles and Guidelines (1998). Institute of Directors in Southern Africa, King Code of Governance for South Africa 2009 (King III).

23 24

See, eg, Toronto Stock Exchange Committee on Corporate Governance, Where were the Directors? Guidelines for Improved Corporate Governance in Canada (Dey Report, 1994); see also, at the European level, Modernisation of Company Law and Enhancement of Corporate Governance (Final Report of the High Level Group of Company Law Experts, 2002). [5.30]

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words, “or under the direction of”, were taken from those of the Delaware General Corporation Law, s 141(a), where they are a mandatory vesting of board power, not the optional provision under Australian law.) The principal powers of the corporation are commonly vested in the board under either model (that is, whether the board manages the business of the company or simply directs its management); shareholders have no power to initiate action within the broad domain reserved to directors and very limited power to approve or reject directors’ decisions made in the exercise of their powers: see [5.120]. Directors and senior managers of publicly held corporations often enjoy de facto control over the exercise of powers formally confided to shareholders, including the power to appoint directors themselves. In such companies it is unusual for nominations to be made for appointment to the board other than by the board itself: see [5.220]. The breadth of board powers and the independence that directors enjoy in their exercise place the board at the centre of corporate governance systems; directors do not, however, possess superhuman capacity so that identification of their effective function becomes important. For many smaller companies, directors will be actively involved in the management of company operations and the older constitutional provision will be an apt descriptor of their role. For larger companies, however, the scale and complexity of business operations require directors to delegate functions to the senior managers whom they appoint and to the staff whom those managers in turn appoint. In those companies the question arises as to what are the proper roles, functions and responsibilities of the board relative to company management. These questions are not peculiar to business corporations. They apply equally to not-for-profit corporations of significant size, such as the governing councils of universities where they sometimes prove contentious. The precise scope of their responsibilities will affect the potential legal liability of directors and senior managers: see [7.75]. This section considers current thinking and practice concerning the boundaries of role, function and responsibility between the board and senior management. It looks also at the optimal mix of inside (viz, executive) and outside (non-executive) directors, the desirable proportion of directors without personal or economic ties to company management, and the committee structure of the board and other supports that empower it to perform its functions most effectively. To ensure a measure of reality and to sharpen focus in this discussion, it begins with a case study dealing with the collapse of Enron in 2001. Enron has been chosen because of the wealth of material available relating to the comprehensive failure of its governance systems. 25

25

Other corporations might have been chosen, each impressed with their individual stamp of governance failure. Thus, alternative recent US subjects might have included WorldCom (falsified financial statements and securities fraud), Tyco (theft by the chief executive and fraud upon investors) or Adelphia Communications (massive unauthorised loans to senior executives and other unsanctioned related party transactions): see the journalistic accounts of these and other governance (and board) failure in J Surowiecki (ed), Best Business Crime Writing of the Year (2002). In Australia, the Royal Commissioner’s report into the collapse of HIH Insurance contains valuable material on the failure of governance systems in one of Australia’s leading corporations: HIH Royal Commission, The Failure of HIH Insurance (3 vols, 2003); see also ASIC v Adler [7.95]. ASIC has taken action which documents many other recent corporate collapses such as that of One.Tel (ASIC v Rich [7.130]) and Centro (ASIC v Healey [7.100]). Other recent major Australian corporate collapses include ABC Learning Centres, Allco Finance Group, Babcock & Brown, the Hastie Group, MFS, Opes Prime and Storm Financial.

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The collapse of Enron: a case study in board failure

The Role of the Board of Directors in Enron’s Collapse [5.35] Report Prepared by the Permanent Subcommittee on Investigations of the Committee on Governmental Affairs, United States Senate, 107th Congress, 2d Session, Report 107-70, July 8, 2002, pp 6-11, 3 [6] Enron Corporation. At the time of Enron’s collapse in December 2001, Enron Corporation was listed as the seventh largest company in the United States, with over $100 billion in gross revenues and more than 2,000 employees worldwide. It had received widespread recognition for its transformation from an old-line energy company with pipelines and power plants, to a high tech global enterprise that traded energy contracts like commodities, launched into new industries like broadband communications, and oversaw a multi-billion-dollar international investment portfolio. [7] One of Enron’s key corporate achievements during the 1990s was creation of an online energy trading business that bought and sold contracts to deliver energy products like natural gas, oil or electricity. Enron treated these contracts as marketable commodities comparable to securities or commodity futures, but was able to develop and run the business outside of existing controls on investment companies and commodity brokers. The nature of the new business required Enron’s access to significant lines of credit to ensure that the company had the funds at the end of each business day to settle the energy contracts traded on its online system. This new business also caused Enron to experience large earnings fluctuations from quarter to quarter. Those large fluctuations potentially affected the credit rating Enron received, and its credit rating affected Enron’s ability to obtain low-cost financing and attract investment. In order to ensure an investment-grade credit rating, Enron began to emphasize increasing its cash flow, lowering its debt, and smoothing its earnings on its financial statements to meet the criteria set by credit rating agencies like Moody’s and Standard & Poor’s. Enron developed a number of new strategies to accomplish its financial statement objectives. They included developing energy contracts Enron called “prepays” in which Enron was paid a large sum in advance to deliver natural gas or other energy products over a period of years; designing hedges to reduce the risk of long-term energy delivery contracts; and pooling energy contracts and securitizing them through bonds or other financial instruments sold to investors. Another high profile strategy, referred to as making the company “asset light,” was aimed at shedding, or increasing immediate returns on, the company’s capital-intensive energy projects like power plants that had traditionally been associated with low returns and persistent debt on the company’s books. The goal was either to sell these assets outright or to sell interests in them to investors, and record the income as earnings which top Enron officials called “monetizing” or “syndicating” the assets. A presentation made to the Finance Committee in October 2000 summarized this strategy as follows. It stated that Enron’s “[e]nergy and communications investments typically do not generate significant cash flow and earnings for 1-3 years.” It stated that Enron had “[l]imited cash flow to service additional debt” and “[l]imited earnings to cover dilution of additional equity.” It concluded that “Enron must syndicate” or share its investment costs “in order to grow.” One of the problems with Enron’s new strategies, however, was finding counterparties willing to invest in Enron assets or share the significant risks associated with long-term energy production facilities and delivery contracts. The October 2000 presentation to the Finance Committee showed that one solution Enron had devised was to sell or syndicate its assets, not to independent third parties, but to “unconsolidated affiliates” – businesses like Whitewing, LJM, JEDI, the Hawaii125-0 Trust and others that were not included in Enron’s financial statements but were so closely associated with the company that Enron considered their assets to be part of Enron’s [8] own holdings. The October 2000 presentation, for example, informed the Finance Committee that Enron had a total of $60 billion in assets, of which about $27 billion, or nearly 50 percent, were lodged with Enron’s “unconsolidated affiliates”. All of the Board members interviewed by the Subcommittee were well aware of and supported Enron’s intense focus on its credit rating, cash flow, and debt burden. All were familiar with the company’s [5.35]

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The Role of the Board of Directors in Enron’s Collapse cont. “asset light” strategy and actions taken by Enron to move billions of dollars in assets off its balance sheet to separate but affiliated companies. All knew that, to accomplish its objectives, Enron had been relying increasingly on complicated transactions with convoluted financing and accounting structures, including transactions with multiple special purpose entities, hedges, derivatives, swaps, forward contracts, prepaid contracts, and other forms of structured finance. While there is no empirical data on the extent to which US public companies use these devices, it appears that few companies outside of investment banks use them as extensively as Enron. At Enron, they became dominant; at its peak, the company apparently had between $15 and $20 billion involved in hundreds of structured finance transactions. Enron Board. In 2001, Enron’s Board of Directors had 15 members, several of whom had 20 years or more experience on the Board of Enron or its predecessor companies. Many of Enron’s Directors served on the boards of other companies as well. At the hearing, John Duncan, former Chairman of the Executive Committee, described his fellow Board members as well educated, “experienced, successful businessmen and women,” and “experts in areas of finance and accounting.” The Subcommittee interviews found the Directors to have a wealth of sophisticated business and investment experience and considerable expertise in accounting, derivatives, and structured finance. Enron Board members uniformly described internal Board relations as harmonious. They said that Board votes were generally unanimous and could recall only two instances over the course of many years involving dissenting votes. The Directors also described a good working relationship with Enron management. Several had close personal relationships with Board Chairman and Chief Executive Officer (CEO) Kenneth L Lay. All indicated they had possessed great respect for senior Enron officers, trusting the integrity and competence of Mr Lay; President and Chief Operating Officer (and later CEO) Jeffrey K Skilling; Chief Financial Officer Andrew S Fastow … Mr Lay served as Chairman of the Board from 1986 until he resigned in 2002. Mr Skilling was a Board member from 1997 until August 2001, when he resigned from Enron. The Enron Board was organized into five committees. [9] (1) The Executive Committee met on an as needed basis to handle urgent business matters between scheduled Board meetings. … (2) The Finance Committee was responsible for approving major transactions which, in 2001, met or exceeded $75 million in value. It also reviewed transactions valued between $25 million and $75 million; oversaw Enron’s risk management efforts; and provided guidance on the company’s financial decisions and policies. … (3) The Audit and Compliance Committee reviewed Enron’s accounting and compliance programs, approved Enron’s financial statements and reports, and was the primary liaison with Andersen [Enron’s auditor]. (4) The Compensation Committee established and monitored Enron’s compensation policies and plans for directors, officers and employees. … (5) The Nominating Committee nominated individuals to serve as Directors. … The Board normally held five regular meetings during the year, with additional special meetings as needed. Board meetings usually lasted two days, with the first day devoted to Committee meetings and a Board dinner and the second day devoted to a meeting of the full Board. Committee meetings generally lasted between one and two hours and were arranged to allow Board members, who typically sat on three Committees, to attend all assigned Committee meetings. Full Board meetings also generally lasted between one and two hours. Special Board meetings, as well as meetings of the Executive Committee, were typically conducted by telephone conference. Committee chairmen typically spoke with Enron management by telephone prior to Committee meetings to develop the proposed Committee meeting agenda. Board members said that Enron management provided them with these agendas as well as extensive background and briefing materials prior to Board meetings including, in the case of Finance Committee members, numerous deal approval sheets (“DASHs”) for approval of major transactions. Board members varied in how much time they spent reading the materials and preparing for Board meetings, with the reported 236

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The Role of the Board of Directors in Enron’s Collapse cont. preparation time for each meeting varying between two hours and two days. On some occasions, Enron provided a private plane to transport Board members from various locations to a Board meeting, and Board members discussed company issues during the flight. Enron also organized occasional trips abroad which some Board members attended to view company assets and operations. [10] During the Committee meetings, Enron management generally provided presentations on company performance, internal controls, new business ventures, specific transactions, or other topics of interest. … At the full Board meetings, Board members typically received presentations from each Committee Chairman summarizing the Committee’s work and recommendations, as well as from Enron management and, occasionally, Andersen or the company’s chief outside legal counsel, Vinson & Elkins. Mr Lay and Mr Skilling usually attended Executive, Finance, and Audit Committee meetings, as well as the full Board meetings. Mr Lay attended many Compensation Committee meetings as well. The Subcommittee interviews indicated that, altogether, Board members appeared to have routine contact with less than a dozen senior officers at Enron. The Board did not have a practice of meeting without Enron management present. Regular presentations on Enron’s financial statements, accounting practices, and audit results were provided by Andersen to the Audit Committee. The Audit Committee Chairman would then report on the presentation to the full Board. On most occasions, three Andersen senior partners from Andersen’s Houston office attended Audit Committee meetings. … The Audit Committee offered Andersen personnel an opportunity to present information to them without management present. Minutes summarizing Committee and Board meetings were kept by the Corporate Secretary, who often took handwritten notes on Committee and Board presentations during the Board’s deliberations and afterward developed and circulated draft minutes to Enron management, Board members, and legal counsel. The draft minutes were formally presented to and approved by Committee and Board members at subsequent meetings. Outside of the formal Committee and Board meetings, the Enron Directors described very little interaction or communication either among Board members or between Board members and Enron or Andersen personnel, until the company began experiencing severe problems in October 2001. From October until the company’s bankruptcy on December 2, 2001, the Board held numerous special meetings, at times on almost a daily basis. [11] Enron Board members were compensated with cash, restricted stock, phantom stock units, and stock options. The total cash and equity compensation of Enron Board members in 2000 was valued by Enron at about $350,000 or more than twice the national average for Board compensation at a US publicly traded corporation. [The Subcommittee made the following findings with respect to the role of the Enron board in the corporation’s collapse and bankruptcy.] [6] (1) Fiduciary Failure. The Enron Board of Directors failed to safeguard Enron shareholders and contributed to the collapse of the seventh largest public company in the United States, by allowing Enron to engage in high risk accounting, inappropriate conflict of interest transactions, extensive undisclosed off-the-books activities, and excessive executive compensation. The Board witnessed numerous indications of questionable practices by Enron management over several years, but chose to ignore them to the detriment of Enron shareholders, employees and business associates. (2) High Risk Accounting. The Enron Board of Directors knowingly allowed Enron to engage in high risk accounting practices. (3) Inappropriate Conflicts of Interest. Despite clear conflicts of interest, the Enron Board of Directors approved an unprecedented arrangement allowing Enron’s Chief Financial Officer to establish and operate the LJM private equity funds which transacted business with Enron and profited at Enron’s expense. The Board exercised inadequate oversight of LJM transaction and compensation controls and failed to protect Enron shareholders from unfair dealing. (4) Extensive Undisclosed Off-The-Books Activity. The Enron Board of Directors knowingly allowed Enron to conduct billions of dollars in off-the-books activity to make its financial condition appear better than it was and failed to ensure adequate public disclosure of material off-the-books liabilities that contributed to Enron’s collapse. [5.35]

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The Role of the Board of Directors in Enron’s Collapse cont. (5) Excessive Compensation. The Enron Board of Directors approved excessive compensation for company executives, failed to monitor the cumulative cash drain caused by Enron’s 2000 annual bonus and performance unit plans, and failed to monitor or halt abuse by Board Chairman and Chief Executive Officer Kenneth Lay of a company-financed, multi-million dollar, personal credit line. (6) Lack of Independence. The independence of the Enron Board of Directors was compromised by financial ties between the company and certain Board members. The Board also failed to ensure the independence of the company’s auditor, allowing Andersen to provide internal audit and consulting services while serving as Enron’s outside auditor.

What is the proper role of the board?

The functions that boards perform in practice [5.40] The Enron case study raises many questions not limited to those relating to director

function and liability. But the focus now is on what functions a board should be expected to perform. One way of addressing the question of the proper role of the board, within the wide powers formally assigned to them, is look at what is known about the roles that directors perform in practice. In an influential analysis of United States board function published in 1971, Mace studied the role played by non-executive directors in large and medium sized corporations whose securities were widely traded and whose directors’ equity holdings were relatively small. He found that in these corporations the board commonly performed three functions. First, it provided a source of advice and counsel to management in such matters as the negotiation of finance, review of pension plans or decisions on plant location and capital appropriation. Only rarely did their advice lead to reversal of a management decision. Second, the discipline of periodic appearances before the board, even without the anticipation of penetrating and challenging questioning, was found to exert a more rigorous standard of internal management reporting and served to protect, through a corporate conscience function, against unconscionable executive remuneration policies. Finally, the directors served as a decision-making body in certain crisis situations, principally the sudden death or incapacity of the chief executive or their unsatisfactory performance. 26 Significantly, Mace found that directors did not establish the basic objectives, strategies and policies for the company; non-executive directors simply did not have the time to make the studies necessary for these judgments. Mace’s and like studies 27 prompted reform proposals in the United States to bring the legal model of board function into line with the functioning model. 28 In an influential analysis, Eisenberg suggested that while management and policy formulation will generally lie beyond the board’s reach, four clusters of functions were feasible and desirable. He suggested that the board might provide advice and counsel to the chief executive, that major corporate changes should require board authorisation, that the board provide a modality through which shareholders and other stakeholders might influence corporate action and, most significantly, 26

M L Mace, Directors: Myth and Reality (1971), pp 184-189.

27

To similar effect, see M A Eisenberg, The Structure of the Corporation (1976), pp 156-170; J W Lorsch & E McIver, Pawns or Potentates: The Reality of America’s Corporate Boards (1989); R A Gordon, Business Leadership in the Large Corporation (1966); the observation is not new: see J C Baker, Directors and Their Functions: A Preliminary Study (1945) and W O Douglas (1934) 47 Harv L Rev 1305.

28

See I M Millstein & P W MacAvoy (1998) 98 Colum L Rev 1283; R J Gilson & R Kraakman (1991) 43 Stan L Rev 863; V Brudney (1982) 95 Harv L Rev 597.

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that directors select and dismiss senior executives and monitor their performance. 29 Such a model of director function in publicly held corporations 30 is now largely expressed in the model of board function contained in the American Law Institute’s Principles of Corporate Governance and in many other influential statements of recommended practice.

Statements of recommended board function [5.45] The American Law Institute’s model vests the management of the business of the

corporation in the senior executives appointed by the directors and casts directors in a supervisory role with respect to those executives. The board role distinguishes between mandatory and discretionary functions. Among the mandatory board functions are the powers to: • select, regularly evaluate, fix the compensation of, and, where appropriate, replace the principal senior executives; • oversee the conduct of the corporation’s business to evaluate whether the business is being properly managed; • review and, where appropriate, approve the corporation’s financial objectives and major corporate plans and actions; • review and, where appropriate, approve major changes in, and determinations of other major questions of choice respecting, the appropriate auditing and accounting principles and practices to be used in the preparation of the corporation’s financial statements; and • perform such other functions as are prescribed by law, or assigned to the board under a standard of the corporation. 31 There are a range of counterpart Anglo-Australian statements of recommended board function. The ASX Principles, with their obligation to comply or explain non-compliance, ask a listed company to “establish and disclose the respective roles and responsibilities of its board and management and how their performance is monitored and evaluated [including] those matters expressly reserved to the board and those delegated to management” (Principles 1 and Recommendation 1.1). The ASX Principles suggest that “matters reserved to the board and those delegated to management will depend on the size, complexity and ownership structure of the entity, and will be influenced by its history and corporate culture, and by the respective skills of directors and management”. The ASX Principles do not specify a particular distribution of functions; rather, they suggest that “usually” the board would be responsible for: • providing leadership and setting the strategic objectives of the entity; • appointing the chair and, if the entity has one, the deputy chair and/or the “senior independent director”; • appointing, and when necessary replacing, the CEO; • approving the appointment and, when necessary, replacement of other senior executives; • overseeing management’s implementation of the entity’s strategic objectives and its performance generally; • approving operating budgets and major capital expenditure; • overseeing the integrity of the entity’s accounting and corporate reporting systems, including the external audit; 29

Eisenberg, The Structure of the Corporation (1976), pp 148-167.

30 31

A publicly held corporation is defined by the Institute as one with 500 shareholders and assets of $5 million. American Law Institute, Principles of Corporate Governance, ss 3.01, 3.02. [5.45]

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• overseeing the entity’s process for making timely and balanced disclosure of all material information concerning the entity that a reasonable person would expect to have a material effect on the price or value of the entity’s securities; • ensuring that the entity has in place an appropriate risk management framework and setting the risk appetite within which the board expects management to operate; • approving the entity’s remuneration framework; and • monitoring the effectiveness of the entity’s governance practices. 32 A survey was made as at 30 June 2013 of the board charters or corporate governance statements of the top 20 ASX listed companies for their statement of responsibilities reserved for the boards. The results are shown in the following table. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20.

Strategic direction of the company (19/20) Monitoring capital management, including approval of major capital expenditure (19/20) Remuneration framework (19/20) Risk management policy (18/20) Overseeing succession planning (18/20) Appointment and performance of CEO and senior management (18/20) Budget/financial approval/financial performance (18/20) Determination/approval of documents (as per constitution/statute/external regulation including financial reports and other reports) (18/20) Review/monitor corporate governance policies and practices (16/20) Overseeing external/internal audit activities and internal control and reporting systems (13/20) Approval of acquisitions and divestments (13/20) Evaluate board performance and composition (13/20) Establishment and empowerment of the committees of the board (13/20) Monitoring performance of management (13/20) Corporate social responsibility (social, ethical and environmental impact of company’s activities) (11/20) Determine/approve dividend policy (9/20) Review diversity initiatives and progress (8/20) External auditor performance (8/20) Right to alter matters reserved for its decision (7/20) Other

A comparison of the top 20 companies with 10 ASX listed small capitalisation companies, randomly chosen, shows broadly similar responsibility allocations. The principal differences were with respect to: • Budget/financial approval/financial performance (listed as a board responsibility by only 30% of small companies in contrast to 90% of the top 20 companies); • Overseeing succession planning (no small companies; 90% of top 20 companies); • Corporate social responsibility (no small companies; 55% of top 20 companies); and • Review diversity initiatives and progress (10% of small companies; 40% of top 20). 33

Identifying clusters of key board roles [5.50] Several clusters of functions are evident in these statements of desirable board function

in publicly held corporations. The first is monitoring the performance of senior management and its implementation of agreed strategy; this is accepted as both a feasible and desirable 32 33

ASX Principles, Recommendation 1.1, Commentary. R Grayson Morison and I Ramsay (2014) 32 C&SLJ 69.

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board function whereas the role of managing the corporation itself is for its senior management. The distinction between monitoring management and managing is clearer in theory than it sometimes is in practice. Essentially, however, monitoring involves general oversight of management, not active supervision or close operational scrutiny, at least in the absence of grounds for board concern. Some formulations of the monitoring role emphasise that the board should set targets with respect to performance and monitor performance against those targets, and resist any temptation to allow managers to “delegate upwards” by embroiling directors in difficult operational decisions. 34 A second cluster of functions relates to approval of corporate strategy, capital expenditures, systems for risk management and compliance with legal obligations, and financial reporting. The board does not generate strategy or develop compliance systems but approves proposals developed or designed (as the case may be) by senior management and provides broad counsel and advice. A third cluster of functions deal with the appointment, removal and remuneration of the chief executive and ratification of the appointment of the chief financial officer and perhaps other senior managers. Although the chief executive will play a key role in succession planning, including for her or his own position, the central importance of this office dictates the board’s primary involvement under most formulations. Implicit in these functions (especially management remuneration setting and financial reporting oversight since remuneration is affected by it) is the review and cleansing of management conflicts of interest. A fourth cluster of functions is not expressed in the statements of recommended practice quoted above. However, there is research evidence and observational experience that directors play a relational role with stakeholder communities, facilitating the exchange of information, maintaining their support and garnering resources and business for the corporation. 35 The board’s relationship with shareholders is obviously important. The network connection that directors bring to the board may reduce uncertainty in both the external and internal environments of the corporation by permitting it to: (1) coordinate with its external environment, (2) obtain advice and access to information from directors with differing backgrounds, skills, and networks, (3) enhance the support, status, and legitimacy of the corporation in the eyes of relevant audiences, and (4) effectuate monitoring of the strategic direction of the corporation. 36

In this relational role, directors act as “boundary scanning agents” who have access to information that is valuable in setting goals, identifying opportunities and avoiding threats. 37 While the corporation might obtain advice externally, directors secure it for the corporation on a more or less continuous basis and with such commitment to its welfare that comes from the associative ties and loyalty of board membership. Intuition suggests that the performance of particular functions will be affected by the composition of a company’s board, especially its mix of insider and outsider directors. Thus, management supervision appears better performed by a board with a majority or significant number of directors independent of management. Similarly, managing conflicts of interest (whether through oversight of executive remuneration or financial reporting systems) points 34

Report of the Independent Working Party into Corporate Governance, Strictly Boardroom: Improving Governance to Improve Corporate Performance (2nd ed, 1998), p 35.

35

B D Baysinger & H N Butler (1985) 1 J L Econ & Org 101; L L Dallas (2003) 40 San Diego L Rev 781, 782-783, 805-807; L L Dallas (1996) 22 J Corp L 1. The networking role was recognised long ago by the courts: “in large financial matters [it may be] better to have directors who may advance the interests of the company by their connection, and by the part which they themselves take in large money dealings” (Imperial Mercantile Credit Association v Coleman (1871) LR 6 Ch App 558 at 567 per Hatherley LC).

36 37

L L Dallas (2003) 40 San Diego L Rev 781 at 805. Dallas at 808. [5.50]

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to independent director participation. Appointment of a chief executive is a task or role that ostensibly indicates outsider involvement although senior executive input may also be necessary for informed judgment. Although strategic development will primarily be a management function in publicly held corporations, outsider input is invaluable and appears likely to be effective in conditions of trust and full information disclosure that might be encouraged by a critical mass of both insiders and outsiders on the board. The board’s relational role seemingly indicates outsider primacy. However, that role also has a significant internal dimension that might be better performed by insiders. Further, the internal harvesting of external relational benefits might favour a critical insider presence upon the board. How then should a company’s board be constituted? Board composition: the role of independent directors

Board demographics [5.55] Principle 2 of the ASX Principles declares: “Structure the board to add value: A listed entity should have a board of appropriate size, composition, skills and commitment to enable it to discharge its duties effectively”. A key corporate governance measure affecting boards concerns the balance between inside and outside directors on the board and the particular role of directors free of ties of economic dependency upon or strong personal loyalty to company management. A related issue is whether the chair of the board should be an independent outside director at least at the time of her or his appointment. “Inside” and “outside” directors are terms more commonly used in North American practice. Their counterparts in Anglo-Australian practice are “non-executive” and “executive” directors. An executive director is one who also has a contract of employment with the company: see [5.245]. Executive directors are therefore senior managers of the corporation who have, in right of that seniority, been appointed to the board. If a company has only one such director, it is the chief executive (often called the managing director) and then perhaps the chief financial officer (often called the finance director) and other executives, perhaps with human resources responsibilities or divisional leadership roles. Non-executive directors are directors without an employment relation with the company. Some of them may meet one or more tests of independence from management so that they are described as independent directors; the term is not therefore applied to executive directors however independent and conscientious they may be in the judgment they bring to their roles: that is not what is intended by the term in this context. A survey by the Australian Council of Superannuation Investors (ACSI) of the board composition of ASX listed companies included in the S&P/ASX200 index at 30 June 2015 revealed an average board size of 8.3 directors for the largest 100 companies (ASX100) and 6.7 for those in the next 100 (ASX101–200). 38 For ASX100 companies a board with seven to nine directors has become common, with relatively few outliers with larger or smaller boards; for ASX100–200 companies, most boards have between five and eight directors. Most companies in the samples had only one executive director on the board, the chief executive officer; it is rare for companies across the ASX200 to have more than two executives on their boards. Non-executive directors made up 85% of board composition for ASX100 companies and 83% for ASX101–200. With one exception (Harvey Norman Holdings), every ASX200

38

This account of board composition is drawn from the study reported in Australian Council of Superannuation Investors, Board Composition and Non-Executive Director Pay in ASX200 Companies (2016).

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company has a majority of its directors classed as independent. 39 The proportion of independent directors on ASX100 boards is a little over 90% of all directorships and around 79% of all directors; the figures are lower for ASX100-200 companies with almost two-thirds of all directors classified as independent, including 79% of non-executive directors. In both groups of companies the principal reason why a director was classified as affiliated, that is, not independent, was because of an affiliation with a substantial shareholder (defined in the Act as a shareholder controlling 5% of voting shares). One quarter of ASX200 companies in 2013 had one or more directors affiliated with a substantial shareholder. 40 The proportion of board seats held by women has been increasing in recent years albeit from a low base; this movement has been aided by initiatives to promote gender diversity discussed later in this paragraph. The 2015 ACSI study found that one in four ASX100 board seats were held by women (143 women holding 199 seats), representing 22% of the ASX100 director pool. While the corresponding figure for ASX100-200 companies was lower at 16% of board seats (and 15% of the director numbers), the growth rate in that cohort is sharply higher, indicating wider net casting for new boardroom talent. (The Australian Institute of Company Directors reports that, as at 31 January 2017, the percentage of women on ASX200 boards is 25.3% and that 14 of these companies do not have a female member. 41) These figures also indicate that women directors in ASX200 companies are more likely than male counterparts to hold multiple rather than single board seats: on average, women directors held 1.47 board seats while male counterparts held 1.09 seats. However, in each of the ASX100 and ASX100-200 cohorts a woman held the office of board chair in only six companies. Further, women’s board participation is primarily in non-executive roles: women held only six of the 119 ASX100 executive directorships and four of 98 executive directorships in the ASX100-200 cohort. The ACSI study found that the average age of non-executive directors of the ASX100 companies was 63.5 years for men and 58 for women. The average for executive directors was around 55 years for both sexes. These figures were largely replicated for the ASX101-200. The relatively high age of non-executive directors is not, however, generally matched by long tenure of office. The average tenure of non-executive directors was 5.9 years and the median 4.8, compared with an average tenure of 6.7 years and a median of 4.6 years for executive directors. Perhaps reflecting the recent rise in their numbers, the average tenure of women directors was lower than that of men. In the United Kingdom, the average board size for listed companies is seven, comprising three executive and three non-executive directors and the chair. Among the top 100 listed companies, that is, those in the FTSE 100, the average board size is 12, with six non-executive directors, five executive directors and the chair. 42 In contrast, on average the boards of listed US companies comprise only two executive directors in a board of 11 directors. 43 Several European countries prescribe separate supervisory and management boards with different 39

The test of director independence adopted is that contained in Australian Council of Superannuation Investors, ACSI Governance Guidelines: A Guide to Investor Expectations of Australian Listed Companies (2015), Recommendation 8.2; this test largely accords with that contained in the ASX Principles, Recommendation 2.3, Commentary and Box 2.3 (p 16) although more stringent in certain respects.

40 41

P Hanrahan and T Bednall (2015) 33 C&SLJ 239 (Annexure A). Australian Institute of Company Directors, Statistics at http://aicd.companydirectors.com.au/advocacy/ board-diversity/statistics.

42 43

D Higgs, Review of the Role and Effectiveness of Non-Executive Directors (2003), para 4.9. L L Dallas (2003) 40 San Diego L Rev 781 at 787; S Bhagat & B Black (1999) 54 Bus Law 921 at 921-922. Among US corporations there has been a significant trend over the past quarter century towards greater proportions of independent outside directors. [5.55]

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mixes of executive and non-executive participation. 44 Of course, in countries where share ownership is not widely dispersed, monitoring by controlling shareholders supplements or substitutes for board monitoring of management: see [2.190]. In recent years, regulators have introduced gender diversity quota laws and disclosurebased approaches to increase the representation of women on corporate boards. In Australia the approach has favoured the latter. The ASX Principles recommend that a listed entity should: • have a diversity policy which includes requirements for the board or a relevant committee of the board to set measurable objectives for achieving gender diversity and to assess annually both the objectives and the company’s progress in achieving them; • disclose that policy or a summary of it; and • disclose as at the end of each reporting period the measurable objectives for achieving gender diversity set by the board in accordance with the company’s diversity policy and its progress towards achieving them. Further, the company should also disclose either the respective proportions of men and women on the board, in senior executive positions and across the whole organisation or, if the entity is a “relevant employer” under the Workplace Gender Equality Act 2012 (Cth) (a non-public employer with 100 employees in Australia), its most recent Gender Equality Indicators, as defined in and published under that Act. 45 While the focus of the ASX recommendation is on gender diversity, it embraces wider dimensions of diversity including those touching age, disability, ethnicity, marital or family status, religious or cultural background, sexual orientation and gender identity. The ASX Principles recommend that companies ensure that recruitment and selection practices from the board downwards are structured so that a diverse range of candidates is considered in a manner free from conscious or unconscious bias. 46 An analysis of disclosures made by listed companies in 2015 revealed a high level of compliance with the ASX recommendation with 87% of the entire sample of 597 entities establishing a diversity policy and 13% providing an explanation as to why they did not do so. There was a correlation between entity size and establishing a diversity policy: as the size of ASX entities decreased, there was a higher occurrence of “why not” explanations. Only three companies across the sample did not outline why they had not established a diversity policy. 47 A number of countries have established mandatory quotas for female representation on publicly traded corporate boards, ranging from 33-50%, with varying sanctions. Arguments in favour of the introduction of such quotas in Australia are based variously in terms of the business case for women on boards and normative justifications grounded in terms of equality, parity and democratic legitimacy. 48 In Norway, the first country to adopt such quotas, a combination of path-dependency, power and money appear to have impelled the introduction of mandatory quotas. 49

Statements of best practice as to independent directors [5.60] It should not surprise that the emphasis placed upon the management monitoring role

of directors should be accompanied by like emphasis upon the role played by non-executive 44

E Bastone & P L Davies, Industrial Democracy: European Experience (1976).

45 46 47

ASX Principles, Recommendation 1.5. ASX Principles, Recommendation 1.5, Commentary. KPMG, ASX Corporate Governance Council Principles and Recommendations on Diversity (2015), p 16.

48

P Spender (2015) 20 Deakin Law Review 95.

49

B Sjåfjell, “Gender Diversity in the Board Room and Its Impacts: Is the Example of Norway a Way Forward?” (2014; SSRN 2536777).

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directors, particularly independent directors. Independent directors, freed of ties of economic dependency and personal affinity, are seen as better placed to promote management accountability, “to safeguard the contractual relationship between the firm and its management”. 50 Independent directors can more easily bring disinterested objectivity to the monitoring role, to the management of conflicts of interest among insiders, and the development of strategy. They might more readily compensate for the cognitive biases of managers who are forced to consider different, perhaps divergent, perspectives to their own in group deliberations. 51 Legal developments concerning directors’ liabilities and shareholder suits also emphasise the value of independence through the greater judicial deference accorded to decisions taken by independent, or at least disinterested, directors. 52 Accordingly, modern corporate governance standards emphasise the role of independent directors as a primary governance measure. In the United States the idea of the independent director grew out of the emerging conception of the monitoring role of the board of directors, acting as guardian of shareholder interests in markets where those interests are atomistic and widely dispersed: see [5.20]. The concept was embraced in the United Kingdom in the Cadbury Report in 1992 and in Australia shortly afterwards. 53 Following major corporate failures in the early 2000s, the earliest form of the ASX corporate governance code and successor versions have recommended that a majority of the board of listed companies should be independent; this recommendation is part of the foundational principle that “[a] listed entity should have a board of appropriate size, composition, skills and commitment to enable it to discharge its duties effectively”. 54 The New York Stock Exchange (NYSE) goes further to require its listed companies to have a majority of independent directors. 55 The UK Corporate Governance Code states as a “main principle” that “[t]he board and its committees should have the appropriate balance of skills, experience, independence and knowledge of the company to enable them to discharge their respective duties and responsibilities effectively” and adds among “supporting principles” that “[t]he board should include an appropriate combination of executive and non-executive directors (and in particular independent non-executive directors) such that no individual or small group of individuals can dominate the board’s decision taking”. 56 To this end it provides that, except for smaller listed companies (that is, those below the FTSE 350), at least half of the board, excluding the chair, should comprise non-executive directors determined by the board to be independent; a smaller listed company should have at least two independent non-executive directors. 57 50

O E Williamson, The Economic Institutions of Capitalism (1985), p 298, quoted in S M Bainbridge, Corporations Law and Economics (2002), p 228.

51 52

D C Langevoorte (2001) 89 Geo L J 797 at 803. See, eg, ss 180(2) (protection from duty of care) and 237(3).

53

See re the process of reception of the independent director concept in Australia, H Bird (1995) 5 Aust J Corporation L 235 at 239-245.

54

ASX Principles, Recommendation 2.4 and Principle 2. The other major Australian corporate governance groups such as the Australian Council of Superannuation Investors (representing industry and other profit-to-member superannuation funds), the Financial Services Council (representing the retail funds management and superannuation sector) and the Governance Institute of Australia also support a majority of independent directors on listed company boards. For APRA regulated entities (eg, banks, general insurance and reinsurance companies, life insurance and private health insurance companies and most entities operating in the superannuation industry) APRA requires boards to have a majority of independent directors: see APRA, Governance, Prudential Standard CPS 510, at [29].

55 56

NYSE Listed Company Manual, s 303A.01. UK Corporate Governance Code, s B.1.

57

UK Corporate Governance Code, s B.1.2. [5.60]

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The tests of director independence under each standard vary both in their terms and their prescriptiveness. They are essentially negative in character. The Australian and United Kingdom codes adopt indicative but not determinative tests of independence including the absence of relationships based upon recent employment with or remuneration from the company, material supply or other contractual dealings and close family ties and other relationships that might be reasonably perceived to materially interfere with the director’s ability to bring an independent judgment to bear on issues before the board and to act in the company’s interests. 58 The length of a director’s tenure upon the board does not of itself indicate loss of independence from management although the ASX Principles recommend that the board regularly assess the independence of a director who has served for more than 10 years. 59 (Recall that several of the Enron directors had served as directors for over 20 years: see [5.35].) The UK Code requires the board to identify in the annual report each non-executive director it considers to be independent and the reasons for this judgment if one or more of several negative indicators of independence are present; these indicators are broadly consistent with those in the ASX Principles. 60 The NYSE standard requires the board to affirmatively determine that the director has no material relationship with the company and to publish the basis for this determination in its annual reporting. 61 The principal difference between the codes in conceptions of independence concerns the treatment of director affiliation with a substantial shareholder. The ASX Principles includes among the indicators that “might cause doubts” about independence whether the director is a substantial shareholder or an officer of or otherwise associated with such a shareholder. Similarly, the UK Corporate Governance Code includes among the negative indicators of independence that a director represents a “significant” shareholder, a term that is not defined and may not be satisfied by the holding of 5% of voting shares that marks a substantial shareholder in Australia. 62 Effectively, therefore, the independence requirement under these codes is from substantial or significant shareholders as well as from management. The United States differs in treating a relationship with a significant shareholder as not being in itself a barrier to director independence: “as the concern is independence from management, the [NYSE] does not view ownership of even a significant amount of stock, by itself, as a bar to an independence finding” (emphasis added). 63 The Australian and United Kingdom codes offer little justification for extending the independence concept to substantial or significant shareholders beyond the ASX Principles statement that “a director holding or representing a substantial stake in the entity is likely to be seen as having a different interest to security holders with smaller stakes”. 64 This suggests that this arm of the independence recommendation is directed at the protection of small shareholders. Le Mire and Gilligan query this concern and point to a further possible (but unarticulated) rationale: One of the motivations for selecting independent directors is to increase the likelihood that these directors would act in the interests of shareholders rather than in the interests of

58 59

ASX Principles, Box 2.1; UK Corporate Governance Code, ss B.1 and B.1.1. ASX Principles, Recommendation 3, Commentary. The UK Corporate Governance Code, s B.1.1 specifies tenure of nine years as triggering need for justification.

60

UK Corporate Governance Code, s B.1.1.

61 62 63

NYSE Listed Company Manual, s 303A.02. UK Corporate Governance Code, s B.1.1. NYSE Listed Company Manual, s 303A.02, Commentary.

64

ASX Principles, Recommendation 2.3, Commentary.

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management. … It would seem logical that the larger the [director’s] shareholding, the more encouragement there would be for a director to act in concert with the interests of shareholders as a group. … The identification of significant shareholders as problematic seems to indicate that there is another agenda that butts up against the idea that the independent director is to represent shareholders and introduces another possibility: that these directors may be intended to act as checks on the exercise of corporate power more generally. It may be that they are intended to protect third parties or those with more distant relationships with the corporation, such as consumers, employees or the local community. 65

Hanrahan and Bednall offer a further justification for the extended reach of the independence test that they consider “more compelling”, namely, that “restricting the number of directors affiliated with a controlling (but not any other) substantial shareholder might be necessary to ensure an appropriate counterbalance between the board, the management team and the general meeting in corporate decision-making”. A more robust corporate governance framework might be secured by ensuring that no two of these sites of decision-making are dominated by the same group, thereby achieving “a dynamic interaction” between them. 66

Separating the role of chief executive and chair of the board [5.65] Under corporate governance standards, the chair of the board is responsible for

leadership of the board, for the efficient conduct of its functions, facilitating the contributions of non-executive directors in particular, and for relations between the board and management. 67 The UK guidance requires the chair to take the lead in providing induction programs for new directors and identifying and meeting the development needs of all directors. The appointment of the chair is potentially an important element in board effectiveness, particularly in the light of studies showing a correlation between capacity to exert influence and position in a hierarchical social structure. 68 The appointment of the chief executive as board chair has multiple potential effects. It concentrates decision-making authority in one individual; it potentially affects the balance of influence between inside and outside directors and it further elevates the importance of the chief executive relative to other executives, thereby accentuating the internal management hierarchy. In four out of five listed US corporations the chief executive is also chair, as one of the two insiders (on average) upon the board. 69 Although the cult of the chief executive is a modern phenomenon, susceptible to export beyond its original American shores, 70 this is not the position in Australia or the United Kingdom. Under the UK Code, the person appointed as chair of the board should be a non-executive director at the time of appointment to that post (continuing independence from management after appointment as chair is apparently assumed to be neither feasible nor 65

S Le Mire and G Gilligan (2013) 13 J Corporate Law Studies 443 at 462-463 (the authors identify elements of effective independence such as structural relationships securing independence from particular interests (formal independence such as that protecting company auditors); intrinsic personal capacity for independence; independence as status marked by compliance with specified criteria of independence; and independence secured by power to achieve desired outcomes); see also S Le Mire (2016) 16 J Corporate Law Studies 1 (positing expertise as a useful partner to independence and developing a theory of expertise for corporate boards suited to their roles).

66 67

P Hanrahan and T Bednall (2015) 33 C&SLJ 239 at 249, 255. ASX Principles, Recommendation 2.5, Commentary; UK Corporate Governance Code, s A.3.

68 69

J C Turner, Social Influence (1991), pp 131, 136-141, quoted in Dallas at 804; see also L L Dallas (1997) 5 Wash & Lee L Rev 91 at 108-111. D Higgs, Review of the Role and Effectiveness of Non-Executive Directors (2003), para 2.9.

70

See G Haigh, Bad Company: The Cult of the CEO (2003). [5.65]

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desirable) and the roles of chair and chief executive should not be exercised by the same person. 71 This appears to be the standard practice in a clear majority of UK publicly held corporations. Similarly, under the ASX Principles the roles of chair and chief executive should not be held by the same person. 72 The ASX Principles also recommend that the chair be an independent director; where the chair is not an independent director the company should consider the appointment of an independent director as the deputy director or as the “senior independent director”. 73

The problem of information asymmetry [5.70] A significant limitation upon the board’s effectiveness in performing each of the

clusters of functions identified above is the information asymmetry between executive and non-executive directors. The Senate Report into the Enron collapse reports that the Enron directors “seemed to indicate that they were as surprised as anyone by the company’s collapse”, 74 echoing older observations that directors are sometimes the last to know when management has done something illicit. 75 Executive directors and senior managers possess a great deal of information about company operations and strategy from their full-time employment and the investment of human capital that they have made in the firm. By contrast, non-executive directors are dependent upon insiders for information other than that which they are given or obtain by questioning and investigation; it takes time to obtain understanding and insight into the organisation; board meetings are at best monthly and of modest duration although board committees will meet in between (the Enron board met five times a year each over a two-day period); non-executive directors have other commitments and are no less susceptible to the temptaion to shirking than are company managers. These pressures undermine the potential efficacy of reliance upon independent directors. The governance models under the three systems respond differently to these challenges. The US model as expressed in the NYSE requirement – itself faithful to the path of reform since the American Law Institute’s Principles of Corporate Governance – is prescriptive as to the majority of independent outside directors; inside directors are a small minority only of the board. In both characteristics, the model clearly favours the monitoring role of the board, a function best performed by outside directors. The UK Code is different in subtle respects. As noted, its “main principle” seeks a balance upon the board so that no group (including independent directors) dominates the board. Its model is one of equality between executive and non-executive directors, balanced by the chair who should be independent when appointed but whose independence is thereafter no longer assumed. In this and other ways, the UK model seeks to develop a partnership and mutual respect between insiders and outsiders through the joinder of executive knowledge and the wider experience of outsiders within the board. A review of non-executive directors whose recommendations inform the Code refers aspirationally to “a virtuous dynamic” in which executive directors’ perceptions of the value of non-executive directors’ experience encourages executives to be more open which in turn encourages greater non-executive director engagement. 76 The model thus seeks to balance the board’s supervisory and strategic roles – 71 72

UKCorporate Governance Code, s A.2.1. ASX Principles, Recommendation 2.5.

73

ASX Principles, Recommendation 2.5, Commentary.

74

75

Report Prepared by the Permanent Subcommittee on Investigations of the Committee on Governmental Affairs, United States Senate, 107th Congress, 2d Session, Report 107-70, (2002), p 12; the report found a number of indicators that should have raised board concerns about the activities of the company. See R Nader et al, Taming the Giant Corporation (1976), pp 91-102.

76

D Higgs, Review of the Role and Effectiveness of Non-Executive Directors (2003), para 8.2.

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An overemphasis upon monitoring and control risks non-executive directors seeing themselves, and being seen, as an alien policing influence detached from the rest of the board. An overemphasis upon strategy risks non-executive directors becoming too close to executive management, undermining shareholder confidence in the effectiveness of board governance. 77

The Australian model is less developed in addressing the informational obstacles facing its favoured modality of majority independent directors. Equally, it does not address the tension between the several board functions which it identifies. Each might optimally be performed by a particular mix of insider and outsider directors. Those mixes are not identical. It is not fanciful to infer in the ASX Principles an overall bias in favour of the US monitoring model although the preference is not explicit.

Performance outcomes and board composition [5.75] What relationship, if any, is there between board composition – the mix of insiders and

outsiders, independent and affiliated directors – and firm performance? Independent directors are intended to reduce agency costs. Do they do so? The empirical evidence is somewhat mixed and confusing. It does not give unqualified support for the importance placed upon independent directors in corporate governance systems. Swan and Forsberg argue from an empirical study of 430 ASX200 stocks in the period 2002-2012 that the increase in the proportion of independent directors at the expense of shareholder or management affiliated non-executive directors resulted in a decline in various measures of corporate value. They estimate the decline to be between $30.7–51.6 billion over the period. They argue that affiliated non-executive directors “make better acquisition decisions, increase the proportion of incentives in CEO pay, and raise dividend payouts” and that the presence of more independent directors conversely “raises their own pay and lowers firm payout”. 78 The majority independent director requirement represents an “apparently anti-capitalist and anti-shareholder stance [favouring] an anodyne professional class of director” at the expense of directors with significant shareholdings and those formerly associated with management. 79 Other empirical studies have reached different, if not always consistent, conclusions. While some earlier studies found a positive correlation between independent outsider presence upon the board and firm performance, 80 other recent analyses of empirical studies of returns on assets suggest that firm performance is positively associated with both a majority of outside directors upon a board and a majority of insider directors upon the board. Thus, both insider and outsider dominated boards are associated with corporate success, although those corporations with a supermajority of independent directors have lower overall levels of performance 81 as do those firms with boards balanced between independent and insider directors. 82 Of course, the identification of director independence is an inherently imprecise exercise. The criteria of independence, being essentially negative, sweep up into this residual category those whose management loyalties rest on less transparent foundations as well as those who simply do not trip the radar but whose modest levels of engagement mock any claim to legitimate independence. Assumed independence levels in a particular firm may therefore be illusory and make the research outcomes unusually muddy. 77

D Higgs, Review of the Role and Effectiveness of Non-Executive Directors (2003), para 6.2.

78 79 80 81

P L Swan and D Forsberg (2014; SSRN 231325), p 30. P Swan (2016) 32(2) POLICY 3. B D Baysinger & H N Butler (1984) 52 Geo Wash L Rev 557 at 572; S Rosenstein & JG Wyatt (1990) 26 J Fin Econ 175. S Bhagat & B Black (1999) 54 Bus Law 921, at 922; J A Wagner et al (1998) 35 J Mgmt Stud 655.

82

Wagner et al. [5.75]

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The studies are consistent with the judgment expressed above that the several functions identified for company boards do not indicate a single model of board composition. If the success of outsider dominated boards reflects their superior potential for management monitoring, and the success of insider dominated boards reflects their potential in developing strategy, it is nonetheless unclear why firms enjoy relatively superior performance by privileging one only of these functions at the expense of the other. What both outsider and insider dominated boards share is a sufficient degree of homogeneity in composition but not to excess since a supermajority outsider board is associated with relatively poor performance outcomes. Homogeneity is not of itself a necessary indicator of superior outcomes in small group deliberations since heterogeneous groups enjoy certain advantages in relation to matters calling for creativity and judgment. 83 There are other possible explanations for the success of these two board types. Too great an emphasis upon management supervision can be at the expense of the co-operation and trust that maximises board effectiveness across all functions. The current priority given to monitoring functions also needs to take account of the monitors’ dependence upon the monitored for the information necessary for judgment. Outsider domination of the board may have the unintended consequence of chilling trust levels between inside and outside directors which in turn inhibits the communication flow necessary for outsider effectiveness and the garnering of their potential inputs. To bridge the divide between monitors and managers some directors may need to play a mediating role between them. 84 It has to be said, however, that outsider domination was demonstrably absent in the Enron board and in many (probably, most) corporate failures. Nonetheless, the trust and communication focus of the UK Code model, with its formal parity between inside and outside directors under a chair who is independent at appointment, may have advantages in forging an effective partnership upon the board.

The ambiguous virtue of the board’s group character [5.80] There is an evident tension at the heart of board functioning and an ambiguity in its

group character. On the one hand, there are considerable advantages for groups under a general norm of consensus decision-making relative to that of individuals acting separately, especially in solving problems calling for complex judgments and evaluation. 85 These are classic board functions. In contrast, creative work appears to be best performed by individuals. Also, given the informational advantages that senior management enjoy over non-executive directors, the board’s collective character may empower non-executive directors in supervisory and evaluative functions with respect to management. Structuring the board as a collegial body of equals potentially strengthens the non-executive directors as a group since their status is independent of management hierarchy. The group character of the board also mobilises the drivers of self-respect, and the group sanctions of reproach and ultimately exclusion, against under-engagement and free-riding. The fact that boards of publicly held corporations are usually self-selecting and self-renewing assists group cohesion even if at the risk of excessive homogeneity and narrowness of composition and outlook. It also encourages a degree of loyalty to their appointer and openness to their opinions. These qualities also have potential weaknesses. Some relate to group decision-making generally, such as the tendency of highly cohesive groups to excessively privilege civility and consensus with the consequent 83

L L Dallas (2002) 76 Tul L Rev 1363 at 1388-1405.

84

D C Langevoort (2001) 89 Geo L J 797 at 814-816. Langevoorte also argues that some significant insider presence upon the board also signals to middle managers that their interests, especially in preservation of the competitive path to board level executive office, are protected: at 806-810.

85

S M Bainbridge (2001) 55 Vand L Rev 1.

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danger of inadequate vigilance and scepticism in decision making. Studies suggest that there are also subtle psychological pressures upon outsiders to conform to the views and outlook of insiders in settings such as company boards. 86 One expression of these pressures is called “groupthink”, described as that “a mode of thinking that people engage in when they are deeply involved in a cohesive in-group, when the members’ striving for unanimity overrides their motivation to realistically appraise alternative courses of actions”. 87 The preconditions to groupthink are excessive cohesiveness, structural faults in the group’s decision-making (eg, excessive reliance upon external information and advice) and the need to make decisions that run counter to ethical or social norms in the wider communities from which members are drawn. The symptoms of groupthink are overconfidence in group opinions, belief in the inherent moral worth of the group, the group’s willingness to rationalise warning signs that should prompt caution, the demonising of dissent within and outside the group, haste in the formation of group judgment with a cascading effect stimulated by an influential member, and the repression, perhaps unconsciously, of oppositional views among members. (These factors may be detected in the Enron board. 88 Which do you discern in the case study above (at [5.35])?) The mechanisms of separate meetings for non-executive directors, information support and access to external advice are significant responses to this problem: see [5.90]. The individual focus of legal liability standards, as well as of ethical and moral obligations, are moderators of conduct that also play against the temptations of easy acquiescence in group opinion and the social norms of group conduct. However, the project of striking a balance between director independence and the cohesion that captures the benefits of group decision remains as important as it is difficult, particularly in governance systems that emphasise the board’s supervisory role over management. Empowering the independent directors

The committee structure of the board [5.85] Several measures have been adopted to strengthen the functioning and effectiveness of

the board. One such measure is through the provisions in the ASX Principles and the UK Corporate Governance Code for the creation of specialised board committees to strengthen the board’s supervisory role in three areas of perceived vulnerability. The first is a nomination committee to make recommendations to the board of persons to be put forward to shareholders for election as directors. Independent directors should be a majority upon the committee and occupy its chair. 89 Second, to safeguard the integrity of financial reporting, the ASX Principles provide for an audit committee to deal with oversight of financial management, performance and reporting. The audit committee should consist only of non-executive directors and with a majority of and a chair drawn from its independent directors. 90 However, for Australian companies in the S&P/ASX All Ordinaries Index (the top 500 86

87

J D Cox & H L Munsinger (1985) Law & Contemp Probs 83 (psychological foundations of the bias evident in the boardroom that undermines director independence in the context of the review of shareholder litigation). I Janis, Victims of Groupthink (1978), p 78, quoted in M O’Connor (2003) 71 U Cinn L Rev 1233 at 1238. Janis’s theory of groupthink has its genesis in political, not corporate, governance, especially in the explanation of decisions among US leaders that defy logic and policy wisdom and the expectations held of the talented members of the group.

88 89

M O’Connor (2003) 71 U Cinn L Rev 1233 at 1270-1294. ASX Principles, Recommendation 2.1; UK Corporate Governance Code, s B.2.1.

90

ASX Principles, Recommendation 4.1, Commentary. Under the UK Corporate Governance Code, all members of the audit committee are to be independent directors: s C.3.1. [5.85]

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companies) this requirement is mandatory rather than subject to the general “comply or explain” regime. 91 Third, the ASX Principles provide for a remuneration committee to review executive remuneration and incentive policies, and the remuneration packages of senior management; the committee’s function does not derogate from the responsibility of the full board; companies in the S&P/ASX300 index are required by the ASX Listing Rules to have a remuneration committee comprised solely of non-executive directors. 92 However, the UK Code provides for delegated responsibility to the committee for setting the remuneration of executive directors and the chair. 93 Under the UK Code only independent directors are on the committee; under the ASX Principles independent directors need only be a majority of the committee: see [7.410]. 94 In respect of each committee, these provisions mirror more exacting and prescriptive requirements for NYSE listed corporations.

Other measures to empower independent directors [5.90] Several other measures have been adopted or proposed to make independent directors

more effective as management monitors. Some measures target the problem of information asymmetry. Thus, in 1940 William O Douglas, when chairman of the Securities and Exchange Commission, proposed the nurturing of a professional class of “paid directors (with) … no common business interest other than serving on the boards of a few corporations”. 95 The proposal is open to objection upon the further ground that unless they have few other responsibilities, professional directors might be unable to give sufficient attention to company affairs. A complementary suggestion is identified with Arthur J Goldberg – like Douglas, another former Justice of the US Supreme Court. In 1972 Goldberg resigned from the board of Trans World Airlines after its management had opposed his attempts to form an overseer committee of the outside directors to provide an independent review of management. Goldberg proposed that his committee of outside directors “would be generally responsible for supervising company operations on a broad scale and [would] make periodic reports to the board”. The committee would be supported by a small independent staff of experts to act as an “independent source of expertise for the board. [The experts] … would be responsible only to the board and would be totally independent of management control”. Their assistance, and that of outside experts whom they consult, “would reassert the position of the board as a focal point for creative policy input for corporate decisions”. 96 The Goldberg proposal has produced variant fruit. Thus, corporate governance standards increasingly encourage non-executive directors to meet separately from the full board under the leadership of the chair or the person designated as the senior or lead independent director; the standards also provide for the board, especially non-executive directors, to take independent professional advice at the company’s expense. 97 Such meetings are more common among large US corporations; the NYSE requires the outside directors of its listed companies to meet at regularly scheduled meetings without management and to set up a 91

ASX Listing Rules 12.7.

92 93

ASX Principles, Recommendation 8.1; ASX Listing Rules 12.8. UK Corporate Governance Code, s D.2.2.

94

ASX Principles, Recommendation 4.1; UK Corporate Governance Code, s D.2.1.

95

Democracy and Finance (1968 revised ed), p 40.

96

A J Goldberg, “Debate on Outside Directors”, New York Times, 29 October 1972, quoted in Eisenberg, fn 25, p 155. Ralph Nader proposed something similar, namely, that directors should serve only on a full-time basis without other employment for a maximum of two four-year terms, supported by their own staff and with full access to corporate information: Nader et al, Ch 4. Another variation is for the independent directors to appoint a corporate ombudsman with full access to corporate meetings and information, reporting also to shareholders annually: see L L Dallas (1997) 54 Wash & Lee L Rev 91.

97

ASX Principles, Recommendation 2.1, Commentary; UK Corporate Governance Code, ss B.5.1.

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channel of communication for interested parties to communicate directly with the presiding director of such sessions. 98 Scheduling such meetings regularly is intended to remove the apprehension or suspicion generated by taking the initiative to convene the meeting. Another variation is in the proposals made from time to time to cap the number of listed directorships that a person may accept, with the intent of providing some assurance that they will devote adequate time to each. The absence of any such assurance and the blindness to other commitments limits the power of these proposals. However, they clearly touch a sensitive nerve since there is a creeping adoption of some caps. The UK Code’s comply or explain rule used to limit a person to occupying the chair of one FTSE 100 company (that is, one of the largest 100 companies by market capitalisation listed on the London Stock Exchange) but this restriction has been removed in the 2012 revision. However, the Code retains its provision that a board should not agree to one of its executive director members taking on more than one appointment as non-executive director of a FTSE 100 company and should not accept office as chair of that other company’s board. 99 The ASX Principles and the NYSE listing rules do not impose such caps; however, in 2004 the Corporations Act was amended to require listed companies to disclose the directorships in other listed companies held in the past three years by their directors: s 300(11)(e). Disclosure is corporate law’s favoured soft form of regulation. These observations on corporate governance systems and the measures relating to director function and effectiveness provide a context for the treatment of the legal powers and duties of shareholders, directors and senior managers in this and the following chapters. It is to that legal treatment that the focus now turns although it is hoped that continuing reference will be made to this contextual material since it explicates the function of the legal rules and the solutions they offer to recurrent problems in corporate governance. [5.92]

Review Problems

1. Is there something peculiar to corporate governance practices or the nature of the corporation’s operations that reduce the relevance of lessons of corporate collapse for other countries? What weaknesses in governance are evident from the Enron case study at [5.35]? The Senate subcommittee recommended strengthening director oversight and director and auditor independence from management. The reforms which Enron prompted to auditor independence and imposition upon the chief executive and chief financial officer of personal liability with respect to company financial statements are discussed at [9.165]. 2. What further measures do you think might be adopted to clarify board role and improve performance? 3. Assume that a like collapse to Enron’s were to occur in Australia today. You are a staffer to the Opposition front bencher with responsibility for corporations law. Prepare a one-page list of reforms that she might canvass on this evening’s news program and at a special meeting of the shadow Cabinet. Ignore for present purposes the political complexion of the Opposition.

98 99

NYSE Listed Company Manual, s 303A.03. UK Corporate Governance Code, s B.3.3. [5.92]

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THE DISTRIBUTION OF CORPORATE POWERS BETWEEN SHAREHOLDERS AND DIRECTORS The derivation of the corporate organs [5.95] The general meeting has historically been the primary corporate organ. For the

common law corporations (such as the boroughs and guilds) the rule was settled early that the corporation could “only do corporate acts at corporate meetings”. 100 Members assembled for a corporate purpose were the corporation which acted through the decision of a majority of those present, although special majorities might be prescribed by the constitution for particular decisions. 101 The principle identifying the corporate will with that of a majority of the corporators duly assembled was applied to the chartered trading corporations 102 and, after the Bubble Act, was commonly expressed in the constitutions of unincorporated joint stock companies and companies incorporated by private statute. 103 Yet it was apparent at an early stage of corporate development that the assembly of members was an unwieldy and inapt body for the routine administration of group affairs. Charters of trading corporations commonly provided for direction of the joint trade by a council of governors, committee members or directors and assistants: see [2.30]. While the nomenclature of office varied, the primacy of the general court of proprietors was a constant. 104 The 18th century deed of settlement company replicated this structure. Deeds usually confided to the general court the exclusive consideration of policy or change of major importance while leaving the day-to-day conduct of the business to a small group of members elected by the general court. 105 (Members of this group were generally called “directors”. 106) While the precise demarcation of roles varied, deeds of settlement would often conclude with a broad delegation of powers to the court of directors. From his study of 18th century companies DuBois found a recurring provision to the effect that the directors were “to order, direct, manage and transact all and every the affairs and things of or belonging to the said Company except such matters which ought to be ordered in and done by a General Court of the said Company”. 107 He concludes that the directors “were thus generally left rather unfettered in scope of action, but the possibility of general court interference and domination was a factor that they were not permitted to forget”. 108 The formal supremacy of the general court notwithstanding, in disputes between the two courts the directors often prevailed in the long run through devices, such as control of the general court agendas and electoral process, which have a distinctly modern flavour. 109 100 101

Conservators of the River Tone v Ash (1829) 10 B & C 349; 109 ER 479 at 378-379 (B & C), 490 (ER). Attorney-General v Davey (1741) 2 Atk 212; 26 ER 531; R v Varlo (1775) 1 Cowp 248; 98 ER 1068; Grindley v Barker (1798) 1 Bos & Pul 229; 126 ER 875.

102

See W S Holdsworth, A History of English Law (1925), Vol VIII, p 202; and I M Cameron (1985) 15 Melb U L Rev 116.

103

104

On the unincorporated company, see A B DuBois, The English Business Company after the Bubble Act 1720-1800 (1971 reprint), pp 302-304 and, for an instance of a private incorporation, see the constitution in Foss v Harbottle (1843) 2 Hare 461; 67 ER 189 and [8.75]. See, eg, Charitable Corporation v Sutton (1742) 2 Atk 400; 26 ER 642 at 405 (Atk), 644 (ER).

105

DuBois, p 291.

106

The alternative term for directors, “assistants”, was a harking back to the “helpmen” of the medieval guilds: C T Carr (ed), Select Charters of Trading Companies 1530-1707 (Selden Society, 1913), Vol 28, p 101n.

107 108 109

DuBois, p 292. DuBois, p 292. See DuBois, pp 297-303 and [2.50].

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The first companies legislation, the Joint Stock Companies Act 1844 (UK) adopted this structure. The “company” (reflecting ancient usage, the term referred to the company in general meeting) was required to appoint directors “for the conduct and superintendence of the affairs of the company” and was enjoined from participating in management “otherwise than by means of directors”. 110 The 1856 Act, however, reverted to the present facultative model by constituting a board of directors and general meeting and leaving to replaceable rules (introduced in 1998) and any supplementary constitutional provisions the division of corporate powers between these organs. A half century later, the courts had elevated the board of directors to the status of an independent, co-ordinate organ of the company along with shareholders in general meeting. The acts of either organ, within authority, are acts of, and not merely for, the corporation: see [5.120]. 111 This demarcation between ownership and management roles, although now placed upon a permissive basis, persisted with the use of corporate form for purely private trading ventures. The boundary between the roles is apt to become confused in those private companies in which the members are for all practical purposes partners. In such companies the formal distinction between shareholder and director roles, and the obligation to act through a particular organ for effective group action, is often at odds with the way the members view and conduct their affairs. Instances abound of members acting in disregard or ignorance of the formal obligations which the legal structure imposes. 112 Corporate form will therefore be an ill-fitting garment for many quasi-partnerships, especially those in which members expect to participate in management and distribute profits by way of salaries. It should not, however, be a straitjacket and by careful tailoring of the constitution intricate private arrangements can be devised for the distribution of control and ownership interests, all within the constraints of a legal structure requiring a separate board and general meeting. The range of devices used for this purpose is examined at [5.195]. Thus, under Australian company law, management structure and allocation of power between the organs is not determined by legislation but is left to the design of the incorporators, with the assistance of some basic replaceable rules. Few fetters are placed upon their freedom of choice. While the Corporations Act vests a few specific powers in the general meeting, it otherwise merely determines the minimum size of the directorate and does not prescribe any particular power or function for it. In contrast, most West European and North American jurisdictions retain the statutory grant of management powers to the board. 113 In practice the distribution of corporate powers is principally effected through a company’s constitution. While patterns of distribution vary, the model set of articles appended to the Companies Acts since 1844 have been widely adopted. Until 1998 the Act provided for the automatic application to a company of the Table A regulations for management of a company limited by shares unless excluded or modified by the newly incorporated company. The repeal of this provision was upon terms that it did not affect the constitutional provisions previously adopted by companies: see [3.145]. Accordingly, continuing reference will be made to standard constitutional provisions such as those under the former Table A model articles of association. This is because many companies were formed before that date and retain their own constitutions which incorporate the terms of the Table A articles current at the time of their formation. 110

Section 27 and Sch A.

111 112

Vestiges of the old thinking, identifying the company solely with the general meeting, persist: see, eg, Mendes v Commissioner of Probate Duties (Vic) (1967) 122 CLR 152 at 160. See, eg, Re Express Engineering Works Ltd [1920] 1 Ch 466; [5.160].

113

See, eg, Model Business Corporation Act (US), s 35; and Canada Business Corporations Act 1974, s 97. [5.95]

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The Corporations Act stipulates a minimum number of directors – three for public companies (two of whom must be Australian residents) and one for proprietary companies (who must be an Australian resident): s 201A. Under the common law and some earlier Australian companies legislation a company might be appointed as director of another company; however, the Act now requires directors to be natural persons aged at least 18 years: s 201B. Original powers of the general meeting [5.100] Where no provision is made by the Act or a company’s constitution as to which organ shall exercise a particular corporate power, the rule remains from the general law of corporations that shareholders assembled in general meeting may act by ordinary resolution for the company. 114 However, this residual authority is usually excluded by standard provisions which permit directors to exercise all the powers of the company except any powers that the Act or the company’s constitution (if any) requires the company to exercise in general meeting: see s 198A(2) (replaceable rule) or the former Table A reg 66. This catch-all provision is of fundamental importance in the allocation of corporate power since the Act and standard constitutional arrangements vest relatively few powers expressly in either the directors or general meeting. The powers which the Act vests in the general meeting relate principally to the constitutional and capital structure, the composition of the board, and certain fundamental changes. Many require a special resolution. 115 Thus, the general meeting may by special resolution 116 • alter the company’s name (s 157); • adopt a constitution for the company and repeal or modify its terms (s 136); and • change the company’s type: s 162(1). As regards capital structure, while directors commonly retain the power to issue shares, the general meeting may • convert all or any of its shares into a larger or smaller number of shares by ordinary resolution (s 254H); • reduce share capital or approve a buy-back of shares (ss 256B, 256C, 257A, 257C, 257D); • alter rights attached to shares (Pt 2F.2); and • under standard constitutional arrangements reflecting the prior Table A provisions, the general meeting may declare dividends and capitalise profits but such resolutions require prior recommendations by directors and, in the case of dividends, must not exceed the amount recommended. The general meeting is not given express powers with respect to the conduct of the company’s business. However, the general meeting is given qualified powers over the composition of the board of directors in whom management powers are commonly vested. Thus, shareholders in general meeting may • appoint a person as director (s 201G) and remove a director at any time (ss 203C – 203D); and • determine the remuneration of directors: s 202A. 114

Clifton v Mount Morgan Ltd (1940) 40 SR (NSW) 31 at 44.

115

A special resolution is one passed with the support of at least 75% of the votes cast by members entitled to vote on the resolution who have notice of intention to propose the special resolution and of its terms: s 9. An ordinary resolution requires only a majority of votes cast on the motion. The notice and other formalities for shareholder voting are discussed in Chapter 6.

116

As to the further restrictions that may be imposed upon the power of constitutional alteration, see [3.145].

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In a number of other instances the Act requires approval of the general meeting for an act or to sanction a transaction; typically that is because of its fundamental character, because the board is likely to be affected by a conflict of interest or because approval is judged necessary to protect shareholder interests. Thus, shareholder approval is required to • appoint and remove company auditors (ss 327A, 327B, 329); • by special resolution, resolve to wind up the company voluntarily (s 491) or resolve that it be wound up by the court (s 461(1)(a)); • approve financial benefits given to related parties of a public company absent applicable exemptions (s 208(1)(a)); and • approve termination payments of company officers: ss 200B, 200C. At the annual general meeting of listed companies, a resolution must be put to the vote for the adoption of the remuneration report that directors of such companies must prepare showing the remuneration of the five highest paid company executives and the five highest paid group executives; however, the vote on the resolution is advisory only and does not bind the directors or the company: s 250R(2), (3); see [6.45]. With the possible exception of the power to petition the court for winding up the company, the powers vested in the general meeting are exclusive to that organ and do not revert to the board when the general meeting is unable to act. The position is otherwise, however, with respect to board powers which revert to the general meeting when the board is deadlocked or otherwise unable to act. This is one of several possible sources of residual power for the general meeting, distinct from the original powers conferred under the Act or constitution: see [5.140]. Under the standard model, of all the groups with an interest in the corporation (eg, employees, creditors and dependent communities), only shareholders possess voting rights and the power to appoint and remove the directors. Depending upon perspective, the reasons for this monopoly are historical, grounded in efficiency considerations or reflect the quasiownership status of shareholders. There are two qualifications to this broad proposition. First, the reality is somewhat different in publicly held corporations where the board and management usually enjoy a large measure of de facto power over the election process and therefore the corporation: see [6.85]. Second, in some private companies the influence of other participants (typically a principal lender or senior manager) may be such that they are granted the right, by contract or constitutional provision, to board membership. The powers of the board

The scope of management powers [5.105] With only minor exceptions, the Act does not require that directors be given any

specific corporate powers although replaceable rules confine to the board of directors some specific powers that had been granted to company boards under Table A provisions. The two principal provisions are the replaceable rule providing that 1. the business of the company is to be managed by or under the direction of the directors (s 198A(1)); and 2.

directors may exercise all the powers of the company except any powers that the Act or the company’s constitution (if any) requires the company to exercise in general meeting: s 198A(2). A like rule applies, but as a mandatory rule, to a proprietary company where the same person is its sole director and shareholder; the business of such companies is to be managed by or under the direction of its director: s 198E. [5.105]

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Similar but more detailed regimes apply to companies with constitutions based upon the Table A model. For such companies, the constitution is the source of directors’ powers all but exclusively. In such companies, corporate powers relating to management and administration of group affairs are usually given to the board. The general management article in s 198A or Table A, reg 66(1), in the final Table A model, is a prime, and not merely a residual, source of power. Accordingly, it is common for the constitution to make only modest provision for specific powers to be vested in directors. Thus, constitutions commonly confer on the board power to issue shares, to make calls, to forfeit shares and pay interim dividends. The directors are given limited powers to refuse registration of share transfers, which powers are commonly expanded in proprietary companies to broad discretionary powers to refuse registration since this condition was a precondition under earlier legislation for registration as a proprietary company. Often, these are the sole specific board powers other than the general management article. Typically, the principal source of board powers is a constitutional provision in terms of the former Table A, reg 66 which declares that “the business of the company shall be managed by the directors” and empowers them to “exercise all such powers of the company as are not, by the Act or by these regulations, required to be exercised by the company in general meeting”. In Campbell v Rofe 117 the Privy Council said of an article in similar terms to the second limb that it “clearly delegated to the directors power to do everything that the company could do except where the authority of a general meeting is expressly prescribed”. The provisions are substantially reproduced in the replaceable rule contained in s 198A. Articles in similar terms to Table A, reg 66 and s 198A have been interpreted to permit directors to pursue activities incidental to the company’s principal business activity or which are necessary for its realisation. Thus, provisions in the terms of the first limb (viz, empowering directors to manage the company’s business) have sustained the exercise of power by directors to bring legal proceedings in the name of the company, 118 to borrow money for the company and grant security over company property, 119 to issue negotiable instruments 120 and to grant bonuses to employees and pensions to their dependents; 121 the provision does not permit directors to fix their own remuneration. 122 The provision has even been interpreted as empowering directors to dispose of company assets, perhaps even the whole of the undertaking, without reference to the general meeting 123 and to apply to the court for the company’s own winding up. 124 Generally speaking, “a provision conferring power on the directors should be given as broad an operation as is reasonably available on the language and without imposing procedural constraints on the board, absent some contextual indication or purpose requiring the language to be so construed”. 125 The effect of entry into particular forms of external administration upon directors’ powers is discussed at [3.190]-[3.200]. 117

[1933] AC 91 at 99.

118

Compagnie de Mayville v Whitley [1896] 1 Ch 788 at 803.

119 120

Gibbs and Webb’s Case (1870) LR 10 Eq 312; Re Pyle Works (No 2) [1891] 1 Ch 173 at 186. Re Peruvian Railways Co (1867) 2 Ch App 617.

121 122

Hampson v Price’s Patent Candle Co (1876) 45 LJ Ch 437. Foster v Foster [1916] 1 Ch 532; this power is reserved to the company in general meeting: s 202A.

123

124 125

See Strong v J Brough & Son (Strathfield) Pty Ltd (1991) 5 ACSR 296; Re H H Vivian & Co Ltd [1900] 2 Ch 654; Re Borax Co [1901] 1 Ch 326; Wilson v Miers (1861) 10 CB (NS) 348; 142 ER 486. Such an exercise of power may, nonetheless, lead to the court winding up the company at the suit of a member if the exercise of power is beyond the general intention and understanding of members: see [8.145]-[8.150]. Re Inkerman Grazing Pty Ltd (1972) 1 ACLR 102 at 103; Re United Medical Protection Ltd (2002) 41 ACSR 623. Dome Resources NL v Silver (2008) 68 ACSR 458 at [12].

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Other variations and restrictions [5.110] There are many variations upon this standard constitutional model. Company

constitutions may give management powers to one or more directors exclusively, sometimes, to persons called governing directors who are vested with plenipotentiary powers 126 or to a sub-set of directors to whom the principal corporate powers are reserved. 127 There appears to be no objection in principle to constitutions which allocate all corporate powers to the general meeting, perhaps with a power of delegation to the board, or which vest management powers concurrently in the board and the general meeting. Instances of such provisions are not, however, common and the imposition of statutory duties of care and good faith upon directors in the exercise of powers and functions may prevent any such constitutional division of power from operating effectively. 128 ASX Listing Rules restrict directors of listed companies from exercising particular powers without the approval of the company in general meeting, including where the company proposes to • issue new shares beyond 15% of its share capital in any period of 12 months and the issue is not to be made equally to existing shareholders in proportion to their holdings (LR 7.1); • enter into a transaction with a related party of a value exceeding 5% of shareholder funds (LR 10.1, 10.2); • make a significant change to its activities (LR 11.1); or • sell its main undertaking: LR 11.2.

The feasible scope of director role and function [5.115] Company constitutions, following Table A, reg 66, commonly provide that the

business of the company shall be managed by the directors. The replaceable rule in s 198A(1) expresses the delegation of power in the alternative (viz, the business shall be managed by or under the direction of the directors), implicit acknowledgment of the difficulty posed by the traditional formulation. In smaller companies, management responsibility may be within the directors’ capacity. However, there is clear evidence that directors of large publicly held companies commonly assume a more modest role and responsibility. This topic is discussed at [5.40].

DIRECTORS’ INDEPENDENCE IN THE EXERCISE OF THEIR POWERS General principles of interpretation of constitutional provisions [5.120] As we have seen, the principle was well settled in the old law of corporations that the

corporation acted through and was bound by the decision of a majority of members assembled in general meeting. Provisions to similar effect were usually contained in the deeds of settlement of joint stock companies and those incorporated by private statute. There, as with the older common law corporations, the general meeting, acting through ordinary resolution only, was the principal, and directors and managers were considered its agents. This view persisted, at least in professional opinion (but with little judicial decision on point), throughout the 19th century in relation to registered companies. Thus, in 1884, in Isle of 126

See, eg, Whitehouse v Carlton Hotel Pty Ltd (1987) 162 CLR 285: see [7.295].

127

As in Quin and Axtens Ltd v Salmon [1909] AC 442; John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113: see [5.130].

128

See Capricornia Credit Union Ltd v ASIC (2007) 62 ACSR 671 at [73]-[78]. [5.120]

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Wight Railway Co v Tahourdin 129 Cotton LJ said concerning a company incorporated by private statute, but in words apparently intended with wider application: It is a very strong thing indeed to prevent shareholders from having a meeting of the company, when such meeting is the only way they can interfere, if the majority of them think that the course taken by the directors, in a matter intra vires of the directors, is not for the benefit of the company. 130

This view was assumed, often without discussion, by contemporary texts to be an accurate statement of shareholder control over the board of directors. 131 The following cases reveal that this view has been largely, but not wholly, superseded. It remains the law that where the statute or constitution makes no provision as to which organ has power with respect to a particular matter or, if such provision is made, the organ is unavailable, the general meeting may by ordinary resolution act so as to bind the corporation. 132 However, the inclusion of a catch-all provision in s 198A(2) and in constitutional provisions such as those in the former Table A reg 66, conferring upon the board “all such powers of the company as are not, by the Act or by these regulations, required to be exercised by the company in general meeting”, restricts the operation of this old corporation principle, in companies with such an article, to the pathogenic situations where a board is deadlocked or lacks a quorum. (These situations are discussed at [5.140].) As the following cases therefore indicate, the general meeting’s control over the board in the exercise of its powers has been significantly eroded during the past century. Company constitutions may express powers upon directors in many different forms and subject to multiple restrictions and conditions. The degree of independence from shareholders that directors enjoy in the exercise of their powers therefore depends upon the terms in which the powers are expressed in the company’s constitution or replaceable rule applicable to it. What principles of construction or underlying notions of the board’s role shape the interpretation of these constitutional provisions, particularly those in the standard delegation of management provision in s 198A and the former Table A reg 66? When answering this question, consider the significance of the terms of the applicable constitutional provision in the following cases.

Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame [5.125] Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame [1906] 2 Ch 34 Court of Appeal, England and Wales [McDiarmid, a shareholder in the plaintiff company, arranged for the sale of its assets and undertaking to another company and had an agreement for sale prepared for execution by the company. At a general meeting convened at McDiarmid’s request a resolution was passed, by 1502 votes to 1198, that the company sell its assets and that the directors should affix the company’s common seal to the agreement. Practically all of the 1502 votes were cast in respect of shares held by McDiarmid and his friends. The directors considered the agreement not to be in the company’s best interests and refused to comply with the resolution. McDiarmid brought suit in his own name and that of the company seeking orders that the directors were bound by the resolution. The plaintiff company’s articles vested powers of management in the directors subject to “such regulations, not being inconsistent with these presents, as may from time to time be made by 129

(1884) 25 Ch D 320.

130

Isle of Wight Railway Co v Tahourdin (1884) 25 Ch D 320 at 329; see also Exeter and Crediton Railway Co v Buller (1847) 16 LJ Ch 449; Harben v Phillips (1883) 23 Ch D 14. See, eg, Buckley on the Companies Acts (7th ed, 1897), p 530, expressing a view which was to be repudiated by its author (as Buckley LJ) in Gramophone and Typewriter Ltd v Stanley [1908] 2 KB 89 at 105-106.

131 132

Clifton v Mount Morgan Ltd (1940) 40 SR (NSW) 31 at 44.

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Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame cont. extraordinary resolution”: cl 96. Under cl 97 the directors were empowered to sell or otherwise deal with company property on such terms and conditions as they might think fit. Clause 81 empowered the company, by special resolution, to remove any director before the expiration of his term of office.] COLLINS MR: [41] This is an appeal from a decision of Warrington J, who has been asked by the plaintiffs, Mr McDiarmid and the company, for a declaration that the defendants, as directors of the company, are bound to carry into effect a resolution passed at a meeting of the shareholders in the company …. The point arises in this way. At a meeting of the company a resolution was passed by a majority – I was going to say a bare majority, but it was a majority – in favour of a sale to a purchaser, and the directors, honestly believing, as Warrington J thought, that it was most undesirable in the interests of the company that that agreement should be carried into effect, refused to affix the seal of the company to it, or to assist in carrying out a resolution which they disapproved of; and the question is whether under the memorandum and articles of association here the directors are bound to accept, in substitution of their own view, the views contained in the resolution of the company. Warrington J held that the majority could not impose that obligation upon the directors, and that on the true construction of the articles the directors were the persons [42] authorised by the articles to effect this sale, and that unless the other powers given by the memorandum were invoked by a special resolution, it was impossible for a mere majority at a meeting to override the views of the directors…. Then come the two clauses which are most material, 96 and 97, whereby the powers of the directors are defined. [His Lordship read cl 96 and cl 97(1).] Therefore in the matters referred to in art 97(1) the view of the directors as to the fitness of the matter is made the standard; and furthermore, by art 96 they are given in express terms the full powers which the company has, except so far as they “are not hereby or by statute expressly directed or required to be exercised or done by the company,” so that the directors have absolute power to do all things other than those that are expressly required to be done by the company; and then comes the limitation on their general authority – “subject to such regulations as may from time to time be made by extraordinary resolution”. Therefore, if it is desired to alter the powers of the directors that must be done, not by a resolution carried by a majority at an ordinary meeting of the company, but by an extraordinary resolution. In these circumstances it seems to me that it is not competent for the majority of the shareholders at an ordinary meeting to affect or alter the mandate originally given to the directors, by the articles of association. It has been suggested that this is a mere question of principal and agent, and that it would be an absurd thing if a principal in appointing an agent should in effect appoint a dictator who is to manage him instead of his managing the agent. I think that that analogy does not strictly apply to this case. No doubt for some purposes directors are agents. For whom are they agents? You have, no doubt, in theory and law [43] one entity, the company, which might be a principal, but you have to go behind that when you look to the particular position of directors. It is by the consensus of all the individuals in the company that these directors become agents and hold their rights as agents. It is not fair to say that a majority at a meeting is for the purposes of this case the principal so as to alter the mandate of the agent. The minority also must be taken into account. There are provisions by which the minority may be over-borne, but that can only be done by special machinery in the shape of special resolutions. Short of that the mandate which must be obeyed is not that of the majority – it is that of the whole entity made up of all the shareholders. If the mandate of the directors is to be altered, it can only be under the machinery of the memorandum and articles themselves. I do not think I need say more. One argument used by Warrington J strongly supports that view. He says in effect: “There is to be found in these articles a provision that a director can only be removed by special resolution. What is the use of that provision if the views of the directors can be overridden by a mere majority at an ordinary meeting? Practically you do not want any special power to remove directors if you can do without them and differ from their opinion and compel something other than their view to be carried into effect.” That argument appears to me to confirm the view taken by the learned judge. COZENS-HARDY LJ: [44] I am of the same opinion. It is somewhat remarkable that in the year 1906 this interesting and important question of company law should for the first time arise for decision, and it is perhaps necessary to go back to the root principle which governs these cases under the Companies [5.125]

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Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame cont. Act 1862 (UK). It has been decided that the articles of association are a contract between the members of the company inter se. That was settled finally by the case of Browne v La Trinidad (1887) 37 Ch D 1, if it was not settled before. We must therefore consider what is the relevant contract which these shareholders have entered into, and that contract, of course, is to be found in the memorandum and articles. I will not again read arts 96 and 97, but it seems to me that the shareholders have by their express contract mutually stipulated that their common affairs should be managed by certain directors to be appointed by the shareholders in the manner described by other articles, such directors being liable to be removed only by special resolution. If you once get a stipulation of that kind in a contract made between the parties, what right is there to interfere with the contract, apart, of course, from any misconduct on the part of the directors? There is no such misconduct in the present case. Is there any analogy which supports the case of the plaintiffs? I think not. It seems to me the analogy is all the other way. Take the case of an ordinary partnership. If in an ordinary partnership there is a stipulation in the partnership deed that the partnership business shall be managed by one of the partners, it would be plain that in the absence of misconduct, or in the absence of circumstances involving the total dissolution of the partnership, the majority of the partners would have no right to apply to the court to restrain him or to interfere with the management of the partnership business … [45] [I]f you once get clear of the view that the directors are mere agents of the company, I cannot see anything in principle to justify the contention that the directors are bound to comply with the votes or the resolutions of a simple majority at an ordinary meeting of the shareholders. I do not think it true to say that the directors are agents, I think it is more nearly true to say that they are in the position of managing partners appointed to fill that post by a mutual arrangement between all the shareholders. So much for principle. On principle I agree entirely with what the Master of the Rolls has said, agreeing as he does with the conclusions of Warrington J. When we come to the authorities there is, I think, nothing even approaching to an authority in favour of the appellants’ [46] case. Isle of Wight Railway Co v Tahourdin (1884) 25 Ch D 320 at the utmost contained a dictum which at first sight looked in favour of appellants; but, treating it as an authority, it was an authority upon an Act which differed in a vital point from the Act which we are now considering, because although by s 90 of the Companies Clauses Consolidation Act 1845 (UK) the directors have powers of management and superintendence very similar to those found in Table A, art 55, and in arts 96 and 97, that section contains these vital words: “And the exercise of all such powers shall be subject also to the control and regulation of any general meeting specially convened for the purpose.” If those words had been found in the present Act of Parliament the appellants’ case would have been comparatively clear. I see no ground for reading them into the Companies Act 1862, or into the memorandum and articles of association of this company. For these reasons I think that the appeal must be dismissed.

John Shaw & Sons (Salford) Ltd v Shaw [5.130] John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113 Court of Appeal, England and Wales [A family company’s articles contained a delegation of management clause in terms identical with the standard Table A clause. Other articles, however, effectively vested all the powers of the directors in three permanent directors. The permanent directors commenced legal proceedings against two ordinary directors for recovery of debts allegedly owing to the company. The general meeting directed that the proceedings be withdrawn. The defendants held shares in the company (the size of their holding is not given) which they appear to have voted on the resolution to discontinue. The defendants sought to have the action against them dismissed on the ground that it was instituted without the authority of the plaintiff company.] GREER LJ: [134] I think the judge was also right in refusing to give effect to the resolution of the meeting of the shareholders requiring the chairman to instruct the company’s solicitors not to proceed further with the action. A company is an entity distinct alike from its shareholders and its directors. Some of its powers may, according to its articles, be exercised by directors, certain other powers may 262

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John Shaw & Sons (Salford) Ltd v Shaw cont. be reserved for the shareholders in general meeting. If powers of management are vested in the directors, they and they alone can exercise these powers. The only way in which the general body of the shareholders can control the exercise of the powers vested by the articles in the directors is by altering their articles, or, if opportunity arises under the articles, by refusing to re-elect the directors of whose actions they disapprove. They cannot themselves usurp the powers which by the articles are vested in the directors any more than the directors can usurp the powers vested by the articles in the general body of shareholders. [Roche LJ agreed with Greer LJ. Slesser LJ considered that, by the articles, authority to bring the proceedings could derive only from a meeting of directors to which the ordinary directors had been summoned. He thought, however, that “(i)f the permanent directors had power under the articles to bring the action, I do not see how the shareholders could interfere with that power, otherwise than by altering the articles”: at 143.]

[5.135]

Notes&Questions

1.

In Marshall’s Valve Gear Co Ltd v Manning Wardle & Co Ltd [1909] 1 Ch 267, Neville J distinguished Cuninghame on the basis that the company’s articles in that case expressed the board’s management powers to be subject to “regulations … made by extraordinary resolution”: at [272]-[274]. There is, however, clear authority that the non-intervention principle in Cuninghame applies equally where the delegation of management clause is in the same terms as the standard Table A provision broadly corresponding to s 198A; see John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113; Gramophone and Typewriter Ltd v Stanley [1908] 2 KB 89 at 105-106; Scott v Scott [1943] 1 All ER 582 at 585; Clifton v Mount Morgan Ltd (1940) 40 SR (NSW) 31 at 44-45. In Scott v Scott Lord Clauson admitted that the authorities offered “some difficulty of interpretation and some difficulty as to their scope; but it must be borne in mind that the professional view as to the control of the company in general meeting over the actions of directors has, over a period of years, undoubtedly varied”: at 585.

2.

The consequence of these decisions is that, in the ordinary course, shareholders have no power to direct the board in the exercise of its powers. They have themselves no power to initiate corporate action outside the particular spheres assigned to them. However, in certain exceptional circumstances, the general meeting or members acting unanimously may exercise powers falling within the board’s domain: see [5.140].

3.

Was the decision in Marshall’s Valve correctly decided? (For argument that it is, see G D Goldberg (1970) 33 MLR 177; G R Sullivan (1977) 93 LQR 569 and J-A MacKenzie (1983) 4 Co Law 99.) Can you think, on general principle, of any other grounds, or considerations of policy, upon which the decisions might be sustained? If the defendant directors in John Shaw & Sons had refrained from voting in, or seeking to influence, the general meeting which directed the discontinuance of proceedings against them, should such disinterested determination of the members have prevailed over the directors’ views as to where the group’s interest lay?

4.

Do the rules as to director independence from shareholders expressed in Cuninghame and John Shaw & Sons reflect a rational and efficient division of function in the publicly held firm: shareholders contribute risk bearing and leave management to others? Is there any feasible alternative rule for shareholder participation in management of such corporations? [5.135]

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5.

For further discussion of the independence of the board from the general meeting, see K A Aickin (1967) 5 MULR 448; G D Goldberg (1970) 33 MLR 177; G R Sullivan (1977) 93 LQR 569; J-A MacKenzie (1983) 4 Co Law 99; B V Slutsky, “The Division of Power Between the Board of Directors and the General Meeting” in J S Ziegel (ed), Studies in Canadian Company Law (1973) Vol 2, p 166; G Hornsey (1950) 13 MLR 470 at 474-477.

[5.138]

Review Problem

Defence Industries Ltd is an Australian stock exchange listed company. Its activities include the manufacture and sale of chemical defoliants. A small group of shareholders proposes a resolution to be moved at the coming annual general meeting of the company which seeks to prohibit the company selling its defoliants to a buyer who will not give reasonable assurances that the substance will not be used on or against human beings. Advise the group on the efficacy of the resolution if raised by the general meeting. How might it be most effectively framed in anticipation of management opposition to its inclusion as being beyond the power of the general meeting? Would the resolution find a more secure place in the agenda if it was expressed in terms of a request or advice to the directors rather than as a direction to them or as a constitutional amendment? See further at [6.30] concerning the power to requisition company meetings and to demand that motions be put to shareholder meetings. For United States litigation concerning such a resolution on the sale of napalm during the Vietnam war see Medical Committee for Human Rights v Securities and Exchange Commission 432 F 2d 659 (1970). Residual control in the general meeting

Where the board is unable to act [5.140] There are several instances where the general meeting retains what might be thought

of as some measure of residual control over directors. The first instance concerns situations when board powers may revert to the general meeting. Thus, if there is a deadlock upon the board or if the board lacks a quorum by reason, for example, of disqualification of interested directors or vacation of all board offices, there is authority that the general meeting may fill the void and by ordinary resolution exercise management powers. 133 There is also authority that injunctive relief and the appointment of a receiver may be granted to restore management to a proper footing where, owing to disputes among directors, they are unable to act. 134 However, a narrower view of the general meeting’s power in these circumstances has been expressed by an Australian appeal court: In my opinion, the source of this reserve power must be considered a matter of implication or presumed intention of the members, on the basis of business efficacy or necessity. It seems reasonable to say that it could not have been the intention of the members, and could not have been the intention of the memorandum and articles of association, that the company be rendered powerless to act in circumstances where the board is unwilling or unable to act. However, especially where the articles contain an express power to appoint additional directors, as in this case, it does not seem to me reasonable to regard a deadlock arising from disagreement between the only two board members as giving rise to any general power of management, when the deadlock can be resolved by the general meeting exercising its power to appoint additional directors. It may be that, even if the articles do not provide for the 133

Barron v Potter [1914] 1 Ch 895; Foster v Foster [1916] 1 Ch 532.

134

Featherstone v Cooke (1873) LR 16 Eq 298; Trade Auxiliary Co v Vickers (1873) LR 16 Eq 303; Steinfield v Gibbons [1925] WN 11.

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appointment by general meeting of additional directors, the power which the general meeting has to remove directors and replace them with other directors would itself be sufficient to prevent the implication of any general reserve powers in the general meeting to undertake management decisions. 135

On this view, the residual power would be limited to reconstituting the board so that it might effectively exercise the management powers vested in it under the company’s constitution. In that case, one director in a deadlocked board of two had irregularly appointed another director and the general meeting purported to ratify the instructions given by the board with the new director to solicitors to litigate for the company. The ratification was held to be ineffective.

Ratification of directors’ acts [5.145] The general meeting’s power to ratify directors’ acts which are in abuse or excess of

their powers vests shareholders with further residual authority. We examine (at [8.25]) the scope of permissible ratification where directors have abused their powers by breaching the fiduciary duties which they owe to their company. Directors may, however, exceed, without abusing, their powers, for example, by exercising borrowing powers in excess of a limitation fixed in the constitution. Under the general law such an act may be ratified by ordinary resolution of the general meeting. 136 The circumstances in which the company may plead the breach of such a restriction are now restricted by ss 124 and 125: see [3.145]. Dual initiative to litigate in the company’s name? [5.150] Commencing litigation on behalf and in the name of the company clearly falls within

the management power conferred upon the board by s 198A or corresponding constitutional provisions. But if the company has a cause of action and the directors will not commence proceedings, may shareholders do so? In certain circumstances (discussed at [8.100]) a shareholder may apply to the Court to enforce the claim for the benefit of the company. But might the general meeting itself authorise the commencement of proceedings in the company’s name? In Alexander Ward & Co Ltd v Samyang Navigation Co Ltd 137 the House of Lords held that the liquidator of a company might ratify the commencement of proceedings on behalf of a company by two unauthorised agents acting as directors when the company lacked directors. While the case might have been decided simply on the application of principles as to the residual powers of the general meeting when the board is unable to act, Lord Hailsham went further to approve a statement in Gower that “it still seems to be the law … that the general meeting can commence proceedings on behalf of the company if the directors fail to do so”. 138 However, doubt has been cast upon this meeting right in other 135

Massey v Wales (2003) 57 NSWLR 718 at [47] per Hodgson JA, Meagher and Beazley JJA concurring. It was significant to the judge that directors, unlike shareholders, were obliged as fiduciaries to act in the company’s interest. Similarly, the Singapore Court of Appeal decided that a term implied in the company’s constitution on the basis of necessity or business efficacy confers reserve or residual powers on shareholders when the board is unable or unwilling to act: Chan Siew Lee v TYC Investment Pte Ltd [2015] 5 SLR 409.

136

Irvine v Union Bank of Australia (1887) 2 App Cas 366; Grant v United Kingdom Switchback Railway Co (1888) 40 Ch D 135. [1975] 1 WLR 673.

137 138

Alexander Ward & Co Ltd v Samyang Navigation Co Ltd [1975] 1 WLR 673 at 679. See also Re Argentum Reductions (UK) Ltd [1975] 1 WLR 186 at 189 where Megarry J pointed to the conflict between Marshall’s Valve and Shaw and, saying that “there are deep waters here”, decided the question of standing on different grounds. See further K W Wedderburn [1957] CLJ 194 at 200-203 and (1976) 39 MLR 327. [5.150]

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decisions; 139 indeed, an Australian appellate court has held that the broad rule that the general meeting may not make management decisions “applies to the commencement of legal proceedings, just as to any other aspect of management of the company’s business”. 140 Informal corporate acts [5.155] A further potential instance of residual general meeting control is of particular

importance for small private companies. As noted above, one problem commonly encountered with such companies is the failure of controllers to observe the formalities necessary for corporate action. Suppose that the directors, individually, at different times and not at a meeting of directors, agree to a course of action proposed by the managing director: is the company bound (see s 248A)? Is the result different if the board is not consulted, on a matter falling within its power, but all the shareholders agree individually and separately to a course of action for the company? This latter question raises the informal corporate acts doctrine, the origins of which can be traced to dicta of Lord Davey in Salomon’s case ([4.30] at 57) that “a company is bound in a matter intra vires by the unanimous agreement of its members”. The doctrine creates a further source of reserve or residual control for the general meeting. In Re George Newman & Co, 141 decided before the House of Lords decision in Salomon’s case, a question arose as to whether the liquidator of a family company might recover two sums from the controlling shareholder, Newman. One sum was in effect a gift to Newman and the second sum was spent by Newman out of assets of the company borrowed by it for the purposes of its business. The payments were sanctioned by resolutions of the directors, who were Newman and his five brothers. Apart from the directors, the only other shareholders were six infant sons of Newman and two associates. It was said that all the shareholders approved the payments except the infant members. The Court of Appeal held that the gifts were ultra vires the company and incapable of validation by the general meeting. Lindley LJ said: But even if the shareholders in general meeting could have sanctioned the making of these presents, no general meeting to consider the subject was ever held. It may be true, and probably is true, that a meeting, if held, would have done anything which Mr George Newman desired; but this is pure speculation, and the liquidator, as representing the company in its corporate capacity, is entitled to insist upon and to have the benefit of the fact that even if a general meeting could have sanctioned what was done, such sanction was never obtained. Individual assents given separately may preclude those who give them from complaining of what they have sanctioned; but for the purpose of binding a company in its corporate capacity individual assents given separately are not equivalent to the assent of a meeting. The company is entitled to the protection afforded by a duly convened meeting, and by a resolution properly considered and carried and duly recorded. The articles of this company, wide as they are, do not authorise such presents as those impeached by the liquidator. 142

Numerous 20th century decisions, however, have made it clear that the informal assent of members (that is, given other than through the formal procedures laid down by the Companies Acts and constitution of the company) will sometimes be effective. What is less clear is the basis for this doctrine. In reading the following cases, consider the following questions that go to the nature of the doctrine and the consequent scope of its operation. 139

140 141

See, eg, John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113 at 134 per Greer LJ and at 143 per Slesser LJ and Kraus v J G Lloyd Pty Ltd [1965] VR 232 at 236-237 in which the power to litigate in the company’s name was confined to the board; but see Danish Mercantile Co Ltd v Beaumont [1951] Ch 680 at 686 where a motion to strike out proceedings commenced in the company’s name was referred to a general meeting. Massey v Wales (2003) 57 NSWLR 718 at [45] per Hodgson JA, Meagher and Beazley JJA concurring. [1895] 1 Ch 674.

142

Re George Newman & Co [1895] 1 Ch 674 at 686.

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2.

3.

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Is the doctrine concerned solely with whether shareholders have waived the formalities for company meetings and is limited to their right to do so? Herrman v Simon [5.185] is perhaps the clearest characterisation of the doctrine in these terms. Alternatively, does the doctrine operate to express the ultimate sovereignty in the totality of members subject only to limited inroads upon unanimity and the interests of creditors where insolvency threatens? On this view, it may not matter whether the subject matter of the unanimous informal agreement is formally within the powers of the general meeting. Under this view, the doctrine might be seen as a genuine exception to Salomon’s case and have a wider operation than under the waiver characterisation. Does Re Express Engineering [5.160] support this approach? A third characterisation is as an application of principles of equitable estoppel which prevent an assenting member from challenging the validity of the informal agreement. What support has this approach in the case law and what consequences ensue?

Re Express Engineering Works Ltd [5.160] Re Express Engineering Works Ltd [1920] 1 Ch 466 Court of Appeal, England and Wales [A private company was formed to acquire assets from a syndicate of five persons. The syndicate had acquired the assets for £7,000 a few days before the company was incorporated. A meeting described in the minutes as the first board meeting was held shortly after incorporation and the five persons were appointed as directors. The meeting resolved that the company should purchase the assets for £15,000 to be paid for by an issue of debentures of that amount. The debentures were issued and at a later meeting fixed with the company’s seal. The constitution provided that no director should vote as a director in respect of a contract in which he might be interested. The company was later wound up and the liquidator claimed that the debentures were not properly issued and should be set aside. There was no suggestion of intention to defraud subsequent shareholders or creditors. The liquidator argued that the meeting was a directors’ meeting and that the five directors were precluded from voting. The contrary argument was that the five directors were the only shareholders and had, at a meeting, indicated their assent. In reply, Re George Newman & Co was relied on.] LORD STERNDALE: [470] There were, however, two differences between that case and the present one. First, the transaction there was ultra vires, and, second, in that case there never was a meeting of the corporators. In the present case these five persons were all the corporators of the company and they did all meet, and did all agree that these debentures should be issued. Therefore it seems that the case came within the meaning of what was said by Lord Davey in Salomon v Salomon & Co [[401] at 57]: “I think it an inevitable inference from the circumstances of the case that every member of the company assented to the purchase, and the company is bound in a matter intra vires by the unanimous agreement of its members.” It is true that a different question was there under discussion, but I am of opinion that this case falls within what Lord Davey said. It was said here that the meeting was a directors’ meeting, but it might well be considered a general meeting of the company, for although it was referred to in the minutes as a board meeting, yet if the five persons present had said, “We will now constitute this a general meeting,” it would have been within their powers to do so, and it appears to me that that was in fact what they did. The appeal must therefore be dismissed. WARRINGTON LJ: [470] It happened that these five directors were the only shareholders of the company, and it is admitted that the five, acting together as shareholders, could have issued these debentures. As directors they could not but as shareholders acting together they could have made the agreement in question. It was [471] competent to them to waive all formalities as regards notice of meetings, etc, and to resolve themselves into a meeting of shareholders and unanimously pass the resolution in question. Inasmuch as they could not in one capacity effectually do what was required but could do it in another, it is to be assumed that as businessmen they would act in the capacity in which they had power to act. In my judgment they must be held to have acted as shareholders and

[5.160]

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Re Express Engineering Works Ltd cont. not as directors, and the transaction must be treated as good as if every formality had been carried out. I agree that the appeal should be dismissed. [Younger LJ delivered a concurring judgment.]

Parker and Cooper Ltd v Reading [5.165] Parker and Cooper Ltd v Reading [1926] Ch 975 Chancery Division [Since the company’s bank was unwilling to increase its overdraft a director, Reading, advanced £1,750 to the company upon the security of a floating debenture. When the company later became insolvent, the liquidator sought to set aside the debenture for defects in the appointment of the directors who executed it as well as in its sealing by the company. The defendants did not admit any of these irregularities, but their main defence was that every act or matter impugned by the plaintiffs was intra vires the company, and had been adopted and ratified by all the shareholders. The judge held that the sealing of the debenture had been done “with the utmost bona fides and solely for the benefit of the company”: at 979.] ASTBURY J: [979] For the purposes of my judgment, I will assume that the defendant Reading and Botterill were not validly or formally appointed directors. But they believed that they were, and they continued during the remaining history of the company to act as such. I will assume again that the sealing of the debenture was quite irregular. The company had the benefit of the money. The debenture was issued with the assent of every shareholder, and the question is whether the plaintiffs, or rather the liquidator, ought to succeed in obtaining a declaration that the debenture and the resolution authorising it were inoperative and invalid, so that the creditors may get the advantage of the defendant Reading’s £1,750 and deprive him of the security on which he made that advance. Unless I am bound by authority to give this relief I certainly do not propose to do so. It is, however, suggested that I am so bound, because the shareholders’ assent to the irregular transactions was not given at any actual meeting. [Astbury J referred to Re Express Engineering Works Ltd.] [984] All three judges no doubt refer to the fact that there had been a meeting. But I cannot think that they came to their decision because the five shareholders happened to meet together in one room or one place, as distinct from agreeing to the transaction inter se in such manner as they thought fit. Warrington LJ said: “It was competent to [the shareholders] to waive all formalities as regards notice of meetings, etc, and to resolve themselves into a meeting of shareholders and unanimously pass the resolution in question.” He is there speaking of the actual facts before him. Now the view I take of both these decisions is that where the transaction is intra vires and honest, and especially if it is for the benefit of the company, it cannot be upset if the assent of all the corporators is given to it. I do not think it matters in the least whether that assent is given at different times or simultaneously. The plaintiffs contend that the two directors acted throughout as if they were partners, and cannot now turn round and shelter themselves behind the company law. I do not take this view. If company law enables the entirety of the corporators to ratify an irregular intra vires transaction why should this not protect an honest bona fide intra vires transaction entered into for the benefit of the company? I can find nothing in Re George Newman & Co [1895] 1 Ch 674 to [985] prevent all the corporators from arranging to carry out an honest intra vires transaction entered into for the benefit of the company, even if they do not meet together in one room or place, but all of them merely discuss and agree to it one with another separately. The action is misconceived, and must be dismissed with costs.

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Re Duomatic Ltd [5.170] Re Duomatic Ltd [1969] 2 Ch 365 Chancery Division [The holders of all the voting shares in the company had informally indicated their assent to payment of directors’ salaries but no attempt had been made to show that the holder of non-voting redeemable preference shares had agreed. The directors relied upon the assent given as the company’s authorisation for the payment to them.] BUCKLEY J: [372] [Counsel] for the liquidator has contended that where there has been no formal meeting of the company and reliance is placed upon the informal consent of the shareholders the cases indicate that it is necessary to establish that all shareholders have consented. He argues that as the preference shareholder is not shown to have consented in the present case, that requirement is not satisfied, and that the assent of those shareholders … who knew about these matters, and who did [373] approve [of them] … is of no significance. It seems to me that if it had occurred to [the shareholders] …, at the time when they were considering the accounts, to take the formal step of constituting themselves a general meeting of the company and passing a formal resolution approving the payment of directors’ salaries, that it would have made the position of the directors who received the remuneration … secure, and nobody could thereafter have disputed their right to retain their remuneration. The fact that they did not take that formal step but that they nevertheless did apply their minds to the question of whether the drawings by [the directors] should be approved as being on account of remuneration payable to them as directors, seems to lead to the conclusion that I ought to regard their consent as being tantamount to a resolution of a general meeting of the company. In other words, I proceed upon the basis that where it can be shown that all shareholders who have a right to attend and vote at a general meeting of the company assent to some matter which a general meeting of the company could carry into effect, that assent is as binding as a resolution in general meeting would be. The preference shareholder, having shares which conferred upon him no right to receive notice of or to attend and vote at a general meeting of the company, could be in no worse position if the matter were dealt with informally by agreement between all the shareholders having voting rights than he would be if the shareholders met together in a duly constituted general meeting.

Re Compaction Systems Pty Ltd [5.175] Re Compaction Systems Pty Ltd (1976) 2 ACLR 135 Supreme Court of New South Wales [The issued capital of Compaction Systems consisted of 20 shares of $1 each. Omnico was registered as holder of 19 of them and a solicitor, McDonald, the chair of the board, was registered as the holder of the remaining share. The liquidator of Omnico believed (semble from the return of shareholders filed with the Corporate Affairs Commission) that Omnico was the legal owner of all 20 shares in the issued capital of the company. (At the time he neither held nor sought access to the share register of Compaction Systems.) He signed, as representative of Omnico, a minute recording that an extraordinary general meeting of members of the company had been held on 28 October 1976, the only member present being Omnico by its official liquidator. The minute recorded a resolution that Compaction Systems be wound up. In effect, he was seeking to take advantage of an informal meeting procedure then available where a company holds the whole of the issued capital of another. On the following day the liquidator caused a petition to issue in the name of Compaction Systems for winding up of the company by the Supreme Court of New South Wales. A provisional liquidator was appointed to preserve the assets of the company. On becoming aware that a provisional liquidator had been appointed McDonald convened a meeting of directors of Compaction Systems, following which counsel was instructed to seek an order to strike out the petition on the ground that the company had not authorised it and to revoke the appointment of the provisional liquidator. The share register of Compaction Systems showed Mr McDonald to be the holder of one “B” class share. McDonald expressed the view in evidence that he held the share registered in his name beneficially. The liquidator disputed that and also tendered a direction given by him to McDonald to discontinue the proceedings brought by him. “B” class shares did not confer any right to vote at a general meeting of [5.175]

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Re Compaction Systems Pty Ltd cont. the company but the resolution dealing with the rights of “B” class shares was silent on the question whether “B” class holders were entitled to receive notice of meetings or to attend or speak at any general meeting. Counsel for the liquidator argued that, under Re Duomatic Ltd, the assent of the liquidator alone was sufficient for the resolution to wind up the subsidiary company.] BOWEN CJ in EQ: [141] If all the shareholders of a company are present together in a meeting, and signify their assent to a transaction which is within the powers of the company, their decision will be effective, as if a resolution to that effect had been passed at a properly constituted meeting. This may be so, notwithstanding those at the meeting thought they were conducting a directors’ meeting and the necessary formalities required for the calling of a general meeting had not been observed: Re Express Engineering Ltd [1920] 1 Ch 466. This may also be so where those present thought they were conducting a meeting and passed a resolution, but where, in fact, the requirements of the articles or the Companies Act 1862 as to notice had not been observed: Re Oxted Motor Co Ltd [1921] 3 KB 32. The cases mentioned dealt with circumstances where all shareholders were involved. In the present case Mr McDonald was not involved. The question arises whether the same principle applies where all persons beneficially entitled to shares agree or where all persons agree who are the registered holders of shares carrying the right to vote. I have not been referred to authority in favour of the first of these propositions, and, as at present advised, I am not persuaded of its correctness. However, counsel for the respondent relied upon Re Duomatic Ltd as authority for the second proposition. [Bowen CJ outlined the facts in Re Duomatic Ltd and quoted from the judgment of Buckley J. He continued:] [142] His Lordship’s attention does not appear to have been directed to the fact that the Companies Act 1948 (UK), s 162(4), provided that the auditors of a company were entitled to attend any general meeting of a company and to receive notice of and to be heard at any general meeting. Whether this statutory requirement has any effect upon the principle laid down in Re Express Engineering Ltd may require some consideration. In the present case the facts fall short even of the looser principle expounded by Buckley J in Re Duomatic Pty Ltd. As I have indicated, it is my view that although the one “B” class share held by Mr McDonald did not entitle him to vote, it did, under the articles of Compaction Systems, entitle him to receive notice of and to attend any meeting. In addition, under art 111 and under [ss 249K, 249V], an auditor is entitled to attend any general meeting of the company and to receive all notices of any general meeting and to be heard. The right to receive notice of a meeting and to attend and to be heard is not an insubstantial right. The right to advance arguments and to influence the course of discussion may in some circumstances have an effect, even a decisive effect, on the decision reached. It may be that the principle laid down in Re Express Engineering Ltd should apply notwithstanding there has been an omission to notify the auditor, but I am not prepared to extend the principle to cover the case where only the shareholders entitled to vote have assented to a transaction while another shareholder entitled to receive notice of meetings and to attend has not been made aware of the transaction and has not assented to it.

Ho Tung v Man On Insurance Co Ltd [5.180] Ho Tung v Man On Insurance Co Ltd [1902] AC 232 Privy Council [A company registered a set of articles of association upon its incorporation in Hong Kong and used these articles as its regulations until it was discovered 19 years later that the articles had never been signed by the subscribers to the memorandum (as required). The registered articles conferred upon the directors a power to refuse to register share transfers. The Table A regulations under the local Companies Ordinance did not. A shareholder whose transfer had been refused registration asserted that the Table A regulations applied to the company by virtue of the counterpart provision which deemed 270

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Ho Tung v Man On Insurance Co Ltd cont. those regulations to apply to a company unless it adopts its own articles. The Supreme Court of Hong Kong held that the registered articles constituted the regulations of the company. The shareholder appealed to the Privy Council.] LORD DAVEY: [234] It appears, therefore, that these articles have been registered, and have been published and put forward as the company’s only articles of association, and have been acted on, amended, and added to by the shareholders of the company, and the company’s business has been conducted under the regulations contained therein for 19 years without any objection, and the company on the record says that these articles are its articles of association. Their Lordships think that in these circumstances they are entitled to draw the inference that all the shareholders have accepted and adopted the articles as the valid and operative articles of association of the company. [236] The articles of association stand on a very different footing from the memorandum, and are in the power of the shareholders themselves. The apparent object of requiring the articles to be signed before registration is to secure the adhesion of the only members of the company at that time to the regulations contained therein. … But there is no reason why the shareholders should not adopt them although irregularly registered. The statutory mode of doing so is by special resolution; but this again is only machinery for securing the assent of the shareholders, or a sufficient majority of them. Their Lordships think that, by the acquiescence and agreement of the shareholders shewn by a long course of dealing, the registered articles have become and are the articles of association of the company as surely as if they had been formally adopted by special resolution.

Herrman v Simon [5.185] Herrman v Simon (1990) 4 ACSR 81 Court of Appeal of the Supreme Court of New South Wales MEAGHER JA: [81] In this matter the appellant appeals against a judgment delivered by Hodgson J in the case, in which his Honour found that a special resolution of a company called HPM Industries Pty Ltd passed on 9 March 1981 purporting to delete art 5 of the articles of association in one form and substituting a new form was invalid. [82] In my view, despite a very able argument from Mr Grieve, senior counsel for the appellant, the appeal cannot succeed and in my view also substantially for the reasons given by his Honour below. The facts of the matters are these, that before the resolution in question the company’s ordinary shares were held as to 502 by a lady called Mrs Simon, 500 by her brother, Mr Herrman. In addition to the ordinary shares there were two classes of preference shares. The first preference shares were held by Mrs Simon as to 4000 and by Mr Herrman as to 2500. As to the second preference shares, they were all held by a company called Short Street Investments Pty Ltd, the company in whose capital Mrs Simon and Mr Herrman each owned one share, and a company called Hill Street Investments Pty Ltd owned 4100 shares, that company, Hill Street Investments Pty Ltd, being itself half owned by Mrs Simon and half by Mr Herrman. Article 5 in its old form is divided into 4 paragraphs. Paragraph (a) dealt with the nominal capital of the company. Paragraphs (b) and (c) dealt with the rights of holders of preference shares, the rights of the first and second preference shareholders being significantly different, and paras (d) and (e) dealt with the powers of directors in relation to the issue of shares. The new resolution passed, insofar as it affected art 5, was to the effect that art 5 be deleted and that a new article be substituted in its place, the new article being a very short one and saying nothing more than that: “The capital of the company is $560,000 divided into 269,500 ordinary shares of $2 each, 6500 5% non-participating cumulative and first preference shares of $2 each and 4000 5% non-participating cumulative second preference shares of $2 each.” In other words, in the terms of it, the new article is a replacement of the first paragraph of art 5 but has no equivalents to paras (b), (c), (d) or (e) of the old art 5. [5.185]

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Herrman v Simon cont. The findings of fact made by his Honour, which are unchallenged and, I should imagine, unchallengeable, are that all parties, with the possible exception of Mr Herrman, did not appreciate either that the paragraphs of art 5 other than para (a) were being deleted or what the effect of that deletion was. All parties concerned, with one possible exception, thought that they were merely replacing in effect the old art 5(a). The exception is Mr Herrman himself, about which the evidence is ambiguous. On his Honour’s finding as I read it, his Honour was rather inclined to the view that Mr Herrman himself shared the ignorance of Mrs Simon and her advisers. On his own version he appreciated exactly what the effect of the amendment was according to its terms but did not illuminate anyone else. In any event it does not matter. The significant – and I think for present purposes the only significant thing – is that Mrs Simon, the predominant shareholder, and her advisers did not understand. In these circumstances she launched a three-pronged attack on the passage of the resolution. She first contended that purely as a matter of construction the new resolution did nothing more than substitute a new para 5(a) for the old para 5(a). His Honour rejected that submission and in my view perfectly correctly so. She next suggested that the article should be rectified and that argument was again rejected and in my view correctly so. [83] The third attack, which however was upheld, was that the resolution was invalid because of failure to comply with art 55, the company’s variation of rights article. There was a failure to comply with art 55 and in two respects. First, no separate meetings were held and the article in the circumstances would have required three separate meetings and secondly no notice was given at all to Short Street, which was the owner of one entire class of shares. That art 55 applied in the circumstances is only faintly in dispute; that it was not complied with is not in dispute. The normal result of that on the authorities is that the resolutions are invalid. This flows from the decision of Jacobs J in Crumpton v Morrine Hall Pty Ltd (1965) 82 WN (Pt 1) (NSW) 456 and from the English decision in Re Old Silkstone Collieries Ltd [1954] 1 Ch 169. How then is this result to be avoided? This is the real point of the appeal. Mr Grieve said in a most attractive way that it is to be avoided by the application of what he described as the Duomatic principle, being the principle enunciated by Buckley J in Re Duomatic Ltd [1969] 2 Ch 365, a decision which has been approved both by courts elsewhere and by the textbooks and which has subsequently been applied. What is that principle? That principle is I think this: where it can be shown that all shareholders having a right to attend and vote at a general meeting of a company assent with full knowledge and consent to some matter which a general meeting of the company could carry into effect, that assent is as binding as a resolution in general meeting would be. In other words, it is a doctrine dispensing with the consumptive effect of formalities. It is a doctrine that formalities may be disregarded if they have been waived by all shareholders acting in concert who want the same substantial result. It is alleged that that doctrine should be applied to cure in the present case the defects which arise from non-compliance with art 55. In my view that doctrine does not really touch the present problem for a number of reasons. In the first place it seems to me a doctrine which goes to formalities and not to substance. If all shareholders want the same substantial result and say so, acting unanimously, that doctrine no doubt applies in order to dispense with any failure to observe formalities but it is not a doctrine which says that substantial rights may be varied. The second reason is that if in the present case art 55 had been complied with, all proper notices had been given and all separate meetings had been held, it is fairly apparent that the effects of the new article would have become clear to the parties involved. If those effects had become clear, namely that the voting rights and other rights were being altered, it is clear on his Honour’s findings that the amendments as proposed would have not been congenial to Mrs Simon and thus would have been lost. 272

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Herrman v Simon cont. The third reason, it seems to me, is that, after all, the Duomatic principle, however formulated, is really only a principle of waiver and it would be a very odd result if one could waive the destruction of rights of whose destruction one was ignorant. The fourth reason – perhaps it may be that these four reasons are merely alternative ways of saying the same thing – is that, again being a doctrine of waiver and a doctrine going to formalities, Buckley J was perfectly correct in stating that it can only operate where the persons attending a meeting have full knowledge and consent. [84] In the present case I do not see how it could possibly be contended that there was full knowledge and consent in Mrs Simon, particularly in view of his Honour’s findings of fact. In this regard also it seems to me unreal to suggest, as Mr Grieve was driven to suggest, that one can treat the question of full knowledge and consent shorn of all subjective elements. In other words, I cannot see how one could sensibly apply some doctrine to Mrs Simon which would amount to saying that she was deemed to have known and consented to the effect of the amendments even though the plain fact was that she did not do so. For those reasons I do not think that the prima facie effect of non-compliance with art 55 is saved by the Duomatic doctrine and in my view the appeal should be dismissed. [Samuels and Priestley JJA agreed with Meagher JA.]

Kinsela v Russell Kinsela Pty Ltd (In Liq) [5.190] Kinsela v Russell Kinsela Pty Ltd (In Liq) (1986) 4 NSWLR 722 Court of Appeal of the Supreme Court of New South Wales [At a time when its financial position was, to say the least, precarious, a company granted a lease of its business premises to two of its directors. The company was wound up three months later as an insolvent company. Its liquidator sought a declaration that the lease was voidable and had been duly avoided. The defendant lessees pleaded that all members of the company had, after full disclosure, authorised the granting of the lease. While the primary judge felt constrained by authority to hold that the unanimous assent of members would cure any irregularity in the grant of the lease, he nonetheless made the orders sought since he found that full disclosure had not been made to one member. The defendants appealed.] STREET CJ: [727] The appellants challenge his Honour’s finding of absence of full disclosure and seek to rely upon the unanimous approval of all the shareholders as placing the transaction beyond successful attack by the company whether on the initiation of the liquidator or otherwise. Whilst it has been appropriate to set out the facts in broad detail, the essential elements can be stated succinctly: this insolvent company, in a state of imminent and foreseen collapse, entered into a transaction which plainly had the effect, and was intended to have the effect, of placing its assets beyond the immediate reach of its creditors; it did this by means of a lease of its business premises entered into with the intention that two of its directors, as lessees, would use those premises for the purpose of continuing to conduct a business of the nature of that which the family of the directors and all of the shareholders had carried on for many years; the lease was executed on behalf of the company by the two directors who were to be lessees with the unanimous approval of all the shareholders of the company; it may be added, [728] for what it is worth, that the terms of the lease were, to say the least, commercially questionable. … [729] The learned judge at first instance held … that he was bound by authority to hold that the approval by all of the shareholders validated an action which would otherwise be beyond the powers of the directors provided that there had been a full and frank disclosure to the shareholders of all of the circumstances relevant to the proposed transactions: Bamford v Bamford [1970] Ch 212 at 238-242; Winthrop Investments Ltd v Winns Ltd [1975] 2 NSWLR 666 at 679, 680-689. He added, however, an express reservation of his own in accepting that such a statement of principle could have been [5.190]

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Kinsela v Russell Kinsela Pty Ltd (In Liq) cont. intended to exclude a challenge based upon an allegation of misuse of a director’s power deliberately to prejudice or encumber creditors. This reservation in my view was well-founded. The authorities to which his Honour submitted, notwithstanding the [730] generality of their enunciations of principle, were not intended to, and do not, apply in a situation in which the interests of the company as a whole involve the rights of creditors as distinct from the rights of shareholders. In a solvent company the proprietary interests of the shareholders entitle them as a general body to be regarded as the company when questions of the duty of directors arise. If, as a general body, they authorise or ratify a particular action of the directors, there can be no challenge to the validity of what the directors have done. But where a company is insolvent the interests of the creditors intrude. They become prospectively entitled, through the mechanism of liquidation, to displace the power of the shareholders and directors to deal with the company’s assets. It is in a practical sense their assets and not the shareholders’ assets that, through the medium of the company, are under the management of the directors pending either liquidation, return to solvency, or the imposition of some alternative administration. … There has been a recent comprehensive and authoritative analysis in New Zealand by Cooke J, of the principles of law to be applied in a case such as that presently under consideration: Nicholson v Permakraft (NZ) Ltd (in liq) (1985) 3 ACLC 453. In that case the directors of a manufacturing company [731] which was facing liquidity problems adopted a reconstruction scheme which had the effect of prejudicing the creditors of the company. The informed assent of all of the shareholders to the reconstruction was established and this was relied upon by the directors as a defence to a claim brought by the company on the initiation of its liquidator seeking to have the transaction set aside. The case was not so straightforward as is the present: the degree of the company’s financial stability was open to some debate; also, the directly prejudicial effect on creditors was not so plainly apparent at the time the transaction was entered into. Cooke J drew upon English, Australian and New Zealand case law as well as upon other learned writings in formulating a series of principles that provide valuable and illuminating guidance in resolving problems within this area. He stated those principles (at 457-460) in his judgment. That entire passage could well be cited in full as pointing to the fate of the present litigation but I shall quote only a few brief extracts: (i) A company is bound in a matter intra vires by the unanimous agreement of its members. … (ii) The principle about assent has a particular application in matters of procedure. As Buckley J put it in Re Duomatic (at 373): where it can be shown that all shareholders who have a right to attend and vote at a general meeting of the company assent to some matter which a general meeting of the company could carry into effect, that assent is as binding as a resolution in general meeting would be. ... A fortiori the creditors in the present case, who of course had no right to attend general meetings of the company or directors’ meetings, cannot take advantage – directly or indirectly through an action by the liquidator in the name of the company – of the informality in the declaration of the dividend. It is cured by the unanimous assent of the shareholders.

(iii) The duties of directors are owed to the company. On the facts of particular cases this may require the directors to consider inter alia the interests of creditors. For instance, creditors are entitled to consideration, in my opinion, if the company is insolvent, or near insolvent, or of doubtful solvency, or if a contemplated payment or other course of action would jeopardise its solvency. … [732] The obligation by directors to consider, in appropriate cases, the interests of creditors has been recognised also in the High Court of Australia. In Walker v Wimborne (1976) 137 CLR 1 Mason J said (at 6-7):

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Kinsela v Russell Kinsela Pty Ltd (In Liq) cont. it should be emphasised that the directors of a company in discharging their duty to the company must take account of the interest of its shareholders and its creditors. Any failure by the directors to take into account the interests of creditors will have adverse consequences for the company as well as for them. Barwick CJ concurred in the judgment of Mason J. It is, to my mind, legally and logically acceptable to recognise that, where directors are involved in a breach of their duty to the company affecting the interests of shareholders, then shareholders can either authorise that breach in prospect or ratify it in retrospect. Where, however, the interests at risk are those of creditors I see no reason in law or in logic to recognise that the shareholders can authorise the breach. Once it is accepted, as in my view it must be, that the directors’ duty to a company as a whole extends in an insolvency context to not prejudicing the interests of creditors (Nicholson v Permakraft (NZ) Ltd and Walker v Wimborne) the shareholders do not have the power or authority to absolve the directors from that breach. [733] I hesitate to attempt to formulate a general test of the degree of financial instability which would impose upon directors an obligation to consider the interests of creditors. For present purposes, it is not necessary to draw upon Nicholson v Permakraft as authority for any more than the proposition that the duty arises when a company is insolvent inasmuch as it is the creditors’ money which is at risk, in contrast to the shareholders’ proprietary interests. It needs to be borne in mind that to some extent the degree of financial instability and the degree of risk to the creditors are interrelated. Courts have traditionally and properly been cautious indeed in entering boardrooms and pronouncing upon the commercial justification of particular executive decisions. Wholly differing value considerations might enter into an adjudication upon the justification for a particular decision by a speculative mining company of doubtful stability on the one hand, and, on the other hand, by a company engaged in a more conservative business in a state of comparable financial instability. Moreover, the plainer it is that it is the creditors’ money that is at risk, the lower may be the risk to which the directors, regardless of the unanimous support of all the shareholders, can justifiably expose the company. The foregoing, and like, considerations point to the desirability of avoiding an attempt to enunciate principles in wide-ranging terms. Having said that, however, I reiterate my own respectful agreement with the passage in the judgment of Cooke J (at 457-460) to which I have already referred. In the view that I hold the challenge by the company is made good and the defence advanced by the appellants must fail. The case presents an unusually straightforward factual pattern. The company was plainly insolvent at the date of the lease and its collapse on that ground was imminent; thus, no occasion arises to analyse the degree of financial instability which may be necessary to impose upon directors the obligation to consider the position of creditors. Secondly the prejudice to the creditors was the direct and calculated result of the lease; its purpose was to place the company’s assets beyond the reach of the creditors; there is thus no occasion to examine on a value basis the commercial wisdom or unwisdom of the decision of the directors. The lease was not ultra vires and void as exceeding the capacity of the company. It was, however, entered into by the directors (albeit with unanimous approval of all of the shareholders) in breach of their duty to the company in that it directly prejudiced the creditors of the company. It was accordingly a voidable transaction and, no third party rights having intervened, the company on the initiation of the liquidator is entitled to the aid of the court to avoid it. [Hope and McHugh JJA agreed with Street CJ.]

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Notes&Questions

1. What is the basis of the doctrine expressed in these cases? If the constitution expresses the consensus of all members (cf Automatic Self-Cleansing Filter Syndicate Co v Cuninghame [5.125] at 43) do these cases elevate unanimous shareholder assent (even if informal) to a [5.192]

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“super-consensus” status? If the unanimous assent of members is equated with a resolution of a general meeting (cf Re Express Engineering at 470, 471), does it matter that the subject matter of the resolution falls within the powers confided by the replaceable rule or constitution to the directors? Modern Australian authority expresses the doctrine in terms similar to that adopted by Meagher JA in Herrman v Simon at 83, namely, where “all shareholders having a right to attend and vote at a general meeting of a company assent with full knowledge and consent to some matter which a general meeting of the company could carry into effect, that assent is as binding as a resolution in general meeting would be”; see also Angas Law Services (in liq) v Carabelas (2005) 226 CLR 507 at 519 (“the unanimous consent of the shareholders, even if there has been no formal resolution of a general meeting, may be as binding as a resolution in general meeting would have been. This line of authority is often invoked to meet the contention that the company is not bound by some decision or conduct by reason of administrative irregularity, failure to comply with articles of association, or want of authority on the part of some internal organ.”); Poliwka v Heven Holdings Pty Ltd (No 2) (1992) 8 ACSR 747 at 786-788 (“[t]he power of the members … to bind a company is dependent upon its constitution. In my view, nothing that was said in Re Express Engineering Works Ltd and the subsequent authorities … detracts from this proposition. In none of those cases were the members precluded by the articles from binding the company to the contracts in question”); Bodikian v Sproule (2009) 72 ACSR 598; [2009] NSWSC 599 at [30]-[32] (“the Duomatic principle allows the court to accept as valid, notwithstanding failure to adhere to formal requirements, a decision made by the unanimous assent of the members entitled to participate in the decision, whether or not they have actually met together. The doctrine does not give the members acting unanimously a power that they do not constitutionally possess (because, eg, the power is vested in the board of directors)”); Rilgar Nominees v BHA Holdings Pty Ltd [2014] VSC 632 at [32]. However, as regards the effect of informal decision upon “substantive rights”, in Bodikian v Sproule at [35] Austin J also said: “The proposition that the application of the Duomatic principle cannot affect substantive rights was not necessary to the decision in Herrman v Simon, and depending precisely on what is meant by ‘substantial rights’ it may significantly narrow the availability of the principle in Australia, in comparison with the English cases …. I regard the issue as a difficult one, to be addressed only after full argument and full consideration of the authorities.” 2. Is the expression of the informal acts doctrine in Herrman v Simon consistent with that applied in the preceding case law? What operation does this formulation have with respect to the rights or claims of persons who are not shareholders in the company? 3. Is the approach adopted in Kinsela’s case sound? Does it inevitably commit the courts to defining acceptable levels of business risk-taking? How would the case have been decided if the company, while solvent, had had three successive years of trading losses but had granted the lease at full market rental and with appropriate rental escalators? The claims of creditors upon the directors’ consideration are further discussed at [7.312], n 5, and the limits of the general meeting’s power to ratify breaches of directors’ duties are discussed at [8.25]. 4. Might shareholders acting unanimously bypass procedures stipulated in the Act itself? For instance, assuming no question of insolvency, may the shareholders informally agree to a selective reduction of share capital: cf s 256C(2)? May shareholders unanimously consent to the company giving financial assistance in connection with the acquisition of shares in the company: cf s 260B? See Re U Drive Pty Ltd (1986) 5 ACLC 117 at 118-119. 276

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5. Does the requirement of unanimity (subject to Re Duomatic Ltd) in practice restrict the operation of the informal acts doctrine to medium sized, if not closely held, companies? Alternatively, what scope has the decision in Ho Tung v Man On Insurance Co Ltd for extending the practical operation of the doctrine to companies with a larger membership? Might the doctrine ever apply to a stock exchange listed company and in what circumstances? The law report of the Ho Tung case does not disclose the number of shareholders in the company or whether it was listed.

[5.194]

Review Problems

1. A director of a solvent company appropriates to herself company funds received from the sale of some of its assets. May she plead as a defence to misfeasance proceedings (for breach of trust) that the company has distributable profits exceeding the amount of the appropriated funds and that, as she and her spouse held all the shares, they must as “businessmen” [sic] (cf Re Express Engineering at 471) be assumed to have declared a dividend in the amount appropriated, to be satisfied by the appropriation? See Re ABC Plastik Pty Ltd (1975) 1 ACLR 446. 2. George and Martha operate Global Health Pty Ltd (“Global”). Each holds 50% of the ordinary share capital and they are joint managing directors. Their fathers are the only other directors. George’s father has invested a small amount of funds in Global as preference shares that have rights to attend shareholder meetings only with the permission of the ordinary shareholders and only then when dividends are in arrears. George and Martha want Global to provide long-term financial support to an organisation, Weapons of Mass Salvation (WMS), which provides international human rights training. They know that the other directors will not support this commitment to WMS and so they sign the donor agreement “on behalf of Global as its proprietors”. They inform WMS that they are doing so despite the board’s opposition. Is Global bound to the agreement with WMS? Would it make any difference to your answer if dividends were in arrears on the preference capital?

PLANNING FOR CONTROL IN THE PRIVATE COMPANY Shareholder agreements [5.195] Lawyers seeking to give effect to particular arrangements for the distribution of

control and interests within the company will usually do so by provisions in its constitution. Typically, such provisions will relate to the division of power between the organs, the attachment of voting rights to shares and the division of shares into classes. The framing of control structures may not, however, end with the constitution. In a number of ventures it may be convenient to prepare a complementary agreement for execution by some or all of the corporators to regulate the exercise of their rights as shareholders under the constitution. Such agreements are often called shareholder agreements and are particularly useful where venturers want the benefits of corporate form while retaining the individual autonomy usually

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enjoyed by partners. 143 The validity of such arrangements as tolerable fetters upon shareholder voting rights has been upheld by English and Canadian courts. 144 There appears to be no Australian authority clearly on point. It is important to appreciate that shareholder agreements are designed to regulate the formal exercise of shareholder rights. They should be distinguished from unanimous informal agreements between members which bind the company under the informal corporate acts doctrine. Shareholder agreements have received little judicial attention, yet often provide an invaluable planning tool. They range in scope from the simple agreement regulating voting rights with respect to the appointment and removal of directors to elaborate arrangements dealing with such matters as: 1. appointments to other key corporate offices (eg, the secretary, managing director and chair); 2. the breaking of deadlocks upon the board; 3. restrictions upon the transfer of shareholdings through “buy-out” and other provisions; 4. 5.

restrictions upon competition between members and the company; and restrictions upon the exercise of board powers designed to ensure unanimous or special majority assent to major business decisions. An interesting example of a provision within (5) was considered in Re A & BC Chewing Gum Ltd 145 where a shareholder agreement provided, inter alia, that members would exercise their voting rights so as to ensure that the company should not make decisions on some 19 matters without unanimous agreement. These matters included (i) the issue by the company of any shares debentures or loan capital or the creation of any … charges in respect of the business or undertaking or assets; (ii) the lending or borrowing of money or the giving of any guarantee … where the individual amount involved exceeds £3,000; … (v) the sale [or purchase] otherwise than in the normal course of trading of any property; … (vii) allocations to reserves; (viii) payment … of dividends or any other distribution of capital or profits; (ix) amounts to be written off assets or against profits in respect of bad debts redundant obsolete or slow moving stock wear and tear and depreciation; (x) the writing up or revaluation of any assets or change in the method of valuing stock; … (xii) the liquidation of the company; (xiii) matters of policy affecting sales; … (xviii) the initiation or abandonment of any litigation or arbitration.

The company was wound up by the court when a member repudiated the agreement. Several, if not all, of the matters in (1) to (5) above might be dealt with expeditiously in the particular instance by provision in the constitution. Often fine questions of judgment will arise as to whether the optimum solution is to be found by provision in the constitution or in a collateral agreement. Factors which will influence this judgment include the operation of doctrines constraining the exercise of directors’ and shareholders’ powers – for example, the duties of nominee directors and the tolerable limits to the fettering of board powers through 143

144

See, eg, the shareholder agreement in Cane v Jones [1980] 1 WLR 1451. Valuable discussions of the utility and scope of shareholder agreements are contained in P D Finn (1978) 6 ABLR 97; S Kruger (1978) 94 LQR 557; J H Farrar & B Hannigan, Farrar’s Company Law (4th ed, 1998), Ch 11; Note (1964) 78 Harv LR 393; F H O’Neal, Close Corporations (2nd ed, 1971), Vol 1, Ch 5; R D Wilson, “Voting Agreements and Unanimous Shareholder Agreements” in Law Society of Upper Canada, Shareholders and Shareholders’ Agreements (1976), pp 61-84. Greenwell v Porter [1902] 1 Ch 530; Puddephatt v Leith [1916] 1 Ch 200; Ringuet v Bergeron (1960) 24 DLR (2d) 449.

145

[1975] 1 WLR 579; for further examples see Oswal v Yara Aust Pty Ltd (No 3) (2011) 86 ACSR 1 and Re Sullivans Cove IXL Nominees Pty Ltd (2011) 82 ACSR 224 at [28]-[35].

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provisions such as (5). Both questions are examined below, at [7.330] and [7.510], although we should here anticipate discussion of the second issue in its application to shareholder agreements. Shareholder agreements have been upset where they operate to impair the independent judgment of the directors 146 or to sterilise the board by transferring its powers to shareholders in defiance of the delegation of management powers to the board under North American statutes. 147 Thus, in Motherwell v Schoof 148 the two shareholders in a company entered into an agreement which provided that any dispute between them as directors of the company would be referred to an independent arbitrator. Since there was only one other director, the arbitrator’s decision would necessarily determine the decision of the board on the disputed issue. Another term of the agreement provided for the appointment of one party as general manager and president of the company, appointments which lay within the power of the board. The Alberta Supreme Court held that each of these provisions fettered the discretion of the parties, as directors of the company, in the management of its affairs. The agreement was therefore invalid. On the other hand, in Ringuet v Bergeron 149 a shareholders’ agreement bound its parties to vote unanimously “dans toutes assemblees de la dite Compagnie”. The Anglophone majority of the Canadian Supreme Court interpreted the clause to refer only to general meetings of shareholders and not, as the Francophone minority held, to directors’ meetings also. The agreement was therefore valid. The minority judges in Ringuet v Bergeron indicated that the shareholders’ agreement would have been valid if all shareholders had been parties to it, notwithstanding the fettering of board powers. 150 Similarly, in Greenwell v Porter 151 vendors of shares contracted with the purchaser that they would vote for, and not oppose, the election of directors appointed by the purchaser. An injunction was granted to restrain the vendors’ threatened breach of their covenant, the court holding that its validity was not affected by the fact that the vendors were also directors of the company. 152 The fetter rule applies only to constraints upon the exercise of board powers. It is not, however, always easy to disentangle obligations, particularly those arising under shareholder agreements, binding individuals in their capacity as directors from those binding them as shareholders or binding the company only. Much will turn upon the construction of the relevant commitment. In the South African decision in Coronation Syndicate Ltd v Lilienfeld 153 the directors of a company undertook to call a general meeting of the company and to submit and support resolutions to increase the company’s share capital. A director later resiled from the agreement. The validity of the director’s commitment to convene the meeting and support the resolutions was considered by the Supreme Court of the Transvaal. Solomon J said: It appears to me that there is a very great difference in principle between the case of a shareholder binding himself by such a contract and the directors of the company undertaking such an obligation. The shareholder is dealing with his own property, and is entitled to consider merely his own interests, without regard to the interests of the other shareholders. But the 146

See, eg, McQuade v Stoneham 263 NY 323; 189 NE 234 (1936); but see Clark v Dodge 269 NY 410; 199 NE 641 (1936).

147 148

See Long Park v Trenton-New Brunswick Theatres Co 77 NE 2d 633 (1948). [1949] 4 DLR 812.

149

[1960] SCR 672.

150

[1960] SCR 672 at 677.

151

[1902] 1 Ch 530.

152

A like injunction was granted in Puddephatt v Leith [1916] 1 Ch 200; see also Re Medefield Pty Ltd (1977) 2 ACLR 406 at 409. [1903] TS 489.

153

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directors are in a fiduciary position, and it is their duty to do what they consider will best serve the interests of the shareholders. If, therefore, they have bound themselves by contract to do a certain thing, and thereafter have bona fide come to the conclusion that it is not in the interests of the shareholders that they should carry out their undertaking, I do not think that the court would be justified in interfering with their discretion and compelling them to do what they honestly believe would be detrimental to the interests of the shareholders. … For this breach of contract they may be personally liable in damages, but if that is their honest conviction I do not see how we can compel them to perform their contract. 154

Other control distribution devices [5.200] Several other devices exist for distributing corporate control other than through the

constitution. The principal of these devices, the voting trust, is discussed in the following extract. 155 The irrevocable proxy and the management contract are control distribution devices of lesser practical significance. Under the irrevocable proxy shareholders authorise another person to exercise the voting rights attached to their shares. Strictly, the proxy will be irrevocable only if it is coupled with an interest, a requirement that is notoriously indeterminate. In contrast to the voting trust, legal title to the shares the subject of the proxy remains with the individual shareholder. A management contract involves the delegation of the general powers of management of a company, not to a managing director (which is quite common), but to an outside person or company. The delegation is usually made by formal agreement. The legality of such contracts (sustained by appropriate delegation powers in the constitution) was assumed without discussion in Investment Trust Corp Ltd v Singapore Traction Co Ltd. 156 Management contracts will often provide for remuneration of the manager by a share in the profits of the company (as in the Investment Trust case). Such management arrangements are now relatively rare among Australian companies. Where they exist, they are more likely to be employed by investment companies and companies trading abroad. 157

“Shareholders’ Voting Rights and Company Control” [5.205] M A Pickering, “Shareholders’ Voting Rights and Company Law” (1965) 81 Law Quarterly Review 248 [257] A voting trust is created when the voting rights of some or all of the shares in a company are settled upon trust. The trust in this context, as in others, can be a very flexible instrument. It may be comprised of all or only some of the shares with voting rights. The powers of the trust may give the trustees an absolute and unfettered discretion to act as they wish or their authority may be restricted. The objects which they are empowered to fulfil may be general or, usually in combination with capital structures conferring appropriate class rights, they may be confined to certain specific matters. In effect a voting trust confers a joint irrevocable proxy with general or restricted powers. It is a more [258] formal device for concentrating control than the voting agreements and usually will have wider effect. The voting trust in some ways has similar effects to the use of non-voting and “loaded” shares as a means of concentrating control in relatively few hands. Together with other inter-member devices it has been widely used in the United States of America, but relatively neglected in the United Kingdom 154

156

Coronation Syndicate Ltd v Lilienfeld [1903] TS 489 at 496-497; see also Northern Counties Securities Ltd v Jackson and Steeple Ltd [1974] 2 All ER 625 at 637. For instances of voting trusts within Australian companies, see Re Kornblums Furnishings Ltd (1981) 6 ACLR 456; and Repco Ltd v Bartdon Pty Ltd (1980) 4 ACLR 787. [1935] Ch 615.

157

See further M A Pickering (1965) 81 LQR 248 at 261-263, 267-269.

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“Shareholders’ Voting Rights and Company Control” cont. where in general the constitutional devices have been preferred. In contrast to the extensive litigation which has taken place in the United States on problems arising from the use of voting trusts, and their regulation by statute in many cases, there is apparently no reported case in English law dealing expressly with issues arising from a corporate voting trust, nor are there statutory provisions specifically applicable to them. There are perhaps three situations where voting trusts may have special usefulness. First, particular circumstances may make the intervention of outside or independent trustees desirable. For example, where there is a close association of members and directors each individually having a comparable status within the company the existence of independent trustees with powers to appoint or supervise the appointment of directors and managing directors may prevent undesirable internecine strife. Second, where a company is incorporated for objects which require for their proper implementation the continued control of persons holding certain beliefs or opinions a voting trust may be one way of achieving this. Third, in very large companies where the membership is both great in number and dispersed in area the interests of shareholders may be more effectively and continuously safeguarded by trustees acting on their behalf than by the efforts of individual members in general meeting. In addition, it can be argued forcefully that such trustees could more appropriately exercise the power of appointing directors than what are, in effect, often self-perpetuating boards of directors, and similarly that they might exercise a valuable independent role in deciding such questions as directors’ remuneration and terms of appointment. These are very contentious points and [259] in practice voting trusts established for this latter purpose are extremely rare or non-existent among larger companies in England. Apart from such specific functions voting trusts may be employed as a straightforward device by which a relatively small group of individuals within a company can acquire majority control. Under it shareholders may surrender more of their legal rights and remedies than under almost any other means of concentrating control, except perhaps the management contract, but the questions raised by its use have not yet been decided by the courts in England.

APPOINTING AND REMOVING DIRECTORS [5.210] This section examines the rules and machinery for appointing and removing directors

and, indirectly, their security of tenure. These rules are part of the wider corporate governance project (see [5.20]) of striking a balance between the goals of assuring directors’ tenure of office so as to encourage independence and vigour and, on the other hand, insinuating a structure of management accountability. Powers over the appointment and removal of directors are the principal controls that shareholders enjoy over directors; these powers are qualified, however, by powers given to directors, for example, to appoint managing directors and subordinate managers. In this aspect company law perhaps most closely approximates the concerns of general constitutional law. The personnel of company management [5.215] The Act stipulates a minimum number of directors – three for public companies (two

of whom must be Australian residents) and one (who must be an Australian resident) for proprietary companies: s 201A. Company constitutions frequently make provision for the size of the board. Commonly, they also recognise particular varieties of directors. 158 The directors may appoint one or more of their number to the office of managing director and confer any of 158

It may be doubted that the legal conception of the office of director sufficiently recognises the range of business role and status which it encompasses. This diversity is well captured by a former chairman of the National Companies and Securities Commission: “The term director is applied to people who vary from [5.215]

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their powers upon her or him: s 198C. In most companies the day-to-day administration of company affairs is left to one or more managing directors and to the staff appointed by them. Such directors are also called executive directors since they serve the company both as employees, usually under a formal contract of employment, and by virtue of their office of director. (This dual status, as both directors and employees, is considered at [5.245].) Other directors are called non-executive directors; those that satisfy applicable tests of independence are called independent directors. Their central role in modern corporate governance systems is discussed at [5.60]. The mix of executive, non-executive and independent directors, and a brief director demographic, is contained at [5.55]. Under standard constitutional provisions directors may appoint a person to be an associate director of the company although such appointments are now unusual. Directors appointed with a specialist title, for example as finance or marketing directors, are also to be found. A director may, with the approval of other directors, appoint an alternate director to exercise some or all of the director’s powers for a specified period: s 201K(1). Alternate directors may be appointed to protect against loss of a quorum or to preserve the balance of representation upon the board (as, eg, in joint venture companies). In foreign-controlled companies senior executives of local subsidiaries may be appointed as alternates for non-resident directors whose attendance at directors’ meetings of the subsidiaries is necessarily irregular. Prior to the current facility for appointing a single person as the sole director and shareholder of a proprietary company, it was not uncommon for all the powers of management and control of a private company to be vested in a single person frequently called a governing director. The practice became evident shortly after the validity of the “one person” company was established in Salomon v Salomon & Co Ltd: see [4.30]. The Act requires a public company to have at least one secretary ordinarily resident in Australia: s 204A(2). A proprietary company may elect to have a secretary who is resident in Australia: s 204A(1). The secretary is appointed by the directors: s 204D. The secretary must be an individual aged at least 18 years: s 204B(1). Normally a company will appoint only one secretary. The term “director” where used in the Act is given an extended definition, unless a contrary intention appears in a particular context, to include not only those validly appointed as director or alternate director but also others if (a) they act in the position of director (de facto directors); or (b)

the directors of the company are accustomed to act in accordance with their instructions or wishes (shadow directors): s 9. Although it is no longer possible as it once was 159 for a company to be appointed as a director of another company, in some circumstances a company may be deemed to be a director of another company and thus exposed to the director liability provisions of the Act: see [7.40]. The term “officer” is widely used in the Act, particularly to sanction corporate and management misconduct, for example, in the general liability provisions of Ch 2D. The term “officer” is defined to include not only the directors and secretaries of a company but also persons who participate in making decisions affecting a substantial part of the company’s business, have the capacity to affect significantly its financial standing or are in a position to communicate instructions or wishes to the directors with the intention that they will be acted

159

great captains of industry, wielding enormous power and bearing enormous responsibility … to people who operate an SP booking agency from a public telephone box and direct a $2 company”: H Bosch (oral testimony), Standing Committee on Legal and Constitutional Affairs, Company Directors’ Duties, Hansard, Senate, 22 March 1989, p 570. Re Bulawayo Market and Offices Co Ltd [1907] 2 Ch 458.

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upon and are in fact acted upon: s 9. The definition of officer therefore includes those who participate at a senior level in corporate management or exercise de facto influence whatever their formal designation, if any. In 2004, the term “senior manager” was introduced into the Act. It seeks to identify a group of senior employees for differential treatment from the general body of employees as context and regulatory purpose is deemed to require. It does this by adopting the first two limbs of the definition of officer, namely, persons who participate in making decisions affecting a substantial part of the company’s business or who have the capacity to affect significantly its financial standing; it excludes directors and secretaries of the company: s 9. In the Act, the term “officer” applies only in relation to corporations; accordingly, the term “senior manager” is defined to apply equally in relation to other forms of business association, namely, partnerships, trusts and joint ventures. Thus, in relation to a partnership, the term refers to persons who participate in making decisions affecting a substantial part of the partnership’s business or who have the capacity to affect significantly its financial standing; it also excludes partners themselves: s 9. Similar definitions apply to the use of the term in relation to trusts and joint ventures. The use of the term is presently restricted in the Act, principally to contexts where forms of business association other than corporations are used, for example, in relation to the supply of audit services: see [9.175]. The term “officer” is that principally used in the Act to define the reach of its provisions beyond directors and secretaries to senior employees. The reach of these extended definitions of directors, other officers and senior managers is explored more closely in the context of directors and officers’ liabilities where (except for the term senior manager) their application is particularly significant: see [7.30] et seq. Appointment of directors [5.220] The first directors are appointed by naming them, with their consent, in the

application to register the company: s 120. What happens subsequently will depend upon whether the company relies exclusively upon replaceable rules for its governance or upon the terms of its constitution. Under replaceable rules, directors may be appointed by the company in general meeting (s 201G) or by the directors themselves: s 201H(1). Where the directors appoint another person as director, the appointment must be confirmed by the general meeting within two months in the case of a proprietary company or at the next annual general meeting, for a public company: s 201H(2) – (3). If the appointment is not confirmed within the stipulated time the person ceases to be a director at that time. Traditional constitutional arrangements based upon longstanding Table A provisions generally provide that one third of directors retire at each annual general meeting but be eligible for re-election. The general meeting fills the vacant offices by electing persons by ordinary resolution. Retiring directors who offer themselves for re-election are often deemed to have been re-elected unless a contrary resolution is passed. These provisions will frequently be modified to take advantage of the dispensation available to all proprietary companies since 1998 from the obligation to hold an annual general meeting: s 250N. Arrangements in standard constitutions based upon Table A give the board subtle powers of influence over its own composition. Thus, in practice it is quite common for a new director to be appointed to fill a casual vacancy or as an addition to the existing directors. That person holds office until the next annual general meeting and is generally eligible for re-election. The Act impinges little upon freedom to frame arrangements for the appointment of directors. There is accordingly considerable variety in the arrangements that are found in proprietary company constitutions. For example, the constitution may appoint a person to be director for life or during her or his pleasure, and vest wide powers in her or him. Further, it is [5.220]

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not uncommon in the case of a company used as a vehicle for a joint venture for the constitution to grant to each venturer the right to appoint and remove a specified number or proportion of the company’s directors, and for such appointment (or removal) to take effect without any confirmation or other act on the part of the company. 160 In unlisted companies the constitution may vest the power to appoint one or more directors in an outsider such as a major supplier of finance and key employees. 161 In public companies a motion to appoint two or more persons as directors by a single resolution may not be made unless the meeting resolves, without any dissenting vote, to do so: s 201E(1). The prohibition seeks to ensure that appointments are made on their individual merits so that an unattractive candidate is not “tacked on” to a popular one. An exception permits election by constitutional amendment or voting by ballot or poll: s 201E(2) – (3). Generally, in public companies the arrangements are closer to those in the Table A model with the general meeting having power to appoint directors. Under standard provisions, whether those in Table A or in the replaceable rules, the holders of a bare majority of voting shares will be entitled to select the entire board. To secure for minority shareholders some influence in the election of directors some United States jurisdictions have imposed mandatory cumulative voting for directors. Under such systems shareholders will be entitled (for each share held) to as many votes as there are candidates. By casting all their votes for a single candidate, minority shareholders may be able to secure the election of a director notwithstanding the opposition of the majority to the appointment. 162 Cumulative voting is not found, however, in the States which are the seats of incorporation of the major US corporations. For stock exchange listed companies ASX Listing Rules mandate regular elections of directors by the general meeting. However, in many publicly held companies there are marked discrepancies between the form and the reality of the democratic electoral processes. It is rare for a person to be nominated for election as a director other than through the existing board and even rarer for such a person to be elected. The principal exception follows a change in corporate control through takeover when directors will usually appoint the nominees of the new controller to the board prior to resigning their own offices. The board of directors routinely identifies persons as new directors, perhaps through a nomination committee with a majority of independent directors: see [5.85]. Persons selected by the board to be directors are usually appointed as such by the directors themselves under the power to fill a casual vacancy arising from the resignation of a director or as an additional director. (It is regarded as good corporate governance practice to keep such a reserve place available.) The directors so appointed, if they are non-executive directors, hold office only until the next annual general meeting; when they are then nominated for election by shareholders, they stand for election with the authority of one who is a serving member of the board. To restore some balance, since 2011 where a public company has not appointed the maximum number of directors allowable under its constitution, directors must obtain shareholder approval before declaring that there are no vacant board positions: ss 201N – 201U. These provisions apply despite anything in the company’s constitution although an approved declaration does not prevent the board from appointing directors to casual vacancies between AGMs. Restrictions upon appointment as director [5.225] No minimum standards of training, competence or academic qualification are

imposed by law upon persons appointed as company directors or secretaries, even of publicly 160

For an instance of such an arrangement see Santos Ltd v Pettingell (1979) 4 ACLR 110.

161 162

See, eg, British Murac Syndicate v Alperton Rubber Co [1915] 2 Ch 186. See F H Easterbrook (1983) 26 J Law & Econ 395; J N Gordon (1994) 94 Columbia L Rev 124.

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held companies. Indeed, it was only in 1981 that companies legislation required directors to be natural (that is, human) persons. 163 For all companies the Act imposes a minimum age of 18 years for appointment: s 201B(1). The Act does not impose any shareholding requirement upon directors although a company’s constitution may do so. Any such holding is usually nominal. Its original function was to ensure that directors held a financial stake in the company to demonstrate their personal commitment to its fortunes. The rationale was overtaken by the emergence of executive directors who may make substantial human capital investments in the company even if they do not also have an equity stake in the company. If the constitution requires the director to obtain the qualification prior to appointment, non-compliance will void the appointment. 164 If the constitution merely fixes a share qualification but does not specify a period for its acquisition, until 1998 the Act required the director to obtain the qualification within two months of appointment. Failure to acquire the qualification within this period, or subsequent loss of the qualification, resulted in automatic vacation of the director’s office. This requirement has now been repealed. Disqualification from office and from managing companies

The grounds of disqualification [5.230] The Act contains provisions that disqualify, or permit a court or ASIC to disqualify, a

person from being a director or prohibit the person from participating in corporate management. Disqualification orders serve several regulatory functions: [they offer] in theory an admirable vehicle for preventing fraud and mismanagement for, by the use of such an order, a person may be disqualified from taking part in management without being imprisoned for the purpose. [Second], such orders offer us an alternative to prosecuting the corporation involved, which may well be as much a victim of the director’s dishonest manoeuvres as is the public generally. … [Third], and perhaps most importantly, providing a stringent means for the enforcement of reporting requirements should be conducive to the timely provision of ample information about corporate affairs and thus make it more difficult, if not to perpetrate, then to conceal fraud. [Fourth], because such orders do not prevent persons from acting honestly as mere employees, they cannot be said to engender further criminality in the sense that they leave their subject without the possibility of honest employment. 165

These provisions are the product of a gradual accumulation of measures designed to meet plural objectives that include investor and public protection, and the more efficient sanctioning of regulatory provisions affecting companies and the markets for their securities. The original ground of disqualification derived from a law reform proposal where the review committee referred to many cases which had been brought to its attention where bankrupts who had not obtained their discharge from bankruptcy had been able to continue trading under the guise of a limited company. The committee recommended that undischarged bankrupts be prohibited from taking part in the management of a company without the leave of the Bankruptcy Court. 166 An undischarged bankrupt continues to be prohibited from managing a company and the prohibition is extended to those who enter into a deed of arrangement or composition under Pt X of the Bankruptcy Act 1966 (Cth): s 206B(3), (4). The prohibition upon managing corporations is defined broadly to include not only automatic loss of office as director or secretary but also participation in decisions that affect a substantial part 163 164 165

Under the common law and prior Australian companies legislation a company might be appointed as director of another company: see Re Bulawayo Market and Offices Company Ltd [1907] 2 Ch 458. Stevens v Commonwealth General Assurance Corp Ltd (1938) 55 WN (NSW) 120. L H Leigh (1986) 7 Co Law 179 at 183.

166

Report of the Company Law Amendment Committee 1925-1926 (Cmd 2657, 1926), paras 56, 57. [5.230]

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of the company’s business or its financial standing and communicating instructions or wishes to the directors with the knowledge or intention that they will be acted upon: s 206A. The scope of the prohibition parallels the definitions of officer and senior manager (s 9) and is common to each of the modern grounds of disqualification which expand the original ground for bankruptcy. The scope of the prohibition is considered more fully at [5.239]. The second ground of disqualification, at least chronologically, was introduced following a recommendation of a later reform committee. 167 It applies automatically where a person is convicted of an offence under one or more categories including indictable offences involving decisions that affect a substantial part of the company’s business or its financial standing, an offence involving dishonesty which is punishable by imprisonment for at least three months, and offences punishable by imprisonment for at least 12 months: s 206B. The period of automatic disqualification is five years (s 206B(2)) although the Court may grant leave to the disqualified person within this period (the power of judicial relief is not limited to this ground of disqualification): s 206G. Upon ASIC’s application, the Court may also extend the period of automatic disqualification by up to 15 years: s 206BA. Third, a discretionary power of disqualification is given to the Court for deemed repeated contraventions of the Act, namely, where a person • has at least twice been an officer of a body corporate that has contravened the Act and the officer failed to take reasonable steps to prevent the contravention or • has at least twice contravened the Act while an officer of a body corporate and the court is satisfied that the disqualification is justified: s 206E(1). In making that latter determination, the Court may have regard to the person’s conduct in relation to the management, business or property of any corporation along with any other matters that it considers appropriate: s 206E(2). A fourth ground of disqualification arises under the discretionary power conferred upon the Court to disqualify directors who have been involved in the management of companies that have failed. The Court may disqualify a person from managing corporations (within the extended scope of that term as it is defined in s 206A) for a period of up to 20 years if, on the application of ASIC, it is satisfied that • within the last seven years the person was an officer of two or more companies that have failed financially; • the manner in which they were managed was at least partly responsible for the failure; and • having regard, inter alia, to the person’s participation in management, the disqualification is justified: s 206D(1). A company is deemed to fail financially if it enters into one of several modes of external administration: s 206D(2). Fifthly, ASIC is given a like power to disqualify for up to five years where the person has, within the past seven years, been an officer of two or more companies whose liquidator has reported under s 533(1) either that the company is unable pay its unsecured creditors more than 50 cents in the dollar or that an officer may have committed an offence in relation to the company, misapplied its property or breached their duty; before making the order, ASIC must give the officer an opportunity to be heard: s 206F. The criteria by reference to which the power may be exercised include whether the disqualification would be in the public interest. 168 167 168

Report of the Committee on Company Law Amendment (Cmd 6659, 1945), para 150. The High Court unanimously rejected a challenge to the power made on the basis that it purported to vest the judicial power of the Commonwealth in ASIC which is not, of course, a Ch 3 court. Although ASIC may look to the conduct of the person in question, that is not for a determination of guilt and would be but one

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Sixthly, on the application of ASIC, the Court may disqualify a person from managing corporations for such period as it considers appropriate if a declaration is made that the person has contravened a civil penalty provision (see [7.55]–[7.65]) and the Court is satisfied that the disqualification is justified: s 206C(1). In determining whether the disqualification is justified, the Court may have regard to the person’s conduct in relation to the management, business or property of any corporation and any other matters that the Court considers appropriate: s 206C(2). It is this ground of disqualification that was exercised in ASIC v Adler (see [5.235] following). Seventhly, a person is also disqualified from managing corporations if the Federal Court has, on the application of the Australian Competition and Consumer Commission, made an order under s 86E of the Competition and Consumer Act 2010 (Cth). Such an order may be made where the person has contravened, attempted to contravene or has been involved in a contravention of Pt IV of that Act relating to restrictive trade practices: s 206EA. The disqualification provisions assign to the Court either power to make the disqualifying order itself or to grant relief from disqualification arising by operation of the Act or notice from ASIC: s 206G. The scope and criteria for the exercise of that relief power are considered at [5.237]. This judgment remains the leading authority on the principles affecting the exercise of the disqualification power. The authority of the propositions expressed in this judgment is, with one exception, unaffected by the later decision of the High Court in Rich v ASIC that a disqualification order involves the imposition of a penalty for the purposes of the common law privilege against exposure to a penalty. 169 The exception is in relation to proposition (v) so that a disqualification order should now be regarded a involving the imposition of a penalty and accordingly a disqualification order may be made for purposes of punishment and general deterrence as well as the protection of shareholders. 170

ASIC v Adler [5.235] ASIC v Adler (2002) 168 FLR 253 Supreme Court of New South Wales [Adler was a non-executive director of HIH, a leading general insurer. He was also a director and 50% shareholder of Adler Corp, the other 50% being owned by his wife. With the knowledge of Williams, the chief executive of HIH, HIHC, a subsidiary of HIH, paid $10 million to PEE, a company controlled by Adler, as trustee for AEUT. The payment to PPE was made so that it did not come to the attention of other HIH directors. Out of the $10 million Adler applied $4 million on the purchase of shares in HIH. Adler sought to convey the false impression to the market that he was purchasing HIH shares for himself or his family as a measure of his personal confidence in the company. His purpose was to stabilise HIH’s falling share price, not to make a quick profit for the trust on the resale of the shares. Adler used part of the balance on the purchase at cost from Adler interests of three investments in unlisted technology and communication stocks. The balance of the $10 million was applied as unsecured loans to interests associated with him. AEUT’s investments in HIH shares were subsequently sold at loss of $2.1 million and there were losses of $3.9 million on unlisted company investments. When its insolvency became apparent, a provisional liquidator, and then liquidators, were appointed to HIH. ASIC sought declarations against Adler and Williams for contraventions of ss 180 – 183 (statutory duties of directors), the provision of financial benefits to related parties without shareholder approval (Ch 2E), and the provision of financial assistance in the acquisition of its shares with material prejudice: s 260A. Each of these provisions is a civil penalty provision and declarations were made

169

element in the disqualification decision; other criteria for that decision, such as that relating to the public interest, point to a determination made by reference to considerations of policy rather than of legal principle and objective standards: Visnic v ASIC (2007) 231 CLR 381 at [14]-[16]. Rich v ASIC (2004) 220 CLR 129 at [48].

170

ASIC v Vizard (2005) 54 ACSR 394 at [35]. [5.235]

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ASIC v Adler cont. against Adler under s 1317E. The following judgment deals with ASIC’s consequent application under s 206C for an order disqualifying Adler from managing corporations.] SANTOW J: 55 It is useful if, at the outset, I identify the propositions, by way of guiding principles or relevant factors, that can be derived from the cases which have dealt with these provisions or their predecessors. 56 The cases on disqualification gave orders ranging from life disqualification to 3 years. The propositions that may be derived from these cases include [cases citations for each paragraph have been removed]: (i)

Disqualification orders are designed to protect the public from the harmful use of the corporate structure or from use that is contrary to proper commercial standards …;

(ii)

The banning order is designed to protect the public by seeking to safeguard the public interest in the transparency and accountability of companies and in the suitability of directors to hold office…;

(iii)

Protection of the public also envisages protection of individuals that deal with companies, including consumers, creditors, shareholders and investors…;

(iv)

The banning order is protective against present and future misuse of the corporate structure …;

(v)

The order has a motive of personal deterrence, though it is not punitive …;

(vi)

The objects of general deterrence are also sought to be achieved …;

(vii)

In assessing the fitness of an individual to manage a company, it is necessary that they have an understanding of the proper role of the company director and the duty of due diligence that is owed to the company …;

(viii)

Longer periods of disqualification are reserved for cases where contraventions have been of a serious nature such as those involving dishonesty …;

(ix)

In assessing an appropriate length of prohibition, consideration has been given to the degree of seriousness of the contraventions, the propensity that the defendant may engage in similar conduct in the future and the likely harm that may be caused to the public …;

(x)

It is necessary to balance the personal hardship to the defendant against the public interest and the need for protection of the public from any repeat of the conduct …;

(xi)

A mitigating factor in considering a period of disqualification is the likelihood of the defendant reforming …;

(xii)

The eight criteria to govern the exercise of the court’s powers of disqualification set out in Commissioner for Corporate Affairs v Ekamper (1987) 12 ACLR 519 have been influential. It was held that in making such an order it is necessary to assess: – Character of the offenders – Nature of the breaches – Structure of the companies and the nature of their business – Interests of shareholders, creditors and employees – Risks to others from the continuation of offenders as company directors – Honesty and competence of offenders – Hardship to offenders and their personal and commercial interests; and – Offenders’ appreciation that future breaches could result in future proceedings.

(xiii)

Factors which lead to the imposition of the longest periods of disqualification (that is disqualifications of 25 years or more) were: – Large financial losses – High propensity that defendants may engage in similar activities or conduct

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ASIC v Adler cont. – Activities undertaken in fields in which there was potential to do great financial damage such as in management and financial consultancy. – Lack of contrition or remorse – Disregard for law and compliance with corporate regulations – Dishonesty and intent to defraud – Previous convictions and contraventions for similar activities; (xiv)

In cases in which the period of disqualification ranged from 7 years to 12 years, the factors evident and which lead to the conclusion that these cases were serious though not “worst cases”, included: – Serious incompetence and irresponsibility – Substantial loss – Defendants had engaged in deliberate courses of conduct to enrich themselves at others’ expense, but with lesser degrees of dishonesty – Continued, knowing and wilful contraventions of the law and disregard for legal obligations – Lack of contrition or acceptance of responsibility, but as against that, the prospect that the individual may reform …

(xv)

The factors leading to the shortest disqualifications, that is disqualifications for up to 3 years were: – Although the defendants had personally gained from the conduct, they had endeavoured to repay or partially repay the amounts misappropriated – The defendants had no immediate or discernible future intention to hold a position as manager of a company – In Donovan’s case, the respondent had expressed remorse and contrition, acted on advice of professionals and had not contested the proceedings …

57 I have earlier set out the relevant findings in the judgment in summary form. These, Mr Adler in the written submissions on his behalf concedes, are “extremely serious”. ASIC, in its supplementary submissions on relief, summarises the position in these terms: So far as Adler is concerned, the findings indicate not only that he contravened the Corporations Law in many respects but also that he did so with knowledge of the impropriety of his conduct and for the purpose of advancing his own personal interests at the expense of the companies of which he was a director or officer. His conduct thus amounted to a most serious dishonesty, occurring not as an isolated act but as a pattern of conduct over a number of months. This conduct was coupled with persistent lies and deceits designed to conceal his conduct and/or its impropriety. 58 Attachment A to ASIC’s submissions fairly summarises those “persistent lies and deceits and the associated impropriety”. [The judge quoted from a long list including items such as that Adler preferred his own position over that of HIH, HIHC and AUET in a number of respects, gave a false impression to financial journalists and to the market that he was purchasing the HIH shares on his own behalf, and that through company reporting he false statements and gave a grossly misleading picture of HIH affairs.] 59 Moreover, Mr Adler’s conduct from the time the PEE transaction first came to the attention of the non-executive directors until the present time has manifested no contrition whatsoever. While it may go only to mitigation of a statutory penalty, lack of contrition has a direct bearing upon disqualification. For here the interest of the public must be paramount. Mr Adler has at all times, by himself and through his counsel, vigorously denied any wrongdoing. In those circumstances, there is [5.235]

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ASIC v Adler cont. nothing whatsoever in his conduct to suggest that he would in the future act any differently in the performance of his duties as a company director or officer that he did in relation to the relevant transactions. 60 It is well settled (see [56(i) to (iii)] above) that the primary purpose of the disqualification power is the protection of the public; see, for example, ASC v Forem-Freeway Enterprises Pty Ltd at 349. That its object is the need to protect the public, with its corollary of personal deterrence, does not mean that its aim should be punitive though personal deterrence is relevant. That is explained in the judgment of Bowen CJ in Re Magna Alloys & Research Pty Ltd (1975) 1 ACLR 203 at 205: The policy to which s 122 [the predecessor to s 206C and s 206E of the Corporations Act] gives effect is that a person convicted of an offence of any of the type specified in that section is not to be permitted to act as a director or take part in the management of a company. The section is not punitive. It is designed to protect the public and to prevent the corporate structure from being used in the financial detriment of investors, shareholders, creditors and persons dealing with the company. In its operation, it is calculated to act as a safeguard against the corporate structure being used by individuals in a manner which is contrary to proper commercial standards. 61 Here, of course, the occasion for considering disqualification does not arise after the conviction by indictment for a criminal offence; compare s 206B which provides for automatic disqualification in the circumstances there delineated. That of itself does not mean that because these proceedings have been by way of civil penalty, the Court is thereby constrained in the exercise of its discretion to apply a lesser period of disqualification than the mandatory five years under s 206B. The discretion of the Court is still directed to the nature of the relevant person’s conduct in relation to the management, business or property of any corporation. It is also directed, more broadly, to any other matters that the Court considers appropriate, once the Court is satisfied that the disqualification is justified. 62 In any event, we are here dealing with a repeated series of contraventions though that needs to be put in proper perspective. While in arithmetic terms, the declarations made on 27 March 2002 produced 101 contraventions by Mr Adler and a further 84 by Adler Corporation, that simply represents the result of multiplying the nine episodes or transactions giving rise to a contravention by the number of corporate entities involved and the number of sections of the Corporations Law contravened by that same conduct. I would agree that the most that could be said is that a multiplicity of contraventions by reference to breaches of not just one but several provisions of the [Corporations Act] may give a broad indication of the seriousness of the contravention, but much more to the point is to look at the contraventions themselves. Thus two factors should be considered. First, the number of episodes or transactions. These are themselves numerous, nine in all for Mr Adler and the same number for Adler Corporation. … 68 In considering the effect of the multiple contraventions, for purposes of determining whether or not to make a disqualification order, the relevant transactions are to be judged individually as well for their cumulative effect. Thus in applying s 206E of the Corporations Act 2001, not only has there been at least two contraventions of the Act by HIH and at least two contraventions of the Act by HIHC, but the relevant person, here Mr Adler, did not merely fail to take reasonable steps to prevent the contravention but was himself directly involved in it so as himself to contravene the Act. That clearly reinforces the basis for applying s 206E with a substantial disqualification order. 69 Indeed the gravity of the contraventions as well as their repetition in distinct transactions, numbering nine in all, make a powerful case for the lengthiest disqualification period. 70 The principles of parity which guide the exercise of judicial discretion do not produce any neat arithmetic algorithm from other cases though the earlier propositions ([56] above) give some guidance. I would adopt what is said by Hill J in ACCC v Universal Music Australia Pty Limited (No 2) [2002] FCA 192 at [34] where, in the analogous context of the Trade Practices Act he says: Hence, while pecuniary penalties imposed in one case provide a guide, that guide will seldom if ever be able to be used mechanically. 290

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ASIC v Adler cont. 71 Austin J, while making similar observation, in ASIC v Parkes [2001] 38 ACSR 355 at 386 refers to a number of factors which are directly applicable to the present case and its circumstances: In reaching this conclusion [disqualification for 25 years], I take into account the following factors: • the contraventions that I have found include some very serious contraventions; • those contraventions have led to loss and damage on the part of companies and investors, contrary to the protective purpose of the relevant provisions of the Corporations Law; • the defendant’s field of activity, management and financial consultancy, is an area where the potential to do damage is especially high, compared, say, with a defendant whose expertise is in making cement; • the defendant’s contraventions have been recurrent, arising in the context of three different sets of companies; • until the end, the defendant asserted explanations for what he had done which I found to be implausible, and this suggests to me that he has no contrition; • all of these facts lead me to believe that there is a high propensity that the defendant will engage in similar conduct if only a short period of prohibition is imposed; • I am conscious of the fact that a prohibition for 25 years will effectively prevent the defendant from managing a corporation for the rest of his life, it will not prevent him from earning income as an employee, using his undoubted financial skills under proper supervision. 72 In the present case each of those factors are present, though it should be noted that Mr Adler himself did not assert any personal explanation for what he had done. Rather, through his legal advisers, he denied that there was any contravention in the circumstances, a denial which is at odds with the findings of the Judgment and thus cannot stand. 73 A review of the cases demonstrates that a wide range of banning periods have been imposed by the courts. For the most serious, there is prohibition for life, though in one case with a right to apply for variation after five years: ASIC v Hutchings. … [Adler argued for “private interest considerations” which it is said should be “weighed against the public interest grounds upon which a disqualification order should be made against Adler”. They were that almost of all of his business interests are carried on through Adler Corp, which is a private company, and of which Adler and his wife are the only directors and shareholders. The strategic decision-making, and financial and investment decisions, are made by Adler. Further, Adler Corp depends on Adler’s personal business relationships built up over many years and his assessment of risks and opportunities in transactions or investments. Many of the private and joint ventures in which Adler Corp is invested also depend upon his personal relationships with them. It was argued on behalf of Adler that any disqualification should apply only to managing public companies or alternatively a disqualification order should permit Adler to be involved in the management of Adler Corp and its wholly-owned subsidiaries; otherwise, it would unfairly deprive him of the means of earning substantially all of his income.] 79 There are fundamental problems in the way of any such course. The first, is that, as stated by Anderson J in Re Gold Coast Holdings Pty Limited (in liq) …, while qualification orders are protective rather than punitive, interests to be protected include “those of the public who may unwittingly deal with companies run by people who are not suitable to be involved in the management of companies and the public interest generality and the transparency and accountability of companies and the suitability of directors to hold office”. [emphasis added]. Clearly members of the public will not cease to deal with companies that are private should Mr Adler continue to be permitted to be involved in their management. Likewise in relation to Adler Corporation. Indeed the fact that he was so permitted to be involved with their management would signal the safety of so dealing. This could be as creditor or customer, even if, as a private company, a member of the public is not able to be a direct investor. The public dangers of that are self-evident. [5.235]

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ASIC v Adler cont. 80 The public protective purpose must clearly be paramount. That precludes a simple balancing exercise. While the disqualification order should not be disproportionate to the public protective purpose it is intended to serve, for that indeed would be punitive, it would subvert that public purpose if private interest considerations were to prevail or preclude an order which went no further than necessary to serve that public purpose. A lesser period of disqualification than that, designed to serve a private interest consideration, would thus sacrifice the public interests to be protected. 81 The second matter is one of jurisdiction. Section 206C and s 206E both confer upon the Court the power to “disqualify a person from managing corporations”. There is no suggestion that an order may discriminate between corporations and thus operate distributively only against a certain class of corporation such as any corporation that is not a public company, or any corporation that is not Adler Corporation and its wholly-owned subsidiaries. Indeed, that logically follows from the public protective purpose earlier identified. 82 Moreover, the power of the Court to grant leave under s206G, in contrast to s 206C and s 206E, does contain language expressly permitting application for leave to manage “a particular class of corporation”, or “a particular corporation”. That strongly suggests that the associated disqualification provisions are not to be read as permitting a qualified order. … 85 The final impediment, even were there no jurisdictional one, is that the proposed distinction between the management of public companies and private ones is unjustified. That the latter but not the former be permitted Mr Adler to manage, proceeds on the false assumption that the statutory protective purpose can sensibly be based upon whether the corporation uses “public capital”. Quite clearly, that protective purpose is not so narrowly based. Members of the public may deal equally with private companies as public companies. Their dealings are broader than simply the provision of equity capital. They include commercial dealings across the whole spectrum, being a spectrum in which private companies may deal as readily as public companies. Thus protection of the public envisages protection of individuals that deal with companies, public or private, including consumers and creditors as well as shareholders and investors (see [56(iii)] above). It is simply nonsense to suppose that the private status of a company represents some kind of safety zone for members of the public in their dealings; that some kind of cordon sanitaire can be placed around private companies so members of the public never deal with them. The statistics are replete with instances where the public have been duped in their dealings with private companies. The present contraventions have indeed occurred in relation to private corporations; Adler Corporation as the contravenor under Mr Adler’s control and PEE as suffering some of the contraventions. Indirectly, the public suffered, as shareholders of HIH. One might moreover reasonably argue that the public need even greater protection dealing with private companies. This is because public companies are subject to the disciplines applicable by statute and, where listed, the Stock Exchange Rules, whereas private companies are subject to a more permissive statutory regime. 86 The alternative suggestion, that Mr Adler be permitted to be involved solely in the management of Adler Corporation and its wholly-owned subsidiaries, may suggest that, perhaps with additional constraints, these difficulties could be overcome, on the basis, presumably, that Adler Corporation would only deal with sophisticated investors who could look after themselves. However, in laying down protection for the public, it is not to be understood that the protection is not also needed for sophisticated investors from the public who may otherwise deal with a private company in good faith and then find that its management betrayed the same failings that had led to earlier contraventions. As was said by Madgwick J in ASC v Forem-Freeway Enterprises Pty Ltd (supra) at 350, [I]t is a legal privilege to be able to [manage a company]: most people manage to make a living without doing it. 87 Here, concededly, Mr Adler will be impeded in his field of activity, which includes financial consultancy and investment, including joint ventures, but that is the very area where he has committed the relevant contraventions. That puts in stark relief the need to make the public protective purpose paramount over Mr Adler’s private interests, though it be the case that disqualifying him may 292

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ASIC v Adler cont. require him to be a passive investor with no seat on the board or role in management. Whether that of itself prevents him investing is a matter for him and not a matter for the court to enter into. To the extent that Adler Corporation and its wholly-owned subsidiaries are already engaged in ongoing financial or business activity, should a disqualification order be made against Mr Adler he will simply have to find others to carry on that activity or manage it, independently of him, on the basis that he must, in the public interest, be excluded wholly from that activity. That is, at least until such time as a court is persuaded to grant leave pursuant to s 206G, if it be so persuaded in light of the then known facts. … Conclusion 110 Taking into account the factors which led to Austin J in Parkes imposing a banning order of 25 years, and being satisfied these are essentially applicable here though I do consider the absence of fraud relevant (see [112]), I thus consider that the appropriate disqualification order for Mr Adler is 20 years. For the reasons that I have earlier identified, I do not consider there is any basis advanced by [Adler] to justify making no order, nor an order for a short period, nor an order (were there power to do so) limited to public companies or companies other than Adler Corporation and its subsidiaries. I am satisfied that, despite the hardship this may entail for Mr Adler and, if relevant, the effect of the other relief imposed against Mr Adler (see below), any lesser order would not satisfy the public interest. I have set the period at 20 years, taking into account the absence of fraud but recognising that there is no expression by Mr Adler to indicate that he would not offend again, so that the public should be protected by a very substantial banning order though short of 25 years. I believe the public protective and deterrent purposes are thereby sufficiently served by this lengthy period, though an argument for lifetime disqualification is not without weight. 111 The distinguishing factors raised by the First Defendant in relation to Parkes were that Mr Parkes managed three corporations whilst an undischarged bankrupt, that he had an intent to defraud, and that he asserted convoluted explanations found to be implausible. But that Mr Adler instead committed offences involving dishonesty (though not fraud) rather than bankruptcy, justifies some differentiation though limited. The distinction between asserting convoluted explanations found to be implausible and asserting none at all, save blanket denial, could hardly operate in Mr Adler’s favour. Finally, the contraventions here, as in Parkes, involved three corporations, namely HIH, HIHC, and PEE. 112 In setting the period of disqualification at 20 years, Mr Adler is not precluded at some future date, from attempting to demonstrate that he should again be permitted to manage a corporation, or a more limited class of corporation [by application under s 206G]. [The Court of Appeal upheld the disqualification orders made by the primary judge. They did so despite his reference in para [111] to Adler having “committed offences involving dishonesty”. Although the term “offence” was “not really appropriate” since these were civil penalty proceedings only, the Court held that its use was not significant in the circumstances. The Court also held that it was open to the judge to “ascribe to Adler’s conduct the character of impropriety or dishonesty”: Adler v ASIC (No 40538/02) (2003) 179 FLR 1 at [746], [758]. Adler’s application for special leave to appeal was rejected by the High Court: Adler v ASIC [2004] HCATrans 182.]

Seeking relief from disqualification [5.237] The Court may grant relief from disqualification (except where the person is

disqualified by ASIC), either generally or for a particular class of corporations or a particular corporation: s 206G. In Adams v ASIC, Lindgren J identified the following as the principles consistently recognised as relevant to the exercise of discretion under the section (citations removed): The applicant bears the onus of establishing that the Court should make an exception to the legislative policy underlying the prohibition … That legislative policy is one of protecting the [5.237]

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public, not one of punishing the offender … Another objective is to deter others from engaging in conduct of the particular kind in question … A further objective is the more general one of deterring others from abusing the corporate structure to the disadvantage of investors, shareholders and others dealing with a company … The prohibition itself contemplates that there will be hardship to the offender. Therefore hardship to the offender alone is not a persuasive ground for the granting of leave. 171 Lindgren J also quoted from Bowen CJ in Eq in Re Magna Alloys and Research Pty Ltd: 172 The court in exercising its discretion will have regard to the nature of the offence of which the applicant has been convicted, the nature of his involvement, and the general character of the applicant, including his conduct in the intervening period since he was removed from the board and from management. Where, as here, the applicant seeks leave to become a director and to take part in the management of particular companies the court will consider the structure of those companies, the nature of their businesses and the interests of their shareholders, creditors and employees. One matter to be considered will be the assessment of any risks to those persons or to the public which may appear to be involved in the applicant’s assuming positions on the board or in management. 173

Another factor of significance in some cases is the applicant’s contrition for wrongdoing and faithful perception of past error. Failure to demonstrate contrition was fatal in Miller v CAC. 174 The unsuccessful applicant in Re Van Reesema 175 was chided for lack of frankness in an affidavit. In Re Macquarie Investments Pty Ltd the applicant’s general demeanour and performance in the witness box led the court to conclude that he was unfit to be entrusted with the responsibilities of managing a company. 176 The problem presented by the disqualification of the key management figure has been met by fashioning protective structures which will not jeopardise the business or the employment of its staff. Thus, in Re Hamilton-Irvine the managing director of a Norfolk Island company, whose continued leadership of the company’s operations was considered essential to its fortunes, was automatically disqualified following his conviction for serious customs frauds committed in connection with the company’s operations. The interests of staff and the island’s economy prompted the court to permit the applicant to act as a director but subject to his retaining, at his own expense, an independent auditor to certify to the Controller of Customs that the company has complied with its customs obligations. 177 Similarly, an applicant was permitted to act as director upon agreeing to have an independent director, with qualifications in law or accounting, appointed to the board. 178 Orders relieving against disqualification have also been made subject to the appointment of an auditor to the company or an independent agent to supervise the company’s business. 179

The scope of the prohibition from managing corporations [5.238] Before 2000, the prohibition upon a disqualified person was from taking part in the

management of a company, a term that was not defined in the legislation. The indeterminacy is 171

(2003) 46 ACSR 68 at [8].

172 173

(1975) 1 ACLR 203 at 205. (1975) 1 ACLR 203 at 205.

174 175 176

Unreported, Supreme Court of New South Wales, Rogers J, 27 February 1986. (1975) 11 SASR 322 at 326; see also Re Ansett (1990) 9 ACLC 277 at 278-281. (1975) 1 ACLR 40.

177 178

(1990) 2 ACSR 616. Dempsey v CAC (1989) 7 ACLC 370.

179

Re Jarrett (1999) 32 ACSR 23; Hosken v ASIC (1998) 28 ACSR 542. In Affleck v ASIC [2015] QSC 236 an order permitting a disqualified person to manage required further court approval before any appointment as director.

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partially addressed in the terms of disqualification contained in s 206A which prohibits the disqualified person from participating in decisions that affect the whole or a substantial part of the company’s business, exercising the capacity to affect significantly the company’s financial standing, and communicating instructions or wishes to the directors with the knowledge or intention that they will be acted upon. This change does not, however, displace the prior jurisprudence entirely. In Commissioner for Corporate Affairs v Bracht Ormiston J said of the former prohibition: I would see the prohibition as covering a wide range of activities relating to the management of a corporation, each requiring an involvement of some kind in the decision-making processes of that corporation. That involvement must be more than passing, and certainly not of a kind where merely clerical or administrative acts are performed. It requires activities involving some responsibility, but not necessarily of an ultimate kind whereby control is exercised. Advice given to management, participation in its decision-making processes, and execution of its decisions going beyond the mere carrying out of directions as an employee, would suffice. If the respondent had been left to negotiate terms with bankers or providers of credit, although those terms had to be confirmed, there would have been sufficient participation, but not if those acts involved only communication or were merely casual. The negotiation of matters of financial importance, such as the rent of its principal premises, may well lead to an inference that a person is concerned in the management of a company, but not if that involved merely communication of instructions on a single occasion. A combination of these activities may likewise lead to the relevant inference, so long as the defendant is given some measure of responsibility or some area of discretion, or so long as his opinion is given some weight in the decision-making processes of management. Beyond this it is difficult to go, for circumstances and procedures may vary widely from company to company. 180

The new specification of scope of the prohibition by reference to the reach of impact or influence within the company (viz, participation in decisions affecting the whole or a substantial part of the company’s business or capacity to affect significantly the company’s financial standing) parallels the definition of officer in s 9: see [7.30]. The current prohibition probably has, however, a narrower reach than that applying before 2000 although it shares a common foundation in the broad distinction between management participation and involvement of a lower order of responsibility, such as through the performance of clerical or low level administrative tasks. 181 Termination of office [5.240] A director’s office may be terminated by resignation, retirement or removal. Under

s 203A and any displacing constitutional provision a director may resign from office at any time by written notice to the company. The office is thereby vacated. Retirement is effected in several ways. Standard constitutional provisions provide for the automatic annual retirement of one third of the directors and, if the vacated office is not filled, for the deemed re-election of the director if they offer themselves for re-election. A person ceases to be a director of a company if they are disqualified from managing corporations: s 203B. At common law corporations enjoyed an incidental power to remove a director during the term of office, but only for just cause. 182 The cause requirement possibly reflects the origins of the rule in the early municipal and religious corporations whose officers often had the duty of regulating the behaviour of members. Since the proper exercise of power might arouse 180

(1989) 7 ACLC 40 at 49-50.

181

For interpretation and application of the current terms of the prohibition see ASIC v Reid (2005) 55 ACSR 152.

182

See, eg, Lord Bruce’s Case (1728) 2 Strange 819; 93 ER 870; R v Richardson (1758) 1 Burr 517; 97 ER 426 at 539 (Burr), 438 (ER). [5.240]

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resentment, the cause requirement protected their tenure of office. 183 In the 19th century the corporation rule was applied to the registered company and shareholders were denied an inherent power to remove directors before the expiration of their term of office, at least where they were appointed for a definite term. 184 The Cohen Committee in 1945 thought it “desirable to give shareholders greater powers to remove directors with whom they are dissatisfied than they have at present”. 185 The committee recommended that shareholders be empowered to remove directors by ordinary resolution at any time during their term of office and without any need to prove justification. The recommendation was adopted in the Companies Act 1948 (UK) and in Australia 10 years later. In England the statutory removal power extends to all companies but in Australia it is confined to public companies. The legislative objective is to override any constitutional provisions which entrench a director in office. Accordingly, a director of a public company may be removed by ordinary resolution notwithstanding anything contained in the company’s constitution or in any agreement between the company, members and the director; if the director was appointed to represent the interests of particular shareholders or debenture holders, the resolution does not take effect until a replacement has been appointed: s 203D(1). Two months notice must be given of intention to move the resolution and the director is entitled to have the company circulate to members a statement setting out her or his case and to speak to the motion at the meeting: s 203D(2) – (6). Predecessor provisions expressed the power of removal to be without prejudice to any entitlement to damages the director might have with respect to the termination, that is, that the section conferred a power, and not a right, of removal: see [5.245]. Directors may not be removed from office in a public company by resolution of fellow directors (s 203E); however, it has been held that a predecessor provision did not prevent directors from exercising powers under the constitution to expel a fellow director from membership of the company which expulsion had the automatic effect of vacating his office as director. 186 In proprietary companies a replaceable rule confers power to remove a director from office and to appoint another person in their place without the protections afforded to directors of public companies under s 203D: s 203C. The constitutions of many public as well as proprietary companies contain such a provision. The question accordingly arises as to whether a public company may choose to exercise the removal power in its constitution rather than following the procedure in s 203D. The question was answered affirmatively in several decisions taken under predecessor provisions to s 203D. Thus, in Holmes v Life Funds of Australia Ltd 187 a dispute arose over the ruling of a chair at a general meeting of a public company in relation to a motion that all the present directors be removed from office. The chair ruled, in accordance with legal advice, that the motion could not be moved as the special notice required by the then predecessor to s 203D had not been given. The company’s constitution contained a provision that the company could remove any director by ordinary resolution. The court held that the chair’s ruling was wrong and that the statutory removal power was not intended to provide a complete code for the removal of directors. Accordingly, if members choose to remove a director under the procedure contained in the constitution, the statutory power has no application; alternatively, however, they might choose to proceed 183 184 185

See A H Travers (1967) 53 Iowa LR 389 at 393-394. Imperial Hydropathic Hotel Co (Blackpool) v Hampson (1882) 23 Ch D 1. Report of the Committee on Company Law Amendment (Cmd 6659, 1945), para 130.

186 187

Maloney v New South Wales National Coursing Association Ltd (No 2) (1978) 3 ALCR 404; on the question whether the prohibition should be relaxed see S Knight (2007) 25 C&SLJ 351. [1971] 1 NSWLR 860. See generally on the removal of company directors J J du Plessis (1999) 27 ABLR 6.

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under the statutory power in which case the constitutional provision for removal has no operation. 188 The two provisions therefore create “concurrent and alternative procedures” by which director removal may be effected at the option of shareholders. 189 However, these decisions were taken with respect to a statutory removal power that differed in its terms from that in s 203D in that they contained the express declaimer that “nothing in the foregoing provisions [viz, the statutory removal power] shall be taken as … derogating from any provisions to remove a director which may exist apart from this section”. These words were omitted when the Act was recast in 2000 to introduce s 203D. Different views have been taken with respect to the significance of the omission of these words. In Allied Mining and Processing Ltd v Boldbow Pty Ltd, Roberts-Smith J held that the omission of these words did not affect the interpretation of the removal power in s 203D whose objective remains that of preventing director entrenchment; consequently, s 203D does not set a minimum standard to be complied with in director removal. 190 Beach J agreed in State Street Australia Ltd v Retirement Villages Group Management Pty Ltd. He said that “although s 203D is mandatory in the sense that it overrides a company’s constitution to the extent of any inconsistency, it does not provide an exhaustive codification of the mechanism for removal. … it is there as a default mechanism rather than the mechanism”. 191 A different view, however, was taken by Bryson AJ in Scottish & Colonial Ltd v Australian Power & Gas Co Ltd who considered that this interpretation paid undue weight to the assumed legislative intent at the expense of the statutory terms which clearly indicated that the statutory removal procedure was intended to apply whatever other removal power might be contained in a company’s constitution. 192 The issue remains to be resolved by an Australian appellate court although the weight of judicial opinion clearly favours the “concurrent and alternative procedures” interpretation of the current s 203D. In England, as noted, the statutory removal power is not limited to public companies. In Bushell v Faith 193 a company’s articles provided that in the event of a resolution being proposed at a general meeting for removal of a director, any shares held by that director should carry three votes per share. The company had an issued capital of 300 £1 shares, distributed equally between the plaintiff, the defendant and their sister. The plaintiff and defendant were the only directors. The plaintiff sought a declaration that a resolution for the removal of the defendant as a director had been validly passed and an injunction restraining the defendant from acting as a director. The defendant claimed that his 100 shares carried 300 votes upon the resolution and that therefore it was lost. The House of Lords held that the article attaching weighted voting rights was valid and prevailed over the statutory power of removal. The majority thought that Parliament had not fettered a company’s right to issue shares with such rights or restrictions as it thought fit and that these rights or restrictions need not be of general application but could be attached to special circumstances and particular types of resolutions. Lord Morris dissented, holding that such an interpretation made a mockery of the removal power. 194 188 189

Link Agricultural Pty Ltd v Shanahan [1999] 1 VR 466; Vision Nominees Pty Ltd v Pangea Resources Ltd (1988) 14 NSWLR 38 at 42. Link Agricultural Pty Limited v Shanahan [1999] 1 VR 466 at 485.

190

(2002) 26 WAR 355 at [46].

191

(2016) 113 ACSR 483 at [16], [19]; compare Dick v Convergent Telecommunications Ltd (2000) 46 ACSR 86; Bison Ltd v Cellante [2002] VSC 504; Dalkeith Resources Pty Ltd v Regis Resources Ltd [2012] VSC 288.

192 193 194

(2007) 215 FLR 100 at [37]-[40]. [1970] AC 1099. In Australia, it has been held that, provided that voting rights are referable to the ownership of shares and not granted to someone who is not a member, they are not open to challenge on the grounds that their quantum is unrelated to the size of the member’s shareholding: Amalgamated Pest Control Pty Ltd v McCarron [5.240]

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Executive directors’ service contracts [5.245] The management of a company’s business is not, as we have seen, conducted by its

directors, at least in an operational sense, in larger companies: see [5.40]. That function is performed by the management or executive staff of the company under the leadership of the chief executive, under that title or appointed as managing director or general manager of the company. Modern company law distinguishes between the two capacities of the managing (or executive) director – as both a director and an employee of the company. A director as such is not an employee of the company. 195 Indeed, there is old authority asserting that the status of director is incompatible with that of employee of the same company. 196 In one such case a managing director was described simply as “an ordinary director entrusted with some special powers”. 197 It is, however, clear from modern cases such as Lee v Lee’s Air Farming Ltd [4.35] that a director may function in dual capacities, in Lee’s case both as governing director and employee of the company. In Anderson v James Sutherland (Peterhead) Ltd 198 Lord Normand expressed the dual nature of the managing director’s office thus: [T]he managing director has two functions and two capacities. Qua managing director he is a party to a contract with the company, and this contract is a contract of employment; more specifically I am of opinion that it is a contract of service and not a contract for services. There is nothing anomalous in this; indeed it is a commonplace of law that the same individual may have two or more capacities, each including special rights and duties in relation to the same thing or matter or in relation to the same persons.

The replaceable rule in s 201J provides that the directors of a company may appoint one or more of their number to the office of managing director for the period and on the terms (including as to remuneration) as the directors see fit. The directors may confer on a managing director any of their powers and revoke or vary the delegation of powers to the managing director: s 198C. Numerous variations on this simple delegation of management power appear in company constitutions, often derived from the terms of the Table A model current at the time of the company’s formation. Another replaceable rule permits directors to delegate any of their powers to a committee of directors, a director or employee of the company or another person; the exercise of power by the delegate is as effective as if the directors had exercised it: s 198D. Often a managing director will be appointed under a written service contract containing covenants that: (a) commit the managing director to serve the company faithfully and carefully for a specified period; (b) define duties; (c) (d)

specify remuneration (including superannuation benefits); protect confidential information of the company;

(e)

provide for summary termination by the company in specified circumstances; and (1994) 12 ACLC 171. In the United Kingdom Bushell v Faith clauses have been widely adopted in family and other private companies to overcome the statutory removal power. In Australia, where s 203D has no application to proprietary companies, the use of such clauses has been largely confined to unlisted public companies, although in some proprietary companies they are used as entrenchment devices to protect against loss of rights through alteration of the constitution.

195 196

Hutton v West Cork Railway Co (1883) 23 Ch D 654 at 671-672. See, eg, Normandy v Ind Coope & Co Ltd [1908] 1 Ch 84 at 104; Re Lee Behrens & Co Ltd [1932] 2 Ch 46 at 53.

197 198

Re Newspaper Proprietary Syndicate Ltd [1900] 2 Ch 349 at 350. [1941] SC 203 at 218.

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(f)

restrict the managing director’s business activities after termination of employment with the company. A replaceable rule provides that a person ceases to be managing director if they cease to be a director; the directors may revoke or vary the appointment of a managing director: s 203F. One common but not universal substitute for this replaceable rule is the Table A provision in place until 1998. It provided: 63 (1) The directors may from time to time appoint one or more of their number to the office of managing director for such period and on such terms as they think fit, and, subject to the terms of any agreement entered into in a particular case, may revoke any such appointment. (2) A director so appointed shall not, while holding that office, be subject to retirement by rotation or be taken into account in determining the rotation of retirement of directors, but the appointment automatically terminates if he ceases from any cause to be a director.

Questions sometimes arise as to the efficacy and consequences of attempts to remove a managing director, for example, by removal as a director. A distinction should be drawn here between the company’s power to break a contract, notwithstanding that breach may expose it to liability for damages, and its right to do so (that is, whether the service contract authorises the particular removal). On the issue of power, it is clear that, even if the constitution does not contain an express power to remove a director (as in s 203C), the company in a general meeting can alter the constitution pursuant to s 136 by inserting such a power which it can then invoke to remove the director. The company cannot contract out of its power to alter its constitution; thus, it cannot deprive itself by contract of the power to alter its constitution even though the constitutional alteration exposes the company to damages for breach of contract. 199 Under s 203F and its common counterpart in company constitutions, a person ceases to be managing director if they cease to be a director of the company. There are several modes of removal as a director depending upon company type and constitutional provision. The question whether a company has the right to terminate the appointment as a director, which termination bring the executive appointment to an end, or to terminate the appointment as managing director expressly and directly, will depend upon the mode of removal and the power that is being invoked under the applicable replaceable rule or constitutional substitute. The question of the company’s right (and not merely its power) to remove will depend also upon the terms of any service contract entered into with the managing director and the express or implied relationship between the company’s constitution and the terms of the service contract. A company’s constitution and the replaceable rules that apply to it are expressed to have effect as a contract between the company, members and directors, and between members inter se: s 140(1) (see [3.145]). In Bailey v New South Wales Medical Defence Union Ltd, 200 Brennan CJ, Deane and Dawson JJ said: Whilst the articles of association of a company regulate the relations of the members amongst themselves as members and with the company, they do not preclude a member from contracting individually with the company upon terms which may or may not be defined by reference to the articles. Such a contract has been called a special contract to differentiate it from the deemed covenants to which [s 140(1)] refers, which regulate the position of a member as a member and not as an individual. Even if the terms of a special contract are to be determined by reference to the articles, an alteration to those articles will not necessarily mean an alteration to the terms of the contract. It will depend upon the intention of the parties to the contract, namely, the member and the company. Thus, a special contract may import as a term one or more of the 199 200

Southern Foundries (1926) Ltd v Shirlaw [1940] AC 701; Allen v Gold Reefs of West Africa [1900] 1 Ch 656; Bailey v New South Wales Medical Defence Union Ltd (1995) 18 ACSR 521. Bailey v New South Wales Medical Defence Union Ltd (1995) 18 ACSR 521 at 526-527. [5.245]

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articles upon the basis that they may be altered by the company and an alteration of the articles in those circumstances will alter the terms of the contract. On the other hand, a special contract may be concluded upon the basis of the articles but with the intention that the terms of the contract are not to be varied by an alteration to the articles. That will not confine the statutory power of the company to alter its articles, but the company in acting upon the basis of an alteration may be acting in breach of contract. That, we think, was what Lindley MR had in mind in Allen v Gold Reefs of West Africa Ltd when, in speaking of special contracts, he said that a “company cannot break its contracts by altering its articles”. Put another way, a company cannot unilaterally vary its contracts by altering its articles unless that is the basis upon which the contract was made. And where a special contract does import as a term one or more of the company’s articles in an alterable form, an alteration to the articles will have the effect of varying the contract prospectively only because, save perhaps in extraordinary circumstances, any other result would be inconsistent with the intention of the parties to the contract.

Questions of construction often arise as to whether the service contract has incorporated as one of its terms the provisions of the replaceable rule or constitutional provision, and whether upon terms that the latter is alterable unilaterally by the company. With so many potential permutations and combinations difficult questions of interpretation arise, for example, whether a service contract has incorporated the company’s constitution so that there is an implied term that the managing director’s tenure is subject to the right of the general meeting to remove a director at any time. These questions of interpretation are considered in the following cases.

Read v Astoria Garage (Streatham) Ltd [5.250] Read v Astoria Garage (Streatham) Ltd [1952] WN 185 Chancery Division [The defendant company adopted as its articles Table A of the Companies Act 1929 (UK), art 68 of which provided: The directors may from time to time appoint one or more of their body to the office of managing director … for such term and at such remuneration … as they may think fit, and a director so appointed shall not, while holding that office, be subject to retirement by rotation, or taken into account in determining the rotation or retirement of directors; but his appointment shall be subject to determination ipso facto if he ceases from any cause to be a director, or if the company in general meeting resolve that his tenure of the office of managing director … be determined. In 1932, at the first meeting of directors of the company it was resolved that the plaintiff “be and he is hereby appointed managing director of the company at a salary of £7 per week”. In 1949, when the plaintiff was in ill health and the company doing badly, the directors resolved that the plaintiff’s “employment be terminated”. Subsequently, an extraordinary general meeting of the company was held at which a resolution approving the directors’ action in removing the plaintiff was passed. The plaintiff sued for damages for wrongful dismissal and breach of contract on the basis that he had not been given reasonable notice.] HARMAN J: There remains the question whether the plaintiff is entitled to damages for wrongful dismissal. He was dismissed by this resolution of the company out of hand. The plaintiff says that that was a breach of contract because a director who is appointed, as he was, in general terms and without limitation of time, is entitled to reasonable notice. In my judgment, it is right to say that as between the plaintiff and the board he was entitled to reasonable notice. I think that under art 68 of Table A, the board, although there is no reference to their having a power to revoke an appointment, must have the right to enter into an agreement with a director or appoint a managing director for a fixed term subject to six months’ notice or whatever it may be, or to appoint him generally, and, if generally, then the ordinary rule will be applied that reasonable notice on either side is necessary to put an end to that relationship. Counsel for the plaintiff very cogently argued that, that being so, it was not open to the 300

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Read v Astoria Garage (Streatham) Ltd cont. company in general meeting by a resolution to do that which the board could not do, viz, dismiss a managing director out of hand. The answer to that, I think, is not very easy. Article 68 provides that his appointment “shall be subject to determination ipso facto if he ceases from any cause to be a director”. That, apparently, is literally any cause, for example, if the company does not re-elect him, or if he becomes bankrupt. But the article goes on: or if the company in general meeting resolve that his tenure of the office of managing director or manager be determined. The company could validly exercise that power as between itself and the managing director. It does not necessarily follow that that would not be a course which would give him a right to damages. … It is difficult to find any direct authority for this matter. The nearest case, I think, is Nelson v Nelson (James) & Sons Ltd [1914] 2 KB 770 where the facts were quite different because, for one thing, there was a special article expressly empowering the board to revoke a managing director’s appointment and not a Table A article, and for another thing (to quote the headnote): The board appointed the plaintiff to be managing director upon the terms of an agreement which provided that he should hold the office so long as he should remain a director of the company and retain his due qualification and efficiently perform the duties of the office. The board subsequently revoked that appointment, relying on their express power to revoke. Lord Reading CJ said (Nelson v Nelson (James) & Sons Ltd [1914] 2 KB 770 at 776) that one must read that power to revoke as subject to the contract which had been made, and the contract, he said, was for a term of years, and the power to revoke only gave the directors power to take away that which they have given provided that they have not bound themselves to give it for any period of time. He said that that was an appointment for a period of time and could not by the exercise of a power of revocation be altered. Swinfen Eady LJ, however, does deal with Table A. He says: The articles may give a power to the directors to appoint one of their number to be managing director, but no power to revoke or cancel the appointment. The company may keep that power in its own hands to be exercised in general meeting. That is the position under Table A in the Companies Act 1908 (UK), which is the same for this purpose as the Act of 1929. He goes on: With an article in that form it is manifest that the directors can only appoint a managing director subject to the right of the company in general meeting to resolve at any time that his tenure of the office of managing director is to be determined. These observations are obiter, but, nevertheless, they are germane to the matter in question. In Southern Foundries (1926) Ltd v Shirlaw [1940] AC 701 there was a division both in the House of Lords and in the Court of Appeal. The majority held that there was a breach of contract if a company which had appointed a managing director for ten years allowed its articles to be so altered that a power to remove was imported. I do not think, in view of the unfortunate differences of opinion which made themselves plain, that that case helps very much. It seems to me that I ought to apply the observations of Swinfen Eady LJ, in the Nelson case. The article does, after all, say quite clearly that the appointment is “subject to determination ipso facto if the company resolve” that that be so. So, everybody who becomes a managing director of this company which has adopted Table A knows that he has certain rights, and that the board cannot alter them. It may be that the company cannot, by altering its articles, give them power to do that. That would seem to be so from the majority decision in the House of Lords in Southern Foundries (1926) Ltd v Shirlaw. But that does not, it seems to me, forbid, as being a breach of contract, the company itself (having power to dismiss) to exercise that power, because every contract which is entered into with the company must on the face of it be subject to that chance. In my judgment, therefore, the

[5.250]

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Read v Astoria Garage (Streatham) Ltd cont. company was entitled to dismiss the director out of hand and not to give him any notice. That being so, he is not in a position to claim damages for wrongful dismissal.

Read v Astoria Garage (Streatham) Ltd [5.255] Read v Astoria Garage (Streatham) Ltd [1952] Ch 637 Court of Appeal, England and Wales (on appeal from decision in previous extract) JENKINS LJ: [640] It is argued for the plaintiff that, notwithstanding the provisions of art 68, there was a contract between the plaintiff and the defendant company in the nature of a contract of general hiring – a plain contract of employment, one of the terms of which was that the plaintiff’s employment should not be determined by the defendant company except by reasonable notice. The judge came to the conclusion that the terms of the plaintiff’s appointment were not such as to entitle him to any notice in the event of the company choosing under art 68 to resolve in general meeting that his tenure of office as managing director be determined, and, in my judgment, the judge was clearly right. [The plaintiff argued] that even if the appointment made by the resolution of the board must be taken as in effect incorporating the provisions of art 68, nevertheless the [642] provisions of the article as so incorporated must be held to be subject to an implied term that the plaintiff’s employment could not be determined without reasonable notice. For my part, I see no ground for implying any such term; indeed, to imply one really comes back to saying over again that the appointment was not on the terms of art 68, but on some other and different terms, including a term as to reasonable notice. I see no ground for implying any such term in the absence of any contract outside the article and the resolution, and in the absence, moreover, of any provision about it at all in the resolution itself. We were referred to various authorities on this topic which, in one form or another, has been fairly often before the courts. The first was the well known case of Nelson v Nelson (James) & Sons Ltd [1914] 2 KB 770. … It is to be observed that this was a case in which there was an actual agreement with the plaintiff that he should be managing director for a period which was inconsistent with the unfettered exercise by the directors of their power under the articles to revoke the appointment of a managing director; and it seems to me that this is a vital distinction from the present case, in which there is no vestige of any contract beyond the minute of the resolution making the appointment and the article by reference to which, in my view, the appointment was made. The learned judge referred in the course of his judgment to a passage in the [643] judgment of Swinfen Eady LJ in the Nelson case in which he drew a distinction between a case like the one there under consideration, where the directors were seeking to exercise a power to revoke an appointment, and a case where the appointment of a managing director is, as in the present case, made subject to a power for the company to deal with it in general meeting; and the Lord Justice, after referring to that kind of article, continued: “With an article in that form it is manifest that the directors can only appoint a managing director subject to the right of the company in general meeting to resolve at any time that his tenure of the office of managing director is to be determined. That, however, is not the article which we have to construe.” It will be seen that the learned Lord Justice was there recognising that where a company in general meeting reserves the right to determine the appointment of a managing director, the directors cannot by the appointment of a managing director for some fixed term, override that power in the company. At all events, I think it is plain that where there is an article in that form, a managing director, whose appointment is determined by the company in general meeting in exercise of that power, cannot claim to have been wrongfully dismissed unless he can show that an agreement has been entered into between himself and the company, the terms of which are inconsistent with the exercise by the company of the power conferred on it by the article to determine a managing director’s appointment in general meeting. In the present case, as I have said before, there is no evidence of the existence of any such contract. We were also referred to the case in the House of Lords of Southern Foundries (1926) Ltd v Shirlaw [1940] AC 701. In that case the majority of their Lordships held the managing director concerned to 302

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Read v Astoria Garage (Streatham) Ltd cont. be entitled to damages. That is, however, an entirely different case from the present one for two reasons. In the first place, there was a contract of service between the company and the managing director dehors the articles of association; and, in the second place, the contract was sought to be determined by a power not present in the articles of association of the company as they stood at the date of the contract, but a power inserted in the articles by subsequent alteration. In my view, therefore, the case was wholly different from the present case, and it does not seem to me that any assistance can be obtained from it for the present purpose. [645] In my view, on the facts of this case, the position was simply that the plaintiff was appointed to be managing director in accordance with art 68 of the 1929 Table A with such tenure of office as was provided for by that article, and had no special right to receive any particular notice of the termination of his employment in the event of the company deciding to determine it and doing so by a resolution in general meeting. Accordingly, in my view, the learned judge came to a right conclusion. [Morris LJ agreed.]

Shindler v Northern Raincoat Co Ltd [5.260] Shindler v Northern Raincoat Co Ltd [1960] 1 WLR 1038 Manchester Assize Court [The plaintiff sold the share capital of the defendant company to Loyds and, as part of the sale agreement, entered into a written agreement with the defendant to serve it as managing director for an agreed salary and a term of 10 years. Shortly after, Loyds sold the equity in the defendant company to another company and, despite negotiations, made no alternative offer of employment acceptable to the plaintiff. The plaintiff sued for wrongful dismissal. The defendant company’s articles included art 68 from the current Table A whose terms were identical with those quoted above in the first extract from Read v Astoria Garage.] DIPLOCK J: [1042] The argument for the defendants on this matter … must, I think, be put thus: where a company’s articles of association include art 68, the directors have no power to appoint a managing director on terms which purport to exclude the company’s right to terminate his office and his appointment as managing director ipso facto upon his ceasing to be a director, or by resolution in general meeting to resolve that his tenure of office as managing director be determined. That argument can be put in alternative ways, either that an agreement for a fixed term which does not incorporate the right of the company set out in art 68 is ultra vires, or else that an agreement for a fixed term must be subject to the implied term, that it is terminable in either of the circumstances set out at the end of art 68. It seems to me that this point is concluded against the defendants by the decision of the House of Lords in Southern Foundries v Shirlaw [1940] AC 701. That case was somewhat complicated, and gave rise to a division of opinion in the House of Lords. Two of their Lordships who were most familiar with the Chancery side came to one conclusion, and three of their Lordships who were perhaps more familiar with the common law side came to another. There are some references in subsequent cases in the Chancery Division which suggest that it is difficult to ascertain what Southern [1043] Foundries v Shirlaw determined. It does, however, seem to me that all five of their Lordships in the Southern Foundries case were agreed upon one principle of law which is vital to the defendants’ contention in this case. That principle of law is that laid down in the case of Stirling v Maitland (1865) 5 B & S 840; 122 ER 1043, where Cockburn LJ said: “if a party enters into an arrangement which can only take effect by the continuance of a certain existing set of circumstances, there is an implied engagement on his part that he shall do nothing of his own motion to put an end to that state of circumstances under which alone the arrangement can be operative.” Applying that respectable principle to this case, there is an implied engagement on the part of the company that it will do nothing of its own motion to put an end to the state of circumstances which enables the plaintiff to continue as managing director: that is to say, an undertaking that it will not revoke his appointment as a director and will not resolve that his tenure of office be determined. … [5.260]

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Shindler v Northern Raincoat Co Ltd cont. [1044] It seems to me, therefore, that the decision of their Lordships in Southern Foundries v Shirlaw, which is, of course, binding [1045] on me, is conclusive in the plaintiff’s favour and that this defence fails. I should, however, be doing an injustice to [the] … argument [of defendant’s counsel] if I did not refer to the cases on which he relies and in particular to Read v Astoria Garage (Streatham) Ltd [1952] Ch 637 before Harman J. … [1046] There is no doubt that in that judgment the ratio decidendi is in the defendants’ favour, although it seems to me, with the greatest respect, that it cannot be reconciled with the opinions of their Lordships in Southern Foundries. Read v Astoria Garage (Streatham) Ltd went, however, to the Court of Appeal, where the decision was upheld. The Court of Appeal did not, however, as I read it, adopt the ratio decidendi of Harman J. After referring to the passage I have already read in the judgment of Harman J, in which he refers to the judgment of Swinfen Eady LJ in Nelson v Nelson (James) & Sons Ltd, Jenkins LJ continues: It will be seen that the learned Lord Justice was there recognising that where a company in general meeting reserves the right to determine the appointment of a managing director, the directors cannot by the appointment of a managing director for some fixed term, override that power in the company. At all events, I think it is plain that where there is an article in that form, a managing director, whose appointment is determined by the company in general meeting in exercise of that power, cannot claim to have been wrongfully [1047] dismissed unless he can show that an agreement has been entered into between himself and the company, the terms of which are inconsistent with the exercise by the company of the power conferred on it by the article to determine a managing director’s appointment in general meeting. In the present case, as I have said before, there is no evidence of the existence of any such contract. It seems to me that Jenkins LJ did not accept the full ratio decidendi of Harman J and left open the question of whether, where an agreement has been entered into between the managing director and the company, the terms of which are inconsistent with the exercise of the company’s power conferred upon it by the articles, and the company exercises that power, there is an action for wrongful dismissal. Having regard to the articles I have indicated and to the authorities in particular, and to Southern Foundries v Shirlaw, I answer this question in the affirmative and hold that the defence fails on this point.

[5.262]

1.

2.

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Notes&Questions

Are the approaches taken, or doctrines applied, in Read v Astoria Garage and Shindler v Northern Raincoat inconsistent? Would Diplock J have reached the same result had he sat in Read’s case? Did the Court of Appeal in Read accept without qualification the dictum of Swinfen Eady LJ in Nelson v Nelson (James) & Sons Ltd, quoted by Harman J at first instance in Read at 924? Another, simpler, variation arose in Shuttleworth v Cox [1927] 2 KB 9. The plaintiff was appointed managing director for life by a clause in the company’s articles and there was no service agreement outside and independent of the articles. The clause specified six grounds for removing a director. The articles were altered by adding a seventh ground (viz, a request in writing by all his co-directors that the director resign his office). This ground was subsequently invoked against the plaintiff. The plaintiff sued for wrongful dismissal. The Court of Appeal held that the contract between the plaintiff and the company contained in the articles in their original form was subject to the statutory power of alteration and, if the alteration was made bona fide for the benefit of the company as a whole (see [8.45] et seq), there was no breach of contract. There being no evidence of bad faith, the plaintiff’s action failed. [5.262]

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[5.263]

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Notes&Questions

The managing director of Security Ltd is appointed pursuant to a written agreement to hold office for a term of eight years. The company has adopted a constitution which includes a provision enabling the general meeting to remove a director by ordinary resolution at any time. Consider her entitlement to damages for wrongful dismissal if she is removed as a director, prematurely and without any suggestion of shortcoming on her part, under each of the following modes: (1) by the directors; (2) by the general meeting under s 203D; (3) by the general meeting under the constitutional provision referred to; and (4) by the general meeting altering the constitution to remove the provisions corresponding to ss 201J and 203F(2) and so extinguishing the power by which she was appointed as managing director. By written agreement a company contracted to employ Alex as managing director “for the term and subject to the company’s constitution and the provisions hereinafter contained”. The agreement provided that the term of Alex’s employment was deemed to commence on 1 January 2012 “and subject to the provisions hereinafter contained shall continue until 31 December 2016”. The agreement contained a provision that “notwithstanding anything hereinafter contained the company shall be at liberty to terminate the term by notice to that effect if the managing director ceases to be a director of the company”. The constitution authorised the directors to appoint a managing director from their number and, subject to the provisions of any contract between him and the company, to dismiss him, and further provided that, if he ceased to hold the office of director, he should cease to be managing director. The constitution also provided that the office of director should ipso facto be vacated if the director were removed under art 91 which was in the following terms: “Subject to the provisions of any agreement for the time being subsisting the company may by special resolution remove any director before the expiration of his period of office.” The company by special resolution amended art 91 by deleting the words “Subject to the provisions of any agreement for the time being subsisting”. Thereupon the company by special resolution removed Alex as a director and gave notice that her service contract had been terminated. Advise Alex on her entitlement to damages for wrongful dismissal. See Carrier Australasia Ltd v Hunt (1939) 61 CLR 534 and Bailey v New South Wales Medical Defence Union Ltd (1995) 132 ALR 1.

2.

FUNCTIONING OF THE BOARD OF DIRECTORS The board as collective [5.265] Directors are members of a collegial body whose powers are to be exercised

collectively: Directors can act only collectively as a board and the function of an individual director is to participate in decisions of the board. 201

An individual director has no power on their own to act on behalf of the corporation. Directors’ powers are collective only, to join with fellow directors acting as a board of directors. Of course, individual directors may be authorised, expressly or impliedly, to act on 201

Northside Developments Pty Ltd v Registrar-General (1990) 170 CLR 146 at 205 per Dawson J; [5.355]. This general rule may be displaced by other constitutional provisions as, eg, where the constitution vests particular corporate powers in a governing director. Such grants of power may be so framed as not to require exercise at a meeting of directors: Whitehouse v Carlton Hotel Pty Ltd (1985) 10 ACLR 20 at 24. [5.265]

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behalf of the company within a given sphere of action; executive directors will commonly have individual authority to act on behalf of the company in their capacities as employees of the company. However, directors’ powers are inherently collective and those deriving from the office of director are simply to participate in decisions of the board. Under the general law, directors may act only at a meeting unless the constitution makes other provision. 202 The rationale for this rule is that consultation and exchange of views is essential to the functioning of the board. However, principle so often yields to expediency and under a replaceable rule and its standard constitutional counterpart, directors may pass a resolution without a directors’ meeting being held if all the directors entitled to vote on the resolution sign a document that they are in favour of the resolution set out in the document: s 248A. The sole director of a proprietary company may pass a resolution simply by recording it and signing the record: s 248B. Although physical meetings may be inconvenient, nonetheless some meeting or coming together of directors remains of central importance. Subject to doctrines protecting those dealing with companies (see [5.310]) or relating to validation by Court order under s 1322, decisions taken by directors will be valid only if the formalities governing the convening and conduct of their meetings are satisfied. This section examines the requirements for valid collective action by directors. Convening directors’ meetings [5.270] Standard form constitutional provisions permit individual directors to convene a

directors’ meeting by giving reasonable notice to every other director: s 248C. In general, a directors’ meeting is properly convened and its business validly transacted only if reasonable notice is given of the meeting, 203 although separate notice need not be given of each meeting if the constitution or directors prescribe regular fixed meetings. Notice must be given of all other meetings, however, even to a director who has previously sought to waive the right to receive it, for example, by indicating verbally that she or he cannot attend a meeting, since there may well be a change of mind. 204 Notice need not be sent to a director beyond reach of communication 205 nor perhaps to one who, though proximate, is so ill as to make attendance impossible. 206 Notice of meeting need not be given in writing and may be oral. 207 If the constitution does not set a minimum notice period, a director is entitled to reasonable notice of meeting. 208 What period of notice is reasonable will depend upon the personal circumstances of the individual director as well as the character, structure and practices of the company. 209 Thus, in one instance less than 10 minutes notice of meeting was held to be adequate where the complaining director was present and able to attend; 210 where a director had other business at the time appointed, three hours notice of meeting was held to be inadequate notwithstanding his physical proximity to the meeting venue. 211 Notice of meeting to consider the appointment of a voluntary administrator that was given one afternoon in respect of a meeting to be held 202 203

Brick and Pipe Industries Ltd v Occidental Life Nominees Pty Ltd (1990) 3 ACSR 649 at 672. Harben v Phillips (1883) 23 Ch D 14.

204

Re Portuguese Consolidated Copper Mines Ltd (1889) 42 Ch D 160 at 168.

205 206

Halifax Sugar Refining Co Ltd v Francklyn (1890) 59 LJ Ch 591. Young v Ladies’ Imperial Club Ltd [1920] 2 KB 523 at 528.

207

Browne v La Trinidad (1887) 37 Ch D 1 at 9.

208 209 210

Re Homer District Consolidated Gold Mines; Ex parte Smith (1888) 39 Ch D 546 at 550. Petsch v Kennedy [1971] 1 NSWLR 494, affirmed (1972) 46 ALJR 356n. Browne v La Trinidad (1887) 37 Ch D 1.

211

Re Homer District Consolidated Gold Mines; Ex parte Smith (1888) 39 Ch D 546.

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the following morning was found to be reasonable notice; 212 in another case, less than two hours notice for such a meeting was held to be unreasonable. 213 A director who participates in a meeting of which he or she has been given inadequate notice thereby waives right to notice unless the director attends for the express purpose of objecting to the transaction of business because the meeting has not been properly convened. 214 If a director’s presence at a meeting is obtained by ambush, for example, by concealing its character as a directors’ meeting, the director’s failure to withdraw immediately from the meeting may not determine its character as a directors’ meeting (this question will typically arise where the director’s presence is essential to a quorum); it may be that equitable relief or some wider remedy will be available on the ground that the director’s consent to the meeting has been obtained by the unconscionable conduct of the other director or directors. 215 Directors’ rights to notice extend only to notice that the meeting is to be held. The notice of meeting is not required to specify the purpose or business to be transacted at the meeting. 216 The conduct of directors’ meetings [5.275] The conduct of directors’ meetings is governed by the replaceable rules in Pt 2G.1 Div

2. Directors may meet together for the despatch of business and adjourn and otherwise regulate their meetings as they think fit. The directors may elect one of their number to chair their meetings; each meeting must be chaired by a member of the board: s 248E. Unless directors decide otherwise, the quorum for a directors’ meeting is two directors who must be present at all times during the meeting: s 248F. A resolution of the directors must be passed by a majority of the votes cast by directors entitled to vote on the resolution; the chair has a casting vote, if necessary, in addition to a deliberative vote: s 248G. In Gillfillan v ASIC Barrett JA addressed director decision-making under s 248G through the casting of individual votes: Value is often attached to collegiate conduct leading to consensual decision-making, with a chair saying, after discussion of a particular proposal, “I think we are all agreed on that”, intending thereby to indicate that the proposal has been approved by the votes of all present. Such practices are dangerous unless supplemented by appropriate formality. The aim is not to consult together with a view to reaching some consensus, although it may well be, as a practical matter, that such consultation facilitates the making of the decision that is ultimately required. The aim is rather that the members of the board should consult together so that individual views may be formed and the individual will of each member may be made known in a clearly communicated way. The culmination of the process must be such that it is possible to see (and to record) that each member, by a process of voting, actively supports the proposition before the meeting or 212

Hickey v Axelford [2003] NSWSC 185 at [26].

213

Re Keneally (2015) 107 ACSR 172 at [62]. In that case the convenors sought to justify the short notice on the basis of their departure overseas on the following day. However, the unreasonableness of notice was “emphasised” by the fact that the convenors’ discussions with the administrator had been going on for over a month; further, there was no evidence of any immediate financial demands against the company. Petsch v Kennedy [1971] 1 NSWLR 494; Spicer v Mytrent Pty Ltd (1984) 8 ACLR 711 at 720. Aqua-Max Pty Ltd v MT Associates Pty Ltd (2001) 3 VR 473, citing Commercial Bank of Australia Ltd v Amadio (1983) 151 CLR 447 and Garcia v National Australia Bank Ltd (1998) 194 CLR 395 as instances of equitable intervention albeit involving contracts or dispositions of property. The court did not express a final opinion on the availability of equitable relief since the question had not been argued before it – it was raised by the appeal court itself – and since it found that the holding of the meeting in the circumstances were grounds for giving the ambushed director the relief sought against oppressive conduct under Pt 2F.1: see [8.180]. Compagnie de Mayville v Whitley [1896] 1 Ch 788. In this respect there is an important contrast between directors’ and shareholders’ meetings since exacting standards of clarity and candour apply to the framing of notices summoning shareholders: see [6.90] et seq.

214 215

216

[5.275]

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actively opposes that proposition; or that the member refrains from both support and opposition. And it is the responsibility of an individual member to take steps to ensure that his or her will is expressed in one of those ways. 217

Advances in communications technology have forced the abandoning of constitutional provisions requiring physical presence at directors’ meetings. A directors’ meeting may be held using any technology agreed to by directors: s 248D. The rule does not, however, displace the requirement of personal participation inherent in the notion of a meeting; accordingly, the section does not overcome the prohibition upon directors voting by proxy. Where, however, directors are in personal communication through some agreed technology, the meeting requirement will be satisfied. In Gillfillan v ASIC Barrett JA said: The statutory permission [in s 248D] for a meeting of directors to be “held” by means of agreed technology entails, as a bare minimum, a requirement that each participating director can, for the duration of the meeting, hear and be heard by every other participating director – or, as it was put by Branson J in Re GIGA Investments Pty Ltd, is “able to be aware of the contributions to the meeting made by each other director and to contribute himself or herself to the meeting without significant impediment”. But more may be required in a given case. For example, where the directors discuss the content of a particular document in the course of the meeting and that document is not already in the possession of every director entitled to participate, the agreed technology by means of which the meeting is “held” must enable each participating director to see the document’s content at the relevant point during the meeting. In the same way, if a document is to be “tabled” at a meeting of directors …, the agreed technology must be such as to allow the full content of the document to be placed before every participating director. Other aspects of a particular meeting’s agenda may, in the same way, dictate attributes of permissible technology. 218

Despite the rule, it appears that a series of separate telephone conversations will be insufficient for a directors’ meeting although the position would be different if directors agree to meet simultaneously in a telephone conference. 219 In small companies all of the directors may be assembled together independently of any summons to attend a directors’ meeting. Indeed, in family companies in which spouses are the only directors, domestic and corporate business may not be easily disentangled. When will such casual exchanges enjoy the status of a directors’ meeting? While directors may agree to meet under any circumstances of their choosing, a casual meeting of both directors of a company cannot be converted into a directors’ meeting at the option of one director only. 220 A discussion between them on company affairs will not be effective as a directors’ meeting unless both are aware, before purporting to proceed to business, that the occasion is to be a directors’ meeting; 221 stated another way, “there must be at least an intention that the occasion be a directors’ meeting and an awareness by the persons present that they are concurring, in their capacity as directors, in the management of the affairs of the company”. 222 Where the only two directors of a company are married to each other, it has been held that any 217

(2013) 92 ACSR 460 at [8]-[11].

218

(2013) 92 ACSR 460 at [15].

219

Re GIGA Investments Pty Ltd (in admin) (1995) 17 ACSR 472 (directors may meet by video link or telephone conference; what is essential is awareness by each director of the contribution of their fellows and the capacity of each to contribute to the meeting).

220

Barron v Potter [1914] 1 Ch 895.

221

Petsch v Kennedy (1971) CLC 40-015 at 27,191-193.

222

Poliwka v Heven Holdings Pty Ltd (No 2) (1992) 8 ACSR 747 at 761, affirmed at 761-762 per Rowland J, 775-777 per Franklyn J and 785-786 per Ipp J.

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event, even most fleeting, in which the directors concur in taking some course of action in the company’s affairs can be described as a directors’ meeting. 223 Directors may delegate their powers to a committee consisting of such of their number as they think fit: s 198D. By delegating powers to a committee, directors neither denude themselves of the right to exercise the power nor divest themselves of responsibility for its exercise. 224 Directors may have rights to prevent their exclusion by fellow directors from participating in board decisions. In Hayes v Bristol Plant Hire Ltd 225 a director had no shares in the company and his only rights to remuneration were under a constitutional provision which permitted the general meeting to pay such remuneration as it should determine from time to time. This entitlement was held to be a sufficient proprietary interest to found an injunction restraining the director’s exclusion from board participation. The basis for this decision appears in Pulbrook’s case [5.280].

Pulbrook v Richmond Consolidated Mining Co [5.280] Pulbrook v Richmond Consolidated Mining Co (1878) 9 Ch D 610 Chancery Division [Pulbrook was elected director of the defendant company. Prior to his election he executed a transfer of his shares in the company by way of mortgage security registrable only upon his default under the loan. In error, the mortgagee had the transfer registered and, although Pulbrook obtained a court order for rectification of the register, his fellow directors refused to recognise him as a director. He sought an injunction restraining the directors from interfering with his acting as a director.] JESSEL MR: [612] The first question is, whether a director who is improperly and without cause excluded by his brother directors from the board from which they claim the right to exclude him, is entitled to an order restraining his brother directors from so excluding him. In this case a man is necessarily a shareholder in order to be a director, and as a director he is entitled to fees and remuneration for his services, and it might be a question whether he would be entitled to the fees if he did not attend meetings of the board. He has been excluded. Now, it appears to me that this is an individual wrong, or a wrong that has been done to an individual. It is a deprivation of his legal rights for which the directors are personally and individually liable. He has a right by the constitution of the company to take a part in its management, to be present, and to vote at the meetings of the board of directors. He has a perfect right to know what is going on at these meetings. It may affect his individual interest as a shareholder as well as his liability as a director, because it has been sometimes held that even a director who does not attend board meetings is bound to know what is done in his absence. [613] Besides that, he is in the position of a shareholder, of a managing partner in the affairs of the company, and he has a right to remain managing partner, and to receive remuneration for his services. It appears to me that for the injury or wrong done to him by preventing him from attending board meetings by force, he has a right to sue. He has what is commonly called a right of action, and those decisions which say that, where a wrong is done to the company by the exclusion of a director from board meetings, the company may sue and must sue for that wrong, do not apply to the case of wrong done simply to an individual. There may be cases where, by preventing a director from exercising his functions in addition to its being a wrong done to the individual, a wrong is also done to the company, and there the company have a right to complain. But in a case of an individual wrong, another shareholder cannot on behalf of himself and others, not being the individuals to whom the wrong is done, maintain an action for that wrong. That being so, in my opinion, the plaintiff in this case has a right of action. 223 224

Swiss Screens (Aust) Pty Ltd v Burgess (1987) 11 ACLR 756 at 758; Versteeg v The Queen (1988) 14 ACLR 1 at 14. The Poliwka intention standard must first be satisfied. Huth v Clarke (1890) 25 QBD 391; Horn v Faulder & Co (1908) 99 LT 524.

225

[1957] 1 WLR 499. [5.280]

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Pulbrook v Richmond Consolidated Mining Co cont. In the next place, assuming him to have a right of action, has he a right to restrain his brother directors from acting without him? That must depend on the question whether he is a director properly elected. … [616] It appears to me that Mr Pulbrook is a director, lawfully elected, and that he has not vacated his office. Therefore I think he is entitled to an injunction to restrain the directors as asked.

Minutes of directors’ meetings [5.285] Minutes of proceedings of directors’ meetings must be recorded in a book kept for the

purpose within one month of each meeting and signed by the chair of the meeting or of the next succeeding meeting of directors: s 251A(1). Any such minute is prima facie evidence of the proceeding to which it relates: s 251A(6). The directors’ minute book must be kept at the company’s registered office, its principal place of business or such other place as ASIC approves: s 251A(5). Unlike minutes of shareholder meetings (s 251B), the directors’ minute book is not required by the subsection to be made available for inspection by shareholders, much less to those external to the company. Indeed, even access for former directors for litigation purposes is assured only by statutory right: see [5.300]. One consequence of this secrecy rule is that few glimpses are offered into corporate boardrooms, their dynamics and decision processes. In politics, even Cabinet secrets yield to the 30-year disclosure rule. Validation of irregularities [5.290] Procedural irregularities under the Act need not be fatal; these include irregularities

with a meeting of directors (and other company meetings) such as the absence of a quorum or a defect or insufficiency in the notice convening a meeting. A proceeding under the Act is not invalidated because of a procedural irregularity unless the Court is of the opinion that the irregularity has caused or may cause substantial injustice that cannot be remedied by judicial order and the court declares the proceeding to be invalid: s 1322(2); “[t]he effect of the subsection is automatic validation subject to a court order to the contrary”. 226 Second, company meetings are not invalidated by reason only of the accidental omission to give notice of the meeting (or a director’s non-receipt of the notice) unless the Court declares the proceedings void: s 1322(3). Third, s 1322(4)(a) empowers the Court to make an order declaring that any act, matter or thing purporting to have been done under the Act or in relation to a company is not invalid by reason of any contravention of a provision of the Act or a provision of the constitution of a corporation. The Court may make an order under s 1322(4)(a) if satisfied that one of the three requirements under s 1322(6)(a) has been met and that no substantial injustice has been or is likely to be caused to any person: s 1322(6)(c). 227 The requirements under s 1322(6)(a) (only one of which needs be satisfied) are that the act etc is essentially of a procedural nature, that the party to the contravention acted honestly or that it is just and equitable for the order to be made. In Weinstock v Beck French CJ explained the function and effect of orders under s 1322(4)(a) and the liberality with which the judicial discretion may be exercised: Corporations, in contemporary Australian society, serve the purposes of enterprises, large and small, owned and operated by men and women, some of whom are sophisticated, knowledgeable and well-advised on matters of corporate governance and some, perhaps many, of whom are not. Section 1322(4) and related provisions reflect a long-standing legislative recognition that 226 227

Weinstock v Beck (2013) 93 ACSR 251 at [7] per French CJ. The power was liberally interpreted in Weinstock v Beck (2013) 93 ACSR 251 at [7] per French CJ.

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mistakes will happen in corporate governance and that it is not in the public interest that the validity of decisions made in relation to corporations be unduly vulnerable to innocent errors which may be corrected without substantial injustice to third parties. In accordance with its evident purpose, s 1322(4) is to be construed broadly and applied pragmatically, principally by reference to considerations of substance rather than those of form. The dispensing power conferred on the Court by s 1322(4)(a) is not in the nature of a general absolution for all past errors. It does not authorise the making of an order declaring that an impugned act, matter or thing is valid. It allows a determination by the Court that the act, matter or thing done “is not invalid” by reason of a provision of the Corporations Act or a provision of the constitution of a corporation. The remedy may be sought by a party fearing or suspecting invalidity on such a ground or, as in the present case, to meet a contention of invalidity advanced by another party in adversarial proceedings. The effect of a declaration under the provision is limited to overcoming invalidity flowing from a particular contravention or contraventions. It could not be otherwise. It is only with respect to particular contraventions that the Court can reach the state of satisfaction required by s 1322(6). 228

The Court may make other remedial or exculpatory orders where it considers that no substantial injustice has resulted or is likely to result: s 1322(4)(b)–(d), (5) and (6). 229 Director and shareholder access to corporate information

Shareholder inspection rights [5.295] Shareholders have no common law rights to inspect the books of their company or its

accounting records; there is, however, at common law a privilege of inspection limited to situations where the inspection is necessary with respect to some specific dispute or question and then only to the extent of that necessity. 230 Constitutional provisions based on the former Table A deny individual members inspection rights except with the authorisation of the board or the company in general meeting; such a provision is now contained as a replaceable rule in s 247D. However, since the mid-19th century shareholders have enjoyed statutory rights of access to membership records. A company must keep a register of its shareholders showing the number of shares held by each member: ss 168 – 169. The register is open for inspection free of charge by any member: s 173. Further, the Court may authorise a member to inspect books of the company, or to have another person do so on the member’s behalf, if it is satisfied that the shareholder is acting in good faith and that the inspection is to be made for a proper purpose: s 247A(1). 231 The term “books” is broadly defined to include any record of information, however compiled, recorded or stored: s 9. Orders are within the discretion of the Court as will be the scope of the access granted, that is, the reach of the order to particular books and records. 232 The elements of good faith and proper purpose in s 247A(1) have been interpreted 228

(2013) 93 ACSR 251 at [39]-[40].

229

See Hui Xian Chia and I Ramsay (2015) 33 C&SLJ 389 (exploring whether the increasing number of s 1322 cases reflects increasing complexity of the Act’s requirements). Edman v Ross (1922) 22 SR (NSW) 351 at 358; R v Merchant Tailors’ Company (1831) 2 B & Ad 115; 109 ER 1086 at 1090-1091.

230 231

An application may also be made by a person who is granted leave under s 237 to bring a statutory derivative action on behalf of the company or who has applied, or is eligible to apply, for such leave: s 247A(3) (see [8.100] re statutory derivative actions). This provision extends to former members and current and former officers although the latter are specifically granted more extensive rights under ss 198F and 290: see [5.300].

232

Majestic Resources NL v Caveat Pty Ltd [2004] WASCA 201; the section provides for inspection of “books” of the company, not “the books”. [5.295]

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as a composite phrase so that the good faith requirement is satisfied if the alleged proper purpose is not a mere pretence so that the application is made with honesty and without ulterior motive. 233 The remedy arises in the legal context that recognises a limited role for shareholders in relation to management functions granted to directors; accordingly, where the application relates to a management matter, a conservative approach is taken in the exercise of discretion. 234 The applicant must do more than merely demonstrate that it is dissatisfied with management decisions 235 and must satisfy the Court that it is entitled to inspect books because the information sought relates to matters “[they] ought to be informed of by the company”. 236 Alternatively expressed, the applicant must do more than merely show dissatisfaction or disagreement with management decisions but must show “a case for investigation as regards past or future wrongful or other undesirable conduct”; 237 this requirement, however, merely emphasises the need for an objective basis for intervention. 238 In Mesa Minerals Ltd v Mighty River International Ltd Katzmann J (with whom Siopis and Gilmour JJ agreed) distilled the following general principles governing applications under the section: 1. The stipulation that an application be made in good faith and for a proper purpose is a composite notion rather than two distinct requirements ... That is to say ... : [T]he reference to good faith colours and so reinforces the requirement of proper purpose. Acting in good faith and inspecting for a proper purpose means acting and inspecting for a bona fide proper purpose. It is as if the case was one of hendiadys. 2. Good faith and proper purpose must be proved objectively. 3. “Proper purpose” means a purpose connected with the proper exercise of the rights of a shareholder as shareholder and not, for example, as a litigant in proceedings against the company or as a bidder under a takeover scheme. 4. The onus of proof is on the applicant. 5. An applicant who has a significant holding and who has been a shareholder for “some considerable time” will more easily discharge the onus than one who has recently acquired a token holding. 6. It is not necessary that the applicant show that its interests are different to those of other shareholders. 7. Nor is it necessary that the applicant have sufficient evidence to bring or make out an action; it is enough that the issue raised by the applicant is “substantive and not fanciful”, not “artificial, specious or contrived”. 8. Pursuing a reasonable suspicion of breach of duty is a proper purpose. 9. Provided that the applicant’s primary or dominant purpose is a proper one, it is not to the point that an inspection might benefit the applicant for some other purpose. 233

Knightswood Nominees Pty Ltd v Sherwin Pastoral Co Ltd (1989) 15 ACLR 151; Barrack Mines Ltd v Grants Patch Mining Ltd (No 2) [1988] 1 Qd R 606 at 614

234

Rowland v Meudon Pty Ltd (2008) 66 ACSR 83 at [41]. The management dimension is not, however, fatal: in Rowland’s case the application was granted where the board’s decision had resulted in a considerable and continuing financial impost on the applicant whose requests for an explanation of its basis had consistently been rebuffed. In that case the company was not a trading company but the company title vehicle for distribution of ownership interests in the apartment building in which the applicant resided as owner.

235 236 237

Re Augold NL [1987] 2 Qd R 297 at 308. Czerwinski v Syrena Royal Pty Ltd (No 1) (2000) 34 ACSR 245 at 248. Intercapital Holdings Ltd v MEH Ltd (1988) 13 ACLR 595.

238

Praetorin Pty Ltd v TZ Ltd (2009) 76 ACSR 236 at [40].

312

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10. Applicants do not necessarily lack a proper purpose merely because they are hostile to other directors. 11. Neither the fact that an applicant may have had sufficient information earlier nor the fact that an applicant may have other means of obtaining the information is detrimental to an application under the section. 12. The procedure under s 247A is not intended to be as wide-ranging as discovery so that the general rule is that inspection will be limited to such documents as evidence the results of board decisions, rather than all board papers leading to decisions, but there may be occasions when it is proper to permit inspection of board papers. 13. The court has a residual discretion whether to order inspection. 239

Especially since the remedy is discretionary, the order made depends largely upon the particular facts established in the application. Applications will fail where their purpose is to assess the value of the applicant’s shares in a listed company and would give access to price-sensitive information not generally available to other shareholders. 240 On the other hand, an application need not fail because it is made for the purpose of assessing whether it is legally and economically viable for the applicant to commence litigation 241 or where it was brought by a director whose primary purpose was the lobbying of proxy holders to vote for his re-election; in the latter case, the judge made the order “where [the] shareholder reasonably takes the view that a transaction could adversely affect his investment and he seeks to investigate the transaction for the purpose of determining what action he should take.” 242 Applications succeeded where the company failed to pay a dividend, prepare financial reports or respond to the applicant’s inquiries about these matters and unauthorised related party transactions, 243 and failed to respond to the applicant’s requests for information after the sudden decline of the company’s financial position and its management’s decision not to report on revenue, earnings or forecasts in the same manner as previously. 244 Applications will fail if made to overcome a claim for legal professional privilege 245 or as a substitute for inspection of documents on affidavit or answers to interrogatories. 246 If the Court makes an order under s 247A, it may make an ancillary order limiting the use that a person who inspects books may make of information obtained during the inspection: s 247B. The fact that inspection may incidentally aid a second purpose that would not be proper, or an improper use of the information, is not itself a reason to impose a restriction on use; such a restriction may also be difficult to implement in some circumstances. 247

Directors’ rights of access to financial records and other information [5.300] The position of directors is somewhat different with respect to access to corporate

information. 248 Directors have a right of access to the financial records of their company at all reasonable times: s 290(1). (The term “financial records” is also broadly defined in s 9 to include documents of prime entry such as invoices, receipts, cheques etc.) On the application 239

(2016) 111 ACSR 289 at [22]. The authorities cited have been omitted.

240 241

Praetorin Pty Ltd v TZ Ltd (2009) 76 ACSR 236;[2009] NSWSC 1237 at [81]. London City Equities Ltd v Penrice Soda Holdings Ltd (2011) 84 ACSR 573.

242 243 244

Re Jervois Mining Ltd; Campbell v Jervois Mining Ltd [2009] FCA 316 at [55]. Yara Australia Pty Ltd v Burrup Holdings Ltd (2010) 80 ACSR 641; see also Coates v Classic Minerals Ltd [2016] WASC 371. Re Style Ltd; Merim Pty Ltd v Style Ltd (2009) 255 ALR 63.

245 246 247

As in Czerwinski v Syrena Royal Pty Ltd (No 1) (2000) 34 ACSR 245 at 248. Re Claremont Petroleum NL (No 2) [1990] 2 Qd R 310 at 314. ENT Pty Ltd v Sunraysia Television Ltd (2007) 61 ACSR 626 at [82]-[83].

248

See generally C Mantziaris (2009) 83 ALJ 621. [5.300]

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of a director, the Court may authorise a person to inspect financial records on the director’s behalf: s 290(2). A company resisting such an application must show very good reason why it should not be made, 249 for example, because the director is seeking access to “abuse the confidence reposed in him and materially … injure the company” 250, “to act in breach of his fiduciary duty to the company” 251 or where there is “clear proof that a misuse of power is involved (the onus of which lies on those asserting it)”. 252 Section 290 protects a director’s access to the financial records of their company but not to other information held by the company. The statutory right is reflective of the common law right but narrower in its scope. At common law directors have a personal right of access to all company information necessary for the proper performance of their office, and not just access to financial records. The common law right is exercisable only for the purposes of the company and not for private or personal reasons. 253 However, the fact that a director is being sued by the company will not, of itself, justify denial of access. 254 The New Zealand decision in Berlei Hestia (NZ) Ltd v Fernyhough illustrates the operation of the discretionary remedy in s 290. 255 An Australian company owned 40% of a New Zealand company. The two companies manufactured similar products. The constitution of the New Zealand company authorised the Australian company to appoint persons as directors of the New Zealand company. The arrangement worked satisfactorily until the board of the New Zealand company decided to export its products to Australia, thus bringing it into direct competition with its Australian shareholder. Considering the Australian company to be its business rival, the New Zealand board excluded the three Australian nominee directors from management participation. The Australian company took proceedings to obtain access to board meetings and company records, accounts and premises. Mahon J thought that the counterpart provision to s 290(2) clearly created a statutory right of inspection. This right was unqualified although “where it is proved that a director is acting or is about to act in breach of his fiduciary duty to the company and intends to aid that process by inspecting the books, then his right to inspection disappears”. 256 This interpretation was approved by the Federal Court in Re Tai-Ao Aluminium (Aust) Pty Ltd. 257 However, since the company’s constitution permitted the directors to remove the applicant as a director and they had indicated their intention to do so, the court refused the order as the director had no further need for access to the information whatever the legitimacy of his reasons for access. (The restriction in s 203E upon directors’ removal of fellow directors did not apply since the company was a proprietary company.) Since the director’s right of access terminates with removal or retirement from office, the position of former directors is fraught. 258 The need to extend personal protection to former directors became evident in litigation arising from the failure of the State Bank of South 249

Re Funerals of Distinction Pty Ltd [1963] NSWR 614 at 615.

250 251 252

Edman v Ross (1922) 22 SR (NSW) 351 at 361. Berlei Hestia (NZ) Ltd v Fernyhough [1980] 2 NZLR 150 at 163. Re Geneva Finance Ltd; Quigley v Cook (1992) 7 ACSR 415 at 426.

253 254

State of South Australia v Barrett (1995) 13 ACLC 1369 at 1372, 1376. McDougall v On Q Group Ltd (2007) 25 ACLC 910; the case concerned an application under s 290(2) where the director expressed concerns about the integrity of the company’s accounts.

255 256

[1980] 2 NZLR 150. [1980] 2 NZLR 150 at 163. Mahon J added that the right was more accurately categorised as a power to inspect corporate records as and when necessary, defeasible if exercised for a corrupt purpose such as would engage the doctrine of fraud upon a power: see Ngurli Ltd v McCann (1953) 90 CLR 425 at 438; see [7.270]. (2004) 51 ACSR 465 at [2].

257 258

Connor v South Queensland Broadcasting Holdings Pty Ltd (1976) 1 ACLR 355; Conway v Petronius Clothing Company Ltd [1978] 1 All ER 185 at 201.

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Australia in the mid-1990s which revealed their limited rights of access to board papers and other key corporate records. 259 The Act was accordingly amended in 2000 to allow current and former directors (at least within seven years of termination of office) to inspect the books of a company at all reasonable times for the purpose of actual or apprehended legal proceedings to which they are or may be a party: s 198F(1), (2). Former directors are also given access to the company’s financial records since s 290 does not extend to them: s 198F(1), (2). Copies may be taken of the company’s books for the purpose of the proceedings: s 198F(3), (4). However, the right under s 198F is available, in relation to proceedings commenced by directors, only to those actions which directors bring in their own name and interest, and not those brought on behalf of the company under Pt 2F.1A since inspection rights for such derivative proceedings are granted by s 247A. 260

Molomby v Whitehead [5.305] Molomby v Whitehead (1985) 63 ALR 282 Federal Court of Australia [The applicant, Molomby, was a director of the Australian Broadcasting Corporation and the respondent, Whitehead, was its managing director. Molomby sought access to various documents held by the Corporation to which he had been denied access by Whitehead. He argued that Whitehead’s decision to refuse him access to the documents was a decision of an administrative character under the Corporations Act 2001 which was reviewable under the Administrative Decisions (Judicial Review) Act 1977 (Cth) on the ground of an error of law. Alternatively, he claimed to be entitled to inspect the documents under the general law by virtue of his office as a director of the Corporation. The court held that Whitehead’s decision fell within the definition of decision in s 3(1) of the Judicial Review Act, making it amenable to review under the Act.] BEAUMONT J: [292] The right or power of a director of a company or corporation to inspect to advance the interests of the company or corporation is well recognised. [Several authorities were cited.] These authorities indicate that there are some exceptions to the general rule. For instance, as arose in Birmingham City District Council v O [1983] AC 578, it may be necessary for a director of a corporation or a councillor of a council who is not a member of a committee dealing with a particular matter to show “good reason” for access – a “need to know”. As Lord Brightman put it (at 594): In the case of a committee of which he is a member, a councillor as a general rule will ex hypothesi have good reason for access to all written material of such committee. So I do not doubt that each member of the social services committee is entitled by virtue of his office to see all the papers which have come into the possession of a social worker in the course of his duties as an employee of the council. There is no room for any secrecy as between a social worker and a member of the social services committee. In the case of a committee of which the councillor is not a member, different considerations must apply. The outside councillor, as I will call him, has no automatic right of access to documentary material. Of him, it cannot be said that he necessarily has good reason, and is necessarily entitled, to inspect all written material in the possession of the council and every committee and the officers thereof. What Donaldson LJ described as a “need to know” must be demonstrated. The complication of a division of the council or board into subcommittees which was central to the debate in the Birmingham case does not arise here: it is not suggested that the matters raised by Mr Molomby fall within the jurisdiction of a committee of the board. It follows that Molomby is not required to demonstrate any particular “need to know” to justify his claim to access. On the contrary, to borrow the language of Lord Brightman, Molomby was entitled to access “by virtue of his office” – “ex hypothesi [he had] good reason for access”. 259 260

State Bank of South Australia v Barrett (1995) 13 ACLC 1369; Kriewaldt v Independent Direction Ltd (1995) 14 ACLC 73. Stewart v Normandy NFM Ltd (2000) 18 ACLC 814. [5.305]

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Molomby v Whitehead cont. Another class of case where the prima facie entitlement of a director to sight corporate material has been displaced is where there is evidence that the director seeks to inspect, not in aid of the proper execution of his fiduciary obligations but, to the contrary, with a view to the apprehended detriment of the corporation. [Several cases] are examples of the exercise of a judicial discretion denying the ordinary right of a director to inspect where the evidence disclosed an ulterior purpose. No such case has been sought to be made here against Mr Molomby. Rather, it was put on behalf of the respondents that the application for review should fail because, on the face of the correspondence, Molomby has failed to show a good reason why access should be granted. In my [293] opinion, if it were necessary, the correspondence does indicate a “need to know”, a matter to which I will return later. But, in any event, in the present circumstances, the authorities cited make it clear that no initial burden of proof rests upon Molomby to show any particular reason for, or utility in, the grant of access. This will ordinarily be assumed. The general position with respect to the onus of proof in this area was described by Street CJ in Eq in Edman v Ross (1922) 22 SR (NSW) 351 in this way (at 361): The right to inspect documents, and, if necessary, to take copies of them is essential to the proper performance of a director’s duties and, though I am not prepared to say that the court might not restrain him in the exercise of this right if satisfied affirmatively that his intention was to abuse the confidence reposed in him and materially to injure the company, it is true, nevertheless, that its exercise is, generally speaking, not a matter of discretion with the court and that he cannot be called upon to furnish his reasons before being allowed to exercise it. In the absence of clear proof to the contrary the court must assume that he will exercise it for the benefit of his company. Slade J in Conway v Petronius Clothing Co Ltd [1978] 1 WLR 72 after citing Street CJ in Eq, said (at 90): “The passage seems to me, if I may say so, consistent with both principle and common sense. If the position were otherwise, a director’s rights of inspection could be rendered more or less nugatory, at least for many months, by specious allegations that he was exercising them with intent to injure the company or for other improper motives.” In my opinion, in refusing or at least deferring access to Mr Molomby, Mr Whitehead wrongly assumed the role of the arbiter of Molomby’s right, as a legal incident of his directorship, to inspect documents held by the Corporation which on their face were relevant to the affairs and management of the Corporation. Since it was a matter of legal right vested in Molomby, such access did not lie within the gift of Whitehead. It follows, in my opinion, that his decision to withhold inspection was vitiated by an error of law. … [S]uch an error is a ground for review for the purposes of the Judicial Review Act: see s 5(1)(f). … [295] Finally, it was argued on behalf of the respondents that the claim for relief should be denied because these are matters for the board, as a whole, to decide. This is not so. A director’s right to inspect corporate material is a legal right which in no sense depends upon the views of the board. Access may be denied for good cause … but that apart, the board is no more able to act as the arbiter of a director’s rights in this regard than is the Corporation’s managing director. In my opinion, given Molomby’s good faith and his apparent need to know, as a director of the Corporation, the matters he raises in his correspondence, no basis exists for withholding from him relief under the Judicial Review Act on discretionary grounds. I propose to grant that relief.

THE AUTHORITY OF CORPORATE AGENTS TO BIND THE COMPANY Problems facing those who deal with companies [5.310] Since the company is an abstraction it may enter into commitments only through the

mediation of natural persons – its organs, the directors or general meeting, acting within 316

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power, or through agents duly appointed. Where an organ contracts in the name of the company, its act is the act of the company itself which contracts directly by its organ. The position is different, however, when the company contracts through an agent whose act is an act for, but not of, the company: see at [5.95]. The Act, in s 126, permits persons acting under the express or implied authority of a company to contract in the name or on behalf of the company in the same manner as if that contract were made by a natural person. Notwithstanding the ease with which a company may enter into contracts, those seeking to contract with a company (such a person is here called “the contractor”) face considerable difficulties in satisfying themselves as to the authority of the organ or agent who professes to contract on behalf of the company. Where the contractor deals with the board, how may they be sure that those persons purporting to act as directors have been properly appointed, that the quorum requirements for their meeting to resolve upon the contract have been satisfied, that the contract (if under seal) has been properly sealed and that the board is acting within power? If dealing with an agent, how may the contractor satisfy herself that the professing agent has been authorised to act on behalf of the company by an organ which is itself properly appointed and acting within power? These (and related) difficulties are addressed by: (a) the doctrine of actual authority; (b) the doctrine of ostensible authority; (c) the indoor management rule; and (d) ss 128 – 129 of the Act. Each of these doctrines or provisions provides a foundation for corporate liability for acts of those professing to act on its behalf and corresponding protection for the contractor. They strike a balance between the competing claims of two parties, the company and contractor, with respect to the loss from a transaction for which the professing agent may be the only unambiguously guilty party. Generally, the protection or authority provided under each of the four bodies of rules is cumulative so that, for example, the absence of one species of authority will not preclude recovery upon another ground. Further, the statutory provisions build upon general law agency doctrines and the indoor management rule (see [5.340]) although with modifications which ensure a somewhat different scheme of officer authority. The statutory scheme does not, however, supplant general law doctrines but provides a complementary body of agency authority. In time, this statutory scheme may obviate much direct recourse to the general law and therefore diminish the significance of rules defining the precise contours of those doctrines. It would be premature to ignore those doctrines, however, not least because they provide the foundations for and much of the material with which the statutory scheme has been created. The four bodies of rules are examined in turn. Actual authority [5.315] The primary source of authority of company officers, as of agents generally, is their

actual authority. Such authority may be express or arise by implication from, for example, appointment to a particular corporate office such as that of managing director, secretary or sales manager. The implied actual authority deriving from appointment to a corporate office may be diminished or even negated by express limitations. Conversely, the implied authority of office may be expanded by express grant or, as in Hely-Hutchinson v Brayhead Ltd [5.325], by the conduct of the parties to the agency. The following extracts examine the elements of actual authority and the principles conditioning its implication. As to the implied actual authority flowing from appointment as a director, see also Northside Developments Pty Ltd v Registrar-General [5.355] at 205.

[5.315]

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Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [5.320] Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480 Court of Appeal, England and Wales [The facts of this case are outlined in the further extract at [5.330] from the judgment of Diplock LJ. They are unnecessary for present purposes.] DIPLOCK LJ: [502] It is necessary at the outset to distinguish between an “actual” authority of an agent on the one hand, and an “apparent” or “ostensible” authority on the other. Actual authority and apparent authority are quite independent of one another. Generally they co-exist and coincide, but either may exist without the other and their respective scopes may be different. As I shall endeavour to show, it is upon the apparent authority of the agent that the contractor normally relies in the ordinary course of business when entering into contracts. An “actual” authority is a legal relationship between principal and agent created by a consensual agreement to which they alone are parties. Its scope is to be ascertained by applying ordinary principles of construction of contracts, including any proper implications from the express words used, the usages of the trade, or the course of business between the parties. To this agreement the contractor is a stranger; he may be totally ignorant of the existence of any authority on the part of the agent. Nevertheless, if the agent does enter into a contract pursuant to the [503] “actual” authority, it does create contractual rights and liabilities between the principal and the contractor. … In ordinary business dealings the contractor at the time of entering into the contract can in the nature of things hardly ever rely on the “actual” authority of the agent. His information as to the authority must be derived either from the principal or from the agent or from both, for they alone know what the agent’s actual authority is. All that the contractor can know is what they tell him, which may or may not be true. In the ultimate analysis he relies either upon the representation of the principal, that is, apparent authority, or upon the representation of the agent, that is, warranty of authority.

Hely-Hutchinson v Brayhead Ltd [5.325] Hely-Hutchinson v Brayhead Ltd [1968] 1 QB 549 Court of Appeal, England and Wales [Suirdale was chair and managing director of Perdio and held substantial equity in the company. In 1964, when Perdio was seeking financial assistance, another electronics company, Brayhead, acquired shares in Perdio and injected funds into it. Suirdale joined the board of Brayhead. In the following year Richards, the chair of Brayhead, urged Suirdale to put more money into Perdio and he agreed to do so on condition (1) that Brayhead indemnify him from liability on a guarantee he had given of Perdio’s indebtedness to another lender; and (2) that Brayhead guarantee repayment of moneys which Suirdale should lend to Perdio. The indemnity and guarantee were given in letters signed on Brayhead’s behalf by Richards as chair. They were not given pursuant to a board resolution. Perdio went into liquidation and Suirdale claimed upon the indemnity and the guarantee. Brayhead denied liability, alleging that Richards had no authority to write the letters and that Suirdale, being himself a director of Brayhead, had notice of that want of authority.] LORD DENNING MR: [583] [A]ctual authority may be express or implied. It is express when it is given by express words, such as when a board of directors pass a resolution which authorises two of their number to sign cheques. It is implied when it is inferred from the conduct of the parties and the circumstances of the case, such as when the board of directors appoint one of their number to be managing director. They thereby impliedly authorise him to do all such things as fall within the usual scope of that office. Actual authority, express or implied, is binding as between the company and the agent, and also as between the company and others, whether they are within the company or outside it. … [584] It is plain that Mr Richards had no express authority to enter into these two contracts on behalf of the company: nor had he any such authority implied from the nature of his office. He had been duly appointed chairman of the company but that office in itself did not carry with it authority to enter into 318

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Hely-Hutchinson v Brayhead Ltd cont. these contracts without the sanction of the board. But I think he had authority implied from the conduct of the parties and circumstances of the case. The judge did not rest his decision on implied authority, but I think his findings necessarily carry that consequence. The judge finds that Mr Richards acted as de facto managing director of Brayhead. He was the chief executive who made the final decision on any matter concerning finance. He often committed Brayhead to contracts without the knowledge of the board and reported the matter afterwards. The judge said: I have no doubt that Mr Richards was, by virtue of his position as de facto managing director of Brayhead or, as perhaps one might more compendiously put it, as Brayhead’s chief executive, the man who had, in Diplock LJ’s words, “actual authority to manage”, and he was acting as such when he signed those two documents. And later he said: the board of Brayhead knew of and acquiesced in Mr Richards acting as de facto managing director of Brayhead. The judge held that Mr Richards had ostensible or apparent authority to make the contract, but I think his findings carry with it the necessary inference that he had also actual authority, such authority being implied from the circumstance that the board by their conduct over many months had acquiesced in his acting as their chief executive and committing Brayhead Ltd to contracts without the necessity of sanction from the board. [Lord Wilberforce and Lord Pearson agreed with the Master of the Rolls.]

Smith v Butler [5.327] Smith v Butler [2012] EWCA Civ 314 Court of Appeal, England and Wales [Butler was managing director of the company and Smith its chairman. Butler owned 31% of its shares and Smith the balance of 69%. In reliance on his authority as managing director, Butler informed Smith that he was suspended from his office as chairman and excluded him from company premises. Butler did not have the authority of a board resolution for this action which was prompted by information suggesting that Smith had misused a company credit card over a seven year period in the sum of £78,000. Butler said he feared that, if he raised that matter with the board before taking action, Smith would have prevented any independent investigation by intimidating staff or witnesses and by destroying evidence. The primary issue on appeal was whether Butler’s powers as a managing director entitled him to act as he did.] LADY JUSTICE ARDEN: [15] We are not in this case concerned with the more usual question whether a third party dealing with a managing director is entitled to assume that he has power to do what he did. As Lindley LJ held in Biggerstaff v Rowatt’s Wharf [1896] 2 Ch 93 at 102, a person dealing with a managing director must see whether according to the constitution of the company a director could have the powers which that director is purporting to exercise. This appeal, however, is concerned with the question of what powers the managing director actually had. There is surprisingly little authority on that point. The powers of a managing director are not, of course, statutorily defined. The parties could have defined Mr Butler’s powers when he was appointed. However, they did not do so. In Hely-Hutchinson v Brayhead [1968] 1 QB 549 at 560, Roskill J, whose decision was affirmed by this court, comprising unusually Lord Denning MR, Lord Wilberforce and Lord Pearson, went so far as to state that the question of the implied authority of a managing director was one of “considerable difficulty”, as well as being “one upon which there appears to be little or no relevant authority”. … [25] The power to appoint a managing director is contained in regulation 72 in the 1985 Table A [adopted as the company’s constitution]. This enables the board of directors to appoint a managing director and to delegate any of their powers to the managing director. Moreover, that delegation may exclude the directors’ own powers on a particular matter. Regulation 72 provides in material part: [5.327]

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Smith v Butler cont. The directors may delegate …. to any managing director or any director holding any other executive office such of their powers as they consider desirable to be exercised by him. Any such delegation may be made subject to any conditions the directors may impose, and either collaterally with or to the exclusion of their own powers and may be revoked or altered… … [27] In this case, however, there is no express delegation of any specific powers by the board to Mr Butler. Mr Butler simply has a contract of employment appointing him as a managing director. This factual scenario is one that is likely to arise in many cases. On the other hand, it was clearly intended that some powers should be implicitly delegated to him. It would, however, be unusual for the powers of the board to be excluded. In those circumstances, the implied delegation of powers to Mr Butler cannot be interpreted as having that effect. [28] … [I]n principle, the implied powers of a managing director are those that would ordinarily be exercisable by a managing director in his position. … Another way of putting that point is that the managing director’s powers extend to carrying out those functions on which he did not need to obtain the specific directions of the board. This is simply the default position. It is, therefore, subject to the company’s articles and anything that the parties have expressly agreed. In essence, the issue is one of interpreting the contract of appointment or employment in the light of all the relevant background, and asking what that contract would reasonably be understood to have meant (Attorney General of Belize v Belize Telecom Ltd [2009] 1 WLR 1485, PC, and see my judgment in Stena Line v Merchant Navy Ratings Pension Fund Trustees Ltd [2010] EWCA Civ 543 at 36-41). [29] On this basis, as might be expected, the test of what is within the implied actual authority of a managing director coincides with the test of what is within the ostensible authority of a managing director: see Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480. [30] The holder of the office of managing director might today more usually be called a chief executive officer in (at least) a public company. He or she has generally to work on the basis that his appointment does not supplant that of the role of the board and that he will have to refer back to the board for authority on matters on which the board has not clearly laid out the company’s strategy. He or she would thus be expected to work within the strategy the board had actually set. [31] In this case, however, it was clear that the strategy of the board was that Mr Smith should be executive chairman. Therefore, his suspension was clearly a matter for the board, and not for Mr Butler acting alone. To my mind it is inconceivable that Mr Butler did not need the instructions of the board on the question of the suspension of the chairman of the board. … [36] … The managing director has certain powers by implication from his office. Even in a small company those powers will often include power to commence proceedings unless the board has expressly or by implication decided that such proceedings should not be taken or would be likely not to ratify the commencement of proceedings. [Rimer and Ryder LJJ agreed with Arden LJ although the former said that he “should prefer not to express any general view as to a managing director’s implied authority (if any) to commence or defend legal proceedings on behalf of the company of which he is such a director” (at [58]).]

Ostensible authority

Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [5.330] Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 480 Court of Appeal, England and Wales [Kapoor was a property developer who commonly used companies as vehicles for his developments. He operated a number of projects out of one office. In 1958 he personally entered into a contract to purchase the Buckhurst Park Estate for £75,000. Not being able to finance the purchase out of his own resources, he agreed with Hoon to form the defendant company with a nominal capital of £70,000 for 320

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Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd cont. which Kapoor and Hoon were to subscribe in equal shares. Kapoor and Hoon were to be directors together with a nominee of each. The nominee directors were a clerk employed by Kapoor’s solicitors and a clerk employed by Hoon’s solicitors. The quorum for a directors’ meeting was four. Hoon went abroad even before the incorporation of the company and was out of the country at all material times thereafter, except for a short period in 1959. In fact, despite the formal arrangements, the parties regarded the transaction as a loan by Hoon to Kapoor, it not being expected that Hoon would take a significant part in management. Kapoor was hoping (as it turned out unsuccessfully) for a quick sale and distribution of proceeds. After incorporation of the company, the Buckhurst Park Estate was conveyed to it. Several meetings of the directors other than Hoon were held which purported to be meetings of the board. In August 1959, Kapoor instructed the plaintiffs, a firm of architects, to assist professionally in the development of the Buckhurst Park Estate. At that time Hoon was in the country but he was not apparently consulted and there was no minute of any board resolution authorising the employment of the plaintiffs. In the ensuing period the plaintiffs were in constant communication with Kapoor in relation to the work done. On the face of it they were acting for Kapoor personally. However, the trial judge specifically accepted the evidence of Freeman, a partner in the plaintiff firm, that he was instructed by Kapoor on behalf of the defendant company. The question which arose was whether, accepting the fact that Kapoor contracted with the plaintiffs in the defendant company’s name, the latter was bound by his act. The plaintiff contended: (1) that on the true inference from all the facts Kapoor had actual authority to engage the plaintiffs on behalf of the defendant company; and (2) in the alternative, that Kapoor was held out by the defendant company as having ostensible authority, estopping it from denying responsibility for his acts.] DIPLOCK LJ: [His Lordship held that there was inadequate material to justify the court in concluding as a matter of fact that actual authority to employ agents had been conferred by the defendant company’s board on Kapoor.] [502] This makes it necessary to inquire into the state of the law as to the ostensible authority of officers and servants to enter into contracts on behalf of corporations. … We are concerned in the present case with the authority of an agent to create contractual rights and liabilities between his principal and a third party whom I will call “the contractor”. This branch of the law has developed pragmatically rather than logically owing to the early history of the action of assumpsit and the consequent absence of a general jus quaesitum tertii in English law. But it is possible (and for the determination of this appeal I think it is desirable) to restate it upon a rational basis. [503] An “apparent” or “ostensible” authority … is a legal relationship between the principal and the contractor created by a representation, made by the principal to the contractor, intended to be and in fact acted upon by the contractor, that the agent has authority to enter on behalf of the principal into a contract of a kind within the scope of the “apparent” authority, so as to render the principal liable to perform any obligations imposed upon him by such contract. To the relationship so created the agent is a stranger. He need not be (although he generally is) aware of the existence of the representation but he must not purport to make the agreement as principal himself. The representation, when acted upon by the contractor by entering into a contract with the agent, operates as an estoppel, preventing the principal from asserting that he is not bound by the contract. It is irrelevant whether the agent had actual authority to enter into the contract. … The representation which creates “apparent” authority may take a variety of forms of which the commonest is representation by conduct, that is, by permitting the agent to act in some way in the conduct of the principal’s business with other persons. By so doing the principal represents to anyone who becomes aware that the agent is so acting that the agent has authority to enter on behalf of the principal into contracts with other persons of the [504] kind which an agent so acting in the conduct of his principal’s business has usually “actual” authority to enter into. In applying the law as I have endeavoured to summarise it to the case where the principal is not a natural person, but a fictitious person, namely, a corporation, two further factors arising from the legal characteristics of a corporation have to be borne in mind. The first is that the capacity of a corporation is limited by its constitution, that is, in the case of a company incorporated under the Companies [5.330]

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Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd cont. ActCompanies Act 1908, by its memorandum and articles of association; the second is that a corporation cannot do any act, and that includes making a representation, except through its agent. Under the doctrine of ultra vires the limitation of the capacity of a corporation by its constitution to do any acts is absolute. This affects the rules as to the “apparent” authority of an agent of a corporation in two ways. First, no representation can operate to estop the corporation from denying the authority of the agent to do on behalf of the corporation an act which the corporation is not permitted by its constitution to do itself. Second, since the conferring of actual authority upon an agent is itself an act of the corporation, the capacity to do which is regulated by its constitution, the corporation cannot be estopped from denying that it has conferred upon a particular agent authority to do acts which by its constitution, it is incapable of delegating to that particular agent. To recognise that these are direct consequences of the doctrine of ultra vires is, I think, preferable to saying that a contractor who enters into a contract with a corporation has constructive notice of its constitution, for the expression “constructive notice” tends to disguise that constructive notice is not a positive, but a negative doctrine, like that of estoppel of which it forms a part. It operates to prevent the contractor from saying that he did not know that the constitution of the corporation rendered a particular act or a particular delegation of authority ultra vires the corporation. It does not entitle him to say that he relied upon some unusual provision in the constitution of the corporation if he did not in fact so rely. The second characteristic of a corporation, namely, that unlike a natural person it can only make a representation through an agent, has the consequence that in order to create an estoppel between the corporation and the contractor, the representation as to the authority of the agent which creates his “apparent” authority must be made by some person or persons who have [505] “actual” authority from the corporation to make the representation. Such “actual” authority may be conferred by the constitution of the corporation itself, as, for example, in the case of a company, upon the board of directors, or it may be conferred by those who under its constitution have the powers of management upon some other person to whom the constitution permits them to delegate authority to make representations of this kind. It follows that where the agent upon whose “apparent” authority the contractor relies has no “actual” authority from the corporation to enter into a particular kind of contract with the contractor on behalf of the corporation, the contractor cannot rely upon the agent’s own representation as to his actual authority. He can rely only upon a representation by a person or persons who have actual authority to manage or conduct that part of the business of the corporation to which the contract relates. The commonest form of representation by a principal creating an “apparent” authority of an agent is by conduct, namely, by permitting the agent to act in the management or conduct of the principal’s business. Thus, if in the case of a company the board of directors who have “actual” authority under the memorandum and articles of association to manage the company’s business permit the agent to act in the management or conduct of the company’s business, they thereby represent to all persons dealing with such agent that he has authority to enter on behalf of the corporation into contracts of a kind which an agent authorised to do acts of the kind which he is in fact permitted to do usually enters into in the ordinary course of such business. The making of such a representation is itself an act of management of the company’s business. Prima facie it falls within the “actual” authority of the board of directors, and unless the memorandum or articles of the company either make such a contract ultra vires the company or prohibit the delegation of such authority to the agent, the company is estopped from denying to anyone who has entered into a contract with the agent in reliance upon such “apparent” authority that the agent had authority to contract on behalf of the company. If the foregoing analysis of the relevant law is correct, it can be summarised by stating four conditions which must be fulfilled to entitle a contractor to enforce against a company a contract entered into on behalf of the company by an agent who had no actual authority to do so. It must be shown: [506] (1)

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that a representation that the agent had authority to enter on behalf of the company into a contract of the kind sought to be enforced was made to the contractor; [5.330]

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Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd cont. (2)

that such representation was made by a person or persons who had “actual” authority to manage the business of the company either generally or in respect of those matters to which the contract relates;

(3)

that he (the contractor) was induced by such representation to enter into the contract, that is, that he in fact relied upon it; and

(4)

that under its memorandum or articles of association the company was not deprived of the capacity either to enter into a contract of the kind sought to be enforced or to delegate authority to enter into a contract of that kind to the agent.

The confusion which, I venture to think, has sometimes crept into the cases is in my view due to a failure to distinguish between these four separate conditions, and in particular to keep steadfastly in mind (a) that the only “actual” authority which is relevant is that of the persons making the representation relied upon, and (b) that the memorandum and articles of association of the company are always relevant (whether they are in fact known to the contractor or not) to the questions (i) whether condition (2) is fulfilled, and (ii) whether condition (4) is fulfilled, and (but only if they are in fact known to the contractor) may be relevant (iii) as part of the representation on which the contractor relied. In each of the relevant cases the representation relied upon as creating the “apparent” authority of the agent was by conduct in permitting the agent to act in the management and conduct of part of the business of the company. Except in Mahony v East Holyford Mining Co Ltd [(1875) LR 7 HL 869], it was the conduct of the board of directors in so permitting the agent to act that was relied upon. As they had, in each case, by the articles of association of the company full “actual” authority to manage its business, they had “actual” authority to make representations in connection with the management of its business, including representations as to who were agents authorised to enter into contracts on the company’s behalf. The agent himself had no “actual” authority to enter into the contract because the formalities prescribed by the articles for conferring it upon him had not been complied with [507] … In Mahony’s case no board of directors or secretary had in fact been appointed, and it was the conduct of those who, under the constitution of the company, were entitled to appoint them which was relied upon as a representation that certain persons were directors and secretary. Since they had “actual” authority to appoint these officers, they had “actual” authority to make representations as to who the officers were. … [T]he constitution of the company, whether it had been seen by the contractor or not, was relevant in order to determine whether the persons whose representations by conduct were relied upon as creating the “apparent” authority of the agent had “actual” authority to make the representations on behalf of the company. In Mahony’s case, if the persons in question were not persons who would normally be supposed to have such authority by someone who did not in fact know the constitution of the company, it may well be that the contractor would not succeed in proving condition (3), namely, that he relied upon the representations made by those persons, unless he proved that he did in fact know the constitution of the company. … The cases where the contractor’s claim failed … were all cases where the contract sought to be enforced was not one which a person occupying the position in relation to the company’s business which the contractor knew that the agent occupied would normally be authorised to enter into on behalf of the company. The conduct of the board of directors in permitting the agent to [508] occupy that position, upon which the contractor relied, thus did not of itself amount to a representation that the agent had authority to enter into the contract sought to be enforced, that is, condition (1) was not fulfilled. The contractor, however, in each of these three cases sought to rely upon the provision of the articles giving to the board power to delegate wide authority to the agent as entitling him to treat the conduct of the board as a representation that the agent had had delegated to him wider powers than those usually exercised by persons occupying the position in relation to the company’s business which the agent was in fact permitted by the board to occupy. Since this would involve proving that the representation on which he in fact relied as inducing him to enter into the contract comprised the articles of association of the company as well as the conduct of the board, it would be necessary for him to establish first that he knew the contents of the articles (that is, that condition (3) was fulfilled in respect of any representation contained in the articles) and second that the conduct of the board in [5.330]

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Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd cont. the light of that knowledge would be understood by a reasonable man as a representation that the agent had authority to enter into the contract sought to be enforced, that is that condition (1) was fulfilled. … In the present case the findings of fact by the county court judge are sufficient to satisfy the four conditions, and thus to establish that Kapoor had “apparent” authority to enter into contracts on behalf of the company for their services in connection with the sale of the company’s property, including the obtaining of development permission with respect to its use. The judge found that the board knew that Kapoor had throughout been acting as managing director in employing agents and taking other steps to find a purchaser. They permitted him to do so, and by such conduct represented that he had authority to enter into contracts of a kind which a managing director or an executive director responsible for finding a purchaser would in the normal course be authorised to enter into on behalf of the company. Condition (1) was thus fulfilled. The articles of association conferred full powers of management on the board. Condition (2) was thus fulfilled. The plaintiffs, finding Kapoor acting in relation to the company’s property as he was authorised by the [509] board to act, were induced to believe that he was authorised by the company to enter into contracts on behalf of the company for their services in connection with the sale of the company’s property, including the obtaining of development permission with respect to its use. Condition (3) was thus fulfilled. The articles of association, which contained powers for the board to delegate any of the functions of management to a managing director or to a single director, did not deprive the company of capacity to delegate authority to Kapoor, a director, to enter into contracts of that kind on behalf of the company. Condition (4) was thus fulfilled. [Wilmer and Pearson LJJ concurred in dismissing the appeal.]

Crabtree-Vickers Pty Ltd v Australian Direct Mail Advertising and Addressing Co Pty Ltd [5.335] Crabtree-Vickers Pty Ltd v Australian Direct Mail Advertising and Addressing Co Pty Ltd (1975) 133 CLR 72 High Court of Australia [Crabtree-Vickers sued Australian Direct Mail Advertising (ADMA) for damages for breach of contract arising out of the alleged sale of a printing machine to ADMA. The contract sued on was alleged to be in writing and to consist of ADMA’s printed order form (No 0795) requesting Crabtree-Vickers to supply the machine for the price of $211,000. The order form (which was an acceptance of an earlier written offer made by Crabtree-Vickers) was headed with ADMA’s name and at the bottom bore the printed signature “B McWilliam” followed by the word “per” and a line for written signature. B McWilliam was described on the form as “Public Officer”. The form was filled in and signed after the word “per” by Peter McWilliam. Bruce McWilliam junior was, at all material times, the managing director of ADMA. His father, also named Bruce McWilliam, was chair of directors. Peter McWilliam (brother of Bruce junior) had been a director but had resigned as director following his bankruptcy. The other directors were the wives of Bruce McWilliam senior and Bruce McWilliam junior. Bruce McWilliam senior worked part-time in ADMA’s business and his two sons worked full-time. Each had an office in the company’s premises and their names appeared on a notice board at those premises. Bruce senior was shown as a director, Bruce junior as managing director but Peter was given no specific designation. In the Supreme Court of Victoria, Lush J found that Peter McWilliam had no actual authority to make the contract on behalf of ADMA. He found that actual authority to purchase the machine rested with the board of directors, or at least with the three men of the family, and that no one alone had actual authority to make this decision without the concurrence of the father (which consent had never been given). Lush J also found it “impossible to suppose that a director, not being a chairman or managing director, or an assistant manager or sales manager or a person holding no designated appointment, but acting as one of the three principal executives of the company, could have inherent authority to 324

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Crabtree-Vickers Pty Ltd v Australian Direct Mail Advertising and Addressing Co Pty Ltd cont. purchase a press costing over $200,000”. The primary judge also concluded that Peter did not have the ostensible authority of ADMA to conclude the contract. Crabtree-Vickers appealed.] GIBBS, MASON and JACOBS JJ: [79] Bruce McWilliam junior being the managing director upon whom under the articles all powers of management could be conferred had, undoubtedly in our opinion, ostensible authority to make the contract. If with this ostensible authority he actually authorised Peter McWilliam to make the contract, there would have been an exercise by him of ostensible authority, provided the appellant believed that [80] the authority was being exercised by Bruce through Peter. Therefore, if with the managing director’s actual authority, Peter McWilliam placed the order No 0795, there was weighty evidence upon which the appellant could conclude that Bruce McWilliam junior was exercising his ostensible authority as managing director. The signature of the order is itself very strong evidence. It was signed in the name of Bruce McWilliam junior. However, the finding that Bruce McWilliam junior did not give actual authority to Peter to sign the order in his name prevents a finding that the contract was made on the ostensible authority of the managing director. On the other hand, if the managing director had had actual authority to make the contract then in that position he had authority to hold out Peter McWilliam as having authority to make the contract. He would have had actual authority to manage the business of the company in the relevant respect and actual authority in such a position as managing director to represent that another officer of the company had authority to make the contract. The position of a managing director is not one where persons dealing with the company would regard his power to delegate as limited in respect of a contract to purchase machinery. But the finding of fact is that this particular managing director did not have power to manage the affairs of the respondent generally (because of the limitation on his power) or in respect of the purchase of this machinery. He therefore had no authority to make the representation which would give Peter McWilliam ostensible authority. In other words, a person with no actual, but only ostensible, authority to do an act or to make a representation cannot make a representation which may be relied on as giving a further agent an ostensible authority. Hence the stress by Diplock LJ on the need that the person or persons making the representation must have actual authority to make the representation. Once it was found as a fact that Bruce McWilliam junior had no authority to make the representation that anyone other than the board of directors or the three men in the company had authority to make the contract, the only question was whether the board or those three represented that Peter McWilliam had authority. One of those three was Peter McWilliam himself. He undoubtedly made the representation. The second was Bruce McWilliam junior and there was strong evidence to support a finding that he made the representation. We need refer only to the conversation with Bates and to the supply to Peter McWilliam of a blank order form, thus arming him with a document which, when he signed it, would bear the hallmark of authenticity. But where the appellant fails is in [81] respect of any representation by Bruce McWilliam senior. He did not hold out his two sons as having full executive power, and he made no representation that Peter McWilliam had authority to enter into such a contract or to convey in writing to the appellant a decision of the respondent that it accepted the offer of the appellant or would make an offer capable of acceptance by the appellant. … The appeal therefore fails. It has been submitted that such a conclusion could substantially impair confidence in common business procedures between companies. We do not think that this is so or that the case should be so regarded. The result turns on particular findings of fact. First there was a finding that the managing director did not have full powers of management and second there is the finding that the contract was not made by him or with his actual assent and knowledge. The question then became whether Peter McWilliam, not being the managing director, or being one who could be regarded as having the general management of the company, had been held out by the company as having authority to make a contract of such magnitude and the conclusion upon this was adverse to the vendor. No previous course of dealing either with or known to the appellant support any apparent authority in Peter McWilliam and the size of the contract in relation to the known size and financial condition of the respondent required at least that the appellant deal with the general management of the company. Nevertheless that this should have happened in a company run in effect by a father and his two sons and that the word of one of the sons should be set at naught without it apparently [5.335]

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Crabtree-Vickers Pty Ltd v Australian Direct Mail Advertising and Addressing Co Pty Ltd cont. affecting his place in the business – he was still in his same employment at the time of trial as he had been at the time of these unhappy events almost four years previously – says little for the business ethics of those concerned.

[5.338]

1.

Notes&Questions

In Pacific Carriers Ltd v BNP Paribas (2004) 218 CLR 451, Gleeson CJ, Gummow, Hayne, Callinan and Heydon JJ said (citations mostly omitted): [36] … Where an officer is held out by a company as having authority, and the third party relies on that apparent authority, and there is nothing in the company’s constitution to the contrary, the company is bound by its representation of authority. “The representation, when acted upon by the contractor by entering into a contract with the agent, operates as an estoppel, preventing the principal from asserting that he is not bound by the contract” [Freeman & Lockyer v Buckhurst Park Properties (Mangal) Ltd at 503] It is not enough that the representation should come from the officer alone. Whether the representation is general, or related specifically to the particular transaction, it must come from the principal, the company. That does not mean that the conduct of the officer is irrelevant to the representation, but the company’s conduct must be the source of the representation. In many cases the representational conduct commonly takes the form of the setting up of an organisational structure consistent with the company’s constitution. That structure presents to outsiders a complex of appearances as to authority. The assurance with which outsiders deal with a company is more often than not based, not upon inquiry, or positive statement, but upon an assumption that company officers have the authority that people in their respective positions would ordinarily be expected to have. In the ordinary case, however, it is necessary, in order to decide whether there has been a holding out by a principal, to consider the principal’s conduct as a whole. [38] A kind of representation that often arises in business dealings is one which flows from equipping an officer of a company with a certain title, status and facilities. In Crabtree-Vickers Pty Ltd v Australian Direct Mail Advertising & Addressing Co Pty Ltd, for example, the court spoke of the representation that might flow from supplying a particular person with ‘a blank order form, thus arming him with a document which, when he signed it, would bear the hallmark of authenticity’ (at 80). The reference to corporate administrative procedures under which an officer is armed with a document to which he or she can, by signature, impart an appearance of authenticity is a reminder of the wider principle of estoppel which may be relevant to a question of ostensible authority (Northside Developments Pty Ltd v Registrar-General [5.355]). The holding out might result from permitting a person to act in a certain manner without taking proper safeguards against misrepresentation.

2.

The common law doctrine of ostensible authority is now expressed in s 129(2)(b), (3)(b), discussed at [5.360].

3.

The ultra vires doctrine referred to by Diplock LJ in Freeman and Lockyer has been abolished in Australia: see [3.145]. Does its abolition affect the principles enunciated in the above cases?

4.

What is the juridical basis for the doctrine of ostensible authority? How does it differ from that of the indoor management rule? See Diplock LJ in Freeman and Lockyer at 503 and Northside Developments Pty Ltd v Registrar-General [5.365].

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5.

How does Diplock LJ explain the decision in Mahony v East Holyford Mining Co (see in Freeman and Lockyer at 506-507, cf Northside Developments v Registrar-General at 192 and [5.357], n 3)? Did the court in Mahony seek to apply doctrines of ostensible authority? Wherein lay the representation upon which the bank relied? Did the representor have authority and power to act for the company in the transactions with the bank?

6.

What is the distinction which Crabtree-Vickers makes between Bruce McWilliam junior exercising his ostensible authority as managing director through the agency of his brother Peter and his representation that Peter has authority to bind the company in the transaction? Does this distinction reflect sound considerations of commercial utility? Is it one which is likely to commend itself to persons dealing with companies?

7.

If Peter McWilliam’s order had been placed for an item of lesser value and if there had been a course of prior dealing between the two companies, would the outcome have been different and, if so, upon what basis?

Indoor management rule [5.340] A third basis for corporate contractual responsibility for acts of professing agents is

under a rule which protects third party contractors from the effect of irregularities in the internal (or indoor) management of the company. The rule is variously known as the indoor management rule or the rule in Turquand’s case after the decision in which it found early expression: at [5.350]. Some doctrines upon which the rule is founded are contained in Ernest v Nicholls [5.345]; later development of the rule, and its relationship with agency doctrines, are examined in the extract from Northside Developments Pty Ltd v Registrar-General [5.355].

Ernest v Nicholls [5.345] Ernest v Nicholls (1857) 6 HLC 401; 10 ER 1351 House of Lords LORD WENSLEYDALE: [418] It is obvious that the law as to ordinary partnerships would be inapplicable to a company consisting of a great number of individuals contributing small sums to the common stock, in which case to allow each one to bind the other by any contract which he thought fit to enter into, even within the scope of the partnership business, would soon lead to the utter ruin of the contributories. On the other hand, the Crown would not be likely to give them a charter which would leave the corporate property as the only fund to satisfy the creditors. The legislature then devised the plan of incorporating [419] these companies in a manner unknown to the common law, with special powers of management and liabilities, providing at the same time that all the world should have notice who were the persons authorised to bind all the shareholders, by requiring the co-partnership deed to be registered, certified by the directors, and made accessible to all; and, besides, including some clauses as to the management, as in the Act 7 and 8 Vict c 110, s 7, etc. All persons, therefore, must take notice of the deed and the provisions of the Act. If they do not choose to acquaint themselves with the powers of the directors, it is their own fault, and if they give credit to any unauthorised persons they must be contended to look to them only, and not to the company at large. The stipulations of the deed, which restrict and regulate their authority, are obligatory on those who deal with the company; and the directors can make no contract so as to bind the whole body of shareholders, for whose protection the rules are made, unless they are strictly complied with.

[5.345]

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Royal British Bank v Turquand [5.350] Royal British Bank v Turquand (1856) 6 E & B 327; 119 ER 886 Court of the Exchequer Chamber [The plaintiff bank lent money to the defendant company on the security of a bond signed by two directors and bearing the seal of the company. The company’s deed of settlement authorised the directors to grant bonds only when authorised by a resolution of the general meeting of the company. The company pleaded that there had been no such resolution.] JERVIS CJ: [332] We may now take for granted that the dealings with these companies are not like dealings with other partnerships, and that the parties dealing with them are bound to read the statute and the deed of settlement. But they are not bound to do more. And the party here, on reading the deed of settlement, would find, not a prohibition from borrowing, but a permission to do so on certain conditions. Finding that the authority might be made complete by a resolution, he would have a right to infer the fact of a resolution authorising that which on the face of the document appeared to be legitimately done.

Northside Developments Pty Ltd v Registrar-General [5.355] Northside Developments Pty Ltd v Registrar-General (1990) 170 CLR 146 High Court of Australia MASON CJ: [151] The appellant is a company which was incorporated [152] in 1965 for the purpose of holding certain land at Frenchs Forest near Sydney under the Real Property Act 1900 (NSW). The appellant was at the relevant time the registered proprietor of that land. The first respondent is the Registrar-General. The appeal concerns an instrument purporting to be a mortgage of the land executed on 24 December 1979 by the appellant, under its common seal, in favour of Barclays Credit Corp Holdings Pty Ltd (“Barclays”), to secure the payment of principal and interest under a loan amounting to approximately $1,400,000 made by Barclays to one or more companies owned and controlled by Robert Sturgess, a director of the appellant. The appellant had no interest of any kind in those companies. The mortgage was registered on 20 May 1980. Following default, Barclays sold the land by auction under the power of sale conferred by the instrument to a third party who became the registered proprietor of the land. The appellant sued the Registrar-General for damages under s 127 of the Act by way of compensation for the loss of its estate or interest in the land on the ground that it did not execute the mortgage instrument. Section 127 permits a person who has sustained loss or damages by the registration of any other person as the proprietor of land, and who is prevented by the Act from bringing proceedings for possession or recovery of the land, to bring an action against the Registrar-General as nominal defendant for recovery of damages. At all material times, the directors of the appellant were Robert Sturgess, John Lees and Robert Ellis. The shareholders were John Lees, Robert Ellis and Rogard Pty Ltd which was controlled by Robert Sturgess. None of the money lent by Barclays in consideration of the execution of the mortgage was received by the appellant. The instrument of mortgage was executed under the common seal of the appellant by Mr Sturgess, who also attested the affixing of the seal. The document also bore the signature of his son, Gerard Sturgess, who purported to sign as “company secretary”. Article 56 of the articles of association of the appellant provided: Subject to the power to delegate conferred by Article 47 the Directors shall provide for the safe custody of the Seal and the Seal shall never be used except by the authority of the Directors and in the presence of one Director at the least who shall sign every instrument to which the Seal is affixed and every such instrument shall be countersigned by the Secretary or by a second Director or some other person appointed by the Directors for the purpose. [153] Article 47 allowed the directors to delegate any of their powers to committees of directors. 328

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Northside Developments Pty Ltd v Registrar-General cont. In two important respects Art 56 was not complied with when Robert and Gerard Sturgess signed the mortgage document and affixed the common seal. In the first place, the directors had not by resolution at a meeting authorised the affixing of the seal to the instrument of mortgage or delegated power to Robert Sturgess; nor had the directors other than Robert Sturgess approved or assented to the execution of the mortgage. The company seal had been sent by the former secretary to solicitors acting for Robert Sturgess and companies under his control. The certificate of title to the relevant land was obtained by Robert Sturgess from the company’s former solicitors. Secondly, Gerard Sturgess was not in fact the company secretary. Upon the resignation of the previous secretary on 14 November 1979, Gerard Sturgess signed a letter consenting to act as secretary, and a statutory return recording his purported appointment was signed by Robert Sturgess and filed with the Corporate Affairs Commission on 22 November 1979. However, neither of the other directors knew of or approved the supposed appointment. [At first instance, damages were awarded to the appellant upon the basis that the mortgage could not be said to have been executed by the appellant, and that Barclays could not claim the protection of Turquand’s case since the circumstances of the transaction were such as to put it upon inquiry as to the authority of the Sturgesses. The New South Wales Court of Appeal allowed an appeal by the Registrar-General upon the basis that, in the circumstances of execution under the corporate seal, Barclays had not been put upon inquiry and were entitled to rely upon Turquand’s case.] [154] In this court the appellant submitted that Barclays had been put upon inquiry and, secondly, that the forgery exception is part of the law and that it is applicable in the present case. The respondent Registrar-General argued that Barclays was entitled to assume that the entering into of the mortgage and the affixing of the seal were authorised by the appellant, that there were no facts shown which put Barclays on notice of any irregularity, and that any “forgery exception” to the indoor management rule was inapplicable. The provisions of s 68A of the Companies Code [now ss 128 – 129] introduced in 1984, are directed to the issues which arise for decision in this appeal. However, as the mortgage was executed in 1979, s 68A has no application and the case must be determined by reference to the pre-existing law. According to the rule in Turquand’s case, persons dealing with a company in good faith may assume that acts within its constitution [155] and powers have been duly performed and are not bound to inquire whether acts of internal management have been regular: Morris v Kanssen [1946] AC 459. There Lord Simonds observed (at 475): It is a rule designed for the protection of those who are entitled to assume, just because they cannot know, that the person with whom they deal has the authority which he claims. This is clearly shown by the fact that the rule cannot be invoked if the condition is no longer satisfied, that is, if he who would invoke it is put upon his inquiry. He cannot presume in his own favour that things are rightly done if inquiry that he ought to make would tell him that they were wrongly done. A person, even one who has no special relationship with the company concerned, may be put upon inquiry by the very nature of the transaction: see EBM Co Ltd v Dominion Bank [1937] 3 All ER 555. [159] This court has accepted that the judgments in Freeman and Lockyer correctly state the relevant principles of law: Crabtree-Vickers Pty Ltd v Australian Direct Mail Advertising and Addressing Co Pty Ltd. The judgments in Freeman and Lockyer especially that of Diplock LJ, indicate that the rule in Turquand’s case in its application to the acts of a company undertaken through its agents is an exemplification of the law of principal and agent and that the ambit of the operation of the rule is to be ascertained by reference to the actual or ostensible authority of the agent who purports to act on behalf of the company. Of course, in applying the rule, account must be taken of the doctrine of ultra vires and the constitution of the company and the contents of its public documents as they may affect the actual or ostensible authority of those who purport to act on behalf of the company. [160] Thus, if according to the constitution of the company, the agent cannot exercise the relevant authority, his act cannot bind the company. [5.355]

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Northside Developments Pty Ltd v Registrar-General cont. But Freeman and Lockyer says nothing about instruments executed under the common seal of a company and it does not compel us to conclude that the rule in Turquand’s case, in its application to instruments so executed, is a principle of the law of agency rather than an organic principle of the law relating to corporations. The affixing of the seal to an instrument makes the instrument that of the company itself; the affixing of the seal is in that sense a corporate act, having effect similar to a signature by an individual, as I noted earlier. Thus, it may be said that a contract executed under the common seal evidences the assent of the corporation itself and such a contract is to be distinguished from one made by a director or officer on behalf of the company, that being a contract made by an agent on behalf of the company as principal. Consequently, it has been held that, if the person dealing with the company receives a document to which the common seal has been affixed in the presence of individuals designated in the articles of association, he is entitled to rely on its formal validity: Re County Life Assurance Co (1870) LR 5 Ch App 288 (where a policy issued by the company was binding even though the persons in whose presence the seal was affixed and who signed the policy were de facto directors who were not duly appointed). … However, there is no reason why a third party should be entitled to rely on the formal validity of the instrument and to assume that the seal has been regularly affixed if the very nature of the transaction is such as to put him upon inquiry. If the nature of the transaction is such as to excite a reasonable apprehension that the transaction is entered into for purposes apparently unrelated to the [161] company’s business, it will put the person dealing with the company upon inquiry. It is one thing to assume that the common seal has been regularly affixed to an instrument apparently executed for the purposes of the company’s business; it is quite another thing to assume that the seal has been regularly affixed when the transaction is apparently entered into otherwise than for those purposes. … [164] [A]t least so far as the present case is concerned, it makes little difference whether the rule is treated as a special rule or as a principle of the law of agency. Nonetheless, the role of the seal as the signature of the company suggests that to speak simply in terms of agency in cases involving its use may be insufficient in some situations. Further, use of agency principles overlooks the significance of the company seal and the reliance which may ordinarily be placed upon it. What is important is that the principle and the criterion which the rule in Turquand’s case presents for application give sufficient protection to innocent lenders and other persons dealing with companies, thereby promoting business convenience and leading to just outcomes. The precise formulation and application of that rule call for a fine balance between competing interests. On the one hand, the rule has been developed to protect and promote business convenience which would be at hazard if persons dealing with companies were under the necessity of investigating their internal proceedings in order to satisfy themselves about the actual authority of officers and the validity of instruments. On the other hand, an overextensive application of the rule may facilitate the commission of fraud and unjustly favour those who deal with companies at the expense of innocent creditors and shareholders who are the victims of unscrupulous persons acting or purporting to act on behalf of companies. Agency principles aside, to hold that a person dealing [165] with a company is put upon inquiry when that company enters into a transaction which appears to be unrelated to the purposes of its business and from which it appears to gain no benefit is, in my opinion, to strike a fair balance between the competing interests. Indeed, there is much to be said for the view that the adoption of such a principle will compel lending institutions to act prudently and by so doing enhance the integrity of commercial transactions and commercial morality. It is not possible to give specific guidance as to the circumstances in which the nature of a transaction will be such as to put a person dealing with a company upon inquiry. So much depends upon the circumstances of the particular case, notably the powers of the company (if relevant), the nature of its business, the apparent relationship of the transaction to that business and the actual or apparent authority of those acting or purporting to act on behalf of the company. Much will also depend upon representations about the transaction made by such persons, for the party dealing with the company may often find protection in the principles of agency or the doctrine of estoppel. … 330

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Northside Developments Pty Ltd v Registrar-General cont. The course of events leading to the giving of the mortgage began in September 1979 with a request by Robert Sturgess to Barclays for financial accommodation for one or more of the Sturgess companies. The appellant had no association of any kind with these companies and there was no apparent connection between them and the appellant or between their respective businesses. The only links between them were that Robert Sturgess was a director of each, that Gerard Sturgess was secretary of each except the appellant and was acting as secretary of the appellant, and that the companies had their registered offices at the same address. In response to Barclays’ demand for additional security over and above that initially offered, Robert Sturgess offered Barclays a mortgage over the property at Frenchs Forest. The officers of Barclays presumed that all was in order. They may have assumed incorrectly that the appellant and the other companies were associated companies linked by shareholding by reason of their having a common registered office, director and secretary. They made no searches or inquiries and there was no evidence as to searches or inquiries made on their behalf by their solicitors. Had inquiries been made the records of the Corporate Affairs Commission would have disclosed that Robert Sturgess was [166] a director, that Gerard Sturgess was shown as secretary of the appellant and that such a transaction was authorised by the articles. And, as I remarked earlier, there was nothing on the face of the mortgage to indicate that it was unauthorised, except that it was given to secure an advance to a third party without any indication that the giving of the mortgage or the procuring of the advance was for the purposes of the appellant’s business or related in any way to that business. That, in my opinion, is the decisive consideration; it requires the conclusion that Barclays was put upon inquiry. If this case were to be disposed of in terms of agency principles, the result would be the same. There was no representation by the directors that the seal was affixed with their authority or that they had approved the transaction which, on its face, appeared not to serve any interest of the appellant. There was no evidence that anyone having authority so to do from the appellant represented that the mortgage was valid. At best there was a representation by Robert or Gerard Sturgess, or both of them, but they were not authorised to make such a representation and, in any event, they were interested parties evidently deriving a benefit, even if only indirectly from the transaction. Moreover, there was no evidence which could justify a finding that Barclays relied on a representation that the seal was affixed with the authority of the directors or that the transaction was approved by them. The result would have been different if Barclays had had a legitimate basis for thinking that the appellant had an interest in the borrowing companies and that they were associated with the appellant, one having an interest in the other: see Re Hapytoz Pty Ltd (in liq) [1937] VLR 40. The participation of the Sturgesses in the affairs of the companies and the common registered office was not an adequate foundation for that belief; nor did it amount to a representation by the appellant that it had an interest in any of the borrowing companies. DAWSON J: [192] The rule in Royal British Bank v Turquand established that persons dealing with a company have constructive notice of the requirements of its memorandum and articles of association and, as Lord Hatherley put it in Mahony v East Holyford Mining Co (1875) LR 7 HL 869 at 894: “when there are persons conducting the affairs of the company in a manner which appears to be perfectly consonant with the articles of association, then those so dealing with them, externally, are not to be affected by any irregularities which may take place in the internal management of the company.” Earlier, Lord Hatherley had referred (at 894) to the “indoor management” of a company and thus the rule is known also as the indoor management rule. The rule in Royal British Bank v Turquand has been applied in a number of cases, not all of which are entirely reconcilable, but for present purposes it is necessary only to have regard to the relevant limits to which the rule is said to be subject. It does not apply where there are suspicious circumstances sufficient to place a person dealing with the company upon inquiry and it is said that it does [193] not apply where a document sealed or signed on behalf of the company is a forgery. … [195] At one time it seems to have been thought to be an open question whether the existence of an article conferring the power to delegate authority to a person to act on behalf of a company might of itself enable that authority to be presumed under the indoor management rule. See Campbell, [5.355]

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Northside Developments Pty Ltd v Registrar-General cont. “Contracts with Companies” (1960) 76 LQR 115 at 123. There is support to be found in various dicta for the proposition that an outsider who deals with a person to whom authority might be delegated is, at least if he has knowledge of the relevant article, entitled to presume that the delegation has taken place: Biggerstaff v Rowatt’s Wharf Ltd [1896] 2 Ch 93 at 102; [196] Kreditbank Cassel GmbH v Schenkers [1927] 1 KB 826 at 832-833; Rama Corp Ltd v Proved Tin and General Investments Ltd [1952] 2 QB 147 at 168. Equally there are dicta the other way saying that a person must be held out by a company to have authority before the exercise of power under the articles to delegate the authority might be presumed: see, eg, Kreditbank Cassel GmbH v Schenkers (at 843); British Thomson-Houston Co v Federated European Bank Ltd [1932] 2 KB 176 at 182. A similar conflict was at one time apparent in this country: Goulburn Valley Butter Factory Co Pty Ltd v Bank of New South Wales (1900) 25 VLR 702 at 715-716; Re Hapytoz Pty Ltd (in liq) [1937] VLR 40 at 46; cf Re Scottish Loan and Finance Co Ltd (1944) 44 SR (NSW) 461. But the notion that potential authority under an article might, without more, be treated as actual authority by an outsider to the company who knows of the article was something which obviously went beyond the reasonable requirements of business convenience and was difficult to sustain upon principle. This was made clear by Sargant LJ (in whose judgment Atkin LJ concurred) in Houghton & Co v Nothard Lowe and Wills [1927] 1 KB 246. In that case, a single director of two companies, both engaged in fruit trade, entered into an agreement with a firm of fruit brokers (the plaintiffs) that in exchange for a loan to one company the brokers would have the right to sell on commission all the fruit imported by both companies, and that 70% of the net proceeds of the sale of both companies could be retained as security for the advance. The director had no actual authority from that company which was not the recipient of the loan (the defendant company). The brokers sought confirmation of the agreement from the defendant company itself but the only confirmation received was from the defendant company’s secretary, who had no actual authority to confirm the agreement. The articles of association contained a wide power, vested in the board of directors, to delegate their power to enter into the type of transaction in question to any person, including a single director or the secretary. The plaintiffs did not know of this power of delegation and the power had not in fact been exercised. At first instance, Wright J took the view that the plaintiffs were entitled to treat the question of whether the power to delegate had been exercised as a matter of internal management only and to assume that the director and secretary in fact possessed the power they [197] purported to exercise by entering into the transaction, so that their actions could bind the company. The Court of Appeal reversed the decision of Wright J. Sargant LJ rejected the notion that the indoor management rule could be so applied, even had the plaintiffs had actual and not merely constructive knowledge of the power of delegation in the articles of association. To extend the scope of the operation of the rule in this way would be to carry the doctrine of presumed power far beyond anything that has hitherto been decided, and to place limited companies, without any sufficient reason for so doing, at the mercy of any servant or agent who should purport to contract on their behalf. On this view, not only a director of a limited company with articles founded on Table A, but a secretary or any subordinate officer might be treated by a third party acting in good faith as capable of binding the company by any sort of contract, however exceptional, on the ground that a power of making such a contract might conceivably have been entrusted to him (Houghton & Co v Nothard Lowe and Wills [1927] 1 KB 246 at 266-267). Atkin LJ confirmed this view in Kreditbank Cassel GmbH v Schenkers ([1927] 1 KB 826 at 842-843): It is said: “You, the defendants, are a limited company, and as such you are in a much more awkward position than if you were a firm, because you have an article in your articles of association empowering the directors to determine who may sign bills of exchange on behalf of the company, and, therefore, any one who purports to sign a bill of exchange in the name of the company is deemed to have authority to do so.” Carried to its logical conclusion, that would be a most alarming doctrine for companies, for any one who has the pen of a ready 332

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Northside Developments Pty Ltd v Registrar-General cont. writer need only sit down and write a bill of exchange in the name of a company having an article in this form, and the company would, presumably, be bound when the bill got into the hands of a holder for value without notice, even although the bill was an absolute forgery. The article cannot have that extended bearing, and if some limitation were not placed upon it, not merely the office boy but any one might purport to sign on behalf of the company. Such a view is not correct. An office boy purporting to sign a cheque on behalf of a company would ordinarily place an outsider upon inquiry, but the point is nevertheless clearly made. [198] The correct view is that the indoor management rule cannot be used to create authority where none otherwise exists; it merely entitles an outsider, in the absence of anything putting him upon inquiry, to presume regularity in the internal affairs of a company when confronted by a person apparently acting with the authority of the company. The existence of an article under which authority might be conferred, if it is known to the outsider, is a circumstance to be taken into account in determining whether that person is being held out as possessing that authority. It may be consistent with that person having the authority which he purports to have. There must, however, be something more than the mere existence of a power within the articles, for instance the power to delegate (which may or may not have been exercised), upon which to base an apparent exercise of authority which will bind the company. And, of course, knowledge on such an article is not essential for the application of the indoor management rule where apparent authority can be established without reliance upon it. In other words, the indoor management rule only has scope for operation if it can be established independently that the person purporting to represent the company had actual or ostensible authority to enter into the transaction. The rule is thus dependent upon the operation of normal agency principles; it operates only where on ordinary principles the person purporting to act on behalf of the company is acting within the scope of his actual or ostensible authority. Whatever the controversy which may previously have existed, the decision in Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd has ensured that it is the latter view which has prevailed. Indeed, in Freeman and Lockyer Diplock LJ preferred to speak entirely in terms of actual or ostensible authority to bind a company and to avoid any express reference to the rule in Royal British Bank v Turquand. But it is clear from his judgment (and that of Willmer LJ (at 496)) that, where an outsider dealing with a company relies upon the ostensible authority of some person purporting to act as its agent, an article permitting that authority to be delegated to the agent will be significant for two reasons. First, whether the article is known to the outsider or not, it will establish that the delegation and exercise of the authority is intra vires. Secondly, where the existence of the article is known to the outsider, it will be relevant as part of the holding out by the company of the person as its agent. Of course, as Diplock LJ [199] points out, the company will hold the person out as having the authority to act as agent if it either expressly represents that he is so authorised or permits him to act as if he were so authorised, particularly where it permits him to act in a position which ordinarily carries such authority with it. In those circumstances the company will be estopped from denying the agent’s authority whether or not – and this is the indoor management rule to which Diplock LJ found it unnecessary to refer – the procedures have been observed which are required to be followed internally in order to confer actual authority upon the agent … Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd has been applied by this court in Crabtree-Vickers Pty Ltd v Australian Direct Mail Advertising and Addressing Co Pty Ltd and there is no reason to doubt the principles which it lays down. In applying these principles in the case of forgery, it is necessary to distinguish between forgery which involves a counterfeit signature or seal and that which does not. A counterfeit signature or seal purports to be that which it is not, not because of any lack of authority, but simply because it is false. There is no representation that the forger is authorised to act as an agent and there is no room for the application of the indoor management rule. The forgery is truly a nullity. In Ruben v Great Fingall Consolidated [1906] AC 439 there were counterfeit signatures and it was in that context that Lord Loreburn said that the indoor management rule did not apply because it “applies only to irregularities that otherwise might affect a genuine transaction”. Of course, if a company represents that a counterfeit signature or seal is genuine, it may be estopped from denying its authenticity. [5.355]

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Northside Developments Pty Ltd v Registrar-General cont. But, as I have said, there may be a forgery where no counterfeit signature or seal is involved – where, for example, a person without actual or ostensible authority purports to sign a document on behalf of a company or affixes its seal to it with intent to defraud. There is then a false document made with the intention [200] that it should be acted upon as genuine and that constitutes a forgery. What if, notwithstanding the fraudulent intent, there is ostensible authority, although no actual authority, to sign or seal the document on behalf of a company? Would the document then constitute a forgery? There have been mixed answers given to the last question: cf Campbell (1960) 76 LQR 115 at 135-136; Thompson, “Company Law Doctrines and Authority to Contract”. The answer is, however, of no real consequence for the purposes of the application of the indoor management rule. Clearly, if the person who signs the document or affixes the seal is held out by the company as having authority to act for it, an outsider dealing with that person is entitled to presume that the company correctly observed the procedures available to it to place the person in that position and the company would be estopped from denying his authority. If, whatever may be the position in the criminal law, the document is not in those circumstances to be regarded as a forgery, then the statement of Lord Loreburn that the indoor management rule cannot apply to a forgery is correct in a quite general sense. Nor is there any warrant for treating the affixation of the seal of a company as attracting some special application of the indoor management rule. Whilst a company’s seal may be authentic evidence of what a company has done or agreed to do … if it is affixed without authority, actual or ostensible, it is a forgery and the company is not bound by it. It adds nothing to speak of “the peculiar significance of the common seal as the external physical symbol of an act of the body corporate itself – a corporate act” (Lindgren, “The Positive Corporate Seal Rule and Exceptions Thereto and the Rule in Turquand’s Case” (1973) 9 MULR 192 at 194). That view must depend on treating the act of affixing the seal as an act, not simply of an agent, but of an organ of the company itself. The organic theory, which was originated by Lord Haldane LC in Lennard’s Carrying Co Ltd v Asiatic Petroleum Co Ltd [see [4.150]], has been used to impose liability upon companies beyond that which could be imposed by the application of the principles of agency alone. It is an approach which has been particularly useful in criminal cases where the liability of a company has depended upon a mental element … But the organic theory merely extends the scope of an agent’s capacity to bind a company and there must first be authority, actual or apparent. It is only then that a person may be regarded not only as the agent of a company, but also as the company itself – an organic part of it – so that “[t]he state of mind of [the agent] is the state of mind of the company” (H L Bolton (Engineering) Co Ltd v T J Graham & Sons Ltd [1957] 1 QB 159 at 172 per Denning LJ). Thus the application of the theory depends in the first instance upon there being authority, that is to say, agency. … A body corporate can only act through agents, even in the affixation of a seal, and, if a person who is not authorised, or held out as being authorised, to enter into a transaction on behalf of a company purports to do so by affixing the company’s seal to a document, the company will not be bound. The document will be a forgery, even if the person concerned would, were the transaction one which he had authority to conclude on behalf of the company, be a person authorised to carry out the physical affixation of the seal. Obviously, if a person has been given general authority to affix the seal of a company that authority does not extend to any transaction whatsoever; it must be limited to those transactions into which the company has decided to enter. In other words, authority to affix the seal is not the same thing as authority to determine those documents to which the seal should be affixed. Of course, as I have said, if a person has apparent authority to enter into a transaction and pursuant to that authority affixes the company’s seal to a document, the indoor management rule may allow an outsider dealing with that person to presume that the seal is affixed in accordance with the requirements of the articles, that being a matter of internal regulation. [204] In the present case, neither Robert Sturgess nor his son, Gerard Sturgess, was authorised to mortgage the land held by Northside Developments Pty Ltd. They had no actual authority and the company had not held either of them out as possessing any authority to enter into a transaction of that type on its behalf. It would seem that the company did not even hold Gerard Sturgess out as 334

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Northside Developments Pty Ltd v Registrar-General cont. being its secretary, but it is unnecessary to determine that question because, even if it did, the office of secretary would not carry with it any apparent authority to encumber the company’s land. The secretary of a company is its administrative officer and, even though his authority ordinarily extends to countersigning the affixation of the company’s seal pursuant to a resolution of the board of directors, he has no apparent authority to enter into commercial transactions upon his own decision, save for [205] transactions of an administrative kind required for the day to day running of the company’s affairs: Panorama Developments v Fidelis Fabrics [1971] 2 QB 711 at 716-717. Plainly the transaction in this case was not of that kind. Nor does an ordinary, individual director of a company have any ostensible authority to bind the company. A managing director may have wide powers, actual or ostensible. In Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd it was held that a person who had assumed the powers of a managing director of a property company with the company’s approval had apparent authority to engage architects on the company’s behalf, this being within the ordinary ambit of the authority of a managing director of a company of that kind. And even ordinary directors may have quite significant functions entrusted to them by the company, although usually these are of a more or less formal nature, such as affixing the company seal to documents which the company requires to be executed: see Lennard’s Carrying Co Ltd v Asiatic Petroleum Co Ltd. But the position of director does not carry with it any ostensible authority to act on behalf of the company. Directors can act only collectively as a board and the function of an individual director is to participate in decisions of the board. In the absence of some representation made by the company, a director has no ostensible authority to bind it. In this case, there is no finding that Northside Developments Pty Ltd held Robert Sturgess out as having authority to encumber its land on its behalf nor on the evidence could there be. The company in fact conducted no business which could be said to have been delegated to an individual director and, in any event, it would have been apparent that this transaction was not in the course of any business which it might have conducted. The transaction was completed without the actual or apparent authority of Northside Developments Pty Ltd and the affixation of the seal of the company was a forgery. This precluded the application of the rule in Royal British Bank v Turquand. It is unnecessary to consider whether, had there been ostensible authority to bind the company, the application of that rule would have resulted in a binding document. Having reached that conclusion, it is also strictly unnecessary for me to consider whether Barclays was, in any event, put upon inquiry. Nevertheless I may indicate briefly that in my view such was the case. [Toohey J agreed with the reasons expressed by Dawson J. Brennan and Gaudron JJ also agreed that the circumstances of the execution of the mortgage were such as to put Barclays upon inquiry as to the authority of the Sturgesses.]

[5.357]

1.

2.

Notes&Questions

What rationale is expressed in Ernest v Nicholls for imposing constructive notice of a company’s constitutional documents upon those who deal with the company? How did this doctrine contribute to the rule in Turquand’s case? See now s 130 (abolishing the constructive notice doctrine in its application to company documents) and s 129(1), discussed at [5.360]. In Hely-Hutchinson’s case [5.325], Roskill J at first instance held that Suirdale could rely on the indoor management rule (that is, Turquand’s case) in relation to his dealings with Brayhead, notwithstanding that he was also a director of the company. He said ([1968] 1 QB 549 at 567): “I do not think the mere fact that a man who is a director of a company makes a contract with the company in a capacity other than that of a director automatically affects him in the capacity in which he is contracting with [5.357]

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constructive knowledge of such disabilities and limitations as he might be deemed to know were he also acting for the company in the transaction in question.” This issue was left open in the Court of Appeal where the issue was decided upon other grounds. See now s 129(1). 3.

In Northside Developments Pty Ltd v Registrar-General at 192 Dawson J referred to the decision of the House of Lords in Mahony v East Holyford Mining Co Ltd (1875) LR 7 HL 869. It remains a striking example of the operation of the indoor management rule. Seven persons signed their names as subscribers to the memorandum and articles of association, which were registered. The articles provided for the subscribers, or a majority of them, to appoint the first directors. None were appointed. Cheques were to be signed and countersigned as directed by the board; the secretary was to be appointed by the directors. These formalities were not observed. Three of the subscribers acted as directors to the knowledge of the others from the de facto office of the company. Persons applied for shares in and lodged deposits with the company. A sum of nearly £4000 was collected and deposited with a bank. An individual acting de facto as company secretary transmitted what purported to be a resolution of the company requesting the bank to pay all cheques signed by two of three named directors. Acting on the faith of this letter the bank paid, on cheques signed in the manner mentioned in the letter, moneys to an amount approaching the whole balance of the company’s account. In an action by the liquidator of the company brought to recover the sum lodged with the bank, judgment for the bank was upheld upon the principle expressed in Turquand’s case.

4.

What scope for the independent operation of the indoor management rule (that is, independent of agency doctrines) emerges from Northside Developments v Registrar-General?

5.

Would the result have been different in the Northside Developments case if the bank had inquired of the person shown as secretary in the borrowing company’s last annual return whether the company had authorised the borrowing, and received an affirmative response?

6.

What conduct or express representation by those associated with Northside Developments might have created ostensible authority on the part of the Sturgesses or engaged the indoor management rule?

The statutory assumptions protecting those dealing with companies [5.360] Sections 128 and 129 were introduced with effect from 1 July 1998. They replace

provisions dating back in one form or another to 1984. The provisions effect a statutory restatement (albeit with substantial modifications) of common law principles relating to contracts or dealings on behalf of companies. While the coverage of the statutory provisions substantially overlaps with that of general law doctrines, they are by no means identical in their coverage and effect, and do not displace the operation of those doctrines where they are not expressed in the statutory rules. 261 In summary, the provisions contain a series of assumptions that a person dealing with a company or acquiring title to property from it is entitled to make with respect to • compliance with the company’s constitution and such replaceable rules as apply to the company (s 129(1)); 261

See, eg, Australian Capital Television Pty Ltd v Minister for Transport and Communications (1989) 7 ACLC 525.

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• the proper appointment and scope of the authority of those who are shown on information made available to the public by ASIC to be a director or secretary of the company (s 129(2)); • the proper appointment and authority of those held out by the company as an officer or agent (s 129(3)); • the proper performance of their duties by company officers and agents (s 129(4)); • the apparent execution by the company of documents with or without its common seal (s 129(5) – (6)); and • warranties by company officers and agents that a document is genuine or a true copy: s 129(7). The company is not entitled to assert in proceedings in relation to the dealing that any of these assumptions is incorrect: s 128(1). The assumptions may be made even if the company officer or agent is acting fraudulently or forges a document in connection with the dealing: s 128(3). The concept of having dealings with a company embraces purported dealings and does not apply only to situations where the person representing the company has actual authority: “the concept of having dealings with a company must embrace, subject to the qualifications contained in the legislation, purported dealings”; if the statutory provisions only extended to cases where the person representing the company had actual authority then they would be largely unnecessary. 262 Nonetheless, to constitute a dealing with the company, some measure of authority is required: “[although] the person representing the company need not have authority to commit the company to the relevant transaction or execute the relevant document, that person must at least have authority ‘to undertake some negotiation or other steps’ so that the relevant negotiation or other step which constitutes the dealing is properly considered to be a dealing with the company”. 263 A person is not, however, entitled to make an assumption if, at the time of the dealing, they knew or suspected that the assumption was incorrect: s 128(4). The material time for the purpose of applying s 128(4) is when the transaction was made rather than when a party takes a step pursuant to the transaction. 264 For the purposes of the defence under s 128(4) it is “actual knowledge or actual suspicion which is necessary”; 265 s 128(4) “appears to place the burden on the company to establish the person’s subjective knowledge or suspicion that the s 129 assumptions relied on were incorrect. That is to say, a person does not lose the benefit of the assumptions in s 129 merely because the person’s suspicions, in the circumstances, should have been aroused”. 266 What degree of apprehension or anticipation will disentitle the outsider from relying upon the assumptions? The words of Kitto J in Queensland Bacon Pty Ltd v Rees, 267 provide “useful guidance” in this context. 268 In that case, Kitto J dealt with a 262 263

264 265

Story v Advance Bank Australia Ltd (1993) 31 NSWLR 722 at 733. Australia and New Zealand Banking Group Ltd v Frenmast Pty Ltd [2013] NSWCA 459 at [44] quoting from Hodgson CJ in Eq in Soyfer v Earlmaze Pty Ltd [2000] NSWSC 1068 at [82]. In ANZ v Frenmast there was a body of communications by the professing agent of a company who had forged his fellow director’s signature to a guarantee so that the bank, which sought to rely upon assumptions under s 129(4) and s 129(5), was held entitled to do so. These communications constituted a dealing or dealings in relation to the taking of the guarantee. Barclays Finance Holdings Ltd v Sturgess (1985) 3 ACLC 662. Soyfer v Earlmaze Pty Ltd [20005] NSWSC 1068 at [71].

266

Sunburst Properties Pty Ltd (in liq) v Agwater Pty Ltd [2005] SASC 335 at [178].

267 268

(1966) 115 CLR 266 at 303. Caratti v Mammoth Investments Pty Ltd (2016) 113 ACSR 31 at [591] per Newnes and Murphy JJA. In Errichetti Holdings Pty Ltd v Western Plaza Hotel Corporation Pty Ltd [2006] WASC 113 Master Newnes said (at [74]): “s 128(4) does not preclude a person from relying upon a s 129 assumption simply because there has been a [5.360]

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provision in bankruptcy legislation dealing with preferential payments made in circumstances where the payee had “reason to suspect” that the payer is insolvent. He said with respect to the provision: A suspicion that something exists is more than a mere idle wondering whether it exists or not; it is a positive feeling of actual apprehension or mistrust, amounting to “a slight opinion, but without sufficient evidence” … a reason to suspect that a fact exists is more than a reason to consider or look into the possibility of its existence. 269

In Eden Energy Ltd v Drivetrain USA Inc the court approved a statement in Ford’s Principles of Corporation Law that it “may take into account the conclusions that a hypothetical reasonable person in the same position would have drawn from the facts known and then presume that the actual person relying on the assumptions in s 129 would have reached the same conclusions”. 270 Such an inference of actual knowledge or suspicion may, however, be displaced by the contractor’s cogent denial. In RCA Corporation v Custom Cleared Sales Pty Ltd the New South Wales Court of Appeal addressed the inference that might be drawn from the opportunities that a contractor has for knowledge that a s 129 assumption is not correct: Where opportunities for knowledge on the part of the particular person are proved and there is nothing to indicate that there are obstacles to the particular person acquiring the relevant knowledge, there is some evidence from which the court can conclude that such a person has the knowledge. However, this conclusion may be easily overturned by a denial on his part of the knowledge which the court accepts, or by a demonstration that he is properly excused from giving evidence of his actual knowledge. 271

As noted, the statutory assumptions overlap with but do not displace the operation of general law doctrines relating to actual and ostensible authority and the indoor management rule. Accordingly, a person dealing with a company may invoke their protection, according to their terms and scope, if the statutory assumptions are inapplicable in the circumstances; however, if they are excluded by s 128(4), it is likely that the facts which engage the exclusion will also preclude the protection of the general law doctrines. The assumptions in s 129 are concerned with both authority to act and performance of duties. The latter is a separate issue from authority: “[a] company director can act in breach of duty independently of whether the act was authorised. … The first three subsections of s 129 are expressly concerned with authority. The next three subsections are then expressly concerned with performance of duties”. 272 The first assumption, in s 129(1) is concerned with any lack of authority that could arise from failure to comply with the constitution; it entitles a person dealing with a company (the contractor) to assume that, at all relevant times, the constitution of the company and any replaceable rules that apply to the company have been complied with. The provision is apparently intended to restate the indoor management rule. Second, s 129(2) entitles a contractor to assume that a person who appears from returns lodged with ASIC to be a director or secretary of the company has been duly appointed and failure on their part to enquire, even where a reasonably prudent person would have made enquiries. The section does not incorporate the concept of being ‘put upon enquiry’. Nor will such a failure be sufficient to establish that the person knew or suspected the fact that such enquiry would have revealed. The person must be found to have had at least an ‘actual apprehension or mistrust, amounting to a slight opinion’ that the fact exists. Of course, in a particular case it might be inferred from what the person did know, or otherwise from the particular circumstances of the case, that no inquiry was made because the person suspected the fact existed and preferred not to have that suspicion confirmed”. 269 270 271

Queensland Bacon Pty Ltd v Rees (1966) 115 CLR 266 at 303. (2012) 90 ACSR 191 at [85]. (1978) 19 ALR 123 at 126.

272

Great Investments Ltd v Warner (2016) 114 ACSR 33 at [98].

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has authority to exercise the powers and perform the duties customarily exercised or performed by a director or secretary of a similar company. To obtain the benefit of the assumption it is not necessary that the contractor actually consult and rely upon the returns in question. 273 Where a director or secretary retires or resigns, they must give written notice of the fact to ASIC: s 205A. The company must also lodge with ASIC notice of such changes within 28 days (s 205B); this obligation is reinforced by that upon the company to update annually the publicly available information held for it by ASIC: Ch 2N. In Ross v GVC Homes Pty Ltd (admin appt) the sole director of a company appointed voluntary administrators of the company in ignorance of his removal as director some days earlier (that removal had not been communicated to him); neither was the ASIC record corrected at the time of the purported appointment of the administrators. The company was accordingly precluded by s 129 from disputing the validity of their appointment. 274 The statutory assumption in s 129(2) therefore provides a strong incentive for companies to update the ASIC record for changes as to its directors and secretaries since third party contractors may invoke the protection of the assumption in relation to dealings purportedly made on a company’s behalf by former directors and secretaries who continue to be shown as holding office. The extent of that risk will depend upon the nature of the transaction and the particular office shown on the ASIC record. Third, dealings by other ostensible officers and agents are affected by the assumptions in s 129(3) which allow a contractor to assume that a person who is held out by the company to be an officer or agent of the company has been duly appointed and has authority to exercise the powers and perform the duties customarily exercised or performed by that kind of officer or agent of a similar company. That is, the statutory authority is articulated both to the particular role apparently occupied and company type. Ordinarily, the holding out will be made to the contractor who seeks to rely upon it; the subsection, however, does not specify that the holding out must be to the person having dealings with the company. It may be that in some circumstances the holding out of authority to a person having dealings with the company will be inferred from past patterns of acquiescence in the agent exercising such authority even in the absence of a representation to the contractor personally. The holding out of authority must, of course, cover the transaction in question. 275 Fourth, contractors may assume that the officers and agents of the company properly perform their duties to the company: s 129(4). The subsection is not concerned with whether acts are authorised but with the performance of duties. This assumption restates the general law presumption of the regular and proper performance of directors’ acts: Directors are fiduciary agents and their powers must be exercised honestly in furtherance of the purposes for which they are given. Under the general law of agency it is a breach of duty for an agent to exercise his authority for the purpose of conferring a benefit on himself or upon some other person to the detriment of his principal. But, at the same time, if his act is otherwise within the scope of his authority it binds the principal in favour of third parties who deal with him bona fide and without notice of his fraud. The rule, no doubt, is the same with respect to the acts of directors. It follows that a transaction carried out by directors for their own or some other persons’ benefit and not to further any purpose of the company is voidable but not void. 276

The remaining assumptions are narrower in scope. Fifthly, a contractor is entitled to assume that a document has been duly executed by the company if it bears what appears to be an 273 274 275

Lyford v Media Portfolio Ltd (1989) 7 ACLC 271. (2016) 110 ACSR 60. R P Austin and I M Ramsay, Ford’s Principles of Corporations Law (16th ed, 2013), para [13.400].

276

See Richard Brady Franks Ltd v Price (1937) 58 CLR 112 at 142. [5.360]

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impression of the seal of the company and the sealing appears to have been witnessed by two directors or by a director and a secretary: s 129(6). Sixthly, a contractor may assume that an unsealed document has been duly executed by the company if it is signed in accordance with s 127(1) (viz, by two directors or a director and a secretary): s 129(5). Seventhly, a contractor is entitled to assume that a contractor or agent of the company who has authority to issue a document or a certified copy of a document on behalf of a company also has authority to warrant that the document is a genuine or a true copy: s 129(7). Accordingly, the company will be unable to escape liability for a false document issued by an officer or agent whom it has authorised to issue another document since the contractor is entitled to assume a warranty of authenticity by the officer. Finally, the common law doctrine of constructive notice of registered company documents (see Ernest v Nicholls [5.345]) is abolished except for documents relating to a registrable charge given by a company: s 130(2). The registration of security interests granted by companies is dealt with in the Personal Properties Securities Act 2009 (Cth).

Brick and Pipe Industries Ltd v Occidental Life Nominees Pty Ltd [5.365] Brick and Pipe Industries Ltd v Occidental Life Nominees Pty Ltd (1991) 6 ACSR 464 Appeal Division of the Supreme Court of Victoria [A deed was executed under the seal of Brick and Pipe guaranteeing repayment of moneys advanced to a related company by Occidental, the other party to the deed. Brick and Pipe and the borrowing company were members of the Goldberg group of companies whose parlous financial state became apparent within a very short time after execution of the guarantee. Brick and Pipe brought proceedings seeking declarations that the guarantee was not binding upon it. The affixing of the common seal of Brick and Pipe to the document was attested to by two directors of the company, Goldberg and Furst, the latter purporting to attest not as director but as company secretary. (The company’s constitution, in art 107, provided that the affixing of the seal was to be attested by a director and a secretary.) Execution of the deed had taken place without the knowledge of other directors of the company and without any board consideration of the transaction. Further, Furst had not been appointed secretary of the company; indeed, Occidental was aware that Furst’s name was not shown as secretary upon the company’s notice to ASIC of directors’ personal details and it proceeded to completion only after receiving verbal assurance from Durlacher, financial controller of the group, in the presence of Goldberg and Furst, that Furst had been duly appointed secretary after recent changes to company officers. Brick and Pipe argued that the agreement was unenforceable by reason of its irregular execution. The primary judge held that, notwithstanding that the agreement was not validly executed, Occidental was entitled by the predecessor to s 129(6) to assume that the agreement had been validly sealed. Brick and Pipe appealed. In this extract reference is made to the Corporations Act counterparts of the Companies Code provisions discussed in the judgment. The provisions are not in identical terms; the terms of the former provisions appear in the judgment where they are relevantly different.] McGARVIE, MARKS and BEACH JJ: [473] Mr Shaw QC, senior counsel for Brick and Pipe, submitted that the learned judge was wrong in deciding that the respondents were entitled to make the assumption in [s 129(6)] that the Guarantee and Indemnity had been duly sealed by the company. It is common ground that the Guarantee and Indemnity was impressed with the seal of Brick and Pipe and had been signed by Goldberg and Furst who were directors. Furst, however, signed as secretary but the learned judge found that he did not hold that office. His Honour did find, however, [474] that Furst had been held out by Brick and Pipe to be its secretary within the meaning of [s 129(3)]. It is this finding which Mr Shaw first challenged, although he also relied on [s 129(4)]. It is convenient to mention at this point that he also sought to rely on [s 129(4)] to the effect that the respondents ought to have known that the Guarantee and Indemnity was not duly sealed but as this argument was specifically abandoned on behalf of the respondents in the court below and the cogency of the argument depends significantly on findings of fact which the learned judge, by reason of the concession, did not make, we ruled that we would not entertain the argument. 340

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Brick and Pipe Industries Ltd v Occidental Life Nominees Pty Ltd cont. Holding out [476] The appellant argued that the respondent’s case necessarily relied on the ostensible authority of Goldberg to hold out Furst as secretary. It was put that the principle of Crabtree-Vickers Pty Ltd v Australian Direct Mail Advertising and Addressing Co Ltd (1975) 133 CLR 72 precluded that reliance. In that case it was held that a person with only ostensible authority to do an act or to make a representation cannot make a representation which may be relied upon as giving another agent ostensible authority to do that act. … It may be accepted, as was explained by Dawson J in Northside, that persons merely holding the office of director are not thereby authorised to commit the company to contracts. At 245 Dawson J observed that an ordinary individual director of a company does not have ostensible authority to bind the company. However, the decision of the learned judge rested on his finding that Goldberg was more than an ordinary director. By virtue of his control of Arnsberg which owned all the shares in Brick and Pipe, Goldberg assumed the role of managing director with the acquiescence of the members of the board of directors who regarded him as the “owner” of Brick and Pipe. … [477] [This] finding was not challenged and there was ample evidence to support it. It included evidence that on numerous occasions after the Goldberg takeover, Goldberg obtained board approval of transactions to which he had already committed Brick and Pipe without first seeking authorisation of its board. Individual directors in evidence confirmed the acquiescence of board members in the activity of Goldberg which culminated in completed transactions for which they gave no prior authorisation. In most, if not all, cases, the transactions committed assets of Brick and Pipe or its subsidiaries as security for borrowings by other Goldberg companies. In our opinion what was said by the learned judge amounted to a finding that Goldberg had actual authority to manage the business of Brick and Pipe and to hold out that Furst was the secretary of that company. There was ample justification for that finding in application of the principle of HelyHutchinson v Brayhead Ltd [1968] 1 QB 549. See also Corporate Affairs Commission (NSW) v Transphere Pty Ltd (No 2) (1985) 9 ACLR 1005. The finding by the learned judge that, by remaining silent when Durlacher gave the assurance that Furst was secretary of all guarantor companies, Goldberg is to be regarded as concurring in the assurance, was a finding which was justified on the evidence. Goldberg by implication gave the same assurance. Although Goldberg gave no indication that he was concurring on behalf of one guarantor company rather than another, he is to be taken as having concurred, on behalf of all guarantor companies on whose behalf he had power to concur: Re Express Engineering Works Ltd [1920] 1 Ch 466 at 471; J W Broomhead (Vic) Pty Ltd (in liq) v J W Broomhead Pty Ltd [1985] VR 891 at 932. He is therefore to be taken as having held out on behalf of Brick and Pipe that Furst was its secretary. [478] We consider that the learned judge was entitled to hold, as he did, that Furst had, within the meaning of [s 129(3)], been held out by Brick and Pipe to be its secretary, so as to entitle the respondents to make the assumption permitted by [s 129(3)]. Assumption a director Mr Shaw, however, contended that the learned judge was in error in holding that Brick and Pipe was unable to rely on [s 128(4)] which disentitles entitlement to make an assumption … if the party in question has “actual knowledge that the matter that, but for this subsection, he would be entitled to assume is not correct”. The expression “actual knowledge” means, we think, what it says. It does not lend itself to definition or elaboration. What amounts to “actual knowledge” is largely dependent on the facts and circumstances in a particular case and the inference they allow. Here, Dodge, the solicitor for the respondents, had actual knowledge of at least some provisions of the articles of association and certainly arts 89 and 107 (respectively the interested directors’ article and the article as to use of the company seal). It was submitted on behalf of Brick and Pipe that Dodge knew that the Guarantee and Indemnity had not been duly sealed because he knew that the only meeting which purported to authorise its execution had not done so because it was said to have taken place on 22 December 1989 at which time the documents were not in existence. Also, the meeting was in breach of art 89 and other articles for its due convening. [5.365]

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Brick and Pipe Industries Ltd v Occidental Life Nominees Pty Ltd cont. As the learned judge pointed out, this submission would be an answer to an attempted reliance by the respondents on [s 129(3)] but the respondents relied on assumption [s 129(6)] which is discrete and confined to due sealing. The legislature could not be taken to have intended that an assumption as to due sealing is not available in circumstances like the present where there was actual knowledge of non-compliance with articles not concerned with authority to fix the company seal and attest it. Accordingly, any actual knowledge of Dodge, which may be attributed to the respondents, of Goldberg’s interest and his disqualification to vote on any Board resolution goes only to the assumption [in s 129(1)]. We did not understand Mr Shaw to submit that Dodge had actual knowledge that Furst was not the secretary. This submission, we consider, was not available because the evidence showed only that Dodge was not satisfied that Furst was the secretary and was given an assurance that he was. It was a matter on which he was to receive a [notice to ASIC] from Durlacher but did not. His state of mind was absence of knowledge whether Furst was or was not the secretary. He had no “actual” knowledge one way or the other. Then he received positive instructions from Roeder to proceed without a confirming [notice] which was expected. It was also submitted on behalf of the respondents that in any event the learned judge should have upheld a submission that they were not required to establish the holding out because [s 129(2)] was available as Furst was a director and shown to be so on the [notice to ASIC]. His Honour described this submission as “ingenious” and although it is unnecessary to consider this alternative, as we do not differ from his Honour as to his conclusions on the prime submission, we do not agree entirely in what his Honour said in this respect. [479] The mere fact that Furst signed as “secretary” when he was not, may not in all circumstances shut out entitlement of a party to rely on the fact that he was a director according to the [notice to ASIC] for the purposes of assumption [in s 129(6)]. We consider that the conclusion of his Honour is not to be disturbed for a rather different reason, namely, that the evidence before his Honour was capable of establishing “actual knowledge” on the part of Dodge that “due sealing” required the attesting signature of a director and the secretary of Brick and Pipe. It is true that the article provided that the board of directors may appoint a person other than its secretary to be the attesting witness but the only information which Dodge had was that the signature of the secretary was required. Accordingly, he had actual knowledge that the attesting signatures of two directors alone would not constitute “due sealing” pursuant to art 107 unless the board had passed a resolution to that effect. Dodge, of course, had no information of any such resolution. In those circumstances it may well have been difficult for the learned judge to have been satisfied that Dodge was entitled to make assumption [in s 129(6)] on the alternative basis. As we understand it, this in substance was the submission of Mr Shaw for Brick and Pipe and in this respect we consider the submission to have been well founded. It is desirable, however, that we elaborate a little on our views as to the operation of [s 129(6)] in combination with [s 129(2)]. In his reasons the learned judge said: If a party is entitled by virtue of [s 129(2)] (or [s 128(3)] for that matter) to assume that a person is a director of a company, it cannot be correct to say that he may also assume that a document was duly sealed if that person purports to attest as secretary. Whether or not [s 128(4)] could then be called in aid, the only attestation by Mr Furst in the present case was in the role of secretary and no assumption can properly be made in favour of the defendants in those circumstances. I would concede that the section talks only of assumptions which may be made and need not necessarily reflect the actual assumptions made by the parties seeking to rely on [s 128]. Nevertheless, if the only source for the proper making of such an assumption is a return showing a person to be a director, he cannot be assumed to be a secretary for the purposes of [s 129(6)]. Moreover the assumption in [s 129(2)] is not merely that a person should be assumed to be a director or secretary but also that he has the “authority to exercise the powers and perform the duties customarily exercised or performed” 342

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Brick and Pipe Industries Ltd v Occidental Life Nominees Pty Ltd cont. by a director or secretary. A director cannot be assumed to have authority to exercise the powers of a secretary and vice versa, so I would reject the defendants’ arguments on this point. However, we do not understand the submission on behalf of the respondents to involve a party being required to make conflicting assumptions. It is predicated on the possible circumstance that a party is unable by reference to a [notice to ASIC] to confirm that a signatory is the secretary but is able to confirm that the person is a director. If then by virtue of the section it may be assumed that the document has been signed by two directors even though one of them has purported to be the secretary, it would seem that the criteria of [s 129(6)] are met. Accordingly, a party may not seek entitlement to make the assumption that a person is both director and secretary. The party may know or believe that a person is not the secretary but know or be entitled to assume that the person is a director. This as we understand it, was essentially the submission which was made on [480] behalf of the respondents. In this case, it was in effect that if Brick and Pipe had not held out Furst as secretary and therefore assumption [s 129(6)] was not available on that basis, then it was available on the basis that he was a director according to the [notice to ASIC]. It must be borne in mind that a person might be both a director and secretary and that articles might authorise “due sealing” in the presence of two directors or alternatively a director and the secretary. The articles of a company might authorise both methods and the methods might vary between them from company to company. It follows that the mere presence of the word “secretary” opposite the signature of a person known not to be secretary does not necessarily mean that the document has not been duly sealed and that a party seeing it thereby has “actual knowledge” that the assumption is not correct. The criteria of assumption [s 129(6)] provided by the section do not include any requirement that a signatory must fit his or her description on the document. In the present case the criteria of the subsection were literally met. It is true, however, that there was evidence that the exception was capable of application because Dodge knew the contents of art 107, that is, that for due sealing a signatory must be the secretary unless the board had approved of someone else. Nevertheless, we are of the opinion that a party may be entitled to make assumption [in s 129(6)] (which in effect creates by virtue of [s 128(1)] an estoppel against Brick and Pipe) if the criteria are met notwithstanding the presence of a wrong designation of the post held by a signatory. We emphasise, of course, that the wrong designation is not for all purposes irrelevant. It might well assist to establish “actual knowledge” within the meaning of [s 128(4)] that the document had not indeed been “duly sealed”, as might have been the case here but for the holding out and the lack of knowledge whether Furst was or was not the secretary. Nevertheless, for the reasons set out above, we are of the opinion that the learned judge was entitled to decide as he did that the respondents were entitled to make the assumption referred to in [s 129(6)].

[5.375]

Notes&Questions

1.

What would be the outcome of the Crabtree-Vickers case [5.335] if its facts had occurred after the introduction of the predecessor to ss 128 – 129? Assume that ADMA’s return to ASIC shows Bruce McWilliam junior as managing director and chief executive officer.

2.

How would the dispute in Northside Developments v Registrar-General [5.355] be decided if the mortgage had been executed in a transaction effected after the introduction of ss 128 and 129 on 1 July 1998? [5.375]

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3.

4.

5.

What is the scope of the exception in s 128(4)? When, if at all, might a contractor be denied the benefit of an assumption where she or he knows of facts which would compel a reasonable person to infer that an agent is exceeding her or his authority? In what circumstances, if any, would s 128(4) deny to a director purporting to contract with her or his company through another officer the protection of the assumptions? Will the subsection apply to deny protection to a controlling shareholder, senior employee or banker of the company? See Roskill J in Hely-Hutchinson v Brayhead Ltd (n 2 [5.357]). What residual application, if any, have the indoor management rule and agency doctrines after the enactment of ss 128 – 129? Can you envisage a situation where a company would escape liability under the statutory provisions, but not those of the general law?

Validation of directors’ acts under defective appointment [5.380] The Act provides that an act done by a director or secretary is effective even if their

appointment or its continuance is invalid because the company or director did not comply with the company’s constitution or the Act: ss 201M, 204E. The subsection validates acts, but not the defective appointment itself. The act in question must have been done before discovery of the fact that there is a defect and the person relying on the section must have acted in good faith and not have been put on inquiry. The section cannot be invoked if there has been no purported appointment at all. 277 A note to these sections explains that the kinds of acts that they validate are those that are legally effective only if the person performing them is a director or secretary (eg, calling a meeting of the company). The provisions do not deal with the question whether an effective act by a director binds the company in its dealings with other people or makes the company liable to another person: ss 201M(2), 204E(2). These questions are decided by reference to ss 128 and 129 and the general law. [5.385]

Review Problems

1. George and Martha operate Global Health Pty Ltd (“Global”). Each holds 50% of the equity and they are joint managing directors. Their fathers are the only other directors. The board decides to dispose of one of its subsidiaries, HealthEquip, and George is instructed to look for potential buyers and to bring back to the board a recommendation as to the proposed purchaser. After canvassing a number of potential buyers, George identifies FixxFit as the highest bidder. Global has sold equipment to FixxFit over a number of years. FixxFit’s owner, Jim Fixx, tells George that he will pay a premium for the assets of HealthEquip but will not buy the HealthEquip shares since he wants to take the assets free of any claims that might be made in the future against HealthEquip. (George understands that Jim is concerned about the risk of future consumer claims.) FixxFit insists upon an immediate sale and George signs written “heads of agreement” specifying all the essential elements of the sale to it. George does so “on behalf of Global”. In the meantime and without informing George, Martha finds a potential buyer who expresses “strong interest” in purchasing the HealthEquip assets for a significantly higher price than FixxFit. May Global avoid the agreement with FixxFit so that it can proceed with Martha’s potential buyer? Would it make any difference if George had authorised his father, as his nominee on the board, to find a bidder for HealthEquip and that it was 277

See Morris v Kanssen [1946] AC 459; Grant v John Grant & Sons Pty Ltd (1950) 82 CLR 1; Albert Gardens (Manly) Pty Ltd v Mercantile Credits Ltd (1973) 131 CLR 60.

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George’s father (not George himself) who had identified FixxFit as the highest bidder and had signed the heads of agreement with FixxFit’s owner, Jim Fixx? 2. Essie has recently been appointed Managing Director of Widgets Pty Ltd. The company needs to sell assets to reduce its debt burden. Essie’s authority to dispose of assets has been capped by the board at $500,000 per individual transaction. She negotiates for the sale to Gullible Pty Ltd of plant and equipment at $550,000 which is valued by Widgets at about $450,000. She tells Gullible’s managing director that she has “an unpredictable board which is prone to changing its mind about corporate strategy”, and that there is “only a narrow window of opportunity for the sale of these assets before the board closes off asset disposals entirely and clamps down on what I’m doing”. Gullible accepts her asking price; she had expected that the sale price would be reduced in negotiations to below the board’s cap of $500,000. The sale is effected by the exchange of letters signed by the managing directors of the two companies. When it hears of it, the board of Widgets wants to unwind the sale of what it sees as a key asset. May it do so?

[5.385]

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CHAPTER 6 Shareholders Acting Collectively: The Company in General Meeting [6.10]

ALTERNATIVES TO MEETINGS ....................................................................................................... 348

[6.15]

CONVENING THE GENERAL MEETING .......................................................................................... 349 [6.15] [6.25] [6.30]

Directors’ powers to convene meetings ........................................................................ 349 Members’ direct right to convene a meeting ............................................................... 351 Members’ right to requisition a meeting ...................................................................... 352

[6.35] [6.40]

Proper purpose ............................................................................................................ 353 Constitutional limitations ............................................................................................. 354

[6.50]

Convening general meetings by court order ................................................................ 356

[6.60]

NOTICE OF MEETINGS ................................................................................................................. 359

[6.65]

MEMBERS’ RIGHTS TO PUT RESOLUTIONS AND HAVE THE COMPANY CIRCULATE STATEMENTS .... 360

[6.70]

CONDUCTING THE MEETING ...................................................................................................... 363

[6.75]

VOTING AT MEETINGS .................................................................................................................. 365

[6.90]

[6.75]

The functions of voting rights ...................................................................................... 365

[6.80]

Voting rights and their exercise .................................................................................... 367

[6.85]

Proxy voting ................................................................................................................ 368

DISCLOSURE OBLIGATIONS .......................................................................................................... 371 [6.90]

The range of disclosure obligations .............................................................................. 371

[6.95]

The equitable duty to disclose matters material to shareholder judgment .................... 373

[6.05] Members of a company have both individual and collective rights. Individual

members’ rights protect against oppression or overreaching by directors and other controllers. In some circumstances individual shareholders may sue to enforce duties imposed on directors and corporate controllers. These individual rights are considered in Chapter 8. The general meeting of members (here also called the shareholders meeting) is the means by which one of the two corporate organs functions: see [3.150]. The collective powers that the Corporations Act vests in the general meeting relate principally to the constitutional and capital structure of the company, the composition of the board, and certain fundamental changes: see [5.100]. These powers may be augmented by those conferred by a company’s constitution. The powers enable the general meeting to act as a counterbalance to the directors, exercising in some instances the role of the organ with ultimate sovereignty, in others a more general gatekeeper function, particularly in relation to organic changes or transactions affected by directors’ conflicts of interest. The exercise of some powers requires a special resolution. Decisions taken by the general meeting will be efficacious only if they comply with procedural and disclosure requirements designed to protect the integrity of those decisions themselves. Irregularities may, however, be cured in some circumstances by judicial order under s 1322. These procedural requirements relate to the convening and conduct of general meetings, notices and circulars distributed to members, and voting at meetings. They are the subject of this chapter. These provisions may apply also to meetings of a class of members, of debenture holders and of other creditors under specific provisions of the Act or under the terms of the instrument creating the interests. [6.05]

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The concerns of this chapter are not, however, purely technical. As we have seen ([2.195]), institutional shareholders engage with company management more or less continuously and are encouraged to do so by industry standards of responsible share ownership. Nevertheless, the general meeting of members remains a central institution of shareholder engagement even if it is now perhaps of greater significance for retail than institutional shareholders in public companies. It provides a physical forum, often augmented by technology, for reporting to shareholders through the annual report in the case of public companies, questioning management, discussing and deliberating on matters for decision in the meeting, and voting on those matters that require collective shareholder decision. The general meeting is the forum for members to exercise such control prerogatives as they possess collectively; indeed, it may be the site for contests for corporate control, through contested director elections or for approval of a transaction that will transfer control or affect its distribution. No less dramatically, the general meeting may be a site through which social and environmental claims upon the company are ventilated with the drama of contest in a public forum. The legitimacy of this use of shareholder meetings has been strongly contested: see [6.40]. This contested use of shareholder meetings, and the industry promotion of continuous institutional shareholder engagement, prompts questions as to the purpose general meetings perform and whether these purposes might be better served by other measures. 1 The status of shareholder meetings has changed dramatically over time, from the sovereign group within the corporation to a body whose formal control prerogatives have in many publicly held companies been effectively ceded to the board through the combined effect of the dispersal of shareholdings and the operation of proxy voting mechanisms: see [2.185] and [6.85]. The sheer number of shareholders in many publicly held companies makes the holding of physical meetings very difficult, even for the minority of shareholders who choose to attend, despite the use of audio-visual communications to simultaneously link several sites together. Would an asynchronous virtual meeting offer a superior alternative to the physical meeting? What other models might be fashioned? At the base of these questions is a more fundamental question: in view of these developments, what is the proper role and entitlement of shareholders in the modern publicly held company?

ALTERNATIVES TO MEETINGS [6.10] The ritual of a periodic general meeting is a necessary part of corporate life for some

but not the majority of companies. A public company (other than a single member company) must hold an annual general meeting (AGM) at least once in every calendar year and within five months after the end of its financial year: s 250N(2). The company’s annual financial report, directors’ report and auditor’s report must be laid before the meeting: s 317 and see [9.130]. Whether or not it is referred to in the notice of meeting, the business of the AGM includes • consideration of these reports • the election of directors • the appointment of the auditor, and 1

See G North (2013) 31 C&SLJ 167; Corporations and Markets Advisory Committee, The AGM and Shareholder Engagement, Discussion Paper (2012), ch 6; Parliamentary Joint Committee on Corporations and Financial Services, Better Shareholders – Better Company: Shareholder Engagement and Participation in Australia (2008); Chartered Secretaries Australia, Rethinking the AGM: A Discussion Paper (2008); Blake Dawson Waldron, 2006 AGMs: Review and Results (2007); Companies and Securities Advisory Committee, Shareholder Participation in the Modern Listed Company, Final Report (2000); R Simmonds (2001) 19 C&SLJ 506; D Birnhak (2003) 29 Rutgers Comp & Tech LJ 423.

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• fixing the auditor’s remuneration: s 250R. Otherwise, the Act does not prescribe that a periodic general meeting shall be held or what its business shall be. 2 Of course, a general meeting may be held for a number of purposes under the Act or a company’s constitution, quite independently of the requirement of an AGM. These include the sanctioning of capital transactions or those affected by affinity relationships involving directors (eg, related party transactions under Ch 2E). Often, of course, to reduce expense these approvals will be sought at an AGM. While the requirement to hold a general meeting may arise from myriad provisions throughout the Act, it regulates in Pt 2G.2 the convening and conduct of those meetings that are held pursuant to some particular provision of the Act or under a company’s constitution. At the other end of the size spectrum, the Act obviates the need for a meeting of members by providing an informal procedure for passing members’ resolutions in single member companies and in proprietary companies generally. A single member company may pass a resolution simply by the member recording it and signing the record: s 249B(1). A proprietary company with more than one member may pass a resolution without a general meeting being held if all the members entitled to vote on the resolution sign a document containing a statement that they are in favour of the resolution set out in the document: s 249A(2). This circulating resolution facility applies to ordinary and special resolutions required or permitted under the Act or a company’s constitution except a resolution to remove an auditor under s 329: s 249A(1). Any document that would otherwise have been given to members if the resolution were being proposed at a general meeting must be distributed with the circulating minute: s 249A(5)(a). The facility does not derogate from general law doctrines relating to the effect of informal shareholder consensus: s 249A(7) and see [5.155].

CONVENING THE GENERAL MEETING Directors’ powers to convene meetings [6.15] The Act and company constitutions provide multiple modes of convening general

meetings. In many situations the provisions of the constitution and the Act will provide parallel provisions differing, if at all, only in the time limits within which action may be taken. Under standard constitutional provisions and the Act, the general meeting may be convened by • an individual director • the board of directors • a member or group of members satisfying a voting standard or • a court order. A company’s constitution will usually make provision for calling a general meeting although the Act provides a replaceable rule authorising a director to call a general meeting: s 249C. In the case of a listed company incorporated in Australia, the rule is mandatory and applies notwithstanding anything in the company’s constitution: s 249CA. The board of directors enjoys an inherent power to convene a general meeting. Indeed, in practice, general meetings are usually convened by a notice signed by the company secretary pursuant to a resolution of directors. Even when the power to convene a meeting is exercised by an individual director, it is a fiduciary power to be exercised for the benefit of the company as a whole, and not for the 2

Following an older usage retained in the constitutions of some companies, general meetings other than an AGM are sometimes referred to as extraordinary general meetings or EGMs. Alternatively, they are called special meetings. [6.15]

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benefit of the directors or a group of shareholders of the company. 3 This general law doctrine was introduced into the Act in 1998 with the requirement that a general meeting must be held for a proper purpose: s 249Q: see [6.35] and [6.70]. 4 A general meeting must be held at a reasonable time and place: s 249R. The provision has been interpreted as not creating any substantive law in view of the constraints of the fiduciary obligation attaching to the exercise of the convening powers by directors or by shareholder requisitionists who stand in their shoes under statutory procedures: see [6.30]. In one case, the court held that the time of 6 pm on 30 December was not an inherently unreasonable time. 5 The governing principles and their application are explored in the following extract.

Smith v Sadler [6.20] Smith v Sadler (1997) 25 ACSR 672 Supreme Court of New South Wales [A company’s AGM was convened to be held on premises licensed under the then Liquor Act 1982 (NSW) of which premises the defendant was licensee. The defendant would not permit the plaintiff member to enter upon the premises because he was apprehensive about the plaintiff’s conduct and owed a duty under the Liquor Act to ensure that no disturbance occurred upon licensed premises. The plaintiff sought to restrain his exclusion from attending the AGM.] YOUNG J: [673] It is clear that at the time when the notice convening the meeting was issued the problem about the plaintiff going onto the premises where the meeting was to be held was a very real one. It seemed to me that because this was known to the board of the co-operative, the convening of the meeting may be invalid. Although in some circumstances the board of a company or co-operative may be able to convene a meeting without any constraint (see, eg, Campbell v Lowe’s Inc 134A (2d) 852 (Del Ch 1957) at 856) in general, directors have a fiduciary duty to convene meetings, particularly annual general meetings at a time and a place where all members of the company present in the state will be able to attend. In Albert E Touchet Inc v Touchet 163 NE 184 (Mass 1928) Rugg CJ emphasised at 188 that the right to participate in the annual general meeting and the right to vote at elections held at that meeting is a right that is inherent in the ownership of the stock. Thus it is not competent for the board of directors to frustrate that right by either not holding a meeting or holding it at a time or place where it is almost impossible for some shareholders to attend: see also Camden & Atlantic Railroad v Elkins 37 NJ Eq (10 Stew) 273 at 276. In Coombs v Dynasty Pty Ltd (1994) 14 ACSR 60 at 93, von Doussa J said: An annual general meeting is not a mere formality, particularly for members who have no opportunity to ask questions about the affairs of the company. To hold a meeting at a time and place where members are unlikely to be able to attend is tantamount to not holding a meeting at all. I respectfully agree. The rules of the co-operative are in evidence. Rule 28 provides that the Annual General Meeting is to be held “at such place as the Board may determine”. The rule in this general form does not exclude the fiduciary duty noted above. So directors must turn their minds to an appropriate place at which all members of the co-operative within the state could attend as of right. They cannot choose a place where they have reason to suspect that one or more members will be excluded by the person in control of the specified premises. There were a series of situations about 30 years ago where companies deliberately scheduled annual general meetings in obscure upstate towns during [674] the festive season. In some countries, this 3 4

Australian Innovation Ltd v Petrovsky (1996) 21 ACSR 218 at 222; see also [7.215] for an overview of remedies and their outcomes. The section does not, however, introduce any new substantive law: Howard v Mechtler (1999) 30 ACSR 434 at 442.

5

Howard v Mechtler (1999) 30 ACSR 434 at 442.

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Smith v Sadler cont. practice was curbed by the regulatory authorities. Where this has not occurred and for private companies and co-operatives, the practice is controlled by the court policing fiduciary duties not to use the power to convene a meeting as a cloak for fraud. In other words, it is ordinarily a fraud on the power to convene a meeting at a time and place when or where at least one member cannot lawfully attend. Obviously this proposition does not apply where a member is in gaol or overseas or merely finds it inconvenient to attend at the specified time and place. After these matters were ventilated, the parties assessed their position and I am able to make the orders ensuring that the plaintiff can attend the meeting, but requiring that it be adjourned for an hour so that those who are present in court will be able to travel to [the meeting] and attend it. It seemed to me that had this consensus not been reached, it would have been necessary to order that the meeting only transact formal business and then adjourn to premises where the plaintiff had a right to attend. In this way the court would cause minimum disruption to the 250 people who may well attend the meeting but still permit the plaintiff to attend. Such an order would get over the problem that the defendant had the right to control who came onto his licensed premises, as well as the principle that the court does not lightly prevent people from meeting: see Uniting Church of Australia Property Trust (NSW) v Macquarie Radio Network Pty Ltd (1997) 24 ACSR 721.

Members’ direct right to convene a meeting [6.25] Members possess two distinct statutory rights to convene meetings. The first is a direct

right to convene a meeting at their own expense. The second is the right to requisition directors to call a meeting and, if directors fail to do so, to convene it themselves. The second mode is discussed at [6.30]. As for the first mode, members with at least 5% of the votes that may be cast at a general meeting may convene a general meeting at their own expense: s 249F(1). The general meeting must be called in the same way, so far as possible, in which general meetings of the company may be called: s 249F(2). 6 Directors may only postpone such a general meeting if the company’s constitution expressly permits them to do so – the general management power in s 198A is not sufficient to confer such authority. 7 The direct right is likely to be of value in two situations. The first is where there are no directors to call meetings or if a company’s constitution does not allow a director to call a meeting. 8 Second, a member might find a tactical advantage over directors in a contested meeting through their choice of its timing and venue, rather than leaving these matters to the directors’ determination under a requisitioned meeting. This advantage comes at the price of bearing the expense of calling and holding the meeting. 6

7 8

See further N Pathak & H Lauritsen (2005) 23 C&SLJ 283. Prior to 1998, the direct power to convene a general meeting applied only “so far as the articles do not make any other provision”. A provision in a company’s constitution which provided for requisitioning of a meeting by members was sufficient to displace the direct right to convene a general meeting even though the constitutional provision added nothing to members’ statutory rights: L C O’Neil Enterprises Pty Ltd v Toxic Treatments Ltd (1986) 4 NSWLR 660. Indeed, the direct right to convene meetings under the former power might be displaced by any provision in the constitution specifying who may call a meeting, even one that confides the power to directors exclusively: Re Totex-Adon Pty Ltd [1980] 1 NSWLR 605 (see [6.55]); Vision Nominees Pty Ltd v Pangea Resources Ltd (1988) 14 NSWLR 38. Accordingly, the removal of this qualification upon the direct right significantly broadens its scope. McKerlie v Drillsearch Energy Ltd (2009) 74 NSWLR 673 at [13]; Carpathian Resources Ltd v Highmoor Business Corp [2010] FCA 1294. Company Law Review Bill 1997, Explanatory Memorandum, [10.22]. The alternative court procedure under s 249G is relatively costly and time consuming. [6.25]

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Members may not convene a meeting for the purpose of passing a resolution that is beyond the constitutional power of the general meeting. This general law rule is reinforced from 1998 by a statutory requirement that general meetings must be held for a proper purpose: s 249Q. These limitations upon the power of direct convening are considered in [6.30] and [6.35] in the context of meetings convened by directors upon shareholder requisition. Members’ right to requisition a meeting

Voting power requirement [6.30] The directors must call and arrange to hold a general meeting on the request of

members with at least 5% of the votes that may be cast at the meeting: s 249D(1). The request must be in writing, signed by the members, state any resolution to be proposed at the meeting and be given to the company: s 249D(2). Upon receipt of the request, the directors must call the meeting within 21 days for a date within two months of the requisition: s 249D(5). If the directors do not call and arrange a meeting within 21 days of a request under s 249D, requisitioning members with more than half of the votes of those who issued the request may themselves convene the meeting: s 249E(1). The meeting must be called in the same way, as far as possible, in which general meetings of the company may be called and must be held within three months of the members’ request: s 249E(2). The company must give the requisitioning members, upon request and without charge, a copy of the register of members and must pay the members their reasonable expenses in convening the meeting: s 249E(3), (4). The company may recover those expenses from the directors who are jointly and individually (that is, severally) liable for them unless individual directors establish that they took all reasonable steps to cause the directors to comply with their obligation to convene a meeting upon the requisition: s 249E(5). Prior to 2015, 100 voting members might also requisition a general meeting under s 249D(1). The numerical test in s 249D(1) then did not stipulate any minimum shareholding for each member joining in the requisition. Accordingly, it was criticised upon the basis that, especially in its application to listed companies, it could result in a relatively small group of shareholders without any significant economic interest in the company validly requisitioning a general meeting to be conducted at the company’s expense. 9 There was considerable pressure from large companies either to abolish the numerical test entirely (and simply require 5% voting power to requisition a meeting), 10 to raise it to a higher proportion of the company’s membership or to couple it with a minimum shareholding requirement for each member joining in the requisition. In 2015, s 249D was amended to confine the requisition right to members holding in aggregate 5% of voting rights. The change was explained on the basis that in large corporations, 100 members may hold a very small percentage of voting shares – often below 1% and that accordingly a very small percentage of shareholders could require a company to hold a general meeting and to incur the subsequent costs; second, resolutions that had been proposed in the past at meetings held at the request of 100 members had generally 9

10

352

Company Law Review Bill 1997, Explanatory Memorandum, [2.4]. It was also said that the requisition power could also be used to give those shareholders undue leverage in negotiating with the company: Company Law Review Bill 1997, Explanatory Memorandum, [2.4]. Comparable jurisdictions in Europe and North America employ only an issued share capital test with thresholds ranging from 5% to 20% of voting capital: [2.7]-[2.10]; for contrasting views on the utility of the 100 member rule, see P Darvas (2002) 20 C&SLJ 390 and S Milne & N Wakefield Evans (2003) 31 ABLR 285. See, eg, the opinions expressed in Companies and Securities Advisory Committee, Shareholder Participation in the Modern Listed Company, Final Report (2000), [2.15]-[2.18]. The Advisory Committee recommended the abolition of the numerical requirement. [6.30]

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received little support. 11 The amendment leaves intact provisions in the Act that permit 100 voting members to put a resolution on the agenda of general meetings and circulate material to other members at the expense of the company: see [6.65]. 12 In his dissenting report to a Parliamentary review of the proposed amendment, Senator Nick Xenophon quoted the Australia Institute’s submission that the amendment “would be an obstacle to civil society, which increasingly plays an important role using shareholder activism in pursuit of socially responsible corporate behaviour”; Senator Xenophon referred to the requisition in 2012, by 210 Woolworths shareholders, of an extraordinary general meeting of the company to vote on a resolution in relation to Woolworths’ ownership of poker machines. He wrote that Woolworths owns 13,000 poker machines and “makes over $1.2 billion in poker machine losses”; if passed, the resolution would have amended Woolworths’ constitution to prevent it owning, operating or benefiting from gaming machines operating at a cost of more than $1 per button push or which exceed specified revenue or operating period thresholds. Although the resolution was ultimately defeated, Senator Xenophon argued that “it nonetheless enabled shareholders to force Woolworths and its shareholders to consider whether profiting from poker machine losses is socially responsible corporate behaviour”. 13 Proper purpose [6.35] A shareholder’s right of requisition must be exercised bona fide and for a proper

purpose: this general law rule is now partly expressed in the statutory requirement that general meetings must be held for a proper purpose (s 249Q) although this provision does no more than restate the general law. 14 Until the expiration of the period within which the directors must convene a meeting pursuant to the requisition, the requisitionist is entitled to act in its own interests provided only “that its requisition is bona fide, in that its objective is to have the resolutions passed and not simply to harass the company and its directors”. 15 However, once the statutory period within which the directors should convene the meeting passes, the requisitionists become a “quasi-official” of the company acting in the place of the directors for the limited purpose of convening the meeting. Where the shareholder requisitionists proceed to convene a meeting, they must exercise their rights “in a manner that has regard to the best interests of the company as a whole”; nonetheless, courts are reluctant to interfere with a minority shareholder’s statutory right to convene a general meeting and generally will do so only when it is clear that their purpose is something other than the passing of the resolutions contained in the requisition. 16 In one instance, despite the inconvenience of the requisition (which proposed resolutions for the removal of directors identical to those which had been 11

Corporations Legislation Amendment (Deregulatory and Other Measures Bill) 2014, Explanatory Memorandum, [1.4]-[1.5].

12

The Australian Shareholders Association queried the change: “over the past 20 years, there have only been about 15 examples of 100 signatures being gathered to trigger a vote at an ASX-200 shareholder meeting, and the vast majority of these occurred on the day of the AGM”; it suggested instead that “the government should cut red tape for Australia’s seven million retail investors by only requiring 10 signatures for AGM shareholder resolutions. This is the best way to energise lifeless AGMs”: Letter, Australian Financial Review (4 March 2014).

13

Senate, Economic Legislation Committee, Corporations Legislation Amendment (Deregulatory and Other Measures Bill) 2014, Dissenting Report by Senator Nick Xenophon (2015), [1.3]-[1.6]; on Woolworths’ application, the court extended the time for holding the meeting to allow it to be held on the same day as the company’s AGM: Woolworths Ltd v GetUp Ltd [2012] FCA 726; see [6.40].

14

“Why it was introduced is uncertain as it is accepted that it brought about no change in the existing common law”: NRMA Ltd v Snodgrass (2001) ACSR 382 at [12]. Adams v Adhesives Ltd (1932) 32 SR (NSW) 398 at 401; Humes Ltd v Unity APA Ltd (1987) 11 ACLR 641 at 646; Re Ariadne Australia Ltd (1990) 2 ACSR 791 at 794; Australian Innovation Ltd v Petrovsky (1996) 21 ACSR 218. Humes Ltd v Unity APA Ltd (1987) 11 ACLR 641 at 647.

15 16

[6.35]

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defeated at the annual general meeting held earlier on the same day), and the substantial expenditure required to hold the meeting, the court was not satisfied that the requisitionist’s motive in calling the meeting was other than to place its resolutions before the meeting. Such a motive was held to be unobjectionable. 17 The position will be otherwise where the purpose of the requisition is improper, for example, because it is intended simply to harass the company and its directors. 18 Where the requisitionist has mixed purposes, one proper and the other improper, the improper purpose need not corrupt the exercise of power: If the purpose for which the requisition is made is truly to have a meeting of members convened in order to consider and, if thought fit, to pass the resolution, then it does not matter that the requisitionist is motivated to pursue that purpose by ill-will or self interest. The rationale underlying the law in this regard is the same as that which applies in the law relating to abuse of process … an abuse of process occurs when the purpose of bringing the proceedings is not to prosecute them to a conclusion but to use them as a means of obtaining some advantage for which they are not designed or for some collateral advantage beyond what the law offers. … If, as in this case, the defendants resort to the rights … to requisition a meeting for the purpose of passing a resolution valid in terms, then their motivation in doing so is irrelevant to the question whether the requisition power is properly exercised. 19

Constitutional limitations [6.40] Members may not requisition a meeting for the purpose of passing a resolution that is

beyond the constitutional power of the general meeting. In National Roads & Motorists’ Association v Parker McLelland J said: it is no part of the function of the members of a company in general meeting by resolution, ie as a formal act of the company, to express an opinion as to how a power vested by the constitution of the company in some other body or person ought to be exercised by that other body or person. … The members of the plaintiff no doubt have a legitimate interest in how these powers are exercised, but in their organic capacity in general meeting they have no part to play in the actual exercise of the powers. 20

The directors may omit such a proposed resolution from the notice of meeting without the consent of the requisitionists 21 or refuse to convene the meeting where its agenda contains a significant number of items that are beyond the power of the meeting and cannot be severed by simple procedural amendment. 22 It is undesirable to allow proposed resolutions that would be legally meaningless, because they are beyond the constitutional power of the meeting, to go forward for consideration lest the later resolution be invested with greater meaning and given effect; the court would restrain such a meeting convened by members and say to directors that they are under no obligation to convene a requisitioned meeting to consider proposed resolutions beyond power. 23 This general law rule was reinforced by the 1998 statutory requirement that general meetings be held for a proper purpose: s 249Q. 17

Humes Ltd v Unity APA Ltd (1987) 11 ACLR 641.

18

Howard v Mechtler (1999) 30 ACSR 434 at 442; Australian Innovation Ltd v Petrovsky (1996) 21 ACSR 218 at 222. NRMA Limited v Scandrett [2002] NSWSC 1123 at [53]-[54], [56]. The alleged impropriety, which was assumed to exist for the sake of argument, was that the requisitions were but part of a campaign being waged by one group of directors to enable them to gain control of the board, regardless of the cost to the company, financial or otherwise; Adams v Yindjibarndi Aboriginal Corporation RNTBC [2014] WASC 467.

19

20

(1986) 6 NSWLR 517 at 522.

21

Turner v Berner (1978) 3 ACLR 272; NRMA v Parker (1986) 11 ACLR 1; Queensland Press Ltd v Academy Investments No 3 Pty Ltd (1987) 11 ACLR 419. Totally & Permanently Incapacitated Veterans’ Association of NSW Ltd v Gadd (1998) 28 ACSR 549; Windsor v National Mutual Life Association of Australasia Ltd (1992) 7 ACSR 210.

22 23

Re Winlyn Investments Pty Ltd (2011) 86 ACSR 197 at [30].

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The criticism of the former 100 member numerical test for requisitioning meetings (see [6.30]) was sometimes linked with the assertion that the requisitioning group was essentially concerned with social, environmental or industrial goals and that its use of the requisitioning power was purely instrumental towards that end. 24 To avoid the objection that the proposed resolution is beyond the constitutional power of the general meeting (a concern that persists with the abolition of the numerical test), requisitionists often link their substantive goals with the election (or removal) of directors or a proposal for constitutional amendment, matters clearly within the meeting’s competence. 25 Thus, in National Roads and Motorists’ Association Limited v Parkin, 4,000 members requisitioned a meeting of a non-profit guarantee company with almost 2 million members. The requisition arose after apparent breakdown in industrial negotiations between the union representing patrol officers and the NRMA. 26 The employees gathered the required number of signatures and called on the directors to call a general meeting of the company to consider two resolutions, both proposing the insertion of an additional clause in the company’s constitution. The first clause stated that the employees “are not [to be] disadvantaged in the provision of [the services which they provide] by having their current working conditions undermined”; the second insertion was for a clause stating that an object of the NRMA is to “ensure fair and equitable remuneration and working conditions are available to all employees” and to ensure that the relevant employees are not “discriminate[d] against”. NRMA disputed the validity of the two resolutions contained in the requisition (and, hence, the validity of the requisition) on the grounds of ambiguity, and alternatively, uncertainty. However, the court held that: Leaving it to the meeting to resolve problems of this kind, where possible, has long been the approach of the courts. … Mere ambiguity (not constituting uncertainty) in expression in defining and delimiting the powers of a company is insufficient reason to hold that the defining and delimiting provisions are invalid. It may be that the company, its members and directors, as 24

Certainly, there have been instances of meetings requisitioned with a social, environmental or industrial dimension. Thus, 210 members (lead by the social activist group GetUp) requisitioned a meeting of Woolworths to consider proposals for constitutional amendments that would prevent it owning, or deriving revenue from, electronic gambling machines in its hotels; under s 1322(4)(d), on the company’s application, the court extended the time for holding the meeting to allow it to be held on the same day as the AGM: Woolworths Ltd v GetUp Ltd [2012] FCA 726. In 1999 about 120 shareholders out of a total of 67,000 shareholders (holding 350,000 shares out of 760 million shares) in North Ltd requisitioned a meeting to deal with issues concerning the company’s Jabiluka uranium project in the Northern Territory. By agreement with company management, the requisitioned meeting was held on the same day as the company AGM. In the same year, a meeting of Wesfarmers Ltd was convened on the requisition of 166 shareholders to consider eight resolutions all relating to forest issues. Of the 166 requests, 109 were from shareholders holding one share in the company and 30 are from shareholders holding less than ten shares each. The 13,792 shares held by the requisitioning shareholders represented 0.005% of the company’s voting shares. A special meeting was held and the resolutions proposed were defeated by substantial margins. See P Darvas (2002) 20 C&SLJ 390. On labour union use of shareholder voting rights to promote employee interests see K Anderson & I Ramsay (2006) 24 C&SLJ 279 (activism usually occurs in the context of an industrial dispute, typically to put pressure on management or to reopen stalled talks, but activism is also used to achieve traditional governance goals such as the appointment of independent directors).

25

Canadian legislation permits directors to refuse to convene a meeting if “it clearly appears that the proposal is submitted by the shareholder primarily for the purpose of enforcing a personal claim or redressing a personal grievance against the corporation or its directors … or primarily for the purpose of promoting general economic, political, racial, religious, social or similar causes”: Canadian Business Corporations Act, ss 143(3)(c), 137(5)(b). [2004] NSWCA 153. By far the greatest single body of litigation contesting the requisitioning of shareholder meetings concerns the NRMA (12 requisitions in a two-year period, most contested unsuccessfully by the company). All requisitions were based upon the numerical test; there is a corresponding body of judicial lament about the (now discarded) 100 member rule: see NRMA Limited v Scandrett [2002] NSWSC 1123 at [57]; NRMA v Snodgrass (2002) 42 ACSR 371 at 376.

26

[6.40]

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a matter of practical business, should not agree to such provisions or should vary them. But that is a matter for them, not the courts. If they wish to operate pursuant to ambiguous powers (which are not uncertain), it is open to them to do so. … [quoting the judge at first instance:] “I would readily accept that it would be necessary, in construing the object set out in the second resolution, to decide what is the criterion by reference to which it is seeking to say discrimination cannot occur. However, I do not see that task as one which is inherently incapable of being performed, difficult as it might be to actually perform it.” [As regards the challenge on the basis of uncertainty] if the Court is capable of putting a meaning on the wording of the document, then it is not void for uncertainty – it has the meaning which the Court decides it has, no matter how difficult the task of ascertaining that meaning might have been. 27

The court concluded in regard to the first resolution that the difficulties in its construction and operation, which NRMA asserted, were capable of resolution by a court and that the second resolution was not uncertain under the criterion it identified. In 2003, one listed Australian company, the building materials company Boral, responded to this problem (as it saw it) by amending its constitution to require that any future proposal for constitutional amendment must first be approved by the board or proposed by members holding 5% of voting shares in the company. In doing so, it relied upon the constitutional entrenchment facility contained in s 136(3): see [3.145]. 28 Convening general meetings by court order [6.50] A meeting may also be convened by court order if it is impracticable to call the meeting

in any other way: s 249G(1). The court may make the order on the application of a director or any member who would be entitled to vote at the meeting: s 249G(2). Thus, in Re El Sombrero Ltd one shareholder held 90% of the issued capital of the company; each of the two directors held 5% of the shares. (The three were the only members of the company.) Under the company’s constitution the quorum for a general meeting was two members and if a quorum was not present within half an hour of the appointed time the meeting, if convened on the requisition of members, was dissolved. No general meeting of the company had ever been held. The majority shareholder requisitioned a meeting for the purposes of passing resolutions for the removal of the directors. The directors deliberately did not attend the meeting and, as a quorum was not present, the meeting was dissolved. The major shareholder applied for an order for a court-convened meeting under the equivalent of s 249G. The application was opposed by the directors. Wynn-Parry J made the order, saying [T]his is eminently a case in which the court ought to exercise its discretion; first, because, if the court were to refuse the application, it would be depriving the applicant of a statutory right which, through the company, he is entitled to exercise under [s 203D] to remove the respondents as directors. Second (and I think that this is a proper matter to take into account as 27

National Roads and Motorists’ Association Limited v Parkin [2004] NSWCA 153 at [63], [74], [100], [36]. At first instance NRMA also argued that the requisition was for an improper purpose but it did not appeal against the rejection of this ground. The position was found to be otherwise in NRMA v Bradley [2002] NSWSC 788 in relation to proposed resolutions which would have the effect of halving the number of directors without a procedure to determine who would remain in office: “[c]ertainty is essential in the management and control of public companies and if the amendment were passed, then there would be no certainty, and more likely chaos. The directors ought not be required to put the proposed resolution in those circumstances. That is not to say it would not be possible to work out some procedure under which the number of directors was reduced, but the proposed resolution does not do so.”

28

However, the measure adopted by Boral is both under and over inclusive: it does not address requisitioned meetings that propose other resolutions and also raises a significant barrier to proposals for constitutional amendment without any social dimensions that emanate from non-institutional shareholders. For them, the 5% voting requirement or that of board approval might be a significant barrier.

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part of the reasons for deciding to exercise my discretion), because the evidence disclosed that the respondents are failing to perform their statutory duty to call an annual general meeting. 29

The case is discussed further in the following case extract.

Re Totex-Adon Pty Ltd [6.55] Re Totex-Adon Pty Ltd [1980] 1 NSWLR 605 Supreme Court of New South Wales NEEDHAM J: [606] (1) This is an application by John Harold Manley for an order under [s 249G] calling a meeting of Totex-Adon Pty Ltd. The respondent is Philip Marco. The summons seeks an order for the calling of a meeting of the holders of “A” class shares in the company; but counsel for the applicant, during argument, sought, alternatively, an order calling a meeting of the company. (2) The facts are not in dispute. Messrs Manley and Marco, in April 1976, agreed to conduct business together in the sale of certain classes of goods in Queensland. The goods were to be supplied by Totex (Aust) Pty Ltd, a company controlled by the applicant. The respondent was to be in charge of the sale of the goods. The parties agreed to form what was called a “joint venture company” for the purposes of this business. They in fact acquired a company called Hatonosu No 5 Pty Ltd from Mr Manley’s accountant, and the name was changed to Totex-Adon Pty Ltd. On 24 May 1976, the original directors resigned, and Messrs Manley and Marco were appointed directors and their respective wives were appointed alternate and associate directors. On the same day, the following shares were allotted: Mr Manley – 1 “A” class share; Mr Marco – 1 “A” class share; Adon Pty Ltd (a company controlled by Mr Marco) – 750 “E” class non-cumulative redeemable preference shares; Totex (Aust) Pty Ltd – 250 “F” class non-cumulative redeemable preference shares. (3) Approval was also granted to the transfer to Mr Manley, from the original shareholders, of two “A” class shares. (4) The company is a Table A company, the capital of which is divided into various classes. The only persons entitled to vote at meetings of the company are holders of “A” class shares. Holders of “E” and “F” class [607] shares are entitled to dividends if “profits of the Company are available to pay such dividends”. The holders of such shares “shall not be entitled to vote either by proxy or in person at any meeting of the Company on any issue whatsoever”. (5) Goods were supplied to Mr Marco, but no payment had been made to the company for them. On 8 August 1977, the company sued Mr Marco in the Common Law Division of this court, claiming the sum of $38,281.51. As no annual general meeting had been called and held, it is common ground that, by 26 September 1977, the company was without directors. The parties were apparently oblivious of this fact. … [Subsequently the proceedings were transferred to the Equity Division.] (7) Correspondence between the respective solicitors followed. By letter of 11 May 1979, Mr Manley’s solicitors asked Mr Marco whether he would attend a meeting of shareholders, the purpose of such meeting being to resolve to call a general meeting of the company to appoint directors. The reply of Mr Marco’s solicitors was argumentative, but not helpful. They did say, however, that they “would be more than happy to co-operate with any real attempt to put the company into the position which it was envisaged it should have”. Despite this apparent air of reasonableness, they declined to approve of the suggestion made, and made no counter-suggestion. They also raised the spectre of the auditor’s right to attend. There has been no minute noted of any agreement of the members of the company that it was not necessary for the company to appoint an auditor and, therefore, the company was bound to appoint one. The solicitors for the applicant wrote again on 22 June 1979, seeking the respondent’s co-operation in meeting for the purpose of calling a general meeting of the company. The proposal was specifically rejected in a letter dated 2 July 1979. “Willingness to co-operate” was again indicated, but in what activity was not stated. The summons was filed on 6 July 1979. (8) The applicant says that it is “impracticable to call a meeting in any manner in which meetings may be called … by the articles or (the Companies) Act”, and that, therefore, the court should call a general 29

Re El Sombrero Ltd [1958] 3 All ER 1 at 5-6. [6.55]

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Re Totex-Adon Pty Ltd cont. meeting, making a direction that one member present should be deemed to constitute a meeting under [s 249G]. The respondent says that a meeting could be called by virtue of the power given by [the predecessor to s 249F] which reads: “So far as the articles do not make other provision in that behalf, two or more members holding not less than one-tenth of the issued share capital or, if the company has not a share capital, not less than five per centum in number of the members of the company may call a meeting of the company.” [608] (9) In spite of this submission, however, the respondent submitted that absence of notice to the auditor of the company would invalidate a meeting. Article 111 of Table A provides that notice of every general meeting shall be given to “every member”, and to “the auditor for the time being of the company”. Section [ss 249K and 249V] 167(7) gives “an auditor of a company” a right to attend a general meeting, and to receive all notices of and other communications relating to such a meeting which a member is entitled to receive. [The court held that the applicant had no right to convene directly under the predecessor to s 249F since the company’s constitution itself made provision for convening meetings which, although presently inapplicable, was sufficient to displace the convocation rights under the then counterpart to s 249F; as noted, s 249F is in different terms.] (18) Where there is no power, either in the Act or in the articles, which can be used in order to call a meeting of the company, the calling of such a meeting is, in my opinion, “impracticable”. To adapt the words of Wynn-Parry J in Re El Sombrero Ltd [1958] 3 All ER 1, one must “examine the circumstances of the particular case and answer the question whether, as a practical matter, the desired meeting of the company can be (convened)”. The respondent has declined to act on the suggestion of the applicant, based on an interpretation of Re Duomatic Ltd (see [5.170]), that a meeting of class “A” shareholders should be held, and has put forward no alternative suggestion for regularising the company’s activities, and there is no means whereby the applicant (or for that matter any shareholder) can secure the calling of the meeting. In such circumstances, it seems to me to be plain that the calling of the meeting is “impracticable”. (19) Section [249G] is couched in terms which appear to give the court a discretion to make the order sought. The respondent, by cross-examination of the applicant, established that the blame for the failure to appoint directors in a proper manner, and to call annual general meetings, should be laid more at the applicant’s door, as he was in charge (through his accountant) of the books of the company, than at the respondent’s. While this may be so, I do not think that that fact disentitles the applicant to relief. It was further established, by the same procedure, that the applicant’s purpose in making the application was to enable the election of directors and the ratification of the legal proceedings against the respondent. Again, I do not think that this fact disentitles the applicant to an order. The respondent called no evidence. (20) The applicant submitted, as an alternative title to relief, that, even if the meeting could be called under [s 249F], it could not be conducted, as the respondent would not attend and, therefore, there would be no quorum. Because of my view of the applicant’s entitlement under [s 249G] on the ground that the calling of the meeting is impracticable, I do not need to decide this point. … (21) There is no evidence that the respondent will not attend a meeting ordered by the court to be called; but, as the applicant has a majority of three to one in voting shares, it is likely that the respondent will not attend. I think there is substance in the applicant’s submission that a [611] quorum must consist of members entitled to vote – if it were not so, validly convened meetings could be impotent, if the members who attended were not entitled to vote. For this reason, I think it proper to make an order that, at the meeting to be called, the presence of one member holding “A” class shares shall constitute a quorum. (22) I do not think I should order the calling of a meeting of “A” class shareholders only. The members not entitled to vote are entitled to notice of the meeting and to attend the meeting: art 111, and Re Compaction Systems Pty Ltd and the Companies Act (see [5.175]). In that case, Bowen CJ in Eq left open the question whether a meeting could be validly called and held where notice of it was not given to the auditor. Where a meeting is called pursuant to an order of the court, that order can include 358

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Re Totex-Adon Pty Ltd cont. directions as to its calling and conduct. In the present case, I think a direction should be given that the meeting should appoint an auditor, unless all the members agree that it is not necessary for the company to do so.

NOTICE OF MEETINGS [6.60] The general rule is that at least 21 days notice of a general meeting must be given; a

company’s constitution may, however, specify a longer minimum period of notice: s 249H(1). This rule is subject to two exceptions. First, a company may call a general meeting on shorter notice if members with at least 95% of the votes that may be cast at the meeting agree beforehand or, in the case of an AGM, all members so agree: s 249H(2). Such consent may be given immediately before the meeting commences. The short notice procedure does not, however, apply to a meeting of a public company at which a resolution will be moved to remove a director or, for all companies, to remove an auditor: s 249H(3), (4). (These exclusions are intended to ensure that the director or auditor has sufficient time to respond to the proposed resolution.) Second, at least 28 days notice must be given of a general meeting of an Australian incorporated listed company notwithstanding anything in the company’s constitution: s 249HA. The notice must be given individually to each member entitled to vote at the meeting and to each director: s 249J(1). This requirement may not be displaced by a company’s constitution although the constitution may require wider distribution of notices, for example, to non-voting members. The auditor is also entitled to receive both notice of general meetings and any other communications relating to the meeting that are sent to members: s 249K. Accidental omission to give notice of a meeting or a defect in the notice does not of itself invalidate the meeting; the court may, however, declare the proceedings at the meeting to be void: s 1322(1), (3), (6). The notice of a general meeting must (a) set out the place, date and time of the meeting and the technology to be used if the meeting is to be held simultaneously at two or more venues; (b) state the general nature of the meeting’s business; (c) if a special resolution is to be proposed at the meeting – state that intention and the text of the resolution; and (d) inform members of their proxy appointment rights: s 249L(1). 30 The information included in the notice of meeting must be worded and presented in a clear, concise and effective manner: s 249L(3). A replaceable rule provides for notice to be given of a resumed meeting if a meeting is adjourned for one month or more: s 249M. These elements of the notice of meeting are not exhaustive of the disclosure obligations of the directors and others convening a meeting. The general law imposes distinct and exacting obligations to inform members about resolutions proposed for their consideration, and to do so in a manner that is not misleading. These obligations are examined at [6.90] et seq. 30

For listed companies, the notice must also inform shareholders that the resolution concerning the remuneration report will be put at the AGM and, if at least 25% of the votes on the resolution would be the second strike under the two-strikes rule, explain that such a vote would result in a spill resolution at the AGM, that is, a resolution for the removal of directors and appointment of persons to fill the resulting vacancies: s 249L(2); see [7.405]. [6.60]

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MEMBERS’ RIGHTS TO PUT RESOLUTIONS AND HAVE THE COMPANY CIRCULATE STATEMENTS [6.65] Directors enjoy tactical advantages in relation to contests with groups of shareholders

in general meeting. Apart from informational advantages deriving from their management oversight role, they may distribute material to members at the company’s expense, at least on issues relating to the management of the company. 31 They are under no obligation at general law to circulate material submitted by members. 32 In 1971 a Canadian review committee recommended legislation to provide a shareholder with machinery enabling him, at the expense of the corporation, to communicate with his fellow shareholders on matters of common concern. At common law, the management of a corporation is under no obligation to make any reference in any of the documents sent out by it to any non-management view of the matters discussed … nor to include in a notice of meeting any proposals other than its own. … This places shareholders wishing to have a matter discussed at a meeting at a severe disadvantage because the meeting cannot effectively do anything not fairly comprehended by the notice of meeting. [The proposed legislation] is based upon the proposition that shareholders are entitled to have an opportunity to discuss corporate affairs in general meeting, and that this is a right and not a privilege to be accorded at the pleasure of management. 33

In certain circumstances members may require the company to put a resolution on the agenda of a general meeting and to circulate to all members a statement about a proposed resolution or any other matter that may properly be considered at the meeting. The request in either case (viz, for a resolution to be added to the agenda of a meeting or the statement to be circulated) must be made in writing by members with at least 5% of voting rights or by 100 voting members: ss 249N, 249P. The proposed resolution will be considered at the next general meeting held two months after the request is served on the company: s 249O(1). (Ordinarily, for a public company this will be the AGM.) The company must give members notice of the resolution at the same time as it gives notice of the meeting or as soon as practicable afterwards: s 249O(2). The company must pay for the distribution of the text of the proposed resolution or the statement if it is received in time to send it out with the notice of meeting: ss 249O(3), 249P(7). Otherwise, the requesting members are jointly and individually liable for expenses reasonably incurred by the company in distributing the resolution or statement to members, although at the general meeting the company may resolve to meet the expenses itself: ss 249O(4), 249P(8). However, a resolution or statement does not have to be circulated (a) if it is more than 1,000 words long or defamatory or (b) if the requesting members are to bear the expenses, they do not tender a sum sufficient to meet the reasonable expenses of circulating it: ss 249O(5), 249P(9). 34 31

Peel v London & North Western Railway Co [1907] 1 Ch 5; Advance Bank Australia Ltd v FAI Insurances Ltd (1987) 12 ACLR 118 (directors’ powers to apply company funds must be exercised bona fide and not for the purpose of securing their re-election).

32

Campbell v Australian Mutual Provident Society (1908) LJPC 117.

33

R W Dickerson, J L Howard & L Getz, “Proposals for a New Business Corporations Law for Canada” (Information Canada, Ottawa, 1971), Vol 1, [274], [276], quoted in Companies and Securities Advisory Committee, Shareholder Participation in the Modern Listed Public Company, Discussion Paper (1999), fn 24, p 23n.

34

The word defamatory in s 249P is “given its usual meaning at common law, namely, whether the meaning of the publication in question has a tendency to lower the plaintiff in the estimate of the ordinary reasonable reader [notwithstanding the] undoubted effect of the construction … that, in a case such as the present, where there is a requisition to remove directors, freeing a company of an obligation to circulate a statement

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There was much less pressure for abolishing the 100 member numerical test as a ground for proposing a shareholder resolution at a AGM or having a statement circulated to members than in relation to abolishing the test as the basis for requisitioning a general meeting itself (a right abolished in 2015): see [6.30]. 35 The reason lies simply in the minor cost and inconvenience of adding an agenda item to a scheduled meeting relative to that of calling a new meeting. It is surprising then that in Australia there have been, until relatively recently, few requests to add resolutions to an AGM; this is in marked distinction to the United States where shareholder resolutions are an established mechanism to ventilate concerns about aspects of corporate operations, practices and policies. 36 In recent years there has been a dramatic rise in shareholder activism in the United States and Europe, a trend becoming evident in Australia, often through s 249N notices. Shareholder activists typically use their investment in a company as leverage to promote their economic interests and effect change within the company; their targets are usually companies with perceived board weakness and an underperforming share price or asset base. Activists usually pursue a change in board composition, corporate strategy or a particular outcome such as a capital reduction or share buy-back or increased dividend distribution: see [9.230], [9.285]. In some cases, the strategy may extend to seeking effective control of the company without paying a premium to shareholders for the transfer of control: see [12.15]. 37 A different species of shareholder activism arises where shareholders use s 249N to address concerns, and responsibilities, with respect to corporate social and environmental impacts. These typically concern matters within the exclusive authority of the directors. The constitutional limitation on members’ rights to convene shareholder meetings applies also to their right to propose resolutions and have them circulated. In Australasian Centre for Corporate Responsibility v Commonwealth Bank of Australia a group of shareholders in the Commonwealth Bank gave notice of proposed resolutions under s 249N stating that it is in the best interests of the company that directors provide a report detailing the greenhouse gas emissions attributable to the bank’s lending activity; if directors declined to do so, an alternative proposed resolution expressed concern at the “absence” of such disclosure. The directors refused to act upon the notice on the grounds that these are matters exclusively for the board and management. Their decision was upheld. Shareholders may only propose effective resolutions: framing proposed resolutions that are beyond shareholder power as which is defamatory will to some extent stifle the debate. … [If] those few paragraphs were defamatory, it seems to me that it is the consequence of s 249P(9) that the statement as a whole could then be characterised as defamatory, and the company would not have any obligation to circulate it”: NRMA v Snodgrass [2002] NSWSC 811 at [10], [19], [22]. The effect of framing the prohibition in terms of its defamatory effect is to deny the requesting member the benefit of any defence, such as truth and public interest, that might be available in other contexts. 35

36

37

Thus, the draft legislation circulated early in 2005 to remove the 100 member rule for convening shareholder meetings would also reduce the requirements for a resolution to be added to the agenda of a meeting or a statement to be circulated from 100 to 20 members. Thus, it has been said that whereas there were 12 shareholder resolutions at Exxon Mobil’s 2003 AGM, “if you exclude Boral, we have not had 12 shareholder resolutions in Australia since the Vietnam War” (testimony of Stephen Mayne, quoted in Parliamentary Joint Committee on Corporations and Financial Services, CLERP (Audit Reform and Corporate Disclosure) Bill 2003: Enforcement, Executive Remuneration, Continuous Disclosure, Shareholder Participation and Related Matters (Part 1, 2004), pp 178-179). The recent exception is in relation to the listed company Boral which amended its constitution in 2003 to require that any request that a resolution be included in the agenda of an AGM must first be approved by the board or proposed by members holding 5% of voting shares in the company: see [6.30]. This followed shareholder resolutions put by a group of 120 truck drivers contracted to Boral each of whom purchased $500 share parcels so they might raise health and safety concerns at the 2003 AGM. Earlier, resolutions have been put to Boral AGMs by environmental groups. For discussion of shareholder activism pursued through s 249N notices, see J Harris (2016) 34 C&SLJ 151. [6.65]

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advisory only, and not directive, does not enlarge rights to inclusion in the meeting agenda and directors may reject such notices. The Full Court of the Federal Court based its decision on the fundamental proposition that the shareholders in general meeting have no authority to speak or act on behalf of the company except to the extent and in the manner authorised by the company’s constitution or any relevant statute, and to an extent and in a manner consistent with the constitution or statute. This proposition extends to the expression of a “wish”” on behalf of the company, unless it is demonstrated that the meeting has legal authority to represent the company on the relevant subject matter. … We accept that the disputed resolutions do not, in terms, require the directors of the Bank to exercise the power of management in any particular way. However, that circumstance is not sufficient to make them resolutions that members are entitled to propose to the shareholders in general meeting. Once it is accepted that a resolution requires some constitutional or statutory basis, it is necessary to find a power that the shareholders may exercise to justify the resolution. The appellant failed to identify any aspect of any “plenary” or “reserve” power vested in the shareholders in general meeting to provide that justification. 38

Neither the bank’s constitution (which included the equivalent of the s 198A management delegation provision), s 249O nor any other statutory provision authorised the resolutions proposed in the notice. In some jurisdictions there is a legal mechanism for shareholders to propose and vote on matters beyond their constitutional power. These resolutions do not bind the board and are in the nature of advisory or precatory resolutions. Whether or not the resolutions influence directors’ decisions, they permit shareholders to formalise and record their collective view, typically on matters relating to company management, without interfering with directors’ decision-making process and role. 39 With one exception, there has been little pressure for such a facility in Australia, primarily upon the grounds that it might blur the distinction between the roles of board and general meeting, diminish director accountability by sanctioning deference to shareholder opinion, and put pressure on directors to disclose confidential information to shareholders. 40 The exception is the introduction in 2004 of a requirement that at a listed company’s AGM a resolution must be put to the vote to adopt the remuneration report that directors of such companies must prepare showing the remuneration of the five highest paid company executives and the five highest paid group executives: see [7.405]. The vote on the resolution is advisory only and does not bind the company or the directors who retain authority to determine executive remuneration: s 250R(2) and (3). In the United States there are relatively few hurdles to shareholders wishing to file advisory or precatory proposals to be submitted to a shareholder vote under r 14a-8 of the Securities Exchange Act 1934. If a corporation wishes to exclude shareholder proposals from its proxy materials it must persuade the SEC to take “no action” if the proposal is omitted; the corporation bears the burden of demonstrating that the proposal is improper. A frequently invoked ground for exclusion is that the proposal pertains to “ordinary company business” although, to be excludable under this exception, the proposal must not only relate to a matter of ordinary corporate business but also must fail to raise any significant policy issue. In recent years, the SEC has regularly found that proposals relating to human rights issues raise significant policy considerations and are, therefore, not properly excludable under this 38 39 40

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[2016] FCAFC 80 at [37], [52] per Allsop CJ, Foster and Gleeson JJ. Companies and Securities Advisory Committee, Shareholder Participation in the Modern Listed Public Company, Discussion Paper (1999), [3.27]-[3.30]. Companies and Securities Advisory Committee, Shareholder Participation in the Modern Listed Public Company, Discussion Paper (1999), [3.3.1]. The Advisory Committee did not recommend the introduction of advisory resolutions in Australia. [6.65]

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exception. 41 During the 2015 proxy season, shareholders submitted approximately 943 proposals for shareholder meetings across four broad categories – governance and shareholder rights; environmental and social issues; executive compensation; and, corporate civic engagement. Proposals on environmental and social issues have comprised the largest single category of shareholder proposals in recent years. 42 The mechanism warrants careful consideration in light of shareholders’ responsibility under the United Nations Guiding Principles on Business and Human Rights to exercise leverage to prevent and mitigate a human rights abuse to which they are linked by their investment: see [2.247].

CONDUCTING THE MEETING [6.70] A company may hold a meeting of members at two or more venues using any

technology that gives the members as a whole a reasonable opportunity to participate in the meeting: s 249S. This facility is not dependent upon authorisation contained in the company’s constitution although it may be that a constitutional provision will restrict the use of technology or specify acceptable technologies. This licence is intended to cure uncertainties in the interpretation of constitutional provisions relating to the necessity for physical presence at directors’ meetings: see [5.270]. If a company conducts a general meeting using technology such as video-links, the requirement of a reasonable opportunity to participate would probably be satisfied by facilities that enable each member to communicate with the chair and be heard by other members attending the meeting, including those at other venues. The Explanatory Memorandum accompanying the 1998 amendments lists the following matters for a company to consider if it holds meetings at multiple venues: (a) the ability of the chair to conduct and control the proceedings; (b) the number of persons attending the meeting; (c) the nature of the business of the meeting (eg, it may include a visual presentation); (d) the voting processes available (eg, it will be necessary to have procedures in place to count members’ votes from all venues); and (e) whether persons at the meeting can communicate with the chair and follow the proceedings. 43 At general law two persons at least are required for a meeting 44 although it may be possible that a particular statutory context permits a meeting of one. 45 Under a replaceable rule, the quorum for a members’ meeting is two members who must be present throughout the meeting: s 249T(1). An individual attending as a proxy or body corporate representative (see [6.85]) is included in the quorum but only once even if attending in more than one capacity, for example, both as a member and as a proxy for another member: s 249T(2). If a quorum is not present within 30 minutes of the time specified in the notice, the meeting is adjourned to the 41

J Featherby (ed), Global Business & Human Rights: Jurisdictional Comparisons (European Lawyer Reference Series, 2011), p 402.

42

43 44

Harvard Law School Forum on Corporate Governance and Financial Regulation, Shareholder Proposal Developments During the 2015 Proxy Season, https://corpgov.law.harvard.edu/2015/07/17/shareholderproposal-developments-during-the-2015-proxy-season/; this group would have been the largest category in 2015 save for an unprecedented number of shareholder proposals to nominate candidates for election to the corporation’s board; B Jacobsen & H Pender (2016) 34 C&SLJ 292 (proposing reforms to strengthen scope for shareholder proposals grounded in social concerns). Company Law Review Bill 1997, Explanatory Memorandum, [10.43]. Sharp v Dawes (1876) 2 QBD 26 at 29; Touzell v Cawthorn (1995) 18 ACSR 328 at 330.

45

East v Bennett Bros Ltd [1911] 1 Ch 163. [6.70]

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date, time and place the directors specify and, in the absence of such specification, to the same day in the next week and at the same time and place: s 249T(3). If no quorum is then present within 30 minutes, the meeting is dissolved: s 249T(4). Under a replaceable rule, the directors may elect an individual to chair meetings of members: s 249U(1). Under this rule the chair of the board does not automatically assume the chair of general meetings, allowing the appointment of an independent person. If a chair is not elected beforehand or is not available for a meeting, the members may elect a chair from among their number: s 249U(2), (3). The chair must adjourn a meeting if directed to do so by members holding a majority of votes at the meeting: s 249U(4). An adjourned meeting may deal with unfinished business: s 249W(2). If the constitution gives the chair of a meeting the power to adjourn the meeting without shareholder approval, the chair’s power, even if it is not fiduciary, must in equity be exercised bona fide and for a proper purpose: It follows from the nature of the chairman’s role and the responsibilities and expectations it entails that it is foreign to the chairman’s function to exercise the power of adjournment to further some personal preference of the chairman or some policy of a body of which the chairman is a member. It is thus foreign to the chairman’s function, when the chairman is a director, to exercise the chairman’s powers to implement some policy or decision of the board of directors. This is particularly so in a context such as the present where the purpose of the general meeting is to determine the constitution of the board itself. The right of the general body of members to remove directors by resolution is a statutory right which may or may not have some parallel in the constitution. If, by ordinary corporate processes, a forum is created to enable members to exercise that right if minded to do so, it will be an abuse of the power of a chairman to remove the opportunity to exercise the right except for some good and proper reason calculated to promote the due exercise of the right in more suitable or constructive circumstances at a later time. It will be a clear abuse of power if the chairman removes or postpones the right simply because he or she (alone or in consultation with others) thinks that it would somehow be more conducive to the interests of the company if members were not allowed to exercise the right to remove directors. 46

The equitable obligation to act bona fide and for a proper purpose applies to the exercise by the chair of other powers under the constitution despite their apparently unqualified terms. At an AGM, the chair must allow a reasonable opportunity for the members as a whole to ask questions about or make comments on the management of the company (s 250S) and, if the auditor is present, to ask questions of the auditor about the conduct of the audit and the preparation of the auditor’s report: s 250T. 47 There is no express legal obligation imposed upon the directors to answer questions at the meeting. 48 The obligation imposed upon the chair to allow a reasonable opportunity for members to ask questions or make comments does not appear to ground a personal right in members individually to ask a question of the directors, but rather is for the benefit of members as a whole. The reasonable opportunity obligation does not, therefore, require the chair to allow each member who wishes to do so to 46

McKerlie v Drillsearch Energy Ltd (2009) 74 NSWLR 673 [38], [39]; see also [6.35] re the requisitioning power and [7.270] at 438-439 on the doctrine of fraud upon a power from which the equitable obligation derives.

47

A company’s auditor is entitled to attend general meetings and to speak on any part of the business of the meeting that concerns the audit: s 249V(1), (2). However, auditors of a listed company must attend the company’s AGM at which their audit report is considered: s 250RA. Members may submit written questions to the auditor in advance of the meeting: s 250PA; if so, the chair of the AGM must also allow the auditor a reasonable opportunity to answer those questions: s 250T(1)(b).

48

The position may be otherwise, however, in relation to written questions put to the auditor in advance of the meeting: s 250PA.

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ask a question. The chair’s responsibility to complete a timely consideration of the business of the meeting is qualified, but not overridden, by this obligation. There is no counterpart statutory obligation to allow a reasonable opportunity for discussion at general meetings other than the AGM. However, company constitutions commonly confer powers upon the chair in relation to the conduct of meetings. The chair also enjoys certain inherent rights that facilitate the smooth conduct of proceedings and enable the sense of the meeting to be clearly ascertained in relation to business before it. Thus, the chair may determine the order of the speakers (often alternating those for and against the motion), decide points of order, contain the debate within the bounds of relevance and decorum, and settle the validity of amendments. The chair also has a duty to protect the right of minorities to ventilate their views at the meeting. 49 At the conclusion of the debate, the chair is usually given express power under the constitution to take the vote upon motions before the meeting.

VOTING AT MEETINGS The functions of voting rights [6.75] The shareholder’s right to vote (where it exists, since it is not an inherent right)

effectively distinguishes the share from debt interests in the company: see [3.160]. Such control of the corporation as shareholders enjoy collectively derives ultimately from the exercise of their monopoly of voting rights through the general meeting. The theoretical analysis of voting rights is most fully elaborated in the law and economics literature. Two principal arguments are put for the attachment of voting rights to ordinary shares exclusively: • the reduction of agency costs (see [2.220]) through shareholder monitoring of management; and • the utility of voting rights as a device to fill in gaps in the necessarily incomplete contracting between shareholders and management. As to the first, it is argued that the power to control the activities of the corporation should rest with those who have the right to the firm’s residual earnings; since they have the prime stake in marginal gains and marginal costs, they have the highest incentive to monitor managers although there is at best a modest degree of interest in doing so in publicly held companies: see [2.195]. 50 If voting rights were to be shared with another group, the dissimilarity of their preferences might preclude aggregation into a consistent system of choices. 51 As for the second consideration, the combination of explicit contracts and the imposition of fiduciary obligations upon managers still leaves much unspecified. The voting mechanism provides the details, including the delegation of authority to elected directors. 52 In Australia, between one half and two thirds of shareholdings in publicly held companies are held by investment institutions, a proportion that has increased sharply especially under the superannuation guarantee charge: see [2.175]. Even so, there is a much lower level of proxy voting by Australian investment institutions relative to the United States, United 49

See Australian Shareholders’ Association Ltd and the Australian Institute of Company Directors, The Conduct of Annual General Meetings (1994), [12].

50

R C Clark, Corporate Law (1986), p 389; F H Easterbrook & D R Fischel, The Economic Structure of Corporate Law (1991), p 68. Easterbrook & Fischel, pp 69-70.

51 52

Easterbrook & Fischel, p 66. On the function of voting rights and voting rules in one species of non-profit organisation, national sporting organisations, see R McDonald & I Ramsay (2016) 34 C&SLJ 387. [6.75]

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Kingdom and Germany. 53 Accordingly, it is sometimes argued that investment institutions (or those with representative investment functions such as fund managers appointed by superannuation trustees) should be required to exercise voting rights in companies in which they have invested. On the other hand, there is a fear that mandating the exercise of voting rights might be at the cost of the quality of voting decisions taken especially among smaller fund managers and superannuation funds lacking the resources to monitoring portfolio companies effectively. A further concern is with disclosure of institutional voting practices, particularly in superannuation and other funds that act in a fiduciary capacity. Thus, the OECD Principles of Corporate Governance state: Institutional investors acting in a fiduciary capacity should disclose their overall corporate governance and voting policies with respect to their investments, including the procedures that they have in place for deciding on the use of their voting rights. The voting record of such investors should also be disclosed to the market on an annual basis. Institutional investors acting in a fiduciary capacity should disclose how they manage material conflicts of interest that may affect the exercise of key ownership rights regarding their investments. 54

United States legislation requires investment funds to disclose their voting record to members either on their website or other public record. 55 As the OECD Principles suggest, disclosure would also direct light onto the conflicts of interest flowing from the concentration of share ownership among a small number of investment institutions with ongoing financial relationships and interlocking directorships with portfolio companies. Traditional thinking about the functions of voting rights in the corporation is challenged by two modern developments. The first is the increasing rate of turnover of shares in the market with the use of algorithmic-based high-speed electronic trading and the emergence of exchange-traded funds. One consequence is rapid decline in the average duration of share ownership in listed companies; some estimates put the decrease in the average holding period of US stocks from eight years in the 1960s to around five days today. 56 A second development is the increasing separation (or decoupling) of the economic interest in shares from the voting rights attaching to them; this assumed nexus underlies much of the economic rationale for exclusive shareholder voting rights. This decoupling typically arises through the use of derivative instruments to acquire an economic stake in a company without title to or voting rights in any shares and from market practices such as share “renting” and securities lending: as to the latter, see [11.176]. These market practices result in the phenomenon of empty voting (voting rights attached to shares without corresponding economic interest) and its converse, hidden ownership, where an investor’s economic interests exceed their voting rights. 57 Since securities loans, despite their nomenclature, are in legal form truly back-to-back sales of shares but with no change in underling economic ownership, they are convenient vehicles for vote buying. The growth of vote buying, with its uncoupling of economic and legal voting interest, challenges the core tenets that underlie the voting franchise and corporate governance systems generally. If votes may easily be “rented” ad hoc, what weight should be attached to 53 54 55

56

G Stapledon, S Easterbrook, P Bennett & I Ramsay, Proxy Voting in Australia’s Largest Companies (Research Report, Centre for Corporate Law and Securities Regulation, University of Melbourne; 2000), pp vii-viii. OECD Principles of Corporate Governance, 2004, II.F. This is the view of the US Department of Labor with respect to the Federal employee retirement savings legislation; indeed, the Department takes the view that voting rights in portfolio companies are assets of the fund to be managed with the same fiduciary care as other assets: see Stapledon, Easterbrook, Bennett & Ramsay, p viii. See http://www.businessinsider.com/stock-investor-holding-period-2012-8#ixzz2Bt6Y8yEm.

57

H T C Hu & B Black (2006) 79 Southern California L Rev 811; H T C Hu & B Black (2006) 61 Business Lawyer 1011; H T C Hu & B Black (2007) 13 J Corporate Finance 343.

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resolutions signifying corporate assent, especially on fundamental, control-affecting or conflict of interest-sensitive decisions? What are the implications of a voting system in which some only of those voting have an economic stake in the subject-matter of the vote, or a stake commensurate with their voting rights, particularly in circumstances where the discrepancy may not be disclosed? Voting rights perform attenuated functions under these developments. Voting rights and their exercise [6.80] The presumptive rule in the Corporations Act, subject to displacement by the

company’s constitution, is that shareholders in a company have one vote each in voting taken by a show of hands and, on a poll, one vote for each share they hold: s 250E(1); members of a company without a share capital have one vote, both on a show of hands and a poll: s 250E(2). The chair of the meeting has a casting vote in addition to any vote held as a member: s 250E(3). These norms are commonly modified in proprietary companies. The one share, one vote principle is, however, enjoined for listed companies by the ASX Listing Rules: see rr 6.8, 6.9. 58 Under a replaceable rule, a resolution put to the vote at a general meeting is decided on a show of hands unless a poll is demanded: s 250J(1). Before the vote is taken, the chair must inform the meeting whether any proxy votes have been received and how they are to be cast: s 250J(2). Under a mandatory rule, a poll may be demanded on any resolution except that the constitution of a company may preclude a poll being called on two matters, namely, a resolution concerning the election of the chair or the adjournment of a meeting: s 250K(1), (2). A poll may be demanded either by five voting members, members with 5% of the votes or by the chair: s 250L(1). However, a company’s constitution may provide that fewer members or members with a lesser percentage of votes may demand a poll: s 250L(2). The poll may be demanded up to the point immediately after the declaration of the voting results on a show of hands: s 250L(3). Under a replaceable rule, a poll demanded on other matters is taken as and when directed by the chair: s 250M. On a poll, a member need not vote or may cast their votes in different ways: s 250H. The powers conferred on the chair with respect to the conduct of a poll are to facilitate the voting and the counting of votes so that the will of the majority of shareholders may be reliably ascertained. 59 The requirements of good faith and proper purpose apply to the exercise of these powers: see [6.70]. Thus, where the constitution gave the chair power to call for a poll in apparently unfettered terms, the chair did not have an unlimited discretion and needed to exercise the power by reference to what was necessary in order to ascertain the sense of the meeting on the matter before it: the power was “not to be exercised according to the chairman’s personal desire or preference but to ensure that the true will of the membership is discovered on the particular proposal”. 60 One consequence of applying this principle may be, commentators write: to invalidate a resolution where the chair, while aware that there are sufficient proxies against the motion that it would be defeated on a poll (whether the proxies are held by the chair or someone else), allows a vote to go forward on a show of hands, and the resolution is accordingly passed. The principle would also apply in the converse situation, where the chair allows the motion to be defeated on a show of hands, while nevertheless aware that proxies in favour of the motion would carry it on a poll, although in that case the remedy to address the wrongdoing would have to be differently framed. 58 59 60

See V Goldwasser (1995) 7 Corp & Bus LJ 205; Expert Panel of Inquiry into Desirability of Super Voting Shares for Listed Companies, Corporations Law – Super Voting Shares (1994). Link Agricultural Pty Ltd v Shanahan (1998) 28 ACSR 498. Re Print Mail Logistics Ltd [2012] NSWSC 792 at [6], quoting McKerlie v Drillsearch Energy Ltd (2009) 74 NSWLR 673. [6.80]

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A more difficult case is where the failure to call for a poll is not determinative of whether the motion is carried, but nevertheless a vote on a poll would have a significance not present on a show of hands. Consider, in particular, the position of a chair who is aware that, on a poll, more than 25% of the votes will be against the resolution to approve the remuneration report. Under s 250U votes against the resolution to approve the remuneration report of at least 25% of the votes cast constitute a first or second strike which can lead to a requirement to put a spill resolution to the shareholders. … We think there is a plausible argument for the view that, in a context where negative votes of at least 25% are given legislative significance, the chair’s duty to ascertain the true will of the shareholders extends to ascertaining whether 25% or more of the shareholders are opposed to the resolution. 61

The effect of a 25% vote against the remuneration report, even though the motion to approve the report passes, will usually be negative from the point of view of the board whose chair will commonly also be chair of the meeting. The mix of duties under these dual roles is considered in [6.85]; as to voting on the remuneration report, see [7.405]. Proxy voting [6.85] Apart from voting in person at company meetings, there are two other forms of voting

theoretically available to shareholders. (A third additional form, noted below in this paragraph, allows a corporate shareholder to appoint a representative at company meetings.) First, the company may adopt in its constitution a mechanism for direct voting under which shareholders may lodge a voting form within a specified time before the meeting. Unlike proxy voting, direct voting operates as a binding direction to the company in the exercise of voting rights. Direct voting is not, however, specifically referred to in the Act and the ASX Listing Rules and its adoption, although not widespread, is increasing. 62 A second form of absentee voting, by proxy, is widely adopted. At common law shareholders had no right to vote by proxy. 63 The origins of this rule may be traced to the old law of corporations which recognised “the voting privilege [as being] in the nature of a personal trust, committed to the discretion of the member, and hence not susceptible of exercise through delegation”. 64 Accordingly, in the early business corporations the privilege of proxy voting was dependent upon a provision in the charter or act of incorporation. Proxy voting was common among joint stock companies in the 18th century, although as a rule the proxy holder would need to be a shareholder. The right to vote by proxy was introduced into the Table A model articles with the English consolidation of 1929. Accordingly, it is a common provision in company constitutions. Members of a company may appoint another person or persons as their proxy to vote some or all of their shares at a general meeting; this rule is mandatory for public companies but may be displaced by constitutional provision in proprietary companies: s 249X(1), (2). 65 (It is no aid to clarity that the term proxy is used to refer not only to the instrument by which authority 61

62

Minter Ellison Alert, When is the Chair Obliged to Demand a Poll at a Shareholders’ Meeting? (9 August 2012), http://www.minterellison.com/publications/when-is-the-chair-obliged-to-demand-poll-at-shareholdersmeeting. See Chartered Secretaries Australia and Blake Dawson, Rethinking the AGM: A discussion paper (2008), p 8; Corporations and Markets Advisory Committee, The AGM and Shareholder Engagement, Discussion Paper (2012), pp 85-87.

63 64

Harben v Phillips (1883) 23 Ch D 14; McLaren v Thompson [1917] 2 Ch 231 at 236. Walker v Johnson 17 DC App 14, quoted by L Getz (1970) 8 Alta LR 18 at 19n.

65

The rationale is that closely held proprietary companies may wish to allow only members to attend company meetings: Company Law Review Bill 1997, Explanatory Memorandum, [10.53]. The person appointed as the member’s proxy may be an individual or a company: s 249X(1A). If the proxy holder is a company, it may nominate an individual to exercise its powers at a general meeting: s 250D(1)(d). This facility therefore allows for proxy solicitation through a corporate vehicle.

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to exercise voting rights is given to another person but also to the recipient of the authority.) A proxy enjoys the same rights as the appointing member to speak, vote (but subject to the terms of their appointment) and join in the demand for a poll: s 249Y(1). A company’s constitution may provide that a proxy is not entitled to vote on a show of hands and may determine the effect of the member’s presence at a meeting upon the authority of the proxy (the default rule is that the authority is suspended during the member’s presence): s 249Y(2), (3). From the first third of the 20th century at least, the outcome of shareholder voting in larger public companies was usually settled by proxy voting before the meeting itself. 66 Many shareholders do not attend company meetings; if they did, it would be impossible for the larger listed companies to conduct their meetings as physical meetings even with the simultaneous use of linked sites. Proxy voting is therefore a major element of the exercise of corporate control through shareholder voting. Proxy solicitation is closely regulated in the United States and Canada but much less so in Australia where directors are entitled, at company expense, to solicit proxies, for the most part burdened only by their fiduciary obligations to the company. 67 These obligations, however, enjoin directors from • applying unreasonable amounts of the company’s money; • spending money on material relevant only to a question of personality and not corporate policy (this is particularly applicable to voting on the election of directors); and • otherwise acting excessively or unfairly, having regard to the corporate purpose to be attained. 68 A notice of meeting must contain a statement of the member’s right to vote by proxy, whether or not the proxy must be a member of the company, and the member’s right to split votes between proxies: s 249L. The appointment of a proxy (as noted, the term proxy refers both to the instrument of appointment and the person appointed) must be signed by the member and contain specified particulars: s 250A(1), (2). There has been persistent concern that proxy holders may not vote shares as instructed, either because they do not vote any shares at all under their proxies or alternatively they “cherry pick” the proxies, voting only those that are undirected or directed in the way that the recipient favours. There is also concern about the possibility of inadequate disclosure in proxy solicitation as to how undirected proxies will be voted. The fundamental concern here is that some shareholders see the proxy as equivalent to a postal vote cast indirectly through the proxy rather than a mere discretionary authority given to an agent. A company may not solicit proxies selectively: if a proxy form is sent to one member who requests it, it must be sent to all who request it; if it is sent without request to one member, it must be sent to all: s 249Z. Amendments made in 2011 further address these concerns; their purpose is to ensure that proxies are voted as intended by the giver and they effect a distinction between proxies held by the chair of the meeting and proxies held by others. 69 A form of proxy appointment sent to a member may specify the way the proxy is to vote (a directed proxy); if the proxy is the chair of the meeting, the proxy must vote those shares on a poll and in the manner directed by the proxy instrument: s 250BB(1)(c). However, if the proxy is not the chair, there is no obligation upon the proxy holder to vote upon a poll but, if she or he does so, they must vote as directed: s 250BB(1)(d). If a nominated proxy (not the meeting chair) does not attend the meeting, or 66

See Re Dorman Long & Co Ltd [1934] Ch 635 at 657-658.

67

See Companies and Securities Advisory Committee, Shareholder Participation in the Modern Listed Public Company, Discussion Paper (1999), pp 35-36.

68

Advance Bank Australia Ltd v FAI Insurances Ltd (1987) 12 ACLR 118 at 136-137; see discussion in R Levy (2015) 33 C&SLJ 404.

69

Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Bill 2011, Explanatory Memorandum, [6.10]. [6.85]

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attends but does not vote, their directed proxies default to the chair who must vote them as directed: ss 250BC, 250BB(1)(c). These amendments do not apply to undirected proxies. Management enjoy a situational advantage in relation to undirected proxies although listed companies are largely denied this advantage under ASX listing rules. If they send out proxy forms, they must be “two-way” forms enabling shareholders to vote for or against each resolution rather than leave the voting decision to the proxy holder as in an undirected proxy. The proxy forms must also permit shareholders to appoint a proxy holder of their choice although a default specification (usually in favour of the chair of the meeting) is permitted. 70 Even so, company boards enjoy a considerable advantage through sending proxy voting forms to shareholders with reply paid envelopes with the chair of the meeting specified as the default proxy holder. By this means the board will receive a not inconsiderable proportion of all proxies as open (that is, undirected) proxies and as proxies that follow the voting recommendations of the board: see [2.185]. 71 To be effective, the proxy’s appointment instrument must be received by the company at least 48 hours before the meeting although this time may be shortened by the company’s constitution or the notice of meeting (s 250(1), (2)); proxies may be sent by fax or electronically: s 250B(3). This requirement allows an investigation of their validity, and the calculation of voting power, prior to the commencement of the meeting. 72 A proxy’s vote will be valid notwithstanding the revocation of the proxy, the transfer of the share in respect of which it was given or the death or incapacity of the member, in the absence of written notice to the company of these occurrences: s 250C(2). The constitution may, however, make other provision since this is a replaceable rule. A corporate shareholder may appoint an individual as a representative to exercise its powers at company meetings or under resolutions that may be passed without meetings; the appointment may be a standing one: s 250D(1). In contrast to a proxy, a representative acts as an organ of the appointing company and not as its agent. 73 A company may appoint more than one representative but only one may exercise the company’s powers at any time: s 250D(3). As noted, the proxy holder is under an obligation to vote directed proxies only when the proxy is given to the chair of the meeting: s 250BB(1)(c), (d). This requirement was imposed following the judicial decision that a chair of the meeting who was also chair of the board and who failed to vote directed proxies was not then acting as a director and was under no fiduciary obligations to the company as distinct from those owed to the proxy donor. The court held that he did not thereby breach his duties to the company as its director: A director who accepts appointment as a proxy will, as agent for the member who made the appointment, have the fiduciary duties of an agent towards the member as principal. If the member has directed the director as proxy to vote in a particular way, then generally those fiduciary duties will require the director as proxy to do so, although there may be some exceptions to this. In addition, the director is subject to statutory requirements [which did not then require the chair to vote directed proxies] … but only in his or her capacity as proxy, not as a director. Further, these duties and requirements are not duties owed to the company: the fiduciary duties are owed to the particular member who appointed the director as proxy, and the statutory requirements do not appear to give rise to any duty owed to any legal entity other 70

ASX Listing Rule 14.2. A listed company must record in the minutes of a meeting details of the proxy votes received and the specification of voting direction: s 251AA.

71

72

Even in the non-binding vote on the remuneration report for listed companies, where key management personnel or closely related parties are precluded from voting, the chair may vote undirected proxies with the shareholder’s express authorisation: ss 250R(5)(b), 250BD; [7.405]. New South Wales Henry George Foundation Ltd v Booth (2002) 54 NSWLR 433 at [19].

73

Atkins v St Barbara Mines Ltd (1997) 15 ACLC 800 at 805.

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than that member and/or the State. Indeed, if the member directs the proxy/director to vote in a way that the director believes is not in the interests of the company, the director will generally, as the member’s fiduciary, be obliged to vote in that way; and generally, this will not be in breach of the director’s duties to the company. … But the general principle is that directors voting their own shares can vote in their own interests, and are not bound by their duty as directors to act in the interests of the company as a whole. In our opinion, the position must be similar in relation to a director voting as proxy on the instructions of other shareholders, in the sense that the director can (and as a fiduciary should) vote as directed by those shareholders, and in doing so is not subject to a duty as director requiring that he or she vote in accordance with what he or she believes is in the best interests of the company. Thus, although there may be circumstances in which a director acting as proxy is discharging a director’s duties, this is not necessarily the case. 74

By way of review, consider whether directors are entitled to access to lodged proxies so that they may monitor the trend of proxy voting? If directors refuse access to a group of shareholders, what remedy, if any, do they have to secure access? (See [5.295] and Lew v Coles Myer Ltd [2002] VSC 535.) 75 There is no statutory requirement for independent verification of votes cast at shareholder meetings. Companies may, however, by constitutional amendment or informal practice, adopt verification procedures such as appointing the company secretary or a share registry to collate votes with the company’s auditor acting as scrutineer. 76 ASX may require a listed company to appoint its auditor or another person approved by the ASX as scrutineer to decide the validity of votes cast at a general meeting and whether any votes should be disregarded: ASX Listing Rule 14.8.

DISCLOSURE OBLIGATIONS The range of disclosure obligations [6.90] In addition to the requirement under s 249L(b) to state the general nature of the

business of a meeting (see [6.60]), there are two distinct species of duty at general law to inform members with respect to proposals that are put to them in a general meeting for decision. The first is an obligation, in framing notices of shareholder meetings, to make a sufficient statement of the objects and general nature of the meeting. A meeting is only competent to deal with business which is properly notified to members in the notice convening it 77 since it is on the basis of this notice that members make their decision as to whether to participate in the meeting. 78 The notice convening a general meeting must sufficiently specify the general nature of the business of the meeting. While the notice need not be meticulously precise, it must give a fair and reasonable intimation of what is proposed to be dealt with at 74

75

Whitlam v ASIC (2003) 46 ACSR 1 at 62-63. Under the 2011 amendments, a meeting chair who contravenes the obligation to vote directed proxies now commits an offence where the proxy solicitation held out the chair as being willing to act as proxy: s 250BB(2). The question whether pre-meeting voting under proxy and direct voting should be disclosed is discussed in Corporations and Markets Advisory Committee, The AGM and Shareholder Engagement, Discussion Paper (2012), pp 87-90. Where resolutions are contested, there are strategic advantages to the contestants in access to this information.

76 77

Corporations and Markets Advisory Committee, pp 93-94. Holmes v Life Funds of Australia Ltd [1971] 1 NSWLR 860; Helwig v Jonas [1922] VLR 261.

78

Tiessen v Henderson [1899] 1 Ch 861 at 870; Devereaux Holdings Pty Ltd v Pelsart Resources NL (No 2) (1985) 9 ACLR 956 at 958. [6.90]

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the meeting. 79 Where a notice of meeting was accompanied by an independent expert’s report which misstated the effect of the proposed resolutions, the notice was held to be insufficient and the resolutions set aside. 80 There is accordingly some danger in a notice of meeting, particularly one for a meeting which would affect the fundamental rights of shareholders, which fails to set out the text of the proposed resolution; this danger is the more egregious when explanatory memoranda circulated with the notice of the meeting do not give shareholders a full, fair and accurate account of the proposed new provision. 81 A further obligation, arising in equity from the fiduciary nature of their office, requires directors to provide members with information material to their deliberations, at least when the directors are proposing or recommending support for shareholder resolutions. The case law establishing the second obligation is predominantly concerned with the fullness, fairness and clarity of directors’ disclosure to the general meeting. Failure to make adequate or accurate disclosure to meetings or defects in the advice and recommendations made to shareholders may vitiate decisions taken at those meetings. In view of its importance, the equitable duty is considered further at [6.100]. The distinction between the duty to frame proper notices 82 and the equitable duty to inform and advise members is not always easily drawn, particularly where explanatory material accompanies the notice of meeting. The distinction between the two species of obligation, and their juridical bases, is made more explicitly in some case law. 83 Further, while some earlier cases, 84 and a modern appellate decision, 85 use the language of directors’ duties to express shareholder information standards, others have looked simply to the adequacy of information available to shareholders, or its misleading tendency, without formally treating the issue in terms of directors’ duties. These disclosure obligations are not, however, confined to director-initiated resolutions and extend to material circulated by directors in response to the initiatives of others. 86 Since the focus of concern of the disclosure rules is with the integrity of shareholder decision-making, there is no reason to suggest that a differential disclosure standard would or should apply as between proposals initiated by majority shareholders and those made by directors as independent agents. In practice, it is directors who convene shareholder meetings, whether on their own motion or at the behest of majority shareholders. These general law obligations are complemented by statutory remedies for misleading and deceptive conduct. Since 1998 the consumer protection provisions of the Trade Practices Act 1974 (Cth) and successor provisions in the Australian Consumer Law in Sch 2 of the Competition and Consumer Act 2010 (Cth) no longer apply to the supply of financial services: s 131A. In their place, Pt 2 Div 2 of the ASIC Act and CA, s 1041H were introduced in substantially similar terms to Ch 2 of the Australian Consumer Law but with their application limited to financial services, including dealings in corporate securities. Not all corporate 79

80 81

Ryan v Edna May Junction Goldmining Co NL (1916) 21 CLR 487 at 500; Re London & Mediterranean Bank, Wright’s Case (1868) 37 LJ Ch 529 at 537 (“fair business-like notice in the circumstances”); Devereaux Holdings Pty Ltd v Parry Corp Ltd (1985) 9 ACLR 837 at 842. Devereaux Holdings Pty Ltd v Parry Corp Ltd (1985) 9 ACLR 837. Bancorp Investments Ltd v Primac Holdings Ltd (1984) 9 ACLR 263.

82

This obligation has been described as a common law duty, to distinguish it from the equitable duty to inform and advise shareholders: Devereaux Holdings Pty Ltd v Pelsart Resources NL (No 2) (1985) 9 ACLR 956 at 958.

83

85

Chequepoint Securities Ltd v Claremont Petroleum NL (1987) 11 ACLR 94 at 96; Devereaux Holdings Pty Ltd v Pelsart Resources NL (No 2) (1985) 9 ACLR 956 at 958; see generally E Magner (1987) 5 C&SLJ 92. See, eg, Bulfin v Bebarfield’s Ltd (1938) 38 SR (NSW) 424 and Peel v London & North Western Railway Co [1907] 1 Ch 5. Fraser v NRMA Holdings Ltd (1995) 15 ACSR 590 at 601-602.

86

See, eg, Bain & Co Nominees Pty Ltd v Grace Bros Holdings Ltd (1983) 7 ACLR 777.

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disputes in this area, however, involve the supply of financial services: see, for example, ENT Pty Ltd v Sunraysia Television Ltd (applying the misleading and deceptive conduct provisions of the former s 52 of the Trade Practices Act 1974 concerning contested corporate disclosure) at [6.125]. The equitable duty to disclose matters material to shareholder judgment

The nature and scope of the duty [6.95] As noted, directors are under an equitable obligation to make full disclosure of facts

within their knowledge which are material to the decision before shareholders, including whether or not to attend the meeting. 87 The obligation requires them to fully and fairly inform and instruct the shareholders upon what is proposed in the resolutions put before them; in particular, where directors take it upon themselves to urge, recommend or advise members to exercise their powers in general meeting in a particular way, they must make full disclosure of all matters within their knowledge which would enable the members to make a properly informed judgment on the matter in question. 88 There is authority that disclosure obligations may not be limited by the boundaries of directors’ knowledge. First, in particular instances, they may be required to undertake inquiries to obtain information for communication to members; further, directors must not consciously refrain from seeking relevant information or turn a blind eye to relevant material in order to avoid placing, before members, information which may contradict or qualify a position taken or advocated by the directors. 89 The obligation to give full information does not require directors to give shareholders every piece of information which might conceivably affect their voting; rather, the obligation is to indicate the information which they consider that shareholders should have, plus that information which it would be obvious to the average commercial reader that they should have. 90 The adequacy of the information provided in documentation is to be assessed in a practical, realistic way having regard to the complexity of the proposal. 91 Thus, disclosure was held to be inadequate when the explanation of proposed resolutions to alter the company’s constitution by reducing directors’ discretion to refuse registration of share transfers did not inform shareholders that the proposed changes would also impose a limit upon beneficial shareholdings in the company and upon shareholders’ voting rights; the text of the proposed changes was not contained in the documents distributed to members. 92 Further, disclosure must be made in terms that do not mislead members whether by suppression of information or by what is expressly stated; 93 directors will mislead shareholders if they provide them with material that is other than substantially true, including explanatory material which is tricky in that its terms, while literally true, are framed to mislead readers as to their meaning or effect. 94 Shareholders are entitled to expect that the information sent to 87 88

Bulfin v Bebarfield’s Ltd (1938) 38 SR (NSW) 424 at 440. Bulfin v Bebarfield’s Ltd (1938) 38 SR (NSW) 424 at 440; Chequepoint Securities Ltd v Claremont Petroleum NL (1987) 11 ACLR 94 at 96; Baillie v Oriental Telephone and Electric Co Ltd [1899] 1 Ch 870; Mott v Mount Edon Gold Mines (Aust) Ltd (1994) 12 ACSR 658 at 662.

89

Fraser v NRMA Holdings Ltd (1995) 15 ACSR 590 at 602.

90 91

Buttonwood Nominees Pty Ltd v Sundowner Minerals NL (1986) 10 ACLR 360 at 362. Fraser v NRMA Holdings Ltd (1995) 15 ACSR 590 at 602.

92 93

Bancorp Investments Ltd v Primac Holdings Ltd (1984) 9 ACLR 263. Devereaux Holdings Pty Ltd v Pelsart Resources NL (No 2) (1985) 9 ACLR 956 at 958.

94

Baillie v Oriental Telephone and Electric Co Ltd [1915] 1 Ch 503 at 514, 515; Jackson v The Munster Bank Ltd (1884) 13 LR Ir 118 at 136-137; Kaye v Croydon Tramways Co [1898] 1 Ch 358. [6.95]

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them is “fairly presented, reasonably accurate, and not misleading”. 95 Breach of this obligation need not be dishonest or involve moral turpitude. 96 On the other hand, if directors make it clear that they are merely putting forward their own views or opinions, in the absence of dishonesty or trickery, they will not breach their duty if those views are objectively wrong: An expression of an honest opinion … does not amount to a misrepresentation or even to inaccuracy if the opinion, even if wrong, is accurately stated as an opinion. 97

The court looks only to whether the information provided to shareholders was capable of misleading, and does not require evidence that some particular person was induced to act by reason of non-disclosure or misstatement; 98 of course, where there is evidence that shareholders have actually been misled, that will usually be determinative. 99

Disclosure where directors derive benefits from the resolution [6.100] The disclosure obligation is “particularly insistent” when directors stand to derive a

benefit under the proposed resolution; where directors have an interest in the subject matter of the resolution or may derive a benefit from its passing, they must make full and true disclosure of benefits which any director may derive from the resolution. 100 Thus, where the notice convening a general meeting to approve an agreement for the sale of the company’s undertaking described it simply as an agreement for sale without disclosing that the purchaser agreed to pay, in addition to the purchase price, a substantial sum to its directors as compensation for loss of their office, the company was restrained from carrying out the agreement; 101 the notice was a “tricky notice … most artfully framed to mislead the shareholders”. 102 The court did not require evidence that any shareholder had been misled by the notice but acted upon its own view that the shareholders had not been sufficiently informed of the meeting’s purposes. 103

Standards of clarity and intelligibility [6.105] The information provided to members should be in a form which is comprehensible

to its readers “on the run”. The expectation is that information which is provided to the ordinary reader who scans or reads it quickly will fully inform them about the matters on which they are asked to vote; an unusually poetic expression stresses “the extreme importance 95

Goldex Mines Ltd v Revill (1974) 54 DLR (3d) 672 at 679; Fraser v NRMA Holdings Ltd (1995) 15 ACSR 590 at 602.

96

Chequepoint Securities Ltd v Claremont Petroleum NL (1987) 11 ACLR 94 at 98.

97

Peters’ American Delicacy Co Ltd v Heath (1939) 61 CLR 457 at 487-488 per Latham CJ; cf 514-515 per Dixon J. Shears v Chisholm (1992) 9 ACSR 691 at 787; Bulfin v Bebarfield’s Ltd (1938) 38 SR (NSW) 424 at 434-435.

98 99 100 101

As in Re Marra Developments Ltd (1976) 1 ACLR 470 at 479-480. Chequepoint Securities Ltd v Claremont Petroleum NL (1987) 11 ACLR 94 at 96; Tiessen v Henderson [1899] 1 Ch 861; Colhoun v Green [1919] 1 VLR 196. Kaye v Croydon Tramways Co [1898] 1 Ch 358.

102 103

Kaye v Croydon Tramways Co [1898] 1 Ch 358 at 369 per Lindley MR. On the other hand, a challenge to the sufficiency of disclosure failed where directors of a company which proposed to make an allotment of shares to another company failed to disclose to shareholders, convened to approve the allotment, that each of the directors had been employed as consultants to the proposed allottee and that several of them were connected with another company in which the proposed allottee had a 40% interest; the challenge failed upon the ground that the association between the directors and the proposed allottee was in the instant case so ephemeral that it could not be said to affect the decision of the shareholders on the issue before them: Buttonwood Nominees Pty Ltd v Sundowner Minerals NL (1986) 10 ACLR 360.

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that these notices should be so plain that those who run may read”. 104 The characteristics of the audience will to some extent shape expected standards of clarity and expression. It is no longer the case, if it ever was, that it can be assumed that readers of company documents are necessarily conversant with business or finance; indeed, modern authority asserts that it is notorious that the class of persons who invest in companies has broadened considerably … and that a significant proportion of shareholders are not businessmen in the sense of having any special knowledge or skills in the field of business. Yet they are just as entitled to a notice that is fair and reasonable in the circumstances. 105

Different standards of clarity, simplicity of expression and perhaps of content, might apply therefore to communications with a small and financially sophisticated shareholder group than to one with a large membership with mixed financial and business experience. Further, it is suggested below that the gravity of the matter for decision may also influence the disclosure standard in a particular instance. The need to make full and fair disclosure must be balanced also against the need to present a document which is intelligible to its readers. Providing more information is not necessarily helpful if it is in a form or quantity which imposes an intolerable burden on its readers and is more likely to confuse than enlighten them. 106 In more complex cases therefore it may be necessary to be selective in the information that is provided, confining it to that which is realistically useful. 107 Views may differ on the application of such a broad standard. One formulation expresses the test of sufficient disclosure in circumstances where there is no suggestion that directors are acting otherwise than honestly and to the best of their ability: the question is not whether the circular might have been differently framed, but whether there is any reasonable ground for supposing that such imperfections as may be found in the circular have had … the result that [shareholders voting for the resolution] have done so under some serious misapprehension of the position. 108

These principles and their application are explored in the following extracts.

Fraser v NRMA Holdings Ltd [6.120] Fraser v NRMA Holdings Ltd (1995) 127 ALR 543 Federal Court of Australia (Full Court) [At the relevant time, NRMA Ltd (the Association) had some 1.8 million members of whom 1.3 million were also members of the NRMA Insurance Ltd (Insurance) with whom they had current contracts of insurance. Both companies have very substantial accumulated surpluses, although in unequal amounts. Both the Association and Insurance were companies limited by guarantee. In March 1994 the directors of both companies, by majority, resolved to propose to members that the group be restructured by “demutualisation”. In consequence, NRMA Holdings Ltd (Holdings) was incorporated as a company limited by shares with the intention that all members of the group would 104

Alexander v Simpson (1889) 43 Ch D 139 at 149 per Bowen LJ, quoted in Re Marra Developments Ltd (1976) 1 ACLR 470 at 479 where the phrase was traced “through Tennyson (‘The Flower’) and Cowper (‘Tirocinium’) to the Old Testament, Habakkuk 2:2, ‘write the vision, and make it plain upon tables, that he may run that readeth it’”; Ryan v Edna May Junction Goldmining Co NL (1916) 21 CLR 487 at 495; Re Dorman Long & Co Ltd [1934] 1 Ch 635 at 665-666; Re Marra Developments Ltd (1976) 1 ACLR 470; Devereaux Holdings Pty Ltd v Pelsart Resources NL (No 2) (1985) 9 ACLR 956 at 958-959.

105 106

Re Marra Developments Ltd (1976) 1 ACLR 470 at 479. Killen v Marra Developments Ltd (Kearney J, Supreme Court of NSW, 5 July 1979; noted at [1979] ACLD [608]).

107 108

Fraser v NRMA Holdings Ltd (1995) 15 ACSR 590 at 603. Re Imperial Chemical Industries Ltd [1936] 1 Ch 587 at 618; aff’d sub nom Carruth v Imperial Chemical Industries Ltd [1937] AC 707 at 768; Re Castlereagh Securities Ltd [1973] 1 NSWLR 624 at 636; Bain & Co Nominees Pty Ltd v Grace Bros Holdings Ltd (1983) 7 ACLR 777 at 781. [6.120]

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Fraser v NRMA Holdings Ltd cont. become members of Holdings, that Holdings would become the sole member of the Association and that Holdings and the Association would become the sole members of Insurance. In effect, individual members of the Association and of Insurance were asked to vote upon constitutional alterations which would extinguish individual membership in the Association and Insurance in exchange for shares in a new company which would assume all membership rights in the two original companies. This new company, Holdings, would seek ASX listing. To effect the reconstruction, the Association and Insurance would be converted to companies limited both by shares and by guarantee. Substantial changes would need to be made to the constitutions of both companies. In due course, court approval would need to be obtained in relation to the distribution to erstwhile members of the Association and Insurance of the “exchange” shares in Holdings credited as fully paid up. Holdings sent a prospectus to all members of the Association and Insurance. Tucked away in the body of the prospectus were notices of meetings of the Association and Insurance convened to consider resolutions to amend the constitution of each company to give effect to the reconstruction. Two distinct sets of documents were thus effectively melded into one. Inter alia, the proposed new articles provided for the extinguishment of membership of each company in exchange for shares to be issued as fully paid in the capital of Holdings. The text of the proposed articles was not set out in the notice of meeting or elsewhere in the prospectus although members were advised that copies were available upon request. There was no statement in summary form of the particular changes to be brought about by the new articles. The significance of what was proposed was, however, outlined elsewhere in the prospectus under the heading “LEGAL STEPS INVOLVED IN CHANGE”. Proxy voting forms accompanied the prospectus. Two members (who were also directors) of the Association sought declarations that members of both companies were not fully and adequately informed of the proposals the subject of the resolutions to be put before them in the general meeting and of the offers made in the prospectus, and that the prospectus and the information in it was misleading and deceptive in certain particulars. They sought relief under s 52 of the former Trade Practices Act 1974(Cth). The proceedings were determined prior to the 1998 amendments that excluded s 52 from applying in relation to financial services (which include dealings in corporate securities) and substituted s 12DA(1) of the ASIC Act and CA s 1041H, in corresponding terms to s 52 but applying only to financial services. The applicants had three principal complaints: first, that the effect of the “persistent reiteration of the phrase ‘Free Shares’ [was] to engender in the reader the notion that the shares may be acquired without any significant loss or outgoing to the offeree who accepts them”; second, the failure of the prospectus to distinguish adequately between the impact of the proposal upon members of the Association and of Insurance; third, by the use of imprecise language, such as references to “business as usual”, to leave in a “half light” the question whether Holdings would conduct its business – especially its road and travel services – in such a way as to “affect in any substantial way the extent or costs of services presently provided to members”. The challenge was upheld at first instance.] BLACK CJ, VON DOUSSA and COOPER JJ: [554] A duty to make disclosure of relevant information arises as part of the fiduciary duties of the directors to the company and its members in relation to proposals to be considered in general meeting and under s 1022 of the Law in respect of the contents of a prospectus. The fiduciary duty is a duty to provide such material information as will fully and fairly inform members of what is to be considered at the meeting and for which their proxy may be sought. The information is to be such as will enable members to judge for themselves whether to attend the meeting and vote for or against the proposal or whether to leave the matter to be determined by a majority attending and voting at the meeting … Examples of a failure to provide sufficient information to enable a member to make an informed decision as to the worth or otherwise of a proposed reconstruction or amalgamation can be found in Garvie v Axmith (1962) 31 DLR (2d) 65; Re National Grocers Co Ltd [1938] 3 DLR 106; Re N Slater Co Ltd [1947] 2 DLR 311. A proper discharge of the duty may require that the directors take reasonable steps to ascertain relevant information for communication to members if that information is not known to the board. Directors must not consciously refrain from seeking relevant information or turn a blind eye to relevant material in order 376

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Fraser v NRMA Holdings Ltd cont. to avoid placing before members information which may contradict or qualify any particular position taken or advocated by the directors or a majority of them. Although s 52 gives rise to no duty to provide information, when information is in fact given in purported discharge of the fiduciary duty, s 52 requires that the [555] information given is not misleading or deceptive or likely to mislead or deceive. Additionally, the section requires that the conduct of the directors in withholding certain information is not itself conduct which is misleading or deceptive or likely to mislead or deceive. It is in the area of proper discharge of the fiduciary duty to provide relevant information that there is an overlap between discharge of the duty and the operation of s 52: a failure properly to discharge the duty may itself constitute a contravention of s 52 as well as a contravention of s 995 of the Law. Thus, the Ontario Court of Appeal in Goldex Mines Ltd v Revill said (at 679): In Charlebois v Bienvenu [1968] 2 OR 635 at 644; 64 DLR (2d) 683 at 692, Fraser J held that the holding of an annual meeting and the election of directors after the sending out of a misleading information circular was a breach of the directors’ fiduciary duty to the company. We hold that such an act is also breach of duty to the other shareholders. If the directors of a company choose, or are compelled by statute, to send information to shareholders, those shareholders have a right to expect that the information sent to them is fairly presented, reasonably accurate, and not misleading. Examples of the courts’ intervention where incomplete and misleading information was given or the notice and accompanying circular could be described as “tricky” can be found in Jackson v Munster Bank Ltd and Baillie v Oriental Telephone and Electric Co Ltd. Whilst s 52 does not by its terms impose an independent duty of disclosure which would require a corporation or its directors to give any particular information to members asked to consider a motion in general meeting, where information for that purpose is promulgated, unless the information given constitutes a full and fair disclosure of all facts which are material to enable the members to make a properly informed decision, the combination of what is said and what is left unsaid may, depending on the full circumstances, be likely to mislead or deceive the membership … The question whether conduct is misleading or deceptive or is likely to mislead or deceive has to be judged objectively and we agree with the trial judge that the objective assessment required is whether by reason of what was said and what was left unsaid there was in all the circumstances a contravention of s 52. [556] This is not necessarily the same question as the one which would have arisen if the applicants had alleged breaches of directors’ duties under the general law. For example, if the applicants had sought relief for a breach of the directors’ duties described in Bulfin a question would have arisen whether the directors had knowledge or must be taken to have had knowledge of facts said not to be disclosed, whereas for the purposes of s 52, if by reason of what was said and what was left unsaid the conduct of the corporation is misleading and deceptive or likely to mislead or deceive, a contravention would occur even if the corporation through its directors and officers did not have knowledge of the undisclosed facts which rendered the conduct in breach of s 52. A contravention of s 52 may occur without knowledge or fault on the part of the corporation, and notwithstanding the exercise of reasonable care: Parkdale Custom Built Furniture Pty Ltd v Puxu Pty Ltd at CLR 197. Where the contravention of s 52 alleged involves a failure to make a full and fair disclosure of information, the applicant carries the onus of establishing how or in what manner that which was said involved error or how that which was left unsaid had the potential to mislead or deceive. Errors and omissions to have that potential must be relevant to the topic about which it is said that the respondents’ conduct is likely to mislead or deceive. The need for an applicant to establish materiality is of particular importance in a case like the present one where the proposal is complex, and involves difficult questions of commercial judgment and matters of degree and conjecture as to the future about which there is room for a range of honestly and reasonably held opinions. If every possible formulation of the commercial objective of the proposal, and arguments for and against every theoretical possibility, were set forth the total package of information to members would be likely to [6.120]

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Fraser v NRMA Holdings Ltd cont. confuse rather than to illuminate the issue for decision, even for people having a familiarity with corporate law and commerce. The need to make full and fair disclosure must be tempered by the need to present a document that is intelligible to reasonable members of the class to whom it is directed, and is likely to assist rather than to confuse: see Devereaux Holdings Pty Ltd v Pelsart Resources NL (No 2) (1985) 9 ACLR 956 at 959; Re Dorman, Long & Co Ltd [1934] 1 Ch 635 at 665-6. In complex cases it may be necessary to be selective in the information provided, confining it to that which is realistically useful. Clearly the present case was one of this kind. However the proposal was formulated, and however the information to members was drafted, it is likely that some criticism could be levelled at it. For example, criticism is made that the prospectus incorporates notices of general meetings of members of the Association and Insurance and fails adequately to recognise them as separate entities – it is said that there should have been a separate explanatory memorandum for each meeting. Yet if three separate documents had been produced it is not difficult to imagine that criticism could be made that the documents were repetitious with the result that the length of the total package was too great, and the interrelationship of transactions separately discussed too difficult, to be understood by ordinary reasonable members. It is important that the adequacy of the information provided by the prospectus and supporting documents be assessed in a practical, realistic way having regard to the complexity of the proposal. In the circumstances the court should not be quick to conclude that a contravention of s 52 has occurred because other information could have been provided that was not. The need for the applicants [557] to establish the materiality of errors and omissions is an important step in the proof of their claims. It will be necessary to return to this topic as the reasons of the learned trial judge are considered. [The Full Court upheld the first of the applicants’ complaints. The second complaint was dismissed; to describe the interests of the members of the Association and of Insurance as “similar” in the context of the proposal was not misleading or deceptive within s 52 notwithstanding that the description is not completely correct legally. The third complaint was upheld on the basis that the prospectus’s assertion that members would be “better off” under the proposed restructure, without any attempt to inform members about its disadvantages of which the directors were aware, was to leave them in a “half light which had the potential to lead them to think that the unidentified disadvantages must be [insignificant]”.]

ENT Pty Ltd v Sunraysia Television Ltd [6.125] ENT Pty Ltd v Sunraysia Television Ltd (2007) 61 ACSR 626 Supreme Court of New South Wales [Sunraysia is a listed Australian company. Its principal asset (95% by asset value, 97% by revenue) is its wholly owned subsidiary Swan TV operating Channel 9 in Perth. Sunraysia and PBL Media enter into an agreement for the sale of Swan TV’s capital conditional upon approval by Sunraysia shareholders. If the sale is approved, the Sunraysia directors indicate to members that they intend to propose in a second transaction a share buy-back of the company’s issued shares, funded by the proceeds of sale of Swan TV. Shareholder approval is required by ASX listing rules since the sale involves the disposal of Sunraysia’s main undertaking. The transaction is in economic effect a takeover but is outside the reach of Chap 6 of the Act since it is structured as a sale of assets rather than a takeover bid. The Sunraysia directors unanimously recommend shareholder approval. They control 49.8% of Swan’s voting power. ENT is a shareholder in Sunraysia; with related companies its shareholding represents 44.6% of voting power. (Only about 6.6% of Swan TV shares are held therefore by other parties.) In these proceedings ENT seeks to restrain the holding of the meeting to approve the sale, claiming that the Explanatory Materials accompanying the notice of meeting make inadequate substantive disclosure of material matters. The claims are made under the fiduciary duty of full and fair disclosure and for misleading and deceptive conduct under s 52 of the former Trade Practices Act 1974. There is no challenge under s 249L.] 378

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ENT Pty Ltd v Sunraysia Television Ltd cont. AUSTIN J: [24] I generally agree with the plaintiff’s submission that the level of disclosure in the present case is influenced by the nature of the decision that the shareholders are being asked to make. Under a typical corporate constitution (and see the replaceable rule in s 198A), the directors are empowered to manage or direct the management of the business of the company. Therefore, the decision to dispose of the company’s main undertaking is the directors’ decision. The Listing Rule gives shareholders the function of approving the directors’ decision (or their proposed decision), and so the shareholders’ meeting supplements the directors’ decision rather than usurping the directors’ power. [25] The shareholders do not need to have all of the information required by the primary decision-makers, the directors. For example, they do not need to be presented with information about the range of alternative proposals that would need to be considered before a particular transaction is chosen. Reviewing all the alternatives is a task for the primary decision-makers. The shareholders’ task is limited to approving or rejecting the particular proposal that the directors present to the meeting, and it is not their role to choose or advocate a transaction of some other kind. The question for the shareholders is not whether the directors have selected the best possible transaction, but whether the transaction they have selected should be approved. However, the shareholders are entitled to receive all of the information that is material to the question whether the transaction proposed by the directors should be approved, including all the commercial information that is material to that question. That includes the material commercial information known to the directors, and also other commercial information that is material and accessible to the directors even if they are not aware of it. [The plaintiff argued that “the Directors have not informed members whether they have an opinion as to whether the Sale Price reflects a fair price for Swan TV, and if they do, what that opinion is and the basis for it. [Further] the Directors have not informed members of the basis upon which it should be concluded that the Sale Proposal is in the members’ best interests.” The judge agreed.] [40] … It is inconceivable that the directors would have recommended the Sale Proposal without first forming a view as to whether the Sale Price is a fair price for Swan TV (or, if not a fair price, one that in the circumstances should be accepted). In my opinion information about their opinion on this vitally important matter, and the basis for their opinion, is highly material to the shareholders’ decision whether to approve the Sale Proposal. It is fundamental. It might be that information about the directors’ opinion on the question whether the Sale Proposal is in the shareholders’ best interests would not be material to a simple decision to approve the sale of an asset, even a substantial one. But in the present case … the directors have presented the Sale Proposal as the first step in a two-stage process, the second stage involving a cash distribution to the shareholders that makes it relevant for the shareholders to consider whether the whole process should be implemented, in their interests, by embarking on the first step. [The judge concluded that this disclosure had not been made in the material circulated to shareholders.] [The plaintiffs then argued that “the Directors have not informed members whether they have any independent or other assessment of the value of Swan TV. If there is such an assessment they have not said what the effect of the assessment is. If there is no such assessment they have not said why they thought the Sale Proposal appropriate in the absence of such an assessment.”] [48] … [T]he defendant says that the directors’ duty does not require them to inform shareholders about these matters. I disagree. In my opinion, the directors’ duty of disclosure requires them to disclose the basis upon which they have formed their opinion as to the fairness or adequacy of the price, and the basis of their decision to commit the company to the Share Proposal and to recommend it for the approval of shareholders. The directors’ duty of care and diligence required them to have a proper basis for committing the company to the Sale Proposal and recommending it to the shareholders, when they decided to do so. This is not to say that they were required to obtain an independent or other external expert’s report as to the value of Swan TV (cf Lion Nathan Australia Pty Ltd v Coopers Brewery Ltd (2005) 55 ACSR 583). Unlike some other listing rules, Rule 11.2 does not require an expert’s report. But if the directors choose to proceed without external expert advice, their duty of care and diligence requires them to identify some other proper basis for their decision. Their duty of disclosure to the shareholders requires that the basis for their decision and their opinion on value be explained, so that the shareholders have the material information they need for the purpose [6.125]

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ENT Pty Ltd v Sunraysia Television Ltd cont. of deciding whether to approve the Sale Proposal. The absence of an independent expert’s report does not exonerate the directors from giving such an explanation. [The plaintiff argued that the directors had not informed members that the Sale Price is significantly less than the value of Swan TV implied by the market price for Sunraysia shares. Trading in Sunraysia shares was very thin: on most days no shares were traded at all and the largest parcel of shares traded was 4,000 shares.] [52] In my opinion, disclosure of [such] matters … is unnecessary, subject to one qualification. The qualification is that if the directors have formed their opinion as to the value of the subsidiary and the adequacy of the price upon the basis of historical trading information, information about that matter should be included in their explanation of the basis for their opinion, for the reasons I have already given. But if, in the present case, the directors have not taken historical trading information into account, there is no obligation to disclose it. The position might be different in a case where the parent entity’s shares are traded in a highly liquid and efficient market where historical trading information may be very helpful in assessing value and adequacy of price. But the evidence indicates this is far from the case with Sunraysia. It would be consistent with discharging their duties for the directors to have formed the view that historical trading information is unreliable and should be excluded from their assessment of value and the adequacy of price. [The plaintiff’s next objection was that the directors had unanimously recommended members vote in favour of the resolution but did not inform them whether any steps were taken to ascertain if there were other bidders who might offer more either for Swan TV or for the shares in Sunraysia (including the plaintiff) nor whether Sunraysia had considered or been offered or sought any alternatives to the Sale Proposal and if so, why the Sale Proposal was preferable to those alternatives.] [55] The question whether directors should disclose negotiations with other potential bidders and the exploration of alternatives to the proposal they have decided to put to the shareholders is a difficult one. It may be that the directors’ duty of care and diligence obliges them to investigate alternative ways of achieving their objectives, and to weigh up the advantages and disadvantages of their preferred proposal against the alternatives, before committing their company to any major transaction. Assuming that to be so, it does not necessarily follow that the directors must on every occasion disclose to the shareholders their consideration of alternatives, and their assessment of the advantages and disadvantages of each. Their duty of disclosure depends upon the question that the shareholders are asked to consider. [56] If the question is whether to adopt a new corporate constitution so as to achieve the demutualisation of a mutual organisation, the members’ decision is the only operative decision and they may need to be given some information about alternatives and their relative advantages and disadvantages (see Fraser v NRMA Holdings (1995) 55 FCR 452 at 487). But when the question for the shareholders is whether to approve the sale of the company’s main undertaking, the operative decision under the typical corporate constitution is the directors’ decision, and the shareholders are required to be consulted only because of the listing rule. The directors’ formulation of the proposal for approval by shareholders sets the metes and bounds of the shareholders’ decision. It is not a case of the shareholders reviewing a range of possibilities and selecting the one that they prefer. The directors have done so, and their decision is binding on the shareholders. The shareholders are merely asked to approve the directors’ proposal. In such a case, it seems to me, it is unnecessary to disclose alternative proposals and their relative advantages and disadvantages. [The Sunraysia directors had stated that the sale proceeds are available to meet warranty claims but did not indicate either the terms of the warranties or their knowledge as to the likelihood of any claims being made under the warranties. The judge perused the sale agreement and considered that it contained no unusual warranties that required disclosure.] [61] I agree with the plaintiff, however, that it is material for the directors to tell shareholders whether they are aware of any circumstances likely to give rise to claims and if so, what those circumstances are, and whether they have any belief as to whether substantial claims are likely, and if they do, what is their belief and the basis for it. Statements about these matters are basic pieces of material information 380

[6.125]

Shareholders Acting Collectively: The Company in General Meeting

CHAPTER 6

ENT Pty Ltd v Sunraysia Television Ltd cont. for shareholders in circumstances where the benefit of the Sale Proposal, namely the receipt of cash, may conceivably be substantially reduced or even eliminated if successful warranty claims are made. [Finally, the plaintiff complained that the directors did not inform members as to whether they considered the buy-back proposal to be in their best interests, their reasons for preferring the share buy-back course over other options of returning the sale proceeds to members, and did not provide sufficient details regarding the buy-back (eg, the tax implications for members) to enable them to properly assess the Sale Proposal in the context of the indication that the Share Buy-Back would be proposed.] [66] I do not regard it as necessary for the directors to set out and review alternatives to distribution of the sale proceeds by share buy-back. It seems to me that it would be premature for the directors to express their opinion at this stage as to whether a share buy-back will be in the best interests of the shareholders, given that the specifics of the proposal have apparently not yet been finalised and there may be good reasons for that (such as the need to obtain a tax ruling). However, I agree … [that] the directors have not provided sufficient details regarding the buy-back proposal to enable the shareholders properly to assess the Sale Proposal. [67] First, the Explanatory Materials do not make it expressly clear whether the proposed buy-back is to be an equal access scheme or a selective buy-back. That is a material matter for the shareholders, who may well take a different attitude to the Sale Proposal depending upon whether the proceeds of sale are to be distributed unequally and in a manner that favours some shareholders over others. If I were asked to guess what the directors have in mind, I would say that they contemplate an equal access scheme, but the matter should not be left to guesswork. [68] Secondly, the Explanatory Materials leave the reader in doubt as to how the amount to be distributed in the buy-back will be calculated. … [69] Thirdly, there is the question of the tax effect of the proposal on members. This issue is not addressed in the Explanatory Materials, except by the statement that further details about the buy-back will be provided in advance of the meeting to approve it. And yet, in circumstances where the directors have referred to the buy-back as part of their case for recommending the Sale Proposal to the shareholders, the tax outcome is an essential component of the shareholder’s assessment of the likely benefit of the scheme as a whole, and hence an important input into the shareholder’s decision to approve or reject the Sale Proposal. … [71] … Having regard to the nature of the deficiencies, I have formed the conclusion that there is strong ground for supposing that the deficiencies would cause shareholders to vote, or abstain from voting, under a serious misapprehension of the position. Therefore, the court should make orders having the effect that, in the absence of corrective disclosure, the meeting should not proceed to any substantive business.

[6.130]

Review Problems

1. Recall the facts outlined in n 7 in the Notes & Questions at [4.127]. If you had been a shareholder in James Hardie Industries Ltd when it was the holding company of the group (that is, before the scheme of arrangement in October 2001 that substituted a Netherlandsincorporated company as the ultimate holding company of the group), and you wished to have the general meeting of James Hardie Industries Ltd use its influence to have the board increase funding for those injured by the operations of the former James Hardie asbestos subsidiaries, what legal options would you have available and what issues of strategy would you consider? 2. Chic Ltd is a listed Australian company. Its only business is the distribution of high end fashions through leading department stores and specialist retailers under its exclusive Chic [6.130]

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label. For some years it has had its garments manufactured in Indonesia from fabrics imported from European mills. It does not own the garment factories but contracts with local manufacturers who supply the finished product to its specification. The arrangement has been highly satisfactory: supply has been to specification, on time and labour conditions in the factories have set new standards for pay and conditions in Indonesia. Its current five year term expires shortly and Chic has negotiated a new supply deal with a Thai garment manufacturer on significantly cheaper terms. In addition, Chic will take a significant but minority equity position in the manufacturer. ASX has indicated that since this involves a significant change to the nature of Chic’s business, it must first obtain shareholder approval for the new supply agreement and the share acquisition (ASX listing rule 11.1). In advance of that meeting, some shareholders, personal and institutional, are concerned that the new arrangements pose considerable reputational risks for the company whose principal assets are intangible, namely, its brand and retail distribution arrangements. They point out that the Thai factories, in Mae Sot, are notorious among Thai civil society organisations for their exploitative working conditions and their heavy reliance upon Burmese workers forced to make the dangerous river crossing and live furtively and unprotected under local labour law. They want to stop the transaction and renew the Indonesian supply agreement. At the least, they want the Chic directors to commission and release the results of a reputational risk assessment by an independent expert. They also have concerns about the financial merits of the Thai investment. Advise them with respect to the legal issues arising, including the disclosure obligations of the board in relation to the proposals they will bring to the shareholders meeting.

382

[6.130]

CHAPTER 7 The Duties and Liabilities of Directors and Managers [7.10]

[7.55]

THE STRUCTURE OF LIABILITIES OF DIRECTORS AND MANAGERS ................................................ 384 [7.10]

Treating directors as fiduciaries .................................................................................... 384

[7.15] [7.20] [7.25]

The scope of directors’ personal liabilities ..................................................................... 386 The functions of directors’ and officers’ duties .............................................................. 388 The moderators of director and executive conduct ...................................................... 390

[7.30]

The reach of statutory obligation: the terms of the extended definition of director and officer ................................................................................... 392

SANCTIONING DIRECTORS’ AND OFFICERS’ DUTIES: THE CIVIL PENALTY SCHEME ....................................................................................................................................... 406 [7.55] [7.60] [7.65]

[7.70]

[7.135]

[7.215]

[7.340]

Sanctioning compliance with the Act ........................................................................... 406 The range of civil penalty provisions ............................................................................. 407 The consequences of contravening a civil penalty provision ......................................... 407

DUTIES OF CARE, DILIGENCE AND SKILL ...................................................................................... 410 [7.70]

An overview of duties and remedies ............................................................................. 410

[7.75] [7.80]

The development of the modern duty of care .............................................................. 412 The content of the duty of care .................................................................................... 415

[7.105] [7.110]

The statutory business judgment rule ........................................................................... 436 The requirement of a positive business judgment ......................................................... 438

THE DUTY TO PREVENT INSOLVENT TRADING .............................................................................. 449 [7.140] [7.145] [7.150] [7.155] [7.160] [7.165]

An overview of the elements of duty ............................................................................ Debts engaging the duty ............................................................................................. The definition of insolvency ......................................................................................... Reasonable grounds for suspecting insolvency ............................................................. The director’s awareness, actual or imputed, of the company’s financial position ......... Defences to liability for failure to prevent insolvent trading ..........................................

449 450 451 453 454 456

[7.190] [7.195]

Compensation remedies with respect to insolvent trading ........................................... 458 The liability of a holding company for insolvent trading by a subsidiary company ........ 459

THE DIRECTOR’S DUTY TO ACT BONA FIDE FOR THE BENEFIT OF THE COMPANY AS A WHOLE ................................................................................................................ 465 [7.215]

An overview of remedies and their outcomes ............................................................... 465

[7.220]

Judicial reluctance to intervene in directors’ decisions .................................................. 466

[7.225] [7.230] [7.235]

The elements of the duty to act in good faith ............................................................... 466 The duty of subjective good faith ................................................................................. 467 The duty to exercise powers for a proper purpose ........................................................ 468

[7.240]

The duty to consult and act by reference to company interests .................................... 469

[7.250]

The statutory duty of good faith .................................................................................. 470

DIRECTORS’ INTERESTS IN TRANSACTIONS WITH THEIR COMPANY ............................................ 504 [7.340]

The general equitable obligation to avoid conflict between duty and interest: an overview ..................................................................................... 504

[7.345]

The tiers of rules affecting directors’ interests in transactions with their company ......... 505

[7.350]

Statutory disclosure obligations with respect to directors’ interests in matters affecting their company ............................................................................... 506

[7.355]

Restriction upon board participation by interested directors of public companies ......... 507 383

Corporations and Financial Markets Law

[7.390] [7.395] [7.415]

[7.455]

[7.505]

Director and executive remuneration ........................................................................... 521 Concerns with executive remuneration levels and disclosure ........................................ 522

RELATED PARTY TRANSACTIONS ................................................................................................... 528 [7.415] [7.420] [7.425]

Background and purpose ............................................................................................. 528 The core prohibition .................................................................................................... 529 When a financial benefit is given .................................................................................. 530

[7.430] [7.435] [7.440]

The definition of a related party of a public company .................................................. 530 Exceptions to the prohibition upon giving financial benefits ........................................ 531 Application in Adler v ASIC ........................................................................................... 532

[7.445] [7.450]

The shareholder approval mechanism .......................................................................... 533 Sanctioning related party transactions .......................................................................... 534

SECRET PROFITS: THE APPROPRIATION OF CORPORATE PROPERTY, INFORMATION AND OPPORTUNITY ............................................................................................. 534 [7.455]

The distinct bases of equitable obligation ..................................................................... 534

[7.500]

Statutory duties ........................................................................................................... 562

FURTHER CONFLICT AVOIDANCE OBLIGATIONS ........................................................................... 563 [7.510] [7.520] [7.530]

The fettering of board discretions ................................................................................ 563 Competing directors .................................................................................................... 565 Interlocking directors ................................................................................................... 567

[7.535]

FIDUCIARY DUTY TO INDIVIDUAL SHAREHOLDERS? ...................................................................... 569

[7.545]

INDEMNIFICATION, EXEMPTION AND INSURANCE ...................................................................... 574 [7.545] [7.550] [7.555] [7.560]

Rationale for restrictions ............................................................................................... Exemption from liability as an officer or auditor ........................................................... Indemnification against liability as an officer or auditor ................................................ Directors and officers insurance ....................................................................................

574 575 575 576

[7.05] This chapter examines the complex of duties and liabilities imposed upon directors and

other corporate officers by the general law and statute. It deals with the following issues: • the process by which fiduciary responsibility was ascribed to directors and the elements and reach of that responsibility; • the duties of care, diligence and skill imposed upon corporate directors and officers and the related duty to prevent the company incurring debts while insolvent; • the duty to act bona fide for the benefit of the company as a whole and to exercise powers for a proper purpose; • the other principal element of the director’s fiduciary obligation, the duty to avoid conflict between duty and interest and its expression in rules relating to directors’ transactions with their company, related party transactions, accountability for the exploitation of corporate opportunities, and the special position of nominee and competing directors; • the exceptional circumstances in which the courts have treated directors as fiduciaries to individual shareholders; and • doctrines relating to the indemnification of directors and their release from duty.

THE STRUCTURE OF LIABILITIES OF DIRECTORS AND MANAGERS Treating directors as fiduciaries [7.10] In modern legal language directors are fiduciaries, one of several categories of office or

occupation which equity has fixed with more or less rigorous obligations of disinterested 384

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conduct. 1 Fiduciary status was ascribed to directors and its proscriptions determined by courts of equity from the middle of the 19th century. The director of the registered company held a novel office although it had its antecedents in the “committee men” of the chartered corporations and deed of settlement companies. The 1844 and later statutes were silent as to the measure of the director’s legal responsibility. Initially the courts resorted to the trust as a model of liability. Directors were declared to be trustees and subjected to like standards of conduct. The description of directors as trustees is apt in its recognition of the trust or confidence reposed in directors, the representative nature of their office and the control they exert over corporate property. Yet the analogy with trustees is only approximate. Directors do not hold title to corporate property and are subject to substantially different expectations as to their caution and risk aversion in decision-making. Another description of directors was in terms of agency. Thus, in 1872 it was said that “directors are the mere trustees or agents of the company – trustees of the company’s money or property, agents in the transactions which they enter into on behalf of the company”. 2 This analogy with agents is also apt in that directors who contract on behalf of their company do so without attracting personal liability unless they have expressly assumed such liability or have exceeded their powers. However, directors’ powers are much more expansive than those usually confided to agents and, as we have seen, directors are usually free from the close supervision of a principal. The courts in the 19th century resorted to other relationships to assimilate the director to the categories of settled doctrine. Thus directors were variously described as “mandatories”, 3 “managing partners”, 4 “fiduciary agents” 5 and “commercial men managing a trading concern for the benefit of themselves and all the other shareholders in it”. 6 However, by the 20th century it was apparent that none of these categories was an adequate model for ascribing responsibility to directors. Thus in 1925 the trustee analogy was set aside for that of the fiduciary: It is sometimes said that directors are trustees. If this means no more than that directors in the performance of their duties stand in a fiduciary relationship to the company, the statement is true enough. But if the statement is meant to be an indication by way of analogy of what those duties are, it appears to me to be wholly misleading. I can see but little resemblance between the duties of a director and the duties of a trustee of a will or of a marriage settlement. It is indeed impossible to describe the duty of directors in general terms, whether by way of analogy or otherwise. 7

To describe directors as fiduciaries does not conclude enquiry as to their responsibilities, but only gives it direction. 8 In this chapter we shall see the evolution of a distinct fiduciary 1 2

See further on the process by which fiduciary responsibilities were ascribed to directors, L S Sealy [1967] CLJ 83; G W Keeton (1952) 5 Current Legal Problems 11. Great Eastern Railway Co v Turner (1872) LR 8 Ch App 149 at 152 per Lord Selborne.

3

Overend and Gurney Co v Gibb (1872) LR 5 HL 480 at 486.

4 5

Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame [1906] 2 Ch 34 at 45. Parker v McKenna (1874) LR 10 Ch App 96 at 124.

6

Re Forest of Dean Mining Co (1879) 10 Ch D 451 at 453.

7

Re City Equitable Fire Insurance Co Ltd [1925] Ch 407 at 426. The offices of director and trustee overlap in at least one respect. Although a company generally holds the legal title to its assets, directors are treated as if they were trustees of company money or property which is in their hands or under their control. Hence, a director who misappropriates property will be liable, in the same manner as a trustee, to restore the property to the company and to account for profits derived from its use: Re Lands Allotment Co [1894] 1 Ch 616 at 639. A similar liability arises where directors pay dividends out of capital: Blackburn v Industrial Equity Ltd (1980) CLC 40-604.

8

See SEC v Chenery Corp 318 US 80 at 85-86 (1943). [7.10]

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doctrine for directors refining, in its application to their office, the trust and agency doctrines to which the courts initially resorted. These duties extend also to senior level executives of the company. Not all of the duties of directors and senior executives are fiduciary in character. Thus, the duty to exercise care, diligence and skill is one imposed both in equity and at common law but may not be fiduciary in character: see [7.70]. 9 The general law duties are supplemented by statutory duties contained in Ch 2D of the Act imposing civil obligations upon directors and other officers • to exercise care and diligence (s 180); • to act in good faith in the interests of the company and for a proper purpose (s 181); • not to improperly use their position to gain an advantage or cause detriment to the company (s 182); 10 and • not to improperly misuse information obtained as a director, officer or employer: s 183. These duties are in addition to general law duties and remedies: s 185. Directors and officers who breach the statutory duties (other than that of care and diligence) either recklessly or intentionally commit an offence: s 184. The statutory duties are examined together with their general law counterpart in this chapter. Directors stand in a fiduciary relationship with their company and, save for exceptional circumstances, they do not owe fiduciary duties to individual shareholders, creditors 11 or other persons dealing with the company. 12 The circumstances in which directors owe duties of good faith and careful conduct to individual shareholders are examined at [7.535]. Two important ideas shape the application of fiduciary law to company directors and officers. The first is the core fiduciary ideology itself, requiring the fiduciary to bring to the office an ethic of self-denial or disinterested service. However, the fiduciary standard is compromised in its application to company directors by the fact that they will usually have interests as shareholders that may be affected by their decisions taken as directors. This interest has prompted the courts to attenuate the fiduciary principle in relation to company directors. 13 The second shaping idea has been to treat the general law fiduciary obligation as contractible, subject to modification or release by private ordering of the parties – through release by corporate consent by informed shareholder resolution or constitutional provision. The apparent rationale for the constitutional displacement of fiduciary obligation is the assumption that directors, managers and shareholders will choose the governance structure that most efficiently contains the risks and costs of managerial opportunism and shirking. 14 The scope of directors’ personal liabilities [7.15] Directors are not personally liable for acts or omissions of their company merely

because of the office they hold, including acts or omissions of the board or performed by 9

The longstanding fiduciary characterisation of the other principal directors’ duties (corresponding to the statutory duties noted in the next following paragraph) has recently been affirmed against challenge that only those duties that are proscriptive (enjoining conduct) may be fiduciary: Westpac Banking Corporation v Bell Group Ltd (in liq) (No 3) (2012) 89 ACSR 1 at [898] per Lee AJA, [1962] per Drummond AJA; but see [2716] per Carr AJA.

10

The duty extends also to secretaries and employees of the company.

11 12 13

Re Wincham Shipbuilding, Boiler and Salt Co (1878) 9 Ch D 322 at 328. Wilson v Lord Bury (1880) 5 QBD 518 at 527. See, eg, Mills v Mills (1938) 60 CLR 150 at 163-165.

14

An earlier judicial justification was in terms of the relational benefits to the company from directors whose connections otherwise compromised the disinterested conduct standard: see Imperial Mercantile Credit Association v Coleman (1871) LR 6 Ch App 558 at 567, extracted at [7.365] and see [5.50] re the network connection function of directors.

386

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individual directors on the company’s behalf. To this general rule there are numerous exceptions under the general law, 15 under the Corporations Act itself and under other statutory provisions. Thus, under the Act directors are personally liable to compensate creditors for losses suffered when the company incurs debts while insolvent and when there were reasonable grounds for suspecting that insolvency: s 588G and [7.135]. Directors of corporate trustees are personally liable for a liability assumed by the company which it is unable to discharge and where it is not entitled to be fully indemnified against the liability out of trust assets because of a breach of trust by the company, it acted outside the scope of its powers as trustee or because a term of the trust denies or limits the company’s right to be indemnified: s 197. Since the 1980s there has been an increasing tendency towards imposing personal liability upon directors and senior managers for breaches of obligations imposed primarily upon their company under regulatory legislation: see [4.185]. 16 There has been an automatic extension of liability to the directors and managers subject to various grounds of exculpation in statutes relating to industrial regulation, the movement of hazardous goods, revenue collection and environmental protection. Liability has been variously imposed upon the basis of the holding of a designated corporate office or one of sufficient seniority, or being concerned in company management or in the company’s breach. There is a great diversity in the grounds of defence or exculpation as well as in the bases of liability. The intended purpose of imposing personal liability has been to sharpen incentives for corporate compliance with the regulatory purpose; the technique has been criticised for regulatory ineffectiveness (for not being well suited to the governance practicalities of many companies) as well as for inherent unfairness in the imposition of personal fault, especially in view of the diversity of forms of potential liability. 17 In 2009, the Ministerial Council for Corporations (now called the Legislative and Governance Forum for Corporations) agreed to a set of principles which were later approved by the Council of Australian Governments (COAG Principles). The principles aim to “ensure that, in areas where personal liability is considered appropriate, it is imposed in accordance with principles of good corporate governance and criminal justice”. COAG agreed that all jurisdictions would apply these guidelines when drafting future legislation. In addition, all 15

16

17

Thus, directors will be personally liable as joint tortfeasors with their company when they have directed or procured tortious acts to be done by the company: “[however] for a director to be liable because he or she directs or procures his or her company to commit a wrong, the context must be such that the director is effectively standing apart from the company and directing and procuring it as a separate entity” (Keller v LED Technologies Pty Ltd [2010] FCAFC 55 at [404] per Jessup J; “[w]here a person is acting in the capacity of a director, the person will not be liable for the act of the company unless it can be shown that, in so acting, the director was doing something more than acting as a director. The person must do something that makes him or her, in addition to the company, an invader of the victim’s rights … [t]he mere fact that a company is small and that the director has control over its affairs is not, of itself, sufficient to make the director a joint tortfeasor with the company” (Keller v LED Technologies Pty Ltd [2010] FCAFC 55 at [83] per Emmett J); see also Young Investments Group Pty Ltd v Mann (2013) 91 ACSR 89 at [58] (noting other judicial formulations of the circumstances in which directors will be liable for the company’s wrongful conduct but not needing in the instant case to choose between them); S H C Lo (2016) 30 Aust Jnl of Corp Law 215. Directors and officers bear no personal liability for contracts entered into on the company’s behalf or as its organ save upon some independent term, such as breach of warranty of authority to contract on behalf of the company. It is claimed that over 700 State and Territory provisions impose personal liability on individual directors and officers for corporate misconduct, sometimes in the absence of any personal involvement in the breach: Australian Institute of Company Directors, “Liability Laws Damaging the Economy Director Survey Reveals”, Media Release, 1 November 2010. Corporations and Markets Advisory Committee, Personal Liability for Corporate Fault: Report (2006). The report recommends a standardised as well as a principled approach in the presumptive imposition of personal fault. [7.15]

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governments agreed to audit existing legislation against these principles and to amend non-conforming legislation to accord with the principles. The COAG Principles are: 1. Where a corporation contravenes a statutory requirement, the corporation should be held liable in the first instance. 2. Directors should not be liable for corporate fault as a matter of course or by blanket imposition of liability across an entire Act. 3. A “designated officer” approach to liability is not suitable for general application. 4. The imposition of personal criminal liability on a director for the misconduct of a corporation should be confined to situations where: • there are compelling public policy reasons for doing so (for example, in terms of the potential for significant public harm that might be caused by the particular corporate offending); • liability of the corporation is not likely on its own to sufficiently promote compliance; and • it is reasonable in all the circumstances for the director to be liable having regard to factors including: – the obligation on the corporation, and in turn the director, is clear; – the director has the capacity to influence the conduct of the corporation in relation to the offending; and – there are steps that a reasonable director might take to ensure a corporation’s compliance with the legislative obligation. 5. Where principle 4 is satisfied and directors’ liability is appropriate, directors could be liable where they: • have encouraged or assisted in the commission of the offence; or • have been negligent or reckless in relation to the corporation’s offending. 6. In addition, in some instances, it may be appropriate to put directors to proof that they have taken reasonable steps to prevent the corporation’s offending if they are not to be personally liable. 18

The Commonwealth and State and Territory governments have passed legislation modifying a range of statutes inconsistent with these principles. 19 The functions of directors’ and officers’ duties [7.20] Arguably the central enterprise of corporate law is to strike a balance between

supporting initiative and enterprise by directors and managers and holding them accountable for decisions and conduct in office. 20 Corporate law recognises that business judgment involves commercial risk taking, sometimes in circumstances of limited information and constrained opportunity for deliberation. Legal governance rules seek to encourage directors and senior management to pursue vigorously their mandate of vicarious acquisitiveness free from the threat of hindsight review by risk-averse tribunals. Simultaneously, it subjects them to some measure of accountability for the exercise of powers through a constitutional structure which sets against their powers limited control prerogatives vested in shareholders collectively and through individual shareholder rights. These prerogatives are buttressed by duties imposed by law upon directors and managers. Striking a balance between management initiative and accountability is a task of some complexity. The balance appropriate to a particular society reflects the developmental stage of 18

Personal Liability for Corporate Fault Reform Bill 2012, Explanatory Memorandum, [1.10].

19

See, eg, Miscellaneous Acts Amendment (Directors’ Liability) Act 2012 (NSW); Statutes Amendment (Directors’ Liability) Amendment Act 2013 (SA). As to whether the present body of duties imposed upon directors strikes a proper balance between the antinomic values at play in director liability setting see N Young QC (2008) 26 C&SLJ 216.

20

388

[7.20]

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its capital markets, regulatory structures and traditions, and its commercial, industrial, legal and social cultures. The appropriate balance will vary over time since the elements to which it is responsive are themselves in constant flux. The imposition of legal duties upon directors protects against hazards inherent in a firm structure that has one group managing the funds of another – the dual dangers of self-dealing and shirking by the managers. 21 These dangers are the more egregious where the funds are contributed by numerous dispersed investors whose individual stakes are insufficiently large to justify close monitoring of management performance, even if that lay within their capacities: see [2.185]. Directors’ duties are but one of a number of devices to reduce the agency costs resulting from the divergent interests of principal and agent. They take their place with bonding expenditures voluntarily incurred by managers to demonstrate commitment to shareholder welfare, such as the adoption of audit committees, appointment of independent directors, and monitoring expenditures by shareholders to detect self-dealing or shirking. 22 Protection against management self-dealing is afforded by fiduciary duties of loyalty which impose obligations of good faith and conflict avoidance upon directors and senior officers. Duties of care, skill and diligence are directed towards the problem of shirking. In relation to both species of duty the general law obligation is reinforced by a statutory duty in similar terms but with wider sanctions and remedies. The duties and remedies depend for their efficacy upon the range of individuals who may enforce the duties which are, save for exceptional circumstances (see [7.530]), expressed for the benefit of the corporate entity and not individual members. There are few reported instances in which a solvent company has brought proceedings against current or former directors for breach of the duties of loyalty or care. The authority to commence such proceedings rests with the directors, perhaps exclusively. 23 We shall see that a rather uneven liability standard results from this inactivity and from the curious paradox that responsibility for enforcement is confided to the potential defendants or their successors in office. Another limit upon the efficacy of legal duties is the difficulty inherent in the ex post evaluation by courts of board decisions and the longstanding reluctance of courts to engage in such examination. The task of judicial second-guessing is especially difficult when the decision maker is a collective body with a mandate of acquisitiveness for others that requires them to trade business risk against uncertain return. The Delaware Court of Chancery has expressed the judicial tradition in these apposite terms: [T]the essence of business is risk – the application of informed belief to contingencies whose outcomes can sometimes be predicted, but never known. The decision- makers entrusted by shareholders must act out of loyalty to those shareholders. They must in good faith act to make informed decisions on behalf of the shareholders, untainted by self-interest. Where they fail to do so, this Court stands ready to remedy breaches of fiduciary duty. Even where decision-makers act as faithful servants, however, their ability and the wisdom of their judgments will vary. The redress for failures that arise from faithful management must come from the markets, through the action of shareholders and the free flow of capital, and not from this Court. Should the Court apportion liability based on the ultimate outcome of decisions taken in good faith by faithful directors or officers, those decision- makers would necessarily take decisions that minimize risk, not maximize value. The entire advantage of the risk-taking, innovative, wealth-creating engine that is the Delaware corporation would cease to exist, with disastrous results for shareholders and society alike. That is why, under our 21

See, eg, A A Alchian & H Demsetz (1972) 62 Am Econ Rev 777.

22

To these devices should be added the disciplines (such as they may be) of the markets for capital, corporate control, the company’s product and for managers themselves: see [2.220] and [5.15].

23

Some dicta support a dual initiative resting with the general meeting to litigate in the company’s name if the directors will not do so. None of this dicta was expressed with respect to this duty: see [5.150]. [7.20]

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corporate law, corporate decision-makers are held strictly to their fiduciary duties, but within the boundaries of those duties are free to act as their judgment and abilities dictate, free of post hoc penalties from a reviewing court using perfect hindsight. Corporate decisions are made, risks are taken, the results become apparent, capital flows accordingly, and shareholder value is increased. 24

Judicial deference to directors’ business judgments is not, therefore, an indefensible position. It does, however, challenge courts to detect the boundaries between legitimate errors of business judgment and unacceptable shirking or self-dealing conduct by directors. There is some evidence demonstrating the importance of liability rules for efficient corporate governance. Effective from 1 July 1986, the Delaware legislature permitted corporations to opt out of the strengthened duty of care established in then recent decisions and to amend their articles of incorporation to eliminate directors’ financial liability for breach of the duty of care. 25 A study of stock prices prior and subsequent to the amendment disclosed that both the enactment of the provision and the announcement that individual Delaware corporations had adopted the liability restriction reduced the value of stockholdings in the firms. 26 The finding is consistent with an earlier study indicating that shareholder wealth increases when derivative actions for enforcement of directors’ duties are permitted to proceed and correspondingly decreases when the actions are terminated. 27 By such measures – the imposition of duties and facilitation of their enforcement – the agency costs of the corporate form are reduced. Hence the necessity to explore ways in which legal duties may better perform their functions of stimulating superior performance and setting standards of management conduct. The moderators of director and executive conduct [7.25] It is perhaps natural for lawyers and law students to assume that legal liability rules are

the primary, if not the exclusive, determinants of director and manager conduct. However, there are other moderators of conduct, in the claims of personal morality, social norms and the financial incentives provided by markets. What is the relative contribution of each to the shaping of director conduct and evolving standards of performance? The question is easier to pose than to answer. A starting point lies with social norms. Social norms have been defined as “rules and regularities concerning human conduct, other than legal rules and organisational rules”. 28 The most important category comprises the obligational norms that members of a group self-consciously adopt and where respect for the norm is grounded in a sense of obligation. 29 This is the way we do things around here, our (board, work section etc) culture. Some norms are non-moral (eg, conceptions of proper dress for board and other business meetings); others are based upon personal moral conviction (such as respect for the views of others) or the shared moral sentiment of a group (such as deference to and respect for the elderly or vulnerable). Where the obligational norm is internalised within an individual or group, it may 24 25

In re Walt Disney Company Derivative Litigation 907 A 2d 693 at 698 (Del 2005). M Bradley & C A Schipani (1990) 75 Iowa L Rev 1 at 7.

26

Bradley & Schipani at 69-70.

27

D R Fischel & M Bradley (1986) 71 Cornell L Rev 261 at 277-283; see also R Romano (1991) 7 Journal of Law, Economics & Organization 55 (data supports conclusion that shareholder litigation is “a weak, if not ineffective, instrument of corporate governance”). M A Eisenberg (1999) 99 Colum L Rev 1253 at 1255.

28 29

Other categories of norms include behavioural patterns that are not grounded in obligation and not even consciously adhered to (such as putting on a jumper when the temperature falls) and practices which are self-consciously adopted but not grounded in any sense of obligation (such as dress conventions when attending social events): see Eisenberg at 1256-1257.

390

[7.25]

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become not simply a matter of cost-benefit analysis, in which the negative of personal guilt is traded against the positive feelings that flow from norm observance, but reflects the force of individual moral character or the group understanding or consensus. Where the obligational norm is not internalised within a group, observance may rest only on the utility calculus that trades benefits against possible costs of non-observance such as the risk of loss of esteem. That may provide a tenuous hold over time. The influence of social norms among company directors and managers is difficult to determine. Their domain is potentially wide ranging but their precise effect is speculative. In the United States, some observers have asserted that there was an increase in standards of care among public company directors during the 1990s that was attributable to social norms among directors rather than changes to legal liability rules: these norms reflected changes in the belief systems of directors and executives deriving from insights garnered from the rise of hostile takeovers as to levels of past managerial inefficiency. The expressive effects of court decisions on legal liability and the subtle messages conveyed via their legal advisers clarified directors’ role expectations; on this view, this has been the primary effect of legal liability developments rather than as a roadmap indicating what is needed to avoid liability. 30 As you read the following material with respect to the director’s duty of care in Australia, consider whether this accurately reflects the likely drivers for change or whether legal developments themselves have been the primary influence upon directors and managers. For the duty of loyalty – to avoid possible conflicts of interest and duty – legal liability rules and social norms may have a mutually reinforcing effect. Legal remedies deny exemplary damages and provide only rescission of the transaction and perhaps disgorgement of profits. Discounted for the risk of non-detection, these remedies need the support of social norms and their sanctioning through loss of reputation. Social norms themselves benefit from the clarification and concretisation of the abstract ethical ideal of conflict avoidance that courts provide through legal liability rules. There are many other areas in corporate governance where social norms play a significant role, sometimes in complex conjunction with legal norm development. They include the emergence of • the monitoring role of the board • institutional investor activism • the distinct role for independent directors individually, as a group and of the lead director • the balance struck between the claims of director independence and group cohesion • desirable gender and other diversity in board representation • the limits of probing questioning of executives by non-executive directors in board meetings • notions of collective and individual responsibility for poor board decisions • the recognition accorded to stakeholder interests where they are diverge from those of shareholders • stock price as the measure of corporate performance • the notion that executive pay should be substantially linked to corporate performance • the centrality of the chief executive officer, sometimes expressed as the cult of the CEO and • the role of shareholders within the company generally. In these and other core areas of corporate governance, there have been dramatic shifts in group opinion and individual belief systems in recent years. These shifts appear to have prompted the change in board practice at least as much as developments in liability rules. In 30

Eisenberg at 1266-1271. [7.25]

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corporate law there is a complex, uneven and largely uncharted symbiosis between legal and social norms. Social norms are the matrix into which the legal norms of director liability discussed in this chapter are embedded. The reach of statutory obligation: the terms of the extended definition of director and officer

The statutory definition of officer [7.30] Liabilities imposed upon company directors by the Act and the general law are not

limited to those formally appointed as directors. 31 General law accessorial liability provisions apply to third parties who knowingly participate in a breach of fiduciary duty. 32 Second, a person who acts as a director or senior manager without legal authority – a manager de son tort, effectively a usurper of corporate office – cannot escape liability under statute or the general law by denying that they are a director or officer. 33 Moreover, the terms “officer” and “director” bear a defined meaning where used in the Act, including in the imposition of statutory duties upon directors and other officers in Pt 2D.1 Div 1. The purpose and effect of the extended statutory definitions is to enlarge the classes of persons concerned in the management and affairs of a corporation upon whom the legislative standards and liabilities are imposed, thereby protecting the corporation and those who deal with it from the consequences of their conduct. 34 The definitions of director and officer are overlapping (eg, a director is expressly included in the definition of an officer); the category of officer extends the reach of regulation to company executives in recognition of the managerial revolution that has seen power flow to those managing the affairs of the large corporation: see [2.185]. It is clear that these extended statutory definitions of director and officer extend the meaning of those terms in Pt 2D.1 Div 1 which impose duties and liabilities upon directors, other officers and, in some provisions, other employees also: s 179(2). The term “officer” of a corporation is defined to mean, in addition to a director, secretary and external administrator of the company (eg, a receiver, administrator or liquidator) persons: i. who make or participate in making decisions that affect the whole or a substantial part of the business of a company; ii.

who have the capacity to affect significantly the company’s financial standing; or

iii.

in accordance with whose instructions or wishes the directors of the company are accustomed to act (excluding advice given in a professional capacity or a business relationship with directors): s 9 “officer” (b).

The first two limbs of this definition of officer extend the reach of duties imposed by the Act to managers in a company who are not members of the board of directors. Their application in a particular instance depends upon the precise circumstances of the individual company. The third limb, the “shadow officer”, parallels the “shadow director” limb of the extended definition of director and may embrace those who need not have any formal employment or other relation with the company: see [7.40]. The focus of the three limbs is “essentially functional in character, its concern being with the stipulated quality of a person’s actions or 31

See D A DeMott (2006) 19 Aust Jnl of Corp Law 251; M Markovic (2007) 25 C&SLJ 101.

32 33

Barnes v Addy (1874) LR 9 Ch App 244 at 251-252 per Lord Selborne LC. CAC v Drysdale (1978) 141 CLR 236; Re Canadian Land Reclaiming and Colonizing Co (1880) 14 Ch D 660 at 664.

34

Grimaldi v Chameleon Mining NL (No 2) (2012) 87 ACSR 260 at [34].

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capacity and their effects”. 35 The definition of the term “senior manager” where used in the Act is cast is similar terms to the first and second limbs of the definition of officer (see [5.215]); the term is not used, however, in the Act to extend or specify the duties and liabilities of company executives and employees. It is not part of the present discussion. The scope of the first limb of the definition of officer was elaborated by the High Court in the appeal by Shafron, company secretary and general counsel (in-house lawyer) of James Hardie Industries Ltd (JHIL), against orders made against him in civil penalty proceedings brought by ASIC for breach of the statutory duty of care in s 180(1) as an officer of JHIL: see [7.55] and [7.80]. Shafron argued that his obligations of care under s 180(1) were limited to those responsibilities that attached to the particular office he held (as secretary) or the circumstances that brought him within the definition of an officer, and that his conduct raised in the proceedings was not done in his capacity as company secretary but rather in his capacity as general counsel which role did not bring him within the definition of officer. The High Court held that the care obligations imposed under s 180(1) are not limited to the discharge of responsibilities imposed on the officer under the Act but “include whatever responsibilities the officer concerned had within the corporation, regardless of how or why those responsibilities came to be imposed on that officer”. 36 The Court’s consideration of whether Shafron fell within the first limb of the definition of officer – whether he was a person who made or participated in making decisions that affect the whole or a substantial part of the business of the corporation – was therefore dicta. Shafron argued that in order to “participate in making a decision” a person must have a role in actually making the decision even if amounting to less than ultimate control of the decision. However, the High Court said that the first limb distinguishes between making decisions of a particular character and participating in making those decisions. Contrary to Mr Shafron’s submissions, participating in making decisions should not be understood as intended primarily, let alone exclusively, to deal with cases where there are joint decision makers. The case of joint decision making would be more accurately described as “making decisions (either alone or with others)” than as one person “participating in making decisions”. Rather, … the idea of “participation” directs attention to the role that a person has in the ultimate act of making a decision, even if that final act is undertaken by some other person or persons. The notion of participation in making decisions presents a question of fact and degree in which the significance to be given to the role played by the person in question must be assessed. … [D]emonstrating that a person’s contribution to a decision can properly be described as a “real contribution” would not be sufficient to show that the person concerned had participated in making the decision. 37 [Emphasis in original]

In assessing Shafron’s actual role in the instant transaction, the High Court concluded that he played a large and active part in formulating the proposal that he and others chose to put to the board as one that should be approved. It was the board that ultimately had to decide whether to adopt the proposal but what Mr Shafron did, as a senior executive employee of the company, was properly described as his participating in the decision to adopt the separation proposal that he had helped to devise. The conclusion that Mr Shafron participated in making that decision is not a conclusion based only on what Mr Shafron did. That what he did can be described as proferring advice or providing information for the board’s consideration is not an end to the relevant inquiry. The conclusion that he participated in making the decision depends not only upon what he did but also upon identifying the relationship between his actions and the decision to adopt the proposal as “participation” in making the decision. In this case, Mr Shafron was one of three 35

Grimaldi v Chameleon Mining NL (No 2) (2012) 87 ACSR 260 at [45].

36 37

Shafron v ASIC (2012) 88 ACSR 126 at [18] per French CJ, Gummow, Hayne, Crennan, Kiefel and Bell JJ. Shafron v ASIC (2012) 88 ACSR 126 at [26] per French CJ, Gummow, Hayne, Crennan, Kiefel and Bell JJ. [7.30]

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executives who shaped and developed the proposal through its successive variants; he was one of the executives who presented successive proposals to the board; he was … part of the “promotion of the separation proposal to the board”, a board that did not itself decide what elements would go to make up any of the several proposals it considered and was, as ASIC submitted, “reactive” rather than “proactive” in the formulation of the proposals. And he did all this as a senior executive employee of the company who, with Messrs Macdonald and Morley, decided what would be put to the board. 38

Accordingly, the effect of the actor’s contribution to the final decision taken may be relevant to the determination of their status as an officer in relation to the conduct in question, and that status may be transaction specific rather than arising from their appointment to a particular corporate office unless that office falls specifically within the definition of officer as in the case of a director or secretary. Similar consideration might possibly apply in both respects to the second limb of the definition – persons who have the capacity to affect significantly the company’s financial standing – although that limb posits capacity rather than mere participation, and this suggests that a less transient or episodic role and function is required. In some circumstances de facto capacity within the second limb might engage the third limb, the “shadow officer”. The current definition of officer has been criticised for inadvertently narrowing the reach of the statutory duties to employees below board level in its 2000 revision. The Corporations and Markets Advisory Committee has recommended that the statutory duties of care and good faith in ss 180 and 181 should apply not only to directors and officers as presently defined but should also include any other person who takes part, or is concerned, in the management of the corporation, thus returning to the pre-2000 formulation. 39

The statutory definition of director, in outline [7.32] The definition given to the term “director” where used in the Act extends the reach of

its norms beyond those formally appointed as director. Subject to a contrary intention appearing in a particular context (s 6(1)), reference to a director includes not only those validly appointed as director or alternate director but also those appointed to the position of a director or alternate director and acting in that capacity regardless of the name that is given to their position (directors under another name): s 9 “director” (a). In addition, the definition includes those i. who act in the position of director (de facto directors); and ii.

in accordance with whose instructions or wishes the directors of the company are accustomed to act (shadow directors): s 9 “director” (b). A person is not a shadow director merely because the directors act on advice given by that person in a professional capacity or business relationship: s 9 “director”. A note to the definition lists the following as examples of provisions of the Act in which the extended reach to de facto or shadow directors would be displaced by contrary intention appearing from the context: 38 39

394

Shafron v ASIC (2012) 88 ACSR 126 at [26], [27], [30], [31] per French CJ, Gummow, Hayne, Crennan, Kiefel and Bell JJ; see T Bednall and V Ngomba (2013) 31 C&SLJ 6; A Hargovan (2012) 27 Aust Jnl of Crp Law 112. Corporations and Markets Advisory Committee, Corporate duties below board level: Report (2006). The problem was exacerbated by the elimination in 2004 from the Act of the term “executive officer”, defined as those who participate in the management of the company. The Committee also said that the reach of the statutory duties in ss 182 and 183 (improper use of position or information) should be extended to persons who act for and on behalf of the corporation, whether or not they are corporate employees or officers. The HIH Royal Commissioner had recommended that the focus should be upon the function performed rather than formal position held, to catch consultants and other non-employee contractors. The scope of the reach to those participating in company management is discussed at [5.238]. [7.32]

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• the power to call general meetings (s 249C); • signing minutes of general meetings (s 251A(3)); and • giving notice to ASIC of change of address: s 205B. However, the extended definitions clearly apply to the provisions of Pt 2D.1 Div 1 imposing duties upon directors and officers: s 179(2). 40 The first limb of the extended definition embraces those governing officials of a company who, under its constitution, for whatever reason, are not called directors but take some other title such as “governor”, “president” or “vizier”. 41 It will generally be a question of fact of only moderate difficulty as to whether the first limb is engaged in a particular instance. The second and third limbs – de facto and shadow directors – present greater difficulty in interpretation. They are considered in more detail in the following paragraphs.

De facto directors [7.35] A person who is not validly appointed as a director will nonetheless be treated as such

under the Act if that person “act[s] in the position of a director”: s 9(b)(i) “director”. The judgment that a person is a de facto director under s 9(b)(i) will depend upon the particular role they have played in the company. Where, for example, a person continues to act in the mistaken belief, shared by fellow directors, that she is a director after her appointment as director has terminated, the question will generally be unproblematic. 42 Where the person is given a different title (eg, as consultant) it will be a question of fact whether they are performing specific functions only or are engaged in the affairs of the company more generally in a manner that is distinctive of a director. 43 In DCT v Austin Madgwick J emphasised the diversity of companies by size and director role. He thought that it was a necessary but not a sufficient condition of acting as a director that the person exercises the top level of management functions. 44 The question whether a person has acted as a director is often a question of degree to be determined in the context of the operations and circumstances of the particular company. Relevant factors include: 1. the size of the company: in a large and diversified company, great discretion to deal with important matters must be reposed in employees who may be less likely to be thereby considered as directors than they might be in small companies; 2.

the internal practices and structure of the company: an employee with particular expertise who is assigned specific responsibilities within that field of expertise is less likely to be treated as a director than one who is concerned with company affairs generally; and

3.

how the putative director was reasonably perceived by outsiders who deal with the company: while express holding out as a director is obviously relevant, its absence will not prevent the person being deemed to be a director if their dealings with third parties are consistent with them having acted as a director. 45

40 41

Indeed, the provisions may extend to de facto directors even absent: s 9; CAC v Drysdale (1978) 141 CLR 236. See, eg, CAC v Drysdale (1978) 141 CLR 236.

42 43 44

Mistmorn Pty Ltd (in Liq) v Yasseen (1996) 21 ACSR 173. DCT v Austin (1998) 28 ACSR 565 at 569-570. (1998) 28 ACSR at 569.

45

DCT v Austin (1998) 28 ACSR at 570. [7.35]

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In Harris v Shepherd the defendant was treated as a de facto director under the section since he had “the practical direction of the company” and was its “driving force”. 46 Grimaldi v Chameleon Mining NL (No 2) states and applies some general principles on the reach of the statutory definition.

Grimaldi v Chameleon Mining NL (No 2) [7.37] Grimaldi v Chameleon Mining NL (No 2) (2012) 87 ACSR 260; [2012] FCAFC 6 Federal Court of Australia, Full Court [Chameleon was a junior mining explorer whose affairs were managed in an “informal (indeed unorthodox) manner”. Grimaldi was not appointed a director of Chameleon but became increasingly involved in its affairs as “consultant” or adviser. The board gave Grimaldi “unconstrained authority” to negotiate the acquisition of mining interests although not the authority to formally bind the company in the transactions. The board also appointed him to prepare and settle the contents of a prospectus for Chameleon and find investors to subscribe funds under the prospectus. Chameleon argued that he was a de facto director under s 9(b)(i) when performing these functions; in response, Grimaldi pointed to the existence of a functioning board and his own distinct consultancy status. The following extract omits citation of the case authority to which reference is made from time to time.] FINN, STONE AND PERRAM JJ: [64] (i) A person may be a director even without any purported appointment of that person to that position at any time. The definition applies as much to a person who is a true usurper of the functions of a director in a company as to a person who takes “an active part in directing the affairs of [a] company” with the acquiescence of de jure directors. [65] (ii) The formula, “acts in the position of a director”, … contemplates that in some degree at least the person concerned, though not appointed a director, has been “doing the work of a director” in that company. Or to put the matter more fully, the person concerned, though not a director de jure, has been acting in a role (or roles) within the company and performing functions one would reasonably expect to have been performed by a director of that company given its circumstances. [66] (iii) The roles and functions so performed will vary with the commercial context, operations and governance structure (to the extent it is operative) of the company. Their performance by that person may well be at variance with what is permitted by the Act or by the company’s constitution. Nonetheless, whether they suffice in the circumstances to constitute the person a director for the Act’s purposes will often be a question of degree having regard to “the nature of the functions or powers which are exercised and the extent of their exercise”. [67] (iv) There is no reason why the relationship of a person with a company may not evolve over time into that of de facto director. It also may be the case that the person only performs the role and functions that constitute him or her a director for a limited period of time. [68] (v) Whether a person has acted in the position of a director is a question of substance and not simply of how that person has been denominated in, or by, the company: see s 9 “director” (a). The fact that a person has been designated a “consultant” for the performance of functions for a company will not as of course mean that person cannot be found to be a director. Whether or not he or she will be a director will turn on the nature and extent of the functions to be performed (both in and beyond the consultancy) and on the constraints imposed thereon. A limited and specific consultancy is unlikely on its own to be caught by the s 9 definition. Not so, a general and unconstrained one which permitted taking an active part in directing the affairs of the company even if not necessarily on a full-time basis. Though we do not consider that the question actually requires determination in this case and thus we do not need to express a concluded view on it, we consider that if a consultant is a corporation and what it does through its own directors or officers results in “acting in the position of a director”, then, and consistently with the policy of s 201B (which requires a director to be a natural person), it will be a question of fact as to which director (or officer) in the consultant company is (or are) the de facto director(s) of the corporation. 46

Harris v Shepherd (1976) 2 ACLR 51.

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Grimaldi v Chameleon Mining NL (No 2) cont. [69] (vi) … [A] rigid distinction between a de facto and a shadow director cannot be maintained. A person’s power or influence over the directors of a company may provide the capacity to secure as of course compliance with his or her wishes or instructions for “shadow director” purposes. But the possession and exercise of such power or influence by a person alleged to be a de facto director may throw direct light on the evaluation of that person’s true position and influence in the affairs of the company. We also consider that like a shadow director whose wishes or instructions need not relate to all facets of the management of the company’s business the functions assumed by a de facto director likewise may be limited in their scope. Nonetheless, … there will commonly be the need to determine “how much a person must do before it can be held that such person is occupying or acting in the position of a director”. [70] (vii) It has commonly been said in both Australian and English cases … that to be a de facto director one must be shown to have assumed or performed functions which only a de jure director or board can properly perform. This shorthand description of what is required to be established may be understandable, but it has the capacity to mislead in that it suggests that the duties or functions that can only properly be performed by de jure directors – or which are their sole responsibility – are capable of a priori enumeration. … In many instances when one asks what can only properly be done by a director (or is the sole responsibility of a director) of a given company, one is actually inquiring whether, in the circumstances of that company, what is being done ought reasonably be regarded as being a responsibility of a director of that company. Or put shortly, was the work done, work for a director of that company? In a given company, this may involve an alleged director in the day-to-day management and business affairs of that company and may require his or her doing many things for reasons of need, expediency or whatever, but which hardly could be said to be things that only a de jure director can properly do. In another corporate setting, the work done may be simply selective and strategic action. In the end what is being asked for is the making of a value judgment about the proper characterisation of what in its context the person in question had been doing. … [74] There are … additional matters upon which we should make some observations. The first is this. That a company has an active director or directors apart from the alleged de facto director, or has a properly constituted and apparently “functioning” board (whatever that might mean in a given setting), does not preclude a finding that the person in question was a director. That person’s activities may, for example, have simply been accepted as of course or acquiesced in by the de jure director(s) whatever their formal powers may have been to disavow them. Or they may be acting together “on an equal footing … in directing the affairs of the company” by for example, sharing (formally or otherwise) responsibilities for the company’s affairs. All this illustrates is that the differing contexts in which the issue can arise can contrive what may or may not be some of the relevant considerations of which account should be taken. [75] Secondly, whether the company itself has held the person out as a director will itself be a relevant but not decisive consideration. Similarly, in our view, perceptions of those dealing with the company that the person was a director can themselves be of some contextual evidentiary significance. This is more likely to be so where those perceptions were independently formed, reasonable in the circumstances and support the appearance that the person was acting “under colour of office”. … Third party perceptions, though, cannot change the reality of the true character of the position in which the person acts. [133] … We accept that the Board members seem only to have allowed Mr Grimaldi’s attendance at Board meetings by invitation and did not appear to regard him as a director as such. However, while they did not hold him out as a director eo nomine, they clearly authorised him on occasion to perform functions such as would lead a reasonable third party dealing with him to believe he was acting as a director of Chameleon. His authorisations to negotiate the acquisitions of the Fijian mining interests and of the Chilean copper mine, instance this and demonstrate that in these matters he stood on an equal footing with them in directing the affairs of the company. More, generally, Mr Grimaldi was allowed either to perform functions, for example fund raising and share placements, or to arrogate to himself functions in which at least either or both of the executive directors acquiesced with knowledge. [7.37]

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Grimaldi v Chameleon Mining NL (No 2) cont. [141] … Even though not authorised to be a director, Mr Grimaldi was either given, or had arrogated to himself with the acquiescence of at least the two executive directors … functions in the affairs of Chameleon which would properly be expected to be performed by a director of that corporation given its circumstances. Given the extent and the significance of those functions, he so acted in the position of a director as to warrant the imposition on him of the liabilities, statutory and fiduciary, of a director.

Shadow directors [7.40] The third limb collects those persons who are the real, though not the nominal,

controllers of the company, that is, the persons “in accordance with [whose] directions or wishes” the directors are accustomed to act: s 9(b)(ii). 47 It is not sufficient in itself that executives who are not directors are accustomed to act on a third party’s instructions or wishes or even individual directors doing so: what is needed is a “board of directors claiming and purporting to act as such”. 48 In Re Hydrodam (Corby) Ltd, Millett J said that [t]o establish that a defendant is a shadow director of a company it is necessary to allege and prove: (1) who are the directors of the company, whether de facto or de jure; (2) that the defendant directed those directors how to act in relation to the company or that he was one of the persons who did so; (3) that those directors acted in accordance with such directions; and (4) that they were accustomed so to act. 49

In Harris v Shepherd, Sangster J thought that for a person to be included as a director under this limb by reason of the control he enjoys over the directors appointed under the constitution “it must be shown that it was his will, and not the independent will of the appointed directors, which determined the resolutions of the board of directors”. 50 Wells J considered that the limb applied only where there are directors who are fulfilling their role and function as directors but who carry out that role and function in accordance with directions or instructions given by someone dehors the directorate, such as the governing directors of a holding company, who directs and instructs the directors of the subsidiary what to do. For this provision to apply it must appear, first, that although the outside person calls the tune, it is the directors who dance in their capacity as directors; and second, that the directors perform positive acts, not simply forbear to act or desist from acting. 51

47

50

The phrase “directions or wishes” was inserted in 2000 to replace “directions or instructions”. The change may have been prompted by concern to include situations arising in cases such as Commissioner for Corporate Affairs (Vic) v Bracht [1989] VR 821 where one family member makes his or her wishes known to another with the confident and correct assumption that the latter will carry them out: Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd (2011) 82 ACSR 703 at [186]. Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180 at 183. Re Hydrodam (Corby) Ltd [1994] 2 BCLC 180 at 183; quoted with approval in Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd (2011) 82 ACSR 703 at [191]-[192]. Harris v Shepherd (1976) 2 ACLR 51 at 72.

51

Harris v Shepherd (1976) 2 ACLR 51 at 63-64.

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The extended definition does not apply, therefore, when a third person’s control or influence over directors is so complete that they effectively abdicate in her or his favour and cease to operate as a board. 52 Some refinements of this interpretation should be noted. First, although the purpose of the definition is to identify those persons, other than professional advisers, who have real influence in, or control of, the affairs of a company, it is not necessary that such influence or control should be exercised over the whole field of corporate activity for which directors are responsible: “there is no inconsistency with a person being a shadow director, and on the other hand the board exercising some discretion or judgment in areas in respect of which the shadow director does not give instructions or express a wish”. 53 Second, it is not necessary that all of the directors are accustomed to act on the directions or wishes of the shadow director; a person at whose direction a “governing majority” of the board is accustomed to act is capable of being a shadow director even though one or a minority of directors are not so accustomed. 54 Third, mere congruence between the wishes of the board and those of a putative shadow director, or directions that reflect the board’s own intentions, do not a shadow director make – there must be a causal connection between the direction or wishes of the shadow director and the action taken by directors: If a person is a shadow director, he, she or it owes statutory duties to act in good faith in the best interests of the company, and with the reasonable care and diligence of a director of the company. A shadow director is also liable to statutory liabilities, such as the liability of a director for insolvent trading. When the definition is construed in the light of the purpose of subjecting a person who is not appointed, and does not (or might not) act as a director, to the statutory duties and liabilities of a director, it makes good sense that there must be a causal connection between the acts of the directors and the instructions of the putative shadow director for the definition to be satisfied. 55

Fourth, where third parties having commercial dealings with a company are able to insist on certain terms for their continued support for the company, they are not thereby to be treated as shadow directors since to insist on such terms as a commercial dealing between a third party and the company is not ipso facto to give an instruction or express a wish as to how the directors are to exercise their powers. Unless something more intrudes, the directors are free and would be expected to exercise their own judgment as to whether it is in the interests of the company to comply with the terms upon which the third party insists, or to reject those terms. If, in the exercise of their own judgment, they habitually comply with the third party’s terms, it does not follow that the third party has given instructions or expressed a wish as to how they should exercise their functions as directors. 56 52

Thus, in Harris v Shepherd the court held that a scheme manager under a company’s scheme of arrangement (effecting a composition with creditors as a form of external administration) did not thereby become a director of the company; so far from the directors of this company acting upon the manager’s instructions, they simply did not act at all: at 354.

53

Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd (2010) 77 ACSR 410 at [241]; affirmed Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd (2011) 82 ACSR 703 at [192]; Secretary of State for Trade and Industry v Deverell [2001] Ch 340 at 354. Ultraframe (UK) Ltd v Fielding [2005] EWHC 1638 at [1272]; Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd (2010) 77 ACSR 410 at [235]. Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd (2010) 77 ACSR 410 at [247]; affirmed Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd (2011) 82 ACSR 703 at [192].

54 55 56

Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd (2010) 77 ACSR 410 at [243]; affirmed Buzzle Operations Pty Ltd (in liq) v Apple Computer Australia Pty Ltd (2011) 82 ACSR 703 at [192]. [7.40]

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The shadow director limb of the definition of director is more difficult than the other limbs. This is partly because the underlying control concept that it embodies is of its nature more complex and ambiguous (see [12.05]); the limb also generates difficulty because it is directed at relationships in which control is unconscious, contested or carefully disguised (eg, to protect a de facto controller from the liability regime applicable to directors). It may in particular cases extend the regime to a holding company, a controlling shareholder or even the directors of a corporate shareholder. Although a company may no longer be appointed as director, it may be deemed such under the statutory definition as the following extracts explore.

Standard Chartered Bank of Australia Ltd v Antico [7.45] Standard Chartered Bank of Australia Ltd v Antico (1995) 38 NSWLR 290 Supreme Court of New South Wales [Giant was a listed company in which Pioneer, another listed company, had a 42% shareholding. Three of Giant’s directors, Antico, Quirk and Gardiner, were nominees of Pioneer. Standard Chartered Bank granted a bill acceptance/discount facility to Giant for the acquisition of shares in another company. Standard was given security over those shares but over no other assets of Giant. Other banks held security over the majority of Giant’s assets. Standard Chartered subsequently extended, the loan facility on several occasions. When Giant’s financial position weakened Pioneer provided loan funds to Giant protected by security over Giant’s assets that ranked behind the other banks’ security. When Standard Chartered’s facility was extended, it was not informed of Pioneer’s security; indeed, it was given little information of Pioneer’s funding of Giant and was not informed of a minor security shortfall under a loan facility with another bank, a default requiring disclosure under the terms of Standard’s security. When Giant was later wound up for insolvency, Standard commenced proceedings against Pioneer and its three nominees upon the Giant board seeking to make them personally liable for loss suffered from insolvent trading under a predecessor to s 588G. That provision, s 556 of the Companies Code, applied not only to a director (as in s 588G) but to a person who “took part in the management of the company”. The following extract deals only with the issue whether Pioneer was a director of Giant or took part in its management within s 556.] HODGSON J: [323] It is common ground that Antico, Quirk and (from 17 February 1989) Gardiner were directors of Giant, and so were persons to whom s 556 applied. The question to be considered here is whether either Pioneer was at material times either a director of Giant, or a person who “took part in the management of Giant” within s 556. … Legal principles On the question of whether Pioneer was a director of Giant, it is clear that it was never appointed a director; so the question is whether it was, in terms of the definition of director in s 5 of the Companies (New South Wales) Code, a person occupying or acting in the position of director, or a person in accordance with whose directions or instructions the directors of Giant were accustomed to act. On the question whether Pioneer took part in the management of Giant, I accept the view of Burchett J in Holpitt Pty Ltd v Swaab (1992) 33 FCR 474 that this expression is limited to persons whose management role in the company may be likened to that of a director. This view was accepted in Taylor v Darke (1992) 10 ACLC 1516 at 1522; and also in Re New World Alliance Pty Ltd; Sycotex Pty Ltd v Baseler (1994) 51 FCR 425 at 442, where Gummow J added that this meant that the person must have some decision-making role in the company. On both questions, the Privy Council decision in Kuwait Asia Bank EC v National Mutual Life Nominees Ltd [1991] 1 AC 187 is of some relevance. In that case, the bank owned shares in a New Zealand company. The company had five directors of whom two were employees of the bank and nominated by the bank to the board. National Mutual, as trustee for the depositors, sought contribution from the bank to payments it had made to settle certain claims made against it by depositors. National Mutual claimed that: (1) the bank was vicariously liable for the acts and omissions of the two directors who were its employees; (2) those directors were agents of the bank, so that the bank was responsible for their acts or omissions; (3) the bank owed depositors a duty of care; and (4) those two directors acted 400

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Standard Chartered Bank of Australia Ltd v Antico cont. in accordance with the bank’s instructions, so that the bank itself was a director within the definition in the New Zealand Companies Act (relevantly similar to that in the Code). The Privy Council held, as regards the first two contentions, that the two directors, acting as directors of the company, were agents of the company, and not of the bank; so that the bank was not liable for their acts either as employer or principal. The Privy Council went on to say that it would have been otherwise, if the bank had exploited its position to obtain some improper advantage, but this was not suggested. The Privy Council held that there was no duty of care owed by the bank; and in relation to the fourth contention, it held that the employees were only two out of the five directors, and there was no allegation that the other [324] directors were accustomed to act on the direction or instruction of the bank. In those circumstances, the bank could not fall within the definition of director. I was also referred to the cases of Tesco Supermarkets Ltd v Nattrass [1972] AC 153 at 199-200 and Nissho Iwai Australia Ltd v Malaysian International Shipping Corporation, Berhad (1989) 167 CLR 219 at 229-230 to support the proposition that none of Antico, Quirk or Gardiner could be considered to be the directing minds of either Pioneer or of Giant. It is clear that the mere fact that Pioneer owned indirectly 42% of the shares of Giant, and had three nominees on its board, is insufficient to make Pioneer either a director or a person who took part in the management of Giant. Furthermore, in general, in the absence of evidence to the contrary, the court would take it that actions performed by Antico, Quirk and Gardiner, as directors of Giant, were actions undertaken by them on behalf of Giant and not as officers or agents of Pioneer. Relevant circumstances However, in this case, there are circumstances in addition to the basic facts which I have already mentioned. Effective control Pioneer had effective control of Giant. It had this by virtue of its 42% shareholding, where the only other significant shareholders held respectively about 10%, 6%, 6% and 3% of the shares. … The position was very different from that in Curragh, where although Giant indirectly held 46% of Curragh’s shares, the other shares were all held by a single shareholder, who had effective control of Curragh. The exercise of Pioneer’s control of Giant was indicated in the other circumstances which I will outline. The fact of control was acknowledged in Giant’s 1988 annual report, where it is noted that control of Giant has moved from Ariadne to Pioneer. Financial reporting Pioneer imposed on Giant requirements for financial reporting consistent with the financial reporting required for the Pioneer group. … The Pioneer board on 28 February 1989 directed management to ensure that there would be proper financial reporting by Giant, and also full Pioneer access to all financial records; and it was noted that this might involve changes in the management of Giant. … [325] Acquisition of Pioneer’s mineral assets On the three major strategic questions concerning Giant decided during the period with which we are mainly concerned, namely the abandonment of Giant’s acquisition of Pioneer’s mineral assets, the mode of Pioneer assistance of Giant involving the taking of security, and the decision to sell Curragh, the effective decisions were taken by Pioneer. Dealing first with the acquisition of Pioneer’s mineral assets [ie, by Giant, potentially], the main consideration of that transaction in the latter part of 1988 and early part of 1989 had been by the Pioneer board, and the negotiations for finance to be provided to Giant for the purchase were mainly conducted by Pioneer. Antico had discussions with Societe Generale with a view to arranging this finance; and it seems clear that he was acting on behalf of Pioneer, since he was chairman of Pioneer but a non-executive director of Giant; and Societe Generale’s proposal dated 11 November 1988 was addressed to Antico as chairman of Pioneer. A note concerning Westpac finance for the asset acquisition was made by Leach, of Pioneer, with a copy to Quirk. A report in the agenda papers for the Pioneer board meeting of 31 January noted that “we” have had a proposal for financing from Societe [7.45]

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Standard Chartered Bank of Australia Ltd v Antico cont. Generale, and that “we” are following up an alternative with Westpac. There is also a record of a meeting between Leach and Societe Generale on 10 February 1989. The Pioneer board on 31 January 1989 authorised a committee to approve terms on which the asset sale could go ahead; and, on 17 February 1989, the Giant board resolved in principle to acquire these assets. However, the decision not to proceed with the acquisition followed a discussion between Antico, Quirk and Gardiner, and a detailed memorandum from Quirk to Antico of 20 February 1989 discussing the matter, and concluding with a recommendation not to proceed: this memorandum went to the board of Pioneer, not of Giant. On 28 February 1989, the Pioneer board resolved that it was not in the best interests of either company to proceed; thereby apparently making a decision, not only as to what was in Pioneer’s interests, but also as to what was in Giant’s interests. There was no further consideration of the matter by the Giant board. Of course, once Pioneer as vendor decided not to sell, Giant as purchaser could not buy. However, in my view, the circumstances I have outlined indicate that Pioneer was really developing, and ultimately abandoning, this transaction on behalf of both parties. Management and financial control The Pioneer board decision of 4 March 1989 to make up to $10 million available to Giant was made on a number of conditions, including the condition that Giant instruct outside consultants, that no new financial commitments be entered into without Pioneer’s approval, and that all payments were to be approved by Leach. Pioneer was closely involved in the briefing of the outside consultants. Antico effectively made the decision that the accountants to be briefed should be Arthur Anderson and not Coopers & Lybrand. The brief to Arthur Anderson was discussed in a meeting at Pioneer’s office attended inter alia by Antico and Leach. Antico reported, on 10 March 1989, to Pioneer directors that he instructed Folwell (that is, Keith Folwell, Giant’s executive general manager, mining) “to make available all information” to the technical consultants. The [326] Pioneer board on 13 March resolved that representatives of Pioneer should be involved in briefing the consultants. The Pioneer board on 30 March directed Pioneer management to strengthen the management team at Giant, and was critical of Giant’s failure to provide timely financial information. At the Pioneer board meeting of 2 June 1989, Antico said that Pioneer management recommended that Pioneer provide further financial support to Giant, subject to conditions including a condition that the Giant board be reconstructed, with Antico as chairman, and the over-representation on the board of Giant management addressed. The Pioneer board resolved to provide the further support, conditional inter alia on tighter management and financial control. Following this, on 5 June 1989, Antico sent a memorandum to Quirk that Quirk was to agree with Needham concerning the Giant board reconstruction. On 14 June 1989, Gardiner sent a memorandum to Antico, Quirk and Needham, advising that Quirk, Needham and Gardiner had agreed to ask [the Giant executive directors] to resign in September. Taking security The decision to fund Giant, to the basis of security provided by Giant, was effectively made by Pioneer, and simply accepted by Giant. At the Pioneer board meeting of 13 March 1989, the management were directed to use their best endeavours to obtain appropriate security from Giant. On 30 March 1989, Leach and Gardiner (acting, it may be inferred, on behalf of Pioneer) met Anthony Sherlock of Coopers & Lybrand to discuss how to deal with the banks in relation to taking security over Curragh. [The judge found that negotiations with the banks (other than Standard Chartered) to obtain their consent to Pioneer taking security over Giant’s assets were conducted by Pioneer management exclusively. The consent was given.] On 2 June 1989, Pioneer resolved that further financial support was conditional on security being granted over shares in Pamour and Curragh. The granting of security was resolved upon by the Giant board only on 22 June, shortly before the actual documents were executed on 30 June. 402

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Standard Chartered Bank of Australia Ltd v Antico cont. Again, the very strong indication is that Pioneer carried this matter forward on behalf of both itself and Giant, and it was ultimately accepted as a fait accompli by Giant on 22 June. … [327] Application of principles I accept that a holding company is not a director of its subsidiaries, merely because it has control of how the boards of its subsidiaries are constituted; that it is not uncommon for lenders to impose conditions on loans, including conditions as to the application of funds and disclosure of the borrower’s affairs; and that it is even less uncommon for lenders to require security for a loan, and then to require the sale of property over which the security is given. Certainly, these factors on their own would not amount to assuming the position of a director, or taking part in the management of a borrower company. However, the circumstances in this case go far beyond these matters. In my view, the conditions imposed following the decision to fund Giant in [328] March 1989 show a willingness and ability to exercise control, and an actuality of control, over the management and financial affairs of Giant. In my view also, the decision as to how Giant was to be funded by Pioneer, and as to the taking of security, was never the subject of careful consideration by the Giant board, but was accepted by the Giant board as something necessary or as a fait accompli. The matter of granting security was not the subject of any resolution until as late as 22 June 1989. These matters were given careful consideration by Antico, Quirk and Gardiner, who were directors of Giant; but the consideration which they gave was in the context of reports to and decisions by the Pioneer board, and so, in my view, was given by them as directors of Pioneer. Very much the same comments apply in relation to the decision to sell Curragh. [Curragh was a producer of zinc, lead and silver in which Giant held a 46% stake.] Antico, Quirk and Gardiner all say that they recognised their duty, as directors of Giant, to act in the interests of all Giant’s shareholders; and they all say they had no instructions from Pioneer as to how they should act in that capacity. Antico and Gardiner said that, if any question arose when they were acting as shareholders of Giant which involved a conflict of Pioneer’s interest, they would abstain from voting on that matter. Quirk asserted that he did not see any conflict, because he considered what was in the best interests of Giant would also be in the best interests of Pioneer, by reason of its 42% shareholding. This evidence does not lead me to the view that, having carefully considered, in their capacity as directors of Pioneer, these strategic decisions concerning the affairs of Giant, they gave any separate consideration to them in their capacity as directors of Giant. In my view, the directors of Giant, including Antico, Quirk and Gardiner, simply accepted the decisions which had effectively been made by Pioneer. For these reasons, although I am not satisfied that Pioneer’s activities prior to 4 March were sufficient to constitute it a director of Giant, or a person who took part in the management of Giant, I do consider that as from 4 March, Pioneer was a person who took part in the management of Giant, and was also a director of Giant.

Australian Securities Commission v AS Nominees Ltd [7.50] Australian Securities Commission v AS Nominees Ltd (1995) 133 ALR 1 Federal Court of Australia [ASN, Ample and Securities were members of a group of companies founded by Windsor. ASN and Ample operated as trustee companies of superannuation and unit trusts with common boards of directors for all practical purposes. Securities acted as manager of ASN and Ample and was the beneficiary of all trustee and management fees paid by the ASN and Ample trusts; Securities was under [7.50]

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Australian Securities Commission v AS Nominees Ltd cont. the direct control of Windsor. ASIC (then called ASC) commenced proceedings to wind up the three companies or for the appointment of a receiver and manager to their property. ASC alleged that the trustee companies had been run largely at the direction and in the interest of Windsor with extensive breaches of trust.] FINN J: [51] The short point here is whether, as the applicant submits, Windsor is “a person in accordance with whose directions or instructions the directors of [either ASN or Ample or both] are accustomed to act”: s 9. If the evidence establishes that such is the case Windsor will be deemed to be a director of either or both companies for the purposes of the Corporations [Act]. The substance of the ASC submission is that Windsor’s relationship to the two companies should be seen in its true light. He should not be seen as a mere accessory of the companies and their directors. Rather, in the matters in which he has been involved, he has been the moving force. The respective boards have in effect been his accessories in the pursuit of his ends. The respondents’ submission acknowledged that Windsor had an influence upon the actions taken by the boards. But this was because he acted (both through Securities and otherwise) as manager of the companies; he introduced much of the trust business; and he was involved in its negotiation. He was a person on whose advice the directors acted. But that “advice [was] given by [him] in the proper performance of the functions attaching to … [his] business relationship with the directors” of each company: s 9. If such was the case, then, because of that subsection, he was not a deemed (or s 9) director. I have found that Windsor: (i)

has induced or procured a range of transactions which constituted or have resulted in breaches of trust. I note in this … the Constant and Securities loans which were for the benefit of companies under his direct control; and

(ii)

brought Ample to the verge of financial disaster in the SECCU transactions through conduct which cannot be condoned. I have also found that the directors of ASN and of Ample: (i)

have acted without due deliberation (and in some cases recklessly so) in entering into transactions introduced by Windsor … and

(ii)

have acted in transactions involving the Windsor interests in ways calculated to protect or advance those interests … Cahill [a director of Ample] in his evidence has suggested that there were, on occasion, disagreements between Windsor and the boards. The one specific instance of which there is evidence resulted in Windsor’s peremptory sacking of the Ample board on 20 June 1995. I would note that while there may be some question as to whether he formally had the power to do so, the dismissed directors did not question his right to remove them. Both Cahill and Sutherland [another director of Ample] have denied that they acted on Windsor’s directions or instructions. Cahill in his affidavit on 11 August 1995 refers specifically to s 9 in this regard. To the extent that Windsor’s actions were reflected in board action, Sutherland related this to his management role and to the trust so placed in him. The burden of this evidence was to suggest that the boards, none the less, retained and exercised independent judgment in the matters which Windsor brought to them. [52] The relationship of Windsor to the directors – and there is no reason for distinguishing the two companies in this – is relatively distinctive. First, it is not one in which the directors can be said at all times and for all purposes to have acted entirely as his puppets without exercising any discretion at all in company matters: cf Selangor United Rubber Estates Ltd v Cradock (No 3) [1968] 1 WLR 1555 at 1577-8. If such had been the case there would have been no dispute as to the applicability of s 9. Secondly, the case likewise is not one of the boards acting simply in the fashion of errant nominee directors who unduly favour the interest they represent: see Scottish Co-operative Wholesale Society Ltd v Meyer [1959] AC 324; see also Berlei Hestia (NZ) Ltd v Fernyhough [1980] 2 NZLR 150. Such without more, would not bring the “nominor” within s 9: Standard Chartered Bank of Australia Ltd v Antico (1995) 131 ALR 1 at 66 … 404

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Australian Securities Commission v AS Nominees Ltd cont. Thirdly, it cannot be said that, if there was “direction or instruction”, this extended to all board decisions. As has been seen, some at least of the transactions I have considered have not on the evidence before me involved Windsor either at all or else significantly. I do not regard this of itself as denying s 9 any application in this matter. The reference in the section to a person in accordance with whose directions or instructions the directors are “accustomed to act” does not in my opinion require that there be directions or instructions embracing all matters involving the board. Rather it only requires that, as and when the directors are directed or instructed, they are accustomed to act as the section requires. Given the findings I previously have made, I conclude that Windsor has exercised control over the affairs of ASN and Ample. However that control has been primarily of a strategic character and, of recent times, increasingly so as he has pursued off-shore dealings. None the less, that control has defined the context in which the companies have operated. It has contrived the transactions of significance in which they were to be involved. In my opinion it cannot be said that in those matters in which Windsor intruded, the boards of either company exercised an independent role at all. The first Fawkner Centre transaction is the Ample’s board’s testament to its servility. The Securities and Constant loans, to the pliability of both boards. When one looks to the aggregate of the transactions analysed, it cannot properly be said that the case is merely one of directors acting on the advice of a manager in the proper performance of his duties: s 9. What so often was asked of, and conceded by, the boards was either to act partially towards Windsor or to act in ways which, in furthering his designs, required the dereliction of their own, and of their trust company’s duties. In these circumstances it can and should be found that Windsor is a director of both ASN and Ample as a result of s 9. This finding does not, in my opinion, require it to be shown that formal directions or instructions were given in those matters in which he involved himself. The formal command is by no means always necessary to secure as of course compliance with what is sought. There is no reason to construe the section so as to deny this. The idea of the section, as Wells J noted of its predecessor in Harris v Shepherd (1976) 2 ACLR 51 at 64, is that the third party calls the tune and the directors dance in their capacity as directors. This aptly describes Windsor’s role. [53] The question the section poses is: Where, for some or all purposes, is the locus of effective decision making? If it resides in a third party such as Windsor, and if that person cannot secure the “advisor” protection of s 9, then it is open to find that person a director for the purposes of the Corporations [Act]. The practical consequences of my finding Windsor to be a director for s 9 purposes are several. First, in transactions such as the first and second Fawkner Centre and the SECCU transactions, he thus becomes liable potentially under [s 181(1)]. Secondly, in the cases of the Securities and Constant loans and of the second Fawkner Centre transaction, the conflict of interest becomes more direct because of this deemed relationship with the lender or vendor company. The net effect is that his liabilities become less that of accessory, more that of principal actor. But in the context of these proceedings that is appropriate. In relation to those matters in which he involved the companies it can be said with some justice: “He is the fons et origo of the whole of this mischief”: cf Midgley v Midgley [1893] 3 Ch 282 at 301.

[7.52]

1.

Notes&Questions Dairy Containers Ltd v NZI Bank Ltd (1995) 13 ACLC 3,211 held that a company (NZDB) which appointed its employees as the directors of a wholly owned subsidiary (DCL) did not thereby become a director of the subsidiary. Thomas J said (at 3,328): As employees they were accustomed to act in accordance with their employer’s directions or instructions, but as directors of DCL they did not as a matter of fact [7.52]

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receive directions or instructions from the parent company. They were, as directors of DCL, standing (or sitting) in the shoes of NZDB at the board table, but they had not and did not receive directions or instructions from their employer. Even when a firm instruction from NZDB was made, it was directed at the company, not at the directors.

2.

What acts, directions or intervention by, for example, the board or senior management of a holding company in the affairs of its subsidiary or in the role played by its employees nominated to the subsidiary’s board, will expose the holding company or its directors to liability by virtue of the extended definition of director? Alternatively, when will such conduct expose the parent to a tortious duty of care to creditors and others affected by the subsidiary? See Kuwait Asia Bank v National Mutual Life Nominees Ltd [1991] 1 AC 187, referred to in Standard Chartered Bank v Antico at 66, and [4.127], n 2. For a fuller discussion of these issues, see R Carroll, “Shadow Director and Other Third Party Liability for Corporate Activity” in I M Ramsay (ed), Corporate Governance and the Duties of Company Directors (1997), pp 162-184; S Girvin [1995] Jur Rev 414; N R Campbell [1994] JBL 609; P M C Koh (1996) 14 C&SLJ 340; M Markovic (1996) 6 Aust Jnl of Corp Law 323.

SANCTIONING DIRECTORS’ AND OFFICERS’ DUTIES: THE CIVIL PENALTY SCHEME Sanctioning compliance with the Act [7.55] The statutory duties imposed upon company directors and officers in Ch 2D sound

both in civil and criminal sanctions. Civil remedies are compensatory in nature; criminal sanctions share the punitive and deterrent objectives of criminal law generally. Since 1993 these sanctions have been complemented by civil penalties whose introduction was accompanied by the winding back of criminal sanctions under the Act to apply only to conduct that is perceived to be genuinely criminal in nature. 57 The civil penalty scheme marks a striking and distinctive feature of Australian corporate law, the public enforcement of key statutory provisions by the regulator, ASIC, alongside private enforcement of rights and duties by the company and shareholders. In this respect, Australian corporate law stands apart from other common law systems such as those of the United Kingdom and the United States which rely solely upon private enforcement. Corporate law has an undoubted private law character in its governance of the relationships between participants in the corporate enterprise. However, since the introduction of statutory duties for directors, and especially in the enforcement role and powers assigned to ASIC under the civil penalty scheme, Australian law also recognises the public character of the duties sanctioned by that scheme. The civil penalty scheme introduced in 1993 and contained in Pt 9.4B of the Act straddles the divide between civil and criminal enforcement and combines their compensatory and deterrent purposes. 58 The scheme provides for a range of sanctions which may operate cumulatively, including orders for payment of a pecuniary penalty, disqualification from managing companies and being a company director, and compensation for damage suffered by the contravention. Thus the civil penalty scheme straddles public and private objectives; when ASIC pursues pecuniary penalty and disqualification sanctions, it asserts the public character of the duty in question; when it pursues compensation, the private character of the duty is vindicated. Contravention need be proved only to the civil standard, that is, on the balance of 57 58

Senate Standing Committee on Legal and Constitutional Affairs, Company Directors’ Duties: Report on the Social and Fiduciary Duties and Obligations of Company Directors (1989), [13.12]. G Gilligan, H Bird & I Ramsay (1999) 22(2) UNSWLJ 417 at 424.

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probabilities: see [7.65] at n 7. Contravention of these provisions generally attracts criminal liability only if some further requirement beyond the fact of contravention is established (although this is not the case for one species of provision, the financial services civil penalty provisions: see [7.65] at n 6). The High Court has declined to classify the civil penalty scheme as either punitive or protective in character on the ground that these are not mutually exclusive categories and the distinction between them is “elusive”. 59 The list of civil penalty provisions has grown rapidly since 1993. In this time, the civil penalty scheme has become a central device for sanctioning key provisions of the Act whose only common feature is their assumed regulatory significance and perhaps their uncertain inherent criminality. The range of civil penalty provisions [7.60] The civil penalty scheme defines particular statutory provisions as civil penalty

provisions. These include the principal provisions of the Act that impose general duties upon directors and officers as well as more specific provisions, compliance with which is intended to be more effectively sanctioned by this device. The civil penalty provisions include: • directors’ and officers’ duties (ss 180(1), 181(1)(2), 182(1)(2), 183(1)(2)); • insolvent trading (s 588G(2); see [7.135]); • involvement in the giving of an unsanctioned financial benefit to a related party of a public company (s 209(2); see [7.410]); • share capital transactions (ss 254L(2), 256D(3), 259F(2) and 260D(2); see Chapter 9); • requirements for financial reporting (s 344(1); see [7.195]); and • measures relating to managed investment schemes: s 1317E(1). In addition, in 2002 a number of provisions relating to financial services and markets were added to the list of civil penalty provisions. They are collectively called financial services civil penalty provisions to distinguish them from the other civil penalty provisions which are referred to in the Act as corporation/scheme civil penalty provisions. The financial services civil penalty provisions deal with continuous disclosure, financial market manipulation, false trading and market rigging, dissemination of provisions about illegal transactions, and insider trading. These topics are examined in Chapter 11. The consequences of contravening a civil penalty provision [7.65] The consequences of contravening a civil penalty provision may be summarised in the

following terms. 60 1. Declaration of contravention If the Court is satisfied that a person has contravened a civil penalty provision, it must make a declaration of contravention specifying the civil penalty provision that has been contravened, the person who contravened the provision, the conduct that contravened the provision and (except for financial services civil penalty provisions) the company to which the conduct related: s 1317E. Only ASIC may seek a declaration: s 1317J(1), (4). The terms in which some civil penalty provisions are expressed apply not only to the primary contravener but also to those involved in the contravention within the definition of that term contained in s 79. 59

Rich v ASIC (2004) 50 ACSR 242 at [32], [35], [37]-[38]. A secondary reason, relevant to the instant litigation, was that adoption of this distinction diverted attention from the question whether the common law privilege against exposure to penalties applies in proceedings under Pt 9.4B. The Court held that it did and accordingly directors against whom civil penalty proceedings were commenced were not required to give discovery to ASIC (at [39]); see V Comino (2005) 18 Aust Jnl of Corp Law 48; J P Krackstredt (2006) 24 C&SLJ 56; P Spender (2008) 26 C&SLJ 249.

60

See M Welsh (2005) 18 Aust Jnl of Corp Law 243; V Comino (2006) 34 ABLR 428; V Comino (2007) 20 Aust Jnl of Corp Law 183; J Mayanja (2007) 20 Aust Jnl of Corp Law 157. [7.65]

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2.

3.

4.

5. 6.

7.

Post-declaration orders; disqualification order Once a declaration of contravention has been made, ASIC may seek a pecuniary penalty order (s 1317G) or a disqualification order: s 206C and [5.230]. In practice, a disqualification order is almost invariably sought where the contravention relates to breach of a director’s duties. Pecuniary penalty order In relation to a corporation/scheme civil penalty provision, the Court may make a pecuniary penalty order requiring the person against whom the declaration of contravention has been made to pay the Commonwealth up to $200,000; the order may, however, only be made where the contravention materially prejudices the interests of the company or its ability to pay its creditors, or is serious: s 1317G(1). In relation to a financial services civil penalty provision, a pecuniary penalty order may only be made if the contravention materially prejudices the interests of those who acquire, dispose of or issue the relevant financial product, or is serious: s 1317G(1A). The court making a pecuniary penalty or disqualification order exercises independent judgment as to the appropriate order in view of the facts leading to the declaration of contravention. Where a statement of agreed facts is presented to the Court along with a penalty agreed between the parties, the Court checks that the statement fully and accurately describes the facts of the contravention and makes an order appropriate in the circumstances; the penalty proposed by the parties has no binding force even if it appears to fall within the range of penalties reasonably available. 61 Compensation In relation to a corporation/scheme civil penalty provision, a company may seek a court order for compensation without a prior declaration of contravention. (Recall that only ASIC may apply for a declaration.) Compensation may be ordered to be paid to a company for damage resulting from a contravention or for disgorgement of profits by the contravener (s 1317H); an application for a compensation order may be made only by the company or ASIC: s 1317J(1), (2), (4). In relation to a financial services civil penalty provision, only ASIC or a person who suffers damage in relation to the contravention may apply for a compensation order: s 1317J(1), (3A), (4). The Court may make a compensation order for damage resulting from the contravention of a financial services civil penalty provision; the profits made from the contravention must be included in the determination of damage suffered: s 1317HA(1), (2). Limitation period Proceedings for a declaration, pecuniary penalty order or compensation order must be started within six years of the contravention: s 1317K. Criminal liability In relation to a corporation/scheme civil penalty provision, the circumstances in which contravention of a civil penalty provision will give rise to criminal liability depends upon the particular provision. Contravention of directors’ and officers’ duties is an offence only if reckless or intentional: s 184. Generally, contravention of other corporation/scheme civil penalty provisions is an offence only if involvement is dishonest: ss 209(3), 254L(3), 256D(4), 259F(3), 260D(3), 344M(2) and 588G(3). 62 For each of the financial services civil penalty provisions, contravention of the provision or failure to comply with it is itself expressed to be an offence as well as a trigger to civil liability for a penalty and compensatory order. Civil standard, evidence rules and procedure The Court must apply the rules of evidence and procedure for civil matters when hearing proceedings for a declaration of

61 62

ASIC v Ingleby (2013) 93 ACSR 274. Contravention of one of the corporation/scheme civil penalty provisions concerning managed investment schemes will give rise to an offence only where the contravention or the involvement in it is intentional or reckless (ss 601FC(6), 601FD(4), 601JD(4)) or is intentional: ss 601FE(4), 601FG(3).

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contravention or a pecuniary penalty order: s 1317L. These rules include the civil standard of proof in those proceedings on the balance of probabilities. However, since the making of a declaration exposes the contravenor to a penalty, the Court applies the Briginshaw v Briginshaw standard requiring proof to comfortable satisfaction. This standard remains, however, the balance of probabilities and may be satisfied by proof of “circumstantial evidentiary facts” and “inference and circumstance”. 63 8.

Civil proceedings may not follow criminal A Court may not make a declaration of contravention or a pecuniary penalty order against a person for a contravention if the person has been convicted of an offence constituted by conduct that is substantially the same as the conduct constituting the contravention: s 1317M.

9.

Criminal proceedings stay earlier civil proceedings Proceedings for a declaration of contravention or pecuniary penalty order against a person are stayed if criminal proceedings are started against the person for an offence constituted by substantially similar conduct: s 1317N(1). 64

10.

Criminal proceedings after civil The converse is not true; criminal proceedings may be started against a person for conduct that has been the subject of a declaration, pecuniary penalty order, disqualification order or compensation order: s 1317P. 65

11.

Inadmissibility of evidence in later criminal proceedings Evidence given in proceedings for a pecuniary penalty order against an individual is not admissible in criminal proceedings against the individual for substantially similar conduct: s 1317Q.

12.

Relief from liability In civil proceedings for contravention of a civil penalty provision, a person may be relieved from liability where the Court determines that the person has acted honestly and, in all the circumstances, ought fairly to be excused for the contravention: s 1317S(1), (2). Relief may not be given against criminal liability: s 1317S(1)(b).

The civil penalty scheme adds to ASIC’s enforcement options with respect to key provisions in the Act. It allows ASIC to move promptly and under the civil standard of proof against a contravention of the provision, to seek orders for disqualification from management and for the payment of a pecuniary penalty. It may also to seek compensation for the company although this remedy is less often sought. If ASIC elects to pursue a civil penalty for a contravention, that election will not preclude a later criminal prosecution although the prosecution will need to depend upon evidence other than that adduced in the civil proceedings. In practice ASIC makes an election between the civil and criminal sanctions. For

63

Briginshaw v Briginshaw (1938) 60 CLR 336 at 362-363, 366 per Dixon J; Vines v ASIC (2007) 62 ACSR 1 at [810]-[813] per Ipp JA.

64

The Court may also exercise its common law discretion to stay civil proceedings in the interests of justice if criminal proceedings could be but have not yet been commenced. Civil proceedings were stayed in Re AWB Ltd (2008) 68 ACSR 374 where criminal proceedings were “on the cards”.

65

In Adler v DPP (Cth) (2004) 51 ACSR 1 the court held that there was no abuse of process involved in the launching of the criminal prosecution. The alleged abuse arose because the prosecution was said to expose the defendant to double jeopardy in that he had already been punished by pecuniary penalty orders for substantially the same conduct as that alleged in the criminal proceedings. However, the court held that the two sets of proceedings were distinguished by the different standards of proof and that there was no suggestion of any attempt in the prosecution to eclipse or challenge a prior acquittal such as would normally attract the double jeopardy rule. [7.65]

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the company or an investor (in the case of a financial services provision), there is the direct compensation remedy independently of any enforcement action by ASIC or a formal declaration of contravention. 66 ASIC and the Commonwealth DPP make extensive use of these enforcement provisions. An empirical analysis of court proceedings brought by ASIC and the Commonwealth DPP for the enforcement of directors’ duties in the ten year period from 2005 to 2014 found: • such proceedings represented approximately half of all public and private proceedings involving breach of directors’ duties; • criminal proceedings accounted for 72 of 99 of all such proceedings and 63 of 78 proven matters; however, measured in terms of the number of defendants rather than proceedings, civil enforcement involved 72 of 142 defendants; 67 • the average civil management disqualification order was about 5.2 years and the median civil pecuniary penalty imposed on defendants who had engaged in a single contravention was $25,000; • contrary to widely held perceptions that civil proceedings are more successful and quicker in view of the more lenient rules of evidence and procedure applicable to them, only a relatively small difference emerged between the success rates and duration of civil and criminal enforcement proceedings: ASIC and the CDPP established liability in 89% and 88% respectively of cases brought; the average duration of civil matters was 6.9 years and of criminal 7.9 years from the first detected contravention to final judgment. 68

DUTIES OF CARE, DILIGENCE AND SKILL An overview of duties and remedies [7.70] Three species of legal rule are directed primarily towards the problem of director and

officer shirking and underperformance: see [7.20]. First, the general law imposes upon directors and other officers a duty to their company to apply reasonable care in the performance of their office. The duty of care was developed initially in courts of equity by analogy to the like duties of trustees; later courts, however, applied the developing common law of negligence from Donoghue v Stevenson 69 to directors so that the duty of care is owed not only in equity as an incident of the director’s office but also in tort: see Permanent Building Society v Wheeler [7.92]. Directors may therefore be liable in an action for liquidated damages for breach of duty at common law and equitable compensation may also be available on a restitutionary basis with equity’s less restrictive rules of causation, remoteness of damage and 66

The privilege that a litigant enjoys against the forced production of documents or information which may be used to establish liability to a penalty in other proceedings (Refrigerated Express Lines (A/Asia) Pty Ltd v Australian Meat and Live-Stock Corporation (1979) 42 FLR 204 at 207-208 per Deane J) applies to compensation proceedings by the company as well as to proceedings by ASIC for a pecuniary penalty order: One.Tel Ltd (in liq) v Rich (2005) 53 ACSR 623 at [73]-[79] (applying the principle in the compensation proceedings removes the fear of circumvention of the privilege in later penalty proceedings).

67

When those directors’ duties provisions that are not criminally sanctioned (viz, ss 180, 191 and 195) are removed from calculation, civil enforcement played a reduced but still significant role (45 of 115 liable defendants). Almost half of criminal proceedings were brought in the inferior courts (viz, district/county courts, local/magistrates courts and Federal Circuit Court) (42 of 87 proven matters and 47 of 142 liable defendants).

68

69

J Hedges et al, An Empirical Analysis of Public Enforcement of Directors’ Duties in Australia: Preliminary Findings (Centre for International Finance and Regulation Working Paper 105/2016); see also J Hedges and I Ramsay (2016) 34 C&SLJ 543. [1932] AC 562.

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measure of damages: “the link required by equity involves no inquiry as to whether the loss was ‘caused by’ or ‘flowed from’ the breach but [merely] whether the loss would have happened if there had been no breach”. 70 Issues of causation in equity are discussed in Permanent Building Society v Wheeler [7.92]. It remains to be settled by an appellate court whether the equitable duty of care is an element of the director’s fiduciary obligation and indeed what the consequences of that further characterisation might be. 71 The general law duty is of particular significance for non-executive directors since executive directors and corporate officers will generally also assume an obligation of careful and competent service as an express or implied term of their contract of service. Second, the general law duty is complemented by a statutory duty of care and diligence contained in s 180(1). Section 180(1) is a civil penalty provision whose contravention attracts the penalty and compensation provisions of Pt 9.4B in addition to general law and other statutory remedies and obligations such as those arising out of contracts of employment: s 185. The Act provides a safe haven from liability for breach of the duty of care in respect of business judgments if certain conditions are met (s 180(2)), and defines the circumstances in which directors and officers may rely upon information or advice provided by others: s 189. These provisions apply not only for the purposes of the statutory duties of care and diligence but also for those arising at general law: see [7.75], [7.105]. Third, the Act imposes a specific obligation upon directors to prevent their company from incurring debts while it is insolvent and imposes personal liabilities upon directors subject to defences. The duty is discussed at [7.135]. The remedy for breach of the general law duty of care and diligence and its statutory complements is the award of common law damages to compensate the company for loss caused by or arising from the breach or equitable compensation for the loss that would not have occurred but for the breach. Both the general law and statutory duties are owed by individual directors and officers who are personally liable for breach of duty. If directors breach their duty of care, the remedy is not for an order to set aside a board decision taken in breach of the duty of care or to restrain action pursuant to such a decision. The rescission remedy may be granted, however, for breach of the general law duty of good faith which requires directors to act bona fide for the corporate interest: see [7.215]. Carelessness in the perception of the company’s interests, or other failures of the board decision-making process, may in exceptional cases amount to breach of that fiduciary duty as well as the duty of care. However, this will generally only arise where there is director self-interest or partiality extended to a third party. Breach would then be remediable by orders affecting the decision taken. The duties of care sound in distinct but overlapping remedies. For a solvent company seeking compensation from current or former directors and officers for loss caused by neglect of duty, the primary private remedies will be those arising under a service contract or for breach of the general law duty of care. The company may also seek compensation where the 70

Westpac Banking Corporation v Bell Group Ltd (in liq) (No 3) (2012) 89 ACSR 1 at [903]. Equitable relief seeks the restoration of the party to the position enjoyed before the event giving rise to the claim for relief: Bell Group Ltd (in liq) v Westpac Banking Corporation (No 10) (2009) 71 ACSR 300 at [3].

71

Contrast dicta in two decisions of the Western Australia Court of Appeal: Permanent Building Society (in Liq) v Wheeler (1994) 11 WAR 187 at 237-239 (the equitable duty of care is not fiduciary) and Westpac Banking Corporation v Bell Group Ltd (in liq) (No 3) (2012) 89 ACSR 1 at [884] per Lee AJA (it is consonant with principle for breach of the obligation to take reasonable care to be treated as a breach of a fiduciary duty in the director’s fiduciary relationship); ct J D Heydon, “Are the Duties of Company Directors to Exercise Care and Skill Fiduciary?” in S Degeling & J Edelman (eds), Equity in Commercial Law (2005), 185-237 with W M Heath (2007) 25 C&SLJ 370. [7.70]

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neglect amounts to contravention of the duty in s 180(1), irrespective of whether a civil penalty order has been sought in relation to the contravention: s 1317H. For an insolvent company, the remedies may also include: • action under Pt 5.7b Div 4 against directors founded upon contravention of s 588G (insolvent trading); • compensation proceedings founded upon contravention of s 180(1) under s 1317H; and • the longstanding remedy under s 598 for breach (inter alia) of the general law duty of care. ASIC may also pursue public enforcement of breaches of s 180(1) seeking payment of a pecuniary penalty or disqualification of a director or officer from office or management participation as well as private compensation remedies. The development of the modern duty of care [7.75] At general law directors owe a duty to their company to take reasonable care in

performing the functions of office. The elements of the general law duty were initially settled in the second half of the 19th century in courts of equity; initially they were not exacting: The idea that the shareholders were ultimately responsible for the unwise appointments of directors led to the duty of care, skill and diligence which a director owed to a company being characterised as remarkably low. In Re Denham and Co 72 the court described a director as a country gentleman and not a skilled accountant. It did not expect him to realise the significance of certain information in the financial accounts. Turquand v Marshall 73 was the nadir. However ridiculous and absurd the conduct of the directors, it was the company’s misfortune that such unwise directors were chosen. In Lagunas Nitrate Co v Lagunas Syndicate, Lindley MR said their negligence must be not the omission to take all possible care; it must be much more blameable than that; it must be in a business sense culpable or gross. 74 In Re Cardiff Savings Bank (Marquis of Bute’s Case) 75 Stirling J, in dismissing a claim by the bank’s liquidator against the Marquis, who had become the president of the board of the bank at the age of six months and held the position for over forty years (during which time he attended only one board meeting), said that the Marquis was entitled to rely on the bank’s trustees and managers to perform their duties properly and could not be fixed with liability for the neglect and omission of others rather than his own. In the result, if trouble brewed, the easiest and safest course for a director was to stay away from board meetings. 76

The decision of Romer J in Re City Equitable Fire Insurance Company Ltd in 1925 was regarded, at least until the 1990s, as the “classic exposition” of the general law standard of diligence, skill and care. 77 Romer J accepted that the performance of a director’s duties did not require a greater degree of skill than might reasonably be expected from a person of the director’s knowledge and experience; the standard of care is “basically an objective one in the sense that the question is what an ordinary person with the experience of the defendant might be expected to have done in the circumstances” – while “basically” objective, the test nonetheless invests the director on the Clapham omnibus with the particular knowledge and 72

(1883) 25 Ch D 752.

73 74 75

(1869) LR 4 Ch App 376. [1899] 2 Ch 392 at 435. [1892] 2 Ch 100 at 109-110.

76

Daniels v Anderson (1995) 37 NSWLR 438 at 494-495; in perhaps the earliest reported case of director liability for want of care, The Charitable Corporation v Sutton (1742) 2 Atk 400; 26 ER 642, the standard of care of honorary directors was set at “gross negligence”, the same standard applied to gratuitous bailees in Coggs v Barnard (1703) 2 Ld Raym 909; 92 ER 107: ASIC v Cassimatis (No 8) [2016] FCA 1023 at [417]-[421].

77

Daniels v Anderson (1995) 37 NSWLR 438 at 495 per Clarke and Sheller JJA.

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experience of the director whose performance is being judged. 78 Second, the duties of a director are of an intermittent nature, to be performed at periodical board meetings and meetings of any board committee of which they are a member; the director is not bound to attend all such meetings although the director should do so when reasonably able. This latter statement, however, no longer reflects modern expectations – a director is expected to attend all meetings unless exceptional circumstances such as illness or absence from the State prevent participation. 79 Third, where duties might properly be left to some other official, a director is justified, in the absence of grounds for suspicion, in trusting that official to perform such duties honestly. 80 Until the early 1990s there were very few reported civil decisions on the general law duty of care in Australia, at least in relation to solvent companies, and consequently little legal development of legal doctrine. Partly this was explicable on the basis that, until 2000, the board of directors was the only corporate organ that might bring civil suit against directors for breach of the duty of care; breach of the duty was not actionable by shareholder suit because it was not covered under any of the recognised exceptions to the general law bar on shareholder standing to litigate for wrongs done to the company. 81 Several developments contributed to dramatic change in legal development of the duty from the early 1990s. First, prior to the introduction for the facility for company formation with a single director from 1998, inactive directors (often family members taking office merely to satisfy the requirement for a second director for proprietary companies) were being held liable under the strict statutory duty to prevent insolvent trading by the company; the discrepancy between this standard of responsibility and that under the general law duty of care expressed in Re City Equitable was becoming notorious and disturbing. 82 Second, the newly created national regulator, the Australian Securities Commission, commenced criminal proceedings for breach of the statutory duty of care against directors of companies that had collapsed following the stock market break of 1987. These judicial decisions applied the common law of negligence developed from Donoghue v Stevenson 83 to directors so that the duty of care is now owed not only in equity, as an incident of the director’s office, but also in tort. Indeed, the weight of modern judicial opinion favours the view that directors owe a single general law duty, recognised by both common law and equity, to take reasonable care. 84 Third, the statutory duty of care was amended to impose an objective standard of care, enforceable by ASIC under its public enforcement powers under the civil penalty scheme, as well as by private enforcement: see [7.65]. Australian companies legislation has imposed a statutory duty of care upon directors and officers since the Uniform Companies Acts in 1962: see [2.80]. 85 The Act now provides that a 78 79

Australian Securities Commission v Gallagher (1993) 10 ACSR 43 at 53 per Pidgeon J, Franklyn and Walsh JJ agreeing. Vrisakis v Australian Securities Commission (1993) 11 ACSR 162 at 170 per Malcolm CJ.

80

Re City Equitable Fire Insurance Co Ltd [1925] Ch 407 at 428-429.

81

See Pavlides v Jensen [1956] Ch 565; on the procedure introduced in 2000 that permits shareholder suit for director negligence, see [8.100].

82

See, eg, Statewide Tobacco Services Ltd v Morley (1990) 2 ACSR 405; Commonwealth Bank of Australia v Friedrich (1991) 5 ACSR 115.

83 84

Donoghue v Stevenson [1932] AC 562 . Daniels v Anderson (1995) 37 NSWLR 438 at 492 per Clarke and Sheller JJA; Permanent Building Society (in liq) v Wheeler (1994) 11 WAR 187 at 239 per Ipp J; ASIC v Cassimatis (No 8) [2016] FCA 1023 at [427]; W Heath (2007) 25 C&SLJ 370. The Uniform Companies Acts followed earlier Victorian legislation, in 1896 (albeit repealed in 1910) and 1958: R Teele Langford, I Ramsay and M Welsh (2015) 37 Syd L Rev 489; the authors note that the 1896 provision was arguably the first such provision in the common law world.

85

[7.75]

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director or officer must exercise the degree of care and diligence that a reasonable person would exercise if they were a director or officer of a company in the company’s circumstances and occupied the office held by, and had the same responsibilities within the company as, the director or officer: s 180(1). The provision was recast in those terms in 2000 to remove doubts persisting with respect to the previous formulation by making it clear that the standard of care and diligence is determined both by reference to the company’s circumstances and the director or officer’s position and responsibilities within the company. It appears that the reference to the director or officer’s position and responsibilities within the company was intended to make it clear that non-executive directors are not subject to the same standard of care as executive directors in view of their distinct roles, and to affirm that the standard of care, while varying along the two axes of company circumstances and officer position and responsibilities, is objective. 86 The standard of care under the s 180(1) is essentially the same as under the general law duty of care; 87 this is so despite the significantly different sanctions under the civil penalty scheme for contravention of the statutory duty, the absence of any requirement of loss to the company for such contravention, and the inability of shareholders to release directors and officers from liability for statutory breach by ratification. 88 The statutory duty introduces a public element into the enforcement of the duty of care alongside private enforcement of the general law – a system of dual public and private wrongs for breach of duty; it is because of the public character of the wrong that shareholders are unable to ratify breach of the statutory duty of care. 89 The statutory duty of care is a civil penalty provision which no longer attracts any criminal sanction for its breach. Previously, a breach of the statutory duty of care with dishonest intent constituted an offence. 90 The criminal sanction was withdrawn in 2000 upon the basis that the concept of negligence is inconsistent with dishonesty since the latter suggests an active awareness of wrongdoing rather than failure to exercise sufficient care and diligence. 91 The statutory duty is reinforced by an obligation upon public companies that are not wholly owned subsidiaries of another company to include in their annual report to members a statement indicating the number of meetings of directors (including meetings of committees of directors) convened that year and the number of such meetings attended by each director: s 300(10) and see [9.135]. Partly in response to these developments, in 2000 directors were given the benefit of a statutory presumption of reasonableness where they rely upon information or advice provided by an employee, other officer, professional adviser or expert whom the director reasonably believes to be reliable and competent; however, reliance must be made in good faith and be based upon the director’s independent assessment of the information or advice: s 189. This protection extends to proceedings brought to determine whether a director has performed their duties under Pt 2D.1 (including the duty of care) or their general law equivalents:

86

ASIC v Rich (2009) 236 FLR 1 at [7196].

87

Vines v ASIC (2007) 62 ACSR 1 at [142]-[143] per Spigelman CJ, [587] per Santow JA and [805] per Ipp JA; see also ASIC v Adler (2002) 168 FLR 253 (extracted and discussed at [7.95]) at [372] (3).

88

Angas Law Services v Carabelas (2005) 226 CLR 507 at 523 per Gleeson CJ and Heydon J; Forge v ASIC [2004] NSWCA 448 at [378]-[383] per McColl JA, Handley and Santow JJA agreeing.

89 90

ASIC v Cassimatis (No 8) [2016] FCA 1023 at [503], [512]. The subsection is excluded from the officers’ liability provisions attracting criminal sanctions under s 184. No such exclusion applied under the previous provision.

91

Corporate Law Economic Reform Program Bill 1998, Explanatory Memorandum, [6.76].

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s 189(c). 92 Second, directors were also relieved of responsibility for the acts of those to whom they have delegated powers where the director believes on reasonable grounds that: • the delegate would exercise the power in conformity with the director’s duties and the company’s constitution; and • in good faith, and after making proper inquiry if the circumstances indicated the need for inquiry, the delegate was reliable and competent in relation to the power delegated: s 190(2). This exculpation displaces the operation of the rule that, if directors delegate a power as they are permitted to do under s 198D, they are responsible for the exercise of power by the delegate as if the power had been exercised by the directors themselves: s 190(1). Accordingly, if the delegate acts fraudulently, negligently or outside the scope of the delegation, then the director will escape responsibility for the acts if the requirements of ss 189 and 190 are satisfied. Not all board functions, however, are delegable to management and remain the responsibility of the board itself: see further discussion at [7.80]. Executive directors may be held to distinct, specified and objective standards of care under their contract of employment reflecting the continuous nature of their responsibilities. Usually employment contracts will contain covenants on the director’s part to meet performance standards appropriate to professional managers. Even where no such express provision is made, however, it may well be an implied term of the contract that the director will perform her or his duties to professional standards of care and diligence, if not skill. 93 The content of the duty of care

The AWA litigation [7.80] The modern phase of development of the director’s duty of care in Australia began in

the early 1990s with the AWA litigation. AWA, a listed company manufacturing electronic and electrical products, sought to protect profit margins against foreign currency fluctuations by a process of “managed hedging” conducted through its young FX manager, Koval. The oversight of FX operations was left to its general manager and finance manager, neither of whom had experience with FX transactions and were out of their depth in the supervisory role in which they were cast. Proper records were not kept of transactions, concealing heavy losses from speculative trading by Koval well beyond permitted hedging. The auditors warned senior management of weaknesses in internal FX controls but did not inform the board. AWA sued the auditors for negligence for failing to report these breaches to the board when they were aware that AWA management had taken no remedial action in response to the auditors’ warnings. The auditors filed cross-claims seeking contribution from the chief executive and three non-executive directors as joint tortfeasors should they be found negligent. At first instance, Rogers CJ Comm Div found the auditors negligent in failing to inform the AWA board of breaches of internal control of FX operations. As regards the non-executive directors, he applied the test of permissable delegation and reliance adopted in Re City Equitable Fire Insurance Co:

92

93

The change was justified upon the basis that uncertainty about the circumstances in which it is appropriate to delegate to, or place reliance on the advice of others could lead to an overly conservative approach to management and impede corporate decision making: Corporate Law Economic Reform Program Bill 1998, Explanatory Memorandum, [6.97]. Lister v Romford Ice and Cold Storage Co Ltd [1957] AC 555. [7.80]

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Reliance would only be unreasonable where the director was aware of circumstances of such a character, so plain, so manifest and so simple of appreciation that no person, with any degree of prudence, acting on his behalf, would have relied on the particular judgment, information and advice of the officers. 94

Rogers CJ Comm Div held that the non-executive directors had no reason to suspect that the board’s FX policy was not being adhered to and that they were entitled to rely upon, and assume proper oversight by, senior management. The NSW Court of Appeal, by majority, upheld the primary judge’s findings of negligence against the auditors, accepting that they owed a duty to report the absence of proper records and internal control to management and, in the absence of timely and appropriate action by management, to the board. The appeal court also considered that it was not unreasonable for the non-executive directors to have accepted the auditors’ assurance as to the genuineness of reported profits and from senior management as to compliance with FX policy. 95 This was despite rejection of the statement of duty in Re City Equitable Fire Insurance Co: the court held that the statement of permissible delegation and reliance in Re City Equitable Fire Insurance Co applied by the primary judge “does not accurately state the extent of the duty of directors, whether non-executive or not, in modern company law”. 96 Further, the modern case law on insolvent trading, “set in the context of a legislative pattern of imposing greater responsibility upon directors, demonstrate[s] that the director’s duty of care is not merely subjective, limited by the director’s knowledge and experience or ignorance or inaction”. 97 By majority, the court elaborated the duty of care which it considered to be “eloquently explained” in the judgment of Pollock J in the Supreme Court of New Jersey in Francis v United Jersey Bank. 98 Clarke and Sheller JJA held that: 1. the responsibilities of directors require that they take reasonable steps to to place themselves in a position to guide and monitor the management of the company; 2.

these monitoring responsibilities require a director to become familiar with the fundamentals of the business in which the corporation is engaged;

3.

directors are under a continuing obligation to keep informed about the activities of the corporation;

4.

directorial management does not require a detailed inspection of day-to-day activities, but rather a general monitoring of corporate affairs and policies, including by way of regular attendance at board meetings; and

5.

a director should maintain familiarity with the financial status of the corporation by a regular review of financial statements; capacity to understand such financial statements was assumed to be a necessary skill for directors. 99

The position with respect to the chief executive was different since he had received information from reliable sources which pointed to serious deficiencies in internal controls, and he had not communicated this to the board. 94 95

AWA Ltd v Daniels t/as Deloitte Haskins & Sells (1992) 7 ACSR 759 at 868; the quoted words were those of Lord Hatherley LC in Overend and Gurney Co v Gibb (1872) LR 5 HL 480 at 487. Daniels v Anderson (formerly practising as Deloitte Haskins & Sells) (1995) 37 NSWLR 438 at 514.

96

Daniels v AWA Ltd (1995) 37 NSWLR 438 at 502.

97

Daniels v AWA Ltd (1995) 37 NSWLR 438 at 503.

98 99

432 A 2d 814 at 821-823(1981). Daniels v AWA Ltd (1995) 37 NSWLR 438 at 501, 503, 504; as regards the first proposition, Rogers CJ Comm Div had adopted a similar statement based upon recent insolvent trading decisions: AWA Ltd v Daniels t/as Deloitte Haskins & Sells (1992) 7 ACSR 759 at 864.

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Balancing of foreseeable risk and benefit [7.82] While these propositions have been accepted in later case law, 100 the statement that

has had wider influence as the “dominant test” 101 for the content of the duty of care is from a judgment in the Full Court of Western Australia in a case decided in the interval between the first instance and appellate decisions in the AWA litigation. In Vrisakis v Australian Securities Commission, in an appeal from a conviction for breach of the predecessor of s 180(1) when that provision attracted criminal as well as civil sanction, Ipp J said that: No act of commission or omission is capable of constituting a failure to exercise care and diligence … unless at the time thereof it was reasonably foreseeable that harm to the interests of the company might be caused thereby. That is because the duty of a director to exercise a reasonable degree of care and diligence cannot be defined without reference to the nature and extent of the foreseeable risk of harm to the company that would otherwise arise. Further, the mere fact that a director participates in conduct that carries with it a foreseeable risk of harm to the interests of the company will not necessarily mean that he has failed to exercise a reasonable degree of care and diligence in the discharge of his duties. The management and direction of companies involve taking decisions and embarking upon actions which may promise much, on the one hand, but which are, at the same time, fraught with risk on the other. That is inherent in the life of industry and commerce. The legislature undoubtedly did not intend by [s 180(1)] to dampen business enterprise and penalise legitimate but unsuccessful entrepreneurial activity. Accordingly, the question whether a director has exercised a reasonable degree of care and diligence can only be answered by balancing the foreseeable risk of harm against the potential benefits that could reasonably have been expected to accrue to the company from the conduct in question. 102

Although liability under s 180(1) does not require actual harm or detriment to the company in contrast to liability in tort, the same balancing of foreseeable risk and benefit applies as under the general law duty. In ASIC v Cassimatis (No 8), Edelman J emphasised and elaborated aspects of this test. First, the reference to “harm” is best understood as a reference to harm to any of the interests of the corporation, interests which are not limited to pecuniary loss or financial harm but might extend to unlawful conduct having non-pecuniary consequences, such as loss of corporate reputation: A corporation has a real and substantial interest in the lawful or legitimate conduct of its activity independently of whether the illegitimacy of that conduct will be detected or would cause loss. One reason for that interest is the corporation’s reputation. Corporations have reputations, independently of any financial concerns, just as individuals do. Another is that the corporation itself exists as a vehicle for lawful activity. For instance, it would be hard to imagine examples where it could be in a corporation’s interests for the corporation to engage in serious unlawful conduct even if that serious unlawful conduct was highly profitable and was reasonably considered by the director to be virtually undetectable during a limitation period for liability. 103

Second, the competing considerations to be weighed by directors are not always commensurate; accordingly, the balancing process of foreseeable risk of harm against potential benefit is an imprecise exercise. Edelman J said that reference to “balancing” should be understood as a reference to the decision of Mason J in Wyong Shire Council v Shirt: 100

See, eg, ASIC v Adler (2002) 168 FLR 253 at 372.

101 102

ASIC v Cassimatis (No 8) [2016] FCA 1023 at [479]. (1993) 11 ACSR 162 at 212; ASIC v Doyle (2001) 38 ACSR 606 at 641 per Ipp J; ASIC v Vines (2007) 62 ACSR 1 at [600] per Santow JA and [814] per Ipp JA.

103

ASIC v Cassimatis (No 8) [2016] FCA 1023 at [480]-[484]. [7.82]

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The perception of the reasonable man’s response calls for a consideration of the magnitude of the risk and the degree of the probability of its occurrence, along with the expense, difficulty and inconvenience of taking alleviating action and any other conflicting responsibilities which the defendant may have. It is only when these matters are balanced out that the tribunal of fact can confidently assert what is the standard of response to be ascribed to the reasonable man placed in the defendant’s position. The considerations to which I have referred indicate that a risk of injury which is remote in the sense that it is extremely unlikely to occur may nevertheless constitute a foreseeable risk. A risk which is not far-fetched or fanciful is real and therefore foreseeable. But, as we have seen, the existence of a foreseeable risk of injury does not in itself dispose of the question of breach of duty. The magnitude of the risk and its degree of probability remain to be considered with other relevant factors. 104

Edelman J considered that the balancing might not be judged solely by reference to financial considerations: [S]uppose a director makes a decision to commit a serious breach of the law, by intentionally discharging large volumes of toxic waste. Suppose the decision is made on the basis that the financial cost of avoiding the breach would be far greater than the cost of a pecuniary penalty under the relevant environmental regulation. This conduct might nevertheless involve a breach of the director’s duty of care and diligence, irrespective of any other breaches. In other words, the director might not avoid liability merely because he or she proved that a balancing exercise showed that the likely financial cost of a penalty was exceeded by the likely profit from a serious contravention of the law. 105

Third, the assessment of foreseeable risk and benefit must, at least in the context of applying s 180(1), take place from the perspective of the corporation’s circumstances and the office and responsibilities of the individual director whose conduct is in question. 106 The responsibilities of the director or officer to which regard must be had include not only the specific tasks delegated by the corporate constitution or board resolution but also to the way “in which work is distributed within the corporation and the expectations placed by those arrangements on the shoulders of the individual director or officer”. 107 When considering the company’s circumstances, it is necessary to have regard to whether the company is listed and, in the case of a parent company, to the size and nature of the businesses of its subsidiaries if they are under the general supervision of the parent. 108 The degree of financial or managerial integration within the group, or entity independence, may also be relevant to this question. In ASIC v Cassimatis (No 8) ASIC brought proceedings against Mr and Mrs Cassimatis, directors and sole shareholders of Storm Financial Ltd, for contravention of s 180(1). ASIC alleged that the Cassimatises breached s 180(1) by placing Storm in a situation in which it had breached the Corporations Act; effectively, ASIC sought to establish a breach by Storm as a “stepping stone” for a finding of contravention by the defendants of s 180(1). Proceedings were taken, however, only against the Cassimatises and under s 180(1), and not against Storm. Although Edelman J expressed “serious doubt” whether breach by a company is a precondition for a director’s breach of s 180(1), he proceeded on the basis that it is required because the parties had assumed this to be the case and conducted their case accordingly. 109 104 105

(1980) 146 CLR 40 at 47-48. ASIC v Cassimatis (No 8) [2016] FCA 1023 at [485].

106 107 108

ASIC v Cassimatis (No 8) [2016] FCA 1023 at [495]. ASIC v Rich (2009) 75 ACSR 1 at [7202], citing ASIC v Rich (2003) 44 ACSR 341 at [50]. ASIC v Rich (2009) 75 ACSR 1 at [7201].

109

ASIC v Cassimatis (No 8) [2016] FCA 1023 at [834].

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The case was also unusual in that Storm remained solvent and it was not disputed that the defendants managed Storm in good faith and in accordance with the wishes of all shareholders, viz, themselves. Storm’s model of advice involved a high level of borrowing by clients. ASIC alleged that Storm’s advice to a not-insignificant group of financially vulnerable clients contravened s 945A of the Act, a provision requiring a financial services licensee to have a reasonable basis for the financial advice it provides to clients. If contravention of s 945A were found, ASIC could suspend or cancel Storm’s Australian Financial Services Licence or make a banning order preventing the holding of a licence. Edelman J applied the test in Vrisakis: As I have explained, the test which I apply in this case for contravention of s 180(1), as expressed in Vrisakis, involves consideration of all circumstances including the foreseeable risk of harm to any of the interests of Storm and the magnitude of that harm, together with the potential benefits that could reasonably have been expected to accrue to the company from the conduct in question, and any burdens of further alleviating action. The consideration of these matters is from the perspective of the conduct of a reasonable person who is a director of Storm, in Storm’s circumstances, having the responsibilities of Mr or Mrs Cassimatis. As I have explained, those circumstances and responsibilities include their experience and skills, the terms and conditions on which they undertook to act as directors, how the responsibility for the company’s business was distributed between them and the company’s employees, and the informational flows and reporting systems within the company. ... My conclusion is that Mr and Mrs Cassimatis each contravened s 180(1) of the Corporations Act by exercising their powers in a way which caused or “permitted” (by omission to prevent) inappropriate advice to be given to the relevant investors. Those relevant investors were members of a class of investor, as pleaded by ASIC, who (in summary terms) were retired or close to retirement, had few assets, little income, and little or no prospect of rebuilding their financial position in the event of suffering significant loss. A reasonable director with the responsibilities of Mr or Mrs Cassimatis would have known that the Storm model was being applied to clients such as those who fell within this class and that its application was likely to lead to inappropriate advice. The consequences of that inappropriate advice would be catastrophic for Storm (the entity to whom the directors owed their duties). It would have been simple to take precautionary measures to attempt to avoid the application of the Storm model to this class of persons. 110

The public character of s 180(1) [7.84] In Cassimatis (No 8) ASIC raised an even more fundamental question as to the public character of the duty in s 180(1). Although it is difficult now to argue that the common law and equity impose public duties on directors, ASIC argued that contravention of s 180(1) is both a public and a private wrong; further, the public duty exists independently of the private duty to the company, as a duty owed to the public at large which is not merely a public duty that attaches additional enforcement and sanctions (pecuniary penalties, disqualification orders and injunctive relief under s 1324) to the private duty. ASIC submitted that s 180(1), in its public character, prescribes a norm of conduct, and therefore requires consideration of the public interest, separate from the interest of the corporation, in determining whether a contravention has occurred. ASIC’s submission was made in response to arguments by Mr and Mrs Cassimatis that directors of a solvent company could not breach duties of care and diligence to a company of which they were the only shareholders. Edelman J noted that “[d]espite decades of litigation, there has rarely been any need to pay close attention to the nature of the public wrong that is created by s 180(1)”. He did not, however, find it necessary to reach a conclusion about the extent to which, if at all, the 110

ASIC v Cassimatis (No 8) [2016] FCA 1023 at [675]-[676], [833]. [7.84]

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s 180(1) duty of care and diligence applies to the exercise of powers and the discharge of duties other than those conferred by, or owed to, the company. That was because the case was concerned only with the obligation in relation to the discharge of the defendants’ duty to manage Storm. He proceeded on the basis that their public duties as directors in managing Storm could only be contravened if they acted contrary to Storm’s interests rather than contrary to any general norm of conduct. Nevertheless, as we have seen, Storm’s interests were not construed narrowly – harm to Storm’s interests is not confined to financial harm, and its interests include its reputation and its interests in the lawful and legitimate conduct of its activities. Further, since the duty of care is owed to the corporate entity, the interests of the company are not necessarily identical with those of the shareholders.

Stepping stones to director and officer liability for corporate breach? [7.86] In Cassimatis (No 8), ASIC argued that breach by Storm of the Act was a “stepping stone” for a finding of contravention of s 180(1) by the directors. The term has been used in several cases to refer to the imposition of liability upon directors and officers for failure to prevent contravention of the Act by the company: action for contravention by the company is a stepping stone to director liability. As is evident from Cassimatis (No 8), however, director liability does not automatically follow from corporate breach. Rather, liability under s 180(1) (and other directors’ duties) is determined by the terms of the statutory provision imposing director liability. Section 180(1) does not impose on directors a general obligation to ensure that the company does not contravene the Act or indeed other legislation: There are cases in which it will be a contravention of their duties, owed to the company, for directors to authorise or permit the company to commit contraventions of provisions of the Corporations Act. Relevant jeopardy to the interests of the company may be found in the actual or potential exposure of the company to civil penalties or other liability under the Act, and it may no doubt be a breach of a relevant duty for a director to embark on or authorise a course which attracts the risk of that exposure, at least if the risk is clear and the countervailing potential benefits insignificant. But it is a mistake to think that ss 180, 181 and 182 are concerned with any general obligation owed by directors at large to conduct the affairs of the company in accordance with law generally or the Corporations Act in particular; they are not. They are concerned with duties owed to the company. 111

Whether directors breach their duty of care in allowing or authorising a contravention by the company is determined by the process of balancing foreseeable risk and reward for the company, that is, whether any jeopardy to which the director exposed the company “obviously outweighed any potential countervailing benefits, and whether there were reasonable steps that could have been taken to avoid them”. 112 A non-executive director did not breach his duty when he left the conduct of capital raising to qualified fellow directors supported by legal and accounting advisers while he supervised the company’s building construction work. 113 However, the director of another company breached his duty of care when, as the “sole controlling mind” of the company and sole signatory to the company’s bank account, he exposed the company to breaches of the Act by failing to hold capital raised under an undersubscribed fundraising in a separate trust account and return it to subscribers upon request. 114 Of course, where the director or other officer participates in the company’s contravention within the civil accessorial liability standard in s 79, they will incur personal liability for their role in the breach. However, s 180 does not provide a “back door” method of 111 112 113

ASIC v Maxwell (2007) 59 ACSR 373 at [104]; ASIC v Mariner Corp Ltd (2015) 106 ACSR 343 at [444]. ASIC v Maxwell (2007) 59 ACSR 373 at [110]. ASIC v Maxwell (2007) 59 ACSR 373 at [111]-[114].

114

ASIC v Warrenmang Ltd (2007) 63 ACSR 623.

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visiting on company directors and officers an additional form of civil accessorial liability for contraventions of the Act: “the question is whether they have breached their statutory duty of care and diligence in exposing their company to contraventions of the law”. 115

Applying s 180(1) to corporate officers [7.88] In Shafron v ASIC, the High Court held that Shafron, appointed as “company

secretary and general counsel” of James Hardie, breached the statutory duty of care by failing to advise the chief executive officer and board that the company was required to disclose certain information to ASX and for failure to advise the board that actuarial information presented to it as to the quantum of projected future asbestos claims did not accurately reflect its recent claims history. 116 His responsibilities as company officer were not determined solely by those referable to his appointment as secretary – which appointment made him an officer subject to the duty in s 180(1) – since it was not possible to divide the duties and responsibilities between the two elements of what was a single composite role: see [7.30]. The court also held that the obligations imposed under s 180(1) are not limited to the discharge of responsibilities imposed on the officer under the Act but “include whatever responsibilities the officer concerned had within the corporation, regardless of how or why those responsibilities came to be imposed on that officer”. 117

Limits to delegation and reliance [7.89] Earlier in the James Hardie litigation the NSW Court of Appeal had affirmed that, if

the James Hardie directors had approved a misleading announcement the company made to the ASX as to the adequacy of the compensation fund set aside for asbestos victims, the directors would have breached their duty of care. This was so since the board had long been considering the separation of its asbestos subsidiaries into some other body, an issue of “high importance” to the company and its stakeholders; it was not a matter in which it was reasonable for directors to rely upon or delegate to management. 118 The Court of Appeal held, however, that ASIC had failed to establish that the draft announcement had been taken to the board for approval, a factual finding overturned by the High Court: see [7.55]. The High Court did not grant special leave to appeal against the finding that board approval of the misleading announcement would have constituted breach of duty and it remitted the matter for determination of issues relating to relief from liability and penalty. Similarly, in ASIC v Healey (2011) 83 ACSR 484 (see [7.100]) the court held that the directors’ statutory financial reporting responsibilities were not delegable to management despite the latter’s integral role in the discharge of the board responsibility. ASIC v Adler (2002) 168 FLR 253 at [372] (see [7.95]), paras (10)-(12) contains a valuable summary of jurisprudence on permitted delegation and reliance. 119

115

ASIC v Rich (2009) 75 ACSR 1 at [7238].

116 117 118

Shafron v ASIC (2012) 88 ACSR 126 at [32]-[34]. Shafron v ASIC (2012) 88 ACSR 126 at [18]. Morley v ASIC (2010) 81 ACSR 285 at [809]-[831].

119

See A Gibbs and J Webster (2015) 33 C&SLJ 297. [7.89]

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Permanent Building Society (in liq) v Wheeler [7.90] Permanent Building Society (in liq) v Wheeler (1994) 11 WAR 187 Supreme Court of Western Australia (Full Court) [Permanent Building Society (in liq) sued its former directors for compensation for breach of their duties as directors, inter alia, for failing to exercise a reasonable degree of care, diligence and skill. The breaches allegedly arose in connection with the purchase by PBS from Tower of a parcel of industrial land (the Vickers Hadwa land) in 1991 with a view to redeveloping the land and selling the subdivided lots to the public. PBS had no expertise in property development. At the same time that PBS was negotiating to purchase the land from Tower, Tower was also negotiating to acquire the capital of JCLD from CHL. CHL held two thirds of the capital of PBS and PBS’s chairman (Wheeler) had a controlling interest in CHL. PBS’s liquidator claimed that Wheeler and two other PBS directors (Holding and Nizzola) had caused PBS to purchase the land so that Tower would be in a position to purchase JCLD. Tower was wound up for insolvency in 1992 so that there was no possibility that the transaction could be rescinded because of Wheeler’s interest: see [7.215]. The three PBS directors were found to be in breach of their fiduciary duty to exercise corporate powers for proper purposes (see [7.235]) and equitable compensation was awarded against them in the amount of the over-value PBS had paid for the land. Hamilton was managing director of both PBS and JCLD at the time of these transactions. He had no shares in JCLD or CHL. He attended the PBS board meetings at which decisions were taken to purchase the land. He declared his interest as managing director of JCLD and took no part in the decision or voting. Following the decision to purchase the land, Hamilton had nothing to do with the negotiations with Tower which were conducted by Nizzola. The liquidator’s claim against him and the remaining director on the grounds of breach of fiduciary duty for improper purpose failed.] IPP J: [235] As an alternative, PBS alleged that Hamilton owed “fiduciary” duties to PBS “to exercise a reasonable degree of care, diligence and skill in the exercise of his powers and the discharge of his duties”. It was further alleged that: (Hamilton) failed to exercise a reasonable degree of care, diligence and skill in the exercise of his powers and in the discharge of his duties as a director of the plaintiff, by failing to express opposition to and vote against the adoption of the resolutions (taken at the meetings of 26 April and 6 May) [viz, to purchase the land from Tower]. … [239] The director’s duty to exercise care and skill has nothing to do with any position of disadvantage or vulnerability on the part of the company. It is not a duty that stems from the requirements of trust and confidence imposed on a fiduciary. In my opinion, that duty is not a fiduciary duty, although it is a duty actionable in the equitable jurisdiction of this court. We were not referred to, and I have not been able to find, any case where equitable compensation has been awarded for the breach by a director of an equitable obligation to exercise care and skill. In Lagunas Nitrate Co v Lagunas Syndicate, however, Lindley MR (at 437) said: But the directors, though not liable for damages, may be liable in equity for misapplying the company’s assets. Having acted throughout intra vires and fraud being out of the question, whether a loss of a company’s assets by directors imposes on them an equitable liability to make them good depends on the principles already explained. The legal liability for damages for the loss and the equitable liability to make good the loss both depend upon the same considerations, namely, carelessness and inattention to the interests of the nitrate company. Taking into account the claim that a beneficiary has against a trustee for breach of the equitable duty to exercise reasonable care and skill, the remarks of the High Court in Bennett v Minister of Community Welfare, and authorities such as Lagunas Nitrate Co v Lagunas Syndicate and the others to which I have referred, I consider that Hamilton owed PBS a duty, both in law and in equity, to exercise reasonable care and skill, and PBS was able to mount a claim against him for breach of the legal duty, and, in the alternative, breach of the equitable duty. For the reasons I have expressed, in my view the equitable duty is not to be equated with or termed a “fiduciary” duty. 422

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Permanent Building Society (in liq) v Wheeler cont. Hamilton: Did he exercise reasonable care and skill? In my reasons in Vrisakis v ASC (1993) 9 WAR 395 at 449-450 (with which Malcolm CJ agreed), I said: [T]he question whether a director has exercised a reasonable degree of care and diligence can only be answered by balancing the foreseeable risk of harm against the potential benefits that could reasonably have been expected to accrue to the company from the conduct in question. The proper test to be applied in determining whether directors have exercised a reasonable degree of care and diligence in accordance with the requisite standard is that laid down more than a century ago by Lord Hatherley LC in Overend & Gurney Co v Gibb [1872] LR 5 HL 480 at 486-487 and referred to by Romer J in Re City Equitable Fire Insurance Co Ltd [1925] Ch 407 at 428, namely whether “… they (ie the directors) were cognisant of circumstances of such a character, so plain, so manifest, and so simple of appreciation, that no men with any ordinary degree of prudence, acting on their own behalf, would have entered into such a transaction as they entered into?” It was put this way by Pidgeon J (with whom Franklyn and Walsh JJ agreed) in Australian Securities Commission v Gallagher (1993) 10 ACSR 43: The test is basically an objective one in the sense that the question is what an ordinary person, with the knowledge and experience of [240] the defendant might be expected to have done in the circumstances if he was acting on his own behalf. Inherent in this test is the balancing exercise, to which I have referred, involving the risk of harm (on the one hand) and potential benefits (on the other). Irrespective of whether the claim against a director for failure to exercise care in the discharge of his duties is for restitutionary compensation in equity, or whether the claim lies in damages at law, the test for determining whether there has been a breach of duty or a director remains as stated. According to the statement of claim the fifth defendant failed to exercise a reasonable degree of care, diligence and skill in the exercise of his powers and in the discharge of his duties as a director of (PBS), by failing to express opposition to and vote against the adoption of the resolutions (taken on 26 April and 6 May) … The respects in which it was pleaded that Hamilton failed to exercise a reasonable degree of care are so broad that it is not possible to identify them, from the pleading, with any precision. No further particulars were sought in this respect. It follows that, at the trial, PBS was very much at large on this issue. I have set out above the many questions which, in my view, should have been asked by the directors of PBS at their meetings of 26 April and 6 May. I have also set out the explanations given by Hamilton for not asking several of those questions and for being satisfied with the information that was in fact provided. Essentially, Hamilton said that he relied on the officers of PBS to do their job and, in particular, relied on Nizzola who he considered was well qualified to take responsibility for the Vickers Hadwa transaction. In submitting that Hamilton was entitled to rely on others, Mr McCusker referred to the remarks of Rogers CJ Comm Div in AWA Ltd v Daniels (1992) 7 ACSR 759 to the effect that generally: The directors rely on management to manage the corporation. The board does not expect to be informed of the details of how the corporation is managed. They would expect to be informed of anything untoward or anything appropriate for consideration by the board. And (at 868): A director is justified in trusting officers of the corporation to perform all duties that, having regard to the exigencies of business, the intelligent devolution of labour and the articles of association, may properly be left to such officers. In Vrisakis v Australian Securities Commission I referred to these observations of Rogers CJ Comm Div and commented: [7.90]

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Permanent Building Society (in liq) v Wheeler cont. It is to be emphasised, however, that these remarks are statements of broad principle alone and act merely as signposts in the search for the determination of the ambit of the duties imposed on a particular director and the particular standard of care required to be met. These matters may be influenced by considerations such as whether a director is an executive or a non-executive director, but are always dependent on the particular circumstances. Hamilton, as I have mentioned, was at the relevant time chief executive and managing director of PBS, which was a building society that operated by inviting deposits from members of the public. PBS had never before embarked upon a land development transaction. It had no expertise in that regard. In the circumstances, my view, there was a heavy duty on the [241] respondents generally and Hamilton in particular to scrutinise the proposed transaction with caution and thoroughness. In my opinion that duty was not affected by the fact that Hamilton believed that he had a conflict of interest and accordingly did not vote when the resolutions in question were taken. It was manifest that the transaction was capable of causing PBS serious harm. In those circumstances, in my opinion, Hamilton could not avoid his duties as chief executive and managing director by asserting his perceived conflict of interest. It may be that, because of the conflict, he should not have spoken or voted in favour of the resolution. But as chief executive and managing director there was a responsibility on him to ensure that the other directors appreciated the potential harm inherent in the transaction, and to point out steps that could be taken to reduce the possibility of that harm. Hamilton could not avoid that duty by, metaphorically speaking, burying his head in the sand while his co-directors discussed whether PBS should enter into such a potentially detrimental transaction: see Joint Stock Discount Co v Brown (1869) LR 8 Eq 381 at 402-404; cf Re Southern Resources Ltd; Residues Treatment & Trading Co Ltd v Southern Resources Ltd (1989) 15 ACLR 770 at 784-785; Darvall v North Sydney Brick & Tile Co Ltd (at 270, 284). The likelihood of rezoning was fundamental to the risk being assumed. It was elementary that the security from Tower and the covenantors should be sufficient, having regard to that risk. That risk could only be measured by a careful analysis of the information then available as to the likelihood of rezoning. In my opinion, Hamilton, as chief executive and managing director, should have ensured that appropriate information in this respect was available to the Board. This could have been done by questioning Nizzola, who had the carriage of the transaction. Furthermore, it was elementary to have regard to whether there was up-to-date financial information relating to Tower and the covenantors and whether that information was independently verified by reliable persons. Hamilton should also have satisfied himself – having regard to the up-to-date financial information that should have been provided – that adequate security was provided to PBS, for example by way of conditions precedent or other forms of security given by Tower and the covenantors. In my view, these were all matters for Hamilton to consider carefully. They could not be delegated either to subordinate officers of PBS or even individual directors. Hamilton either failed to make inquiries which he should have made or was satisfied with superficial and inadequate answers in circumstances requiring further investigation. Applying the test in Australian Securities Commission v Gallagher, an ordinary person with the knowledge and experience of Hamilton would be expected to have made the inquiries to which I have referred if he was acting on his own behalf. Accordingly, I am satisfied that Hamilton breached his duty to exercise skill and care as a director of PBS. Hamilton and the breach of the legal duty of care: the causal connection between breach and loss It does not necessarily follow from this conclusion, however, that PBS succeeds against Hamilton. It still must be proved that the breach of duty caused loss to PBS. I shall deal first with the legal duty to take reasonable care and skill. [242] As Mason CJ said in March v E & M H Stramare Pty Ltd (1991) 171 CLR 506 at 515: The common law tradition is that what was the cause of a particular occurrence is a question of fact which “must be determined by applying commonsense to the facts of each particular case”, in the words of Lord Reid: Stapley v Gypsum Mines Ltd [1953] AC 663 at 681. 424

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Permanent Building Society (in liq) v Wheeler cont. Deane J (at 522) remarked that the question of causation, for the purposes of the law of negligence, arises “in the context of the attribution of fault or responsibility whether an identified negligent act or omission of the defendant was so connected with the plaintiff’s loss or injury that, as a matter of ordinary common sense and experience, it should be regarded as a cause of it …”. Of course the general standard of proof in civil actions governs the question of causation: see Poseidon Ltd v Adelaide Petroleum NL (1994) 68 ALJR 313 at 323. And this is not a case which involves the important point of principle decided by that case, namely that the loss of a commercial opportunity is to be valued by reference to the degree of probabilities or possibilities once the plaintiff establishes that some loss has been sustained. In the circumstances, at common law, for PBS to prove that Hamilton’s breach of duty caused loss to PBS, PBS was required to establish that had a reasonable director in Hamilton’s position exercised reasonable care and skill, he or she would have expressed opposition to PBS entering into the Sale Agreement. In expressing the issue in this way, I accept the submission of [PBS] that it should not be assumed that, had Hamilton complied with his duty of care, the other directors would have continued to act improperly. Plainly, the decision of a reasonable director of PBS, when faced with the resolutions put to the meetings of 26 April and 6 May, would have depended substantially upon the financial situation of Tower and the covenantors. Their financial situation, in turn, depended significantly on the value to be placed on their assets. If their financial position at that time was the same as that reflected in the accounts as at June 1990 or March 1991 I do not think that it would be possible to criticise a director who voted for the resolutions. That is because, even if development approvals were refused, Tower’s excess of assets over liabilities of between $11 million and $13 million, would have been adequate protection to PBS. After all, PBS’s maximum exposure was, at most, in the vicinity of $3 million less the value of the Vickers Hadwa land. According to the accounts in question, PBS would have had a buffer of some $8 million plus the value of the land; the ratio of assets available as security to potential loss would have been some 400%. This takes only Tower into account (and not the covenantors). In such circumstances a reasonable director, in my view, could have concluded that the transaction as proposed was worth entering into. Moreover, on this hypothesis, it would have been unnecessary to have obtained additional security from the covenantors. In fact the only evidence of the financial position of Tower and the covenantors, and the true value of their underlying assets, was the unaudited and unverified June 1990 and March 1991 accounts. No other evidence was placed before the court in this regard and no witness was cross-examined in relation to these matters. Although Tower was ordered to be wound up on 30 September 1992, that was so long after the resolutions of 26 April and 6 May 1990 that no relevant inference can be drawn from that fact. In other [243] words, it cannot be inferred from the subsequent winding-up on 30 September 1992 that, some two and a half years earlier, the financial position of Tower and the covenantors was different to that set out in the June 1990 and March 1991 accounts. Therefore, on the best evidence available (ie that showing the position as at 31 March 1991), Tower’s net assets were $11,409,723 and the covenantors, ignoring their investments in Tower, had a net worth of more than $800,000. Accordingly, it cannot, in my opinion, be said that a reasonable director of PBS – knowing the true position of Tower and the covenantors – would have expressed opposition to and voted against the Sale Agreement. In the circumstances, PBS has failed to establish on the balance of probabilities, that the loss brought about by any failure to recover from Tower and the covenantors was caused by a breach by Hamilton of his duty of care owed to PBS at common law. Causality and the breach of the equitable duty of care The next question is whether there is any different result in respect of the breach by Hamilton of the equitable duty to exercise a reasonable degree of care and skill as a director of PBS … [The judge referred to the judgement of Deane J in Chan v Zacharia (see [1.155]) and other cases on the principles governing the liability of a fiduciary to account for profits arising where a conflict or the [7.90]

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Permanent Building Society (in liq) v Wheeler cont. real sensible possibility of a conflict is raised between duty and interest: see [7.455] et seq. In such cases account does not depend upon proof of causation between breach of duty and profit.] [247] The considerations to which Deane J refers have no application whatever to the breach of a duty to exercise care and there is no reason to apply to the latter the rules of causation that govern the obligation of a fiduciary to account for such a breach. There is a fundamental distinction between breaches of fiduciary obligations which involve dishonesty and abuse of the trustee’s advantages and the vulnerable position of beneficiaries, on the one hand, and, honest but careless dealings which breach mere equitable obligations, on the other. There is ample justification on policy grounds for more stringent rules in the case of breaches of fiduciary obligations, but not where there has been honest but careless dealings. Further, in my opinion, a court of equity, applying principles of fairness, should not require an honest but careless trustee to compensate a beneficiary for losses without proof that but for the breach of duty those losses would not have occurred: cf Day v Mead [1987] 2 NZLR 443. It is also significant, as regards matters of policy, that the tortious duty not to be negligent, and the equitable obligation on the part of a trustee to exercise reasonable care and skill are, in content, the same. There is every [248] reason, in my view, in such circumstances, to apply the maxim that “equity follows the law”. … I conclude that PBS failed to prove that, but for the breach by Hamilton of his equitable duty to exercise reasonable care, the loss to PBS would not have occurred. I come to this conclusion, because – for the reasons I have already expressed – it cannot be said that a reasonable director of PBS, knowing the true position of Tower and the convenantors, would have expressed opposition to and voted against the Sale Agreement. Accordingly, the claim against Hamilton, for breach of his equitable duty to exercise reasonable care, fails. [Malcolm CJ and Seaman J agreed with the reasons and decision of Ipp J.]

ASIC v Adler [7.95] ASIC v Adler (2002) 168 FLR 253 Supreme Court of New South Wales [Adler was a director of HIH, a listed insurance company. On 15 June 2000, Adler caused HIHC, a subsidiary of HIH, to make an unsecured loan of $10 million to a company, PEE, which he controlled, as trustee under the AUET trust for HIH. The loan was made with the knowledge only of Williams, the chief executive of HIH, and Fodera, the chief financial officer, and was thus in breach of the company’s investment guidelines. The loan funds were applied in part in the purchase of HIH shares; these purchases were ostensibly made by Adler with his personal funds, with the purpose of signalling his confidence in the company and thereby stabilising its falling share price. The loan moneys were also applied in purchasing unlisted technology stocks held by Adler at the consideration that Adler had earlier paid for them and without an independent current valuation. The balance of the loan moneys were applied as unsecured loans to companies associated with Adler. HIH went into liquidation. ASIC commenced civil proceedings under Pt 9.4B against Adler, Williams and Fodera for contravention of several civil penalty provisions including s 180(1). The judge found that Adler was an “officer” of HIHC since he was a member of its investment committee and thereby participated in decisions which “affected the whole or a substantial part of the business of” HIHC.] SANTOW J: [372] I commence by setting out as a series of summary propositions, the principles applicable to the duty of care and diligence, now as enacted in s 180 of the Corporations Act and as they relate to delegation. … The principles applicable to s 180 now follow: (1)

Directors owe a duty of care and skill at common law and in equity: Permanent Building Society (in liq) v Wheeler (1994) 11 WAR 187; Daniels t/as Deloitte Haskins & Sells v AWA Ltd (1995) 37 NSWLR 438.

(2)

However, the equitable duty to exercise reasonable care and skill is not properly classified as a fiduciary duty: Permanent Building Society (in liq) (supra) per Ipp J (at 235).

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ASIC v Adler cont. (3)

The statutory duty of care and diligence, s 180, is framed in similar terms to its predecessor s 232(4). It has been said of the latter that the duties imposed upon directors by it are essentially the same as the duties of directors under the common law: Sheahan (as liquidator of South Australian Service Stations) (In liq) v Verco (2001) 37 ACSR 117 per Mullighan J (at 134); Daniels v Anderson (1995) 37 NSWLR 438 per Powell JA at 603; see also Lockhart J in Australian Innovation Ltd v Petrovsky (1996) 21 ACSR 218 at 222.

(4)

In determining whether a director has exercised reasonable care and diligence one must ask what an ordinary person, with the knowledge and experience of the Defendant might be expected to have done in the circumstances if he or she was acting on their own behalf: Permanent Building Society v Wheeler (supra) per Ipp J (at 239); ASC v Gallagher (1993) 10 ACSR 43.

(5)

However, under the implied term in a contract of employment of an executive director, the director (such as here Mr Williams and Mr Fodera) will be taken to have promised the company that he or she has the skills of a reasonably competent person in his or her category of appointment and that he or she will act with reasonable care, diligence and skill: Permanent Building Society v Wheeler.

(6)

Although the standard of reasonable care is generally said to be that of an ordinary prudent person (Re City Equitable Fire Insurance Co Ltd [1925] Ch 407 per Romer J) there is some suggestion that directors of a professional trustee company owe a higher duty of care: Wilkinson v Feldworth Financial Services Pty Ltd (1998) 29 ACSR 642 at 693.

(7)

In determining whether a director has breached the statutory standard of care and diligence (s 180(1)), the court will have regard to the company’s circumstances and the director’s position and responsibilities within the company: see also Explanatory Memorandum to the CLERP Bill 1999 ([6.75]).

(8)

In accordance with these responsibilities directors are required to take reasonable steps to place themselves in a position to guide and monitor the management of the company: Daniels t/as Deloitte (supra) at 664. That is to say, (supra) at 666-67: (a) a director should become familiar with the fundamentals of the business in which the corporation is engaged; (b)

a director is under a continuing obligation to keep informed about the activities of the corporation;

(c)

directorial management requires a general monitoring of corporate affairs and policies, by way of regular attendance at board meetings; and

(d)

a director should maintain familiarity with the financial status of the corporation by a regular review of financial statements. Indeed, he or she will be unable to avoid liability for insolvent trading by claiming that they had never learned to read financial statements: Commonwealth Bank of Australia v Friedrich (1991) 5 ACSR 115 at 125.

(9)

A director appointed to a company because of special expertise in an area of the company’s business is not relieved of the duty to pay attention to the company’s affairs which might reasonably be expected to attract inquiry, even outside that area of expertise: Re Property Force Consultants Pty Ltd (1995) 13 ACLC 1051 at 1061.

(10)

At general law, a director is entitled to rely without verification on the judgment, information and advice of management and other officers appropriately so entrusted. However, reliance would be unreasonable where directors know, or by the exercise of ordinary care should have known, any facts that would deny reliance on others: Daniels t/as Deloitte at 665-6.

(11)

Although reasonableness of the reliance or delegation must be determined in each case, the following may be important in determining reasonableness: (a) the function that has been delegated is such that “it may properly be left to such officers”: Re City Equitable Fire Insurance Co Ltd (supra) per Romer J. [7.95]

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ASIC v Adler cont. (b)

the extent to which the director is put on inquiry, or given the facts of a case, should have been put on inquiry: Re Property Force Consultants Pty Ltd (supra) per Derrington J at 1,060.

(c)

the relationship between the director and delegate, must be such that the director honestly holds the belief that the delegate is trustworthy, competent and someone on who reliance can be placed. Knowledge that the delegate is dishonest or incompetent will make reliance unreasonable: Biala Pty Ltd v Mallina Holdings Ltd (1994) 15 ACSR 1 at 62.

(d)

the risk involved in the transaction and the nature of the transaction: Permanent Building Society v Wheeler (although in this case the Chief Executive Officer in question also had a conflict of interest).

(e)

the extent of steps taken by the director, for example, inquiries made or other circumstances engendering “trust”;

(f)

whether the position of the director is executive or non-executive: Permanent Building Society v Wheeler per Ipp J, though, in Daniels v Anderson (supra), the majority have moved away from this distinction.

(12)

That general law explains what the Corporations Act now requires when referring (s 190(2)) to “reasonable grounds” in codifying the directors’ responsibilities for the actions of the delegate. Thus under s 198D of the Corporations Act directors may delegate any of their powers to a committee of directors, a single director, an employee of the company or any other person (This delegation must be recorded in the company’s minute book: see s 251A). Moreover, the director will be responsible for the delegate’s exercise of power if he or she did not believe on reasonable grounds and in good faith, after making proper inquiries if the circumstances indicate the need for it, that the delegate was reliable and competent in relation to the power delegated and would exercise the power in conformity with the duties imposed on the directors of the company by the Corporations Act: s 190(2).

(13)

For the purposes of s 180(1) and relevantly in the present case, failing to ensure that a company makes loans only in accordance with its authorised practices and failing to ensure that the company has a proper system of controls and audit in its business to avoid any defalcation by officers and employees may amount to breaches of the statutory duty of care and diligence: Cashflow Finance Pty Ltd v Westpac Banking Corp [1999] NSWSC 671 per Einstein J.

(14)

Where there is a transaction involving the potential for conflict between interest and duty, as here arose, the duty of care and diligence falls to be exercised in a context requiring special vigilance, calling for scrupulous concern on the part of those officers who become aware of that transaction to ensure that any necessary corporate approvals are obtained and safeguards put in place. While the primary responsibility will fall on the director or officer proposing to enter into the transaction, this does not excuse other directors or officers who become aware of the transaction.

[387](a) A reasonably careful and diligent director or officer of HIH or HIHC in the position of Mr Adler, would not have caused or procured the payment on 15 June 2000 of $10 million by HIHC to PEE to be applied as it was (in part) in purchasing HIH shares. To the extent that $3,973,397.84 was so used for the purpose of assisting PEE to acquire shares in HIH, not only did that assistance materially prejudice the interests of HIH and HIHC and in that sense was not advantageous to AEUT, the unit holders of AEUT, including HIHC or to HIHC’s holding company HIH, but also it was not disclosed as it should have been to other directors of HIH (save Mr Adler, Mr Williams, Mr Fodera and to a limited extent only, as regards the subscription to AEUT, Mr Cassidy). Nor was it brought by Mr Adler to the attention of the Investment Committee of HIH for approval or ratification, as it should, nor was the mandate for AEUT’s investments ever brought to the Investment Committee for approval by Mr Adler, as mandatorily required by the Investment Committee’s Terms of Reference. The semi-covert bypassing of proper corporate safeguards for these arrangements (only executive directors apart from Mr Adler 428

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ASIC v Adler cont. were aware), reflects consciousness of impropriety on Mr Adler’s part. Furthermore, the purchase was made with Mr Adler stating publicly that he was purchasing HIH shares and with the object to maintain or support the HIH share price rather than for HIH’s purpose, of enabling HIHC to obtain, through its interests in AEUT, the benefit of a quick profit on the resale of HIH shares so acquired. Mr Adler thereby breached s 180 of the Corporations Act. This was in failing to follow authorised practices (see [372](13) above) and in properly safeguarding the interests of HIH and HIHC (in the latter case as an officer), falling well short of the standard of a reasonably competent person in his category of appointment, well familiar as he was with investment practices …. … [680] No reasonable director in Mr Adler’s position and possessing his knowledge and acting bona fide for a proper purpose would have committed PEE to acquire Adler Corporation’s investments in [the technology companies] at the prices Adler Corporation paid for these investments in the circumstances. [681] The risk of total loss on these investments had heightened considerably after Adler Corporation’s purchases, as was borne out by subsequent events, most markedly in Australia by the financial collapse of [two companies] within a matter of months after PEE’s acquisitions. Such a conclusion is supported by the known radical change in market conditions in mid-April 2000 after Adler Corporation’s purchases of these technology stocks and before they were on-sold at cost to AEUT, the lack of any due diligence, and the misleading statements and omissions made by Mr Adler in relation to on-sale of these investments. This was all in circumstances where it may properly be inferred that Mr Adler had lost confidence in these investments, having been an early round investor where it was obvious that the critical capital needs of those companies was not forthcoming. So it is quite fallacious to suggest that AEUT was getting the benefit of a high risk/ high prospective gain opportunity. What it got was the known prospect, that is, known to Mr Adler, of a likely loss, when these three investments were to varying degrees at real risk. … [453] As to s 180 and the duty of care and diligence, Mr Williams was not entitled to rely on Mr Adler to make investments, which conformed with the law and were not detrimental to the interests of HIH, without at the least making sure there were put in place proper safeguards including independent appraisal of the investments made by way of proper due diligence and by ensuring that before the arrangements were put in place, the terms of the mandate were approved by the Investment Committee, if not the Board. Mr Williams simply did not do this either when making the original commercial deal or by instructing Mr Howard [to confirm the legalities of the transaction]. It is nothing to the point to say that he hoped that the investment would turn out profitably or he would not have made it. The fact of the matter was that Mr Williams did not ensure that the company complied with its own safeguards laid down for approval of such a mandate by its Investment Committee, nor did he put in place safeguards to avoid investments being made which were in breach of the law and which, directly or indirectly, advantaged Mr Adler, Adler Corporation and PEE and were not reasonable in the circumstances even if HIHC and PEE had been dealing at arm’s length. Mr Williams’ concern should have been heightened by the fact that he was dealing with a fellow director. That is enough, though one can add that Mr Adler, as should have been apparent, had an obvious inherent conflict of interest as a significant shareholder in HIH. That is quite apart from his early intention to on-sell investments to AEUT …; the evidence of the extent of Mr Williams’ knowledge about such investment is set out … below. Accordingly, I conclude that Mr Williams was in breach of s 180 … … [512] (a) Mr Fodera failed to exercise the degree of care and diligence required by s 180 of the Corporations Act by reason of the failure of Mr Fodera to take such steps as were open to him to have the proposal either submitted for approval in advance to the Investment Committee, if not the Board, or thereafter submitted for ratification by the Investment Committee if not the Board. This was especially in circumstances where extraordinary features of the transaction should have been apparent to him, including in particular involvement of a fellow director Mr Adler and the purchase of shares in HIH by an entity associated with Mr Adler with part of the $10 million. He was not entitled to rely on [7.95]

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ASIC v Adler cont. others to do this, though primary responsibility to do so lay with Mr Williams and Mr Adler. He must be taken to have known that there had been no submission to the Board or Investment Committee, as he was a member of both. Yet he took no steps from July 2000 to 8 or 12 September 2000 when the auditors first drew attention to the transaction. [A declaration of contravention of s 180(1) was made against the three officers and, in later proceedings addressed to relief, disqualification and pecuniary payment orders were made against them ([5.235]); Adler and Williams were also ordered to pay compensation of almost $8 million to HIHC in respect of the loan. Upon appeal, no challenge was made to the primary judge’s statement of the legal principles governing the duty of care and no error was found in their application: Adler v ASIC [2003] NSWCA 131. As to the applicable test of causation to determine whether the loss as a result of investing in the AEUT was damage suffered by HIHC which “resulted from” the contraventions, the Court of Appeal held that “the words ‘resulted from’ in s 1317H are words by which, in their natural meaning, only the damage which as a matter of fact was caused by the contravention can be the subject of an order for compensation”: at 709.]

ASIC v Healey [7.100] ASIC v Healey (2011) 83 ACSR 484 Federal Court of Australia [On 6 September 2007 the directors of the Centro companies, at a joint board meeting attended by all directors, resolved to approve the consolidated financial statements for the year ending on 30 June 2007 and to make the required declarations that the financial statements complied with the Act, Australian Accounting Standards and other mandatory professional reporting requirements, and gave a true and fair view of the financial position of the companies and the consolidated group. It later became evident that the financial statements misclassified $2.6 bn of borrowings as non-current when under the accounting standards they were current liabilities due within 12 months of the balance date. The statements also failed to disclose guarantees of short term liabilities of an associated company of $1.75 bn that were given by Centro after the end of the financial year; the court held that these guarantees were material post-balance date events requiring disclosure under the accounting standards and that the directors had been informed of these guarantees. The principal Centro entities were stock exchange listed. The annual financial report must contain a declaration as to whether in the directors’ opinion there are reasonable grounds to believe that the company will be able to pay its debts as and when they become due and payable (s 295(4)(c)) and whether the financial statements comply with approved Australian Accounting Standards and give a true and fair view of the financial position and performance of the company or consolidated group: s 295(4)(d). ASIC applied for declarations of contravention against the directors in relation to ss 180(1) and 344 which sanctions compliance with the financial reporting and audit provisions (see [127] in the extract below and [9.120] ff) and for orders that directors pay pecuniary penalties and be disqualified from managing corporations. The primary focus here is upon the alleged contravention of s 180(1) although that necessarily involves some consideration of s 344.] MIDDLETON J: [8] By way of briefest summary, I make the following comments regarding the directors. The directors are intelligent, experienced and conscientious people. There has been no suggestion that each director did not honestly carry out his responsibilities as a director. However, I have found, in the specific circumstances the subject of this proceeding, that the directors failed to take all reasonable steps required of them, and acted in the performance of their duties as directors without exercising the degree of care and diligence the law requires of them. … [124] In my view, the objective duty of competence requires that the directors have the ability to read and understand the financial statements, including the understanding that financial statements classify assets and liabilities as current and non-current, and what those concepts mean. This 430

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ASIC v Healey cont. classification is relevant to the assessment of solvency and liquidity. Equally, a director should have an understanding of the need to disclose certain events post balance sheet date. It would not be possible for a director to form the opinion required by s 295(4)(d) without such an understanding. It is not suggested that a director could vote in favour of a resolution in support of the required directors’ statements when he did not hold the opinions referred to at all. [125] The Act explicitly requires that the declaration required by s 295(4) and the annual directors’ report must be made in accordance with a resolution of the directors. In that manner the Act imposes ultimate responsibility for those matters upon the directors in a way that they cannot delegate. They must themselves determine to adopt the required resolution. … [127] The director’s obligation, under s 344 is to take all reasonable steps to comply, or secure compliance, with Pt 2M.3 (which deals with financial reports, directors’ reports, audit, reporting to members and lodgement with ASIC). … If they fail to take all reasonable steps to comply or secure compliance, they contravene the Act. … [132] It is apparent that the legislative scheme imposes overall responsibility for the financial report and the directors’ report upon the directors. … … Section 180 of the Act [165] In determining whether a director has exercised reasonable care and diligence, as s 180(1) expressly contemplates, the circumstances of the particular corporation concerned are relevant to the content of the duty. These circumstances include: the type of company, the provisions of its constitution, the size and nature of the company’s business, the composition of the board, the director’s position and responsibilities within the company, the particular function the director is performing, the experience or skills of the particular director, the terms upon which he or she has undertaken to act as a director, the competence of a company’s management, the competence of the company’s advisors, the distribution of responsibilities within the company and the circumstances of the specific case. [166] Directors are required to take reasonable steps to place themselves in a position to guide and monitor the management of the company. A director must become familiar with the fundamentals of the business in which the corporation is engaged; a director is under a continuing obligation to keep informed about the activities of the corporation; directorial management requires a general monitoring of corporate affairs and policies, and a director should maintain familiarity with the financial position of the corporation. [167] While directors are required to take reasonable steps to place themselves in a position to guide and monitor the management of the company, they are entitled to rely upon others, at least except where they know, or by the exercise of ordinary care should know, facts that would deny reliance. There was no suggestion in this proceeding that the reliance on others was not warranted, nor was there any prior alerting to cause trust in those whom the directors had relied upon was misplaced. … [171] The position of non-executive directors (as distinct from directors in general) has also been the subject of judicial consideration. In ASIC v Macdonald (No 11) (2009) 71 ACSR 368, Gzell J noted at [255] that: While Clarke and Sheller JJA in Daniels rejected the test propounded by Rogers CJ Comm Div for the limit of a director’s entitlement to rely on management, they did recognise that the role of a non-executive director was to guide and monitor the management of the company rather than to be involved at an operational level. [172] It is clear that an objective standard of care is applicable to both executive and non-executive directors. [7.100]

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ASIC v Healey cont. [173] This approach to the standard of care has been adopted by the case law. An example of such is found in Gamble v Hoffman (1997) 24 ACSR 369. The court refused to subjectify the standard of care to (namely, in that case) the standard of a person who “left school at the age of 14 years, has no tertiary qualifications and has spent his life…essentially as a fruit and vegetable market gardener”. The court, at [373], rejected the assertion that: [S]ubjective considerations of that nature and extent should affect the minimum content of the duty or standard of care required of the respondents in this matter… … [T]he ambit of the duty and the standard of care depend on particular circumstances. However, the test is essentially objective that is did the officer exercise the degree of care and diligence that a reasonable person in a like position in a corporation would exercise in the corporation’s circumstances? I doubt whether the factors which Mr Bates advanced would justify a lower standard of care. [174] In this proceeding, the directors’ responsibilities and duties were outside the realm of operational responsibility. ASIC does not contend that the directors needed to be involved at “an operational level”. This is not a case concerning the need to verify information or scrutinise data of a type outside each director’s own knowledge. The salient feature here is that each director armed with the information available to him was expected to focus on matters brought before him and to seriously consider such matters and take appropriate action. This task demands critical and detailed attention, and not just “going through the motions” or sole reliance on others, no matter how competent or trustworthy they may appear to be. [175] Directors cannot substitute reliance upon the advice of management for their own attention and examination of an important matter that falls specifically within the Board’s responsibilities as with the reporting obligations. The Act places upon the Board and each director the specific task of approving the financial statements. Consequently, each member of the board was charged with the responsibility of attending to and focusing on these accounts and, under these circumstances, could not delegate or “abdicate” that responsibility to others. … Relationship between ss 180 and 344 [185] It is now convenient to consider the interplay between s 180 and s 344 of the Act. ASIC relies on the same conduct as giving rise to a breach of both ss 180(1) and 344. The directors submitted that the standard of conduct required of them under s 180(1) does not and cannot rise higher than the obligation imposed under s 344. [186] Undoubtedly, Part 2M of the Act contains a detailed and specific set of obligations on companies and directors in relation to the contents of financial reports and directors’ reports and their release to the market. There are no other provisions of the Act which contain financial reporting requirements. The general duty under s 180(1) must (in respect of directors’ duties concerning financial statements) be read consistently and harmoniously with the specific requirements of s 344 and with the specific requirements of any other provision in the Act. [187] Whether or not I would go so far as to say that the general law duty of the directors reflected in s 180(1) in the context of financial reporting is, in effect, delineated by s 344 I need not finally decide. [188] In my view, the interplay between s 180 and s 344 in the circumstances of this case is simply this: (a)

The directors were required by s 180 to be diligent and careful in their consideration of the resolution to approve the accounts and reports; and

(b)

The directors were required by s 344 to take all reasonable steps to secure compliance with the relevant provisions of the Act, and to at least inquire about any potential deficiency in the accounts and reports that they observed or ought by the exercise of the requisite care and diligence to have observed.

… [206] Further, it may well be that directors should have a degree of accounting literacy that requires a knowledge of accounting practice and accounting standards. That is not for decision in this 432

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ASIC v Healey cont. proceeding. All that is being alleged is that where the accounts on their face refer, as here, to classification of debt and post balance date events, the director adopting and approving the accounts should have a knowledge of and apply the basic elements of the one or two standards relevant to this proceeding. … [211] … As I have indicated, and as I will expand upon later, it is not being alleged that directors need to check the accuracy of figures or accounting treatment. It is being alleged that a director is to have a sufficient knowledge of conventional accounting practice concerning the basic accounting concepts in accounts, and to apply that knowledge based upon the information each director has or should have if he or she adequately carried out their responsibilities. … [214] For the purposes of this proceeding, I accept that the directors were assured by PwC [Centro’s external auditors], by their audit plans, that PwC would audit the accounts to ensure their compliance with accounting standards. Management also assured the non-executive directors that the accounts complied with accounting standards. Further, … there seems no doubt that (in accordance with PwC’s audit plans) they gave the … accounts and the full financial statements audit clearance. Further, there is no evidence in this proceeding that PwC did raise any concerns regarding the accounts or the capability or diligence of management in the private sessions which management did not attend. … [220] The directors concluded their submissions, by saying that in light of assurances given and having regard to the highly skilled composition of the Centro accounting team and the auditors (who gave all the necessary assurances and did not raise any concerns) and the scope of PwC’s retainer (which extended to all areas of compliance with the accounting standards), the directors were entitled to rely on PwC and management to ensure that the necessary disclosures had been made. It was submitted that in the circumstances of this proceeding, failure to detect management’s error and the auditor’s error (if there in fact was an error) does not constitute breach of any duties owed by the non-executive directors. … [229] In relation to this submission relating to the extent of the papers [viz, that ASIC relied upon errors or omissions in two pages only of a board pack of more than 1180 pages], I also make the following observations. A board can control the information it receives. If there was an information overload, it could have been prevented. If there was a huge amount of information, then more time may need to be taken to read and understand it. The complexity and volume of information cannot be an excuse for failing to properly read and understand the financial statements. It may be for less significant documents, but not for financial statements. … … [240] … (a) ASIC does not allege that the non-executive directors need to personally scrutinise each line of the financial statements as suggested. What is pleaded and contended for by ASIC is that having a sufficient knowledge of conventional accounting practice to enable a director to carry out his or her responsibility, each director had to read and understand the financial statements, and then giving consideration to those financial statements with each director’s accumulated knowledge, draw the error or apparent error to the attention of executive management or the other directors. It is then said, that in failing to draw the attention of the error or apparent error to the executive management or the other directors, the directors, and each of them failed to take all reasonable steps to secure compliance by Centro. (b) I accept that directors may rely on others to assist them in fulfilling a requirement even where it is one directly imposed upon them by the Act. To a degree, the directors can rely upon the processes they have put in place. However, this is not exclusively the situation in the case of financial accounts, as I have endeavoured to explain. Of course, the drafting of a financial statement will be the domain of management. Nevertheless, the whole purpose of the directors’ involvement in the adoption and [7.100]

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ASIC v Healey cont. approval of the accounts is to have the directors involved in the process at a level and responsibility commensurate with their role. In other words a reasonable step would be to delegate various tasks to others, but this does not discharge the entire obligation upon the directors. A further step is required, so it can be said that all reasonable steps have been taken by the directors. To complete the process, this step, as I have said repeatedly in answer to the contentions of the directors, involves the directors and each of them taking upon themselves the responsibility of reading and understanding the financial statements in the way I have described. … [315] On the basis of this documentation, without more, I find that there were short-term liabilities as alleged by ASIC which each of the directors were aware of or should have been aware of. This information concerning debt was put before the Board and was readily available to each director over a period of time. … [497] In my view … the entry into the guarantees was a material event occurring after the balance date, and was a matter or circumstance that may “significantly affect” [Centro’s] operations in future financial years for the purposes of s 299 [which requires disclosure of such post-balance date events]. Similarly, in those circumstances, information regarding the entry into the guarantees was a matter that the members of [Centro] reasonably required to make an informed assessment of the operations, financial position, business strategies and prospects for future financial years of [Centro]. [498] It was then submitted that even if the entry into the guarantees was “significant” for the purpose of s 299 or was information that was reasonably required by members of [Centro] under s 299A, it does not follow that the non-executive directors have breached their obligations under s 180 or s 344. The directors’ obligation was to take reasonable steps to ensure that the company fulfilled that obligation. As such, it was submitted, the directors were reasonably entitled to rely on management to form a view regarding events after 30 June 2007, their likely impact on the company’s affairs in future years and whether those events required mention in the directors’ report. The directors were also reasonably entitled to rely on PwC, having had access to records of events after 30 June 2007 (including entry into the guarantees) to ensure that the directors’ report complied with the Act. … [500] … [I]t was submitted [by the directors] that it is notoriously much easier to consider and comment on what is in a document than it is to comb the universe of one’s knowledge to identify what is not referred to. It was said that the whole of the allegations concerning the guarantees was that, as the non-executive directors knew they had been entered into, they necessarily failed in their duties because they did not notice that they were not referred to in the full financial statements. Having been assured by management that they were aware of the need to disclose post balance date events, and having retained PwC to audit the accounts (which process involves checking for post balance date events), it was submitted that the directors cannot be said to have failed in their duties simply because they did not notice an omission that escaped the attention of those whose core function it was to ensure compliance with accounting standards, (which necessarily entailed making appropriate post balance date disclosures). [The judge found that PwC was clearly aware of the guarantees.] … [504] The difficulty with this analysis, accepting that the guarantees needed to be disclosed (as I have found), is that the non-executive directors failed to turn their mind to the omission and solely relied upon advice. No non-executive director gave evidence, for instance, that because of the equity accounting treatment in [Centro’s] accounts, no further disclosure was required. No non-executive director gave evidence that he gave any consideration or proper consideration to the issue of disclosure. Mr Scott [Centro’s CEO] also failed to give any consideration to the disclosure of the guarantees as a post balance date event. He undoubtedly assumed a number of things, and had a particular mindset, perhaps now formulated by him with the benefit of hindsight. However, he did not consider, or raise the appropriate question, regarding the guarantees. Just because Mr Scott (as with 434

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ASIC v Healey cont. the other directors) was in receipt of general assurances from management and PwC in determining post balance date disclosure, this does not excuse the failure to specifically raise the non-disclosure in view of Mr Scott’s specific knowledge of the guarantees. All that ASIC’s case requires in the circumstances was that each director, aware of the need to disclose post balance date events, and being aware of the guarantees magnitude, make the appropriate enquiries with management. [505] In my view, each director failed to exercise the requisite degree of care and diligence, and failed to take all reasonable steps to comply with the Act in relation to the disclosure of the guarantees as alleged in the amended statement of claim. … [583] In relation to each director in his capacity as a director (or officer) of each relevant entity … I find that each director failed to take the following reasonable steps and failed to take the following steps that a reasonable person would have taken if they were in the director’s position: (a)

to properly read, understand and give sufficient attention to the content of the financial statements prior to participating in the resolutions occurring on 6 September 2007 in so far as they related to: (i) the classification of liabilities as either current or non-current; (ii)

the disclosure of guarantees relating to [two controlled entities].

(b)

to consider or properly consider the content of the financial statements prior to participating in the resolutions occurring on 6 September 2007 in so far as they related to [the classification of liabilities and the disclosure of guarantees]

(c)

to raise or make enquiry or adequate enquiry with management, the BARMC [viz, Board Audit and Risk Management Committee] and other members of the Board prior to participating in the resolutions occurring on 6 September 2007 [concerning the classification of liabilities and the disclosure of guarantees and]

(d)

to have the apparent failures with respect to the financial statements corrected prior to participating in the resolutions occurring on 6 September 2007. [In the penalty proceedings that followed, Middleton J considered that the seriousness of the contraventions and the need for general deterrence precluded the exercise of discretion to grant relief from liability under s 1317S: see [7.65] at n 12. However, the judge imposed no penalty upon the non-executive directors beyond the declaration of contravention after taking into account • Centro’s compliance with the ASX Corporate Governance Principles; • the directors’ prompt action in informing the market of the errors once they came to light; • the adverse personal effect upon the directors of the liability decision; • the directors’ good faith action and absence of any dishonesty, personal gain or deceptiveness and • the directors’ assumption of responsibility for the errors. A pecuniary penalty of $30,000 was imposed upon the chief executive officer. 120]

[7.102]

1.

120

Notes&Questions

What influence, if any, upon the standard of care and diligence expected of directors under the general law have the particular knowledge, experience and skill of the individual director? Do the circumstances of the individual director operate to elevate ASIC v Healey (No 2) (2011) 196 FCR 430. Some commentators have contrasted the rigour of the Centro liability decision and the orders not to impose a penalty on the non-executive directors in the later penalty proceedings; any contrast may reflect the recurrent judicial tension evident in US corporate jurisprudence in this area between prescribing legal rules and setting aspirational standards: see J G Hill (2012) 35(1) UNSWLJ 341. [7.102]

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the standard of care in particular circumstances but not to reduce it in others? Alternatively, do subjective qualities operate to determine a subjective standard of care in all cases? What changes, if any, have Daniels v Anderson and later cases wrought to the City Equitable decision in this respect? To what extent, if any, do the particular circumstances of the company (eg, its size, public investment, nature of its business operations, and organisational structure) determine the standard of care of its directors at general law and under s 180(1)? See further P Crutchfield and C Button (2012) 30 C&SLJ 83; G Golding (2012) 35(1) UNSWLJ 266; W M Heath (2007) 25 C&SLJ 370; J Harris, A Hargovan & J Austin (2008) 26 C&SLJ 355; M Byrne (2008) 21 Aust Jnl of Corp Law 238; J Cassidy (2000) 28 ABLR 180; C Riley (1999) 62 MLR 697; D Ipp (1997) 18 Co Law 162; Lord Hoffmann (1997) 18 Co Law 194; G F K Santow (1997) 73 ALJ 336; J Cassidy (1997) 25 ABLR 102 and (1995) 23 ABLR 184; JH Farrar, “The Duty of Care of Company Directors in Australia and New Zealand” in I M Ramsay (ed), Corporate Governance and the Duties of Company Directors (1997), p 81; R Baxt, The Duty of Care of Directors: Does it Depend on the Swing of the Pendulum? in Ramsay, p 92; A S Sievers (1997) 15 C&SLJ 392 and (1993) 21 ABLR 111; C A Schipani (1994) 4 Aust Jnl of Corp Law 152; J Bird (1999) 17 C&SLJ 141; J Hill (1999) 17 C&SLJ 288; A Comerford & L Law (1998) 16 C&SLJ 103; V Finch (1992) 55 MLR 179; M J Trebilcock (1969) 32 MLR 499; A L Mackenzie [1982] JBL 460. For a classic (if dated) North American analysis of the director’s duty of care, see J J Bishop (1968) 77 Yale LJ 1078; for other significant analyses of North American doctrines, see E N Veasey & W E Manning (1980) 35 Bus Law 919; B Manning (1984) 39 Bus Law 1477; (1985) 41 Bus Law 1; C Hansen (1986) 41 Bus Law 1237; M A Eisenberg (1990) 51 U Cincinnati L Rev 319.

2.

3.

The statutory business judgment rule

The provenance of the statutory rule [7.105] Several law reform committees have proposed a statutory rule that would protect

company directors and officers from litigation in respect of disinterested business judgments taken in good faith and which meet a rationality standard. 121 The model is the rule fashioned by courts in the United States where it is not reduced to statutory form. On the simplest level, the business judgment rule is an aspect of judicial doctrine that states that courts will not substitute their own opinion of the wisdom of a business decision for that of the directors who originally made it. Judges are not directors, and should not try to be. Thus, it is said: should the directors be sued by shareholders because of their decision, the court will examine the decision only to the extent necessary to verify the presence of a business decision [that is, a 121

Senate Standing Committee on Legal and Constitutional Affairs, Company Directors’ Duties: Report on the Social and Fiduciary Duties and Obligations of Company Directors (1989), [3.35]; House of Representatives Standing Committee on Legal and Constitutional Affairs, Corporate Practices and the Rights of Shareholders (1991), [5.4.30]; Companies and Securities Law Review Committee, Company Directors and Officers: Indemnification, Relief and Insurance, Report No 10 (1990), [81]. For discussion of the provenance, function and merits of the statutory business judgment rule see W Bainbridge and T Connor (2016) 34 C&SLJ 415; T Connor (2016) 34 C&SLJ 403; M Legg and D Jordan (2014) 34 Adelaide L Rev 403; J J du Plessis (2011) 32 Company Lawyer 347-352, 377-382; F Carrigan (2002) 14 Aust Jnl of Corp Law 215; A Clarke (2000) 12 Aust Jnl of Corp Law 85; G F K Santow (1999) 73 ALJ 336; A Finlay (1999) 27 ABLR 98; A Greenhow (1999) 11 Bond LR 33; L Law (1997) 15 C&SLJ 174; D Tan (1995) 5 Aust Jnl of Corp Law 442; J H Farrar (1993) 6 C&BLJ 1; D A DeMott (1992) 4 Bond LR 193; P Redmond, “Safe Harbours or Sleepy Hollows: Does Australia Need a Statutory Business Judgment Rule?” in I M Ramsay (ed), Corporate Governance and the Duties of Company Directors (1997), p 185.

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positive act], disinterestedness and independence, due care, good faith, and the absence of an abuse of discretion. If these elements are present – and they are presumed to be present – and the case does not involve fraud, illegality, ultra vires conduct or waste, then the court will not second guess the merits of the decision. 122

At a more practical level, in the United States the rule operates as a presumption or a burden of proof issue because it requires a person who seeks to challenge the conduct of a director or officer to establish first that one of the conditions to which the protection of the rule is subject has not been satisfied. Only if the plaintiff shareholder establishes that the decision was not taken in good faith, that directors had a personal interest in the decision or it was made without adequate information may the shareholder proceed to establish breach of the duty of care; the director or officer is then judged by reference to the standards of the duty. The United States business judgment rule therefore operates as an obstacle to raising allegations of breach of duty against directors and officers, a safe but not inviolable haven. Its security is breached when a shareholder displaces one of the preconditions to the protection. Australian courts have traditionally deferred to directors’ business judgments taken in good faith and been reluctant to “second guess” their decisions: see [7.220] and ASIC v Rich [7.130] at [7251]-[7254] where Austin J referred to the elements of this judicial tradition as “business judgment considerations”. The existence of these considerations notwithstanding, advocacy of a statutory business judgment rule emerged in Australia, further stimulated by the AWA litigation in the early 1990s, and a statutory rule was introduced in 2000. It is found in s 180(2) and applies for the purpose of the statutory duty of care and diligence and its general law counterpart. It provides that a director or officer who makes a business judgment is taken to have met the requirements of those duties in respect of the judgment if they (a) make the judgment in good faith for a proper purpose; (b) do not have a material personal interest in the subject matter of the judgment; (c)

inform themselves about the subject matter of the judgment to the extent they reasonably believe to be appropriate; and (d) rationally believe that the judgment is in the best interests of the corporation. The director or officer’s belief that the judgment is in the best interests of the corporation is a rational one unless the belief is one that no reasonable person in their position would hold: s 180(2). A business judgment is defined as any decision to take or not take action in respect of a matter relevant to the business operations of the company: s 180(3). A note to the subsection reminds that it only operates in relation to duties under s 180(1) and their equivalent duties at common law or in equity; it does not operate in relation to duties under other provisions of the Act or under any other laws such as the myriad regulatory provisions affecting directors and officers in environmental, occupational health and industrial legislation: see [7.15]. The original reform recommendations seem clear that their proposed statutory business judgment rules would operate after the model of the US rule as a rebuttable presumption in favour of directors which, if rebutted by a plaintiff, would then still require the plaintiff to establish the elements of breach of the duty of care. 123 However, the rule expressed in s 180(2) has received a very different interpretation in the few decisions where it has been considered. In ASIC v Adler, Santow J referred to the rule in s 180(2) “either as a defence or as an element 122

D J Block, N E Barton & S A Radin, The Business Judgment Rule: Fiduciary Duties of Corporate Directors (4th ed, Aspen Publishers, 1993), p 3.

123

Directors’ Duties and Corporate Governance: Facilitating Innovation and Protecting Investors, Corporate Law Economic Reform Program: Paper No 3 (1997), [28]-[29]; Companies and Securities Law Review Committee, Company Directors and Officers: Indemnification, Relief and Insurance, Report No 10 (1990), [68]-[69] (explicit advertence to US rule as the foundation of its proposal). [7.105]

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to be rebutted by the prosecutor” although he preferred the former characterisation with the onus placed on the director. He did so because it would be “an odd position … if the plaintiff bore the burden of establishing another more serious contravention, namely of s 181, when it comes to whether the judgment was made ‘in good faith for a proper purpose’” within s 180(2)(a). 124 In Adler the court found that elements of s 180(2) were not established. This interpretation was followed in ASIC v Rich [7.130] where Austin J rejected the interpretation of s 180(2) in terms of the US rule, that is, as an in limine or threshold protection against shareholder suit that collapses if the plaintiff shareholder succeeds in negating one of the four conditions to its protection. He concludes his detailed analysis with the observation that the question of whether the plaintiff or defendant bears the onus of proving the ingredients of s 180(2) needs to be resolved at the appellate level (at [7269]). Finally, in ASIC v Fortescue Metals Group Ltd, the Full Court of the Federal Court assumed without discussion that s 180(2) operated as a defence with the onus upon the director who sought its protection. 125 This interpretation raises important questions as to the underlying policy of the rule and the process of judicial discernment of legislative intent. There is a careful analysis of the question in ASIC v Rich [7.130] at [7256]-[7270]. This is arguably the core issue with respect to the Australian statutory rule. The elements of the statutory rule are also discussed in ASIC v Rich [7.130]. The following paragraphs introduce that discussion. The requirement of a positive business judgment [7.110] There are several preconditions to the rule’s protection. First, the rule applies only to

business judgments, defined as a judgment in respect of a matter relevant to the business operations of the company. Thus, the rule only protects judgments made by directors and officers, that is, decisions which are consciously made and involve the exercise of judgment provided that they involve a “decision to take or not to take action”: ASIC v Rich [7.130] at [7274]. Failure to act is not protected unless it is a decision taken by exercise of judgment. Accordingly, the rule does not protect omissions to act such as failure in oversight or monitoring. Where, for example, directors have failed to exercise any financial oversight functions, and the lack of any such system has enabled fraud by a subordinate official to occur, the rule’s protection would not be available and their conduct would be judged solely by reference to the duty of care standard. There is inevitably an evidentiary difficulty in particular instances of distinguishing a conscious decision from inexcusable inattentiveness. 126 In the United States, the rule extends to decisions preparatory to the making of a business decision. 127 While most business judgment cases in the United States deal with “risky” or “economic” decisions, the rule applies also to decisions relating to corporate personnel, the 124

125

ASIC v Adler (2002) 41 ACSR 72 at [410]. Of course, it might be considered equally or even more anomalous to put the director to proof on this matter and all the other elements of s 180(2) in order to obtain its protection. ASIC v Fortescue Metals Group Ltd (2011) 81 ACSR 563 at [197]-[198] per Keane CJ, Emmett and Finkelstein JJ concurring at [217], [218]. In Westpac Banking Corporation v Bell Group ltd (in liq) (No 3) (2012) 89 ACSR 1 at [866], [869] Lee AJA went further, saying that s 180(2) modifies directors’ duties of care and diligence in respect of decisions relevant to business operations. Specifically, in Cassegrain v Gerard Cassegrain & Co Pty Ltd (2012) 88 ACSR 358 at [224] Bergin CJ said that, in applying the required standard of care and diligence, s 180(2)(b) obliges a director when making a business judgment not to have a material personal interest in the subject matter of the judgment.

126

American Law Institute, Principles of Corporate Governance: Analysis and Recommendations (1994), pp 230232.

127

American Law Institute, p 174.

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termination of litigation and other less obviously business decisions. 128 Accordingly, the American Law Institute’s (ALI) restatement of the general law rule embraces those and like decisions, including the setting of policy goals and the apportionment of responsibilities between the board and senior management. 129 In ASIC v Fortescue Metals Group Ltd the alleged contravention of s 180(1) comprised false statements to the ASX as to the binding character of framework agreements that the company had entered into, statements which the Full Court of the Federal Court found to breach the continuous disclosure provisions of Ch 6CA. The court held that the managing director’s decision not to disclose the true effect of the agreements was not a business judgment within s 180(2) since it was not a decision related to the business operations of the company but rather was “a decision related to compliance with the requirements of the Act. It is not an intention lightly to be attributed to the legislature that a director of a corporation under his or her direction should not comply with a requirement of the Act”. 130 The court also said that section 180(2) cannot be construed as affording a ground of exculpation for a breach of s 180(1) where the director’s want of diligence results in a contravention of another provision of the Act and where that other provision contains specific exculpatory provisions enacted for the benefit of the director. 131

The High Court overturned the decision with respect to the contravention of the continuous disclosure provisions and accordingly did not need to discuss s 180: see Forrest v ASIC [11.143].

The requirements of good faith and disinterestedness [7.115] The business judgment rule is inapplicable where a director or officer has an interest

in the subject matter or outcome of the business judgment. Where directors stand to benefit personally from a decision as director, the risk that business judgment will be compromised by interest displaces the protective operation of the rule. Courts’ general “unwillingness to assess the merits (or fairness) of business decisions of necessity ends when a transaction is one involving a predominantly interested board with a financial interest in the transaction adverse to the corporation”. 132 The disqualifying effect of this requirement operates upon directors and officers as individuals. Accordingly, its impact with respect to a board decision and the resulting mix of liability exposures will vary with the particular constellation of individual director interests. The requirements of a “material personal interest”, a concept used at several junctures in Ch 2D, are discussed at [7.350].

The requirement of an informed decision [7.120] One of the original reform proposals would have required the director to be informed

“to an appropriate extent” about the subject of the decision, a formulation imposing an exclusively objective assessment of preparedness. 133 However, the formulation contained in 128

American Law Institute, pp 173-174.

129

American Law Institute, pp 173-174. The text in this paragraph was approved and applied in ASIC v Rich (2009) 75 ACSR 1 at [7273]-[7274] subject to the proviso that the matters encompassed involve a “decision to take or not to take action”.

130

ASIC v Fortescue Metals Group Ltd (2011) 81 ACSR 563 at [197]-[198] per Keane CJ, Emmett and Finkelstein JJ concurring at [217], [218].

131 132

ASIC v Fortescue Metals Group Ltd (2011) 81 ACSR 563 at [199] per Keane CJ, Emmett and Finkelstein JJ concurring at [217], [218]. AC Acquisitions Corp v Anderson, Clayton & Co 519 A 2d 103 at 114 (Del Ch 1986), quoted in Block et al, p 22.

133

Companies and Securities Law Review Committee, [85]. [7.120]

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s 180(2) is based upon that adopted by the ALI in its restatement of the general law rule. Its protection applies only where the director or officer informs themselves about the subject of the judgment to the extent that they reasonably believe to be appropriate. This standard mixes objective and subjective characteristics. The focus is upon the preparedness of the director or officer in reaching a particular decision as opposed to the quality of the decision itself. 134 The ALI concedes that there is no precise way of measuring what information is required for a particular decision. It lists the following as matters that may be relevant to an assessment of “appropriateness” of the information before a board: • the importance of the business judgment to be made; • the time available for obtaining information; • the costs related to obtaining information; • the director’s confidence in those exploring a matter and making presentations; and • the state of the company’s business at the time and the nature of competing demands for the board’s attention. 135 The different backgrounds of individual directors, the distinct role each plays in the company, and the general value of maintaining board cohesiveness may all be relevant when determining whether a director acted reasonably in believing that the information before her or him was appropriate under the circumstances. 136 There is United States case authority supporting the determination of informational adequacy by reference to a “gross negligence” 137 test in the sense of “reckless indifference to or a deliberate disregard of the whole body of shareholders” or conduct “without the bounds of reason”. 138 The amount of information required for a decision to ensure the protection of the business judgment rule is itself a business judgment which attracts the protection of the rule if it itself satisfies the informed decision prerequisite. 139 Despite the apparently self-referential nature of this element, the strength of its exactions is revealed in two well known decisions of the mid 1980s. In Smith v Van Gorkom 140 the Delaware Supreme Court held that the board of Trans Union Corporation was not adequately informed with respect to their decision to approve a cash-out merger for the company. The directors approved the merger on the basis of a 20-minute presentation by the chief executive, Van Gorkom, without sighting the merger documents or receiving any valuation of the stock. The principal deficiencies which disentitled the directors to the protection of the rule – and which were characterised as grossly negligent – were that the directors: • did not adequately inform themselves as to the role of Van Gorkom in “forcing” the merger and establishing the cash-out price; • were uninformed as to the intrinsic value of the company; and 134 135

American Law Institute, p 177. American Law Institute, p 178.

136 137

American Law Institute, p 178. See, eg, Smith v Van Gorkom 488 A 2d 858 (Del 1985) at 872-873; Aronson v Lewis 473 A 2d 805 (Del 1984) at 812 (quoted in Block et al, pp 32-33).

138

Tomczak v Morton Thiokol, Inc [1990 Transfer Binder] Fed Sec L Rep (CCH) 95,327 at 96,585 (quoted in Block et al, p 33).

139

In re R J R Nabisco, Inc Shareholders Litigation [1988-1989 Transfer Binder] Fed Sec L Rep (CCH) 94,194 at 91,713 (cited in Block et al, p 49).

140

488 A 2d 858 (Del 1985).

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• approved the merger upon a mere two hours consideration, without prior notice, and without the exigency of a crisis or emergency. 141 In Smith v Van Gorkom the board did not seek any valuation or other justification for the sale price and made no inquiry as to the basis for Van Gorkom’s assertions as to the fairness of the negotiated price for which he sought board approval. In Hanson Trust PLC v ML SCM Acquisition Inc 142 directors of a target company granted a lock-up option over its most valuable assets to one of two rival bidders. The directors in a three-hour meeting late at night apparently relied upon a conclusory opinion provided by an independent financial advisor that the option prices “were within the range of fair value”. If they had inquired, however, they would have discovered that no range of fairness had been established. The Second Circuit held that the directors had “some oversight obligations to become reasonably familiar with an opinion, report, or other source of advice before becoming entitled to rely upon it”. 143 Had they done so, they would have asked some obviously relevant questions. These two decisions, however, are described by Block et al as the exception rather than the rule. In other decisions the business judgment rule has been successfully invoked by directors on the basis of such factors as: • a majority of outside directors or the creation of a special committee consisting solely of outside directors; • consultation with financial advisors and legal counsel retained either by the board as a whole or separately by the outside directors acting as a group (but not by management acting on its own); • questioning by outside directors of management representatives and financial and legal advisors rather than reliance on conclusory statements by these advisors; • meetings limited to outside directors; • pre-meeting distribution of relevant documentation, including summaries of the transaction to be discussed and/or copies of agreements to be executed; • the directors’ reading and careful review of this documentation; • counsel’s review of documentation with the directors; • discussion of the proposed transaction at a lengthy rather than a short (perhaps late night and/or telephone) meeting and/or at more than one meeting; • use of the time the directors have in which to act; • previous consideration of similar or related transactions; • discussion of the proposed transaction’s likely effect upon the company; and • the existence, duration and other bona fides of arm’s-length negotiations with third parties with whom the company is entering into the transaction, and the extent of outside director involvement in those negotiations. 144 The authors observe that the courts look at the record as a whole, and the presence or absence of one or even a majority of the factors listed is not of itself dispositive. 145 These factors were mostly absent in Smith v Van Gorkom, Hansen v ML SCM at 275 (2d Cir 1986) and other decisions denying protection on this ground. 141

Smith v Van Gorkom 488 A 2d 858 at 874 (Del 1985).

142 143 144

781 F 2d 264 (2d Cir 1986). Hanson Trust PLC v ML SCM Acquisition Inc 781 F 2d 264 at 275 (2d Cir 1986). Block et al, pp 61-66.

145

Block et al, p 66. [7.120]

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The requirement of rational belief as to company benefit [7.125] The final prerequisite to the protection of the rule relates to the rationality of, or some

measure of reasonableness attaching to, the challenged business judgment. In the US it is in this prerequisite that the business judgment rule delivers its benefits to directors and officers through a safe harbour from after-the-event judicial review. Those benefits are the less exacting standard of scrutiny under the rationality standard than under the duty of care. Thus, if the other pre-conditions for the rule’s protection are satisfied, the effect of the rule is that a person who would sue for breach of the duty of care must first establish that directors did not have a rational belief that the business judgment was in the best interests of the company. Only if they can establish this may action for breach of duty proceed. Of course, having established the want of rational belief, it will not be difficult in most cases to establish the elements of breach of duty of care. 146 The preceding paragraph indicates how s 180(2) would operate if it were interpreted to operate in the manner of the US rule, as an in limine or threshold protection against shareholder suit that collapses if the plaintiff shareholder succeeds in negating one of the conditions to its protection. As noted, however, that is not the interpretation given by Australian courts: see [7.105]. However, even on the Australian interpretation of s 180(2) as a defence to liability for breach of the duty of care, the rational belief requirement in s 180(2)(d) does not greatly add, if it does at all, to the defendant’s burden. It has two elements. First, it requires a rational belief on the part of each director or officer that the business judgment is in the best interests of the company. The belief requirement is purely subjective; the rationality standard is objective, and pitched below a requirement that the decision be reasonable. Second, a director or officer’s belief that the judgment is in the company’s best interests is deemed to be rational unless the belief is one that no reasonable person in their position would hold. 147 That standard is lower than the standard of reasonableness applying under the duty of care. This and other elements of s 180(2), including the character of, and onus of proof under the rule, are discussed in the following extract.

ASIC v Rich [7.130] Australian Securities and Investments Commission v Rich (2009) 75 ACSR 1 Supreme Court of New South Wales [ASIC applied for declarations of contravention of s 180(1) against several of the directors of One.Tel, a company that provided mobile telephone services to consumers and went into liquidation for insolvency in 2001. ASIC alleged contraventions of s 180(1) by the chairman and three executive directors on the basis that they knew or ought to have known that financial information provided to the board did not accurately reflect the true financial position of the company. Austin J held that ASIC had failed to prove its pleaded case. This extract relates solely to the directors’ claim to the protection of s 180(2).] AUSTIN J: [7251] The defendants submitted that in addition to the statutory business judgment rule applying particularly to the statutory duty of care and diligence, there is a broader business judgment rule at general law, which applies to the statutory as well as the general law duty of care and diligence, and also to some other duties of directors and officers (citing Ford’s Principles of Corporations Law (looseleaf) at [8.060]). They referred, in particular, to the following judicial statements: 146

147

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It may be said that the benefits of the business judgment rule are not concentrated in this precondition since other limbs may equally be displaced and action proceed. However, other limbs set the bar to suit somewhat higher; eg, absence of good faith and proper purpose under the first limb will often be sufficient to sustain suit for breach of the director’s fiduciary obligation which suit is unprotected by s 180(2). The realm of reasonableness test is one by reference to which shareholder decisions may be assessed under the general law and statutory standards for oppressive conduct by controlling shareholders: see [8.63], n 4 and [8.200]. [7.125]

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ASIC v Rich cont. • “Directors in whom are vested the right and duty of deciding where the company’s interests lie and how they are to be served may be concerned with a wide range of practical considerations, and their judgment, if exercised in good faith and not for irrelevant purposes, is not open to review in the courts” (Harlowe’s Nominees Pty Ltd v Woodside (Lake’s Entrance) Oil Co NL (1968) 121 CLR 483 at 493; [1968] HCA 37 per Barwick CJ, McTiernan and Kitto JJ); • “There is no appeal on the merits from management decisions to courts of law: nor will courts of law assume to act as a kind of supervisory board over decisions within the powers of management honestly arrived at” (Howard Smith Ltd v Ampol Petroleum Ltd [1974] 1 NSWLR 68; [1974] AC 821 at 832 (Privy Council). [7252] ASIC submitted that it is difficult to see what continuing work notions of “business judgment” under the general law have to play in the court’s consideration of s 180(1), in view of the statutory defence in s 180(2). [7253] It seems to me that the matters identified in the judicial observations quoted above form part of the court’s assessment of whether, in the particular case, the defendants’ impugned conduct is in breach of a general law duty. There is no “bright line” business judgment rule at general law, but rather the matters referred to in the quoted passages are in the nature of relevant considerations, in the same category as the distinction between errors of judgment and negligence, and the proposition that the court should not merely substitute its opinion on the merits of a matter for the opinion of the defendants. They are, moreover, relevant considerations that are an integral part of the application of the standard applied by the general law: in particular, the standard of care and diligence is perceived and understood by contrasting breach of that standard with an error going to the merits of a business decision. To take the “business judgment rule” out of the assessment of breach of the general law duty of care would be to remove one of the entrance points to an understanding of the standard of care itself, and to distort the underlying concept. [7254] [Above] I set out my reasons for concluding that the statutory duty of care and diligence is essentially the same as the duty of care and diligence of a director or officer at general law. Since business judgment considerations are an integral part of the general law duty, it follows from my earlier reasoning that those considerations are to be taken into account in applying the statutory standard of care and diligence. But it does not follow that the statutory defence in s 180(2) is therefore redundant. The business judgment considerations that figure in the articulation and application of the statutory standard of care and diligence are open-ended, whereas s 180(2) is a specific statutory rule having defined components and a defined outcome. It is at least theoretically possible that s 180(2) might protect defendants from liability for acts or omissions that would otherwise constitute a contravention of s 180(1) notwithstanding business judgment considerations at that level. Additionally, on a practical level s 180(2) articulates criteria that can be a reference point for directors and officers and their advisers, and can offer a direct solution to the issue of breach of duty in a straightforward case (see, eg, Deangrove Pty Ltd (recs and mgrs apptd) v Buckby (2006) 56 ACSR 630; [2006] FCA 212 at [68] per Branson J). [7255] The extent to which s 180(2) affords a broader protection than the general law business judgment considerations imported into s 180(1) depends upon the meaning of subparagraphs 180(2)(a) – (d). It seems to me that in circumstances such as those of the present case, a crucially important question is whether, for the purposes of subparagraph (d), there can be a “rational” but nevertheless unreasonable belief that the decision is in the best interests of the corporation. That question is addressed below. 23.9.3 The US model [7256] It has been said that the business judgment rule in s 180(2) was drawn, to a large extent, from the business judgment rule contained in the American Law Institute’s Principles of Corporate Governance: Analysis and Recommendations, adopted by the ALI in 1992 (Ford’s Principles of Corporations Law (looseleaf), at [8.310]). The ALI formulation, at [4.01(c)], has (broadly speaking) the same four elements as s 180(2). The ALI publication contains commentary, which refers to the extensive US case law. [7.130]

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ASIC v Rich cont. [7257] While the ALI’s formulation of the US rule, and the wealth of US case law on the subject, provide a useful resource when a business judgment rule is raised in Australian litigation, obviously the primary task of an Australian court is to construe and apply the statute, which is not necessarily a complete reflection of the US position. 23.9.4 Who bears the onus of proof of the elements of s 180(2)? [7258] Where s 180(2) applies, it has the effect that the director or other officer to whom it applies is taken to have met the requirements of s 180(1) and also their equivalent duties at common law and in equity. … [7259] In some cases the facts concerning the alleged contravention will incidentally establish the presence or absence of some or all of these elements and the question of onus of proof will not matter. But it is likely that in many cases, the court’s decision as to whether the elements of the business judgment rule are present will require substantial findings of fact, and then the issue of onus of proof may be critically important. [7260] ASIC submitted that both the linguistic context and the purpose underlying the enactment of s 180(2) favour the view that the defendants bear the onus of proof of the elements of that subsection. The defendants submitted that the legal onus of proof of the elements of the business judgment rule rests with ASIC. … [7262] Parliament has not expressly indicated who carries the onus of proving the application of the business judgment rule. A different drafting style could have been adopted, to clarify the question of onus. … If the legislative drafters wanted to replicate the US position, they might have said … that a director is taken to have met the standard prescribed by s 180(2) “unless the party asserting liability establishes” that the director did not meet one of the four criteria for the application of the presumption. [7263] Unfortunately s 180(2) takes a decidedly more opaque approach. It says that a director or officer who makes a business judgment is “taken to meet the requirements of” the statutory and general law duties of care and diligence “if” they satisfy the elements set out in s 180(2)(a) – (d). The question is whether subsection 180(2), so expressed, sets out some additional requirements to be satisfied by the person asserting a contravention, similarly to the US position, or has the effect of articulating a defence, the ingredients of which are to be established by the person who seeks to rely on it. [7264] … It seems to me that statutory language is profoundly ambiguous. If, say, subsection (2) had been part of the text of subsection (1), following on from the present wording of subsection (1), it would be at least as plausible to say that the additional wording was a continuation of the requirements for contravention, the onus of addressing which lay on the plaintiff, as it would be to say that it was up to the director to establish that the four criteria had been met. Separating the business judgment rule into a separate subsection, for the sake of drafting clarity, should not affect its meaning. I have reached the position that I cannot extract any reliable indication either way from simply reading the text. [7265] Unfortunately no real assistance can be obtained on this question by consulting explanatory materials. The Explanatory Memorandum to the Corporate Law Economic Reform Program Bill 1998 (Cth), which introduced s 180 in its present form, stated: 6.3 While it is accepted that directors should be subject to a high level of accountability, a failure to expressly acknowledge that directors should not be liable for decisions made in good faith and with due care, may lead to failure by the company and its directors to take advantage of opportunities that involve responsible risk-taking. 6.4 The statutory formulation of the business judgment rule will clarify and confirm the common law position that the Courts will rarely review bona fide business decisions. However the statutory formulation will provide a clear presumption in favour of a director’s judgment. In particular, while the substantive duties of directors will remain unchanged, absent fraud or bad faith, the business judgment rule will allow directors the benefit of a presumption that, in 444

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ASIC v Rich cont. making business decisions, if they have acted on an informal basis, in good faith, and in the honest belief that the decision was taken in the best interests of the company, they will not be challenged regarding the fulfilment of their duty of care and diligence. [7266] But that begs the question of onus of proof of the prerequisites for the application of the rule. The use of the word “presumption” could be taken to invoke the US approach, except that the Explanatory Memorandum makes clear that the presumption applies only when certain requirements are satisfied. Nor, in my view, is any significant assistance to be derived from the statement of legislative policy considerations in the Explanatory Memorandum. On the one hand, the legislative effort to encourage responsible risk-taking would be dampened if directors were at risk of liability unless they could demonstrate that their decision was informed, in good faith for a proper purpose, without any material personal interest, and made in the rational belief that it was in the best interests of the corporation. On the other hand, if the party alleging contravention were required to demonstrate that one or more of the ingredients for the application of the business judgment rule was absent, the effect of the introduction of the rule would be to add substantial elements to the burden of proof of contravention, that were not present in previous statutory formulations of the duty of care and diligence, and therefore the objective of holding directors to a high level of accountability would be compromised. [7267] The confusion implicit in the Explanatory Memorandum is made express in the second reading speech of the responsible minister, Mr Hockey MHR, who said (Hansard, 3 December 1998, p 1284): A business judgment rule will be introduced to provide directors with a safe harbour from personal liability in relation to honest, informed and rational business judgments. The rule will apply where an officer makes an informed decision in good faith, without material personal interest in the subject matter of the decision and rationally believes that the decision is in the best interests of the company. The objective of the rule is to protect the authority of directors in the exercise of their management duties. It is not designed to, and will not, insulate them from liability for negligent, ill-informed or fraudulent decisions. The rule will not lead to any reduction in the level of director accountability, but will ensure that they are not liable for decisions made in good faith and with due care. Directors will benefit from the certainty that the rule provides in terms of their liability as they will be encouraged to take advantage of business opportunities and not behave in an unnecessarily risk averse way. [7268] Thus, after paraphrasing the proposed subsection (2), the Minister said it would not insulate directors from liability for negligent decisions and would ensure that directors are not liable for decisions made with due care. But unless the business judgment rule provides a safe harbour for directors from what would otherwise be, at least potentially, negligence or breach of their duty of care, it is pointless. [7269] The question whether the plaintiff or the defendant bears the onus of proving the ingredients of s 180(2) is an important one that will eventually need to be resolved at the appellate level. With some hesitation in light of the US approach, I have reached the conclusion that the Australian statute casts the onus of proving the four criteria in s 180(2) on the defendants. I have reached this conclusion for two reasons. The first is that if the onus were borne by the plaintiff, the enactment of the Australian statutory business judgment rule would have the effect of adding to the elements of contravention to be proven by the plaintiff, notwithstanding the clear intention expressed in the Explanatory Memorandum and the Second Reading Speech that there was to be no reduction in the statutory requirement. Second, as Santow J pointed out in ASIC v Adler (2002) 41 ACSR 72; [2002] NSWSC 171 at [410], it would be unusual if, as part of its evidentiary burden of establishing breach of the statutory duty of care and diligence, ASIC were required to establish (as one of the four alternatives) that the defendant’s business judgment was not made in good faith for a proper purpose, since that would amount to proving a more serious contravention of the law, namely a contravention of s 181. Approximately the same point can be made with respect to proving a material personal interest, in the sense that proving a material personal interest leading to an improper use of position or information [7.130]

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ASIC v Rich cont. (ss 182 and 183) is a more serious matter than proving negligence. An additional consideration is that the four elements in subparas (a)-(d) are matters principally within the knowledge of the director or officer, and it seems appropriate to make provision for him or her to come forward with evidence concerning those matters. [7270] As revealed in the Explanatory Memorandum, [6.1]-[6.10], the purpose of the introduction of a business judgment rule was (generally speaking) to ensure that directors and officers are not discouraged from taking advantage of opportunities that involve responsible risk-taking. Casting the onus of proof of the elements of the defence on the director or officer is not necessarily incompatible with that purpose, because it may happen in practice that the evidential burden can be shifted to the plaintiff relatively easily, if the defendant addresses the statutory elements in his or her affidavit, though the price to be paid is that the defendant is exposed to cross-examination on those matters. 23.9.5 The elements of s 180(2) 23.9.5.1 “Business judgment” [7271] The first element of the business judgment rule is that there must be a “business judgment” made by the director or officer, defined to mean a decision to take or not take action in respect of a matter relevant to the business operations of the corporation. … [7274] To be a business judgment for the purposes of the Australian definition, there must be a decision to take or not to take action in respect of matters relevant to the business operations of the corporation. It seems to me that matters of planning, budgeting and forecasting are “matters relevant to the business operations of the corporation” the purposes of s 180(3), because they provide a financial framework within which business operations are conducted. In my opinion, the Australian statutory definition of “business judgment” encompasses all of the matters mentioned by Professor Redmond in his description of the US position [text corresponding to [7.110]], provided that they involve a “decision to take or not take action”. … [7277] There is, however, an important limitation contained in the statutory language. For the statutory defence to be available in Australia, there must be a “decision to take or not to take action”, consciously made so that judgment has actually been exercised. A director who “simply neglected to deal with proper safeguards, with no evidence that he even turned his mind to a judgment of what safeguards there should be” has not made a business judgment and accordingly cannot invoke the defence: ASIC v Adler at [406] per Santow J; Gold Ribbon (Accountants) Pty Ltd (in liq) v Sheers [2006] QCA 335 at [247] per Keane JA. … It is plain from the statutory definition in s 180(3) that a decision does not have to be a decision to take action; a decision to refrain from doing something may constitute a business judgment according to the definition. The important question is whether the director or officer has turned his or her mind to the matter. [7278] I agree with ASIC that the discharge by directors of their “oversight” duties, including their duties to monitor the company’s affairs and policies and to maintain familiarity of the company’s financial position, is not protected by the business judgment rule, because the discharge or failure to discharge those duties does not involve any business judgment as defined. That is important in the present case because one aspect of ASIC’s claim is that the defendants failed to discharge their monitoring duty. Monitoring the company’s affairs and maintaining familiarity with its financial position are not in themselves matters that involve a “decision to take or not to take action” in respect of a matter relevant to the company’s business operations. An application of this, noted by the ALI, p 175, is that the defence is not available to protect failure by an officer to oversee the conduct of the company’s business by not considering the need for an effective audit process, as there is no business decision-making involved. … 23.9.5.2 In good faith for a proper purpose [7281] ASIC submitted that it is doubtful whether the element of good faith can be established when an officer has failed to take action, in discharge of his or her responsibility to supervise, and the 446

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ASIC v Rich cont. inaction has resulted in a failure to discover substantial corporate losses … It seems to me that as far as the Australian law is concerned, the problem in such a case is that the officer who has failed to take action has probably not made any decision not to take action, and therefore there is no business judgment to be protected. If an officer decides not to do something, and that decision results in a failure to discover substantial corporate losses, there may well be a question of good faith on the facts, but there is no reason in principle why good faith cannot be established by evidence. 23.9.5.3 Material personal interest [7282] ASIC accepts that the defendants did not have any material personal interest in relation to the matters in dispute in the present case. 23.9.5.4 Informing oneself about the subject matter [7283] The element of the business judgment rule set out in s 180(2)(c) is that the director or officer must inform themselves about the subject matter of the judgment to the extent that they reasonably believe to be appropriate. I agree with ASIC’s submission that the reasonableness of the belief should be assessed by reference to: • the importance of the business judgment to be made; • the time available for obtaining information; • the costs related to obtaining information; • the director or officer’s confidence in those exploring the matter; • the state of the company’s business at that time and the nature of competing demands on the board’s attention (referring to the ALI Principles at 178); and • whether or not material information is reasonably available to the director (citing Smith v Van Gorkom 488 A.2d 858 at 872 (Sup Ct Del, 1985)). [7284] ASIC submitted that the requirement that the director or officer inform themselves “to the extent they reasonably believe to be appropriate” reflects the view that regard must be had not only to what the director or officer actually knew, but what he or she should have known (citing People’s Department Store Inc v Wise [2004] 3 SCR 461 at [67]). In my view that submission distorts the statutory language, for it would deny protection unless the director were able to show previous compliance with the duty of care and diligence on another issue, namely to keep informed of material matters affecting the exercise of the powers and the discharge of the duties office. The statutory language relates to the decision-making occasion, rather than the general state of knowledge of the director. It requires the director to become informed about the subject matter of the decision prior to making it, since the business judgment rule should not protect decisions taken in disregard of material information readily available. The qualifying words, “to the extent they reasonably believe to be appropriate”, convey the idea that protection may be available even if the director was not aware of available information material to the decision, if he reasonably believed he had taken appropriate steps on the decision-making occasion to inform himself about the subject matter. 23.9.5.5 Rational belief as to the best interests of the corporation [7285] The element of the business judgment rule set out in s 180(2)(d) is that the director or officer rationally believes that the judgment is in the best interests of the corporation. The section then explains that the director’s or officer’s belief that this is so is a rational one unless it is one that no reasonable person in his or her position would hold. [7286] According to the ALI Principles, p 142, the phrase “rationally believes” is intended in the United States to permit a significantly wider range of discretion for directors and officers than the term “reasonable” would permit. According to the ALI, the expression “rationally believes” gives the director or officer a safe harbour from liability for business judgments that might arguably fall outside the term “reasonable”. The primary author of the ALI Principles, Professor Melvin A Eisenberg, had previously expressed the view (“The Duty of Care of Corporate Directors and Officers” (1990) 51 U Pitt L Rev 945, 963) that the business judgment rule “goes much further than the honest-error-ofjudgment of ordinary tort law”, and he said there is no liability even if the decision is unreasonable. [7.130]

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ASIC v Rich cont. [7287] ASIC submitted that the Australian provision is quite different from the American rule, in that the Australian defence is not available if the decision taken by the director or officer is based on an unreasonable belief … [7289] In my opinion there is an alternative and preferable construction of subparagraph (d) and the definition, which avoids these consequences and gives the Australian business judgment rule a justifiable field of operation. The drafters’ objective was to define the words “rationally believe”, taken from the US business judgment rule. According to the Shorter Oxford English Dictionary, while one meaning of the word “rational” is “agreeable to reason, reasonable, sensible; not foolish, absurd or extravagant”, there are other meanings including (pertinently for present purposes) “based on, derived from, reason or reasoning”. It is plausible to say that the drafters of the definition of “rationally believe” intended to capture this latter idea, namely that the director’s or officer’s belief would be a rational one if it was based on reason or reasoning (whether or not the reasoning was convincing to the judge and therefore “reasonable” in an objective sense), but it would not be a rational belief if there was no arguable reasoning process to support it. The drafters articulated the latter idea by using the words “no reasonable person in their position would hold”. [7290] On this view, which I favour, subparagraph (d) is satisfied if the evidence shows that the defendant believed that his or her judgment was in the best interests of the corporation, and that belief was supported by a reasoning process sufficient to warrant describing it as a rational belief, as defined, whether or not the reasoning process is objectively a convincing one. Consequently the Australian position on this matter is very close to the US position and s 180(2) has some protective work to do in cases where in its absence, there would or would arguably be a contravention of s 180(1). [7291] The director or officer’s belief about the best interests of the corporation is to be formed, and its rationality assessed, on the basis of the information obtained through compliance with subpara (c). It is not to be assumed, for the purpose of applying subpara (d), that the director or officer knew everything that he or she ought to have known, but only the things that he or she reasonably believed to be appropriate to find out. 23.9.5.6 General observations about the statutory business judgment rule [7294] It seems to me [despite commentary that s 180(2) as interpreted does not protect directors from liability for inadequate performance] that s 180(2) is capable of providing a defence in some cases that would otherwise involve breach of s 180(1). These are cases where: • the impugned conduct is a business judgment as defined; • the directors or officers are acting in good faith, for proper purpose and without any material personal interest in the subject matter; • they make their decision after informing themselves about the subject matter to the extent they believe to be appropriate having regard to the practicalities listed at 23.9.5.4; • their belief about the appropriate extent of information gathering is reasonable in terms of the practicalities of the information gathering exercise (including such matters as the accessibility of information and the time available to collect it); • they believe that their decision is in the best interests of the corporation; and • that belief is rational in the sense that it is supported by an arguable chain of reasoning and is not a belief that no reasonable person in their position would hold.

[7.132]

Review Problem

Sir Lewis Carroll writes to you for your advice: I am a director of Foodstuff Ltd which is listed upon the Australian Securities Exchange. The company has diversified interests in primary production, including dairy products, cotton farm 448

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interests in northern New South Wales, and wool and beef production elsewhere. I am one of nine non-executive directors of the company; there are three executive directors. I was invited to become a director of the company in the mid 1990s at the time when Foodstuff purchased my sheep farm on the basis of my extensive network of rural contacts in western New South Wales. I still live in far western New South Wales and do not attend board meetings regularly since they are always held in Sydney. Several other non-executive directors are in much the same position. I regularly read the papers distributed in advance of board meetings although I confess that much of it is too technical for my taste, particularly in its accounting and financial content. Accordingly, I have largely confined myself to issues with respect to the performance of the wool division of the company and to acting as a trouble shooter in relation to dealings with stock and station agents and farming interests and organisations. Our managing director, Tom Mix, has got us into a mess. Mix has concealed from the board what appears to have been a very poor performance by the cotton division of the company. Production and budget figures for the division have not been included in the papers for board meetings over the past six months on some pretext or other such as “the divisional general manager is on holidays”. It now seems that in fact the general manager of that division, who is not a member of the board, has consistently been under-reporting production figures and over-reporting the prices realised for our cotton product. Second, the company’s cotton farms have been infected with an exotic pest which has substantially ruined our plantings, and infected our farms and quite likely neighbouring farms. It appears that the company may have been responsible for the introduction of this pest into the region and for the consequent damage suffered by the industry in this major cotton growing area. The divisional general manager concealed this fact from Mix for some months and Mix himself has withheld it from the board for some time. Little has been done to arrest the spread of the disease. Third, Mix has apparently caused Foodstuff to purchase a number of rural properties at a substantial overvalue. At least one of them has been purchased from a farming partnership in which his wife’s family was interested. I cannot recall that these problematic transactions were brought to the board for approval but it is possible.

Advise Sir Lewis with respect to his possible liability as a director of Foodstuff.

THE DUTY TO PREVENT INSOLVENT TRADING [7.135] The interpretation of the insolvent trading provision underwent significant judicial

revision (see Daniels v Anderson [7.85]) before their terms were recast in 1993. They are now contained in Pt 5.7B Div 3 which imposes a positive duty upon directors to ensure that their company does not trade while it is insolvent. The duty was imposed simultaneously with the introduction of the procedure contained in Pt 5.3A for the voluntary administration of the affairs of an insolvent company. Part 5.3A provides for an administrator to take over the affairs of a company with a view to developing a deed of company arrangement under which the company might be restored to financial health: see [3.190]. An administrator may be appointed by the directors by resolution if they consider that the company is insolvent or is likely to become insolvent at some future time: s 436A(1). Thus, directors will not need to wait until the company actually becomes insolvent before appointing an administrator. If they do not take such action, however, directors face the prospect of personal liability in respect of debts incurred by the company during the period of apprehended insolvency. An overview of the elements of duty [7.140] The duty to prevent insolvent trading contains five distinct elements. 148 First, the

duty applies only to a person who was a director at the time when the company incurred a debt: s 588G(1)(a). The extended definition of director contained in s 9 applies to this 148

See generally A Hanak (2007) 25 C&SLJ 180; D B Goldman (2005) 23 C&SLJ 216. [7.140]

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provision: see [7.30]. Second, the company must have been insolvent at that time, or became insolvent by incurring that debt, or by incurring at that time debts including that debt: s 588G(1)(b). Third, the debt was incurred after the commencement of Pt 5.7B, viz, on or after 23 June 1993: s 588G(1)(d). Fourth, at that time there were reasonable grounds for suspecting that the company was insolvent, or would so become insolvent, as the case may be: s 588G(1)(c). Fifth, the director must be aware at the time that there are such grounds for suspecting insolvency or a reasonable person in a like position in a company in the company’s circumstances would be so aware: s 588G(2). By failing to prevent the company from incurring the debt in circumstances where the five elements are satisfied a director contravenes s 588G(2) unless she or he establishes one or more of the defences within s 588H. Section 588G(2) does not impose a further independent element which must be established before liability arises under the section: “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”. 149 Accordingly, the director against whom the five elements are proven bears the burden of establishing one of the defences, for example, that they took all reasonable steps to prevent the company incurring the debt: s 588H(5). Section 588G(2) is a civil penalty provision: s 1317E(1). In civil proceedings founded upon contravention, the defendant’s liability needs be established only on the balance of probabilities and to the extent that its proof is “clear and cogent such as to induce, on a balance of probabilities, an actual persuasion of the mind as to the existence of [the liability]”; 150 correspondingly, the defences afforded by s 588H need only be established on the balance of probabilities. 151 If the first two elements are satisfied and the director actually suspects at the time when the debt is incurred that the company is insolvent or would become insolvent as a result of incurring that debt or other contemporaneous debts, an offence is committed if the failure to prevent the company incurring the debt is dishonest: s 588G(3). These elements of duty and defences are more fully examined in the following paragraphs. Debts engaging the duty [7.145] The duty to prevent insolvent trading applies only if the company incurs a debt which

term bears its ordinary technical meaning as “something recoverable by action for debt and nothing can be recovered in an action for debt except that which is ascertained or can be ascertained”. 152 The term “debt” signifies, therefore, an obligation sounding in the payment of a sum of money or money’s worth. Further, the obligation must be an ascertainable debt involving an obligation to pay a liquidated sum as distinct from, for example, an obligation to pay unliquidated damages or equitable compensation for breach of fiduciary duty by the director. 153 Several capital management transactions such as the payment of a dividend, the reduction of share capital and buying back shares (discussed in Chapter 9) are deemed to be the incurring of a debt within s 588G(1), as is entering into uncommercial transactions within s 588FB (see [3.210]): s 588G(1A). The deemed date for the incurring of the debt varies with the individual transaction. These sensitive transactions are thereby sanctioned against negative effects upon corporate solvency. 149 150 151

Elliott v ASIC (2004) 48 ACSR 621 at [116]. Rejfek v McElroy (1965) 112 CLR 517 at 521; Metropolitan Fire Systems Ltd v Miller (1997) 23 ACSR 699 at 703. Metropolitan Fire Systems Pty Ltd v Miller (1997) 23 ACSR 699 at 703; Sodeman v R (1936) 55 CLR 192.

152 153

Ogden’s Ltd v Weinberg (1906) 95 LT 567 per Lord Davey, applied in Hamilton v Wright (1980) 5 ACLR 391 at 394; Hussein v Good (1990) 1 ACSR 710 at 718. Hawkins v Bank of China (1992) 7 ACSR 349 at 356-357.

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The definition of insolvency [7.150] The duty to prevent a company from incurring a debt arises only if the company is

insolvent at the time when the debt is incurred or becomes insolvent by incurring that debt or by incurring at that time debts including that debt: s 558G(1)(b). Under the Act a company is deemed to be solvent if, and only if, it is able to pay all its debts as and when they become due and payable: s 95A(1). A company which is not solvent is said to be insolvent: s 95A(2). This test of insolvency applies throughout the Act and is both mandatory and exhaustive. The requirement that the company be insolvent at the time when the debt is incurred limits the operation of Pt 5.7B Div 3 to a class of companies which have failed financially or are at least under the threat of such failure. The company’s ability to pay its debts is not tested by inquiry as to the state of its balance sheet so that it is unnecessary for the plaintiff to prove that at the date in question the company’s liabilities exceeded its assets. Rather, the subsection is concerned with the question of the company’s ability to pay its debts as and when they fall due. A convenient shorthand reference, often used by lawyers in this context, distinguishes between the characterisation of a troubled company’s financial position as simply one of a “temporary lack of liquidity” or whether it is part of “an endemic shortage of working capital whereby liquidity can only be restored by a successful outcome of business ventures in which the existing working capital has been deployed”. 154 The latter, but not the former, situation betokens insolvency. In determining whether a company is able to pay its debts as and when they become due for purposes of a predecessor provision it is said that “all the cash resources available to the company, including credit resources, are to be looked at and in determining those credit resources there are to be taken into account the times extended to the company to pay its creditors, on the one hand, and the times within which it will receive payment of debts owing to it on the other hand”. 155 The cash resources available to the company include funds which may be obtained by the sale, mortgage or pledge of assets within a relatively short time. 156 A review of the authorities on insolvency that has been cited with approval in several cases identifies these six propositions with respect to determination of insolvency (citations of authority have been deleted): (i) whether or not a company is insolvent for the purposes of CA ss 95A, 459B, 588FC or 588G(1)(b) is a question of fact to be ascertained from a consideration of the company’s financial position taken as a whole …; (ii)

(iii)

154

in considering the company’s financial position as a whole, the Court must have regard to commercial realities. Commercial realities will be relevant in considering what resources are available to the company to meet its liabilities as they fall due, whether resources other than cash are realisable by sale or borrowing upon security, and when such realisations are achievable …; in assessing whether a company’s position as a whole reveals surmountable temporary illiquidity or insurmountable endemic illiquidity resulting in insolvency, it is proper to have regard to the commercial reality that, in normal circumstances, creditors will not always insist on payment strictly in accordance with their terms of trade but that does not result in the company thereby having a cash or credit resource which can be taken into account in determining solvency …;

155

Hymix Concrete Pty Ltd v Garrity (1977) 2 ACLR 559 at 566; Re Newark Pty Ltd (in liq); Taylor v Carroll (1991) 9 ACLC 1,592 at 1,595. Heide Pty Ltd (t/as Farmhouse Smallgoods) v Lester (1991) 3 ACSR 159 at 165.

156

Sandell v Porter (1996) 115 CLR 666 at 670. [7.150]

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(iv)

(v)

the commercial reality that creditors will normally allow some latitude in time for payment of their debts does not, in itself, warrant a conclusion that the debts are not payable at the times contractually stipulated and have become debts payable only upon demand …; in assessing solvency, the Court acts upon the basis that a contract debt is payable at the time stipulated for payment in the contract unless there is evidence, proving to the Court’s satisfaction, that: • there has been an express or implied agreement between the company and the creditor for an extension of the time stipulated for payment; or • there is a course of conduct between the company and the creditor sufficient to give rise to an estoppel preventing the creditor from relying upon the stipulated time for payment; or • there has been a well established and recognised course of conduct in the industry in which the company operates, or as between the company and its creditors as a body, whereby debts are payable at a time other than that stipulated in the creditors’ terms of trade or are payable only on demand …;

(vi)

it is for the party asserting that a company’s contract debts are not payable at the times contractually stipulated to make good that assertion by satisfactory evidence. 157

The fourth, fifth and sixth propositions are not exhaustive statements of the circumstances in which a creditor’s indulgence may be taken into account. 158 Industry practice and the general state of the economy may be relevant to the question of solvency: [D]espite what is written on the invoices etc as to time for payment, industry practice or dealings between the parties demonstrate that everyone accepts that debtors will often not pay creditors within normal trading terms. In business circumstances sometimes this is quite necessary in an industry which is experiencing recession because otherwise creditors may not be able to sell their product at all. Even though they would prefer people to stick to their 30 day terms it is better to have recalcitrant debtors than sell no product at all. 159

When the commitment of financial support from an external source is tenuous or highly conditional, it adds little to the company’s ability to pay its debts. 160 Numerous factors are potentially engaged in the inquiry into a company’s ability to pay its debts as they fall due. Thus, the availability (actual or potential) of loan funds, the adequacy of such funds to ensure payment of all debts at the proper times, a promise to lend and the reliability of such a promise, are also potentially relevant to the issue of the company’s ability to pay. The list is not exhaustive. A company’s failure to keep proper financial records will not assist it to evade determination of its insolvency at a particular time. A company which fails to keep and retain financial records that correctly record its transactions over the previous seven years and its financial position is presumed to be insolvent throughout this period: s 588E. Except for small proprietary companies, directors must make a declaration as part of the company’s annual financial report whether there are reasonable grounds to believe that the company will be able to pay its debts as and when they become due and payable: s 295(4)(c). Directors of other 157

158 159

Southern Cross Interiors Pty Ltd (in liq) v DCT (2001) 53 NSWLR 213 at 224-225, quoted in White Constructions (ACT) Pty Ltd (in liq) v White (2004) 49 ACSR 220 at [289]. The propositions have been approved in ASIC v Plymin (No 1) (2003) 175 FLR 124; Emanuel Management Pty Ltd v Foster’s Brewing Group Ltd (2003) 178 FLR 1; Iso Lilodw’ Aliphumeleli Pty Ltd (in liq) v Commissioner of Taxation (2002) 42 ACSR 561; Keith Smith East West Transport Pty Ltd (In liq) v Australian Taxation Office (2002) 42 ACSR 501. White Constructions (ACT) Pty Ltd (in liq) v White (2004) 49 ACSR 220 at [291]. Manpac Industries Pty Ltd v Ceccattini [2002] NSWSC 330 at [40].

160

Williams v NCSC (1990) 2 ACSR 131; Taylor v Powell (1993) 10 ACSR 174.

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companies must pass a solvency resolution annually; payment by the company of the annual review fee is taken to be a representation of solvency by the directors unless they have passed a negative solvency resolution and notify ASIC of that resolution within seven days: ss 347A – 347C. The concept of insolvency is discussed further in the extract from Hall v Poolman at [7.207]. Reasonable grounds for suspecting insolvency [7.155] The fourth element of the duty to prevent insolvent trading requires that, at the time

when the debt is incurred, there are reasonable grounds for suspecting that the company is insolvent or would become insolvent by incurring that debt or by incurring at that time debts including that debt: s 588G(1)(c). The requirement of reasonable grounds for suspecting insolvency requires a prediction of the company’s future financial capacity which may involve an assessment of several contingencies. The adoption of a legal standard of suspicion to replace that of expectation in the prior provision lowers the threshold of apprehension which will engage the section and to that extent exacts a higher standard of oversight by directors of their company’s financial condition. 161 The degree of apprehension or anticipation which will constitute reasonable grounds for suspecting insolvency is pitched between circumstances which prompt idle wondering or the mere possibility of insolvency and those which amount to an actual expectation. Thus, it is said that a “suspicion that something exists is more than a mere idle wondering whether it exists or not; it is a positive feeling of actual apprehension or mistrust, amounting to ‘a slight opinion, but without sufficient evidence’ … a reason to suspect that a fact exists is more than a reason to consider or look into the possibility of its existence”. 162 The test to be applied in relation to s 588G(1)(c) is objective and “the state of knowledge of a particular director and any assessment which he may have made as to the ability of the company to pay its debts is irrelevant. The Court must make its own judgment on the basis of facts as they existed at the relevant time and without the benefit of hindsight.” 163 In Metropolitan Fire Systems Pty Ltd v Miller, Einfeld J said: Under s 588G the new test requires that whatever is suspected must be based on reasonable grounds, thus importing into the test an objective test for the suspicion. It has been said that the actual state of mind or knowledge of a director will not be a relevant factor in determining whether reasonable grounds exist: Group Four Industries Pty Ltd v Brosnan (1991) 56 SASR 234 at 238; 8 ACSR 463; 9 ACLC 1181 at 1184 in which Duggan J dealt with the predecessor of [s 588G] (s 556 of the Companies Code): The words “reasonable grounds” which appear in both subparagraphs of s 556(1)(b) require a consideration of objective criteria and an assessment as to reasonableness. The state of knowledge of the particular defendant and any assessment he may have made as to the ability of the company to pay its debts are irrelevant considerations in so far as this subsection is concerned. It is for the court to make a judgment on the basis of the facts as they existed at the relevant time and without the benefit of hindsight. A slightly different perspective was taken by Hodgson J of the New South Wales Supreme Court in Standard Chartered Bank of Australia Ltd v Antico (Nos 1 & 2) (1995) 38 NSWLR 290. His Honour was of the view that the facts to be taken into account when assessing whether there were reasonable grounds to expect that a company would not be able to pay its debts were not limited to facts which were reasonably capable of being known by a director, but extended 161

3M Australia Pty Ltd v Kemish (1986) 10 ACLR 371 at 378; Dunn v Shapowloff [1978] 2 NSWLR 235 at 249.

162 163

Queensland Bacon Pty Ltd v Rees (1966) 115 CLR 266 at 303 per Kitto J. Powell v Fryer (2001) 37 ACSR 589 at [76]. [7.155]

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to all facts actually known to the director. For example, if directors learned by some other means of circumstances constituting reasonable grounds to expect that the company would not be able to pay all its debts, the section would apply. Irrespective of how the test is formulated, it is one of objectively reasonable grounds which must be judged by the standard appropriate to a director of ordinary competence: 3M Australia Pty Ltd v Kemish (1986) 10 ACLR 371 at 373. Questions of knowledge of and participation in the incurring of the relevant debt are now relegated to the status of factual matters which may arise should the director seek to establish one of the statutory defences afforded by the legislation. The establishment of liability is, therefore, not contingent on elements personal to the respondent. 164

The director’s awareness, actual or imputed, of the company’s financial position [7.160] The final element of liability relates to the director’s awareness of the company’s actual or impending insolvency or the appreciation which the director should have as to that condition. By failing to prevent the company from incurring the debt, the director contravenes the section if: (a) the director is aware at that time that there are such grounds for suspecting that the company is insolvent or (b) a reasonable person in a like position in a company in the company’s circumstances would be so aware: s 588G(2). The awareness requirement is therefore satisfied by either of two limbs, corresponding to whether the director was or should have been aware of the company’s condition. The subjective character of this requirement, at least as expressed in the first limb, complements the objective character of the other elements of liability under s 588G(1). The director’s subjective appreciation of the company’s financial condition is also relevant to the defence under s 588H(2) which is expressed in terms of the director’s expectations as to the company’s solvency: see [7.170]. Under the first limb it is necessary to establish that, at the time when the company incurs the debt, the director is aware that there are reasonable grounds for suspecting that the company is insolvent or that, by incurring the debt in question or by incurring at that time debts including that debt, it becomes insolvent: s 588G(2)(a). It is not necessary for the director to be aware that the company is insolvent, merely that there are reasonable grounds for suspecting its insolvency. It would appear, however, that the limb is satisfied if a director has actual knowledge of facts or circumstances concerning the company’s financial condition which comprise reasonable grounds for suspecting insolvency, even though the director fails to appreciate their significance and, in particular, their implications for the company’s solvency. Alternatively, the second limb is satisfied even where the director lacks such personal awareness if a reasonable person in a like position to the director in a company in this company’s circumstances would be aware that there are reasonable grounds for suspecting that the company is insolvent or that it would become insolvent by incurring the debt in question or by incurring at that time debts including that debt: s 588G(2)(b). The reasonable person is, therefore, invested with characteristics specific to the particular director’s office and to the particular company’s circumstances. This dual positional differentiation is articulated with that contained in s 180(1) in relation to the director’s duties of care and diligence: see [7.80]. The Explanatory Memorandum which accompanied an earlier exposure draft of Pt 5.7B identified particular expectations which it anticipated that a court would bring to the 164

Metropolitan Fire Systems Pty Ltd v Miller (1997) 23 ACSR 699 at 702-703.

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interpretation of this second limb. 165 The Explanatory Memorandum stated that the court could be expected to look at what a reasonable person “in the position of director” would normally be expected to do to ensure that she or he would be aware of any solvency problem; in particular, the memorandum considered that a court might expect: (i) that directors of a large company would ensure that among their number there should be one or more who are talented in the field of corporate financial management; (ii) that directors of a large company should read, be able to understand and seek any necessary clarification of the key financial information put before the board, such as a balance sheet and a profit and loss statement; (iii) that the board ensure that appropriately skilled people are engaged to carry out the company’s accounting functions; (iv) that the board would require relevant accounting information to be supplied ahead of regular board meetings at which key financial decisions are to be made, and that, where a significant borrowing is to be undertaken, the management should supply the board with a statement of the company’s current financial position as well as the particulars of the way in which the principal, interest and other charges are to be serviced over the anticipated term of the loan; (v) that the board make arrangements for monitoring the use of any authorisation granted in relation to the use of the company seal, the entering into contracts with financiers or the signing of cheques and bills of exchange; and (vi) where the nature of the business may expose the company to a high risk of sudden liquidity restriction, or the company is known by the director to be in a delicate financial position, that extra care and more rigorous safeguards may be adopted. 166 As regards the statutory reference to the company’s circumstances, the memorandum stated that these would include the size and type of the company, the nature of its enterprise, the provisions of its constitution, the composition of its board and the distribution of work between the board and other officers. Those norms or expectations from which an awareness of insolvency might be attributed to a reasonable person in the director’s position in the company are more explicit than those developed in relation to the director’s statutory and general law duties of care and diligence although they clearly have potential application to these doctrines. Several of those norms may be traced to case law with respect to defences available to insolvent trading. In other respects, however, they are inconclusive. Thus, their status is, as had been noted, unclear. They are silent with respect to the existence of a general expectation that directors will actively monitor the company’s solvency, independent of situations within para (iv) where a significant borrowing is to be undertaken. They do not discriminate between corporate offices – the character of the director’s particular office in the company, for example, as a non-executive director or (say) an executive finance director, might be expected to influence the standard of reasonable apprehension. Company-specific characteristics, such as those going to company size and patterns of delegation of routine management and financial 165

166

Section 588G(2)(b) and its exposure draft counterpart are not, however, in identical terms since the latter referred simply to a “reasonable director” of a company in the company’s circumstances whereas s 588G(2)(b) refers to a “reasonable person in a like position”. The enacted provision is, therefore, articulated by reference to the specific position occupied by the particular director and not that of a hypothetical “reasonable director” of the company in question. The change in statutory formulation does not diminish the relevance of the Explanatory Memorandum’s statement although it does tailor the expectation to the specific office occupied by the director such as, for example, whether the director is an executive or non-executive director. Corporate Law Reform Bill 1992, Public Exposure Draft and Explanatory Paper (1992), [1229]. [7.160]

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oversight responsibilities to company officials, might also be relevant to the process of attributing a standard of reasonable awareness to individual directors. Defences to liability for failure to prevent insolvent trading [7.165] Several defences are created to apply for the purposes of proceedings in respect of a

contravention of the duty to prevent insolvent trading. These defences apply where, when the debt in question was incurred, the director had reasonable grounds to expect and did expect that the company was solvent and would remain solvent even if it incurred that debt, the director believed on reasonable grounds that a competent person was monitoring the company’s solvency and keeping the director informed, where illness or other good reason prevented the director from taking part in management of the company at the time when the particular debt was incurred, or where the director took all reasonable steps to prevent the company from incurring the debt: s 588H. These defences are briefly noted.

Reasonable grounds to expect solvency [7.170] The first defence requires the defendant to prove not only her or his actual

expectation of solvency but also that the director had reasonable grounds for that expectation: s 588H(2). While the existence of grounds for suspecting insolvency is sufficient for liability under s 588G(1) (in conjunction with other elements of liability), the defence available under s 588H(2) is cast in terms of expectation of solvency. The term “expect” imports a higher degree of certainty than “mere hope or possibility” or “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 a 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 entirely of their own making, has been contributed to by their own failure to make further necessary inquiries. 167

The exculpation standard is therefore higher than that of the primary liability. In consequence, liability is triggered by matters which merely provide reasonable grounds for suspecting that the company is trading while insolvent while the defence under s 588H(2) is satisfied only by such inquiry or other knowledge which gives reasonable grounds to expect that the company is and will remain solvent. Grounds which merely excite suspicion as to insolvency require of the director inquiry to the higher standard of expectation for exculpation under s 588H(2). The point of time at which reasonable grounds are to be established is immediately before the debt is incurred, thus formally eliminating all sense of hindsight review. 168

Reliance upon information as to solvency provided by another [7.175] Section 588H(3) provides a defence where a director establishes that, at the time

when the debt was incurred, she or he: (a) had reasonable grounds to believe, and did believe (i) that a competent and reliable person was responsible for providing to the director adequate information about whether the company was solvent; and (ii) that the other person was fulfilling that responsibility; and (b) the director expected, on the basis of information provided by the other person, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time. 167 168

Tourprint International Pty Ltd (in liq) v Bott (1999) 32 ACSR 201 at [67]. Metropolitan Fire Systems Pty Ltd v Miller (1997) 23 ACSR 699 at 703.

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The defence has two limbs, each of which must be satisfied. The first limb requires the director to establish belief in the existence of an adequate system for monitoring the company’s solvency and in its continuing functioning, a belief which in both cases is founded upon reasonable grounds. The defendant is not put to proof that the delegate was actually competent and reliable and fulfilling the delegated responsibilities, but only of the director’s actual belief based on reasonable grounds that compliance was occurring. The second limb requires the director to establish an expectation of continuing solvency that is founded upon the basis of information provided by the delegate. An expectation founded upon information from other sources does not support the defence although, if it casts doubt upon the reliability of information as to solvency provided by the delegate, it may affect the first limb requirement of reasonable belief in the continuing integrity of the monitoring system. The defendant needs to establish under the second limb an expectation rather than the belief required under the first limb. The defence in s 588H(3) builds upon the permitted scope for delegation to and reliance upon company officials conceded to directors under their duties of care and diligence: see [7.75]. In Manpac Industries Pty Ltd v Ceccattini 169 Young CJ in Eq held that directors could not rely upon statements from a business consultant appointed to assist the company survive threats to its solvency when those statements were based on information supplied by the directors themselves; in doing so, he indicated that the defence was primarily directed to larger enterprises: [T]he prime thrust of the defence [in s 588H(3)] is to cover the situation where there is a large corporation with bulky accounts and where there is a system in place of competent accountants, credit controllers and financial management and the board has a regime whereby those people, provided they are competent and responsible, will report to the board any problems that the board may pick up. The prime thrust of the exception is not to deal with the situation where a small company with directors who have little idea of accountancy, bring in a trouble-shooter, supply the trouble-shooter with information which may not be complete, receive reports back from the trouble-shooter and then intend to rely on a report which is incomplete because they have provided incomplete information.

Public companies make up only 8% of companies against which allegations of insolvent trading have been made since the inception of the remedy in 1961. 170 The remedy’s use is thus primarily against directors of proprietary companies.

Non-participation in management due to illness or other good reason [7.180] A further defence applies where a director establishes that, at the time when the

particular debt was incurred, he or she did not take part in the management of the company because of illness or for some other good reason: s 588H(4). Non-participation in management must be because of the illness or other good reason precluding participation. If the director would not have been any more involved in company management if they were not disabled by illness or other cause, that disability does not provide a defence in respect of contemporaneous debts. The scope of this defence is canvassed in the extract from Deputy Commissioner of Taxation v Clark at [7.210]. 169

[2002] NSWSC 330 at [54]. In McLellan v Carroll (2009) 76 ACSR 67 the court had regard to the fact that a director had relied upon the business advice of his external accountant for the purposes of exercising jurisdiction under s 1317S to relieve the director from liability under s 588G. The director’s defence under s 588H(3) failed because the accountant was a business advisor and his role did not include giving the director information as to the company’s solvency.

170

P James, I Ramsay & P Siva, Insolvent Trading – An Empirical Study (Research Report; Clayton Utz and Centre for Corporate Law and Securities Regulation, University of Melbourne; 2004), p 24. [7.180]

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Reasonable steps to prevent the incurring of the debt [7.185] A further defence is conceded to a director who establishes that he or she took all

reasonable steps to prevent the company from incurring the debt which is the subject of the contravention of s 588G: s 588H(5). In determining whether a defence under the subsection has been proved, regard may be had to matters including, but not limited to: (a) any action the person took with a view to appointing an administrator of the company; (b) when the action was taken; and (c) the results of that action: s 588H(6). The central concept is that relating to the reasonableness of any steps taken by the director to prevent the company from incurring the debt in question. The explanatory paper accompanying the earlier exposure draft of the provision that later became s 588H(5) discussed the reasonableness requirement in these terms: The use of the word reasonable in this provision requires the court to have regard to factors such as the size and complexity of the company concerned, the size of the debt which was incurred and the nature of the grounds which gave rise to the suspicion of insolvency. Clearly, where a company has liquidity problems, a court might expect a company to more stringently monitor its expenditure and income, and where reasonable grounds exist for suspecting that the particular transaction would result in the insolvency of the company, for that to cause immediate action to be taken to ascertain whether or not this would result. To take advantage of subsection 588H(5) a court might require unequivocal action on the part of those directors seeking to rely on the defence to exercise what powers and functions they possess, either to prevent the incurring of the debt directly or to bring the matter to the attention, either of an officer with the necessary authority to prevent the incurring of the debt or to the board of directors where that is required. The provision is not intended to hamstring the company by requiring that every transaction no matter how small be scrutinised because of an academic possibility of the company’s trading whilst insolvent. 171

The exposure draft did not include a provision corresponding to s 588H(6). The subsection identifies one category of response by the director to apprehensions as to the company’s solvency, namely, action taken towards timely initiation of voluntary administration under Pt 5.3A. A director who argues in favour of voluntary administration but does not persuade a majority of fellow directors to this view may well escape liability; the burden of advocacy necessary for this defence may be a continuing one, however, not necessarily discharged by a single expression that fails to carry the day. Compensation remedies with respect to insolvent trading [7.190] Section 588G(2) is a civil penalty provision. In addition to the company’s right of

recovery under Pt 9.4B, specific remedies are contained within Pt 5.7B Div 4 which enable proceedings to be taken for compensation for loss arising from contravention of the duty to prevent insolvent trading. These remedies provide for recovery at the suit of the liquidator and in some circumstances of individual creditors. Each of the grounds of recovery under Pt 5.7B Div 4 applies only where the debt in question is wholly or partially unsecured. The incurring of a debt which is wholly secured may contravene the director’s duty to prevent insolvent trading but it will not trigger civil recovery remedies under Pt 5.7B Div 4. The contravention through the incurring of a wholly secured debt will, however, trigger civil recovery remedies under Pt 9.4B: see [7.65]. Recovery under Pt 5.7B Div 4 may be awarded in civil penalty proceedings (s 588J), in criminal proceedings where a court finds that the director is guilty of an offence constituted by 171

Corporate Law Reform Bill 1992, Public Exposure Draft and Explanatory Paper (1992), [1240].

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breach of the duty to prevent insolvent trading (s 588K), by direct recovery by the liquidator (s 588M) or, in limited circumstances, by direct recovery by individual creditors: ss 588R, 588T. The liability of a holding company for insolvent trading by a subsidiary company

The elements of contravention by the holding company [7.195] Under Pt 5.7B Div 5 an action for compensation may be brought against a holding

company where it allows a subsidiary company to trade while insolvent. The subsidiary’s liquidator may sue for compensation for loss suffered by unsecured creditors as a result of insolvent trading by the subsidiary: s 588W. A holding company contravenes the Act, which contravention serves as one of the foundations for compensation proceedings, if each of four elements is satisfied. First, the company must be the holding company of a company at the time when the subsidiary company incurs a debt: s 588V(1)(a). Second, the subsidiary company must be insolvent at that time, or become insolvent by incurring that debt or by incurring at that time debts including that debt: s 588V(1)(b). Third, at the time when the subsidiary company incurs the debt there must be reasonable grounds for suspecting that the company is insolvent, or would become insolvent, by incurring that debt or by incurring at that time debts including that debt, as the case may be: s 588V(1)(c). The fourth requirement may be satisfied in either of two ways. The first is if the holding company, or one or more of its directors, is aware when the debt is incurred that there are reasonable grounds for suspecting such insolvency: s 588V(1)(d)(i). Alternatively, the fourth requirement will be satisfied if, having regard to the nature and extent of the holding company’s control over the subsidiary’s affairs and to any other relevant circumstances, it is reasonable to expect either that a holding company in the company’s circumstances would be so aware or that one or more directors of such a holding company would be so aware: s 588V(1)(d).

Recovery of compensation [7.200] The liquidator of the subsidiary may recover compensation from the holding

company for loss resulting from insolvent trading by the subsidiary where each of four conditions is satisfied: • the holding company must have contravened Pt 5.7B Div 5 in relation to the incurring of a debt by the subsidiary; • the person to whom the debt is owed must have suffered loss or damage in relation to the debt because of the company’s insolvency; • the debt must have been wholly or partly unsecured when the loss or damage was suffered; and • the subsidiary company is being wound up. Where each of these requirements is satisfied, the liquidator of the subsidiary may recover from the holding company, as a debt due to the subsidiary, an amount equal to the amount of the loss or damage it has suffered: s 588W(1). Proceedings by the liquidator must be begun within six years after the beginning of the winding up: s 588W(2). The measure of compensation liability to which a holding company is exposed by order made under Pt 5.7B Div 5 is expressed as the amount of the loss or damage suffered in relation to the debt because of the subsidiary’s insolvency by the person to whom the debt was owed. Recovery under Pt 5.7B Div 5 is available only where the debt in question is wholly or partly unsecured and an amount paid to a company under the Division may not be applied towards payment of a secured debt unless all the company’s unsecured debts have been paid in full: [7.200]

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s 588Y(1). Where a payment order is made under the Division, and the court is satisfied that, at the time when the subsidiary incurred the debt, the person who suffered the loss or damage knew that the company was insolvent at that time or would become insolvent by incurring that or other contemporaneous debts, the court may order that the compensation paid to the company is not available to pay that debt unless all the company’s unsecured debts have been paid in full: s 588Y(2).

Defences to liability [7.205] Several defences apply for the purpose of proceedings for compensation under Pt 5.7B

Div 5. Thus, it is a defence to such proceedings if the holding company proves that, at the time when the debt was incurred, it and each director who was aware that there were grounds for suspecting that the subsidiary was insolvent had reasonable grounds to expect, and did expect, that the subsidiary was solvent at the time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time: s 588X(2). A further defence has two requirements, each of which must be satisfied. The first requires belief in the existence of an adequate system for monitoring the company’s solvency and in its continuing functioning, a belief which in either case is founded upon reasonable grounds. Thus, the defence is provided where the holding company establishes that, at the time when the debt was incurred, the holding company and each relevant director had reasonable grounds to believe, and did believe, that a competent and reliable person was responsible for providing to the holding company adequate information about whether the subsidiary was solvent and that the other person was fulfilling that responsibility: s 588X(3)(a). The holding company is not put to proof that the delegate was actually competent and reliable and was fulfilling the delegated responsibilities, but only of the actual belief based on reasonable grounds that compliance was occurring. The second requirement obliges the holding company to establish an expectation of continuing solvency which is founded upon information provided by the delegate. Thus, the holding company must establish that it and each relevant director expected, on the basis of information provided by the other person, that the subsidiary was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time: s 588X(3)(b). An expectation founded upon information derived from other sources does not support the defence, although if it casts doubt upon the reliability of information as to solvency provided by the delegate it may affect the burden of exculpation under the first requirement. The holding company needs to establish under the second requirement an expectation rather than the belief necessary under the first. Third, the fact that a relevant director of the holding company is aware that there are grounds for suspecting the insolvency of the subsidiary shall be disregarded 172 where that director did not take part in the management of the holding company at the time when the subsidiary incurred the debt because of illness or for some other good reason: s 588X(4). The defence is available only when the illness or other good reason prevents the director from taking part in the management of the company. The defence will not therefore be available where the director takes no part at all in company management but happens fortuitously to be ill at the time that the debt in question is incurred by the subsidiary. A fourth defence is conceded to a holding company which establishes that it took all reasonable steps to prevent the subsidiary from incurring the debt in question: s 588X(5). 173 172 173

The significance of such disregard is that the director’s awareness does not satisfy the element of holding company liability under s 588V(1)(d)(i). The defence has a counterpart in s 588H(5) although s 588X contains no provision corresponding to s 588H(6) which permits regard to be had to what action the director took to have an administrator appointed to the company incurring the debt.

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Reasonableness is assessed with regard to factors such as the size and complexity of the company concerned, the size of the debt which was incurred and the nature of the grounds which gave rise to the suspicion of insolvency. A court might require unequivocal action on the part of a holding company seeking to rely on the defence to exercise what powers and functions it possesses, either to prevent the incurring of the debt directly or to bring the matter to the attention, either of an officer with the necessary authority to prevent the incurring of the debt or to the board of directors of either company. 174

Reform options to facilitate company restructure [7.206] In 2017 the Australian Government, under its National Innovation and Science

Agenda, released draft legislation for consultation that would provide directors with a safe harbour from insolvent trading liability where the company is undertaking a restructure. The draft Explanatory Memorandum stated that the threat of Australia’s insolvent trading laws, combined with uncertainty over the precise moment a company becomes insolvent, can drive companies into voluntary administration, even in circumstances where the company may be viable in the long term. 175 Three “perverse outcomes” are identified: 1. as the relevant threshold is not actual insolvency, but “reasonable grounds for suspecting” insolvency, directors may cease trading prior to the commencement of insolvency proceedings, limiting the ability of a company to trade through financial difficulty; 2. directors (particularly of larger companies) may have disproportionate concern as to their own personal exposure during times of financial stress and may move to formal insolvency prematurely or focus on their own liability rather than other potential ways to remedy the situation; and 3. because of their own existing personal financial commitment to a business, directors of small and medium enterprises may not be sufficiently focused on the implications for other stakeholders of continuing to trade and may move to formal insolvency too late, missing the opportunity to engage earlier with creditors to find a solution to the company’s problems. 176 In each case, it is said, this shifts directors’ focus on their other duties to the company and the unnecessary destruction of enterprise value where there are clear opportunities to adjust the business and continue operating. The appointment of an administrator to a company is almost always value destructive because of loss of confidence amongst its suppliers, credit providers and employees, making it harder for the company to restructure and increasing the likelihood of its eventual liquidation. The consultation document says that the change seeks to encourage honest directors to remain in control of a financially distressed company and take reasonable steps to restructure and allow it to trade out of its difficulties, encouraging directors to engage early with financial distress, and then actively take steps to either restructure the business or, if that is not possible, to quickly move to formal insolvency processes. 177 The proposed safe harbour would protect directors from liability for debts incurred by an insolvent company if they take a course of action that is reasonably likely to lead to a better 174

Corporate Law Reform Bill 1992, Public Exposure Draft and Explanatory Paper (1992), [1240].

175

Treasury Laws Amendment (2017 Enterprise Incentives No 2) Bill 2017 No XXX 2017, Explanatory Memorandum, p 5 (Overview); see also Australian Government, Productivity Commission, Business Set-up, Transfer and Closure, Report No 75 (2015), p 378; A Hargovan (2016) 34 C&SLJ 414. Treasury Laws Amendment (2017 Enterprise Incentives No 2) Bill 2017 No XXX 2017, Explanatory Memorandum, [1.7].

176 177

Treasury Laws Amendment (2017 Enterprise Incentives No 2) Bill 2017 No XXX 2017, Explanatory Memorandum, [1.8]-[1.9]. [7.206]

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outcome for the company and its creditors and the debt was incurred as part of that course of action. Directors would only be liable for an insolvent company’s debts where it can be shown that they were not taking a course of action reasonably likely to lead to a better outcome for the company and its creditors as a whole than proceeding to immediate administration or liquidation; the safe harbour would not protect those who merely take a passive approach to the business’s position. Directors will not be able to rely on the safe harbour where the company is not meeting its obligations in relation to employee entitlements (including superannuation) and its taxation reporting obligations.

Hall v Poolman [7.207] Hall v Poolman (2007) 65 ACSR 123 Supreme Court of New South Wales PALMER J: ... 265 … In order for the defence [in s 588H(2)] to succeed, there must be an expectation, held on reasonable grounds, that recourse to assets will enable debts to be paid, not at some indefinite time in the future, but so as to keep the companies solvent according to the definition in CA s 95A, namely, as the debts fall due for payment. It is not appropriate to base an expectation of solvency: … upon the prospect that [the company] might trade profitably in the future thereby restoring its financial position. … The question is whether the company at the relevant time is able to pay its debts as they become due not whether it might be able to do so in the future if given time to trade profitably …: Sheahan v Hertz Australia Pty Ltd (1995) 16 ACSR 765 at 769; Powell v Fryer (2001) 37 ACSR 589 at [75]. 266 The law recognises that there is sometimes no clear dividing line between solvency and insolvency from the perspective of the directors of a trading company which is in difficulties. There is a difference between temporary illiquidity and “an endemic shortage of working capital whereby liquidity can only restored by a successful outcome of business ventures in which the existing working capital has been deployed”: Hymix Concrete Pty Ltd v Garrity (1977) 2 ACLR 559 at 566; Re Newark Pty Ltd (in liq); Taylor v Carroll (1991) 6 ACSR 255. The first is an embarrassment, the second is a disaster. It is easy enough to tell the difference in hindsight, when the company has either weathered the storm or foundered with all hands; sometimes it is not so easy when the company is still contending with the waves. Lack of liquidity is not conclusive of insolvency, neither is availability of assets conclusive of solvency: Expo International Pty Ltd (in liq) v Chant [1979] 2 NSWLR 820 at 837. 267 Where a company has assets which, if realised, will pay outstanding debts and will enable debts incurred during the period of realisation to be paid as they fall due, the critical question for solvency is: how soon will the proceeds of realisation be available. … Bearing in mind the commercial reality that creditors will usually prefer to wait a reasonable time to have their debts paid in full rather than insist on putting the company into insolvency if it fails to pay strictly on time, I think it can be said, as a very broad general rule, that a director would be justified in “expecting solvency” if an asset could be realised to pay accrued and future creditors in full within about ninety days. 268 The position becomes murkier the less certain are the outcomes. The market value of the asset may not be ascertainable until the market is tested, so that it is not certain that the realisation will pay in full both existing debts and those to be accrued during the realisation period. The time at which the proceeds of realisation become available may depend upon the state of the market and the complexity of the transaction. 269 There comes a point where the reasonable director must inform himself or herself as fully as possible of all relevant facts and then ask himself or herself and the other directors: “How sure are we that this asset can be turned into cash to pay all our debts, present and to be incurred, within three months? Is that outcome certain, probable, more likely than not, possible, possible with a bit of luck, possible with a lot of luck, remote, or is there is no real way of knowing?” 270 If the honest and reasonable answer is “certain” or “probable”, the director can have a reasonable expectation of solvency. 271 If the honest and reasonable answer is anywhere from “possible” to “no way of knowing”, the director can have no reasonable expectation of solvency. 462

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Hall v Poolman cont. 272 If the honest and reasonable answer is “more likely than not”, the director runs the risk that a Court will hold to the contrary in an insolvent trading claim. 273 If the honest and reasonable answer is “no way of knowing yet, we need more information”, the director must then ask: “How long before we have the information so that we can give a final answer?” 274 If the honest and reasonable answer to that question is: “By a definite date which will not extend the realisation period (if there is to be one) beyond three months”, the director may reasonably say: “Let’s wait until then before deciding”. 275 If the honest and reasonable answer is “there is no way of knowing yet when we will have the information to make a decision”, the director must say: “Then there is no way that we can now have a reasonable expectation of solvency and there is no way we can reasonably justify continuing to trade without knowing when we will know whether the company is insolvent. Call the administrators”. By this series of questions and answers I do not mean to lay down some pro forma test of directors’ liability for insolvent trading. Each case depends on its particular facts. These questions and answers merely serve to illustrate that when a company is struggling to pay its debts, the directors must face up to the issue of insolvent trading directly and with brutal honesty: they must not shirk from asking themselves the hard questions and from acting resolutely in accordance with the honest answers to those questions.

Deputy Commissioner of Taxation v Clark [7.210] Deputy Commissioner of Taxation v Clark (2003) 57 NSWLR 113 Court of Appeal of the Supreme Court of New South Wales [Mrs Clark was a director of SCI, the vehicle for her husband’s carpentry business. He was the other director, two directors then being required of proprietary companies under the Corporations Act. The company was wound up and the company’s liquidator obtained an order against the Deputy Commissioner of Taxation for the recovery of payments made by SCI by way of group tax on the ground that it was an unfair preference. Mr Clark was ordered to indemnify the DCT for the amount, but Mrs Clark succeeded in establishing the defence pursuant to s 588FGB(5) which is in corresponding terms to s 588H(4). The DCT appealed against the judgment in favour of Mrs Clark.] SPIGELMAN CJ: 108 What constitutes breach of the standards of care and of diligence, in a particular case, will depend on a wide variety of circumstances including the precise nature of the business conducted by the company and the composition of its board. However, the case law indicates that there is a core, irreducible requirement of involvement in the management of the company. 109 Although the standard of skill may vary in accordance with the particular skills of the director, the core, irreducible requirement of skill involves an objective test, such as “ordinary competence” … or “reasonable ability” … An equivalent objective test applies to the core, irreducible requirement of diligence, such as “reasonable steps to place themselves in a position to guide and monitor the management of the company” …. 110 The existence of a core, irreducible requirement of participation in management was one of the factors underlying the scheme for insolvent trading which falls to be construed in the present case. … 114 Part 5.7B, including s 588G and s 588H, was based on the assumption that a director would participate in the management of the company. This assumption strongly suggests that a total failure to participate, for whatever reason, should not be regarded as a “good reason” for failing to participate at a particular time. … 115 Parliament has chosen to use words of great generality in the phrase “other good reason” in the various statutory provisions in which it appears. A phrase of this character must take its colour from its surroundings. The contemporary approach to statutory interpretation is literal but not literalistic and requires words to be construed in their total context. … 116 The focus of attention must be on what constitutes a “good reason” for a director not to participate in management for the purposes of corporations law. This requires consideration of the [7.210]

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Deputy Commissioner of Taxation v Clark cont. duties of directors, particularly in, but not limited to, situations of insolvent trading. In my opinion, the process of interpretation should commence with a recognition that, for the reasons outlined above, it is a basal structural feature of corporations legislation in Australia that directors are expected to participate in the management of the corporation. … 121 For the reasons I have given above, every director is expected to participate in the management of the company. The test is well expressed in terms of a duty to put himself or herself into a position to guide and monitor the management of the company. Section 588H, and therefore s 588FGB, operate on the assumption that that will occur. That is why the defence is only available with respect to non-participation at a specific point of time. … 161 There is often an acute dilemma when deciding whether the principled application of the law requires formal equality or gender neutral treatment, on the one hand, or recognition that the position of women in particular relationships requires separate treatment on the other. The issues that arise are as old as Aristotle, who identified injustice as treating equals unequally or treating unequals equally. The difficulty is to identify the circumstances in which persons are relevantly equal or unequal. … 164 The recognition of complete abdication of responsibilities as a director as a “good reason”, for purposes of the statutory defences, carries with it the risk of reinforcing gender stereotypes and undermining the confidence with which potential creditors will deal with small companies in which women participate with their husbands. Maintaining a firm position on the duties of directors will encourage the use of single director corporate structures for small business. In my opinion, it is desirable to promote coherence between appearance and reality in corporate practice. 165 It is by no means clear what will prove to be the long term effect of the abolition of the requirement of two directors. Instinctively one would expect the number of small companies with a second sleeping director to decline. However, in the context of family companies there remain possible advantages in the form of income splitting for tax purposes or as a protection for the assets of the family, including the husband. 166 The change in the policy of the Corporations Act to permit single director companies abolished a requirement which had, as a practical matter, resulted in many small businesses having sleeping directors, often spouses. Although this change acknowledged the fact that some directors did not participate in management in the past, it does not, in my opinion, alter the basic requirement of the law that directors should participate. 167 In my opinion, there is no justification for a doctrine which would hold sleeping directors to be “de facto non-directors”, who should be relieved of their liabilities. Although, as a practical matter, the conduct of such directors may never meet the requisite standard of participation in management, such conduct should not be excused as a “good reason” in law. 168 Accordingly, [Mrs Clark]’s total reliance on her husband in the management of SCI is not a “good reason”, within the meaning of s 588FGB(5), for her non-participation in the management of the company at the time when payments were made to the Appellant. [Mrs Clark] cannot, on that basis, resist her liability under s 588FGA as a director of SCI. HODGSON JA: [172] I agree with the orders proposed by Spigelman CJ, and generally with his reasons. … 174 Whether a director knows it or not, he or she has a duty to exercise reasonable care and diligence in the discharge of his or her duties, with the standard of reasonableness being largely an objective one. A director’s non-participation in the management of the company will usually involve a breach of that duty, whether the director is aware of this or not; although if the non-participation is because of illness or for some other good reason, then there will not be a breach of duty if the illness or other good reason is such as to make the non-participation reasonable, on the same standard of reasonableness. 175 In my opinion, a director’s non-participation in the management of a company at a particular time will be “because of illness or for some other good reason” within s 588FGB(5) of the Corporations 464

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Deputy Commissioner of Taxation v Clark cont. Act only if the illness or other good reason is of this character, that is, such as to make the non-participation reasonable (on the appropriate standard) and thus not a breach of the director’s duty to exercise reasonable care and diligence. [Handley JA agreed with Spigelman CJ.]

THE DIRECTOR’S DUTY TO ACT BONA FIDE FOR THE BENEFIT OF THE COMPANY AS A WHOLE An overview of remedies and their outcomes [7.215] As noted, judicially created doctrines have imposed fiduciary duties upon directors in

an attempt to protect against the misuse of power and the temptations of self-dealing. One element of this duty, in its classic formulation, requires directors to exercise their powers “not only in that manner required by law but also bona fide for the benefit of the company as a whole”. 178 That duty is here simply called the duty of good faith although it contains several distinct and independent elements of obligation. A second element of the director’s fiduciary obligation is the duty to avoid situations involving a conflict of interest without the company’s consent: see [7.340] et seq. The duty of good faith may be distinguished from other general law duties imposed upon directors in two principal respects. First, the duty applies to directors when they make decisions or exercise powers for the corporation, or perform some function as individuals which has been delegated to them by the board; in either case, they are exercising corporate powers and acting in a corporate role. Second, the duty of good faith permits a challenge to be made to a particular decision taken or transaction entered into by directors; the remedies for breach of the duty include orders setting aside the decision or transaction in appropriate cases. Accordingly, the duty permits an attack upon directors’ decisions and does not simply sound in personal liability of directors and officers although such personal liability may also flow from breach of the duty. The right of a company to set aside a transaction by reason of the breach of duty of good faith on the part of the directors, or a majority of them, who took the decision depends upon proof that the other party to the transaction had notice of the breach of duty: see Harlowe’s Nominees Pty Ltd v Woodside (Lakes Entrance) Oil Co NL [7.265] at 494. The breach of duty and notice must be established, displacing the assumption that company officers properly perform their duties: s 129(4). The assumption is displaced by knowledge or suspicion that it is incorrect: s 128(4) and see [5.360]. In contrast, directors’ duties with respect to the avoidance of conflict of interest (viz, derivation of profits from their office or transactions with their company) may attach to conduct by directors acting in their personal or individual capacities and in circumstances which do not involve the exercise by them of corporate powers or functions. Further, although rescission of transactions may be sought where the director has an interest in a transaction with the company, the remedies for breach of these duties, and the duty of care and diligence, are primarily compensatory or restitutionary in character; remedies for their breach do not attack a particular decision but are concerned with the director’s personal liability, either for equitable compensation, to account for profits or liability as constructive trustee of property acquired in circumstances sufficiently connected with the corporate office as to offend the equitable rule enjoining conflict avoidance by fiduciaries. 178

Richard Brady Franks Ltd v Price (1937) 58 CLR 112 at 135 per Latham CJ. [7.215]

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Judicial reluctance to intervene in directors’ decisions [7.220] Courts have long been reluctant to be drawn into disputes with respect to matters of

corporate policy, the merits of particular corporate decisions or grievances as to the conduct of company affairs generally. “This court,” Lord Eldon protested in 1812, “is not to be required to take the management of every playhouse and brewhouse in the Kingdom”. 179 Similarly, in 1864 a court hearing a challenge to a resolution of directors of a statutory corporation would say nothing on the question whether the policy advocated by the directors … is the more for the interest of the company. That is a matter wholly for the shareholders. 180

The modern formulation is even more explicit with respect to non-intervention: There is no appeal on merits from management decisions to courts of law, nor will the courts of law assume to act as a kind of supervisory board over decisions within the powers of management honestly arrived at. 181

The principle of limited judicial intervention is expressed not only in narrowly cast grounds of judicial review for breach of directors’ duties of good faith but in procedural rules which limit shareholder standing to sue for breaches of duty or irregularities in corporate procedure and governance; thus, it might be said to be an “elementary principle” of company law that “the court will not interfere with the internal management of companies acting within their powers, and in fact has no jurisdiction to do so.” 182 The reluctance of courts to substitute their own judgment for that of directors and managers is defensible in view of the limits of the institutional expertise of courts and the likely claims upon their jurisdiction under an alternative policy. It expresses what might be called a business judgment rule unaided by s 180(2) which applies only to the statutory duty of care and diligence and its general law counterpart: see [7.105]. The imposition of duties of good faith upon directors in the exercise of corporate powers is significant as establishing the principal foundation for judicial review of directors’ decisions and the exercise of their discretionary powers. Under this duty, courts exercising equitable jurisdiction have fashioned a tool for limited judicial control of the exercise of directors’ powers and management decisions generally. The review standard reflects judicial reluctance to intervene in corporate decision making, much less to second-guess directors’ business judgments; yet, evolution of the duty has inexorably led to increased judicial intervention in board decisions and to substitution of judicial views for those of directors, at least in egregious cases. The contours of the duty therefore mark out the boundaries of the judicial role in reviewing directors’ discretions and intervening in their decision making. The elements of the duty to act in good faith [7.225] The traditional formulation expressing the duty of good faith requires directors to act

bona fide for the benefit of the company as a whole. The formulation is in the same terms as that which has traditionally expressed the equitable limitation upon the exercise of shareholder voting power (see [8.15]); its content varies, however, between the two contexts, reflecting the fiduciary character of directors’ powers in contrast to those of shareholders. 183 179 180 181

Carlen v Drury (1812) 1 Ves & B 154; 35 ER 61 at 158 (Ves & B), 63 (ER) (the case was decided with respect to a partnership and not a registered company); see A J Boyle (1965) 28 MLR 317. Fraser v Whalley (1864) 2 Hem & M 10; 71 ER 361. Howard Smith Ltd v Ampol Petroleum Ltd at 832; Harlowe’s Nominees Pty Ltd v Woodside (Lakes Entrance) Oil Co Pty Ltd (1968) 121 CLR 483 at 493 ([7.265]).

182

Burland v Earle [1902] AC 83 at 93.

183

Traditionally, the duty of good faith has been characterised as fiduciary: see, eg, Ngurli Ltd v McCann (1953) 90 CLR 425 at 438-439 (see [7.270]). An area of unresolved conflict arises from statements made by six

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The composite phrase is not readily divisible into discrete elements; certainly, in neither application (viz, to shareholder resolutions or directors’ actions) does it embody cumulative requirements of subjective good faith on the part of the directors (or shareholders) and objective benefit to the company. 184 In its application to directors, the inquiry is directed to the intention, motive and beliefs of the directors, and whether they have made the interests of the company their principal consideration. Thus, directors will abuse their discretionary powers if they use them in order to achieve an advantage for themselves, 185 to confer a benefit upon a third party, a shareholder or class of shareholders 186 or a stranger to the company, 187 or to damage the company itself. The modern duty of good faith comprises three distinct, independent but interrelated duties applicable to directors when acting as such and exercising corporate powers. Each duty sustains an independent ground for judicial review and intervention in directors’ decisions. Indeed, there is much to be said for the view that the obligations referred to as duties are more appropriately considered primarily as grounds for judicial intervention or review of directors’ action. 188 The duty of subjective good faith [7.230] The first obligation is a duty to act honestly in the company’s interests as the directors

perceive those interests. This element might be termed a duty of honesty or of subjective good faith. While the good faith of each director is determined objectively by the court, the process of judicial review is otherwise confined to inquiry as to each director’s subjective intent. Certain decisions emphasise this element of duty, for instance, Re Smith and Fawcett Ltd [7.255] and Harlowe’s Nominees Pty Ltd v Woodside (Lakes Entrance) Oil Company NL [7.265]. Honest belief that action is in the company’s interest is a necessary but not, however, judges of the High Court in Breen v Williams (1996) 186 CLR 1, a case concerning patients’ access rights to their medical records; see also Pilmer v The Duke Group Ltd (in liq) (2001) 207 CLR 165 at 198. Those statements apparently accept the proposition that fiduciary duties are proscriptive, not prescriptive: they stop fiduciaries from doing things but do not compell action. The grant of special leave to appeal to the High Court from the decision of the Court of Appeal of Western Australia in the Bell Group litigation would have permitted the Court to address the issue; that resolution was thwarted by the late settlement of the litigation. At first instance in the Bell Group litigation, Owen J did not consider that these two cases had overruled earlier High Court authorities treating the duty as fiduciary despite its positive obligation with respect to the exercise of corporate powers: Bell Group (in liq) Ltd v Westpac Banking Corp (2008) 70 ACSR 1 at [4569]-[4572]. A majority of the Court of Appeal agreed. Lee AJA considered that prescriptive obligations might arise in the course of a fiduciary relationship, referring by way of example, to Chan v Zacharia (1984) 154 CLR 178 (see [1.155]): Westpac Banking Corporation v The Bell Group Ltd (in liq) (No 3) (2012) 89 ACSR 1 at [897]-[212]; Drummond AJA stated that directors “undoubtedly stand in a fiduciary relationship with their company and … have long been subject to duties to act bona fide in the interests of the company and to exercise their powers for proper purposes, both of which have long been described as fiduciary obligations. If the fiduciary obligations of directors to their company are limited to the two prescriptive ones, not to benefit and not to be in a conflict situation, an extensive revision of the law governing directors’ duties must have taken place without any examination of the particular issue at the intermediate or final appellate level” (at [1962]). 184

Peters’ American Delicacy Co Ltd v Heath (1939) 61 CLR 457 at 509; Sidebottom v Kershaw Leese & Co Ltd [1920] 1 Ch 154 at 167, 172.

185

Re National Provincial Marine Insurance Co; Gilbert’s Case (1870) 5 Ch App 559; Alexander v Automatic Telephone Co [1900] 2 Ch 56.

186

See, eg, European Assurance Society, Manistry’s Case (1873) 17 Sol Jo 745; Spackman v Evans (1868) LR 3 HL 171; Kerry v Maori Dream Gold Mines Ltd (1898) 14 TLR 402. See, eg, Anglo-French Co-operative Society; ex p Pelly (1882) 21 Ch D 492.

187 188

This “often overlooked” part of fiduciary law has recently been emphasised along with its similarities with the judicial review of administrative action: Grimaldi v Chameleon Mining NL (No 2) (2012) 87 ACSR 260 at [174]. [7.230]

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sufficient condition of the validity of their action; the decision may be vitiated by breach of either of two other elements of duty, each of which has an objective content and sustains judicial review by reference to objective grounds. The duty to exercise powers for a proper purpose [7.235] The second element is a duty upon directors to exercise corporate powers only for the

purposes for which they were granted to directors. This duty permits courts to invalidate decisions taken by directors where their motivating purpose is one which a court interprets as beyond those for which the particular power may legitimately be exercised or is not to benefit the company generally. While the purpose limitation of some specific powers may be precisely expressed, other powers may be so general in character that the purposes for which they may be exercised cannot be more precisely defined other than by reference to a general “corporate purpose” or to the director’s intention to benefit the company. In Ngurli Ltd v McCann [7.270] at 438-440 the High Court identified the origin of the doctrine of equitable fraud in the proper purpose doctrine in equitable doctrines relating to fraud upon powers of appointment given by one person to another with respect to disposition of their property. These doctrines enjoin the donee of a power from exercising it for a purpose foreign to that for which it was granted. Directors may therefore exercise a power for an improper purpose even though they derive no personal benefit from their decision and are motivated by an honest belief that they are acting in the best interests of the company. Some applications of the duty of good faith do not distinguish between the good faith and purpose elements as independent heads of duty but invoke each as a synonymous expression of a single underlying equitable obligation. Thus, it is said that a discretionary power must be exercised by directors “bona fide – that is, for the purpose for which it was conferred, not arbitrarily or at the absolute will of the directors, but honestly in the interest of the shareholders as a whole.” 189 The relationship between the obligation to act in good faith and the proper purpose doctrine is not always transparent in case law. In most instances the need to distinguish between the elements is unnecessary since the directors’ conduct may be characterised equally as lacking subjective good faith or motivated by an improper purpose. This will be the case especially where the purpose characterisation of the corporate power in question is solely in terms of intent to benefit the company. The need to distinguish between the subjective good faith and the proper purpose requirements becomes important, therefore, where the power in question is capable of more objective characterisation. In such cases, action taken by directors for a purpose that a court considers improper will not be saved by the directors’ honest belief that they are acting in the interests of the company. This became clear in decisions since the 1960s where courts have invalidated directors’ decisions upon the basis that the purposes animating their decision were improper notwithstanding the subjective good faith with which those decisions were taken: see, for example, Hogg v Cramphorn Ltd [7.275] and Howard Smith Ltd v Ampol Petroleum Ltd [7.285]. The strict fiduciary standard does not sit comfortably with the realities of the director’s office, especially in proprietary companies, where directors will often have a shareholding interest in the company. Accordingly, a mixed purposes doctrine has been developed by the courts to temper the rigour of the equitable rule. Thus, in Mills v Mills Latham CJ said that to invalidate their action merely for the fact of such interest would be to set “an impossible standard” and require directors “to live in an unreal region of detached altruism”. 190 He 189

Australian Metropolitan Life Assurance Co Ltd v Ure (1923) 33 CLR 199 at 217 ([7.260]) per Isaacs J (original emphasis); Ngurli Ltd v McCann (1953) 90 CLR 425 at 444 ([7.270]) (“If, in fact, he exercised power for an ulterior purpose it would not be in law a bona fide exercise thereof”).

190

Mills v Mills (1938) 60 CLR 150 at 163.

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posed the test of validity in terms of “[w]hat was ‘the moving cause’ of the action of the directors?” 191 Dixon J expressed the attenuation rationale and rule thus: When the law makes the object, view or purpose of a man, or of a body of men, the test of the validity of their acts, it necessarily opens up the possibility of an almost infinite analysis of the fears and desires, proximate and remote, which, in truth, form the compound motives usually animating human conduct. But logically possible as such an analysis may seem, it would be impracticable to adopt it as a means of determining the validity of the resolutions arrived at by a body of directors, resolutions which otherwise are ostensibly within their powers. The application of the general equitable principle to the acts of directors managing the affairs of a company cannot be as nice as it is in the case of a trustee exercising a special power of appointment. It must, as it seems to me, take the substantial object the accomplishment of which formed the real ground of the board’s action. If this is within the scope of the power, then the power has been validly exercised. But if, except for some ulterior and illegitimate object, the power would not have been exercised, that which has been attempted as an ostensible exercise of the power will be void, notwithstanding that the directors may incidentally bring about a result which is within the purpose of the power and which they consider desirable. 192

Many of the modern decisions on proper purposes have been concerned with the question whether directors’ powers may be exercised with the purpose or effect of manipulating control of the company; indeed, the disputed exercise of directors’ powers has arisen in several cases as part of a contest for control of the company: see Hogg v Cramphorn Ltd [7.275], Teck Corp Ltd v Millar [7.280], Howard Smith Ltd v Ampol Petroleum Ltd [7.285], Cayne v Global Natural Resources Plc [7.290] and Whitehouse v Carlton Hotel Pty Ltd [7.295]. Underlying this issue is the question of the proper constitutional balance of power and prerogative between directors and shareholders within the company. Several of these cases have arisen in the context of contested takeovers. Litigation became a common takeover defence strategy in Australia during the 1980s. Amendments to the Act made in 2000 preclude court proceedings in relation to a takeover bid or other acquisitions of voting shares that engage a threshold short of corporate control. These provisions assign a virtually exclusive dispute resolution role to the Takeovers Panel which has developed a frustrating action doctrine that looks not to target directors’ motive and purpose but solely to the impact of their conduct upon the bid. The provisions apply to acquisitions of shares in listed companies and those with more than 50 members: see Chapter 12. Their effect is to diminish the practical significance of fiduciary rules for listed and other companies in such contexts although directors’ conduct may still be tested against these standards in civil and criminal proceedings commenced after the conclusion of the bid or during its currency with the consent of ASIC or the Minister: s 659B(1). Such consent would be wholly exceptional. The duty to consult and act by reference to company interests [7.240] The third element is a duty to consult, and act by reference to, those interests which

the law identifies as the interests of the company, and to have regard to outside interests only derivatively, if at all. The duty to consult company interests represents a longstanding ground of judicial review that is not tied to the individual director’s subjective good faith and denies directors the role of definitive interpreters of company interests. Thus, in Hutton v West Cork Railway Co, Bowen LJ said concerning the scope of implied powers to apply corporate funds: 191 192

Mills v Mills (1938) 60 CLR 150 at 165. Mills v Mills (1938) 60 CLR 150 at 185-186. [7.240]

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Bona fides 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. 193

The duty to consult company interests and the proper purpose duty, in so far as the latter is founded upon objective purpose characterisation, create a wider role for judicial intervention through review of directors’ decisions than under the subjective duty of good faith. The legal conception of company interests which directors are bound to consult appears above in several of the decisions extracted here, particularly the formulation of Evershed MR in Greenhalgh v Arderne Cinemas Ltd 194 quoted in Ngurli Ltd v McCann [7.270] at 438 and in Parke v Daily News Ltd [7.300] and the second extract from Teck Corp Ltd v Millar [7.305]. The particular application of these general principles to corporate groups is examined at [7.315]. This legal issue, in the specific aspect of the permitted scope of recognition of nonshareholder stakeholder interests, lies at the heart of the questions posed at [2.200]–[2.205] with respect to the corporate purpose and objective and corporate social responsibility. Where directors act by reference to interests extraneous to those recognised by law as the interests of the company, their action will not be saved by their honest belief that they are acting for the company’s benefit. Of course, directors’ conduct which is not founded upon an honest belief as to company benefit may offend each of the other heads of duty. The three elements of duty identified here mark out realms of conduct that will sustain judicial intervention in directors’ decisions. The three spheres are substantially overlapping so that particular conduct may fall within each of the three; in this case, each duty provides an alternative expression of the vitiating element of the decision. In other instances, varying with the purpose specificity of the corporate power, one sphere only might sustain judicial review for directors’ failure to act in good faith.

The individual subjects of the duty [7.245] While the duty of good faith in each of its elements primarily attaches to the exercise of powers vested in directors acting collectively as a board, the duty is owed by directors individually. Whether the duty has been breached, and the consequent validity of the directors’ decision, is tested by inquiry as to each individual director’s intention and purpose; the validity of the directors’ decision is determined by reference to the motives and purposes animating a majority of the board. Of course, where the relevant corporate power is vested in an individual, for example, by the corporate constitution in a governing director 195 or by delegation from the board to a managing director, the relevant purpose and intention is simply that of the individual director. In their formal expression in a number of cases, these duties apply to directors without corresponding reference to other corporate officers. This narrow focus reflects the development of doctrine prior to the modern separation between director and management roles in large business organisations and the rise of a senior management group within them. The doctrines apply equally, however, to action taken by other senior corporate officers exercising powers delegated to them by directors or vested in them by the corporate constitution.

The statutory duty of good faith [7.250] The general law duty of good faith is complemented by a specific statutory duty. A

director or other officer must exercise their powers and discharge their duties (a) in good faith 193

Hutton v West Cork Railway Co (1883) 23 Ch D 654 at 671 per Bowen LJ: see [7.300] at 950-952.

194

[1951] Ch 286 at 291.

195

See, eg, Whitehouse v Carlton Hotel Pty Ltd (1987) 162 CLR 285 at 291-292; Hannes v MJH Pty Ltd (1992) 7 ACSR 8; Kokotovich Constructions Pty Ltd v Wallington (1995) 17 ACSR 478.

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in the best interests of the company and (b) for a proper purpose: s 181(1). A person who is involved in a contravention of s 181(1) contravenes s 181(2); both subsections are civil penalty provisions. In addition, a director or other officer commits an offence if they are (a) reckless or (b) intentionally dishonest and fail to exercise their powers and discharge their duties: (c) in good faith in the best interests of the corporation or (d) for a proper purpose: s 184(1). A predecessor provision simply required directors and officers to act honestly. In Marchesi v Barnes 196 Gowans J said of this provision: [T]o “act honestly” refers to acting bona fide in the interests of the company in the performance of the functions attaching to the office of director. A breach of the obligation to act bona fide in the interests of the company involves a consciousness that what is being done is not in the interests of the company, and deliberate conduct in disregard of that knowledge. … If the term “fraud” is applicable in this situation, it is only so in the sense of a “fraud on the power”. In effect, the common law obligation in respect of acting honestly … has been made a statutory duty.

This interpretation was widely 197 but not invariably 198 applied to successor provisions. The immediate predecessor to s 181(1) also required officers to act honestly and the additional reference to “dishonestly” in the criminal sanction in the predecessor to s 184(1) created particular difficulty. The Explanatory Memorandum accompanying the 2000 amendments to ss 181 and 184(1) explains the intent of the changes: The draft provisions overcome these difficulties by rewriting [the statutory duty] to mirror the fiduciary duty of a director to act in what they believe to be in the best interests of the corporation and for proper purposes. 199

Accordingly, the content of s 181(1) now reflects general law doctrines. The statutory duty is therefore breached by a director or officer who exercises powers with subjective good faith but for an improper purpose because the motivating purpose is beyond the purposes for which the power may legitimately be exercised: see [7.235]. If, however, the director or officer acts with (in the language of Gowans J in Marchesi v Barnes) “a consciousness that what is being done is not in the interests of the company, and deliberate conduct in disregard of that knowledge”, the contravention has criminal as well as civil consequences. As with the duty of care (see [7.75]), the statutory duty introduces the additional sanctions of the civil penalty scheme, adding a public element into the enforcement of the duty alongside private enforcement of the general law, a system of dual public and private wrongs for breach of duty.

196 197

[1970] VR 434 at 438. Fitzsimmons v R (1997) 23 ACSR 355; Southern Resources Ltd v Residues Treatment & Trading Co Ltd (1990) 3 ACSR 207; CAC v Papoulias (1990) 20 NSWLR 503; Morgan v Flavel (1983) 1 ACLC 831; ASIC v Maxwell (2007) 59 ACSR 373.

198

Australian Growth Resources Corp Pty Ltd v van Reesema (1988) 13 ACLR 261 (a contravention occurs when a director exercises powers for a purpose that the law considered improper, regardless of whether the director considered they were acting in the best interests of the company). See M J Whincop, “Directors’ statutory duties of honesty and propriety” in I M Ramsay (ed), Corporate Governance and the Duties of Company Directors (1997), p 125; R Carroll (1995) 5 Aust Jnl of Corp Law 214; V Mitchell (1994) 12 C&SLJ 231; B Fisse (1992) JBFLP 151.

199

Corporate Law Economic Reform Program Bill 1998, Explanatory Memorandum, [6.82]. [7.250]

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Re Smith and Fawcett Ltd [7.255] Re Smith and Fawcett Ltd [1942] Ch 304 Court of Appeal, England and Wales [A company was formed to take over the business carried on by two individuals, Smith and Fawcett. The company’s issued capital of 8,002 shares was divided equally between them and they were its only directors. Article 10 of the company’s articles provided: “The directors may at any time in their absolute and uncontrolled discretion refuse to register any transfer of shares.” Fawcett died. His executors applied to Smith as surviving director to be registered as members of the company and to have the plaintiff, Fawcett’s son and beneficiary, appointed as a director of the company. Smith refused to consent to the registration or appointment, but offered to register 2,001 shares and to buy the remaining 2,000 shares at a price to be fixed by himself. The plaintiff rejected this offer. After Smith had appointed his solicitor as a director of the company, the plaintiff again applied to be registered as a member. When the application was rejected, he sought to have the company’s share register rectified by inserting his name as holder of the 4,001 shares. The primary judge dismissed the application.] LORD GREENE MR: [306] The principles to be applied in cases where the articles of a company confer a discretion on directors with regard to the acceptance of transfers of shares are, for the present purposes, free from doubt. They must exercise their discretion bona fide in what they consider – not what a court may consider – is in the interests of the company, and not for any collateral purpose. They must have regard to those considerations, and those considerations only, which the articles on their true construction permit them to take into consideration, and in construing the relevant provisions in the articles it is to be borne in mind that one of the normal rights of a shareholder is the right to deal freely with his property and to transfer it to whomsoever he pleases. When it is said, as it has been said more than once, that regard must be had to this last consideration, it means, I apprehend, nothing more than that the shareholder has such a prima facie right, and that right is not to be cut down by uncertain language or doubtful implications. The right, if it is to be cut down, must be cut down with satisfactory clarity. It certainly does not mean that articles, if appropriately framed, cannot be allowed to cut down the right of transfer to any extent which the articles on their true construction permit. Another consideration which must be borne in mind is that this type of article is one which is for the most part confined to private companies. Private companies are in law separate entities just as much as are public companies, but from the business and personal point of view they are much more analogous to partnerships than to public corporations. Accordingly, it is to be expected that in the articles of such a company the control of the directors over the membership may be very strict indeed. There are, or may be very good business reasons why those who bring such companies into existence should give them a constitution which confers on the directors powers of the widest description. The language of the article in the present case does not point out any particular matter as being the only matter to which the directors are to pay attention in deciding whether or not they will allow the transfer to be registered. The article does not, for instance, say, as is to be found in some articles, that they may refuse to register any transfer of shares [307] to a person not already a member of the company or to a transferee of whom they do not approve. Where articles are framed with some such limitation on the discretionary power of refusal as I have mentioned in those two examples, it follows on plain principle that if the directors go outside the matters which the articles say are to be the matters and the only matters to which they are to have regard, the directors will have exceeded their powers. … [308] There is nothing, in my opinion, in principle or in authority to make it impossible to draft such a wide and comprehensive power to directors to refuse to transfer as to enable them to take into account any matter which they conceive to be in the interests of the company, and thereby to admit or not to admit a particular person and to allow or not to allow a particular transfer for reasons not personal to the transferee but bearing on the general interests of the company as a whole – such matters, for instance, as whether by their passing a particular transfer the transferee would obtain too great a weight in the councils of the company or might even perhaps obtain control. The question, therefore, simply is whether on the true construction of the particular article the directors are limited by anything except their bona fide view as to the interests of the company. In the present case the article is drafted in the widest possible terms, and I decline to write into that clear language any 472

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Re Smith and Fawcett Ltd cont. limitation other than a limitation, which is implicit by law, that a fiduciary power of this kind must be exercised bona fide in the interests of the company. Subject to that qualification, an article in this form appears to me to give the directors what it says, namely, an absolute and uncontrolled discretion. That being my view on the question of law in this case, it only remains to consider the issue of fact which has been raised. It is said that on the evidence before us we ought to infer that the directors here were purporting to exercise their power to refuse a transfer not bona fide in the interests of the company but for some collateral purpose, namely, the desire of the leading director to acquire part of the shares for himself at an undervalue. Speaking for myself, I strongly dislike being asked on affidavit evidence alone to draw inferences as to the bona fides or mala fides of the actors. If it is desired to charge a deponent with having given an account of his motives and his reasons which is not the true account, then the person on whom the burden of proof lies should take the ordinary and obvious course of requiring the deponent to submit himself to cross-examination. That does not mean that it is illegitimate in a proper case to draw inferences as to bona fides or mala fides in cases where there is on the face of the affidavit sufficient justification for doing so, but where the oath of the deponent is before the court, as it is here, and the only grounds on which the court is asked to disbelieve it are matters of inference, many of them of a [309] doubtful character, I decline to give to those suggestions the weight which is desired. In the present case the principal director has sworn an affidavit which, if accepted, makes it clear that, whether rightly or wrongly, the directors have bona fide considered the interests of the company and come to the conclusion that it would be undesirable to register the transfer of the totality of these shares. Accordingly, on the evidence I am satisfied, as the learned judge was satisfied, that there is no ground shown here for saying that the directors’ refusal has been due to anything but a bona fide consideration of the interests of the company as the directors see them. That being so, and that being, on the true construction of the article, the only matter to which the directors have to pay regard, I am of opinion that the learned judge was right in the conclusion to which he came and that this appeal fails. [Luxmore CJ and Asquith J agreed.]

Australian Metropolitan Life Assurance Company Ltd v Ure [7.260] Australian Metropolitan Life Assurance Company Ltd v Ure (1923) 33 CLR 199 High Court of Australia [A contest for control of an insurance company developed between two groups of shareholders. The majority of the board supported one faction. Mrs Ure, a leading member of the other faction, purchased a parcel of shares sufficient to enable the faction to command an ordinary resolution in general meeting and thereby procure the election of her husband to the board. The purchaser submitted share transfers to the board for registration. Article 21 conferred on the board a power to refuse to register share transfers without assigning a reason for its decision. The directors refused to register the transfers and gave no reason for their refusal although reference was made independently to Mr Ure being a disbarred solicitor. The directors also convened an extraordinary general meeting of the company to consider a resolution authorising the board to issue a substantial block of shares, half to existing members and half to staff and such other persons as the directors should think fit. Mrs Ure commenced proceedings to have the company register the transfers and to restrain the holding of the proposed meeting and the proposed share issue.] ISAACS J: [217] A regulation such as art 21 entrusts to the directors a corporate power, which is exercisable by them as agents of the company. But, although it is a power which necessarily involves some discretion, it must be exercised, as all such powers must be, bona fide – that is, for the purpose for which it was conferred, not arbitrarily or at the absolute will of the directors, but honestly in the interest of the shareholders as a whole. … The general character of such a regulation is clear, but the ambit of the purpose of the power of course varies with the circumstances of each particular case. The nature of the company, its constitution and the scheme of its regulations as a whole must all be taken into [7.260]

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Australian Metropolitan Life Assurance Company Ltd v Ure cont. account in determining whether a given factor comes within its range. Solvency of a transferee is, of course, important; for otherwise the mutual undertaking to contribute would be ineffectual, and creditors would be unjustly dealt with. But his solvency is not necessarily the only consideration. The reputation of the company may be an essential element of success, and where, as in the present case, the corporation is one appealing to the public for its confidence and transfers are presented which are of such magnitude as to control the whole administration of the company, the maintenance of a board of directors against whom not even a suggestion of reproach can be made is manifestly a high business consideration, which no person charged with the beneficial administration of the corporate affairs would be likely to overlook, in the interests of the shareholders as a whole. It is necessary to notice here an argument very strenuously pressed by [counsel for Ure]. [218] He urged that directors had no right to refuse a transfer to prevent a majority from carrying its way. That is true, but not completely true. The accuracy of the statement has its limits. A majority has not the right to destroy or injure the common property or otherwise deprive the minority of their rights. … If directors, possessing by the regulations the power of protecting and guiding the company’s affairs that the regulations of this company provide, honestly come to the conclusion that the general destruction or injury will ensue by reason of a proposed transfer of shares, it cannot be said that, because the transfer if effected by registration would enable a majority to effect its will, they are bound to register. Directors may be regularly displaced, or the articles may be regularly altered. But until that is done, the position is not doubtful. Directors obtain their powers from the consensus of all the shareholders as expressed in the articles because the primary maxim of corporate action is ubi major pars ibi totum, that is, the whole corporation: Grant on Corporations, p 68. The duty of directors is consequently primarily to the company itself. … The consensus of the shareholders is therefore not as individuals, and even if the whole of them were unanimously to attempt to withdraw the powers of the directors, it would be ineffectual unless done in the way prescribed by law. So long as the articles stand … the directors, and not the company by its general body of shareholders, have the power to manage the corporate affairs unless some provision to the contrary is found. … It follows that if the directors honestly acted upon the business consideration mentioned, it was within their power, even though a transient majority thought differently or desired differently. It is possible, of course, that the directors were not really moved by that legitimate consideration, but acted upon some extraneous reason, perhaps some unworthy reason. If they did, then their power is gone, and [219] the court would … hold that the right had become absolute and would direct registration. That depends on the facts, and the first thing to ascertain is the proper approach to them. It is well established that the onus of showing that a power has not been properly exercised is on the party complaining. … [220] It is provided by art 21 that the directors need not assign any reason for their refusal to register. They have preserved silence in this case. The authorities just cited establish that their silence is not a sufficient circumstance in itself on which to base an inference of impropriety. Indeed, it is part of the basic contract that no reason need be assigned. … But an applicant is not helpless; nor is the court deprived of its power to do justice in a proper case. The court will judge of circumstances, and form its conclusions on reasonable probabilities. It is for the applicant to place, if he can, such circumstances before the court as will reasonably lead to the conclusion that in some way an improper use has been made of the power, so that the discretion committed to the directors has not been exercised. In the House of Lords case, Hindle v John Cotton Ltd (1919) 56 Sc LR 625 at 630 Viscount Finlay said: Where the question is one of abuse of powers, the state of mind of those who acted, and the motive on which they acted, are all important, and you may go into the question of what their intention was, collecting from the surrounding circumstances all the materials which genuinely throw light upon that question of the state of mind of the directors so as to show whether they were honestly acting in discharge of their powers in the interests of the company or were acting from some bye-motive, possibly of personal advantage, or for any other reason. … [221] While silence per se is no starting point from which to infer impropriety, silence preserved when once a prima facie case of impropriety is presented may be entirely different. There is no initial duty to 474

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Australian Metropolitan Life Assurance Company Ltd v Ure cont. speak created by the mere refusal to register, but such a duty may arise from proof of circumstances pointing in themselves, if unexplained, either affirmatively to the existence of an unjustifiable reason or negatively to the absence of any legitimate reason. Applying those rules of guidance to the circumstances of this case, I am clear that the applicant has not discharged the required onus. On the contrary, I am morally clear, notwithstanding the official silence of the directorate as to their reasons, that the basic ground of objection was the genuine apprehension of, humanly speaking, the certain results that would follow upon registration, namely, first the election of Mrs Ure’s husband to the directorate through the commanding voting power that she, moved by her husband, would exert … and then the disruption of the directorate, a want of harmonious company-operation, and possibly a general prejudicial effect on the company as a whole. That being so, the matter was one which by the terms of the social compact rested within the uncontrolled discretion of the directors. Acting entirely within the scope of their power, honestly basing their action on their own business opinion, they were exercising a function with [222] which no court can interfere, and over which no court has any jurisdiction of review or appeal. [Knox CJ and Starke J delivered concurring judgments.]

Harlowe’s Nominees Pty Ltd v Woodside (Lakes Entrance) Oil Company NL [7.265] Harlowe’s Nominees Pty Ltd v Woodside (Lakes Entrance) Oil Company NL (1968) 121 CLR 483 High Court of Australia [Woodside was engaged in oil and gas exploration and had collaborated in its exploration activities with other companies including Burmah. It had an issued share capital of 20 million shares issued for 50 cents each, almost half of which sum was uncalled. Woodside directors were concerned that a “mystery buyer” was acquiring a substantial shareholding in the company through purchases on the stock exchange. In these circumstances Woodside made an allotment to Burmah of 9 million 50 cent shares paid to 10 cents per share at a premium of 20 cents each. Under the allotment agreement, Burmah was to pay the 10 cents per share upon application, was bound to payment of the premium notwithstanding forfeiture of the shares, but was entitled to full voting rights upon allotment and to appoint a nominee to Woodside’s board. Its share certificate was marked “Not negotiable until fully paid as to calls and premiums”. In the result Woodside had issued a block of approximately 38% of its issued capital, non-transferable for the immediate future, to a company with which it had close operational and management links. The mystery buyer (now unmasked) challenged the allotment upon the grounds that it was made in abuse of the directors’ power to issue shares, for the collateral and improper purpose of preventing the plaintiff from securing a position of influence in the company or at least without due consideration as to whether or not the issue was in the interests of the company as a whole. The plaintiff argued that Woodside did not stand in immediate need of the capital paid by Burmah and, indeed, being a no liability company unable to enforce future calls, was securing no tangible long-term capital or related benefits. Relying upon an obiter statement of Williams J in Grant v John Grant & Sons Pty Ltd (1950) 82 CLR 1 at 32, the plaintiff contended that, as a corollary to the general fiduciary principle, it could not be suggested that the power to issue shares had been exercised bona fide in the interests of the company unless the company had at the time an immediate need for the capital secured by the new issue.] BARWICK CJ, McTIERNAN and KITTO JJ: [492] In many a case this [suggested corollary] may be true as a proposition of fact; but in our opinion it is not true as a general proposition of law. To lay down narrow lines within which the concept of a [493] company’s interests must necessarily fall would be a serious mistake. … The principle is that although primarily the power is given to enable capital to be raised when required for the purposes of the company, there may be occasions when the directors may fairly and properly issue shares for other reasons, so long as those reasons relate to a purpose of [7.265]

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Harlowe’s Nominees Pty Ltd v Woodside (Lakes Entrance) Oil Company NL cont. benefiting the company as a whole, as distinguished from a purpose, for example, of maintaining control of the company in the hands of the directors themselves or their friends. An inquiry as to whether additional capital was presently required is often most relevant to the ultimate question upon which the validity or invalidity of the issue depends; but that ultimate question must always be whether in truth the issue was made honestly in the interests of the company. … Directors in whom are vested the right and the duty of deciding where the company’s interests lie and how they are to be served may be concerned with a wide range of practical considerations, and their judgment, if exercised in good faith and not for irrelevant purposes, is not open to review in the courts. Thus in the present case it is not a matter for judicial concern, if it be the fact, that the allotment to Burmah would frustrate the ambitions of someone who was buying up shares as opportunity offered with a view to obtaining increased influence in the control of the company, or even that the directors realised that the allotment would have that result and found it agreeable to their personal wishes. … But if, in making the allotment, the directors had an actual purpose of thereby creating an advantage for themselves otherwise than as members of the general body of shareholders, as for instance [494] by buttressing their directorships against an apprehended attack from such as Harlowe, the allotment would plainly be voidable as an abuse of the fiduciary power, unless Burmah had no notice of the facts. [The court concluded that Woodside’s directors had not offended these principles. It found ample evidence to support the primary judge’s conclusion that the directors’ purpose in issuing the shares was to give Woodside vastly greater freedom to plan for future joint operations with Burmah and so ensure its long-term stability, rather than the impermissible purpose of defeating the mystery buyer. On the plaintiff’s alternative submission, the court declined to interfere with the primary judge’s findings that each director had addressed his mind to the needs of the company, however imprecise, intuitive and possibly erroneous his appreciation might have been.]

Ngurli Ltd v McCann [7.270] Ngurli Ltd v McCann (1953) 90 CLR 425 High Court of Australia [Clifford Southcott had substantial shareholdings in Southcott Ltd. For tax avoidance purposes, he formed four companies (referred to in the report as the holding companies) and transferred to each company 2,000 of his shares in Southcott Ltd. The purchase price in each transaction was left outstanding as an unsecured interest-free debt. As part of the tax avoidance scheme, in each company 60 out of the 61 issued shares were allotted to Clifford’s sister and her daughter (the McCanns). The other share in each company was designated as the life governor’s share and was held by Clifford. Under the articles of each company, this share conferred upon its holder complete control of the company including full powers vested in the corporate organs. The four companies received dividends from Southcott Ltd which moneys were applied towards repayment of the debts to Clifford. Clifford bequeathed to his brother Horace the four life governor’s shares and the debts from the four companies. However, under the articles of each company the life governor’s share would lose its control (including the power to appoint a new governing director who would enjoy full board powers) when it ceased to be held by Clifford or his legal personal representative. Each life governor’s share would then rank equally in all respects with the shares held by the McCanns. Clifford died. Before the administration of his estate was complete, Horace and the trustee company which Clifford had appointed as his executor took steps to transfer to Horace the voting control of each company which had always attached to the life governor’s shares (but which would be brought to an end by the completion of the administration of Clifford’s estate). Meetings of each company were held at which Horace was appointed governing director and as such he issued 4,199 £1 shares in each company to the trustee company in satisfaction of debts owed to Clifford’s estate, upon the understanding with Horace that he, being entitled under the will to these debts, would have 476

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Ngurli Ltd v McCann cont. transferred to him the shares so issued. A dividend was then declared and distributed upon the basis of shareholdings as they stood after the allotment. The McCanns challenged the capitalisation of the debts.] WILLIAMS ACJ, FULLAGAR and KITTO JJ: [438] But the powers conferred on shareholders in general meeting and on directors by the articles of association of companies can be exceeded although there is a literal compliance with their terms. These powers must not be used for an ulterior purpose. The term fraud in connection with frauds on a power does not necessarily denote any conduct on the part of the appointor amounting to fraud in the common law meaning of the term or any conduct which could be properly termed dishonest or immoral. It merely means that the power has been exercised for a purpose, or with an intention, beyond the scope of or not justified by the instrument creating the power (Vatcher v Paull [1915] AC 372 at 378 per Lord Parker). “The court will not allow him” (that is the appointor) “to interpret the donor’s intention in any other sense than the court itself holds to be the true construction of the instrument creating the power; and a literal execution of the power, with a purpose which it does not sanction, is regarded as a fraud on the power” (Topham v Duke of Portland (1869) 5 Ch App 40 at 59 per Hatherley LC). Voting powers conferred on shareholders and powers conferred on directors by the articles of association of companies must be used bona fide for the benefit of the company as a whole. In Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286 at 291, Evershed MR, in a case relating to a special resolution altering the articles of association, said: In the first place, I think it is now plain that “bona fide for the benefit of the company as a whole” means not two things but one thing. It means that the shareholder must proceed upon what, in his honest opinion, is for the benefit of the company as a whole. The second thing is that the phrase, “the company as a whole,” does not (at any rate in such a case as the present) mean the company as a commercial entity, distinct from the corporators: it means the corporators as a general body. That is to say, the case may be taken of an individual hypothetical member and it may be asked whether what is proposed is, in the honest opinion of those who voted in its favour, for that person’s benefit. There are two lines of cases in which it has been held that the courts will interfere to prevent the abuse of powers conferred by articles of association. One instance is where it is necessary to prevent an abuse by the majority of the powers [439] conferred upon a company in general meeting. The other instance is where it is necessary to prevent an abuse by the directors of the powers conferred on them by the articles. The court is more ready to interfere in the second than it is in the first instance. Shareholders even where they are also directors are not trustees of their votes and as individuals in general meetings can usually exercise their votes for their own benefit. But there is a limit even in general meetings to the extent to which the majority may exercise their votes for their own benefit. That limit is expressed in the classic passage from the judgment of Lindley MR in Allen v Gold Reefs of West Africa [1900] 1 Ch 656 at 671. The power of a three fourths majority to alter the articles of association must, Lord Lindley said “like all other powers, be exercised subject to those general principles of law and equity which are applicable to all powers conferred on majorities and enabling them to bind minorities. It must be exercised, not only in the manner required by law, but also bona fide for the benefit of the company as a whole, and it must not be exceeded”. … The powers entrusted to the directors by the articles of association to be exercised on behalf of the company are fiduciary powers. In Peters’ American Delicacy Company Ltd v Heath (at 482), Latham CJ pointed out that where the validity of acts of directors exercising a fiduciary power is questioned, a higher standard would be required than in the case of shareholders who did not, in voting at a general meeting, exercise any power of a fiduciary nature. In the present case we are concerned with the exercise by Horace Southcott of his fiduciary power as a director to issue new shares. The boundary between the proper and improper use of such a power is discussed in this court in Mills v Mills (1938) 60 CLR 150. The power must be used bona fide for the purpose for which it [440] was conferred, that is to say, to raise sufficient capital for the benefit of the company as a whole. It must not be used under the cloak of such a purpose for the real purpose of benefiting some shareholders or their friends at the expense of other shareholders or so that some [7.270]

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Ngurli Ltd v McCann cont. shareholders or their friends will wrest control of the company from the other shareholders. In the present case Horace Southcott was the donee of this fiduciary power. It was still a fiduciary power although he could issue the new shares to the trustee company, if it agreed to accept them on trust for himself to the exclusion of the McCanns. He could take advantage of the power to benefit himself if such a benefit was incidental to a bona fide exercise of the power but he could not use the power ostensibly to benefit the company but really to benefit himself at the expense of the McCanns. In Hirsche v Sims [1894] AC 654 at 660, 661, Lord Selborne said: “If the true effect of the whole evidence is, that the defendants truly and reasonably believed at the time that what they did was for the interest of the company, they are not chargeable with dolus malus or breach of trust merely because in promoting the interest of the company they were also promoting their own.” In Mills v Mills, the present Chief Justice [then Dixon J] said: Directors of a company are fiduciary agents, and a power conferred upon them cannot be exercised in order to obtain some private advantage or for any purpose foreign to the power. It is only one application of the general doctrine expressed by Lord Northington in Aleyn v Belchier (1758) 1 Eden 132 at 138; 28 ER 634 at 637: “No point is better established than that, a person having a power, must execute it bona fide for the end designed, otherwise it is corrupt and void”. The interests of the McCanns, who held 60 of the 61 issued shares in each holding company, were interests which Horace was bound to take into account in deciding whether it would be in the interests of the corporators as a whole to liquidate the debts of £4,199 by the issue of new shares at par. It is unfortunate that he died on 8 October 1949, before the hearing of the suit, and that his evidence was not available, but there is ample evidence, we think, to support the inference drawn by both Mayo J and the Full Supreme Court that Horace, on 20 December 1948, was intent only upon advancing his own interests and left the interests of the McCanns completely out of account. He was not thinking of what would benefit the corporators as a whole. He was thinking only of what would benefit himself.

Hogg v Cramphorn Ltd [7.275] Hogg v Cramphorn Ltd [1967] Ch 254 Chancery Division [The defendant company carried on a business previously conducted in unincorporated form by the family of its chairman and managing director, Cramphorn. Cramphorn was approached by Baxter who sought to acquire the whole of the company’s issued capital. Cramphorn thought that if Baxter acquired control there would be a harmful change in the nature of the company’s trading activities and, indeed, that any offer from him would itself have an unsettling effect upon the company’s staff. Cramphorn informed his fellow directors of Baxter’s intention. They responded by creating a trust for the benefit of company employees, appointing as trustees Cramphorn, an accountant from the company’s auditors and a representative of the staff. The directors issued 5,707 shares to the trustees, the subscription money to be paid from funds advanced for that purpose to the trustees as an interest-free loan (specific statutory facility for employee share schemes is now contained in s 260C(4)). These shares were issued with voting rights sufficiently weighted to ensure that the directors, their supporters and the trustees would enjoy the major voting power in the company. The directors then informed Baxter that they considered his proposed offer price to be inadequate and that they did not intend placing his offer before shareholders. Baxter allowed the bid to lapse. Nonetheless, an associate holding some 50 shares challenged the issue of shares to the trustees as an improper exercise of power and, in the alternative, the attachment of special voting rights to the trustees’ shares as beyond the directors’ powers. Buckley J held that under the company’s articles the directors had no power to attach special voting rights to shares. However, he held that, while the trustees might have been entitled to have the allotment set aside upon this ground, the plaintiff was not so entitled.] 478

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Hogg v Cramphorn Ltd cont. BUCKLEY J: [265] I now turn to what has been the main matter of debate in this case, which is whether the allotment of the 5,707 shares was an improper use by the directors of their discretionary and fiduciary power under [the company’s constitution] to decide to whom these unissued shares should be allotted. [Counsel for the plaintiff] has submitted that the allotment was made with the primary object of preventing Mr Baxter from obtaining control of the company and ousting the then existing board of directors and that the allotment was accordingly a breach of the directors’ fiduciary duties and should be set aside. … In this connection, I should, I think, ignore the fact that the directors were incompetent to attach to the shares the special voting rights which they purported to attach to them. It is common ground that the scheme of which this allotment formed part was formulated to meet the threat, as the directors regarded it, of Mr Baxter’s offer. The trust deed would not have come into existence, nor would the 5,707 shares have been issued as they were, but for Mr Baxter’s bid and the threat that it constituted to the established management of the company. It is also common ground that the directors were not actuated by any unworthy motives of personal advantage, but acted as they did in an honest belief that they were doing what was for the good of the company. Their honour is not in the least impugned, but it is said that the means which they adopted to attain their end were such as they could not properly adopt. I am satisfied that Mr Baxter’s offer, when it became known to the company’s staff, had an unsettling effect upon them. I am also satisfied that the directors and the trustees of the trust deed genuinely considered that to give the staff through the trustees a sizeable, though indirect, voice in the affairs of the company would benefit both the staff and the company. I am sure that Colonel Cramphorn and also probably his fellow directors firmly believed that to keep the management of the company’s affairs in the hands of the existing board would be more advantageous to the shareholders, the company’s staff and its customers than if it were committed to a board selected by Mr Baxter. The steps which the board took were intended not only to ensure that if Mr Baxter succeeded in obtaining a shareholding which, as matters stood, [266] would have been a controlling shareholding, he should not secure control of the company, but also, and perhaps primarily, to discourage Mr Baxter from proceeding with his bid at all. [Counsel for the company and the trustees] has submitted that a trading company and its board of directors are fully entitled to take an interest in who becomes a member of the company and to arrange or influence matters in such a way that a particular person shall not become a member. In the present case he says that the board were entitled to try to kill Mr Baxter’s bid, if in doing so they acted in good faith, having regard to what they believed to be the interests of the company, and if the means they employed were lawful. … Accepting as I do that the board acted in good faith and that they believed that the establishment of a trust would benefit the company, and that avoidance of the acquisition of control by Mr Baxter would also benefit the company, I must still remember that an essential element of the scheme, and indeed its primary [267] purpose, was to ensure control of the company by the directors and those whom they could confidently regard as their supporters. Was such a manipulation of the voting position a legitimate act on the part of the directors? Somewhat similar questions have been considered in the well-known cases of Punt v Symons & Co Ltd [1903] 2 Ch 506 and Piercy v S Mills & Co Ltd [1920] 1 Ch 77. In Punt v Symons & Co Ltd the directors had issued shares with the object of creating a sufficient majority to enable them to pass a special resolution depriving other shareholders of special rights conferred on them by the company’s articles. In Piercy v S Mills & Co Ltd the directors had issued shares with the object of creating a sufficient majority to enable them to resist the election of three additional directors, whose appointment would have put the two existing directors in a minority on the board. In each case the directors were held to have acted improperly. In Punt v Symons & Co Ltd Byrne J said: A power of the kind exercised by the directors in this case, is one which must be exercised for the benefit of the company: primarily it is given them for the purpose of enabling them to raise capital when required for the purposes of the company. There may be occasions when the directors may fairly and properly issue shares in the case of a company constituted like the present for other reasons. For instance, it would not be at all an unreasonable thing to create [7.275]

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Hogg v Cramphorn Ltd cont. a sufficient number of shareholders to enable statutory powers to be exercised; but when I find a limited issue of shares to persons who are obviously meant and intended to secure the necessary statutory majority in a particular interest, I do not think that is a fair and bona fide exercise of the power. In Piercy v S Mills & Co Ltd, Peterson J, after citing Fraser v Whalley (1864) 2 H & M 10; 71 ER 361 and Punt v Symons & Co Ltd said: The basis of both cases is, as I understand, that directors are not entitled to use their powers of issuing shares merely for the purpose of maintaining their control or the control of themselves and their friends over the affairs of the company, or merely for the purpose of defeating the wishes of the existing majority of shareholders. That is, however, exactly what has happened in the present case. With the merits of the dispute as between the directors and the plaintiff I have no concern whatever. The plaintiff and his friends held a majority of the shares of the company, and they were entitled, so long as that majority remained, to have their views prevail [268] in accordance with the regulations of the company; and it was not, in my opinion, open to the directors, for the purpose of converting a minority into a majority, and solely for the purpose of defeating the wishes of the existing majority, to issue the shares which are in dispute in the present action. With those observations I respectfully agree. Unless a majority in a company is acting oppressively towards the minority, this court should not and will not itself interfere with the exercise by the majority of its constitutional rights or embark upon an inquiry into the respective merits of the views held or policies favoured by the majority and the minority. Nor will this court permit directors to exercise powers, which have been delegated to them by the company in circumstances which put the directors in a fiduciary position when exercising those powers, in such a way as to interfere with the exercise by the majority of its constitutional rights; and in a case of this kind also, in my judgment, the court should not investigate the rival merits of the views or policies of the parties. Thus, in Fraser v Whalley Page Wood V-C said: “I say nothing on the question whether the policy advocated by the directors, or that which I am told is to be pursued by Savin, is the more for the interest of the company,” and in Piercy v S Mills & Co Ltd, Peterson J said that he had no concern whatever with the merits of the dispute. It is not, in my judgment, open to the directors in such a case to say, “We genuinely believe that what we seek to prevent the majority from doing will harm the company and therefore our act in arming ourselves or our party with sufficient shares to outvote the majority is a conscientious exercise of our powers under the articles, which should not be interfered with.” Such a belief, even if well-founded, would be irrelevant. A majority of shareholders in general meeting is entitled to pursue what course it chooses within the company’s powers, however wrong-headed it may appear to others, provided the majority do not unfairly oppress other members of the company. These considerations lead me to the conclusion that the issue of the 5,707 shares, with the special voting rights which the directors purported to attach to them, could not be justified by the view that the directors genuinely believed that it would benefit the company if they could command a majority of the votes in general meetings. The fact that, as I have held, the directors were mistaken in thinking that they could attach to these shares more than one vote [269] each is irrelevant. The power to issue shares was a fiduciary power and if, as I think, it was exercised for an improper motive, the issue of these shares is liable to be set aside. [Buckley J also held that the allotment to the trustees might be affirmed by the company in general meeting, provided the disputed shares were not voted. Accordingly, before setting the allotment aside, the judge stood the action over to allow the company in general meeting an opportunity to ratify the allotment. A footnote to the report indicates that a specially convened general meeting ratified the allotment, the establishment of the trust and the advance to the trustees.

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Teck Corp Ltd v Millar [7.280] Teck Corp Ltd v Millar (1973) 33 DLR (3d) 288 Supreme Court of British Columbia [Afton was formed in 1965 to take over certain mining claims in British Columbia. Afton lacked the resources for a full drilling program or to carry any mine into production. It was common for junior mining companies with potentially exploitable claims to seek a contract (known in the industry as the “ultimate deal”) with a major company to develop the property. Such contracts usually provided for the major to conduct an exploratory drilling program and, if successful, to develop the mine, providing the necessary technical, financial and marketing services. A major almost invariably required as part of the ultimate deal a bonus in the form of substantial equity in the junior company. Afton had been attempting to interest suitable majors in its claims but it was not until 1972, when favourable assay results were obtained from a limited drilling program, that it achieved any success with two companies expressing interest in making an ultimate deal – Teck and Placer, the latter through its Canadian subsidiary Canex. Afton’s directors were impressed by Placer’s reputation and its excellent record in mine development (in which Teck was relatively inexperienced). Accordingly they favoured Placer for future exploitation of the mine, although they continued to hold discussions with several majors (including Placer and Teck) on the development of the mines. A major issue in these negotiations was the size of the equity bonus a major would obtain upon the mine going into production. The Afton directors sought to keep this figure as low as possible. In late May 1972 the Afton directors and Placer realised that Teck was steadily buying Afton shares in the market and was close to securing control of the company. Their reaction was to accelerate negotiations and on 1 June, after Afton’s directors had been informed that Teck had acquired 52% of Afton’s capital, they signed an agreement with Canex. Under the agreement Canex assumed responsibility for the exploration and development of the Afton property and, if it elected to put it into production, would be allotted sufficient shares to bring its equity in Afton up to 30%. In the result the Afton directors had succeeded during the course of negotiations in reducing the bonus equity component of the deal from the 60% interest initially sought by Placer to 3%. The agreement was made in the face of an offer by Teck to make an ultimate deal twice as good as that offered by any other major, although it had proposed no specific terms. On behalf of itself and all other shareholders, Teck sued Afton, its directors and Canex, alleging that the Afton directors were actuated by an improper and extraneous purpose in making the agreement, seeking not the best interests of their company but to frustrate Teck’s attempt to obtain control. It alleged that since Canex knew of their purpose the agreement was accordingly null and void.] BERGER J: [309] Now counsel for Teck does not accuse the defendant directors of a crass desire merely to retain their directorships and their control of the company. Teck acknowledges that the directors may well have considered it to be in the best interests of the company that Teck’s majority should be defeated. Even so, Teck says, the purpose was not one countenanced by the law. … Counsel for Teck says the reasoning in Hogg v Cramphorn Ltd … is applicable in the case at bar. He says the defendant directors believed Teck would use its dominant position to compel Afton to give Teck the ultimate deal. They believed that under Teck’s management the property would not be developed as profitably as it would under Placer’s management. They also believed that the value of Afton’s shares, including their own, would decline, under Teck’s management. Therefore, the argument goes, the defendant directors entered into the contract with Canex so that shares would be allotted under the contract to defeat Teck’s majority. The case then is on all fours with Hogg v Cramphorn Ltd. Counsel for Teck says that Hogg v Cramphorn Ltd offers an elaboration of the rule that directors may not issue shares for an improper purpose. If their purpose is merely to retain control, that is improper. So much may be taken for granted. Counsel then goes on to say that Hogg v Cramphorn Ltd lays it down

[7.280]

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Teck Corp Ltd v Millar cont. that an allotment of shares, and any transaction connected with it, made for the purpose of defeating an attempt to secure a majority is improper, even if the directors genuinely consider that it would be deleterious to the company if those seeking a majority were to obtain control. This, it seems to me, raises an issue of profound importance in company law. Lord Greene MR expressed the general rule in this way in Re Smith and Fawcett Ltd: [312] “They [the directors] must exercise their discretion bona fide in what they consider – not what a court may consider – is in the interests of the company, and not for any collateral purpose.” Yet, if Hogg v Cramphorn Ltd is right, directors may not allot shares to frustrate an attempt to obtain control of the company, even if they believe that it is in the best interests of the company to do so. This is inconsistent with the law as laid down in Re Smith and Fawcett Ltd. How can it be said that directors have the right to consider the interests of the company, and to exercise their powers accordingly, but that there is an exception when it comes to the power to issue shares, and that in the exercise of such power the directors cannot in any circumstances issue shares to defeat an attempt to gain control of the company? It seems to me this is what Hogg v Cramphorn Ltd says. If the general rule is to be infringed here, will it not be infringed elsewhere? If the directors, even when they believe they are serving the best interests of the company, cannot issue shares to defeat an attempt to obtain control, then presumably they cannot exercise any other of their powers to defeat the claims of the majority or, for that matter, to deprive the majority of the advantages of control. I do not think the power to issue shares can be segregated, on the basis that the rule in Hogg v Cramphorn Ltd applies only in a case of an allotment of shares. Neither can it be distinguished on the footing that the power to issue shares affects the rights of the shareholders in some way that the exercise of other powers does not. The court’s jurisdiction to intervene is founded on the theory that if the directors’ purpose is not to serve the interest of the company, but to serve their own interest or that of their friends or of a particular group of shareholders, they can be said to have abused their power. The impropriety lies in the directors’ purpose. If their purpose is not to serve the company’s interest, then it is an improper purpose. Impropriety depends upon proof that the directors were actuated by a collateral purpose, it does not depend upon the nature of any shareholders’ rights that may be affected by the exercise of the directors’ powers. … [314] So how wide a latitude ought the directors to have? If a group is seeking to obtain control, must the directors ignore them? Or are they entitled to consider the consequences of such a group taking over? [315] My own view is that the directors ought to be allowed to consider who is seeking control and why. If they believe that there will be substantial damage to the company’s interest if the company is taken over, then the exercise of their powers to defeat those seeking a majority will not necessarily be categorised as improper. I do not think it is sound to limit the directors’ exercise of their powers to the extent required by Hogg v Cramphorn Ltd. … But the limits of their authority must be clearly defined. It would be altogether a mistake if the law, in seeking to adapt itself to the reality of corporate struggles, were to allow the directors any opportunity of achieving an advantage for themselves at the expense of the shareholders. … If the directors have the right to consider the consequences of a takeover, and to exercise their powers to meet it, if they do so bona fide in the interests of the company, how is the court to determine their purpose? In every case the directors will insist their whole purpose was to serve the company’s interest. And no doubt in most cases it will not be difficult for the directors to persuade themselves that it is in the company’s best interests that they should remain in office. Something more than a mere assertion of good faith is required. How can the court go about determining whether the directors have abused their powers in a given case? … I think the courts should apply the general rule in this way: The directors must act in good faith. Then there must be reasonable grounds for their belief. If they say that they believe there will be substantial damage to the company’s interests, then there must be reasonable grounds for that belief. If there are not, that will justify a finding that the directors were actuated by an improper purpose. … 482

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Teck Corp Ltd v Millar cont. [317] I am not prepared therefore to follow Hogg v Cramphorn Ltd. I think that directors are entitled to consider the reputation, experience and policies of anyone seeking to take over the company. If they decide, on reasonable grounds, a takeover will cause substantial damage to the company’s interests, they are entitled to use their powers to protect the company. That is the test that ought to be applied in this case. … [Berger J went on to say that, if he was wrong in rejecting Hogg v Cramphorn Ltd, that case was not applicable to the present facts. In Hogg, the directors’ primary purpose was to frustrate an attempt to obtain control of the company. The position was otherwise, however, in the instant case.] [328] I find their [viz, the Afton directors’] object was to obtain the best agreement they could while they were still in control. Their purpose in that sense was to defeat Teck. But, not to defeat Teck’s attempt to obtain control, rather it was to foreclose Teck’s opportunity of obtaining for itself the ultimate deal. That was, as I view the law, no improper purpose. In seeking to prevent Teck obtaining the contract, the defendant directors were honestly pursuing what they thought was the best policy for the company. … [330] I find here that the directors had a sufficient knowledge of Teck’s reputation, its technical and managerial capacity, and its previous experience, to consider the consequences of a take- [331] over. They decided to make a deal with Placer while they still had the power to do so. They wanted to see the company’s principal asset, its copper property, developed efficiently and profitably. They believed, and they had reasonable grounds for such belief, that the property would not be developed efficiently and profitably for the benefit of the shareholders, if Teck got control of it.

Howard Smith Ltd v Ampol Petroleum Ltd [7.285] Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 Privy Council [On 22 May 1972 Ampol Petroleum Ltd acquired a substantial parcel of shares in R W Miller (Holdings) Ltd (Millers) bringing its holdings to 30% of Millers’ capital. Two days later Ampol gave formal notice of its intention to make a takeover offer, at $2.27 per share, for all Millers’ shares it did not already hold. On 15 June Ampol made its formal offer to Millers’ shareholders. On 16 June senior management of Howard Smith Ltd called on Millers’ chairman and offered to purchase Millers’ tankers. The offer was rejected. There was, however, general agreement that it was undesirable that control of the tankers should fall to Ampol. The meeting concluded with an invitation to Howard Smith to make an offer for Millers’ shares. Within three days Millers’ management had given Howard Smith management comprehensive access to data as to the company’s financial position. On 22 June Howard Smith gave Millers formal notice of intention to make an offer for the whole of Millers’ issued capital at $2.50 per share. On the following day the Millers’ board resolved to recommend to shareholders that they reject the Ampol offer as inadequate. On 27 June Ampol and another Millers’ shareholder, Bulkships, announced that they intended to act jointly in relation to the future operation of Millers and that they had decided to reject any offer for their shares. Between them, Ampol and Bulkships controlled over 55% of Millers’ capital. The next Millers’ board meeting was scheduled for 6 July. In the intervening period discussions were held between management teams from Millers and Howard Smith. The developments in this period were described thus by the Privy Council (at 830): The position was then considered afresh by Howard Smith and the Millers’ management team and a plan was evolved to make an issue of shares to Howard Smith of sufficient size to convert Ampol and Bulkships together into minority shareholders, so that Howard Smith could proceed with its offer. Since this was higher than the Ampol offer, there was every prospect of it succeeding, and Howard Smith would then control Millers. The exact number of shares to be issued was worked out upon the basis of Millers known or assumed capital requirements and upon the footing of legal advice that an issue would be justified if, and only if, it were bona fide related to these requirements. Millers in fact did require some $10m to [7.285]

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Howard Smith Ltd v Ampol Petroleum Ltd cont. finance the tankers under construction and generally to secure its financial position, so it was calculated that, at an issue price of $2.30 per share, 4,500,000 shares needed to be issued; the figures were fixed accordingly. On 6 July, shortly before the Millers’ board meeting, Howard Smith applied for an allotment of 4,500,000 $1 ordinary shares at a premium of $1.30 per share. The letter read (at 830): This combination by the two largest shareholders of your company [viz, Ampol and Bulkships] would in the present circumstances effectively deprive the very large number of minority shareholders of R W Miller (Holdings) Ltd of the opportunity of securing a substantially higher price for their shares. My board would be most reluctant to proceed with a bid which, even if every shareholder other than Ampol or Bulkships accepted, could only result in Howard Smith Ltd being the largest individual shareholder in a company the future operations of which would be controlled by a combination of two smaller shareholders. We believe that your board is conscious of the injustice being suffered by your smaller shareholders and we submit for your consideration a proposal which, if it meets with the approval of your board, would enable Howard Smith Ltd to proceed with its intended offer thereby restoring to your minority shareholders the right to sell their shares to the highest bidder, and would give Ampol Petroleum Ltd and Bulkships Ltd a similar opportunity. The Millers’ board resolved, by a majority of four to two, to accept the Howard Smith application and 4,500,000 shares were allotted. Ampol challenged the allotment upon the bases: (1) that the directors who voted in favour of the allotment were actuated by the purpose of reducing the proportionate holding of Ampol and Bulkships in Millers; (2) that they did so with the purpose of defeating Ampol’s takeover offer and facilitating the Howard Smith bid; (3) that they did so for the purpose of preserving their own positions as directors; and thus (4) that they did not act bona fide in the interests of Millers as a whole. The findings of fact by Street J in the Supreme Court of New South Wales are summarised by Lord Wilberforce who delivered the judgment of the Privy Council.] LORD WILBERFORCE: [831] The judge found … that the Millers’ directors were not motivated by any purpose of personal gain or advantage, or by any desire to retain their position on the board. The judge said: I discard the suggestion that the directors of Millers allotted these shares to Howard Smith in order to gain some private advantage for themselves by way of retention of their seats on the board or by obtaining a higher price for their personal shareholding. Personal considerations of this nature were not to the forefront so far as any of these directors was concerned, and in this respect their integrity emerges unscathed from this contest. He then proceeded to consider the main issue which he formulated in accordance with the principle stated in the High Court of Australia by Dixon J in Mills v Mills (1938) 60 CLR 150 at 185-86 (see [7.235]). … This was to ascertain the substantial object the accomplishment of which formed the real ground of the board’s action. The issue before him he considered to be whether the primary purpose of the majority of directors was to satisfy Millers’ need for capital or whether their primary purpose was to destroy the majority holding of Ampol and Bulkships. … [833] After hearing and considering the evidence of [the majority directors] each asserting that his primary purpose in voting for the allotment on 6 July 1972, was to meet an urgent capital need of Millers, the judge found that he was unable to accept these assertions. He found that the primary purpose so far as the management team was concerned (this is not the directors, but the [management] team … which negotiated with Howard Smith) was to issue shares to Howard Smith so as to enable the Howard Smith takeover to proceed. As to the Millers’ majority directors he said: They had found themselves enmeshed in a takeover struggle. The greater part, if not the whole, of their thinking in the critical days up to and including 6 July was directed to this takeover situation. It is unreal and unconvincing to hear them assert in the witness box that their dominant purpose was to obtain capital rather than to promote the Howard Smith’s takeover offer, and I do not believe these assertions. 484

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Howard Smith Ltd v Ampol Petroleum Ltd cont. The conclusion that I have reached is that the primary purpose of the four directors in voting in favour of this allotment was to reduce the proportionate combined shareholding of Ampol and Bulkships in order to induce Howard Smith to proceed with its takeover offer. There was a majority bloc in the share register. Their intention was to destroy its character as a majority. The directors were, and had for some weeks been, concerned at the position of strength occupied by Ampol and Bulkships together. They were aware that in the light of the attitude of these two shareholders Howard Smith could not be expected to proceed with its takeover offer that these directors regarded as attractive. They issued the shares so as to reduce the interest of these two shareholders to something significantly less than that of a majority. This was the immediate purpose. The ultimate purpose was to procure the continuation by Howard Smith’s of the takeover offer made by that company. Their Lordships accept these findings. … [834] [T]he issue was clearly intra vires the directors. But, intra vires though the issue may have been, the directors’ power under this article is a fiduciary power: and it remains the case that an exercise of such a power, though formally valid, may be attacked on the ground that it was not exercised for the purpose for which it was granted. It is at this point that the contentions of the parties diverge. The extreme argument on one side is that, for validity, what is required is bona fide exercise of the power in the interests of the company: that once it is found that the directors were not motivated by self-interest – that is by a desire to retain their control of the company or their positions on the board – the matter is concluded in their favour and that the court will not inquire into the validity of their reasons for making the issue. All decided cases, it was submitted, where an exercise of such a power as this has been found invalid, are cases where directors are found to have acted through self-interest of this kind. On the other side, the main argument is that the purpose for which the power is conferred is to enable capital to be raised for the company, and that once it is found that the issue was not made for that purpose, invalidity follows. It is fair to say that under the pressure of argument intermediate positions were taken by both sides, but in the main the arguments followed the polarisation which has been stated. In their Lordships’ opinion neither of the extreme positions can be maintained. It can be accepted, as one would only expect, that the majority of cases in which issues of shares are challenged in the courts are cases in which the vitiating element is the self-interest of the directors, or at least the purpose of the directors to preserve their own control of the management; see Fraser v Whalley (1864) 2 H & M 10; 71 ER 361; Punt v Symons & Co Ltd [1903] 2 Ch 506; Piercy v S Mills & Co Ltd [1920] 1 Ch 77; Ngurli Ltd v McCann (1953) 90 CLR 425 and Hogg v Cramphorn Ltd at 267. Further it is correct to say that where the self-interest of the directors is involved, they will not be permitted to assert that their action was bona fide thought to be, or was, in the interest of the company; pleas to this effect have invariably been rejected (eg, Fraser v Whalley (1864) 2 H & M 10; 71 ER 361 and Hogg v Cramphorn Ltd [1967] Ch 254) – just as trustees who buy trust property are not permitted to assert that they paid a good price. But it does not follow from this, as the appellants assert, that the absence of any element of self-interest is enough to make an issue valid. Self-interest is only one, though no doubt the commonest, instance of improper motive: and, before one can say that a fiduciary power has been exercised for the purpose for which it was conferred, a wider investigation may have to be made. This is recognised in several well-known statements [835] of the law. Their Lordships quote the clearest which has so often been cited: Where the question is one of abuse of powers, the state of mind of those who acted, and the motive on which they acted, are all important, and you may go into the question of what their intention was, collecting from the surrounding circumstances all the materials which genuinely throw light upon that question of the state of mind of the directors so as to show whether they were honestly acting in discharge of their powers in the interests of the company or were acting from some bye-motive, possibly of personal advantage, or for any other reason (Hindle v John Cotton Ltd (1919) 56 Sc LR 625 at 630-631 per Viscount Finlay). [7.285]

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Howard Smith Ltd v Ampol Petroleum Ltd cont. On the other hand, taking the respondents’ contention, it is, in their Lordships’ opinion, too narrow an approach to say that the only valid purpose for which shares may be issued is to raise capital for the company. The discretion is not in terms limited in this way: the law should not impose such a limitation on directors’ powers. To define in advance exact limits beyond which directors must not pass is, in their Lordships’ view, impossible. This clearly cannot be done by enumeration, since the variety of situations facing directors of different types of company in different situations cannot be anticipated. No more, in their Lordships’ view, can this be done by the use of a phrase – such as “bona fide in the interest of the company as a whole”, or “some corporate purpose”. Such phrases, if they do anything more than restate the general principle applicable to fiduciary powers, at best serve, negatively, to exclude from the area of validity cases where the directors are acting sectionally, or partially: that is, improperly favouring one section of the shareholders against another. Of such cases it has been said: The question which arises is sometimes not a question of the interest of the company at all, but a question of what is fair as between different classes of shareholders. Where such a case arises some other test than that of the “interests of the company” must be applied (Mills v Mills at 164 per Latham CJ). In their Lordships’ opinion it is necessary to start with a consideration of the power whose exercise is in question, in this case a power to issue shares. Having ascertained, on a fair view, the nature of this power, and having defined as can best be done in the light of modern conditions the, or some, limits within which it may be exercised, it is then necessary for the court, if a particular exercise of it is challenged, to examine the substantial purpose for which it was exercised, and to reach a conclusion whether that purpose was proper or not. In doing so it will necessarily give credit to the bona fide opinion of the directors, if such is found to exist, and will respect their judgment as to matters of management; having done this, the ultimate conclusion has to be as to the side of a fairly broad line on which the case falls. The application of the general equitable principle to the acts of directors managing the affairs of a company cannot be as nice as it is [836] in the case of a trustee exercising a special power of appointment (Mills v Mills at 185-186 per Dixon J). The main stream of authority, in their Lordships’ opinion, supports this approach. [His Lordship referred to Punt v Symons & Co Ltd and quoted from the joint judgment in Harlowe’s Nominees Pty Ltd v Woodside (Lakes Entrance) Oil Co NL at 493. He also outlined the facts of Teck Corp Ltd v Millar. He then summarised the findings of the judge.] [837] Berger J found, at 328: their [sc the directors’] purpose was to obtain the best agreement they could while … still in control. Their purpose was in that sense to defeat Teck. But, not to defeat Teck’s attempt to obtain control, rather it was to foreclose Teck’s opportunity of obtaining for itself the ultimate deal. That was … no improper purpose. His decision upholding the agreement with Canex on this basis appears to be in line with the English and Australian authorities to which reference has been made. In relation to a different but analogous power, to refuse registration of a transfer, the wide range of considerations open to directors, and to the court upon challenge to an exercise of the power, is set out in the judgment of the High Court of Australia in Australian Metropolitan Life Assurance Co Ltd v Ure. By contrast to the cases of Harlowe and Teck, the present case, on the evidence, does not, on the findings of the trial judge, involve any considerations of management, within the proper sphere of the directors. The purpose found by the judge is simply and solely to dilute the majority voting power held by Ampol and Bulkships so as to enable a then minority of shareholders to sell their shares more advantageously. So far as authority goes, an issue of shares purely for the purpose of creating voting power has repeatedly been condemned: Fraser v Whalley (1864) 2 H & M 10; 71 ER 361; Punt v Symons & Co Ltd [1903] 2 Ch 506; Piercy v S Mills & Co Ltd [1920] 1 Ch 77 (“merely for the purpose of defeating the wishes of the existing majority of shareholders”) and Hogg v Cramphorn Ltd. In the leading Australian case of Mills v Mills, it was accepted in the High Court that if the purpose of issuing shares was solely to alter the voting power the issue would be invalid. And, though the reported 486

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Howard Smith Ltd v Ampol Petroleum Ltd cont. decisions, naturally enough, are expressed in terms of their own facts, there are clear considerations of principle which support the trend they establish. The constitution of a limited company normally provides for directors, with powers of management, and shareholders, with defined voting powers having power to appoint the directors, and to take, in general meeting, by majority vote, decisions on matters not reserved for management. Just as it is established that directors, within their management powers, may take decisions against the wishes of the majority of shareholders, and indeed that the majority of shareholders cannot control them in the exercise of these powers while they remain in office (Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame [1906] 2 Ch 34), so it must be unconstitutional for directors to use their fiduciary powers over the shares in the company purely for the purpose of destroying an existing majority, or creating a new majority which did not previously exist. To do so is to interfere with that element of the company’s constitution which is separate from and set against their powers. If there is added, moreover, to this immediate purpose, an ulterior purpose to enable an offer for shares to proceed which the existing majority was in a position to block, the departure from the legitimate use of the fiduciary power becomes not less, but all the greater. The right to dispose of shares at a given price is essentially an individual right to be exercised on individual decision and on which a majority, in the absence [838] of oppression or similar impropriety, is entitled to prevail. Directors are of course entitled to offer advice, and bound to supply information, relevant to the making of such a decision, but to use their fiduciary power solely for the purpose of shifting the power to decide to whom and at what price shares are to be sold cannot be related to any purpose for which the power over the share capital was conferred upon them. That this is the position in law was in effect recognised by the majority directors themselves when they attempted to justify the issue as made primarily in order to obtain much needed capital for the company. And once this primary purpose was rejected, as it was by Street J, there is nothing legitimate left as a basis for their action, except honest behaviour. That is not, in itself, enough. Their Lordships therefore agree entirely with the conclusion of Street J that the power to issue and allot shares was improperly exercised by the issue of shares to Howard Smith. It was not disputed that an action to set aside the allotment and for rectification of the register was properly brought by Ampol as plaintiff. [At the trial, Street J held that Howard Smith had notice of the impropriety of Millers’ directors, “mainly, but not exclusively, because of the terms of their own letter of 6 July 1972, addressed to Millers”. In the Privy Council their Lordships expressed “their complete concurrence on this point”: at 838.

Cayne v Global Natural Resources Plc [7.290] Cayne v Global Natural Resources Plc (unreported, Chancery Division, 12 August 1982) [Megarry V-C dismissed an application for an interlocutory injunction and the Court of Appeal dismissed the interlocutory appeal: see Cayne v Global Natural Resources Plc [1984] 1 All ER 225. Both cases turn upon the principles governing the grant of interlocutory injunctions and the following extract from the unreported judgment of Megarry V-C is therefore strictly obiter. Page references are to the transcript of judgment.] MEGARRY V-C: [7] A particular application of these principles which has caused some difficulty is the case of directors who issue shares in order to maintain themselves in office in the honest belief that this is for the good of the company, and not for any unworthy motives of obtaining a personal advantage. In Hogg v Cramphorn Ltd it was held that this honest belief did not prevent the motive for issuing the shares from being an improper motive. At the same time, this principle must not be carried too far. If Company A and Company B are in business competition, and Company A acquires a large holding of shares in Company B with the object of running Company B down so as to lessen its competition, I would have thought that the directors of Company B might well come to the honest conclusion that it was contrary to the best interests of Company B to allow Company A to effect its purpose, and that in [7.290]

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Cayne v Global Natural Resources Plc cont. fact this would be so. If, then, the directors issue further shares in Company B in order to maintain their control of Company B for the purpose of defeating Company A’s plans and continuing Company B in competition with Company A, I cannot see why that should not be a perfectly proper exercise of the fiduciary powers of the directors of Company B. The object is not to retain control as such, but to prevent Company B from being [8] reduced to impotence and beggary, and the only means available to the directors for achieving this purpose is to retain control. This is quite different from directors seeking to retain control because they think that they are better directors than their rivals would be. I think that Harlowe’s Nominees Pty Ltd v Woodside (Lakes Entrance) Oil Co NL and Teck Corp Ltd v Millar … go some way towards supporting such a restriction on the scope of Hogg v Cramphorn Ltd, though I do not forget the way in which the Teck case was mentioned in the Howard Smith case at 837. I may add that Mills v Mills shows that where the main purpose of the directors’ resolution is to benefit the company it matters not that it incidentally benefits a director.

Whitehouse v Carlton Hotel Pty Ltd [7.295] Whitehouse v Carlton Hotel Pty Ltd (1987) 162 CLR 285 High Court of Australia [The constitution of the Carlton Hotel Pty Ltd provided that Mr Whitehouse should be the permanent governing director of the company and that, for so long as he should retain such office, “all powers and authorities and discretions vested in the board of directors by the Companies Acts or these articles shall be vested in him alone”: art 127. The company’s capital structure was divided into three classes of shares. The “A” class shares, of which two were issued, were held by Mr Whitehouse. They alone held unrestricted voting rights. The “B” class shares, of which two had been issued, were held by Mrs Whitehouse. They carried full voting rights only after the death of Mr Whitehouse. The “C” class shares, of which 6,400 had been issued, were beneficially owned by the two sons (1,200 each) and four daughters (1,000 each), all of whom were adults. The “C” class shares alone carried rights to share in profits and surplus capital but conferred no voting rights. Relations soured between Mr and Mrs Whitehouse and they were divorced. The daughters aligned themselves with their mother and the sons with their father. Mr Whitehouse purported to allot two “B” class shares to each of his sons. The primary judge concluded “that the purported allotment by Mr Whitehouse … was made to ensure that the daughters and their husbands would not gain practical control over the company on his death through the voting power which might then attach to the ‘B’ class shares held by Mrs Whitehouse”: at 286. This conclusion was not challenged before the High Court. In the event, however, Mrs Whitehouse predeceased her former husband who (after a realignment of family loyalties) now disputed the validity of the allotment of “B” class shares which he had earlier purported to make to his sons.] MASON, DEANE and DAWSON JJ: [290] Mr Whitehouse’s purpose in alloting the “B” class shares to his sons was to procure the dilution of the voting power which might attach to Mrs Whitehouse’s shares on his death and to ensure that those whom he favoured would then command a majority. Plainly, such a purpose would ordinarily be an impermissible and invalidating one for the exercise by directors of a company of a fiduciary power to allot shares in its capital. The question arises [291] whether there is anything in the provisions of the company’s Articles or in the circumstances of the present case which avoids the invalidity of the allotment of the “B” class shares for that purpose. The Articles of a company may be so framed that they expressly or impliedly authorise the exercise of the power of allotment of unissued shares for what would otherwise be a vitiating purpose. It was submitted on behalf of the appellants that that is so here. … It is true that the powers attached to the “B” class shares make it clear that the allotment of such shares will necessarily be, and was intended to be, concerned with the conferral of voting rights. The same can be said of the “A” class shares. Thus, it would seem plain enough that the allotment of “A” and “B” class shares was for the initial purpose of conferring voting power upon Mr Whitehouse during his life and Mrs Whitehouse during any period of survivorship. It is, however, one thing for those involved in 488

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Whitehouse v Carlton Hotel Pty Ltd cont. the establishment of a company to exercise the power to allot shares for the purpose of creating a voting structure where otherwise there would be a vacuum filled only by the votes (if any) attaching to the subscribers’ shares. It is another thing to exercise the power to allot shares for the purpose of defeating the voting power attaching to established shareholdings after such a voting structure has been established. … [292] The argument that it is implicit in art 127 that Mr Whitehouse should be freed of the ordinary restraints upon the exercise of the power to allot shares seems to us to be without substance. It may be assumed that the Articles of a company could be so framed that they conferred upon a governing director authority to exercise a power to allot shares for the purpose of diluting the voting power or other rights of existing shareholders. They have not been so framed in the present case. All that the relevant provision of art 127 does is confer upon Mr Whitehouse the “powers and authorities and discretion vested in the Board of Directors by the Companies Acts or these Articles”. It does not change the nature of those “powers and authorities and discretion”. It does not convert what is a fiduciary power in the hands of the directors into a non-fiduciary power in the hands of Mr Whitehouse. It does not authorise the exercise by Mr Whitehouse of that fiduciary power for what would be an impermissible and vitiating purpose if it were exercised by the directors. Put differently, what was conferred upon Mr Whitehouse was the power to allot shares “vested in the Board of Directors” and the cases clearly establish that a purpose of manipulating the voting power of shareholders is at least ordinarily, foreign to such a power. It is arguable that special circumstances may arise in which the dilution of the voting power of an existing shareholder or group of shareholders or the creation of new voting power may constitute a legitimate purpose to be pursued by directors in the exercise of a fiduciary power to allot shares. Circumstances in which statutory provisions make a particular spread of voting power compulsory or commercially essential are a possible example of the kind of case where that may be so. It is unnecessary to pursue that question here however since it is plain that no such special circumstances existed to legitimise Mr Whitehouse’s purpose in allotting the “B” class shares to his sons. In that regard, it is unavailing that Mr Whitehouse was not motivated by purely selfish considerations in that he believed that the manipulation of voting power in favour [293] of his sons at the expense of his former wife was in the interests of the company in that it would ensure that the management of the company after his death was in the hands of those whom he favoured. Indeed, in the ordinary case of a purported allotment of shares for such an impermissible purpose, it is likely that the directors will genuinely believe that what they are doing to manipulate voting power is in the overall interests of the particular company: see, for example, Piercy v S Mills and Co [1920] 1 Ch 77 at 84-85; Hogg v Cramphorn Ltd [1967] Ch 254 at 267-269. In this as in other areas involving the exercise of fiduciary power, the exercise of a power for an ulterior or impermissible purpose is bad notwithstanding that the motives of the donee of the power in so exercising it are substantially altruistic. Thus, for example, the “noblemen and gentlemen” in Fraser v Whalley were acting in what they saw as the interests of the company of which they were directors when they allotted shares for the purpose of diluting the voting power of the “contractor”, Savin, whom they believed to have conflicting interests in other companies and who had, by what they saw as “an unfortunate accident”, acquired a majority of the ordinary shares. Their belief that they were so acting could not, however, serve to overcome the invalidity of the allotment. As the Vice Chancellor (Sir William Page Wood, as Lord Hatherley then was) commented (at (1864) 2 H & M 10 at 29; 71 ER 361 at 369): I have no doubt that the court will interfere to prevent so gross a breach of trust. I say nothing on the question whether the policy advocated by the directors, or that which I am told is to be pursued by Savin, is the more for the interest of the company. That is a matter wholly for the shareholders. It should be mentioned that one finds in some statements of the vitiating effect of a purpose of diluting the voting power of one or more existing shareholders a qualification to the effect that the allotment will be invalid if it is “merely” or “purely” or “solely” for that purpose: see, for example, Piercy v S Mills and Co at 84; Grant v John Grant & Sons Pty Ltd (1950) 82 CLR 1 at 32; Howard Smith v Ampol at 837-838. The introduction of such a qualification is intended to put to one side cases in which there [7.295]

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Whitehouse v Carlton Hotel Pty Ltd cont. are present both permissible and impermissible purposes. In such cases of competing purposes, practical considerations have prevented the law from treating the mere existence of the impermissible purpose as sufficient to render voidable the exercise of the fiduciary power to allot shares: see [294] Mills v Mills at 185-186 and note, as to Dixon J’s apparently inadvertent use of the word “void”, Richard Brady Franks Ltd v Price (1937) 58 CLR 112 at 142. In this court, the preponderant view has tended to be that the allotment will be invalidated only if the impermissible purpose or a combination of impermissible purposes can be seen to have been dominant – “the substantial object” (Ngurli Ltd v McCann at 445 per Williams ACJ, Fullagar and Kitto JJ, quoting Dixon J in Mills v Mills at 186 and see Harlowe’s Nominees at 493); “the moving cause” (Mills v Mills at 165 per Latham CJ). The cases in which that view has been indicated have not, however, required a determination of the question whether the impermissible purpose must be “the” substantial object or moving cause or whether it may suffice to invalidate the allotment that it be one of a number of such objects or causes. As a matter of logic and principle, the preferable view would seem to be that, regardless of whether the impermissible purpose was the dominant one or but one of a number of significantly contributing causes, the allotment will be invalidated if the impermissible purpose was causative in the sense that, but for its presence, “the power would not have been exercised” (Mills v Mills at 186 per Dixon J). It is, however, unnecessary to express a concluded view on the question of precise formulation of the relevant test in such case since the present case does not raise any problem of competing permissible and impermissible purposes. The only substantial or moving purpose of the allotment in the present case was the manipulation of voting power. As has been said, it is simply not to the point that Mr Whitehouse believed that it was in the overall interests of the company that the voting power attaching to the shares held by his former wife be diluted so as to ensure that the control of the company in the period after his death would be in the hands of those whom he favoured. That belief was an explanation of, or reason for the allotment for the impermissible purpose. It did not constitute a competing permissible purpose. [Wilson and Brennan JJ dissented. Wilson J found that Mr Whitehouse had acted bona fide and reasonably in making the share issue and had acted with a view to ensuring the profitable operation of the company. Brennan J interpreted the power to allot “B” class shares as conferred to determine who would have the voting power after Mr Whitehouse’s death. The present allotment was, therefore, validly made.]

Parke v Daily News Ltd [7.300] Parke v Daily News Ltd [1962] Ch 927 Chancery Division [The defendant company published two newspapers which had been making substantial losses over a long period. The board entered into a contract for the sale of the newspapers. The sale would dispose of substantially all of the company’s assets and result in the redundancy of the overwhelming majority of its employees. The directors proposed to apply the balance of the sale money after deducting the costs of the transaction as ex gratia payments to workers made redundant by the closure of the plant. A minority shareholder challenged the proposed payment as ultra vires the company.] PLOWMAN J: [949] It is the plaintiff’s submission that in these circumstances the proposed payment of compensation is gratuitous and ultra vires the defendant company. Mr Finer, on behalf of the plaintiff, referred me to a large number of authorities, but it will be sufficient for me to refer to two or three of them. The first is the well known case of Hutton v West Cork Railway Co (1883) 23 Ch D 654. That was a case where a company had transferred its undertaking to another company and was going to be wound up. After completion of the transfer, a general meeting of the transferor company was held at which a resolution was passed to apply (among other sums) a sum of 1,000 guineas in compensating certain paid officials of the company for their loss of employment, although they had no legal claim for compensation. It was held by the Court of Appeal (Baggallay LJ dissenting) that the resolution was invalid, as [950] the company was no longer a going concern and only existed for the purpose of winding up. On the facts, of course, it differs from the present case in that (among other things) here 490

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Parke v Daily News Ltd cont. the defendant company has transferred only part (albeit the main part) of its undertaking and is proposing, not to wind up, but to continue trading. In an oft-cited judgment, Bowen LJ said … (at 671): Now can a majority compel a dissentient unit in the company to give way and to submit to these payments? We [951] must go back to the root of things. The money which is going to be spent is not the money of the majority. That is clear. It is the money of the company, and the majority want to spend it. What would be the natural limit of their power to do so? They can only spend money which is not theirs but the company’s, if they are spending it for the purposes which are reasonably incidental to the carrying on of the business of the company. That is the general doctrine. Bona fides 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. The test must be what is reasonably incidental to, and within the reasonable scope of carrying on, the business of the company. Applying that kind of view, what is the character of these payments? … [w]hat is the general law about gratuitous payments which are made by the directors or by a company so as to bind dissentients. It seems to me you cannot say the company has only got power to spend the money which it is bound to pay according to law, otherwise the wheels of business would stop, nor can you say that directors are always to be limited to the strictest possible view of what the obligations of the company are. They are not to keep their pockets buttoned up and defy the world unless they are liable in a way which could be enforced at law or in equity. Most businesses require liberal dealings. The test there again is not whether it is bona fide, but whether, as well as being done bona fide, it is done within the ordinary [952] scope of the company’s business, and whether it is reasonably incidental to the carrying on of the company’s business for the company’s benefit. Take this sort of instance. A railway company, or the directors of the company, might send down all the porters at a railway station to have tea in the country at the expense of the company. Why should they not? It is for the directors to judge, provided it is a matter which is reasonably incidental to the carrying on of the business of the company, and a company which always treated its employees with Draconian severity, and never allowed them a single inch more than the strict letter of the bond, would soon find itself deserted – at all events, unless labour was very much more easy to obtain in the market than it often is. The law does not say that there are to be no cakes and ale, but there are to be no cakes and ale except such as are required for the benefit of the company. Now that I think is the principle to be found in the case of Hampson v Price’s Patent Candle Co (1876) 45 LJ Ch 437. The Master of the Rolls there held that the company might lawfully expend a week’s wages as gratuities for their servants; because that sort of liberal dealing with servants eases the friction between masters and servants, and is, in the end, a benefit to the company. It is not charity sitting at the board of directors, because as it seems to me charity has no business to sit at boards of directors qua charity. There is, however, a kind of charitable dealing which is for the interest of those who practise it, and to that extent and in that garb (I admit not a very philanthropic garb) charity may sit at the board, but for no other purpose. … [962] These and other passages [from the evidence] appear to me to show that the view was taken that in respect of the proceeds of an enterprise which they had helped to build, the employees had claims to consideration to which it was proper for the defendant company to pay regard, and that the interests of the shareholders would be satisfied by ensuring that the other assets of the company remained intact for their benefit. The view that directors, in having regard to the question what is in the best interests of their company, are entitled to take into account the interests of the employees, irrespective of any consequential benefit to the company, is one [963] which may be widely held. Traces of it appeared in Mr Redhead’s evidence, and Mr Leach, an accountant of great experience, said in examination-in-chief: “I think that although obviously the prime duty of directors is to their shareholders to conserve the assets, they also have these days a very practical obligation to their employees.” Mr Leach was cross-examined about that statement: “(Q) One of the matters which affected the conclusion, at least in your mind, as I understand it, was that a company’s duty these days [7.300]

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Parke v Daily News Ltd cont. must be regarded as one not only to the shareholders, but also to the employees? (A) Yes. I think I said that the prime duty must be to the shareholders; but boards of directors must take into consideration their duties to employees in these days.” But no authority to support that proposition as a proposition of law was cited to me; I know of none, and in my judgment such is not the law. In Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286 Lord Evershed MR said, in a different context, that the benefit of the company meant the benefit of the shareholders as a general body, and in my opinion that is equally true in a case such as the present. In my judgment, therefore, the defendants were prompted by motives which, however laudable, and however enlightened from the point of view of industrial relations, were such as the law does not recognise as a sufficient justification. Stripped of all its side issues, the essence of the matter is this, that the directors of the defendant company are proposing that a very large part of its funds should be given to its former employees in order to benefit those employees rather than the company, and that is an application of the company’s funds which the law, as I understand it, will not allow. If this is right, then it appears to me to follow from the Hutton case that the proposal to pay compensation is one which a majority of shareholders is not entitled to ratify.

Teck Corp Ltd v Millar [7.305] Teck Corp Ltd v Millar (1973) 33 DLR (3d) 288 Supreme Court of British Columbia [The facts of this case are outlined in the extract at [7.280].] BERGER J: [313] The classical theory is that the directors’ duty is to the company. The company’s shareholders are the company … and therefore no interests outside those of the shareholders can legitimately be considered by the directors. But even accepting that, what comes within the definition of the interests of the share- [314] holders? By what standards are the shareholders’ interests to be measured? In defining the fiduciary duties of directors, the law ought to take into account the fact that the corporation provides the legal framework for the development of resources and the generation of wealth in the private sector of the Canadian economy. … A classical theory that once was unchallengeable must yield to the facts of modern life. In fact, of course, it has. If today the directors of a company were to consider the interests of its employees no one would argue that in doing so they were not acting bona fide in the interests of the company itself. Similarly, if the directors were to consider the consequences to the community of any policy that the company intended to pursue, and were deflected in their commitment to that policy as a result, it could not be said that they had not considered bona fide the interests of the shareholders. I appreciate that it would be a breach of their duty for directors to disregard entirely the interests of a company’s shareholders in order to confer a benefit on its employees: Parke v Daily News Ltd. But if they observe a decent respect for other interests lying beyond those of the company’s shareholders in the strict sense, that will not, in my view, leave directors open to the charge that they have failed in their fiduciary duty to the company.

Gaiman v National Association for Mental Health [7.310] Gaiman v National Association for Mental Health [1971] Ch 317 Chancery Division [The defendant, a charitable association incorporated as a company limited by guarantee, was formed to promote research into mental health and to conduct facilities for persons suffering from mental or emotional disorders. In the weeks before the company’s annual general meeting it received an extraordinary number of applications for membership. The association had recently been under strong 492

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Gaiman v National Association for Mental Health cont. attack from the Church of Scientology which was hostile to its work and its notions of mental illness. The governing council feared an attempt by the Scientologists to swamp the meeting and gain control of its affairs. The council was empowered by the articles to expel members from the company. Before the meeting the council invoked the power against 302 members “known or reasonably suspected of being Scientologists”. Several challenged the decision as an abuse of fiduciary power.] MEGARRY J: [330] The question, then, is whether that power of deprivation of membership has been exercised by the council in good faith for the purpose for which it was conferred. Such a power is, I think, plainly conferred in order that it may be exercised in the best interests of the association. The association is, of course, an artificial legal entity, and it is not very easy to determine what is in the best interests of the association without paying due regard to the members of the association. The interests of some particular section or sections of the association cannot be equated with those of the association, and I would accept the interests of both present and future members of the association, as a whole, as being a helpful expression of a human equivalent: see Palmer’s Company Law (21st ed, 1968), p 531, and for a possible alternative expression see Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286 at 291. In this sense, did the council act as they did in the bona fide belief that it was in the best interests of the association? [331] I think the answer is plainly “Yes”. Lord Balniel in terms deposes that the decision of the council was taken in good faith and in what were believed to be the best interests of the association and the members as a whole; and this is not impugned. The basic reason for the decision is stated to be “the threat that Scientology posed to the association and all that it stood for”; and various other factors are set out, including the loss of moral and active support for the association, loss of revenue, and the association’s responsibility to those in its charge. The evidence before me provides ample grounds for saying that at the very lowest this is a possible view to hold.

[7.312]

1.

2.

3.

4.

Notes&Questions

In Re Smith and Fawcett Ltd might the result have been different if the article had said that the directors “may refuse to register a share transfer to a person whom they do not consider fit for membership”? Generally, when (if at all) may directors exercise powers with the object or consequence that control arrangements within the company are affected? When (if at all) may they exercise corporate powers to thwart a would-be controller whose assumption of control would, in their honest view, lead to the “general destruction or injury” of the company? Do you agree with Lord Wilberforce when he says (Howard Smith v Ampol at 837) that the decision in Teck “appears to be in line with the English and Australian authorities”? Do the majority in Whitehouse v Carlton Hotel [7.295] accept that a constitution might be so framed as to permit directors to exercise corporate powers so as to manipulate control of the company? What significance attaches to the directors’ determination as to where company interests lie? Within what bounds may such determination be made? In what circumstances and with what consequences will such determination be reviewed? Do the decisions extracted above disclose a shift in the legal conception of those interests? In Gaiman Megarry J adopted a formulation of company interests which balanced the interests of present shareholders against those of future members. Does the formulation sit comfortably with other expressions of the corporate interests, eg, with the exclusion of the claims of the company as a commercial entity in Ngurli Ltd v McCann [7.270] at 438? Are the interests of future shareholders a surrogate for the entity’s claims for continuity and growth? [7.312]

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5.

Recall the recognition required for creditors’ interests where solvency is threatened in Kinsela v Russell Kinsela Pty Ltd [5.190]. In Spies v R (2000) 201 CLR 603, the majority judgment referred to comments by Mason J in Walker v Wimborne [7.320] at 6-7 on the claims of creditors, saying that: Statements in this and other cases came within Professor Sealy’s description of: words of censure directed at conduct which anyway comes within some wellestablished rule of law, such as the law imposing liability for misfeasance, the expropriation of corporate assets or fraudulent preference. Hence the view that it is “extremely doubtful” whether Mason J “intended to suggest that directors owe an independent duty directly to creditors.” To give some unsecured creditors remedies in an insolvency which are denied to others would undermine the basic principle of pari passu participation by creditors.

In Re New World Alliance Pty Ltd; Sycotex Pty Ltd v Baseler (No 2) (1994) 122 ALR 531 at 550, Gummow J pointed out: It is clear that the duty to take into account the interests of creditors is merely a restriction on the right of shareholders to ratify breaches of the duty owed to the company. The restriction is similar to that found in cases involving fraud on the minority. Where a company is insolvent or nearing insolvency, the creditors are to be seen as having a direct interest in the company and that interest cannot be overridden by the shareholders. This restriction does not, in the absence of any conferral of such a right by statute, confer upon creditors any general law right against former directors of the company to recover losses suffered by those creditors … the result is that there is a duty of imperfect obligation owed to creditors, one which the creditors cannot enforce save to the extent that the company acts on its own motion or through a liquidator.

6.

In so far as remarks in Grove v Flavel (1986) 43 SASR 410 suggest that the directors owe an independent duty to, and enforceable by, the creditors by reason of their position as directors, they are contrary to principle and later authority and do not correctly state the law: at [93]-[95] per Gaudron, McHugh, Gummow and Hayne JJ. See further with respect to recognition of employee interests within corporate governance A Clarke (2004) 32 ABLR 111 and A Forsyth (2004) 31 ABLR 81; with respect to the elements of the duty generally see R Teele Langford (2016) 75 Cambridge Law Journal 505; R Teele Langford, Directors’ Duties: Principles and Application (2014) chs 4, 5 and 7; R Teele Langford (2014) 32 C&SLJ 64; R Maslen-Stannage (2013) 31 C&SLJ 76; A Lumsden and S Fridman (2012) 30 C&SLJ 493; J D Heydon, “Directors’ Duties and the Company’s Interests” in P D Finn (ed), Equity and Commercial Relationships (1987), p 120; J H Farrar (1989) 15 Can Bus LJ 15; L S Sealy (1989) 15 Mon L Rev 265; J P Hambrook (1989) 2 C&BLJ 133; T Steel (1986) 4 C&SLJ 30; L Ritson (1985) 10 Syd LR 627; S J Burridge (1981) 44 MLR 40; G F K Santow (1979) 53 ALJ 41; P Heath (1978) 3 Auck LR 307; B H McPherson (1977) 51 ALJ 460; N C A Franzi (1976) 10 MULR 392; K E Lindgren (1972) 10 UWALR 364 and F Iacobucci (1973) 11 Osgoode Hall LJ 353.

[7.313]

Review Problems

1. Shoesmith held eight shares in a company. Under the sliding scale of voting rights contained in the company’s articles, members were entitled to one vote each for holdings of up to 10 shares. Shoesmith executes transfers of one share to each of seven individuals and lodges the transfers with the directors for registration. The directors resolve that transfers be refused “on the ground of vote splitting”. Under the articles, shares are to be transferred “only at the discretion of the directors”. Each of the seven transferees holds his 494

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share as trustee for Shoesmith. May Shoesmith compel the board to register the transfers or have the share register rectified? See Manning River Co-operative Dairy Co Ltd v Shoesmith (1915) 19 CLR 714. 2. Some decades ago Western Estates Pty Ltd acquired a substantial tract of what was then rural land in Sydney’s west (the “Estate”); although it has never been developed it is now very valuable. Western has simply held the land passively. Western has five directors; A and B who each hold 10% of the shares, C and D who are business associates of A and generally follow her wishes, and E who holds 15% of the shares. C and D each hold only a few shares; the remaining 65% of capital is distributed evenly among 20 investors. In January, the board enters into discussions with a major developer, RD, with a view to developing the Estate. The negotiations envisage an initial feasibility study to establish lines of development and perhaps a contract with RD under which it will take a percentage of profits to be realised by sale of completed residential and shopping centre units. In December, E tells Western’s board that he intends to make an offer for all shares in Western at $10 per share with a view to getting control and causing Western to sell the Estate without further delay. A board meeting of Western is held immediately at which A and B reject E’s offer as inadequate. A and B arrange for Bank to advise on the bid. It estimates the worth of the Estate if sold outright at $50 million and advises that if it were to be effectively developed, somewhat along the lines RD has proposed, a much greater return over some years could accrue to Western, or it could sell some of the development and retain a major part so as to have significant continuing profits from rents and gains. Bank proposes that a new joint venture company be formed with Western receiving 45% of the capital in exchange for the Estate, Bank taking a 30% shareholding for financing the development and RD the remaining 25% for all the development work, sales and management of the site. It is estimated that the gains ultimately accruing to Western itself from all of this could amount to a much greater sum than that offered by E. At the next Western board meeting, A and B report on Bank’s advice and also on the fact that a telephone poll of shareholders indicates that it is just possible that E’s takeover offer may succeed. A and B assert that the offer is clearly not in the company’s interests; they recommend that Western act on Bank’s advice without delay “so as to preserve for the company and its shareholders the opportunity to realise the real value of the assets”. E objects, saying that many shareholders want cash now and he gives them the chance to exit the company. He demands that the matter be put to a general meeting. The other directors reply that it is for the Board to run the company and protect its interests and that E is just trying to make a “quick killing”. They resolve over E’s dissent to enter into the agreement on behalf of Western to sell the Estate to the new joint venture company which agreement is signed immediately. Advise E. (These facts are based on those in Darvall v North Sydney Brick and Tile Co Ltd (No 2) (1989) 16 NSWLR 260.)

Fiduciary loyalty within corporate groups [7.315] Two issues principally arise with respect to the duties of directors within corporate groups. Each explores the precise focus of fiduciary loyalty. The first concerns the scope for any latitude for directors to have regard to collective welfare considerations within a financially integrated or centrally managed corporate group. The second issue explores the significance for traditional doctrine of the licence accorded to nominee directors under case law to pay special regard to their appointor’s interests. This second issue is considered at [7.330]. [7.315]

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The typical characteristics of the financial and managerial integration within corporate groups which frame the context for these issues are described by Hadden: Financial integration is likely to involve occasional or regular transactions by individual group companies which are not in the best interests of that company, such as loans or guarantees to other companies in the group or the sale or transfer of goods or property at less than the optimal price, in order to produce the most advantageous level of profit or loss in particular companies. Managerial integration is likely to involve the issuing of orders to the directors of individual subsidiaries by group managers and the appointment of representatives of the group on the boards of those subsidiaries to ensure that all relevant information is passed on to group headquarters. 200

Such financial and managerial practices sit uncomfortably with a conception of fiduciary loyalty defined exclusively in terms of the interests of individual companies and which eschews regard for the group as a whole. The practices also raise some nice questions as to the protection of minority interests in subsidiaries, that is, those that are not held by or affiliated with the controlling block. 201 From 2000 the Act provides that a director of a wholly owned subsidiary is taken to act in good faith in the best interests of the subsidiary where the constitution of the subsidiary expressly authorises the director to act in the best interests of the holding company and the director acts in good faith in the best interests of the holding company; the licence applies only where the subsidiary is solvent at the time the director acts and does not become insolvent because of the director’s action: s 187. This provision reflects developments in doctrine in relation to nominee directors’ duties: see [7.330].

Walker v Wimborne [7.320] Walker v Wimborne (1976) 137 CLR 1 High Court of Australia [The liquidator of Asiatic brought misfeasance proceedings against its directors, inter alia, for making an unsecured loan to Australian Sound, then in financial difficulty. (Misfeasance proceedings are brought under s 598.) The loan was not recovered and the liquidator sought to make the directors personally liable for the loss sustained thereby. The two companies, and several others, had common directors and were administered as an integrated group. In fact, funds were moved around the group on the basis of need with little regard to the borrower’s capacity to repay.] MASON J: [6] [T]he primary judge concluded that the liquidator had not made out a prima facie case of misfeasance. Why his Honour came to this conclusion does not appear with any clarity. His Honour seems to have been influenced [by the consideration] … that as the transaction was undertaken for the benefit of the group, or another company in the group, this invested the transaction with an aura of legitimacy. To speak of the companies as being members of a group is something of a misnomer which may well have led his Honour into error. The word “group” is generally applied to a number of companies which are associated by common or interlocking shareholdings, allied to unified control or capacity to control. In such a case the payment of money by company A to company B to enable company B to carry on its business may have derivative benefits for company A as a shareholder in company B if that company is enabled to trade profitably or realise its assets to advantage. Even so, the transaction is one which must be viewed from the standpoint of company A and judged according to the criterion of the interests of that company. Here, however, the companies were not members of a group in the sense already described. There were no common or interlocking shareholdings. Asiatic did not hold shares in Australian Sound. Asiatic 200

T Hadden, “The Regulation of Corporate Groups in Australia” (1992) 15(1) UNSWLJ 61 at 64-65.

201

See further with respect to directors’ duties in corporate groups (beyond the cases extracted below) S Haddy (2002) 20 C&SLJ 138.

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Walker v Wimborne cont. did not stand to lose if Australian Sound went into liquidation; nor did it derive any benefit if Australian Sound succeeded in staving off liquidation. The “group” argument therefore provides no justification for what occurred. Indeed, the emphasis given by the primary judge to the circumstance that the group derived a benefit from the transaction tended to obscure the fundamental principles that each of the [7] companies was a separate and independent legal entity, and that it was the duty of the directors of Asiatic to consult its interests and its interests alone in deciding whether payments should be made to other companies. In this respect it should be emphasised that the directors of a company in discharging their duty to the company must take account of the interest of its shareholders and its creditors. Any failure by the directors to take into account the interests of creditors will have adverse consequences for the company as well as for them. The creditor of a company, whether it be a member of a “group” of companies in the accepted sense of that term or not, must look to that company for payment. His interests may be prejudiced by the movement of funds between companies in the event that the companies become insolvent. [Barwick CJ agreed with Mason J. Jacobs J dissented. He considered that there was a business association between the two companies and that there was no evidence that the Asiatic directors did not intend to secure the benefit of all the companies.]

Equiticorp Finance Ltd (in liq) v Bank of New Zealand [7.325] Equiticorp Finance Ltd (in liq) v Bank of New Zealand (1993) 32 NSWLR 50 Court of Appeal of the Supreme Court of New South Wales [The Bank of New Zealand lent $200 million to Uruz Pty Ltd, a wholly owned subsidiary of ETL, a member of the Equiticorp group of companies. About 41% of the equity of EHL, the ultimate holding company of the group, was controlled by Hawkins who was also chairman of group companies. The balance of equity in EHL was held by public investors. The ownership structure of the Equiticorp group is shown in the diagram [over page]. The loan was made to Uruz to finance a takeover bid for Monier Ltd. The loan was secured by lodgment of Monier shares and by a guarantee from ETL. Following difficulties in the Monier takeover associated with the stock market break of October 1987, the bank reviewed its exposure to the Equiticorp group. Two members of the group, EFL and EFSA, had $50 million in funds on deposit with the bank as a so-called “liquidity reserve”. The bank insisted that these funds be applied in reduction of the Uruz debt and this action was reluctantly taken by Hawkins on behalf of those companies. Subsequently, EFL and EFSA went into liquidation and their liquidators sought orders that this application of their funds was in breach of the fiduciary duties of the directors of those two companies. At trial, Giles J concluded that an intelligent and honest man in the position of a director of EFL and EFSA could believe that the application of the liquidity reserves towards repayment of the Uruz debt was for the benefit of EFL and EFSA in view of six considerations, namely: (i)

the indirect shareholding in and substantial advances to other members of the group;

(ii)

the adverse effect of loss of Bank of New Zealand’s support on the company’s own funding;

(iii)

the adverse effect of loss of Bank of New Zealand’s support on the funding of other members of the group;

(iv)

the adverse consequences of the effect on other members of the group;

(v)

the intention, albeit imperfectly executed, to provide compensation for loss of the liquidity reserve; and

(vi)

the prospect (clearly enough not a certainty, but historically justified and in fact realised) that a liquidity reserve could be in place within a short time.] [7.325]

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Equiticorp Finance Ltd (in liq) v Bank of New Zealand cont.

Figure 7.1 The equiticorp group of companies

CLARKE and CRIPPS JJA: [146] It is trite law that directors must exercise their powers for the benefit of the company: Kinsela [5.190]. If they exercise those powers for other, and improper, purposes they will breach their duty to the company. Where a case of breach of fiduciary duties on the part of the directors is raised upon the ground that they have acted otherwise than for the benefit of the company it will be necessary for the court to determine, as a factual issue, whether the directors did exercise their powers for the benefit of the company. This is a straightforward question of fact which can, in most cases, be answered in the affirmative or negative. Problems may, however, arise when particular companies form part of a group of companies. Mason J referred to them in Walker v Wimborne and pointed out that each transaction must be viewed according to the criterion of the interests of the company in the group which is about to participate in the transaction. Nonetheless, his Honour recognised that a transaction involving two companies in a group may benefit one of the companies directly but as well have derivative benefits for the other company: see also Northside Developments Pty Ltd v Registrar-General (1990) 170 CLR 146 at 183, per Brennan J. It may be accepted, therefore, that actions carried out for the benefit of the group as a whole may, in particular circumstances, be regarded as benefiting as well one or more companies in the group. This [147] may occur even where, for instance, a company is providing a guarantee for its holding company or another company in the group. Similarly a transaction carried out for the benefit of one of the companies in the group, company A, may be seen to be for the benefit of another company in the group, company B. A particular difficulty arises when the directors of the particular company enter into the transaction on behalf of that company because they consider that the transaction is of benefit to the group as a whole and do not give separate consideration to the benefit of their company. It was this difficulty which faced Pennycuick J in Charterbridge. He referred at (74-75) to the submission of counsel for the company saying: … [Counsel] contended that in the absence of separate consideration, they must, ipso facto, be treated as not having acted with a view to the benefit of Castleford. That is, I think, an unduly stringent test and would lead to really absurd results, ie, unless the directors of a company addressed their minds specifically to the interest of the company in connection with 498

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Equiticorp Finance Ltd (in liq) v Bank of New Zealand cont. each particular transaction, that transaction would be ultra vires and void, notwithstanding that the transaction might be beneficial to the company. Having considered the competing contention his Lordship went on to say: … The proper test, I think, in the absence of actual separate consideration, must be whether an intelligent and honest man in the position of a director of the company concerned, could, in the whole of the existing circumstances, have reasonably believed that the transactions were for the benefit of the company. That was the test which was applied by Giles J and all parties have advised this Court that the same test should be applied on the appeal. Although we are content to deal with the issues in the case upon the basis put by counsel we should indicate that we have reservations about the test proposed by Pennycuick J. The directors are bound to exercise their powers, bona fide, in what they consider is in the interests of the company and not for any collateral purpose. Whether they did so or not is a question of fact … [148] Accordingly there seems to us to be difficulties in substituting an objective test (How would an intelligent and honest man have acted?) for the factual question raised in the proceedings. It may be that if a director bluntly states that he or she did not consider the interests of the particular company at all and solely had regard to the interests of the group then difficulties would arise in resolving that factual question. But the position will rarely be such a black and white one and it would usually be possible to discern whether in deciding to take certain action for the benefit of the group the directors perceived, and were justified in their perception, that in so doing they were acting for the benefit of the particular company. On the other hand it may be possible to discern that the directors embarked on a course to support the group unconcerned about the detrimental effect of the action on the particular company or were prepared to sacrifice that company for the good of the other companies in the group. A careful analysis of the factual situation will usually reveal the answer to the factual question posed although no doubt on some occasions the problem may very well be a difficult one. We are mindful of the fact that Pennycuick J was not substituting the objective test for the subjective one which had traditionally been applied. In his view the occasion to apply the objective test only arose when it was clear that the directors had not considered the interests of the relevant company at all. In a sense he proposed a legal test to be applied only in limited cases to avoid what he regarded as an absurd situation. Nonetheless we have reservations about this means of resolving those difficulties. A preferable view may be that where the directors have failed to consider the interests of the relevant company they should be found to have committed a breach of duty. If, however, the transaction was, objectively viewed, in the interests of the company, then no consequences would flow from the breach. Such an inquiry would not require the court to consider how the hypothetical honest and intelligent director would have acted. On the contrary it would accept that a finding of breach of duty flows from a failure to consider the interests of the company and would then direct attention at the consequences of the breach. However the approach adopted by the parties in this case both before Giles J and this Court requires that the Charterbridge test be applied and absolves the Court from further considering this tantalising question. His Honour found that the loss of the Bank of New Zealand support would have been significantly against the interests of, and potentially disastrous for, [EFL] and [EFSA]. That was a finding which was open to him and we see no reason to interfere with it. There is no doubt that Hawkins feared, and had reason to fear, that if the [149] Uruz Pty Ltd debt was not repaid in part or in whole the group would lose that support. Hawkins said that he had regard to the interests of the group as a whole. He saw that as the most important thing because of the effect the welfare of the group had on each of the companies within it. Everyone may not agree with that approach but there is no suggestion that it was not a bona fide view and that encompassed within it was the view that the two appellant companies were better off if the transaction proceeded. One very important factor was that from 13 January 1988 the Uruz Pty Ltd debt was guaranteed by the holding company [viz, ETL]. If the guarantee had been called on and that had created a severe liquidity crisis for the holding company it is not difficult to [7.325]

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Equiticorp Finance Ltd (in liq) v Bank of New Zealand cont. visualise disaster, or at least a significantly worsened position, for the Australian financial group and the two appellant companies in particular. At least that was a permissible view. Indeed it is almost inconceivable that, if the holding company had lost public confidence, the companies in the financial groups would not themselves have suffered the same fate and that would have been disastrous from the point of view of each company. For these reasons and the more detailed reasons of Giles J we agree, on the application of the objective test, with the answer given by the learned primary judge. If we posed the straightforward factual question, to which we earlier adverted, we would reach the same conclusion. Mr Hawkins considered, with some justification, that the welfare of the group was intimately tied up with the welfare of the individual companies. If one pays regard to that the scheme for [EFL] and [EFSA] to be compensated for the loss of the liquidity reserve it is clear that consideration was given to the interests of the two companies. In a climate of substantial liquidity problems and having regard to the holding company’s guarantee of the Uruz Pty Ltd debt we would conclude … that those responsible for managing the two companies thought that the steps taken to protect the group as a whole, and in particular the holding company, coupled with the compensation scheme, were of definite benefit to the companies. The alternative was possible disaster for the whole group including the two companies. The appellants argued that a number of his Honour’s ultimate findings were factually erroneous or at least inaccurate. We have had regard to those submissions but nothing that was there said persuades us that his Honour was led into any factual error. [Kirby P dissented, saying that “[a]n unbroken line of Australian authority since Walker v Wimborne has laid emphasis upon the duty of directors of companies within a group of companies, in circumstances analogous to the present, to consider the separate position of their company within a group. … No intelligent and honest person in the position of a director of [EFL] or [EFSA] could, in the circumstances described, have considered that it was in the best interests of those companies to authorise the deployment of the liquidity reserves for the purpose for which they were used, viz, the reduction of the Uruz Pty Ltd facility of [ETL]”: at 98, 100-101.]

[7.327]

Review Problem

M Ltd is a New Zealand company whose capital is owned as to 76% by GA Ltd, an Australian company, and as to the balance by local investors. It has no business activity other than holding passively a valuable undeveloped site outside of Sydney. M’s directors are all executive directors of GA. When GA was experiencing cash flow problems it borrowed from NC, a finance company, against the security of a mortgage over M’s site. GA defaulted and NC executed the security. M seeks advice with respect to remedies against its directors. These facts are based upon those in Maronis Holdings Pty Ltd v Nippon Credit Aust Pty Ltd (2001) 38 ACSR 404.

The position of nominee directors [7.330] The attenuation of fiduciary loyalty has both special significance and difficulty in its application to nominee directors. Developments in this area have shaped the licence contained in s 187: see [7.315]. The concept of a nominee director has no single settled meaning. The term is not employed in legislation and courts have been little troubled with problems of definition. In commercial practice, however, the term is often applied to the person appointed as a director of a company on the understanding that they will represent or generally advance the interest of some other person or group. Persons may, of course, be nominated to company boards without being 500

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under any obligation or expectation that they will represent their appointee’s interests and such persons will fall outside the general conception of a nominee director. Here the term is used to refer to persons who, independent of the method of their appointment, but in the performance of their office, act in accordance with some understanding, arrangement or status which gives rise to an obligation (in the wide sense) to the appointor. 202

Typically, such an appointor might be an individual shareholder, a class of shareholders, a major lender to the company, a participant in a corporate joint venture or, less commonly, a group of employees of the company. 203 The understanding may also take a variety of forms, from provisions in the constitution formally appointing a director as nominee of another to tacit understandings or mere expectations that a nominee will represent particular interests upon the board. A distinction has been drawn between representative and independent nominee directors with the former acting more explicitly as the guardian of the appointor’s interests. 204 Thus, a representative nominee director might be an executive appointed to the board of a subsidiary company with the express purpose of protecting the parent’s interests or to the board of a joint venture company to represent the interests of an individual venturer. Other nominees will differ only in the degree of independence they bring to the representation of appointor interests. Thus a director might be appointed to a subsidiary company to safeguard minority interests but allowed wide latitude in the exercise of judgment. Perhaps an independent nominee director will merely be expected to report back to the appointor on company affairs, either generally or with respect to some particular transaction. However, if the independent director is to be a nominee director within the definition adopted he or she will be under an obligation of partisan loyalty. It is impossible to identify with any precision the incidence of nominee directors and the particular interests which they are appointed to represent. There is no obligation to register nominee appointments or to notify such understandings except under general statutory provisions requiring disclosure of directors’ conflicts of interests: see [7.345]. Company constitutions may impose similar obligations of disclosure but neither body of provisions is addressed specifically to the nominee director and will in most cases not apply to compel disclosure of the fact or terms of the nominee’s understanding with the appointor. Nominee directors occupy a delicate position. At first sight appointment of a nominee director appears inconsistent with the director’s duties of loyalty and conflict avoidance. Thus, is not the duty of loyalty to general shareholder interests compromised where a nominee director is appointed for the very purpose of acting partially, whether by subordinating the interests of the general body of members to those of the appointor or by identifying company interests with those of the appointor? As to the conflict avoidance obligation, is it likely (if not inevitable) that the nominee’s agreement or understanding with the appointor will create either a personal stake or a duty to the appointor in possible conflict with the duty to advance general shareholder interests? The Act, in s 203D(1), provides that the removal of a director appointed to represent the interests of a particular class of shareholders or debenture holders does not take effect until a replacement has been appointed. This provision implies that the 202

See Companies and Securities Law Review Committee, Nominee Directors and Alternate Directors (Discussion Paper No 7, 1987), [101].

203

Perhaps the best known instances of formalised nominee representation are the European co-determination structures which ensure employee representation on supervisory boards. For a survey and analysis of those structures see E Batstone & P L Davies, Industrial Democracy: European Experience (1976); J J du Plessis & O Sandrock [2005] ICCLR 67; J J du Plessis [2004] EBLR 1139.

204

See Companies and Securities Law Review Committee, Nominee Directors and Alternate Directors (Discussion Paper No 7, 1987), [102]-[105]. [7.330]

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Corporations and Financial Markets Law

appointment of a nominee director is not in itself unlawful but the Act is silent as to the adjustment of conflicting loyalties. How should that adjustment be made?

Levin v Clark [7.335] Levin v Clark [1962] NSWR 686 Supreme Court of New South Wales [A company’s constitution provided for the appointment of the defendants, Clark and Rappaport, as governing directors of the company but their powers were to be exercisable only in the event of the plaintiff’s default under a mortgage security which it had given over its shares in the company. Notice of default was given by the mortgagee, and Clark and Rappaport proceeded to exercise the powers of governing directors. The plaintiff challenged their assumption of power, inter alia, upon the ground that they owed primary allegiance to the mortgagee and not the company as a whole.] JACOBS J: [700] It has been argued that the resolutions which Clark and Rappaport have now purported to pass are invalid because Clark and Rappaport were not acting in the interests of the company but were acting solely in the interests of the mortgagee, Perren Productions Pty Ltd. Mr Staff [counsel for the plaintiff] has referred to the fact that Clark in evidence admitted that he acted solely in the interests of Perren Productions Pty Ltd, and has argued that the only conceivable purpose was to assist the mortgagee. I consider that Clark and Rappaport did act primarily in the interests of the mortgagee once they resumed the exercise of their powers as governing directors. However, I consider that it was permissible for them so to act. It is of course correct to state as a general principle that directors must act in the interests of the company. There is no necessity to refer to the large body of authority which supports this as a general proposition. However, that leaves open the question in each case – what is the interest of the company? It is not uncommon for a director to be appointed to a board of directors in order to represent an interest outside the company – a mortgagee or other trader of a particular shareholder. It may be in the interests of the company that there be upon its board of directors one who will represent these other interests and who will be acting solely in the interests of such a third party and who may in that way be properly regarded as acting in the interests of the company as a whole. To argue that a director particularly appointed for the purpose of representing the interests of a third party, cannot lawfully act solely in the interests of that third party, is in my view to apply the broad principle, governing the fiduciary duty of directors, to a particular situation, where the breadth of the fiduciary duty has been narrowed, by agreement amongst the body of the shareholders. The fiduciary duties of directors spring [701] from the general principles, developed in courts of equity, governing the duties of all fiduciaries – agents, trustees, directors, liquidators and others – and it must be always borne in mind that in such situations the extent and degree of the fiduciary duty depends not only on the particular relationships, but also on the particular circumstances. Among the most important of these circumstances are the terms of the instrument governing the exercise by the fiduciary of his powers and duties and the wishes, expressed directly or indirectly, by direction, request, assent or waiver, of all those to whom the fiduciary duty is owed. In the present case, the sole shareholders, assuming the validity of the share issues and transfers, are the plaintiff and Clark and Rappaport. By agreement with the plaintiff, Clark and Rappaport remain in the company so that upon default arising under the security agreement they can immediately commence to act in the affairs of the company in order to protect the interests of the mortgagee of the shares. It does not follow, in my opinion, that by acting in the interests of the mortgagee, and solely in the interests of the mortgagee, those directors necessarily cease to act in the interests of the company. Certainly they may cease to act in the interests of the plaintiff, and admittedly the plaintiff is the registered holder of the shares, but it would be quite artificial to ignore the interests of the mortgagee in these circumstances.

[7.337]

1.

502

Notes&Questions

Similar questions arose before the same judge two years later in Re Broadcasting Station 2GB Pty Ltd [1964-65] NSWR 1648. Jacobs J found that certain directors were [7.335]

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“to all intents and purposes” nominees of another group of companies who would be likely to act in accordance with the wishes of the group, and would be expected to do so. Jacobs J considered that such conduct would not be reprehensible “unless it can also be inferred that the directors, so nominated, would so act even if they were of the view that their acts were not in the best interests of the company”: at 1663. There was no evidence from which such an inference might be drawn. The nominees did, however, follow the wishes of the group “without a close personal analysis of the issues”; yet such compliance was not objectionable as long as they had a bona fide belief that the group’s interests were identical with the interests of the company as a whole. To require a higher standard of nominee loyalty would be “to ignore the realities of company organisation [and] … make the position of a nominee or representative director an impossibility”: at 1663. These two decisions have been cited with approval by the Supreme Court of New Zealand: Berlei Hestia (NZ) Ltd v Fernyhough [1980] 2 NZLR 150 at 165-166. 2.

“Nor would it have been an answer to an allegation that a director … had not acted in the interests of the society as a whole for that director to say that he or she had acted according to the wishes of the person who had, directly or indirectly, brought about the appointment of that director to the board. The position of nominee directors has given rise to some debate. It is not necessary to attempt, in this matter, to resolve all of those issues. It is enough to say that the fact that a director of a body corporate is nominated to office by another does not permit the director to act in disregard of the interests of the corporation as a whole. 205 Whether the statements by Jacobs J in Re Broadcasting Station 2GB Pty Ltd, about what must be shown to establish a breach of duty by such a director, are accepted (a question we need not consider) nothing in that decision, or other cases which have considered the matter, 206 can or should be understood as denying the more basic proposition about the duty that we have earlier described: that directors may not act in disregard of the interests of the corporation as a whole”: SGH Ltd v Commissioner of Taxation (2002) 210 CLR 51 at [30].

3.

There are English dicta which suggest that the nominee director’s duty of loyalty is in no way compromised by the expectations of their appointor. This dicta suggest that the nominee director will breach their duty to the company if the director subordinates its interests to those of their patron, even if this subordination merely takes the form of passive inactivity in the face of improper conduct by the patron; see Boulting v Association of Cinematograph, Television and Allied Technicians [1963] 2 QB 606 at 627; Scottish Co-operative Wholesale Society Ltd v Meyer [1959] AC 324 at 367. In Levin v Clark and Berlei Hestia (NZ) Ltd v Fernyhough reference was made to the fact that the companies’ constitutions provided for the appointment of the nominee directors and thereby compelled some adjustment of their fiduciary obligations. Is the latitude extended to nominee directors dependent on whether the rights of the appointor to appoint (and remove) the nominee are expressed in the constitution, and the constitution contains an express or implied attenuation of the nominee’s obligations to the company? Alternatively, if the constitution makes no such provision, does the attenuation of duty depend upon some expression of corporate consent to the nominee’s special position, such as through a resolution of shareholders in general meeting? The constitutions in Levin v Clark and the Berlei Hestia case, while they may

4.

205 206

See the discussion by Street J in Bennetts v Board of Fire Commissioners of NSW (1967) 87 WN (Pt 1) (NSW) 307 at 310-311. See, eg, Berlei Hestia (NZ) Ltd v Fernyhough [1980] 2 NZLR 150 at 165-166 per Mahon J. [7.337]

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have made express provision for appointment of the nominee directors, did not expressly state their representative functions nor make any attempt to modify the duties applicable to them. 5.

Is the development reflected in the two decisions of Jacobs J a salutary one? Should nominee directors be permitted to depart from the fiduciary standard applicable to directors generally? Would the “realities of company organisation” be wholly confounded by holding nominees to the general standard of conduct? If the standard of loyalty demanded of nominee directors is to be relaxed, need (and should) the nominee’s allegiance to the general body of shareholders be weakened to the extent suggested by Jacobs J? An intermediate formulation is adopted in the Companies Code 1961 (Ghana) which empowered representative directors to give “special, but not exclusive, consideration” to the interests of their appointors: s 203(3). If some attenuation of the fiduciary obligations of nominees is to be formalised, what definition of nominee director should be adopted? Should a notification or registration mechanism be established to identify those subject to the differential standard?

6.

Several other issues raised by the appointment of nominee directors are canvassed above: as to the potential liability of the appointor for the acts or omissions of the nominee, see [7.52], nn 1 and 2; as to nominee’s rights of access to corporate information, see Molomby v Whitehead [5.305].

7.

The duties and liabilities of nominee directors and their appointors are discussed in P Lee [2003] JBL 449; R Baxt & T Lane (1998) 16 C&SLJ 628; R Baxt (1998) 16 C&SLJ 500; E W Thomas, “The Role of Nominee Directors and the Liability of their Appointors” in I M Ramsay (ed), Corporate Governance and the Duties of Company Directors (1997), pp 148-161; J Pizer (1997) 15 C&SLJ 81; A S Sievers (1993) 3 Aust J Corp L 1; P Crutchfield (1992) 20 ABLR 109; Companies and Securities Law Review Committee, Nominee Directors and Alternate Directors (Report No 8, 1989); E Boros (1989) 10 Co Law 211 and (1990) 11 Co Law 6; L Thomson, “Nominee and Multiple Directors and Confidential Information” in J H Farrar (ed), Contemporary Issues in Company Law (1987), p 159; P Redmond (1987) 10 UNSWLJ 194.

DIRECTORS’ INTERESTS IN TRANSACTIONS WITH THEIR COMPANY The general equitable obligation to avoid conflict between duty and interest: an overview [7.340] A second component of the director’s fiduciary obligation, in addition to the duty of

good faith (see [7.215]), is the duty to avoid situations where, without the consent of the company, the director’s personal interest (or another interest which the director is bound to protect) conflicts or may possibly conflict with their duty to the company. This conflict avoidance obligation is expressed in a number of specific rules touching directors’ dealings with or touching their company. The first applies to transactions between a director and their company and to other transactions with the company in which the director is less directly interested. These principles are considered in this section ([7.345] et seq) together with those affecting director and executive remuneration: see [7.390]. The second rule concerns the liability of directors to account for profits made from transactions touching their office and to restore to the company property acquired under such transactions: see [7.455]. A third cluster of rules deals with residual applications of the obligation. These include the extent to which directors may fetter the future exercise of discretionary powers and the position of a director 504

[7.340]

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who is also a director of a competing company: see [7.505] et seq. These norms are bolstered by statutory provisions including those regulating the giving of financial benefits to related parties of public companies: see [7.415]. The tiers of rules affecting directors’ interests in transactions with their company [7.345] Three tiers of legal rules apply in relation to transactions or other dealings with a

company in which one of its directors has an interest: • the equitable principle enjoining conflict avoidance which makes such transactions voidable at the suit of the company irrespective of the fairness of the transaction from the company’s perspective provided it is possible to restore the parties to their original position (that is, restitutio in integrum remains possible); • provisions in company constitutions modifying the equitable rule or its consequences, usually by relieving against its rigour; and • the statutory duty of disclosure imposed by the Act. 207 Equitable rules generally contain either permission or absolute prohibition with respect to conduct rather than condition liability upon a judicial determination of some state of affairs. Thus, conflicts of interest are prohibited per se. Considerations of fairness or otherwise are irrelevant in self-dealing transactions and courts refuse to look to any basis of liability beyond the fact that interest has been opposed to duty. As the High Court said in Furs Ltd v Tomkies, “it is neither wise nor practicable for the law to look for [another] criterion of liability. The consequences of such a conflict are not discoverable. Both justice and policy are against their investigation.” 208 Indeed, a 19th century judge thought that the “safety of mankind” would be put at risk by a rule which made a fiduciary liable only for preferring interest to duty. 209 In contrast, under United States corporate law doctrines a fairness standard usually requires judicial verification of information, the value of a diverted business opportunity or of assets the subject of an interested transaction before it is rescinded. However, the absolute prohibition of Australian corporate law upon conflicts is contractible so that directors may be released by the consent of the beneficiary of the obligation, the company. Indeed, standard and widely adopted contracting-out provisions invert the primary norm of disinterested service so that the company may secure the services of well networked directors. 210 In a proprietary company the replaceable rule in s 194 operates to validate transactions that would be invalidated by the equitable principle because of the director’s interest, and permits directors to retain benefits under the transaction provided that the required disclosure is made: see [7.350]. Public companies (and proprietary companies that replace the provision in s 194) will usually adopt a provision in similar terms to, or along the lines of, the various constitutional provisions whose interaction with the equitable rule is examined in the cases extracted below. 207

On the interaction between the three tiers of legal rules see M Conalgen (2013) 31 C&SLJ 403.

208

Furs Ltd v Tomkies (1936) 54 CLR 583 at 592 ([7.460]).

209 210

Parker v McKenna (1874) LR 10 Ch App 96 at 124 per James LJ. Thus, see, eg, Imperial Mercantile Credit Association v Coleman (1871) LR 6 Ch 558 at 567 per Lord Hatherley LC ([7.365]) (“It must be left to [adult] persons to form their own contracts and engagements, and this court has only to sit here and construe them … [they are competent, therefore, to decide] that in large financial matters of this description it is better to have directors who may advance the interests of the company by their connection, and by the part which they themselves take in large money dealings, than to have persons who would have no share in such transactions as those in which the company is concerned”). [7.345]

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Statutory disclosure obligations with respect to directors’ interests in matters affecting their company [7.350] A director of a company who has a material personal interest in a matter that relates

to the affairs of the company (affairs of a company are expansively defined in s 53) must give the other directors notice of the interest: s 191(1). Disclosure is required for interests in contracts or proposed contracts, offices and property but the duty of disclosure may extend more widely. A director does not need to give notice of the interest if: • the interests falls within an exempted category several of which are separately regulated; • the company is a proprietary company and the other directors are aware of the nature and extent of the interest and its relation to the affairs of the company; or • the director has given a standing notice of the nature and extent of the interest under s 192: s 191(2). A director of a company who has an interest in a matter may give the other directors standing notice of the nature and extent of the interest in the matter: s 192(1). Standing notice will expire if a new director is appointed and is not given the notice. The notice required by s 191(1) must give details of: • the nature and extent of the interest and • the relation of the interest to the affairs of the company at a directors’ meeting as soon as practicable after the director becomes aware of the interest in the matter: s 191(3). The details must be recorded in the minutes of the meeting. A director’s contravention of s 191 does not affect the validity of any act or transaction: s 191(4). These provisions do not displace the operation of equitable rules about conflict of interest and constitutional provisions restricting directors from interests or offices which might involve a conflict: s 193. It also appears that they do not affect the operation of the constitutional provisions that attenuate the effect of the equitable rules. The Act provides such an attenuating provision for proprietary companies through a replaceable rule. If a director of a proprietary company has a material personal interest in a matter relating to the affairs of the company and either the director discloses the interest under s 191 or it need not be disclosed under s 191, then: • the director may vote on matters that relate to the interest; • any transactions that relate to the interest may proceed; • the director may retain benefits under the transaction even though the director has the interest; and • the company cannot avoid the transaction merely because of the existence of the interest: s 194. The “material personal interest” that attracts the statutory disclosure obligation in s 191(1) must self-evidently be both personal and material. The phrase is not, however, defined in the Act. Interpretation of like terms in other contexts suggests that a personal interest includes a pecuniary interest but is not limited to such interests. Personal interests may include interests arising from close personal relationships, 211 especially family relationships. 212 As regards the materiality element, in McGellin v Mount King Mining NL Murray J interpreted the use of the phrase in the predecessor to s 195(1) (see [7.355]) by reference to equitable principles of conflict avoidance: 211

R v District Council of Victor Harbor; Ex parte Costain Australia Ltd (1983) 34 SASR 188 at 190, 196, 205.

212

R v District Council of Victor Harbor; Ex parte Costain Australia Ltd at 196. The specific categories of family relationship embraced by the prohibition are left at large; contrast s 228(2)(d), (3) with respect to the definition of related parties of public companies for purposes of prohibitions upon the giving of financial benefits.

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“Material” in this context, I think, means that the interest involves a relationship of some real substance to the matter under consideration or the contract or arrangement which is proposed. In that way the nature of the interest should be seen to have a capacity to influence the vote of the particular director upon the decision to be made, bearing in mind that both the article and the section are concerned with that aspect of a director’s fiduciary duties which relates to the resolution of conflict of interest which must, of itself, be of a real or substantial kind. The interest with which both the article and the section are concerned should be of a kind as to give rise to a conflict of that character. If that test is met, it seems to me not to matter that the nature of the interest may be described as direct or indirect, or vested in interest or contingent. It is the substance of the interest, its nature and capacity to have an impact upon the ability of the director to discharge his or her fiduciary duty which will be important. 213

The standard of materiality adopted in related contexts looks to the showing of a substantial likelihood that, under all the circumstances, the interest would have assumed actual significance in the deliberations. 214 Where the director of a public company is a director of another company which is contracting with the public company, the materiality standard would ordinarily be satisfied so that disclosure is required. 215 Disclosure is not required in relation to an interest that the director has as a member of the company and in common with other members of the company: s 191(2)(a)(i). Generally, however, for purposes of disclosure an interest need not be direct but may be held through intermediate companies in which a controlling interest is held. 216 Restriction upon board participation by interested directors of public companies [7.355] A director of a public company who has a material personal interest in a matter that is

being considered at a directors’ meeting must not be present while the matter is being considered at the meeting or vote on the matter: s 195(1). The exclusion does not apply if the interest is exempted from disclosure under s 191(2) or if directors who do not have a material personal interest in the matter pass a resolution that: • identifies the director, the nature and extent of the director’s interest in the matter and its relation to the affairs of the company; and • states that those directors are satisfied that the interest should not disqualify the director from voting or being present: s 195(2). The director may also participate with ASIC approval where the matter could not otherwise be dealt with for want of a quorum and because of its urgency or other compelling reason cannot be dealt with by the general meeting: s 195(3). However, if a director with a material personal interest also possesses confidential information relevant to a matter before the board

213 214

215 216

McGellin v Mount King Mining NL (1998) 144 FLR 288 at 304, applied in Drillsearch Energy Ltd v McKerlie [2009] NSWSC 517 at [24]. TSC Industries Inc v Northway Inc 426 US 438 at 449 (1976) (United States Supreme Court), followed in Coleman v Myers [1977] 2 NZLR 225 at 334 ([7.540]); Re Rossfield Group Operations Pty Ltd [1981] Qd R 372 at 376. Transvaal Lands Co v New Belgium (Transvaal) Lands and Development Co [1914] 2 Ch 488. See Devereaux Holdings Pty Ltd v Pelsart Resources NL (unreported, Supreme Court of New South Wales, Equity Division, No Eq 4206/1985, Cohen J). [7.355]

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disclosure and non-participation may not be sufficient in the circumstances to discharge duty: Permanent Building Society (in liq) v Wheeler [7.92] at 241. 217

Aberdeen Railway Co v Blaikie Bros [7.360] Aberdeen Railway Co v Blaikie Bros (1854) 1 Macq 461 House of Lords [A railway company contracted to purchase goods from a partnership. The partnership sued for performance of the contract. The company sought to avoid the contract upon the ground that, at the time of contracting, one of its directors was a member of the partnership.] LORD CRANWORTH LC: [471] This, therefore, brings us to the general question, whether a director of a railway company is or is not precluded from dealing on behalf of the company with himself, or with a firm in which he is a partner. The directors are a body to whom is delegated the duty of managing the general affairs of the company. A corporate body can only act by agents, and it is of course the duty of those agents so to act as best to promote the interests of the corporation whose affairs they are conducting. Such agents have duties to discharge of a fiduciary nature towards their principal. And it is a rule of universal application, that no one, having such duties to discharge, shall be allowed to enter into engagements in which he has, or can have, a personal interest conflicting, or which possibly may conflict, with the interests of those whom he is bound to protect. So strictly is this principle adhered to, that no question is allowed to be raised as to the fairness or unfairness of a contract so entered into. [472] It obviously is, or may be, impossible to demonstrate how far in any particular case the terms of such a contract have been the best for the interest of the cestui que trust, which it was possible to obtain. It may sometimes happen that the terms on which a trustee has dealt or attempted to deal with the estate or interests of those for whom he is a trustee, have been as good as could have been obtained from any other person, – they may even at the time have been better. But still so inflexible is the rule that no inquiry on that subject is permitted. It is true that the questions have generally arisen on agreements for purchases or leases of land, and not, as here, on a contract of a mercantile character. But this can make no difference in principle. The inability to contract depends not on the subject matter of the agreement, but on the fiduciary character of the contracting party, and I cannot entertain a doubt of its being applicable to the case of a party who is acting as manager of a mercantile or trading business for the benefit of others, no less than to that of an agent or trustee employed in selling or letting land. Was then Mr Blaikie so acting in the case now before us? – if he was, did he while so acting contract on behalf of those for whom he was acting with himself? Both these questions must obviously be answered in the affirmative. Mr Blaikie was not only a director, but (if that was necessary) the chairman of the [473] directors. In that character it was his bounden duty to make the best bargains he could for the benefit of the company. While he filled that character, namely, on 6 February 1846, he entered into a contract on behalf of the company with his own firm, for the purchase of a large quantity of iron chairs at a certain stipulated price. His duty to the company imposed on him the obligation of obtaining these chairs at the lowest possible price. 217

See also Fitzsimmons v R (1997) 23 ACSR 355 (director possessing confidential information from another directorship that was relevant to a decision being taken by his board and who took no part in that decision held to have made improper use of his position as director (see [7.500]): “the mere fact that he owed conflicting duties did not make him immune from the consequences of breach of those duties to one or other of the companies” (at 359 per Owen J)).

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Aberdeen Railway Co v Blaikie Bros cont. His personal interest would lead him in an entirely opposite direction, would induce him to fix the price as high as possible. This is the very evil against which the rule in question is directed, and I here see nothing whatever to prevent its application. I observe that Lord Fullerton seemed to doubt whether the rule would apply where the party whose act or contract is called in question is only one of a body of directors, not a sole trustee or manager. But, with all deference, this appears to me to make no difference. It was MrBlaikie’s duty to give to his co-directors, and through them to the company, the full benefit of all the knowledge and skill which he could bring to bear on the subject. He was bound to assist them in getting the articles contracted for at the cheapest possible rate. As far as related to the advice he should give them, he put his interest in conflict with his duty, and whether he was the sole director or only one of many, can make no difference in principle. The same observation applies to the fact that he was not the sole person contracting with the company; he was one of the firm of Blaikie, Brothers, with whom the contract was made, and so interested in driving as hard a bargain with the company as he could induce them to make. [Lord Brougham delivered a concurring judgment.]

Imperial Mercantile Credit Association v Coleman [7.365] Imperial Mercantile Credit Association v Coleman (1871) LR 6 Ch App 558 Court of Appeal in Chancery, England and Wales [Coleman was a stockbroker in partnership with Knight. He was also a director of the plaintiff association, a finance company. As a broker, Coleman contracted with Peto & Co to “place” (that is, procure subscriptions for) debentures to be issued by a new company for a commission of 5% in cash and 5% in shares. At a board meeting Coleman proposed that the association subscribe for the debentures which he had undertaken to place. He offered the association a commission of 1.5% only. He did not inform the meeting of his agreement with Peto & Co although he did indicate that he was interested in the transaction. The board accepted Coleman’s proposal. The association later went into liquidation and the terms of Coleman’s agreement with Peto & Co came to light. The liquidator sued to compel Coleman to account for the commission he had received upon the debentures placed with the association. Article 83 of the association’s constitution provided: “The office of director shall be vacated if he contracts with the company, or is concerned in or participates in the profits of any contract with the company … without declaring his interest at the meeting of directors at which such contract is determined on … and no director so interested shall vote at any meeting … on any question relating to such contracts.”] LORD HATHERLEY LC: [567] The matter would be much more simple if the regulations of the association were in the ordinary form, if nothing whatever were said about directors interested or not interested, and if it were left to the ordinary operation of the rules of this court, which lay down firmly that no director of a company can, in the absence of any stipulation to the contrary, be allowed to be a partaker in any benefit whatever from any contract which requires the sanction of a board of which he is a member. The reasons are … that the company have a right to the services of their directors, whom they remunerate by considerable payments; they have a right to their entire services, they have a [568] right to the voice of every director, and to the advice of every director in giving his opinion upon matters which are brought before the board for consideration; and that the general rule that no trustee can derive any benefit from dealing with those funds of which he is a trustee applies with still greater force to the state of things in which the interest of the trustee deprives the company of the benefit of his advice and assistance. However, the question then remains, whether the company cannot stipulate that this is a benefit of which they do not desire to avail themselves, and if they are competent so to stipulate, whether they may not think that in large financial matters of this description it is better to have directors who may [7.365]

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Imperial Mercantile Credit Association v Coleman cont. advance the interests of the company by their connection, and by the part which they themselves take in large money dealings, than to have persons who would have no share in such transactions as those in which the company is concerned. It is not for me to say which was the wiser or better course of the two, nor do I think that this court professes to lay down rules for the guidance of men who are adult, and can manage and deal with their own interests. It would be a violent assumption if anything of that kind were attempted. It must be left to such persons to form their own contracts and engagements, and this court has only to sit here and construe them, and also to lay down certain general rules for the protection of persons who may not have been aware of what the consequences would be of entrusting their property to the management of others where nothing is expressed as to the implied arrangement. In this case it does appear to me that there was a distinct contemplation of directors being interested in the concerns of the company, and acting and voting when the matter came before the board of directors, and that the shareholders took such precautions as they thought necessary. [The Lord Chancellor found that Coleman had made adequate disclosure of his interest for purposes of art 83 and that this article impliedly validated Coleman’s agreement with the association. The liquidators appealed to the House of Lords where it was assumed (although the point was expressly not decided) that the article had such an implied validating effect. As the following extract indicates, a different view was taken, however, as to the adequacy of Coleman’s disclosure.]

The Liquidators of the Imperial Mercantile Credit Association v Coleman [7.370] The Liquidators of the Imperial Mercantile Credit Association v Coleman (1873) LR 6 HL 189 House of Lords LORD CAIRNS: [204] Now it does not admit of argument that, if there was nothing more in the case, this is a transaction which could not for a moment be supported in a court of equity, and that Mr Coleman would have to account to the association for his profit upon the sale, which profit was in reality so much money taken by him from the association. That this would be so in an ordinary case appears to have been clearly the opinion of the Lord Chancellor, and was not indeed disputed at your Lordships’ Bar. … [At the meeting of directors at which Coleman proposed that the association should acquire the debentures,] Coleman stated openly to the meeting that he was interested in the sale of these debentures, and offered to leave the room whilst the proposal for their sale to the association was discussed, but the chairman said it was unnecessary. [205] A director … claiming to give validity to a contract which otherwise would be invalid must shew that he has, in letter and in spirit, complied with the provisions of the clause. Now has the respondent done so? Did he “declare”, or, as that word implies, shew clearly his interest? His interest might be anything, from the absolute ownership of the property sold, down to a right of a nominal charge on or payment out of it. Did he, then, “declare” what his intention was? Certainly he did not. A man declares his opinion or his intentions when he states what his opinion is, or what his intentions are, not that he has an opinion or that he has intentions; and so, in my opinion, a man declares his interest, not when he states that he has an interest, but when he states what his interest is. Now was it material that Mr Coleman’s co-directors should know what his interest was? In my opinion it was most material. No better instance of the materiality of such a declaration could be found than in the present case. If the directors had known that without any risk to himself the respondent was to receive 5% in cash and 5% in shares on what they, bearing all the risk, were to receive only 1 1/2% upon in cash, can it be doubted that one of two things must have happened, either that they would have seen that the transaction was, as between the respondent and Sir Morton Peto & Co, known to be attended with risk, and would therefore have declined it altogether, or else that they would have insisted on a much larger share of the profit. 510

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The Liquidators of the Imperial Mercantile Credit Association v Coleman cont. [206] But then, my Lords, it was contended on the respondents’ behalf, and this appears to have had a considerable effect on the mind of the Lord Chancellor in his judgment, that although Mr Coleman stated merely that he had an interest, it was open to the directors who were then present to have cross-questioned him, and to have elicited from him what his interest really was. My Lords, if this had been a case in which a person standing in a fiduciary relation to another had in the presence of another stated that he had an interest, and that other was then able to ask some farther questions as to what his interest was, I should have thought a good deal of weight might be attached to this argument. But it was not to the company, or even to a general meeting of the company that Mr Coleman stated that he had an interest. It was to some other persons, who were just as much in a fiduciary position as he was himself, and in my opinion it was not open to Mr Coleman, if he desired to comply with the clause, merely to state to those other trustees what might have led them to make farther inquiry, but to leave it open to the chance of whether they would make that inquiry or not. … [207] My Lords, I arrive therefore at the conclusion, that the 83rd article affords no justification whatever upon which this transaction can be upheld, and that the general rule which I stated some time ago applies to the transaction. But then it was contended that even if Mr Coleman is liable to make good to the association any part of this money, it is only his own share of the profits which he is bound to restore; and that [208] inasmuch as he was in partnership with Mr Knight, it is only that portion of the profits which as between Mr Knight and himself he would have taken out of the transaction. My Lords, I think there is no foundation for this argument. The profit on the transaction was obtained by Mr Coleman, and, in the view that I take, was obtained by him as a director of the association. Whether he desired or whether he determined to reserve it all to himself or to share it with his firm appears to me to be perfectly immaterial. The source from which the profit is derived is Mr Coleman. It is only through him that his firm can claim. He is liable for the whole of the profits which were obtained; and it is not the course for a court of equity to enter into the consideration of what afterwards would have become of those profits. [Lord Chelmsford and Lord Colonsay concurred.]

Transvaal Lands Co v New Belgium (Transvaal) Land and Development Co [7.375] Transvaal Lands Co v New Belgium (Transvaal) Land and Development Co [1914] 2 Ch 488 Chancery Division and Court of Appeal, England and Wales [The following statement of facts is taken from the law report.] [488] This was an action to set aside two transactions between the plaintiff and defendant companies on the ground that the resolutions of the board of the plaintiff company by which they were authorised were invalid owing to the directors’ interests therein. The plaintiff company’s articles provided (art 109) that two directors should form a quorum and (art 98) that No contract or arrangement entered into on behalf of the company with any directors, or any firm of which a director is a member, shall be avoided, nor shall such directors be liable to account to the company for any profit realised by any contract or work, by reason of such directors holding that office or of the fiduciary relation thereby established, provided he discloses the nature of his interest; but no director shall vote in respect of any contract in which he is concerned. In 1911 the directors of the plaintiff company were Young, Samuel, and Harvey. Samuel was also a director of the [489] defendant company. Young died in 1913, and Harvey died recently. … [7.375]

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Transvaal Lands Co v New Belgium (Transvaal) Land and Development Co cont. At a special board meeting of 8 February 1911, at which Young, Samuel, and Harvey were present, Samuel submitted the desirability of acquiring shares of the Lydenberg Co with a view to securing, in conjunction with the defendant company, control of the Lydenberg Co, and it was decided to fall in with the suggestion. In view of the fact that the market in the Lydenberg shares was very restricted and that any bidding would unduly inflate the price, Samuel stated that he was empowered by the board of the defendant company, who held about 17,000 Lydenberg shares, to offer to sell to the plaintiff company a portion of their holding at 6s per share, which offer was accepted to the extent of investing £1,000. Samuel “being a director of the” defendant company did not vote. It was further resolved to endeavour to effect the sale of certain forfeited shares in the plaintiff company, and that Samuel be empowered to negotiate the sale of 20,410 forfeited shares. … Samuel put the matter before the board of the defendant company and in the result it was arranged that the defendant company should take the shares with 16s paid at 1s per share. At a board meeting of the plaintiff company held on 29 March 1911, at which Young, Samuel, and Harvey were present, a letter from the defendant company accepting the offer of 20,410 forfeited shares 16s paid at 1s per share made by Samuel on behalf [490] of the plaintiff company was submitted. It was resolved that the 20,410 forfeited shares of the plaintiff company should be and they were thereby allotted to the defendant company. Samuel “being a director of” the defendant company “and interested in the purchase” did not vote. … [Both agreements were completed. The plaintiff paid for the Lydenberg shares transferred by the defendant company and allotted the forfeited shares to that company.] The plaintiff company subsequently discovered that at the date of both the above transactions Samuel, who was acting as agent for the defendant company, held 11,062 shares in the defendant company, being about 5% of their capital. There was a conflict of evidence as to whether Samuel disclosed the nature or amount of this interest to the plaintiff company’s board, and the court held that if the onus lay on the defendant company to prove disclosure that onus had not been discharged. The plaintiff company also discovered that at the date of both transactions Harvey held 1,000 shares in the defendant company. Harvey in fact held 1,000 shares in the defendant company as trustee in the following circumstances. The shares were put into his name by his father-in-law Thompson so that he might look after Thompson’s interest and have a chance of obtaining a directorship. The shares remained in his name after Thompson’s death in 1904, the calls being paid by Thompson’s executors, and at the dates of the impeached resolutions Harvey’s wife as one of the residuary legatees under Thompson’s will had a vested reversionary interest in the shares subject to the life interest of her mother, who died in November 1912. Harvey had voted for the resolutions without disclosing his shareholding in the defendant company, and also without disclosing the fact that two days before the second resolution he had been appointed a director of the defendant company by [491] Samuel and another director, which appointment he was about to accept, and did in fact accept three days later. The other director, Young, who voted for the resolutions, had no interest in the defendant company. In these circumstances the plaintiff company brought this action on 13 November 1913, to rescind both transactions on the ground that the resolutions were invalid. The plaintiff company still held the Lydenberg shares, and the defendant company still held the reissued forfeited shares, so that there was no difficulty about rescission and restitutio in integrum. ASTBURY J: [494] The question is whether the transactions effected by these resolutions can stand. On the pleadings there are three matters only that I am entitled to take into consideration. One is that at the dates of both these meetings, and in respect of the transactions which took place at both, Samuel was present in his capacity as agent for the defendant company. In the second place, at the date of both of these meetings Harvey was a holder in trust for his wife and others of the shares which he held in the defendant company, and third at the date of the second meeting Harvey knew that he had been elected a director of the defendant company, and certainly had no intention, as far as I can judge, of doing otherwise than accepting that position. 512

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Transvaal Lands Co v New Belgium (Transvaal) Land and Development Co cont. Now in ordinary cases “a director of a company is precluded from dealing, on behalf of the company, with himself, and from entering into engagements in which he has a personal interest conflicting, or which possibly may conflict, with the interests of those whom he is bound by fiduciary duty to protect; and this [495] rule is as applicable to the case of one of several directors as to a managing or sole director”. That I take from the judgment of Sir Richard Baggallay in North-West Transportation Co v Beatty (1887) 12 App Cas 589 at 593, which is a statement of the general rule of this court. [Astbury J also quoted from the judgment of Lord Hatherley LC in Imperial Mercantile Credit Association v Coleman at 566 and from the judgment of Lord Cranworth LC in Aberdeen Railway Co v Blaikie Bros at 471.] [496] Now as a matter of fact in these cases the remedy which the court has given to the parties complaining of the transactions impeached has apparently taken the form of depriving the director interested in the transaction of all profits made by him thereby; and it has been contended before me that the mere fact that Harvey was interested as a shareholder in the defendant company, and especially having regard to the fact that that [497] interest was an interest as a trustee and not on his own behalf, is not such an interest as ought, especially having regard to art 98, to render these resolutions invalid. That involves two matters for consideration. In the first place, having regard to the principles laid down by Lord Eldon in Ex parte Bennett (1805) 10 Ves Jun 381; 32 ER 893 unless such a transaction is authorised by the articles, a resolution of directors to deal with another company in which one of the directors forming the quorum to the resolution was interested as a shareholder is and ought to be sufficient to invalidate the transaction. I have been asked to say that the fact of Harvey being a mere trustee of these shares ought to make a difference. … I cannot see on principle why, if a man is interested as a trustee to do the best he can for his cestui que trust instead of doing the best he can for himself if he were interested personally, that ought to make any difference in principle as to that duty being in conflict with the duty which he owes to the company of which he is a director in such a transaction as the present. In the present case it was Harvey’s duty to make the best bargain he could for the plaintiff company in relation to these Lydenberg shares. It was his duty as trustee of the shares in the defendant company to make the best bargain he could for his cestui que trust in connection with that holding. That conflict seems to me to fall within the danger referred to by Lord Eldon in Ex parte Bennett, and apart from the question of art 98 I see no reason why I should whittle down any such wholesome principle. It is contended, however, second that, whether that be right or not, this company has by art 98 contracted itself out of the common law principle, and that directors may contract on behalf of this company with themselves or with a firm in which they are partners, and that no such contract shall be avoided by reason [498] of their fiduciary relation, provided that the director discloses the nature of his interest and does not vote in respect of any contract in which he is concerned. Now the article in terms does not refer at all to shareholding in another company, but it has been contended that the greater must include the less, and that, if this company intended to exclude the wholesome common law rule with regard to contracts made directly with directors or with firms in which they happen to be partners, a fortiori it must have been intended to exclude contracts made with companies in which the directors were merely shareholders, and for that proposition [two cases were cited]. … But I do not myself find in either of those authorities any justification for the proposition that, if the common law rule is excluded with regard to a certain class of contract provided the director discloses his interest and does not vote, another and perhaps less vicious character of contract shall also be excluded in a case where the director does not disclose his interest and does vote. I think myself that in this particular case there is no sufficient justification for saying that this is a company in which a director who is a shareholder in another contracting company may take part in passing a resolution in the way that Harvey has done; and for this reason, coupled with the fact that the Lydenberg transaction was introduced to this company by Samuel as agent [499] for the defendant company, that transaction ought not to stand. Everything that I have said with regard to Harvey’s shareholding in the defendant company equally applies to the second transaction. But there is also in addition the difficulty, if difficulty it be, of Harvey having been appointed two days prior to the second resolution a director of the defendant company [7.375]

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Transvaal Lands Co v New Belgium (Transvaal) Land and Development Co cont. which, although such directorship was not completed by his acceptance, he, in my judgment, on the evidence before me, had obviously no intention of doing otherwise than accepting. The second resolution I think is further vitiated by that fact, and the question of Samuel’s agency for the defendant company in respect of that transaction is also an important matter to be taken into consideration. … The next point was that both these matters have been completed. In the first case the shares have been handed over by the defendant company to the plaintiff company, and the money paid; and in the second case the forfeited shares have been re-allotted to the defendant company; and it has been contended that the defendant company completed the transactions without notice of any irregularity. Now I do not think that that plea is open to the defendant company. It is admitted here, and it must be taken as admitted for the purposes of this case, that with regard to both and in respect of both these transactions Samuel was the agent of the defendant company. He was a director of the plaintiff company and knew everything that was going on as agent of the defendant company. He was their servant or agent for the purpose of dealing with and entering into these transactions, and as such capable of receiving notice, and I think that the plea is unavailing to the defendant company. [Astbury J made an order rescinding both transactions. The defendant company appealed from this order.] SWINFEN EADY LJ READ THE JUDGMENT OF THE COURT OF APPEAL: [His Lordship referred to Aberdeen Railway Co v Blaikie Bros.] [504] Where a director of a company has an interest as shareholder in another company or is in a fiduciary position towards and owes a duty to another company which is proposing to enter into engagements with the company of which he is a director, he is in our opinion within this rule. He has a personal interest within this rule or owes a duty which conflicts with his duty to the company of which he is a director. It is immaterial whether this conflicting interest belongs to him beneficially or as trustee for others. He is bound to do as well for his cestuis que trust as he would do for himself. Again the validity or invalidity of a transaction cannot depend upon the extent of the adverse interest of the fiduciary agent any more than upon how far in any particular case the terms of a contract have been the best obtainable for the interest of the cestui que trust, upon which subject no inquiry is permitted. … [505] With regard to the plaintiff company, this matter is regulated by art 98. This is the only provision in the plaintiff company’s articles modifying what would otherwise be the rule of law applicable, and enabling a director of the plaintiff company to be interested as a member of a company with which the plaintiff company is contracting; but it requires that the director shall disclose the nature of his interest, and shall not vote in respect of any contract in which he is concerned. The provisions of this article were not observed when the resolution to purchase the Lydenberg shares was carried, as Harvey voted in favour of it, and without his vote being counted there was no quorum, whereof the defendants, the other contracting party, had full notice. The result is that the contract was voidable, and has been duly avoided, and the plaintiffs are accordingly entitled to have the purchase money repaid, but they must return the Lydenberg shares. It was not disputed by the appellants that if the first transaction in Lydenberg shares is voidable, by reason of Harvey’s vote having carried it, the second transaction in the partly paid shares of the plaintiff company stands in no better position and is voidable also, and the like result must follow. In our opinion the judgment appealed from was right, and the appeal fails and should be dismissed.

Gray v New Augarita Porcupine Mines Ltd [7.380] Gray v New Augarita Porcupine Mines Ltd [1952] 3 DLR (2d) 1 Privy Council [During a five-year period to 1941, Gray had exclusive management control of the company. He kept very few records of the transactions he conducted for the company and its property and dealings were thoroughly intermingled with his own. The company’s affairs were conducted from the offices of Gray’s legal practice. Bourne, the only other director of the company, was an accountant employed by Gray. During this period Gray used the company’s funds for his own purposes, in “incessant breaches 514

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Gray v New Augarita Porcupine Mines Ltd cont. of his fiduciary obligations” as a director of the company: at 11. In particular, he made large profits by issuing to himself (with the connivance of Bourne) large blocks of shares in the company as fully paid up, taking them at an effective discount of 80% on their par value. He then traded these shares upon the stock exchange at much higher prices. In 1941 pressure from the Ontario Securities Commission precipitated the reconstitution of the company’s board. One of the new directors, Bouck, conducted his own investigation of the company’s affairs and, early in December 1941, prepared a document representing the financial position of the company at that time. This report showed Gray to be indebted to the company for $18,765, subject to certain assumptions. “The crucial assumption”, said Lord Radcliffe in the Privy Council, “was that he ought to be charged with approximately 20 cents for every share that had been issued for cash … [notwithstanding that] his allotments to himself had realised for him, apparently, a much larger average figure per share”: at 7. This report was considered at a board meeting on 9 December 1941. Discussion ensued and agreement was reached between Gray and his fellow directors along the lines outlined in Bouck’s report. Outstanding claims between Gray and the company were to be settled by a payment from Gray of $18,765. The board minutes noted that Gray declared his interest “in all matters in which he was interested” and refrained from voting. The company later brought action against Gray seeking recovery of profits derived in the period prior to the reorganisation of the board or damages for the loss sustained. Gray pleaded the agreement of 9 December 1941 as a full release of all claims against him. It was accepted in the Court of Appeal of Ontario and the Privy Council that restitutio in integrum was now impossible.] LORD RADCLIFFE delivered the judgment of the PRIVY COUNCIL: [12] It is beyond dispute that there are certain special obligations upon a director who places himself in the position of contracting [13] with his company. The general principle is that such a contract is not binding on the company, for a director is not entitled to place himself in a position in which his interest is in conflict with his duty. The company, it has been said, has a right to the services of its directors as an entire board. Even if the contract is not avoided, whether because the company elects to affirm it or because circumstances have rendered it incapable of rescission, the director remains accountable to the company for any profit that he may have realised by the deal. Subject to any statutory requirements that cannot be dispensed with, it is open to companies to make such provisions as they please for the purpose of modifying the incidence of this general principle. [The company’s by-laws made just such a modification.] … In the result Gray as a director was not precluded from entering into contracts or arrangements with the company, but he was not permitted to vote upon a board resolution dealing with such a contract or arrangement and he could only retain for himself any profit arising from the transaction if at the meeting which passed the resolution he had disclosed to his colleagues “the nature of his interest”. Gray did not vote at the meeting of 9 December: but did he make a disclosure of the nature of his interest? If he did not he remains liable to the company for any profit which accrued to him from the settlement. … [14] A director who wishes to keep for himself the benefit arising from some deal with his company has to establish that he has satisfied all necessary conditions. The onus is upon him. But it seems fairly plain that in this case Gray made no such disclosure as was required. He came to the meeting under very heavy liabilities towards the company: he had been making large profits out of his transactions in the shares that he had allotted to himself, he had been making liberal use of the company’s funds for his own purposes. He left the meeting with all those liabilities extinguished for a secured payment of $18,765, a sum which charged him with the equivalent of no more than his ostensible issue price for the shares and which ignored altogether the benefits that he may have obtained from the use of the company’s funds. It was imperative that he should reveal to his colleagues before they voted the fact that to settle with him on the basis of 20 cents per share was to release him from liability at a price that was singularly favourable to himself. The nature of his interest in the agreement proposed consisted of just this fact that he stood to gain so much by the transaction: and only he at the time had the means of knowing how much. There is no precise formula that will determine the extent of detail that is called for when a director declares his interest or the nature of his interest. Rightly understood, the two [7.380]

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Gray v New Augarita Porcupine Mines Ltd cont. things mean the same. The amount of detail required must depend in each case upon the nature of the contract or arrangement proposed and the context in which it arises. It can rarely be enough for a director to say “I must remind you that I am interested” and to leave it at that, unless there is some special provision in a company’s articles that makes such a general warning sufficient. His declaration must make his colleagues “fully informed of the real state of things” (see Imperial Mercantile Credit Association v Coleman at 201 per Lord Chelmsford). If it is material to their judgment that they should know not merely that he has an interest, but what it is and how far it goes, then he must see to it that they are informed: see Lord Cairns in the same case at 205. Tried by any test of this sort Gray’s action falls short of what was required. It is true that the minutes contain a formal record that he declared his interest, but … evidence [on discovery and at the trial] … shows that he never made any attempt to tell the other di- [15] rectors what relation the 20 cents per share bore to his real liabilities to the company. Gray’s attitude was quite explicit: he did not think that there was any necessity for him to make any disclosure. He could not remember that he had said anything at the meeting. He regarded the settlement proposals as having been laid down by the others and himself as having done “pretty well what I was told”. “I wasn’t on the company’s side in that settlement. I was J J Gray in that settlement.” The evidence of [other directors] … is to the same effect: nothing was said by Gray that would have helped to enlighten them as to the real nature of his liabilities to the company. It is said that it would have made no difference if he had told them. They had decided on the basis of settlement that they were going to impose upon him, they did not think that they could get any more out of him, and their main concern for the company was to recover for it some cash that would keep it running and to achieve an agreement that would regularise its disordered affairs. There may be an element of truth in all this, but in fact it constitutes an irrelevant speculation. If a trustee has placed himself in a position in which his interest conflicts with his duty and has not discharged himself from responsibility to account for the profits that his interest has secured for him, it is neither here nor there to speculate whether, if he had done his duty, he would not have been left in possession of the same amount of profit. It has often been said that a trustee who is accountable is not the less accountable if he shows that the transaction impugned is both reasonable and fair … and the principle is the same. It follows that Gray must be held liable to account for all profit that he made by the settlement which he obtained in the manner that has been described. Speaking in general terms, this means the difference between what may have been his real debt at the date of the settlement and the $18,765 for which the directors released the company’s claims. [Their Lordships ordered that Gray “account to the company for the profit that he realised by the settlement agreement made on 9 December 1941”: at 17. An inquiry was directed to ascertain this sum.]

Peninsular and Oriental Steam Navigation Co Ltd v Johnson [7.385] Peninsular and Oriental Steam Navigation Co Ltd v Johnson (1938) 60 CLR 189 High Court of Australia [Amalgamated Collieries was engaged in coal mining in Western Australia. It appointed W Johnson and Co Ltd and Johnson and Lynn Ltd as joint selling agents for its coal. The agency agreement provided for a remuneration of 2s (shillings) 6d (pence) per ton for the joint agents who were to bear all commissions for overseas agents and subagents. In circumstances, evidence as to which Dixon J described as “exiguous and vague” (at 230), the board of Amalgamated Collieries undertook for a period of one year to pay the commission charges of one London selling agent at the rate of 1s per ton. These charges were in due course paid and the joint agents relieved from their obligation to meet them. The board of Amalgamated Collieries included the managing directors of the joint agents, Messrs Johnson and Lynn. Its articles included the following as art 65: No director shall be disqualified by his office from entering into any contract or arrangement with the company either as vendor, purchaser, broker, banker, solicitor, commission agent or 516

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Peninsular and Oriental Steam Navigation Co Ltd v Johnson cont. otherwise, but no such director shall vote in respect of any such contract or arrangement in which he is so interested as aforesaid or if he does his vote shall not be counted. A shareholder in Amalgamated Collieries brought action in its own name challenging the board resolution to pay this commission charge. Dixon J found that the resolution to meet the commission charges was not made dishonestly and did not amount to a voluntary benefit to the selling agent. The plaintiff also sought recovery for the company in respect of other transactions. The principal such claim was for an account of profits, or the award of damages, against Johnson and Lynn Ltd in respect of its sale of certain mining machinery to Amalgamated Collieries. The facts relating to this claim appear in the following extract: at 244-245.] DIXON J: [234] There remains the contention that the resolution is ineffective because the defendant Walter Johnson was a director of the Amalgamated Collieries company and of W Johnson and Co Ltd or of Johnson and Lynn Ltd. Lynn was also a director of the Amalgamated Collieries company as well as no doubt of his own company R J Lynn Ltd and afterwards of Johnson & Lynn Ltd. In accordance with … art [65] … neither Walter Johnson nor Lynn voted. [Article 65] does not expressly validate contracts but says that no director shall be disqualified by his office from entering into a contract with the company. This means, as is well understood, that the contract shall be binding on the company notwithstanding that he is a director. The article refers to various capacities in which a director shall be qualified to enter into a contract or arrangement with the company and then ends with a completely general “or otherwise”. One of the capacities is that of broker, another banker, and a third commission agent. Now, it is not logically impossible that the contract made in any of these three capacities [235] to which the article refers is one in which the director contracts as a principal only. On this view it would cover the contract involved in employing a broker or commission agent but not the contract which he negotiated or made acting for an opposite contracting party. Such a contract might be voidable: see Haywood v Roadknight [1927] VLR 512. But it seems more reasonable to read it as including cases in which the director acts as agent or servant of the other principal to the contract. Indeed, such a construction seems to be demanded by the word “banker”. There have been few examples in Australia of banks conducted by individuals as proprietors, and it is long since any have been known. Unless “banker” includes the officer of a banking company, it could have no practical application, and, if it does so, it is clear that contracts made by a director as the representative of the other principal to the contract are included in the article. Some support for the view that the article extends to such a case is given by the expression “in which he is so interested”: it suggests the inclusion of remoter interests than that of a contracting party. In my opinion, therefore, the article covers contracts or arrangements to which the director is not personally a party but in which he acts as representative of another party whose interests raise a conflict with his duty to the company. So interpreting it, I see no reason why the words “or otherwise” should not extend to the position of a director and shareholder of another company which contracts with the Amalgamated Collieries company. It appears reasonable to give this construction to an article which expressly refers to the more immediate conflicts between interest and duty created by contracting as a principal; for example, as vendor to or purchaser from the Amalgamated Collieries company. It may be said that the strict reading given by Astbury J in Transvaal Lands Co v New Belgium (Transvaal) Land and Development Co at 497-499 tends against the view I have adopted; but it must be noticed that the Court of Appeal in that case preferred to place their judgment on entirely different grounds. I think the resolution was not voidable or inefficacious. But, even if the resolution might have been disregarded in the beginning by the Amalgamated Collieries [236] company as affected by the interest of Lynn and the defendant Walter Johnson, I doubt very much whether it could be treated as ineffective after it had been acted on by the defendant Johnson and Lynn Ltd. That company, on the faith of the resolution, undertook to [the London selling agent] a liability to pay it 1s a ton on coal sold. Simply to disregard the resolution is like rescission when restitutio in integrum is impossible. [244] The more important is a claim that the defendants Johnson and Lynn Ltd and Walter Johnson are accountable for the profit made on the sale by that company of certain mining machinery to the Amalgamated Collieries company. [The property was purchased from the] … receiver of a partnership which had carried on mining operations at Ravensthorpe in Western Australia. On 14 December 1929 [7.385]

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Peninsular and Oriental Steam Navigation Co Ltd v Johnson cont. Johnson and Lynn Ltd bought from him the assets of the undertaking in situ at Ravensthorpe. They consisted of machinery, plant, tools, houses, and material. The price was £1,500. … [A portion of this machinery was sold to persons not associated with any of the parties.] [245] At or towards the end of 1930, however, a larger quantity of the machinery which Johnson and Lynn Ltd had bought from the receiver was resold by that company to the Amalgamated Collieries company. The transaction was never brought before the board of directors of the Amalgamated Collieries company, at all events in any formal manner. The transaction was conducted on both sides entirely by the defendant Walter Johnson, with the help of Lumb, who, at that time, was an officer and director of Johnson and Lynn Ltd as well as a director and assistant general manager of the Amalgamated Collieries company. … I think that upon the facts it must be taken that Johnson and Lynn Ltd bought the assets of the mine at Ravensthorpe as a speculation with the object of selling them to best advantage and not for the [246] definite purpose of reselling them or any of them to the Amalgamated Collieries company. At the same time the defendant Walter Johnson was doubtless then alive to the possibility of reselling them to the Amalgamated Collieries company. The evidence is very defective upon a number of matters in connection with the machinery, as, for instance, the actual value which it possessed for the Amalgamated Collieries company, the use to which it was put, and, indeed, as to the price which that company paid for it. … The statement of claim alleges that the total profit made by Johnson and Lynn Ltd from the resale to the Amalgamated Collieries company and to others of the assets bought from the receiver amounted to £6,000, and the defence admits “a substantial profit”, but the amount was not proved. It is conceded that the machinery could not be restored to Johnson and Lynn Ltd and, therefore, that restitutio ad integrum is out of the question. It is, of course, quite plain that, if rescission were possible, the sale of the machinery to the Amalgamated Collieries company could not stand. The defendant Walter Johnson was a fiduciary agent of that company and with Lumb, who was also a fiduciary agent, assumed to effect a sale to their principal of property belonging to a company of which they were both directors and in which the defendant Walter Johnson was very largely interested. The defendant Walter Johnson acted in the transaction as buyer and seller for his respective principals. There was no disclosure of his interest to any disinterested directors of the Amalgamated Collieries company so far as appears and certainly no independent determination by the board to acquire the assets. The sale was, therefore, in its inception clearly voidable at the option of that company: Salomons v Pender (1865) 3 H & C 639; 159 ER 682; Transvaal Lands Co v New Belgium (Transvaal) Land and Development Co at 503. But, as restitutio in integrum has become impossible, the transaction cannot be rescinded, and the question is whether any and what other relief should be given. If [247] at the time when Johnson and Lynn Ltd bought the plant of the Ravensthorpe mine from the receiver the purchase could be considered as made on behalf of the Amalgamated Collieries company or for any other reason the assets bought could be impressed with an equity in favour of the latter company, there would be no difficulty in making Johnson and Lynn Ltd accountable for the profit made upon the transaction. But, in my opinion, no facts have been established which would support the conclusion that Johnson and Lynn Ltd acquired the assets from the receiver in such circumstances that they became trustees thereof for the Amalgamated Collieries company. Shortly before the time of the purchase, the defendant Walter Johnson had been appointed, at all events de facto, managing director of the Amalgamated Collieries company and Johnson and Lynn Ltd had become “general sales manager” of that company. No doubt it was within the scope of the managing director’s authority to buy secondhand mining machinery for the company if he considered that it was required. If, therefore, he had determined that the Ravensthorpe machinery was needed and should be acquired by the Amalgamated Collieries company and had caused Johnson and Lynn Ltd to buy simply for the purpose of intercepting an intermediate profit upon the acquisition of the machinery by the former company upon which he had so determined, it may well be that, inasmuch as Johnson and Lynn Ltd were represented in the transaction by the defendant Walter Johnson, they would be saddled with a constructive trust arising from his abuse of his authority as managing director of the Amalgamated Collieries company. But there is no satisfactory proof, direct or circumstantial, that in December 1929 the defendant Walter Johnson had determined that the machinery should be acquired by the Amalgamated Collieries 518

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Peninsular and Oriental Steam Navigation Co Ltd v Johnson cont. company, and there is some ground for the view that he then intended that it should be resold in other quarters. Johnson and Lynn Ltd were perfectly at liberty to buy and sell secondhand machinery, and the mere fact that their managing director, the defendant Walter Johnson, was also managing director of the Amalgamated Collieries company could impose no fetter upon the former company’s right of doing so. Once the view is adopted that Johnson and Lynn Ltd were at liberty to resell the machinery to [248] whomsoever they chose and were not bound to hold it for the benefit of Amalgamated Collieries company, the title of the latter company to call upon the former to account for the profit made on the transaction falls to the ground. This position is made very clear by a passage from the opinion of the Privy Council in Cook v Deeks (see [7.465]) at 563, delivered by Lord Buckmaster. Referring to the judgment of the Supreme Court of Ontario, their Lordships say that in their opinion that court has insufficiently recognised the distinction between two classes of case and has applied the principles applicable to the case of a director selling to his company property which was in equity as well as at law his own, and which he could dispose of as he thought fit, to the case of a director dealing with property which, though his own at law, in equity belonged to his company. The cases of North-West Transportation Co v Beatty (1887) 12 App Cas 589 and Burland v Earle [1902] AC 83 both belonged to the former class. In each, directors had sold to the company property in which the company had no interest at law or in equity. If the company claimed any interest by reason of the transaction, it could only be by affirming the sale, in which case such sale, though initially voidable, would be validated by subsequent ratification. If the company refused to affirm the sale the transaction would be set aside and the parties restored to their former position, the directors getting the property and the company receiving back the purchase price. There would be no middle course. The company could not insist on retaining the property while paying less than the price agreed. This would be for the court to make a new contract between the parties. It would be quite another thing if the director had originally acquired the property which he sold to his company under circumstances which made it in equity the property of the company. … [249] In Re Cape Breton Co (1885) 29 Ch D 795 at 803 which is perhaps the foundation authority upon this matter, Cotton LJ says: The principle of those cases is very clear. It is this, that having bought the property while he was a director, and so in the position of a trustee for the company, and having afterwards made it over to the company without disclosing his interest, he was estopped from saying that he originally bought the property on his own behalf, or otherwise than for and on behalf of the company. When, therefore, he pays a large additional sum of money out of the coffers of the company for the property, he is putting into his own pocket a sum of money by way of purchase money paid by the company for that which was already their own. The reference to estoppel must not be misunderstood. It is based upon the assumption that to purchase the property otherwise than for the company would have been a breach of the director’s duty to the company. It appears to me to have no application to the position of a director or a general agent, who is at perfect liberty to purchase property on his own account and does so without any breach of duty and without raising any conflict between his duty and interest. For instance, suppose the general manager of an industrial company bought vacant land as a speculation without any thought of its acquisition by his company but after holding it for many years, sold it to the company as a factory site without disclosing his interest. No one could doubt that the transaction would be voidable at the option of the company; but, on the other hand, the company could not affirm the transaction and recover the profit on the resale on the ground that the general manager was precluded from denying that he bought originally on behalf of the company. There remains the question whether the defendant Walter Johnson is not liable in damages for breach of duty. That it was a breach of his duty as managing director to act as he did in causing the machinery to be transferred from Johnson and Lynn Ltd to the Amalgamated Collieries company at an advanced price, I feel no doubt. But running through the line of authorities which are now accepted is the principle that “the court will not fix a new price [250] between the parties. In such a case the measure [7.385]

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Peninsular and Oriental Steam Navigation Co Ltd v Johnson cont. of damage will be the principal’s loss in the whole transaction. If he has suffered no such loss, there can be no damages” (Jacobus Marler Estates Ltd v Marler 85 LJPC 167n per Lord Parker; see [3.250]). This statement supposes, of course, that the question arises between a vendor who is a fiduciary agent, for example, a director, and a purchaser who is his principal. But it explains why the principal cannot recover the difference between the price paid for the property and its estimated value. In Re Cape Breton Co (1885) 29 Ch D 795 at 812 Fry LJ says: It appears to me that to allow the principal to affirm a contract, and after the affirmance to claim, not only to retain the property, but to get the difference between the price at which it was bought and some other price, is, however you may state it, and however you may turn the proposition about, to enable the principal, against the will of his agent, to enter into a new contract with the agent, a thing which is plainly impossible, or else it is an attempt on the part of the principal to confiscate the property of his agent on some ground which, I confess, I do not understand. To allow a measure of compensation based on the difference between the estimated value of the property when acquired and the price given is to go back to the dissenting judgment of Bowen LJ (1885) 29 Ch D 795 at 809, which, however cogent it may appear, has not been accepted. But in the measure of damages it is hard to suppose that a distinction can be made between cases where the vendor is the agent himself and cases where the vendor is a company in which the agent is interested. In each case it must be “the loss on the whole transaction”. In the present case no attempt has been made to show that the Amalgamated Collieries company made a loss on the whole transaction. Indeed, payment of the profit made on the resale or, alternatively, an account is the only relief claimed in the prayer of the plaintiff’s statement of claim. In my opinion no relief should be given in respect of the sale of the plant, machinery and other things bought from the receiver of the assets of the Ravensthorpe mine. [McTiernan J merely expressed his “substantial” agreement with the reasons of Dixon J: at 259. In respect of the first claim, Latham CJ held that the plaintiff had not challenged the resolution in its pleadings and might not therefore do so upon appeal; furthermore, any agreement resulting from such resolution would be voidable, not void, and could not now with the lapse of years be set aside by the company: at 205. Latham CJ also rejected the claims concerning the Ravensthorpe machinery for reasons substantially similar to those expressed by Dixon J: at 212-213.]

Notes&Questions

[7.387]

1.

The thrall of a director’s fiduciary obligation will usually not extend to acts done qua shareholder. Thus, a director interested in a contract with the company (and who does not rely solely upon the validating effect of an article) will generally be entitled to vote as a shareholder to ratify the otherwise voidable contract. In North-West Transportation Co Ltd v Beatty (1887) 12 App Cas 589 at 593-594 Sir Richard Baggallay, on behalf of the Privy Council, said: [A] director … is precluded … from entering into engagements in which he has a personal interest conflicting, or which possibly may conflict, with the interests of those whom he is bound by fiduciary duty to protect. … Any such dealing or engagement may, however, be affirmed or adopted by the company, provided such affirmance or adoption is not brought about by unfair or improper means, and is not illegal or fraudulent or oppressive towards those shareholders who oppose it.

Oppression does not arise from the mere fact that the interested director held and cast a majority of votes in support of the resolution to ratify and an attempt to exclude interested directors from voting to ratify has been rejected: Esplanade Developments Ltd v Dinive Holdings Pty Ltd (1980) 4 ACLR 826. For an example of a shareholders’ 520

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resolution which purported to validate a contract vitiated by directors’ interest but which was held to be fraudulent towards the dissenting minority, see Cook v Deeks [7.465]; see further on the reach of a director’s obligation, Northern Counties Securities Ltd v Jackson and Steeple Ltd [1974] 2 All ER 625. 2.

What degree of “interest” by a director in a contract with her company will engage the equitable rule? Is there any requirement of materiality of interest and, if so, how is it satisfied? What relation has the interest that engages the equitable rule with that which attracts the disclosure obligation under s 191?

3.

X is a director of Y Ltd which enters into a contract with Z Ltd for the supply of goods. Will the equitable rule be engaged if: (a) X is an employee of Z remunerated by a salary; (b) X is a substantial creditor of Z; (c) X is a director of Z’s parent company; (d) X’s spouse is a director of Z; (e) X’s daughter is employed by Z; or (f) X’s son attends a school conducted by Z? See Baker v Palm Bay Island Resort Pty Ltd (No 2) [1970] Qd R 210 at 221-222; Wilson v London Midland and Scottish Railway [1940] Ch 393; Boulting v Association of Cinematograph, Television and Allied Technicians [1963] 2 QB 606 at 636-637.

4.

What would have been the outcome in the Transvaal Landscase if Samuel had had no interests at all in the defendant company?

5.

In the Transvaal Lands case Astbury J held that the defendant company had notice of the irregularities through Samuel who acted as its agent in both transactions. What is the present effect here of s 128(4) and s 129? See Harkness v Commonwealth Bank of Australia (1993) 12 ACSR 165 at 169-177.

6.

How may a director be released by her company to participate in a contract with the company? What degree of disclosure, and to whom, will satisfy the applicable release doctrine?

7.

What practical limitations are there upon the company’s primary remedy of rescission? What other remedies will be available to the company? In particular, what are the company’s remedies (if any) if a director sells property to the company at a substantial overvalue, the contract not being validated either through the articles or by resolution in general meeting, and the company deals with the property in such a way as to make restitutio in integrum impossible? What would the result be if the director had originally bought the property: (a) with company funds; (b) with personal funds but for the company (how evidenced?); (c) with personal funds and for himself, but with a view to selling the property to the company; or (d) with personal funds, for himself and with a view to selling to best advantage? See Peninsular and Oriental v Johnson.

Director and executive remuneration

The structure of regulation [7.390] At general law, directors’ claims to remuneration were settled by reference to that

analogous class of fiduciaries, trustees, whose functions were treated as purely honorary. Thus, in Hutton v West Cork Ry Co, 218 Bowen LJ said: But what is the remuneration of directors? … It is a gratuity … In some companies there is a special provision for the way in which the director should be paid, in others there is not. If there

218

(1883) 23 Ch D 654. [7.390]

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is a special provision … you must look to the special provision to see how to deal with it. But if there is no special provision their payment is in the nature of a gratuity. 219

Similarly, in Re George Newman & Co 220 Lindley LJ remarked: Directors have no right to be paid for their services, and cannot pay themselves or each other, or make presents to themselves out of the company’s assets, unless authorised so to do by the instrument which regulates the company or by the shareholders at a properly convened meeting. 221

Directors’ rights to remuneration therefore arise only from express provision in a company’s constitution and generally only at the decision of members. That, at least, is the formal position. Thus, under a replaceable rule, directors are paid the remuneration that the company determines by ordinary resolution: s 202A(1). Remuneration paid to directors of a public company does not require separate shareholder approval as a related party transaction if the remuneration (including superannuation contributions and termination payments) is reasonable given the circumstances of the company and the director’s responsibilities: s 211(1); as to related party transactions see [7.415] et seq. Directors determine the remuneration of executives. Shareholder approval is also required for a benefit to be given to a person in connection with retirement from a “managerial or executive office” in the company: s 200B(1). The category of managerial or executive office is defined as directors of the company or a related company and, in the case of listed companies, its key management personnel as defined in the applicable approved accounting standard: ss 200AA, 9 “key management personnel”. A termination payment may, however, be made without shareholder approval where it is • a genuine payment by way of damages for breach of contract; or • given to that person under an agreement made before the person assumed that office as part of the consideration for doing so; and where the payment does not exceed one year’s average base salary: s 200F. Following the collapse of One.Tel (see [7.130]) which paid generous bonuses to its joint chief executives in the preceding year, provisions were introduced in 2003 to constrain the quantum of director remuneration by adding a new category of “unreasonable director-related transactions” to the categories of transactions that might be clawed back by a liquidator under the voidable transaction provisions of the Act: see [3.210]. Liquidators may reclaim unreasonable payments made to the directors of insolvent companies: ss 588FDA, 588FE. The provision applies to transactions that involve a director of the company or close associate, defined as a relative of the director or the spouse of a director. The transaction must have been unreasonable and entered into during the four years immediately preceding the company’s liquidation, regardless of its solvency at the time of the transaction. Unreasonable directorrelated transactions are defined as transactions made to a recipient in circumstances where a reasonable person in the company’s circumstances would not have entered into the transaction. In determining the reasonableness of a transaction factors such as the benefits and detriments to the company and the benefits to the recipient arising as a result of entering the transaction and any other relevant matters are considered: s 588FDA(1). Concerns with executive remuneration levels and disclosure [7.395] Executive remuneration is a particularly sensitive issue in corporate governance, one

where concerns are barely assuaged by the provisions relating to repayment of directors’ 219

Hutton v West Cork Ry Co (1883) 23 Ch D 654 at 672.

220 221

[1895] 1 Ch 674. Re George Newman & Co [1895] 1 Ch 674 at 686.

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unreasonable bonuses. The focus of concern is primarily upon executive rather than director remuneration although the two issues are interrelated since the most senior executives are often also directors; however, non-executive director remuneration is typically in a much lower sum and is formally determined by shareholders: s 202A and [5.100]. 222 In the United States the principal category of shareholder-initiated resolutions at AGMs concern executive remuneration. The issue is no less contentious in Australia where • in the period from 1993 to 2007 CEO remuneration at the 50-100 largest Australian listed companies increased by as much as 300% in real terms; 223 • in the decade to 2010, median CEO fixed pay in the Top 100 ASX Australian companies increased by 131% and the median bonus increased 190%, far outstripping the 31% increase in the S&P/ASX 100 over this period; 224 and • a study of remuneration at Australia’s 50 largest companies in 2010 revealed the typical CEO then received remuneration almost 100 times that of the average worker. 225 Two practices that emerged in the 1990s contributed to these developments. The first is the “pay for performance” idea, namely, that executive remuneration should be structured to reflect corporate performance and the individual executive’s contribution to it. Accordingly, the fixed component of executive remuneration has generally been reduced in favour of a bonus or other flexible pay on the basis of corporate or individual performance. The second practice is in the rapid growth of equity-based remuneration for executives, typically in the form of grants of shares or share options. This practice is related to the first in that the performance component is delivered through equity compensation: 62% of the top 200 listed companies have an executive share plan offering options whose value depends upon an increase in stock price before their exercise. 226 The disciplinary effect of performance-based pay depends on setting appropriate performance hurdles, the effective pricing of options and determination of exercise or grant periods; it will be undercut if options are repriced ex post to reflect downward stock price movements. The disciplinary effect will be further weakened if executives participate in the determination of their own remuneration. 227 Hence, corporate governance standards seek to ensure that executive remuneration is set or recommended by a committee of the board from which executives are either excluded or are in a minority: see [5.85] and [7.410]. These measures notwithstanding, concerns have persisted about the nexus between executive pay 222

ASX listing rules provide that non-executive directors be paid a fixed sum and not performance based remuneration (r 10.17.2); see [7.410]. This sum might be in cash or non-cash benefits such as shares. However, they should not receive share options or bonus payments.

223

Productivity Commission, Executive Remuneration in Australia (Report No 49, Final Inquiry Report, 2009), xv.

224

Australian Council of Superannuation Investors, CEO Pay in the Top 100 Companies: 2010 (Research Paper, September 2011), p 3.

225

Executive PayWatch 2010–Special Report by the ACTU, http://www.actu.org.au (accessed 11 January 2013). It has been estimated that Australian chief executives are the third highest paid executives after those in the US and UK, the two other countries with dispersed share ownership structures (see [2.195]): J Hill & C M Yablon (2002) 25(2) UNSWLJ 294 at 26, n 10

226

The next most popular form of equity compensation is performance rights, adopted by 16% of ASX 200 companies; these are long term incentive plans that grant rights to acquire shares (typically at no cost) at the end of a performance period based on the extent to which specific performance conditions have been satisfied: A Hepworth, Australian Financial Review, Salary Review 2004, 9 November 2004, sect 4. In the US equity-based compensation constituted approximately two-thirds of the median income of chief executives of large publicly held corporations in 2001; the corresponding figures in 1990 and 1984 were 8% and zero, respectively: J C Coffee (2004) 84 Boston U L Rev 301 at 327; correspondingly, Coffee reports that in the decade to 2001 stock options grew from 5% of the equity of major United States corporations to 15%.

227

On the positional conflicts of interest besetting management remuneration determination see J Hill & C M Yablon (2002) 25 (2) UNSWLJ 29. [7.395]

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and corporate performance and failure of the intended alignment between executive and corporate interests. Some key points that emerged from the Productivity Commission inquiry into executive remuneration in 2009 were • executive pay varies greatly across Australia’s listed public companies from 110 times average weekly earnings for the top 20 CEOs to four times AWE for the smallest listed companies • liberalisation of the Australian economy and global competition, increased company size, and the shift to incentive pay structures have been major drivers of executive remuneration • some past trends and specific pay outcomes appear inconsistent with an efficient executive labour market and have possibly weakened company performance – incentive pay imported from the US and introduced without appropriate hurdles spurred pay rises in the 1990s; more recently, complex incentive pay structures may have delivered unanticipated benefits for executives and either weakened or created perverse performance incentives such as excessive risk-taking in the finance industry – some termination payments appear excessive and could indicate compliant boards • excessive payments and perceived inappropriate behaviour could reduce investor and community trust in the corporate sector more broadly, with adverse ramifications for equity markets. 228 Equity-based remuneration creates wider problems. Depending on its form, it may provide an incentive for executives to focus on short rather than long term stock price maximisation; this is especially the case where compensation is in the common form of stock options rather than longer term performance rights. The second is through the further incentive for executives to exploit information asymmetries through the timing of information release (such as premature earnings recognition or delayed release of bad news) or simple misrepresentation, manipulating stock price to their advantage. These opportunities arise since executives may capture significant personal benefits by the immediate exercise of options upon their maturity and sale of the shares; the determination of performance conditions and exercise periods is therefore crucial.

Disclosure of director and executive remuneration [7.400] Concerns about executive remuneration have prompted serial revision of the legal regime for remuneration disclosure in annual financial reports. Amendments made in 2011 implemented reform proposals made by the Productivity Commission in its 2009 report. 229 The exposure draft of proposed amendments to the Act released in December 2012 (“2012 Exposure Draft”) 230 adds to these disclosure obligations. The annual directors’ report must include details of options granted over unissued shares during the year to any of the directors or the five most highly remunerated officers of the company: s 300(1)(d). Listed companies incorporated in Australia must also include under the heading “remuneration report” in a separate and clearly identified section of the directors’ report: 228

229

Productivity Commission, Executive Remuneration in Australia (Report No 49, Final Inquiry Report, 2009), pp xiv-xxv. For a less sanguine view of the operation and potential of corporate governance mechanisms, and the barriers to effective board determination of compensation uninfluenced by management, see L Bebchuk and J Fried, Pay Without Performance: The Unfulfilled Promise of Executive Compensation (2004). Following the Productivity Commission report the Minister referred several matters to CAMAC for examination: see Corporations and Markets Advisory Committee, Executive Remuneration, Report (2011).

230

Corporations Legislation Amendment (Remuneration Disclosures and Other Measures) Bill 2012 (Exposure Draft).

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(a)

discussion of board policy for determining the nature and amount of remuneration of key management personnel of the company or the consolidated entity (group) in the case of consolidated financial statements; 231 key management personnel (“KMP”) are as defined in accounting standards: s 9;

(b)

discussion of the relationship between such policy and the company’s performance that deals specifically with the company’s earnings and the consequences of its performance for shareholder wealth in the current and previous four financial years through dividends paid and changes to share price;

(ba)

if an element of remuneration is dependent on the satisfaction of a performance condition: a detailed summary of the performance condition, an explanation of why it was chosen, a summary of the methods used in assessing whether the performance condition is satisfied and an explanation of why those methods were chosen; 232

(c)

prescribed details of the nature and amount of each element of the remuneration of each KMP including the relative proportion of performance-related remuneration and the value of options granted during the year; and

(h)

if a remuneration consultant made a recommendation in relation to any KMP, details of arrangements with the consultant that bear upon their independence from undue influence by KMP: 233 s 300A(1), (2), (3), reg 2M.3.03. (Paragraph numbers reflect those of the sub-section.)

The 2012 Exposure Draft would add to the remuneration report disclosure requirements of s 300A(1) (aa) a general description of the remuneration governance framework of the company or group – its process for determining the remuneration of KMP – unless disclosed elsewhere in the report (such as qualifications and experience of members of the remuneration committee and arrangements for management of conflicts of interest around remuneration setting); (ca)

details of present, past and future remuneration for KMP: showing separately the portions for current year performance, past pay crystallising during the year and the value of remuneration granted in the year that would be paid in the future; and

(ea)

details of retirement payments made to KMP, including non-contractual payments such as discretionary payments, gratuitous bonuses and post-employment consultancy arrangements.

231

The inclusion of the reference to the group seeks to give a better picture of remuneration practices across the corporate group and to prevent corporate structures being used to circumvent the reporting requirements (eg, by employing the highest paid officers elsewhere in the group). All sources of remuneration within the group must be included: s 300A(4). If the performance condition involves a comparison with factors external to the company, the remuneration report must include a summary of the factors to be used in making the comparison and, if any of these factors relate to the performance of another company or companies, their identity or the relevant index in which they are included: s 300A(1)(ba)(iv). The Productivity Commission inquiry pointed to the potential for conflicts of interest where remuneration consultants report directly to management or provide other services to the company: Productivity Commission, Executive Remuneration in Australia (Report No 49, Final Inquiry Report, 2009), pp 377-379 (recommendations 10 and 11). Improved disclosure assists shareholders to assess the independence of the advice that remuneration consultants provide to boards and their remuneration committees. The engagement of a remuneration consultant must first be approved by the board or remuneration committee and the consultant must report directly to the non-executive directors or the remuneration committee rather than executive management: ss 206K, 206L.

232

233

[7.400]

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The 2012 Exposure Draft would also require listed companies that become aware of material misstatements or omissions 234 in any of the three previous financial year statements to disclose in the remuneration report whether any overpayments to KMP have been or will be clawed back as a result of the overpayment. If no remuneration is clawed back despite the overpayment, an explanation must be provided. Faithful to the general corporate regulatory preference for disclosure over prescription, mandatory disclosure of clawback policy was rejected in favour of the “comply or explain” model. The “comply or explain” obligation is engaged only if the company becomes aware of a material misstatement or omission. Before 2011 the remuneration report was required to disclose the company’s policy with respect to hedging of incentive remuneration through derivatives or other contract-based mechanisms. Hedging reduces the risk that the director or executive will fail to meet performance hurdles for incentive remuneration; its effect therefore is to weaken performance incentives and decouple remuneration from performance. In this area, disclosure gave way to prescription: the KMP of a listed company and their closely related parties must not enter into an arrangement (with anyone) if it has the effect of limiting the KMP’s exposure to risk relating to an element of the KMP’s remuneration that is unvested (due to time or other conditions) or is vested but remains subject to a holding lock: s 206J(1). Members who have 5% of the votes or 100 voting members may direct the company to disclose all remuneration paid to directors of the company or a controlled entity in whatever capacity: s 202B(1). ASX Listing Rules impose additional shareholder approval requirements. Thus, a company must not increase the total amount of the fees payable to directors without the approval of ordinary shareholders; this does not apply to the salary of an executive director: r 10.17. Listing rules require shareholder approval for termination benefits that exceed 5% of the equity interests of the company (r 10.19); termination benefits may not be paid or increase by reason of changes in the shareholding or control of the company: r 10.18. 235

Shareholder meeting input into director and executive remuneration [7.405] Concerns about executive remuneration have also prompted serial strengthening of

the mechanisms of shareholder influence, stopping short of transferring executive remuneration setting from directors to shareholders. These measures also implement proposals in the Productivity Commission report. At a listed company’s AGM, the chair of the meeting must allow a reasonable opportunity for discussion of the remuneration report: s 250SA. In addition, a resolution must be put to the vote at each AGM for the adoption of the remuneration report: s 250R(2). The notice of meeting must also inform members that the resolution on the remuneration report will be voted on: s 249L(2)(a). The vote is advisory only so that it does not bind the directors or the company: s 250R(3). The vote is not intended to detract from the responsibility of directors to determine executive remuneration. Its stated function in its introduction in 2004 was to allow collective expression of opinion on the board’s remuneration policy and the remuneration paid and thereby to strengthen the institutions of director accountability. 236 Although this provision was criticised by peak business organisations, it is broadly consistent with the OECD Principles of Corporate Governance that provide that shareholders should be able to express their views about 234 235

Materiality would be determined by reference to the applicable accounting standard: proposed addition to the dictionary in s 9. On the impact of increased share-based (equity) remuneration on this regulation see C Fenwick & K Sheehan (2008) 26 C&SLJ 71.

236

Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill 2003, Explanatory Memorandum, [5.345].

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remuneration policy for board members and executives and submit questions to auditors. Of course, the non-binding character of the vote meant that the board was entitled to proceed with its remuneration report despite a negative shareholder vote. In 2011 the non-binding vote mechanism was strengthened but not by making the vote binding. The Productivity Commission had concluded that there would be significant practical difficulties and risks associated with introducing a binding vote: companies would be unable to finalise a contract with an executive until shareholder approval was obtained, a situation likely to create uncertainty and delay; further, a binding vote would represent a fundamental change to the role of directors and would impact on their capacity to manage the company. 237 What emerged instead is the “two strikes” mechanism. Where a company’s remuneration report receives a “no” vote of 25% or more, the company’s subsequent remuneration report must explain the board’s proposed action in response or, if the board does not propose any action, its reasons for inaction: s 300A(1)(g). If the company’s subsequent remuneration report receives a “no” vote of 25% or more, a resolution must be put (the “spill resolution”) to shareholders at the same AGM: s 250U. Notice of the spill resolution must be contained in the meeting papers for the second AGM to ensure that notice has been given in the event that the second strike is triggered; the notice must explain the circumstances in which the resolution will apply: s 249L(2). If the spill resolution passes with 50% or more of the eligible votes cast, another meeting of the company’s shareholders (the “spill meeting”) must be held within 90 days: s 250V. A company will still need to provide the minimum notice period for holding the spill meeting as required by the Act and any minimum notice period in its constitution for the nomination of candidates for the board; this ensures that shareholder nominated candidates can seek endorsement at the spill meeting: s 250W(3). The separation of the “second strike” resolution and the “spill resolution” is intended to ensure that shareholders are not discouraged from voting against the remuneration report because they fear removal of certain board members. It also seeks to ensure that shareholders are free to express their concerns on the remuneration report and to provide a clearer signal of shareholders’ views on the remuneration report. 238 At the spill meeting, those individuals who were directors when the directors’ report was considered at the later (second) AGM and wish to continue as directors are required to stand for re-election (other than the managing director who continues to hold office as director during appointment as managing director under ASX listing rules and standard constitutional arrangements: see [5.245]): s 250V(1). These directors cease to hold office immediately before the end of the spill meeting; any new directors elected at the spill meeting automatically hold office at the end of the meeting: s 250W(9). Where none of the individuals who were directors when the directors’ report was considered at the second AGM remain as directors of the company (ie, they all resign after the second meeting), there is no need for the spill meeting (s 250W(4)) although new directors would need to be appointed by the outgoing. If the company fails to hold the spill meeting within 90 days of the spill resolution being passed, each person who is a director of the company at the end of those 90 days commits an offence: s 250W(5). Failure to hold the spill meeting within 90 days is a strict liability offence: s 250W(6); see [4.182]. The Act contains a mechanism to ensure that a minimum of three directors remain after the spill meeting as required by s 201A(2) if none of the candidates offering themselves for election attracts majority voting support. To ensure the appointment of three directors, the remaining 237

Productivity Commission, Executive Remuneration in Australia (Report No 49, Final Inquiry Report, 2009), pp 286-287.

238

Corporations Amendment (Improving Accountability on Director and Executive Remuneration) Bill 2011, Explanatory Memorandum, [1.14]. [7.405]

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positions are automatically filled by those with the highest percentages of votes at the spill meeting on the resolution for their appointment even if that resolution failed: s 250X(3). KMPs and their closely related parties, or a person acting on their behalf, must not vote in the resolution on the remuneration report or at the spill meeting: ss 250R(4), 250V(2). There is an exception where the person is exercising a directed proxy (which specifies how the proxy is to vote on the proposed resolution) on behalf of someone other than the KMP or a closely related party: s 250R(5). A KMP or their closely related party that is appointed as a proxy must not exercise the proxy on a resolution connected directly or indirectly with the remuneration of a KMP if the proxy is undirected unless they are the chair of the meeting and the proxy giver expressly provides informed consent for the chair to exercise the proxy despite the interest of the chair in the resolution: s 250BD(1), (2). This authorisation might be obtained by completing a proxy form containing the statements in ASX Listing Rule 14.2.3B.

ASX Principles and remuneration [7.410] The ASX Corporate Governance Principles and Recommendations contain recommendations for listed entities which are intended to reflect international best practice: see [5.25]. Principle 8, Remunerate fairly and responsibly, enjoins companies to ensure that the “level and composition of remuneration is sufficient and reasonable and that its relationship to performance is clear. … It is important that there be a clear relationship between performance and remuneration, and that the policy underlying executive remuneration be understood by investors.” An ASX listed company’s remuneration policy should be designed so that it: • motivates senior executives to pursue the long-term growth and success of the company and • demonstrates a clear relationship between senior executives’ performance and remuneration: Recommendation 8.1 (Commentary).

The ASX Principles provide that the board establish a remuneration committee with defined responsibilities, with at least three members a majority of whom should be independent directors, and the committee should be chaired by an independent director: Recommendation 8.2. Its function is to review the company’s remuneration, recruitment, retention and termination policies and procedures for senior executives; senior executives’ remuneration and incentives; superannuation arrangements; the remuneration framework for directors; and remuneration by gender. An “if not, why not?” or “comply or explain” rule applies to the ASX Principles. The comparable UK Code delegates responsibility to the committee for setting the remuneration of executive directors and the chair: see [5.85].

RELATED PARTY TRANSACTIONS Background and purpose [7.415] Chapter 2E prohibits the giving of financial benefits to related parties of public

companies unless the benefits are covered by particular exceptions or are disclosed to and approved by shareholders in general meeting: s 208(1). The reach of the prohibition extends beyond longstanding concerns with loans and guarantees given to directors to embrace a wider range of transactions and recipients of benefits. The purpose of Ch 2E is to protect the interests of a public company’s members as a whole by requiring their approval for benefits to related parties that could endanger those interests: s 207. That protection is not, however, at the expense of those dealing with the company since contravention of s 208(1) does not 528

[7.410]

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invalidate the contract or transaction that gives the unauthorised benefit (ss 209(1), 103(2)): in this context certainty is preferred to invalidity. 239 The provisions acknowledge the constraints of fiduciary protection, the limitations upon its reach and the breadth of permitted attenuation through company constitutions. Indeed, the problems to which the proposals were directed include the self-dealing transactions to which the conflict avoidance rules have traditionally been addressed: Following the corporate collapses of the 1980s, it has become evident that some corporate controllers abused their positions of trust by arranging for the shifting of assets around and away from companies and corporate groups, and into their own hands. They achieved this by various means, including remuneration payments, asset transfers or loan arrangements, on terms highly advantageous to themselves but to the detriment of these companies. In other instances, substantial inter-corporate loans were entered into with the apparent purpose or effect of disguising the true financial position of individual companies within a group. This was made easier by the lack of any general statutory requirement that shareholders either consent to, or be informed of, these transactions. These abuses generally involved significant losses of corporate funds, with adverse effects on investor and creditor returns and confidence. They also brought into question the integrity of Australian financial markets, with detrimental consequences for the national economy. 240

The requirements of Ch 2E are prescriptive and may not be overridden by provisions contained in a company’s constitution. If benefits under a transaction are exempted or approved by shareholders under Ch 2E, that does not relieve directors from duties under the Act or their fiduciary duties in connection with the transaction: s 230. The core prohibition [7.420] A public company must not give a financial benefit to a related party of the public

company unless it falls within an identified exception or is approved by shareholders under a special procedure within the preceding 15 months; a like prohibition applies to an entity that the public company controls giving a financial benefit to a related party of the public company: s 208(1). The term “entity” in Ch 2E refers to a corporation, partnership, unincorporated body, individual or trust: s 9. A company controls an entity if it has the capacity to determine the outcome of decisions about the entity’s financial and operating policies: s 50AA(1). In determining whether a company has this capacity: (a) the practical influence the company can exert (rather than the rights it can enforce) is the issue to be addressed; and (b)

any practice or pattern of behaviour affecting the entity’s financial or operating policies is to be taken into account (even if it involves a breach of an agreement or a breach of trust): s 50AA(2).

The legislative focus is upon the practical influence a company can assert, rather than the active exercise of control. Therefore, the mere fact that an entity acts in a manner consistent with the interests of another company may be sufficient to indicate control. In terms of the basic capacity to determine the outcome of decisions, the strength of voting power in the entity may be more significant than economic dependence through financial provision, although the duration of the voting power or of the economic dependence may be significant; a short-lived ability (even for a few hours only) to control the outcome of decisions taken by the company 239

Re Summit Resources Pty Ltd (2012) 261 FLR 365 at [67]-[75].

240

Companies and Securities Advisory Committee, Report on Reform of the Law Governing Corporate Financial Transactions (1991), p 1. [7.420]

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would be unlikely to satisfy the control test. 241 Merely because the company and an unrelated entity jointly have the capacity to determine the outcome of decisions about another entity’s financial and operating policies (eg, under a joint venture agreement) does not mean that the company controls the other entity: s 50AA(3). Also, a company is not taken to control an entity because of a capacity in which it is under a legal obligation to exercise for the benefit of someone other than its shareholders (eg, if the company holds shares as a bare trustee): s 50AA(4). When a financial benefit is given [7.425] The concept of a financial benefit is not defined exhaustively. Rather, the Act gives examples of an entity giving a financial benefit in the context of laying down general principles to guide the interpretation of the concept. First, a reference to an entity giving a financial benefit is intended to operate broadly even though criminal or civil penalties may be involved and includes a reference to giving a financial benefit indirectly (eg, through one or more interposed entities) or by making or giving effect to an agreement that is informal, oral or non-binding: s 229(1)(a), (2)(a) and (b). Second, in deciding whether an entity has given a financial benefit the economic and commercial substance and effect of what the entity has done prevails over its legal form, and any consideration given for the benefit is to be disregarded even if it is adequate: s 229(1)(b), (c). 242 Third, a benefit that does not involve the payment of money can still be a financial benefit if, for example, it confers some financial advantage: s 229(2)(c). There is no threshold level of financial benefit that requires shareholder approval; hence, any benefit to a related party of a public company that is not covered by an exception will require shareholder approval. The examples given of a financial benefit include: • giving or providing finance or property to the related party; • the sale, purchase or leasing of an asset to or from the related party; • the receipt or provision of services; and • the issue of securities or grant of an option to the related party: s 229(3).

The definition of a related party of a public company [7.430] The second key concept is that of a related party of a public company. Broadly

speaking, a related party of a public company is defined to include its directors, other persons who are in a position to influence the company’s decision to give them a financial benefit and those within defined familial relationships. 243 More precisely, the related parties of a public company are: • the directors of the public company; • an entity that controls it; • the directors of an entity that controls the public company; • the persons constituting an unincorporated entity that controls the public company; • the spouses or de facto spouses of any of the above persons; • the parents and children of any of the above persons; and 241

243

This proposition is derived from statements made in Company Law Review Bill 1997, Explanatory Memorandum, [12.61]. However, the adequacy of that consideration will be relevant in determining whether the principal exception is satisfied, namely, for transactions no more favourable to the related party than those negotiated at arm’s length (s 210): see [7.435]. Corporate Law Reform Bill 1992, Explanatory Memorandum, [205].

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[7.425]

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• an entity controlled by any of the above persons or entities: s 228(1) – (4). An entity is also a related party of a public company at a particular time if the entity: • was a related party of the public company at any time within the previous six months (s 228(5)) (this provision seeks to inhibit, for example, avoidance devices such as temporary resignation or divestiture with a view to avoiding the prohibition upon giving benefits); • believes or has reasonable grounds to believe that it is likely to become a related party of the public company at any time in the future (s 228(6)) (this provision catches the giving of financial benefits in anticipation of a related party relationship with a public company); or • acts in concert with the related party of a public company on the understanding that the related party will receive a financial benefit if the public company gives the entity a financial benefit: s 228(7). The definition of a related party of a public company therefore includes: • its directors and their immediate relatives as identified; • a holding company, its directors and their immediate relatives; • a controlling entity and its constituents or governing officers (such as a controlling shareholder); and • entities under the common control of the public company. This list is not exhaustive. By way of further exemplification, the definition does not include: • a subsidiary or other controlled entity of the public company; • the subsidiary’s directors or those of a fellow subsidiary of the public company unless they are also directors of the parent entity or otherwise a related party; and • siblings or other relatives of these directors or of a director’s spouse, apart from a parent or child. Exceptions to the prohibition upon giving financial benefits [7.435] The prohibitions upon the giving of financial benefits are subject to exceptions that

obviate the need for shareholder approval. The principal exception applies in relation to a financial benefit on terms no more favourable to the related party than those that would be reasonable in the circumstances if the parties were dealing at arm’s length: s 210. 244 Transactions between a public company, or its controlled entity, and a related party of the public company that are on different terms must be approved by shareholders who are fully informed of their details. In addition, the prohibitions do not apply to: • remuneration paid to a related party as an officer or employee of the public company, of an entity that it controls or which controls the public company or which is under common control with the public company; however, the remuneration must be reasonable given the circumstances of the company or entity giving the remuneration and of the related party, including the responsibilities of office or employment (s 211(1)); remuneration includes contributions made to a superannuation fund and termination payments (s 211(3)); • payment or reimbursement of expenses to such an officer or employee (s 211(2));

244

It may not be necessary that the benefit is given in the ordinary course of the company’s business or that the company extends like benefits to unrelated parties. A company may seek to support its judgment as to the reasonableness of terms provided by the related party for the benefit by obtaining independent expert advice. [7.435]

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• an indemnity, exemption or insurance premium in respect of a liability incurred as an officer, or an agreement to give or pay such a benefit, which is reasonable in the circumstances of the public company or entity giving the benefit (s 212(2)); 245 • paying or agreeing to pay the reasonable legal costs of an officer in defending an action for liability incurred as an officer of the public company or entity (s 212(2)); • advances to a director of the public company or their spouse under the prescribed limit (s 213); • benefits passing between a company and its closely held subsidiary or from such a subsidiary to another entity which is also under the control of the parent (s 214(1)); a closely held subsidiary is one that would be a wholly owned subsidiary of the other company if non-voting shares were disregarded (s 214(2)); • benefits given by a public company to any of its own members in their capacity as members where they do not discriminate unfairly against other members (s 215); 246 and • benefits given pursuant to a court order: s 216. Application in Adler v ASIC [7.440] In Adler v ASIC (see [7.95]), HIHC paid $10 million to PEE under the effective

control of Adler who had a 10% interest in the AEUT trust of which PEE later became trustee (HIHC held the 90% interest in AEUT). ASIC claimed that the payment involved a contravention of s 208 by HIHC and HIH on the basis that PEE was a related party of HIHC. In the Court of Appeal, Giles JA (with whom other members of the court agreed) held that it was immaterial to resolution of the s 208 issue whether the payment to PEE was treated as an unsecured interest-free loan (as ASIC contended) or a payment held on trust (as Adler contended): On [Adler’s] view, the appellants fare no better. PEE had $10,000,000 which it previously did not have, with an absolute discretion as to its use and de facto ability to apply the money or misapply the money and, at least in the way the AEUT was dealt with, continuance of the entitlement to 10% of the profits. Adler Corporation gained an entitlement to income and capital, and through it Mr Adler gained a benefit. The general position that the trustee could not derive any remuneration or other personal benefit from its role as trustee was abrogated by the terms of the AEUT trust deed, and the reality was that Mr Adler procured PEE to act for his own benefit in the acquisition of the shares from Adler Corporation and the making of the loans. … PEE was controlled by Mr Adler, who was known to favour less conservative investment policies than those in place at HIH and was also a director of HIH, and the terms of the AEUT left HIH the major contributor but with a minority voice in the Trust; HIH was locked in and had no effective control over its investment. If it was in contest that the reasonable arms length terms test was failed, it clearly was. 247

Adler argued that for him to be involved in the contraventions of s 208 by HIHC and HIH ASIC had to establish that he appreciated that the payment to PEE gave a financial benefit. The Court held that Adler knew all the facts which made the payment to PEE the giving of a financial benefit otherwise than on arm’s length terms even if he mistakenly assumed that the 245

246

As to the circumstances in which a company may grant an indemnity or exemption or pay an insurance premium for its officers see [7.560]. In working out for the purposes of this exception or that relating to legal costs whether a benefit is reasonable in the circumstances, the relevant time is that at which the benefit is agreed to be paid or, absent prior commitment, is paid; any other financial benefit given or payable to the officer by the public company or entity is to be disregarded: s 212(3). The exception may therefore sustain the payment of dividends, issue of bonus shares, reduction of capital and other financial distributions made to members on an equal basis.

247

Adler v ASIC (2003) 179 FLR 1 at [317].

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transaction was protected by s 210. 248 The same conclusion followed for Williams whose knowledge of the essential facts constituting the contraventions did not materially differ from that of Adler. The shareholder approval mechanism [7.445] Financial benefits within Ch 2E that are not covered by an exception require the approval of the public company’s members in general meeting under Pt 2E.1 Div 3; the benefit must be given within 15 months after the approval: s 208. The approval may be given by reference to class or kind of benefit: s 217. 249 A resolution of a public company approving a financial benefit to a related party is effective only if conditions as to disclosure and voting are satisfied. First, the conditions require the public company to prepare an explanatory statement setting out the related parties to whom the proposed resolution would permit financial benefits to be given and the nature of the benefits: s 219(1)(a), (b). The statement must set out the recommendation each director of the company makes about the proposed resolution and their reasons for it; if a director does not wish to make a recommendation, or was not available to consider the proposed resolutions, the reasons for that decision or unavailability must be disclosed: s 219(1)(c), (d). The statement must also contain all such information known to the company or any of its directors that is reasonably required by members in order to decide whether or not it is in the company’s interests to pass the proposed resolutions: s 219(1)(e). Such disclosure might include information about what, from an economic and commercial point of view, are the potential costs of the proposed benefits, including opportunity costs, taxation consequences and benefits forgone by the entity giving the benefits: s 219(2). At least 14 days before the notice convening the meeting is given to members, the company must lodge with ASIC • the proposed notice of meeting; • the proposed explanatory statement;

• any other document proposed to accompany the notice convening the meeting; and • any other document which can reasonably be expected to be material to a member in deciding how to vote on the proposed resolution that the company, the related party to whom the financial benefit is to be given and associates of either proposes to give to members before or at the meeting: s 218(1). 250 Within 14 days after a public company lodges these documents, ASIC may give to the company written comments on those documents, other than comments about whether the proposed resolution is in the company’s best interests: s 220(1). Where ASIC has given comments to the public company, these comments must accompany the notice convening the meeting given to members. This notice must be the same in all material respects as the proposed notice lodged with ASIC and must be accompanied by the explanatory statement and other documents lodged with ASIC, and by no other material: s 221. The resolution approving the giving of the benefits must be the same as that earlier proposed in the notice of meeting lodged with ASIC: s 223. At the general meeting, a vote on a proposed resolution must not be cast by or on behalf of a related party who would benefit under the resolution or an associate of such a related party: 248

Adler v ASIC (2003) 179 FLR 1 at [340].

249

This facility is presumably intended to permit companies to give group rather than individual approval to executive remuneration and share option plans at an AGM.

250

The term “associate” is defined in Pt 1.2 Div 2; in its application to takeovers it is discussed at [12.75]. [7.445]

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s 224(1). If any votes on the resolution are cast in contravention of this restriction, the resolution will be valid only if it would still be passed even if those votes were disregarded (s 225(1)); otherwise, contravention of the voting restriction does not affect the validity of a resolution: s 224(8). The votes cast by each member of the public company who voted on the resolution in person or by proxy must be recorded in writing showing the member’s name and how many votes the member cast for the resolution and how many against: s 225(3) – (5). Within 14 days after the resolution is passed, the public company must lodge with ASIC a notice setting out the text of the resolution: s 226. Sanctioning related party transactions [7.450] The fact that the giving of a financial benefit contravenes s 208 does not affect the

validity of any contract or transaction connected with the giving of the benefit, and the public company or entity is not guilty of an offence: s 209(1). However, a person who is involved in a contravention of s 208 contravenes s 209(2), a civil penalty provision with consequences within Pt 9.4B: see [7.65]. An offence is committed by a person who is involved in a contravention of s 208 and their involvement is dishonest: s 209(3). [7.452]

Review Problems

1. Z Ltd is controlled by H Ltd although it has outside shareholders. May Z Ltd subscribe for shares in a business venture initiated by Sam, the spouse of the managing director of H, or lend funds to the venture on commercial terms, although in either case, Z will need to borrow funds for the purpose? Would it make a difference if Z was Z Pty Ltd? Alternatively, would it make any difference to your answer if Sam was the spouse of the managing director of another subsidiary company of H Ltd, and not H Ltd itself? 2. Would the prohibitions of Ch 2E apply to the supply of goods in the hypothetical situations posed in [7.387], n 3?

SECRET PROFITS: THE APPROPRIATION OF CORPORATE PROPERTY, INFORMATION AND OPPORTUNITY The distinct bases of equitable obligation [7.455] While directors are not generally trustees of company property, 251 they are treated as

trustees of company funds in their hands or under their control; accordingly, if directors misapply company funds, they are liable to make good the moneys upon the same footing as if they were trustees. 252 Similarly, a director who misappropriates other property of the 251

The application of the like fiduciary principle to promoters is discussed in Tracy v Mandalay [3.230] and, to partners, at [1.140]. For valuable discussions of these doctrines see R P Austin, “Fiduciary Accountability for Business Opportunities” in P D Finn (ed), Equity and Commercial Relationships (1987), p 141; J R F Lehane, “Fiduciaries in a Commercial Context” in P D Finn (ed), Essays in Equity (1985), p 95; Meagher, Gummow & Lehane, Ch 5; S M Beck (1971) 49 Can Bar Rev 80 and (1975) 53 Can Bar Rev 771; G Jones (1968) 84 LQR 472; A J McClean (1969) 7 Atla LR 218; D D Prentice (1972) 50 Can Bar Rev 623; V Brudney & R C Clark (1981) 94 Harv LR 997; A G Anderson (1978) 25 UCLALR 738 and K J Hopt, “Self-Dealing and Use of Corporate Opportunity and Information: Regulating Directors’ Conflicts of Interest” in K J Hopt & G Teubner (eds), Corporate Governance and Directors’ Liabilities (1985), p 285.

252

O’Brien v Walker (1982) 1 ACLC 59; Re Lands Allotment Co [1894] 1 Ch 616 at 631; Belmont Finance Corp Ltd v Williams Furniture Ltd (No 2) [1980] 1 All ER 393 at 405.

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company will also be liable as constructive trustee of the property. 253 More difficult questions arise, however, where directors and senior officers acquire property or derive profits not by direct appropriation of company funds or tangible property but by use of their position in the company or in other circumstances where personal interest is opposed to duty. This section deals with obligations and remedies arising with respect to property and profits derived not from such appropriation or other dealing with the company but in circumstances bearing a sufficient nexus with corporate office that the assets or profits are impressed with a constructive trust or are subject to the equitable remedy of account. A company director or senior officer is under a fiduciary obligation to account to the company for benefits derived in two general situations. The first arises where the benefit was obtained in circumstances where there existed a conflict, or significant possibility of conflict, between the director’s duty to the company and personal interest or another interest which the director is bound to protect. 254 Liability is imposed in such circumstances, not primarily to redress abuse but prophylactically, to prevent the fiduciary from being swayed by considerations of personal interest. 255 The second arises where the benefit was obtained or received by use or by reason of the office of director or of opportunity or knowledge resulting from it. 256 In either case the director or officer may retain the benefit only if all the material facts are disclosed to the appropriate organ of the company and approved by it. In Chan v Zacharia, Deane J described these elements of obligation: 257 The variations between more precise formulations of the principle governing the liability to account are largely the result of the fact that what is conveniently regarded as the one “fundamental rule” embodies two themes. The first is that which appropriates for the benefit of the person to whom the fiduciary duty is owed any benefit or gain obtained or received by the fiduciary in circumstances where there existed a conflict of personal interest and fiduciary duty or a significant possibility of such conflict: the objective is to preclude the fiduciary from being swayed by considerations of personal interest. The second is that which requires the fiduciary to account for any benefit or gain obtained or received by reason of or by use of his fiduciary position or of opportunity or knowledge resulting from it: the objective is to preclude the fiduciary from actually misusing his position for his personal advantage. … [T]he two themes, while overlapping, are distinct. Neither theme fully comprehends the other and a formulation of the principle by reference to one only of them will be incomplete. Stated comprehensively in terms of the liability to account, the principle of equity is that a person who is under a fiduciary obligation must account to the person to whom the obligation is owed for any benefit or gain (i) which has been obtained or received in circumstances where a conflict or significant possibility of conflict existed between his fiduciary duty and his personal interest in the pursuit or possible receipt of such a benefit or gain or (ii) which was obtained or received by use or by reason of his fiduciary position or of opportunity or knowledge resulting from it. Any such benefit or gain is held by the fiduciary as constructive trustee … That constructive trust arises from the fact that a personal benefit or gain has been so obtained or received and it is immaterial that there was no absence of good faith or damage to the person to whom the fiduciary obligation was owed. In some, perhaps most, cases, the constructive trust will be consequent upon an actual breach of fiduciary duty: for example, an active pursuit of personal interest in disregard of fiduciary duty or a misuse of fiduciary power for personal gain. In other cases, however, there may be 253

255 256

Re Lands Allotment Co [1894] 1 Ch 616 at 639; Re Faure Electric Accumulator Co (1888) 40 CH D 141; Flitcroft’s Case (1882) 21 Ch D 519. Phipps v Boardman [1967] 2 AC 46 at 124 ([7.480]); Chan v Zacharia (1984) 154 CLR 178 at 198-199 ([1.155]). Chan v Zacharia (1984) 154 CLR 178 at 198-199. Chan v Zacharia (1984) 154 CLR 178 at 199.

257

Chan v Zacharia (1984) 154 CLR 178 at 198-199 ([1.155]).

254

[7.455]

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no breach of fiduciary duty unless and until there is an actual failure by the fiduciary to account for the relevant benefit or gain: for example, the receipt of an unsolicited personal payment from a third party as a consequence of what was an honest and conscientious performance of a fiduciary duty.

In the middle of the 19th century, in Parker v McKenna, James LJ put the case for exacting strict self-denial of fiduciaries: I do not think it is necessary, but it appears to me very important, that we should concur in laying down again and again the general principle that in this court no agent in the course of his agency, in the matter of his agency, can be allowed to make any profit without the knowledge and consent of his principal; that that rule is an inflexible rule, and must be applied inexorably by this court, which is not entitled, in my judgment, to receive evidence, or suggestion, or argument as to whether the principal did or did not suffer any injury in fact by reason of the dealing of the agent; for the safety of mankind requires that no agent shall be able to put his principal to the danger of such an inquiry as that. 258

A century later, it was said that the statement might “[i]n the nuclear age … perhaps seem something of an exaggeration, but, nonetheless, it is eloquent of the strictness with which throughout the last century and indeed in the present century, courts of the highest authority have always applied this rule”. 259 Similarly, in another classic statement, Cardozo CJ of the New York Court of Appeal referred to the fiduciary’s duty of loyalty as a: tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the “disintegrating erosion” of particular exceptions. … Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd. 260

The working out of this standard in a particular commercial context appears in the following cases. Its strictness can produce results which do not always satisfy notions of fairness; on the other hand, in some cases outcomes are not obviously consonant with fiduciary ideology. Furs Ltd v Tomkies sets out the equitable principles, their rationale and remedies and canvasses release through informed shareholder consent. Cook v Deeks examines the circumstances where directors may be under a duty to acquire an opportunity for their company and the limits of shareholder renunciation of interest in such an opportunity. Other cases extracted examine the application of the equitable principle in the corporate context including the circumstances in which a director may exploit an opportunity renounced by the company and the conditions for such release.

Furs Ltd v Tomkies [7.460] Furs Ltd v Tomkies (1936) 54 CLR 583 High Court of Australia [The defendant Tomkies was managing director of the plaintiff company and manager of the tanning, dyeing and dressing branch of its business. Another company expressed interest in purchasing this portion of the business and Tomkies was directed by his board to conduct negotiations on behalf of the plaintiff. During these negotiations, the potential purchaser told Tomkies that it was interested in acquiring the business only if it was assured of securing his (that is, Tomkies’) services. Tomkies conveyed this condition to his chairman who informed him that if the sale went ahead the plaintiff could not retain him on its staff. He added, “I would advise you to make the best deal you can in the new company.” The initial price sought by the plaintiff for the tanning etc business was £8,500 for plant and equipment plus £4,500 for formulae. However, after Tomkies had agreed to a service contract with the 258

Parker v McKenna (1874) LR 10 Ch App 96 at 124-125.

259 260

Industrial Development Consultant Ltd v Cooley [1972] 1 WLR 443 at 452. Meinhard v Salmon 249 NY 456; 164 NE 545 at 464 (NY), 546 (NE).

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Furs Ltd v Tomkies cont. purchaser which included payment to him of £5,000 in addition to salary, the purchaser’s final offer was only for £8,500. The board of the plaintiff company accepted this offer. Neither the board nor shareholders were aware of the payment to Tomkies, who took pains to conceal it from them. When the payment became known, the plaintiff claimed it as an undisclosed profit received while acting in a fiduciary capacity. The primary judge found that Tomkies had been put into this position of conflict by the plaintiff and was entitled to secure his own advantage so long as he treated the plaintiff fairly. No such unfairness was proved and the action failed. The plaintiff appealed to the High Court.] RICH, DIXON and EVATT JJ: [592] In our opinion the decision of this appeal is governed by the inflexible rule that, except under the authority of a provision in the articles of association, no director shall obtain for himself a profit by means of a transaction in which he is concerned on behalf of the company unless all the material facts are disclosed to the shareholders and by resolution a general meeting approves of his doing so, or all the shareholders acquiesce. An undisclosed profit which a director so derives from the execution of his fiduciary duties belongs in equity to the company. It is no answer to the application of the rule that the profit is of a kind which the company could not itself have obtained, or that no loss is caused to the company by the gain of the director. It is a principle resting upon the impossibility of allowing the conflict of duty and interest which is involved in the pursuit of private advantage in the course of dealing in a fiduciary capacity with the affairs of the company. If, when it is his duty to safeguard and further the interests of the company, he uses the occasion as a means of profit to himself, he raises an opposition between the duty he has undertaken and his own self-interest, beyond which it is neither wise nor practicable for the law to look for a criterion of liability. The consequences of such a conflict are not discoverable. Both justice and policy are against their investigation. With reference to a transaction arising out of another relation of confidence, Lord Eldon said: “The general interests of justice” require “it to be destroyed in every instance; as no court is equal to the examination and ascertainment of the truth in much the greater number of cases” [593] (Ex parte James (1803) 8 Ves Jun 337; 32 ER 385 at 345 (Ves Jun), 388 (ER)). … [598] [T]he fact of paramount legal significance is that the payment was obtained by the respondent in course of a transaction which he was carrying out on behalf of the company in execution of his office of managing director. It was only because it fell to his lot to negotiate the sale on behalf of his company that he was able to demand and obtain the sum. His fiduciary character was alike the occasion and the means of securing the profit for himself. To our minds it is quite plain that, by doing so, he greatly diminished the price obtainable by the company. He himself admitted on his cross-examination that his entering into the service agreement decidedly depreciated the formulas as an asset for sale and that no value would be left in them. It is not improbable that the price which the company might have got was diminished to the full extent of £5,000. But this is just one of the inquiries that is excluded. So too, on the question of liability to account, is the inquiry into the advantages which the purchasers expected, or had a right to expect, in return. The respondent had a plain duty with which he brought his private interest into conflict and that is enough. … [599] The case presents no analogy to the sale by a fiduciary agent to his principal of tangible property which, although the principal does not know it, belongs to the agent but was not acquired by him in the course of the agency. In such a case, in the present state of the authorities, rescission seems to be the only remedy: Re Cape Breton Co (1885) 29 Ch D 795; Burland v Earle [1902] AC 83; Jacobus Marler Estates Ltd v Marler (1913) 85 LJPC 167n; [213]. There is no transaction by the directors with the company, nothing for it to rescind. No doubt his co-directors’ action in confiding the negotiations to the respondent and advising him to look after himself exposed him to the temptation of preferring his own advantage to the interests of the company. But the board could not relieve him of the equitable obligations which arose out of this conflict of duty and of private interest. His one resource, if he was resolved to adopt the unwise course of acting in the transaction on behalf of his company and yet seeking a profit for himself, was complete disclosure to and confirmation by the shareholders. But complete disclosure he was not prepared to make. We are unable to agree with the view that the respondent’s principal placed him in a position in which his duty and interest conflicted and thus waived the right to the performance of an undivided duty. [7.460]

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Furs Ltd v Tomkies cont. The board of directors could not do this in the case of a fellow director and, even if it could, no one contemplated anything but an ordinary agreement of employment at a salary. Nor did the board assume [600] to release him from his duties as manager. It is immaterial, if it be the case, that, unless he had agreed to go over with the business, no sale would have taken place. [McTiernan J agreed with this judgment. Latham CJ and Starke J delivered concurring judgments. In respect of the argument that the chairman of the plaintiff company had authorised Tomkies to negotiate for the payment, Latham CJ said (at 590): “[I]f the directors did purport to give him such an authority, their action would be ineffectual. It would involve a breach of their duty to the company, and the defendant himself would be a party to that breach of duty. The directors were not at liberty to determine, in favour of any of their own body, that the rights of the company should be disregarded.”]

Cook v Deeks [7.465] Cook v Deeks [1916] 1 AC 554 Privy Council [The Toronto Construction Co was formed to execute a tender for the construction of a railway line for the Canadian Pacific Railway Co (CPR). When that contract was successfully completed the CPR commenced negotiations with two directors of the Toronto Co, Deeks and Hinds, for the construction of another line. Deeks, his brother and Hinds together held three quarters of the capital in the Toronto Co. The remaining capital was held by Cook. The four were the only directors of the company. Cook’s fellow directors decided that he should be excluded from any new contract. To this end the Deek brothers and Hinds formed a new company, the Dominion Construction Co in which Cook had no interest. The Dominion Co then carried out the new contract. A general meeting of the Toronto Co was held at which the Deeks and Hinds used their voting power to approve the sale of part of the company’s plant to the Dominion Co and to declare that the Toronto Co had no interest in the new contract. Cook brought proceedings against the other directors and the Dominion Co claiming that they held the contract for the benefit of the Toronto Co. At trial the action was dismissed. Cook appealed to the Privy Council.] LORD BUCKMASTER LC: [561] Two questions of law arise out of this long history of fact. The first is whether, apart altogether from the subsequent resolutions, the company would have been at liberty to claim from the three defendants the benefit of the contract which they had obtained from the Canadian Pacific Railway Co; and the second, which only arises if the first be answered in the affirmative, whether in such event the majority of the shareholders of the company constituted by the three defendants could ratify and approve of what was done and thereby release all claim against the directors. … [The first question] cannot be properly answered by considering the abstract relationship of directors and companies; the real matter for determination is what, in the special circumstances of this case, was the relationship that existed between Messrs Deeks and Hinds and the company that they controlled. Now it appears plain that the entire management of the company, so far as obtaining and executing contracts in the east was concerned, was in their hands, and, indeed, it was in part this fact which was one of the causes of their disagreement with the plaintiff. The way they used this position is perfectly plain. They accelerated the work on the expiring contract of the [562] company in order to stand well with the Canadian Pacific Railway when the next contract should be offered, and although Mr McLean [the company manager] was told that the acceleration was to enable the company to get the new contract, yet they never allowed the company to have any chances whatever of acquiring the benefit, and avoided letting their co-director have any knowledge of the matter. … [The defendant directors] intentionally concealed all circumstances relating to their negotiations until a point had been reached when the whole arrangement had been concluded in their own favour and there was no longer any real chance that there could be any interference with their plans. This means that while entrusted with the conduct of the affairs of the company they deliberately designed to exclude, and used their influence and position to exclude, the company whose interest it was their first duty to protect. … 538

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Cook v Deeks cont. [565] [M]en who assume the complete control of a company’s business must remember that they are not at liberty to sacrifice the interests which they are bound to protect, and, while ostensibly acting for the company, divert in their own favour business which should properly belong to the company they represent. Their Lordships think that, in the circumstances, the defendant [directors] … were guilty of a distinct breach of duty in the course they took to secure the contract, and that they cannot retain the benefit of such contract for themselves, but must be regarded as holding it on behalf of the company. There remains the more difficult consideration of whether this position can be made regular by resolutions of the company controlled by the votes of these three defendants. … In their Lordships’ opinion the Supreme Court has insufficiently recognised the distinction between two classes of case and has applied the principles applicable to the case of a director selling to his company property which was in equity as well as at law his own, and which he could dispose of as he thought fit, to the case of a director dealing with property which, though his own at law, in equity belonged to his company. The cases of North-West Transportation Co v Beatty (1887) 12 App Cas 589 and Burland v Earle [1902] AC 83 both belonged to the former class. In each, directors had sold to the company property in which the company had no interest at law or in equity. If the company claimed any interest by reason of the [564] transaction, it could only be by affirming the sale, in which case such sale, though initially voidable, would be validated by subsequent ratification. If the company refused to affirm the sale the transaction would be set aside and the parties restored to their former position, the directors getting the property and the company receiving back the purchase price. There would be no middle course. The company could not insist on retaining the property while paying less than the price agreed. This would be for the court to make a new contract between the parties. It would be quite another thing if the director had originally acquired the property which he sold to his company under circumstances which made it in equity the property of the company. … If, as their Lordships find on the facts, the contract in question was entered into under such circumstances that the directors could not retain the benefit of it for themselves, then it belonged in equity to the company and ought to have been dealt with as an asset of the company. Even supposing it be not ultra vires of a company to make a present to its directors, it appears quite certain that directors holding a majority of votes would not be permitted to make a present to themselves. This would be to allow a majority to oppress the minority. To such circumstances the cases of North-West Transportation Co v Beatty and Burland v Earle have no application. In the same way, if directors have acquired for themselves property or rights which they must be regarded as holding on behalf of the company, a resolution that the rights of the company should be disregarded in the matter would amount to forfeiting the interest and property of the minority of shareholders in favour of the majority, and that by the votes of those who are interested in securing the property for themselves. Such use of voting power has never been sanctioned by the courts, and, [565] indeed, was expressly disapproved in the case of Menier v Hooper’s Telegraph Works (1874) LR 9 Ch App 350. If their Lordships took the view that, in the circumstances of this case, the directors had exercised a discretion or decided on a matter of policy (the view which appears to have been entertained by the Supreme Court) different results would ensue, but this is not a conclusion which their Lordships are able to accept. It follows that the defendants must account to the Toronto Co for the profits which they have made out of the transaction. [It was not disputed that the new company formed to perform the diverted contract had acquired the contract with full knowledge of the facts. Accordingly, an order for account was made against it as well as against the three directors.]

[7.467]

1.

Notes&Questions

What duty does this case impose upon directors? Is it a duty not to acquire for themselves business (including tangible property and intangible opportunities) which [7.467]

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2.

3.

4.

they ought to acquire for their company? If the duty is of this general nature, note the formulations which identify the particular property and opportunities the subject of the duty: “business which should properly belong to the company” (at 563), “property or rights which they must be regarded as holding on behalf of the company” (at 564) and a “contract entered into under such circumstances that the directors could not retain the benefit of it for themselves” (at 564). What facts in Cook v DeeksCook v Deeks [1916] 1 AC 554 impelled the conclusion that these general formulary were engaged in the instant case? Would the result have been different if, for example, Deeks and Hinds had learned of the new CPR contract after work in a hotel bar or in any other manner unrelated to their activities as directors of the Toronto Construction Co? What if Deeks was a non-executive director only and had learnt of the new CPR contract in a different capacity? What if the contract offered by CPR, although potentially profitable, was of a different nature (eg, involving the construction of a bridge rather than rail track)? Recall that, in Peninsular and Oriental Steam Navigation Co v Johnson [7.385], the High Court held that the Ravensthorpe mining machinery, acquired by Johnson and Lynn Ltd and sold to Amalgamated Collieries, was not impressed from its acquisition with an equity in favour of Amalgamated Collieries. Walter Johnson who acquired the property on behalf of Johnson and Lynn Ltd was managing director of both companies. Why was he not under a duty to acquire the property for Amalgamated Collieries? How are the principles expressed by Dixon J (at 247-248) as to when such an equity will be impressed distinguished from those expressed in Cook v Deeks?

Regal (Hastings) Ltd v Gulliver [7.470] Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134n House of Lords [This case was decided in 1942 and reported in [1942] 1 All ER 378. It was not however reported in the Law Reports until 1967 where it appears as a note, following the report of Boardman v Phipps in which frequent reference is made to it. The facts giving rise to the litigation are outlined by Lord Russell.] LORD RUSSELL OF KILLOWEN: [140] The appellant is a limited company called Regal (Hastings) Ltd, and may conveniently be referred to as Regal. … It owned, and managed very successfully, a freehold cinema theatre at Hastings called the Regal. In July 1935, its board of directors consisted of one Walter Bentley and the respondents Gulliver, Bobby, Griffiths and Bassett. Its shareholders were 20 in number. The respondent Garton acted as its solicitor. In or about that month, the board of Regal formed a scheme for acquiring a lease of two other cinemas (viz, the Elite at Hastings, and the Cinema de Luxe at St Leonards), which were owned and managed by a company called Elite Picture Theatres (Hastings and Bristol) Ltd. The scheme was to be carried out by obtaining the grant of a lease to [141] a subsidiary limited company, which was to be formed by Regal, with a capital of 5,000 £1 shares, of which Regal was to subscribe for 2,000 in cash, the remainder being allotted to Regal or its nominees as fully paid for services rendered. The whole beneficial interest in the lease would, if this scheme were carried out, enure solely to the benefit of Regal and its shareholders, through the shareholding of Regal in the subsidiary company. The respondent Garton, on the instructions of Regal, negotiated for the acquisition of the lease, with the result that an offer to take a lease for 35 or 42 years at a rent of £4,600 for the first year, rising in the second and third years up to £5,000 in the fourth and subsequent years, was accepted on behalf of the owners on 21 August 1935, subject to mutual approval of the form of the lease. Subsequently, the owners of the two cinemas required the rent under the proposed lease to be guaranteed. On 11 September 1935, Walter Bentley died; and on 18 September 1935, his son, the respondent Bentley, who was one of his executors, was appointed a director of Regal. It should now be stated that, concurrently with the negotiations for the acquisition of a lease of the two cinemas, Regal was 540

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Regal (Hastings) Ltd v Gulliver cont. contemplating a sale of its own cinema, together with the leasehold interest in the two cinemas which it was proposing to acquire. On 18 September 1935, at a board meeting of Regal, the respondent Garton was instructed that the directors were prepared to give a joint guarantee of the rent of the two cinemas, until the subscribed capital of the proposed subsidiary company amounted to £5,000. He was further instructed to deal with all offers received for the purchase of Regal’s own assets. On 26 September 1935, the proposed subsidiary company was registered under the name Hastings Amalgamated Cinemas Ltd, which may, for brevity, be referred to as Amalgamated. Its directors were the five directors of Regal, and in addition the respondent Garton. Harry Bentley, who had been appointed a director of Regal only on 18 September, at the end of the board meeting of that date, inquired from Garton the position as regards the new company, Amalgamated. In reply, he received a letter dated 26 September 1935, in which the position, as at that date, is set out by Garton. After stating that the capital of Amalgamated is £5,000, of which £2,000 is being subscribed by Regal, “which sum will form virtually the whole of the present paid up capital” of Amalgamated, and that the rent is to be guaranteed by the directors so long as the issued capital of Amalgamated is under £5,000, he concludes as follows: Inasmuch as it is the intention of all the parties that the Regal (Hastings) Ltd will not only control the Hastings (Amalgamated) Cinemas Ltd, but will continue to hold virtually the whole of the capital, the position of a shareholder of Regal (Hastings) Ltd, is merely that he has the advantage of a possible asset of the two new cinemas on sale by the Regal (Hastings) Ltd, of its undertaking, so that the price realised to the shareholders of the Regal (Hastings) Ltd, will be the amount that he would normally have received for his interest in such company, plus his proportion of the sale price of such two new cinemas. [142] On 2 October 1935, an offer was received from would-be purchasers offering a net sum of £92,500 for the Regal cinema and the lease of the two cinemas. Of this sum £77,500 was allotted as the price of Regal’s cinema, and £15,000 as the price of the two leasehold cinemas. This splitting of the price seems to have been done by the purchasers at the request of the respondent Garton; but it must be assumed in favour of the Regal directors that they were satisfied that £77,500 was not too low a price to be paid for their company’s cinema, with the result that £15,000 cannot be taken to have been in excess of the value of the lease which Amalgamated was about to acquire. On the afternoon of 2 October, the six respondents met at 62 Shaftesbury Avenue, London, the registered offices of Regal. Various matters were mentioned and discussed between them, and they came to certain decisions. Subsequently, minutes were prepared which record the different matters as having been transacted at two separate and distinct board meetings, viz, a meeting of the board of Regal, and a meeting of the board of Amalgamated. The respondent Gulliver stated in his evidence that two separate meetings were held, that of the Amalgamated board being held and concluded before that of the Regal board was begun. On the other hand, the respondent Bentley says: It was more or less held in one lump, because we were talking about selling the three properties. The respondent, Garton, states that, after it was decided that Regal could only afford to put up £2,000 in Amalgamated, which was purely a matter for the consideration of the Regal board, the next matter discussed was one which figures in the minutes of the Amalgamated board meeting. Moreover, both meetings are recorded in the minutes as having been held at 3 pm. Whatever may be the truth as to this, the matters discussed and decided included the following: (i) Regal was to apply for 2,000 shares in Amalgamated; (ii) the offer of £77,500 for the Regal cinema and £15,000 for the two leasehold cinemas was accepted; (iii) the solicitor reporting that completion of the lease was expected to take place on 7 October, it was resolved that the seal of Amalgamated be affixed to the engrossment when available; and (iv) the respondent, Gulliver, having objected to guaranteeing the rent, it was resolved that the directors be invited to subscribe for 500 shares each and that such shares be allotted accordingly. [7.470]

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Regal (Hastings) Ltd v Gulliver cont. On 7 October 1935, a lease of the two cinemas was executed in favour of Amalgamated, for the term of 35 years from 29 September 1935, in accordance with the agreement previously come to. The shares of Amalgamated were all issued, and were allotted as follows: 2,000 to Regal, 500 to each of the respondents, Bobby, Griffiths, Bassett, Bentley and Garton, and (by the direction of the respondent, Gulliver) 200 to a Swiss company called Seguliva AG, 200 to a company called South Downs Land Co Ltd, and 100 to a Miss Geering. In fact, the proposed sale and purchase of the Regal cinema and [143] the two leasehold cinemas fell through. Another proposition, however, took its place, viz, a proposal for the purchase from the individual shareholders of their shares in Regal and Amalgamated. This proposal came to maturity by agreements dated 24 October 1935, as a result of which the 3,000 shares in Amalgamated held otherwise than by Regal were sold for a sum of £3 16s 1d per share, or in other words at a profit of £2 16s 1d per share over the issue price of par. As a sequel to the sale of the shares in Regal, that company came under the management of a new board of directors, who caused to be issued the writ which initiated the present litigation. By this action Regal seek to recover from its five former directors and its former solicitor a sum of £8,142 10s either as damages or as money had and received to the plaintiffs’ use. The action was tried by Wrottesley J, who entered judgment for all the defendants with costs. An appeal by the plaintiffs to the Court of Appeal was dismissed with costs. My Lords, those are the relevant facts which have led up to the debate in your Lordships’ House, and I now proceed to consider whether the appellants are entitled to succeed against any and which of the respondents. The case has, I think, been complicated and obscured by the presentation of it before the primary judge. If a case of wilful misconduct or fraud on the part of the respondents had been made out, liability to make good to Regal any damage which it had thereby suffered could, no doubt, have been established; and efforts were apparently made at the trial, by cross-examination and otherwise, to found such a case. It is, however, due to the respondents to make it clear at the outset that this attempt failed. The case was not so presented to us here. We have to consider the question of the respondents’ liability on the footing that, in taking up these shares in Amalgamated, they acted with bona fides, intending to act in the interest of Regal. Nevertheless, they may be liable to account for the profits which they have made, if, while standing in a fiduciary relationship to Regal, they have by reason and in course of that fiduciary relationship made a profit. This aspect of the case was undoubtedly raised before the primary judge, but, in so far as he deals with it in his judgment, he deals with it on a wrong basis. … [144] In the Court of Appeal, upon this claim to profits, the view was taken that in order to succeed the plaintiff had to establish that there was a duty on the Regal directors to obtain the shares for Regal. Two extracts from the judgment of Lord Greene MR, show this. After mentioning the claim for damages, he says: The case is put on an alternative ground. It is said that, in the circumstances of the case, the directors must be taken to have been acting in the matter of their office when they took those shares; and that accordingly they are accountable for the profits which they have made. … There is one matter which is common to both these claims which, unless it is established, appears to me to be fatal. It must be shown that in the circumstances of the case it was the duty of the directors to obtain these shares for their company. … Other portions of the judgment appear to indicate that upon this claim to profits, it is a good defence to show bona fides or absence of fraud on the part of the directors in the action which they took, or that their action was beneficial to the company. … [The reasoning behind the judgments in the Court of Appeal may be made clearer by the following portion of the judgment of Lord Greene MR, quoted by Viscount Sankey (at 137): If the directors in coming to the conclusion that they could not put up more than £2,000 of the company’s money had been acting in bad faith, and if that restriction of the company’s investment had been done for the dishonest purpose of securing for themselves profit which not only could but which ought to have been procured for their company, I apprehend that 542

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Regal (Hastings) Ltd v Gulliver cont. not only could they not hold that profit for themselves if the contemplated transaction had been carried out, but they could not have held that profit for themselves even if that transaction was abandoned and another profitable transaction was carried through in which they did in fact realise a profit through the shares … but once they have admittedly bona fide come to the decision to which they came in this case, it seems to me that their obligation to refrain from acquiring these shares came to an end. In fact, looking at it as a matter of business, if that was the conclusion they came to, a conclusion which, in my judgment, was amply justified by the evidence from a business point of view, then there was only one way left of raising the money, and that was putting it up themselves. … That being so, the only way in which these directors could secure that benefit for the company was by putting up the money themselves. Once that decision is held to be a bona fide one and fraud drops out of the case, it seems to me there is only one conclusion, namely, that the appeal must be dismissed with costs.] My Lords, with all respect I think there is a misapprehension here. The rule of equity which insists on those, who by use of a fiduciary position make a profit, being liable to account for that profit, in no way depends on fraud, or absence of bona fides; or upon such questions or considerations as whether the profit would or should otherwise have gone to the plaintiff, or whether the profiteer was under a duty to obtain the source of the profit for the plaintiff, or whether he took a risk or acted as he did for the benefit of the plaintiff, or whether the plaintiff has in fact been damaged or benefited by his action. [145] The liability arises from the mere fact of a profit having, in the stated circumstances, been made. The profiteer, however honest and well-intentioned, cannot escape the risk of being called upon to account. The leading case of Keech v Sandford (1726) Sel Cas Ch 61; 25 ER 223 is an illustration of the strictness of this rule of equity in this regard, and of how far the rule is independent of these outside considerations. A lease of the profits of a market had been devised to a trustee for the benefit of an infant. A renewal on behalf of the infant was refused. It was absolutely unobtainable. The trustee, finding that it was impossible to get a renewal for the benefit of the infant, took a lease for his own benefit. Though his duty to obtain it for the infant was incapable of performance, nevertheless he was ordered to assign the lease to the infant, upon the bare ground that, if a trustee on the refusal to renew might have a lease for himself, few renewals would be made for the benefit of cestuis que trust. Lord King LC said (at 62; 223): This may seem hard, that the trustee is the only person of all mankind who might not have the lease: but it is very proper that the rule should be strictly pursued, and not in the least relaxed. … One other case in equity may be referred to in this connection, viz, Ex parte James (1803) 8 Ves Jun 337; 32 ER 385 decided by Lord Eldon LC. That was a case of a purchase of a bankrupt’s estate by the solicitor to the commission, and Lord Eldon LC (at 345; 388) refers to the doctrine thus: This doctrine as to purchases by trustees, assignees, and persons having a confidential character, stands much more upon general principles than upon the circumstances of any individual case. It rests upon this: that the purchase is not permitted in any case however honest the circumstances; the general interests of justice requiring it to be destroyed in every instance; as no court is equal to the examination and ascertainment of the truth in much the greater number of cases. Let me now consider whether the essential matters, which the plaintiff must prove, have been established in the present case. As to the profit being in fact made there can be no doubt. The shares were acquired at par and were sold three weeks later at a profit of £2 16s 1d per share. Did such of the first five respondents as acquired these very profitable shares acquire them by reason and in course of their office of directors of Regal? In my opinion, when the facts are examined and appreciated, the answer can only be that they did. The actual allotment no doubt had to be made by themselves and Garton (or some of them) in their capacity as directors of Amalgamated; but this was merely an executive act, necessitated by the alteration of the scheme for the acquisition of the lease of the two cinemas for the sole benefit of Regal and its shareholders through Regal’s shareholding in [7.470]

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Regal (Hastings) Ltd v Gulliver cont. Amalgamated. That scheme could only be altered by or with the consent of the Regal board. Consider what in fact took place on 2 October 1935. The position immediately before that day is stated in Garton’s letter of 26 September 1935. The directors were [146] willing to guarantee the rent until the subscribed capital of Amalgamated reached £5,000. Regal was to control Amalgamated and own the whole of its share capital, with the consequence that the Regal shareholders would receive their proportion of the sale price of the two new cinemas. The respondents then meet on 2 October 1935. They have before them an offer to purchase the Regal cinema for £77,500 and the lease of the two cinemas for £15,000. The offer is accepted. The draft lease is approved and a resolution for its sealing is passed in anticipation of completion in five days. Some of those present, however, shy at giving guarantees, and accordingly the scheme is changed by the Regal directors in a vital respect. It is agreed that a guarantee shall be avoided by the six respondents bringing the subscribed capital up to £5,100 [sic]. I will consider the evidence and the minute in a moment. The result of this change of scheme which only the Regal directors could bring about may not have been appreciated by them at the time; but its effect upon their company and its shareholders was striking. In the first place, Regal would no longer control Amalgamated, or own the whole of its share capital. The action of its directors had deprived it (acting through its shareholders in general meeting) of the power to acquire the shares. In the second place, the Regal shareholders would only receive a large reduced proportion of the sale price of the two cinemas. The Regal directors and Garton would receive the moneys of which the Regal shareholders were thus deprived. This vital alteration was brought about in the following circumstances – I refer to the evidence of the respondent Garton. He was asked what was suggested when the guarantees were refused, and this is his answer: Mr Gulliver said “We must find it somehow. I am willing to find £500. Are you willing,” turning to the other four directors of Regal, “to do the same?” They expressed themselves as willing. He said, “That makes £2,500.” and he turned to me and said, “Garton, you have been interested in Mr Bentley’s companies; will you come in to take £500?” I agreed to do so. Although this matter is recorded in the Amalgamated minutes, this was in fact a decision come to by the directors of Regal, and the subsequent allotment by the directors of Amalgamated was a mere carrying into effect of this decision of the Regal board. The resolution recorded in the Amalgamated minute runs thus: After discussion it was resolved that the directors be invited to subscribe for 500 shares each, and that such shares be allotted accordingly. As I read that resolution, and my reading agrees with Garton’s evidence, the invitation is to the directors of Regal, and is made for the purpose of effectuating the decision which the five directors of Regal had made, that each should take up 500 shares in the Amalgamated. The directors of Amalgamated were not conveying an “invitation” to themselves. That would be ridiculous. They were merely giving effect to the Regal directors’ decision to provide £2,500 cash capital themselves, a decision which had been followed by a successful appeal by Gulliver to Garton to provide the balance. My Lords, I have no hesitation in coming to the conclusion, upon [147] the facts of this case, that these shares, when acquired by the directors, were acquired by reason, and only by reason of the fact that they were directors of Regal, and in the course of their execution of that office. It now remains to consider whether in acting as directors of Regal they stood in a fiduciary relationship to that company. [Lord Russell answered this question affirmatively.] In the result, I am of opinion that the directors standing in a fiduciary relationship to Regal in regard to the exercise of their powers as directors, and having obtained these shares by reason and only by reason of the fact that they were directors of Regal and in the course of the execution of that office, are accountable for the profits which they have made out of them. The equitable rule laid down in Keech v Sandford and Ex parte James and similar authorities applies to them in full force. It was contended that these cases were distinguishable by reason of the fact that it was impossible for Regal to get the shares owing to lack of funds, and that the directors in taking the shares were really acting as members of the public. I cannot accept this argument. It was impossible for the cestui que trust in Keech v Sandford to obtain the lease, nevertheless the trustee was [150] accountable. The suggestion that the directors 544

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Regal (Hastings) Ltd v Gulliver cont. were applying simply as members of the public is a travesty of the facts. They could, had they wished, have protected themselves by a resolution (either antecedent or subsequent) of the Regal shareholders in general meeting. In default of such approval, the liability to account must remain. The result is that, in my opinion, each of the respondents Bobby, Griffiths, Bassett and Bentley is liable to account for the profit which he made on the sale of his 500 shares in Amalgamated. The case of the respondent Gulliver, however, requires some further consideration, for he has raised a separate and distinct answer to the claim. He says: “I never promised to subscribe for shares in Amalgamated. I never did so subscribe. I only promised to find others who would be willing to subscribe. I only found others who did subscribe. The shares were theirs. They were never mine. They received the profit. I received none of it.” If these are the true facts, his answer seems complete. The evidence in my opinion establishes his contention. [As earlier indicated, the 500 shares were allotted to a Swiss company Seguliva AG (200), South Downs Land Co Ltd (200) and a Miss Geering (100). Gulliver was a director of Seguliva and managing director of the other company. He signed each company’s cheque for the subscription moneys and corresponded with Regal on their behalf, in both the allotments and the sale of the 500 shares.] From the evidence of Gulliver it appeared that Miss Geering is a friend who from time to time makes investments on his advice; that the issued capital of South Downs Land Co Ltd, is £1,000 in £1 shares, held by some 11 or 12 shareholders, of whom Gulliver is one and holds 100 shares; and that in the Swiss company Gulliver holds 85 out of 500 shares. … [151] I can see no reason for doubting that the shares never belonged to Gulliver, and that he made no profit on the sale thereof. It was further argued that, even if the shares and the proceeds of sale did not belong to Gulliver, he is nevertheless liable to account to Regal for the profit made by the owners of the shares, and that upon the authority of Imperial Mercantile Credit Association (Liquidators) v Coleman (see [7.370]). One of the contentions put forward there by Coleman was that his transaction was a transaction for the benefit of a partnership in the profits of which he was only interested to the extent of a half, and that accordingly he could only be made accountable to that extent. That contention was disposed of by Lord Cairns in the following terms (at 208): My Lords, I think there is no foundation for this argument. The profit on the transaction was obtained by Mr Coleman, and, in the view that I take, was obtained by him as a director of the association. Whether he desired or whether he determined to reserve it all to himself or to share it with his firm appears to me to be perfectly immaterial. The source from which the profit is derived is Mr Coleman. It is only through him that his firm can claim. He is liable for the whole of the profits which were obtained; and it is not the course for a Court of Equity to enter into the consideration of what afterwards would have become of those profits. [152] I am unable to see how this authority helps Regal if it be assumed that neither the shares nor the profit ever belonged to Gulliver. It was further said that Gulliver must account for whatever profits he may have made indirectly through his shareholding in the two companies, and that an inquiry should be directed for this purpose. As to this, it is sufficient to say that there is no evidence upon which to ground such an inquiry. Indeed, the evidence so far as it goes, shows that neither company has distributed any part of the profit. … There remains to consider the case of Garton. He stands on a different footing from the other respondents in that he was not a director of Regal. He was Regal’s legal adviser; but, in my opinion, he has a short but effective answer to the plaintiffs’ claim. He was requested by the Regal directors to apply for 500 shares. They arranged that they themselves should each be responsible for £500 of the Amalgamated capital, and they appealed, by their chairman, to Garton to subscribe the balance of £500 which was required to make up the £3,000. In law his action, which has resulted in a profit, was taken at the request of Regal, and I know of no principle or authority which would justify a decision that a solicitor must account for profit resulting from a transaction which he has entered into on his own behalf, not merely with the consent, but at the request of his client. … One final observation I desire to make. In his judgment Lord Greene MR, stated that a decision adverse to the directors in the present case involved the proposition that, if directors bona fide decide not to [7.470]

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Regal (Hastings) Ltd v Gulliver cont. invest their company’s funds in some proposed investment, a director who thereafter embarks his own money therein is accountable for any profits which he may derive therefrom. As to this, I [153] can only say that to my mind the facts of this hypothetical case bear but little resemblance to the story with which we have had to deal. LORD WRIGHT: [154] [The] question can be briefly stated to be whether an agent, a director, a trustee or other person in an analogous fiduciary position, when a demand is made upon him by the person to whom he stands in the fiduciary relationship to account for profits acquired by him by reason of his fiduciary position, and by reason of the opportunity and the knowledge, or either, resulting from it, is entitled to defeat the claim upon any ground save that he made profits with the knowledge and assent of the other person. The most usual and typical case of this nature is that of principal and agent. The rule in such case is compendiously expressed to be that an agent must account for net profit secretly (that is, without the knowledge of his principal) acquired by him in the course of his agency. The authorities show how manifold and various are the applications of the rule. It does not depend on fraud or corruption. The courts below have held that it does not apply in the present case, for the reason that the purchase of the shares by the respondents, though made for their own advantage, and though the knowledge and opportunity which enabled them to take the advantage came to them solely by reason of their being directors of the appellant company, was a purchase which, in the circumstances, the respondents were under no duty to the appellant to make, and was a purchase which it was beyond the appellant’s ability to make, so that, if the respondents had not made it, the appellant would have been no better off by reason of the respondents abstaining from reaping the advantage for themselves. With the question so stated, it was said that any other decision than that of the courts below would involve a dog-in-the-manger policy. What the respondents did, it was said, caused no damage to the appellant and involved no neglect of the appellant’s interests or similar breach of duty. However, I think the answer to this reasoning is that, both in law and equity, it has been held that, if a person in a fiduciary relationship makes a secret profit out of the relationship, the court will not inquire whether the other person is damnified or has lost a profit which otherwise he would have got. The fact is in itself a fundamental breach of the fiduciary relationship. Nor can the court adequately investigate the matter in most cases. The facts are generally difficult to ascertain or are solely in the knowledge of the person who is being charged. They are matters of surmise; they are hypothetical because the inquiry is as to what would have been the position if that party had not acted as he did, or what he might have done if there had not been the temptation to seek his own advantage, if, in short, interest had not conflicted with duty. [Other members of the court agreed. Lord MacMillan adopted the following formulation as the basis of the directors’ liability (at 153): “The plaintiff company has to establish two things: (i) that what the directors did was so related to the affairs of the company that it can properly be said to have been done in the course of their management and in utilisation of their opportunities and special knowledge as directors; and (ii) that what they did resulted in a profit to themselves.”]

[7.472]

1.

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Notes&Questions

In Regal the basis of the directors’ liability is expressed not in terms of a failure to cause the company to acquire the shares (or contract, opportunity etc) but in terms of a liability to account for profits acquired in the course of office. Is there any substantial difference here or are these merely alternative formulations of the same principle? Or can it be said that the “line of office” test is applicable where the company is unable to acquire the opportunity and that the Cook v Deeks duty overlaps with the line of office test where this impossibility is no bar? [7.472]

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2.

Similarly, does it make any difference that the plaintiff in Cook v Deeks sought to hold the defendants liable as constructive trustees and the plaintiff in Regal sought an account of profits?

3.

Is Lord Russell convincing when he finds that the respondents acquired their Amalgamated shares by reason and in the course of their office as directors of Regal? Is it consistent with the separate legal personalities within groups of companies to assert that their decision as directors of Amalgamated to allot the shares to themselves was “merely an executive act” (at 146), being a matter which “was in fact a decision come to by the directors of Regal, and the subsequent allotment by the directors of Amalgamated was a mere carrying into effect of this decision of the Regal board”? If it had been determined that the respondents had strictly been acting as directors of Amalgamated would their liability to account for their profits have been less certain? (Note, inter alia, that Garton was a director of Amalgamated.) What if the Amalgamated board had included persons who were not also directors of Regal? Are there problems in applying this “course of office” test to directors (particularly executive directors) in a corporate group structure?

4.

If the respondents had made it clear, by board minute etc, that they were offering the shares to themselves in their capacity as directors of Amalgamated (or in some other capacity than that of directors of Regal) might they have put themselves beyond reach of the present (or like) proceedings?

5.

In Regal Lord Russell said that the directors might “have protected themselves by a resolution (either antecedent or subsequent) of the Regal shareholders in general meeting”: at 150; cf Lord Wright at 157. The editorial note to the case asserts that such approval “would have been a mere matter of form, since [the directors] doubtless controlled the voting”: see also Furs Ltd v Tomkies at 599. A different view was, however, taken in Cook v Deeks as to the ratifiability of the directors’ breach of duty. Are the breaches of duty in the two cases distinguishable? See [8.25].

6.

Who benefited from the success of the plaintiff’s action in Regal? Were such beneficiaries the same persons as were injured by the directors’ breach of duty? If, as Lord Porter says (at 157), the judgment for the company is an “unexpected windfall” for the “financial group” who purchased the shares, may not a strong argument be made either for relaxing the strict fiduciary rule to avoid an even greater injustice or to fine tune the remedy by ensuring that the correct interests within the company receive due return? How might this be achieved?

7.

Upon what basis did Gulliver escape liability to account for profits on sale of his quota of Amalgamated shares? Even if one stifles the suspicion (and consequent paradox) that Gulliver and Garton were the principal architects of the scheme, is it clear that his exculpation is soundly based? Why should he escape liability by outright divestment of his share of the diverted corporate opportunity? Is Lord Russell’s rejection (at 151-152) for the argument based upon Coleman’s case convincing? If Miss Geering had been his spouse or lover, should another test have been applied? If she had been aware of the circumstances in which Gulliver had acquired the shares, would she have escaped liability to account? See Barnes v Addy (1874) 9 Ch App 244.

8.

If Seguliva AG or the South Downs Land Co had received dividends in a year in which the company had derived a profit from the sale of the Amalgamated shares, would Gulliver have been liable to account for those “profits”, and for what amount? What about the accretion to capital value of their shareholding? Is the prophylactic principle [7.472]

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expressed, for example, in Keech v Sandford undermined by denying recovery against the fiduciary for such third party profits. Should the courts adopt a restitutionary or prophylactic policy in this area? 9.

If there had been a space of three years, and not three weeks, between the Regal board’s decision to invest only £2,000 in Amalgamated and the sale of the directors’ shares, do you think that the House of Lords might have decided the action differently?

Peso Silver Mines Ltd (NPL) v Cropper [7.475] Peso Silver Mines Ltd (NPL) v Cropper (1966) 58 DLR (2d) 1 Supreme Court of Canada [Peso was actively exploring mining claims which it held in the Yukon region. Dickson, a prospector, had a number of claims in this district, some contiguous to the Peso claims and others not far away. Seeking to sell his claims, Dickson approached Dr Aho, a consulting geologist retained by a number of mining companies, including Peso. Dr Aho suggested that Dickson offer the claims to Peso. The board of Peso (which included the defendant Cropper) considered the offer in March 1962 and rejected it. At the time, Peso was receiving two or three such offers each week. A short time later, Dr Aho approached Cropper to suggest that they form a syndicate to acquire Dickson’s claims. Two other venturers were found. It was common ground that the syndicate’s purchase was highly speculative and that Dr Aho had no special knowledge as to the presence of minerals on the claim sites. A company was incorporated in May 1962 to acquire the claims for the syndicate. Two years later, “a spirit of unfriendliness” developed within the Peso board (to which Cropper had made no prior disclosure of this interest in the syndicate). Upon disclosing his interests, he was asked to transfer them to Peso at cost. He refused and, at the board’s request, resigned as director of the company. Peso commenced an action for a declaration that Cropper held these interests upon a constructive trust, as property acquired as a result of his position as a director of Peso. The action was dismissed at trial, as was the appeal to the Court of Appeal for British Columbia. Peso appealed to the Supreme Court of Canada. Cartwright J delivered the judgment of the court.] CARTWRIGHT J: [8] On the facts of the case at bar I find it impossible to say that the respondent obtained the interests he holds in Cross Bow and Mayo by reason of the fact that he was a director of the appellant and in the course of the execution of that office. When Dickson, at Dr Aho’s suggestion, offered his claims to the appellant it was the duty of the respondent as director to take part in the decision of the board as to whether that offer should be accepted or rejected. At that point he stood in a fiduciary relationship to the appellant. There are affirmative findings of fact that he and his co-directors acted in good faith, solely in the interests of the appellant and with sound business reasons in rejecting the offer. There is no suggestion in the evidence that the offer to the appellant was accompanied by any confidential information unavailable to any prospective purchaser or that the respondent as director had access to any such information by reason of his office. When, later, Dr Aho approached the appellant it was not in his capacity as a director of the appellant, but as an individual member of the public whom Dr Aho was seeking to interest as a co-adventurer. The judgments in the Regal case in the Court of Appeal are not reported but counsel were good enough to furnish us with copies. In the course of his reasons Lord Greene MR, said: To say that the company was entitled to claim the benefit of those shares would have involved this proposition: Where a board of directors considers an investment which is offered to their company and [9] bona fide comes to the conclusion that it is not an investment which their company ought to make, any director, after that resolution is come to and bona fide come to, who chooses to put up the money for that investment himself must be treated as having done it on behalf of the company, so that the company can claim any profit that results to him from it. That is a proposition for which no particle of authority was cited; and goes, as it seems to me, far beyond anything that has ever been suggested as to the duty of directors, agents, or persons in a position of that kind. 548

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Peso Silver Mines Ltd (NPL) v Cropper cont. In the House of Lords, Lord Russell of Killowen concluded his reasons (at 152-153) with the following paragraph: One final observation I desire to make. In his judgment Lord Greene MR, stated that a decision adverse to the directors in the present case involved the proposition that, if directors bona fide decide not to invest their company’s funds in some proposed investment, a director who thereafter embarks his own money therein is accountable for any profits which he may derive therefrom. As to this, I can only say that to my mind the facts of this hypothetical case bear but little resemblance to the story with which we have had to deal. I agree with Bull JA [in the court below] when after quoting the two above passages he says: As Greene MR, was found to be in error in his decision, I would think that the above comment by Lord Russell on the hypothetical case would be superfluous unless it was intended to be a reservation that he had no quarrel with the proposition enunciated by the Master of the Rolls, but only that the facts of the case before him did not fall within it. … If the members of the House of Lords in Regal had been of the view that in the hypothetical case stated by Lord Greene the director would have been liable to account to the company, the elaborate examination of the facts contained in the speech of Lord Russell of Killowen would have been unnecessary. The facts of the case at bar appear to me in all material respects identical with those in the hypothetical case stated by Lord Greene and I share the view which he expressed that in such circumstances the director is under no liability. [In the Court of Appeal for British Columbia ((1966) 56 DLR (2d) 11), Bull JA distinguished the instant case from Keech v Sandford and Regal (Hastings) Ltd v Gulliver on the following basis.] BULL JA: [155] If the transaction had taken place when and as it did, but without the offer of these contiguous properties being before the appellant’s directors for decision or during the time the appellant was considering the matter, the situation would have been entirely different, and the respondent might well have had to account to the appellant for his participation. But that is not the case here, and I cannot conclude that because offers of properties are continuously put before a mining company and rejected, henceforth any personal dealing with any of them by a director raises a conflict of personal interests with the interests of the company. On the contrary, it would seem that an out-and-out [156] bona fide rejection by the company would be the best evidence that any later dealings with the property by anyone would not be against its interests. This is not a case like Keech v Sandford where a trustee took unto himself property that had been trust property but which was impossible, although desired, to be continued as such. Nor is it the situation found in the Regal (Hastings) Ltd case, where the full acquisition of the property was conceived and wanted by the company but other circumstances made it impossible to take that portion which the directors personally took. The interests of the trustee in the one case and of the directors in the other remained always in conflict with those of the principal.

[7.477]

1.

Notes&Questions

Is Lord Greene MR asserting, and Cartwright J and Bull JA accepting, that the exploitation of an investment opportunity by a director after its bona fide rejection by his company will not lead to any liability to account or other equitable remedy in respect of the profit from the transaction? Do you agree with Lord Greene’s proposition?

[7.477]

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2.

3.

4.

5.

6.

What proposition does Peso stand for with respect to the profits rule? Is it asserting that the director is only accountable for profits from transactions in respect of which he is acting as a director or otherwise for the company? If so, is that a correct reading of Regal? “The difficulties connected with the decision in [Peso] … are neatly posed by asking the question of how would Keech v Sandford (see [7.470] at 145) have been decided if the reason why the lease had not been renewed was a bona fide decision by the trustee that renewal was not in the best interests of the trust. There is no doubt that the court would have found the trustee to be in breach of trust even though he acted bona fide”: D D Prentice (1972) 50 Can Bar Rev 623 n 3. Do you agree with both propositions? Is the Supreme Court making a distinction between “proper” and “improper” exploitation of corporate opportunities? If so, how should such a distinction be framed? May a stronger case be made for the strict application of the prophylactic principle where the directors decide to renounce the opportunity for the company other than in other situations where the impossibility of the company’s exploitation does not depend upon the directors’ determination? Would the conflict rule applied in Phipps v Boardman have compelled a different result in Peso? Does the later decision of the Supreme Court of Canada in Canadian Aero Services Ltd v O’Malley [7.490] cast doubt upon Peso? Suppose that Dr Aho had said to Cropper when he first put the offer of Dickson’s claims before the Peso board, “If our company doesn’t want these claims, I’ll put together a syndicate myself to acquire them.” Do you think that the Supreme Court might then have come to a different decision?

Phipps v Boardman [7.480] Phipps v Boardman [1967] 2 AC 46 House of Lords [The estate of C W Phipps contained 8,000 out of the 30,000 issued shares in a private company, Lester and Harris Ltd. The trustees of the will were the testator’s widow, his daughter and Fox, an accountant. The widow was in poor health and took no part in the affairs of the trust; Fox was the active trustee. Boardman was solicitor to the trustees. In late 1955 Boardman received an inquiry from someone wishing to acquire the estate’s shareholding in Lester and Harris. Boardman and Fox investigated the company’s accounts with the second appellant Tom Phipps, a residuary legatee, and all expressed dissatisfaction with the conduct of the company’s affairs. In the result, at the request of Fox and with proxies signed by him, Boardman and Tom Phipps (here called the appellants) attended the annual general meeting of the company in December 1956. There Boardman expressed the family’s dissatisfaction with company affairs, sought further information (which was given) and tried (unsuccessfully) to have Tom Phipps elected to the board. After the meeting the appellants reported to Fox that, in their view, the only way to get results was to get control of the company and that they had therefore decided to make an offer for all shares in the company apart from those held by the estate. Two of the trustees, Fox and the testator’s daughter, approved of the appellants’ plan but the widow, being infirm if not senile, was at no time consulted. Since trustees are required to act unanimously, there was, therefore, no question that the trustees had approved of the appellants’ subsequent action. The trustees could not have made such an offer without the sanction of the court since the Lester and Harris shares were not an authorised investment under the will. Indeed, Fox later gave evidence that he would not consider the trustees buying the shares under any circumstances. The appellants offered £3 per share but attracted few acceptances. Boardman then sought to secure a division of the company’s assets between the Phipps family and other shareholders but this too came to naught, although in the process Boardman obtained a great deal of information about the company and the potential value of its shares. In these negotiations Boardman purported to act on behalf of the trustees. After further protracted negotiations the appellants purchased the shareholdings 550

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Phipps v Boardman cont. of the directors at £4 10s per share and agreed to make similar offers to other shareholders except for the trust. The appellants received acceptances for almost 22,000 shares. Parts of the business were sold off and capital returns totalling £5 17s 6d per share were made. The shares retained a value of at least £2 per share. The rationalisation was clearly beneficial both to the appellants and the trust. A residuary beneficiary brought proceedings claiming, in proportion to his beneficial entitlement, that (a) the appellants held the shares as constructive trustees for him and (b) an account of their profits from such shares. The primary judge made the orders sought although he allowed payment to the appellants on a liberal scale for their work and skill in bringing the scheme to fruition. The Court of Appeal upheld the orders.] LORD HODSON: [105] The proposition of law involved in this case is that no person standing in a fiduciary position, when a demand is made upon him by the person to whom he stands in the fiduciary relationship to account for profits acquired by him by reason of his fiduciary position and by reason of the opportunity and the knowledge, or either, resulting from it, is entitled to defeat the claim upon any ground save that he made profits with the knowledge and assent of the other person. … There is no question of fraud in this case; it has never been suggested that the appellants acted in any other than an open and honourable manner. … [106] So far as Mr Tom Phipps is concerned, he was not placed in a fiduciary position by reason of his being a beneficiary under his father’s will. He was acting as agent for the trustees with Mr Boardman before any question of acting with him for his own benefit arose. He has not, however, sought to be treated in a different way from Mr Boardman upon whom the conduct of the whole matter depended and with whom he has acted throughout as a co-adventurer; he does not claim that he should succeed in this appeal if Mr Boardman fails. Mr Boardman’s fiduciary position arose from the fact that he was at all material times solicitor to the trustees of the will of Mr Phipps senior. This is admitted, although counsel for the appellants has argued, and argued correctly, that there is no such post as solicitor to trustees. The trustees either employ a solicitor or they do not in a particular case and there is no suggestion that they were under any contractual or other duty to employ Mr Boardman or his firm. Nevertheless as a historical fact they did employ him and look to him for advice at all material times and this is admitted. It was as solicitor to the trustees that he obtained the information which … enabled him to acquire knowledge of a most extensive and valuable character, as the learned judge pointed out, which was the foundation upon which a decision could and was taken to buy the shares in Lester and Harris Ltd. This information was obtained on behalf of the trustees, most of it at a time during the history of the negotiations when the proposition was to divide the assets of the company between two groups of shareholders. This object could not have been effected without a reconstruction of the company and Mr Boardman used the strong minority shareholding which the trustees held, that is to say, 8,000 shares in the company, wielding this [107] holding as a weapon to enable him to obtain the information of which he subsequently made use. As to this it is said on behalf of the appellants that information as such is not necessarily property and it is only trust property which is relevant. I agree, but it is nothing to the point to say that in these times corporate trustees, for example, the Public Trustee and others, necessarily acquire a mass of information in their capacity of trustees for a particular trust and cannot be held liable to account if knowledge so acquired enables them to operate to their own advantage, or to that of other trusts. Each case must depend on its own facts and I dissent from the view that information is of its nature something which is not properly to be described as property. We are aware that what is called “knowhow” in the commercial sense is property which may be very valuable as an asset. I agree with the learned judge and with the Court of Appeal that the confidential information acquired in this case which was capable of being and was turned to account can be properly regarded as the property of the trust. It was obtained by Mr Boardman by reason of the opportunity which he was given as solicitor acting for the trustees in the negotiations with the chairman of the company. … The end result was that out of the special position in which they were standing in the course of the negotiations the appellants got the opportunity to make a profit and the knowledge that it was there to be made. [7.480]

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Phipps v Boardman cont. The appellants argue that this is not enough, and in support of the contention rely on the authority of Aas v Benham [1891] 2 Ch 244. This case was concerned with a partnership of ship brokers, and the defendant carried on the business of ship builder, using knowledge acquired in the partnership business. A claim against him to account to the partnership for the profits of his business as ship builder failed. Lindley LJ said (at 256) that it is not the source of the information but the use to which it is put which is important: “To hold that a partner” (or trustee) “can never derive any personal benefit from information which he obtains as a partner would be manifestly absurd.” It was held that the defendant was not liable to account because the profit was made outside the scope of the partnership and that in no sense was the defendant acting as the agent of the partners. Similarly the appellants contend that the purchase of the shares [108] in question was outside the scope of the fiduciary relationship existing between them and the trustees. The case of partnership is special in the sense that a partner is the principal as well as the agent of the other partners and works in a defined area of business so that it can normally be determined whether the particular transaction is within or without the scope of the partnership. It is otherwise in the case of a general trusteeship or fiduciary position such as was occupied by Mr Boardman, the limits of which are not readily defined, and I cannot find that the decision in the case of Aas v Benham assists the appellants, although the purchase of the shares was an independent purchase financed by themselves. … Regal (Hastings) Ltd v Gulliver differs from this case mainly in that the directors took up shares and made a profit thereby, it having been originally intended that the company should buy these shares. Here there was no such intention on the part of the trustees. There is no indication that they either [109] had the money or would have been ready to apply to the court for sanction enabling them to do so. On the contrary, Mr Fox the active trustee and an accountant who concerned himself with the details of the trust property, was not prepared to agree to the trustees buying the shares and encouraged the appellants to make the purchase. This does not affect the position. As Keech v Sandford (1726) Sel Cas Ch 61; 25 ER 223 shows, the inability of the trust to purchase makes no difference to the liability of the appellants, if liability otherwise exists. … The relevant information is not any information but special information which I think must include that confidential information given to the appellants. … [111] The appellants obtained knowledge by reason of their fiduciary position and they cannot escape liability by saying that they were acting for themselves and not as agents of the trustees. Whether or not the trust or the beneficiaries in their stead could have taken advantage of the information is immaterial, as the authorities clearly show. No doubt it was but a remote possibility that Mr Boardman would ever be asked by the trustees to advise on the desirability of an application to the court in order that the trustees might avail themselves of the information obtained. Nevertheless, even if the possibility of conflict is present between personal interest and the fiduciary position the rule of equity must be applied. [Lord Cohen and Lord Guest agreed that the appeal should be dismissed. Viscount Dilhorne and Lord Upjohn considered that the appellants had not breached any duty. Viscount Dilhorne held that the information concerning Lester and Harris acquired while representing the trust was of no value to the trust since it was unable to exploit it: compare Bowen LJ in Aas v Benham at 257. Accordingly, the information was not the property of the trust: at 89-91. Further, he considered that Boardman was under no duty to advise the trustees of the possibility of seeking court approval to their acquiring the outstanding capital since Fox must have been aware of this option and was in a position to assess its prospects. Accordingly there was no conflict between Boardman’s interest and duty: at 92. Lord Upjohn’s dissent was also founded upon a different application of the principles.] LORD UPJOHN: [His Lordship quoted a passage in Aberdeen Railway Co v Blaikie Bros [7.360] at 471 enjoining directors from undertaking commitments which may possibly conflict with their fiduciary duties.] [124] The phrase “possibly may conflict” requires consideration. In my view it means that the reasonable man looking at the relevant facts and circumstances of the particular case would think that 552

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Phipps v Boardman cont. there was a real sensible possibility of conflict; not that you could imagine some situation arising which might, in some conceivable possibility in events not contemplated as real sensible possibilities by any reasonable person, result in a conflict. … The real rule is, in my view, that knowledge learnt by a trustee in the course of his duties as such is not in the least property of [129] the trust and in general may be used by him for his own benefit or for the benefit of other trusts unless it is confidential information which is given to him (1) in circumstances which, regardless of his position as a trustee, would make it a breach of confidence for him to communicate to anyone for it has been given to him expressly or impliedly as confidential, or (2) in a fiduciary capacity, and its use would place him in a position where his duty and his interest might possibly conflict. Let me give one or two simple examples. A, as trustee of two settlements X and Y holding shares in the same small company, learns facts as trustee of X about the company which are encouraging. In the absence of special circumstances (such, eg, that X wants to buy more shares) I can see nothing whatever which would make it improper for him to tell his co-trustees of Y who feel inclined to sell that he has information that this would be a bad thing to do. Another example: A as trustee of X learns facts that make him and his co-trustees want to sell. Clearly he could not communicate this knowledge to his co-trustees of Y until at all events the holdings of X have been sold for there would be a plain conflict, reflected in the prices that might or might possibly be obtained. … [In December 1956] the appellants went to the meeting with the object of persuading the shareholders to appoint Tom a director; admittedly they were acting on behalf of the trustees at that meeting. It is the basis of the respondent’s case that this placed the appellants in a fiduciary relationship which they never after lost or, as it was argued, it “triggered off a chain of events” and gave them the opportunity of acquiring knowledge so that [130] they thereafter became accountable to the trustees. … My Lords, I must emphatically disagree. The appellants went to the meeting for a limited purpose (the election of Tom as a director) which failed. Then the appellants’ agency came to an end. They had no further duties to perform. The discussions which followed showed conclusively that the trustees would not consider a purchase of further shares. So … I can see nothing to prevent the appellants from making an offer for shares for themselves, or for that matter, I cannot see that Mr Boardman would have been acting improperly in advising some other client to make an offer for shares (other than the 8,000) in the company. In the circumstances, the appellants’ duties having come to an end, they owed no duty and there was no conflict of interest and duty, they were in no way dealing in trust property. Further, of course, they had the blessing of two trustees in their conduct in trying to buy further shares. So had [the first offer] … been successful I can see nothing to make them constructive trustees of the shares they purchased for the trust. Consider a simple example. Blackacre is trust property and next to it is Whiteacre; but there is no question of the trustees being interested in a possible purchase of Whiteacre as being convenient to be held with Blackacre. Is a trustee to be precluded from purchasing Whiteacre for himself because he may have learnt something about Whiteacre while acting as a trustee of Blackacre? I can understand the owner of Whiteacre being annoyed but surely not the beneficial owners of Blackacre, they have no interest in Whiteacre and their trustees have no duties to perform in respect thereof. … [When the appellants commenced negotiations leading to the final offer] the only conflict between the duty and interest of the appellants that can be suggested is that having learnt so much about the company and realised that in the hands of experts like Tom the shares were a good buy at more than £3 a share they should have communicated this fact to the trustees and suggested that they ought to consider a purchase and an application to the court for that purpose. This, so far as I can ascertain, was suggested for the first time in the judgment of Lord Denning MR. Had this been an issue in the action this might have been a very difficult matter, but it never was. There is no sign of any such case made in the pleadings; but what is much more important is that from start to finish in all three courts there was no suggestion of this in argument on behalf of the respondent; and what is most important of all, there is no suggestion in cross-examination of either of the trustees [7.480]

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Phipps v Boardman cont. or of the appellants that the latter were under any such obligation. Mr Fox must in fact have known all about these negotiations and the value of the shares at this time. In these circumstances can it really be asserted that by failure (if, indeed, they did so fail; we simply do not know) formally to tell the trustees that the shares were worth more [132] than had previously been thought the appellants had placed themselves in a position where their interest might possibly conflict with their duty? For my part unless the trustees, which means in fact the active trustee Mr Fox, had communicated some change of policy as to the purchase of further shares I cannot conceive why the appellants should have thought themselves under any duty to communicate to the trustees the fact that they, the appellants, were prepared to pay £4 10s for the shares, for that is all that had happened over the intervening … negotiations. … My Lords, it would, in my opinion, be most unjust to the appellants to draw any inference against them in such circumstances without giving them any opportunity of explaining the situation as it really occurred in 1958. We do not know what would have been said on this point in the witness box, but it is not unlikely Mr Fox would have said: “I knew all about it but I was still inflexibly opposed to a purchase of more shares. All along I hoped the appellants would buy them.” Had he said that, it would seem to me perfectly clear that there would be no possible conflict between the appellants’ duty and interest. … [133] As a result of the information they acquired, admittedly by reason of the trust holding, they found it worthwhile to offer a good deal more for the shares … I cannot see that in offering to purchase non-trust shares at a higher price they were in breach of any fiduciary relationship in using the information they had acquired for this purpose.

[7.482]

Notes&Questions

1.

In Industrial Development Consultants Ltd v Cooley [7.485] Roskill J said, concerning Phipps v Boardman “I should have added that Lord Upjohn’s speech was a dissenting speech. I do not, however, detect any difference in principle between the speeches of their Lordships but merely a difference in the application of the facts to principles which were not in dispute”: at 450-451. In Queensland Mines Ltd v Hudson, Lord Scarman, delivering the judgment of the Privy Council, also said concerning Phipps v Boardman that while “their Lordships in that case differed in their analysis of the facts, they were agreed on the law”: at 177. Do you agree?

2.

What precisely is the duty upon Boardman which conflicted, actually or potentially, with his personal interest? What was it about the information and opportunity acquired by the appellants that compelled the majority judges to hold them accountable for its exploitation? Is Lord Upjohn’s application of the conflict rule more consistent with the policy and interests advanced by the rule?

3.

Does Phipps v Boardman address the issue posed in Peso? Is Fox’s effective rejection on behalf of the trustees equivalent to the Peso board’s rejection of Dickson’s claims? If so, are the cases otherwise distinguishable? The judgment of the Supreme Court of Canada in Peso was handed down after the decision of the Court of Appeal in Phipps v Boardman and just before the House of Lords delivered its judgment upon the appeal.

4.

Is there a causation issue to be addressed here? What degrees of contribution must the information make to the outcome of the successful venture? If it is creatively and energetically applied (as by Boardman) should the proportionate contributions be assessed and the liability to account be limited to the proportionate contribution of the

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information? Or is the primary judge’s solution of liberal remuneration for work and skill adequate? What if Tom Phipps had been the active party and he had been, say, an architect?

Industrial Development Consultant Ltd v Cooley [7.485] Industrial Development Consultant Ltd v Cooley [1972] 1 WLR 443 Birmingham Assize Court [The plaintiff company provided comprehensive construction services (viz, as architects, engineers and project managers) to large industrial enterprises. The defendant Cooley, an architect, had been its managing director. In February 1968, shortly after his appointment, Cooley wrote on behalf of the plaintiffs to the Eastern Gas Board offering the plaintiffs’ services in designing and constructing new gas depots for the Board. The approach was rejected. On 13 June 1969 Smettom, the deputy chairman of the Board, approached Cooley, indicating that the Board was interested in building gas depots and enquiring as to his availability to undertake the work. Cooley immediately prepared some documents to advance his claims to this project and on 16 June he represented to the chairman of the plaintiffs’ holding company that his health was such as to prevent him from carrying on as managing director. On this basis he was released from his position as from 1 August. On 6 August he was employed by the Board for a project which was substantially the same work as the plaintiffs had tried to obtain in February 1968. The plaintiffs sought a declaration that the defendant held all contracts with the Board upon trust for them and was liable to account for all fees and remuneration received. In their evidence Smettom and another senior officer of the Board said that they would not have employed the plaintiffs because of their objection to that type of conglomerate organisation. Note that in the judgment the plaintiff company is referred to as “the plaintiffs”.] ROSKILL J: [446] There can be no doubt that the defendant got this Eastern Gas Board contract for himself as a result of work which he did whilst still the plaintiffs’ managing director. … [451] The first matter that has to be considered is whether or not the defendant was in a fiduciary relationship with his principals, the plaintiffs. Mr Davies [counsel for the defendant] argued that he was not because he received this information which was communicated to him privately. With respect, I think that argument is wrong. The defendant had one capacity and one capacity only in which he was carrying on business at that time. That capacity was as managing director of the plaintiffs. Information which came to him while he was managing director and which was of concern to the plaintiffs and was relevant for the plaintiffs to know, was information which it was his duty to pass on to the plaintiffs because between himself and the plaintiffs a fiduciary relationship existed. … It seems to me plain that throughout the whole of May, June and July 1969 the defendant was in a fiduciary relationship with the plaintiffs. From the time he embarked upon his course of dealing with the Eastern Gas Board, irrespective of anything which he did or he said to Mr Hicks, he embarked upon a deliberate policy and course of conduct which put his personal interest as a potential contracting party with the Eastern Gas Board in direct conflict with his pre-existing and continuing duty as managing director of the plaintiffs. That is something which for over 200 [452] years the courts have forbidden. … Therefore, I feel impelled to the conclusion that when the defendant embarked on this course of conduct of getting information on 13 June [453] using that information and preparing those documents over the weekend of 14/15 June and sending them off on 17 June, he was guilty of putting himself into the position in which his duty to his employers, the plaintiffs, and his own private interests conflicted and conflicted grievously. There being the fiduciary relationship I have described, it seems to me plain that it was his duty once he got this information to pass it to his employers and not to guard it for his own personal purposes and profit. He put himself into the position when his duty and his interests conflicted. As Lord Upjohn put it in Phipps v Boardman [1967] 2 AC 46 at 127: “It is only at this stage that any question of accountability arises.” [7.485]

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Industrial Development Consultant Ltd v Cooley cont. Does accountability arise? It is said: “Well, even if there were that conflict of duty and interest, nonetheless, this was a contract with a third party in which the plaintiffs never could have had any interest because they would have never got it.” That argument has been forcefully put before me by Mr Davies. The remarkable position then arises that if one applies the equitable doctrine upon which the plaintiffs rely to oblige the defendant to account, they will receive a benefit which, on Mr Smettom’s evidence at least, it is unlikely they would have got for themselves had the defendant complied with his duty to them. On the other hand, if the defendant is not required to account he will have made a large profit, as a result of having deliberately put himself into a position in which his duty to the plaintiffs who were employing him and his personal interests conflicted. … When one looks at the way the cases have gone over the centuries it is plain that the question whether or not the benefit would have been obtained but for the breach of trust has always been treated as irrelevant. I mentioned Keech v Sandford a few moments ago and this fact will also be found emphasised if one looks at some of the speeches in Regal (Hastings) Ltd v Gulliver though it is true, as was pointed out to me, that if one looks at some of the language used in the speeches in Regal such phrases as “he must account for any benefit which he obtains in the course of and owing to his directorship” will be found. In one sense the benefit in this case did not arise because of the defendant’s directorship; indeed, the defendant would not have got this work had he remained a director. However, one must, as Lord Upjohn pointed out in Phipps v Boardman at 125, look at the passages in the speeches in Regal having regard to the facts of that case to which those passages and those statements were directed. I think Mr Brown [counsel for the plaintiffs] was right when he said that it is the basic principle which matters. It is an overriding principle of equity that a man must not be allowed to put himself in a position in which his fiduciary duty and his interests conflict. The variety of cases where that can happen is infinite. The fact that [454] there has not previously been a case precisely of this nature with precisely similar facts before the courts is of no import. The facts of this case are, I think, exceptional and I hope unusual. They seem to me plainly to come within this principle. I think that, although perhaps the expression is not entirely precise, Mr Brown put the point well when he said that what the defendant did in May, June and July was to substitute himself as an individual for the company of which he was managing director and to which he owed a fiduciary duty. It is upon the ground I have stated that I rest my conclusion in this case.

Canadian Aero Service Ltd v O’Malley [7.490] Canadian Aero Service Ltd v O’Malley (1973) 40 DLR (3d) 371 Supreme Court of Canada [Canaero was engaged in topographical mapping and geophysical exploration. O’Malley was its president and chief executive officer; Zarzycki was an executive vice-president. Canaero learnt that the Canadian government might grant financial assistance to the government of Guyana to have a topographical mapping project carried out in that country. To assist Canaero to secure the contract for any such work, Zarzycki visited Guyana on several occasions and prepared detailed proposals for such mapping. Zarzycki and O’Malley pursued the Guyana project on behalf of Canaero until late July 1966 by which time they knew that the project had been approved in principle by the Canadian government. O’Malley expressed the view at this time that Canaero was certain to obtain the contract. In August 1966 O’Malley and Zarzycki formed their own company, Terra Surveys Ltd, and resigned from Canaero. O’Malley advised the Canadian government of their company’s interest and it was among the group of five companies invited on 23 August 1966 to bid for the project contract. In the end, Canaero did not submit a proposal with its bid, while Terra Surveys submitted a detailed proposal covering “the operation in much greater detail than might normally be expected”. The contract was awarded to Terra Surveys. 556

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Canadian Aero Service Ltd v O’Malley cont. Canaero sued O’Malley and Zarzycki claiming that they “had improperly taken the fruits of a corporate opportunity in which Canaero had a prior and continuing interest”: at 372. Terra Surveys was joined as the vehicle through which the individual defendants had obtained the benefit for which Canaero had been negotiating. The Ontario Court of Appeal upheld an appeal from the primary judge’s determination in favour of Canaero. The court held O’Malley and Zarzycki were not fiduciaries but employees of Canaero, and were subject to no limitations upon post-employment competition except those relating to trade secrets and the enticement of customers (which were not presently applicable). Canaero appealed to the Supreme Court of Canada. Laskin J delivered the judgment of the court.] LASKIN J: [381] There are four issues that arise for consideration. … There is, first, the determination of the relationship of O’Malley and Zarzycki to Canaero. Second, there is the duty or duties, if any, owed by them to Canaero by reason of the ascertained relationship. Third, there is the question whether there has been any breach of duty, if any is owing, by reason of the conduct of O’Malley and Zarzycki in acting through Terra to secure the contract for the Guyana project; and, fourth, there is the question of liability for breach of duty if established. I do not think it matters whether O’Malley and Zarzycki were properly appointed as directors of Canaero or whether they did or did not act as directors. What is not in doubt is that they acted respectively as president and executive vice-president of Canaero for about two years prior to their resignations. To paraphrase the findings of the trial judge in this respect, they acted in those positions and their remuneration and responsibilities verified their status as senior officers of Canaero. They were “top management” and not mere employees whose duty to their employer, unless enlarged by contract, consisted only of respect of trade secrets and for confidentiality of customer lists. Theirs was a larger, more exacting duty which, unless modified by statute or by contract (and there is nothing of this sort here), was similar to that owed to a corporate employer by its directors. I adopt what is said on this point by Gower, Principles of Modern Company Law (3rd ed, 1969), p 518 as follows: these duties, except in so far as they depend on statutory provisions expressly limited to directors, are not so restricted but apply equally to any officials of the company who are authorised to act on its behalf, and in particular to those acting in a managerial capacity. The distinction taken between agents and servants of an employer is apt here, and I am unable to appreciate the basis upon which the Ontario Court of Appeal concluded that O’Malley and Zarzycki were mere employees, that is servants of Canaero rather than agents. Although they were subject to supervision of the officers of the controlling company, their positions as senior officers of a subsidiary, which was a working organisation, charged them with initiatives and with responsibilities far removed from the obedient role of servants. It follows that O’Malley and Zarzycki stood in a fiduciary [382] relationship to Canaero, which in its generality betokens loyalty, good faith and avoidance of a conflict of duty and self-interest. Descending from the generality, the fiduciary relationship goes at least this far: a director or a senior officer like O’Malley or Zarzycki is precluded from obtaining for himself, either secretly or without the approval of the company (which would have to be properly manifested upon full disclosure of the facts), any property or business advantage either belonging to the company or for which it has been negotiating; and especially is this so where the director or officer is a participant in the negotiations on behalf of the company. An examination of the case law in this court and in the courts of other like jurisdictions on the fiduciary duties of directors and senior officers shows the pervasiveness of a strict ethic in this area of the law. In my opinion, this ethic disqualifies a director or senior officer from usurping for himself or diverting to another person or company with whom or with which he is associated a maturing business opportunity which his company is actively pursuing; he is also precluded from so acting even after his resignation where the resignation may fairly be said to have been prompted or influenced by a wish to acquire for himself the opportunity sought by the company, or where it was his position with the company rather than a fresh initiative that led him to the opportunity which he later acquired. It is this fiduciary duty which is invoked by the appellant in this case and which is resisted by the respondents on the grounds that the duty as formulated is not nor should be part of our law and that, [7.490]

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Canadian Aero Service Ltd v O’Malley cont. in any event, the facts of the present case do not fall within its scope. [The judge quoted from the speeches of Viscount Sankey and Lord Russell of Killowen in Regal (Hastings) Ltd v Gulliver Viscount Sankey is expressing “(t)he general rule of equity … that no one who has duties of a fiduciary nature to perform is allowed to enter into engagements in which he has or can have a personal interest conflicting with the interests of those whom he is bound to protect”: at 137. Lord Russell of Killowen is finding the directors liable because they obtained their shares “in the course of the execution of” their offices as directors: at 147.] [383] What I would observe is that the principle, or, indeed, principles, as stated, grew out of older cases concerned with fiduciaries other than directors or managing officers of a modern corporation, and I do not therefore regard them as providing a rigid measure whose literal terms must be met in assessing succeeding cases. In my opinion, neither the conflict test, referred to by Viscount Sankey, nor the test of accountability for profits acquired by reason only of being directors and in the course of execution of the office, reflected in the passage quoted from Lord Russell of Killowen, should be considered as the exclusive touchstones of liability. In this, as in other branches of the law, new fact situations may require a reformulation of existing principle to maintain its vigour in the new setting. The reaping of a profit by a person at a company’s expense while a director thereof is, of course, an adequate ground upon which to hold the director accountable. Yet there may be situations where a profit must be disgorged, although not gained at the expense of the company, on the ground that a director must not be allowed to use his position as such to make a profit even if it was not open to the company, as for example, [384] by reason of legal disability, to participate in the transaction. [Reference is made to Phipps v Boardman and Industrial Development Consultants Ltd v Cooley.] What these decisions indicate is an updating of the equitable principle whose roots lie in the general standards that I have already mentioned, namely, loyalty, good faith and avoidance of a conflict of duty and self-interest. Strict application against directors and senior management officials is simply recognition of the degree of control which their positions give them in corporate operations, a control which rises above day to day accountability to owning shareholders and which comes under some scrutiny only at annual general or at special meetings. It is a necessary supplement, in the public interest, of statutory regulation and accountability which themselves are, at one and the same time, an acknowledgment of the importance of the corporation in the life of the community and of the need to compel obedience by it and by its promoters, directors and managers to norms of exemplary behaviour. … That the rigorous standard of behaviour enforced against directors and executives may survive their tenure of such offices was indicated as early as Ex parte James (1803) 8 Ves Jun 337; 32 ER 385, where Lord Eldon, speaking of the fiduciary in that case who was a solicitor purchasing at a sale, said (at 352; 390-391): With respect to the question now put, whether I will permit Jones to give up the office of solicitor, and to bid, I cannot give that permission. If the principle is right, that the solicitor cannot buy, it would lead to all the mischief of acting up to the point of the sale, getting all the information that may be useful to him, then discharging himself from the character of solicitor, and buying the property. … On the other hand I do not deny, that those interested in the question may give the permission. … In my opinion, the fiduciary duty upon O’Malley and Zarzycki, if it survived their departure from Canaero, would be reduced to an absurdity if it could be evaded merely because the Guyana project had been varied in some details when it became the subject of invited proposals, or merely because Zarzycki met the variations by appropriate changes in what he prepared for Canaero in 1965, and what he proposed for Terra in 1966. I do not regard it as necessary to look for substantial resemblances. Their presence would be a factor to be considered on the issue of breach of fiduciary duty but they are not a sine qua non. The cardinal fact is that the one project, the same project which Zarzycki had pursued for Can- [389] aero, was the subject of his Terra proposal. It was that business opportunity, in line with its general pursuits, which Canaero sought through O’Malley and Zarzycki. There is no suggestion that there had been such a change of objective as to make the project for which 558

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Canadian Aero Service Ltd v O’Malley cont. proposals were invited from Canaero, Terra and others a different one from that which Canaero had been developing with a view to obtaining the contract for itself. Again, whether or not Terra was incorporated for the purpose of intercepting the contract for the Guyana project is not central to the issue of breach of fiduciary duty. Honesty of purpose is no more a defence in that respect than it would be in respect of personal interception of the contract by O’Malley and Zarzycki. This is fundamental in the enforcement of fiduciary duty where the fiduciaries are acting against the interests of their principal. Then it is urged that Canaero could not in any event have obtained the contract, and that O’Malley and Zarzycki left Canaero as an ultimate response to their dissatisfaction with that company and with the restrictions that they were under in managing it. There was, however, no certain knowledge at the time O’Malley and Zarzycki resigned that the Guyana project was beyond Canaero’s grasp. Canaero had not abandoned its hope of capturing it. … Although it was contended that O’Malley and Zarzycki did not know of the imminence of the approval of the Guyana project, their ready run for it, when it was approved at about the time of their resignations and at a time when they knew of Canaero’s continuing interest, are factors to be considered in deciding whether they were still under a fiduciary duty not to seek to procure for themselves or for their newly-formed company the business opportunity which they had nurtured for Canaero. Counsel for O’Malley and Zarzycki relied upon the judgment of this court in Peso Silver Mines Ltd (NPL) v Cropper … as representing an affirmation of what was said in Regal (Hastings) Ltd v Gulliver respecting the circumscription of liability to circumstances where the directors or senior officers had obtained the challenged benefit by reason only of the fact that they held those positions and in the course of execution of those offices. In urging this, he did not deny that leaving to capitalise on their positions would not necessarily immunise them, but he submitted that in the [390] present case there was no special knowledge or information obtained from Canaero during their service with that company upon which O’Malley and Zarzycki had relied in reaching for the Guyana project on behalf of Terra. There is a considerable gulf between the Peso case and the present one on the facts as found in each and on the issues that they respectively raise. In Peso, there was a finding of good faith in the rejection by its directors of an offer of mining claims because of its strained finances. The subsequent acquisition of those claims by the managing director and his associates, albeit without seeking shareholder approval, was held to be proper because the company’s interest in them ceased. … What is before this court is not a situation where various opportunities were offered to a company which was open to all of them, but rather a case where it had devoted itself to originating and bringing to fruition a particular business deal which was ultimately captured by former senior officers who had been in charge of the matter for the company. Since Canaero had been invited to make a proposal on the Guyana project, there is no basis for contending that it could not, in any event, have obtained the contract or that there was any unwillingness to deal with it. It is a mistake, in my opinion, to seek to encase the principle stated and applied in Peso, by adoption from Regal (Hastings) Ltd v Gulliver, in the straitjacket of special knowledge acquired while acting as directors or senior officers, let alone limiting it to benefits acquired by reason of and during the holding of those offices. As in other cases in this developing branch of the law, the particular facts may determine the shape of the principle of decision without setting fixed limits to it. So it is in the present case. Accepting the facts found by the trial judge, I find no obstructing considerations to the conclusion that O’Malley and Zarzycki continued, after their resignations, to be under a fiduciary duty to respect Canaero’s priority, as against them and their instrument Terra, in seek- [391] ing to capture the contract for the Guyana project. They entered the lists in the heat of the maturation of the project, known to them to be under active government consideration when they resigned from Canaero and when they proposed to bid on behalf of Terra. In holding that on the facts found by the trial judge, there was a breach of fiduciary duty by O’Malley and Zarzycki which survived their resignations I am not to be taken as laying down any rule of liability to be read as if it were a statute. The general standards of loyalty, good faith and avoidance of a conflict of duty and self-interest to which the conduct of a director or senior officer must conform, must be tested in each case by many factors which it would be reckless to attempt to enumerate [7.490]

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Canadian Aero Service Ltd v O’Malley cont. exhaustively. Among them are the factors of position or office held, the nature of the corporate opportunity, its ripeness, its specificness and the director’s or managerial officer’s relation to it, the amount of knowledge possessed, the circumstances in which it was obtained and whether it was special or, indeed, even private, the factor of time in the continuation of fiduciary duty where the alleged breach occurs after termination of the relationship with the company, and the circumstances under which the relationship was terminated, that is whether by retirement or resignation or discharge. [392] Liability of O’Malley and Zarzycki for breach of fiduciary duty does not depend upon proof by Canaero that, but for their intervention, it would have obtained the Guyana contract; nor is it a condition of recovery of damages that Canaero establish what its profit would have been or what it has lost by failing to realise the corporate opportunity in question. It is entitled to compel the faithless fiduciaries to answer for their default according to their gain.

Queensland Mines Ltd v Hudson [7.495] Queensland Mines Ltd v Hudson (1978) 52 ALJR 399 Privy Council [Queensland Mines Ltd was formed by AOE and Factors Ltd, a financier, to acquire uranium mining options held by AOE. However, when drilling was complete no company was immediately forthcoming to take up a mining lease to exploit the uranium and the company turned its attention to mining for iron ore. Hudson was managing director of Queensland Mines. (He was also managing director of Kathleen Investments Ltd which owned almost all of the capital of AOE.) With the encouragement of Korman (who controlled Factors), Hudson approached the Tasmanian government in August 1960 to seek a mining exploration licence for iron ore in the Savage River district. Notwithstanding that in these negotiations Hudson had used the resources and good name of Queensland Mines, the formal application for the licence was made in Hudson’s own name, possibly because he and Korman then had in mind to form a new company to exploit any licence obtained. When the Tasmanian government issued a licence to Hudson in February 1961, Korman’s financial affairs were in crisis. At about the end of February 1961, Korman met with Hudson and Redpath (then the Chairman of Queensland Mines). Korman informed his co-adventurers that he was unable to finance the project for which the licence had just been issued. Redpath testified that Hudson informed them that “he would keep faith with the arrangements he had made with the Tasmanian government, even if it meant bringing in other people to do the work”: at 403. Redpath testified that he and Korman told Hudson that they had no objection to him doing so. On 15 March 1961 Hudson resigned as managing director of Queensland Mines to devote his full energies to the iron ore project. (He did, however, remain a director of the company until 1971.) From 1961 he acted entirely on his own and at his own expense in relation to the Tasmanian iron ore project. He proved the existence of valuable deposits in the area covered by the exploration licence and in June 1966 a mining lease of this land was granted to an American company with Hudson deriving substantial royalties upon the ore mined. At a board meeting of Queensland Mines on 13 February 1962 Hudson reported on his negotiations with the Tasmanian government. The following resolution was passed: “There was no question of any Promoters Profits in the plan which envisaged the forming of a company to develop the area. … It was agreed that in view of all the explanations and the large amount of cash that would be required to finance the project, nothing could be gained by pursuing the matter any further.” Queensland Mines claimed an account of Hudson’s profits from the project. In the Supreme Court of New South Wales, Wootten J found that Hudson would have been liable to account had not the claim been statute barred ((1975-76) CLC 40-266). The company appealed to the Privy Council. Its judgment was delivered by Lord Scarman.] LORD SCARMAN: [His Lordship referred to Boardman v Phipps and Regal (Hastings) Ltd v Gulliver and quoted statements concerning the limits of the fiduciary’s liability to account.] [401] In the course of 560

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Queensland Mines Ltd v Hudson cont. the judgment under appeal, Wootten J examined the case law in great detail and reached a conclusion from which their Lordships would in no way dissent. He said … That obligation [that is, the duty owed by Mr Hudson as managing director to Queensland Mines] was twofold, namely, that he should not make a profit or take a benefit through his position as fiduciary without the informed consent of his principal, and that he should not act in a way in which there was a possible conflict between his own interest and that of his principal. In their Lordships’ opinion, therefore, the facts have to be examined to determine whether Mr Hudson acted in a way in which “there was a real sensible possibility of conflict” between his interest and the interest of Queensland Mines, and whether in exploiting for himself the opportunity provided by the mining exploration licence obtained by him while managing director he did so with the informed consent of Queensland Mines. The learned primary judge found against Mr Hudson on both these questions. … In the present case … their Lordships have reached the clear conclusion that in the circumstances there was after 13 February 1962, no real, sensible possibility of a conflict of interest between Mr Hudson and Queensland Mines, and that Queensland Mines were fully informed as to the facts and assented to Mr Hudson’s exploitation of the mining exploration licence in his own name, for his own gain, and at his own risk and expense. … [403] Their Lordships agree with the learned trial judge’s conclusion that the opportunity to earn these royalties arose initially from the use made by Mr Hudson of his position as managing director of Queensland Mines. He must, therefore, account to that company unless he can show that, fully informed as to the circumstances, Queensland Mines renounced its interest and assented to Mr Hudson “going it alone” that is, at his own risk and expense and for his own benefit. Their Lordships have reached the conclusion that by February 1962, at the latest, and possibly much earlier, the board of Queensland Mines, fully informed as to all relevant facts, had reached a firm decision to renounce all interest in the exploitation of the licence and had assented to Mr Hudson taking over the venture for his own account. … The board of the company knew the facts, decided to renounce the company’s interest, whatever it was, in the Tasmanian iron ore venture, and assented to Mr Hudson doing what he could with the licences at his own risk and for his own benefit. The position after 13 February can be put in either of two ways. It can be said that from that date the venture based on the licences was “outside the scope of the trust and outside [404] the scope of the agency” created by the relationship of director and company – a relationship which continued to exist between Mr Hudson and Queensland Mines. Or it can be said that on that date Queensland Mines gave their fully informed consent to pursue the matter no further and to leave Mr Hudson to do what he wished or could with the licences. In their Lordships’ opinion it does not matter how it is put. Liability to account must, as Lord Cohen said in Phipps v Boardman at 103, “depend on the facts of the case”. And the facts of this case are that with the fully informed consent of the Queensland Mines board Mr Hudson was left on his own, for better or for worse, with the Tasmanian licences – certainly from 13 February, but in truth from a much earlier date, that is, ever since Mr Redpath, chairman of the company, Mr S Korman and Mr Hudson had discussed the consequences of the Korman withdrawal. … The judge appears to have thought significant the absence of evidence that AOE or Kathleen Investments were kept in the picture. This could be relevant only if the matter of the licences could be said in the circumstances to fall outside the scope of the authority of the board. There is no indication that it did, and every indication that all concerned treated it as a board matter. The shareholders were Factors and AOE, both of whom were represented on the board. It is inconceivable that AOE was not aware of Queensland Mines’ early interest in the venture and of the manner and circumstances of the company’s escape after the Korman collapse.

[7.495]

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Queensland Mines Ltd v Hudson cont. [Since the issue was unnecessary for its decision the Privy Council did not consider the limitation point upon which Hudson had succeeded at trial.]

[7.497]

Notes&Questions

What principles emerge from Queensland Mines, Regal and Furs Ltd v Tomkies as to the effect of board approval to one of their number taking a profit from office? There is no reference in the Privy Council judgment in Queensland Mines to the presence of a constitutional provision expressly empowering the board to release a director to exploit such an opportunity. Would such disclosure and consent be sufficient in the case of a company with articles in terms of those contained in Peninsular and Oriental Steam Navigation v Johnson [7.385]? Statutory duties [7.500] The general law duties of conflict avoidance also have statutory complements in

relation to company directors and other officers and employees. 261 A director, secretary, other officer or employee of a corporation must not improperly use their position to: (a) gain an advantage for themselves or someone else; or (b) cause detriment to the corporation: s 182(1). Similarly, a person who obtains information because they are, or have been, a director or other officer or employee of a corporation must not improperly use the information to: (a) gain an advantage for themselves or someone else; or (b) cause detriment to the corporation: s 183(1). These are civil penalty provisions with civil consequences for any person involved in a contravention: s 1317E and see [7.65]. The provisions may also attract criminal sanctions. Directors, other officers and employees commit an offence if they use their position dishonestly: (a) with the intention of directly or indirectly gaining an advantage for themselves, or someone else, or causing detriment to the corporation; or (b) recklessly as to whether the use may result in themselves or someone else directly or indirectly gaining an advantage, or in causing detriment to the corporation: s 184(2). A person who obtains information because they are, or have been, a director or other officer or employee of a corporation commits an offence if they use the information dishonestly: (a) with the intention of directly or indirectly gaining an advantage for themselves, or someone else, or causing detriment to the corporation; or (b) recklessly as to whether the use may result in themselves or someone else directly or indirectly gaining an advantage, or in causing detriment to the corporation: s 184(3). In Byrnes v R 262 High Court said concerning the impropriety element of an earlier form of s 182: Impropriety does not depend on an alleged offender’s consciousness of impropriety. Impropriety consists in a breach of the standards of conduct that would be expected of a person in the position of the alleged offender by reasonable persons with knowledge of the duties, powers 261 262

In their explicit reach to employees in addition to directors and other officers, these provisions differ from the statutory duties of care and good faith under ss 180(1) and 181. (1995) 183 CLR 501 at 514-515 per Brennan, Deane, Toohey and Gaudron JJ.

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and authority of the position and the circumstances of the case. When impropriety is said to consist in an abuse of power, the state of mind of the alleged offender is important (Hindle v John Cotton Ltd (1919) 56 SLR 625 at 630-631): the alleged offender’s knowledge or means of knowledge of the circumstances in which the power is exercised and his purpose or intention in exercising the power are important factors in determining the question whether the power has been abused. But impropriety is not restricted to abuse of power. It may consist in the doing of an act which a director or officer knows or ought to know that he has no authority to do.

Accordingly, except for situations where impropriety is said to consist of an abuse of power, the assessment of impropriety involves a purely objective test. Under the standard in R v Byrnes, “intention or purpose does not form part of the requirement of improper use of position, yet it may be relevant in assessing impropriety. An officer who honestly believed that his or her actions did not amount to improper use could nevertheless be found to have improperly used his or her position”. 263 The use will be improper where the officer ought to appreciate, for example, the absence of authority for their action since “there is no safe haven for the morally obtuse”. 264 Thus, impropriety may arise from an act that the officer knows or ought to know that they should not do. Three decisions indicate the scope of the provision, at least in its earlier form. In Grove v Flavel 265 a director had used his knowledge of the precarious position of the company to secure preferential repayment of debts to himself and other companies in the group. Applying Walker v Wimborne and other case law on creditor interests (see [7.320]), the court held that such conduct was within the section since it was “inconsistent with the proper discharge of the duties of his office”. In Jeffree v National Companies and Securities Commission 266 a director transferred company assets at full value to a new company under identical ownership and management. The transfer was prompted by a fear that an arbitral award would be made against the company which it would be unable to satisfy. The transfer secured for the director the advantage of being able to continue working in the same business under a different corporate structure, unimpeded by the claims of a prospective creditor. That advantage was held to be sufficient for the subsection. Finally, in Clark v R two directors of a company entered into agreements with its controlling shareholder which had the effect of stripping the company of its assets through consulting agreements and the purchase and exercise of share options. 267

FURTHER CONFLICT AVOIDANCE OBLIGATIONS [7.505] Two further clusters of rules apply the principle requiring directors to avoid conflict

between interest and duty. First, there is a limitation, of somewhat uncertain scope, upon the extent to which directors may fetter the future exercise of their powers. A second group of rules governs the extent to which a director may compete with the company, either directly or indirectly through a directorship with a competing company. The fettering of board discretions [7.510] It is a basic rule of company law that directors must bring to bear an independent judgment in the exercise of their powers. The rule prohibits directors from delegating 263

Angas Law Services Pty Ltd (in liq) v Carabelas (2005) 226 CLR 507 at [65] per Gummow and Hayne JJ. The officer’s intention or state of mind is essential, however, with respect to the separate element of gaining a personal advantage or causing a corporate detriment.

264

Doyle v ASIC (2005) 227 CLR 18 at [37] per Gleeson CJ, Gummow, Kirby, Hayne and Callinan JJ.

265 266 267

(1986) 43 SASR 410. (1989) 15 ACLR 217. Clark v R (2004) 50 ACSR 592; see also Forge v ASIC [2004] NSWCA 448 (stripping company funds through retrospective and future payments of management and consulting fees, and the making of unsecured loans, to companies associated with the directors). [7.510]

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discretionary powers to another group or individual (at least without the sanction of the constitution) or from binding themselves as to the future exercise of those powers. Although there is a paucity of authority directly on point, there are undoubted limitations upon the extent to which directors may bind themselves by agreement with each other, or with outsiders, as to how they shall vote as directors. (The scope for fettering board powers through shareholder agreements is discussed at [5.195].) Thus, in Boulting v Association of Cinematograph, Television and Allied Technicians 268 Lord Denning MR said: It seems to me that no one, who has duties of a fiduciary nature to discharge, can be allowed to enter into an engagement by which he binds himself to disregard those duties or to act inconsistently with them. No stipulation is lawful by which he agrees to carry out his duties in accordance with the instructions of another rather than on his own conscientious judgment or in which he agrees to subordinate the interests of those whom he must protect to the interests of someone else. Suppose a Member of Parliament should be in the pay of some outside body, in return for which he binds himself to vote as he is directed to do. The agreement would clearly be void as against public policy. 269

Any such an agreement by directors would be vitiated by the assumption of obligations to act “in a specified manner to be decided by considerations other than [their] own conscientious judgment at the time as to what is best in the interests of [their company]”. 270 However, not every fetter upon the future exercise of directors’ powers will offend the rule, as the following case indicates.

Thorby v Goldberg [7.515] Thorby v Goldberg (1964) 112 CLR 597 High Court of Australia [A company proposed to demolish a building standing upon land owned by it, erect a modern multi-storey building upon the site and dispose of the space in it by selling or letting professional suites, shops and offices. The defendants (referred to as the O Group) were the only shareholders in the company; seven of their number its only directors. The defendants made an agreement with the plaintiffs with the general purpose of bringing their capital into the company upon mutually satisfying terms, including terms as to rights to occupancy of space in the proposed new building. The agreement contained a covenant by the O Group to cause a meeting of directors of the company to allot specified shares to the plaintiffs and a covenant for three of the five directors to resign and two members of the plaintiffs’ group to be appointed to the board. The O Group challenged the validity of the agreement, inter alia, upon the basis that the agreement purported to bind the directors of the company in the exercise of powers, that this fetter offended public policy and the agreement was accordingly void for illegality.] KITTO J: [605] The argument for illegality postulates that since the discretionary powers of directors are fiduciary, in the sense that every exercise of them is required to be in good faith for the benefit of the company as a whole, an agreement is contrary to the policy of the law and void if thereby the directors of a company purport to fetter their discretions in advance. … It is said that the agreement in the present case does purport to bind those of the O Group who are directors to take future steps as to which it is their duty to exercise an unfettered discretion when the time comes for taking those steps. There may be more answers than one to the argument, but I content myself with one. There are many kinds of transactions in which the proper time for the exercise of the directors’ discretion is the time of the negotiation of a contract, and not the time at which the contract is to be performed. A sale of land is a familiar example. Where all the members of a company desire to enter as a group into a transaction such as that in the present case, the transaction being one which requires action by the board of directors for its effectuation, it seems to me that the proper time for the directors to decide 268

[1963] 2 QB 606.

269 270

Boulting v Association of Cinematograph, Television and Allied Technicians [1963] 2 QB 606 at 626. Osborne v Amalgamated Society of Railway Servants [1909] 1 Ch 163 at 187 per Fletcher Moulton LJ.

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Thorby v Goldberg cont. whether their proposed action will be in the interests of the company as a whole is the time when the transaction is being entered into, and not the time when their action under it is required. [606] If at the former time they are bona fide of opinion that it is in the interests of the company that the transaction should be entered into and carried into effect, I see no reason in law why they should not bind themselves to do whatever under the transaction is to be done by the board. In my opinion the defendants’ contention that the agreement is void for illegality should be rejected. [McTiernan, Menzies, Windeyer and Owen JJ agreed with Kitto J.]

Competing directors [7.520] It might be thought obvious that the obligation to avoid possible conflict between

duty and interest, or between competing duties, would preclude directors from participating in a business competing with their company. Partnership law prohibits such competition with the firm without the consent of other partners: see [1.140]. Company law does not, however, impose a blanket prohibition upon competitive activity by directors. Indeed the early case law imposed few constraints upon such competition.

London and Mashonaland Exploration Co Ltd v New Mashonaland Exploration Co Ltd [7.525] London and Mashonaland Exploration Co Ltd v New Mashonaland Exploration Co Ltd [1891] WN 165 Chancery Division [A company sought to restrain its chairman from acting as a director of a rival company. The chairman had attended no board meeting of the applicant company and had made no undertaking not to become a director of a similar company. The constitution of the applicant contained no such restraint.] CHITTY J said, even assuming that Lord Mayo had been duly elected chairman and director of the plaintiff company, there was nothing in the articles which required him to give any part of his time, much less the whole of his time, to the business of the company, or which prohibited him from acting as a director of another company; neither was there any contract express or implied to give his personal services to the plaintiff company and to another company. No case had been made out that Lord Mayo was about to disclose to the defendant company any information that he had obtained confidentially in his character of chairman: the analogy sought to be drawn by the plaintiff company’s counsel between the present case and partnerships was incomplete: no sufficient damage had been shewn, and no case had been made for an injunction: the application was wholly unprecedented, and must be dismissed with costs.

[7.527]

1.

Notes&Questions

The Mashonaland case was cited with approval by Lord Blanesborough in Bell v Lever Bros Ltd [1932] AC 161 who added that “(w)hat he could do for a rival company, he could, of course, do for himself”: at 195. In Berlei Hestia (NZ) Ltd v Fernyhough [1980] 2 NZLR 150 Mahon J, in the Supreme Court of New Zealand, conceded that “there seems at first sight to be some measure of anomaly” between the strict liability imposed in the Regal Hastings decision and the latitude extended to competing directors, yet the difference “may be in point of commercial practice fully justified”. He said (at 161): Without committing myself to any final view, I should have thought that there was a wide distinction between asking a director to account for a profit made out of his [7.527]

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fiduciary relationship, and asking a director not to join the board of a competing organisation in case he should, at some future time, decide to act in breach of his fiduciary duty.

Is this consideration a compelling rationale for the Mashonaland decision? 2.

“Despite the development of the law affecting the position and duties of directors of a company, there does not yet seem to have been accepted as a general principle, affecting all directors any prohibition against a director of a company being a director of another company which competes in a way of business with the first company; indeed, such dicta as may be found in the cases would suggest that, at least if he not be an executive director, a director may be a director of a rival company, so long as he does not divulge to, or use for the benefit of, the rival company confidential information of the first company … That being so, and [there being] … no real evidence that the defendant had removed any lists of advertisers, or the like, from the plaintiff’s premises, or that, in her role as editor of The Drum Media the defendant was using any information relating to the plaintiff’s business which could properly be described as ‘confidential’, it follows, in my view, that the plaintiff has failed to make out a case for any injunction restraining the defendant from continuing to be actively involved in the affairs of Drum Media Pty Ltd.”: On the Street Pty Ltd v Cott (1990) 3 ACSR 54 at 61, 62.

3.

“It is, in my view, a striking feature of the authorities referred to above how rare have been the circumstances in which a court has been called on to deal with the pure case of a director’s involvement in a competing business, without any additional or complicating factor. However, as a Judge sitting at first instance, I must accept that, in Australia, Bell v Lever Bros is good law to the extent that it stands for the proposition that merely by acting as a director of a competing company, or carrying on a competitive business on his or her own behalf, a company director will not be regarded as being in breach of his or her fiduciary obligations. I so conclude from the treatment of the subject in On the Street, Rosetex and SEA Food, limited though it was. Stated in its highest form, the proposition for which Bell v Lever Bros stands is, as put by McLure P in Streeter (278 ALR at 303 [69]), ‘a director is permitted to occupy board positions in competing companies’. That is to say, merely by occupying such positions, the director will not be regarded as placing himself or herself in a position of conflict. But, it must be accepted, Lord Blanesburgh’s words in Bell v Lever Bros extended also to the permissibility of a director conducting a business on his or her own account in competition with the company on the board of which he or she sat. That would, presumably, involve the performance of active, executive, functions in a competitive business, and would not be analogous to a situation in which the director held non-executive positions on the boards of two companies. But it would seem to be permitted, as for example was the involvement of a non-executive director in an executive role in a competing company in On the Street. As against this, my attention has been drawn to no decision of an Australian court in which Bell v Lever Bros has been rejected”: Links Golf Tasmania Pty Ltd v Sattler (2012) 90 ACSR 288 at [562]. “A company is entitled to the unbiased and independent judgment of each of its directors. A director of a company who is also a director of another company may owe conflicting fiduciary duties. Being a fiduciary, the director of the first company must not exercise his or her powers for the benefit or gain of the second company without clearly disclosing the second company’s interests to the first company and obtaining the first company’s consent. Nor, of course, can the director exercise those powers for the director’s own benefit or gain without clearly disclosing his or her interest and obtaining the company’s consent. A fiduciary must not exercise an authority or power

4.

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for the personal benefit or gain of the fiduciary or a third party to whom a fiduciary duty is owed without the beneficiary’s consent” R v Byrnes (1995) 183 CLR 501 at 516-517. 5.

Doubting voices have been raised about the Mashonaland decision. In Scottish Co-operative Wholesale Society Ltd v Meyer [1959] AC 324 Lord Denning expressed the opinion that a director who joined the board of a rival company placed himself in an “impossible position” and would be in breach of his fiduciary obligations. Referring to the dictum of Lord Blanesborough in Bell v Lever Bros Ltd, he said: “That may have been so at that time. But it is at the risk now of an application under [Pt 2F.1] if he subordinates the interests of the one company to those of the other.” See also In Plus Group Ltd v Pyke [2002] EWCA Civ 370, discussed in R Grantham (2003) 66 MLR 109.

6.

Is the Mashonaland case correctly decided? Does it sit comfortably with the fiduciary ideology applied elsewhere in defining the duties of directors? Even if the case is correctly decided would it protect, hypothetically, the director Tomkies who exploited, for the benefit of the competitor whose board he had joined, trade secrets and technical processes acquired as a director (cf Furs Ltd v Tomkies [7.460]) or his knowledge of the company’s customers: Measures Bros Ltd v Measures [1910] 2 Ch 248? See Riteway Express Pty Ltd v Clayton (1987) 10 NSWLR 238.

7.

Where the director is also an employee of the company (eg, under a service contract), she may be held to the higher standard of fidelity demanded (in this area at least) of employees. Thus, in Hivac Ltd v Park Royal Scientific Instruments Ltd [1946] Ch 169 employees of a company were held to have breached an implied term of their contract of employment by working in their spare time for a competitor of their employer. The decision does not impose a general prohibition upon leisure time competitive activity. Rather such a constraint will depend upon such considerations as the skilled nature of the employee’s work, the damage to which her or his employer is exposed by such activity (including the risk of disclosure of confidential information) and any deception practised by the employee. There is no doubt, however, that the implied contractual obligation of fidelity applies to executive directors as well as to their skilled staff. For an application of the rule to a managing director who had breached his duty of fidelity as an employee by dealing with the company’s customers for his own and not the company’s benefit, see Thomas Marshall (Exports) Ltd v Guinle [1979] Ch 227 at 244-245.

Interlocking directors [7.530] The legal rules concerning competing directors address a situation at once both

egregious and marginal. Competing directors perhaps represent the most acute instance of potential conflict between duties. But the less extreme conflicts that arise from director interlocks upon companies that are not in direct competition are arguably of greater importance. Interlocking directorships arise where the same person serves on the board of two or more companies, whether or not they are competitors in markets. Almost a century ago, Louis Brandeis warned about the phenomenon of interlocking directorships: The practice of interlocking directorates is the root of many evils. It offends human law and divine. Applied to rival corporations it tends to the suppression of competition. … Applied to corporations which deal with each other it tends to disloyalty and to violation of the

[7.530]

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fundamental law that no man can serve two masters. In either event it leads to inefficiency for it removes incentive and destroys soundness of judgment. 271

Three principal vices are asserted for the practice – the inherent conflict between the fiduciary duties owed to the several companies, the negative effects upon business competition between them and the concentration of business power and influence to which interlocks peculiarly contribute. 272 The legal response to the first consideration is canvassed throughout this chapter; the second is outside the scope of this book. 273 The third is as elusive as it is significant. The concerns about interlocking directors derive from the links within a business network which are created by a single director sitting on the boards of two or more companies. The links increase factorially with each additional directorship held as the following diagram prepared by Alexander and Murray reveals. 274

Figure 7.2 Multiple directorship, network links and company interlocks

A single director holding two board appointments creates a single network link between the two companies; viewed from the perspective of each of the two companies, the single link constitutes two interlocks. However, when one person holds four directorships, a total of six network links and 12 interlocks are created. A study by Stapledon and Lawrence of the top 100 Australian companies in 1995 reported a total of 889 directorships and 690 directors, an average of 1.29 directorships per director. There was a total of 287 network links between the companies and 574 interlocks (that is,

271

273

“Breaking the Money Trusts”, Harper’s Weekly, 6 December 1913, quoted in R Carroll, B Stening & K Stening (1990) 8 C&SLJ 290. Of course, there are other concerns such as the ability of the director with multiple appointments to act independently and to reach a sufficient understanding of the activities of each company. Director interlocks under trade practices law are explored in R Carroll & M Thanos (1994) 22 ABLR 411.

274

M Alexander & G Murray (1992) 10 C&SLJ 385 at 391.

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networks links per firm), an average of 5.74 per company. 275 Network links are unevenly distributed, reflecting the factorial increase in networks with each additional directorship held. Thus, in the 1995 Australian study almost 81% of directors had only a single directorship in a top 100 company; 12.8% had two top 100 board seats, 4.2 per cent had three such seats and 2.2% had four or more seats. However, the small group of directors with four or more top 100 board seats, the “big linkers” (15 out of 690 directors), held 7% of all directorships and were responsible for 39% of network links. The high concentration of multiple directorships among big linkers is said to have the effect of creating a denser network among Australian boards “with a more identifiable elite of multiple directorship holdings and far less middle range directors” than the United States. 276 There has been little research conducted on the effect in Australia of director interlocks as a medium for influence and exchange, and as determinants of company performance and standards of corporate governance. They are perhaps limited and uncertain indicators of the organisation of business concentration and power. Close examination of individual organisations would be required before inferences could confidently be drawn as to the influence of interlocks upon corporate control in a particular setting. [7.532]

Review Problem

Good Books Pty Ltd is owned by members of the Good family. It operates a successful chain of bookstores in Adelaide and Perth. In recent years it has been looking for opportunities to expand its business. Susan Good, the managing director, is approached by Celebs Ltd, which has a stable of celebrity speakers with the proposal that the Good bookshops be used for regular public readings, lectures and celebrity events involving its speakers. Susan mentions the approach to some board members at a family barbeque and they are unenthusiastic on the grounds that it might disrupt business. The approach is not canvassed further in the company and she tells Celebs that it will not be involved but that she will personally organise for other book stores in Adelaide and Perth to offer a regular program with Celebs and, if successful, a national program through her interstate contacts. She forms a joint venture company with Celebs and the venture proves a great financial success. Some members of the Good family query her role with Celebs when the family learns of it. Advise.

FIDUCIARY DUTY TO INDIVIDUAL SHAREHOLDERS? [7.535] Directors’ duties are owed to the company which is the primary agent for their

enforcement: see [8.75]. It has been said that “[w]here a director’s fiduciary duties are owed to the company this prevents the recognition of concurrent and identical duties to its shareholders covering the same subject matter [but] this should not preclude the recognition of a fiduciary duty to shareholders in relation to dealings in their shares where this would not

275

See G P Stapledon & J Lawrence (1997) 21 MULR 150 at 178-179. The study also found that the average top 100 company had 8.22 interlocks with non-Top 100 All Ordinaries Index companies. These figures are broadly consistent with those from earlier Australian studies using different groups of large, mostly listed, companies; see M Alexander (1994) 29 Australian J Political Science 40; M Alexander & G Murray (1992) 10 C&SLJ 385; R Carroll, B Stening & K Stening (1990) 8 C&SLJ 290; B Stening & Wan Tai Wai (1984) 20(1) A&NZ J Sociology 47. The incidence of Australian interlocks is only slightly higher than in Britain (4.72) and well below Canada (13.72), continental Europe (12.36) and the United States (10.46): Alexander at 47-48.

276

Alexander at 52. Alexander asserts that the wide dispersal of a smaller number of directorships is characteristic of the United States: at 52. [7.535]

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compete with any duty owed to the company”. 277 The leading authority on the circumstances in which directors will owe duties of good faith and careful conduct to individual shareholders is Coleman v Myers.

Coleman v Myers [7.540] Coleman v Myers [1977] 2 NZLR 225 New Zealand Court of Appeal [Campbell and Ehrenfried Co Ltd (C & E) was a New Zealand family company with shareholdings spread across several generations of the Myers family. Sir Kenneth Myers, a family leader, was chairman of the company and his son Douglas its managing director. There were no other directors. Douglas conceived and executed, with the assistance of his father, a plan by which he would acquire all the shares in C & E by a cash offer to members. On Douglas’s calculations (based on his offer price of $4.80 per share), once the acquisition was complete, the company’s liquid assets coupled with funds from the sale of real estate would release funds to pay him a capital dividend sufficient to discharge the borrowings he had made to finance the acquisition and still yield a company with assets worth several millions. To secure the benefit of the compulsory acquisition provisions of the takeover legislation, the offer was made through another company, wholly owned by Douglas. As directors of C & E, Sir Kenneth and Douglas recommended that shareholders accept the offer. During negotiations with shareholders they represented that the offer price reflected the true value of the shares; Douglas also denied that there would be any liquidation of the company’s assets after the bid. He did not disclose that the company had liquid assets available for distribution as dividends, that he intended to effect such distributions or that real estate held by the company could be realised for sums well in excess of values shown in the company’s accounts. The offer attracted sufficient acceptances to permit the bidder to compulsorily acquire the shares of a small group of family members who had opposed the bid. In such circumstances, the dissentients reluctantly agreed to sell. However, when they learnt of the successful completion of Douglas’s scheme, yielding him the company for no net outlay, they brought proceedings against Douglas and his father claiming, inter alia, fraud, breach of fiduciary duty and negligence. Mahon J dismissed the action. The plaintiffs appealed.] WOODHOUSE J: [323] The … cause of action alleges that a fiduciary duty was owed in the particular circumstances of the case by each of the two directors of C & E to the shareholders. The claim is that the directors were in breach of that duty by allowing a conflict of interest to arise in relation to the takeover bid and then failing to ensure that the shareholders were equipped to make an informed decision. It is a complaint that despite the repose and acceptance of confidence the directors failed to disclose material facts which in a takeover situation affected the worth of the shares when considered from the point of view not only of vendors but the purchaser as well. There is, of course, the added complaint that in certain respects the shareholders were actually given wrong advice or information. In advancing their case the appellants did not rely upon the mere status of the first and second respondents as directors of the company. They asserted that the fiduciary relationship had arisen because those respondents were executive directors in a private company with a shareholding largely spread over a few associated family groups each one of which had come to rely upon Sir Kenneth Myers and later his son, not simply for the development of policy within the company and the good management of its affairs, but for the protection and cultivation of their own particular interests as shareholders. Associated with those general considerations are a number of particular matters referable to the takeover offer itself. They include the recommendations the directors made that the offer should be accepted by the shareholders; the dimensions of the capital gain that was at stake; and the wholesale use of C & E funds which alone could make the total achievement possible. In a sentence, the complaint is that Mr Douglas Myers, by the use of inside knowledge, got himself into a position where he could literally name his own price for the shares and get it accepted because the shareholders were uninformed or had been positively misled. 277

Brunninghausen v Glavanics (1999) 32 ACSR 294 at [58].

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Coleman v Myers cont. For the respondents it is denied at the outset that any fiduciary duty was owed to the shareholders. Then it is said that even if there were such a duty it had been discharged by the provision of all facts which would reasonably affect the value of the shares. It was contended also that the appellants had independently acquired all the material information; that the proposals of Mr Douglas Myers to use C & E funds to finance the takeover offer were irrelevant; that the price paid for the shares was a fair one; and that the claim by appellants as minority shareholders was based upon the misconception that they were entitled to share in the assets of the undertaking. In this area of the case a good deal of attention was focused on a decision of Swinfen Eady J in Percival v Wright [1902] 2 Ch 421. It involved a purchase of shares by the directors of a company at a time when they had knowledge of a likely and favourable sale of the whole undertaking. The vendor shareholders later brought proceedings against the directors claiming that the latter were in a fiduciary position towards them at the time of the sale. The judge disagreed and some textbook writers have regarded the decision as authority for the proposition that a company director, while owing a [324] fiduciary duty to his company, will never have such a duty in respect of the shareholders. Not unnaturally the respondents have sought to rely upon the case which they submit should be regarded as having decided the law upon the point in New Zealand. I do not think that it does. The restricted nature of the argument addressed to the court in Percival v Wright and the surprising nature of a concession deliberately associated with it needs to be appreciated in order to understand the true implications of the decision. It was submitted that the directors held a fiduciary position for the shareholders where negotiations for a sale of the whole undertaking of the company were on foot; but not otherwise. The argument was that in such circumstances the directors were in the position of trustees for sale. And there was a further concession: it was accepted that there had been no unfair dealing by the directors or a purchase of the shares at an undervalue. So the very limited point put to the court was simply that fortuitous negotiations for the sale of the undertaking altered the whole position. That, in my view, could not possibly be the test and, with respect, the decision of the judge in that particular case, restricted as I think it was to that one point, was inevitable. In my opinion it is not the law that anybody holding the office of director of a limited liability company is for that reason alone to be released from what otherwise would be regarded as a fiduciary responsibility owed to those in the position of shareholders of the same company. Certainly their status as directors did not protect the defendants in a Canadian case which finally made its way to the Privy Council: see Allen v Hyatt (1914) 30 TLR 444. The decision in that case turned upon the point that the directors of the company had put themselves in a fiduciary relationship with some of their shareholders because they had undertaken to sell shares of the shareholders in an agency capacity. But there is nothing in the decision to suggest that in the case of a director the fiduciary relationship can arise only in an agency situation. On the other hand, the mere status of company director should not produce that sort of responsibility to a shareholder and in my opinion it does not do so. The existence of such a relationship must depend, in my opinion, upon all the facts of the particular case. When dealing with this part of the present case Mahon J himself came to the conclusion that Percival v Wright had been wrongly decided. Then he expressed his opinion generally upon the point in the following way: The essential basis of breach of fiduciary duty is the improper advantage taken by the defendant of a confidence reposed in him either by, or for the benefit of, the plaintiff. When one considers the legal relationship between the shareholder in a limited liability company and the directors entrusted with the management of that company, it appears to me that in any transaction involving sale of shares between director and shareholder, the director is the repository of confidence and trust necessarily vested in him by the shareholder, or by his legal status, in relation to the existence of information affecting the true value of those shares. He then qualified that conclusion by restricting it to those holding office as directors in private companies. It may be that he intended some qualification beyond that but if he did not then, with respect, I think myself the conclusion is too broadly stated. [7.540]

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Coleman v Myers cont. As I have indicated it is my opinion that the standard of conduct required from a director in relation to dealings with a shareholder will differ depending upon all the surrounding circumstances and the nature of the responsibility which in a real and practical sense the director has assumed towards the share- [325] holder. In the one case there may be a need to provide an explicit warning and a great deal of information concerning the proposed transaction. In another there may be no need to speak at all. There will be intermediate situations. It is, however, an area of the law where the courts can and should find some practical means of giving effect to sensible and fair principles of commercial morality in the cases that come before them; and while it may not be possible to lay down any general test as to when the fiduciary duty will arise for a company director or to prescribe the exact conduct which will always discharge it when it does, there are nevertheless some factors that will usually have an influence upon a decision one way or the other. They include, I think, dependence upon information and advice, the existence of a relationship of confidence, the significance of some particular transaction for the parties and, of course, the extent of any positive action taken by or on behalf of the director or directors to promote it. In the present case each one of those matters had more than ordinary significance and when they are taken together they leave me in no doubt that each of the two directors did owe a fiduciary duty to the individual shareholders. The reasons are implicit in the account I have given of the C & E company and those associated with it together with the depth of knowledge and experience on the one side when contrasted with the relative lack of it on the other and the careful development of the takeover proposals. I have read the judgment about to be delivered by Cooke J and I am in agreement with all that he has said upon both facts and law concerning breach of the fiduciary duty and breach of the duty of care. COOKE J: [333] [I]n the setting seen here there must be an obligation not to make to shareholders statements on matters material to the proposed dealing which are either deliberately or carelessly misleading. And in my opinion there must at least be an obligation to disclose material matters as to which the director knows or has reason to believe that the shareholder whom he is trying to persuade to sell is or may be inadequately informed. As to what matters are material, there was some debate in argument before us. … [334] As a broad test of materiality, then, one may speak of “those considerations which can reasonably be said, in the particular case, to be likely materially to affect the mind of a vendor or of a purchaser”. The same idea is expressed more fully by Marshall J in delivering the opinion of the United States Supreme Court in TSC Industries Inc v Northway Inc 426 US 438 (1976), a case under the Securities Exchange Act 1934 and concerning proxy solicitation: The general standard of materiality that we think best comports with the policies of Rule 14a-9 is as follows: An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. This standard is fully consistent with Mills’ general description of materiality as a requirement that “the defect have a significant propensity to affect the voting process”. It does not require proof of a substantial likelihood that disclosure of the omitted fact would have caused the reasonable investor to change his vote. What the standard does contemplate is a showing of a substantial likelihood that, under all the circumstances, the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder. Put another way, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available (ibid at 449). [Counsel for the parties] accepted the principle stated in that passage as applicable here in its entirety … I am well content to do the same. … [340] Although the … respondents by their counsel denied that they were under any fiduciary duty, it was conceded on behalf of them both, that because they had chosen to make a recommendation in terms of the Companies Amendment Act 1963 (NZ), there was a duty of care in respect of the formulation of that recommendation. … The New Zealand Parliament has laid down a statutory procedure for takeovers, applying to this case, and as part of it has given the directors of an offeree company certain options, one of which is to make a positive recommendation likely to have a strong influence on their shareholders. If they take that course, it is hardly conceivable that the legislature 572

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Coleman v Myers cont. would have intended them to be legally free to do so carelessly. I would base the duty of care on the need to give efficacy to the assumption of Parliament in enacting the statute. Alternatively, however, the case may be brought within the ambit tentatively contemplated by the majority of their Lordships in Mutual Life and Citizens’ Assurance Co Ltd v Evatt [1971] AC 793 at 809, in that the directors had financial interests in the transaction upon which they gave advice. As the duty is conceded, further discussion of the authorities about when a duty of care arises in the making of a recommendation is not called for. … [353] One can be sure that, if faced with an outside bidder and if prepared to entertain at all the possibility of selling, they would certainly not have recommended acceptance of a first offer of $4.80 without bargaining. In these circumstances I think that at the very least they should have refrained from a positive recommendation; and that the appellants have made out their allegation that the respondents knew or ought to have known that the price of $4.80 per share was not a fair one and should not have been recommended to the shareholders. Even assuming that they were under no fiduciary duty, I do not think that the recommendation to sell at $4.80 was made with reasonable care for the interests of shareholders. [Casey J agreed with Woodhouse and Cooke JJ that the respondents had breached their fiduciary duties to the plaintiffs. Woodhouse and Casey JJ also found that statements by Douglas Myers as to the retention of company assets and the commitment of cash resources amounted to fraudulent misrepresentation. On the question of remedies, all judges agreed that, the scheme having been effected, it was no longer “practically just” to make an order for rescission of the contracts of sale. Rather an order was made for compensation for the sale of their shares at an undervalue, fair value being assessed at $7 per share. The court did not think it practicable in the instant circumstances to draw a distinction between compensation for breach of fiduciary duty and damages for negligent advice.]

[7.542]

Notes&Questions

1.

For other instances where fiduciary obligations were imposed upon directors in favour of individuals (usually under the agency rubric), see Allen v Hyatt (1914) 30 TLR 444 and Briess v Woolley [1954] AC 333; see Brunninghausen v Galvanics (1999) 32 ACSR 294; cf Hurley v BGH Nominees Pty Ltd (No 2) (1984) 2 ACLC 497 at 506; Jones v Jones (2009) 27 ACLC 1,021; but see also Glandon Pty Ltd v Strata Consolidated Pty Ltd (1993) 11 ACSR 543; Esplanade Developments Ltd v Dinive Holdings Pty Ltd (1980) 4 ACLR 826. Such doctrines are now strengthened by statutory provisions relating to insider trading: see Chapter 11. These cases are also reinforced by general principles which underpin the imposition of fiduciary obligation: see, for example, Hospital Products Ltd v US Surgical Corp (1984) 156 CLR 41 and United Dominions Corp Ltd v Brian Pty Ltd (1985) 157 CLR 1.

2.

In Brunninghausen v Glavanics (1999) 32 ACSR 294, a fiduciary relationship was held to exist between two brothers-in-law one of whom sold his minority stake in their company to the other for a sum much less than its value as disclosed by contemporaneous negotiations which the other shareholder was conducting for the sale of the whole undertaking. They were the only directors; indeed, the defendant was the sole effective director. At first instance, the judge held that the plaintiff’s case was not as strong as that which existed in Coleman v Myers. He considered that there was no conscious dependence by the plaintiff on information and advice from the defendant, and there was no relationship of confidence. However, “one factor had quite extraordinary significance”, the plaintiff’s “entire dependence on [the defendant] for information and advice about the transforming circumstance that negotiations were in [7.542]

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hand directed to selling the entire undertaking to business people who appeared seriously interested in buying it”. This advantage came to the defendant through his position as the active director of the company. On appeal, the decision was upheld upon the basis that the plaintiff was entitled to expect that he would not be cheated by non-disclosure of negotiations such as those that were being conducted (at 312-313): A fiduciary duty owed by directors to the shareholders where there are negotiations for a takeover or an acquisition of the company’s undertaking would require the directors to loyally promote the joint interests of all shareholders. A conflict could only arise if they sought to prefer their personal interests to the joint interest. That is the very conduct which should be proscribed by the duty.

While it was not necessary for the decision, reference was made to the family relationship within the company and the initiative taken by the mother-in-law of the parties to resolve differences between them by the sale of the plaintiff’s interest to the defendant. For further discussion of the circumstances where directors owe duties to shareholders individually see B Saunders (2004) 22 C&SLJ 535; J Lawrence (1996) 14 C&SLJ 428; M Hetherington (1976) 4 ABLR 220 and (1978) 6 ABLR 81; B A K Rider (1977) 40 MLR 471 and (1978) 41 MLR 585; F Dawson (1979) 8 NZULR 256; B S Cooney (1980) 4 Auck ULR 103.

3.

INDEMNIFICATION, EXEMPTION AND INSURANCE Rationale for restrictions [7.545] There are several possible modes by which directors and other officers might secure

release from liability arising from doctrines considered in this chapter. First, we have seen that within limits yet to be explored (see [8.25]) they may be released by general meeting resolution ratifying their breach of duty or otherwise validating the transaction resulting from it. Second, as in the Queensland Mines case ([7.495]), the board may itself be empowered to release one of its number from duty or the consequence of its breach. Third, the court is empowered by ss 1317S (contravention of civil penalty provisions) and 1318 (breach of duty more generally) to grant relief in particular circumstances. Directors may also secure release through provisions in company constitutions indemnifying them against liabilities arising from their office. Provisions have long been inserted into constitutions to exempt or indemnify directors against liability incurred in defending proceedings in which they are acquitted or judgment given in their favour. Gower says that these provisions were inserted since directors’ common law rights of indemnity from their company apply only where the proceedings arose out of lawful acts as directors, and they are accordingly not entitled to be indemnified for successfully defending charges “that they had done something which they had not done, and which it was not their duty to do”. 278 However, by the early part of the 20th century it had become common to grant much more generous indemnity rights in the constitution. In 1926 the Greene Committee reported on this practice: The decision in the City Equitable case (see [7.85] at 495) has directed public attention to the common article which exempts directors from liability for loss except when it is due to their “wilful neglect or default”. Another form of article which has become common in recent years goes even further and exempts directors in every case except that of actual dishonesty: see Re 278

L C B Gower et al, Gower’s Principles of Modern Company Law (4th ed, 1979), p 612.

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Brazilian Rubber Estates [1911] 1 Ch 425. We consider that this type of article gives a quite unjustifiable protection to directors. Under it a director may be guilty of the grossest negligence provided that he does not consciously do anything which he recognises to be improper. … The position is one which in our opinion calls for an alteration of the law. To attempt by statute to define the duties of directors would be a hopeless task and the proper course in our view is to prohibit articles and contracts directed to relieving directors and other officers of a company from their liability under the general law for negligence, breach of duty or breach of trust. 279

In consequence, from 1928 companies legislation in Britain has regulated the circumstances in which companies may release officers and auditors from the liabilities of office, indemnify them against such liabilities or pay premiums upon insurance policies in respect of their performance as director. The provisions now contained in Pt 2D.2 Div 1 of the Act were substantially revised with effect from March 2000. Briefly stated, officers or auditors may not be exempted at all by their company for a liability incurred as officer or auditor of the company; however, indemnification and the payment of insurance premiums are permitted in circumstances other than those expressly prohibited. The provisions are, however, essentially prohibitive rather than facultative: they do not authorise anything that would otherwise be unlawful: s 199C(1). Anything that purports to indemnify or insure an officer or auditor against liability, or exempt them from a liability, is void to the extent that it contravenes these provisions: s 199C(2). Exemption from liability as an officer or auditor [7.550] First, a company or related company must not exempt a person (whether directly or

through an interposed entity) from a liability to the company incurred as an officer or auditor of the company: s 199A(1). It is apparent from the cases on directors’ interests in company contracts and secret profits that duties imposed by equity upon directors may be relaxed through a company’s constitution without offending s 199A. Of course, the right to attenuate the operation of the equitable rule was settled before the introduction of the prohibition now contained in s 199A and this prohibition is couched in terms of exemption rather than attenuation. However, the boundary between these notions is not a bright line. What limits to release, arising from s 199A or otherwise, can be asserted? For example, would a constitutional provision be valid which (a) purported to permit a director to vote on any contract in which she or he is interested or (b) which attempted to relieve an interested director from any obligation of disclosure at least at general law? 280 Indemnification against liability as an officer or auditor [7.555] Second, in relation to indemnification against liability, a distinction is drawn between

liability for legal costs and other forms of liability. Except in relation to a liability for legal costs, a company or related company must not indemnify a person against three species of liability incurred as an officer or auditor of the company: (a) a liability owed to the company or a related company; (b) a liability for a pecuniary penalty order under s 1317G or a compensation order under s 1317H; or 279

Report of the Company Law Amendment Committee 1925-1926 (Cmd 2657, 1926), [46].

280

See Capricornia Credit Union Ltd v ASIC (2007) 62 ACSR 671 at [73]-[78]; on the permissible scope of attenuation of duty through the constitution see I M Ramsay (1987) 5 C&SLJ 129 and R W Parsons (1967) 5 MULR 395. On the relationship between this attenuation and the prohibition in the equivalent to s 199A, see Movitex Ltd v Bulfield (1986) 2 BCC 99,403 and the discussion in J Birds (1987) 8 Co Law 31 and (1976) 39 MLR 394; R Gregory (1982) 98 LQR 413 and (1983) 99 LQR 194; J E Parkinson [1981] JBL 335; R Instone [1982] JBL 171 and (1982) 98 LQR 548; C D Baker [1975] JBL 181. [7.555]

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(c)

a liability that is owed to someone other than the company or a related company and did not arise out of conduct in good faith: s 199A(2). An indemnity is prohibited whether it occurs through an agreement or by making a payment and whether directly or through an interposed entity. However, the prohibition only applies to “companies” and “related companies” as defined in the Act and so does not affect indemnities given by foreign companies which are part of the same corporate group. In relation to liability for legal costs, a company or related company must not indemnify a person against legal costs incurred in defending an action for liability incurred as an officer or auditor of the company if the costs are incurred in either of four species of proceeding: (a) in defending or resisting proceedings in which the person is found to have a liability for which they could not be indemnified under s 199A(2); (b) in defending or resisting criminal proceedings in which the person is found guilty; (c) in defending or resisting proceedings brought by ASIC or a liquidator for a court order if the grounds for making the order are found by the court to have been established; 281 or (d) in connection with proceedings for relief to the person under the Act in which the Court denies the relief: s 199A(3). Again, the indemnity is prohibited whether it occurs through an agreement or by making a payment and whether directly or through an interposed entity. Accordingly, an indemnity might be given against liability for legal costs which is contingently expressed so as not to cover the outcomes referred to in paras (a) and (b) of s 199A(3) and which excludes coverage of proceedings in paras (c) and (d). However, the company might be permitted to give an officer or auditor a loan or advance in respect of the legal costs beyond those in paras (c) and (d): s 212. In that case, once the outcome of the proceedings is known, they would (depending on the outcome) either be obliged to pay back the loan or advance if they were not entitled to an indemnity or might retain the loan moneys as the indemnity to which the person would now be entitled. Directors and officers insurance [7.560] The third form of regulated officer protection from liability is insurance. 282 On its

face, insurance protection against personal liability as a director and officer creates a moral hazard problem by removing, or at least reducing, their incentive to comply with legal duties. On the other hand, it might also be argued that the longer term effect of insurance is to enhance discipline: by providing a fund that might satisfy a judgment, it creates a litigation incentive to observe duties and, in the insurer interest, an incentive for insurers to impose their own discipline upon directors and officers by restricting cover or making it conditional. 283 Whatever its governance effects, there has been a market for directors and officers insurance in the United States for many years and in Australia for at least two decades. It is not a compulsory form of insurance as in some professions. Indeed, corporate regulation is limited to defining the circumstances in which the company is permitted to pay the premium for the 281

282

This paragraph includes proceedings by ASIC for an order under ss 206C, 206D or 206E (disqualification), 232 (oppression), 1317E, 1317G or 1317H (civil penalties) or 1324 (injunction). However, it does not apply to costs incurred in responding to actions taken by ASIC or a liquidator as part of an investigation before commencing proceedings for the court order. Legal costs incurred in these circumstances will be able to be indemnified, even if grounds for making orders in proceedings later taken by ASIC or a liquidator are found by the Court to have been made out. On directors’ liability insurance see C Boxer (1996) 4(3) Int’al Insur Rev 71; S Ansell (1995) 23 ABLR 164; V Finch (1994) 57 MLR 880.

283

C Parsons (2000) 21(3) Co Law 77.

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insurance policy and requiring disclosure of the payment and cover. In doing so, the Act preserves the disciplinary effects of legal obligation in some key provisions. A company or a related company must not pay, or agree to pay, a premium for a contract insuring a person who is or has been an officer or auditor of the company against a liability (other than one for legal costs) arising out of: (a) conduct involving a wilful breach of duty in relation to the company; or (b) a contravention of ss 182 or 183 (improper use of position or information from office for gain): s 199B. The prohibition applies to a premium whether it is paid directly or through an interposed entity. The annual directors’ report to shareholders must include details of indemnities given, insurance premiums paid and liability covered by the insurance during or since the end of the financial year for officers and auditors: s 300(1)(g), (8), (9). These provisions require disclosure of transactions that are exceptions to the prohibitions contained in ss 199A and 199B. Directors and officers (D & O) insurance policies cover nominated directors and officers against liability for “wrongful acts” committed in the course of their office. Surveys indicate that over 90 per of listed companies have such policies. 284 Cover is generally limited to liabilities to third parties and do not cover liabilities to the company itself. The standard definitions of “wrongful acts” against which coverage is given include breaches of duty, neglect, misstatement, omission or other act of the insured or liability arising from the performance of office. There may also be a company reimbursement section of the policy reimbursing the company for loss arising under any indemnity granted to directors and officers for “wrongful acts” as defined in the policy. The policies are subject to the exclusions contained in s 199B. Standard additional exclusions under D & O policies include claims alleging dishonesty or fraud, insolvent trading, claims brought by shareholders, claims arising from breaches of environmental or environmental health, prospectus liability and insider trading. Directors and officers may take out personal insurance cover at their own expense to cover liabilities, including for legal costs, beyond company D & O policies. The statutory exclusions do not apply to such policies.

284

Corporations and Markets Advisory Committee, Directors and Officers Insurance: Report (2004), p 13. The material in this paragraph draws upon this report. [7.560]

577

CHAPTER 8 Shareholder Remedies [8.05]

[8.15]

THE PROTECTION OF MINORITY SHAREHOLDERS IN OVERVIEW .................................................. 579 [8.05]

Protecting the few from the many ............................................................................... 579

[8.10]

Shareholder litigation ................................................................................................... 581

EQUITABLE LIMITATIONS UPON THE VOTING POWER OF MAJORITIES ......................................... 581 [8.15]

The general principle ................................................................................................... 581

[8.20]

Appropriation of corporate property and rights ............................................................ 582

[8.25]

Release of directors’ duties of good faith ...................................................................... 583

[8.40]

Where the general meeting is unwilling to sue and is controlled by the wrongdoers ...................................................................................... 591 Alterations of the company’s constitution that prejudice shareholder rights ........................................................................................................ 592

[8.45] [8.70]

SHAREHOLDER REMEDIES: HISTORICAL CONTEXT ....................................................................... 602 [8.70]

The functions of shareholder suits ................................................................................ 602

[8.75]

The traditional bias against shareholder standing at general law .................................................................................................................. 604

[8.80]

The former derivative suit for fraud upon the minority ................................................. 606

[8.85]

Special majorities ......................................................................................................... 607

[8.90]

Personal rights ............................................................................................................. 607

[8.95]

Illegal and ultra vires acts ............................................................................................. 607

[8.100]

THE STATUTORY DERIVATIVE ACTION ............................................................................................ 607

[8.110]

THE SHAREHOLDER’S PERSONAL ACTION .................................................................................... 618

[8.140]

[8.180]

[8.110]

Introduction ................................................................................................................. 618

[8.115]

The statutory contract in the constitution .................................................................... 619

[8.125]

The scope of individual shareholder rights ................................................................... 623

[8.135]

Injunctions against contravention of the Act ................................................................. 629

COMPULSORY LIQUIDATION REMEDIES ....................................................................................... 631 [8.140]

Introduction ................................................................................................................. 631

[8.145]

The just and equitable ground ..................................................................................... 632

[8.165]

Directors acting in their own interests .......................................................................... 644

THE STATUTORY REMEDY FOR OPPRESSION ................................................................................. 647 [8.180]

Early interpretations ..................................................................................................... 647

[8.195]

The modern grounds of relief ....................................................................................... 648

[8.210]

Recurring instances of relief for oppression ................................................................... 660

[8.215]

The range of orders ...................................................................................................... 665

THE PROTECTION OF MINORITY SHAREHOLDERS IN OVERVIEW Protecting the few from the many [8.05] Within a company there are many areas of potential disagreement among members.

They range from matters relating to the appointment, remuneration and removal of directors to the alteration of capital and constitutional structure and decisions as to reconstruction or liquidation of the company. As the range of instances of potential disagreement is very broad, [8.05]

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so also is the scope for exploitation and abuse of minority interests within the company. However, it is in the small private company that the plight of the minority shareholder is most severe. In public companies, a market generally exists for the company’s shares and members have this exit from the company should they be dissatisfied with the conduct of its affairs. However, where the dissentient’s holding is substantial and the market is thin or dominated by the company’s controllers, exit may not provide an adequate solution. Minority shareholders in private companies have no market exit option. Indeed, the company’s constitution frequently imposes some restriction upon the right to transfer shares and may also impose pre-emptive rights over shareholdings. In light of these restrictions and of the majority’s right to elect the board and (subject generally to special resolution) to effect constitutional and capital changes, the minority have no assurance of proportionate participation in company management and affairs. Minority shareholders are also susceptible to exploitation through a number of techniques directed to diminishing the value of their investment or procuring its disposal at an undervalue. These techniques include the withholding of dividends with profits effectively distributed among the majority in the form of salaries, bonuses and other emoluments. They may involve exclusion from management participation, diversion of corporate assets to interests associated with the majority, disproportionate share allotments, withholding of information concerning company affairs or the making of fundamental corporate changes affecting the value of minority interests. These techniques typically take the form of seeking a discriminatory advantage for the majority at the expense of the minority or may change the ground rules for financial or other participation in the company. Several techniques are illustrated in the cases extracted in this chapter. 1 This chapter is concerned with the legal protection of the minority in the conduct of company affairs, partly through the imposition of equitable constraints upon the voting power of the majority in general meeting. Two fundamental principles contend in this area, grinding against each other like giant tectonic plates. The first has long been central to the governance of business corporations and joint stock companies – the principle identifying the corporate will with the decision of a majority of members by value of shareholding, at least for those matters in respect of which the general meeting is competent to act. The decision of the majority therefore binds the minority. This principle treats members’ voting rights as being in the nature of property to be exercised in their personal, albeit selfish, interests. The second principle is expressed in doctrines which prevent majorities in general meetings from acting oppressively towards minorities or using powers for an improper purpose notwithstanding that the majority are acting within the scope of their powers. Thus, some exercises of the power to alter company constitutions by prejudicially affecting the rights of some members have been struck down under this principle despite the fact that the alteration has been regularly passed with the requisite majority. Conduct which violates this equitable limitation upon the powers of majorities is often called fraud on the minority. The contest between these two principles is the eternal political contest between the many and the few. Its elaboration in this context commences with a general examination of the equitable limitations imposed upon majorities and then with specific instances or categories where the principle has been invoked: see [8.15]-[8.65]. The difficulty lies in the formulation of a general standard and in the identification of the factors or conceptions which prompt 1

For a comprehensive survey and analysis of these techniques, see F H O’Neal, Oppression of Minority Shareholders (1975) and Close Corporations (1971), Ch 9. Of course, shareholders in private companies may seek to protect themselves against abuse by provisions in the constitution or by separate agreement between some or all of the members: see [5.195]. Those protective provisions might also be entrenched through the use of distinct classes of shares, the variation of whose rights requires the separate consent of the class: see [9.105].

580

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judges to invoke the formulary. The formulation of a general standard, and its application, requires a distinction to be drawn between conduct which is properly characterised as the legitimate exercise of majority power (notwithstanding that it causes disappointment and dissension among the minority) and that which may be termed over-reaching and unfair. The absence of clear and unambiguous standards here reflects differing notions of justice and fairness, the claims of the majoritarian principle and the diversity and complexity of the competing interests. Shareholder litigation [8.10] A second means for protecting minority shareholders is by granting them legal standing

to litigate not only in respect of wrongs done to them personally but also for certain wrongs to the company itself. The first category of suit – personal, individual or direct – presents no great difficulty beyond that of the characterisation of the cause of action as personal rather than corporate: see [8.125]-[8.135]. However, the second standing right – in respect of wrongs done to the company – raises greater difficulty; it displaces the rule that allocates to directors the corporate power to litigate for the company: see [5.105]. Why and when should a shareholder be permitted to sue on behalf of the company to enforce its rights? One potential instance is where the alleged wrongdoers are among the company’s directors or senior managers; if the duties imposed upon directors and managers are to be more than merely aspirational, some alternative enforcement modality needs to be found in view of directors’ natural reluctance to sue some of their number. Confiding enforcement exclusively to the class of potential defendants creates an incentive problem of no little order. Similarly, where the acts complained of are those of the company’s controllers and amount to fraud upon the minority, minority shareholder standing rights will be necessary if the substantive protection of minorities is to be effective. Accordingly, the general law permitted shareholders to secure the protection of judicial oversight by suing on behalf of the company (that is, derivatively) in some instances where the wrongdoers effectively controlled the company’s decision not to bring the suit itself. A statutory derivative action procedure has now been introduced to replace the general law derivative action; the statutory derivative procedure requires court approval prior to commencing legal action for the company: see [8.100]. 2 In addition to the derivative and personal action procedures, other shareholder remedies have been granted by statute. Thus, compulsory liquidation remedies and the statutory oppression suit provide grounds for relief under different criteria and with flexible remedies for conflict resolution within the company. These further statutory remedies are examined at [8.140]-[8.230].

EQUITABLE LIMITATIONS UPON THE VOTING POWER OF MAJORITIES The general principle [8.15] As noted, two principles contend in relation to the exercise of shareholder voting

power. It is long established that “shareholders of a company may vote as they please, and for the purpose of their interests”. 3 Again, “[t]hey vote in respect of their shares, which are property, and the right to vote is attached to the share itself as an incident of property to be 2 3

The new statutory derivative suit does not affect the standing of a shareholder at general law to bring proceedings on their own behalf in respect of infringement of a personal right: s 236 (note). Menier v Hooper’s Telegraph Works (1874) LR 9 Ch App 350 at 354 per Mellish LJ. [8.15]

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enjoyed and exercised for the owner’s personal advantage”. 4 The second principle imposes an equitable constraint upon the powers conferred by company articles upon majorities. A longstanding expression of this doctrine is that of Lindley MR in Allen v Gold Reefs of West Africa Ltd: 5 [The power of a three fourths majority to alter company articles must] like all other powers, be exercised subject to those general principles of law and equity which are applicable to all powers conferred on majorities and enabling them to bind minorities. It must be exercised, not only in the manner required by law, but also bona fide for the benefit of the company as a whole, and it must not be exceeded.

Although this test adopts the same language as the director’s duty of good faith, the content of the limitation is quite different since the limitation upon majorities does not impose a fiduciary obligation towards the company or the minority. 6 However, in Gambotto v WCP Ltd the High Court rejected this test as inappropriate and adopted the language of oppression and improper purpose to define the vitiating overreach by majorities. 7 General meeting resolutions which offend this second principle have traditionally been called fraud on the minority. In this section the principal cases on the equitable limitation are grouped into categories although it is difficult to be confident that the categories correctly identify the principles or factors which have prompted courts to invoke the doctrine or provide reliable predictors of future judicial decision. 8 Indeed, it may well be that the task of divining either categories or principles in this area is futile and betrays a misconception of the judicial process. Thus, in Crumpton v Morrine Hall Pty Ltd 9 Jacobs J said: It seems to me that the truth is that the courts in each generation or in each decade have set a line up to which shareholders have been allowed to go in affecting the rights of other shareholders by alterations of articles of association, and beyond which they have not been allowed to go. It seems to me that no amount of legal analysis or analytical reasoning can conceal the fact that the decision has in the past turned, and must turn ultimately, on a value judgment formed in respect of the conduct of the majority – a judgment formed not by any strict process of reasoning or bare principle of law but upon the view taken of the conduct.

Appropriation of corporate property and rights [8.20] One of the enduring specific applications of the general formulary is in respect of

resolutions of the general meeting which are characterised as effecting an appropriation of corporate property or rights. An early instance is Menier v Hooper’s Telegraph Works. 10 A company had commenced proceedings against a third party for the recovery of valuable rights. Its directors subsequently resolved to abandon the proceedings and the general meeting resolved that the company go into voluntary liquidation. A shareholder sued, alleging that the abandonment of the claims and the resolution for liquidation had been procured by the majority shareholder pursuant to an arrangement made with the third party to their mutual advantage. The majority shareholder demurred to the plaintiff’s claim. Upon appeal, James LJ said: 4

5 6 7 8

Peters’ American Delicacy Co Ltd v Heath (1939) 61 CLR 457 at 504. There are many other statements to similar effect; see, eg, Pender v Lushington (1877) 6 Ch D 70 at 75-76 and North-West Transportation Co Ltd v Beatty (1887) 12 App Cas 589 at 593. [1900] 1 Ch 656 at 671.

9

See Ngurli Ltd v McCann (1953) 90 CLR 425 at 438-439: see [7.270]. Gambotto v WCP (1995) 182 CLR 432 at 444: see [8.65]. For another categorisation, to which present debts are obvious, see L C B Gower et al, Gower’s Principles of Modern Company Law (4th ed, 1979), Ch 25. [1965] NSWR 240 at 244.

10

(1874) LR 9 Ch App 350.

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[8.20]

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The minority of the shareholders say in effect that the majority has divided the assets of the company, more or less, between themselves, to the exclusion of the minority. I think it would be a shocking thing if that could be done, because if so the majority might divide the whole assets of the company, and pass a resolution that everything must be given to them, and that the minority should have nothing to do with it. 11

Menier’s case also demonstrates the relation between the equitable constraint and the general law standing rules. The defendant’s plea that the suit should have been brought in the company’s name was rejected on the ground that this was an exceptional case “where the majority were the defendants, the wrongdoers, who were alleged to have put the minority’s property into their pockets”. 12 There were instances in Chapter 7 where a general meeting resolution was challenged as amounting to an appropriation of corporate property. Thus, in Cook v Deeks [7.465] at 564 the Privy Council said that a resolution of the general meeting to relinquish the company’s rights under the Canadian Pacific Railway Co contract “would amount to forfeiting the interest and property of the minority of shareholders in favour of the majority, and that by the votes of those who are interested in securing the property for themselves. Such use of voting power has never been sanctioned by the courts”. Similarly, in Ngurli Ltd v McCann [7.270] at 447 the High Court said that “even in general meeting a majority of shareholders cannot exercise their votes for the purpose of appropriating to themselves property or advantages which belong to the company for that would be for the majority to oppress the minority”. The reference to oppression in this context is not to the statutory remedy for minority shareholders under Pt 2F.1 (discussed at [8.180]) but is an alternative expression of the equitable limitation upon the majority’s powers. 13 There are considerable difficulties, however, in discerning what will be treated as an appropriation of corporate property. In Regal (Hastings) Ltd v Gulliver the House of Lords accepted that the directors might have “protected themselves by a resolution (either antecedent or subsequent) of the Regal shareholders in general meeting”. 14 Such a resolution, then, would not be treated as an appropriation of corporate property. A like view was taken in Furs Ltd v Tomkies [7.460] at 599. What distinguishes the exercise of the ratification power in these cases from that in Cook v Deeks and Ngurli Ltd v McCann? Gower suggests the following explanation: A satisfactory answer, consistent with common sense and with the decided cases, is difficult (and perhaps impossible) to provide. The solution may be that a distinction is to be drawn between (i) misappropriating the company’s property and (ii) merely making an incidental profit for which the directors are liable to account to the company. As we have seen, an incidental profit is not treated as the company’s property unless it flows from a use of the company’s property. Cook v Deeks clearly came within (i) for it was the duty of the directors to acquire the contracts on behalf of the company. Hence the company in general meeting could not ratify, at any rate if the directors’ own votes caused the resolution to be passed. 15

Release of directors’ duties of good faith [8.25] A second cluster of cases in which resolutions of the general meeting have been struck

down for fraud on the minority concern resolutions to release directors from the consequences 11

Menier v Hooper’s Telegraph Works (1874) LR 9 Ch App 350 at 353.

12

Menier v Hooper’s Telegraph Works (1874) LR 9 Ch App 350 at 353.

13

A further instance of this usage appears in North-West Transportation Co Ltd v Beatty (1887) 12 App Cas 589 at 593-594, quoted in [7.385], Notes and Questions. Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134n at 150 per Lord Russell and at 157 per Lord Wright: see [7.470].

14 15

Gower’s Principles of Modern Company Law (4th ed, Stevens, 1979), pp 617-618. [8.25]

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of their breach of duties of good faith to the company. Indeed, many of the cases under the “appropriation” category concerned resolutions, actual or prospective, to ratify breaches of such duties: Ratification … is a specific absolution, afforded usually though not always, retrospectively, but necessarily for specific and properly disclosed infractions of the director’s duties and subject to certain limitations … The essence of ratification is that the release so given obviates the liability, so far as any right of action to enforce it by existing shareholders is concerned. 16

There is little doubt that breaches of particular duties of directors may be ratified by the general meeting without offending the fraud on the minority doctrine. These include the derivation of secret profits in circumstances falling short of misappropriation of company property, 17 breaches of the duties of care, diligence and skill 18 and failure to declare interests in company contracts. 19 Until relatively recently, however, it was widely assumed, although not clearly established, that breaches of duty involving a want of honesty by directors might not be ratified. Thus, purported ratification was ineffective to relieve directors from the consequences of their failure to consult company interests by preferring their own interests or interests other than those of the company generally. 20 Purported ratification here amounted to fraud upon the minority. Several modern decisions have permitted the general meeting to ratify breaches of the duty of good faith. The first such decision was in 1963 in Hogg v Cramphorn Ltd [7.275] at 268-269 where Buckley J in the Chancery Division remitted a challenged share allotment to the general meeting for decision as to ratification. In that case the judge had found that the directors “had acted in good faith [and] were not actuated by any unworthy motives of personal advantage, but acted as they did in an honest belief that they were doing what was for the good of the company”. 21 The allotment was, however, set aside subject to possible ratification, since it was made with the “improper motive” of ensuring that the directors retained control of the company. The decision was upheld by the English Court of Appeal in Bamford v Bamford extracted at [8.30]. Several questions arise from the cases on the ratification of breaches of the duty of good faith. May shareholders effectively ratify mala fide breaches of duty by directors (eg, where directors act solely in their own selfish interest rather than those of their company)? Alternatively, is ratification limited to breaches of duty where the directors have a bona fide belief as to company benefit and where the vitiating element arises from the purpose for which powers are exercised? Bear these questions in mind when reading the following cases. No less important is the impact upon the ratification power of the introduction of the statutory derivative action procedure in 2000. One of the justifications for the statutory procedure was that it would remove the uncertainty that surrounds the general law derivative action, particularly in relation to the issue of ratification of directors’ decisions taken with less than unanimous shareholder support. 22 A key difficulty with the general law is the uncertainty 16

Miller v Miller (1995) 16 ACSR 73 at 87.

17

Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134n at 150 (the directors “could, had they wished, have protected themselves by a resolution (either antecedent or subsequent) of the Regal shareholders in general meeting”). Pavlides v Jensen [1956] Ch 565.

18 19

North-West Transportation Co v Beatty (1887) 12 App Cas 589: see [7.385], Notes and Questions.

20

See, eg, Atwool v Merryweather (1867) LR 5 Eq 464; Cook v Deeks [1916] 1 AC 554 at 564-565 (see [7.465]); Ngurli Ltd v McCann (1953) 90 CLR 425 at 447-448: see [7.270]. Hogg v Cramphorn Ltd [1967] Ch 254 at 265-266.

21 22

Directors’ Duties and Corporate Governance (Corporate Law Economic Reform Program, Proposals for Reform: Paper No 3, 1997), pp 29-33.

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as to whether ratification by a majority but not all shareholders has the effect of denying other shareholders the right to bring a derivative action for the benefit of the company as a whole. Under the new statutory procedure, ratification of conduct does not prevent a person from applying for leave to bring proceedings on behalf of a company or from bringing proceedings with leave; neither does ratification have the effect that an application for leave must be refused or proceedings brought with leave must be determined in favour of the defendant: s 239(1). If members ratify conduct, the court may take that into account, having regard to (a) how well informed about the conduct the members were in deciding whether to ratify; and (b)

whether the members who ratified the conduct were acting for proper purposes: s 239(2).

The effect of this provision is not to relegate ratification doctrines to the stuff of legal history although it certainly diminishes their importance. Ratification was not, however, a complete answer to other statutory remedies for minorities, such as the statutory oppression remedy under Pt 2F.1. The statutory procedure therefore draws many of the teeth of the ratification doctrine but does not deal a fatal blow to it: see [8.100].

Bamford v Bamford [8.30] Bamford v Bamford [1970] Ch 212 Court of Appeal, England and Wales [A company’s constitution empowered its directors to issue shares. Directors responded to an unwelcome takeover bid by issuing a substantial block of shares. A general meeting of the company at which full and frank disclosure was made, and at which the contested shares were not voted, resolved to ratify the allotment. The preliminary point of law was concerned solely with the question whether the allotment was capable of being ratified by ordinary resolution. It was assumed for the purposes of the preliminary point that the share issue had not been made “bona fide in the interests of [the company] because it was a tactical move in a battle for control of [the company] having as its primary purpose to make it more difficult for [the bidder] to obtain such control”: at 217. The proceedings were constituted as a representative suit with the plaintiff shareholders suing on behalf of themselves and all other shareholders apart from the defendant directors. The company was also joined as a defendant. At first instance, Plowman J held that the general meeting retained and had exercised a residual inherent power of allotment. Upon appeal the plaintiffs argued that the general meeting possessed no residual allotment power and that the purported allotment, not being made bona fide in the interests of the company, was void and therefore incapable of ratification.] HARMAN LJ: [237] Now to me from the very start that sounded odd, and I shall be forgiven if, after all the eloquence which we have had in this case, I am expressing the view which I have held throughout – that this is a tolerably plain case. It is trite law, I had thought, that if directors do acts, as they do every day, especially in private companies, which, perhaps because there is no quorum, or because their appointment was defective, or because [238] sometimes there are no directors properly appointed at all, or because they are actuated by improper motives, they go on doing for years, carrying on the business of the company in the way in which, if properly constituted, they should carry it on, and then they find that everything has been so to speak wrongly done because it was not done by a proper board, such directors can, by making a full and frank disclosure and calling together the general body of the shareholders, obtain absolution and forgiveness of their sins; and provided the acts are not ultra vires the company as a whole everything will go on as if it had been done all right from the beginning. I cannot believe that that is not a commonplace of company law. It is done every day. Of course, if the majority of the general meeting will not forgive and approve, the directors must pay for it. It will be remembered that in the well-known case of Regal (Hastings) Ltd v Gulliver Lord Russell of Killowen in the course of his speech made a very significant observation about this. In that case certain directors had acquired some shares by reason of the fact that they were directors of a certain company. [8.30]

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Bamford v Bamford cont. They afterwards sold those shares at a profit. It was held that they must account for the profit because it had been obtained as a result of their directorships and therefore was in the nature of trust property of the company. Lord Russell said (at 150): The suggestion that the directors were applying simply as members of the public is a travesty of the facts. They could, had they wished, have protected themselves by a resolution (either antecedent or subsequent) of the Regal shareholders in general meeting. In default of such approval, the liability to account must remain. So that the noble Lord considered it obvious that they could, by obtaining either a previous approval or a subsequent ratification, retain the profit, which otherwise they must disgorge. So it seems to me here that these directors, on the assumptions which we have to make, made this allotment in breach of their duty – mala fide, as it is said. They made it with an eye primarily on the exigencies of the takeover war and not with a single eye to the benefit of the company, and, therefore, it is a bad allotment. But it is an allotment. There is no doubt that the directors had power to allot these shares. There is no doubt that they did allot them. There is no doubt that the allottees are on the register and are for all purposes members of the company. The only question is whether the allotment, having been made, as one must assume, in bad faith, is voidable and can be avoided at the instance of the company – at their instance only and of no one else, because the wrong, if wrong it be, is a wrong done to the company. If that be right, the company, which had the right to recall the allotment, has also the right to approve of it and forgive it; and I see no difficulty at all in supposing that the ratification by the decision of 15 December in the general meeting of the company was a perfectly good “whitewash” of that which up to that time was a voidable transaction. And that is the end of the matter. [Russell and Karminski LJJ agreed. At first instance Plowman J had thought it clear “that the assumption is merely that the board exceeded its powers, not that it acted mala fide” (Bamford v Bamford [1968] 2 All ER 655 at 658. The statement is not contained, however, in the judgment published in the law reports.) The language of the two members of the Court of Appeal who delivered judgments in Bamford is more ambiguous. Despite finding the case “very much on a parallel with” Hogg v Cramphorn Ltd, Harman LJ nonetheless regarded the allotment as having been made in “bad faith … these directors, on the assumptions which we have to make, made this allotment in breach of their duty – mala fide, as it is said. They made it with an eye primarily on the exigencies of the takeover war and not with a single eye to the benefit of the company”: at 241 and 238. Russell LJ interpreted the assumption as meaning that “the allotment was not made by the board bona fide in the interests of the company”: at 241.]

Winthrop Investments Ltd v Winns Ltd [8.35] Winthrop Investments Ltd v Winns Ltd [1975] 2 NSWLR 666 Court of Appeal of the Supreme Court of New South Wales [This case also concerned action taken by directors which discouraged an unwelcome takeover bid. The constitution of Winns gave its directors the power to issue shares. After the Winns directors learned that a takeover bid was to be made for shares in the company they entered into negotiation with Burns Philp for the purchase of a major group of assets in exchange for a substantial issue of shares in Winns. The bidder Winthrop obtained interlocutory injunctions restraining the arrangements. Subsequently, a general meeting of Winns resolved to approve the company’s entry into the agreement to purchase the assets and to issue shares in partial consideration. The effect of this resolution was tested in the Supreme Court of New South Wales before Bowen CJ in Eq upon the agreed assumption “that the decision of the directors to enter into the arrangement [for the purchase of the stores and the share allotment] … was not made bona fide in the interests of the company in that it was in part motivated by a desire to frustrate a takeover bid”: at 678. His Honour dissolved the injunctions.] 586

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Winthrop Investments Ltd v Winns Ltd cont. SAMUELS JA: [679] [C]ounsel for Winthrop made two primary points. First, he said that the resolutions passed at the extraordinary general meeting were ineffective, because the shareholders in general meeting had no power to validate the agreement into which the directors proposed to enter in breach of their obligation to the company. This submission involved an attack on Bamford v Bamford whose authority we were urged to reject on the ground that it was inconsistent with the reasoning of the High Court in Grant v John Grant and Sons Pty Ltd (1950) 82 CLR 1 and Ngurli Ltd v McCann ([7.270]). Second, he contended that, if the shareholders did have such power, the resolutions were still ineffective because the directors had failed to disclose to the meeting the material facts necessary to enable the shareholders to arrive at an informed judgment upon the matters submitted for their decision. The first submission requires consideration of the powers of the shareholders in general meeting. But first it is necessary to say something of the consequences which the law attaches to a decision of directors made otherwise than bona fide in the interests of the company, and thus in breach of their fiduciary obligations. This was the nature of the decision taken in the present case because of the factual assumption made. The purpose assumed was an improper purpose in the limited sense now relevant, there being no suggestion that the directors were seeking any profit or advantage for themselves. The assumption establishes that “the substantial object the accomplishment of which formed the real ground of the board’s action” was outside the scope of the power conferred upon the directors: Mills v Mills (1938) 60 CLR 150. It follows to my mind, that the purported or ostensible exercise of power to achieve such an illegitimate object, was voidable at the option of the company, that is, Winns. It seems to me to be correct to say that such an exercise of power is voidable and not void: Harlowe’s Nominees Pty Ltd [680] v Woodside (Lakes Entrance) Oil Co NL ([7.265] at 493, 494). … It was argued, however, that the power of avoiding or affirming a voidable act of the kind in question resided not in the company, that is, a majority of the shareholders in general meeting, but in the shareholders individually. If this is right, then it follows that the directors owe their duty not to the company alone, but to shareholders also … [681] … There are many more cases which can be cited on both sides of the question. But we were not referred to any other decision of the High Court said to be inconsistent with Bamford v Bamford. I, therefore, follow the views which their Lordships there expressed. I do so with all the more confidence because the ultimate conclusion to which I have come does not require me to decide this issue. I will, therefore, assume, at all events, that a majority of the shareholders in general meeting have power to affirm a decision of their directors, otherwise voidable because in breach of a fiduciary duty owed to the company. But in the present case the directors had merely decided to act in the future; at the time of the general meeting they had not done the act upon which they had determined. They had not, therefore, committed any act in breach of their duty. So, in the strict sense, there was nothing to ratify. If the power of the shareholders was confined to ratification of an act already done, that power was not exercisable for want of appropriate subject matter. The submission put by … counsel for Winns, which his Honour evidently accepted, was however more widely framed. He argued that a general meeting might antecedently or subsequently approve or ratify an act otherwise improper as done in breach of the directors’ fiduciary duty; and sought support for the submission in Furs Ltd v Tomkies ([7.460]); Regal (Hastings) Ltd v Gulliver ([7.470]) and, of course, in Bamford v Bamford. Antecedent or prospective ratification of an act yet to be done really describes the grant of authority to do the act in contemplation. The present case is concerned with an act of particular character. It involves … an improper act; and the circumstances in which the shareholders can cure its defect. I am prepared to assume that the shareholders in general meeting have a dispensing power which they may use to validate, retrospectively or prospectively, an improper act (in the sense now relevant) of the directors. That power is limited by its purpose, which is to release the rights which the company would otherwise be able to assert to set aside the act impugned. … [683] [The shareholders] have no general power to transact the company’s business, or to give effective directions about its management. As Jordan CJ said in Clifton v Mount Morgan Ltd (1940) 40 [8.35]

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Winthrop Investments Ltd v Winns Ltd cont. SR (NSW) 31 at 44: “But there is no universal rule that shareholders in general meeting may by ordinary resolution bind or represent the company with respect to anything and everything.” Here, of course, there was no question of any explicit contest between the directors and shareholders. The directors themselves referred the matter to the general meeting. They sought the shareholders’ approval of the course which the directors had otherwise determined to follow. They asked for the shareholders’ advice; and undertook to act in accordance with the shareholders’ opinion. But that advice did not represent any exercise of power, [684] because the directors were not bound to take it. They said that they would; but voluntary acquiescence is not the same as submission. If, therefore, these resolutions are regarded as the expression by the shareholders of their approval of the transaction which the directors contemplated, they do not involve the exercise of power at all. They were not acts in the law, and could have no effect. It is not sufficient, therefore, if I may respectfully say so, to regard these resolutions as effective, merely because they may be said to have expressed the will of the general meeting. The general meeting is not, I think, the proper forum to determine matters of management, however critical they may be. The area of management is one in which the shareholders have no directly effective will. In order to determine the force of these resolutions, it is necessary, first, to see whether they are referable to some specific head of power, and then to consider the conditions necessary for its exercise. To my mind, the only way in which the resolutions can effectively do the work which the defendants require of them is to regard them as an exercise of the shareholders’ power to authorise the directors to do an act in breach of fiduciary duty; in other words, the power to waive the rights which such an act would vest in the company. This is, indeed, the basis on which the defendants presented their case. And once this view of the case prevails, it requires the final issue to be determined in the plaintiffs’ favour. Winthrop contended that the general meeting’s purported exercise of power was ineffective because the directors had failed to make such disclosure to the shareholders as was necessary to enable them to exercise their judgment: Re Dorman Long & Co Ltd ([6.110]). His Honour, however, found that there was neither concealment nor any material non-disclosure. But, in arriving at this conclusion, he failed to bear sufficiently in mind the only relevant purpose of the resolutions which the general meeting was called to consider. As I have endeavoured to show, there was no question of the shareholders merely offering advice to the directors, or of their simply weighing up whether the proposed transaction was or was not in the commercial interests of the company. If the resolutions go no further than this, then the competing assertions of the adversaries may well have put the shareholders in possession of the material facts: Peters’ American Delicacy Co Ltd v Heath ([8.50]). But, if the directors are to get the protection which they seek, the resolutions must reach well beyond any question of commercial interest. They are ineffective, unless they can be regarded as having authorised a breach of duty, or as having waived its consequences. I would myself have thought it clear beyond argument that, the purpose of the meeting being to excuse the directors, that purpose must have been clearly stated, and the nature of the contemplated breach of duty clearly disclosed by the directors seeking to be absolved. … The circulars issued by the directors of Winns did not disclose what I think must be regarded as the real purpose of the resolutions to be passed. Nor did they explain that the directors intended to enter into the transaction with Burns Philp in order, in part, to frustrate Winthrop’s takeover bid. Indeed, on the footing of the assumed facts, it is at least arguable that this motive was deliberately concealed. It is true, as his Honour pointed out, that Winthrop made this assertion in their circulars. But that left it to the shareholders to decide which faction was right. And in reliance upon their own directors’ statements they might well have come to a conclusion contrary to the truth which we are asked to assume. In that event they could have had no proper appreciation of what they were being asked to do, and there can be no waiver without knowledge. … To my mind there was one material fact which was essential for the shareholders to know. That was that the directors were proposing to act in breach of their duty. The necessity for this disclosure is made clear by Harman LJ in Bamford v Bamford (at 238). This fact the directors ought to have disclosed. 588

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Winthrop Investments Ltd v Winns Ltd cont. But they did not do so. Accordingly, in my view, the shareholders never had before them the information which they required and the law demands. … Accordingly, the resolutions do not validate either the proposed contract with Burns Philp or the allotment of shares which it contemplates. Hence, they provide no answer to the plaintiffs’ case. I add that I have assumed that, had proper disclosure been made, the general meeting would have had power to authorise the directors to enter into a transaction whose real object was to defeat a takeover. Whether this assumption is well or ill-founded may yet arise: and I expressly do not decide the question. MAHONEY JA: [707] It is established that resolutions of shareholders in general meeting would not be effective in this way, if the purpose of the majority at the meeting was otherwise than for the purposes of the company as a whole, as explained in Ngurli v McCann. It has not yet been settled whether, if the purpose of that majority be that which the directors are here assumed to have, viz the defeating of the Winthrop takeover, that will be an improper purpose of that majority within the principles adverted to in Ngurli Ltd v McCann. Bamford v Bamford decides that, in an exercise by the shareholders of the power of the company to avoid a transaction voidable on that ground, a resolution may be valid to affirm the transaction; it decides … nothing as to whether that resolution may be ineffective, because the majority had the same purpose. Therefore, if Winthrop, at the hearing of the proceeding in this case, can show that the majority passed the resolution for the same purpose that the directors had, to defeat the takeover, a serious question remains to be argued whether the resolutions in any way assist the defendants … One further matter remains. … [I]t is not clear whether, upon the basis of the assumption which we are to make for the purpose of this application, it follows that the court should infer that, in saying what they did to the shareholders, the directors were setting out to mislead the shareholders as to the directors’ real purpose in entering into the proposed transaction. If this assumption requires, in effect, that it be assumed that, as a fact, their purpose was a collateral purpose, it would, at the least, not [708] be difficult to convince a court that the directors were deliberately misleading the shareholders by what they put to them. If a court were so convinced, then that also would affect the significance of the resolutions in the proceeding. I am, therefore, not able to agree with the defendants’ submission that the proceeding generally is concluded against Winthrop by reason of the resolutions. There remains a serious question to be argued as to the effect of the resolutions, whether as indicating the intention of the shareholders to affirm a voidable transaction, or as operating otherwise to prevent the plaintiff restraining the directors from acting for a collateral purpose. [Glass JA dissented. He considered that disclosure to Winns shareholders had been adequate. Further, he considered that the question of the general meeting’s ratification power was “governed by an express decision of the Court of Appeal in England [which] … this court should, as a general rule follow … unless there is a contrary relevant decision of the High Court”: at 671. His Honour was unable to find in Ngurli v McCann or Grant’s case a decision on this question of law and accordingly he followed Bamford in upholding the general meeting resolution.]

[8.37]

1.

Notes&Questions In Residues Treatment and Trading Co Ltd v Southern Resources Ltd (1988) 51 SASR 177 at 204-205 ([8.130]) King CJ (with whom Matheson and Bollen JJ agreed) said: It has been argued, however, that there is a firm rule of law that a shareholder does not have standing to seek relief in respect of any act of the directors which is capable of ratification by the members in general meeting. My first comment on that proposition is that it is by no means clear to me that the allotment in question, if made for the improper purpose alleged, is capable of ratification … An important factor in Winthrop Investments Ltd v Winns Ltd was that the court felt constrained to follow a decision to [8.37]

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the same effect of the English Court of Appeal in Bamford v Bamford, a constraint which is now recognised not to apply to the Supreme Court of the Australian States … If it is correct that a shareholder has a personal right to have the voting power of his shares undiminished by an allotment of shares made for an improper purpose, there is to my mind a substantial argument that an exercise of the voting power of the majority to ratify such an allotment would be beyond the scope of the purpose for which that power exists. This is an issue which may have to be resolved at trial.

The passage was adopted in Colarc Pty Ltd v Donarc Pty Ltd (1991) 4 ACSR 155 where a share allotment, made for the improper purpose of depriving a shareholder of a controlling influence in the company, was held to be not capable of cure through ratification. 2.

In Forge v ASIC (2004) 52 ACSR 1, the company in general meeting passed resolutions that were asserted to be effective as ratification of breaches of duty by directors against whom a declaration had been made under s 1317EA(2) of contravention of the predecessor of s 182 (improper use of position) and the related party provisions. Upon receipt of $6 million from the Commonwealth of Australia for the issue of preference shares in the company, the funds were substantially applied in making retrospective and future payments of management and consulting fees and unsecured loans to companies associated with the directors. These acts grounded the declarations under Pt 9.4B. After quoting from Ngurli Ltd v McCann at 439 (viz, shareholders “must not exercise their vote so as to appropriate to themselves or some of themselves property, advantages or rights which belong to the company”), in the New South Wales Court of Appeal McColl JA (with whom Handley and Santow JJA agreed) held that (at [376]) the ratification resolutions were ineffective because they sought to cure the appellants’ wrongful taking of [the company’s] resources. Further, the shareholders did not exercise their voting power for the benefit of the company as a whole in the sense referred to in Ngurli Ltd v McCann. The Commonwealth either remained a preference shareholder or was a creditor of [the company] if it had validly rescinded the preference share allotment. The shareholders were not asked to take into consideration the interests of the Commonwealth either as a preference shareholder or as a creditor in recouping its $6,000,000. Indeed they were encouraged to focus on the claims [the company] had against the Commonwealth.

Second, McColl JA held that “even if the shareholders could, contrary to what I have already found, ratify the private law breaches of the directors’ duties, the ratification resolutions were ineffective to cure the breaches of statutory duty”: at [384]. Third, she considered that the purported ratification of the impugned transactions was also ineffective as being too late in time, following as it did upon the declaration of contravention in respect of the acts sought to be excused: at [387]-[389]. Finally, McColl JA found that the resolutions were not, in any event, based upon full disclosure of all material circumstances (at [402]): [I]t was necessary for the ratification to be effective that the shareholders be fully informed both of [the company’s] rights consequent upon the declarations of contravention and that the effect of the ratification resolutions could be that [the company] would lose both its statutory and equitable rights. The shareholders were never given that information.

3.

590

What is the precise nature of the breach of directors’ duties in Hogg v Cramphorn [7.275] and of the assumed breaches in Bamford and Winthrop v Winns? Specifically, did these breaches involve mala fide conduct by directors or were they of a less serious [8.37]

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character, for example, bona fide decisions vitiated by some impropriety of purpose? Are these breaches of duty distinguishable from those in Ngurli v McCann [7.270] and Cook v Deeks [7.465]? 4.

How extensive is the power conceded to the general meeting in Bamford to release directors from breaches of their duty? Does the power extend to the release of mala fide conduct? Is the court in Bamford saying that all breaches involving the exercise of power mala fide are ratifiable? If so, would such a principle be consistent with the decision in Ngurli v McCann that Horace Southcott’s acts as governing director were not capable of ratification by reason of the fraud on the minority doctrine? What is the authority of Bamford in Australia in light of Winthrop and Residues Treatment and Trading Co Ltd v Southern Resources Ltd (see n 1)? Is the ratification power limited to the release of breaches constituted by bona fide action but for an improper purpose?

5.

If the majority of members voting to ratify a breach of duty by directors is actuated by the same collateral purpose which vitiated the board’s resolution, will that purpose also vitiate their ratification resolution? Will it matter that the balance of voting power on the resolution is determined by proxies held by the chairman of the meeting? Was the purported ratification resolution in Cook v Deeks invalid for such a collateral purpose? See further, on the fraud on a power doctrine in its application to majorities, Peters’ American Delicacy Co Ltd v Heath [8.50] at 511-513.

6.

What disclosure must directors make to the general meeting when seeking release from breach of duty? If directors do not believe that a course of conduct which they have taken or propose to take involves a breach of duty, but they wish to have the protection of the general meeting’s sanction, how are they to satisfy the disclosure requirement?

7.

Recall the limits upon unanimous shareholder ratification where creditor interests are in jeopardy: Kinsela v Russell Kinsela Pty Ltd (in liq) [5.190]. Might a cogent case be made for the imposition of a prophylactic rule precluding any waiver of breach of duty or alternatively for a requirement of ratification by a disinterested majority? In Mason v Harris (1879) 11 Ch D 97 at 109, James LJ lamented that there was no procedure for submitting matters to the vote of independent shareholders only. Might the general meeting effectively release a director from civil or criminal liability under Pt 2D.1? See further, on the scope of the ratification power, S Kevans (1996) 18 Syd L Rev 110; S Fridman (1992) 10 C&SLJ 252; R Yeung (1992) 66 ALJ 343; R J C Partridge [1987] CLJ 122; R Baxt (1978) 5 Mon LR 16; S M Beck (1974) 52 Can Bar Rev 159 at 174-175.

8.

9. 10.

Where the general meeting is unwilling to sue and is controlled by the wrongdoers [8.40] Most of the cases on the misuse of majority power concern resolutions of the general

meeting. However, majorities may also abuse their powers by acquiescence or inaction. A principal instance arises where the majority unjustifiably refuse to allow an action to be brought in the name of the company to redress a wrong done to it by one of their number or by directors acting at their behest. 23 Where the majority will not permit the company to bring such an action, an individual shareholder might be permitted to sue to vindicate the 23

Peters’ American Delicacy Co Ltd v Heath (1939) 61 CLR 457 at 505. [8.40]

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company’s rights as one of the principal exceptions to the general bar on shareholders suits under the general law: see [8.80]. This exception has been supplanted by the statutory derivative action procedure: see [8.100]. Alterations of the company’s constitution that prejudice shareholder rights [8.45] A company’s constitution may be altered by special resolution; the alteration power is,

however, subject to compliance with any further requirements contained in the company’s constitution: see [3.145]. A major instance of challenges under the fraud upon the minority doctrine concerns resolutions for the alteration of company constitutions that prejudicially affect the rights of some members. Indeed, the classic formulation of Lindley MR in Allen v Gold Reefs of West Africa Ltd, 24 that powers of majorities must be exercised “bona fide for the benefit of the company as a whole”, was made in the context of reviewing an alteration to company articles. However, the difficulty under this and other formulations of the fraud doctrine is to distinguish between those alterations which are proper notwithstanding that they prejudice or even extinguish shareholder rights and those which offend the equitable limitation upon voting rights. Among the more egregious alterations which might be thought to engage the doctrine are those which introduce machinery for the appropriation of members’ shareholdings.

Peters’ American Delicacy Co Ltd v Heath [8.50] Peters’ American Delicacy Co Ltd v Heath (1939) 61 CLR 457 High Court of Australia [A company’s constitution contained (apparently as the result of faulty drafting) two inconsistent modes of making a bonus issue of shares. (Bonus shares are shares for whose issue no consideration is payable to the issuer: see [9.210].) First, art 108 provided that “[t]he profits of the company shall be divisible among the members in proportion to the capital paid up on the shares held by them respectively.” Further, art 120 provided that [n]otwithstanding anything in any other article the whole or any part of the undivided profits … may with the sanction of the company in general meeting be converted into capital of the company by distributing the same amongst the holders of shares as a special dividend or bonus by issuing partly or fully paid up shares in respect thereof to the holders of such shares in proportion to the shares held by them in the company … (emphases added). The company had been prosperous and there was general agreement that a distribution of profits should be made in the form of bonus shares. Special resolutions were passed which deleted art 120 and substituted other articles under which it would be possible to make a distribution of new shares in proportion to the amount of capital paid up on the shares held by members. The plaintiffs, holders of partly paid shares, opposed the resolutions. They argued that the resolutions were invalid on the ground that those who voted for them did so solely for the purpose of benefiting fully paid shareholders to the disadvantage of partly paid shareholders, and not in the interests of the company or the whole body of shareholders.] DIXON J: [507] The considerations which I have mentioned all arise in attempting to discover and fasten upon some element the presence of which will always vitiate a resolution for the alteration of articles of association. But, whatever may constitute bad faith, it is evident that, if a resolution is regularly passed with the single aim of advancing the interests of a company considered as a corporate whole, it must fall within the scope of the statutory power to alter the articles and could never be [508] condemned as mala fides. A positive test was therefore available, conformity with which necessarily spelt validity. … [511] If no restraint were laid upon the power of altering articles of association, it would be possible for a shareholder controlling the necessary voting power so to mould the regulations of a company that 24

[1900] 1 Ch 656 at 671: see [8.15].

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Peters’ American Delicacy Co Ltd v Heath cont. its operations would be conducted or its property used so that he would profit either in some other capacity than that of member of the company or, if as member, in a special and peculiar way inconsistent with conceptions of honesty so widely held or professed that departure from them is described, without further analysis, as fraud. For example, it would be possible to adopt articles requiring that the company should supply him with goods below cost or pay him 99% of its profits for some real or imaginary services or submit to his own determination the question whether he was liable to account to the company for secret profits as a director. The chief reason for denying an unlimited effect to widely expressed powers such as that of altering a company’s articles is the fear or knowledge that an apparently regular exercise of the power may in truth be but a means of securing some personal or particular gain, whether pecuniary or otherwise, which does not fairly arise out of the subjects dealt with by the power and is outside and even inconsistent with the contemplated objects of the power. It is to exclude the purpose of securing such ulterior special and particular advantages [512] that Lord Lindley used the phrase “bona fide for the benefit of the company as a whole”. The reference to “benefit as a whole” is but a very general expression negativing purposes foreign to the company’s operations, affairs and organisations. But unfortunately, as appears from the foregoing discussion, the use of the phrase has tended to cause misapprehension. If the challenged alteration relates to an article which does or may affect an individual, as, for instance, a director appointed for life or a shareholder whom it is desired to expropriate, or to an article affecting the mutual rights and liabilities inter se of shareholders or different classes or descriptions of shareholders, the very subject matter involves a conflict of interests and advantages. To say that the shareholders forming the majority must consider the advantage of the company as a whole in relation to such a question seems inappropriate, if not meaningless, and at all events starts an impossible inquiry. The “company as a whole” is a corporate entity consisting of all the shareholders. If the proposal put forward is for a revision of any of the articles regulating the rights inter se of shareholders or classes of shareholders, the primary question must be how conflicting interests are to be adjusted, and the adjustment is left by law to the determination of those whose interests conflict, subject, however, to the condition that the existing provision can be altered only by a three fourths majority. Whether the matter be voting rights, the basis of distributing profits, the basis of dividing surplus assets on a winding up, preferential rights in relation to profits or to surplus assets, or any other question affecting mutual interests, it is apparent that though the subject matter is among the most conspicuous of those governed by articles and therefore of those to which the statutory power is directed, yet it involves little if anything more than the redetermination of the rights and interests of those to whom the power is committed. No-one supposes that in voting each shareholder is to assume an inhuman altruism and consider only the intangible notion of the benefit of the vague abstraction called by Lord Robertson in Baily’s case (at 39) “the company as an institution”. An investigation of the thoughts and motives of each shareholder voting with the majority would be an impossible proceeding. … [513] In my opinion it was within the scope and purpose of the power of alteration for a three fourths majority to decide the basis of distributing shares issued for the purpose of capitalising accumulated profits or profits arising from the sale of goodwill, and in voting for the resolution shareholders were not bound to disregard their own interests. … In these circumstances it appears to me that the resolution involved no oppression, no appropriation of an unjust or reprehensible nature and did not imply any purpose outside the scope of the power.

Greenhalgh v Arderne Cinemas Ltd [8.55] Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286 Court of Appeal, England and Wales [The company’s constitution contained a provision prohibiting the sale of shares to non-members so long as any member was willing to purchase them at a fair price. A detailed pre-emption mechanism was specified. The defendant Mallard wished to sell his controlling interest in the company to an outsider. He procured the passage of a special resolution to alter the pre-emptive rights article by [8.55]

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Greenhalgh v Arderne Cinemas Ltd cont. adding the proviso that any member with the sanction of an ordinary resolution might transfer shares to a non-member. That resolution was followed by an ordinary resolution sanctioning the transfer of Mallard’s shares to the outsider. The plaintiff, a minority shareholder, challenged the resolutions as fraud on the minority.] EVERSHED MR: [290] The burden of the case is that the resolution was not passed bona fide and [291] in the interests of the company as a whole, and there are, as Mr Jennings [counsel for the plaintiff] has urged, two distinct approaches. The first line of attack is [that] this is a special resolution, and, on authority, Mr Jennings says, the validity of a special resolution depends upon the fact that those who passed it did so in good faith and for the benefit of the company as a whole. The cases to which Mr Jennings referred are Sidebottom v Kershaw Leese & Co Ltd [1920] 1 Ch 154, Peterson J’s decision in Dafen Tinplate Co Ltd v Llanelly Steel Co (1907) Ltd [1920] 2 Ch 124 and, finally, Shuttleworth v Cox Bros & Co (Maidenhead) Ltd [1927] 2 KB 9. Certain principles, I think, can be safely stated as emerging from those authorities. In the first place, I think it is now plain that “bona fide for the benefit of the company as a whole” means not two things but one thing. It means that the shareholder must proceed upon what, in his honest opinion, is for the benefit of the company as a whole. The second thing is that the phrase, “the company as a whole”, does not (at any rate in such a case as the present) mean the company as a commercial entity, distinct from the corporators: it means the corporators as a general body. That is to say, the case may be taken of an individual hypothetical member and it may be asked whether what is proposed is, in the honest opinion of those who voted in its favour, for that person’s benefit. I think that the matter can, in practice, be more accurately and precisely stated by looking at the converse and by saying that a special resolution of this kind would be liable to be impeached if the effect of it were to discriminate between the majority shareholders and the minority shareholders, so as to give to the former an advantage of which the latter were deprived. When the cases are examined in which the resolution has been successfully attacked, it is on that ground. It is therefore not necessary to require that persons voting for a special resolution should, so to speak, dissociate themselves altogether from their own prospects and consider whether what is thought to be for the benefit of the company as a going concern. If, as commonly happens, an outside person makes an offer to buy all the shares, prima facie, if the corporators think it a fair offer and vote in favour of the resolution, it is no ground for impeaching the resolution that they are considering their own position as individuals. Accepting that, as I think he did, Mr Jennings said, in effect, that there are still grounds for impeaching this resolution. … second, because it prejudiced [292] the plaintiff and minority shareholders in that it deprived them of the right which, under the subsisting articles, they would have of buying the shares of the majority if the latter desired to dispose of them. … As to the second point, I felt at one time sympathy for the plaintiff’s argument, because, after all, as the articles stood he could have said: “Before you go selling to the purchaser you have to offer your shares to the existing shareholders, and that will enable me, if I feel so disposed, to buy, in effect, the whole of the shareholding of the Arderne company.” I think that the answer is that when a man comes into a company, he is not entitled to assume that the articles will always remain in a particular form; and that, so long as the proposed alteration does not unfairly discriminate in the way which I have indicated, it is not an objection, provided that the resolution is passed bona fide, that the right to tender for the majority holding of shares would be lost by the lifting of the restriction. I do not think that it can be said that that is such a discrimination as falls within the scope of the principle which I have stated. [293] In my opinion, … this was, in substance, an offer by an outside man to buy the shares of this company at 6s a share from anybody who was willing to sell them. As commonly happens, the defendant Mallard, as the managing director of the company, negotiated and had to proceed on the footing that he had with him sufficient support to make the negotiation a reality. That was the substance of what was suggested. It discriminated between no types of shareholder. Any who wanted to get out at that price could get out, and any who preferred to stay in could stay in.

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Greenhalgh v Arderne Cinemas Ltd cont. That being the substance of the thing, and the evidence, to my mind, clearly suggesting that 6s a share (allowing for the privilege of control) was a fair price, I can see no ground for [294] saying that this resolution can be impeached. [Asquith and Jenkins LJJ agreed.]

Australian Fixed Trusts Pty Ltd v Clyde Industries Ltd [8.60] Australian Fixed Trusts Pty Ltd v Clyde Industries Ltd (1959) 59 SR (NSW) 33 Supreme Court of New South Wales [The directors of the defendant company gave notice of an extraordinary general meeting to consider a proposal to alter the company’s constitution by disenfranchising any member who held shares as trustee under a publicly held unit trust (a custodian trustee). Such a member might not vote unless and until it had received the direction of a majority of unit holders as to the manner in which the shares were to be voted. The plaintiffs sued, as members of the company, to restrain the proposed alteration. The case appears to represent an early instance of management apprehension at the emergence of institutional investors on a company’s share register.] McLELLAND J: [58] The inference I draw from [the evidence] … is that although it is possible that a custodian trustee could obtain a majority direction in time it is more probable than not that in many cases it would be unable to do so. Putting the matter another way I think that a custodian trustee could never feel reasonably sure that it could get a majority direction within time. … [Further] I am satisfied, so far as it may be relevant that the cost to a custodian trustee of endeavouring to obtain a direction from a holder would be a substantial one. The conclusion I have arrived at is, that if the right of a shareholder custodian trustee to vote has not been in substance taken away, and I rather think it has, such right has been greatly reduced in effectiveness. In so far as the right has been rendered less effective, the right to vote of the other shareholders has been rendered more effective and valuable. … [60] No evidence has been given by any person who sponsored or supported the article. … I approach the problem on the basis that the plaintiffs and each of them are responsible and reputable companies and that there is nothing to suggest that they will not continue to remain such. The proposed [disenfranchising article] was one of a new set of articles recommended to the shareholders by the directors as “advisable for the efficient administration of the company” and according to the directors who sought its adoption it was drafted with the intention of ensuring that the beneficial holders of shares in your company (holders of units in unit trusts) shall control the voting power of the shares in which they are the real owners. Your directors believe this to be a matter of vital importance and an expression of democratic principle. Counsel for the defendants stated that the basic principle of the article, and I assume that by this he meant basic purpose, was that the affairs of the company should be in the hands of those who have a financial stake in the company and should not be in the hands of, or capable of influence by, those who have no such financial stake and who are irresponsible in the exercise of the vote; that is, not responsible and accountable to those who have a financial stake in the company in any respect. But assuming that the article will in fact enable a vote at times to be recorded by custodian trustee shareholders it does not in my opinion carry out the purpose stated by the directors or by counsel, for it is confined in its operation to only one class of shareholder falling within the stated purpose. Why was it so confined? How was it for the company’s benefit that the voting right of this class of shareholder only should be controlled? There is no evidence before me that the features referred to by counsel were in fact those that the persons who sponsored or supported the article had in mind. But even if there were I am not able to [8.60]

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Australian Fixed Trusts Pty Ltd v Clyde Industries Ltd cont. discern a reasonable connection for “a company purpose” between their existence and the restriction of the operation of the article to one class of shareholder. It may be that further evidence would have disclosed the connection but I am confined to the evidence before me. If there be discrimination and nothing reasonably to explain it, I think the inference is open that the purpose of the article was not “a company purpose” and in the absence of explanatory evidence coming from the side best able to produce it I draw the inference that the purpose of the article was not “a company purpose”. I am of opinion that the effect of the article is to discriminate between the majority shareholders and the minority shareholders so as to give the former an advantage of which the latter are deprived. It would perhaps be more accurate to say that the majority shareholders have been left with [61] an advantage of which the minority shareholders were deprived but this would not be any different in principle and in one sense since, any affectation of the rights of the minority shareholders results in a benefit to the majority, the majority have been given an advantage of which the minority have been deprived. I have come to the conclusion that there are no grounds upon which reasonable men could decide that the article confined in its terms to the plaintiff shareholders was for the benefit of the company as a whole. I am of opinion that the majority shareholders no doubt with the best motives have not considered the matters which they ought to have considered.

Notes&Questions

[8.63]

1.

2.

3.

4.

596

In Peters’ case at 505, Dixon J said that “the ground upon which the invalidity is placed is fraud, but what amounts to fraud has not been made the subject of definition”. Notwithstanding judicial reluctance to define the vitiating element, the above cases contain several formulations of this element. These formulations need not, it seems, be mutually exclusive or exhaustive. What tests do you discern in the cases? Do the formulations identified in the following paragraphs accurately reflect the principles expressed in the cases? In Peters’ case at 507-508 Dixon J proposes as a “positive” test of validity the formulation that “if a resolution is regularly passed with the single aim of advancing the interests of a company considered as a corporate whole, it … could never be condemned as mala fides”. How is this test applied in the above cases? What is the “corporate whole” and how is the “single purpose” of the resolution to be determined? A second approach describes invalidity in terms of the prejudicial effect of the resolution upon minority rights. While mere prejudice itself does not betoken invalidity, the purpose animating the resolution “must not be simply the enrichment of the majority at the expense of the minority”: Peters’ case at 495 per Rich J. Alternatively, the alteration must not “sacrifice the interests of the minority to those of a majority without any reasonable prospect of advantage to the company as a whole”: at 504 per Dixon J (see also his reference at 513 to the absence of any “appropriation of an unjust or reprehensible nature”). A third formulation is that adopted by Bankes LJ in Shuttleworth v Cox Bros & Co (Maidenhead) Ltd [1927] 2 KB 9 at 18: “The alteration may be so oppressive as to cast suspicion on the honesty of the persons responsible for it, or so extravagant that no reasonable men could really consider it for the benefit of the company.” Is this test among those applied in Australian Fixed Trusts Pty Ltd v Clyde Industries Ltd [8.60] at 61? [8.63]

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5.

A fourth formulation is the “individual hypothetical member” test proposed by Evershed MR in Greenhalgh v Arderne Cinemas Ltd at 291. With what characteristics will the hypothetical member be invested? How might the test have been applied to the facts of Greenhalgh’s case itself? What regard (if any) does the test require shareholders to have for the claims of the company as a financial or commercial institution, or for the claims of future shareholders: cf Gaiman v National Association for Mental Health [7.310]? How might this formulation be applied where shareholder interests are balkanised into two or more hostile groups?

6.

In Clemens v Clemens Bros Ltd [1976] 2 All ER 268 shares in a family company were held by the aunt (as to 55% of the equity) and her niece (the remaining 45%). Under the articles, power to issue shares was vested in the general meeting which by ordinary resolution diluted the niece’s interest to below 25% by a share issue to employees of the company. This reduction effectively denied her a veto of any corporate act requiring a special resolution and diminished her pre-emptive rights under the articles. The niece challenged the validity of the share issue. Foster J thought that the individual hypothetical member test should be applied by asking (at 281) whether the aunt, “when voting for the resolutions, honestly believe[d] that these resolutions, when passed, would be for the benefit of the [niece]”? In the event, however, the judge decided the issue by reference to other criteria. He said (at 282): I think that one thing which emerges from the cases … is that … [the aunt] is not entitled to exercise her majority vote in whatever way she pleases. The difficulty is in finding a principle, and obviously expressions such as “bona fide for the benefit of the company as a whole”, “fraud on a minority” and “oppressive” do not assist in formulating a principle … [I]t would be unwise to try to produce a principle, since the circumstances of each case are infinitely varied … [The aunt’s right to vote] is “subject … to equitable considerations which may make it unjust … to exercise [it] in a particular way”.

(The quoted words are from Ebrahimi v Westbourne Galleries Ltd [8.155].) The judge concluded (at 282) that the resolutions have been so framed as to put in the hands of [the aunt] and her fellow directors complete control of the company and to deprive the [niece] of her existing rights as a shareholder with more than 25% of the votes and greatly reduce her rights under [the pre-emption article]. They were accordingly set aside. 7.

8.

A fifth test was proposed by Evershed MR in Greenhalgh v Arderne Cinemas Ltd at 291 in terms of the discriminatory effect of the challenged resolution. What meaning was given to it in Greenhalgh’s case itself? Specifically, why was the contested alteration not found to be discriminatory, both in form and substance, in favour of any majority shareholding group or individual in the company? Would the alteration have been valid if it had been expressly confined to exempting the particular transfer of Mallard’s shareholding to the outsider? Is the discrimination test really directed towards the burden of explanation as to the company purpose or benefit secured by the resolution? On this question see the Australian Fixed Trusts case at 60. In Crumpton v Morrine Hall Pty Ltd [1965] NSWR 240 at 244 Jacobs J said that the “weightiness of the reasons may depend on the degree of interference with the [shareholder] rights”. A sixth formulation was expressed by Dixon J in Peters’ case at 511-513 and applied by McLelland J in the Australian Fixed Trusts case at 60-61. Dixon J explained the reference to “the benefit of the company” in Lord Lindley’s phrase in Allen v Gold Reefs of West Africa as “but a very general expression negativing purposes foreign to [8.63]

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9.

10.

the company’s operations, affairs and organisations”. He concluded that the instant resolution “did not imply any purpose outside the scope of the power”: at 513. In the Australian Fixed Trusts case McLelland J was, however, unable “to discern a reasonable connection for ‘a company purpose’ between their existence and the restrictions of the operation of the article to one class of shareholder”: at 60. Is this purpose limitation related, in juridical basis and scope, to the proper purpose doctrine applying to directors: see [7.235]? How is the purpose of a shareholders’ resolution to be determined? See Dixon J in Peters’ case at 512-513. The alteration may also be challenged upon the ground that it was procured or affected by misleading statements or material non-disclosure to the meeting which passed it. Indeed, the increasing frequency with which resolutions have been challenged upon this doctrinal basis is noted at [6.95]. See further E J Boros, Minority Shareholders’ Remedies (1995), pp 298-305; S Lo (2004) 16 Aust Jnl of Corp Law 96; J H Farrar, “The Duties of Controlling Shareholders” in J H Farrar (ed), Contemporary Issues in Company Law (1987), p 185; G Coleman (1989) 15 Can Bus LJ 1; J G McIntosh (1989) 15 Can Bus LJ 276; J G MacIntosh (1989) 27 Osgoode Hall LJ 561; F G Rixon (1986) 49 MLR 446; L S Sealy, “Equitable and Other Fetters on the Shareholder’s Freedom to Vote” in N E Eastham & B Kirvy (eds), The Cambridge Lectures 1981, p 80; P G Xuereb (1985) 6 Co Law 199 and (1987) 8 Co Law 16; B A K Rider [1978] CLJ 270; M J Trebilcock (1967) 31 Conv 95. For a comparative study of techniques for eliminating minority interests other than through alteration of rights in company constitutions, see Q Digby (1992) 10 C&SLJ 105.

Gambotto v WCP Ltd [8.65] Gambotto v WCP Ltd (1995) 182 CLR 432 High Court of Australia [The capital of WCP Ltd was held as to 99.7% by wholly owned subsidiaries of Industrial Equity Ltd (IEL). Their shareholding in WCP was such that IEL and its associates could not have acquired the minority shares compulsorily under the then modes of compulsory acquisition in the Act. The articles of association of WCP were altered by inserting art 20A which provision permitted the majority shareholders to acquire within a specified period any shares to which they were not entitled at a price of $1.80 per share. The resolution to introduce art 20A was unanimously supported by the minority shareholders other than the appellants who did not attend the meeting or vote upon the resolution by proxy. A report accompanying the notice of meeting valued the minority shares at $1.365. The appellants conceded that the valuation was a fair and independent one; it did not, however, take into account income tax benefits of $4 million which would accrue to WCP when it was able to group tax losses after elimination of minority shareholdings. The appellants held almost 0.01% of the shares and wished to retain their shares. They challenged the alteration which introduced art 20A. The court reviewed the authorities on equitable limitations on the alteration of company constitutions.] MASON CJ, BRENNAN, DEANE and DAWSON JJ: [444] The foregoing analysis of the authorities reveals that the courts have struggled to strike a balance between the interests of the majority and the minority. On the one hand, the courts have recognized that the proprietary rights attaching to shares are subject to modification, even destruction, by a special resolution altering the articles and that the power to vote is exercisable by a shareholder to his or her own advantage. On the other hand, the courts have acknowledged that the power to alter the articles should not be exercised simply for the purpose of securing some personal gain which does not arise out of the contemplated objects of the power. The problem of stating a workable criterion arises, as Dixon J said in Peters (1939) 61 CLR, at p 507, “in attempting to discover and fasten upon some element the presence of which will always vitiate a resolution for the alteration of articles of association”. 598

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Gambotto v WCP Ltd cont. The test for determining whether an expropriation is valid In the context of a special resolution altering the articles and giving rise to a conflict of interests and advantages, whether or not it involves an expropriation of shares, we would reject as inappropriate the “bona fide for the benefit of the company as a whole” test of Lindley MR in Allen v Gold Reefs of West Africa Ltd. The application of the test in such a context has been criticized on grounds which, in our view, are unanswerable. It seems to us that, in such a case not involving an actual or effective expropriation of shares or of valuable proprietary rights attaching to shares, an alteration of the articles by special resolution regularly passed will be valid unless it is ultra vires, beyond any purpose contemplated by the articles or oppressive as that expression is understood in the law relating to corporations. Somewhat different considerations apply, however, in a case such as the present where what is involved is an alteration of the articles to allow an expropriation by the majority of [445] the shares, or of valuable proprietary rights attaching to the shares, of a minority. In such a case, the immediate purpose of the resolution is to confer upon the majority shareholder or shareholders power to acquire compulsorily the property of the minority shareholder or shareholders. Of itself, the conferral of such a power does not lie within the “contemplated objects of the power” to amend the articles: Peters, at p 511. The exercise of a power conferred by a company’s constitution enabling the majority shareholders to expropriate the minority’s shareholding for the purpose of aggrandizing the majority is valid if and only to the extent that the relevant provisions of the company’s constitution so provide. The inclusion of such a power in a company’s constitution at its incorporation is one thing. But it is another thing when a company’s constitution is sought to be amended by an alteration of articles of association so as to confer upon the majority power to expropriate the shares of a minority. Such a power could not be taken or exercised simply for the purpose of aggrandizing the majority: In re Bugle Press Ltd, [1961] Ch, at pp 286-287, 287-288. In our view, such a power can be taken only if (i) it is exercisable for a proper purpose and (ii) its exercise will not operate oppressively in relation to minority shareholders. In other words, an expropriation may be justified where it is reasonably apprehended that the continued shareholding of the minority is detrimental to the company, its undertaking or the conduct of its affairs – resulting in detriment to the interests of the existing shareholders generally – and expropriation is a reasonable means of eliminating or mitigating that detriment. Accordingly, if it appears that the substantial purpose of the alteration is to secure the company from significant detriment or harm, the alteration would be valid if it is not oppressive to the minority shareholders. So, expropriation would be justified in the case of a shareholder who is competing with the company, as was the case in Sidebottom v Kershaw, Leese & Co [1920] 1 Ch 154, so long as the terms of expropriation are not oppressive. Again, expropriation of a minority shareholder could be justified if it were necessary in order to ensure that the company could continue to comply with a regulatory regime governing the principal business which it carries on. To take a hypothetical example: if the conduct of a television station were the undertaking of a company and a renewal of a television licence under a statute depended upon the licensee’s [446] entire share capital being held by Australian residents, the expropriation of foreign shareholders who are unwilling to sell their shares to Australian residents might be justified assuming it is fair in all the circumstances. But that is not to say that the majority can expropriate the minority merely in order to secure for themselves the benefit of a corporate structure that can derive some new commercial advantage by virtue of the expropriation. Notwithstanding that a shareholder’s membership of a company is subject to alterations of the articles which may affect the rights attaching to the shareholder’s shares and the value of those shares, we do not consider that, in the case of an alteration to the articles authorizing the expropriation of shares, it is a sufficient justification of an expropriation that the expropriation, being fair, will advance the interests of the company as a legal and commercial entity or those of the majority, albeit the great majority, of corporators. This approach does not attach sufficient weight to the proprietary nature of a share and, to the extent that English authority might appear to support such an approach, we do not agree with it. It is only right that exceptional circumstances should be required to justify an amendment to the articles authorizing the compulsory expropriation by the majority of the minority’s interests in a company. To allow expropriation where it would advance the interests of the company as [8.65]

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Gambotto v WCP Ltd cont. a legal and commercial entity or those of the general body of corporators would, in our view, be tantamount to permitting expropriation by the majority for the purpose of some personal gain and thus be made for an improper purpose: Brown v British Abrasive Wheel Co, [1919] 1 Ch, at pp 295-296. It would open the way to circumventing the protection which the Corporations Act gives to minorities who resist compromises, amalgamations and reconstructions, schemes of arrangement and takeover offers. As noted in the preceding paragraphs, an alteration to the company’s articles permitting the expropriation of shares will not be valid simply because it was made for a proper purpose; it must also be fair in the circumstances. Fairness in this context has both procedural and substantive elements. The first element, that the process used to expropriate must be fair, requires the majority shareholders to disclose all relevant information leading up to the alteration (Re John Labatt Ltd (1959) 20 DLR (2d) 159, at p 163) and it presumably requires the shares to be valued by an independent expert. Whether it also requires the majority shareholders to refrain from voting on the proposed amendment is a question that is best left open at this stage. [447] The second element, that the terms of the expropriation itself must be fair, is largely concerned with the price offered for the shares. Thus, an expropriation at less than market value is prima facie unfair (Nova Scotia Trust Co v Rudderham (1969), 1 NSR (2d) 379, at p 398; but cf Phillips v Manufacturers’ Securities Ltd (1917), 116 LT 290), and it would be unusual for a court to be satisfied that a price substantially above market value was not a fair value: Re Sheldon; Re Whitcoulls Group Ltd (1987) 3 NZCLC 100,058 at p 100,060. That said, it is important to emphasize that a shareholder’s interest cannot be valued solely by the current market value of the shares: Weinberger v UOP Inc (1983), 457 A 2d 701. Whether the price offered is fair depends on a variety of factors, including assets, market value, dividends, and the nature of the corporation and its likely future: ibid, at p 711. Onus The respondents’ submissions, which are based heavily on Peters, are premised on the proposition that an alteration allowing an expropriation is prima facie valid. It is conceded that the suggested presumption of validity will be rebutted if the minority shareholder proves either that the alteration was made for an improper purpose or that it is oppressive to that particular shareholder. Nonetheless, the respondents’ approach, which forces the minority shareholder to shoulder a heavy onus of proof, tilts the balance too far in favour of commercial expediency and fails to attach sufficient weight to the proprietary nature of a share. A share is liable to modification or destruction in appropriate circumstances (Peters (1939), 61 CLR, at p 507, per Dixon J), but is more than a “capitalized dividend stream” (but cf Sanford v Sanford Courier Service Pty Ltd (1986), 10 ACLR 549, at p 563; Re Shoppers City Ltd and M Loeb Ltd, [1969] 1 OR 449, at p 454): it is a form of investment that confers proprietary rights on the investor. Accordingly, in the case of expropriation, we consider that the onus lies on those supporting expropriation to show that the power is validly exercised. It is for the majority to prove that the alteration is valid because it was made for a proper purpose and is fair in all the circumstances. This approach ensures that the application of the relevant principle does not unduly favour the majority and it largely alleviates the sting of practical difficulties, such as poor access to information, that would otherwise confront minority shareholders. [448] The validity of art 20A As the appellants did not contend that the expropriation was not fair in the sense explained above, the validity of art 20A hinges on whether the respondents have proved that the amendment was not made for a proper purpose. The immediate purpose of the amendment was to allow the expropriation by the majority shareholder of the shares held by the minority, including the shares held by the appellants. There is no suggestion that the appellants’ continued presence as members puts WCP’s business activities at risk or that the appellants have in some way acted to WCP’s detriment. Nor is there any suggestion that WCP sought 100% ownership in order to comply with a regulatory regime. All that is suggested is that taxation advantages and administrative benefits would flow to WCP if minority shareholdings were expropriated and WCP were to become a wholly-owned subsidiary of IEL. In our view, however, that cannot by itself constitute a proper purpose for a resolution altering the 600

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Gambotto v WCP Ltd cont. articles to allow for the expropriation of a minority shareholder’s shares. In that regard, it is not irrelevant to note that it is difficult to conceive of circumstances in which financial and administrative benefits would not be a consequence of the expropriation of minority shareholdings by a majority shareholder. Accordingly, we would hold art 20A invalid and ineffective on the basis that it was not made for a proper purpose. [The remaining judge, McHugh J, held that the expropriation power was validly inserted into the articles provided that it was necessary to protect or promote the interests of the company and the alteration was not oppressive to the shareholders against whom it was exercisable. He differed from the joint judges both with respect to the content of the purpose constraint to which the alteration power is subject and in the application of the oppression element. McHugh J held that an alteration effecting the compulsory acquisition of shares is valid “only when it will enable the company to pursue some significant goal, or to protect itself from some action, that is external to the company. Administrative convenience or cost, for example, could never by itself justify an alteration for the purpose of expropriation”: at 455. He considered that the business objective underlying the alteration was proper since it “would enable the company to save over $4 million in taxes”: at 459. Accordingly, there was sufficient justification for the expropriation of each member’s shares provided that the expropriation was otherwise fair to that member. McHugh J held that the concept of fairness has two basic aspects: fair dealing and fair price. Prima facie the fair price requirement is satisfied by setting compensation for the expropriated securities which accords with their market value; market price is not, however, decisive of fairness which must take account of “numerous factors” including the assets of the company, market value, the company’s earnings and future prospects, and any other elements that affect the intrinsic or inherent value of the security. Consideration of these factors might lead to the conclusion that the market price, or a higher price, is not the fair price of the shares. The fair dealing aspect embraces questions of timing of the expropriation, how it was structured, initiated, negotiated and disclosed, and how approvals to the transactions by directors and other shareholders were obtained. McHugh J said that “in the forefront” of the requirement of fair dealing is “the necessity for the majority shareholders through the company to make a full disclosure of all matters that may affect a judgment as to the fairness of the proposed alteration”; these matters will “usually” require disclosure of the purpose of transaction, full reasons for rejecting alternative means of achieving that purpose, justification of the fairness of the compensation offered, and an independent valuation of the expropriated interests. Further, in “most cases” full disclosure will also require disclosure of information concerning the current and historical stock market prices of the shares where they are applicable, the net book value of the assets and the value of the company, both as a going concern and on a liquidation, any reports and valuations prepared in relation to the alteration, and any firm offers for, or serious inquiries about the purchase of, the assets of the company. McHugh J held that the company had failed to prove that the expropriation was not oppressive. While the price stipulated “may well have been a fair price for the shares … almost no attempt was made to make the full disclosure that is required in this class of case”; accordingly, he concluded that the “evidence falls short of proving that WCP and the majority shareholders have dealt with each appellant fairly”: at 459-460.]

[8.67]

1.

Notes&Questions Following Gambotto (although not necessarily in consequence of it), the Act was amended to introduce the power of compulsory acquisition contained in Pt 6A.2 Div 1. A person who either holds full beneficial ownership in 90% of securities of a class or has 90% of the voting power in the company may compulsorily acquire the remainder of the shares of the class: s 664A. The power must, however, be exercised within six months of satisfying either of the 90% control tests: s 664AA. The acquisition may be [8.67]

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challenged by court proceedings only for failure to pay fair value for the securities; the onus of establishing such fairness lies with the acquirer: s 664F. A person who, either alone or with a related company, holds full beneficial ownership of all the securities of a class may compulsorily acquire securities that are convertible into securities of that class: s 665A. This power secures total ownership and may be combined with exercise of the power of compulsory acquisition in Pt 6A 2 Div 1. In many instances the division of share capital into separate classes will attract the protection of Pt 2F.2 with respect to alteration of the rights of their holders, requiring separate approval by special resolution by members of the class affected. This provision is considered at [9.105].

2.

3.

See further I M Ramsay & B B Saunders (2011) 25 Aust Jnl of Corp Law 112 (placing Gambotto in the broader political context of the role of the High Court at the time of the decision, a time of unprecedented judicial activism, and subsequent restricted application of the decision); H Bird (1998) 22 Melb U L Rev 131; P Spender (1998) 22 Melb U L Rev 96; I M Ramsay (ed), Gambotto v WCP Ltd: Its Implications for Corporate Regulation (Centre for Corporate Law and Securities Regulation, University of Melbourne; 1996); R Walton (2000) 12 Aust Jnl of Corp Law 20; A Colla (2001) 19 C&SLJ 7; A Colla (2002) 20 C&SLJ 318; N Calleja (2002) 20 C&SLJ 236.

[8.68]

Review Problems

1. A company has a single class of shares. The company’s constitution provides that while Mary, appointed as Governing Director under the constitution, holds shares in the company she may unilaterally vary the voting rights attached to other shares in the company. By direction made in accordance with the terms of this provision, Mary directs that the voting power of the capital held by her children shall be increased by a factor of 1.5. To compensate other shareholders for their loss of voting power, she also directs that the financial participation rights (viz, to dividends and capital return) of those other shareholders shall be proportionately increased. May they invoke the doctrines discussed in Gambotto and Peters’ case to contest this alteration of their voting rights? Would it make any difference if the alteration were effected by formal alteration of the constitution? 2. The directors of a company issue a significant block of shares. This has the effect of frustrating a takeover offer that the directors consider not to be in the company’s interest. They decide that their action should be considered by shareholders. They issue notices convening a general meeting at which two resolutions will be proposed. The first, proposed as an ordinary resolution, is to “confirm and adopt” the resolution of the board to issue shares; the second, proposed as a special resolution, is to alter the articles by inserting a new provision giving the chair of the meeting power to direct that votes cast in respect of shares in the company shall be disregarded if the board has formed the opinion, after proper investigation, that those shares are beneficially owned by a foreign corporation whose membership of the company they consider not to be in the interests of the company. If these two resolutions should be passed with the necessary majorities, would they be valid exercises of power?

SHAREHOLDER REMEDIES: HISTORICAL CONTEXT The functions of shareholder suits [8.70] The second means of protecting shareholders, especially minority shareholders, is

through the provision of legal remedies against directors and controllers, especially the grant 602

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of rights to sue derivatively for wrongs done to the company. The power to litigate in the company’s interest rests with the board of directors and is discussed at [5.105]. To permit shareholders to litigate on behalf of the company necessarily involves intrusion in the internal management of the company. The shareholder suit undercuts corporate law’s general disposition towards assuring management vigour through security of tenure and independence from external review. The justification for doing so lies in the accountability gains from judicial scrutiny and the elaboration of legal rules that clarify the scope of permitted management and controller conduct. Shareholder litigation rights are but part of the mosaic of measures that address the divergence of interest between directors, managers and controllers, on the one hand, and shareholders, on the other, and seek to make managers accountable to shareholders. Shareholder suits enable the shareholder to secure judicial intervention in company affairs in circumstances where the self-interest of managers and controllers might be expected to lead them to avoid the prospect of judicial scrutiny through corporate litigation. In the publicly-held company shareholder remedies are efficient in that they do not depend upon the ability of widely dispersed shareholders to take co-ordinated action, for example, through the mobilisation of votes through proxy solicitation. Relative to market disciplines, shareholder litigation is also a particularly efficient way of deterring opportunistic behaviour by managers, particularly “one shot” killings that the market cannot sanction effectively (typically, where the gains are such that the fraudulent manager withdraws from the employment market). 25 Shareholder litigation is not a substitute for regulatory enforcement but its natural complement. Resource limits necessarily constrain agency enforcement and dictate priority preferences that may not match those of shareholders. There are natural limits to shareholder litigation as a governance device. While problems confronting collective action apply throughout corporate law, possibly their greatest impact is in the disincentives against suit that face shareholders in the publicly held company. The shareholder assumes the whole of the financial and other risks involved in bringing the suit but shares the benefits of a successful suit with other shareholders who “free ride” upon her or his efforts. Apathy is not less rational here than in other domains of corporate governance. The United States derivative suit procedure addresses this utility disincentive by allowing the plaintiff’s attorney, a specialist in this form of litigation, to assume the risk of the suit and have the first and relatively more generous claim upon its proceeds. This system conversely offers incentives for unmeritorious actions that are undertaken for their nuisance or settlement value. In particular, there is the risk of collusive settlement of the claim in which advocacy of the corporate interest is compromised by the attorney’s own self-interest. 26 Under both systems, the threat of shareholder suit may also inhibit managers from taking risks and affect recruitment to company boards. These negative considerations apply with less force in relation to the personal or individual action undertaken by the shareholder to vindicate a wrong to the shareholder personally. Such action, however, may have a lesser benefit for shareholders collectively. Both forms of shareholder action share deterrent as well as compensatory functions. Indeed, many argue that the deterrent function of shareholder suits is their primary justification. 27 25 26

27

J D Cox (1984) 52 Geo Wash L Rev 745. See American Law Institute, Principles of Corporate Governance: Analysis and Recommendations (Vol 2, 1994), pp 6-17, 204-221; J R Macey & G P Miller (1991) 58 U Chi L Rev 1 (economic analysis of the role of the plaintiff’s attorney in shareholder litigation). Macey & Miller assert that “[m]ost observers agree that strike suit litigation is relatively uncommon”: at 78. See, eg, J C Coffee & D E Schwartz (1981) 81 Colum L Rev 261. [8.70]

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The traditional bias against shareholder standing at general law [8.75] The boundaries of shareholder standing at general law were marked out by the rule in

Foss v Harbottle 28 which prevented shareholders from litigating in respect of wrongs characterised as done to the corporate entity rather than shareholders individually; shareholder suit was permitted only in narrowly drawn exceptional circumstances. In 2000, one of the principal exceptions, the general law derivative suit, was replaced with a statutory derivative action (see [8.100]); however, the other principal exception, permitting shareholder suit for wrongs that are characterised as personal, persists: see s 236 (note). The statutory derivative action procedure has displaced the derivative suit procedure at general law but not the personal action. 29 A distinct set of issues and procedures apply under the new statutory procedure, although necessarily it addresses common problems facing any system that needs to mark out a legitimate sphere for individual initiative in relation to group activity. However, since the interpretation of the new remedy will invariably be developed in light of the system that it replaces (in particular, its general bias against shareholder suit), an outline of the policy and broad structure of general law standing rules is essential to an understanding of the current system. The rule in Foss v Harbottle circumscribes the rights of individual shareholders to prosecute breaches of duty by directors and other officers, over-reaching by controlling shareholders, and, irregularities in the conduct of company affairs. The rule has two aspects, reflecting the hybrid nature of the registered company as a “partnership which has been invested with the character of incorporation”. 30 The proper plaintiff aspect recognises the separate personality of the corporation and requires that proceedings in respect of wrongs to the company be brought by the company in its own name. This aspect was emphasised in the decision in Foss v Harbottle itself, decided in 1843. A suit was brought by two shareholders against directors of a company incorporated by private Act of Parliament alleging that they had fraudulently misapplied company property. The suit was filed on behalf of themselves and all other members of the company except the directors. The court held that there was nothing in the constitution of the company (which made the directors the governing body subject to the superior control of the general meeting of members) to displace the prima facie principle that the corporation should sue in its own name and in its corporate character for the alleged wrong done to it. The suit might be brought by shareholders individually only if there was no internal machinery to supervise directors or if resort to it had proved ineffectual. That was not alleged in the instant case. 31 Four years later the rule was extended, in Mozley v Alston, 32 to a shareholder action to prevent strangers usurping the office of director. Since the company possessed the means of rectifying the dispute internally, it was held that only a suit in the corporate name should be 28

(1843) 2 Hare 461; 67 ER 189.

29

30 31

Although the rule in Foss v Harbottle (1843) 2 Hare 461 was a barrier to shareholder suit for enforcement of directors’ duties, this barrier was less formidable in Australia than in the United Kingdom. Before the introduction of the statutory derivative action in 2000, there were relatively few reported instances of the exclusionary rule against standing being invoked against shareholder litigation in Australia and, where the rule was considered by an Australian court, a more liberal attitude was applied to its operation. This liberality is evident also in greater willingness to recognise a personal shareholder right upon which standing might be founded notwithstanding Foss v Harbottle: see L S Sealy (1989) 10 Co Law 52 at 52-53 and Residues Treatment and Trading Co Ltd v Southern Resources Ltd (No 4) (1988) 14 ACLR 569. The rule in Foss v Harbottle continues to apply to some other corporate forms to which the statutory derivative action procedure under the Corporations Act is inapplicable, such as owner corporations under strata title legislation in New South Wales: Carre v Owners Corporation Strata Plan–SP 53020 (2003) 58 NSWLR 302; [2003] NSWSC 397. Australian Coal & Shale Employees’ Federation v Smith (1937) 38 SR (NSW) 48 at 53 per Jordan CJ. Foss v Harbottle (1843) 2 Hare 461; 67 ER 189.

32

(1847) 1 Ph 790; 41 ER 833.

604

[8.75]

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entertained. By the end of the 19th century this internal management aspect of the rule could be expressed by the Privy Council as “an elementary principle of the law relating to joint stock companies that the court will not interfere with the internal management of companies acting within their powers, and in fact has no jurisdiction to do so”. 33 The non-intervention principle, once established, was applied to a variety of corporate irregularities viewed as matters of internal management under the control of the majority. Examples were rife and notorious. Thus, shareholder complaints of improprieties in the conduct of company meetings, for example, over the refusal to call a poll as provided in the constitution 34 and the absence of a quorum at a directors’ meeting which summoned a general meeting, 35 being matters of internal management, were remitted to the internal forum where the majority ruled. The courts also invoked the principle as the basis for not intervening in corporate disputes over the appointment, removal and remuneration of directors and other officials. In disputes between shareholder groups, jurisdiction was denied in disputes concerning the making of calls, the payment of dividends, the setting up of reserves, the reduction of capital, the creation of new classes of shares and the issue of bonus shares. 36 By 1875 the rationale for the non-intervention principle was expressed thus in MacDougall v Gardiner: 37 In my opinion, if the thing complained of is a thing which in substance the majority of the company are entitled to do, or if something has been done irregularly which the majority of the company are entitled to do regularly, or if something has been done illegally which the majority of the company are entitled to do legally, there can be no use in having a litigation about it, the ultimate end of which is only that a meeting has to be called, and then ultimately the majority gets its wishes. Is it not better that the rule should be adhered to that if it is a thing which the majority are the masters of, the majority in substance shall be entitled to have their will followed?

Three quarters of a century later, in Edwards v Halliwell, 38 Jenkins LJ explained the relevance of ratification to standing and the relationship between the proper plaintiff and internal management aspects of the rule: if the alleged wrong is ratifiable, a minority shareholder may not sue since either (1) the majority will approve of the alleged wrong, in which case no wrong has been done to the company and no action can lie; or (2) if the majority opposes what has been done, there is no reason why action should not be brought by and in the name of the company itself. This explanation identifies the corporate will with that of the majority. This identification is consistent with the old corporation rule. It was made explicit in Foss v Harbottle and is reflected in judicial and professional opinion throughout the 19th century; it was, however, displaced with respect to the autonomy of board powers by the line of cases commencing with Automatic Self Cleansing Filter Syndicate v Cuninghame: see [5.125]. Another justification for the rule in Foss v Harbottle is more pragmatic. Thus, in 1873 it was said: 39 33 34

Burland v Earle [1902] AC 83 at 93 per Lord Davey. MacDougall v Gardiner (1875) 1 Ch D 13.

35 36 37 38

Browne v La Trinidad (1887) 37 Ch D 1. These examples are taken from S M Beck, “An Analysis of Foss v Harbottle” in J S Ziegel (ed), Studies in Canadian Company Law (1967), pp 556-557. (1875) 1 Ch D 13 at 25 per Mellish LJ. [1950] 2 All ER 1064 at 1066.

39

Gray v Lewis (1873) LR 8 Ch App 1035 at 1050-1 per James LJ. [8.75]

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Corporations and Financial Markets Law

One object of incorporating bodies of this kind was, in my opinion, to avoid the multiplicity of suits which might have arisen where one shareholder was allowed to file a bill on behalf of himself and a great number of other shareholders. The shareholder who first filed a bill might dismiss it, and if he was a poor man the defendant would be unable to obtain his costs, then another shareholder might file a bill, and so on. It was also stated to us in the course of the argument that even after the plaintiff had dismissed his bill against a particular defendant a fresh bill might be filed against the defendant so dismissed. Therefore there might be as many bills as there are shareholders multiplied into the number of defendants, The result would be fearful, and I think the defendant has a right to have the case made against him by the real body who are entitled to complain of what he has done.

The former derivative suit for fraud upon the minority [8.80] Under the traditional view the scope of the rule in Foss v Harbottle is marked out by the limits of the general meeting’s power of ratification. 40 Four exceptions have been identified where such ratification would be ineffective. The first arises where the persons against whom relief is sought hold and control the majority of voting shares in the company and will not permit an action to be brought against them in the company’s name. In Burland v Earle 41 Lord Davey explained the exception in these terms: In that case the courts allow the shareholders complaining to bring an action in their own names. This, however, is mere matter of procedure in order to give a remedy for a wrong which would otherwise escape redress, and it is obvious that in such an action the plaintiffs cannot have a larger right to relief than the company itself would have if it were plaintiff, and cannot complain of acts which are valid if done with the approval of the majority of the shareholders, or are capable of being confirmed by the majority. The cases in which the minority can maintain such an action are, therefore, confined to those in which the acts complained of are of a fraudulent character or beyond the powers of the company. A familiar example is where the majority are endeavouring directly or indirectly to appropriate to themselves money, property, or advantages which belong to the company, or in which the other shareholders are entitled to participate.

A derivative suit might be brought by a shareholder at general law where two elements were satisfied: 1. the persons against whom relief was sought controlled a majority of shares in the company and would not permit an action to be brought against them in the company’s name (the control requirement); and 2. the wrong complained of was incapable of cure by shareholder litigation (the fraud upon the minority requirement). The requirements of each element were gradually relaxed by judicial decision in the second half of the 20th century and the remedy was made more readily available. 42 The derivative suit for fraud upon the minority was replaced in its entirety from 2000 by a new statutory procedure: see [8.100].

40

41

The scope and variety of shareholder suits generally are discussed in K W Wedderburn (1957) CLJ 194 and (1958) CLJ 93; A J Boyle, “The Private Law Enforcement of Directors’ Duties” in K J Hopt & G Teubner (eds), Corporate Governance and Directors’ Liabilities (1985), p 261 and (1965) 28 MLR 317 (touching 19th century origins); D A Wishart (1984) 14 MULR 601; S M Beck (1974) 52 Can Bar Rev 159; C Baxter (1987) 38 NILQ 6; J G MacIntosh (1989) 27 Osgoode Hall LJ 561. [1902] AC 83 at 93.

42

See, with respect to the fraud requirement, Daniels v Daniels [1978] Ch 406 at 414 (a minority shareholder who has no other remedy may sue where directors use their powers, intentionally or unintentionally, fraudulently or negligently, in a manner which benefits themselves at the expense of the company) and, concerning the control requirement, Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1981] Ch

606

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Special majorities [8.85] A second exception to the exclusionary rule in Foss v Harbottle arises with respect to

corporate acts carried out by ordinary resolution but for which a special majority is prescribed by statute or the constitution. 43 To include such irregularities within the internal management principle would negate the statute or permit the de facto alteration of the constitution by a lesser majority than that required by the Act. Personal rights [8.90] Two further exceptions to the rule are frequently asserted by writers although neither is

strictly an exception to the rule but an instance of its inapplicability. The first concerns personal rights conferred upon members by statute or the constitution. Whereas the derivative suit vindicates a wrong done to the company by a third party (albeit, in many cases, an insider), the shareholder’s personal action lies in respect of wrongs done to the plaintiff. Until quite recently it has been assumed that rights within this category are “not even within the general ambit of the rule [in Foss v Harbottle]” 44 for they relate to matters which are “ultra vires the majority of the shareholders”. 45 It is extremely difficult to identify a principle underlying the myriad instances of personal rights held to lie outside the internal management aspect of the rule. Among the provisions in company constitutions which have been construed as creating personal rights of action are the right to vote, 46 to restrain persons not validly appointed directors from acting as such 47 and to enforce pre-emptive rights with respect to new share issues. 48 The difficulty of reconciling these personal rights with the internal management rule appears most starkly in the contrast between the decision to allow a personal action for the denial of voting rights 49 but to treat as a ratifiable corporate irregularity the denial of a shareholder’s right to call for a poll. 50 The scope of the rights enforceable by individual shareholder action is examined at [8.75]. Illegal and ultra vires acts [8.95] The fourth exception relates to corporate acts which are illegal 51 or beyond its

capacity. The scope of this exception is affected by the abolition of the ultra vires doctrine in relation to companies.

THE STATUTORY DERIVATIVE ACTION [8.100] Several law review committees recommended the introduction of a statutory

procedure to enable individual shareholders to commence proceedings on behalf of a company 257 at 324-325 (asking whether the persons against whom the action is brought on behalf of the company are able by any means of manipulation of their position in the company to ensure that the action is not brought by the company, adding that the means of manipulation should not be narrowly defined). 43 44

Baillie v Oriental Telephone and Electrical Co Ltd [1915] 1 Ch 503. Edwards v Halliwell [1950] 2 All ER 1064 at 1066 per Jenkins LJ.

45 46

Kaye v Croydon Tramways Co [1898] 1 Ch 358 at 375 per Vaughan Williams LJ. Pender v Lushington (1877) 6 Ch D 70.

47

Grant v John Grant & Sons Pty Ltd (1950) 82 CLR 1 at 35; Kraus v J G Lloyd Pty Ltd [1965] VR 232; Link Agricultural Pty Ltd v Shanahan (1998) 28 ACSR 498 at 505.

48 49 50

James v Buena Ventura Nitrate Grounds Syndicate Ltd [1896] 1 Ch 456. Pender v Lushington (1877) 6 Ch D 70. MacDougall v Gardiner (1875) 1 Ch D 13.

51

See, eg, Drown v Gaumont-British Picture Corp Ltd [1937] Ch 402 (restraining illegal payment of dividends). [8.100]

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Corporations and Financial Markets Law

where the company is unwilling or unable to litigate itself. 52 The proposals enacted as Pt 2F.1A of the Act in 2000 were justified upon the grounds of: • the uncertain scope of rights of standing at general law and the impediments they posed to shareholder derivative litigation notwithstanding recent liberalisation of standing rules; • promoting investor confidence; • uncertainty surrounding the effect upon the general law right to sue derivatively of purported ratification of conduct challenged in the action; and • the deterrent posed by the threat to the shareholder prosecuting the derivative action of having to bear the costs of the action, whether successful or not, while the benefit of the action accrues solely to the company whose cause of action it is that is being prosecuted. 53 Under the statutory procedure a person may bring proceedings on behalf of a company or intervene in proceedings to which it is a party if the person (a) is a member, former member, or entitled to be registered as a member, of the company or of a related company or an officer or former officer of the company 54; and (b)

has been granted leave under s 237: s 236(1).

Proceedings brought on behalf of a company must be brought in the company’s name: s 236(2). 55 The same conditions apply to intervening in proceedings to which the company is a party for the purpose of taking responsibility on behalf of the company for these proceedings or for a particular step (eg, settling them): s 236(1). The general law right to bring a derivative suit is abolished with the introduction of the statutory action: s 236(3). The proceedings might be brought in respect of a cause of action that a company has, for example, against an insider such as a director of the company for breach of duty to the company or against a third party for a breach of contract or for a tortious act. 56

52

53

54

55

Legal Committee of the Companies and Securities Advisory Committee, Report on a Statutory Derivative Action (1993); House of Representatives Standing Committee on Legal and Constitutional Affairs, Corporate Practices and the Rights of Shareholders (1991), Recommendation 26; Companies and Securities Law Review Committee, Enforcement of the Duties of Directors and Officers of a Company by means of a Statutory Derivative Action (Report No 12, 1990). Directors’ Duties and Corporate Governance (Corporate Law Economic Reform Program, Proposals for Reform: Paper No 3, 1997), pp 29-33. See further K B de Vere Stevens (1997) 25 ABLR 127; R Baxt (1994) 12 C&SLJ 178; J Kluver (1993) 11 C&SLJ 7; I Ramsay (1992) 15(1) UNSWLJ 149. The provisions substantially expand the field of potential prosecutors and intervenors since at general law only members might bring derivative proceedings on behalf of a company. Other proposals for a statutory derivative action would have expanded the field of applicants even further by including creditors of the company, ASIC, and any other person approved by the court: see, eg, Companies and Securities Law Review Committee, Enforcement of the Duties of Directors and Officers of a Company by means of a Statutory Derivative Action (Report No 12, 1990). The exclusion of ASIC is justified upon the grounds that the remedy repairs deficiencies in the general law standing regime to which ASIC was a stranger and that the action is “not intended to be regulatory in nature” but to facilitate private enforcement of rights: Corporate Law Economic Reform Program Bill 1998, Explanatory Memorandum, [6.30]. Former members are included because they may have been compelled to leave the company because of the underlying dispute; members of a related company are included because they may have been adversely affected and officers are included because they are likely to be the first to become aware of a right of action that is not being pursued by the company: [6.26]-[6.28]. In contrast, derivative proceedings at general law were commenced in the name of the shareholder initiating the suit with the company joined as nominal defendant to secure for it the benefit of orders made in the proceedings.

56

But see the rebuttable presumption that may arise in relation to an application to take proceedings against unrelated third parties: s 237(2), (3).

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The criteria for granting leave seeks to strike a balance between the need to provide an avenue for redress on behalf of a company which it is unable to obtain itself and the need to prevent actions that are vexatious or without merit. Thus, the Court must grant an application for leave if it is satisfied that: (a) it is probable that the company will not itself bring the proceedings, or properly take responsibility for them, or for the steps in them; 57 (b)

the applicant is acting in good faith; 58

(c)

it is in the best interests of the company that the applicant be granted leave; 59

(d)

if the applicant is applying for leave to bring proceedings – there is a serious question to be tried; and 60

57

In practice, the company’s response to the notice of intention to apply for leave under s 237(2)(e) would provide relevant evidence; the Explanatory Memorandum states that the applicant might also seek to address this criterion by demonstrating that the alleged wrongdoer has a dominant influence on the board of directors: [6.34]. Ratification by the general meeting would also be a relevant, but not decisive, consideration: s 239.

58

The requirement is intended to prevent proceedings being taken for the purposes of the applicant rather than those of the company. The court might also consider whether there has been any complicity by the applicant in the matters complained of: Explanatory Memorandum, [6.36]-[6.37]. This criterion casts the court in the role of assessing the relative costs and benefits to the company of the projected proceedings, to ensure that victory is not obtained at too great a cost: Explanatory Memorandum, [6.38]. In Prudential Assurance Co Ltd v Newman Industries Ltd (No 2) [1981] Ch 257, the trial judge declined to consider standing issues until the conclusion of the 70-day trial. The board stated at the outset that “it is a concern … that the company shall not be killed by kindness”. At day 34 of the hearing, counsel for the company withdrew, informing the court that the board had independently of the two defendant directors confirmed its view that any advantage to the company from the action was vastly outweighed by its resulting harm and adverse publicity. On appeal, damages were reduced to £45,000. Costs at first instance were unofficially estimated at £750,000. The “serious question to be tried” test is that applied by courts in considering applications for interim injunctions and is preferred to the prima facie test favoured by the Court of Appeal in the Prudential Assurance case; of course, it is more exacting than those formerly adopted by Australian courts at general law: [8.80]. For the interpretation of this requirement developed since 2000, see the discussion Oates v Consolidated Capital Services Ltd (2008) 66 ACSR 277. When the requirement was introduced in 2000 it was considered unnecessary as a condition of relief for the shareholders to have to bring the matter before a general meeting since an independent condition already requires the court to be satisfied that the company will not itself bring the proceedings or take responsibility for them: Explanatory Memorandum, [6.45][6.48]. The Explanatory Memorandum suggests that the serious question criterion would be difficult to establish unless the applicant shows that it had tried to gain the support of the company by at least attempting to convene a general meeting. A policy decision was also taken not to limit the remedy to situations where a dominant shareholder is affecting the interests of the company. Such situations are “already addressed in the majority of cases under the [statutory] oppression remedy, while the statutory derivative action is specifically designed to go beyond instances of strict oppression”: [6.48]. As regards the degree of specificity required of applicants, the judicial practice since 2000 is described thus in Ehsman v Nutectime International Pty Ltd (2006) 58 ACSR 705 at [43]-[44]: “Section 237 authorises the court to grant leave to permit a person to bring proceedings on behalf of a company. Part 2F.1A does not explain the word ‘proceedings’ or give any direct indication of the level of specificity of pleaded allegations and prayers for relief that the applicant for leave must achieve. Typically the applicant will provide the court with a draft statement of claim or (as here) points of claim, or some other document giving particulars of the derivative claims. But in my view it cannot be the case that a full statement of the derivative claims must be presented before the court can consider and determine a leave application. … In my opinion the applicant for leave must identify and describe the proposed proceedings with sufficient precision that the court can properly assess the application having regard to the criteria that it is required to consider under s 237(2), and the opponents can respond to the application in terms of those criteria. That may be achieved by presenting the court with a draft pleading, but it may be achieved in other ways such as by outlining the claims in affidavit evidence.”

59

60

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(e)

either at least 14 days before making the application, the applicant gave written notice to the company of intention to apply for leave and of the reasons for applying or it is appropriate to grant leave without such notice: s 237(2).

“A consequence of the conclusion that, if all five criteria be satisfied, leave must be granted, and that otherwise leave must be refused, is that the relevant considerations are limited to the five specified criteria.” 61 It is for the applicant to establish each of these criteria on the balance of probabilities. 62 If leave is granted under s 237 to bring proceedings, those proceedings must be derivative, that is, brought on behalf and in the interest of the company. 63 In Huang v Wang, Bathurst CJ said (authorities cited have been omitted): Section 237(2) provides for five criteria for the grant of leave. It is well established that, if these criteria are made out, the court is required to grant leave and conversely, if any one is not made out, the court should refuse leave. In Swansson v Pratt [extracted at [8.105]], Palmer J at [24] stated that leave should not be given lightly. He stated that the requirement of best interests requires the applicant to establish on the balance of probabilities that the action is in the best interests of the company, a fact which can only be determined by taking into account all relevant circumstances. That approach has been followed consistently … That is consistent with the words of s 237(2)(c) and recognises the serious nature of an order requiring a company to bring proceedings which it is unwilling to take itself. The appellants were correct in submitting that the best interests of the company means best interests in the sense of its separate and independent welfare. Best interests, at least assuming the company concerned is solvent, will predominantly reflect the interests of shareholders in that capacity. The fact that, in the present case, either Dr Huang or Dr Wang may derive some collateral benefit from the bringing or otherwise of the proceedings, in my view, is irrelevant. A question of some difficulty is whether, having concluded that there is a serious question to be tried, the court can again consider the question in determining whether it is in the best interests of the company to bring the proceedings. In Re Gladstone Pacific Nickel Ltd, 64 Ball J at [58] indicated it was necessary to consider the prospects of success. It must be remembered that an application under the section does not involve a consideration of the underlying merits of the proposed litigation, except to the extent it is necessary to determine if there is a serious question to be tried. Further, in cases where a court has doubts as to the prospects of success, a court can make an order conditional on the applicant undertaking to indemnify the company from any liability for costs which it may incur in pursuing the action. 65

There is a rebuttable presumption that granting leave is not in the best interests of the company if the company has decided not to bring or defend the proceedings with an unrelated third party 66 (or to discontinue or settle them) and all of the directors who participated in that decision satisfy the conditions of the business judgment rule: s 237(3). Underlying the presumption is the notion that decisions regarding transactions at arm’s length by the company are most appropriately made by its directors and that external interference in them is

61

Maher v Honeysett & Maher Electrical Contractors Pty Ltd [2005] NSWSC 859 at [13]; Oates v Consolidated Capital Services Pty Ltd (2009) 72 ACSR 506 at [71].

62 63

64

Cassegrain v Gerard Cassegrain & Co Pty Ltd [2008] NSWSC 976 at [69]. Oates v Consolidated Capital Services Pty Ltd (2009) 72 ACSR 506 at [55]-[65], rejecting the submission that, since s 237 contained no reference to “on behalf of a company”, its requirements are satisfied by an applicant within s 236(1) who establishes such of the five matters listed in s 237(2)(a)–(e) as are applicable to the particular application being made. (2011) 86 ACSR 432.

65

[2016] NSWCA 164 at [57], [59]-[60].

66

For purposes of s 237(3) a person is a third party if it is not a related party (as defined in s 228) of the company (and would not be if the company were a public company): s 237(4).

610

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generally not in the best interests of the company. 67 It may be that the proportion of participating to non-participating directors would be relevant in considering whether the presumption is displaced. The Court may substitute another member or former member or officer for a person to whom leave has been granted: s 238. Proceedings brought or intervened in with leave must not be discontinued or settled without the leave of the Court: s 240. This provision seeks to prevent collusive settlements in the applicant’s but not the company’s interests. The Court is given extensive powers to make orders and give directions in relation to the proceedings including an order appointing an independent person to investigate and report to the Court on the (a) financial affairs of the company (b)

facts giving rise to the cause of action or

(c)

costs incurred in the proceedings: s 241(1).

This person is entitled, on reasonable notice, to inspect any books of the company (defined in s 9) for any purpose connected with their appointment: s 241(2). The power may be used at the application stage or after leave is granted. It enables the Court to determine independently of the parties whether the complaint discloses a good cause of action and whether shareholder funds are being or would be reasonably spent on the proceedings. The Court may make costs orders as it thinks appropriate, including indemnification for costs: s 242. The discretion might be exercised in the light of the merits of the case as they unfold. Hence, the derivative prosecutor who brings an action ultimately judged to be frivolous will remain vulnerable to a costs order. Equally, the Court is at large in apportioning costs between the company and defendants, depending upon the outcome. We have noted the peculiar, inhibiting, imbalance between cost and benefit under the derivative action, with the prosecutor bearing the former but the latter accruing to the company. The practice under the statutory action has not ameliorated this problem: in the early years of the statutory remedy, no successful applicant for leave was granted an indemnity against costs from the company on whose behalf they had leave to sue. 68 On the contrary, judicial practice then was to grant leave only upon the basis that the applicant indemnify the company for costs arising from the derivative proceedings although some softening is evident in current practice. 69 Under the statutory procedure, ratification of conduct does not prevent a person from applying for leave to bring proceedings on behalf of a company or from bringing proceedings with leave; neither does ratification have the effect that an application for leave must be refused or proceedings brought with leave must be determined in favour of the defendant: s 239(1). If members ratify conduct, the Court may take that into account, having regard to (a) how well-informed about the conduct the members were in deciding whether to ratify; and 67

Corporate Law Economic Reform Program Bill 1998, Explanatory Memorandum, [6.4.1].

68

I M Ramsay & B Saunders, Litigation by Shareholders and Directors: An Empirical Study of the Statutory Derivative Action, Research Report (Centre for Corporate Law and Securities Regulation, 2006), p 35; Y Lim (2008) 26 C&SLJ 267 at 271, n 36.

69

Y Lim (2008) 26 C&SLJ 267 at 271; see, eg, Roach v Winnote Pty Ltd (2006) 57 ACSR 138 at [23]-[29] (“[m]easures of this kind are intended to protect the company’s financial resources and are merely part of the domestic arrangements within the company as to the basis on which the person concerned will be permitted to act”: at [29]); as to current practice, see, for example, the language of Bathurst CJ in Huang v Wang [2016] NSWCA 164 at [60] quoted above: “in cases where a court has doubts as to the prospects of success, a court can make an order conditional on the applicant undertaking to indemnify the company from any liability for costs which it may incur in pursuing the action”. [8.100]

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(b)

whether the members who ratified the conduct were acting for proper purposes: s 239(2). As noted at [8.25], the effect of this provision is not to displace general law ratification doctrines entirely although it undoubtedly diminishes their practical importance. The motive of the applicant is not determinative of the question whether the good faith requirement in s 237(2)(b) is satisfied since, as Palmer J said in [8.105] Swansson v Pratt at [41], “it is not the law that only a plaintiff who feels goodwill towards a defendant is entitled to sue”. Similarly, in Pottie v Dunkley an applicant for leave was held to be acting in good faith “even though she may bear some personal animosity towards [the defendant] and even though she may have commenced these proceedings due to dissatisfaction with the succession arrangements within the family” since she was a current shareholder whose shares may increase in value as a result of the suit and in recognition of the fact that s 237(2)(b) sets a “relatively low threshold to meet”. 70 However, in Goozee v Graphic World Group Holdings Pty Ltd the application was denied since the applicants were held to be acting for a collateral purpose in that they were seeking to bring the action to force the directors to pay dividends or alternatively force the directors to arrange for the applicants’ shares to be purchased. 71 The applicant’s personal interest in the outcome of the application or personal animus against other shareholders is also “not significant or decisive” on the question whether it is in the best interests of the company since such an interest or animus will be common in disputes that lead to derivative actions. 72 On this latter criterion, the Court must be satisfied, not that the proposed derivative action is likely to be in the best interests of the company, but that it is in its best interests that the proceedings should be brought on its behalf by this applicant. 73 It is in a company’s liquidation, especially an insolvent liquidation, that attention may focus most clearly upon what causes of action are available to the company and any breaches of duties owed to it. Where a company is in liquidation, the liquidator is the person with authority, as general rule, to bring proceedings on behalf of the company. 74 In Chahwan v Euphoric Pty Ltd the New South Wales Court of Appeal, noting an earlier division of opinion in first instance decisions, held that the statutory derivative action procedure does not apply to a company in liquidation; a member or former officer of a company in liquidation may not therefore apply for leave under s 237. 75 However, the introduction of the statutory procedure does not affect the court’s power, as an aspect of its general equitable jurisdiction, to allow a member or creditor to sue in the name of a company in liquidation under a process functionally similar to the general law derivative suit. 76 The discretion to grant leave to sue is exercised by reference to these criteria: 70

Pottie v Dunkley [2011] NSWSC 166 at [58].

71

Goozee v Graphic World Group Holdings Pty Ltd (2002) 170 FLR 451 at [68].

72 73 74 75

Pottie v Dunkley [2011] NSWSC 166 at [60]. Power v Ekstein [2010] NSWSC 137 at [105]-[107]. Scarcel Pty Ltd v City Loan & Credit Corp Pty Ltd (1988) 12 ACLR 730. Chahwan v Euphoric Pty Ltd (2008) 65 ACSR 661 (both the statutory context and the mischief that the remedy was intended to correct indicate legislative intent to limit the remedy to companies which are a going concern). This was the first intermediate appeal court decision addressing the question. Chahwan v Euphoric Pty Ltd (2008) 65 ACSR 661 at [124]; Ragless v IPA Holdings Pty Ltd (in liq) (2008) 65 ACSR 700 at [43]-[45]. The principle underlying the jurisdiction is explained by Sir George Jessel MR in Cape Breton Co v Fenn (1881) 17 Ch D 198 at 207-208: “on what principle is it that a creditor or contributory has been allowed to sue in the name of the company? On the same principle on which a man could always have filed a bill in the old Court of Chancery against his trustee to be allowed to use his name to recover the trust property. That is the principle.” The decision holds that this principle and the jurisdiction are unaffected by the abolition of the general law derivative action in s 236(3). It had earlier been held that it was no objection to an application under s 237 that the company on whose behalf the proceedings would be brought is under administration: Mhanna v Sovereign Capital Ltd [2004] FCA 1040.

76

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2.

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The question whether the proceedings proposed to be pursued have some solid foundation, in that they exhibit such a degree of merit as to be neither vexatious nor oppressive and to present reasonable prospects of success. The attitude of the liquidator to the question whether the proceedings should be pursued.

3.

The question whether “practical considerations support the initiation of the proceedings”, with particular reference to financial protection of the liquidator and the estate of the company by means of indemnity and, if indicated, security. 77 Extracted below is the widely cited judgment of Palmer J in Swansson v Pratt [8.105] explicating and applying the criteria. As you read this decision, consider whether the statutory procedure as applied has strengthened or weakened shareholder remedies and the mechanisms for deterring managerial misconduct. Recall the policy considerations, noted above, that prompted the introduction of the statutory derivative action in 2000 to replace the general law derivative action.

Swansson v Pratt [8.105] Swansson v Pratt (2002) 42 ACSR 313 Supreme Court of New South Wales [The applicant, Swansson, was a director and shareholder of the first defendant (RAPP) and the former wife of the second defendant, Highland. Swansson and Highland were divorced in May 1997. Highland was a director of RAPP between 1992 and December 1997. Swansson sought leave under s 237 to bring proceedings to have Highland compensate RAPP for a payment made by Highland from RAPP’s funds for his own benefit in breach of his duties as its director. Swansson held 25% of the capital of RAPP and the balance was held by her mother and brother, Pratt. Pratt was the only other director of RAPP. Swansson’s mother and Pratt opposed RAPP commencing any proceedings against Highland. By affidavit, Pratt stated that the disputed payment was part of a complicated family arrangement made in 1991 or 1992 between Highland and Swansson, while they were still married, and Swansson’s parents. Pratt, a chartered accountant, said that in 1996 he had conducted a due diligence investigation into the financial affairs of Highland and his companies in order to advise Swansson as to a proposed property settlement with him. At the conclusion of that investigation, Pratt said, he explained in detail to his sister and her solicitor the transactions which had taken place pursuant to the family arrangement in 1991 and 1992. Pratt said that those were then taken into account in working out the provisions of the Deed of Settlement made between Swansson and Highland. Swansson and her solicitor denied that this explanation was then given. The application was considered entirely on the basis of affidavit evidence; no party sought leave to cross examine any of the deponents to the affidavits.] PALMER J: 22 Pt 2F.1A is, by its terms, intended to keep a careful balance between facilitating the bringing of derivative actions, where the earlier rule in Foss v Harbottle and its exceptions were seen to create undue difficulty, and protecting a company from too ready and unwarranted interference in its internal management. 23 The ability to bring a derivative action is no longer confined to shareholders who, under the exceptions to the rule in Foss v Harbottle, were formerly regarded as being the only persons who could represent the interests of the company as a whole … Standing is now conferred on shareholders, former shareholders and those with inchoate rights as shareholders, as well as upon officers and former officers. By operation of the definition of “officer” in CA s 9, current directors, secretaries and other senior executives as well as persons who have formerly held such positions may now seek leave to commence a derivative action even though they may never have been, and might never become, 77

Carpenter v Pioneer Park Pty Ltd (2008) 66 ACSR 564 at [34]; in Re Colorado Products Pty Ltd (in prov liq) (2014) 97 ACSR 581 it was assumed that an application for leave to bring a derivative suit on behalf of a company in provisional liquidation need be made under the inherent jurisdiction. [8.105]

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Swansson v Pratt cont. shareholders of the company. The inclusion of such persons in s 236(1) raises difficult questions as to the content of the requirement that the applicant must be acting in good faith. I will return to this issue shortly. 24 It is clearly the intent of Pt 2F.1A that leave to bring a derivative action must not be given lightly. An application under s 237(2) is not interlocutory in character; the relief sought is final and the applicant bears the onus of establishing the requirements of the subsection to the Court’s satisfaction. 25 In order to ascertain whether there is a serious question to be tried for the purposes of s 237(2)(d), the Court will not normally enter into the merits of the proposed derivative action to any great degree. The applicant has the same relatively low threshold to surmount as in the case of an application for an interlocutory injunction: Beecham Group Ltd v Bristol Laboratories Pty Ltd (1968) 118 CLR 618, at 622. Thus, cross examination on the merits of the proposed derivative action will usually be permitted only with leave of the Court and to a limited extent. 26 However, because of the possibly serious consequences to the company if the application is allowed and the company is thereby compelled to engage in litigation as a plaintiff against its will, all facts and circumstances relevant to the consideration of the requirements of s 237(2)(a), (b), (d) and (e) must be considered and the applicant bears the onus of satisfying the Court that, on the balance of probabilities, those requirements have been fulfilled. There is no reason in principle for restricting the parties’ rights of cross examination if any matter relevant to those requirements is in contest. 27 I turn now to the requirements of s 237(2). The company will not probably take proceedings 28 In most cases, it will be readily apparent whether this requirement is satisfied. Usually the defendant in the proposed derivative action is in control of the company or is supported by the majority of shareholders or of the board. 29 Some cases, however, will not be so clear. The applicant may say there is equivocation on the part of a company in deciding whether to initiate proceedings so that refusal or probable refusal should be inferred. Where there is not a clear-cut and authoritative refusal by the company to take specific proceedings after a properly particularised request to do so by or on behalf of the applicant, the applicant bears the onus of establishing that in all of the relevant circumstances actual refusal or the probability of refusal is to be inferred. 30 There may be other cases where the applicant may say that the company will probably not take the proceedings because, even if it wished to do so, it has insufficient funds. Again, the applicant bears the onus of establishing that proposition. 31 In this case, Mr Pratt has given evidence that he and his mother do not wish RAPP to take proceedings against Mr Highland. They hold 75% of the company’s issued shares and Mr Pratt is the only director of the company besides Ms Swansson. Accordingly, I am satisfied that the requirement of s 237(2)(a) has been met. Good faith – principles 32 There is no elaboration in s 237 as to what matters the Court should take into account in determining whether an applicant is “acting in good faith”. That phrase is one which occurs in very many different contexts in the law: it must take its content in any particular case from the context in which it is used. 33 As I have observed, prior to the commencement of Pt 2F.1A only current share holders could take advantage of the exceptions to the rule in Foss v Harbottle. Pt 2F.1A now gives a right to initiate proceedings to some persons who, but for those provisions, would have had no such right at all under the general law. Such persons are all those within the categories created by s 236(1)(a) who are not shareholders of the company when the application for leave is made. Further, there is no requirement in s 236 that a person seeking leave must have been a shareholder or officer when the alleged wrong was committed against the company. Accordingly, under Pt 2F.1A a former shareholder or director may seek to sue in the company’s name for a wrong which was committed after he or she had disposed of all shares in the company or had ceased to hold office. 614

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Swansson v Pratt cont. 34 The Court is not given power in Pt 2F.1A to grant final relief in a suit instituted in a company’s name to any person other than the company itself. Accordingly, applicants for leave who are not current shareholders of the company cannot gain by increase in the value of their shares if the derivative action succeeds and the company recovers compensation. Likewise, applicants who are former officers of the company cannot obtain orders resolving conflicts in which they themselves are engaged. Yet such persons are entitled to be given leave if they satisfy the requirements of s 237(2). The section, therefore, suggests that it must be possible for persons to satisfy the requirement of good faith even when they have no financial interest in the company and no present involvement in its management. 35 At this early stage in the development of the law on the statutory derivative action created by Pt 2F.1A it would be unwise to endeavour to state compendiously the considerations to which the Courts will have regard in determining whether applicants in all categories defined by s 236(1) are acting in good faith. The law will develop incrementally as different factual circumstances come before the Courts. 36 Nevertheless, in my opinion, there are at least two interrelated factors to which the Courts will always have regard in determining whether the good faith requirement of s 237(2)(b) is satisfied. The first is whether the applicant honestly believes that a good cause of action exists and has a reasonable prospect of success. Clearly, whether the applicant honestly holds such a belief would not simply be a matter of bald assertion: the applicant may be disbelieved if no reasonable person in the circumstances could hold that belief. The second factor is whether the applicant is seeking to bring the derivative suit for such a collateral purpose as would amount to an abuse of process. 37 These two factors will, in most but not all, cases entirely overlap: if the Court is not satisfied that the applicant actually holds the requisite belief, that fact alone would be sufficient to lead to the conclusion that the application must be made for a collateral purpose, so as to be an abuse of process. The applicant may, however, believe that the company has a good cause of action with a reasonable prospect of success but nevertheless may be intent on bringing the derivative action, not to prosecute it to a conclusion, but to use it as a means for obtaining some advantage for which the action is not designed or for some collateral advantage beyond what the law offers. If that is shown, the application and the derivative suit itself would be an abuse of the Court’s process: Williams v Spautz (1992) 174 CLR 509, at 526. The applicant would fail the requirement of s 237(2)(b). 38 Where the application is made by a current shareholder of a company who has more than a token shareholding and the derivative action seeks recovery of property so that the value of the applicant’s shares would be increased, good faith will be relatively easy for the applicant to demonstrate to the Court’s satisfaction. So also where the applicant is a current director or officer: it will generally be easy to show that such an applicant has a legitimate interest in the welfare and good management of the company itself, warranting action to recover property or to ensure that the majority of the shareholders or of the board do not act unlawfully to the detriment of the company as a whole. 39 However, where the applicant is a former shareholder or officer with nothing obvious to gain directly by the success of the derivative action, the Court will scrutinise with particular care the purpose for which the derivative action is said to be brought. 40 For example, a creditor may happen to be a former shareholder of the company and may seek, by the derivative action, to place the company in a financial position to repay the debt. There would be no abuse of process in commencing and maintaining the derivative action itself in that the action is commenced and maintained in order to achieve the purpose for which it is designed, namely, to recover property for the company. However, it may well be said that, in making an application for leave under Pt 2F.1A, the applicant is not acting in good faith because he or she is, in reality, seeking to vindicate his or her interest as a creditor and not whatever interest he or she may have as a former shareholder. 41 To take another example: a derivative action sought to be instituted by a current shareholder for the purpose of restoring value to his or her shares in the company would not be an abuse of process even if the applicant is spurred on by intense personal animosity, even malice, against the defendant: it is not the law that only a plaintiff who feels goodwill towards a defendant is entitled to sue: see eg [8.105]

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Swansson v Pratt cont. Dowling v Colonial Mutual Life Assurance Society (1915) 20 CLR 509, at 521-522; IOC Australia Pty Ltd v Mobil Oil Australia Ltd (1975) 11 ALR 417, at 426-427. On the other hand, an action sought to be instituted by a former shareholder with a history of grievances against the current majority of shareholders or the current board may be easier to characterise as brought for the purpose of satisfying nothing more than the applicant’s private vendetta. An applicant with such a purpose would not be acting in good faith. 42 If a wrong appears to have been done to a company and those in control refuse to take proceedings to redress it, the Court should permit a derivative action to be instituted only by those within the categories allowed by s 236(1) who would suffer a real and substantive injury if the action were not permitted. The injury must be necessarily dependent upon or connected with the applicant’s status as a current or former shareholder or director and the remedy afforded by the derivative action must be reasonably capable of redressing the injury. 43 Further, if an applicant for leave under s 237 seeks by the derivative action to receive a benefit which, in good conscience, he or she should not receive, then the application will not be made in good faith even though the company itself stands to benefit if the derivative action is successful. Such a benefit would include, for example, a double recovery by the applicant for a wrong suffered or recompense for a wrongful act inflicted upon the company in which the applicant was a direct and knowing participant with the proposed defendant in the derivative action. In such a case the law would not permit the applicant to derive a benefit from his or her own wrongdoing. [The judge found it inherently improbable that Swansson would have appointed Pratt as her own financial adviser to investigate Highland’s financial affairs if she had any misgivings about his independence, integrity and capacity to conduct the investigation properly. Accordingly, he was not satisfied that Swansson was acting in good faith in seeking leave to bring the proposed proceedings.] … The best interests of the company 54 In case I am wrong in my finding as to good faith and for the sake of completeness, I should set out my findings as to whether Ms Swansson has satisfied me that it is in the best interests of the company that the application be granted. 55 At the outset, it is important to note that s 237(2)(c) requires the Court to be satisfied, not that the proposed derivative action may be, appears to be, or is likely to be, in the best interests of the company but, rather, that it is in its best interests. In this respect, s 237(2) differs significantly from its counterpart in the Canadian legislation, which requires the Court to be satisfied that the proposed derivative action “appears to be” in the interests of the company, and from s 165(3) of the New Zealand Act which requires that the Court “have regard to … the interests of the company”. These provisions seem to have led the Courts of those countries to the view that the best interests of a company need be considered only in a prima facie way: see eg Re Bellman and Western Approaches Ltd (1981) 130 DLR (3d) 193, at 201; Vrij v Boyle (1995) 3 NZLR 763, at 765; Techflow (NZ) Ltd v Techflow Pty Ltd (1996) 7 NZCLC 261,138. 56 The requirement of s 237(2)(c) that the applicant satisfy the Court that the proposed action is in the best interests of the company is a far higher threshold for an applicant to cross. It requires the applicant to establish, on the balance of probabilities, a fact which can only be determined by taking into account all of the relevant circumstances. Accordingly, the enquiry will normally require the applicant to adduce evidence at least as to the following matters. 57 First, there should be evidence as to the character of the company: different considerations may well apply depending on whether the company is a small, private company whose few shareholders are the members of a family or whether it is a large public listed company. If the company is a closely held family company, it may be relevant to take into account the effect of the proposed litigation on the purpose for which the company was established and on the family members who are the shareholders. If the company is a public listed company, such considerations will be irrelevant. Again, the company may be a joint venture company in which the venturers are deadlocked so that the proposed derivative action is seen as being for the purpose of vindicating one side’s position rather 616

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Swansson v Pratt cont. than the other’s in a way which will not achieve a useful result: see, eg, Talisman Technologies Inc v Queensland Electronic Switching Pty Ltd [2001] QSC 324. 58 Second, there should be evidence of the business, if any, of the company so that the effects of the proposed litigation on its proper conduct may be appreciated. 59 Third, there should be evidence enabling the Court to form a conclusion whether the substance of the redress which the applicant seeks to achieve is available by a means which does not require the company to be brought into litigation against its will. So, for example, if the applicant can achieve the desired result in proceedings in his or her own name it is not in the best interests of the company to be involved in litigation at all. This was the case in Talisman Technologies in which it appeared from the evidence that the most desirable outcome for the applicant was to obtain an order for specific performance of a contract, which it could do in a suit in which the company did not need to be a party. 60 Fourth, there should be evidence as to the ability of the defendant to meet at least a substantial part of any judgment in favour of the company in the proposed derivative action so that the Court may ascertain whether the action would be of any practical benefit to the company. [The judge found that on the facts alleged by the applicant she would be entitled to apply to the Family Court for an order under the Family Law Act revoking the Court’s approval of the Deed of Settlement on the ground that approval of the Deed had been obtained by fraud. She could then seek an adjustment of rights between herself and Highland. He was not, therefore, satisfied that it was in the best interests of RAPP that Swansson’s application for leave be granted.]

[8.108]

1.

Notes&Questions

In Swansson v Pratt Palmer J said that only “those within the categories allowed by s 236(1) who would suffer a real and substantive injury if the action were not permitted should be permitted to sue”: at [42]. Is the policy implicit in this interpretation of the requirement of good faith well founded? Should the applicant who falls within s 236(1) but does not have a significant personal financial interest be disqualified from suing? Consider the personal utility confounding plaintiffs in Wallersteiner v Moir (No 2) [1975] QB 373 and Jenkins v Enterprise Gold Mines NL (1992) 6 ACSR 539 ([8.225]) (a statutory oppression suit) who were prompted primarily by concern for the public interest in management integrity of publicly held companies. Should their initiative be encouraged or protected against in considering applications under Pt 2F.1A? In this respect consider the following remarks of Kirby P on “the legitimate role of corporate gadflies” in Parker v NRMA (1992) 11 ACSR 370 at 383: People who pursue a path of integrity, disturbing settled practices long established, generally accepted and widely regarded by those involved to be perfectly reasonable, tend – almost without exception – to invoke at first amusement, bemusement and then extreme irritation on the part of those whose conduct is questioned. Yet the history of our legal system is replete with troublemakers. In Neal v R (1982) 149 CLR 305 at 316ff Murphy J reminded Australian lawyers of Oscar Wilde’s opinion: “Agitators are a set of interfering, meddling people, who come down to some perfectly contented class of the community and sow the seeds of discontent amongst them. That is the reason why agitators are so absolutely necessary. Without them, in our incomplete state, there would be no advance towards civilisation.”

2.

If the proceedings in Winthrop v Winns [8.35] had been brought in 2000 and with leave under Pt 2F.1A, would the issues as to the effect of the purported ratification upon those proceedings have been differently decided? [8.108]

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3.

See further L Thai (2002) 30 ABLR 118; K Fletcher (2001) 13 Aust Jnl of Corp Law 290.

[8.109]

Review Problems

1. A joint venture agreement was entered into some time ago for the provision of information technology services to Sunshine Bank, a leading regional bank. JV Co is formed under the agreement with Sunshine holding 49.9% of its capital through a subsidiary company, 5% held by a computer supplier, WenDell, and the balance of 45.1% held by BeeGee Enterprises Pty Ltd, controlled by local entrepreneur, Bill Gates. These three are the parties to the joint venture agreement. The agreement is subject to conditions subsequent involving the adoption of a business plan, budget and funding for JV Co on terms satisfactory to the parties, and Sunshine obtaining necessary regulatory approvals in respect of its obligations under the contract. BeeGee says that, for commercial reasons of their own and in breach of duties under the contract, Sunshine and WenDell have decided to rid themselves of the joint venture contract and their obligations under it. Specifically, BeeGee alleges that, by conduct or deliberate inaction on their part, Sunshine and WenDell have repudiated the contract by preventing fulfilment of the conditions or by wrongly denying that they had been satisfied. Might BeeGee claim specific performance of the contract under Pt 2F.1A? Alternatively, would it be better advised to seek another remedy such as an application for declarations that the conditions subsequent have been satisfied and damages in lieu of specific performance? (These facts are based upon those considered in Metyor Inc v Queensland Electronic Switching Pty Ltd (2002) 42 ACSR 398.) 2. Arthur, Bruce and Charlie formed three companies for a business venture they were commencing in Europe. CCL Ireland, the ultimate parent company, was incorporated in Ireland for tax minimisation reasons. It held all the equity in CCL Aust, incorporated in Australia, which in turn owned all the equity in CCL UK, incorporated in England. The three together held the equity in CCL Ireland and were directors of each company until Arthur resigned from the three boards. A short time after Arthur’s resignation, Bruce and Charlie, in their personal capacities and as directors of CCL Aust and CCL UK, executed a deed with those companies under which the companies assigned the intellectual property used in the business to Bruce and Charlie in purported discharge of loans they had made to the two companies. CCL Ireland was dissolved and its holdings in CCL Aust vested in the Irish State. Arthur, as a former director of CCL Aust, wishes to bring derivative proceedings in Australia against Bruce and Charlie and CCL UK for what he claims was the unauthorised diversion of valuable property and opportunities belonging to CCL Aust and CCL UK. What need he establish to succeed in the application? Does it matter whether the rights assigned to Bruce and Charlie were owned by CCL Aust or CCL UK? See Oates v Consolidated Capital Services Ltd (2009) 72 ACSR 506.

THE SHAREHOLDER’S PERSONAL ACTION Introduction [8.110] Shareholders may not bring an action in their own interest in respect of a wrong done

to their company, even where it reduces the value of their shareholding in the company. To allow such an action in addition to the corporate action (whether or not pursued derivatively) would be to permit a form of double recovery, the individual shareholder’s loss being merely a 618

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reflection of the company’s loss for which the company alone may sue. 78 The rule is accordingly called the reflective loss rule. 79 However, where the company suffers loss but has no remedy in respect of that loss, a shareholder who has a personal right of action may sue in respect of loss suffered even though it merely reflects the diminution in the value of her or his shareholding. 80 The introduction of the statutory derivative action does not prevent a member bringing, or intervening in, proceedings on their own behalf in respect of breach of a right recognised as of a personal or individual character, that is, not a wrong done to the corporate entity: s 236 (note 3). As noted at [8.90], these rights typically arise under the Act or from the terms of a company’s constitution or replaceable rule. In exceptional cases, directors may owe duties to shareholders directly and not merely to the corporation: see [7.535]. To these non-corporate rights the proper plaintiff aspect of the rule in Foss v Harbottle has no application. The difficulty here lies in characterising a particular right as personal or corporate and in divining the principles underlying their differentiation. Three species or sources of individual shareholder rights may be identified. The first are the contractual rights of members arising under the corporate constitution by virtue of its statutory expression as a contract between members, officers and the company. The second are the myriad instances of personal right recognised under statute and constitutional provision. The third arise from rights given to affected parties to seek injunctions or damages in respect of contraventions of the Act. These three topics are considered in this section. The statutory contract in the constitution [8.115] Australian companies statutes long contained the following provision: Subject to this Act the [constitution] shall when registered bind the company and the members thereof to the same extent as if they respectively had been signed and sealed by each member and contained covenants on the part of each member to observe all the provisions of the [constitution]. 81

The provision may be traced to the Joint Stock Companies Act 1856 (UK) 82 which substituted the memorandum and articles for the deed of settlement of the joint stock company. Curiously, the provision made no reference to deemed execution and covenants by the company. However, the provision was amended from the 1980s and now provides that a company’s constitution and any replaceable rules that apply to it have effect as a contract: 1. between the company and each member; 2.

between the company and each director and company secretary; and

78

Ballard v Multiplex Ltd (2008) 68 ACSR 208; Thomas v D’Arcy (2005) 52 ACSR 609; Nestegg Holdings Pty Ltd v Smith [2001] WASC 227; Johnson v Gore Wood & Co [2001] 2 WLR 72 at 94-95, 120-121; Prudential Assurance v Newman Industries [1982] Ch 204 at 222-223; but see contra Christensen v Scott [1996] 1 NZLR 273 at 280 (“the diminution in value of [the plaintiffs’] shares in the company is by definition a personal loss and not a corporate loss”).

79

VPlus Holdings Pty Ltd v Bank of Western Australia Ltd (2012) 91 ACSR 545 at [42].

80 81 82

Johnson v Gore Wood & Co [2001] 2 WLR 72 at 94-95, 120-121. For example, Uniform Companies Act, s 33(1). Section 10. The section obviated the need under prior legislation for every new member to execute the deed of settlement, effecting a complete novation with each admission to membership. See J H Farrar et al, Farrar’s Company Law (3rd ed, 1991), pp 121-122. [8.115]

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3. between a member and each other member, under which each person agrees to observe and perform the constitution and rules so far as they apply to that person: s 140(1). However, many of the older cases discussed below were decided by reference to the earlier statutory provision; differences from s 140(1) need to be borne in mind.

Hickman v Kent or Romney Marsh Sheep-Breeders’ Association [8.120] Hickman v Kent or Romney Marsh Sheep-Breeders’ Association [1915] 1 Ch 881 Chancery Division [The association was incorporated as a non-profit company with objects, inter alia, to encourage the breeding of Kent or Romney Marsh sheep and maintenance of the purity of the flock. Article 49 of its constitution provided for reference of disputes to arbitration. The plaintiff was a member of the association. A dispute arose and he issued a writ to have the association and its secretary restrained in various ways from acts in derogation of his rights as a member. The association issued a summons asking that all further proceedings be stayed on the ground that art 49 constituted a submission to arbitration.] ASTBURY J: [891] The principal authorities in support of the view that the articles do not constitute a contract between the company and its members are Pritchard’s case (1873) LR 8 Ch 956; Melhado v Porto Alegre Railway Co (1874) LR 9 CP 503; Eley v Positive Life Assurance Co (1876) 1 Ex D 88; and Browne v La Trinidad (1887) 37 Ch D 1. [The judge examined Pritchard’s case and Melhado v Porto Alegre Railway Co.] [892] In Eley v Positive Life Assurance Co the articles of association contained a clause in which it was stated that the plaintiff, a solicitor, should be the solicitor to the company and transact its legal business. The articles were registered and the company incorporated, and 11 months later the plaintiff became a member. The plaintiff was not appointed solicitor by any resolution of the directors, nor by any instrument bearing the seal of the company, but he acted as such for a time. Subsequently the company ceased to employ him and he brought an action for breach of contract against the company for not employing him as its solicitor … [893] Amphlett B said (at 26, 28): the articles, taken by themselves, are simply a contract between the shareholders inter se, and cannot, in my opinion, give a right of action to a person like the plaintiff, not a party to the articles, although named therein. … For these reasons, I think that there was no contract at all between the plaintiff and the company…. Cleasby B … said (at 30): “I am of opinion that cl 118 of the articles cannot by itself be taken to operate as a contract between the solicitor and the company….” [894] This case went to the Court of Appeal and Lord Cairns LC said (at 89): This case was first rested on the 118th article. Articles of association, as is well known, follow the memorandum, which states the objects of the company, while the articles state the arrangement between the members. They are an agreement inter socios, and in that view, if the introductory words are applied to art 118, it becomes a covenant between the parties to it that they will employ the plaintiff. Now, so far as that is concerned, it is res inter alios acta, the plaintiff is no party to it. No doubt he thought that by inserting it he was making his employment safe as against [895] the company; but his relying on that view of the law does not alter the legal effect of the articles. This article is either a stipulation which would bind the members, or else a mandate to the directors. In either case it is a matter between the directors and shareholders, and not between them and the plaintiff. [The judge then examined Browne v La Trinidad (1887) 37 Ch D 1.] [896] Now in these four cases the article relied upon purported to give specific contractual rights to persons in some capacity other than that of shareholder, and in none of them were members seeking to enforce or protect rights given to them as members, in common with the other corporators. The 620

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Hickman v Kent or Romney Marsh Sheep-Breeders’ Association cont. actual decisions [897] amount to this. An outsider to whom rights purport to be given by the articles in his capacity as such outsider, whether he is or subsequently becomes a member, cannot sue on those articles treating them as contracts between himself and the company to enforce those rights. Those rights are not part of the general regulations of the company applicable alike to all shareholders and can only exist by virtue of some contract between such person and the company, and the subsequent allotment of shares to an outsider in whose favour such an article is inserted does not enable him to sue the company on such an article to enforce rights which are res inter alios acta and not part of the general rights of the corporators as such. … The wording of [the section] is difficult to construe or understand. A company cannot in the ordinary course be bound otherwise than by statute or contract and it is in this section that its obligation must be found. As far as the members are concerned, the section does not say with whom they are to be deemed to have covenanted, but the section cannot mean that the company is not to be bound when it says it is to be bound, as if, etc, nor can the section mean that the members are to be under no obligation to the company under the articles in which their rights and duties as corporators are to be found. Much of the difficulty is removed if the company be regarded, as the framers of the section may very well have so regarded it, as being treated in law as a party to its own memorandum and articles. It seems clear from other authorities that a company is entitled as against its members to enforce and restrain breaches of its regulations. See, for example, MacDougall v Gardiner (1875) 1 Ch D 13; Pender v Lushington (1877) 6 Ch D 70; and Imperial Hydropathic Hotel Co Blackpool v Hampson (1882) 23 Ch D 1 at 13. In the last case Bowen LJ said: “The articles of association, by [the section], are to bind all the company [898] and all the shareholders as much as if they had all put their seals to them.” It is also clear from many authorities that shareholders as against their company can enforce and restrain breaches of its regulations, and in many of these cases judicial expressions of opinion appear, which, in my judgment, it is impossible to disregard. In Johnson v Lyttle’s Iron Agency (1877) 5 Ch D 687 at 693, in an action by a shareholder against the company, James LJ said: “The notice … did not comply strictly with the provisions of the contract between the company and the shareholders which is contained in the regulations of Table A.” In Wood v Odessa Waterworks Co (1889) 42 Ch D 636 at 642, which was an action by the plaintiff on behalf of himself and all other shareholders against the company, Stirling J said: “The articles of association constitute a contract not merely between the shareholders [899] and the company, but between each individual shareholder and every other.” In Salmon v Quin and Axtens Ltd [1909] 1 Ch 311 at 318 Farwell LJ, referring to this last statement, said: “I think that that is accurate subject to this observation, that it may well be that the court would not enforce the covenant as between individual shareholders in most cases.” In Welton v Saffery [1897] AC 299 at 315 Lord Herschell [said]: It is quite true that the articles constitute a contract between each member and the company, and that there is no contract in terms between the individual members of the company; but the articles do not any the less, in my opinion, regulate their rights inter se. Such rights can only be enforced by or against a member through the company, or through the liquidator representing the company; but I think that no member has, as between himself and another member, any right beyond that which the contract with the company gives. In all these last mentioned cases the respective articles sought to be enforced related to the rights and obligations of the members generally as such and not to rights of [900] the character dealt with in the four authorities first above referred to. It is difficult to reconcile these two classes of decisions and the judicial opinions therein expressed, but I think this much is clear, first, that no article can constitute a contract between the company and a third person; second, that no right merely purporting to be given by an article to a person, whether a member or not, in a capacity other than that of a member, as, for instance, as solicitor, promoter, director, can be enforced against the company; and, third, that articles regulating the rights and obligations of the members generally as such do create rights and obligations between them and the company respectively. [8.120]

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Hickman v Kent or Romney Marsh Sheep-Breeders’ Association cont. In Bisgood v Henderson’s Transvaal Estates [1908] 1 Ch 759 Buckley LJ said: “The purpose of the memorandum and articles is to define the position of the shareholder as shareholder, not to bind him in his capacity as an individual.” [903] In my judgment, art 49, for the reasons above referred to, creates rights and obligations enforceable as between the plaintiff and the association respectively and those rights and obligations are contained in a written document, but whether that document is a contract or agreement between the plaintiff and the association within s 27 of the Arbitration Act [that is, a submission to arbitration] depends upon whether the decisions in Eley v Positive Life Assurance Co (1876) 1 Ex D 20, 88, and the other three cases of a similar character above referred to, ought to be regarded as only dealing with and applying to articles purporting, first, to contain an agreement with the company and a third person, or, secondly, to define the rights of a shareholder in some capacity other than that of a member of the company. To reconcile those decisions with the other expressions of judicial opinion above mentioned, some such view should, I think, be adopted and general articles dealing with the rights of members “as such” treated as a statutory agreement between them and the company as well as between themselves inter se, and, in my judgment, art 49 in the present case does constitute a submission to arbitration within the true meaning and intent of the Arbitration Act. [The judge made a stay order against the proceedings commenced by the plaintiff member and directed that the dispute be referred to arbitration.]

Notes&Questions

[8.123]

1.

2.

3.

Are the restrictions in Hickman’s case upon the enforcement of “outsider rights” affected by the new terms of s 140(1)? For example, will the scope of enforceable rights vary with whether the member is also an officer of the company? Would Eley’s case now be differently decided? Would it make any difference if the articles appointed Eley principal executive officer of the company instead of solicitor? Notwithstanding Farwell LJ in Salmon v Quin and Axtens Ltd and Lord Herschell in Welton v Saffery (see Hickman at 899) provisions in company constitutions have been held to be a contract between members inter se enforceable by personal action. Thus, in Rayfield v Hands [1960] Ch 1 the constitution of a company entitled every member to sell their shares to the directors at a fair valuation (in effect, a put option). In a somewhat strained interpretation, Vaisey J held that the obligation which the constitution imposed on the directors for the time being was imposed upon them in their capacity as members and was therefore enforceable against them. If the constitution had not required directors to be members of the company, would the constitution have been enforceable? See also Peters’ American Delicacy Co Ltd v Heath (1939) 61 CLR 457 at 480 and Re Caratti Holding Co Pty Ltd (1975) 1 ACLR 87, affirmed sub nom Caratti Holding Co Pty Ltd v Zampatti (1979) 52 ALJR 732. Does s 140(1) in its current form affect the status and scope of the constitution as a contract between members? In Beattie v E & F Beattie Ltd [1938] Ch 708 a derivative suit was brought against a director (who was also a shareholder) alleging that sums had been paid to him improperly as remuneration. The constitution contained an arbitration clause concerning disputes between the company and its members. The director applied unsuccessfully for a stay of proceedings. Greene MR said (at 721-722): [T]he contractual force given to the articles of association by the section is limited to such provisions of the articles as apply to the relationship of the members in their capacity as members. … [T]he real matter which is here being litigated is a dispute

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between the company and the appellant in his capacity as a director, and when the appellant … seeks to have that dispute referred to arbitration … he is not, in my judgment, seeking to enforce a right which is common to himself and all other members.

4.

5.

(How then was the director in Pulbrook v Richmond Consolidated Mining Co [5.280] able to bring an action to restrain his exclusion from the boardroom?) Does s 140(1) now permit the shareholder-director to enforce rights under the constitution affecting them in their capacity as an officer? If the shareholder-director is employed under a service contract with the company expressed in the constitution, may they enforce those conditions relating to the contract of employment? Conversely, does the subsection now expose the officer to a potentially wider range of personal liabilities? Members’ remedies against the company appear to be limited to the granting of an injunction or declaration or an order for payment of a liquidated sum such as a dividend which has been declared but not paid. A shareholder will not be awarded damages against the company for breach of contract: see Re Addlestone Linoleum Co Ltd (1887) 37 Ch D 191 and Re Dividend Fund Inc (in liq) [1974] VR 451. Will the restriction apply to actions by an officer against the company? The restriction does not apply to actions by the company against a member: see, eg, Heron v Port Huon Fruitgrowers Co-op (1922) 30 CLR 315. The statutory contract possesses some distinctive features. Thus, in Scott v Frank Scott (London) Ltd [1940] Ch 794 it was held that the court has no jurisdiction to rectify the constitution even if its terms do not accord with what is proved to have been the intention of the signatories. The English Court of Appeal said that the power to alter the constitution is purely statutory and that in view of the provisions of the Act there is no room for application of equitable principles of rectification. If hardship were to result the court suggested that the appropriate remedy might be an application for winding up. But see also Re Medefield Pty Ltd (1977) 2 ACLR 406.

The scope of individual shareholder rights [8.125] In Pender v Lushington 83 a shareholder, Pender, had split his shareholding among

nominees to maximise his voting power. (The company’s constitution adopted a sliding scale of voting rights.) The chair of the general meeting refused to accept the nominees’ votes on a resolution proposed by Pender. Jessel MR said: This is an action by Mr Pender for himself. He is a member of the company, and whether he votes with the majority or the minority he is entitled to have his vote recorded – an individual right in respect of which he has a right to sue. That has nothing to do with the question like that raised in Foss v Harbottle and that line of cases. He has a right to say, “Whether I vote in the majority or minority, you shall record my vote, as that is a right of property belonging to my interest in this company, and if you refuse to record my vote I will institute legal proceedings against you to compel you.” What is the answer to such an action? It seems to me it can be maintained as a matter of substance, and that there is no technical difficulty in maintaining it. 84

Several other provisions in company constitutions have been interpreted as creating personal rights enforceable by individual shareholder action: see [8.90]. May individual shareholders bring a personal action to challenge the exercise of directors’ powers? Three species of shareholder suit are evident in the law reports: 83 84

(1877) 6 Ch D 70. (1877) 6 Ch D 70 at 80-81. [8.125]

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1.

proceedings in the nature of a derivative suit for the vindication of corporate rights (see, eg, Ngurli Ltd v McCann 85 and Wallersteiner v Moir (No 2)); 86

2.

proceedings for the rectification of the share register either pursuant to statutory power under s 175 or general law rights; 87 and

3.

proceedings in the nature of a personal action against the company and its directors to restrain acts in breach of their fiduciary duties. Thus, in Ngurli v McCann [7.270] at 447 and possibly Harlowe’s Nominees [7.265] and Howard Smith v Ampol Petroleum [7.285], the courts recognised wrongs as done to the shareholder personally and not to the corporate body. Accordingly, they granted the shareholder standing to bring a personal action.

The derivative suit has been discussed. As for the rectification suit, s 175 gives a company or a person aggrieved a right to have a register maintained under Ch 2C, including the register of members under s 169, corrected. (Predecessor provisions were expressed in terms that gave a member standing to seek rectification of the register of members if a name is entered on the register without sufficient cause.) Although this provision can be traced to the Act of 1862, it is only in Australian case law that the provision has been relied upon to found standing in intra-corporate disputes generally. 88 Thus, Williams J in Grant v John Grant & Sons Pty Ltd 89 after quoting Lord Davey in Burland v Earle 90 on the fraud exception, continued: But these remarks do not, in my opinion, apply to an action brought to rectify the register of members of a company. [The equivalent of s 175] gives a shareholder an individual right to have the register rectified if a name is entered on the register without sufficient cause. The Act treats the wrong not as one done to the company but as a wrong to every shareholder and gives every shareholder an individual remedy. 91

In Grant’s case an order was made for rectification of the register to remove reference to shares allotted by an improperly constituted board. Similarly, in Ngurli Ltd v McCann (at 447) the High Court held that the plaintiff shareholder was entitled to a rectification order where the contested issue was in breach of the directors’ duties. 92 Third, standing has been granted to individual shareholders to challenge board action upon fiduciary principles where no order for rectification is sought. These proceedings seek injunctive relief, usually coupled with declaratory orders. An English example appears in Galloway v Halle Concerts Society 93 where two individual shareholders, not suing in representative form, successfully challenged for breach of fiduciary duty a board decision to levy calls on particular shareholders. Similarly constituted actions challenging decisions to issue shares were successful in other English suits. 94 85

(1953) 90 CLR 425 ([7.270]).

86 87

[1975] QB 373. No new rights are conferred by s 175: see Re New Pinnacle Grove Silver Mining Co NL (1897) 18 LR (NSW) Eq 168.

88

See C J H Thompson (1975) 49 ALJ 134 at 135 and, generally, S Rees (1990) 8 C&SLJ 149.

89 90 91

(1950) 82 CLR 1. [1902] AC 83 at 93: see [8.80]. Grant v John Grant & Sons Pty Ltd (1950) 82 CLR 1 at 31-32.

92

See also Ansett v Butler Air Transport (No 1) (1958) 75 WN (NSW) 299 at 303; Kathleen Investments (Australia) Ltd v Australian Atomic Energy Commission (1978) 52 ALJR 45 at 52, 55, 59-60, 63.

93 94

[1915] 2 Ch 233. See, eg, Re a Company [1987] BCLC 82; Piercy v S Mills & Co Ltd [1920] 1 Ch 77; Punt v Symons & Co Ltd [1903] 2 Ch 506; Fraser v Whalley (1864) 2 H & M 10; 71 ER 361.

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Shareholder suits in Australian courts contesting directors’ decisions have often been constituted in non-representative form; 95 the basis of the plaintiff’s standing has often received scant attention from courts and counsel. Thus, the suit in Harlowe’s Nominees v Woodside (Lakes Entrance) Oil Co was cast in a non-representative form seeking declarations of the invalidity of certain share allotments and consequential orders for rectification. In argument before the High Court, counsel for the appellant (plaintiff) asserted that “[t]he plaintiff is not a representative party and is suing because of its personal right and the dilution of its personal interests”. 96 Opposing counsel conceded that under Foss v Harbottle “there would be a locus standi in equity that does not go to the length of enabling an agreement to be set aside which deals with other matters besides the allotment of shares”. 97 Similarly, in Ashburton Oil NL v Alpha Minerals NL 98 the constitution of the suit, a representative action by certain shareholders on behalf of all others against the company alone, is consistent with a personal action. 99 The plaintiffs charged personal injury from the directors’ acts 100 and the language of three members of the High Court recognised the personal nature of the plaintiffs’ claim. Thus, Menzies J said: “A shareholder who would be affected by the exercise of a company’s powers is entitled to demand and enforce that the company’s power should be exercised lawfully.” 101 Similarly, Barwick CJ acknowledged “the equity of a shareholder to restrain action on the part of the directors in excess of the powers given them by the articles of association of the company”. 102 Windeyer J did not doubt “that a shareholder can invoke the aid of a court to prevent the threatened issue of further shares that is not being proposed in good faith for the benefit of the company”. 103 Problems of general law standing have not greatly troubled Australian courts and litigants in relation to contested exercises of board powers. Where the power whose exercise is being challenged is the power of allotment, standing has been granted upon the alternative grounds of rectification pursuant to s 175, recognition of a personal action or, as in Ngurli v McCann, characterisation of the board action as a fraud upon the minority sustaining a derivative suit. 104 In those rare instances where the challenged board action relates to another corporate power, similar principles appear to have been applied. 105

95

See, eg, Savoy Corp Ltd v Development Underwriting Ltd (1963) 80 WN (NSW) 1021; Television New England Ltd v Northern Rivers Television Ltd (1971-3) CCH CLC 40-006.

96

Harlowe’s Nominees v Woodside (Lakes Entrance) Oil Co (1968) 121 CLR 483 at 486 per K A Aickin QC.

97

Harlowe’s Nominees v Woodside (Lakes Entrance) Oil Co (1968) 121 CLR 483 at 486 at 489 per J McI Young QC.

98 99

(1971) 123 CLR 614. Ashburton Oil NL v Alpha Minerals NL (1971) 123 CLR 614 at 641 where Gibbs J queried the constitution of the suit for non-joinder of directors.

100

Ashburton Oil NL v Alpha Minerals NL (1971) 123 CLR 614 at 618 per R Brooking QC.

101 102

Ashburton Oil NL v Alpha Minerals NL (1971) 123 CLR 614 at 630. Ashburton Oil NL v Alpha Minerals NL (1971) 123 CLR 614 at 619.

103

Ashburton Oil NL v Alpha Minerals NL (1971) 123 CLR 614 at 631.

104

But see Hooker Investments Pty Ltd v Email Ltd (1986) 10 ACLR 443 at 443-446; Kirton Investments Pty Ltd v CC Bottlers Ltd (1984) 10 ACLR 167; Condraulics Pty Ltd v Barry and Roberts Ltd (1984) 8 ACLR 915.

105

See, eg, Re Smith and Fawcett Ltd [1942] Ch 304 and Australian Metropolitan Life Assurance Co Ltd v Ure (1923) 33 CLR 199 (power to refuse registration of share transfers); Savoy Corp Ltd v Development Underwriting Ltd (1963) 80 WN (NSW) 1021 (power to make calls); cf Bancorp Investments Ltd v Primac Holdings Ltd (1984) 9 ACLR 263. [8.125]

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Residues Treatment and Trading Co Ltd v Southern Resources Ltd [8.130] Residues Treatment and Trading Co Ltd v Southern Resources Ltd (1988) 51 SASR 177 Supreme Court of South Australia (Full Court) [In editing this extract, references to the Corporations Act have been substituted for their counterparts referred to in the judgment. There are no presently relevant differences in their terms.] KING CJ: [197] This appeal raises for decision the important question whether a shareholder in a limited liability company has locus standi to prosecute an action to challenge an allotment of shares made by the directors for an improper purpose. The appellants have appealed to this court against an order of a single judge striking out their statement of claim on the ground that they lacked standing to prosecute the claims made in the statement of claim. The allegations in the statement of claim are as follows. The plaintiffs are minority shareholders in Southern Resources Ltd. The first plaintiff is a wholly owned subsidiary of another company, Emperor Mines Ltd. Emperor Mines Ltd owns 40% of the shares in the second plaintiff. Emperor Mines Ltd took certain steps towards making a takeover offer to the shareholders Southern Resources Ltd. The directors of Southern Resources, the second to seventh defendants, thereupon announced to the Stock Exchange that Southern Resources intended to make takeover offers to [198] acquire 100% of the issued share capital of another company, Square Gold and Minerals Ltd, in consideration of the allotment of shares in Southern Resources. This offer, if implemented, would give the defendant McDougall and his associates, by reason of their present shareholdings in Square Gold, a majority of the voting shares in Southern Resources. The directors also made allotments of shares in Southern Resources to a syndicate comprising the eighth to 12th defendants and a further allotment to the 13th defendant. It is alleged that in pursuing the takeover of Square Gold and in making the allotments referred to, the directors acted in breach of their duty to act bona fide in the best interests of the company as a whole and for the purpose of gaining control of the company for the McDougall associates and for the further purposes of ensuring that control of the board remained with the present directors and of frustrating the proposed takeover by Emperor Mines. The plaintiffs seek injunctions restraining the proposed takeover of Square Gold and the avoidance of the allotments. Directors are in a fiduciary relationship to the company and are therefore under a duty to exercise the powers, including the power to allot shares, conferred upon them by statute or the articles of association, for the purpose for which they are conferred, namely the benefit of the company as a whole. The exercise of such powers for a purpose other than the benefit of the company as a whole is an abuse of those powers. It is well established that the allotment of shares for the purpose of ensuring the control of existing directors by defeating a takeover bid or of placing control of the company in the hands of a particular shareholder or group of shareholders is an abuse of the powers of the directors and a breach of their duty to the company. An allotment of shares by the directors for an improper purpose is a breach of their fiduciary duty to the company for which they are liable to the company. It is not open to an individual shareholder, generally speaking, to sue to enforce the company’s rights. The proper plaintiff in an action for that purpose is the company itself: Foss v Harbottle (1843) 2 Hare 461; 67 ER 189. Even where the company should properly be the plaintiff, a shareholder may sue, in certain circumstances however, for remedies for the benefit of the company in what is often called a derivative action if the company is under the control of persons who refuse to institute proceedings. I have qualified the rule in Foss v Harbottle stated above by the phrase “generally speaking” because there are well recognised exceptions to the rule. One such exception exists where the actions for which a remedy is sought amount to an infringement of a shareholder’s personal rights. In such a situation the shareholder has locus standi to sue to enforce those personal rights. The statement of claim which has been struck out does not plead the plaintiffs’ claim as a derivative action to enforce the company’s rights or to obtain a remedy for the directors’ alleged breach of duty to the company: Hillhouse v Gold Copper Exploration NL (No 2) (1988) 6 ACLC 351 esp at 353-354. If there is locus standi it must be because the statement of claim raises a cause or causes of action based upon the infringement of the plaintiffs’ personal rights. Mr Bathurst QC, who appeared on the appeal for the plaintiffs, based his argument firmly upon that ground. It matters not to the plaintiffs whether an 626

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Residues Treatment and Trading Co Ltd v Southern Resources Ltd cont. action for the infringement by the company or the directors of a shareholder’s personal rights is regarded as an exception to the rule in Foss v Harbottle or as an action to which that rule has no [199] application by reason of the action not being one to enforce the company’s rights or to seek a remedy in favour of the company for a wrong done to the company. Mr Bathurst preferred the latter basis but put his argument in the alternative. It is necessary to consider whether the causes of action pleaded in the statement of claim which has been struck out, are based, properly understood, not upon the wrong which has undoubtedly been done to the company, if the allegations are true, but upon a wrong done to the plaintiffs as shareholders amounting to an infringement of their personal rights. … There are many cases in which allotments of shares made by directors for an improper purpose have been declared invalid at the suit of an individual shareholder. [Reference was made to several leading cases concerning share issues contested on fiduciary grounds.] [201] None of the above cases is decisive of the present point. There are strong indications in them to my mind, however, of the recognition of a personal right in a shareholder to be protected against dilution of his voting rights in the company by improper action on the part of the directors. … The personal right of a shareholder to which I refer is founded, in my [202] opinion, upon general equitable considerations referred to in the cases cited above arising out of membership of a body whose management is in the hands of directors having fiduciary obligations. It is fortified by the nature of the contract between the company and the members constituted by the memorandum and articles of association and given statutory force by s 140(1). I do not mean that the relevant right of a shareholder is founded in contract or that his remedies for infringement are remedies for breach of contract. The shareholder’s right is founded in equity and is a right to have the say in the company which accrues to him by virtue of the voting rights which are attached to his shares by his contract with the company, preserved against improper actions by the company or the directors who manage its affairs. It is true, as the learned judge appealed from observed, that a person taking shares in a company must be taken to have agreed to suffer such effects as may flow from the allotment of further shares made by the company, but that is not to say that he is without rights in relation to such further allotment as may be made by the directors for improper purposes. The rule in Foss v Harbottle clearly operates to preclude a shareholder from suing in his personal capacity in respect of a detriment which he suffers in common with other shareholders in consequence of a wrong done to the company. There is a clear distinction, however, between such a detriment and the diminution of a shareholder’s effective voting power by an improper allotment of shares by directors acting on behalf of the company. The latter is not merely a breach of duty by the directors to the company, it is also a wrong done to the shareholder by the company acting through its agents. To make that distinction is not necessarily to subscribe to the view that a shareholder has a personal right not to be affected detrimentally by any breach of what is said to be an implied term in the contract between the member and the company that the affairs of the company will be managed without impropriety on the part of the directors. Diminution of voting power stands on a fundamentally different footing from other detriments resulting from abuse of power by directors. A member’s voting rights and the rights of participation which they provide in the decision making of the company are a fundamental attribute of membership and are rights which the member should be able to protect by legal action against improper diminution. The rule in Foss v Harbottle has no application where individual membership rights as opposed to corporate rights are involved: Ephstathis v Greek Orthodox Community of St George (1988) 13 ACLR 691 esp at 696 per Ryan J. It must be acknowledged that there has often been a lack of clear differentiation in the cases between the situations in which the company is the only proper plaintiff, the situations in which a shareholder may prosecute a derivative action for a remedy in favour of the company and situations in which a shareholder may bring an action on his own behalf for a personal remedy. There is also a lack of clarity as to the basis upon which individual shareholders have been allowed to sue to have allotments of shares made for improper purposes set aside. I think, however, that there is a clear trend in cases of the highest authority tending to indicate the existence of a personal right in a shareholder, grounded upon equitable principles, to have the voting power of his shares undiminished by improper actions [8.130]

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Residues Treatment and Trading Co Ltd v Southern Resources Ltd cont. on [203] the part of the directors and of his locus standi to institute and prosecute proceedings to protect that right. I think that the time has come for the courts to give unequivocal recognition to such a right. … In addition to the considerations of principle and authority which I have developed, there are moreover, as it seems to me, considerations of policy which should now incline the courts to recognise the standing of individual shareholders to sue to have allotments made for improper purposes set aside. A number of sections of the Companies Act confer standing on shareholders [204] to seek remedies of a similar kind on grounds which are analogous to the equitable grounds for such relief. Section 175 authorises any member of the company to apply for rectification of the register. The close relationship of this remedy to the corresponding or analogous equitable remedy can only lead to confusion and unedifying technicality if standing which exists for the statutory proceeding is denied for the equitable proceeding. There is also considerable scope for overlapping of remedies and grounds between an action of the present kind based on equitable grounds and proceedings for statutory relief under Pt 2.F1 in respect of which an affected shareholder is given standing by the statute. It has been argued, however, that there is a firm rule of law that a shareholder does not have standing to seek relief in respect of any act of the directors which is capable of ratification by the members in general meeting. My first comment on that proposition is that it is by no means clear to me that the allotment in question, if made for the improper purpose alleged, is capable of ratification. It is clear law that the voting power of a majority may not be exercised in a way which is oppressive of or in fraud of minority shareholders … The High Court in Ngurli Ltd v McCann ([7.270] at 438) said that “voting powers conferred on shareholders and powers conferred on directors by the articles of association of companies must be used bona fide for the benefit of the company as a whole”. If it is correct that a shareholder has a personal right to have the voting power of his shares undiminished by an allotment of shares made for an improper purpose, there is to my mind a substantial argument that an exercise of the voting power of the majority to ratify such an allotment would be beyond the scope of the purpose for which that [205] power exists. This is an issue which may have to be resolved at trial. I have adverted to the issue because I do not wish it to be assumed from my consideration of the submission as to locus standi that I necessarily accept that the allotment is capable of ratification. I think, however, that the submission as to locus standi can be disposed of without resolving the issue as to the capacity of a general meeting to ratify the allotment. The submission as to locus standi is based upon the principle enunciated in MacDougall v Gardiner (1875) 1 Ch D 13 that if an irregularity is capable of being cured by resolution of a general meeting, an individual shareholder may not sue on his own behalf or on behalf of himself and other shareholders to complain of that irregularity. There is no difficulty with that principle where the complaint is of an irregularity in a matter concerning the internal management of the company. The English Court of Appeal in Bamford v Bamford ([8.30]) applied the principle to an improper allotment of shares. If, however, such an allotment infringes the personal rights of shareholders, it is difficult to see how the potential for ratification can deprive the wronged shareholder of locus standi while the infringement continues. Even if the shareholder’s action can be defeated by ratification of the allotment by a general meeting on the basis that the infringement ceases because the shareholder has no right to have the voting power of his shares remain unaffected by the lawful issue of further shares by the company, there appears to be no reason in principle why his locus standi should not exist until the infringement is expunged by ratification. I do not think that the potential for ratification, if it exists, is sufficient reason for depriving the plaintiffs of locus standi. Certain paragraphs of the statement of claim challenge the validity of resolutions said to have been passed at a general meeting ratifying the impugned allotments. The challenge is made substantially upon the basis that a poll was wrongly refused in respect of one resolution and that proxies given for an earlier meeting were used in support of two other resolutions. No argument was addressed to us on the question of locus standi to make that challenge and I consider that standing exists in respect of the challenge to those resolutions. 628

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Residues Treatment and Trading Co Ltd v Southern Resources Ltd cont. I am prepared to hold, for the above reasons, that the plaintiffs have locus standi to prosecute this action upon the basis of the allegations and claims pleaded in the impugned statement of claim. [Matheson and Bollen JJ agreed with the judgment of King CJ.]

[8.132]

Notes&Questions

1.

We have seen that the modern ratification cases appear to touch solely upon shareholders’ rights to bring derivative proceedings. Personal rights, upon the traditional view, were unaffected by the rule in Foss v Harbottle and therefore unaffected by general meeting action. However, in Winthrop v Winns [8.35] Mahoney JA concluded that ratification by the general meeting also extinguished a shareholder’s right to seek rectification of the share register under the predecessor to s 175: see Winthrop Investments Ltd v Winns Ltd [1975] 2 NSWLR 666 at 690-697; semble Samuels JA concurred at 680-681. The plaintiff in Winthrop argued that it had an individual right to have the directors exercise corporate powers for the purposes of the company and not for collateral purposes. It relied upon the passage from the judgment of Williams J in Grant v John Grant & Sons Pty Ltd (1950) 82 CLR 1 that s 175 conferred a statutory right to rectification in respect of shares irregularly allotted. Mahoney JA held, however, that the right was subject to the entry on the register being made “without sufficient cause” and where the wrong in question is done to the company, and the act voidable, s 175 does not affect the power to affirm: at 696-697. Samuels JA also accepted that s 175 conferred no individual rights immune to ratification: at 680-681.

2.

For further discussion of the scope of the personal action (with particular reference to whether s 140 enables a member to sue for enforcement of the articles generally) see K W Wedderburn [1957] CLJ 194 at 209-215; Beck at 169-179; C Baxter [1983] CLJ 96; S Chumir (1965) 4 Alberta LR 96; R R Drury [1986] CLJ 219; G D Goldberg (1985) 48 MLR 158 and (1972) 35 MLR 362; R Gregory (1981) 44 MLR 526; G N Prentice (1980) 1 Co Law 179; R J Smith (1978) 41 MLR 147; L S Sealy, “The Enforcement of Partnership Agreements, Articles of Association and Shareholder Agreements” in P D Finn (ed), Equity and Commercial Relationships (1987), pp 92-107; A G Diethelm (1989) 5 Aust Bar Rev 262; L Trotman, “Articles of Association and Contracts” in J H Farrar (ed), Contemporary Issues in Company Law (1987), p 31; G P Stapledon (1990) 8 C&SLJ 213. On the circumstances where a personal action may be brought for breach of duty by directors to shareholders see B Saunders (2004) 22 C&SLJ 535.

Injunctions against contravention of the Act [8.135] Where a person has engaged, is engaging or is proposing to engage in conduct which

contravenes the Act (or is ancillary to such a contravention), the Court may grant an injunction restraining the first person from engaging in the conduct or requiring the person to do an act: s 1324(1). It may do so on the application of ASIC or of a person whose interests have been, are or would be affected by the conduct; the Court may order the defendant to pay damages, either in addition to or in substitution for the injunction: s 1324(10). The power under s 1324 is discretionary and, although relief is not constrained by equitable principles, [8.135]

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the section does not displace the court’s equitable jurisdiction. 106 The considerations which the court must take into account in an application under s 1324 “may be gathered under the broad question whether the injunction would have some utility or would serve some purpose within the contemplation of the [Act]”. 107 Particularly where ASIC is the applicant, since the Act is “concerned primarily with the protection of the public interest in the prevention of particular conduct … the statutory jurisdiction is essentially a public interest provision”. 108 It is possible that Pt 2D.1 and s 1324 might in conjunction confer standing upon minority shareholders to restrain directors from breaching their fiduciary duties or duties of care, diligence and skill. (It is not clear whether proceedings under s 1324 would be derivative or personal in character; neither is its relation to Foss v Harbottle generally settled. 109) If so, s 1324(10) might permit an order for damages for the company or some or all of its shareholders. Since Pt 2D.1 imports the fiduciary obligations of the general law, conduct which contravenes the section might possibly found an application under s 1324(10). By this side-wind, the exclusionary rules against shareholder standing might be evaded, at least if the minority shareholder is a person whose interests are affected by contravention of the provision. A broad interpretation was conceded for the phrase in Broken Hill Proprietary Co Ltd v Bell Resources Ltd, 110 where standing was granted to the target company to challenge the validity of the takeover offers. A narrow interpretation of the nature of the discretion was taken in Mesenberg v Cord Industrial Recruiters (Nos 1 & 2) where the court held that, since the predecessor to s 181 was a civil penalty provision, only ASIC had power to enforce the provision. Young J said: I have extreme disquiet as to whether the legislature really intended that whenever there is a breach of even a very minor part of the Corporations Law, any shareholder or creditor of the company, because he or she can say that he or she has a stronger interest than the ordinary member of the company, should be able to displace the role of the directors or the liquidators and make the decision to prosecute a breach. As a matter of court administration and in having cost effective dispute resolution, that is a very unwise thing to do because the rule in Foss v Harbottle came about through the expensive and time-wasting experience of a series of individual or class actions by people who had agreed that the directors should be in control of the company, yet were taking matters into their own hands. Commercially it is also undesirable. The liquidator or the directors are usually the people who can see the whole picture, whereas the individual shareholder or creditor often does not have all the information. For instance, it may be that the board of directors knows that the Chief Executive Officer is paying himself or herself some thousands of dollars in unauthorised commissions, but are prepared to tolerate the situation because the person is really vital to the organisation and if he or she were not riddled by the guilt complexes of being paid unauthorised moneys, the person may well be in a position to demand and get a much higher remuneration package. There are many other examples. 111

The decision has been criticised judicially as “[going] against the plain terms of s 1324”. 112 Commentators have queried whether the narrow interpretation is confined to s 181 or extends 106

Re Brunswick NL (1990) 3 ACSR 625.

107 108

ASIC v Mauer-Swisse Securities Ltd (2002) 42 ACSR 605 at [36]. Re Idyllic Solutions Pty Ltd (2013) 93 ACSR 421 at [69].

109

Scarel Pty Ltd v City Loan & Credit Corp Pty Ltd (1988) 12 ACLR 730 at 734.

110

(1984) 8 ACLR 609 at 613. The BHP decision was followed in QIW Retailers Ltd v Davids Holdings Pty Ltd (No 2) (1992) 8 ACR 333. The section was also relied upon in a challenge to directors’ decisions with respect to convening a general meeting: Premier Gold NL v Ocean Resources NL (1994) 14 ACSR 695; see also Allen v Atalay (1993) 11 ACSR 753 at 757-758.

111 112

Mesenberg v Cord Industrial Recruiters (Nos 1 & 2) (1996) 19 ACSR 483 at 488-489. Airpeak Pty Ltd v Jetstream Aircraft Ltd (1997) 23 ACSR 715 at 721; see also Emlen Pty Ltd v St Barbara Mines Ltd (1997) 24 ACSR 303 at 306 (“the decision in Mesenberg is not so plainly correct that a contrary conclusion is unarguable”).

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to other civil penalty provisions; the balance of role between shareholders and ASIC in enforcement of the Act and especially the duties of officers is cogently disputed. 113 If the criticisms of Mesenberg prevail, and if the right under s 1324 is personal rather than derivative, the armoury of individual shareholders is powerfully strengthened in a manner unaffected by the introduction of the statutory derivative procedure since it does not affect the enforcement of individual rights: s 236 (note 3).

COMPULSORY LIQUIDATION REMEDIES Introduction [8.140] It will be apparent that general law doctrines for the protection of minorities are

deficient in significant respects. First, despite the introduction of the statutory derivative action, their formulation is unclear and scope uncertain. Second, they focus upon a single act or transaction rather than upon the whole picture or pattern of conduct over a period. Third, the remedies are directed to particular transactions and are confined to the restraint of conduct, the recovery of property or the ordering of financial compensation. These are, of course, important remedies but some disputes may call for more comprehensive intervention to restore the relationship between the parties to a secure footing. Alternatively, the proper solution may be to enable a disaffected shareholder to realise her or his investment on just terms. The statutory remedies for minorities act as a gloss upon the general law doctrines and go some way towards supplementing these deficiencies. The statutory remedies fall into two broad categories – the compulsory liquidation remedies and the remedies for oppression or injustice. Both categories concede clear and unequivocal standing to individual shareholders. The former category permits the Court to make an order for the winding up of a company on the application, inter alia, of a contributory 114 if: 1. the Court is of opinion that it is just and equitable that the company be wound up (s 461(k)); 2. directors have acted in affairs of the company in their own interests rather than in the interests of the members as a whole, or in any other manner whatsoever that appears to be unfair or unjust to other members (s 461(e)); 3. affairs of the company are being conducted in a manner that is oppressive or unfairly prejudicial to, or unfairly discriminatory against, a member or in a manner that is contrary to the interests of the members as a whole (s 461(f)); or 4.

an act or omission, or a proposed act or omission, by or on behalf of the company, or a resolution or proposed resolution of a class of members of the company, was or would be oppressive or unfairly prejudicial to, or unfairly discriminatory against, a member or members or was or would be contrary to the interests of the members as a whole: s 461(g). The oppression or injustice remedy in Pt 2F.1 allows for a much wider range of orders to be made with respect to a company where the Court finds that its affairs are being conducted in a manner that is oppressive or unfairly prejudicial to, or unfairly discriminatory against, a member or in a manner that is contrary to the interests of the members as a whole. An order may also be made when an act, omission or resolution, actual or proposed, by the company 113

114

H A J Ford, R P Austin & I M Ramsay, Ford’s Principles of Corporations Law (looseleaf service), [10.310.24]; H Bird (1997) 25 ABLR 179; R Baxt (1996) 14 C&SLJ 312. On the issue of the relative enforcement capacity with respect to corporate rights and duties as between shareholders and ASIC, see the empirical study in I M Ramsay (1995) 23 ABLR 174. Section 462(2)(c), defined in s 9 to include present and some past members. [8.140]

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satisfies any of these descriptions. Any member of a company who believes that its affairs or transactions are within the formulations may apply for an order under the section: see [8.195]. The just and equitable ground

The history and broad scope of the remedy [8.145] The just and equitable ground of winding up 115 (s 461(k)) may be traced to an

English Act of 1848. 116 Initially the eiusdem generis rule was applied to its construction and its meaning read down by reference to that of the other grounds for compulsory liquidation. 117 When the clause was freed of this interpretation late in the 19th century, 118 it was limited to particular categories by reference to which a shareholder need frame the complaint to have any prospect of success. In 1973 the House of Lords in Ebrahimi v Westbourne Galleries Ltd disparaged the tendency to create such categories: “Illustrations may be used, but general words should remain general and not be reduced to the sum of particular instances.” 119 The just and equitable clause is a legacy of partnership and provides a bridge between company and partnership doctrines. 120 Indeed, the principal modern application of the clause is with companies which are in the nature of incorporated partnerships or quasi-partnerships although a formal partnership between the parties satisfying the requirements of the Partnerships Acts is unnecessary. 121 Much of this development derives from Ebrahimi’s case [8.155] where partnership doctrines were applied to such a company to give effect to understandings on which the company was formed but which had not been fully realised in its legal structure. The deeper origins of partnership law explain this development: Company law developed from the law of partnership. Partnership itself was a development of societas, one of the Roman law consensual contracts. Societas was a perfectly bilateral contract in Roman law. Accordingly, it was enforced according to principles of bona fides. That is to say, the strict enforcement or exercise of legal rights would not be permitted if that strict enforcement or exercise was contrary to good faith. Matters that were recognised by practices and custom could be taken into account in the enforcement of a synallagmatic contract, rather than restricting such enforcement to the literal meaning of words (See Digest 21.1.31.20). The tradition of the enforcement of contracts of partnership in equity carried over into company law, such that equitable considerations may make it unfair for those conducting the affairs of a company to rely upon strict legal powers. Unfairness may consist of the use of the provisions of a constitution in a manner that equity would regard as contrary to good faith. 122

Other categories (or illustrations) under the clause arise where the company has abandoned its main objects or has entered upon activities beyond the general intention of its corporators (the failure of substratum), where the company is unable to carry on business because of a 115 116

For a fuller discussion of the clause, see F H Callaway, Winding Up on the Just and Equitable Ground (1978). 11 & 12 Vict c 45.

117

Re Agriculturist Cattle Insurance Co; Ex parte Spackman (1849) 1 Mac & G 170; 41 ER 1228 at 174 (Mac & G), 1230 (ER). See Callaway, pp 3-4.

118 119

Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 at 374-375: [8.155].

120 121

122

A like clause appears in partnership statutes: see, eg, Partnership Act 1892 (NSW), s 35(f). Brooker v Friend & Brooker Pty Ltd [2006] NSWCA 385 at [142]-[143]; Nassar v Innovative Precasters Group Pty Ltd [2009] NSWSC 342 at [74]-[76]. In MMAL Rentals Pty Ltd v Bruning [2004] NSWCA 451 at [71] Spigelman CJ avoided what he called “the often misleading terminology of quasi partnership”, referring instead to “a majority controlled business requiring mutual cooperation and a level of trust”. Use of the quasi-partnership terminology persists, however, in judicial decisions. HNA Irish Nominee Ltd v Kinghorn (No 2) [2012] FCA 228 at [501].

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deadlock in its management 123 and where the company’s management or control is characterised by fraud or misconduct or otherwise gives rise to a justifiable lack of confidence by shareholders. Concerning the latter instance, Lord Shaw said in Loch v John Blackwood Ltd: It is undoubtedly true that at the foundation of applications for winding up on the “just and equitable rule”, there must lie a justifiable lack of confidence in the conduct and management of the company’s affairs. But this lack of confidence must be grounded on conduct of the directors, not in regard to their private life or affairs, but in regard to the company’s business. Furthermore, the lack of confidence must spring not from dissatisfaction at being outvoted on the business affairs, or on what is called the domestic policy, of the company. On the other hand, whenever the lack of confidence is rested on a lack of probity in the conduct of the company’s affairs, then the former is justified by the latter and it is, under the statute, just and equitable that the company be wound up. 124

A contemporary Canadian formulation has been approved in New South Wales: [There must be] misconduct sufficient to destroy a reasonable shareholder’s confidence that the business, if left in the hands of the respondents, will be conducted competently and honestly and in the interests of all shareholders, including the petitioners. 125

The subjective failure of confidence alone is insufficient to found a winding up order on this ground. 126 While the grounds upon which an order might be made on the basis of justifiable lack of confidence will commonly involve breach of duty by directors or controllers or non-compliance with procedural requirements remediable at general law, the remedy has the advantage of shifting the focus of inquiry from specific acts to the total pattern of conduct over a period. This may justify an order where the specific incidents complained of, viewed in isolation, would not do so at general law. In ASIC v Kingsley Brown Properties Pty Ltd, Mandie J identified in the cases on the just and equitable ground the following principles and criteria for decision: • lack of confidence in the conduct and management of the company’s affairs lies at the foundation of applications for winding up on the just and equitable ground; • the classes of conduct justifying an order are not closed and there is no necessary limit to the generality of the words “just and equitable”; • the facts or conduct which make it just and equitable must have a direct or immediate relationship to, or bearing upon, the management or administration of the affairs of the company or the subject of its business (“a sufficient nexus”); • fairness was a relevant criterion thus freeing the Court, where appropriate, from technical considerations of legal rights; • relevant public interest considerations included the protection of investors and the prevention or condemnation of repeated breaches of the law; • a stronger case might be required where the company was prosperous, or at least solvent, and/or where there was an established business being carried on. 127 The just and equitable remedy is not only applicable to disputes between shareholders but may be invoked, with leave of the Court, by ASIC: s 459P(1)(f), (2)(d). In Australian Securities 123

126

As in Re Yenidje Tobacco Co [1916] 2 Ch 426; Wagner v International Health Promotions Pty Ltd (1994) 14 ACSR 466; Gregor v British-Israel-World Federation (2002) 41 ACSR 641. [1924] AC 783 at 788. Re James Lumbers Ltd (1925) 58 OLR 100 at 118 per Rode J, quoted in International Hospitality Concepts Pty Ltd v National Marketing Concepts Inc (No 2) (1994) 13 ACSR 368 at 371. International Hospitality Concepts Pty Ltd v National Marketing Concepts Inc (No 2) (1994) 13 ACSR 368.

127

ASIC v Kingsley Brown Properties Pty Ltd [2005] VSC 506 at [96].

124 125

[8.145]

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Commission v AS Nominees Ltd, ASC (ASIC’s predecessor) applied to wind up companies operating superannuation and unit trusts, alleging that the trustee companies had been run for the benefit of the founder and the directors, and that there had been breaches of trust, repeated breaches of corporations law, and fraud. Finn J held that where a statutory authority such as ASIC was authorised to apply on the just and equitable ground “there seems to be no reason at all why a court entertaining such an application should not have regard to such actual public interest considerations as have … induced the governmental body to seek a just and equitable winding up order”. 128 That public interest included a distinct public interest in ASIC securing compliance with the corporations law where regular and repeated breaches had occurred, especially where investor protection was affected. The order was made, based upon a lack of management propriety and competence, and misconduct and mismanagement in the trust business that held investors’ money on a fiduciary basis. He concluded that winding up was not only a convenient means of removing companies from the control of the trusts but also “the appropriate expression of the lack of confidence one must have in the directors of these companies in their conduct and management of the affairs of their companies”. 129 The bold decision in Ebrahimi’s case may have had the paradoxical effect of reducing, rather than enhancing, the practical significance of the clause. Ebrahimi’s case highlighted the restrictions which courts had placed upon the statutory oppression remedy and within a decade in both England and Australia that remedy had been comprehensively recast and its utility greatly enhanced. Of course, the just and equitable clause enables a shareholder to have a liquidator (under the supervision of the court) investigate, recover company property and distribute any surplus among members. In some situations, however, this solution may be only a marginal advance over the former condition of the minority, Hence the greater appeal of the wider range of orders under the oppression remedy. Indeed, it is not uncommon for an application under the just and equitable ground to be coupled with an application for orders under the oppression remedy. It may be that the just and equitable ground is an essential remedy only in instances of irreconcilable differences between the parties or other applications of the quasi-partnership principle 130 since irreconcilable differences may not of themselves constitute oppression or unfair prejudice. 131 Further, it is a well established practice for a court, before making an order under the just and equitable clause, where the company is not deadlocked and is otherwise functioning profitably, to postpone the dissolution order until the parties have had an opportunity to negotiate a buy-out or reach some other compromise. 132 Partly, the reason is the extreme reluctance of the court to wind up a solvent company. 133 Indeed, where a shareholder petitioning for a winding up order on the just and equitable ground or under s 461(k) is also entitled to some other remedy and is acting unreasonably in not pursuing that alternative remedy, the petitioner loses her or his entitlement to a winding up order: s 467(4). The alternative remedy need not be a legal remedy in the sense of a cause of 128

Australian Securities Commission v AS Nominees Ltd (1995) 18 ACSR 459 at 517; see [7.50].

129

Australian Securities Commission v AS Nominees Ltd (1995) 18 ACSR 459 at 519.

130 131

As in Thomas v Mackay Investments Pty Ltd (1996) 22 ACSR 294. Nassar v Innovative Precasters Group Pty Ltd [2009] NSWSC 342; Fexuto Pty Ltd v Bosnjak Holdings Pty Ltd [2001] NSWCA 97 at [89]; McMillan v Toledo Enterprises International Pty Ltd (1995) 18 ACSR 603 at 614, citing Re a Company (1986) 2 BCC 99,191 for the proposition that such irreconcilable differences are inadequate to found relief under the oppression remedy; Campbell v Backoffice Investments Pty Ltd (2009) 238 CLR 304 at [68], [177]. See, eg, Re City Meat Co Pty Ltd (1984) 8 ACLR 673; Ruut v Head (1996) 20 ACSR 160 at 163. A winding up order may even be recalled after it has been pronounced: Re XL Petroleum Ltd [1971] VR 560. International Hospitality Concepts Pty Ltd v National Marketing Concepts Inc (No 2) (1994) 13 ACSR 368 at 372. But such reluctance will give way where the force of equitable considerations requires it: see, eg, Kokotovich Constructions Pty Ltd v Wallington (1995) 17 ACSR 478 at 494.

132 133

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action but includes a course of action that is reasonably available to the petitioner such as an offer to purchase the petitioner’s shares on fair terms. 134 The following cases comprise the leading modern decisions with respect to the failure of substratum and the quasi-partnership instances in which the remedy may be invoked.

Re Tivoli Freeholds Ltd [8.150] Re Tivoli Freeholds Ltd [1972] VR 445 Supreme Court of Victoria [Tivoli Freeholds Ltd had managed the Tivoli and Lyceum theatres in Melbourne. After the Tivoli was damaged by fire, the company sold the theatres and ceased its theatrical activities. The company in general meeting resolved to lend its surplus funds to its principal shareholder which had increased its holding to a majority of the Tivoli capital. These funds were being applied for the purpose of assisting the parent’s corporate raiding activities (viz, acquiring undervalued companies for their more profitable operation or disposal of their assets). Approximately 93% by number of the minority shareholders (representing 42% of issued capital) opposed the current direction of company policy. A minority shareholder petitioned for an order under the equivalent of s 461(k).] MENHENNITT J: [468] In relation to the ground that it is just and equitable that the company be wound up, the following propositions appear to me to be applicable to this case and to be established by authority: (1)

The ground is that it is just and equitable to wind up the company. These are well known words and there is no adequate equivalent for them. They give the court a wide discretion which must, of course, be exercised judicially: Baird v Henry Lees 1924 SC 83 at 90; Re Wondoflex Textiles Pty Ltd [1951] VLR 458 at 484, 485. The question involved is basically a question of fact and all the circumstances must be looked at. …

(2)

The facts rendering it just and equitable that a company be wound up and the decisions on that ground cannot be resolved into an exhaustive set of categories. … For convenience the textbooks group the cases under headings. … These headings are not an exhaustive set of categories and when all the facts of a case are examined it may be found that more than one of the recognised headings is relevant or that some new or additional aspect makes it just and equitable to wind up a company.

(3)

At the same time, in so far as decisions binding upon me have defined basic elements necessary to constitute a particular concept, those decisions are of course to be observed by me and in so far as a case involves one concept alone such decisions might well indicate the only conclusion that was open to me. However, before reaching such a conclusion it would be necessary to have regard to changing circumstances and developments in relation to company practices including any relevant changes in the law.

(4)

It has been recognised that it may be just and equitable to wind a company up if the company engages in acts which are entirely outside what can fairly be regarded as having been within the general intention and common understanding of the members when they became members: H A Stephenson & Son Ltd (in liq) v Gillanders Arbuthnot & Co (1931) 45 CLR 476 at

134

See, eg, Re A Company [1983] 1 WLR 927 where Vinelott J said (at 933) that what the subsection is directed at is “a situation in which the continuance of the company would be unjust to the petitioner and where the injustice cannot be remedied by any step reasonably open to the petitioner”. In that case it was held that an out-of-court offer to purchase the plaintiff’s shareholding on fair terms was another remedy within the equivalent provision and that prima facie no winding up order should therefore be made while such an offer is current. This is the preferred view in Australia (see, eg, John J Starr (Real Estate) Pty Ltd v Robert R Andrew (A’Asia) Pty Ltd (1991) 6 ACSR 63 at 66; Triulcio v Chase Property Investments Pty Ltd [2004] NSWSC 31; Host-Plus Pty Ltd v Australian Hotels Association [2003] VSC 145 at [67]) although the contrary view has also been adopted in Australia, viz, that the reference in s 467(4) to “any other remedy” is limited to another legal cause of action, common law or statutory, available to the petitioner: Bernhardt v Beau Rivage Pty Ltd (1989) 15 ACLR 160 at 164; this interpretation has not been followed in several other Australian decisions including those cited elsewhere in this footnote. [8.150]

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Re Tivoli Freeholds Ltd cont. 487; Re Wondoflex Textiles Pty Ltd [1951] VLR 458 at 467. The [469] cases on loss or failures of substratum are an illustration of this more basic concept: Re Wondoflex Textiles Pty Ltd. This more basic concept is not, it appears to me, confined to cases of “partnership” companies or “main object” companies. Whilst it may be easier to find the general intention and common understanding in those cases I can see no reason in principle why it should be confined to such cases and I am not aware of any decision that it is so confined. (5)

As to the ground that a company be wound up because of the failure of the substratum of a company, Lord Justice-Clerk Moncrieff said in Galbraith v Merito Shipping Co 1947 SC 446 at 456: “And I further agree that a failure of substratum, as this phrase has been interpreted by the court, is not evidenced by a mere discontinuance of business activities even for a lengthy period by a company; so long as this does not evidence a final and conclusive abandonment of the business.” Later he said: “I do not propose to examine the numerous decisions and authorities which were referred to at the debate. It is enough to say that … all the learned judges from Lord Cairns LJ, who first coined the phrase in Re Suburban Hotel Co (1867) 2 Ch App 737, to the learned judges who have made the most recent pronouncements, have uniformly insisted on the demonstrated and concluded finality of such an event by requiring that, before the substratum should be found to have been withdrawn, business within the objects of incorporation should have become at least in a practical sense ‘impossible’.”

Further, in Re Kitson & Co Ltd [1946] 1 All ER 435, and Re Taldua Rubber Co Ltd [1946] 2 All ER 763, where Re Kitson & Co Ltd was applied, the courts refused to wind up companies where a main or paramount object was still capable of being carried on by carrying on some business of the same kind as the original business, even although the original business had ceased, and it was stressed that whatever intention existed at the time of the petition was irrelevant because it was still open to the company to carry on business within the original object and the absence of a concrete scheme as to what the company proposed to do was no ground for winding up the company. But where, even although a company could still pursue its original objects, whether they be main or paramount objects or not, if in fact the matter has gone beyond intention and the company had in fact embarked upon a course which, even although it is within power, is quite outside and different from what was originally commonly intended and understood, then it appears to me that it may be just and equitable to wind up a company. The case of Re National Portland Cement Co Ltd [1930] NZLR 564, was one in which a main object had never been pursued for five years and it was then proposed to pursue a subsidiary object. However, it appears to me that Myers CJ, was stating a principle which can have general application when he said at 572: The most that can be said by the directors is that if their present proposed experiment of hydrating lime is successful they may be able to secure capital to carry out the main object for which the company was established. It seems to me that this really involves an abandonment of the primary object of the company, and that the shareholders who have taken up contributing shares are being asked to leave their money in a venture different altogether from that to which they have subscribed. [470] … (6) The question in issue and the tests to be applied in ascertaining the general intention and common understanding of the members or what is the substratum of the company are different from those for determining whether or not an act is ultra vires. The submission for the respondents that the question in issue and the tests involved are the same is contrary to the highest authority. Lord Parker of Waddington said in Cotman v Brougham [1918] AC 514 at 520: My Lords, Mr Whinney in his able argument suggested that, in considering whether a particular transaction was or was not ultra vires a company, regard ought to be had to the question whether at the date of the transaction the company could have been wound up on the ground that its substratum had failed. Upon consideration I cannot accept this suggestion. The question whether or not a company can be wound up for failure of 636

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Re Tivoli Freeholds Ltd cont. substratum is a question of equity between a company and its shareholders. The question whether or not a transaction is ultra vires is a question of law between the company and a third party. In H A Stephenson & Son Ltd (in liq) v Gillanders Arbuthnot & Co (1931) 45 CLR 476 Dixon J said at 487, 488: When the question is whether a particular transaction binds the company, or is extra vires, the well known principle may not apply by which, in considering whether a company should be wound up because the substratum of its constitution has failed, its true, main, dominant or paramount purpose is ascertained and general clauses are understood as subsidiary, as conferring powers not independent but subserving the main end. In the one case the ultimate question is whether it is just and equitable that the company should be wound up, and, for its determination, general intention and common understanding among the members of the company may be important. In the other case the question is one of corporate capacity only, and this must be ascertained according to the true meaning of the memorandum interpreted by a fair reading of the whole instru- [471] ment. … (8) All the authorities appear to me to recognise that the prime source for ascertaining the general intention and common understanding of the members is the company’s memorandum of association which among other things states its objects. [472] (9) Whether it is permissible to go beyond the company’s memorandum to ascertain the prime or main object or the general intention and common understanding of members is a matter on which there is a conflict of authority. … A prospectus was considered for the purpose in the case of Re National Portland Cement Co Ltd [1930] NZLR 564. It may well be that more can be looked at in the case of “partnership” company than in other cases. … However, a basic consideration is that the material being looked at must establish something general or common to all members and this consideration of itself precludes something passing between only the company and a particular shareholder unless it can be concluded that it was a matter common to all shareholders. The company’s course of conduct may be relevant but it could not prevail against the conclusion to be drawn from the memorandum; on the other hand, it may be useful to remove ambiguity. [The judge held that it was just and equitable that the company be wound up. The company’s main objects were concerned with entertainment and for a period of three years its funds had been wholly applied for purposes foreign to those objects and to the general intention of its members.]

[8.152]

Notes&Questions

1.

What, if any, is the effect on this doctrine of the 1983 and 1985 amendments that made the specification of objects optional (cf s 125(2))? If a company does not adopt objects, to what other material might a court look for evidence of the projected trading or investment sphere of the company? See Strong v J Brough & Son (Strathfield) Pty Ltd (1991) 5 ACSR 296 (any prospectus relevant to the subscription for shares, although it is doubtful how far a prospectus would be determinative, and any preliminary agreements between the founding members or other evidence as to the general intention and common understanding of the members).

2.

What tests emerge from Tivoli Freeholds to identify the substratum of a company? When is the substratum lost? Should a distinction be drawn between loss through supervening events and those arising from the company’s voluntary abandonment of particular activities? [8.152]

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3.

For a modern instance where an order was unsuccessfully sought under this category, see Re Community Press Pty Ltd (1980) 4 ACLR 782 where a newspaper publisher had ceased to trade but retained the right to publish several dormant newspapers; see also Re Johnson Corp Ltd (1980) 5 ACLR 227.

Ebrahimi v Westbourne Galleries Ltd [8.155] Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 House of Lords [Nazar and Ebrahimi formed a private company to carry on the business of dealing in carpets which they had previously conducted as equal partners. On incorporation of their business they each subscribed for 500 shares and were appointed directors. Later, Nazar’s son was made a director and the other two each transferred 100 shares to him. The company made good profits which were wholly distributed as directors’ remuneration. No dividends were ever paid. Eleven years after the incorporation, an ordinary resolution was passed in general meeting by the votes of the Nazars to remove Ebrahimi from office as director. (The removal power, under the English equivalent to s 203D, applies to private as well as public companies: see [5.240].) Ebrahimi petitioned for the winding up of the company on the just and equitable ground. The order was made but was set aside by the Court of Appeal. Ebrahimi appealed.] LORD WILBERFORCE: [375] [I]t has been suggested, and urged upon us, that (assuming the petitioner is a shareholder and not a creditor) the words [in the clause] must be confined to such circumstances as affect him in his capacity as shareholder. I see no warrant for this either. No doubt, in order to present a petition, he must qualify as a shareholder, but I see no reason for preventing him from relying upon any circumstances of justice or equity which affect him in his relations with the company, or, in a case such as the present, with the other shareholders. One other signpost is significant. The same words “just and equitable” appear in the Partnership Act 1892 (UK), s 25, as a ground for dissolution of a partnership and no doubt the considerations which they reflect formed part of the common law of partnership before its codification. The importance of this is to provide a bridge between cases under [s 461(k)] and the principles of equity developed in relation to partnerships. The winding up order was made following a doctrine which has developed in the courts since the beginning of this century. As presented by the appellant, and in substance accepted by the learned judge, this was that in a case such as this the members of the company are in substance partners, or quasi-partners, and that a winding up may be ordered if such facts are shown as could justify a dissolution of partnership between them. The common use of the words “just and equitable” in the company and partnership law supports this approach. Your Lordships were invited by the respondents’ counsel to restate the principle on which this provision ought to be used; it has not previously been considered by the House. The main line of his submission was to suggest that too great a use of the partnership analogy had been made; that a limited company, however small, essentially differs from a partnership; that in the case of a company, the rights of its members are governed by the articles of association which have contractual force; that the court has no power or at least ought not to dispense parties from observing their contracts; that, in particular, when one member has been excluded from the directorate, or management, under powers expressly conferred by the Companies Act and the articles, an order for winding up, whether on the partnership analogy or under the just and equitable provision, should not be made. Alternatively, it was argued that before the making of such an order could be considered the petitioner must show and prove that the exclusion was not made bona fide in the interests of the company. My Lords, I must first make some examination of the authorities in order to see how far they support the respondents’ propositions. … [378] Re Wondoflex Textiles Pty Ltd [1951] VLR 458 was a case where again the company was held to resemble a partnership. The petitioner, owner of a quarter share, was removed from office as director by the governing director exercising powers under the articles. Thus the issue, and the argument, closely resembled those in the present case. The judgment of Smith J contains the following passage, at 467: 638

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Ebrahimi v Westbourne Galleries Ltd cont. It is also true, I think, that, generally speaking, a petition for winding up, based upon the partnership analogy, cannot succeed if what is complained of is merely a valid exercise of powers conferred in terms by the articles: … To hold otherwise would enable a member to be relieved from the consequences of a bargain knowingly entered into by him: … But this, I think, is subject to an important qualification. Acts which, in law, are a valid exercise of powers conferred by the articles may nevertheless be entirely outside what can fairly be regarded as having been in the contemplation of the parties when they became members of the company; and in such cases the fact that what has been done is not in excess of power will not necessarily be an answer to a claim for winding up. Indeed, it may be said that one purpose of [the just and equitable provision] is to enable the court to relieve a party from his bargain in such cases. [379] My Lords, in my opinion these authorities represent a sound and rational development of the law which should be indorsed. The foundation of it all lies in the words “just and equitable” and, if there is any respect in which some of the cases may be open to criticism, it is that the courts may sometimes have been too timorous in giving them full force. The words are a recognition of the fact that a limited company is more than a mere legal entity, with a personality in law of its own: that there is room in company law for recognition of the fact that behind it, or amongst it, there are individuals, with rights, expectations and obligations inter se which are not necessarily submerged in the company structure. That structure is defined by the Companies Act and by the articles of association by which shareholders agree to be bound. In most companies and in most contexts, this definition is sufficient and exhaustive, equally so whether the company is large or small. 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. It would be impossible, and wholly undesirable, to define the circumstances in which these considerations may arise. Certainly the fact that a company is a small one, or a private company, is not enough. There are very many of these where the association is a purely commercial one, of which it can safely be said that the basis of association is adequately and exhaustively laid down in the articles. The superimposition of equitable considerations requires something more, which typically may include one, or probably more, of the following elements: (i) an association formed or continued on the basis of a personal relationship, involving mutual confidence – this element will often be found where a pre-existing partnership has been converted into a limited company; (ii) an agreement, or understanding, that all, or some (for there may be “sleeping” members), of the shareholders shall participate in the conduct of the business; (iii) restriction upon the transfer of the members’ interest in the company – so that if confidence is lost, or one member is removed from management, he cannot take out his stake and go elsewhere. It is these, and analogous, factors which may bring into play the just and equitable clause, and they do so directly, through the force of the words themselves. To refer, as so many of the cases do, to “quasi-partnerships” or “in substance partnerships” may be convenient but may also be confusing. It may be convenient because it is the law of partnership which has developed the conceptions of probity, good faith and mutual confidence, and the remedies where these are absent, which become relevant once such factors as I have mentioned are found to exist: the words “just and equitable” sum these up in the law of partnership itself. And in [380] many, but not necessarily all, cases there has been a pre-existing partnership the obligations of which it is reasonable to suppose continue to underlie the new company structure. But the expressions may be confusing if they obscure, or deny, the fact that the parties (possibly former partners) are now co-members in a company, who have accepted, in law, new obligations. A company, however small, however domestic, is a company not a partnership or even a quasi-partnership and it is through the just and equitable clause that obligations, common to partnership relations, may come in. [8.155]

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Ebrahimi v Westbourne Galleries Ltd cont. My Lords, this is an expulsion case, and I must briefly justify the application in such cases of the just and equitable clause. The question is, as always, whether it is equitable to allow one (or two) to make use of his legal rights to the prejudice of his associate(s). The law of companies recognises the right, in many ways, to remove a director from the board. Section 184 of the Companies Act 1948 (UK) confers this right upon the company in general meeting whatever the articles may say. Some articles may prescribe other methods: for example, a governing director may have the power to remove: compare Re Wondoflex Textiles Pty Ltd [1951] VLR 458. And quite apart from removal powers, there are normally provisions for retirement of directors by rotation so that their re-election can be opposed and defeated by a majority, or even by a casting vote. In all these ways a particular director-member may find himself no longer a director, through removal, or non-re-election: this situation he must normally accept, unless he undertakes the burden of proving fraud or mala fides. The just and equitable provision nevertheless comes to his assistance if he can point to, and prove, some special underlying obligation of his fellow member(s) in good faith, or confidence, that so long as the business continues he shall be entitled to management participation, an obligation so basic that, if broken, the conclusion must be that the association must be dissolved. And the principles on which he may do so are those worked out by the courts in partnership cases where there has been exclusion from management (see Const v Harris (1824) Tur & Rus 496; 37 ER 1191 at 525 (Tur & Rus)) even where under the partnership agreement there is a power of expulsion: see Blisset v Daniel (1853) 10 Hare 493; 68 ER 1022; Lindley on Partnership (13th ed, 1971), pp 331, 595. I come to the facts of this case. It is apparent enough that a potential basis for a winding up order under the just and equitable clause existed. The appellant after a long association in partnership, during which he had an equal share in the management, joined in the formation of the company. The inference must be indisputable that he, and Mr Nazar, did so on the basis that the character of the association would, as a matter of personal relation and good faith, remain the same. He was removed from his directorship under a power valid in law. Did he establish a case which, if he had remained in a partnership with a term providing for expulsion, would have justified an order for dissolution? This was the essential question for the judge. Plowman J dealt with the issue in a brief paragraph in which he said [1970] 1 WLR 1378 at 1389: while no doubt the petitioner was lawfully removed, in the sense that he ceased in law to be a director, it does not follow that in [381] removing him the respondents did not do him a wrong. In my judgment, they did do him a wrong, in the sense that it was an abuse of power and a breach of the good faith which partners owe to each other to exclude one of them from all participation in the business upon which they have embarked on the basis that all should participate in its management. The main justification put forward for removing him was that he was perpetually complaining, but the faults were not all on one side and, in my judgment, this is not sufficient justification. For these reasons, in my judgment, the petitioner, therefore, has made out a case for a winding up order. Reading this in the context of the judgment as a whole, which had dealt with the specific complaints of one side against the other, I take it as a finding that the respondents were not entitled, in justice and equity, to make use of their legal powers of expulsion and that, in accordance with the principles of such cases as Blisset v Daniel (1853) 10 Hare 493; 68 ER 1022, the only just and equitable course was to dissolve the association. To my mind, two factors strongly support this. First, Mr Nazar made it perfectly clear that he did not regard Mr Ebrahimi as a partner, but did regard him as an employee. But there was no possible doubt as to Mr Ebrahimi’s status throughout, so that Mr Nazar’s refusal to recognise it amounted, in effect, to a repudiation of the relationship. Second, Mr Ebrahimi, through ceasing to be a director, lost his right to share in the profits through directors’ remuneration, retaining only the chance of receiving dividends as a minority shareholder. It is true that an assurance was given in evidence that the previous practice (of not paying dividends) would not be continued, but the fact remains that Mr Ebrahimi was thenceforth at the mercy of the Messrs Nazar as to what he should receive out of the profits and when. He was, moreover, unable to dispose of his interest without the consent of the Nazars. All these matters lead only to the conclusion that the right course was to dissolve the association by winding up. 640

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Ebrahimi v Westbourne Galleries Ltd cont. I must deal with one final point which was much relied on by the Court of Appeal. It was said that the removal was, according to the evidence of Mr Nazar, bona fide in the interests of the company; that Mr Ebrahimi had not shown the contrary; that he ought to do so or to demonstrate that no reasonable man could think that his removal was in the company’s interest. This formula “bona fide in the interests of the company” is one that is relevant in certain contexts of company law and I do not doubt that in many cases decisions have to be left to majorities or directors to take which the courts must assume had this basis. It may, on the other hand, become little more than an alibi for a refusal to consider the merits of the case, and in a situation such as this it seems to have little meaning other than “in the interests of the majority”. Mr Nazar may well have persuaded himself, quite genuinely, that the company would be better off without Mr Ebrahimi, but if Mr Ebrahimi disputed this, or thought the same with reference to Mr Nazar, what prevails is simply the majority view. To confine the application of the just and equitable clause to proved cases of mala fides would be to negative the generality of the words. It is because I do not accept this that I feel myself obliged to differ from the Court of Appeal. [Viscount Dilhorne and Lords Pearson, Cross and Salmon concurred.]

Australian applications of the quasi-partnership analogy [8.160] Three groups of Australian decisions indicate the scope of the clause for subjecting

legal rights to “equitable considerations” arising from understanding between the corporators. First, in Re Caratti Holdings Ltd 135 a company’s constitution gave its governing director the power to acquire the shares of other members at the nominal value for which they were originally issued. In the Supreme Court of Western Australia Burt J held that the exercise of the power against a particular shareholder, although formally valid, was a sufficient ground for an order under the clause. To permit the governing director to acquire the shares compulsorily at a gross undervalue was contrary to a clear understanding that had existed from the outset that the shareholder would have a 10% “partnership” interest in the business. Similarly, in Kokotovich Constructions Pty Ltd v Wallington 136 a winding up order was made at the suit of a minority shareholder whose small shareholding was granted on the formation of a company, otherwise under sole proprietorship, in recognition of a “moral partnership” founded upon a pre-existing intimate and business relationship. The winding up order was justified by reference to the continuing animosity between the parties, the risk of further oppression (the majority shareholder had purported to have a very large share issue made to him to render the other holding near to worthless) and the very limited nature of the company’s activities. Second, in Re City Meat Co Pty Ltd 137 all the shareholders in a company were members of a single family and had acquired their shares by inheritance. The company had assets of approximately $4 million but its trading generated few profits and it rarely paid dividends. The majority shareholder (who was managing director) received regular income from the family by way of salary and director’s fees and had come to regard the company as his own. The court held that he had consistently ignored the “rights, expectations and obligations” 138 of the petitioners’ branch of the family (which held 36% of the capital). Accordingly, it was just and equitable that a winding up order be made. 139 135 136 137

(1975) 1 ACLR 87, affirmed sub nom Caratti Holding Co Pty Ltd v Zampatti (1979) 52 ALJR 732; see also Kounis v Kounis (1987) 11 ACLR 854. (1995) 17 ACSR 478; see also O’Neill v Phillips [1999] 2 All ER 961. (1984) 8 ACLR 673.

138

Compare Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 at 379.

139

See, however, Re G Jeffrey (Mens Store) Pty Ltd (1984) 9 ACLR 193 where Re City Meat Co (1984) 8 ACLR 673 was distinguished and an order refused. [8.160]

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Third, in Re Dalkeith Investments Pty Ltd 140 shares in a company were divided equally between former spouses and their daughter. The company was “[in] substance … a partnership in corporate form”. In the Supreme Court of Queensland McPherson J found that the arrangement between the corporators: was a family arrangement in which their expectation was that they would act in the affairs of the company in a spirit of friendly co-operation for their common benefit and not one in which they contemplated that their rights and relations inter se would be governed by a strict application of the rules of company law. It is no part of my function to attempt to analyse or apportion the reasons for the animosity that has grown up between the parties. The divorce, and the inevitable litigation that has preceded or accompanied it, has in my view, destroyed the relationship of mutual trust and confidence which might otherwise have been expected to subsist between them as members of the same family group. It is no longer possible for them to work together for the common good or to rely, for the protection of their interests and investments in the company, upon the goodwill which they supposed would exist between them. The point has now been reached where such a state of animosity exists between them as precludes all reasonable hope of reconciliation and friendly co-operation in the affairs of the company. 141

The petitioner was, in consequence, entitled to a winding up order. Similarly, in a non-family context, relief was granted where the relationship between the parties had broken down, the petitioner’s proportionate shareholding was under threat, his role in the management of the company had been marginalised by the conduct of the other director, the company accounts had not been properly kept, there was a dispute as to the validity of a board appointment and an urgent need for funds. Those factors reflected a serious and operative state of mistrust and disharmony between the two directors. 142 In Tomanovic v Argyle HQ Pty Ltd, Austin J accepted the proposition that two additional elements beyond the “breakdown” or loss of “confidence” between incorporators must generally also be satisfied (citations omitted): First, the “breakdown” must be of a nature and degree that materially frustrates the commercially viable and sensible operations of the company in accordance with the incorporators’ expectations; and any “loss of confidence” must be justified. Thus, it has been held that winding up on the just and equitable ground may be appropriate: (a) “where a working relationship predicated on mutual co-operation, trust and confidence has broken down”, such that the “continuation of such an association would be a futility; (b) where there is “no real prospect that the parties can work together sensibly to reach the necessary agreement to be able to conduct the company’s business in the future”, such that “the company’s operations in the future will not be able to be conducted in any commercially viable and sensible way”; (c) there is a “serious and operative state of mistrust and disharmony” between incorporators; (d) where the relationship between incorporators “has completely broken down”, such that the company “could not continue to function meaningfully”; (e) where “the foundation of the whole agreement that was made, that the [incorporators] would act as reasonable men with reasonable courtesy and reasonable conduct in every way towards each other”, and there has been a breakdown in communication;

140

(1985) 3 ACLC 74.

141 142

Re Dalkeith Investments Pty Ltd (1985) 3 ACLC 74 at 79. McMillan v Toledo Enterprises International Pty Ltd (1995) 18 ACSR 603.

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(f) there is a “justifiable lack of confidence in the conduct and management of the company’s affairs” or (expressed another way) “it is impossible for the partners to place that confidence in each other which each has the right to expect, and that such impossibility has not been caused by the person seeking to take advantage of it”. Consequently, unfounded lack of confidence should not of itself support a winding up. (g) mere disagreement is insufficient to ground a winding up order. Secondly, there must generally be a restriction upon the transfer of the member’s interest. In circumstances where there are no restrictions on transfer, and there is no evidence that the “board would refuse to register a transfer in favour of a respectable transferee”, “this factor alone makes it extremely difficult for the plaintiff to succeed in the application” for winding-up on the just and equitable ground in the absence of oppression. 143

This statement of legal principles, not challenged upon the successful appeal, recognised that winding up is a remedy of last resort and one which ought not be granted if some less drastic relief is available under the statutory remedy for oppression. 144 The facts behind that dispute between the two men after their joint venture broke down are described at [8.210] when discussing the appeal decision in Tomanovic v Global Mortgage Equity Corporation Pty Ltd concerning the statutory oppression remedy. Relief was granted under that remedy. Austin J had held at first instance that there was no basis for winding up on the just and equitable ground arising merely from the failure of the two to effectuate the separation of their interests; further, such an order would “likely compromise the business as a going concern and cause a very substantial loss of shareholder value”. 145 An oppression order was considered appropriate on the facts. [8.162]

1.

2.

Notes&Questions

In Re A & BC Chewing Gum Ltd [1975] 1 WLR 579 an order was made for the winding up of a private company in which the petitioner had a one third equity but under a detailed shareholders’ agreement had a right to equal control with the two other shareholders. These latter shareholders repudiated the agreement and excluded the petitioner from management participation. The fact that the petitioner was a publicly listed New York corporation did not displace the superimposition of the equitable considerations expressed in the shareholders’ agreement. Generally, the stock exchange listing of a company will be incompatible with undisclosed expectations of shareholders as to the nature of the company’s operations and their place within them in view of the claims of public investors and their interest in the integrity of the company’s formal constitutional structure: see Re Blue Arrow plc (1987) 3 BCC 618. Ebrahimi’s expansive interpretation has been followed in other jurisdictions. Thus, in Re North End Hotel (Huntley) Ltd [1976] 1 NZLR 446 a winding up order was made for a company formed by a chartered accountant, his wife and a retired farmer. The three were the only directors of the company and the articles provided that the decisions of the directors were to be taken by a majority. There was also a restriction upon the transfer of shares. The company was running well and was successfully managed but the farmer was frustrated in his desire for a more active involvement. In making an order to wind up the company upon the basis that the petitioner’s expectations as to the degree of his participation in management had not been realised, Mahon J laid stress on the petitioner’s relative inexperience in commercial matters, his

143

Tomanovic v Argyle HQ Pty Ltd [2010] NSWSC 152 at [50]-[51].

144 145

Tomanovic v Global Mortgage Equity Corporation Pty Ltd (2011) 84 ACSR 121 at [289]. Tomanovic v Argyle HQ Pty Ltd [2010] NSWSC 152 at [9]. [8.162]

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failure to take independent advice before incorporation and the fact that the disintegration of the mutual confidence between the shareholders had in part resulted from the exercise of dominant powers unwittingly vested by the petitioner in the other shareholders.

Review Problem

[8.163]

Oceans Pty Ltd was incorporated to conduct a restaurant venture. It has four shareholders: Mr and Mrs Turner, Pope and Lewis. Under the Shareholder Agreement, the Turners are the sole directors and are alone responsible for day-to-day operations of Oceans while Pope and Lewis are to provide finance. Share capital is distributed equally amongst the four shareholders, and all major decisions (that is, those which involved the spending of more than $2,500) require the approval of at least three shareholders. As agreed, Pope and Lewis provided $80,000 and provided an overdraft facility of $20,000 to establish Oceans on the assurance that that would be the total investment required of them. Within a month of the restaurant opening in June, the whole $80,000 and the overdraft facility had been exhausted and Pope and Lewis were approached for more funds; they put in a further $10,000 in July. When they were again approached for more funds in September, they declined to do so. This weakened the already strained relationship with the Turners. Pope and Lewis argue that the shareholders have reached a complete deadlock so that it is impossible to conduct business. They want Oceans wound up. They say that there is a breakdown in the relationship between the parties and point to Oceans’ near insolvency. The Turners dispute the breakdown and argue that, in any event, the Shareholder Agreement provides that they shall manage the business without interference from Pope and Lewis. They add that Pope and Lewis have another remedy under Pt 2F.1 although they deny that oppression has occurred. (These facts are based upon those in Johnny Oceans Restaurant Pty Ltd v Page [2003] NSWSC 952.) Directors acting in their own interests [8.165] Section 461(e) permits the making of a winding up order where the directors have

acted in affairs of the company in their own interests rather than in the interests of the members as a whole, or in any other manner whatsoever that appears to be unfair or unjust to other members. The provision was introduced by the Companies Act 1936 (NSW) and has no English equivalent. Although the remedy has not been widely used, its utility derives from the breadth of its language. The ground posits an objective standard, namely, whether the directors have acted in their own interests etc or otherwise unfairly or unjustly. This standard avoids the problems which have plagued the law on directors’ duties in defining subjective notions of good faith or equitable fraud as the criteria for relief. The ground in s 461(e) is complemented by the grounds in s 461(f) and (g). These grounds were introduced in 1983 and their terms parallel those in which in the oppression remedy in Pt 2F.1 is now cast. They will be considered when discussing that remedy: see [8.195].

Re Cumberland Holdings Ltd [8.170] Re Cumberland Holdings Ltd (1976) 1 ACLR 361 Supreme Court of New South Wales [In editing this extract, references to the Corporations Act have been substituted for their predecessor provisions referred to in the judgment. There are no relevant differences in their terms.] BOWEN CJ in EQ: [374] Upon the interpretation of this paragraph my view is as follows: (1)

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When it refers to “directors” it does not limit its application to the case where the whole board acts unanimously; it will be met where it is shown that the effective majority has acted in its [8.163]

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Re Cumberland Holdings Ltd cont. own interests or in the interests of one or more of those board members, or even where one director, by some means or other, has caused his will to be carried into effect by the board with the result that his personal interest has been preferred. (2)

Likewise the word “directors” has what may be termed a distributive application in relation to the second limb of para (e).

(3)

The words “the affairs of the company” are as wide as one could well have. They are not limited to business or trade matters, but encompass capital structure, dividend policy, voting rights, [375] consideration of takeover offers, and indeed, all matters which may come before the board for consideration.

(4)

Directors may be held to have acted in their “own interests” when they have acted in the interests of another company of which they are also directors and shareholders: see Re National Discounts Ltd (1951) 52 SR (NSW) 244.

(5)

The words “the interests of the members as a whole” present some difficulty. From the discussion in cases such as Greenhalgh v Arderne Cinemas Ltd [1951] 1 Ch 286; Ngurli v McCann (1953) 90 CLR 425, and Australian Fixed Trusts Pty Ltd v Clyde Industries Ltd (1959) 59 SR (NSW) 33, the concept of action taken for “the benefit of the company”, that is for “the benefit of the corporators as a general body” is a familiar one. The difficulty with a concept such as “the interests of the members as a whole” arises when it has to be applied where the interests of members are diverse or conflicting. This may happen, for example, where there are different classes of members, or within one class of members where the interests of particular members differ. The present case furnishes an illustration in the conflict in relation to the takeover offer between the interests of the majority and the minority. One possible interpretation is that the first limb of para (e) applies only where the directors are shown to have preferred their own interests to the interests of the members as a whole, in the sense of the interests which are common to all the members. Another possible interpretation is that the first limb of para (e) applies where the directors are shown to have preferred their own interests to the interests of one or more or perhaps some significant section of the members. This argument depends upon the proposition that the directors are then seen not to have been acting in the interests of all the members and cannot be said to have been acting in the interests of the members as a whole. If the first interpretation be correct, the action of directors cannot be challenged under the first limb of para (e) where what they have done coincides with the interests of a majority shareholder or, for that matter, coincides with the interests of any minority shareholder. If the second interpretation be correct, the action of directors may be open to challenge notwithstanding it coincides with the interests of the majority shareholder. Having regard to the words used, and the context, including the second limb of para (e) and [Pt 2F.1], it is my opinion that the second interpretation is the correct one.

(6)

The second limb of s 461(e) applies where it is shown that the directors have acted in the affairs of the company in any other manner whatsoever which appears to be unfair or unjust to other members. Not much weight can be placed on the word “appears”, since conduct which, on its face, appeared to be unfair or unjust, but on further analysis was found not to be so, would hardly induce a court to make a winding up order. However, under the second limb the conduct does not have to be shown to be unfair or unjust to the members as a whole; it is sufficient, it appears to me, if it is shown that the conduct is unfair or unjust at least to any significant body of other members, and perhaps to any other member. The nature of the injustice or unfairness, and the extent to which this operates to the detriment of any other

[8.170]

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Re Cumberland Holdings Ltd cont. member or [376] members, will no doubt be material for consideration by the court in exercising its discretion whether or not to make a winding up order: see Re Weedmans Ltd [1974] Qd R 377.

Re Weedmans Ltd [8.175] Re Weedmans Ltd [1974] Qd R 377 Supreme Court of Queensland [Sportscraft secured voting control of Weedmans and appointed nominees to constitute a majority of the Weedmans board. The directors then issued a substantial block of shares to a Sportscraft subsidiary in abuse of their fiduciary powers. They subsequently took steps to facilitate a takeover bid by Sportscraft for the outstanding equity in Weedmans. Notwithstanding that the bid price was “grossly less than a true or fair price”, the Sportscraft nominee directors recommended that shareholders accept the offer. Further, they announced that they intended to accept the offer for their shares without disclosing that they held those shares as nominees for Sportscraft. They misinformed and misled the minority shareholders in other material respects. The judge apparently accepted that the recommendation for acceptance of the bid, even at a gross undervalue, did not of itself involve breach of the nominee directors’ duty. The nominee directors’ conduct would now trigger additional remedies under Ch 6 of the Act: see Chapter 12.] LUCAS J: [398] One could imagine a case in which a board of directors quite properly decided that no dividend should be declared; that might force an elderly indigent shareholder on to the old age pension and so be unfair to him, but I would think that few people would regard it as a ground for winding up the company. On the other hand, most people might think otherwise about a board of directors which used its voting power (in a case in which it could do so) consistently to refuse to pay dividends and at the same time to authorise the payment to itself of extravagant sums by way of directors’ remuneration. That would be a breach of commercial morality, and perhaps that is what the subsection is directed against. I do not overlook the fact that the situation I have imagined could no doubt also give rise to proceedings under [Pt 2F.1], but it is well settled that the alternative remedies may be sought. Looking at the whole history of the matter, it seems to me that the board (other than [two independent directors]) were concerned more with the interests of Sportscraft than with the interests of Weedmans. In particular, I am of opinion that there can be no other explanation for the forcing through of the allotment of shares in March 1970 against the opposition of the independent directors, or for the gross misstatements in the Part B statement as to the intention of the directors to transfer the beneficial interest in their shares. I emphasise however, that I do not act upon these two matters alone. The whole of what happened in relation to the takeover offer seems to me to show that the directors, other than [the independents] failed to observe the requisite standard of commercial morality. The effect of their failure, considered against the whole background, reacted unfairly and unjustly against other members. If the allotment of shares in March 1970 stood in isolation, no doubt the petitioners would have had another remedy; they could have instituted proceedings to have the allotment set aside. But it does not stand in isolation, and the petitioners of course do not rely on this feature [399] alone; in the absence of a case for relief under [Pt 2F.1] they have in my opinion no remedy other than a winding up.

646

[8.175]

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Notes&Questions

[8.177]

1.

CHAPTER 8

An appeal was successfully made to the Privy Council from the order of Bowen CJ in Eq in Re Cumberland Holdings. The Privy Council found that the petitioner had failed to make good its case for a winding up. The judgment of the Privy Council did not, however, take issue with the propositions enunciated by Bowen CJ in Eq: Cumberland Holdings Ltd v Washington Soul Pattinson & Co Ltd (1977) 13 ALR 561. Delivering the judgment of the Privy Council, Lord Wilberforce said (at 566-567): No complaint has been made that the company’s affairs were being mismanaged or that the minority shareholders were being denied a fair share of the company’s profits. Their Lordships accept that these are not the only grounds on which the court will intervene in order to protect minority shareholders in a company. Indeed the statutory provisions are widely expressed and effect should be given to them in accordance with their terms whenever the court comes to the conclusion that there has been a lack of fairness, of oppression, or lack of probity on the part of the majority, or of the directors representing the majority. But to wind up a successful and prosperous company and one which is properly managed must clearly be an extreme step and must require a strong case to be made.

2.

3.

Other instances of orders under s 461(e) include directors issuing shares to an entity controlled by one of them with the purpose of manipulating the balance of the voting power in the company (Netbush Pty Ltd v Fascine Developments Pty Ltd [2005] WASC 73) and where a dominant director diverted company funds to entities he controlled and in other matters acted contrary to board decisions: ASIC v v Green Pacific Energy Ltd [2006] FCA 1254. For fuller discussion of the remedy, see S Rees (1985) 3 C&SLJ 63.

[8.178]

Review Problem

Rocco holds a minority interest in the several companies within a property development group. The Eliot family holds the majority interests. Rocco and Tom Eliot are directors of each of the companies. Rocco says that his relationship with the Eliot family had been harmonious but that for some time he has been excluded from decision making and his requests for board meetings and copies of financial statements have gone unanswered. Tom Eliot says that the breakdown occurred earlier when Rocco’s behaviour became irrational. However, neither side contests that there has been an irretrievable breakdown in the relationship. What had commenced and been conducted as an association based on personal relations and conjoint participation in the affairs of the companies has come to an end and Rocco no longer plays a part in those affairs. Rocco alleges that Tom took $300,000 in cash from one group company that was not recorded as a charge against his loan account. He also alleges that the accounts have not been properly maintained. The accounts are not audited. Despite these disputes, the companies have been very successful financially and are solvent. Rocco wants the companies wound up; Tom wants an order for the purchase of Rocco’s shares under s 233(1)(d), the oppression remedy, or under s 467(1)(c). (These facts are loosely based on those in Triulcio v Chase Property Investments Pty Ltd [2004] NSWSC 31.)

THE STATUTORY REMEDY FOR OPPRESSION Early interpretations [8.180] Since 1947 in the United Kingdom (and later in Australia) there has been a statutory

remedy for shareholders who complain that the affairs of their company are being conducted [8.180]

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in a manner oppressive to them. The courts have been empowered to make a wide range of orders with a view to bringing the oppression to an end. The initial English provision was adopted by several Australian States. The scope of the section was expanded in 1981 and substantial amendments have been made regularly since then. The thrust of the amendments has been to free the provision from some of the fetters which judicial interpretation have placed upon its predecessors. The shape of the modern oppression remedy is largely explicable in terms of the restrictive body of interpretation which had grown up around the initial provision. The restrictive character of that interpretation is the more surprising in light of the imaginative and forthright approach adopted in the first two decisions on the English provision. Those decisions and the subsequent interpretation are summarised in the following two extracts.

The Principles of Modern Company Law [8.185] L C B Gower, The Principles of Modern Company Law (3rd ed, Stevens, 1969) [601] The first successful application, and the only one to reach the House of Lords, was Scottish Co-op Wholesale Society v Meyer [1959] AC 324. There the two petitioners were managing directors and minority shareholders of a subsidiary company formed by the co-operative society to enable it to enter the rayon industry. Later the need to operate through a separate company ceased and the society, through its nominee directors and otherwise, pursued a deliberate policy of running down the subsidiary’s business with the result that its shares became valueless. The House of Lords held that the petitioners’ case had been established and the society was ordered to buy out the two minority shareholders at £3 15s per share, the fair value had there not been oppression. This decision was followed by the Court of Appeal in Re H R Harmer Ltd [1959] 1 WLR 62 which concerned the well known firm of stamp dealers. The founder of the firm had incorporated it in 1947 and he and his sons were life directors. As a result of gifts of shares by the father the sons had become the majority shareholders, but the father and his wife, who did what he told her, had voting control. The father continued to run the business as if it was his own and to disregard the wishes of his fellow shareholders and of his co-directors and resolutions of the board. This, he asserted, he was entitled to do. As a result of his autocratic and unbusinesslike behaviour it became impossible for the company to be carried on successfully. Roxburgh J held that a case of oppression had been made out. He ordered that the father should be employed as a consultant only, should not interfere in the affairs of the company otherwise than in accordance with valid decisions of the board, but should, as a face-saving device, be appointed life “president” of the company without any duties, rights or powers as such. The Court of Appeal unanimously affirmed his decision.

The modern grounds of relief [8.195] The oppression remedy now contained in Pt 2F.1 is the product of serial amendments

to provide for progressively wider grounds of relief. The Court, on the application of an expanded category of current and former members (s 234), may make one or more of a wide range of remedial orders under s 233 if the conduct of a company’s affairs (within the inclusive definition in s 53), actual or proposed action by or on behalf of a company or a resolution or proposed resolution is either • contrary to the interests of the members as a whole (s 232(d)); or • oppressive to, unfairly prejudicial to, or unfairly discriminatory against, a member or members whether in that capacity or in any other capacity: s 232(e).

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These criteria are expressed in parallel terms to the grounds for compulsory winding up contained in s 461(f) and (g). 146 The addition of the words “unfairly prejudicial to” and “unfairly discriminatory against” to the original reference to “oppression” indicates an intention that the jurisdiction conferred “should not be confined to technical distinctions”. 147 The concept of unfair prejudice may be traced to an English company law review committee in 1962 which thought that the term oppressive was “too strong a word” to be appropriate for all the cases where relief should be granted. 148 It recommended that the section be extended to cases where company affairs are being conducted in a manner unfairly prejudicial to the interests of some part of the members and not merely in an oppressive manner. 149 Conduct brought within the section should “at the lowest involve a visible departure from the standards of fair dealing, and a violation of the conditions of fair play on which every shareholder who entrusts his money to the company is entitled to rely”. 150 As instances of the desirable reach of the section, the committee included: [situations] in which directors appoint themselves to paid posts with the company at excessive rates of remuneration, thus depriving the complaining members of any dividend, or any adequate dividend, on their shares; or in which the directors, having power to do so under the articles, refuse to register personal representatives in respect of shares devolving upon them in that capacity, and by this expedient (coupled with the absorption of profits in payment of the directors’ remuneration) force the personal representatives to sell their shares to the directors at an inadequate price. Other possibilities are the issue of shares to directors and others on advantageous terms; and the passing of non-cumulative preference dividends on shares held by the minority. 151

The phrase “unfairly discriminatory” derives from a recommendation made without elaboration by a New Zealand committee. 152 The explanatory memorandum accompanying the Australian legislation in 1983 did not offer any explanation for the adoption of this wider ground of relief or of the further ground where the affairs of the company are conducted in a manner contrary to the interests of the members as a whole. The concept of action or a resolution “contrary to the interests of the members as a whole” is independent of the “oppressive, unfairly prejudicial or unfairly discriminatory” ground in s 232(e). 153 This element of s 232 has not been subject to extensive judicial exegesis. It is, however, clear that such conduct need not involve commercial unfairness. In Turnbull v NRMA Campbell J observed: An action is capable of being “contrary to the interests of the members as a whole” in ways other than by being commercially unfair. Being pointlessly wasteful is one example. 154

The test under s 232(d) is objective, determined by reference to whether the challenged conduct adheres to accepted standards of corporate behaviour or is in accordance with how reasonable directors would act in attending to the affairs of the company. The decision of what 146 147

ASIC may also authorise a person to apply for an order in light of a current or completed investigation it has conducted into the company’s affairs: s 234(e). Fexuto Pty Ltd v Bosnjak Holdings Pty Ltd [2001] NSWCA 97 at [4] per Spigelman CJ.

148

Report of the Company Law Committee (Cmnd 1749, 1962), [202].

149 150

Report of the Company Law Committee, [212(c)]. Report of the Company Law Committee, [204], quoting Elder v Elder and Watson Ltd 1952 SC 49 at 55 per Lord Cooper.

151 152

Report of the Company Law Committee, [205]. Final Report of the Special Committee to Review the Companies Act (Macarthur Committee) (1973), [364], adopted in Companies Act 1955 (NZ), s 209. Turnbull v National Roads and Motorists’ Association Ltd (2004) 50 ACSR 44 at [32] per Campbell J. (2004) 50 ACSR 44 at [32].

153 154

[8.195]

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is contrary to the interests of the members as a whole directs attention not to the interests of the persons who are, in fact, the members for the time being, but rather on the interests of a hypothetical individual member. 155 As for the ground in s 232(e), in Thomas v H W Thomas Ltd Richardson J in the New Zealand Court of Appeal, said: In employing the words “oppressive, unfairly discriminatory or unfairly prejudicial”, Parliament has afforded petitioners a wider base on which to found a complaint. Taking the ordinary dictionary definition of the words from the Shorter Oxford English Dictionary: oppressive is “unjustly burdensome”; unfair is “not fair or equitable; unjust”; discriminate is “to make or constitute a difference in or between; to differentiate”; and prejudicial, “causing prejudice, detrimental, damaging (to rights, interests, etc)”. I do not read the subsection as referring to three distinct alternatives which are to be considered separately in watertight compartments. The three expressions overlap, each in a sense helps to explain the other, and read together they reflect the underlying concern of the subsection that conduct of the company which is unjustly detrimental to any member of the company whatever form it takes and whether it adversely affects all members alike or discriminates against some only is a legitimate foundation for a complaint under [s 232]. The statutory concern is directed to instances or courses of conduct amounting to an unjust detriment to the interests of a member or members of the company. It follows that it is not necessary for a complainant to point to any actual irregularity or to an invasion of his legal rights or to a lack of probity or want of good faith towards him on the part of those in control of the company. 156

We have seen, in the context of the just and equitable remedy for quasi-partnerships, the superimposition of “equitable considerations” that protect the expectations of parties that are not expressed in the legal structure they have adopted: see [8.145] and [8.155]. That recognition is traced to the influence of partnership law and perhaps also to its origins in the Roman law societas. Although the oppression remedy is modern and statutory, there is an emerging vein of judicial reference to “legitimate expectations” expressing a similar notion of supervening considerations of a personal nature arising from the underlying intentions of the parties not fully expressed in the structure chosen for their legal relationship. In O’Neill v Phillips, Lord Hoffmann referred to earlier unfair prejudice judgments in which he had adopted the notion of “legitimate expectation” as a label for the “correlative right” to which a relationship between company members may give rise in a case when, on equitable principles, it would be regarded as unfair for a majority to exercise a power conferred upon them by the articles to the prejudice of another member. I gave as an example the standard case in which shareholders have entered into association upon the understanding that each of them who has ventured his capital will also participate in the management of the company. In such a case it will usually be considered unjust, inequitable or unfair for a majority to use their voting power to exclude a member from participation in the management without giving him the opportunity to remove his capital upon reasonable terms. The aggrieved member could be said to have had a “legitimate expectation” that he would be able to participate in the management or withdraw from the company. 157

However, in the same judgment he expressed misgivings: It was probably a mistake to use this term, as it usually is when one introduces a new label to describe a concept which is already sufficiently defined in other terms. In saying that it was “correlative” to the equitable restraint, I meant that it could exist only when equitable principles of the kind I have been describing would make it unfair for a party to exercise rights 155 156

Goozee v Graphic World Group Holdings Pty Ltd (2002) 42 ACSR 534 at [41]-[44]; Australian Institute of Fitness Pty Ltd v Australian Institute of Fitness (Vic/Tas) (No 3) (2016) 109 ACSR 369 at [84]. (1984) 2 ACLC 610 at 616-617.

157

O’Neill v Phillips [1999] 2 All ER 961 at 970.

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under the articles. It is a consequence, not a cause, of the equitable restraint. The concept of a legitimate expectation should not be allowed to lead a life of its own, capable of giving rise to equitable restraints in circumstances to which the traditional equitable principles have no application. 158

Despite warnings that the “the introduction of a word such as ‘legitimate’ before a noun referring to an act or condition is more a mode of expressing a conclusion than an independent criterion”, 159 and that the language of “expectations” might suggest that it is the subjective expectations of a party that are of importance to the remedy, 160 the notion has taken a modest life of its own in the oppression context to recognise underlying notions of “justice and equity”: But I think that one useful cross-check in a case like this is to ask whether the exercise of the power in question would be contrary to what the parties, by words or conduct, have actually agreed. Would it conflict with the promises which they appear to have exchanged? In Blisset v Daniel the limits were found in the “general meaning” of the partnership articles themselves. In a quasi-partnership company, they will usually be found in the understandings between the members at the time they entered into association. But there may be later promises, by words or conduct, which it would be unfair to allow a member to ignore. Nor is it necessary that such promises should be independently enforceable as a matter of contract. A promise may be binding as a matter of justice and equity although for one reason or another (eg, because in favour of a third party) it would not be enforceable in law. 161

Other formulations stress that unfairness for the purpose of the oppression remedy is assessed by reference to whether “objectively in the eyes of a commercial bystander, there has been unfairness, namely conduct that is so unfair that reasonable directors who consider the matter would not have thought the decision fair”. 162 In Wayde v New South Wales Rugby League Ltd (see [8.200]) Brennan J observed that conduct will be oppressive if that conduct is unfair “according to ordinary standards of reasonableness and fair dealing” and that oppression, “at a minimum”, imports unfairness. 163 In Catalano v Managing Australia Destinations Pty Ltd the Full Federal Court expressed the test in these terms: The test of unfairness requires an objective assessment of the conduct in question with regard to the particular context in which the conduct occurs. The question is whether objectively in the eyes of the commercial bystander there has been unfairness, namely conduct that is so unfair that reasonable directors who consider the matter would not have thought the conduct or decision fair. As the test is objective, whether or not the conduct is oppressive will not depend upon the motives for what was done. It is the effect of the acts that is material. 164

When you read the following judgments, reflect on the balance (or tension) between this strain of language with its recognition of subjective considerations and the weight accorded by the courts to the objective assessment of fairness. The following extracts reveal the scope and 158

O’Neill v Phillips [1999] 2 All ER 961 at 970.

159

Fexuto Pty Ltd v Bosnjak Holdings Pty Ltd [2001] NSWCA 97 at [62] per Spigelman CJ. Similarly, the notion invites but does not assist resolution of the further issue when (and why) expectations cease to be legitimate: at [649]-[650] per Fitzgerald JA. One instance may be where irreconcilable differences emerge between the parties which confound the underlying expectations of management participation: at [90] per Spigelman CJ.

160

Tomanovic v Global Mortgage Equity Corporation Pty Ltd (2011) 84 ACSR 121 at [171] per Campbell JA.

161

Fexuto Pty Ltd v Bosnjak Holdings Pty Ltd [2001] NSWCA 97 at [420] per Priestley JA; see also Smolarek v Liwszyc [2006] WASCA 50 at [77]; Remrose Pty Ltd v Allsilver Holdings Pty Ltd [2005] WASC 251 at [74]; Nassar v Innovative Precasters Group Pty Ltd [2009] NSWSC 342 at [88]-[98].

162 163

Campbell v Backoffice Investments Pty Ltd (2008) 66 ACSR 359 at [181] per Basten JA, quoting Young J in Morgan v 45 Fleurs Ave Pty Ltd (1986) 10 ACLR 692 at 704. Wayde v New South Wales Rugby League Ltd (1985) 59 ALJR 798 at 803.

164

[2014] FCAFC 55 at [9] per Siopis, Rares and Davies JJ. [8.195]

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interpretation of the modern oppression remedy augmented as it is by references to unfair prejudice and unfair discrimination. The following section at [8.215] specifically examines the scope of the remedial orders made when conduct within the provision is found to exist.

Wayde v New South Wales Rugby League Ltd [8.200] Wayde v New South Wales Rugby League Ltd (1985) 59 ALJR 798 High Court of Australia [The defendant company was incorporated in 1983 to succeed to the functions of an unincorporated association which had conducted rugby league football competitions in Sydney since 1907. The company’s objects included the fostering and control of the game and such action as may be conducive to its best interests: cl 3(b). The company’s constitution authorised its board of directors to determine which teams should participate in the league’s competitions: art 76. From June 1984 the board engaged in consultation with the district clubs concerning the conduct of the premiership competition in 1985. It called for applications for entry into the competition and circulated guidelines by reference to which those applications would be considered. It also requested comment on the format of the competition, including a proposal that the number of competing teams be reduced from 13 to 12. The board adopted the proposal and, after further discussion, the application by one club, Wests, for inclusion in the premiership competition was refused. Two members of the company, in their capacity as representatives of Wests, sought relief against the decision under the equivalent of Pt 2F.1. In editing this extract, references to the Corporations Act have been substituted for their statutory counterparts in the judgment. There are no presently relevant differences in their terms.] MASON ACJ, WILSON, DEANE and DAWSON JJ: [801] It is conceded that the board made the decisions which are under attack in good faith. There is no suggestion that, in exercising the power conferred by art 76, it failed to have regard to relevant considerations or that it took irrelevant considerations into account. It is a point of great importance that the decisions were made in the exercise of a power that is expressly conferred on the board, a power to determine the nature and extent of the competition that was to take place in 1985 and the clubs that were to be permitted to participate in it. It is not a case where the directors of a company, in the exercise of the general powers of management of the company, might bona fide adopt a policy or decide upon a course of action which is alleged to be unfairly prejudicial to a minority of the members of the company. In that kind of case it may well be appropriate for the court, on an application for relief under s 233, to examine the policy which has been pursued or the proposed course of action in order to determine the fairness or unfairness of the course which has been taken by those in control of the company. The court may be required in such circumstances to undertake a balancing exercise between the competing considerations disclosed by the evidence: compare Thomas v H W Thomas Ltd (1984) 2 ACLC 610 at 618, 620. But here the decision to limit the premiership competition to 12 participants – and this was the critical decision – was taken honestly in pursuit of the object of fostering the game of rugby league and serving its best interests: cl 3(b), memorandum of association. The board was not only empowered but obliged to face up to the difficulties presented by a competition which occupied too long a period of the year and to exercise the power expressly bestowed upon it in a manner which it considered to be in the best interests of the game. It is not seriously suggested that the board overlooked the extreme consequences which the decision would visit upon Wests, amounting perhaps to its virtual extinction. The appellants’ contention is that, while the board could reasonably conclude that a competition confined to 12 clubs was preferable to one involving 13 clubs, the facts that the latter was not wholly unworkable and that Wests was a viable competitor lead to the conclusion that the prejudice to Wests so outweighs the perceived benefits to the League as to be unfair. They submit that the exclusion of a viable club, such exclusion not being required to render the competition workable, would promote “purposes foreign to the company’s operations, affairs and organisations”, adopting the meaning ascribed to the phrase “benefit of the company as a whole” by Dixon J in Peters’ American Delicacy Co Ltd v Heath (1939) 61 CLR 457 at 512. The answer to this contention is that no amount of sympathy for Wests can obscure the fact that the League was expressly constituted to promote the best interests of the sport and empowered to 652

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Wayde v New South Wales Rugby League Ltd cont. determine which clubs should be entitled to participate in competitions conducted by it. It was upon this basis that the clubs, including Wests, chose to incorporate. Indeed, the 1984 correspondence between Wests and the League which is in evidence plainly shows that Wests itself fully appreciated that it had no secure right to participate in the premiership competition. In truth, the board was confronted with a conflict of immediate interest between Wests on the one hand and the League as a whole on the other and the exercise of the power conferred by art 76 must necessarily be prejudicial to one or the other. Given the special expertise and experience of the board, the bona fide and proper exercise of the power in pursuit of the purpose for which it was conferred and the caution which a court must exercise in determining an application under s 233 in order to avoid an unwarranted assumption of the responsibility for management of the company, the appellants faced a difficult task in seeking to prove that the decisions in question were unfairly prejudicial to Wests and therefore not in the overall interests of the members as a whole. It has not been shown that those decisions of the board were such that no board acting reasonably could have made them. The effect of those decisions on Wests was harsh indeed. It has not, however, been shown that they were oppressive or unfairly prejudicial or discriminatory or that their effect was such as to warrant the conclusion that the affairs of the League were or are being conducted in a manner that was or is oppressive or unfairly prejudicial. BRENNAN J: [802] [The judge reviewed the grounds of judicial review of directors’ decisions under fiduciary doctrines: see [7.220].] Section 232, however, extends the grounds for curial intervention. It provides a wide range of remedies when the court is of the opinion, inter alia, that a resolution or a proposed resolution “was or would be oppressive or unfairly prejudicial to, or unfairly discriminatory against, a member or members … or was or would be contrary to the interests of the members as a whole” (s 232(d)). The remedies for which s 233 provides are available whether or not the resolution complained of is a valid resolution. To say that the resolution was adopted in good faith and for a purpose within the power conferred is relevant to but not conclusive of the question whether relief should be granted under s 233. [803] Clearly the legislature intends to provide a greater measure of curial protection to members of a company, especially if they be in a minority, than the protection afforded under earlier Companies Acts. In Thomas v H W Thomas Ltd (1984) 2 ACLC 610, the Court of Appeal of New Zealand held that under a similar but not identical provision (s 209 of the Companies Act 1955 (NZ)) it was not necessary for a complainant to point “to any actual irregularity or to an invasion of his legal rights or to a lack of probity or want of good faith towards him on the part of those in control of the company” (at 617 per Richardson J). I would respectfully adopt that observation and apply it to Pt 2F.1. Here, the appellants seek to restrain the exercise of a power of such a nature that its exercise is apt to discriminate among the clubs whose representatives are members of the League and to prejudice any club which is excluded from the Premiership Competition. The expression “the interests of the members as a whole” is not likely to provide a criterion for intervention in respect of a decision made in exercise of a power that is conferred to resolve a conflict of interests between one or more members on the one hand and the League’s object of fostering the game on the other. In that context the interests of the members as a whole “tends to become a cant expression”, to adopt the words of Rich J in Richard Brady Franks Ltd v Price (1937) 58 CLR 112 at 138. In the present case, the relevant expressions are “oppressive or unfairly prejudicial to, or unfairly discriminatory against, a member”. Where the directors of a company are empowered to discriminate among its members and to prejudice the interests of one of them, the adoption of a resolution which has that effect and which is made in good faith and for a purpose within the power is not, without more, “oppressive or unfairly prejudicial to, or unfairly discriminatory against, a member”. Section 232 requires proof of oppression or proof of unfairness: proof of mere prejudice to or discrimination against a member is insufficient to attract the court’s jurisdiction to intervene. In the case of some discretionary powers, any prejudice to a member or any discrimination against him may be a badge of unfairness in the exercise of the power, but not when the discretionary power contemplates the effecting of prejudice or discrimination. It is not necessary now to decide whether “oppressive” carries in the context of s 232 the meaning which it carried in the context of the statutory precursors of s 232. At a minimum, oppression imports unfairness and that is the critical question in the present case. [8.200]

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Wayde v New South Wales Rugby League Ltd cont. It is not necessarily unfair for directors in good faith to advance one of the objects of the company to the prejudice of a member where the advancement of the object necessarily entails prejudice to that member or discrimination against him. Prima facie, it is for the directors and not for the court to decide whether the furthering of a corporate object which is inimical to a member’s interests should prevail over those interests or whether some balance should be struck between them. The directors’ view is not conclusive, but an element in assessing unfairness to a member is the agreement of all members to repose the power to affect their interests in the directors: see s 140 of the Act. Nevertheless, if the directors exercise a power – albeit in good faith and for a purpose within the power – so as to impose a disadvantage, disability or burden on a member that, according to ordinary standards of reasonableness and fair dealing is unfair, the court may intervene under Pt 2F.1. The question of unfairness is one of fact and degree, which Pt 2F.1 requires the court to determine, but not without regard to the view which the directors themselves have formed and not without allowing for any special skill, knowledge and acumen possessed by the directors. The operation of Pt 2F.1 may be attracted to a decision made by directors which is made in good faith for a purpose within the directors’ power but which reasonable directors would think to be unfair. 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. The test assumes (whether it be the fact or not) that reasonable directors weigh the furthering of the corporate object against the disadvantage, disability or burden which their decision will impose, and address their minds to the question whether a proposed decision is unfair. The court must determine whether reasonable directors, possessing any special skill, knowledge or acumen possessed by the directors and having in mind the importance of furthering the corporate object on the one hand and the disadvantage, disability or burden which their decision will impose on a member on the other, would have decided that it was unfair to make that decision. The question here is whether the resolutions which were manifestly prejudicial to and discriminatory against Wests, were also unfair – that is, so unfair that reasonable directors who considered the disability the decision placed on Wests would not have thought it fair to impose it. The decision by the League’s directors to reduce the number of competitors to 12 and to exclude Wests was in fact taken with full knowledge of the disability that that decision would place on Wests. But the directors also knew that the larger competition was burdensome to, and perhaps [804] dangerous for, players and that a shorter season was conducive to better organisation of the Premiership Competition. The directors had to make a difficult decision in which it was necessary to draw upon the skills, knowledge and understanding of experienced administrators of the game of rugby league. The court, in determining whether the decision was unfair, is bound to have regard to the fact that the decision was admittedly made by experienced administrators to further the interests of the game. There is nothing to suggest unfairness save the inevitable prejudice to and discrimination against Wests, but that is insufficient by itself to show that reasonable directors with the special qualities possessed by experienced administrators would have decided that it was unfair to exercise their power in the way the League’s directors did.

Re Ledir Enterprises Pty Ltd [8.205] Re Ledir Enterprises Pty Ltd (2014) 96 ACSR 1 Supreme Court of New South Wales [David, Ian and Rosemary are the children of the marriage of Louis and Ethel Aboud. Louis was the dominant figure during his lifetime in the businesses established within the Ledir group of companies although David and, to a lesser extent, Rosemary also worked in those businesses at different times. (The company took its name from the first letters of their personal names.) After Louis’ death in 2004, the already fractious relationships between family members declined further with David and Ian at odds with Rosemary, and Rosemary with her mother at least from 2006. Upon Louis’ death Ethel held all the voting power in the holding company for the group, Enterprises, in which all family members and a family trust (the Ledir Trust) held equity interests. In December 2006 Ethel exercised her voting 654

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Re Ledir Enterprises Pty Ltd cont. power to remove Rosemary as a director of Enterprises so that David and Ian remained as its only directors. From early 2007, with professional advice, David and Ian effected the distribution of the assets of the Trust that involved the payment of cash dividends by Enterprises and a subsidiary, Investments, to the Trust and from it payments to the three children in 2007 and 2008. Rosemary sought relief against oppression by reason of her exclusion from management of Enterprises, the withholding of information as to its affairs, its failure to hold general meetings after her removal as director, and the payments made to effect those distributions from the Trust. Citations of cases referred to in this extract had been removed for ease of reading.] BLACK J: 177 I should first refer to the genesis of s 232(d) of the Corporations Act. … The language of the section was amended by the Corporate Law Economic Reform Program Act 1999 (Cth) to separate the concepts which now appear in s 232(d) and (e) respectively. In Turnbull v NRMA, Campbell J noted that an action may be “contrary to the interests of the members as a whole” in ways other than by being commercially unfair, and expressed the view that that concept was intended to be an independent alternative to the ground of “being oppressive to, unfairly prejudicial to, or unfairly discriminatory against a member or members in that section”. Conduct that is in breach of directors’ duties, including in contravention of s 181 of the Corporations Act, may but will not necessarily, amount to oppression on this basis or under s 232(e) of the Corporations Act. 178 Rosemary also contends that the relevant conduct was “oppressive to, unfairly prejudicial to, or unfairly discriminatory against, a member or members” within s 232(e) of the Corporations Act. That paragraph is directed to conduct which involves “commercial unfairness” or a departure from the standards of fair dealing, or where a decision has been made so as to impose a disadvantage, disability or burden on the plaintiff that, according to ordinary standards of reasonableness and fair dealing, is unfair. All parties accept that that, in a family situation, fairness must be considered against the background of the fair treatment of the whole body of shareholders, in the light of the history of the company and the family and the purpose for which the company was formed. The terms of the companies’ constitutions and the Ledir Trust are also relevant. 179

In Thomas v HW Thomas Ltd, Richardson J observed that Fairness cannot be assessed in a vacuum or simply from one member’s point of view. It will often depend on weighing conflicting interests of different groups in the company. It is a matter of balancing all the interests involved in terms of the policies underlying the companies legislation in general and s 209 [the NZ oppression provision] in particular; thus to have regard to the principles governing the duties of a director in the conduct of the affairs of a company and the rights and duties of a majority shareholder in relation to the minority; but to recognise that s 209 is a remedial provision designed to allow the Court to intervene where there is a visible departure from the standards of fair dealing; and in the light of the history and structure of the particular company and the reasonable expectations of the members to determine whether the detriment occasioned to the complaining member’s interests arising from the acts or conduct of the company in that way is justifiable.

180 In Wayde v New South Wales Rugby League Ltd, Brennan J noted that the oppression provisions may apply where directors make a decision which is unfair, on an objective test, by the standard of reasonable directors possessed of any special skill, knowledge or acumen possessed by the directors and that: The Court must determine whether reasonable directors, possessing any special skill, knowledge or acumen possessed by the directors and having in mind the importance of furthering the corporate object on the one hand and the disadvantage, disability or burden which their decision will impose on a member on the other, would have decided that it was unfair to make that decision. 181 In Morgan v 45 Flers Avenue Pty Ltd, Young J formulated this aspect of the test for oppression by reference to the nature of the business carried on by the company and the nature of the relations between its participants and as: [8.205]

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Re Ledir Enterprises Pty Ltd cont. whether objectively in the eyes of a commercial bystander, there has been unfairness, namely conduct that is so unfair that reasonable directors who consider the matter would not have thought the decision fair. That test adopted was in turn applied in Dynasty Pty Ltd v Coombs and in John J Starr (Real Estate) Pty Ltd v Robert R Andrew (A’Asia) Pty Ltd, Young J somewhat expanded his statement in Morgan v 45 Flers Avenue Pty Ltd by noting that unfairness may result from conduct which is not of a commercial character. 182 In Fexuto Pty Ltd v Bosnjak Holdings Pty Ltd, Spigelman CJ observed that the statutory formulation of “oppression” confers a wide-ranging remedial jurisdiction on the court and that jurisdiction should not be confined by technical distinctions. His Honour noted that the individual elements of oppression, unfair prejudice and unfair discrimination referred to in the statutory formulation in s 232(e) of the Corporations Act illuminate each other and each reflect the essential criterion of commercial fairness. In Joint v Stephens, the Court of Appeal of the Supreme Court of Victoria observed that the expression “oppressive or unfairly prejudicial or unfairly discriminatory against” was a compound expression, concerned with “commercial unfairness”, which was to be assessed in the context of the particular relationship in issue, and would not infrequently involve a balancing exercise between competing considerations. Unfairness is in turn assessed by reference to whether the relevant conduct was so unfair that reasonable directors who considered the matter would not have thought the decision fair and can be established by matters such as wrongful exclusion from participation in a company’s management even if the person undertaking that conduct thinks he or she is acting properly. 183 The principles applicable to a claim for oppression were summarised by Austin J in Tomanovic v Argyle HQ Pty Ltd, and the Court of Appeal noted the parties did not challenge that summary of the applicable principles in Tomanovic v Global Mortgage Equity Corporation Pty Ltd. His Honour observed that: (a) consistent with the principle that the purpose of relief is to terminate the effects of oppression, relief will generally be inappropriate as a matter of discretion if there is no continuing oppression; (b) unfairness is assessed by reference to whether “objectively in the eyes of a commercial bystander, there has been unfairness, namely conduct that is so unfair that reasonable directors who consider the matter would not have thought the decision fair”: eg, Campbell v Backoffice Investments Pty Ltd; (c) while it is recognised that conduct may be oppressive if inconsistent with the “legitimate expectations” of shareholders, expectations are not immutable. The non-fulfilment of expectations will not establish oppression, if there has been some good reason for the extinguishment of the expectation; (d) “it is important when assessing corporate activities to see if there has been oppression that judges do not remain in their ivory tower”; (e) a particular matter which will be taken in account in assessing the gravity of any allegation of oppression, is the extent to which the minority shareholder has “baited” the majority shareholder to act in an oppressive manner. 184 I have also borne in mind the observation in Tomanovic v Global Mortgage Equity Corporation Pty Ltd that each case has to be considered on its own facts and circumstances, and by reference to the conduct as a whole; and that, as French CJ noted in Campbell v Backoffice Investments Pty Ltd, the language and history of the sections indicate that they should be read broadly and the imposition of judge-made limitations on their scope should be approached with caution. I will address each of the matters on which Rosemary relies separately and will then assess their collective impact.

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Re Ledir Enterprises Pty Ltd cont. Exclusion from management 185 Exclusion from management can support a claim for oppression, at least where there is an expectation of participation in management, and that principle has its origin, and is most obvious application, in respect of companies that are, in effect, incorporated partnerships or quasipartnerships. Relevant factors to whether such an expectation exists include the company’s constitution and, if it does not support the claimed expectation, the understandings of the parties on entry into the corporate relationship; and the impact on the party claiming to be oppressed. However, as Spigelman CJ observed on appeal in Fexuto Pty Ltd v Bosnjak Holdings Pty Ltd, one cannot infer a right to have a status quo continue merely from the fact that it is the status quo, and something more is needed to establish a right or expectation that it would continue, usually an agreement or understanding between the parties or an expectation induced by the conduct of the business. Exclusion from management will also not necessarily amount to oppression where the differences between the parties are such that participation by a shareholder in management is no longer possible. 186 It is, of course, plain that David and Ian initiated and implemented the removal of Rosemary as a director of Enterprises and other companies within the Ledir Group, although that removal was effected by the exercise of Ethel’s voting power in general meeting of Enterprises and I have found above that Ethel at least did not object to it. As I noted above, the steps taken to remove Rosemary as a director of Enterprises ultimately had little (if any) practical impact because she retired from office as a director of Enterprises (although not other companies within the Ledir Group) at the general meeting held in December 2006, by operation of article 64 of Enterprises’ articles of association, and was not re-elected as a director. While this matter is not a complete answer to a claim in oppression, it is relevant to the assessment of the significance of the relevant actions. David also acknowledged in cross-examination that the transfer of funds to the new account at a different bank gave him complete control of the cash resources of Investments to the exclusion of Rosemary, although rightly pointing out that Rosemary had previously been in the corresponding position. 187 In my view, the evidence did not establish an understanding or basis for an expectation that Rosemary would necessarily remain as a director of Enterprises or the other companies within the Ledir Group. Enterprises was established by Louis, and there is no evidence for any understanding that any of David, Ian or Louis would be its directors; and the company was not a quasi-partnership, at least so far as David, Ian and Rosemary are concerned, where Louis exercised a dominant role prior to his death. Rosemary was previously a director of Enterprises, and she had been involved in maintaining company records and some dealings with the companies’ accountants, because Louis appointed her to that position and requested her to take that role, but that was no more than what Spigelman CJ described as the “status quo”. Enterprises’ articles of association did not reflect any right of Rosemary or any other member of the family to continue as a director. To the contrary, the provision for retirement of directors in the Company’s articles provided for her (and other directors) to cease to be a director at a general meeting at which she was or they were not re-appointed. 188 The emergence of irreconcilable differences may also cause the Court to conclude that an understanding or expectation as to participation in management should cease, in a manner not entitling the person excluded from such participation to relief under the statutory provisions, including where the person excluded is responsible for the breakdown in the relationship: Fexuto v Bosnjak. In this case, it could not be said that Rosemary was blameless in respect of the differences that had arisen between the parties, although it is plain that at least Ian also contributed to those differences. ... 191 In my view, Rosemary’s refusal to acknowledge David’s role as a director and his concern about [her] use of company funds for personal expenses and her unreasoned and unequivocal refusal to discuss or consider the reinstatement of dividends which had been authorised by the earlier resolution of Enterprises passed in April 2002 would also indicate that that the exercise of Ethel’s voting power to remove her as a director of Enterprises would not be objectively unfair or unreasonable. More generally, the breakdown of the relationship between at least Rosemary and David also meant that the exercise of Ethel’s voting power to remove either one or both of them as a director of Enterprises would not be unfair or unreasonable. Conversely, the fact that both David and Rosemary had both [8.205]

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Re Ledir Enterprises Pty Ltd cont. previously been directors of Enterprises did not mean (as Rosemary’s position implies) that it would be oppressive for Ethel to exercise her voting power to remove either of them and that she was bound to allow a position where the directors would not deal with each other in a constructive (or, on David’s uncontested evidence, a civil) manner to continue. ... 193 Accordingly, I do not consider that Rosemary’s removal from management supports the oppression claim. Provision of information and absence of general meetings 194 Denial of access to information or a repeated or persistent failure to hold meetings required under the Corporations Act or a company’s constitution can also constitute oppression in an appropriate case. Rosemary complains that the information provided to her since 2006 has largely resulted from production of documents in compulsory court procedures. David acknowledged in cross-examination that, after he and Ian removed company records from [the home occupied by Rosemary] in late September 2006, he kept control of all the company records to the exclusion of Rosemary and that he gave Rosemary no information between that day and when she was removed as a director on 29 December 2006. … [A]fter Rosemary was removed as a director, any information about the company’s affairs that David gave her was provided formally to her or through advisors. 195 After Rosemary ceased to be a director of Enterprises in December 2006 … her rights to access to information were those of a shareholder in Enterprises rather than a director. I can see no basis for criticism of the provision of information by formal means given the breakdown in the parties’ relationship and the obvious difficulty with personal interactions between them. I accept, as David contends, that the extent of information provided to Rosemary concerning Enterprises’ affairs must be considered by reference to her statutory rights as a member to information, including her right to apply to the Court under s 247A of the Corporations Act to inspect Enterprises’ books. Nonetheless, it seems to me that the absence of provision of information to a shareholder is of greater significance in a closely held company than, for example, in a public company with numerous shareholders. ... 197 However, it is also clear that David and Ian were less than forthcoming as to the fact of and the circumstances surrounding the payments made in 2007 and 2008. David acknowledged in cross-examination that he did not tell Rosemary of the decision to reinstate his dividends at $9,000 a month between late 2006 and mid-2007 and also did not tell Rosemary of the distribution made to him in June 2007 or the payments to Ian … at about the same time … 198 David also accepted in cross-examination that no notices of general meetings have been sent to Rosemary since December 2006 and there is no evidence that such meetings were held. The absence of formal meetings within a family company does not necessarily amount to oppression. In the period prior to Louis’ death, it appears that Louis dominated the Ledir Group’s affairs and meetings were either not held, or were only held for formal purposes. However, it seems to me that there was greater need for such meetings once informal relationships between the shareholders had deteriorated, Rosemary had ceased to be a director of Enterprises, particularly given the limits to the information she obtained by other means. Such meetings would provide a proper avenue for Rosemary to be informed of Enterprises’ affairs, and to ask questions or raise concerns, notwithstanding that she did not have a vote at a general meeting, and notwithstanding that s 249D of the Corporations Act would not permit her unilaterally to call that meeting because she held no voting shares. 199 I do not consider that the lack of transparency in David’s and Ian’s dealings with Rosemary and the absence of general meetings are consistent with commercial fairness in the context of a family company plainly set up as part of a structure intended to benefit all of Louis’ children including Rosemary. This matter supports the oppression claim. The 2007 and 2008 payments 200 David submits that the payments to Ian and David were not part of the conduct of the affairs of Investments or Enterprises as defined in s 53 of the Corporations Act and the Court’s jurisdiction to 658

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Re Ledir Enterprises Pty Ltd cont. make orders under ss 232–233 of the Corporations Act is not established unless any oppressive or unfair conduct occurred in the conduct of the relevant company’s affairs. On the other hand, Rosemary draws attention to the decision in Re Norvabron Pty Ltd (No 2). In that case, complaint was made as to the conduct of the affairs of a wholly-owned subsidiary of Norvabron. Derrington J observed that: It has been argued that this conduct upon which the application relies is limited to the affairs of [the subsidiary], whereas the application is necessarily directed at Norvabron, and the suggestion is that the directors of Norvabron have not been shown to be at fault in the affairs of that company in the same way as they were in respect of [the subsidiary]. However, such an approach is artificial in the extreme. The technical answer is that the directors of Norvabron knew very well what was happening in respect of [the subsidiary] because they were the persons involved. 201

Similarly, in Re Dernacourt Investments Pty Ltd, Powell J observed that: The words “affairs of the company” are extremely wide and should be construed liberally: (a) in determining the ambit of the “affairs” of a parent company for the purposes of s 320, the court looks at the business realities of a situation and does not confine them to a narrow legalistic view; (b) “affairs” of a company encompass all matters which may come before its board for consideration;

(c) conduct of the “affairs” of a parent company includes refraining from procuring a subsidiary to do something or condoning by inaction an act of a subsidiary, particularly when the directors of the parent and the subsidiary are the same. 202 The proposition that a company’s affairs extend to the affairs of a wholly owned and controlled subsidiary was accepted by Brereton J in IceTV Pty Ltd v Ross. I will assume, although it does not seem to me necessary to decide for the purposes of this case, that that proposition can be applied to Investments where it was not strictly a wholly-owned subsidiary of Enterprises, but Enterprises held both of its ordinary shares and all but one of the special shares on issue. 203 The case law to which Rosemary refers does not provide a complete answer to David’s submission that the payments were not within the affairs of Enterprises so far as, as I have held above, the 2007 payments were distributions made by Comserv as trustee of the Ledir Trust. Although Comserv plainly played a role in the distribution of assets to family members, it was not a related company of Enterprises or Investments [although it held shares in Enterprises]; Rosemary acknowledges that, since Louis’ death, Ethel has held all the issued shares in Comserv. I do not consider that the affairs of Comserv were affairs of Enterprises, for the purposes of the oppression remedy. However, I accept Rosemary’s submission that, as I have noted above, the payment of dividends and making of loans by Investments (which was a subsidiary of Enterprises) and Enterprises were plainly part of a connected series of actions to bring about the distributions from the Trust. I therefore consider that the distributions from the Ledir Trust in 2007 must be taken into account in determining whether the conduct in Investments and Enterprises was oppressive, although those distributions were not themselves part of the affairs of Enterprises. 204 I have referred above to the circumstances surrounding the 2007 payments and subsequent monthly dividend payments to David. David and Ian respond that Rosemary never asked for the amount paid to her to be increased; I do not accept that this is a complete response to the differential treatment of David and Rosemary, since any decision whether to reverse the view previously taken by Louis needed at least to have regard to Rosemary’s interests as a shareholder in Enterprises and a discretionary beneficiary in the Trust. ... 207 I do consider that the 2008 payments to Ian support a claim for oppression, given the failure of David and Ian to have proper regard to the nature of the payments or the interests of Investments or its members at the time they were made, to which I referred in holding that those payments amounted to a breach of ss 180 and 181 of the Corporations Act on the part of David and Ian. … 233 Rosemary has been unsuccessful in several aspects of her oppression claim. Nonetheless, I have ultimately formed the view, for the reasons set out above, that oppression is established in all the [8.205]

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Re Ledir Enterprises Pty Ltd cont. circumstances, albeit on narrower grounds than those for which Rosemary contended. The Court would therefore have power to grant relief under s 233 of the Corporations Act. Whether such relief is ultimately justified and the nature of such relief is matter to be addressed at the second stage of the proceedings. [The litigation was resolved without further judical proceedings.]

Recurring instances of relief for oppression [8.210] The oppression remedy is applicable to all types and size of companies although,

given the frequent absence of investment exit options in small proprietary companies and the complex personal understandings and expectations often underlying their formation, the remedy has particular significance in such enterprises. A second consideration applying here is the influence on corporate law of doctrines of good faith and bona fides inherited from its partnership law origins. In O’Neill v Phillips Lord Hoffmann captured both elements in the application of notions of fairness in the oppression context: Although fairness is a notion which can be applied to all kinds of activities, its content will depend upon the context in which it is being used. Conduct which is perfectly fair between competing businessmen may not be fair between members of a family. In some sports it may require, at best, observance of the rules, in others (“it’s not cricket”) it may be unfair in some circumstances to take advantage of them. All is said to be fair in love and war. So the context and background are very important. In the case of [the UK counterpart to s 232], the background has the following two features. First, a company is an association of persons for an economic purpose, usually entered into with legal advice and some degree of formality. The terms of the association are contained in the articles of association and sometimes in collateral agreements between the shareholders. Thus the manner in which the affairs of the company may be conducted is closely regulated by rules to which the shareholders have agreed. Secondly, company law has developed seamlessly from the law of partnership, which was treated by equity, like the Roman societas, as a contract of good faith. One of the traditional roles of equity, as a separate jurisdiction, was to restrain the exercise of strict legal rights in certain relationships in which it considered that this would be contrary to good faith. These principles have, with appropriate modification, been carried over into company law. 165

In Trafalgar West Investments Pty Ltd v Superior Lawns Aust Pty Ltd (No 6) Kenneth Martin J addressed the submission that, in the context of a close held family company, notions of oppression need give way to the reality of family control so that the hypothetical member is given the character of a family member and outsiders’ interests accordingly attenuated: I should say at the outset that, in my view, it would be incorrect in legal principle to approach this issue on a basis that there is some unlegislated category of corporation, whether one terms it a “close held family company” or otherwise, the conduct of whose affairs can never be oppressive or which fall to be assessed at some lesser standard. The day-to-day experience of the courts rather suggests that loose or informal management practices, underlying personal relationships and frequently uncommercial conduct or decision making (from a company’s perspective) routinely characterise the operations of family companies. Yet these circumstances are highly conducive to the manifestation of corporate oppression scenarios. In sum, I accept this submission of [counsel] in argument: The relevant principles don’t change, whether it’s a closely held company or a family company or BHP. Principles in regard to oppression don’t change. How those principles 165

[1999] 1 WLR 1092 at 1098.

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operate on a particular factual matrix changes. Clearly what might be oppressive to a shareholder of BHP may not be oppressive to a shareholder of a small family company, particularly if there was unanimous assent. 166

As already noted, the great bulk of oppression cases concern such companies, reflecting the lack of investment exit options for minority shareholders. A third consideration reflects the proposition that the court must “avoid an unwarranted assumption of the responsibility for management of the company”. 167 Accordingly, “the Court’s power should not be lightly exercised especially where lack of probity or want of good faith is not established, because the Courts must respect the traditional roles of directors and shareholders in relation to corporate management”. 168 Further, the position of a minority shareholder is inherently limited, if not vulnerable: In assessing the facts of the present case it is necessary to remember that the petitioner is a minority shareholder. There are in the position of such a shareholder in a proprietary company many grave disadvantages but however galling and even financially damaging these may be they do not in themselves constitute oppression. 169

Oppression will not arise, therefore, from the mere fact that: • a minority shareholder does not get her way in the conduct of company affairs; 170 • controllers take decisions in the exercise of business judgement on matters upon which there may be legitimate differences of opinion; 171 • irreconcilable differences have emerged between the participants; 172 or • the company has been mismanaged or managed poorly. 173 Nonetheless, a series of situations recur where applications under the oppression remedy have been successful. The following list of such recurrent instances is offered with the caution that while “[s]uch lists are undoubtedly helpful as reminders of matters that can be relevant to whether oppression is made out, and to assist in identifying similarities and differences between the situation that obtained in a decided case and the situation that obtains in the case that falls for decision ... they do not provide a substitute for the application of the statutory test directly to the fact of the case in issue”. 174 Each case needs to be looked at on its own facts and circumstances, and their cumulative effect considered. 175 Improper diversion of corporate assets and opportunities: Since the first application under the oppression remedy in Scottish Co-op Wholesale Society v Meyer (discussed in [8.185]), the remedy has been applied frequently in relation to the misapplication or misappropriation of corporate assets. Thus, in Re Bright Pine Mills Pty Ltd, an early application was successful where a corporate controller diverted a business opportunity to which the company was entitled to another entity in which he was interested. 176 In Cassegrain v Gerard Cassegrain & Co Pty Ltd an oppression application was successful where two directors of a company 166

(2014) 102 ACSR 130 at [91], [105].

167

Wayde v NSW Rugby League Ltd (1985) 180 CLR 459 at 467 per Mason ACJ, Wilson, Deane and Dawson JJ.

168 169

McCausland v Surfing Hardware International Holdings Pty Ltd [2013] NSWSC 902 at [651]. Re M Dalley & Co Pty Ltd v Sims (1968) 1 ACLR 489 at 492.

170 171

McCausland v Surfing Hardware International Holdings Pty Ltd [2013] NSWSC 902 at [647]. Ireland v Retallack [2011] NSWSC 846 at [20].

172 173 174 175

McMillan v Toledo Enterprises International Pty Ltd (1995) 18 ACSR 603 at 614. Donaldson v Natural Springs Australia Ltd [2015] FCA 498 at [250]; Ananda Marga Pracaraka Samgha Ltd v Tomar (No 6) (2013) 94 ACSR 199 at [417]. Tomanovic v Global Mortgage Equity Corporation Pty Ltd (2011) 84 ACSR 121 at [185] per Campbell JA. Tomanovic v Global Mortgage Equity Corporation Pty Ltd (2011) 84 ACSR 121 at [331] per Young JA.

176

[1969] VR 1002. [8.210]

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procured the sale of company assets to their family members at an undervalue without an independent valuation or the consent of minority shareholders. 177 Similarly, Re Spargos Mining NL (see [8.220]) and Jenkins v Enterprise Gold Mines NL (see [8.225]) concerned related party transactions by corporate controllers without the consent of minority shareholders. Other misuse of a controller’s office or power: In other situations the improper exercise of power by controllers can lead to a finding of oppression and a remedial order such as when directors pursue their own interests or the interests of third parties to the detriment of the company or other shareholders. Instances includeunauthorised payments or transfers of property, 178 participation in a competing business, 179 paying themselves excessive remuneration 180 or issuing shares with the dominant purpose of reducing a shareholder’s proportional stake in the company. 181 In Corbett v Corbett Court Pty Ltd an oppression application was successful were the controller issued shares in an attempt to resolve an impasse between siblings with equity interests in a famly business. Disagreement was exacerbated by their parents dying intestate. The share issue was made in circumstances where there was no demonstrated requirement for the company to raise equity nor material benefit to it from doing so. The effect of the share issue was to dilute the shareholdings of the controller’s siblings to an immaterial amount with the consequence that consequent corporate benefit would enure overwhelmingly to the controller. 182 Exclusion from management participation: Exclusion from participation in the management of the company has often been held to amount to oppressive conduct; indeed, the second oppression application, in Re HR Harmer Ltd (discussed at [8.185]) concerned such conduct. Expectations of management participation often arise in quasi-partnership companies or other ventures founded upon personal or family relationships. Improper exclusion from a legitimate expectation to participate in the management of the company may be oppressive 183 and the situation of “a minority shareholder finding themselves or their capital locked into a proprietary company but also ‘locked out’ of decision-making and then denied any real commercial return on their investment capital at the hands of a dominant decision-making faction of other members and appointed directors [is] hardly a novel scenario [and is] familiar to courts in statutory oppression actions”. 184 “The mere fact, however, that a person is unable to regain capital or dispose of his or her shares does not amount to oppression.” 185 Tomanovic v Global Mortgage Equity Corporation Pty Ltd was not strictly a case of exclusion from management since one of two initially equal partners in a financial services joint venture had voluntarily relinquished office as director after the partners had reached a decision to go their separate ways but had made no binding agreement on terms. As part of their proposed separation, an outside investor took a minority equity stake which was later sold to the director partner. When the parties later failed to agree on terms for the termination of the venture, the now minority equity partner sought to resume as director and participant in 177 178

(2012) 88 ACSR 358. Re Wan Ze Property Development (Aust) Pty Ltd (2012) 90 ACSR 593; Patterson v Humfrey (2015) 103 ACSR 152.

179 180

Australian Institute of Fitness Pty Ltd v Australian Institute of Fitness (Vic/Tas) (No 3) (2016) 109 ACSR 369. Sanford v Sanford Courier Services Pty Ltd (1986) 10 ACLR 549.

181

Re Dalkeith Investments Pty Ltd (1985) 3 ACLC 74, discussed at [8.160].

182 183 184

(2016) 109 ACSR 296. Campbell v Backoffice Investments Pty Ltd (2008) 66 ACSR 359 at [401] per Young CJ in Eq. Trafalgar West Investments Pty Ltd v Superior Lawns Aust Pty Ltd (No 6) (2014) 102 ACSR 130 at [25].

185

Lucy v Lomas [2002] NSWSC 448 at [43]; Re G Jeffrey (Mens Store) Pty Ltd (1984) 9 ACLR 193 at 199.

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the business. When the other refused, he sought relief under s 233. The court considered that the following elements of commercial unfairness justified the making of a compulsory buy-out order of the plaintiff’s interest: • resumption of the former basis on which the two men had earlier co-operated was no longer possible; • the income that the plaintiff had earlier received on the basis that it was his to keep has stopped being paid; • there is no present prospect of the plaintiff receiving income from his shareholding other than at the discretion of the majority shareholder, regardless of how the business fared; • in view of complex intra-group dealings and the informality with which the group affairs have been conducted, there was no real prospect of the plaintiff selling his interests for a fair value to anyone other than the other director; and • the majority shareholder was effectively keeping the value of the plaintiff’s equity locked up in the companies, running the companies in his own interest. 186 The significance of a fair offer for purchase of the plaintiff’s shares: In O’Neill v Phillips Lord Hoffmann in dicta (since the point did not need to be decided 187) contemplated that exclusion from management might not be unfairly prejudicial conduct if the respondent “has plainly made a reasonable offer” before the petition had been presented. He identified characteristics of a reasonable offer as being to purchase the shares at a “fair value”, and that “the value, if not agreed, should be determined by a competent expert”, as an expert not an arbitrator, and in circumstances where both parties have access to information about the company and the opportunity to make submissions to the expert. 188 In Tomanovic v Global Mortgage Equity Corporation Pty Ltd Campbell JA in the NSW Court of Appeal considered that the making of a reasonable offer to buy out the minority shareholding is merely one factor that can be relevant to whether oppression is made out; the making of a reasonable offer does not necessitate a conclusion that there was no oppression. On the other hand, it may not be necessary for the offer to be an offer in the sense that is relevant for contract formation and the period for which the offer is open and the reasonableness of the offer are all factors which are relevant to, but not decisive of, the issue of oppression. 189 Denial of access to corporate information: We saw in Re Ledir Enterprises (see [8.205] at [194]) that denial of access to information, such as corporate books and records (even such access as complies with shareholder access rights under s 247A), can also constitute oppression in an appropriate case. 190 Oppression in the conduct of board or shareholder meetings: Repeated or persistent failure to hold meetings of directors or members which are required by the Act or constitution to be held, or to give proper notices of meetings, or to allow proper time for discussion at meetings, can constitute oppression. 191 In John J Starr (Real Estate) Pty Ltd v Robert R Andrew (A’asia) Pty Ltd Young J said: 186 187

(2011) 84 ACSR 121 at [196]-[206]. Tomanovic v Global Mortgage Equity Corporation Pty Ltd (2011) 84 ACSR 121 at [231] per Campbell JA.

188 189

O’Neill v Phillips [1999] 1 WLR 1092 at 1107; the type of offer that his Lordship was contemplating was not necessarily an offer to purchase and might include “some other fair arrangement”. (2011) 84 ACSR 121 at [235], [242], [255], [256]; Macfarlan and Young JJA agreed with Campbell JA.

190

See, eg, Re Back 2 Bay 6 Pty Ltd (1994) 12 ACSR 614.

191

See, eg, Shum Yip Properties Development Ltd v Chatswood Investment & Development Co Pty Ltd (2002) 40 ACSR 619 at 659. [8.210]

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It is essential in company law that all persons who are entitled to participate in meetings are able to participate in them to the extent which the law allows. There must be proper notices of meetings; there must be proper time for discussion at meetings; everybody’s views must be respected before the vote is taken, on which the majority will succeed, if they wish but only after they have listened. Where the rights of the minority are affected by persistent conduct of the board, so that they our not able fully to participate in meetings, then there is, in my view actual oppression. 192

In that case one director enjoyed a “moral ascendancy” and a great deal of influence on the board which he referred to as “my board” and the company as “my company”. This language seemed to extend beyond the figurative and his attitude was judged to be overbearing. The judge considered that it is “oppressive for a member of the board of directors using his or her tactical skills to secure an advantage, at least beyond a certain limit. This is so whether the director concerned is in the majority or in the minority”. This strategic manipulation becomes a ground of complaint where tactics are so constantly employed by the majority that the minority are virtually deprived of their statutory right to participate fully in shareholder or directors’ meetings. 193 Failure to declare dividends or limiting dividend distributions: Dividend policy is a long-standing source of grievance in closely-held companies. The recurrent concern is that a company is failing to declare dividends or taking an overly restrictive approach to their distribution. In Thomas v H W Thomas Ltd the New Zealand Court of Appeal found that there was no oppression when a family company continued its long-adopted conservative approach to dividend distributions. In that case, it was held relevant that the plaintiff had inherited his shares, that various members of the founder’s family continued to work in the company, and that there was no basis for concluding that the petitioner had contributed in any way to the value of the company’s assets. 194 In contrast, in Tomanovic v Global Mortgage Equity Corporation Pty Ltd the plaintiff had contributed to the business success and his complaint concerned a change in the historical practice of income distribution, not by paying dividends but by distributing income from the businessto the new partners in other ways. After they decided to terminate the venture but without settling terms, income distribution to the plaintiff changed instead to a loan repayable upon termination of the venture where the plaintiff’s income prospects were thereafter at the discretion of the majority shareholder. That was an element of the commercial unfairness found in the defendant’s conduct and in the buy-out order made in response to the oppression. 195 [8.212]

1.

Notes&Questions

It is not clear whether relief may be granted under s 233 even though the conduct complained of is no longer continuing at the time the court considers making an order. In Campbell v Backoffice Investments Pty Ltd (2008) 66 ACSR 359 at [132] Giles JA said “claimed relief founded on conduct which is no longer continuing may be refused, but will not always be refused, in the exercise of the discretion”. Young CJ in Eq thought, however, that “the authorities still require one to show continuing oppression at the date of hearing unless one is complaining about an act in the past of a director or other controller of the company which has a continuing effect”: at [382]. The third judge, Basten JA, did not address the specific issue although his view (at [195]), that there is nothing in s 232 that requires that relief is only available if the business of the

192 193 194

(1991) 6 ACSR 63 at 71-72. (1991) 6 ACSR 63 at 78. [1984] 1 NZLR 686; Re G Jeffrey (Mens Store) Pty Ltd (1984) 9 ACLR 193.

195

Tomanovic v Global Mortgage Equity Corporation Pty Ltd (2011) 84 ACSR 121 at [207].

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company is continuing, may be interpreted as supporting the view of Giles JA. The court was unanimous is setting aside the repurchase order. 2.

Must shareholders now show that the conduct etc of which they complain affects them in their capacity as members? Need the conduct be adverse or detrimental to the member’s financial interests as a shareholder? Would the solicitor in Eley v Positive Government Life Assurance Co (1875) 1 Ex D 20 (see [8.120] at 892-895) be permitted to complain under the section in respect of the company’s dealing with him as solicitor? Would the petitioner in Ebrahimi v Westbourne Galleries, denied office as a director and employment with the company, be entitled to relief under Pt 2F.1?

3.

Would the “unwise, inefficient and careless” conduct of the managing director in Re Five Minute Car Wash Service Ltd [1966] 1 WLR 745 be remediable under s 233? Would the actions of the majority directors in Re Weedmans [8.175] justify the making of an order under s 233?

4.

What does the concept of unfair discrimination add to that of unfair prejudice? What relation has the unfair discrimination concept to the discrimination test propounded by Evershed MR in Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286 [8.55] at 290?

5.

What scope emerges for the oppression remedy in respect of shareholder grievances about directors and controllers’ decisions? Does Pt 2F.1 add further grounds of judicial review with respect to those decisions? What relation does it have to the doctrines which impose equitable limitations upon the powers of directors and majorities? What principles emerge from the oppression cases as to the circumstances in which the exercise of voting power (by directors or shareholders) will ground an order under s 233? Thus, would the plaintiff in Hogg v Cramphorn Ltd [7.275] be entitled to an order under s 233 in respect of the conduct of the directors in issuing shares for an improper purpose? Would it make any difference if the company were a quasipartnership such as that in Ebrahimi v Westbourne Galleries Ltd? See Re DR Chemicals Ltd (1989) 5 BCC 39, discussed (1990) 8 C&SLJ 63.

6.

For further discussion of the scope of the oppression remedy, see R J Turner (2013) 31 C&SLJ 278; P Roberts & J Poole [1999] JBL 38; E J Boros, Minority Shareholders’ Remedies (1995), ch 6; L Griggs (1993) 9 Qld U Tech LJ 101; J Hill (1992) 10 C&SLJ 86; D Bouchier [1990] JBL 132; I M Cameron (1985) 8 UNSWLJ 236; J F Corkery (1985) 9 Adel LR 437; R R Pennington et al (1984) 5 Co Law 264 and (1985) 6 Co Law 21; D D Prentice (1983) 3 OJLS 417; D Wishart (1987) 17 UWALR 94.

The range of orders [8.215] If one of the grounds in s 232 is established, the Court can make any order under

s 233(1) that it considers appropriate in relation to the company, including an order (a) that the company be wound up; (b)

that the company’s existing constitution be modified or repealed;

(c)

regulating the conduct of the company’s affairs in the future;

(d)

for the purchase of any shares by any member or person to whom a share in the company has been transmitted by will or by operation of law;

(e)

for the purchase of shares with an appropriate reduction of the company’s share capital;

(f)

for the company to institute, prosecute, defend or discontinue specified proceedings; [8.215]

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(g)

(h) (i) (j)

authorising a member, or a person to whom a share in the company has been transmitted by will or by operation of law, to institute, prosecute, defend or discontinue specified proceedings in the name and on behalf of the company; appointing a receiver or a receiver and manager of any or all of the company’s property; restraining a person from engaging in specified conduct or from doing a specified act; or requiring a person to do a specified act.

The word “if” in the opening words in s 232, viz, that the Court “may make an order under s 233 if …” “does not simply indicate the precondition to making an order, but is an indicator of why an order should be made. At its widest, the order is to provide a remedy for the oppression … the exercise of the discretion should be with a view to ending the oppression”. 196 These specific orders may not exhaust the range of remedial orders since counterparts of the general direction to “make any order … that it considers appropriate in relation to the company” has grounded orders to award damages or make orders for compensation. 197 As noted in Re H R Harmer Ltd (see [8.185] at 601), an order was made to address grievances within a family company in a manner that carefully avoided humiliation of the founder. The potential of the remedy for creative dispute resolution was thus established early. It would, however, be a rare situation where an order would be made to wind up a stock exchange listed company, the more so where the company is solvent. 198 Orders for the purchase of the petitioner’s shares (under s 233(1)(d) and (e)) have raised problems of valuation. While the valuation of shareholdings in private companies is inherently problematic, 199 the difficulty is often exacerbated by the fact that the conduct which sustains the order has also diminished the value of the petitioner’s shareholding. Different solutions have been applied to the problem. In Scottish Co-op Society Ltd v Meyer (see [8.185] at 601) the purchase price of the petitioner’s shares was fixed by reference to the value which they would have had at the date of the petition if there had been no oppression. In Bright Pine Mills Pty Ltd, 200 where the oppression lay in the diversion of a profitable opportunity to a partnership in which some of the directors were interested, the petitioner’s shares were valued on the basis that the partnership was a wholly owned subsidiary of the company. In yet another case where directors of a private company had taken excessive remuneration, shares were valued by capitalising the dividend stream from a typical year after adjustment to restore emoluments to commercially justifiable levels. 201 Section 233(g) is directed expressly at Foss v Harbottle and enables an individual shareholder to overcome the procedural obstacles to corporate litigation. The Court may direct the company to institute specified proceedings or may authorise a member to do so in the name and on behalf of the company. The provision was applied in Re Overton Holdings Pty Ltd 202 with an order made authorising a shareholder to institute proceedings in the name and on behalf of a company in respect of loan arrangements made with its controlling 196 197

Campbell v Backoffice Investments Pty Ltd (2008) 66 ACSR 359 at [122] per Giles JA. Re Chime Corp Ltd [2004] 7 HKCFA 546 (Hong Kong Court of Final Appeal); Gamlestaden Fastigheter AB v Baltic Partners Ltd [2007] 4 All ER 164 (Privy Council).

198 199 200

Noble Investments Pty Ltd v Southern Cross Exploration NL [2008] FCA 1963. See, eg, Re Bird Precision Bellows Ltd [1986] 2 WLR 158; V Krishna (1987) 8 Co Law 66. [1969] VR 1002.

201

Sanford v Sanford Courier Service Pty Ltd (1986) 10 ACLR 549 and Sanford v Sanford Courier Service Pty Ltd (No 2) (1987) 11 ACLR 373.

202

(1984) 2 ACLC 777.

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shareholder after attempts to convene a general meeting had been thwarted. The general utility of the remedy is affected by the introduction of Pt 2F.1A although that provision does not affect the exercise of the remedial power under s 233. The factors conditioning the exercise of discretion under s 233 are complicated in proceedings concerning the conduct of the affairs of stock exchange listed companies. Two sets of proceedings involving related companies were initiated by tenacious minority shareholders who pursued the litigation in the public interest. In Re Spargos Mining NL 203 the court found that the company’s property and resources had been transferred to related companies under transactions which were “almost entirely devoid of any discernible commercial benefit” to it, and were of benefit only to other members of the group. The case for relief under Pt 2F.1 being established, attention turned to the form of relief. That process and its outcome are outlined in the first extract below. The orders made included the appointment of an independent board of the court’s choosing, charged (inter alia) with the investigation of past defaults and bringing appropriate recovery proceedings. The second extract also relates to a company in the Independent Resources group of companies, and was initiated by the same petitioners: see Jenkins v Enterprise Gold Mines NL [8.225]. In both extracts references to the Corporations Act have been substituted for their contemporary counterparts; further, the Independent Resources group is referred to simply as “IRL” in both extracts.

Re Spargos Mining NL [8.220] Re Spargos Mining NL (1990) 3 ACSR 1 Supreme Court of Western Australia MURRAY J: [47] It is, of course, clear that the powers of the court are very broad. The discretion conferred by s 233(1) is to make such order as the court thinks fit. I have spoken of the way in which the petition is framed and the relief sought therein. I have spoken of the fact that an order that the company be wound up is not the principal relief sought, nor … is that an order which I would make. In my view, such an order would of itself unfairly prejudice the shareholders of Spargos, if made at the present time, and there is no call for it, I think. I can say at the outset that I do not propose to make an order under s 233(1) instructing the company to [48] institute any specified proceedings. I have already said that I regard that as a matter consequential upon further investigation of particular transactions. I am most attracted to the consideration of the power conferred in s 233(1)(c) which expressly refers to the making of an order “for regulating the conduct of affairs of the company in the future”. However, I should deal specifically with the principal relief sought which is in terms of s 233(1)(h), the appointment of a receiver and manager of property of the company with consequential orders directed to laying down the framework of future management of the company. I note also that it is quite clear, not only from s 233(1), but also from s 233(3) that an order I may make may alter in any appropriate way the articles of the company and in that event I may create a situation in which the company may not amend the result I create without leave of the court. Under s 233(3), any such alteration has effect as if duly made by resolution of the company. As to the usual justification for the appointment of a receiver, the option preferred by both the petitioner and the NCSC, the case Re A Company [1987] BCLC 133 provides some useful discussion, in the context of a small company operated much in the character of a partnership. Reference was made by Harman J (at 135) to the appointment of a receiver pending final resolution of the dispute “to hold the ring and ensure that the status quo of the assets is preserved, but the value of the business is there, so that the whole thing may best be realised for the advantage of all partners in due course”. Similarly, in corporate circumstances reference was made (at 136) to the appointment of a receiver where there is “a jeopardy to the assets of the business”. After citation of authority his Honour said: “Both cases are important because they illustrate that the court will not interfere with the ordinary day-to-day 203

(1990) 3 ACSR 1. [8.220]

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Re Spargos Mining NL cont. management of a company and yet they hold that a receiver can be appointed, although for a limited time, when there are serious dissensions and a high degree of difficulty in managing the company properly while the dissensions are sorted out.” I think it is clear that in the context of this case whatever remedy I provide should be upon the basis that it is temporary to provide breathing space to allow for proper investigation of the past affairs of the company, including the transactions brought forward by the petitioner, but not limited thereto. In the meantime, provision should be made to manage the company effectively and efficiently, but not subject to the ordinary limitation in relation to a receiver, that he is simply there to “hold the ring”. … [49] [T]he company opposes such a remedy. It points out, as I have already observed and as is conceded by the other parties, that, for example, in respect of the mortgage granted to Esanda Finance Ltd over its office building at 50 Collins Street, West Perth, to secure an indebtedness of $8.5m and the securities granted to Rothschild Australia Ltd over Spargos’ 50% interest in the Bellevue Goldmine in relation to a loan granted, the appointment of a receiver would constitute an act of default which would expose Spargos to action under those agreements. … [50] The evidence would indicate that [Spargos] remains a viable and satisfactory company, with some chance of recovering from the harm of past mismanagement if appropriate skills can be brought to bear, including the thorough investigation and pursuit of remedies for past defaults. I am conscious that in that regard there may or may not be more to be unearthed than has been the subject of evidence before me. Having regard to all the foregoing, I propose to make an order which will effectively replace the existing elected board of Spargos with a board of my own choosing. I propose that Spargos under the management of that board should not be given any special protection as to its future, but for a period of 12 months from the date of my order I will secure the existence of the board I propose. That will provide the independent management necessary for the relief of Spargos and its members, but without the appointment of a receiver and in the expectation that within that period progress will be made [51] to again place the company on a sound footing and pursue remedies in respect of past defaults…. [T]he substance of my final orders will be as follows: (1)

Pursuant to s 233(3) Spargos’ articles of association art 98 is deleted for a period of 12 months or until further order (the rotary resolution procedure).

(2)

The existing directors and any alternate directors shall upon the making of this order cease to hold office.

(3)

There shall hereby be appointed as directors of Spargos the following [four named] persons….

(4)

The board so appointed shall assume the duties, responsibilities and powers of management of the company pursuant to its articles of association art 102 and as otherwise stipulated therein and as conferred and imposed by law. Each of the persons so appointed shall be a director of Spargos within the meaning of the articles of association and collectively they shall be the “board” of Spargos, as defined by art 1(d).

(5)

To secure the position of that board and any court approved replacements of the personnel so appointed for the period of this order, the following articles of association are deleted and neither they nor any article to similar effect shall be introduced without the leave of the court…. [52] (6) To give emphasis to the matter I shall order that the board specifically investigate or cause to be investigated, the transactions entered into by Spargos from 1 January 1988 (shortly after which date the board became dominated by IRL nominees) and 31 March 1990 (shortly before which date the board became as presently constituted) and the conduct of the company’s affairs by directors during that period, and that the board do institute and prosecute in the name of the company all such causes of action against whomsoever they may exist as the directors shall ascertain or be advised may be open.

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Re Spargos Mining NL cont. (7)

At the expiration of each period of three months during the operation of this order, the directors shall report to the court in a form which gives a true and fair view of the affairs of Spargos as at that date. Such report shall provide adequate information as to the state of investigation and the pursuit of causes of action referred to in the previous order. It shall be published as directed by the court for the information of all shareholders and served upon the NCSC.

(8)

Prior to the expiration of the term of this order and in accordance with the provisions of the articles of association, the directors shall convene a general meeting of Spargos the business of which shall be, inter alia, the election of directors to replace those appointed hereby who shall, however, be eligible for election.

No other special orders are in my view required. It will be seen from the above that my purpose is specifically to secure to Spargos an independent administration capable of investigating past malfeasance and pursuing remedies therefor as well as continuing in a responsible way the management of the company in accordance with the generality of the articles of association, the operation of which I have preserved. The ordinary powers, subject to the interference I have made under this order, of directors and members of the company under the articles of association will continue.

Jenkins v Enterprise Gold Mines NL [8.225] Jenkins v Enterprise Gold Mines NL (1992) 6 ACSR 539 Supreme Court of Western Australia (Full Court) [The trial judge found that in several substantial transactions the defendant company’s interests had been wholly subordinated to those of other group companies to the detriment of the defendant. The transactions were found to be oppressive or unjust within the meaning of s 232. At the same time, however, the principal transaction had been ratified by the shareholders in general meeting under a process with which the judge declined to interfere. Further, two persons independent of the Independent Resources group had latterly been appointed to the company’s board, being two of the court appointed directors of Spargos Mining NL. One was made chairman of the board. There were two other directors, both associated with the Independent Resources group. For these reasons the trial judge declined to make the order sought by the petitioner for the appointment of a receiver and manager to the company. An appeal was made against the refusal to make this appointment.] MALCOLM CJ, ROWLAND and FRANKLYN JJ: [559] (2) In our view, in the absence of any adequate explanation from the directors of Enterprise, the combination of conflict of interest, the existence for reasons for grave doubts about and failure to explain the benefits to Enterprise, and failure otherwise to explain how the conflicts of interest were resolved in the above transactions, also lead to an inference of unfair conduct for the purposes of s 232. To these we would add relevant unfairness in the following discrete transactions – the CGMA loan transactions; Benguet share purchase; Advocate purchase and the chairman’s use of proxies at the annual general meeting to ratify an oppressive transaction which by then was likely to lead to a loss to Enterprise. (3) His Honour found that: (a)

for all practical purposes IRL interests, or those associated with IRL were “capable of controlling the destiny and the affairs of Enterprise on the floor of any general meeting”;

(b)

Fuller [the IRL Chair], at all relevant times, by proxies held on behalf of IRL as well as other shareholders controlled 45% of the voting power of Enterprise shareholders;

(c)

to borrow from his Honour’s terminology in relation to his description of certain individual directors, they showed “hopeless unresolved conflict of duty”; “a fine disregard for the conflict of interest involved”; “the air was redolent with the scent of conflict of interest which as will be seen remained quite unresolved.” [8.225]

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Jenkins v Enterprise Gold Mines NL cont. (4) In our view it is not necessary to consider whether there was illegality in the conduct of the annual general meeting 1989. What does emerge from that meeting is the clear indication that the holding of a general meeting of shareholders for the purpose of remedying oppression does not work where the oppressor effectively controls the voting power of such meeting. The meeting itself worked further oppression. … [561] Once the relevant oppression or unfairness is found, it is the obligation of the court to grant whatever relief is best suited to deal with that conduct. Oppression was found as fact. One act of oppression found by his Honour was exacerbated in that it was in fact ratified at a general meeting. Those who were responsible for the oppressive conduct effectively controlled the voting power of the general meeting and ratified the issue of the preference shares whereby $12m went out of Enterprise with little prospect of any [562] return. There were other acts of oppression found by his Honour. There have been transactions entered into in circumstances which demanded the fullest explanation where there were unresolved conflicts of interest and which disclosed huge losses to Enterprise. The mere recitation of these matters shows that there was a requirement for a receiver and manager to be appointed with full powers to investigate. … There is nothing in any of the authorities, however, which would tend to place a limit on the grant by the court of an appropriate remedy once it is found that the conduct complained of is oppressive, unfairly prejudicial, or unfairly discriminatory. The powers given to the court are extremely wide. They include the power to make orders regulating the conduct of the affairs of the company in the future. This necessarily involves the court making orders which may interfere with the internal administration of the company. There is nothing in the language of Pt 2F.1 which suggests that the court should be reluctant to interfere where that is necessary or desirable to give effective relief. There is express power to order the appointment of a receiver and manager. … [563] [T]he relief proposed by his Honour was in our view inadequate and was based on a wrong premise. It was based on a conservative view that the shareholders in annual general meeting could overcome any unfairness to minority shareholders. Objectively that does not follow and in the present case has been shown to be wrong. As well, the order proposed by his Honour did not give any relief to the appellant which would enable the earlier transactions to be fully investigated. These transactions involved apparent conflict of interest and unfairness to the minority shareholders which has resulted in huge losses to the company.

[8.235]

Review Problems

1. John holds 20% of the equity in a private company which carries on business as franchisor of real estate agencies. Robert and his wife hold 60% of the equity and the balance is distributed among company employees. John and Robert are both directors, Robert being managing director. The constitution gives Robert power to nominate a majority of the board. Personal relations between John and Robert have seriously deteriorated and John now resents Robert’s dominance of board proceedings. Specifically, John complains that board meetings have been conducted without regard to the views of directors other than Robert, that meetings of Robert and his board faction are held before full directors’ meetings to formulate a position and strategy with respect to items arising at board meetings, that Robert sometimes restricts the speaking time available to John and on one occasion called a board meeting upon shorter notice than required by the constitution at a time when it was known that a director generally supporting John would be unable to 670

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attend. John and Robert do not speak to each other save for absolutely necessary communications. John would like to terminate the relationship. Advise him of his possible remedies. (These facts are based upon those in John J Starr (Real Estate) Pty Ltd v Robert R Andrew (A’Asia) Pty Ltd (1991) 6 ACSR 63.) 2. Albert Jnr holds 50% of the shares in an engineering company founded by his late father, Albert Snr, who held the balance of equity. Albert Jnr has been managing director of the company since Albert Snr retired from active involvement in the business 10 years ago. Albert Jnr has continued his father’s longstanding practice of dealing loosely with company funds. Thus, he receives an above-market salary and his wife receives a salary for which she performs no services; they also pay for holidays and other personal expenses out of company funds. The company has never paid a dividend and its continuing profits have either been taken as salary and emoluments or ploughed back into the business. Two years ago, Albert Snr died. To his son’s surprise, his shares passed under his will to his second wife who is not Albert Jnr’s mother. The executor of the will is not satisfied by Albert’s assurances that dividends will be paid in the future and wishes to have Albert purchase the balance of the capital. Advise her. (These facts are based upon those in Cooke v Fairbairn [2003] NSWSC 232.)

[8.235]

671

CHAPTER 9 Corporate Finance [9.10]

[9.45]

[9.75]

[9.120]

[9.200]

THE SOURCES OF CORPORATE FINANCE ...................................................................................... 674 [9.10]

Some functions of capital markets generally ................................................................. 674

[9.15]

Stock exchange listing and the quotation of securities ................................................. 675

[9.35]

Some principal sources of corporate finance ................................................................ 677

DEBT FINANCE ............................................................................................................................. 679 [9.45]

Some characteristics of debt finance ............................................................................ 679

[9.55]

Debentures .................................................................................................................. 680

CLASSES OF SHARES ..................................................................................................................... 683 [9.75]

Introduction ................................................................................................................. 683

[9.80]

The construction of preference shares .......................................................................... 685

[9.105]

The protection of class rights ....................................................................................... 690

FINANCIAL REPORTS AND AUDIT .................................................................................................. 697 [9.120]

Corporate regulation through mandated corporate disclosure ..................................... 697

[9.125]

Accounting and auditing standards .............................................................................. 699

[9.130]

The financial report ...................................................................................................... 701

[9.135]

The directors’ report .................................................................................................... 702

[9.145]

Half-yearly reporting for listed companies .................................................................... 704

[9.150]

Auditing the financial report ........................................................................................ 704

[9.155]

Appointment and removal of auditors .......................................................................... 705

[9.160]

Communication of the financial reports to members and the public ............................ 706

[9.165]

Strengthening auditor independence ........................................................................... 707

[9.190]

Exemptions and modifications ..................................................................................... 713

[9.195]

Sanctioning financial reporting and auditing obligations .............................................. 713

THE RAISING OF SHARE CAPITAL .................................................................................................. 714 [9.200]

Members’ liability to contribute share capital ............................................................... 714

[9.205]

The abolition of par value shares .................................................................................. 715

[9.210] [9.215]

Bonus shares ................................................................................................................ 716 The issue of shares for non-cash consideration ............................................................. 717

[9.225]

REDEEMABLE PREFERENCE SHARES ............................................................................................... 719

[9.230]

SHARE CAPITAL REDUCTION ......................................................................................................... 720

[9.280]

[9.230] [9.235] [9.240]

The forms of capital reduction ..................................................................................... 720 Schemes of arrangement in outline .............................................................................. 721 Relaxing the capital maintenance rules ......................................................................... 721

[9.245]

Share capital reductions specifically authorised ............................................................ 723

[9.250] [9.255] [9.260]

Procedure for capital reduction .................................................................................... 724 Substantive criteria for valid capital reduction .............................................................. 726 Sanctions and remedies for unauthorised reductions .................................................... 726

[9.265]

A case study: The James Hardie cancellation of partly paid shares ................................................................................................................... 728

SHARE BUY-BACK .......................................................................................................................... 738 [9.280]

The policy underlying reform of the traditional prohibition .......................................... 738 673

Corporations and Financial Markets Law

[9.285] [9.290]

[9.320]

[9.355]

The scope of the buy-back power ................................................................................ 740

SELF-ACQUISITION AND CONTROL OF SHARES ........................................................................... 742 [9.295]

Direct self-acquisition ................................................................................................... 742

[9.300] [9.305] [9.310]

Taking security over shares of a company or controller ................................................. 742 Indirect self-acquisition ................................................................................................ 742 Expanded notion of control of an entity for purposes of Pt 2J.2 .................................... 744

[9.315]

Sanctions and remedies ............................................................................................... 744

FINANCIAL ASSISTANCE FOR THE ACQUISITION OF A COMPANY’S SHARES ......................................................................................................................................... 745 [9.325] [9.330] [9.335]

Origins and rationale ................................................................................................... 745 The conditional licence for financial assistance ............................................................. 746 Exempted financial assistance ...................................................................................... 747

[9.340] [9.350]

The scope of the prohibition ........................................................................................ 747 Other grounds of civil liability ...................................................................................... 751

DIVIDENDS ................................................................................................................................... 753 [9.355] [9.360]

Dividends and capital maintenance .............................................................................. 753 The power to determine, declare and pay dividends .................................................... 758

[9.365] [9.395]

Profits available for distribution under the profits test ................................................... 760 Civil liabilities ............................................................................................................... 769

[9.05] A company may obtain finance for its operations from a number of sources.

Shareholders, of course, subscribe for share capital. In addition, they usually contribute towards what might loosely be called the capital fund by permitting the company to retain earnings otherwise available for dividends and by the creation of a variety of reserves. Shareholders in private companies often advance loan funds. For larger companies debt finance is a principal source of funds. This chapter is concerned with the principal sources of corporate finance, debt and equity (or share capital) finance. This chapter initially surveys the several species of commercial finance and some principal incidents and the relative importance of each species of capital. The section also outlines the process of stock exchange listing and the quotation of equity and debt securities. Subsequently, the chapter examines serially • some principal characteristics of debt finance; • classes of share capital, in particular the rights attached to preference shares and the protection given to class rights generally; • statutory requirements for corporate financial reporting including some concepts important to an understanding of share capital; • legal rules relating to the reduction of share capital that underpin the protection of the capital fund to which shareholders subscribe against the threat of its dissipation contrary to creditor interests; and • related doctrines touching the raising and maintenance of share capital.

THE SOURCES OF CORPORATE FINANCE Some functions of capital markets generally [9.10] The capital markets (or financial system) serve the economic function of effecting

transfers between those segments of a society with surplus resources for investment and those seeking funds for productive enterprise. Direct transfers may be made between savers and users as, for example, when governments issue bonds or other debt claims to households and 674

[9.05]

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other investors to finance their activities. However, in sophisticated economies financial intermediaries play a significant role in channelling flows between savers and borrowers. In the Australian financial system the principal financial intermediaries are the life insurance offices, pension and superannuation funds, unit trusts, finance companies, building societies and credit unions. The term “capital markets” comprehends a series of diverse submarkets differentiated by the character of the financial intermediation employed or the nature of the financial claim issued. From the perspective of companies and securities law, the most important submarket is the cluster of markets known as the securities markets. The term “securities market” is sometimes used to refer to the market for government and semi-government securities as well as the market for corporate securities (that is, shares and debentures). However, this chapter is concerned exclusively with the latter usage. The stock exchanges are the principal form of securities market. A stock exchange provides a market for the sale and purchase of corporate securities. Transactions upon the exchanges are effected by stockbrokers whose business is the sale or purchase of securities on the exchange, acting on an agency basis and charging a commission (or brokerage) generally varying with the size of the transaction. Until 1990 Australian stock exchanges provided a physical marketplace – the trading floor – although some larger deals were effected off the trading floor. The trading floors were replaced in 1990 by a fully computerised trading system: see [11.40]. The second principal capital market is the so-called money market comprising the institutional networks which bring together lenders and borrowers of short-term funds. As with securities markets, money markets are not conducted through a physical marketplace but by the complex of dealings and trading relationships through which short-term debt claims are created and negotiated. One important classification of capital markets refers to their primary and secondary functions. The primary function involves the transfer of funds from savers to borrowers who will use those funds for productive purposes. The issue of shares or debentures by corporations is an example, the new issue market for those securities being part of the securities market generally. The secondary function of a financial system is the provision of markets for trading claims or securities created at the primary stage. The principal example is the secondary market provided by the stock exchanges where stockbrokers trade in securities which have been admitted to quotation. The stock exchanges do not formally provide a market for new issues since subscriptions are not solicited on the exchanges. However, stockbrokers are centrally involved in the marketing of new securities issues to their clients and other potential subscribers. While secondary markets do not contribute directly to capital formation, they provide essential support. First, they provide liquidity by enabling holders to convert securities into cash, ideally at minimum cost and without a significant decrease in price caused by the sale. The availability of liquidity is often an important inducement to investment. Second, secondary markets help to establish the cost of capital (or finance) for the issuer and the rate of return for the holder on the basis of information made available to the market and through the operation of forces of supply and demand. Thus, companies whose prospects are judged favourably by the secondary market will be able to raise finance more cheaply. The calculation of the opportunity costs of financing through retained earnings or depreciation charges is facilitated by knowledge of the returns expected by the market at certain prices. Stock exchange listing and the quotation of securities [9.15] Relatively few public companies will seek listing upon a stock exchange and obtain

quotation for their securities: see [2.150]. However, this small group of companies generally [9.15]

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Corporations and Financial Markets Law

contains the largest and most significant corporations and their listing and quotation represents the mature stage of the capital-raising process. The legal incidents of listing and the powers of the stock exchanges are examined in Chapter 11. The present treatment of listing and quotation is therefore preliminary and for the limited purpose of understanding the role of the stock exchanges in capital accumulation for business enterprise.

The benefits and cost of listing [9.20] Listing and quotation upon a securities exchange secures particular advantages. Four

may be singled out. First, the company gains access to wider sources of finance through the new issue facilities of the securities markets. Stock exchange listing provides access to sources of equity capital and may liberate a company from reliance upon debt as a primary source of funding for its activities. The long-term character of equity and its freedom from any repayment obligation during the life of the company are transparent advantages. Further, floating a company gives it access to a larger pool of equity capital than is generally available through private placement of its securities. Listing also facilitates the raising of additional capital through rights issues made to existing shareholders entitling them to subscribe for further quoted securities in proportion to their existing holdings. Rights issues are usually made at a slight discount to the market price of the security. 1 Second, listing secures liquidity for interests in the company, thus facilitating the raising of further capital. Third, listing enables proprietors whose capital has been effectively locked up in their shareholdings to realise the value of their investment through sale upon a public market. Finally, listing generally conveys a reputational signal that may have advantages in dealings with financiers and suppliers. Listing undoubtedly has its costs. The public market facility for the company’s securities exposes its erstwhile controllers to the threat of an unwelcome takeover if they have used the listing to realise a significant portion of their holding. Listed companies also suffer a loss of privacy through their continuous exposure to the stock exchange, market and press inquiry as to price sensitive company developments. They are also subject to higher expenses – for listing fees, share registry, annual reports to shareholders and general investor relations.

The methods of listing [9.25] The standard mode for the initial listing of a company and quotation of its securities is

through a public offering made by means of a disclosure document lodged with ASIC under Ch 6D: see [10.55]. Quotation may also be granted to rights to subscribe for new capital and for that capital when it is issued upon exercise of those rights. A third method of listing, applicable both to an initial listing and the raising of additional capital, is by private placement made to institutional and other investors under exemption from lodgment of a disclosure document under Ch 6D. Before such a company is listed and its securities granted quotation, it would need to satisfy stock exchange criteria for admission which require disclosure broadly comparable to that required under Ch 6D.

The process of listing [9.30] In the Introduction to its listing rules, the Australian Securities Exchange (ASX)

reserves to itself an absolute discretion as to whether to admit a company to the list. The provisions of the listing rules governing admission of companies to the list embrace criteria 1

The rights issue may be expressed to be renounceable, that is, the shareholder may be entitled under the terms of issue of the rights to renounce in favour of another, her or his entitlement to subscribe for the securities at the rights price. Since this price is usually less than market value, the rights are themselves valuable and may be granted quotation along with the security to which they relate.

676

[9.20]

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touching both the financial condition of the company and the distribution of its securities among holders. The financial criteria are designed to minimise the risk associated with an investment and to provide investors with information necessary for its assessment; the minimum spread criteria are designed to provide holders with a reasonable expectation as to the liquidity of their investment in an orderly market. The specific admission criteria vary as between the several types of entity which may seek listing. For companies seeking quotation for shares upon ASX, the financial criteria require proof either of a demonstrated record of trading profits from a continuing business activity or a minimum level of net tangible assets in respect of which the company has firm proposals for deployment or investment. If the company is an industrial company it must also provide independent expert opinion that it has sufficient working capital to meet its objectives and that its product, service or technology is sufficiently developed to provide a reasonable expectation of earnings within the next three years. The distributional criteria require at least a minimum number of shareholders each with a minimum shareholding value. Under established practice, applicants for ASX listing are sponsored by a member of the exchange who will assume responsibility for organising listing and quotation, including the scrutiny of the draft prospectus by the ASX Listing Committee. If the securities offering is underwritten, the sponsoring broker assumes this role alone or in conjunction with an investment bank. Underwriting involves the performance of an insurance function in relation to an issue of securities. It is an important mechanism in the securities market in guaranteeing the capital sought to be raised against the vagaries of the market. It is closely allied to the process of marketing the securities. There are different types of underwriting. The first is the classic or “old-fashioned” style of underwriting. This involves a contract whereby the underwriter, for a fee or commission, agrees to procure subscriptions for the securities and to subscribe itself for any not taken up. The company allots the securities directly to the subscriber. The underwriter commonly arranges for subunderwriters to accept responsibility for part of the issue on a similar basis, taking a subunderwriting fee which is below the underwriting commission. This is the most common type of underwriting arrangement in Australia. A second type is firm-commitment underwriting whereby the underwriter is allotted the whole issue and markets it by offering it for sale. In the United Kingdom and United States this is the dominant form of underwriting. A third type of underwriting is that in which the underwriter agrees to use its best efforts to place the securities. This involves no obligation to take up the shortfall, but is rather a selling agreement. It is often the best that a weak company can arrange and sometimes wellestablished companies are happy with this arrangement since, with the lower underwriting risk, the cost is proportionately reduced. Some underwriting agreements thought to be of the first variety, on close examination of the escape clauses, turn out to be closer to the third. Apart from their insurance and marketing functions, underwriters are usually closely involved in the design of the flotation process and in the nurture of a healthy secondary market for the security after its issue, for example, by the preparation and dissemination of research material and the creation of institutional interest in the stock. Some principal sources of corporate finance

Short-term funding [9.35] If short-term funding is defined as those sources of finance for a period of one year, it is

clear that such funding is limited to debt rather than equity capital. 2 Debt funding takes 2

For fuller treatments of both short- and long-term funding see Mallesons Stephen Jaques, Australian Finance Law (6th ed, 2008), Pt III; S R Bishop, H R Crapp & G J Twite, Corporate Finance (2nd ed, 1988), Chs 9 and 11; [9.35]

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Corporations and Financial Markets Law

several principal forms. Bank overdraft facilities are a major source of business finance, especially for small to medium businesses. Second, the unofficial money market provides distinct financing modes. Under the inter-company market, loans are made between companies of standing on an unsecured basis and for very short terms, often overnight or at 24 hours call. The commercial paper market permits the issue and negotiation of marketable short-term debt claims, commercial bills and promissory notes. A term of 90 to 180 days is common for commercial bills although the term of the bill may be renegotiated (or “rolled over”). The bill may be indorsed by a bank which thereby assumes a contingent liability as guarantor of repayment by the borrower. Promissory notes contain no such facility for third party indorsement and are essentially an extension of the inter-company money market. 3 Availability of this finance is therefore restricted to companies which enjoy substantial credit rating. A third source of short-term finance, employed by companies across the size spectrum, is the trade credit arising from the interval between the receipt of and the payment for supplies and services provided to a business. Trade credit often provides a very substantial portion of short-term finance.

Long-term funding [9.40] One species of long-term corporate finance is, of course, equity capital, whether raised

through an initial public offering, a private placement, a rights issue or under special schemes such as employee share schemes or dividend reinvestment schemes. Companies establish dividend reinvestment schemes to permit their shareholders to receive newly issued shares in lieu of a cash dividend. The shares are usually offered at a discount to the current market price of the share. Long-term finance is also raised through the issue of debt claims. One species is the debenture or unsecured note, issued under a public offering process similar to public equity capital raising. A disclosure document is required under Pt 6D.2. Such debt issues may be underwritten. Term loans and mortgage loans, often assembled by an investment bank on behalf of a syndicate of potential lenders, provides a substantial source of finance for larger companies. Sophisticated variations upon this theme include project finance under which the financier has recourse only to the cash flow and assets of a particular project (such as a mining venture or large retail development) and complex leasing arrangements securing long-term finance. Other securities issued by a corporation combine elements of both debt and equity capital. Preference shares more closely approximate debt in function and in some aspects of their legal treatment, although their legal classification remains as share capital: see [9.80]. Their particular advantage to the corporate issuer is the option which they confer to withhold dividend payments in periods of unprofitability without attracting the default remedies applicable to debt. Their issue also increases the equity base of the corporation and lowers its gearing. 4 The convertible note is a second popular hybrid. This is an unsecured note (or debt R Bruce et al (eds), Handbook of Australian Corporate Finance (3rd ed, 1989); E Carew, Fast Money 3: The Financial Markets in Australia (1991). The focus of this section is largely upon domestic sources. For valuable surveys of international capital markets, and the resort made to them by Australian users and providers of funds, see Bruce et al, Part D; M T Skully (ed), International Corporate Finance (1990); R Russell, “International Capital Markets: A Legal Survey” in Mallesons Stephen Jaques, Australian Finance Law (4th ed, 1999). For interesting biographies of some of the principal figures in the development of Australian capital markets see R Appleyard & C B Schedvin (eds), Australian Financiers: Biographical Essays (1988); see also R R Hirst & R H Wallace (eds), The Australian Capital Market (1974). 3

See Bishop, Crapp & Twite, p 271.

4

A company’s gearing is the ratio of its debt to its equity capital. It indicates the extent to which creditors will be able to rely upon shareholders’ contributions in the event of financial difficulty. A company is said to be

678

[9.40]

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interest) issued upon terms which grant its holder the option to convert the debt claim into share capital. The conversion price and period for exercise of the option are usually specified in the terms of issue of the notes. The appeal of this security to the issuer lies in the reduced interest rate (relative to straight debt borrowings) arising from the attachment of the conversion option; conversely, since the option lies with the lender it is an uncertain source of long-term funding.

DEBT FINANCE Some characteristics of debt finance

Comparison with equity capital [9.45] Debt finance (or capital) is money which has been lent to the company (eg, through the

issue of debentures) or which at least is owed by it (eg, trade credit). In company law there is a temptation to concentrate upon share capital at the expense of debt finance: traditional doctrine regards the suppliers of equity as members of the company and the suppliers of credit as external to it. However, functional analysis suggests less clear-cut lines of distinction between the two; in addition, it is quite possible – indeed, in smaller companies common – for a person to be simultaneously a member and creditor of a company. Practical experience would certainly not relegate debt finance to a lesser place than share capital, either on a day-to-day basis or when the focus of attention is a company’s demise. Nevertheless, debt finance brings into prominence some legal principles not otherwise central to company law (notably those of property law) as well as others that are (eg, the law of contract). It is perhaps for this reason that practitioners specialising in the area of debt finance do so more often under the label of banking and finance law than of corporate law.

The function of credit and the meaning of security [9.50] Running a business requires the spending of money. If a company does not have

sufficient resources of its own, from contributions towards share capital or accumulated surpluses, funds must be borrowed for the purpose. The word “credit” relates to financial accommodation of this kind. Credit may take the form of a loan, in which case it may be of a fixed sum or a revolving amount. (The latter refers to a facility to borrow to an agreed limit as and when needed: an example is a bank overdraft.) Credit may also take the form of deferment of an obligation to pay; a simple example is a monthly credit account. Of course, comparable results can be achieved by other means, strictly speaking outside the purview of credit, as when a company’s accounts receivable are sold to a financier at a discount, or when a company has recourse to the short-term money market by drawing a bill of exchange. Such situations in one form or another engage the principles of the law of contract. In most such situations, and certainly in any involving credit in the stricter sense, the creditor will wish to be assured of repayment in accordance with the terms agreed upon – in particular, at the due date, and with any interest payable. Nevertheless, this may be easier said than done. Tardy repayment may give rise to a right of action in the courts, and judgment may in due course be given for the creditor, but there still remains the question of enforcement. This may be “highly geared” when its debt is relatively large and its share capital relatively small. High gearing tends to concentrate the benefits for members when a company is doing well but, correspondingly, accentuates the risks for members (and creditors) when it is doing badly. What is regarded as appropriate gearing varies from company to company, depending among other things upon the nature of the business of the company concerned. The calculation of gearing provides one of the occasions upon which there is movement in the lines of distinction between share capital and debt finance: for this purpose, some forms of preference shares are classified as debt. [9.50]

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Corporations and Financial Markets Law

attempted by execution proceedings (against the property of the debtor company) or garnishee proceedings (against obligations due to it by others). When commenced early, such proceedings may well succeed. However, when too many creditors bring pressure to bear at once, a more probable outcome is the winding up (liquidation) of the company concerned. That is a generally unsatisfactory outcome since most creditors will be entitled only to be treated pari passu – that is, they will be entitled to no more than to share in the proceeds of available assets (if any) in proportion to the size of their individual claims: see [3.200]. For this reason, creditors generally seek from the outset to engage the principles of the law of property by ensuring that they have recourse not only against the debtor company itself but also against some or all of its property, real or personal. That is, they seek to take security. Security may arise by operation of law although more commonly it is created by arrangement between the parties. In this connection, the interests which most naturally spring to mind are those created by the debtor – for instance, mortgages and charges. Such an approach is common when credit takes the form of a loan. But when credit is in the form of deferment of an obligation to pay, a different mechanism is likely to be utilised: reservation of title by the creditor, either under a sale, or under one of the variants upon hire-purchase. Whichever approach is taken, appropriate formalities will need to be observed in order to ensure that the interests concerned are properly created or reserved between the parties. In addition, both parties must be aware of what is sometimes referred to as perfection: in order to bind others, compliance may also be required with requirements as to registration, usually for the purpose of providing notice to the public of the interest concerned. These are now regulated by the Personal Property Securities Act 2009 (Cth). The doctrines relating to credit, security and finance generally apply to corporate debtors in a similar, if not identical, mode to natural persons. Their fuller treatment is outside the scope of this book, as indeed, is one peculiar application to corporations, their capacity to grant a floating charge (now called a “circulating security interest” under the Personal Properties Securities Act 2009 (Cth)). A circulating security interest is a particularly attractive financing instrument from a lender’s perspective. It is a security interest which “floats” over the subject property (often the whole of the company’s undertaking) allowing the company to deal with its assets in the ordinary course of business (including by sale) unless and until some defined act or event occurs which has been set in advance by the lender as a marker of prospective insolvency or excessive leverage. It is not clear whether the company’s power to deal with its assets notwithstanding the former floating charge (ie, the circulating security interest) is best considered as flowing from an implied licence or consent on the part of the lender or on the footing that the security interest does not attach specifically to any of the company’s assets until default. 5 Debentures

Uses of the term [9.55] One distinctive aspect of corporate debt finance is, however, noted here – the

characteristics of a peculiar form of debt interest, the debenture. A debenture is the written acknowledgment of a debt owed by a company. Alternatively, the term is used to refer to an instrument not only acknowledging the debt but charging the property of the company issuing it with repayment of the debt. Third, the term is sometimes used to refer to an instrument that acknowledges the corporate debt, charges the company’s property with its repayment and further restricts the company from giving any prior ranking charge over the property. 6 Each of these usages conveys a distinct characteristic of this peculiar debt interest. 5 6

Reynolds Bros (Motors) Pty Ltd v Esanda Ltd (1983) 1 ACLC 1,333 at 1,341. English & Scottish Mercantile Investment Co Ltd v Brunton [1892] 2 QB 1 at 9.

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[9.55]

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Debentures as functionally comparable with shares [9.60] In the Act the term “debenture” was defined until 2000 in terms of the first usage, viz,

as a document issued by a company acknowledging its indebtedness in respect of money deposited with or lent to the company, whether constituting a charge on the property of the company or not. From 2000, however, a definition has been adopted to focus upon the legal right to repayment of the debt, rather than on the document evidencing it: s 9. (The change is intended to facilitate electronic commerce in debentures.) A number of exclusions are identified from this definition. The older usage reflects the long established practice of companies raising funds from the public by way of deposit in exchange for the issue of debt interests (or debentures). Typically, such debt interests have a long-term repayment obligation at a specified rate of interest, albeit perhaps fluctuating by reference to some economic indicator. The borrowing may be either secured or unsecured. Debentures may be disposed of before the maturity of the repayment obligation; indeed, until the past decade or two, it was not uncommon for debentures to be quoted upon the stock exchange to promote their liquidity. This practice declined with easier access to bank financing free from the Act’s regulation of the public fundraising process in the interests of investor protection. In consequence, Australia has an under-developed corporate debt (or bond) market relative to other comparable economies, impoverishing both corporations in their range of funding sources and investors in their range of options. The Australian Government is circulating proposals aimed at developing the retail corporate bond market by streamlining disclosure and liability requirements. 7 Unlike shareholders, debenture holders do not have voting rights in the company; their claims are claims against, not in, the company. They stand outside the collectivity whose interests define those of the company. Their remedies are those of creditors rather than those of members, the primary focus of much of the governance provisions of the Act (eg, the oppression remedy). Their natural affinity is with preference shares which they functionally mimic in their interest and capital repayment obligations and general non-voting character. That affinity is reinforced by the canons of construction developed during the 20th century whose general effect is to treat preference holders as if they were debenture holders: see [9.80]. Debenture holders are given the benefit of a governance structure and protective mechanism through the requirement of a debenture trust deed and trustee for debenture holders. This governance requirement faintly mirrors the protection afforded to shareholders. Chapter 2L contains provisions applying specifically to offerings of debentures. These provisions are supplementary to the general fundraising provisions in Ch 6D regulating the offering of corporate securities since debentures are included within the definition of a security whose distribution is regulated by those provisions. Chapter 2L also imposes a structure to protect the holders of the debt interests. When a company makes offers of debt interests for subscription or purchase and they require the lodgment of a disclosure document under Ch 6D, the company is required to make provision in a trust deed for the appointment of a trustee for holders of those debentures: s 283AA. The trustee must be a corporation within a narrow class of substantial financial institutions (the functions have traditionally been performed by public trust companies): s 283AC. The trustee may not retire from the office until another qualified corporation has been appointed in its stead: s 283AD. The requirement of a trust deed and trustee is a response to the traditional pattern of public debt raising by corporations. Deposits are received from 7

Australian Government, Discussion Paper: Development of the Retail Corporate Bond Market: Streamlining Disclosure and Liability Requirements (2011). In 2010 ASIC granted class order relief for “vanilla” bonds (CO 10/231 and 10/232) although only one issuer had taken advantage of this facility by the end of 2011 when the discussion paper was released. [9.60]

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numerous investors, sometimes in relatively modest accounts, so that few have significant incentive to monitor the borrower’s compliance with protective covenants. The facility also permits the borrowing corporation to deal routinely with a single trustee rather than the numerous scattered lenders. The debenture trust deed defines the respective functions, rights and obligations of the borrowing corporation, trustee and debenture holders. It will commonly contain detailed restrictions upon the indebtedness of the borrowing corporation, the particulars of any security given and, where applicable, the terms of any guarantees given by related corporations. Trust deeds commonly provide for specific rights to be held in trust for the benefit of debenture holders including the right to enforce the borrower’s duty to repay, rights under any charge or security for repayment and the right to enforce any duties that the borrower and guarantor have under the terms of the debentures. The borrower and guarantor are also commonly required by trust deeds to prepare periodic reports on their affairs, including compliance with borrowing limitations in the trust deed, the enforceability of the security and restrictions upon the creation of further charges. In addition to any duties under the deed, the Act requires the borrower to prepare quarterly reports which disclose, among other matters: • any failure of the borrower or guarantor to comply with the terms of the debentures, the trust deed or Ch 2L; • any event which triggers repayment or enforcement rights; • circumstances which materially prejudice the borrower, the security or the interests of debenture holders; and • any substantial change in the nature of the business of the borrower, its subsidiaries or any of the guarantors: s 283BF. In addition to duties imposed by the trust deed, the trustee is subject to duties imposed in the Act. These duties require the trustee to satisfy itself that the borrower retains property of sufficient value to repay the debt, complies with other obligations under the deed and debentures and ensure that the borrower and guarantor remedy any breaches: s 283DA. Where the borrower or guarantor refuses to remedy a breach, the trustee may bring the matter before a meeting of debenture holders and obtain the directions of the meeting: s 283EB. The trustee may seek extensive judicial orders relating to the property and affairs of the borrower: Pt 2L.8.

Restricted use of the term “debentures” in fundraising documents [9.65] There is a longstanding tradition of restricting the manner in which debt interests may

be described in fundraising documents with a view to indicating differential underlying risk levels. Debt interests may be described in a prospectus and in the debentures themselves as a mortgage debenture or debenture only if the repayment of money lent under the debt interests is secured by a first mortgage given to the trustee over land owned by the borrower or guarantor and the amount secured by the mortgage and equal ranking securities does not exceed 60% of the value of the borrower’s or guarantor’s interest in the land: s 283BH(1), (2). However, the term “debenture” may also be used (and more commonly is) where the tangible property that constitutes the security for the charge is reasonably likely to be sufficient to meet all higher or equal ranking liabilities of the borrower: s 283BH(1), (3). Other debt interests which are unsecured or do not meet these security standards may be referred to in the offering document or in the instruments themselves simply as “unsecured notes” or “unsecured deposit notes”.

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Negative pledges and debt subordination [9.70] The term “debenture” is, as noted, also used to refer to a charge granted by a company

to secure its indebtedness, typically to a single lender or syndicate of lenders. It is not uncommon for a floating charge on other security granted by a company over its property to contain a covenant by the borrowing company that it will not grant any prior ranking or equal and rateable security over the same assets without the consent of the lender. This longstanding form of negative pledge is part of the instrument for the security (or debenture) granted by a company. In modern finance practice, however, the term “negative pledges” also describes like covenants where no security is granted in the loan instrument. 8 Alternatively, a company may also borrow funds upon the basis that the debt is contractually subordinated (or deferred) to the claims of other lenders, even perhaps to the extent of ranking equally in a winding up with shareholders. The contractual subordination permits the borrower’s unsecured lenders to settle an order of priorities among themselves. An instance is the high yield (or “junk”) loan bonds issued by John Fairfax Ltd in 1989: see [2.275]. Reflecting their intermediate risk and yield ranking, these deferred unsecured notes are sometimes referred to as mezzanine finance, between pure debt and equity. As with preference shares, subordinated debt attracts longer-term capital with equity characteristics but without diluting control. Interest payments are generally tax deductible by the borrowing company.

CLASSES OF SHARES Introduction [9.75] As noted at [3.170], company constitutions commonly provide for different classes of

shares. While a class structure for share capital may perform several functions, two should be particularly noted. First, the creation of distinct classes, typically of ordinary shares, enables rights conferred upon their holders to be entrenched against alteration of the constitutions. Part 2F.2 of the Act protects the rights attached to a class of shares against a variation made without the consent of a specified proportion of the holders of the shares of that class. The provision augments the rather uncertain protection under the fraud on the minority doctrine against prejudice to shareholder rights through constitutional alteration: see [8.45]. A second function is to attach a sweetener to a proposed share issue in the form of preferred entitlement to dividends or return of capital (or both). In Beck v Weinstock French CJ explored the history of preference shares and the changing reasons for their creation and issue: The preference share emerged in the United Kingdom in the 18th and 19th centuries out of the need for private infrastructure corporations to raise capital to fund the completion of projects for which inadequate initial capital had been subscribed. To induce investors to provide that additional capital, shares were issued which attracted preferential dividend rights. The term “preference share” was not always used. Designations such as “active”, “county”, “profitable”, “new” and “privileged” were also used to describe such shares. Although initially “a device for emergency finance” directed to raising additional capital, over time the preference share was put to wider uses including the retirement of debt. It came to confer priorities in relation to dividends, capital and voting rights in different combinations. The variety of its uses and the priority rights it conferred made a narrow legal definition elusive.

8

See, eg, National Australia Bank v Bond Brewing Holdings Ltd (1990) 169 CLR 271. [9.75]

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What all preference shares had in common, however, was that they conferred upon their holders one or more entitlements in priority to the holders of ordinary shares. 9

In these circumstances, preference shares become more clearly a functional alternative to debt capital. The approximation to debt is most evident in the case of the standard preference share whose terms of issue provide for a fixed dividend entitlement which must be satisfied before any dividend is paid on the ordinary shares. The dividend entitlement may be expressed to be cumulative so that any arrears from previous years must be made up before ordinary shareholders receive any dividends. This share may also have a right to return of capital on winding up in advance of a like return to ordinary shareholders although, of course, ranking after creditors. This is the standard form of preference share in which the parallel with debt is most evident. However, preference shares may be given further entitlements, for example, to participate with ordinary shareholders in further distributions of dividends beyond their preferred entitlement and in distributions of a capital surplus on a winding up after repayment of capital. Such shares might fairly be called preferred ordinaries. A company can issue preference shares only if the rights attached to the preference shares with respect to these matters are set out in the company’s constitution or have been otherwise approved by special resolution of the company: (a) repayment of capital; (b) participation in surplus assets and profits; (c)

cumulative and non-cumulative dividends;

(d) (e)

voting; and priority of payment of capital and dividends in relation to other shares or classes of preference shares: s 254A(2). In practice, those relating to dividends, distributions on winding up and voting are the most important. In Beck v Weinstock, the High Court held that the question whether shares are preference shares does not depend on whether the company has issued ordinary shares at the time. (The company in question had none.) Instead, it falls to be answered by reference to whether or not the putative preference shares confer preferential rights as to one of the matters listed in s 254A(2); if so, they are preference shares whether or not the company has any ordinary shares on issue relative to which they enjoy that preferential entitlement. 10 Preference shares are among the class of investments that are informally called “hybrids” because they contain both debt and equity characteristics. (Other hybrids include debt interests that permit the holder to convert units of debt into equity through defined windows and terms.) As with standard debt instruments, preference shares have a pre-defined “coupon” rate, referring to their preferred entitlement to dividends, a functional but not a legal equivalent to an interest entitlement upon debt. They rank behind debt in the event of company failure and liquidation. In return for this subordination (and higher risk) investors are generally paid a higher coupon rate; this rate may be set by reference to some floating measure such as an inter-bank lending rate. What factors will affect the judgment of corporate 9 10

684

(2013) 93 ACSR 251 at [23]-[24]. The Chief Justice cited as authority for these propositions G H Evans, British Corporation Finance 1775–1850: A Study of Preference Shares (1936) pp 150, 75, 152-154. (2013) 93 ACSR 251 at [36] per French CJ (“[n]othing in the Act excluded from the concept of preference share, shares issued in the absence of issued ordinary shares … nothing in the history of the preference share supports such an exclusion”), [67] per Hayne, Crennan and Kiefel JJ (“[w]hat was a ‘preference share’ for the purposes of the 1961 Act was to be determined by reference to the relevant company’s memorandum and articles of association, not by reference to the state of the issued capital of that company at any time”) and [91] per Gaegeler J (“[i]t is inherent in the concept of a preference share that the rights attaching to it are differentiated from the rights attaching to an ordinary share. But it is not intrinsic to that differentiation of rights that there be ordinary shares on issue”); see discussion at K Tomasic (2013) 31 C&SLJ 457. [9.75]

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financial managers choosing between preference shares and debt as a source of further capital? What are costs and benefits to the company of each form of capital? By long convention, accepted in stock exchange listing rules, preference shares typically do not enjoy voting rights unless dividends are in arrears or in respect of resolutions effecting fundamental corporate changes. A particular concern for the stock exchanges, therefore, is to ensure that non-voting preference share issues are not in substance offerings of ordinary stock clothed in the guise of preference capital. Stock exchange quotation has long been denied to such securities although such resistance may be weakening. 11 This section examines the canons of construction which have been developed by courts to determine the rights of preference shares in situations where, despite s 254A(2), their terms of issue are silent or ambiguous with respect to a particular head of entitlement. It then considers the protection afforded to class rights against unwelcome variations. The construction of preference shares [9.80] The effect of the canons of construction developed by the courts during the 20th

century has been to reduce the legal status of preference shares to resemble more closely that of debentures. The starting point in the development of the modern canons is generally taken to be the 1889 decision of the House of Lords in Birch v Cropper. 12 A surplus fund remained for a company in voluntary liquidation after payment of debts and return of capital. The company had issued preference shares with a preferred 5% dividend entitlement but their terms of issue were silent as to participation in a surplus on liquidation. The ordinary shareholders claimed that they were entitled to the whole of the surplus. Lord Macnaghten dismissed the contention: The ordinary shareholders say that the preference shareholders are entitled to a return of their capital, with 5% interest up to the day of payment, and to nothing more. That is treating them as if they were debentureholders, liable to be paid off at a moment’s notice. Then they say that at the utmost the preference shareholders are only entitled to the capital value of a perpetual annuity of 5% upon the amounts paid up by them. That is treating them as if they were holders of irredeemable debentures. But they are not debentureholders at all. For some reason or other the company invited them to come in as shareholders, and they must be treated as having all the rights of shareholders, except so far as they renounced those rights on their admission to the company. There was an express bargain made as to their rights in respect of profits arising from the business of the company. But there was no bargain – no provision of any sort – affecting their rights as shareholders in the capital of the company. 13

This general principle applies to the holders of all classes of shares although its application is subject to the provisions of the company’s constitution and the terms on which the respective classes of shares have been issued. 14 However, as the following cases reveal, in subsequent years this presumption of equality was considerably eroded. The first development occurred with respect to the entitlement of preference shareholders to dividends: see Will v United Lankat Plantations Co Ltd [9.85]. The second concerns rights to participate in distributions on the winding up of the company: Scottish Insurance Corp Ltd v Wilsons and Clyde Coal Co Ltd [9.90]. 11

13

See in relation to the approval given in 1991 for the quotation of equity shares with limited voting rights, P L Swan & G Garvey (1991) 9 C&SLJ 158. (1889) 14 App Cas 525. An excellent analysis of the canons is contained in L C B Gower et al, Gower’s Principles of Modern Company Law (4th ed, 1979), pp 412-423. This material is indebted to Gower’s analysis. See also J Hill, “Preference Shares” in R P Austin & R Vann (eds), The Law of Public Company Finance (1986), pp 139-143; R Baxt (1970) 9 UWALR 146; and M A Pickering (1963) 26 MLR 499. Birch v Cropper (1889) 14 App Cas 525 at 546.

14

Re Sullivans Cove IXL Nominees Pty Ltd (2011) 82 ACSR 224 at [48].

12

[9.80]

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Will v United Lankat Plantations Co Ltd [9.85] Will v United Lankat Plantations Co Ltd [1914] AC 11 House of Lords [A company’s constitution authorised the issue of preference shares: art 43. Preference shares were issued carrying “a cumulative preferential dividend at the rate of 10% per annum on the amount for the time being paid up on such shares [which] rank, both as regards capital and dividend, in priority to the other shares”. The directors proposed to sell a substantial part of the company’s assets and to divide the profit from the sale among the ordinary shareholders. A holder of preference shares sought a declaration that such shares were entitled to rank for dividend pari passu with ordinary shares after providing for a 10% dividend for both classes.] VISCOUNT HALDANE LC: [15] My Lords, this appeal raises a question of great interest from a business point of view, but it is difficult to see how it can be said to raise any question of general legal principle. The point in dispute is one of construction, and construction must always depend on the terms of the particular instrument; it is only to a limited extent that other cases decided upon different documents afford any guidance. I make that observation because a good deal of authority has been cited in the course of the argument, and reference has been made to dicta of various learned judges. But in all those cases they were dealing with documents which were different from those we have to construe, and our primary guide must be the language of the documents we have before us. My Lords, the action was brought by the appellant to obtain a declaration – and this is the only substantial point before the House – that the preferential shares which have been issued were entitled to rank for dividend pari passu with the ordinary shares of the company as against any profits of the company available for distribution as dividend after providing for a cumulative [16] preferential dividend of 10% on the preference shares and a dividend of 10% on the ordinary shares. That was the claim and that was the point of controversy between the parties. … [17] My Lords, I should have thought that if we were dealing with an ordinary case of two individuals coming together, and if a document were produced saying “You are to have a cumulative preferential dividend of 10%” or whatever might be the equivalent in the circumstances of the bargain, it would be naturally concluded that that was the whole of the bargain between the parties on that point. You do not look outside a document of this kind in order to see what the bargain is; you look for it as contained within the four corners of the document. [The general meeting resolution of 13 July 1891 which gave rise to the preference share issues] defined the whole terms of the bargain between the shareholders and the company. … [18] I think that when you find – as you do find here – the word “dividend” used in the way in which the expression is used in the resolution and defined to be “a cumulative preferential dividend” you have something so definitely pointed to as to suggest that it contains the whole of what the shareholder is to look to from the company. And I think that is borne out by the concluding words of the resolution of 13 July 1891, to which I have just referred, namely, that the preference shares are to rank “both as regards capital and dividend in priority to the other shares”. That is appropriate when the provision is for a cumulative preferential dividend at a fixed amount such as I have stated. It is not a natural expression if the rights are to be such as the appellant has asked us to infer [viz, that they are participating as to further dividend distributions.] [Earl Loreburn and Lords Atkinson and Kinnear concurred.]

Scottish Insurance Corp Ltd v Wilsons and Clyde Coal Co Ltd [9.90] Scottish Insurance Corp Ltd v Wilsons and Clyde Coal Co Ltd [1949] AC 462 House of Lords [After the colliery assets of a coal mining company were nationalised, it was the intention of the company to go into voluntary liquidation. In the meantime it proposed to reduce its capital by returning preference stock to its holders. The company’s constitution authorised directors to set aside a reserve fund which they might use, inter alia, for paying off the preference capital: art 139. Further, the company might convert any undistributed profits into capital and distribute it among members: 686

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Scottish Insurance Corp Ltd v Wilsons and Clyde Coal Co Ltd cont. art 141. Articles 159 and 160 provided that in the event of a winding up the preference stock ranked before the ordinary stock to the extent of repayment of the amounts called up and paid thereon. Several preference stockholders opposed the return of capital as unfair in their interests. They sought to have the court withhold its sanction to the proposed capital return as then required by companies legislation. The Court of Session (Scotland) granted its sanction. The preference stockholders appealed to the House of Lords.] LORD SIMONDS: [486] The Companies Act 1929 (UK), no more than its predecessors, prescribes what is to guide the court in the exercise of its discretionary jurisdiction to confirm or to refuse to confirm a reduction of capital. But I agree with the learned Lord President that, important though its task is to see that the procedure, by which a reduction is carried through, is formally correct and that creditors are not prejudiced, it has the further duty of satisfying itself that the scheme is fair and equitable between the different classes of shareholders: see, for example, British and American Trustee and Finance Corp Ltd v Couper [1894] AC 399. But what is fair and equitable must depend upon the circumstances of each case and I propose … to consider the elements on which the appellants rely for saying that this reduction is not fair to them. In the formal case which they have presented to the House the element of unfairness on which the appellants insist is that the reduction deprives them of their right to participate in the surplus assets of the company on liquidation and leaves the ordinary stockholders in sole possession of those assets. But in their argument both in the Court of Session and before your Lordships they have further relied on the fact that they have been deprived of a favourable 7% investment which they cannot hope to replace and might have expected to continue to enjoy. They further contend that the deprivation of these rights, which would in any case have been an unmerited hardship, is rendered the more unfair because it is likely to be followed at an early date by liquidation of the company or, as it is less accurately expressed, because it is itself only a step in the liquidation of the company. The first plea makes an assumption, viz, that the articles give the preference stockholders the right in a winding up to share in surplus assets, which I for the moment accept but will later examine. Making that assumption, I yet see no validity in the plea. The company has at a stroke been deprived of the enterprise and undertaking which it has built up over many years: it is irrelevant for this purpose that the stroke is delivered by an Act of Parliament which [487] at the same time provides some compensation. Nor can it affect the rights of the parties that the only reason why there is money available for repayment of capital is that the company has no longer an undertaking to carry on. Year by year the 7% preference dividend has been paid; of the balance of the profits some part has been distributed to the ordinary stockholders, the rest has been conserved in the business. If I ask whether year by year the directors were content to recommend, the company in general meeting to vote, a dividend which has left a margin of resources, in order that the preference stockholders might in addition to repayment of their capital share also in surplus assets, I think that directors and company alike would give an emphatic negative. And they would, I think, add that they have always had it in their power, and have it still, by making use of art 139 or 141, to see that what they had saved for themselves they do not share with others. … Reading these articles as a whole with such familiarity with the topic as the years have brought, I would not hesitate to say, first, that the last thing a preference stockholder would expect to get (I do not speak here of the legal rights) would be a share of surplus assets, and that such a share would be a windfall beyond his reasonable expectations and, second, that he had at all times the knowledge, enforced in this case by the unusual reference in art 139 to the payment off of the preference capital, that at least he ran the risk, if the company’s circumstances admitted, of such a reduction as is now proposed being submitted for confirmation by the court. Whether a man lends money to a company at 7% or subscribes for its shares carrying a cumulative preferential dividend at that rate, I do not think that he can complain of unfairness if the company, being in a position lawfully to do so, proposes to pay him off. No doubt, if the company is content not to do so, he may get something that he can never have expected but, so long as the company can lawfully repay him, whether it be months or years before a contemplated liquidation, I see no ground for the court refusing its confirmation. … [9.90]

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Scottish Insurance Corp Ltd v Wilsons and Clyde Coal Co Ltd cont. [488] It will be seen, my Lords, that, even making an assumption favourable to the appellants, I reject their first plea. But it is perhaps necessary, in case there should be a division of opinion which would make this a decisive issue, that I should shortly examine the assumption. It is clear from the authorities, and would be clear without them, that, subject to any relevant provision of the general law, the rights inter se of preference and ordinary shareholders must depend on the terms of the instrument which contains the bargain that they have made with the company and each other. … Reading the relevant articles, as a whole, I come to the conclusion that arts 159 and 160 are exhaustive of the rights of the preference stockholders in a winding up. The whole tenor of the articles, as I have already pointed out, is to leave the ordinary stockholders masters of the situation. If there are “surplus assets” it is because the ordinary stockholders have contrived that it should be so, and, though this is not decisive, in determining what the parties meant by their bargain, it is of some weight that it should be in the power of one class so to act that there will or will not be surplus assets. There is another somewhat general consideration which also, I think, deserves attention. If the contrary view of arts 159 and 160 is the right one and the preference stockholders are entitled to a share in surplus assets, the question will still arise what those surplus assets are. For the profits, [489] though undrawn, belong, subject to the payment of the preference dividend, to the ordinary stockholders and, in so far as surplus assets are attributable to undrawn profits, the preference stockholders have no right to them. This appears to follow from the decision of the Court of Appeal in Re Bridgewater Navigation Co [1891] 2 Ch 317, in which the judgment of the House of Lords in Birch v Cropper (1889) 14 App Cas 525 is worked out. This again is not decisive of the construction of particular articles, but I am unwilling to suppose that the parties intended a bargain which would involve an investigation of an artificial and elaborate character into the nature and origin of surplus assets. But, apart from those more general considerations, the words of the specifically relevant articles, “rank before the other shares … on the property of the company to the extent of repayment of the amounts called up and paid thereon,” appear to me apt to define exhaustively the rights of the preference stockholders in a winding up. Similar words, in Will v United Lankat Plantations Co Ltd [1914] AC 11 at 13, “rank, both as regards capital and dividend, in priority to the other shares,” were held to define exhaustively the rights of preference shareholders to dividend, and I do not find in the speeches of Viscount Haldane LC or Earl Loreburn in that case any suggestion that a different result would have followed if the dispute had been in regard to capital. … [490] Finally on this part of the case I ought to deal with an observation made by Lord Macnaghten in Birch v Cropper (1889) 14 App Cas 525 at 546 upon which counsel for the appellants relied. “They,” he said, “[sc the preference shareholders] must be treated as having all the rights of shareholders, except so far as they renounced these rights on their admission to the company.” But, in my opinion, Lord Macnaghten can have meant nothing more than that the rights of the parties depended on the bargain that they had made and that the terms of the bargain must be ascertained by a consideration of the articles of association and any other relevant document, a task which I have endeavoured in this case to discharge. I cannot think that Lord Macnaghten intended to introduce some new principle of construction and to lay down that preference shareholders are entitled to share in surplus assets unless they expressly and specifically renounce that right. [Viscount Maugham and Lord Normand delivered concurring judgments. Lord Morton of Henryton dissented.]

Re Isle of Thanet Electricity Supply Co Ltd [9.100] Re Isle of Thanet Electricity Supply Co Ltd [1950] Ch 161 Court of Appeal, England and Wales [Article 3 of the company’s constitution provided: The issued preference shares shall confer on the holders the right to a fixed cumulative preferential dividend at the rate of 6% per annum upon the amounts for the time being paid 688

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Re Isle of Thanet Electricity Supply Co Ltd cont. up or credited as paid up thereon respectively in priority to the ordinary shares, and the right to participate pari passu with the ordinary shares in the surplus profits which in respect of any year it shall be determined to distribute remaining after paying or providing for the said preferential dividend and a dividend for such year at the rate of 6% per annum on the amounts for the time being paid up or credited as paid up on the ordinary shares, and the preference shares shall confer the right on a winding up of the company to repayment of capital together with arrears (if any) and whether earned or not of the preferential dividend to the date of the commencement of the winding up in priority to the ordinary shares. The company went into voluntary liquidation. After payment of arrears of dividend on the preference shares and repayment of capital, a substantial sum remained. Roxburgh J held that the preference shareholders were entitled to participate equally with the ordinary shareholders in the distribution of this surplus. An ordinary shareholder appealed.] EVERSHED MR: [174] At the end of his judgment Roxburgh J stated his conclusion thus: “It is quite clear that if, on a fair construction of the article, I cannot find that the preference shareholders are excluded from participation in the surplus assets, then they are entitled to participate.” That conclusion was based on the decision of this court in Re William Metcalfe & Sons Ltd [1933] Ch 142, which governed this case when it was before Roxburgh J. Since then the law has been substantially affected by the decision of the House of Lords in Scottish Insurance Corp Ltd v Wilsons and Clyde Coal Co Ltd [1949] AC 462. … [175] I think, for myself, that during the 60 years which have passed since Birch v Cropper (1889) 14 App Cas 525 was before the House of Lords the view of the courts may have undergone some change in regard to the relative rights of preference and ordinary shareholders, and to the disadvantage of the preference shareholders, whose position has, in that interval of time, become somewhat more approximated to the role which Sir Horace Davey attempted to assign to them, but which Lord Macnaghten rejected in Birch v Cropper, namely, that of debenture holders. [176] I therefore on the point of law conclude that, after the Wilsons and Clyde case [1949] AC 462, the onus is, so to speak, on the preference stockholders. It is, of course, quite true that the matter in the last resort is one of the construction of the articles. … I think that the onus has not been discharged. It is true that this case possesses in some respects notable features: for example, the facts that the preference shareholders have a majority of the voting powers and that they have at the end of art 3 a position in regard to reduction of capital which is … unique in my experience; nor do I forget that they are given earlier in the article a right to participate with the ordinary shareholders in surplus profits. But I cannot come, on any of those matters or on all of them together, to a conclusion which would discharge the onus placed upon the preference stockholders, even if (without saying that it is right to do so) regard is had to the state of the law as it was thought to be when the article was first adopted. … [177] I think … that this appeal should be allowed, and that the appropriate declarations should be to the effect that the surplus assets are now distributable exclusively among the ordinary shareholders. [Wynn-Parry J delivered a concurring judgment and Asquith LJ concurred.]

[9.102]

1.

Notes&Questions

If shares are issued with a preferential dividend entitlement, they are presumed to be cumulative so that arrears from previous years must be made up before ordinary shareholders receive any dividends: Webb v Earle (1875) LR 20 Eq 556. The presumption may, however, be displaced by terms which indicate that preference shareholders may look only to current year profits for their dividends: see, eg, Staples v Eastman Photographic Materials Co [1896] 2 Ch 303. [9.102]

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2.

3.

It is presumed that dividends are not payable unless they are declared: Re Buenos Ayres Great Southern Railway Co Ltd [1947] Ch 384. Gower comments that the right is “not so much to the payment of a preference dividend as to restrain payments to the ordinary shareholders until they themselves are paid”: L C B Gower et al, Gower’s Principles of Modern Company Law (4th ed, 1979), p 419n. The presumption may, however, be displaced (as, eg, in Evling v Israel and Oppenheimer Ltd [1918] 1 Ch 101) by words indicating that dividends are payable out of annual profits of the company as they are earned and the accounts settled without the formal declaration of a dividend. In the absence of special provision, it is presumed that preference shareholders have no right to undeclared arrears of dividend once a winding up has commenced: Re Crichton’s Oil Co [1902] 2 Ch 86. Gower (p 420) observes, however, that in English decisions “the slightest straw has been clutched in order to avoid this conclusion, and provided the court can spell out some reference to payment of dividends, the preference shareholders will be protected”: see, eg, Re F de Jong & Co Ltd [1946] Ch 211; Re Walter Symons Ltd [1934] Ch 308. A like tendency may be discerned in some Australian decisions: see Pell v Marshall (1984) 8 ACLR 1015 and Seaton v Federal Hotels Ltd (1981) 6 ACLR 214; but see also Re William Bedford Ltd (in liq) [1967] VR 490 and Re Collie Power Co Pty Ltd (1952) 54 WALR 44.

[9.103]

Review Problems

1. If shares have a preferential claim to dividends at a specified rate, when may they participate with ordinary shares in a dividend distribution beyond the amount of their preference? 2. Preference shares are issued with a cumulative preferred dividend entitlement and, on a winding up, to the prior return of capital and dividend arrears and a right to participate pro rata with ordinary shareholders in surplus assets. The shares are not participating as to dividends. On a winding up of the company a substantial proportion of its assets are represented by unappropriated profits. Might preference shareholders participate in their distribution on a winding up? See Scottish Insurance Corp v Wilsons and Clyde Coal Co at 488-489; Dimbula Valley (Ceylon) Tea Co Ltd v Laurie [1961] Ch 353; Re Saltdean Estate Co Ltd [1968] 1 WLR 1844. Might the ordinary shareholders have secured their claims to unappropriated profits by a distribution prior to the commencement of the winding up? See D G Rice (1961) 24 MLR 525 and M A Pickering (1963) 26 MLR 499 at 503-511. The protection of class rights [9.105] As noted, one of the recurrent reasons for adopting different classes of share capital is

to enable important shareholder rights to be secured against alteration of the constitution. Of course, the constitution may entrench rights by imposing further requirements beyond a special resolution for their alteration: s 136(3) and [3.145]. However, Pt 2F.2 provides a convenient and more flexible alternative. It has long been common for company constitutions and the model provisions contained in the former Table A standard articles from time to time, to contain a provision for the modification of class rights with the approval of a special resolution passed by the holders of the shares in the class. If a company has a constitution that sets out the procedure for varying or cancelling rights attaching to shares in a class of shares (or, in the case of a company without share capital, the rights of members in a class of members), those rights may be varied or cancelled only in accordance with the procedure; the procedure may be changed only if the 690

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procedure itself is complied with: s 246B(1). If the company does not have a constitution, or if its constitution does not set out the procedure for varying or cancelling such rights, the rights may be varied or cancelled only with the sanction of a special resolution of the company and either a special resolution passed at a meeting of members holding shares in the class (or, if the company is without a share capital, the class of members whose rights are being varied or cancelled) or the written consent of members with at least 75% of the votes of the class: s 246B(2). (In view of the focus of this chapter upon corporate finance, the focus is upon the provisions of Pt 2F.2 relating to share capital.) The following changes are deemed to vary the rights of a class of shares: • the division of shares in a class into further classes (s 246C(1)); • the variation of the rights of other shares in the same class (after the variation the two groups form separate classes of shares) (s 246C(2)); • in the case of a company with one class of shares only, the issue of new shares with different rights which are not provided for in the constitution or in a document or resolution lodged with ASIC (s 246C(5)); and • the issue of new preference shares ranking equally with existing preference shares unless the issue is authorised by the terms of issue of the existing preference shares or by the constitution of the company as in force when the latter shares were issued: s 264C(6). Members of a class who do not agree to the variation or cancellation of class rights, and who hold at least 10% of the votes in the class, may apply to the Court to have the variation, cancellation or modification of the constitution set aside: s 246D. Part 2F.2 extends protection to “rights attached to shares included in a class of shares”. What is a class of shares? When are rights attached to shares in such a class? Surprisingly, until the Cumbrian Newspapers case [9.110] these questions had received only slight judicial analysis. The second significant question that arises concerns what will constitute a variation of those rights that engages the separate class consent procedure: see White v Bristol Aeroplane Co [9.115].

Cumbrian Newspapers Group v Cumberland and Westmorland Herald Newspaper [9.110] Cumbrian Newspapers Group Ltd v Cumberland and Westmorland Herald Newspaper and Printing Co Ltd [1987] Ch 1 Chancery Division [In 1968 the plaintiff company acquired 10.7% of the issued ordinary shares in the defendant. At the same time and as part of the same arrangement, the defendant adopted a constitution which granted the plaintiff (1) rights of pre-emption over the other ordinary shares of the defendant (arts 7, 9); (2) rights in respect of unissued shares (art 5); and (3) the right, while it held 10% of the issued ordinary capital, to appoint a director of the defendant: art 12. The companies, both newspaper publishers, had sought to maximise advertising revenues by a partial merger of their activities. The share issue and adoption of articles by the defendant were part of that rationalisation. In 1986 the directors of the defendant proposed that the articles under which the plaintiff held its special rights be cancelled. The plaintiff argued that these rights were class rights which could not be varied or abrogated without its consent. The Companies Act 1985 (UK), s 125 contains a protective code for “rights attached to a class of shares” in similar terms to s 246B. The defendant company had incorporated into its constitution the provisions of Table A, art 4 (UK) which provided for the variation of class rights with the consent of a special resolution of the class.] SCOTT J: [15] [T]he question [is] whether or not the plaintiff’s rights can properly be described as rights attached to any class of shares. If the rights can be so described, both s 125 and art 4 of Table A apply. The effect would be that arts 5, 7, 9 and 12 could not be altered without the plaintiff’s consent. But if the rights cannot be so described, then neither s 125 nor art 4 of Table A apply. The articles could [9.110]

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Cumbrian Newspapers Group v Cumberland and Westmorland Herald Newspaper cont. therefore, it is said, be varied or cancelled by special resolution under the statutory authority granted by s 9. In effect, the plaintiff could be deprived of the rights which it enjoys under arts 5, 7, 9 and 12 by the other members of the company who do not enjoy such rights. Moreover, that would have been the position at all times since the adoption of the articles in August 1968. I turn to the critical question: are the plaintiff’s rights under arts 5, 7, 9 and 12, rights attached to a class of shares? Rights or benefits which may be contained in articles can be divided into three different categories. First, there are rights or benefits which are annexed to particular shares. Classic examples of rights of this character are dividend rights and rights to participate in surplus assets on a winding up. If articles provide that particular shares carry particular rights not enjoyed by the holders of other shares, it is easy to conclude that the rights are attached to a class of shares, for the purpose both of s 125 of the Act of 1985 and of art 4 of Table A. It is common ground that rights falling into this category are rights attached to a class of shares for those purposes. [The defendant] submitted at first that this category should be restricted to rights that were capable of being enjoyed by the holders for the time being of the shares in question. Such a restriction would exclude rights expressly attached to particular shares issued to some named individual, but expressed to determine upon transfer of the shares by the named individual. Palmer’s Company Precedents (17th ed, 1956), Pt I, p 818, contains a form for the creation of a life governor’s share in a company. [The defendant’s counsel] accepted that the rights attached to a share in accordance with this precedent would be rights attached to a class of shares. He accepted, rightly in my judgment, that a provision for defeasance of rights on alienation of the share to which the rights were attached, would not of itself prevent the rights, pre-alienation, from being properly described as rights attached to a class of shares. The plaintiff’s rights under arts 5, 7, 9 and 12 cannot, however, be brought within this first category. The rights were not attached to any particular shares. In arts 5, 7 and 9, there is no reference to any current shareholding held by the plaintiff. The rights conferred on the plaintiff under art 12 are dependent on the plaintiff [16] holding at least 10% of the issued ordinary shares in the defendant. But the rights are not attached to any particular shares. Any ordinary shares in the defendant, if sufficient in number and held by the plaintiff, would entitle the plaintiff to exercise the rights. A second category of rights or benefits which may be contained in articles (although it may be that neither “rights” nor “benefits” is an apt description), would cover rights or benefits conferred on individuals not in the capacity of members or shareholders of the company but, for ulterior reasons, connected with the administration of the company’s affairs or the conduct of its business. Eley v Positive Government Security Life Assurance Co Ltd (1875) 1 Ex D 20, was a case where the articles of the defendant company had included a provision that the plaintiff should be the company solicitor. The plaintiff sought to enforce that provision as a contract between himself and the company. He failed. The reasons why he failed are not here relevant, and I cite the case only to draw attention to an article which, on its terms, conferred a benefit on an individual but not in the capacity of member or shareholder of the company. It is, perhaps, obvious that rights or benefits in this category cannot be class rights. They cannot be described as rights attached to a class of shares. The plaintiff in Eley v Positive Government Security Life Assurance Co Ltd was not a shareholder at the time the articles were adopted. He became a shareholder some time thereafter. It is easy, therefore, to conclude that the article in question did not confer on him any right or benefit in his capacity as a member of the company. In a case where the individual had been issued with shares in the company at the same time and as part of the same broad arrangement under which the article in question had been adopted, the conclusion might not be so easy. But if, in all the circumstances, the right conclusion was still that the rights or benefits conferred by the article were not conferred on the beneficiary in the capacity of member or shareholder of the company, then the rights could not, in my view, be regarded as class rights. They would not be rights attached to any class of shares. The evidence in this case has clearly established that the adoption by the defendant of arts 5, 7, 9 and 12, was inextricably connected with the issue to the plaintiff, and the plaintiff’s acceptance, of the 280 ordinary £5 shares in the defendant. The purpose of the rights and privileges conferred on the plaintiff 692

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Cumbrian Newspapers Group v Cumberland and Westmorland Herald Newspaper cont. by those articles, was to enable the plaintiff, in its capacity as shareholder in the defendant, to obstruct an attempted takeover of the defendant. In my judgment, the plaintiff’s rights under those articles do not fall within this second category. That leaves the third category. This category would cover rights or benefits that, although not attached to any particular shares, were nonetheless conferred on the beneficiary in the capacity of member or [17] shareholder of the company. The rights of the plaintiff under arts 5, 7, 9 and 12 fall, in my judgment, into this category. Other examples can be found in reported cases. In Bushell v Faith [1970] AC 1099, articles of association included a provision that on a resolution at a general meeting for the removal of any director from office, any shares held by that director should carry the right to three votes. The purpose of this provision was to prevent directors being removed from office by a simple majority of the members of the company. The validity of the article was upheld by the Court of Appeal and by the House of Lords; the reasons do not, for present purposes, matter. But the rights conferred by the article in question fall, in my view, firmly in this third category. They were not attached to any particular shares. On the other hand, they were conferred on the director/beneficiaries in their capacity as shareholders. The article created, in effect, two classes of shareholders – namely, shareholders who were for the time being directors, on the one hand, and shareholders who were not for the time being directors, on the other hand. The present case is, and Bushell v Faith was, concerned with rights conferred by articles. The other side of the coin is demonstrated by Rayfield v Hands [1960] Ch 1. That case was concerned with obligations imposed on members by the articles. The articles of the company included an article entitling every member to sell his shares to the directors of the company at a fair valuation. In effect, the members enjoyed “put” options exercisable against the directors. Vaisey J held that the obligations imposed by the article on the directors for the time being were enforceable against them. He held that the obligations were imposed on the directors in their capacity as members of the company. It follows from his judgment that, as in Bushell v Faith [1970] AC 1099, there were in effect two classes of shareholders in the company. There were shareholders who were not for the time being directors, and shareholders who were for the time being directors: the former had rights against the latter which the latter did not enjoy against the former. The two classes were identifiable not by reference to their respective ownership of particular shares, but by reference to the office held by the latter. But the rights of the former, and the obligations of the latter, required their respective ownership of shares in the company. Accordingly, as a matter of classification, the rights in question fall, in my view, into the third category. In the present case, the rights conferred on the plaintiff under arts 5, 7, 9 and 12 were, as I have held, conferred on the plaintiff as a member or shareholder of the defendant. The rights would not be enforceable by the plaintiff otherwise than as the owner of ordinary shares in the defendant. If the plaintiff were to divest itself of all its ordinary shares in the defendant, it would not then, in my view, be in a position to enforce the rights in the articles. But the rights were not attached to any particular share or shares. Enforcement by the plaintiff of the rights granted under arts 5, 7 and 9, would require no more than ownership by the plaintiff of at least some shares in the defendant. [18] Enforcement by the plaintiff of the rights granted under art 12, require the plaintiff to hold at least 10% of the issued shares in the defendant. But any shares would do. It follows, in my judgment, that the plaintiff’s rights under the articles in question fall squarely within this third category. The question for decision is whether rights in this third category are within the meaning of the phrase in s 125 of the Companies Act 1985 and in art 4 of Table A, rights attached to a class of shares. [Counsel for the defendant] relied on the natural meaning of the language used. Article 4 is expressed to apply “If at any time the share capital is divided into different classes of shares”. Section 125 is expressed, by subs (1) to be dealing with companies “whose share capital is divided into shares of different classes”. This language, submitted [counsel], coupled with the repeated references to the rights attached to any class of shares, shows that the legislature had in contemplation only the first category of rights. It intended to protect rights attached to particular shares; it withheld protection from rights which were not attached to particular shares. [9.110]

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Cumbrian Newspapers Group v Cumberland and Westmorland Herald Newspaper cont. [Counsel for the plaintiff], on the other hand, submitted that whenever rights were conferred by articles on individuals in their capacity as members or shareholders, the shares that they for the time being held, and by virtue of which they were for the time being entitled to the rights, constituted a class of shares for the purposes of s 125 and art 4 of Table A. For those purposes, the rights were, he submitted, attached to the shares for the time being held. This is a question on which there is, it seems, no authority. It is a question to which the language of s 125 of the Act of 1985 provides, in my view, no certain answer. I ought, therefore, I think, to try and discern the legislative purpose behind s 125 and take that purpose into account in construing the section. [21] In my judgment, if it is right, as the defendant contends, that third category rights are not rights attached to a class of shares, for the purposes of s 125, it must follow that articles containing such rights can be altered by special resolution pursuant to s 9 of the Act of 1985. This conclusion is, I think, relevant to the question whether the defendant’s contention is right. It would, in my opinion, be surprising and unsatisfactory if class rights contained in articles were to be at the mercy of a special resolution majority at a general meeting, unless they were rights attached to particular shares. If the articles of a particular company grant special rights to a special class of members, it would be odd to find that members not in that class could cancel the rights simply by means of a special resolution. A number of considerations lead me to the conclusion that the purpose of ss 125 and 127 of the Act of 1985 … was to deal comprehensively with the manner in which class rights in companies having a share capital could be varied or abrogated. They are these: first, Chapter II of Pt V of the Act (which includes ss 125 to 129) is headed “Class Rights”. The side note to s 125 reads “Variation of class rights”. The language seems to treat “class rights” as synonymous with “rights attached to any class of shares”, at any rate so far as companies with a share capital are concerned. Secondly, the use in s 17(2)(b) of the Act of 1985 of the expression “rights of any class of members” in connection both with companies having a share capital and with companies having no share capital, underlines the point that the expression “rights attached to any class of shares” in s 125, must have been regarded by the legislature as synonymous with the former phrase, so far as companies with a share capital were concerned. Thirdly, the evident intention of the legislature to protect rights attached to any class of shares against variation or abrogation by the mere alteration of articles, would, if coupled with an intention to provide no such protection against variation or abrogation of class rights of the third category, be anomalous and arbitrary. [The judge referred to other considerations flowing from the inflexible character of the memorandum of association under the English statute.] [22] For these reasons I conclude that s 125 of the Act of 1985 was intended by the legislature to cater for the variation or abrogation of any special rights given by the memorandum or articles of a company to any class of members – that is to say, not only rights falling into the first category I have described, but also rights falling into the third category. I must, therefore, construe s 125 so as to give effect to that legislative intention if the language of the section so permits. In my judgment, it does. Subsection (1) refers to “the rights attached to any class of shares in a company whose share capital is divided into shares of different classes”. In my judgment, if specific rights are given to certain members in their capacity as members or shareholders, then those members become a class. The shares those members hold for the time being, and without which they would not be members of the class, would represent, in my view, a “class of shares” for the purpose of s 125. The class would include those shares the ownership of which for the time being entitled the members of the company to the rights in question. For the purposes of s 125, the share capital of a company is, in my judgment, divided into shares of different classes, if shareholders, qua shareholders, enjoy different rights. This construction of s 125 has the consequence that shares may come into or go out of a particular class on acquisition or disposal of the shares by a particular individual. I do not see any conceptual difficulty in this. [The defendant’s counsel] pointed out certain administrative difficulties that might follow, mainly regarding the details to be included in annual returns. These seem to me to be capable of administrative solution. I do not think they have any real weight on the question of construction of s 125. In my judgment, a company which, by its articles, confers special rights on one or more of its members in the capacity of member or shareholder thereby constitutes the shares for the time being held by 694

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Cumbrian Newspapers Group v Cumberland and Westmorland Herald Newspaper cont. that member or members, a class of shares for the purposes of s 125. The rights are class rights. I have already expressed the opinion that the rights conferred on the plaintiff under arts 5, 7, 9 and 12, were conferred on the plaintiff as member or shareholder of the defendant. It follows that, in my judgment, the shares in the defendant for the time being held by the plaintiff constitute a class of shares for the purpose of variation or abrogation of those rights.

White v Bristol Aeroplane Co [9.115] White v Bristol Aeroplane Co [1953] Ch 65 Court of Appeal, England and Wales [A company had issued 600,000 £1 preference shares and 2,640,000 ordinary shares of 10 shillings each. It now proposed to make a bonus issue to ordinary shareholders of 660,000 preference shares ranking pari passu with existing preference capital. A preference shareholder objected, arguing that that proposed bonus issue “affected, modified, varied, dealt with or abrogated” the rights attaching to the preference capital within the terms of the modification of rights clause in the company’s constitution which was in similar terms to Table A, art 4(1). The preference shares had preferred rights with respect to dividends and the return of capital, but voting rights only when dividends were in arrears.] EVERSHED MR: [74] It is necessary, first, to note … that what must be “affected” are the rights of the preference stockholders. The question then is – and, indeed, I have already posed it – are the rights which I have already summarised “affected” by what is proposed? It is said in answer – and I think rightly said – No, they are not; they remain exactly as they were before; each one of the manifestations of the preference stockholders’ privileges may be repeated without any change whatever after, as before, the proposed distribution. It is no doubt true that the enjoyment of, and the capacity to make effective, those rights is in a measure affected; for as I have already indicated, the existing preference stockholders will be in a less advantageous position on such occasions as entitle them to register their votes, whether at general meetings of the company or at separate meetings of their own class. But there is to my mind a distinction, and a sensible distinction, between an affecting of the rights and an affecting of the enjoyment of the rights, or of the stockholders’ capacity to turn them to account; and [75] that view seems to me to flow necessarily from certain other articles. … [76] Without going into too much detail, I cannot make those articles consistent with the view that any variation which in any manner touches or affects the value of the preference stock, or the character or enjoyment of any of their privileges, is within the contemplation of art 68 [the modification of rights article]. I think that [counsel for the preference shareholders] had to admit, going still further, that even a deliberate increase of new ordinary shares to rank pari passu with the existing ordinary shares, would on this view of it make necessary separate meetings of the existing preference stockholders and also of the existing ordinary stockholders. I cannot think that such a result ought to be attributed to articles which are, after all, fairly well known as common form. Such a result seems to me to strike at the usual conception of the relations, in a company of this sort, of preference and ordinary stockholders, where the former take their rights subject always to the normal incidence of the company’s right to increase its capital. [Denning and Romer LJJ concurred.]

[9.117]

1.

Notes&Questions

Many older apartment blocks use the corporation form to distribute ownership interests through separate classes of shares for each apartment often because the building’s construction pre-dates strata title legislation. They pose distinctive questions as to the scope of class rights protection. One issue goes to the concept of a class itself. [9.117]

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“I think that in the present case the shares are divided into different classes. I take heed of the fact that the articles dividing up the groups of shares do not refer to the groups as classes, but it seems to me that when you have a home unit company and the shares divided up into different groups so that one group has quite different rights from another group it makes no difference that the articles avoid the use of the word ‘class’. In fact the groups of shares are different, the rights attaching to them are different, with the result that the capital is divided into different classes within the meaning of art 44”: Crumpton v Morrine Hall Pty Ltd [1965] NSWR 240 at 245-246 per Jacobs J. However, in Reid House Pty Ltd v Beneke (1986) 5 ACLC 451 at 458 the company title property was a commercial and business property and the variation of rights article imposed a quorum of two persons for class meetings. The court distinguished Crumpton’s case and declined to equate “groups” of shares with “classes” of shares. 2.

Another issue concerns those changes to the building and apartment owners’ user rights that engage class rights protection. In Dungowan Manly Pty Ltd v McLaughlin (2012) 90 ACSR 62 the applicants complained that an alteration to the company’s constitution that permitted structural changes to be made to the building affected their amenity as occupants even though they did not formally alter their rights to occupy their own apartment. The constitution provided that the occupancy rights of members “shall not be abridged varied restricted or released except by unanimous resolution of the members”. The court held at [71]-[72] that the alteration was within the article: [Wilson v Meudon Pty Ltd [2005] NSWCA 448] clearly established that a variation of the class rights of a shareholder entitled to occupy a company title home unit may occur even if the rights to exclusive use and occupation of the area comprising that unit remain unaffected. Subject to the qualification referred to below, rights will be varied where there is a material alteration, conflicting with specifications in the Articles of Association, in the manner in which the rest of the building is used. [In Wilson v Meudon Pty Ltd] Bryson JA considered that “a right is conferred [by the constitution] on the holder of each group that the rest of the building will be used in the ways specified and within the areas specified and not otherwise” (at [47]). Hodgson JA qualified his agreement with Bryson JA’s approach by confining relevant alterations to the building, as distinct from the home unit itself, to those that “materially alter the characteristics of the home unit as indicated by the plan, for example, by altering its situation in the building or the character of the building” ([13]). This statement represents the view of the Court in Wilson v Meudon as Handley JA also adopted this qualification to Bryson JA’s approach. It is accordingly one which must be followed in this case, there being no challenge to the correctness of Wilson v Meudon.

3.

4.

5. 6.

696

Is the authority of the Cumbrian Newspapers case in Australia diminished by reason of differences in the relevant statutory provisions (cf the references in s 246B to “rights attached to shares included in a class of shares”)? Might a director-shareholder in Rayfield v Hands (see Cumbrian at 17) claim the protection of s 246B in respect of an alteration which affects her rights but not by reference to her status as a director, for example, by making all partly paid shares subject to a lien for unpaid calls? If the constitution expressly describes rights as “class rights” within the section, will that description guarantee the protection of its provisions? See Re Old Silkstone Collieries Ltd [1954] Ch 169. If the constitution declares rights attached to a class of shares to be unalterable, may that provision itself be altered? If the constitution contains no provision for the variation of class rights, may the company alter its constitution to adopt such a provision? See s 246B(2) and Re National Dwellings Society Ltd (1898) 78 LT 144. [9.117]

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7.

If the constitution contains a variation procedure, may it be altered without separate class consents simply by deleting this provision?

8.

Is the unwanted return of capital to preference shareholders followed by the cancellation of their shares a variation of their class rights? See Scottish Insurance Corp Ltd v Wilsons and Clyde Coal Co Ltd [1949] AC 462; House of Fraser Plc v ACGE Investments Ltd [1987] AC 387 and R Levy (1987) 5 C&SLJ 262. Might the preference shareholders resist the return of their capital by an application under Pt 2F.1?

[9.118]

Review Problems

1. In White v Bristol Aeroplane Co Evershed MR referred to the decision of the same court in Greenhalgh v Arderne Cinemas Ltd [1946] 1 All ER 512. He outlined its facts thus (at 78): In that case the plaintiff had, as part of a transaction for advancing money to the defendants, obtained the issue to him of a number of what were called “1941 2s 0d shares,” and it was one of the terms of the original arrangement that each of those shares should, as regards voting, rank pari passu with the other issued ordinary shares of the company, which happened to be 10s 0d shares; so that, in effect, so long as that arrangement stood in relation to the actual paid up capital, the plaintiff had five times as many votes as the other shareholders. The proposal, on behalf of the other shareholders, was to reverse the situation by subdividing the existing shares, so that at a stroke their voting power was made five times as great. Not unnaturally the plaintiff strongly objected, and among other points taken by him was the point that they could not do so without first calling a separate meeting of the 1941 2s 0d shares, treating them as a separate class; and the court proceeded to consider that matter on the footing that the 1941 2s 0d shares were a separate class.

How do you think that this point was decided? 2. Preference shares are issued which are participating as to a capital surplus but not as to dividends. Would Pt 2F.2 prevent the company distributing unappropriated profits by a bonus issue to ordinary shareholders exclusively without the separate consent of preference shareholders? See Dimbula Valley (Ceylon) Tea Co Ltd v Laurie [1961] Ch 353. 3. In 2015, in anticipation of the centenary of the club’s only first grade premiership, the North Sydney District Rugby League Football Club (the North Sydney Bears) proposes a special category of membership for those who attended the grand final match against Glebe on 7 September 1922, or their lineal descendants. The proposal is that such persons would be given a right to attend the club’s home games at a considerably reduced rate. Assume that the club is constituted as a company limited by shares. How might this proposal be implemented and the rights entrenched?

FINANCIAL REPORTS AND AUDIT Corporate regulation through mandated corporate disclosure [9.120] Since the first general incorporation statute in 1844, the price of incorporation and,

shortly after, limited liability has been the circulation to members, and publication of, audited company accounts under the general policy of regulation through exacted and sanctioned disclosure. In many areas of corporate law regulation is effected, not by prohibition or direct intervention, but by requiring disclosure from the corporation or its directors, managers or promoters with respect to the transaction and imposing sanctions for false or misleading statements. As a regulatory tool, disclosure shifts responsibility onto the relevant actors, on the [9.120]

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basis of the self-cleansing and liberating power of truth telling (and perhaps the state’s incapacity to achieve superior outcomes through more intrusive regulation): see [2.55]. In Brandeis’ telling phrase, “Sunlight is said to be the best of disinfectants, electric light the most efficient policeman”. 15 Mandated disclosure takes several forms with differing content. New issue disclosure applies when securities are offered to investors for the first time. The prospectus or other disclosure document must contain all information deemed material to the assessment that prospective investors will make of the enterprise and the interests in it that are being offered: see [10.100]. Distinct disclosure obligations are indicated for secondary distributions such as offers and sales of issued securities at least when a regime of timely or continuous disclosure of price sensitive information exists in relation to those securities; such a regime is imposed in respect of quoted securities: see [11.125]. Where persons possess such information that has not been disclosed to the market by the issuer, its disclosure might be exacted as the price of their trading in the security under the “disclose or abstain” rule imposed under insider trading laws; since disclosure will often not be possible or convenient, the person possessing price sensitive knowledge will be prevented from trading as the price of non-disclosure: see [11.200]. Disclosure may be imposed on grounds of efficiency and equity under takeover bids or other corporate control transactions: see [12.195]. A further form of disclosure is discussed here, namely, mandatory periodic disclosure of the company’s financial performance and position. The contours of disclosure obligation are shaped by the particular regulatory policy and mix of affected interests. In the present context of periodic financial reporting, disclosure is important for resource allocation functions of capital markets and to underpin investor protection at the level of the individual company. The requirements with respect to financial reporting and audit are contained in Pts 2M.3, 2M.4 and 2M.5. Their content is affected by the range of entities to which these provisions of the Act apply and the differentiation that is made in that application and its resulting mix of obligations. Thus, the financial reporting provisions apply to the following entity types: • all public companies; • all large proprietary companies; • all registered schemes (viz, a managed investment scheme registered under Pt 5C.1); and • all disclosing entities. An entity is a disclosing entity if it has issued “ED securities”, the term signifying an enhanced disclosure obligation upon the issuer. At the core of this group are the securities of a listed entity that have been granted quotation upon ASX. However, the definition of ED securities includes other securities in which there is a wider investment interest arising from the circumstances of their issue and extent of their distribution. 16 The definition draws upon concepts not presently relevant and consideration is postponed until treatment of continuous (non-periodic) disclosure obligations: see [11.125]. The financial reporting provisions do not apply, however, to small proprietary companies absent direction. 17 In the interests of overall clarity of exposition, the term “company” will be used compendiously here to refer to each of these entity types unless the context requires explicit reference to a particular entity type. The differentiated nature of financial reporting 15

L D Brandeis, Other People’s Money (1914), Ch 5.

16

Thus, the term includes, in addition to quoted securities, securities continuously held by at least 100 persons, the circumstances of whose issue are considered sufficient to require a higher level of investor protection through disclosure. The obligation to prepare an annual financial report and directors’ report arises where the small proprietary company is directed to do so by shareholders with at least 5% of votes or by ASIC, or is controlled by a foreign company that has not lodged consolidated accounts with ASIC: s 292(2); see [3.140].

17

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[9.120]

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obligations requires this from time to time. Therefore, it is necessary to bear in mind that the term “company”, referring to the reporting and audited body, is generally employed here with this extended meaning (viz, embracing public companies, large proprietary companies and disclosing entities). One set of obligations extends to all companies under the Act. As the foundation of any effective system of financial reporting, each entity must keep such written financial records 18 that: (a) correctly record and explain its transactions and financial position; and (b) would enable true and fair financial statements to be prepared and audited: s 286(1). 19 There are several distinct elements of financial reporting obligation. Every company except for a small proprietary company 20 must prepare a financial report and a directors’ report for each financial year: s 292(1) and see [9.130]-[9.140]. The financial report must be audited ([9.150]); the financial report, directors’ report and the auditor’s report must be sent to members, laid before the AGM and lodged with ASIC: see [9.160]. For listed companies, a half-yearly financial report and directors’ report must also be prepared, audited and, with the auditor’s report, lodged with ASIC: see [9.145]. Accounting and auditing standards [9.125] A company’s financial statements, the principal element of its financial report, must

comply with applicable accounting standards: s 296. Accounting standards lie at the heart of the financial reporting system. They provide the substantive content for the machinery of the Act relating to financial report preparation and audit. Their purpose is to facilitate the provision of financial information about companies and other entities so that investors, creditors, analysts and the entities themselves can make informed decisions about the allocation of financial resources. 21 The efficiency of capital markets in allocating resources to their most efficient users is predicated upon the quality of the accounting information provided in compliance with accounting standards. The interests of investors in individual companies are no less dependent upon the quality of accounting information. Accounting standards are made by Australian Accounting Standards Board (AASB) by legislative instrument under the power given in s 334(1). Accordingly, new standards must be laid before both Houses of Parliament for 15 sitting days during which time they are subject to a motion for disallowance. The AASB is established as a corporate body with a Chair appointed by the Minister: ASIC Act, ss 226, 236B(1). It is a technical body under the broad supervision of the Financial Reporting Council (FRC). The AASB’s functions include making accounting standards and developing a conceptual framework for the purpose of evaluating proposed accounting standards and international standards: ASIC Act, s 227(1). The AASB may make an accounting standard simply by issuing the text of an international accounting standard which it may modify to the extent necessary to take account of the Australian legal or institutional environment: ASIC Act, s 227(3). International accounting standards refer to the standards 18 19

20 21

Financial records are defined to include invoices, receipts, cheques, documents of prime record etc: s 9. This obligation applies irrespective of whether financial statements need to be prepared and audited. Further, if a company fails to keep or retain financial records as required, it is presumed to be insolvent during the period of this default: see [7.150]. This presumption has particular significance for potential exposure of its directors to liability for insolvent trading. Unless it is directed by shareholders with at least 5% of votes or by ASIC, or is controlled by a foreign company that has not lodged consolidated accounts with ASIC: s 292(2). Accounting Standards (Corporate Law Economic Reform Program, Proposals for Reform: Paper No 1, 1997), p 13. [9.125]

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made by the International Accounting Standards Board (IASB), an international body responsible for setting authoritative International Financial Reporting Standards (IFRS). 22 The FRC approved the adoption of international accounting standards in Australia, generally to take effect from 2005. The Minister may give a direction to the AASB, with which it must comply, about the role of international accounting standards in the Australian accounting standards system; before doing so the Minister must first receive and consider a report from the FRC about the desirability of giving the direction: ASIC Act, s 233. The general policy intention is clear: Australian accounting standards should conform more closely to international standards which set a firm benchmark for Australian standards. The language of accounting standards (see, eg, the broad definitions of corporate control discussed at [4.90]) adopts a quite different style and expressive tradition to that shaping most legal instruments. The international accounting standards adopted in Australia are described as principles-based in that they are framed as statements of accounting principles to guide the accounting profession rather than the rules-based system adopted in the United States where accounting requirements are spelt out in more detail. 23 Perhaps reflecting a concern that users and courts might take an excessively legalistic, rather than a purposive approach, in their interpretation of an Australian accounting standard, a construction is to be preferred that would promote the objects of the AASB or the purpose or object of the standard, even where it is not expressly stated in the standard itself: ASIC Act, s 228. Auditing standards are standards made by the Auditing and Assurance Standards Board (AUASB) by legislative instrument under power conferred in s 336(1). A purposive interpretation is to be preferred in their construction: ASIC Act, s 234A. The AASB and the AUASB are bodies of technical experts. They operate under the supervision of the FRC which appoints their members other than the Chairs, who are each appointed by the Minister. Members of the FRC are directly appointed by the Minister: ASIC Act, s 235A. The FRC provides broad oversight of the process for setting accounting and auditing standards; it may determine the broad strategic direction of the AASB and AUSB and give them directions and feedback on matters of general policy and of procedure; it monitors the operation of the standards made by the Boards to assess their continued relevance and effectiveness: ASIC Act, s 225. The FRC is not, however, empowered to determine the content of particular standards or influence directly the technical deliberations of the Boards or veto, in whole or in part, any standard they make. 24 The FRC’s functions also include monitoring and assessing the nature and adequacy of the systems and processes of securing compliance with the requirements of the Act with respect to auditor independence: see [9.170]-[9.175]. Reflecting the scope for disagreement with respect to the application of accounting standards, the Financial Reporting Panel (FRP) was established in 2005 to resolve disputes between ASIC and companies concerning accounting treatments in financial reports. The FRP may hold hearings which are informal and without legal representation. Its findings are not binding on either party and disputes may ultimately be resolved in the courts; the FRP provides 22

The IASB is an independent body established by the IFRS Foundation to develop the IFRS and to approve interpretations developed by the IFRS Interpretations Committee. The IFRS Foundation website states that “The goal of the IFRS Foundation and the IASB is to develop, in the public interest, a single set of high-quality, understandable, enforceable and globally accepted financial reporting standards based upon clearly articulated principles. … Progress toward this goal has been steady. All major economies have established time lines to converge with or adopt IFRSs in the near future”, www.ifrs.org/Use-around-theworld/Pages/Use-around-the-world.aspx (accessed 30 January 2013).

23

Parliamentary Joint Committee on Corporations and Financial Services, Report on Australian Accounting Standards tabled in compliance with the Corporations Act 2001 on 30 August and 16 November 2004 (2005), [3.16]-[3.23].

24

That was the intention of the legislation that created the FRC: see Corporate Law Economic Reform Program Bill 1998, Explanatory Memorandum, [9.6].

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[9.125]

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an expeditious alternative. The FRP resembles the Takeovers Panel (see [12.25]) in its constitution as a large group of specialist practitioners appointed by the Minister from whom a particular panel is chosen for resolution of disputes. It differs, however, in the voluntary nature of its jurisdiction and powers. The financial report [9.130] The financial report comprises the company’s financial statements for the year,

explanatory notes to the statements as required, inter alia, by accounting standards, and a declaration by directors: • whether, in the directors’ opinion, there are reasonable grounds to believe that the company will be able to pay its debts as and when they become due and payable; and • whether, in the directors’ opinion, the financial statements and notes comply with the Act and accounting standards, and give a true and fair view of the financial position and performance of the company: s 295(1), (4). The directors’ declaration must be made in accordance with a resolution of the directors: s 295(5). For a listed company, the directors’ declaration must be made only after each person who performs the functions of chief executive and chief financial officer has given a written declaration to the directors whether the financial records have been properly maintained in accordance with s 286 and the financial statements comply with the accounting standards and give a true and fair view: s 295A(2). 25 The financial statements comprise either three or four documents: (a) a profit and loss statement for the year; (b) a balance sheet as at the end of the year; (c) a statement of cash flows for the year; and (d)

if required by the accounting standards – a consolidated profit and loss statement, balance sheet and statement of cash flows: s 295(2). 26 The profit and loss statement is a statement of financial performance of the company or the consolidated entity for the financial year. It shows revenue and expenses, segmented as required by accounting standards, and net profit or loss for the year. Profits not distributed as dividends are carried into the balance sheet as retained profits. The balance sheet is a statement of financial position of the company or the consolidated entity at the end of the financial year (that is, at a particular date). It shows assets and liabilities with the balance represented by shareholders’ equity (often called shareholders’ funds) comprising and separately reported as: • contributed (that is, subscribed for and issued) capital; • capital reserves created by the company; and • retained (that is, undistributed) profits available from earlier financial periods and perhaps augmented by not fully distributing as dividends the profits earned in the current year. 25

The US Sarbanes-Oxley Act, passed in response to evident failure of financial reporting and audit among some major corporations (see [9.165]), goes further to require the CEO and CFO of listed corporations to certify that periodic financial statements lodged with the SEC fairly present the operations and financial condition of the issuer.

26

The obligation to prepare consolidated financial statements arises when one or more entities is deemed to be controlled by another under the test contained in the relevant accounting standard, viz, “the capacity of an entity to dominate decision-making, directly or indirectly, in relation to the financial and operating policies of another entity so as to enable that other entity to operate with it in pursuing the objectives of the controlling entity”: Accounting Standard 1024: Consolidated Accounts, [9]. Commentary elaborating on this broad conception of control is contained at [4.90]. The consolidated financial statements aggregate the controller and its controlled entities and treat the whole as a single economic entity for the purposes of financial reporting. [9.130]

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Corporations and Financial Markets Law

The financial report (viz, the financial statements, accompanying notes and the directors’ report) must comply with the accounting standards and any further requirements in the regulations: s 296. The financial statements and notes must give a true and fair view of: (a) the financial position and performance of the company; and (b) if consolidated financial statements are required – the financial position and performance of the consolidated entity: s 297. This requirement is in addition to the obligation under s 296 for a financial report to comply with the accounting standards: s 297. A note to the section states that, if the financial statements and notes prepared in compliance with the accounting standards would not give a true and fair view, additional information must be included in the notes to the statements. The directors’ report

Disclosure common to all entities [9.135] In addition to the financial report, a directors’ report must also be prepared for each

financial year. The directors’ report must be made in accordance with a resolution of the directors: s 298(2). It must provide the following general information which is common to all entities which are required to prepare a directors’ report: 27 (a) a review of operations during the financial year of the company; (b) details of any significant changes in the company’s state of affairs during the year; (c)

the company’s principal activities and any significant changes in the nature of those activities during the year; (d) details of any development since the end of the year that may significantly affect the company’s future operations; (e) likely developments in the company’s future operations and the expected results of those activities; and (f) details of the entity’s performance in relation to environmental regulation under other legislation: s 299(1). If consolidated financial statements are required, the report must relate to the consolidated entity: s 299(2). A company or other entity may omit material concerning future operations if it is likely to result in unreasonable prejudice in which case the report must say so: s 299(3). In addition, for all entities, the directors’ report must include further specific information including details of: • dividends paid to members during the year or recommended or declared for payment but not paid; • the names of directors during the year; • the names of persons who were partners in or directors of an entity that was the company’s auditor for the year while they were also officers of the company; • options granted over unissued shares or interests during the year to directors and the five other most highly remunerated officers of the company as part of their remuneration, including the number of options, their issue price and expiry date; • unissued shares or interests under option as at the date of the report; • shares or interests issued during the year as a result of the exercise of options over unissued shares; 27

That is, all public companies, large proprietary companies, registered schemes, disclosing entities and, if directed to do so, small proprietary companies.

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[9.135]

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• indemnities given and insurance premiums paid by the company during the year for the benefit of an officer or auditor; and • details of any application for leave made under the statutory derivative procedure and of proceedings brought with the leave of the Court during the year: s 300(1), (14) – (15). Further disclosure is required of public companies that are not wholly owned subsidiaries of another company. For such companies, the directors’ report must also include details of: • each director’s experience, qualifications and special responsibilities; • the number of meetings of the board or its committees held during the year and each director’s attendance at those meetings; and • the qualifications and experience of the company secretary: s 300(10).

Additional disclosure for listed companies [9.140] A further level of disclosure is required in the directors’ report of a listed company. It has four elements. First, the report must also include the following further information for each director: • their relevant interests 28 in shares in the company or a related company, in debentures of the company or a related company or in rights or options over those securities;

• contracts to which the director is a party or under which the director may benefit that confer a right to call for or deliver such securities; and • their directorships of other listed companies in the three years immediately before the end of the financial year: s 300(11). 29 Second, the directors’ report for a listed company must also contain information that members of the company would reasonably require to make an informed assessment of the operations and financial position of the company and its business strategies and its prospects for future financial years: s 299A. This operating and financial review, as it is called, was introduced in 2004. It is intended to provide directors’ views on corporate overview and strategy, and include a review of operations, investments for future performance and a review of the company’s financial condition. 30 Third, the directors’ report of a listed company must contain disclosures that seek to assure auditor independence. Thus, the report must include: (a) details of the amounts paid or payable to the auditor for non-audit services provided during the financial year by the auditor; (b)

a statement whether the directors are satisfied that the provision of non-audit services by the auditor is compatible with the general standard of independence for auditors imposed by the Act (as to which see [9.170]-[9.175]); and

(c)

their reasons for being satisfied that those non-audit services did not compromise auditor independence: s 300(11B) – (11E).

28

The term “relevant interest” is used in the Act to reach beyond legal owners of securities to those with the power to exercise, or to control the exercise of, voting or disposal rights over the security; power and control are very broadly defined: ss 608, 609. Such rights are considered relevant to effective control over the security for certain purposes such as takeover regulation; the concept is discussed at [12.80].

29

There are corresponding special disclosure obligations for the directors of the responsible entity of listed registered schemes: s 300(12), (13).

30

This expectation is based upon guidance material prepared by international financial reporting bodies: Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill 2003, Explanatory Memorandum, [5.308]. ASIC has released a regulatory guide to improve disclosure in the review: RG 247: Effective Disclosure in an Operating and Financial Review. [9.140]

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Fourth, the directors’ report must include in a separate and clearly identified section headed “Remuneration report”: (a) discussion of board policy for determining the nature and amount of emoluments of directors and senior executives of the company; (b) discussion of the relationship between such policy and the company’s performance; 31 (ba) where an element of remuneration depends on a performance condition, a summary of that condition and an explanation of why it was chosen; and (c)

prescribed details of the nature and amount of each element of the remuneration of each director and each of the five most highly remunerated executives of the company or the group: s 300A(1), (1A), (2), reg 2M.3 and [7.400]. 32 Companies that are also listed upon an overseas stock exchange will make periodic financial disclosure to those exchanges or regulators. They must disclose to ASX any information they disclose to the United States Securities and Exchange Commission, the New York Stock Exchange or a prescribed securities exchange in an overseas country, by the next following business day: s 323DA. Half-yearly reporting for listed companies [9.145] A disclosing entity such as a listed company must also prepare a financial report and

directors’ report for each half-year and have them audited and lodged with ASIC together with the auditor’s report: s 302. The half-yearly reports need not be sent to members. Although the half-yearly financial report and directors’ declaration follow the form of the annual report and declaration, the half-yearly directors’ report is a truncated version focusing upon a review of operations during the half-year: ss 302 – 306. Some overseas exchanges require quarterly financial reporting and that is available as a voluntary measure for entities listed on ASX except for mining companies where disclosure is also required of production and exploration activities and reserve estimates. For other Australian listed companies quarterly reporting is not, however, widely adopted, sometimes justified upon the basis that quarterly reporting encourages an unwelcome short-term perspective in corporate planning and investor behaviour. 33 Auditing the financial report [9.150] The financial report, whether the annual or half-yearly report, must be audited under

Pt 2M.3 Div 3 and an auditor’s report obtained: ss 301(1), 302. 34 The auditor must form an opinion about: (a) whether the financial report is in accordance with the Act, including whether it complies with accounting standards and discloses a true and fair view of the financial position and performance of the audited body; 31

The discussion must deal specifically with the company’s earnings and the consequences of the company’s performance on shareholder wealth in the financial year and in the previous four years, including through dividends paid, market price movement and capital returned: s 300A(1AA), (1BB).

32

The inclusion of the reference to the group seeks to give a better picture of remuneration practices across the corporate group and to prevent corporate structures being used to circumvent the reporting requirements (eg, by employing the highest paid officers in subsidiary companies). All sources of remuneration within the group must be included: s 300A(4).

33

Of Australia’s top 100 companies, only 15 produced quarterly profit statements along with their mandatory reports in 2004: Australian Financial Review, 22 October 2004, p 64.

34

A small proprietary company’s financial report does not have to be audited if it is prepared in response to a shareholder direction which does not require the report to be audited: s 301(2).

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[9.145]

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(b)

whether the auditor has been given all necessary information, explanation and assistance;

(c)

whether financial records have been kept which are sufficient to enable a financial report to be prepared and audited; and

(d)

whether other records and registers have been kept as required by the Act: s 307.

The auditor must report her or his opinion on (a) to members and, if it is negative, explain why: s 308(1). If the auditor believes that the financial report does not comply with an accounting standard, the report must, to the extent that it is practicable to do so, quantify the effect that non-compliance has on the financial report: s 308(2). The auditor’s report must also describe any defect or irregularity in the financial report and any deficiency in relation to (b)-(d) above: s 308(3). If the financial report is a half-yearly report, it may be reviewed by the auditor under Pt 2M.3 Div 3 rather than audited: s 302(b). The auditor who conducts such a review must report to members on whether they became aware of any matter in the course of the review that makes them believe that the financial report does not comply with the requirements for half-yearly reports; an explanation must be given for the belief: s 309(4), (5). An individual, firm or company conducting an audit or reviewing a half-yearly financial report must conduct the audit or review in accordance with auditing standards: s 307A. Unless ASIC otherwise determines in exceptional circumstances, the auditor must retain audit working papers for seven years from the date of the audit report: s 307B. The auditor has a right of access at all reasonable times to the books of the company and to receive information, explanation or assistance from their officers: ss 310, 312, 323A, 323B. 35 The auditor (or lead auditor where the audit is conducted by a company) must notify ASIC if they have reasonable grounds to suspect that a contravention of the Act has occurred and the contravention is a significant one or the auditor believes that it has not been or will not be adequately dealt with by commenting on it in the auditor’s report or bringing it to the attention of the directors; 36 a similar reporting obligation arises where an attempt is made to unduly influence, manipulate or mislead the auditor in the conduct of the audit: s 311. The auditor of a borrowing corporation must give to the trustee for debenture holders a copy of the audit report and other documents given to the company, and report to the trustee and the company on any matter discovered during the audit that is prejudicial to the interests of debenture holders or relevant to the trustee’s powers or duties: s 313. Appointment and removal of auditors [9.155] The qualifications, appointment, removal and resignation of auditors are regulated

with a view to securing the auditor’s independence from directors and some measure of stability of tenure appropriate to the mixed private and public character of their office and responsibilities.

35 36

The provisions referred to in this paragraph are expressed to be strict liability offences for purposes of the Criminal Code Act 1995 (Cth) so that no mental element is required for the offence. In determining whether a contravention is a significant one, regard must be had to the level of penalty provided for in relation to the contravention and the effect that the contravention has, or may have, on the overall financial position of the company or the adequacy of the information available about its overall financial position: s 311(4). [9.155]

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A person, firm or company may not be appointed as an auditor unless they satisfy the registration requirements as an auditor. ASIC registers persons as auditors who satisfy the educational or competency standards or experience requirements which it has approved: s 324BA, Pt 9.2 Div 2. 37 The auditor of a public company is appointed by the company in general meeting 38 and holds office until death, removal or resignation from office, loss of qualification for appointment or supervening conflict of interest within Pt 2M.4 Div 2 (see [9.175]): s 327(1A), (1) – (4). An auditor may be removed from office by resolution of the company in general meeting of which two months notice of intention to move the resolution has been given: s 329(1), (1A). The auditor may make written representations and have the company circulate them to members: s 329(3), (4). Where an auditor is removed from office by the general meeting, the company may at that meeting (without adjournment), by special resolution appoint a new auditor: s 327D(2). If such resolution is not passed, the meeting may be adjourned for 20-30 days and at the adjourned meeting the company may appoint an auditor by ordinary resolution: s 327D(3), (4). The auditor appointed under either provision holds office until the next AGM: s 327D(5). Where, after removal, the company fails to appoint a new auditor under this process it must notify ASIC within seven days whereupon ASIC must appoint an auditor to hold office until the next AGM: s 327E. The auditor of a public company may resign from office if, after application for consent to do so, stating reasons, ASIC consents to the resignation: s 329(5), (9). An auditor’s statement in the application to ASIC or in answer to an inquiry relating to the reasons, is not admissible in evidence in any civil or criminal proceedings against the auditor and may not be made the ground of prosecution, action or suit against the auditor: s 329(7). Communication of the financial reports to members and the public [9.160] A company must send to members a copy of the financial report, the directors’ report

and the auditor’s report for the financial year (or a concise version) 21 days before the next AGM and within four months after the end of the financial year: ss 314, 315. The directors of a public company other than a single member company must hold an AGM and lay before the meeting the reports for the last financial year prior to the AGM: s 317. A borrowing corporation must give a copy of the reports to the trustee for debenture holders or, upon request, to a debenture holder: s 318. The auditor of a listed company must attend or be represented at the AGM by a suitably qualified member of the audit team that conducted the audit and who is in a position to answer questions on it: s 250RA. Members of the listed company who are entitled to vote at the AGM may submit a written question to the auditor that is relevant to the content of the audit report or the conduct of the audit: s 250PA. The chair of the meeting must allow a reasonable opportunity for the members as a whole to ask the auditor questions relevant to the conduct of the audit, the auditor’s report, accounting policies adopted by the company in the preparation of the financial statements, and the auditor’s independence; the chair must also allow a reasonable opportunity for the auditor to answer written questions submitted in advance of the meeting: s 250T.

37

ASIC may permit a proprietary company to appoint as auditor a person who is not a registered company auditor if it is satisfied that it is impracticable for the company to obtain the services of a registered auditor because of the location of its business and that the individual is suitably qualified or experienced: s 324BD.

38

The directors of a proprietary company may appoint an auditor if the general meeting does not do so: s 324.

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[9.160]

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The financial report must be lodged with ASIC within four months after the end of the financial year: s 319(1), (3). 39 Half-yearly reports must be lodged with ASIC within 75 days after the end of the half-year: s 320. Strengthening auditor independence

The context of reform [9.165] Several scandalous corporate collapses in Australia (eg, HIH Insurance) and the

United States (especially Enron) focused attention on the role of auditors in verifying financial statements. In Enron’s case, the scandal palpably engulfed the firm’s auditor, Arthur Andersen, whose bankruptcy followed that of its client. A wave of accounting and financial irregularities in the United States and, to a lesser extent in Australia, pointed to a failure of professional gatekeeping functions and in some instances acquiescence in management fraud. 40 In response to these failures in both countries, particular attention was paid to mechanisms for assuring auditor independence from management to protect the reliability and credibility of financial reporting. The rapid growth in recent years in the provision of non-audit services by audit firms was also seen as threatening auditor independence. 41 These concerns are compounded by the concentration of audit services among a small group of very large firms which together enjoy an effective monopoly in the provision of audit services to publicly held companies. In Australia, comprehensive reforms were made to auditor independence requirements, effective from 2004. They follow similar but not identical reforms made by the United States Congress in the Sarbanes-Oxley Act to strengthen the quality of the audit function. The reforms are in addition to those undertaken to strengthen the board’s capacity to exercise its oversight functions with respect to financial management and reporting, including through the role of audit committees: see [5.85]. 42

General requirement of auditor independence [9.170] The Act imposes both a general requirement of auditor independence and specific

requirements. As to the general requirement, an auditor (including a member of an audit firm or director of an audit company) must not engage in audit activity in relation to an audited body when a “conflict of interest situation” exists in relation to that body of which the auditor is aware and which the auditor does not, as soon as practicable after becoming aware, take steps to bring to an end: ss 324CA(1), 324CB(1), 324CC(1). A conflict of interest situation exists if, because of circumstances existing at that time, an auditor or professional member of the audit team is not capable of exercising objective and impartial judgment in relation to the conduct of the audit or a reasonable person with full knowledge of the facts would conclude 39 40

This obligation does not, however, apply to a small proprietary company that prepares the report in response to a shareholder direction or ASIC direction: s 319(2). See J C Coffee (2004) 84 Boston UL Rev 301. Coffee argues that the sudden shift to equity-based executive compensation in the 1990s greatly increased management incentives to manipulate corporate earnings and to induce gatekeepers such as auditors to allow them to do so. Gatekeeper failure was also widely asserted in the United States on the part of securities analysts who were subject to growing conflicts of interest and among attorneys advising on securities transactions such as initial public offerings.

41

An influential report shaped professional and legislative responses: see I Ramsay, Independence of Australian Company Auditors: Review of Current Australian Requirements and Proposals for Reform (Report to the Minister of Financial Services and Regulation, October 2001).

42

For comparative reviews of Australian regulatory responses to auditor independence dilemmas, see L Chapple & B Koh (2007) 21 Aust Jnl of Corp Law 1 and E Ladakis (2005) 23 C&SLJ 416; for audit committee members’ views on auditor independence reforms see A Brooks et al (2005) 23 C&SLJ 151; on the auditor as whistleblower see G Gay & P Bir (2006) 24 C&SLJ 245 and M Legg (2005) 23 C&SLJ 264; J J Schmidt (2012) 87(3) Acounting Review 1033. [9.170]

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Corporations and Financial Markets Law

that they were not capable of exercising that judgment: s 324CD(1). In determining this question, regard must be had to the relationships, past, present or likely to exist in future, between: (a) an individual auditor; (b)

if it is a firm, its current or former members; and

(c) if it is a company, its current or former directors and the audited company, its current or former directors or persons currently or formerly involved in its management: s 324CD(2). 43 The individual auditor, firm member and director of the audit company must notify ASIC within seven days of becoming aware of the conflict of interest situation if it continues: ss 324CA(1A), 324CB(1A), 324CC(1A). 44 An individual auditor or audit company who would have contravened the general independence requirement but for their lack of awareness of the conflict of interest situation contravenes the section if they would have been so aware if the auditor or company had had in place a quality control system reasonably capable of making the auditor aware of the existence of the conflict of interest situation: s 324CA(2). Liability extends also to members of an audit firm and to the directors of an audit company where one member of the firm or a director is aware that the conflict of interest situation exists or, if no one was so aware, a member of the firm or director would have been if the firm or company had had in place a quality control system reasonably capable of making the firm or company aware of the conflict of interest situation: ss 324CB(2), (4), 324CC(2), (4). However, in each instance, the auditor, member or director does not commit an offence if they had reasonable grounds to believe that the organisation had in place at the time a quality control system that provided reasonable assurance (taking into account the size and nature of its audit practice) that the auditor and its employees complied with the general requirement for auditor independence: ss 324CA(4), (5), 324CB(6), 324CC(6). Strict liability applies to the physical elements of each offence: ss 324CA(3), 324CB(3), (5), 324CC(3), (5).

Specific requirements of auditor independence [9.175] Specific requirements are also imposed for auditor independence; they are much more

detailed in their prescription although simplified through the use of tables. They apply where an auditor engages in audit activity and at the time a relevant item in the table of relationships with the audited body (the audited body relationships table, Table 9.1) contained in s 324CH applies to a person who is covered in the table of persons with an interest in or relationship with the auditor (the auditor table, Table 9.2). The auditor table varies with the auditor type, viz, whether the auditor is an individual, firm or company. In each case, the specific requirements are breached when the auditor does not, as soon as practicable after it becomes aware that the audited body relationships table relevantly applies to a person who is covered by the auditor table in relation to the audit, take all reasonable steps to ensure that it ceases to engage in audit activity in those circumstances: ss 324CE(1) (individual auditor), 324CF(1)

43

The subsection extends the relationship test to counterpart persons in other disclosing entities and registered schemes where they are the audited body.

44

The privilege against self-incrimination is ousted in relation to the notification although the information and the fact that it is given is not admissible in evidence against the person in criminal proceedings or those for the recovery of a penalty other than those for an offence based on the information given being false or misleading: ss 324CA(1B), (1C), 324CB(1B), (1C), 324CC(1B), (1C).

708

[9.175]

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(audit firm), 324CG(1) (audit company). 45 If within seven days of the auditor becoming aware that the relevant item in the audited body relationships table applies to a person covered in the auditor table, the auditor must notify ASIC if the circumstances remain in existence: ss 324CE(1A), 324CF(1A), 324CG(1A). Set out below is the table of relevant relationships with the audited body that is contained in s 324CH(1). Items 1-9 list employment and other economic relationships with the audited body and items 10-19 list financial relationships which in each case are considered to threaten the auditor’s independence or be incompatible with its discharge of the audit function. 46

TABLE 9.1 [Table of] relevant relationships [with audited body] Item 1 2 3

This item applies to a person (or, if applicable, to a firm) at a particular time if at that time the person (or firm)… is an officer of the audited body is an audit-critical employee 47 of the audited body is a partner of: (a) an officer of the audited body; or (b) an audit-critical employee of the audited body

4

is an employer of: (a) an officer of the audited body; or (b) an audit-critical employee of the audited body

5

is an employee of: (a) an officer of the audited body; or (b) an audit-critical employee of the audited body

6

is a partner or employee of an employee of: (a) an officer of the company; or (b) an audit-critical employee of the company

7

provides remuneration to: (a) an officer of the audited body; or (b) an audit-critical employee of the audited body; for acting as a consultant to the person

8

was an officer of the audited body at any time during: (a) the period to which the audit relates; or (b) the 12 months immediately preceding the beginning of the period to which the audit relates; or (c) the period during which the audit is being conducted or the audit report is being prepared

9

was an audit-critical employee of the audited body at any time during: (a) the period to which the audit relates; or (b) the 12 months immediately preceding the beginning of the period to which the audit relates; or (c) the period during which the audit is being conducted or the audit report is being prepared

10

45

46 47

has an asset that is an investment in the audited body

The auditor must also notify ASIC if the conflict of interest is not terminated within seven days: ss 324CE(1A), 324CF(1A), 324CG(1A). As with the general requirement, the privilege against self-incrimination is displaced in relation to the notification although the information is not admissible in evidence in criminal or penalty proceedings except those relating to its own falsity: ss 324CE(1B), (1C), 324CF(1B), (1C), 324CG(5B), (5C). Items 1-9 are expressed not to apply if the audited body is a small proprietary company for the relevant financial year. This exclusion has been removed from the statement for each of these items in the table. Defined as an employee who is able because of their position to exercise significant influence over a material aspect of the contents of the financial report being audited or the conduct or efficacy of the audit: s 9. [9.175]

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Item 11 12 13 14 15

16

17

18 19

This item applies to a person (or, if applicable, to a firm) at a particular time if at that time the person (or firm)… has an asset that is a beneficial interest in an investment in the audited body and has control over that asset has an asset that is a beneficial interest in an investment in the audited body that is a material interest has an asset that is a material investment in an entity that has a controlling interest in the audited body has an asset that is a material beneficial interest in an investment in an entity that has a controlling interest in the audited body owes an amount to: (a) the audited body; or (b) a related body corporate; or (c) an entity that the audited body controls; unless the debt is disregarded under subsection (5), (5A) or (5B) is owed an amount by: (a) the audited body; or (b) a related body corporate; or (c) an entity that the audited body controls; under a loan that is not disregarded under subsection (6) or (6A) is liable under a guarantee of a loan made to: (a) the audited body; or (b) a related body corporate; or (c) an entity that the audited body controls [Repealed] is entitled to the benefit of a guarantee given by: (a) the audited body; or (b) a related body corporate; or (c) an entity that the audited body controls in relation to a loan unless the guarantee is disregarded under subsection (8)

The table of persons or entities with an interest in or relationship with an audit firm that is contained in s 324CF(5) is set out below. It identifies for each person or entity in the table the particular relationships with the audited body that are prohibited. The table (viz, Table 9.2, the auditor table) does so by reference to items in the audited body relationships table (Table 9.1) which appear in the right hand column of Table 9.2. The tables that apply when the auditor is an individual or company vary only with the character of the auditor entity type: see ss 324CE(5) (an individual auditor) and 324CG(9) (audit company). For brevity, only the table applicable when the auditor is a firm (viz, partnership) is included here. To provide immediate examples of the operation of the tables (and, for simplicity’s sake, ignoring qualifications and definitions which are outlined in Table 9.2), prohibited relationships arise where: • a member of the audit firm (item 3 in the auditor table) provides remuneration to an officer or audit-critical employee of the audited body (item 7 in the audited body relationships table); • a professional member of the audit team (item 4) is an officer of the audited body during the audit period or the immediately preceding 12 months (item 8) or owes or is owed moneys under a loan to or from the body (items 16 and 19); and • an immediate family member of a non-audit services provider to an audited body (item 7) has an investment (defined in s 9) in the body: item 10.

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TABLE 9.2 Audit firm [The auditor table] Item

For this person or entity …

1

the firm

2

a service company or trust acting for, or on behalf of, the firm, or another entity performing a similar function

3

a member of the firm

4

a professional member of the audit team conducting the audit of the audited body an immediate family member of a professional member of the audit team conducting the audit of the audited body a person who: a) is a non-audit services provider; and b) does not satisfy the maximum hours test in subsection (6)

5 6

the relevant items of the table in s 324CH(1) are… 4 7 10 to 19 4 7 10 to 19 1 to 7 9 15 1 to 6 8 to 19 1 and 2 10 to 19 10 to 12

7

an immediate family member of a person who: a) is a non-audit services provider; and b) does not satisfy the maximum hours test in subsection (6)

10 to 12

8

an entity that the firm (or a service company or trust acting for, or on behalf of, the firm, or another entity performing a similar function) controls a body corporate in which the firm(or a service company or trust acting for, or on behalf of, the firm, or another entity performing a similar function) has a substantial holding an entity that a member of the firm controls or a body corporate in which a member of the firm has a substantial holding a person who: a) is a former member of the firm; and b) does not satisfy the independence test in subsection (7)

15

a person who: a) is a former professional employee of the firm; and b) does not satisfy the independence test in subsection (7)

1 and 2

9 10 11

12

15 15 1 and 2

Item 6 in the auditor table refers to a non-audit services provider and imposes a maximum hours test. A non-audit services provider is defined as one who provides services (other than services related to the conduct of an audit) to the audited body and is either an employee of the individual auditor, a member or senior manager 48 of the audit firm or a director or senior manager of the audit company (as the case may be): s 9. The exempting maximum hours test is satisfied if the person provides non-audit services to the audited body on behalf of the auditor for less than 10 hours during the audit period or the preceding 12 months: ss 324CE(6), 324CF(6), 324CG(10). For purposes of items 9 and 10 in the auditor table, a person has a substantial holding if they have voting rights of 5% or more in the entity: s 9. The independence test in item 11 is satisfied in relation to an auditor if the person has no financial

48

Defined as a person (other than a director or secretary) who makes, or participates in making, decisions that affect the whole, or a substantial part, of the business of the company or has the capacity to affect significantly its financial standing: s 9. [9.175]

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interest in and does not influence the operations or financial policies of its accounting and audit practice or participate in its business or professional activities: ss 324CE(7), 324CF(7), 324CG(11). In the audited body relationships table in s 324CH(1), disregard the following: • in item 15, debts arising from a loan made in the ordinary course of business to assist the purchase of a primary residence (s 324CH(5)); • in item 16, debts to immediate family members of a professional member of the audit team or of a non-audit services provider that are incurred in the ordinary course of business (s 324CH(6)); and • in item 19, a guarantee given in like circumstances: s 324CH(8). Strict liability applies to the physical elements of the offence constituted by the auditor engaging in audit activity while a relevant item in the audited body relationships table applies to a person or entity covered in the auditor table: ss 324CE(2), (3), 324CF(2), (3), 324CG(2), (3), (5). However, the auditor, member of an audit firm or director of an audit company does not commit an offence if they had reasonable grounds to believe that the organisation had in place at the time a quality control system that provided reasonable assurance (taking into account the size and nature of its audit practice) that the auditor and its employees complied with the specific requirements of auditor independence: ss 324CE(4), 324CF(4), 324CG(8).

Other provisions reinforcing auditor independence [9.180] Several other measures were introduced in 2004 to strengthen auditor independence.

First, the auditor must give directors of the audited company a written declaration that to the best of their belief there were no contraventions of these auditor independence requirements or to those relating to auditor rotation (see [9.185]) in relation to the audit or review or of any applicable code of professional conduct, or none beyond those specified in the declaration: s 307C. 49 Second, a two-year “cooling off” period is imposed before a member of an audit firm or director of an audit company may become an officer of an audited body where the person was a professional member of the audit team for that body’s audit: s 324CI. The restriction applies also to a former professional employee of an audit company who was a lead auditor or review auditor (defined as the registered auditor primarily responsible for the conduct of the audit or for reviewing the conduct of the audit, respectively): s 324CJ. Third, following a recommendation of the HIH Royal Commission, the Act prohibits more than one former member or director of an audit firm or company from becoming an officer of a company which their former firm or company is auditing: s 324CK. 50

Rotation requirements for auditors [9.185] A threat to auditor independence evident in some major corporate collapses was an

excessive affinity between and auditor and audited company that may not be addressed by the general and specific auditor independence requirements. According to a 19th century judge, an auditor is a “watch-dog, but not a bloodhound”. 51 Even so, long exposure to the audited body and its management may blunt the sharpness of the auditor’s scrutiny by aligning them 49

50

The privilege against self-incrimination is ousted in relation to the declaration although the information is inadmissible against both in its direct and derivative use (viz, both the information included in the declaration and that which is obtained as a direct or indirect consequence of the disclosure in the declaration) in criminal proceedings or for a penalty except for those for an offence for false or misleading statements or the giving of false information in relation to the declaration itself: s 307C(6), (7). See also [9.140] concerning the disclosures in the directors’ report of a listed company that seek to assure auditor independence.

51

Re Kingston Cotton Mill (No 2) [1896] 2 Ch 279 at 288 per Lopes LJ.

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too closely with its management and culture. The 2004 reforms introduced a requirement of auditor rotation for listed companies. The obligation contemplates continuing appointment of an audit firm or company but the rotation of individuals as lead and review auditors. Where an individual plays a significant role in the audit of a listed company for five successive financial years they may not play a significant role in the audit of that company for the following two successive financial years without ASIC’s consent: ss 324DA, 324DB, 342DA. 52 The phrase “play a significant role” refers to a person who acts as lead or review auditor in relation to audit of the listed company: s 9. Individual liability is also imposed upon the members of an audit firm and directors of an audit company when an individual acting on behalf of the firm or company fails to retire from an audit as required, subject to a defence for reasonable reliance upon quality control systems to assure compliance: ss 324DC, 324DD. ASIC’s modification power is limited to granting relief from rotation for up to two years (viz, from five to a maximum of seven years) where it is satisfied that earlier rotation would impose an unreasonable burden on the auditor or audited company: s 342A. Exemptions and modifications [9.190] More generally, ASIC may make an order in relation to a company or a specified class

of companies relieving directors, a company or auditors from any or all of the requirements relating to financial record keeping, financial reporting and auditor appointment and removal: ss 340, 341. Before doing so, ASIC must be satisfied that complying with the relevant requirements would • make the financial report or other reports misleading; • be inappropriate in the circumstances; or • impose unreasonable burdens: s 342(1). ASIC has exercised this power to make class orders relieving wholly owned subsidiaries from the obligation to prepare financial statements where they are included in the consolidated financial statements for the group: see [4.12], Notes and Questions. The relief is subject to conditions including the granting of cross-guarantees. Sanctioning financial reporting and auditing obligations [9.195] Particular provisions in Pts 2M.2, 2M.3 and 2M.4 express their contravention to be

an offence, usually of strict liability. They and other provision in these Parts are also sanctioned by the general penalty provision in s 1311 which creates offences for acts that a person is forbidden to do, or not doing an act which they are required to do, where the provision is referred to in Sch 3 of the Act: s 1311(1), (1A). 53 The provisions in Pts 2M.2 and 2M.3 are further sanctioned by the civil penalty provision applying where a director of a 52

The two-year prohibition is expressed to apply from the end of the audit role so that it may not be avoided, eg, by resigning from the audit for one year after four years of acting as lead auditor. In 2012 the prohibition was relaxed by allowing the directors, before the expiration of the five year term, to extend the term for a further one or two year period: ss 324DAA, 324DA(3)(a). If the company does not have an audit committee, its directors must be satisfied that its approval is consistent with maintaining the quality of the audit provided to the company and would not give rise to a conflict of interest situation within s 324CD; the directors must set out the reasons why they are satisfied: s 324DAB(2).

53

The application of s 1311 to provisions in Pt 2M.4 relating to the appointment and removal of auditors and requirements for their independence do not depend upon Sch 3 reference by virtue of their carve out from this general requirement that is contained in s 1311(1A)(c). On the operation of the general penalty provisions of s 1311, see [7.55]. [9.195]

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company or disclosing entity fails to take all reasonable steps to comply or secure compliance with their provisions: s 344(1). A director commits an offence if they contravene s 344(1) and the contravention is dishonest: s 344(2). 54 These sanctions are complemented by the general prohibitions upon false or misleading statements in Pt 9.4 Div 1. An offence is committed by a person who knowingly makes or authorises a statement in a document required by the Act that is false or misleading in a material particular or knowingly omits any matter without which the document is materially misleading: s 1308(2). An offence is also committed where the statement or omission is not made knowingly but the person has not taken reasonable steps to avoid a false or misleading statement: s 1308(4), (5). If a person votes in favour of a resolution (eg, at a meeting of directors or shareholders) approving a document required for the Act which contains a false or misleading statement to the person’s knowledge, the person is deemed to have authorised the statement on omission: s 1308(6). An officer or employee of a company also commits an offence if they provide false or misleading information, or authorises its provision, to an auditor of the company or of a parent entity, or to a director or member of the company relating to the affairs of the company, either knowingly or without taking reasonable steps to ensure that the information was not false or misleading: s 1309. The civil liability provisions relating to misleading or deceptive conduct in relation to financial services may also be attracted: ASIC Act, s 12DA and Pt 2 Div 2 Subdiv G. The former provision is not subject to a materiality threshold: see [10.215].

THE RAISING OF SHARE CAPITAL Members’ liability to contribute share capital [9.200] The subject of the issue of share capital was introduced at [3.155]. The subject is

more fully explored in this section. For companies with a share capital, members contribute capital to the company and are issued shares in the company in return. An application for registration of a company limited by shares or an unlimited company must state (i) the number and class of shares each intending member agrees to take; (ii) the amount each member agrees to pay for each share; and (iii) if the amount is not paid in full on registration, the amount each member agrees will be unpaid on each share: s 117(2)(f). These shares are taken to be issued to members on registration of the company: s 120(2). Upon incorporation a company may issue shares on the terms and with the rights and restrictions as it determines: ss 124, 254B(1). The power to issue shares is usually confided to directors: see [5.100]. The intending member will usually submit to the board a form of application for a specified number of shares which, when accepted, results in a contract of allotment. The contract is completed by the issue of shares when the board enters the member’s name in the share register in respect of identified shares or delivers a share certificate in respect of those shares. Directors will issue shares to members for an agreed consideration representing a judgment as to the worth of the rights acquired. In the case of publicly held companies in whose management the shareholders will not play an active role, that worth is largely determined by the likely future dividend stream from the shares. The full consideration agreed for the issue of 54

An exception is made for the provisions of ss 310, 312, 323A and 323B requiring access, information and assistance to be provided to the auditor: s 344(3).

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shares may be paid upon application; alternatively, some or all of the consideration may be payable in the future, enforceable by calls made by the directors during the life of the company: s 254M(1). The share (or issued) capital of a company is the aggregate of the amounts of money that members and those applying for membership have paid and agreed to pay as future calls for the shares for which they have subscribed. Where shares are issued for a non-cash consideration, the agreed value of the consideration is the capital represented by those shares: see [9.215]. Share capital is distinctive in that it is committed in consideration for the issue of shares and is therefore subscribed as a member and not in another capacity such as where a member lends money to the company. The aggregate amounts of money or its value that has been received by the company for the issue of its shares is called its “paid up capital”. The aggregate of issued capital for which payment has yet to be made is called its “unpaid” or “uncalled” capital. The latter terms are, however, not strictly synonymous since some unpaid capital may have been called up but not yet paid by its holder. On winding up of a company limited by shares, a member need not contribute to the company’s debts and liabilities any more than the amount, if any, unpaid on the shares for which the member is liable as a present or past member: s 516. A member is liable as a present member for shares registered in their name or which they have agreed to take. A past member is under no liability to contribute if they ceased to be a member more than a year before the commencement of the winding up of the company: s 521. If the past member was a member for some portion only of that year, they need not contribute in respect of a debt or liability of the company contracted after they ceased to be a member: s 520. In the case of an unlimited company, the liability of the member to contribute to the company’s debts and liabilities is unlimited: ss 515, 519, 523. A company may not relieve members of the obligation to pay unpaid capital except through an authorised reduction of capital: see [9.230]. A limited company may, however, pass a special resolution restricting the company’s right to make calls on unpaid share capital to situations where the company comes under external administration such as receivership, administration or liquidation, almost invariably for insolvency: s 254N(1). Such capital is commonly called reserve capital. The price at which shares are issued therefore serves to fix an upper limit upon the member’s liability to contribute to debts of the company. It may also, depending upon the terms of issue, serve to fix preferred entitlements to dividend participation or capital return upon winding up. Shareholders can check the amount, if any, unpaid on their shares by consulting the register of members including, in the case of listed companies, for share capital issued before 1 July 1998: s 169(3)(f), (5). From that date the requirement for par value of shares was abolished. The abolition of par value shares [9.205] Section 254C simply states that shares in a company have no par value. Prior to 1 July

1998, however, shares were issued with a nominal (or par) value which served the function of fixing the extent of a member’s liability to contribute to the debts of the company – to the amount of the par value, if any, unpaid upon their shares. The amount that the member paid, or agreed to pay, for the share might exceed its par value (whose nexus with the real value of the share was rare and mostly fortuitous, at least once business operations had commenced). Sums paid or agreed to be paid as consideration for the issue of the share over and above its par value were called share premiums and were treated for many purposes of company law as if they were share capital. From 1 July 1998 any amount standing to the credit of a company’s share premium account became part of the company’s share capital. [9.205]

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The concept of par value had a correlate in authorised or nominal share capital. The constitution of a company required it to state the amount of share capital with which the company was registered and the division of that capital into shares of a fixed amount (par value). Nominal capital was usually stated in company constitutions in impressively high-sounding amounts, even though the company might never secure commitments for any but the smallest portion of this capital, or ever intended to do so. The concept of authorised share capital was abolished on the ground that it no longer served any purpose, and certainly not that of allowing a company’s creditors to assess the size of the company’s business undertaking and assets. In the case of a company limited by shares, the company’s par value not only served to fix the upper limit on the member’s liability but also a minimum level of liability. Accordingly, the purported issue of shares at a discount to par value was ineffectual and the holder remained liable to contribute their full par value. 55 The prohibition against, indeed, the concept of, issuing shares at a discount was wholly abolished with par value. Shares may be issued now for the price and upon the terms that the company and the intending subscriber autonomously agree: s 254B(1). Bonus shares [9.210] In order to prevent doubt, the Act provides that a company’s power to issue shares

includes the power to issue bonus shares, preference shares (including redeemable preference shares, discussed at [9.225]) and partly paid shares: s 254A(1). Partly paid shares have been noted already although special provision is made for no liability companies: ss 254P – 254R. Bonus shares are shares for whose issue no consideration is payable to the issuing company: s 254A(1)(a). Typically, bonus shares are issued by a company with undistributed profits, sometimes in relatively large amounts. Bonus shares may be issued in either of two ways. First, bonus shares may be distributed by declaring a dividend against distributable profits (see [9.355]) and simultaneously treating shareholders as having applied for new fully or partly paid shares of aggregate value corresponding to the dividend and in amounts corresponding to their individual dividend entitlement. In lieu of the cash dividend, the shareholders receive bonus shares. Alternatively, a company may issue bonus shares directly by distributing to members as a special dividend full or partly paid shares in the company. 56 It is almost invariable for bonus shares to be issued as fully paid under either mode. Both modes of capitalising profits are sanctioned by the Act; the capitalisation of profits may, however, be effected without the issue of bonus shares: s 254S. A replaceable rule requires directors of a proprietary company to offer shares of a particular class to existing holders of shares of that class, in proportion to their holdings, before they are offered to others: s 245D(1). Members in general meeting may, however, waive the benefit of the rule by ordinary resolution without a separate class meeting: s 254D(4). The general law does not impose pre-emptive rights although such a provision is not uncommon in the constitutions of private companies. The court may validate a purported issue of shares by confirming their terms if the issue is or may be invalid for any reason or the terms of issue are inconsistent with the Act, another law or the company’s constitution; an order may be made upon the application of the company, a shareholder, creditor or any other person whose interests have been or may be affected: s 254E(1). Upon lodgment with ASIC, the order applies from the time of the purported issue: s 254E(2). A company may divide some or all of its shares into a smaller or 55

Ooregum Gold Mining Co of India Ltd v Roper [1892] AC 125.

56

See, eg, Peters’ American Delicacy Co Ltd v Heath (1939) 61 CLR 457 (see [8.50]) where the company’s constitution provided for both modes of distribution but upon incompatible bases.

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[9.210]

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larger number of shares by resolution of the general meeting; any amount unpaid on shares being converted is to be divided equally among the replacement shares: s 254H. The issue of shares for non-cash consideration [9.215] In Ooregum Gold Mining Co v Roper Lord Watson said that “shares may be lawfully

issued as fully paid up for considerations which the company has agreed to accept as representing in moneys’ worth the nominal value of the shares”. 57 When will the value which the company has placed upon the non-cash consideration for its shares be reviewed? The question is discussed in Re Wragg Ltd [9.220].

Re Wragg Ltd [9.220] Re Wragg Ltd [1897] 1 Ch 796 Court of Appeal, England and Wales [Wragg and Martin had carried on business for many years. They wished to convert their partnership into a private company and by agreement of 10 January 1894 they transferred its assets to a company which they had incorporated. They were also the directors and principal shareholders of the company. In exchange for the assets the company issued to Wragg and Martin shares in the company credited as fully paid up. The company later went into liquidation and the liquidator challenged the value which Wragg and Martin had placed upon the assets.] LINDLEY LJ: [824] The liquidator contends that the shares issued to Martin and Wragg were improperly issued as fully paid up, and cannot be properly so treated. No attempt has been made to impeach or set aside the agreement of 10 January 1894. Nor, having regard to the decision of the House of Lords in Salomon v Salomon & Co [1897] AC 22, is it possible to hold that agreement invalid on the materials before us. The company, although a small one, promoted by the vendors and managed by them, must be treated as competent to buy the property which it was formed to acquire, and to take it at the price named by the vendors. The only question is whether the shares issued as fully paid up in part payment of the price can be treated as fully paid up. … [826] As regards the value of the property which a company can take from a shareholder in satisfaction of his liability to pay the [827] amount of his shares, there has been some difference of opinion. But it was ultimately decided by the Court of Appeal that, unless the agreement pursuant to which shares were to be paid for in property or services could be impeached for fraud, the value of the property or services could not be inquired into. In other words, the value at which the company is content to accept the property must be treated as its value as between itself and the shareholder whose liability is discharged by its means. … [830] That shares cannot be issued at a discount was finally settled in the case of the Ooregum Gold Mining Co of India v Roper [1892] AC 125, the judgments in which are strongly relied upon by the appellant in this case. It has, however, never yet been decided that a limited company cannot buy property or pay for services at any price it thinks proper, and pay for them in fully paid up shares. Provided a limited company does so honestly and not colourably, and provided that it has not been so imposed upon as to be entitled to be relieved from its bargain, it appears to be settled by Pell’s Case (1869) LR 8 Eq 222 and the others to which I have referred, of which Anderson’s Case (1877) 7 Ch D 75 is the most striking, that agreements by limited companies to pay for property or services in paid up shares are valid and binding on the companies and their creditors. The legislature in 1867 appears to me to have distinctly recognised such to be the law, but to have required in order to make such agreements binding that they shall be registered before the shares are issued. … [831] It is not law that persons cannot sell property to a limited company for fully paid up shares and make a profit by the transaction. We must not allow ourselves to be misled by talking of value. The value paid to the company is measured by the price at which the company agrees to buy what it thinks it worth its while to acquire. Whilst the transaction is unimpeached, this is the only value to be considered. … 57

Ooregum Gold Mining Company of India Ltd v Roper [1892] AC 125 at 136. [9.220]

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Re Wragg Ltd cont. A L SMITH LJ: [836] If … the consideration which the company has agreed to accept as representing in money’s worth the nominal value of the shares be a consideration not clearly colourable nor illusory, then, in my judgment, the adequacy of the consideration cannot be impeached by a liquidator unless the contract can also be impeached; and I take it to be the law that it is not open to a liquidator, unless he is able to impeach the agreement, to go into the adequacy of the consideration to shew that the company have agreed to give an excessive value for what they have purchased. [Rigby LJ concurred in dismissing the application.]

[9.222]

1.

Notes&Questions

H B Buckley QC was counsel for the liquidator in Re Wragg. As Buckley LJ, and as author of the 9th edition (1909) of Buckley on the Companies Acts, he wrote (p 213) that he had always keenly regretted that Re Wragg Ltd was not carried to the House of Lords. The decision involves that the corporation may by agreeing the price of a property at a figure issue paid up shares to that amount whatever be in fact the value of the property – meaning by that expression the value as measured by the price at which the company could have acquired it but for an agreement on their part to fix the value … – a proposition which involves in fact that the corporation may agree to issue shares at a discount. Do you agree with Buckley? (This opinion is quoted in Companies and Securities Law Review Committee, Share Premiums (Discussion Paper No 4, 1986), [15].)

2.

In Re White Star Line Ltd [1938] Ch 458 at 476 Clauson LJ (delivering the judgment of the English Court of Appeal) said: In view of the principles to be deduced from the authorities it is clear … that the consideration which is given [for the issue of shares] must not be a mere blind or clearly colourable or illusory, and that the question whether it is so or not is one of fact.

Similarly, in Tintin Exploration Syndicate Ltd v Sandys (1947) 177 LT 412 at 418 an allotment was set aside where the company had given no regard to whether it was receiving consideration which fairly represented the nominal value of the shares issued. See also Stanton v Drayton Commercial Investment Co Ltd [1983] 1 AC 501 at 513. 3.

718

An Australian law review committee recommended that the statute be amended so that a company may not issue shares for a non-cash consideration or for a consideration containing a non-cash element “unless the directors have made in good faith a determination of the amount of money that would have been payable by the company to obtain the non-cash advantage to be obtained by the issue of the shares”. In making their determination directors must have regard, inter alia, to any valuation obtained by the company from an expert or indicated by transactions which are a matter of public knowledge. Such determination and the matters to which directors have had regard must be recorded in a resolution of the directors a certified copy of which must be lodged with the return of allotment of the relevant shares: Companies and Securities Law Review Committee, Report to the Ministerial Council on the Issue of Shares for Non-Cash Consideration and Treatment of Share Premiums (1986), [12]. Although the proposal has not been implemented, does it represent good practice?

[9.222]

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REDEEMABLE PREFERENCE SHARES [9.225] Preference shares may be issued upon the terms that they are liable to be redeemed

either at the company’s option or that of their holder, at a fixed time or on the happening of a particular event: s 254A(3). Creditors are protected by provisions that ensure that the company’s share capital is maintained despite the redemption. This category of shares is an exception to the longstanding prohibition, enduring until 1998, upon a company returning its capital to members without the sanction of a court order: see now [9.240]. This form of reduction of share capital is expressly authorised if it complies with s 254K: s 258E(a). The practice of issuing redeemable preference shares derives from their use by statutory corporations in the United Kingdom. The Greene and Cohen Committees sanctioned their use by registered companies subject to safeguards affecting their redemption. 58 At different times redeemable preference shares have enjoyed considerable popularity as financial instruments, essentially for taxation reasons. To restrict their taxation advantages, the Treasurer announced in 1986 that redeemable preference shares would henceforth be treated for tax purposes as debt, and not equity, if they carried a redemption period of less than two years. The dividend imputation provisions independently diminished the tax utility of redeemable preference shares although they retain particular taxation advantages. 59 Only preference shares may be issued as redeemable although the nature and extent of their preferred entitlement is nowhere specified. 60 The Act permits the issue of redeemable shares and not the conversion of irredeemable shares (s 254G(3)) except through the indirect means of cancelling the irredeemable capital and simultaneously issuing redeemable capital in its place. 61 The redemption conditions are the principal safeguards against dissipation of the capital fund. Shares may be redeemed only on the terms on which they are on issue; on redemption, the shares are cancelled: s 254J(1). (Redeemable preference shares may also be cancelled on different terms under a reduction of capital or a share buy-back under Pt 2J.1 (see [9.280]): s 254J(2).) The shares may only be redeemed if they are fully paid up and are redeemed out of the proceeds of a new issue of shares made for the purpose of the redemption: s 254K. If a company redeems redeemable preference shares in contravention of these restrictions, the contravention does not affect the validity of the redemption or any transaction connected with it, and the company is not guilty of an offence: s 254L(1). This provision secures the interests of third parties not involved in the contravention. However, any person involved in the contravention (within the meaning in s 79) contravenes s 254L(2) which is a civil penalty provision: s 1317E. If the involvement is dishonest, an offence is committed: s 254L(3). A company must be solvent when it redeems redeemable preference shares that are redeemable at its option or when it issues such shares that are redeemable at the shareholder’s option; the redemption or issue is deemed to be the incurring of a debt for purposes of liability for insolvent trading: s 588G(1A). Accordingly, directors may be exposed to liability to compensate the company if it is or becomes insolvent when it redeems or issues the shares.

58

On these antecedents, see R Fox (1954) 28 ALJ 186.

59

See K J Burges, T W Magney & R J Vann, “Income Tax – a Driving Force Behind Financing Decisions” in R P Austin & R Vann (eds), The Law of Public Company Finance (1986), p 24.

60

In Beck v Weinstock (2013) 93 ACSR 251, the High Court held that the validity of redeemable preference shares does not depend on whether the company has issued ordinary shares at the time; see discussion at [9.75].

61

Re St James’ Court Estates Ltd [1944] Ch 6. [9.225]

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SHARE CAPITAL REDUCTION The forms of capital reduction [9.230] Share capital may be reduced in several ways and for different purposes. A loss

reduction is typically made when a company has sustained trading losses so that its shareholder funds are significantly greater in value than its net assets. Balance may be restored by cancelling a portion of the issued capital, usually on a pro rata basis. No repayment of funds is involved. Before the abolition of par value and the related prohibition on the issue of shares at a discount to par, the loss reduction might be practically necessary if new capital was to be raised since no one would be likely to assume obligations to subscribe for new shares whose value was significantly below their par value which fixed the obligation to contribute to company debts. The abolition of par value has diminished the need for this form of capital reduction. A second form of reduction occurs in the opposite situation, where the company has funds or other assets in excess of its needs. Such a company might wish to repay capital to members either by a cash payment 62 or by distribution of assets in specie to members. 63 In these situations, typically the share capital would not be cancelled although its amount, repayable on winding up, might be reduced. There would be no loss of membership of the company. A variant arises where the company releases the holders of partly paid shares from some part or the whole of their obligation to contribute future capital to the company; an example was the release of the obligation of the Dutch holding company of the James Hardie group in 2003 through the cancellation of the partly paid shares that it had subscribed for as part of the group restructuring: see [9.265]. A third form has become more common in recent years. A selective capital reduction may be made to allow one or more shareholders to retire by agreement from a company by having their capital repaid to them in an amount agreed to reflect its value, and their shares cancelled. 64 Perhaps a more important variant, at least for publicly held companies, allows majority shareholders to consolidate their control or eliminate minority interests by cancelling some or all of the shares that they do not hold. This form of reduction need not be wholly consensual; indeed, it has become a popular mode of control transfer. Payment might be made in cash or other consideration moving from the company or a third party. While the company might not in fairness force a minority to accept shares in another company in a reduction of capital, 65 that exchange might be made (and, subject to protective conditions, lawfully imposed on a dissenting minority) if the reduction is combined with and forms part of a scheme of arrangement under Pt 5.1. Indeed, capital reductions are commonly an essential element of a restructuring effected through a scheme of arrangement, whether as a transaction effecting a transfer of corporate control or one of myriad other forms of corporate restructuring. 66 The reductions under consideration in Re Tiger Investment Co Ltd [9.270] and Winpar Holdings Ltd v Goldfields Kalgoorlie Ltd [9.275] are instances of control 62

As in Re Fowlers Vacola Manufacturing Co Ltd [1966] VR 97.

63

As in Ex parte Westburn Sugar Refineries Ltd [1951] AC 625.

64

See, eg, Re Hudson Conway Ltd (1993) 12 ACSR 668.

65

Re Hunter Resources Ltd (1992) 7 ACSR 436.

66

Thus, the transfer of domicile of the parent companies of the former Australian-based corporate groups, News Corp and James Hardie Industries, to the United States and the Netherlands respectively, were effected by schemes combined with capital reductions. Shares in the former Australian parent company were cancelled and in exchange their holders received shares in the new foreign holding company, the reduction avoiding stamp duty that would have been payable upon a transfer of their shares to the new parent company. The foreign parent subscribed for capital in the former Australian parent company.

720

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transactions effected through selective reductions, the former through a scheme of arrangement. Since reductions are in practice often linked with schemes, their elements are briefly outlined here. 67 Schemes of arrangement in outline [9.235] Reference has already been made to creditors’ schemes of arrangement as devices to

enable a failing company to restructure its financial obligations: see [3.215]. Members’ schemes take many forms and are not primarily concerned with insolvency. A members’ scheme involves a “compromise or arrangement” proposed between a company and its members or a class of them. A summary application is made to the Court for an order convening a meeting of the members, either generally or of the relevant class only, and approving the documents to be sent to members for consideration (the explanatory statement): s 411(1). The information that must be included in the explanatory statement is specified in s 412. The scheme binds members only if it is approved by a majority of members, either generally or of the relevant class, who choose to vote in person or by proxy and who together hold 75% of the votes cast on the resolution: s 411(4)(a). The scheme must also be approved by court order after the meeting or meetings: s 411(4)(b). Although the court is not bound to approve the scheme at the second hearing, in practice shareholders are accepted as the best judges of their own interests. Accordingly, the court will generally only interfere if shareholders are not properly informed or the classes of members who gave separate approval were not properly constructed to reflect the distinct communities of interest with respect to the scheme. 68 Beyond these considerations, the court generally looks only to compliance with the law and for manifest unreasonableness or unfairness in the scheme, elements which would have been scrutinised for at the first hearing. In contrast to the share capital transactions in Ch 2J, Pt 5.1 does not impose any substantive criterion, such as fairness or reasonableness, that must be satisfied if the scheme is to bind minorities. In Gambotto’s case ([8.65] at 446), the High Court expressly referred to schemes of arrangement as providing structured protections displacing general law protections against expropriation of shares or extinguishment of rights. ASIC has gatekeeper functions where the scheme process is being used to effect a takeover that might have been made under Ch 6: s 411(17). ASIC’s policy is that shareholders should receive equivalent, although not necessarily identical, protection whether the acquisition is made by a scheme, capital reduction or takeover. If equivalent protection is provided, ASIC does not favour one form of control transfer over another. 69 Parties proposing a scheme must lodge copies of its terms and the draft explanatory statement with ASIC at least 14 days before the court hearing to convene the scheme meetings: s 411(2). In many schemes ASIC is the only other party appearing before the court and effectively represents shareholder and creditor interests. 70 Relaxing the capital maintenance rules [9.240] Under the capital maintenance doctrine, as Lord Watson said in Trevor v Whitworth,

creditors of a limited company are “entitled to assume that no part of the capital which has been paid into the coffers of the company has been subsequently paid out, except in the 67

See further B McLaughlin & J Balazs (2005) 23 C&SLJ 347; A Colla (2001) 19 C&SLJ 7.

68

Sovereign Life Assurance Co v Dodd [1892] 2 QB 573 (“are their rights so dissimilar as to make it impossible for them to consult with a view to their common interest?” (at 583 per Bowen LJ)). ASIC Regulatory Guide 60.7 (Schemes of arrangement – s 411(17)).

69 70

For ASIC’s policy with respect to its review and Court intervention functions, see ASIC Regulatory Guide 142 (Schemes of arrangement and ASIC review). [9.240]

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legitimate course of its business”. 71 The House of Lords accordingly held that a limited company might not return its share capital to holders by applying its funds to the purchase of their shares. The statute was subsequently amended to permit the return and other reductions of capital that are authorised by the company’s constitution, a special resolution of the company and court order confirming the reduction. This procedure was substantially recast in 1998, inter alia, by removing the requirement for court approval. However, in this context, it is valuable to understand the prior protective regime in assessing that which replaced it. The criteria for confirmation of the reduction ranged beyond the protection of the creditors and minority shareholders to public interest considerations at least as conceived in corporate terms. In Ex parte Westburn Sugar Refineries Ltd, a company voted to return capital not by a cash payment but by transferring to its shareholders shares in another company. The values of those shares stood in the company’s books at an amount equivalent to that of the capital to be reduced although it seemed probable that this was a conservative estimate of their value; a more precise valuation had not been obtained. Confirming the reduction, Lord Reid framed the test in these terms: What then is the duty of the court in considering a matter of this kind? In the first place, the interests of creditors must be safeguarded, but here that has been done. Secondly, the interests of shareholders may have to be considered, but in this case there has been no opposition by any shareholder at any time and it is difficult to see how there could be any prejudice to any single shareholder. Thirdly, there is the public interest to consider. … I would not be disposed, by attempting to define the public interest, to narrow in any way the discretion of the court in any future case, but in a case like the present I think that it is right to scrutinise the facts somewhat closely, having in mind the position of those who may, in future, form connections with the company as creditors or shareholders. It appears to me to be proper to consider what assets the company will retain if the proposed reduction of capital is confirmed. In the present case the assets to be distributed, taken at their real value, form only a comparatively small part of the total assets of the company. … In my opinion, these facts are amply sufficient to remove any apprehension that the future conduct of the company may be adversely affected by confirmation of the present proposal. 72

When the capital reduction was selective, fairness between shareholders depended upon the form of the reduction. Where capital was being repaid to some shareholders only without cancellation of their shares fairness presumptively required equal distribution between shareholders or according to the relative priority in repayment of capital between classes of shares on a winding up. 73 Where the selective reduction eliminated some shareholders by cancelling their shares, fairness was measured by the money terms offered. 74 The court required full disclosure of all information material to the shareholder decision including the reasons for the reduction and the advantages accruing to those promoting it. 75 ASIC’s practice note recommended that shareholders proposing the resolution should not vote on the special resolution to cancel the shares. These protections reflected the underlying principle that, in the interests of creditors who might look only to a company’s assets, its share capital is not at the unfettered discretion of its members who should not be at liberty during the company’s life to subvert the insolvency priorities or weaken solvency by liberal capital transactions.

71

Trevor v Whitworth (1887) 12 App Cas 409 at 423-424.

72 73 74

Ex parte Westburn Sugar Refineries Ltd [1951] AC 625 at 632-633. Re Fowlers Vacola Manufacturing Co Ltd [1966] VR 97 at 105. Nicron Resources Ltd v Catto (1992) 8 ACSR 219.

75

Re Albert Street Properties Ltd (1997) 23 ACSR 318; Melcann Ltd v Super John Pty Ltd (1995) 13 ACLC 92.

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However, in 1998 these capital maintenance rules were significantly relaxed in relation of some capital transactions by the introduction of Ch 2J which substituted protections that looked principally to the effect of the transaction upon the company’s solvency. 76 These capital transactions are: • reductions in share capital such as the return of capital to members, the release of members’ obligations to contribute unpaid share capital or the cancellation of shares ([9.245]-[9.275]); • share buy-backs where the company buys back its own shares from members under voluntary individual dealings ([9.280]-[9.285]); and • the giving of financial assistance by a company for a person to acquire shares in the company or its holding company: [9.320]-[9.345]. These are fundamental transactions involving share capital that have traditionally been the subject of prohibition or strict regulation in the interest of creditors and minority shareholders. Gradually, regulation has been loosened so that each set of provisions now contains not a prohibition but a limited facility or licence conditional upon shareholder approval. That licence does not, however, relieve directors from their general law and statutory duties in connection with a transaction because of its authorisation by the Act or approval by members: s 260E. The deterrent effect of personal director liability for allowing the company to trade while insolvent appears to have been judged to be sufficient creditor protection: see [7.135]ff. The capital maintenance rules have not been wholly displaced. They continue to apply substantially in their traditional form to the prohibitions under Pt 2J.2 upon acquisitions by a company of its own shares and the taking of security over its shares or those of a company that controls it (see [9.290]), and possibly (but unintentionally) to the payment of dividends: see [9.355]. As noted, a reduction of capital may take several forms. It may be made through the return of capital to shareholders, release from obligations to pay uncalled capital or cancellation of partly or fully paid shares. The current process for effecting reductions of capital and procedures under which a company may buy back its own shares in Ch 2J are designed to protect the interests of shareholders and creditors by (a) addressing the risk of these transactions leading to the company’s insolvency; (b) seeking to ensure fairness between shareholders; and (c) requiring the company to disclose all material information: s 256A. They do so, however, under a more permissive regime than applied before 1998 when court approval was required for capital reductions that reduced the fund to which creditors have recourse or which had internal distributional effects between groups of shareholders. The relaxation was justified upon the basis that the time and expense of judicial sanction was not required in every instance and that the interests of shareholders and creditors might be secured by other safeguards. 77 The Act now permits shareholders to effect capital reductions but subject to protective safeguards that do not include judicial sanction unless initiated by a party opposing the reduction: see [9.260]. Share capital reductions specifically authorised [9.245] Specific authorisation is given to particular capital reductions so that they need not

comply with the shareholder consent procedure. They comprise the following transactions, in some cases for more abundant caution since not all are self-evidently capital reductions: 76 77

For an account of the “rise and fall” of the capital maintenance doctrine (the latter under these changes) see R Tomasic (2015) 26(5) International Company and Commercial Law Review 174. Company Law Review Bill 1997, Explanatory Memorandum, [12.10]-[12.13]. [9.245]

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• any capital reduction by an unlimited company (to which the general law doctrines never applied) (s 258A); • grant of occupancy rights to apartments in a company title home unit scheme (s 258B); • payment of brokerage or commission, typically to an underwriter, for agreeing to take up shares in the company (s 258C); • cancellation of shares that have been forfeited under the terms on which they are on issue (s 258D); • redemption of redeemable preference shares out of the proceeds of a new issue of shares made for the purpose of the redemption (see [9.225]) (s 258E(1)(a)); • a company’s buying back its own shares under Pt 2J.1 Div 2 if the shares are paid for out of share capital (see [9.280]) (s 258E(1)(b)); • share cancellations made in the context of a takeover (s 258E(2)); and • cancellation of paid up capital that is lost or not represented by available assets, unless the cancellation also involves cancelling shares or where it is inconsistent with Australian accounting standards: s 258F. 78 Procedure for capital reduction [9.250] Both creditors and minority shareholders are at risk in reductions of capital, the

former through the risk of diminution of the fund available to meet their claims and the latter through unfairness in treatment by the majority (eg, through selective reductions against the wishes of those shareholders). Accordingly, the power of reduction contains protective conditions: a company may reduce its share capital in a way not otherwise authorised by the Act if the reduction (a) is fair and reasonable to the company’s shareholders as a whole; (b) does not materially prejudice the company’s ability to pay its creditors; and (c) is approved by shareholders under s 256C which requires requisite majority consent after sufficient disclosure to shareholders: s 256B(1). 79 Where the reduction takes the form of cancellation of a share for no consideration (that is, does not involve any transfer from the company or release of obligation), the second condition is expressed to be inapplicable: s 256B(1). The precise effect of these words is unclear; the better view appears to be that these words do not exempt from scrutiny as to solvency effects a cancellation of partly paid shares made for no consideration. 80 78

The Explanatory Memorandum to the 1997 Bill states that this section will not apply in the case of trading losses incurred in the ordinary course of business, but is intended to apply in cases where company assets disappear (eg, are stolen or destroyed by fire): [12.39(f)]. The provision allows companies to write down the value of the company’s capital in situations where a company incurs certain types of losses by writing-off accumulated losses against its share capital. The section was amended in 2010 to make it clear that a company may only cancel share capital in circumstances where it is not inconsistent with Australian Accounting Standards. The amendment allows companies to write off accumulated losses to share capital but does not allow companies to take expenses directly to share capital; doing so would overstate the profitability of the company and not accurately reflect its financial performance.

79

The power to undertake a capital reduction under s 256B is vested in the directors and the function of the shareholders is to approve a decision to do so taken by the directors. This division of power cannot be altered by amendment to the company’s constitution, so that shareholders may not requisition a meeting under s 258D to vote on a capital reduction that is opposed by the directors: Molopo Energy Ltd; Molopo Energy Ltd v Keybridge Capital Ltd (2015) 104 ACSR 46. This was the view accepted by the Commissioner in the James Hardie Special Commission of Inquiry: Report of the Special Commission of Inquiry into the Medical Research and Compensation Foundation (D F Jackson QC, Commissioner; 2004), [27.43]; see further [9.265].

80

724

[9.250]

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The shareholder approval requirement also varies with the nature of the reduction. An ordinary resolution is sufficient if the reduction is an equal reduction since it carries no serious threat of minority shareholder oppression: s 256C(1). A reduction is an equal reduction if (a) it relates only to ordinary shares; (b) it applies pro rata to each holder of ordinary shares; and (c) the terms of the reduction are the same for each shareholder (ignoring differences referable to different accrued dividend entitlements or amounts paid up on shares, or introduced solely to avoid fractional holdings): s 256B(2), (3). Other reductions are selective reductions and require special shareholder approval which may take either of two forms: (a) a special resolution passed at a general meeting of the company, with no votes being cast in favour of the resolution by any person who, or whose associate (as defined in Pt 1.2 Div 2), is to benefit from the transaction or (b) a resolution agreed to, at a general meeting, by all ordinary shareholders: s 256C(2). The facility in s 256C(2)(b) may be useful in situations where all shareholders are prohibited from voting in favour of a resolution to approve the transaction, at least in companies with small shareholder numbers and where there is consensus with respect to the reduction. The requirement in s 256C(2)(a) addresses the situation where capital is being repaid without cancellation of the share, typically where it is in excess of the company’s needs. The danger is that the repayment is made to some classes of shareholders only or some shareholders only within a class. The danger is addressed by disenfranchising the recipients of the payment. However, when the reduction involves the cancellation of shares, their holders are more likely to be the vulnerable group, at risk from the continuing shareholders. Accordingly, when the reduction involves the cancellation of shares, s 256C(2) requires that the reduction also be approved by a special resolution passed at a meeting of the shareholders whose shares are to be cancelled. Several questions arise here. First, where a special resolution involves the cancellation of shares, do the continuing shareholders receive consideration “as part of the reduction” within s 256C(2)(a) through, for example, the consolidation of their control? Second, what is meant by the words “no votes being cast” in s 256C(2)(a)? Is it sufficient compliance if the votes are formally cast but not counted? This question assumes particular significance if the answer to the first question is yes although a further issue then arises as to how a special resolution might then be achieved unless some shareholders continue who are outside the control group. These questions are considered in Re Tiger Investment Co Ltd [9.270]. Third, where the reduction involves the cancellation of shares, is it necessary to hold a separate meeting of the holders of the capital proposed to be cancelled or may a single meeting be held with separate resolutions proposed for consideration by all shareholders and by the subset of non-continuing shareholders? Fourth, do the protections of Pt 2J.1 Div 1 supplant those required in Gambotto [8.65] for the elimination of minority interests? The third and fourth questions are addressed in Winpar Holdings Ltd v Goldfields Kalgoorlie Ltd [9.275]. A company that calls a meeting to seek approval for a capital reduction must include with the notice of meeting a statement setting out all the information known to the company that is material to the shareholders’ decision on how to vote on the resolution; the company need not, however, disclose information if it would be unreasonable to require it to do so because it had previously disclosed the information to members: s 256C(4). 81 Before the notice of meeting is sent to shareholders, the company must lodge with ASIC a copy of that notice and any other 81

A like disclosure standard earlier applied as a condition of judicial approval: see, eg, Re Campaign Holdings Pty Ltd (1989) 15 ACLR 762; as to general law disclosure obligations see [6.90]. [9.250]

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Corporations and Financial Markets Law

documents that will accompany the notice such as an independent expert’s report that the company may commission: s 256C(5). There is no obligation, however, upon the company to notify individual creditors. It is expected that interested creditors will receive advance notice of the proposed reduction through ASIC’s electronic alert system which gives subscribers notice of specified types of document lodged with ASIC in relation to particular companies. A company approving a selective reduction must lodge a copy of the resolution with ASIC within 14 days; the company must not make the reduction within 14 days of the resolution: s 256C(3). However, the validating effect of s 256D(2) places a premium upon legal challenges in the period prior to the meeting and opposition at the meeting itself: see below and in Winpar Holdings Ltd v Goldfields Kalgoorlie Ltd [9.275]. Substantive criteria for valid capital reduction [9.255] The protection of members and creditors depends upon not only the shareholder

approval and disclosure requirements but also the requirements of s 256B(1) requiring no material prejudice to creditors and the reduction being fair and reasonable to the shareholders as a whole. Material prejudice will depend upon all relevant circumstances, including those of the company and the creditors themselves. The fair and reasonable test is no less difficult. It is a composite requirement conveying a single meaning, negating the possibility that consideration might be fair but not reasonable and vice versa. 82 Relevant factors might include • the adequacy of consideration paid to shareholders; recent market price history of the stock is a useful indicator at least where the market for the stock is liquid; it is not, however, a necessary determinant of fairness; 83 • whether the benefits of the reduction have been fully disclosed 84 and fairly distributed between continuing and retiring shareholders (as to which see Winpar Holdings Ltd v Goldfields Kalgoorlie Ltd [9.275] at [106]-[117]); • whether the reduction would have the practical effect of depriving some shareholders of their rights (eg, by selective cancellation of shares or by return of funds that might be available for distribution to preference shareholders); and • whether the reduction is being used to effect a transfer of control bypassing the takeover provisions. 85 The fair and reasonable test is directed to the company’s shareholders as a whole; it may be satisfied even though the reduction, for example, a selective reduction involving share cancellation, is not fair and reasonable from the perspective of an individual shareholder. It may be that the shareholder has remedies under Pt 2F.1 (oppression) or under general law doctrines protecting against expropriation of shareholders’ property rights: see [8.20]. As to whether the objective standard expressed in the fair and reasonable test displaces the purpose-based criteria under Gambotto’s case [8.65] in relation to resolutions effecting selective capital reductions: see Winpar Holdings Ltd v Goldfields Kalgoorlie Ltd [9.275] at [85]-[96]. Sanctions and remedies for unauthorised reductions [9.260] A company must not make the reduction unless it complies with the conditions in

s 256B(1): s 256D(1). This is a civil penalty provision (s 1317E) so that a person who is 82

Company Law Review Bill 1997, Explanatory Memorandum, [12.24].

83 84

Catto v Ampol Ltd (1989) 16 NSWLR 342 at 361. Re Albert Street Properties Ltd (1997) 23 ACSR 318; Melcann Ltd v Super John Pty Ltd (1995) 13 ACLC 92.

85

Several of these examples are drawn from Company Law Review Bill 1997, Explanatory Memorandum, [12.24].

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[9.255]

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involved (within the meaning of s 79) in a capital reduction which fails to satisfy the fairness standard, materially prejudices creditors, is not approved with the requisite majority or fails the disclosure standard is exposed to a civil penalty including an order to compensate the company for its loss: s 256D(3). If the person’s involvement is dishonest, they commit an offence: s 256D(4). If a company effects the capital transaction in contravention of the statutory authorisation procedure, the contravention does not affect the validity of the transaction or of any contract or transaction connected with it; further, the company is not guilty of any offence: s 256D(2). This provision secures the interests of third parties who are not involved in the contravention by privileging certainty over invalidity. 86 A further remedy is provided in relation to capital reductions that impair the company’s solvency. When a company reduces its share capital (other than a reduction that simply cancels shares without any consideration moving to their holder), it is deemed to incur a debt when the reduction takes effect: s 588G(1A) (item 2). Hence, if the company is or becomes insolvent when the reduction takes effect, its directors may breach their duty to prevent insolvent trading if the other elements of liability are established and no defences are available. If so, they will be liable to compensate the company for loss sustained by reason of their contravention of s 588G(2), under s 588J or s 1317H: see [7.190]. Technically, this remedy might arise even if the reduction does not contravene Pt 2J.1 although a reduction that exposes directors to liability under s 588G(2) would necessarily offend the requirement that it not materially prejudice the company’s ability to pay creditors: s 256B(1)(b). Standing is expressly conferred on members, creditors and ASIC to seek orders restraining reductions that contravene or would contravene the Act because they do not comply with conditions of the licence to effect the reduction: s 1324(1A). The conditions that attract express standing relate, first, to the condition that the transaction does not materially prejudice the company’s ability to pay its creditors: s 1324(1A)(b)(ia). The application of the notion of material prejudice will depend upon all relevant circumstances, including those of the company and its creditors themselves, although the prejudice is not to creditors personally but to the company’s capacity to pay their debts. Where such prejudice exists, it is not curable by shareholder approval since the absence of such prejudice is clearly an independent condition of the exercise of the capital reduction power. Second, members may also seek an injunction against a reduction that fails the fair and reasonable test in s 256B(1)(a): s 1324(1A)(c). In an application for such relief, the onus is upon the company or person supporting the reduction to demonstrate that it complies with s 256B(1): s 1324(1B). ASIC may also seek injunctive relief under s 1324(1). ASIC may also apply to the Takeovers Panel concerning a reduction or proposed reduction of capital that it considers unreasonable having regard to its effect on the control of the company or another company; an application may also be made by a person whose interests are affected: s 657C(2). If the Panel declares circumstances to be unacceptable having regard to their effect on control of the company, the acquisition of a substantial interest in the company or another company or if they constitute a contravention of the takeovers Chapters, it may make a wide variety of orders to protect the interests of persons affected by the circumstances: s 657A(2) and [12.30]. Finally, it may be that other remedies and protective procedures may be engaged by a non-compliant reduction, such as those affecting the variation of class rights (see [9.105]) or, in the case of public companies, benefits to directors or related parties: see [7.415]. Signposts to these and other possible remedies are provided in s 256E. 86

Winpar Holdings Ltd v Goldfields Kalgoorlie Ltd (2001) 166 FLR 144 at [60]. [9.260]

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A case study: The James Hardie cancellation of partly paid shares [9.265] The scope of the licence conferred on companies to effect capital reductions free from

the previous requirement for judicial approval is indicated by events surrounding the restructuring of the James Hardie group of companies. In October 2001 the Supreme Court of New South Wales approved a scheme of arrangement under which shares in the former Australian holding company, JHIL, were exchanged for shares in a new holding company formed in the Netherlands, JHI NV. As part of the scheme, JHI NV became the only shareholder in JHIL and held partly paid shares with an uncalled liability of $1.96 billion. In March 2003, following a resolution of the JHI NV board directing them to do so, the two directors of JHIL (both employees of James Hardie group companies) resolved to cancel the partly paid shares, thereby releasing JHI NV from any liability upon them. JHI NV gave no consideration for and received no benefit under the cancellation which was not publicly announced. It was made at a time when there was a prospective shortfall in the capacity of JHIL’s former operating subsidiaries to meet tort claims likely to be made against them with respect to previous asbestos operations. JHIL had informed the court hearing the application to approve the convening of scheme meetings that JHIL “has access to the capital of the group through the partly paid shares”. 87 JHIL denied that it had any liability with respect to those tort claims and might be liable only for claims from its own asbestos operations before 1937 when the subsidiaries took them over. After the cancellation, JHINV transferred its shareholding in JHIL to a new foundation which it had established for the purpose. This transfer completed the separation of ownership interests between JHI NV and the former Australian companies in the group. A Special Commission of Inquiry found that the cancellation was “almost inevitable” after the scheme of arrangement, that it “achieved no useful object” for JHIL to be considered separately from JHI NV, and that its main impact was to destroy any hope for recovery by asbestos claimants if, contrary to its legal advice, claims were successfully made against JHIL as parent of the inadequately funded subsidiaries. 88 The Commissioner made no finding of breach of s 256B or under ss 180(1) and 181(1).

Re Tiger Investment Co Ltd [9.270] Re Tiger Investment Co Ltd (1999) 158 FLR 321 Supreme Court of New South Wales SANTOW J: 1 The Plaintiff, Tiger Investment Company Limited (“T”), is a publicly listed company registered under the Corporations Law. 89 T’s business largely involves investing in Asian assets. 2 Under the current corporate structure of T, 50.321% of T is owned by Metals Exploration Limited (“M”) and its subsidiary, “MI”, and the remaining 49.689% is owned by the public. 3 The proposal, in substance, involves the public shareholders of T having their shares in T cancelled and being issued by M with shares in M on a 5 for 6 basis. Those M shares do not at any time vest in T for onward transfer to the T shareholders but come from M direct. Thus the “consideration” for the reduction – the M shares – emanates from M not T. M, for its part, will (with MI) “inherit the earth” by becoming at the conclusion of these steps the sole shareholder in T, so that it receives value for the issue of its shares. The proposal is to be achieved by the combination of a fully interdependent 87

The judge asked: “Is there any possible basis upon which a call of partly paid shares upon a Dutch Company could be resisted under Dutch law? [His concern was] to ensure that there is no blockage in the flow of funds to Australia”: Report of the Special Commission of Inquiry into the Medical Research and Compensation Foundation, [25.21].

88

Report of the Special Commission of Inquiry into the Medical Research and Compensation Foundation (see fn 80), [27.90].

89

The Corporations Law contained the substantive text of corporations legislation in the years immediately prior to the Corporations Act 2001: see [2.85]. Its provisions are for present purposes identical to those of the Act.

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Re Tiger Investment Co Ltd cont. selective reduction of capital and a scheme of arrangement to be put to the members of T at a series of court ordered meetings causing the T shareholders to take up the M shares without further consent than the scheme meetings. 4 The shares of all T shareholders other than those of M and MI will also be cancelled pursuant to a reduction of capital under s 256B. 5 The following meetings will be convened for the purpose of approving this capital reduction: (a)

a meeting of members of T to consider two special resolutions to selectively reduce T’s share capital; and

(b)

a meeting of T’s members (excluding M and MI) to pass a special resolution to selectively reduce T’s share capital by cancelling shares held by the Scheme Shareholders.

6 In addition there will be the three scheme of arrangement meetings with and without M and MI (see 43 below) 7 After the proposed scheme of arrangement and reduction of capital, M and MI will own 100% of the shares in T. Issues 8 The legal issue which arises in the present case is the operation of s 256C(2) of the Corporations Law in relation to such a capital reduction made in association with a scheme of arrangement. … [To address uncertainty as to the interpretation of s 256C(2)(a) and, in particular, who would receive consideration under the proposed reduction and thereby be prevented from casting a vote, two identical resolutions were to be proposed for the first meeting, namely, the general meeting of T under s 256C(2)(a). Both resolutions would be in the same terms, approving the capital reduction. M and MI indicated that they did not intend to vote on the first resolution so that the resolution would express only the opinion of the public shareholders of the company. It was proposed that only M and MI would vote on the second resolution so that their views on the capital reduction were separately recorded.] 12 For present purposes, the issues which arise in relation to s 256C(2) relate to the first of the two meetings mentioned above, namely, the meeting to consider the two special resolutions to selectively reduce T’s capital; these are identical in their terms save as to whose role may be accepted. 13 M and MI have indicated their intentions not to vote in favour of the first resolution of this meeting. The notice of this meeting also notes that the public shareholders of T “may vote against resolution 2, but are not required to vote on resolution 2. If any shareholders other than M and MI vote in favour of resolution 2 those votes will not be accepted due to requirements under the s 256C(2) of the Corporations Law.” 14 The submissions of the Plaintiff raise two issues for consideration in the context of s 256C(2)(a). 15 First, whether the shareholders of a company to which the proposed capital reduction relates will be prevented from voting because they receive any consideration “as part of the reduction”, (employing the words used in s 256C(2)). This must be considered in relation to the two separate classes of shareholders – the public whose shares in T are to be cancelled, and M and MI, who as a consequence of the capital reduction will become the sole shareholders of T. It will be appreciated that if one but not the other class can vote in conformity with s 256C(2)(a), then one of the identical resolutions will be passed. If neither class can thus vote, then neither resolution will be passed. If both classes can thus vote, then again the resolution will be passed. 16 Secondly, if one determines in relation to the above issue that shareholders do receive consideration “as part of the reduction”, what is meant by the words “no votes being cast” in s 256C(2)(a). In particular does “cast” mean the act of voting, or the result of counting the vote? Is a vote made but not counted nonetheless cast? Submissions on first issue 17 As to the first issue, the submission put by the Plaintiff was that the word “consideration” in the quoted phrase in s 256C(2)(a) refers only to consideration moving from the company in which the [9.270]

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Re Tiger Investment Co Ltd cont. reduction of capital is to occur. The Plaintiff submitted that “consideration” in this context does not include consideration from a third party, not the company, moving as part of an interdependent scheme of arrangement. 18 Counsel for the Plaintiff provided the court with the following reasons in support of this submission: • Section 256C(2)(a) seeks to preserve the capital of a company and regulates the procedure in relation to a return of capital. The section is not intended to regulate schemes of arrangement. This interpretation of s 256C(2)(a) is consistent with s 256B(1)(b), which allows a company to reduce its share capital in a way not otherwise authorised by law, provided the reduction does not materially prejudice the company’s ability to pay its creditors. Counsel for the Plaintiff has made the point that in the present circumstances, given that there is no liberation of T’s assets to its public shareholders as part of the reduction, there is no prejudice to the creditors of T. • Although the proposed selective reduction of T’s shares ought to be said to have the effective result of a successful takeover bid by M for T’s shares, the Plaintiff submits that Division 1 of Pt 2J.1 … does not prohibit such a result. The concern of the Division is rather to ensure fairness between T’s shareholders inter se in relation to the liberation of company assets via a reduction, not fairness in every conceivable aspect (including, eg, in relation to the consideration moving from a third party). • The phrase “as part of the reduction” in s 256C(2)(a) should not be read so broadly as to include what occurs pursuant to the scheme of arrangement, as the scheme and reduction are separate and distinct mechanisms that operate in different ways under different parts of the Corporations Law. This is so even if both a scheme and a reduction are connected via their expressed interdependence, as in the present case. Thus the reduction (if validly voted upon) effects cancellation of the shares, whilst the scheme of arrangement effects the compulsion upon a shareholder to accept an allotment of shares (here allotted directly by M, a third party); see my decision in Re Advance Bank (1997) 22 ACSR 513 at 528 to 533 especially at 532. • Accordingly, the Plaintiff submits that neither the public nor M receives consideration “as part of the reduction”. In short this is so because the only consideration that the public receives comes from the company and comes from the scheme, not the reduction. In the case of M, this is so because the consideration it receives is not a part of the reduction but the consequence of the cancellation of shares taking effect. 19 If these submissions of the Plaintiff were correct, then the result would be that all the shareholders could vote on the special resolution for capital reduction (though not for the scheme resolutions). The first of the proposed resolutions is not inconsistent with this analysis. Simply, M will be choosing not to exercise the right it has to vote on the special resolution. 20 However, what the Plaintiff has done is to propose that the resolution will be put twice. On the first resolution, because M will not vote, it will meet the possibility that M is receiving consideration under the reduction. For the second resolution, what the Plaintiff proposes is that the public will be told that although they may vote against the resolution, any vote in favour of the resolution by them will not be accepted. This is indicated on the notice of meeting, the proxy form and it is what the Chairman intends to do at the meeting. This second resolution is designed to meet the argument that the public receives consideration under the reduction. 21 However, this then raises the second issue, which is precisely what is meant by “no votes being cast” in s 256C(2)(a). Submissions on second issue … 24 The Plaintiff’s submission was that the words “no votes being cast” in s 256C(2)(a) operate only at the stage of the counting of the votes for the particular purposes of that section. 25 The section permits and, it was submitted, requires the company not to count the votes of those who receive consideration but nevertheless cast a vote in favour of the resolution to reduce the company’s capital. The section does not prohibit those shareholders from voting either in favour of or against the resolution … Nor is the section a self-denying ordinance such that the resolution is invalidated if any shareholder who is not entitled to cast a vote under the section votes in favour of it. 730

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Re Tiger Investment Co Ltd cont. 26 As this submission was put, the effect of the section is that the special resolution will not be invalidated merely because any one or more shareholders receiving consideration as part of the reduction vote in favour of it; rather, the company has a statutory mandate to disregard their votes in determining whether a special resolution has been passed for the purposes of this particular section. It may be that for other purposes, such as the company’s constitution, a special resolution is required, on which everyone can vote. If that be so, then the votes cast in favour of the resolution by the shareholder receiving consideration as part of the reduction can be counted for that other purpose, but have not been “cast” in favour of the reduction resolution, as not able to be counted for that purpose. 27 However, against this further possibility that this argument may not be accepted, the Plaintiffs have agreed to call a general meeting to amend their articles of association and, for precaution, to hold that meeting the day before the meeting to consider the resolutions for the reduction of capital. … [This] ensures that any resolution to amend T’s articles takes effect before the resolution to reduce T’s capital is put to the meeting and passed. [The proposed constitutional alteration would say that any vote purported to be cast by a person who is precluded from casting a vote should not be accepted and should be treated as not cast.] 30 The scheme of s 256C can be seen as one designed to protect two classes of shareholder. 31 Section 256C(2)(a) seeks to exclude shareholders who will receive consideration as part of the reduction (or whose liability to pay amounts on unpaid shares will not be reduced) or their associates from a consideration of the special resolution to approve the selective reduction. The logic of this exclusion is clear. The remaining shareholders could be disadvantaged if the capital reduction were too generous. The exclusion ensures that the resolution is not passed by reason of the influence of shareholders that stand specially to benefit from the capital reduction. These shareholders whose shares are to be cancelled are protected by the requirement in the last paragraph of s 256C for a special resolution to be passed in a general meeting of these shareholders. 32 Although it is not necessary to decide the point at this stage, there is merit in the argument that neither class of shareholder is precluded from voting because the reduction involves no liberation of the company’s assets and therefore no risk that it is too generous to one class of shareholders over another. 33 It is unfortunate that such a cumbersome mechanism as that in s 256C(2)(a) should have been used. The reference to “no votes being cast in favour of the resolution by any person who is to receive consideration” may, at first glance, seem an economic way of convening and regulating meetings. However, the effect of this is that, rather than protecting a class of shareholders it may give a veto right to any shareholder who is to receive consideration as part of the reduction to prevent the reduction from being passed. The opportunity for an approval under s 256C(2)(b) would be to no avail because it requires unanimity at the general meeting by all ordinary shareholders (presumably being those ordinary shareholders who are present in person or by proxy and vote at the general meeting). 34 The second protection afforded by s 256C(2) is that if the reduction involves a cancellation of shares, the reduction must be approved by a special resolution passed at a meeting of shareholders whose shares are to be cancelled. In extending the potential protection to shareholders under this subsection, s 256C(2) contemplates a meeting in which only those shareholders whose shares are to be cancelled are present. 35 Similar drafting to that contained in s 256C can be found in s 257D(1)(a) (which deals with buy-backs) and by s 260(D)(1)(a) (which deals with financial assistance approval). …

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Re Tiger Investment Co Ltd cont. Conclusion … 42 It is not necessary at this stage of making orders convening the scheme meetings in this case finally to resolve all of the issues exposed above in what is essentially a takeover proceeding by an interdependent selective reduction and scheme. In the present case, through the combination of two resolutions, with their different voting requirements and the prior amendment to the articles, the Plaintiff contends, and I accept, that the requirements of s 256C should be able to be met, whatever view is taken on the meaning of the section. 43 Indeed if the exclusion from casting votes does not apply, because the consideration emanates from a third party rather than T then it may well be the case that only one resolution was needed so that either resolution would have sufficed. That still leaves the necessity, which only a scheme of arrangement lays down, for the three class meetings for the scheme of arrangement (that is with all T shareholders, all T shareholders without M and MI and only M and MI). It also provides the fairness appraisal mandated for a scheme of arrangement; contrast an equal reduction which has no fairness appraisal and a selective reduction where the fairness appraisal might be arguably most concentrated on creditors. Clearly for Scheme purposes different classes for voting are here involved as between M and MI on the one hand, and all the rest who receive their consideration in M shares. They so vote by virtue of the scheme, not by virtue of the reduction, doing so after cancellation of their T shares by the reduction. … 45 Without foreclosing any argument that may be made by any other party in this matter at a later stage or any submissions then by ASIC, I am prepared to make orders convening the scheme meetings on the basis that the Plaintiff will proceed in the manner referred to above being satisfied that the proposal may thus proceed to the next stage.

Winpar Holdings Ltd v Goldfields Kalgoorlie Ltd [9.275] Winpar Holdings Ltd v Goldfields Kalgoorlie Ltd (2001) 166 FLR 144 Court of Appeal of the Supreme Court of New South Wales [Goldfields and its subsidiary (the Goldfields shareholders) held 87.7% of the capital of GKL; QBE held 11.4% and the remaining 0.895% was held by a few further shareholders including Winpar (together called the “non-Goldfields shareholders”). GKL convened a meeting to consider a proposal for a selective capital reduction by cancelling the shares of the non-Goldfields shareholders in consideration of the payment of 55 cents per share. A single meeting was held at which separate resolutions were passed by the non-Goldfields and Goldfields shareholders. Winpar voted against the former resolution. Winpar challenged the validity of the capital reduction.] GILES JA: 22 One of Winpar’s grounds for contravention of the Law was that s 256C(2) required that the two resolutions be passed at separately convened meetings, and GKL filed a protective cross-claim in which it claimed an order pursuant to s 1322(4) of the Law declaring that the resolutions were not invalid by reason of any contravention of s 256C. A meeting of shareholders whose shares were to be cancelled? … 40 There is a risk of conflating two separate matters. One is having separate meetings. The other is having a meeting at which persons not shareholders entitled to vote at the meeting are present. The matters are related, but are not the same. A meeting called as a general meeting of the company is not a meeting of the shareholders whose shares are to be cancelled, even if those shareholders whose shares are to be cancelled are present. Conversely, a meeting of the shareholders whose shares are to be cancelled will remain such a meeting if shareholders present of that description agree to the presence of other shareholders or of strangers. Having a separate meeting of the shareholders whose 732

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Winpar Holdings Ltd v Goldfields Kalgoorlie Ltd cont. shares are to be cancelled, however, is material to the protection of minority shareholders from the influence of other shareholders or strangers. It is not to the point, it seems to me, to say that the presence of non-voting others is an irrelevancy, or that the presence of non-voting others may mean that the capital reduction is not fair and reasonable to the company’s shareholders as a whole (and I respectfully question whether it may mean that). 41 By its terms s 256C(2) required a class meeting, a meeting of the shareholders whose shares were to be cancelled, distinct from the general meeting at which the special resolution was passed or resolution agreed to. A class meeting would generally be called on notice with a proposed resolution and accompanying information. From that it could initially be seen whether there was a meeting of the class of shareholders. That there were present at the purported class meeting other shareholders or strangers would not necessarily prevent it from being a meeting of the class of shareholders, although possibly it would do so (Carruth v Imperial Chemical Industries Ltd), but if the purported class meeting was not conducted as such but as a general meeting of all present it may be that there was not in the result a meeting of the class of shareholders. 42 Was there in the present case a meeting of the shareholders whose shares were to be cancelled? 43 The notice of meeting was of one meeting only, to be held at 2pm on 28 June 2000. The meeting was called an extraordinary general meeting, and referred to as such in the body of the document. Two resolutions were to be proposed at the meeting, one for the consideration of the non-Goldfield shareholders and the other for the consideration of the Goldfields shareholders. But it was still one meeting, with the explanatory notes distinguishing between voting entitlements according to classes of shareholders and not between meetings. The voting restriction notes spoke of disregarding votes of shareholders not part of the relevant class, and did not distinguish between meetings. The one proxy form was provided, referring to voting “at the meeting”. In my opinion one meeting was called, a meeting of shareholders, although two resolutions according to classes of shareholders were proposed. The meeting called was not of the shareholders whose shares were to be cancelled. 44 The meeting as held was opened as one meeting, and Mr Warburton chaired the one meeting: there was no question of the non-Goldfields shareholders electing their own chairman. In Mr Warburton’s address shareholders were urged to support the capital reduction without distinction between the classes of shareholders. There were votes on the two resolutions, but the noting that there was no objection to the proxies for the Goldfields shareholders being present during the vote on the resolution proposed for the non-Goldfield shareholders continued to treat the meeting as one meeting, albeit distinguishing between voting entitlements according to the class of shareholders. In the end, the two polls were taken concurrently. What was closed was “the meeting”. 45 In my view neither as called nor as held was there a meeting of the shareholders whose shares were to be cancelled. There was a meeting of all shareholders, at which a resolution was proposed for the consideration of the shareholders whose shares were to be cancelled and was passed by those shareholders. That was not compliance with s 256C(2). There was no suggestion of impropriety in the present case, but in other cases a distinct class meeting could be important to the protection of minority shareholders (see Carruth v Imperial Chemical Industries Ltd, above). The interpretation and application of s 256C(2) should accommodate the other cases. 46 In my opinion, therefore, there was not the approval by shareholders required by s 256B(1)(c). Protection under s 256D(2)? 47 The second issue, not raised before Santow J [the primary judge], is whether Winpar’s challenge to the capital reduction nonetheless fails because, although GKL did not comply with s 256B(1) of the Law in that the capital reduction was not approved by shareholders under 256C, pursuant to s 256D(2) the validity of the capital reduction is not affected. … 58 Winpar responded that it would be remarkable if a fundamental transaction for which the Law stated requirements was valid even if those requirements were not met. It submitted that s 256D gave a capital reduction no more than provisional or prima facie effect, subject to the intervention of the court where it was in fact defective … And it said that if contravention of s 256B(1) was of sufficient moment to give rise to an offence by any person involved in the contravention, it would be even more remarkable if the shareholders affected were left without remedy. [9.275]

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Winpar Holdings Ltd v Goldfields Kalgoorlie Ltd cont. 59 ASIC did not put submissions on this issue. 60 The force of Winpar’s last point is greatly diminished by the express statement that the company was not guilty of an offence. I do not think that s 256D(2) can be cut down to only provisional or prima facie validity. Until it was made, a proposed capital reduction could be restrained if s 256B(1) of the Law was or would be contravened. Once it was made, although in contravention of s 256B(1), it was valid. The sanction for the contravention was imposed on those involved in the contravention, no doubt the directors of the company, by way of a civil penalty. No sanction was imposed on the company itself, nor was the capital reduction itself struck down by way of sanction. The legislation gave those affected an opportunity to restrain the making of a contravening capital reduction, but once it was made preferred certainty over invalidity. 61 In my opinion, therefore, Winpar’s challenge to the capital reduction fails by force of s 256D(2). Protection under s 1322? 62 It is not necessary to deal with this third issue. In case I am incorrect in my view of s 256D(2), I will nonetheless briefly address it. ASIC did not put submissions on the issue, save that it said that it “would not object to the making of orders under s 1322(4)”. (a) Section 1322(2) 63 This sub-issue was raised before Santow J but not dealt with by him, presumably reflecting the practice to which Bowen CJ in Eq referred in Re Compaction Systems Pty Ltd (1976) 2 NSWLR 477 of applying for an order under s 1322(4) rather than relying on “the contingent validation afforded by [s 1322(2)]” (at 491). 64 There had to be a “proceeding under this Law”, and there had to be a “procedural irregularity” potentially invalidating it. 65 Winpar submitted that there was no proceeding under the Law, because the meeting required by s 256C(2) was not called at all as distinct from being called irregularly. In my opinion this gives too narrow a scope to the concept of a proceeding under the Law. The requirement of approval by a special resolution passed at a meeting of the shareholders whose shares were to be cancelled was a proceeding under the Law, and it is wrong to focus on the meeting alone and say that there was no proceeding because there was no meeting. In re Broadway Motors Holdings Pty Ltd (in liquidation) (1986) 6 NSWLR 45 at 56 it was said that a procedure was to be regarded as a proceeding under the then Act if it was required to be taken by the company or was one which the Act required if the company or its members wished successfully to achieve particular legal consequences. That encompasses the procedure under s 256C(2) required pursuant to s 256B(1)(c), and there is no reason to take a narrower view. 66 Winpar then submitted that there was not a procedural irregularity, because “a separate meeting” was mandatory and of such significance to a selective capital reduction involving the cancellation of shares that it could not be regarded as procedural. … 67 … There was a meeting, of which notice was given to, amongst others, the shareholders whose shares were to be cancelled, and for which a resolution on which those shareholders were to vote was proposed. The defect was that the meeting was not called or conducted as a meeting of the shareholders whose shares were to be cancelled. Failure to give notice of a meeting to some shareholders can be a procedural irregularity (Holmes v Life Funds of Australia Ltd (1971) 1 NSWLR 860), so may failure to give any notice at all (re Broadway Motors Holdings Pty Ltd (in liquidation); Roma Industries Ltd v Bliim (1983) 1 ACLC 1079). Failure to call a meeting as the particular meeting required is a lesser irregularity. In my opinion what occurred in the present case was a procedural irregularity. 68 It was then necessary for Winpar to establish that the irregularity caused or might have caused substantial injustice that could not be remedied by any order of the court, and to obtain an order declaring the proceedings to be invalid: Australian Hydrocarbons NL v Green (1985) 10 ACLR 72. … 71 I do not think the irregularity caused or might have caused substantial injustice. Although there was not a meeting called or conducted as a meeting of the shareholders whose shares were to be 734

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Winpar Holdings Ltd v Goldfields Kalgoorlie Ltd cont. cancelled, those shareholders received notice of the meeting, and no one can have been in doubt that the non-Goldfields shareholders were being brought together to consider and if thought fit pass their special resolution. They did so. … Winpar and the holder or holders of a small number of shares were comprehensively outvoted. The resolution was significant to the shareholders voting against it in that it founded cancellation of their shares, but the procedural irregularity had no bearing on the result. Indeed, in substance all the non-Goldfields shareholders, including Winpar, recognised that they were not prejudiced when they did not object to the holders of proxies for the Goldfields shareholders being present during the vote on their resolution and did not object to the concurrent polls. 72 In my opinion, therefore, protection under s 1322(2) was made out. (b) Section 1322(4) … 75 What I have said in relation to s 1322(2) can be taken up. The defect in the calling of the meeting, that is, the failure to call or conduct a meeting as a meeting of the shareholders whose shares were to be cancelled, was essentially of a procedural nature: see re Vanfox Pty Ltd [1995] 2 Qd R 445, in which failure properly to convene and hold a meeting at which a scheme of arrangement was approved was held to be of a procedural nature. There was and was not likely to be substantial injustice to any person. That is enough for the making of an order. 76 As well, there was evidence explaining why the meeting of 28 June 2000 was called as it was, and Winpar did not suggest failure to act honestly. Going beyond its additional ground of appeal, it submitted that it was not in the public interest that an order be made because it was in the public interest “that the procedure set down by the legislature regarding the expropriation of property be complied with strictly”. It should be firmly borne in mind that cancellation of the shares of the non-Goldfields shareholders was at stake, but the power conferred by s 1322(4) meant that strict compliance was not an over-arching constituent of the public interest; further, the public interest was to be assessed in the particular circumstances of a holder of 12,373 (or possibly the holders of 243,275) shares opposed to the wishes of the holders of 28,057,750 shares. In my opinion, in the circumstances of this case it was in the public interest that an order be made, because it was not in the public interest that the dissenting non-Goldfields shareholders, having concurred in the holding of the meeting as it was held, should then upset the capital reduction on what was in this case a technicality. On those further two bases the making of an order was warranted. 77 In my opinion, therefore, protection under s 1322(4)(a) was made out several times over. … A scheme of arrangement? 80 The next issue … is whether the capital reduction could have been made otherwise than by a scheme of arrangement under s 411 of the Law. … 81 At the heart of Winpar’s submissions on appeal … was its characterisation of the capital reduction as a “takeover by cancellation”. His Honour appears to have accepted that it fell within what he described as “that species of takeover which is effected by a selective reduction of capital whether directed at a minority or a majority”, although also saying that with Pt 2J.1 of the Law in 1998 the species of takeover was expressly recognised and provided for in detail. His Honour said – The technique has long been used without such explicit recognition. The intended ultimate holding company retains a handful of shares after all other shares are cancelled, so inheriting the earth as the sole remaining shareholder in the intended target. Where such a selective reduction is effected by giving those whose shares are to be cancelled, not cash emanating from the reducing company but shares in another company (typically the new holding company), it is well accepted that such a process requires a scheme of arrangement. This is in order to compel the assent of all shareholders to their receiving shares. No one can be so compelled in the absence of express assent which may be deemed to have been given if the articles clearly enough anticipate that possibility or if there be a binding scheme of arrangement; see the discussion in Re Advance Bank Australia Ltd (1996-97) 22 ACSR 513 at 529 and the authorities I there cite. [9.275]

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Winpar Holdings Ltd v Goldfields Kalgoorlie Ltd cont. Here, however, the acquisition involves no such compulsion on a shareholder to take shares. Rather the shareholder is compensated for the cancellation of shares by cash emanating from the company whose capital is reduced utilising an available specific statutory regime – selective reduction of capital – for the purpose. That cannot also require a scheme of arrangement to be effective when there is no compulsion to take new shares in substitution. Indeed that answers the first sub-question posed; no scheme is necessary. 82 Winpar’s submissions on appeal on this issue relevantly amounted to saying that, because the capital reduction had to satisfy the Gambotto principles, a selective capital reduction was not available. … 83 In my view, the present issue is determined simply by regard to Pt 2J.1 of the Law. Descriptions of takeover by cancellation and species of takeover are really not to the point. Nor is whether the capital reduction could have been made by a scheme of arrangement. To adopt the words of Bryson J in Nicron Resources Ltd v Catto (1992) 8 ACSR 219 at 235, a scheme of arrangement procedure “is not to be followed merely because it is there; it is not Mount Everest”, and a selective capital reduction is not excluded because the same outcome could have been achieved by a scheme of arrangement. The true question is whether Pt 2J.1 authorised a capital reduction in which the shareholding of the Goldfields shareholders remained but the shareholdings of the non-Goldfields shareholders were cancelled. In my opinion the answer to the question, subject to whether more was needed under the Gambotto principles, is that it did provided the requirements in s 256B(1) of the Law were satisfied. 84 If the requirements in s 256B(1) could not be satisfied, or more was needed under the Gambotto principles and those principles could not be satisfied, as a practical matter it may have been that a capital reduction amounting to a takeover by cancellation could only have been made by a scheme of arrangement. That would not have been by dictate of law. Gambotto principles? 85 The next issue … is whether the capital reduction had to satisfy the Gambotto principles as well as the requirements in s 256B(1) of the Law. … 91 Selective capital reduction had been accepted in the High Court (Thornett v Federal Commissioner of Taxation (1938) 59 CLR 787), but protection to minorities who resisted selective capital reduction was not included in the catalogue emphasised in the passage set out above. Selective capital reduction in which minority shareholdings are cancelled on payment of fair prices has frequently been recognised by the courts, and in many cases confirmed … … 93 In re Tiger Investment Company Ltd (2000) 33 ACSR 437, decided after Pt 2J.1 was introduced, Santow J posed as a question for another day whether “a cash takeover masquerading as a selective reduction of capital, but not associated with a scheme, [would] fall foul of the decision in Gambotto v WCP Ltd”. He observed that the argument would be that such a selective reduction of capital “amounts to expropriation without a Court fairness appraisal”. In the present case his Honour answered the question in the negative. In short, he concluded that the legislature had created “its own comprehensive, protective code” and that the Gambotto principles “are left with no further work to do”. 94 In my opinion, the capital reduction did not have to satisfy the Gambotto principles. My reasons are essentially the same as those given by Santow J for his conclusion. 95 So far as the Gambotto principles called for a proper purpose, the context was the taking by the majority of a power to expropriate the shares of a minority. Section 256B of the Law gave the power to make a selective capital reduction – at that level, the majority did not take the power. When the power was exercised the minority, relevantly those whose shares were to be expropriated, were not at the mercy of the majority. The legislature had sought to ensure fairness between the shareholders (s 256A(b)), and had given the minority what amounted to a veto by the requirement of a special resolution passed at a meeting of the shareholders whose shares were to be cancelled. If there were 736

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Winpar Holdings Ltd v Goldfields Kalgoorlie Ltd cont. complaint about expropriation, it would not be because the majority had taken a power to aggrandize itself, but because amongst the minority there was decisive support for the cancellation of their shares. It could be said that the majority of the minority would be imposing its will on the minority of the minority. But it would be doing no more than the legislature had said it could do, it would not be taking a power to itself, and it would not be getting for itself the shares of the minority of the minority. It makes little sense, in the circumstances, to speak of the majority of the minority having the purpose of securing the company from significant detriment or harm. The reasoning of the High Court does not transpose to the exercise the power given by Pt 2J.1. 96 So far as the Gambotto principles called for procedural and substantive fairness, as well as seeking to ensure fairness between the shareholders the legislature had required disclosure of all material information (s 256A(c)); and it had required that the capital reduction be fair and reasonable to the company’s shareholders as a whole (s 256B(1)(a)), thereby providing its own test of substantive fairness which looked to the whole rather than to the class selectively affected and leaving it to that class to make its decision upon fairness through the class meeting. A discontented shareholder was not without curial protection, and could apply for relief pursuant to s 1324 of the Law: s 1324(1B)(a) specifically referred to contravention of s 256B(1)(b). The approach to fairness was not identical to that which would flow from the Gambotto principles. But it was comprehensive, and superadded Gambotto principles would be conflicting and confusing. … The capital reduction not fair and reasonable? 106 The last issue … is whether the capital reduction was not fair and reasonable to GKL’s shareholders as a whole, as required by s 256B(1)(a), because the special value last mentioned was allocated pro rata over all the issued shares and was not allocated solely to the shares of the shareholders whose shares were to be cancelled. Winpar contended that this meant that the benefit received by the non-Goldfields shareholders was less than the benefit received by the Goldfields shareholders, so that the capital reduction was unfair and unreasonable. … 107 As before, it may be that s 256D(2) is material to this aspect of the challenge to the validity of the capital reduction, but it is not necessary to go into the matter. … 109 [Santow J, the primary judge] stated his conclusion – Here, if it be the case that the special benefits are of such unique value that they should lead to the minority shareholders receiving more than a pro rata proportion, it may be that it would be fair and reasonable for a greater than pro rata proportion of that special value to be attributed to the shares of the minority. However, there is nothing in the facts before me which indicates that any special value is other than the normal advantages of having a wholly-owned subsidiary as against partial ownership. These advantages include the ability to group tax losses for tax purposes (but there are none here) and the rationalisation savings from combining head offices which clearly do exist.… [T]here is nothing in the pro rata allocation and the associated 8 cents premium [that was being paid above the upper range of the independent valuation of the cancelled shares] that in the present circumstances would lead me to conclude that the minority have been treated in other than a “fair and equitable” manner … 110 The issue was one of fact. Nothing in the Law or elsewhere prescribed that in arriving at a fair value for the shares a pecuniary estimation of the reduction in head office costs following the capital reduction should be allocated wholly to the shares of the non-Goldfields shareholders. The statutory test threw up the question. Was the capital reduction unfair or unreasonable to GKL’s shareholders as a whole if that were not done? His Honour was not satisfied that it was. … 114 In Melcann Ltd v Super John Pty Ltd confirmation of the capital reduction was refused because the price to be paid for the minority’s shares did not take account of “substantial financial advantages” [9.275]

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Winpar Holdings Ltd v Goldfields Kalgoorlie Ltd cont. which would be available to the majority shareholder from its ability after the cancellation of the minority shareholdings “to merge substantial elements of the company’s activities with those of [the majority shareholder] itself” (at 83). It was said that 100% ownership of the company had special value to the majority shareholder of very considerable financial significance, and that the valuation of the shares had not had regard to it at all. 115 That the capital reduction should not be confirmed was a decision on the facts, and the facts included that the special value had been entirely left out of account, not that it had been taken into account but allocated over all the shares. The present case is very different. 116 One of the benefits of the capital reduction was a reduction in head office costs. Receipt of that benefit, through the value of the shares or otherwise, was at least one reason why the capital reduction was proposed and no doubt one reason why Goldfields shareholders favoured the capital reduction. Absent the capital reduction, the non-Goldfields shareholders would not have received, through the value of their shares or otherwise, the benefit of the reduction in head office costs. By the capital reduction each of the Goldfields shareholders and the non-Goldfields shareholders stood to receive that benefit, something which they would not otherwise have received. It was in that sense, I believe, that [the trial judge] described the special value as (part of) the normal advantages of having a wholly owned subsidiary as against partial ownership. The advantage is an advantage to the acquiring majority, but it is also an advantage to the acquired minority in that, on acquisition, they obtain an enhanced price for their shares. There is no necessary unfairness or unreasonableness if the advantage is shared. 117 In my opinion, it was well open to Santow J to conclude that a pro rata allocation did not mean that the capital reduction was not fair and reasonable to the shareholders as a whole. 119 DAVIES AJA: I agree with the orders proposed by Giles JA. I also agree with his Honour’s reasons for judgment, save in one respect. 120 Section 256C(2) of the Corporations Law specifies requirements with which a selective reduction of capital must comply. In my view, the failure to hold a meeting of the shareholders whose shares were to be cancelled was a substantive not a procedural irregularity. No such meeting was called or held. The only meeting called and held was a general meeting of the shareholders. I need not further discuss the operation of s 1322 of the Corporations Law as, by reason of s 256D of the Corporations Law and the implementation of the reduction, the failure to hold the meeting does not now affect the validity of the reduction or of any contract or transaction connected with it. [Beazley JA agreed with Giles JA.]

SHARE BUY-BACK The policy underlying reform of the traditional prohibition [9.280] A buy-back is a transaction between a company and one or more shareholders who

accept the company’s offer to buy back their shares. It is a voluntary, individual transaction without the coercion that may accompany a reduction of capital which of its nature is taken by collective shareholder decision. However, a buy-back may be coupled with a scheme so that its consensual character is changed and the buy-back imposed upon all holders of the relevant class or group of shares subject to the statutory procedure and criteria being satisfied. 90 The prohibition upon a company buying back its own share capital was a cornerstone of company law’s protection of those who extend credit to limited companies: see, for example, Trevor v Whitworth, quoted at [9.240]. Several notorious instances of avoidance of the 90

As in Village Roadshow Ltd v Boswell Film GmbH (2004) 8 VR 38.

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prohibition in the 1980s, relying upon manipulation of the then narrowly cast terms of the self-acquisition prohibition (see [9.290]), were among the factors that stimulated a reexamination of the prohibition. In 1987 the Companies and Securities Law Review Committee recommended that companies be permitted to acquire directly their own shares through on-market purchases, pari passu offers to all shareholders or selective buy-backs from individual members. The self-purchase power would be subject to procedural and solvency requirements varying with the mode of purchase. 91 The committee perceived the following as among the potential benefits for listed companies: 1. improved competitiveness of Australian securities in international financial markets by conferring a flexible power possessed by United Kingdom and North American corporations; 2.

increased market information: an announcement of a proposed self-purchase might supply new or further information to the market about a company’s operating performance and future projects;

3.

self-investment: a self-purchase might be a prudent commercial investment by a company when the current market price of its shares is less than their perceived long-term value; and

4.

reduction of administrative overheads: selective self-purchases might be used to eliminate fractional shares and odd lot holdings which may otherwise be costly for companies to administer. 92

The committee thought that the self-purchase power would be particularly beneficial to smaller private companies since it would enable them to raise equity capital without running the risk of surrendering control of the company; it would also encourage the development of shareholder liquidity arrangements in smaller companies and permit the settlement of disputes with its shareholders by recovering the member’s shares. 93 The potential benefits which the committee perceived as common to listed and unlisted companies included: 1. the encouragement of employee share schemes by enabling the company to acquire the shares of departing employees; 2.

increased managerial efficiency through the capacity to buy out hostile or apathetic shareholders; and

3.

a more flexible means of returning excess capital. 94

The problems anticipated by the committee, to which its procedural and solvency requirements were directed, included the enhanced risk of 1. internal inequities; 2.

market price manipulation and insider trading;

3.

improper attempts to secure or consolidate corporate control;

4.

greenmail (a repurchase made at a premium over market price with a view to forestalling a full bid); and

5.

increasing the risk of corporate failure. 95

91

Companies and Securities Law Review Committee, A Company’s Purchase of Its Own Shares (1987); see also Australian Associated Stock Exchanges, Companies Purchasing Their Own Shares (1986).

92 93 94

Companies and Securities Law Review Committee, pp 7-9. Companies and Securities Law Review Committee, pp 9-10. Companies and Securities Law Review Committee, p 11.

95

Companies and Securities Law Review Committee, p 12. [9.280]

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The committee’s proposals provided the wellspring of the buy-back provisions introduced in 1989, subsequently revised in 1995 and re-enacted in 1998 with amendments to ensure their consistency with the other capital reduction changes effected in Ch 2J. There is empirical evidence from Australian companies that the market reacts positively to on-market buy-backs (in the sense of enhanced stock price for the corporation), while the reaction to other types of share buy-backs is positive but generally not statistically significant. 96 The scope of the buy-back power [9.285] A company may buy back 97 its own shares if

(a)

the buy-back does not materially prejudice the company’s ability to pay its creditors; and

(b) it follows the procedures laid down in Pt 2J.1 Div 2: s 257A. The procedures applicable to particular species of buy-back are set out in the table contained in s 257B(1). This table itself prescribes obligations and does not merely summarise the effect of those imposed by other provisions; however, it draws upon their terms to flesh out the procedures which it requires. A central concept is that of an equal access scheme. An equal access scheme is one that satisfies all of the following conditions: (a) the offers under the scheme relate only to ordinary shares; (b) (c)

the offers are made to all holders of such 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;

(d)

buy-back agreements are not entered into until a specified time for acceptance of offers has closed; and (e) the terms of all the offers are the same: s 257B(2). Differences in consideration attributable to different dividend entitlements and unpaid capital, and in order to avoid fractional holdings, are ignored: s 257B(3). Certain satellite terms define other permitted forms of buy-back. An on-market buy-back is one made in the ordinary course of trading on ASX by a listed company: s 257B(6). 98 An employee share scheme buy-back is a scheme for the acquisition of shares in a company by or on behalf of its employees or directors that has been approved by the company in general meeting: s 9. A minimum holding buy-back is a buy-back of all of a holder’s shares in a listed company if the shares are less than a marketable parcel (the minimum trading size) under ASX rules: s 9. A selective buy-back, on the other hand, is a residuary category afforded no such preferential treatment. It is a buy-back that is not one of the other defined buy-back types: s 9. The other central concept is of a 10/12 limit. It defines, for a company proposing to make a buy-back, the number of shares that represents 10% of voting shares in the company over the past 12 months: s 257B(4). The procedures imposed by the table in s 257B(1) for the different modes of buy-back can be summarised thus: • buy-backs under an equal access scheme, an employee share scheme and an on-market scheme require shareholder approval only if they exceed the 10/12 limit; that approval is 96

A S Lamba & I M Ramsay (2005) 17 Aust Jnl of Corp Law 261.

97

See further T C Harris & I M Ramsay (1995) 4 Aust Jnl of Corp Law 393; B McCabe (1991) 3 Bond LR 115; J Hewett (1990) 8 C&SLJ 383; G Peirson (1990) 8 C&SLJ 281.

98

ASIC may approve an overseas securities exchange where buy-backs are made simultaneously on ASX: s 257B(7). This approval is necessary where a company is listed on an overseas exchange as well as on ASX.

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given by ordinary resolution only (s 257C(1)); the notice of meeting must include a statement setting out all information known to the company that is material to the shareholders’ decision on how to vote on the resolution: s 257C(2); 99 • a minimum holding buy-back requires no shareholder approval and may be effected at any time; • a selective buy-back requires special shareholder approval, either by a special resolution of a company passed with no votes being cast by any person whose shares are proposed to be bought back or by their associates, or a resolution of a meeting agreed to by all ordinary shareholders (s 257D(1)); 100 • offer documents must be lodged with ASIC only for an equal access scheme and a selective buy-back (s 257E); the offer documents must include a statement setting out all information known to the company that is material to the shareholders’ decision whether to accept the offer (s 257G); • except for a minimum holding buy-back, 14 days notice of the buy-back must be lodged with ASIC (s 257F); and • once a company has entered into a buy-back agreement, all rights attaching to the shares are suspended, the shares are transferred to the company and cancelled (s 257H) and ASIC notified: s 254Y. Buy-back obligations are sanctioned as civil penalty provisions since failure to follow the procedure for a buy-back and its material prejudice to the company’s ability to pay its creditors will contravene the prohibition upon a company directly acquiring its own shares (s 259A(a)) and, if a reduction in share capital is involved (as it usually will be), s 256D. The remedies for breach of these civil penalty provisions, the insolvent trading remedies, 101 and injunctive remedies under s 1324 apply in relation to contraventions of the buy-back provisions in a similar manner to non-complying reductions of capital: see [9.260]. A signpost to other relevant provisions of the Act relevant to reductions in share capital is contained in s 256E. The exercise of the buy-back power may engage the jurisdiction of the Takeovers Panel and lead to a declaration of unacceptable circumstances, with its consequential exposure to a wide range of orders, having regard to its effect on control or potential control of a company or the acquisition of a substantial interest in the company: see [12.30]. 102

99 100

101 102

There is no obligation, however, upon the company to notify individual creditors who must rely upon ASIC’s electronic alert or other commercial monitoring systems to protect their interests. A person whose shares are proposed to be bought back pursuant to a selective capital reduction is, however, entitled to vote against the special resolution if they are entitled to vote on the issue under rights conferred in the constitution or terms of issue of the shares: Village Roadshow Ltd v Boswell Film GmbH (2004) 8 VR 38. The one-way voting exclusion may in particular situations allow a minority an effective veto with respect to the buy-back proposal which enjoys the support of a special majority of the class. The balance in protecting against oppression by the majority and of the majority by the minority exploiting strategic advantage for opportunistic gain can be a delicate one. For purposes of s 588G(1), the company is deemed to incur the debt when it enters into the buy-back agreement: s 588G(1A) (item 3). As in Re Village Roadshow Ltd (No 3) (2005) 52 ACSR 238 (unacceptable circumstances by reason of inadequate disclosure to shareholders and market uncertainty as to the voting entitlement of major shareholder and the potential consolidation of its control if it voted to approve buy-back but did not participate in it). [9.285]

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SELF-ACQUISITION AND CONTROL OF SHARES [9.290] Consistently with the capital maintenance doctrine, Pt 2J.2 imposes a prohibition

upon a company acquiring shares (or units of shares) in itself other than in defined, exceptional circumstances: s 259A. This prohibition is complemented by one upon a company taking security over shares (or units of shares) in itself or in a company that controls it: s 259B(1). Finally, the issue or transfer of shares (or units of shares) of a company to an entity that it controls is declared void except in defined circumstances: s 259C. Part 2J.2 is concerned with these three prohibitions, the exceptions to them and the consequences of their breach. Its general effect is to strengthen traditional capital maintenance protections in this domain. Direct self-acquisition [9.295] The statutory prohibition upon direct self-acquisition is longstanding and

uncontroversial. It extends beyond shares to units of shares, a notion defined to mean in relation to a share a right or interest, whether legal or equitable, in the share, including an option to acquire such a right or interest in the share. (For brevity of expression, a reference to shares in this section will include units of shares.) A company may, however, acquire shares in itself: • by buying back shares under s 257A; • by acquiring an interest (other than a legal interest) in fully paid shares in the company if no consideration is given for the acquisition by the company or an entity it controls; 103 • under a court order; • under an employee share scheme approved by a resolution passed at a general meeting of the company and by its listed domestic holding company or other ultimate Australian holding company; or • under security taken by a financial institution in the ordinary course of its business and on ordinary commercial terms: s 259A. Taking security over shares of a company or controller [9.300] A company is prohibited from taking security over shares in the company or in a

company that controls it: s 259B(1). A broad definition of control applies to the prohibition (s 259E); it is examined at [9.310]. The only exceptions are those noted for employee share schemes and financial institutions: s 259B(2), (3). If a company acquires shares in itself because it exercises rights under an exempted security, the company must cease to hold the shares (by disposal or cancellation) within 12 months; voting rights attaching to shares cannot be exercised while the company holds the shares: s 259B(4), (5). If the company continues to hold any of the shares at the end of the 12-month period, or any extension granted by ASIC, the company commits an offence for each day while that situation continues: s 259B(6). Indirect self-acquisition [9.305] Companies legislation has long prohibited a company from being a member of its

holding company and declared void any allotment or transfer to the subsidiary of shares in the holding company. This prohibition has been justified upon several grounds, including the necessity to reinforce the capital maintenance principle by enjoining indirect self-acquisition. Certainly, instances arose in the 1980s of avoidance of the spirit, if not the letter, of this prohibition by substantial acquisition of shares in a company by companies that may not have 103

This exemption expresses the general law principle: see, eg, Kirby v Wilkins [1929] 2 Ch 444. Such shares are held by a trustee for the company.

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been its subsidiaries but were companies in which the upstream company had a very significant economic interest. 104 Accordingly, the Act was amended to prohibit indirect acquisition by a company of its own shares by expanding the prohibition upon a subsidiary’s cross-investment in its holding company to a prohibition upon an entity 105 taking an interest in a company that controls it under an expanded definition of control similar to that adopted in accounting standards and s 50AA: see [9.310]. Accordingly, the issue or transfer of shares of a company to an entity it controls is void unless (a) the issue or transfer is to the entity as a personal representative (that is, as executor or administrator of a deceased estate); (b)

the issue or transfer is to the entity as trustee in which trust neither the company nor its controlled entities has a beneficial interest apart from that arising from a security provided by a financial institution in the ordinary course of its business to a non-associated entity;

(c)

the issue to the entity is made as a result of an offer to all members of the company of that class, and is made on a basis that does not discriminate in favour of the entity; or

(d)

the transfer is between wholly-owned subsidiaries of the company: s 259C(1). 106

In four situations in which a holding by an entity in its controller exists without contravening s 259C(1), the entity and its controller are allowed a period of 12 months, or such extension as ASIC allows, either for the entity to cease to hold the shares or the company to cease to control the entity, viz, where: (a) the company obtains control of an entity that holds shares in it; (b)

a company increases its control over an entity that holds shares in it;

(c)

the company issues shares to the entity under the exemption in s 259C(1)(c); and

(d)

shares are transferred between wholly-owned subsidiaries under the exemption in s 259C(1)(d): s 259D(1). 107

The third and fourth exceptions are intended to allow companies to take steps preparatory to the unwinding of a “controlled member” relationship. 108

104

See August Investments Pty Ltd v Poseidon Ltd (1971) 2 SASR 71 which sanctioned the acquisition, in some circumstances at least, of the capital of a non-subsidiary corporate shareholder. Several other companies launched indirect buy-backs relying upon this decision. Thus, in 1987 Pioneer Concrete Services Ltd, under apparent threat of an unsolicited takeover, purchased the equity in Neoma Securities Pty Ltd, a subsidiary of the Bell Group Ltd, which held 6% of Pioneer’s ordinary capital. These Pioneer shares were sold nine months later for a reported loss of $10 million: see Australian Financial Review, 9 September 1988, p 18.

105 106

In this context the term “entity” refers to a natural person, corporation, partnership or trust: s 64A. ASIC has discretion to exempt a company from the section: s 259C(2). The Explanatory Memorandum envisaged that ASIC might exercise this discretion to exempt investments by the statutory fund of a life insurance company in its holding company on conditions designed to provide adequate safeguards including ensuring that the holding company is not able to exercise control inappropriately over its shares: Company Law Review Bill 1997, Explanatory Memorandum, [12.67]. The issue of bonus shares by the company is treated as the issue of shares for purposes of the sell-down obligation: s 259D(2). There are exceptions to the obligation for shares held by the entity as a personal representative or as a bare trustee where this interest arises from a security given by a financier in the ordinary course of business to a non-associated entity: s 259D(5).

107

108

Company Law Review Bill 1997, Explanatory Memorandum, [12.63]. [9.305]

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The entity cannot exercise any voting rights attached to the shares while it remains under the control of the company: s 259D(3). 109 If the holding persists beyond the deadline for disinvestment, the controlling company commits an offence for each day the contravention continues although this does not affect the validity of any transaction: s 259D(4), (6). A company can obtain control of an entity that holds shares in the company without itself taking any steps to increase its interest or influence in the entity. Consider this example: C Ltd is held as to 35% of its voting shares by A Ltd, as to 51% by B Ltd and the balance is widely held. C has a small shareholding in A. If B divests itself entirely of its holding to non-associated small shareholders, A will be left with a controlling interest and will be under an obligation to secure a disposal of C’s cross-investment or its own interest in C, at least down to a level falling short of control. 110 Expanded notion of control of an entity for purposes of Pt 2J.2 [9.310] The prohibitions in s 259B upon taking security and the prohibition in s 259C upon

indirect self-acquisition are expressed to apply not only to situations where a holding company exercises formal legal control but also those of actual or de facto control as measured by criteria based upon those adopted in accounting standards: see [4.90]. For the purposes of Pt 2J.2 only, a company controls an entity if it has the capacity to determine the outcome of decisions about the entity’s financial and operating policies: s 259E(1). In determining whether a company has this capacity: (a) the practical influence the company can exert (rather than the rights it can enforce) is the issue to be addressed; and (b)

any practice or pattern of behaviour affecting the entity’s financial or operating policies is to be taken into account even if it involves a breach of an agreement or a breach of trust: s 259E(2). The legislative focus is upon the practical influence a company can assert, rather that the active exercise of control. Therefore, the mere fact that an entity acts in a manner consistent with the interests of another company may be sufficient to indicate control. In terms of the basic capacity to determine the outcome of decisions, the strength of voting power in the entity may be more important than economic dependence through financial support, although the duration of the voting power or of the economic dependence may be significant; a short-lived (eg, for a few hours only) ability to control the outcome of decisions taken by the company would be unlikely to satisfy the control test. 111 Merely because the company and an unrelated entity jointly have the capacity to determine the outcome of decisions about another entity’s financial and operating policies (eg, under a joint-venture agreement) does not mean that they each control the other entity: s 259E(3). Also, a company is not taken to control an entity merely because of a capacity that it is under a legal obligation to exercise for the benefit of someone other than its shareholders (eg, if the company holds shares as bare trustee): s 259E(4). Sanctions and remedies [9.315] Contravention of the prohibitions in ss 259A and 259B(1) does not affect the validity

of the acquisition or security or any contract or transaction connected with it and the company 109

110

If voting rights are, however, exercised, the meeting or resolution will be invalid on that ground only if the Court considers a substantial injustice has been or may be caused that cannot be remedied by court order, and the Court declares the meeting or resolution invalid: s 1322(3B). This example is drawn from Company Law Review Bill 1997, Explanatory Memorandum, [12.70].

111

These observations upon the legislative intent are drawn from Company Law Review Bill 1997, Explanatory Memorandum, [12.61].

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is not guilty of an offence: s 259F(1). Any person who is involved in the company’s contravention of these provisions contravenes s 259F(2), a civil penalty provision so that persons involved in the contravention may be the subject of pecuniary penalty or compensation orders: s 1317E. If the involvement is dishonest, the person commits an offence: s 259F(3). The disinvestment obligation in s 259D sounds in a criminal sanction which does not, however, affect the validity of any connected transaction: s 259D(4), (6). The issue or transfer of shares in contravention of s 259C(1) is declared void by the subsection itself. The sanctions and remedies applying to capital reductions and buy-backs, under ss 588G and 1324, do not apply in Pt 2J.2. However, as with reductions of capital, in particular circumstances the Takeovers Panel may have jurisdiction with respect to direct or indirect acquisition of control by a company of shares in itself: see [9.260]. [9.318]

Review Problem

Flush Ltd is listed on the ASX. Its directors believe that its quoted securities are significantly underpriced by the market and they can think of no better investment for the substantial funds presently available to the directors. They wish to buy back as much of the company’s equity capital as possible. On present market prices, they can acquire as much as 15% of issued capital. Battling Ltd holds 9% of the ordinary shares in Flush. Battling has notified the Flush directors informally that it is under pressure from its banks to dispose of its investment in Flush and that it is prepared to do so by private sale at less than the current market price. (It anticipates that any attempt to dispose of so large a holding through the market will depress the price.) Its investment in Flush is held through a wholly owned subsidiary. Flush is not committed to acquiring Battling’s stake. Flush seeks your advice on the buy-back options open to it and the merits of each recommendation you can make as to the legally preferred course of action open to it.

FINANCIAL ASSISTANCE FOR THE ACQUISITION OF A COMPANY’S SHARES [9.320] The final element of Ch 2J relating to transactions affecting share capital is the

financial assistance provisions of Pt 2J.3. Until 1998, these provisions were more usually seen as a broad prohibition, albeit one ameliorated by a shareholder authorisation procedure introduced in 1981. The prohibition was upon a company giving financial assistance for the purpose of or in connection with the acquisition, or proposed acquisition, by any person of shares in the company or in its holding company. It was immaterial that the assistance was given before, after or simultaneously with the acquisition. Origins and rationale [9.325] The prohibition derives from a recommendation of the Greene Committee, a United

Kingdom law review committee, in 1926. 112 Harding explains the recommendation thus: Considering the time, effort and money since spent on the provision, the Greene Committee’s discussion is remarkably brief. The Committee said that a practice had made its appearance in recent years “which we consider to be highly improper”. It launched immediately into an example: “a syndicate agrees to purchase from the existing shareholders sufficient shares to control a company, the purchase money is provided by a temporary loan from a bank for a day or two, the syndicate’s nominees are appointed directors in place of the old board and 112

Report of the Company Law Amendment Committee 1925-1926 (Cmd 2657, 1926), [30]; see generally Y-Y Cho & V Kishore (2004) 78 ALJ 194; E Ferran (2004) 63 CLJ 225. [9.325]

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Corporations and Financial Markets Law

immediately proceed to lend to the syndicate out of the company’s funds (often without security) the money required to pay off the bank.” The Committee commented that thus “in effect the company provides money for the purchase of its own shares. This is a typical example although there are, of course, many variations. Such an arrangement appears to us to offend against the spirit if not the letter of the law which prohibits a company from trafficking in its own shares and the practice is open to the gravest abuses.”

Harding comments on some difficulties implicit in this rationale and points to what is perhaps the fundamental justification put forward for the prohibition in its traditional form: The difficulty is that the impropriety [in the terms of the assistance extended may be] difficult to prove, civilly or criminally, and action may be too late. The policy behind the prohibition on giving financial assistance thus appears to be one of reinforcing the general principles on impropriety in management of a company, by forbidding certain transactions altogether because of the abuse which may well be associated with them. 113

The conditional licence for financial assistance [9.330] Since 1998, the prohibition has been recast as a conditional facility. A company may

financially assist a person to acquire shares (or units of shares) in the company or a holding company of the company only if (a) giving the assistance does not materially prejudice either the interests of the company or its shareholders or its ability to pay its creditors; (b) the assistance is approved by shareholders under s 260B; or (c) the assistance is exempted under s 260C: s 260A(1). Financial assistance may be given before or after the acquisition, and may take the form of paying a dividend: s 260A(2). The acquisition of shares may be by the issue or transfer of shares or any other means: s 260A(3). The licence to assist an acquisition is expressed to apply if one only of the three conditions in s 260A(1) is satisfied. If the assistance does not materially prejudice either the interests of the company or its shareholders or the company’s ability to pay its creditors, the assistance is unobjectionable. If, however, one of these elements is not satisfied and the assistance is not exempted under s 260C, the assistance is sustained only by shareholder approval. Where shareholder approval is relied upon, it must be given either by a special resolution passed at a general meeting of the company with no votes being cast in favour of the resolution by the person acquiring the shares or their associates or by a resolution agreed to at a general meeting by all ordinary shareholders: s 260B(1). If the company will be a subsidiary of a listed domestic (viz, Australian-incorporated) company immediately after the acquisition, the financial assistance must also be approved by a special resolution passed at a general meeting of that company: s 260B(2). Otherwise, if, immediately after the acquisition, the company will have a holding company that is a domestic company but is not listed, the financial assistance must also be approved by a special resolution passed at a general meeting of its ultimate Australian holding company: s 260B(3). Consistently with other capital transactions in Ch 2J, if a company gives financial assistance in contravention of s 260A, the contravention does not affect the validity of the transaction or of any contract or transaction connected with it and the company is not guilty of any offence: s 260D(1). A person who is involved (within the meaning of s 79) in the company’s contravention of s 260A contravenes s 260D(2), a civil penalty provision, with consequent exposure to sanctions and remedies under Pt 9.4B. If the person’s involvement in the 113

D E Harding, (1978) 10 Comm Law Assoc Bull 1 at 3; for criticism of the statutory regime and its modern recasting, see K Fletcher (2000) 11 Aust Jnl of Corp Law 119 and (2005) 17 Aust Jnl of Corp Law 323 and K Wellington (2008) 26 C&SLJ 7.

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company’s contravention is dishonest, they commit an offence: s 260D(3). As with the sanctioning of other share capital transactions under Ch 2J, sanctions and remedies are provided where contravention of s 260A affects the company’s solvency. These are through the insolvent trading provisions, where the financial assistance is deemed to incur a debt when it is agreed to or provided (s 588G(1A) (item 6)), and by allowing creditors and shareholders to seek injunctive relief under s 1324 with the benefit of the deemed standing and reversal of the onus of proof: s 1324(1A)(b)(ii), (1B)(b)(iii) and see [9.260]. Exempted financial assistance [9.335] Several categories of exemption may displace the need for inquiry as to whether the

financial assistance creates material prejudice and requires shareholder approval: • assistance given in the ordinary course of financial dealing that consists either of acquiring or creating a lien on partly paid shares for amounts payable to the company on the shares or an agreement for the payment for shares by instalments (s 260C(1)); • assistance given by a company whose ordinary business includes providing finance which is given in the ordinary course of that business and on ordinary commercial terms (s 260C(2)); • guarantees or other security given in the ordinary course of commercial dealing by a subsidiary of a borrowing corporation of the latter’s repayment obligations (s 260C(3)); • assistance given under an employee share scheme that has been approved by the general meeting of the company and any listed domestic holding company or other ultimate Australian holding company (s 260C(5)); • a discharge on ordinary commercial terms of a liability that the company incurred as a result of a transaction itself entered into on ordinary commercial terms (s 260C(5)(d)); • assistance given under a court order (s 260C(5)(c)); and • a reduction of share capital or share buy-back complying with Pt 2J.1: s 260C(5)(a), (b). The scope of the prohibition [9.340] One of the traditional difficulties with the financial assistance prohibition has been in

discerning the meaning of those two words whose denotation centrally but not exclusively defines the scope of the prohibition. Those difficulties persist after the 1998 recasting of the provisions. Indeed, they have been compounded by grafting onto them an exception for financial assistance not otherwise exempted that does not materially prejudice the interests of the company or its shareholders or its ability to pay its creditors: s 260A(1)(a). The nexus between financial assistance and the acquisition has also been recast; no longer is there a prohibition on assistance for the purpose of or in connection with the acquisition but a conditional authorisation of assistance to acquire shares. It has been held that “the words ‘financial assistance’ have no technical meaning. The task is to examine the commercial realities of the transaction to determine whether it can properly be described as the giving of financial assistance by the company”. 114 When, prior to the 1998 amendments, there was no carve out for financial assistance that did not involve material prejudice, the principal test for determining whether action constituted financial assistance was expressed in terms of whether it effected an impoverishment of the company’s resources. Thus, in Burton v Palmer, Hutley JA said: [T]he essence of the matter is clear – has the company diminished its financial resources, including future resources, in connection with the sale and purchase of its shares? As the 114

Re Skilled Group Ltd (2016) 113 ACSR 525 at [90], citing Charterhouse Investment Trust Ltd v Tempest Diesels Ltd [1986] BCLC 1 at 10 per Hoffman J; Milburn v Pivot Ltd (1997) 78 FCR 472 at 501-503 per Goldberg J. [9.340]

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reduction may be indirect, it is not to be determined by considering only what is done by the parties to the transaction. Others may acquire rights against the company which diminish its resources in connection with the transaction and thus bring the section into play. The issue is what is the impact upon the company of what took place, it being borne in mind that the assumption by a company of obligations, even if it is unlikely that they may have to be honoured, diminishes its resources. However, the execution of an instrument by which the company appears to be bound to do something, but which on analysis can be shown to have no content does not infringe the section. This, it appears to me, has happened here. 115

The introduction of the material prejudice requirement adds a further dimension to consideration albeit one that dispenses with the need for close consideration of many corporate acts where the assistance has a de minimis (insignificant) character. Obvious forms of potential prejudice include the acquisition by the company of assets at an inflated price, loans to insolvent borrowers or a guarantee of obligations of a person who is likely to default upon them. Arbitrary rules such as the percentage impact of the transaction may not be a secure guide to materiality. 116 In practice, the shareholder approval mechanism will often be invoked to protect against uncertainty and the risk of contravention. It is not, however, always available and is never costless. Hence, there is continuing importance in the construction of the elements of the section, as in the following extract from ASIC v Adler [9.345].

ASIC v Adler [9.345] ASIC v Adler (2002) 41 ACSR 72 Supreme Court of New South Wales [The facts of this litigation appear at [7.95]. This extract concerns the application of s 260A.] SANTOW J: 338 The principally relevant issue is whether the giving of the financial assistance did in the present circumstances materially prejudice: “(i) The interest of the company or its shareholders”. 339 When regard is had to the substance of the transaction, it amounts to this. HIHC handed over $10 million to PEE, without in the first instance any documentation, of which $3,991,856.21 (inclusive of stamp duty and brokerage) was used to pay for the HIH share purchases, such intended use being known to Mr Williams, the Chief Executive Officer of the HIH Group. Thus, the interest of HIHC and through it HIH in the cash amount so applied, was converted into the interest, but only by 7 July 2000, of a unit holder in a unit trust in which HIH had no direct interest in the assets. It is said … that this materially prejudiced the interests of HIHC and through it HIH by bringing about: “exposure to diminution in the value of HIHC’s stake in PEE should the price of HIH shares fall and therefore cause PEE to suffer a loss”. … [The judge referred to the Explanatory Memorandum for the Company Law Review Bill 1997 (Cth) which stated that the Bill would prevent “a company giving financial assistance to a person to acquire shares, or units of shares, in the company or holding company if the transaction would materially prejudice the interests of the company [etc]”.] 342 I have emphasised the word “transaction” because it supports an interpretation of the expression “the assistance does not materially prejudice” which embraces the whole transaction constituted by the assistance to acquire the shares and so brings into account its immediate consequences in terms of “material prejudice”. That invites the Court to take the kind of commercial approach advocated by Hofmann J (as he then was) in Charterhouse Investment Trust Ltd v Tempest Diesels Ltd [1986] PCLC 1. Hofmann J said (at 10-11) that: “It was necessary to look at all interlocking elements in a commercial transaction as a whole, and to determine where the net balance of financial advantage lay.” [emphasis added] 343 As is said in Ford’s Principles of Corporations Law (“Ford”) at 24,710: “Under s 260A the question is whether the net transfer value so assessed is materially prejudicial to the interests which the section 115 116

Burton v Palmer [1980] 2 NSWLR 878 at 881. Company Law Review Bill 1997, Explanatory Memorandum, [12.77].

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ASIC v Adler cont. protects.” See also Sheller JA in Wambo Mining Corporation Pty Ltd v Wall Street (Holdings) Pty Ltd (1998) 16 ACLR 1601 at 1607 who applied the net transfer of value test on the predecessor provision. 344 Thus, it can be seen that the new s 260A opted for what might be called the “impoverishment” doctrine as against a more wide ranging prophylactic approach (which asks whether the dominant intention of the company was to facilitate an acquisition of shares, whether or not the company’s assets were reduced). Thus as is pointed out in Ford: “The law will … apply to a transaction which involves conversion of a company asset into one of lesser quality (eg where cash is converted into an unsecured loan without interest to the purchaser of shares).” 345 Prior to the present statutory regime, there were competing lines of authority as to whether impoverishment was necessary (see Ford 24.711). 346 Finally, I would adopt what Ford says as to onus being on the party seeking to demonstrate lack of material prejudice (at 24.710): “The notion that the onus is on those seeking to defend the transactions to show that there is no material prejudice is reinforced by s 1324(1B) which says that in proceedings for relief under that section based on the alleged contravention of s 260A(1)(a), the Court must assume that the transaction constitutes a contravention unless the Defendant proves otherwise.” 346 That contention is reinforced by the presence of the “material prejudice” provisions (s 260A(1)(a)) immediately alongside what in earlier versions of the prohibition on financial assistance was the other gateway out of that prohibition, namely shareholder approval (see s 260A(1)(b)) and note the final gateway added in the contiguous s 260A(1)(c). 347 I turn now to the potential application of s 260A in the present circumstances. … 355 HIHC suffered material prejudice as a result of its financial assistance, so contravening s 260A of the Corporations Act. It did so by exchanging cash for either unsecured indebtedness owed to it, or alternatively in the first instance equitable rights by way of resulting or other trust in respect of the HIH shares being contemporaneously bought. Such rights against PEE were from the start of materially lesser value than the cash handed over. This is because such equitable rights would be likely to be contentious and to require expensive litigation to enforce in Court. Thereafter material prejudice also resulted from the other elements of the transaction, that is, the lack of safeguards in, and disadvantageous terms of, the AEUT Trust documentation and the circumstances which, from its inception, rendered the investment in HIH shares inherently likely to give rise to the loss that in fact occurred. These included Mr Adler’s intention, not to make a quick profit, but to support the HIH share price. A loss was inherently likely from the inception, and did in fact eventuate, both in HIH’s carrying value as an investment and when the shares were realised at a loss. Either would constitute “material prejudice” both to HIHC and HIH within the meaning of s 260A(1)(a) and in terms of the pleaded Particulars. That completes the elements for such contravention by HIH and HIHC to have occurred. It leads to the conclusion that both HIH and HIHC contravened s 260A of the Corporations Act. “Involvement” by Messrs Adler, Williams and Fodera, and of Adler Corporation in breach of s 260A 356 I turn now to consider whether Mr Adler, Mr Williams or Mr Fodera were involved in HIHC’s contravention of s 260A so as to be liable under s 260D(2) of the Corporations Act. Similarly as to Adler Corporation. I shall deal with each of them in turn. But before doing so I need to deal with a preliminary question, namely, whether “involved” as defined by s 79 requires that there be actual knowledge on the part of the person concerned, not only of financial assistance to acquire shares, but also that the assistance did materially prejudice, in this case, “the interests of the company or its shareholder”, as the First and Fourth Defendants contend. 357 In Yorke v Lucas (1985) 158 CLR 661, in construing the equivalent provision in the Trade Practices Act to s 79, the High Court held that where it is thought to make a person liable as an accessory to a contravention it is necessary to establish that the person had intentionally participated in the contravention. To establish intentional participation, the Court held that it must be proven that the [9.345]

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ASIC v Adler cont. person has knowledge of the essential matters that make up the offence or breach (in that case of s 52(1) of the Trade Practices Act). At 670, the majority comprising Mason ACJ, Wilson, Deane and Dawson JJ, observed that the words require: …a party to a contravention to be an intentional participant, the necessary intent being based upon knowledge of the essential elements of the contravention. The majority went on to say: There can be no question that a person cannot be knowingly concerned in a contravention unless he has knowledge of the essential facts constituting the contravention. 358 That knowledge is actual and not constructive. But a combination of suspicious circumstances and the failure to make appropriate inquiry when confronted with the obvious, makes it possible to infer knowledge of the relevant essential matters: Pereira v DPP (1988) 63 ALJR 1 at 3. 359 Turning to s 260A, if it be the case that the onus lies upon the company to demonstrate, relevantly, that giving the assistance does not materially prejudice the interests of the company or its shareholders, this being in effect by way of defence rather than an element of the contravention, it would follow that each of Mr Adler and Mr Williams (I leave aside Mr Fodera) had the necessary knowledge of the essential facts. This is because, first, each were aware that HIHC was financially assisting AEUT when formed with an intent for it to buy HIH shares. Before that, each were aware that the assistance was to an entity, initially Drenmex then PEE, to acquire shares in HIHC’s holding company HIH. … [I]f actual knowledge had to extend to whether the assistance did in fact materially prejudice the interests of the company, while I would conclude that Mr Adler had knowledge of that too, I will need to deal in more detail with the extent and relevance of the knowledge of Mr Williams and later Mr Fodera. … 365 Mr Williams, who gave no evidence as to his knowledge, may nonetheless have been unaware of Mr Adler’s true purpose in having PEE, through AEUT, purchase shares in HIH in order to support the HIH share price. If so, he would most likely have had the purpose which Mr Adler (falsely) professed. That purpose was to make a short term profit from the dealing in HIH shares. But even absent that knowledge of Mr Adler’s real purpose (supporting HIH’s share price), Mr Williams was aware of all of the other features of the transaction which rendered the assistance materially prejudicial to the interests of the company, even if, as might be assumed in his favour, he gambled on ultimate benefits outweighing any material prejudice. But if that were so, what he was gambling on was that later events would produce a profit for the company notwithstanding that at the time of the financial assistance he was aware of all of the factors pointing to material prejudice, save (it may be) Mr Adler’s true motive. 366 Moreover, Mr Williams and Mr Adler had co-operated to ensure that the in-house HIH expertise was not brought to bear in assessing the wisdom of purchasing shares in HIH itself, through the fact that the transaction was entered into with no input from the Investment Committee or the Board or indeed from those involved with investment management. Mr Howard’s role was purely to implement the transaction, not to advise on its wisdom. In circumstances where Mr Williams has chosen not to give evidence of matters which would be peculiarly within his knowledge and where otherwise an inference is amply available that he had actual knowledge of all the elements of the contravention, both in the wider and narrower sense, Mr Williams must be taken to have been “involved” in HIHC’s contravention of s 260A, for the purposes of s 260D of the Corporations Act. 367 Finally I turn to Mr Fodera. On the narrower view of the scope of knowledge (excluding material prejudice), he knew two essential facts. First he knew of the financial assistance (if not its precise mode) and second its application (by an Adler associate) to the purchase of HIH shares … As Mr Fodera occupied the position of the Financial Officer, he was aware of the company’s “lousy results” and must be taken to have been aware of the declining share price throughout the year. He would not have been aware of Mr Adler’s true motive. Most certainly, he procured implementation of the transaction in arranging for Mr Howard to carry it out, bypassing Mr Ballhausen. There was no question that Mr Fodera knew that the $10 million was urgently needed to pay for the purchase of HIH shares. 750

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ASIC v Adler cont. 368 One does not here need to reach a conclusion as to whether Mr Fodera actively set about bypassing the Investment Committee and Board or simply assumed Mr Williams would deal with those matters, though as I conclude later, he at least took no steps later to ensure that the matter did go to the Investment Committee for ratification. Thus, on the narrow knowledge test, and taking into account the role he played, he too would be a person who “is involved in a company’s contravention of s 260A”. If the wider knowledge test were applied (contrary to the view I consider correct) that is, knowledge of the essential facts going to material prejudice, though it be a defence, I would give Mr Fodera the benefit of the doubt, though the case is close to the line. As to Adler Corp, [since Mr Adler’s knowledge was attributed to the company which was under his effective control] …, it too was involved in the contravention of s 260A. Conclusion 369 Each of Mr Adler and Mr Williams were “involved” in the contravention by HIHC of s 260A of the Corporations Act, in giving financial assistance to HIHC to acquire shares in its holding company HIH, being assistance which did materially prejudice the interests of the company or its shareholders. However, if it be the case that for Mr Fodera to be so involved, he had to have knowledge not only of the financial assistance but also of the essential facts pertaining to material prejudice (though it be a defence rather than an element of the contravention) then I could not be positively satisfied that at the time Mr Fodera had that knowledge of material prejudice. As I do not consider that there need be knowledge of what is essentially a defence rather than an ingredient of the contravention, I conclude that he too was sufficiently involved, though to a lesser degree than Messrs Williams and Adler. The result is that each contravened s 260D(2) of the Corporations Act as did Adler Corp, with the above qualification concerning Mr Fodera. [Upon appeal, the judge’s findings were upheld: Adler v ASIC (2003) 179 FLR 1; [2003] NSWCA 131 at [393] and [426].]

Other grounds of civil liability [9.350] Prior to 1982, where a company gave financial assistance for the acquisition of its

shares the contract or transaction was (because of the statute’s silence as to contractual consequences) generally void for illegality. 117 This consequence not infrequently compounded the wrong suffered by the company. Part 2J.3 substitutes a distinct liability regime: see [9.330]. These statutory remedies are not, however, exhaustive and those involved in the giving of financial assistance may be civilly liable on wider grounds, for example, for the tort of conspiracy. The elements of the tort are a combination of persons to effect an illegal purpose (viz, the provision of unsanctioned financial assistance) resulting in damage to the company. 118 A further potential basis of liability arises from the imposition of a constructive trust. A constructive trust may be imposed under either of two limbs identified in Barnes v Addy. 119 A stranger to a trust is liable as a constructive trustee where they: 1. receive and become chargeable with some part of the trust fund; or 2. assist the trustees of a trust with knowledge of the facts in a dishonest design on the part of the trustees to misapply some part of a trust fund. This rule was applied as to both limbs in Belmont Finance Corp Ltd v Williams Furniture Ltd (No 2) in relation to prohibited financial assistance. As to the first limb, Buckley LJ said: 117 118

See, eg, Dressy Frocks Pty Ltd v Bock (1951) 51 SR (NSW) 390; Shearer Transport Co Pty Ltd v McGrath [1956] VLR 316; E H Dey Pty Ltd v Dey [1966] VR 464. Belmont Finance Corp v Williams Furniture Ltd (No 2) [1980] 1 All ER 393 at 404.

119

(1874) LR 9 Ch App 244 at 251-252 per Lord Selborne LC. [9.350]

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A limited company is of course not a trustee of its own funds: it is their beneficial owner; but in consequence of the fiduciary character of their duties the directors of a limited company are treated as if they were trustees of those funds of the company which are in their hands or under their control, and if they misapply them they commit a breach of trust. … So, if the directors of a company in breach of their fiduciary duties misapply the funds of their company so that they come into the hands of some stranger to the trust who receives them with knowledge (actual or constructive) of the breach, he cannot conscientiously retain those funds against the company unless he has some better equity. He becomes a constructive trustee for the company of the misapplied funds. 120

In the Belmont case, the Court of Appeal held that a payment of £500,000 by Belmont to assist an acquisition of its shares, being a contravention of the statutory prohibition, was a misapplication of its money and made in breach of the duties of its directors. A portion of the £500,000 came into the hands of a third party who had knowledge of the circumstances of the transaction. The third party was accordingly accountable to Belmont as a constructive trustee of this portion under the first limb of Barnes v Addy. As to the second limb, Buckley LJ said: a stranger to a trust notwithstanding that he may not have received any of the trust fund which has been misapplied will be treated as accountable as a constructive trustee if he has knowingly participated in a dishonest design on the part of the trustees to misapply the fund; he must himself have been in some way a party to the dishonesty of the trustees. 121

The third party escaped liability as a constructive trustee under the second limb. The third party would have been liable if Belmont’s directors were guilty of dishonesty in effecting the complex transaction by which the shares were acquired and the third party, with knowledge of the facts, assisted them in that dishonest design. However, the court found that, while the directors of Belmont were guilty of negligence, they had not acted dishonestly. What degree of knowledge or suspicion will make a third party liable under the second limb? In Consul Development Pty Ltd v DPC Estates Pty Ltd Gibbs J (as he then was) described the degree of apprehension as to directors’ dishonesty which will make a third party liable as a constructive trustee: It may be that it is going too far to say a stranger will be liable if the circumstances would have put an honest and reasonable man on inquiry, when the stranger’s failure to inquire has been innocent and he has not wilfully shut his eyes to the obvious. On the other hand, it does not seem to me to be necessary to prove that a stranger who participated in a breach of trust or fiduciary duty with knowledge of all the circumstances did so actually knowing that what he was doing was improper. It would not be just that a person who had full knowledge of all the facts could escape liability because his own moral obtuseness prevented him from recognising an impropriety that would have been apparent to an ordinary man. 122

In the same case Stephen J (with whom Barwick CJ agreed) said: If the [third party] knows of facts which themselves would, to a reasonable man, tell of fraud or breach of trust the case may well be different, as it clearly will be if [he] has consciously refrained from inquiry for fear lest he learn of fraud. But to go further is, I think, to disregard equity’s concern for the state of conscience of the defendant. 123

These statements in Consul Development were reviewed by Austin J in NCR Australia v Credit Connection who by way of obiter expressed this conclusion: 120

Belmont Finance Corp Ltd v Williams Furniture Ltd (No 2) [1980] 1 All ER 393 at 405.

121

Belmont Finance Corp Ltd v Williams Furniture Ltd (No 2) [1980] 1 All ER 393 at 405.

122 123

Consul Development Pty Ltd v DPC Estates Pty Ltd (1975) 132 CLR 373 at 398. Consul Development Pty Ltd v DPC Estates Pty Ltd (1975) 132 CLR 373 at 398 at 412. See further R P Austin, “Constructive Trusts” in P D Finn (ed), Essays in Equity (1985), p 196; C Harpum (1986) 102 LQR 114 and 267; R Gregory (1981) 44 MLR 107 and (1979) 42 MLR 707.

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What seems to emerge from these observations is that liability arises where the defendant has assisted in the trustee’s dishonest and fraudulent design and: • has actual knowledge of the dishonest and fraudulent design; or • has deliberately shut his or her eyes to such a design; or • has abstained in a calculated way from making such inquiries as an honest and reasonable person would make, where such inquiries would have led to discovery of the dishonest and fraudulent design; or • has actual knowledge of facts which to a reasonable person would suggest a dishonest and fraudulent design. But there is no liability if the defendant merely knows facts that would have been investigated by a reasonable person acting diligently, thereby discovering the truth, where the defendant has innocently but carelessly failed to make the appropriate investigations. 124

[9.353]

Review Problems

1. Holding Co Ltd holds all the equity in Operating Co Ltd and Jane owns all the equity in Holding. She agrees to sell her shares in Holding to Metals Ltd for a price of $400,000 plus a sum equal to 7.5% of the increase in the gross turnover of Operating during the coming four years; rather than Metals paying the turnover figure, it is agreed that Operating will pay this amount to Jane by means of a fee for consultancy services. Would that arrangement offend s 260A? Would it make any difference if the transaction was effected by means of payment of a dividend by Operating and, if so, how might the agreement be expressed? See Independent Steels Pty Ltd v Ryan (1989) 15 ACLR 518. 2. Bid Co proposes to make takeover offers for Target Co shares. Its intention is that temporary bid financing will be partially retired after the bid is completed by having Sub Co, a 51% subsidiary of Target (which has substantial cash reserves) lend its excess funds to Finance Co, Target’s wholly owned finance company, at a commercial rate of interest. Finance will then lend the funds to Bid Co. To avoid financial assistance problems Bid Co proposes that Target will sell down its holding in Sub Co to just under 50% of its issued share capital before the loan is made to Finance. Would this measure avoid any contravention of the section? Are other means available to Bid Co?

DIVIDENDS Dividends and capital maintenance [9.355] Dividends are seen by shareholders as the periodic income return upon their

investment and one means by which shareholders participate in the financial success of the company. Until very recently the body of rules which determines what amounts may be paid to shareholders by way of dividend remained faithful to their 19th century origins in the capital maintenance rules. The rules were substantially recast in 2010 and have since been under further review because of concern that the 2010 reforms had not moved as fully as intended from those origins; these reviews have not, however, resulted in legislative change. Traditionally, legal norms have required that dividends are paid out of profits and not out of the capital of the company. The distinction between capital and profits lies at the centre of the complex of legal and accounting rules that defined the boundaries of the fund (the dividend 124

NCR Australia v Credit Connection [2004] NSWSC 1 at [168]-[169]. [9.355]

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fund 125) that might be distributed to members without offending capital maintenance doctrines. The precise contours of the fund have been determined by judicial and professional accounting decisions rather than by detailed statutory specification since the “profits” that constituted the dividend fund have never been defined in corporations legislation. In this area more than any other, legal norms bear the imprint of accounting principles, and continue to do so although the two perspectives are more or less in constant tension. 126 Directors and shareholders are given a broad discretion as to when dividends shall be paid within the limits set by the dividend fund and the allocation of functions in the company’s constitution. The longstanding legal rule that dividends might only be paid out of the profits of the company did not require the existence of a separate cash fund from which profits might be extracted for the purpose of payment of dividends. All that was required was that at the relevant date the company’s financial statements disclosed profits recognised as such under legal and accounting rules in the amount of the proposed dividend; this fund conferred a licence to pay dividends and its quantum set an upper limit for the payment. Those profits might be in current year or past accumulated operating profits, or realised or unrealised gains on the value of fixed assets. The payment of dividends within this limit raised quite separate questions. Thus, a company might have ample profits available for distribution as dividends but no cash to fund their payment. Such a company might be forced to borrow funds for the payment of dividends and, provided solvency was not impaired, might do so although it was hardly regarded as best practice. 127 In 2010 the Act was amended with the clear purpose of replacing the dividends from profits test. 128 Three considerations were said to drive the change: • the traditional rule that dividends be paid only from profits relied upon old legal precedents that were out of step with current accounting principles and gave insufficient guidance on the meaning of profits; • especially since the adoption of the International Financial Reporting Standards with the focus on fair value in accounting standards, the profitability of Australian companies had become increasingly volatile with non-cash expenses (eg, a decline in the realised or unrealised value of assets) being included in the dividend fund calculation; conversely a company might have cash to pay a dividend but be precluded from doing so because the accounting profits of the company had been eliminated by changes in asset values; and • the requirement for companies to pay dividends only out of profits was considered to be inconsistent with the recent Australian relaxation of other capital maintenance rules. 129 Accordingly, in 2010 the Act replaced the provision that a dividend may only be paid out of the profits (the profits test) with a rule articulated with the Ch 2J share capital rules and adding a requirement based on asset values relative to liabilities. Under the new provision in s 254T(1), a company must not pay a dividend unless: • the company’s assets exceed its liabilities immediately before the dividend is declared and the excess is sufficient for the payment of the dividend (the net assets test); • the payment is fair and reasonable to the company’s shareholders as a whole; and 125

To borrow Yamey’s phrase: see B S Yamey (1941) 4 MLR 273. See further on the extent of the dividend fund R M Bryden, “The Law of Dividends” in J S Ziegel (ed), Studies in Canadian Company Law (1967), Vol 1, p 270 and H H Mason & K L Fletcher (1982) 1 C&SLJ 16.

126

QBE Insurance Group Ltd v ASC (1992) 8 ACSR 631 at 645, 649-652.

127

See Re Mercantile Trading Co, Stringer’s Case (1869) LR 4 Ch App 475; Mills v Northern Railway of Buenos Ayres Co (1870) LR 5 Ch App 621.

128

Corporations Amendment (Corporate Reporting Reform) Bill 2010, Explanatory Memorandum, [3.4].

129

Corporations Amendment (Corporate Reporting Reform) Bill 2010, Explanatory Memorandum, [19] (the first three concerns).

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• the payment does not materially prejudice the company’s ability to pay its creditors. For the purposes of this 2010 rule, assets and liabilities are calculated in accordance with accounting standards in force at the relevant time even if the accounting standard does not otherwise apply to the company concerned, for example, because it is a small proprietary company that is not required to prepare a financial report: s 254T(2). The revised s 254T leaves unaffected the director’s duty under s 588G to prevent insolvent trading on payment of dividends. Curiously, if the purpose of the 2010 revision was to remove the profits test, it made no reference to profits and it is cast as a prohibition rather than an authorisation for the purposes of the capital maintenance rules. Its effect is to leave the profits test extant in one and probably two instances. First, some companies have a constitution that requires dividends to be paid out of profits; indeed, the statutory profits test was initially introduced to reflect this company practice. The prohibition in s 254T leaves that provision unaffected and adds a further set of criteria to be satisfied for a dividend distribution. Second, if a company wishes to pay dividends other than out of profits within the profits test, the prevailing view professionally is that it need comply also with the share capital reduction rules in Ch 2J, specifically, the further requirement for shareholder approval, since the reduction would be “not otherwise authorised by law” within s 256B and thereby exempted from its provisions: see [9.240]. 130 This is because s 254T is expressed not as an enabling provision but as a prohibition. Other questions arise from the conditions that must be satisfied to escape the prohibition under s 254T. First, s 254T(1)(a) requires the net assets test to be satisfied immediately before the dividend is declared. The term “declared” bears a specific meaning in the dividend provisions, distinct from the “determination” of a dividend: see [9.360]. Might the prohibition in s 254T be evaded by directors simply determining to pay a dividend rather than declare a dividend? Further, the net assets test must be satisfied at the time when the dividend is declared; in contrast, the other two conditions must be satisfied at the time of payment. This seems to require companies declaring a dividend to apply the dividends test twice, at the time of declaration and the time of payment. Second, s 254T(1)(b) stipulates that the payment must be fair and reasonable to the company’s shareholders as a whole. In the dividends context, this condition is primarily concerned with fairness between shareholder groups with different dividend rights. The Act requires that every share in a class of shares in a public company shall have the same dividend rights unless the company has a constitution that provides for the shares to have different dividend rights or those rights are provided for by special resolution of the company: s 254W(1). For proprietary companies a replaceable rule provides that directors may pay dividends as they see fit subject only to the terms of issue of its shares: s 254W(2). It may be that the provision is intended to permit directors of a proprietary company to pay differential dividends to shareholders of the same class or where the capital is not divided into classes. 131 This condition is discussed, in the context of its usage in Ch 2J, at [9.255] and [9.275] Winpar Holdings Ltd v Goldfields Kalgoorlie Ltd. In KGD Investments Pty Ltd v Placard Holdings 130

This is because, despite the intention evident in the Explanatory Memorandum that the new provision should operate as an exception to the capital maintenance rules, s 254T is couched as a prohibition and not as an authorisation under those rules; Treasury accepts that there Is “substantial doubt” as to whether s 254T permits an authorised reduction of capital without complying with Ch 2J: Treasury, Proposed Amendments to the Corporations Act, Discussion Paper (2011), p 8. The question has not been considered judicially.

131

I Ramsay, The New Corporations Law (1998), p 90. The holder of a share in a no liability company is not entitled to a dividend on the share if a call has been made upon the share that is due and unpaid: s 254W(3). In no liability companies dividends must be payable in proportion to the number of shares held by members and not the capital paid up on them, except where the constitution provides otherwise for preference shares or other special classes: s 254W(4). Companies limited by guarantee are precluded from paying dividends: see [3.110]. [9.355]

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Pty Ltd all shareholders in a proprietary company had entered into a shareholders agreement which provided that “investors and management” shareholders (who together held 75% of the issued shares) had a preferred right to receive dividends until they had recovered the amount paid for their shares. The company sought to pay a special dividend to these shareholders using borrowed funds. The other shareholder objected on the grounds that the payment would not be “fair and reasonable to the company’s shareholders as a whole” within s 254T(1)(b). Almond J held that the phrase “conveyed ‘one merged concept’ and that in ‘assessing what is fair and reasonable a wide range of matters relevant to the particular circumstances of the case will need to be taken into account’”. 132 The loan and dividend proposal, viewed objectively, was held to be commercially justifiable and to make due allowance for risk; nothing was found in the circumstances to support the argument that the payment was not fair and reasonable within s 254T(1)(b) in the context of the special regime in place under the shareholders agreement. 133 Third, a note to s 254T(1) offers, as an obvious example of a payment under s 254T(1)(c) that would materially prejudice the company’s ability to pay its creditors – a dividend whose payment would cause the company to become insolvent: Note 1. The condition in s 254T(1)(c) must be satisfied at the time of payment. Especially in the case of a large public company, where payment may be some time after the declaration of the dividend (if the company declares rather than determines to pay a dividend), the declaration decision must therefore anticipate changes in fortune in the intervening period since the obligation to pay arises from the time of declaration of the dividend even though the no material prejudice condition looks to the time of payment: see [9.360], noting the different position where the directors determine or declare the dividend. Almost immediately after the 2010 recasting of s 254T, concerns were raised about the new dividends test, including that: • linking the test to the accounting standards places an unreasonable burden on companies that are not otherwise required to comply with the standards because, for example, they are small proprietary companies; • the net assets test might bear little relationship to the company’s solvency because it does not take into account the timing and magnitude of flows of funds; 134 further, having a test using accounting standards-based calculations gives rise to some of the problems that existed under the profits test; and • the net assets test requires assets to exceed liabilities immediately before the dividend is “declared”; however, s 254U and most company constitutions now provide for the board to “determine” that dividends are payable: see [9.360]. 135 In 2011, Treasury responded to these concerns by exposing four reform options for comment: • retaining the 2010 s 254T test; 132 133

(2016) 110 ACSR 399 at [34], quoting from Elkington v CostaExchange Ltd [2011] VSC 501 concerning the like phrase in s 256B(1). No reference was made in the judgment to the terms of the company’s constitution. (2016) 110 ACSR 399 at [115], [120]. The plaintiff’s challenge upon statutory oppression grounds also failed.

134

The accountancy profession research body had proposed in 2002 that the profits test should be discarded in favour of sole reliance upon the solvency requirement: Legislation Review Board, Australian Accounting Research Foundation, Payment of Dividends under the Corporations Act 2001 (Discussion Paper, 2002). This recommendation is reflected in s 254T(1)(c) but is not the sole criterion to be met.

135

Treasury, Proposed Amendments to the Corporations Act, Discussion Paper (2011), p 5. Another concern is that, within a corporate group where each entity must satisfy the criteria individually and not merely the group as a whole (see [4.105]), an intermediate holding company that is unable to meet the net assets test although the group as a whole can do so, would impede the “streaming up” of a dividend from a subsidiary to the ultimate holding company: pp 10-11. This problem might be solved, of course, by its parent company approving the payment and the other requirements of Ch 2J being satisfied.

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• adopting a test based solely upon the company’s solvency; • returning to the profits test; and • allowing a company a choice for determining whether it might pay a dividend by: – paying a dividend out of its profits or – retaining the 2010 s 254T test but modifying it to allow calculation of assets and liabilities, in the case of a company not required to prepare a financial report, by reference to its own written financial records. 136 Two of these four options would explicitly retain the profits test; further, its probable continuing operation in two further contexts under the 2010 s 254T test is noted above. In December 2012 an exposure draft of an amended s 254T was circulated for comment. The exposure draft provision tied the dividends test more closely to company solvency by requiring only that • the company’s assets exceed its liabilities, and the excess is sufficient for the payment of a dividend, and • the directors reasonably believe that the company will be solvent immediately after the dividend is declared or paid. The 2010 requirements that payment is fair and reasonable to the company’s shareholders as a whole and does not materially prejudice the company’s ability to pay creditors would be removed under this proposed provision. The 2012 exposure draft provision allowed the company to choose between declaring and determining to pay a dividend: • where the company declares a dividend, the dividends test would apply immediately before the declaration; and • where the company determines and later pays a dividend without declaring it first, the dividends test would apply immediately before payment. This provision was intended to avoid the concern that companies declaring a dividend need to apply the dividends test twice, at both the time of declaration and the time of payment. 137 The 2012 exposure draft provision would also allow companies that are not required to adhere to accounting standards (eg, small proprietary companies) to calculate assets and liabilities for the purposes of dividend distributions with reference to their own financial records rather than accounting standards. All companies are required to keep written financial records which correctly record and explain their transactions, financial position and performance, and enable true and fair financial statements to be prepared and audited: s 286 and [9.120]. However, the 2012 exposure draft provision continued to be cast in prohibitive terms rather than as an enabling provision. Further, the proposed dividends test would did not displace the existing requirements in relation to share capital reductions and share buy-backs under Ch 2J, and these provisions would continue to apply. Hence, if a company wishes to pay dividends other than out of profits within the profits test, on the analysis above in this paragraph, it appears that it must comply also with the share capital reduction rules in Ch 2J,

136

Treasury, p 5. The second limb of the fourth option would require accounting standards to apply either at the time of declaration or payment of the dividend.

137

Corporations Legislation Amendment (Remuneration and Other Measures) Bill 2012, Explanatory Memorandum, [1.15]. [9.355]

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specifically, the further requirement for shareholder approval, since the reduction would be “not otherwise authorised by law” within s 256B and thereby exempted from its provisions: see earlier in this paragraph and [9.240]. 138 In 2014 a further exposure draft proposed measures to simplify the dividend rules, displacing those canvassed in 2012 and addressing the difficulties just noted in that draft. Thus, the 2014 exposure draft proposed: • to replace s 254T with a pure solvency test – the directors reasonably believe that the company will, immediately after the dividend is declared (or paid, if payment is made without a declaration), be solvent; • to exempt dividend payments from the share capital reduction requirements in Ch 2J if they are “equal reductions” of capital for ordinary shares, where all ordinary shareholders participate equally; and • when dividends are otherwise than out of profits (ie, the share capital account), directors disclose details of the source of dividends, and the board’s dividend policy, in their annual directors’ report. 139 These proposed provisions have not, however, make their way into legislation and, like the 2012 proposals, remain unenacted. Accordingly, the legal principles established by courts to define distributable profits remain relevant. They are examined at [9.365]–[9.390]. The question whether dividends are sourced from profits rather than capital will likely remain important for income tax purposes even if dividends are ultimately uncoupled from profits in corporations law. Under income tax law, franking credits are not recognised in the hands of the shareholder if the dividend is sourced from the share capital account; accordingly, companies continue to focus on the source of the dividend – hence the requirement in the 2014 exposure draft for directors to disclose the source of dividends paid other than out of profits. The power to determine, declare and pay dividends [9.360] Company constitutions usually provide that the determination of dividends is

discretionary. 140 Directors and shareholders (to or between whom the relevant powers are allocated by the constitution) are not obliged to pay dividends, even if the company is clearly solvent and has ample profits since trading and other surpluses may be applied to a variety of purposes of which dividends distributions are but one. Indeed, there is a potential conflict between directors and managers, on the one hand, and shareholders on the other as to the extent to which distributable profits should be retained for future operations and their expansion or, alternatively, paid out to shareholders. 141 The traditional constitutional allocation of power with respect to dividends addressed this conflict by giving the power to declare dividends to shareholders in general meeting but allowed directors to cap the amount that might be paid. However, the emerging modern practice, in both large and small companies, is for directors to have sole control over dividend distributions by giving them either a power to declare a dividend or to determine that a dividend is payable (that is, to pay a dividend). The difference between these verbs became significant with amendments made to the Act in 1998. The difference is based upon the 138

See discussion in S Alveras and J du Plessis (2014) 32 C&SLJ 312.

139

Corporations Legislation Amendment (Deregulatory and Other Measures) Act 2014 (Exposure Draft).

140

The constitution may, however, be so framed that dividend entitlement arises merely upon the adoption of accounts that disclose profits available for distribution: see, eg, Evling v Israel and Oppenheimer Ltd [1918] 1 Ch 101 and [9.102], n 2. For advocacy of mandatory disclosure of the dividend decision (viz, the amount of dividends and the reasons for their payment) as the most appropriate solution to the conflict between shareholders and managers with respect to dividends, see J Farrer (1998) 20 Syd L Rev 42.

141

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distinction drawn in the case law between the power in a company’s constitution to declare a final dividend and the power to pay an interim dividend (a power generally given to the board). A final dividend reflects the results of a completed year of trading; an interim dividend anticipates those final results during the course of the financial year. In Bluebottle UK Ltd v DCT, 142 the joint judges of the High Court said: A decision to pay an interim dividend, even if described as a “declaration”, was revocable until the dividend was paid. 143 By contrast, “the declaration of a final dividend [gave] rise to a debt payable by the company to the shareholder immediately or from the date stipulated for payment”. 144 And, in the case of a final dividend, it was clear from at least the end of the nineteenth century that, absent particular provision to the contrary in the company’s constituent documents, a shareholder could not sue to recover a dividend unless and until it had been declared. 145

To avoid the problems arising where profits that would have been sufficient to cover the dividend when it was declared cease to exist when the time comes to pay the dividend, the Act was amended in 1998 by adopting the constitutional norm that directors might determine to pay dividends and, if so, they retain the power to revoke that decision until the moment of payment, as in the case of an interim dividend. 146 However, it was recognised that a company might elect to retain a constitution that provided for the declaration of a dividend; in this case, the old rule would apply. Accordingly, a replaceable rule provides that the directors may determine that a dividend is payable (that is, may determine to pay a dividend) and fix the amount and the time and method of payment; the latter may include the payment of cash, the issue of shares, the grant of options over unissued shares or the transfer of assets: s 254U(1). In a company to which the replaceable rule applies, the company does not incur a debt merely by fixing the amount or time for the payment of a dividend; the debt arises only when the time fixed for payment arrives and the directors have not revoked their determination; the directors may therefore revoke the determination to pay the dividend at any time prior to that date: s 254V(1). In contrast, companies that have a constitution that provides for the declaration of dividends, either by the directors or the general meeting, incur a debt to members immediately the dividend is declared even though payment is usually fixed for a later date: s 254V(2). 147 This distinction is reflected in the structure of the insolvent trading provisions: a debt is deemed to be incurred when a dividend is paid or, if the company has a constitution that provides for the declaration of a dividend, when the dividend is declared: s 588G(1A) and [7.145]. There are many possible constitutional variations with respect to the dividend power. In Bluebottle UK Ltd v DCT Virgin Blue’s constitution excluded the replaceable rules; however, its r 63 was in identical terms to s 254U. The constitution had other provisions apart from r 63 that referred to the “declaration” as well as the determination of dividends although it did not in terms confer on directors the power to declare a dividend. On 11 November 2005 the directors resolved to “declare” a final dividend payable on 15 December. The company argued that their decision should be construed in the language of s 254U as the “determination” of a 142

Bluebottle UK Ltd v DCT (2007) 232 CLR 598 at [20].

143

Brookton Co-operative Society Ltd v Federal Commissioner of Taxation (1981) 147 CLR 441 at 455; Marra Developments Ltd v B W Rofe Pty Ltd [1977] 2 NSWLR 616 at 622.

144

Industrial Equity Ltd v Blackburn (1977) 137 CLR 567 at 572.

145

In re Severn and Wye and Severn Bridge Railway Co [1896] 1 Ch 559; Bond v Barrow Haematite Steel Co [1902] 1 Ch 353 at 362.

146

Company Law Review Bill 1997, Explanatory Memorandum, [11.40].

147

Unless, as in Bluebottle UK Ltd v DCT (2007) 232 CLR 598, a condition is imposed in which case the debt arises upon satisfaction of the condition. [9.360]

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dividend and not an a declaration to which s 254V(2) applied. However, the High Court said that the power needed to be construed in the context of the constitution as a whole, and not by itself: [T]he better construction of r 63 is that the word “determine” means “decide”. The rule [viz, r 63] should not be construed as confining the directors’ power over dividends to making only what s 254U identifies as a “determination” as distinct from a “declaration” of dividend. So understood, the rule would empower the directors to declare a dividend or to determine that one is to be paid. … If, as we would hold to be the better construction of Virgin Blue’s constitution, the board of that company was empowered to choose between declaring a dividend and determining that a dividend would be paid, fixing its amount and time for payment, the question of when did the company incur a debt will be decided by applying the relevant branch of s 254V. In this matter, on 11 November 2005, the board of Virgin Blue declared a dividend and, by operation of s 254V(2), the company incurred a debt when the dividend was declared. Because the declaration made in this case was subject to satisfaction of a condition precedent (receiving an unqualified audit report [on 16 November]) the declaration took effect on satisfaction of that condition. 148

The implicit assumption in the Bluebottle reasoning in the High Court is that the replaceable rule in s 254U taken by itself does not give directors a choice between determination and declaration of a dividend: the directors may only determine to pay a dividend, with the consequence specified in s 254V(1). Their power to declare a dividend must depend upon the grant of power in the company’s constitution. It is not clear that this is an interpretation foreseen by the drafters of the 1998 amendments. Profits available for distribution under the profits test [9.365] Under the profits test the size of the dividend fund depends upon the norms defining

profit. 149 The following cases disclose a starting point in the trading experience for the relevant accounting period: Profit refers to a comparison between the state of a business at the beginning and the end of the relevant financial period. It is the amount of gain made by the business during the year or the net balance of all gains earned and losses incurred during a relevant accounting year. … The statement of principle that profit should be calculated by reference to changes in the value of assets of a business during the relevant financial period … is as valid today as it was in 1911 when expounded. 150

The figure for changes in asset value in the financial year is then adjusted for abnormal items and to recoup certain deficits from prior accounting periods; it also includes profits from earlier financial periods that have not been distributed as dividends or capitalised (viz, converted into share capital through a bonus share issue or transferred to a capital reserve). Thus, to pay a dividend, a company need not make a profit in the current accounting period if it can draw upon undistributed profits from prior periods. The circumstances in which it may 148

Bluebottle UK Ltd v DCT (2007) 232 CLR 598 at [35], [40].

149

150

These norms are not exhaustive since the directors may be obliged by their general obligations of good faith to declare a dividend in some circumstances and to withhold the declaration (notwithstanding the formal state of the dividend fund) in others, if, eg, it would result in the company being unable to pay its debts as they fall due: Hilton International Ltd (in liq) v Hilton (1988) 4 NZCLC 64,721. It is rare, however, for courts to interfere with directors who refuse to recommend the declaration of a dividend or to declare such dividends where that power rests with them: but see Miles v Sydney Meat Preserving Co Ltd (1912) 12 SR (NSW) 98 and Dodge v Ford Motor Co 170 NW 668 (Mich, 1919). The compulsory liquidation and oppression remedies may, however, be available in respect of failure to declare adequate dividends: see, eg, Re City Meat Co Pty Ltd (1984) 8 ACLR 673. QBE Insurance Group Ltd v ASC (1992) 8 ACSR 631 at 646.

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do so are examined in the following cases. The legal rules they establish are not the only norms which seek to define the dividend fund; the accounting standards approved by the Australian Accounting Standards Board may qualify the legal rules in particular ways: see [9.125]. Finally, directors will breach their general law and statutory duties to the company if dividends are declared or paid so that the company’s solvency is impaired; this “overriding condition of solvency” is perhaps the most fundamental of the diverse rules governing dividend distributions. 151 The payment of a dividend is deemed to be the incurring of a debt by the company for the purpose of the director’s duty to prevent insolvent trading; the debt is deemed to be incurred when the dividend is paid or, if the company has a constitution that provides for the declaration of dividends, when the dividend is declared: s 588G(1A) (item 1). As you read the following decisions defining the contours of the dividend fund, review the alternative bases or principles which might be adopted for determination of the fund. Consider the respective merits of principles which fix the fund by reference exclusively to: 1. the company’s solvency or its capacity to pay the dividend; 2. whether the surplus of assets over liabilities exceeds the amount of shareholder funds (that is, whether share capital is lost or unrepresented by existing assets); 3. the state of the company’s current profits; or 4.

the state of the company’s accumulated profits, unappropriated from previous years. 152 The following cases refine the fundamental principles for the determination of profits available for distribution as dividends that are noted earlier in this paragraph. The first issue is whether and, if so, when, deduction must be made for the loss or depreciation of capital assets (Lee v Neuchatel Asphalte Co [9.370] and Verner v Commercial and General Investment Trust [9.375]) and revenue losses from previous financial years: Ammonia Soda Co Ltd v Chamberlain [9.380]. On the other hand, when may the dividend fund be increased by including realised profits on fixed assets (Lubbock v British Bank of South America [9.385]) and unrealised accretions to value of fixed assets: Dimbula Valley (Ceylon) Tea Co Ltd v Laurie [9.390]?

Lee v Neuchatel Asphalte Co [9.370] Lee v Neuchatel Asphalte Co (1889) 41 Ch D 1 Court of Appeal, England and Wales [A company was formed for the purpose of working a lease of asphalt mines in Switzerland. After several years marked by generally profitable activity the company resolved to declare a dividend out of current year profits. A shareholder objected to payment of the dividend on the ground that a great part of the capital of the company had been lost. The trial judge found that, on the contrary, the lease (through renegotiation of its terms) was worth more when the dividend was proposed than at the formation of the company.] LINDLEY LJ: [19] The actual point to be decided appears to me to be comparatively easy. The difficulty in the case arises from the invitation made to us by Mr Rigby [counsel for the plaintiff] to lay down certain principles, the adoption of which would, in my judgment, paralyse the trade of the country. … [21] What I have stated is the whole of the enactments relating to capital which are to be found in the Companies Acts. If you look further you find next to nothing about profits or dividends. There is nothing at all in the Acts about how dividends are to be paid, nor how profits are to be reckoned; all that is left, and very judiciously and properly left, to the commercial world. It is not a subject for an Act 151

L C B Gower, The Principles of Modern Company Law (3rd ed, 1969), p 117 citing Peter Buchanan Ltd v McVey [1955] AC 516n; QBE Insurance Group Ltd v ASC (1992) 8 ACSR 631 at 649.

152

One or other of each of these tests is adopted in United States jurisdictions: R C Clark, Corporate Law (1986), Ch 14. [9.370]

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Lee v Neuchatel Asphalte Co cont. of Parliament to say how accounts are to be kept; what is to be put into a capital account, what into an income account, is left to men of business. Mr Rigby, with the courage which was necessary, asked us to say there was in these articles a provision as to division of profits which was contrary to law. If he can make that out he wins, but if he cannot make it out he loses. He saw that plainly enough. … Then s 100 contains a provision which carries the case against Mr Rigby unless it is illegal. It [22] says: The directors may, before recommending any dividend on any of the shares, set aside out of the net profits of the company such sum as they think proper as a reserve fund to meet contingencies, or for equalising dividends, or for repairing or maintaining the works connected with the business of the company or any part thereof, and the directors may invest the sum so set apart as a reserve fund, or any part thereof, upon such securities as they may select; but they shall not be bound to form a fund or otherwise reserve moneys for the renewal or replacing of any lease, or of the company’s interest in any property or concession. First of all let us see what that means. We are dealing with a lease for a limited number of years, which is a wasting property, and while it is wasting the capital spent in acquiring it is wasting. The article says in so many words that although in every year the capital may be wasted by working out the mine so that at the end there may be nothing left, yet this company is formed on the principle that it shall not be obliged to replace year by year that which is so wasted. Mr Rigby says that is contrary to law. Let us see whether that is made out. Having stated shortly what are the provisions of the Acts of Parliament relating to this matter, I may safely say that the Companies Acts do not require the capital to be made up if lost. They contain no provision of the kind. There is not even any provision that if the capital is lost the company shall be wound up, and I think this omission is quite reasonable. The capital may be lost and yet the company may be a very thriving concern. As I pointed out in the course of the argument, and I repeat now, suppose a company is formed to start a daily newspaper; supposing it sinks £250,000 before the receipts from sales and advertisements equal the current expenses, and supposing it then goes on, is it to be said that the company must come to a stop, or that it cannot divide profits until it has replaced its £250,000, which has been sunk in building up a property which if put up for sale would perhaps not yield £10,000? That is a business matter left to business men. If they think their prospects of success are considerable, so long as they pay their creditors, there is no reason why they should not go on and [23] divide profits, so far as I can see, although every shilling of the capital may be lost. It may be a perfectly flourishing concern, and the contrary view I think is to be traced to this, that there is a sort of notion that the company is debtor to capital. In an accountant’s point of view, it is quite right, in order to see how you stand, to put down company debtor to capital. But the company does not owe the capital. What it means is simply this: that if you want to find out how you stand, whether you have lost your money or not, you must bring your capital into account somehow or other. But supposing at the winding up of the concern the capital is all gone, and the creditors are paid, and there is nothing to divide, who is the debtor? No one is debtor to anyone. If there is any surplus to divide, then, and not before, is the company debtor to the shareholders for their aliquot portions of that surplus. But the notion that a company is debtor to capital, although it is a convenient notion, and does not deceive mercantile men, is apt to lead one astray. The company is not debtor to capital; the capital is not a debt of the company. Having shewn from the Acts (negatively, of course, because this is a negative proposition, and can only be proved by looking through the Acts) that the Acts do not require the capital to be made up if lost, I cannot find anything in them which precludes payment of dividends so long as the assets are of less value than the original capital. If they are so, it becomes a question of prudence for mercantile men whether they will wind up or not. I have already pointed out that the Act says nothing to make the loss of the capital a ground for winding up, and I have already pointed out that it says nothing about profits. The Act does not say that dividends are not to be paid out of capital, but there are general principles of law according to which the capital of a company can only be applied for the purposes mentioned in the memorandum of association. That is a fundamental principle of law, and if any of those purposes are expressly or impliedly forbidden by the statutes, the capital cannot be applied for those purposes even though there may be a clause in the memorandum that it shall. … 762

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Lee v Neuchatel Asphalte Co cont. [24] Now we come to consider how the Companies Act is to be applied to the case of a wasting property. If a company is formed to acquire and work a property of a wasting nature, for example, a mine, a quarry, or a patent, the capital expended in acquiring the property may be regarded as sunk and gone, and if the company retains assets sufficient to pay its debts, it appears to me that there is nothing whatever in the Act to prevent any excess of money obtained by working the property over the cost of working it, from being divided amongst the shareholders, and this in my opinion is true, although some portion of the property itself is sold, and in some sense the capital is thereby diminished. If it is said that such a course involves payment of dividend out of capital, the answer is that the Act nowhere forbids such a payment as is here supposed. The fact is, you cannot get out of the Act any prohibition against paying dividends out of capital except by having reference to the general principles to which I have alluded, and which general principles cannot be stretched, to my mind, to such a length as Mr Rigby invites the court to stretch them. It appears to me that the proposition that it is ultra vires to pay dividend out of capital is very apt to mislead, and must not be understood in such a way as to prohibit honest trading. If you treat it as an abstract proposition that no dividend can be properly paid out of moneys arising from the sale of property bought by capital, you find yourself landed in consequences which the common sense of mankind would shrink from accepting. On the other hand, if the working expenses exceed the current gains, you cannot divide your capital under the head of profits when there are no profits in any sense of the term. … [25] As regards the mode of keeping accounts, there is no law prescribing how they shall be kept. There is nothing in the Acts to shew what is to go to capital account or what is to go to revenue account. We know perfectly well that business men very often differ in opinion about such things. It does not matter to the creditor out of what fund he gets paid, whether he gets paid out of capital or out of profit net or gross. All he cares about is that there is money to pay him with, and it is a mere matter of book-keeping and internal arrangement out of what particular fund he shall be paid. Therefore you cannot say that the question of what ought to go into capital or revenue account is a matter that concerns the creditor. The Act does not say what expenses are to be charged to capital and what to revenue. Such matters are left to the shareholders. They may or may not have a sinking fund or a deterioration fund, and the articles of association may or may not contain regulations on those matters. If they do, the regulations must be observed; if they do not, the shareholders can do as they like, so long as they do not misapply their capital and cheat their creditors. In this case the articles say there need be no such fund, consequently the capital need not be replaced; nor, having regard to these articles, need any loss of capital by removal of bituminous earth appear in the profit and loss account. [Cotton and Lopes LJJ delivered concurring judgments.]

Verner v Commercial and General Investment Trust [9.375] Verner v Commercial and General Investment Trust [1894] 2 Ch 239 Court of Appeal, England and Wales [A company was formed to invest in stocks, shares and securities of various descriptions and the income from such investments was by the constitution available for distribution as a dividend. The market price of some securities had fallen and others had proved worthless so that the value overall of the company’s assets had materially diminished. However, the investment income for the year considerably exceeded expenses. One of the trustees of the company sought to restrain the payment of a dividend out of profits until the lost capital was made up.] LINDLEY LJ on behalf of himself and A L SMITH LJ: [265] It is obvious that dividends cannot be paid out of capital which is lost; they can only be paid out of money which exists and can be divided. Moreover, [9.375]

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Verner v Commercial and General Investment Trust cont. when it is said, and said truly, that dividends are not to be paid out of capital, the word “capital” means the money subscribed pursuant to the memorandum of association, or what is represented by that money. … [266] But, although there is nothing in the statutes requiring even a limited company to keep up its capital, and there is no prohibition against payment of dividends out of any other of the company’s assets, it does not follow that dividends may be lawfully paid out of other assets regardless of the debts and liabilities of the company. A dividend presupposes a profit in some shape, and to divide as dividend the receipts, say, for a year, without deducting the expenses incurred in that year in producing the receipts, would be as unjustifiable in point of law as it would be reckless and blameworthy in the eyes of business men. The same observation applies to payment of dividends out of borrowed money. Further, if the income of any year arises from a consumption in that year of what may be called circulating capital, the division of such income as dividend without replacing the capital consumed in producing it will be a payment of a dividend out of capital within the meaning of the prohibition which I have endeavoured to explain. It has been already said that dividends presuppose profits of some sort, and this is unquestionably true. But the word “profits” is by no means free from ambiguity. The law is much more accurately expressed by saying that dividends cannot be paid out of capital, than by saying that they can only be paid out of profits. The last expression leads to the inference that the capital must always be kept up and be represented by assets which, if sold, would produce it; and this is more than is required by law. Perhaps the shortest way of expressing the distinction which I am endeavouring to explain is to say that fixed capital may be sunk and lost, and yet that the excess of current receipts over current payments may be divided, but that floating or circulating capital must be kept up, as otherwise it will enter into and form part of such excess, in which case to divide such excess without deducting the capital which forms part of it will be contrary to law. … [268] It follows from what has been said above that the proposed payment of dividend in this particular case cannot be restrained. … It is plain there is nothing in them which requires lost capital to be made good before dividends can be declared: on the contrary, they are so framed as to authorise the sinking of capital in the purchase of speculative stocks, funds, and securities, and the payment of dividends out of whatever interest, dividends, or other income such stocks, funds, and securities yield, although some of them are hopelessly bad, and the capital sunk in obtaining them is lost beyond recovery. [Kay LJ delivered a concurring judgment.]

Notes&Questions

[9.377]

1.

B S Yamey, “Aspects of the Law Relating to Company Dividends” ((1941) 4 MLR 273 at 278-279) describes the contemporary reaction to Lee v Neuchatel Asphalte Co: One may expect that accountants would have welcomed the decision, leaving business matters to business men; because accountants, as a profession, represent a very responsible section of business opinion, especially on matters of accounts. But the decision met with a storm of disapproval from accountants, despite the opinion of the law journals that the decision was in accordance with the “principles of business”. An editorial in The Accountant declared that “the principles it lays down are simply startling and as they are directly applicable to all colliery and other mining concerns, the danger to be apprehended from their general adoption is neither fanciful nor small.” The same journal later denounced the judgment as “the most mischievous which has ever been given in relation to company matters”, and as being “entirely against the almost universal practice of accountants”. In his efforts to free business men from the “strait-waistcoat of a legal formula”, Lindley had sanctioned practices frowned upon by specialists in company accounting.

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Do you agree with Yamey’s view (at 280) that Lee v Neuchatel and Verner’s case knocked the bottom … out of the creditors’ safeguard. … As regards creditor protection the new rule created an anomalous position. An investment company which was in a poor way as a result of serious security value depreciation, but which nevertheless had received large dividends from a few of its investments, could further jeopardise the creditors’ position by paying a dividend; while a sound investment company which had suffered little or no capital depreciation, but which had not received sufficient dividends to cover its working expenses as well as a dividend distribution, was prevented from paying its shareholders a penny.

Ammonia Soda Co Ltd v Chamberlain [9.380] Ammonia Soda Co Ltd v Chamberlain [1918] 1 Ch 266 Court of Appeal, England and Wales [A manufacturing company carrying on a newly formed business incurred trading losses for several years before becoming profitable. The directors set off the losses against an appreciation of the company’s capital assets as ascertained by a valuation made by two of their number and approved by the company in general meeting. They proposed to pay dividends out of subsequent profits without any further provision for past revenue losses. The plaintiff shareholder argued that no profits were available for dividend until such revenue losses had been made good.] SWINFEN EADY LJ: [283] In my judgment this argument is unsound and has been exposed again and again. The Companies Acts do not impose any obligation upon a limited company, nor does the law require, that it shall not distribute as dividend the clear net profit of its trading unless its paid up capital is intact or until it has made good all losses incurred in previous years. … [286] The distinction between “fixed” capital and “circulating” capital is not to be found in any of the Companies Acts; it appears to have first found its way into the Law Reports in Lee v Neuchatel Asphalte Co (1889) 41 Ch D 1, where Lindley LJ in his judgment adopted the expression which had been used by Sir Horace Davey in argument, derived from writers on political economy. It is necessary to consider the sense in which the expressions “fixed capital” and “circulating capital” were used in that case and in Verner’s case [1894] 2 Ch 239. What is fixed capital? That which a company retains, in the shape of assets upon which the subscribed capital has been expended, and which assets either themselves produce income, independent of any further action by the company, or being retained by the company are made use of to produce income or gain profits. A trust company formed to acquire and hold stocks, shares, and securities, and from time to time to divide the dividends and income arising therefrom, is an instance of the former. A manufacturing company acquiring or erecting works with machinery and plant is an instance of the latter. In these cases the capital is fixed in the sense of being invested in assets intended to be retained by the company more or less permanently and used in producing an income. What is circulating capital? It is a portion of the subscribed capital of the company intended to be used by being temporarily parted with and [287] circulated in business, in the form of money, goods or other assets, and which, or the proceeds of which, are intended to return to the company with an increment, and are intended to be used again and again, and to always return with some accretion. Thus the capital with which a trader buys goods circulates; he parts with it, and with the goods bought by it, intending to receive it back again with profit arising from the resale of the goods. A banker lending money to a customer parts with his money, and thus circulates it, hoping and intending to receive it back with interest. He retains, more or less permanently, bank premises in which the money invested becomes fixed capital. It must not, however, be assumed that the division into which capital thus falls is permanent. The language is merely used to describe the purpose to which it is for the time being appropriated. This purpose may be changed as often as considered desirable, and as the constitution of the bank may allow. Thus bank premises may be sold, and conversely the money used as circulating capital may be expended in acquiring bank premises. The terms “fixed” and “circulating” are merely terms convenient for describing the purpose to which the capital is for the time being devoted when considering its position in respect to the profits available for dividend. Thus when circulating capital is expended in buying goods which are sold at a profit, or in buying raw [9.380]

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Ammonia Soda Co Ltd v Chamberlain cont. materials from which goods are manufactured and sold at a profit, the amount so expended must be charged against, or deducted from, receipts before the amount of any profits can be arrived at. This is quite a truism, but it is necessary to bear it in mind when you are considering what part of current receipts are available for division as profit. … [289] [The plaintiff] invited the court to lay down that wherever there was a debit to the profit and loss account, irrespective of the way in which it arose, of the stage in the company’s operations, and of the nature and business of the company, it was illegal to divide profits subsequently earned without first writing off out of those profits the amount of the debit. To do so … would only serve to harass and embarrass business men and impose upon companies a burden which Parliament has abstained from casting upon them: see Dovey v Cory [1901] AC 488. The directors in this case were of opinion that no capital had been really lost, and they were of opinion that the value of the land and works as a going concern had been increased, as a result of their boring and exploratory work. … [290] The transaction was carried out with the full approval of the shareholders in general meeting, and in all honesty and good faith. The dividends complained of, paid out of net earnings in the subsequent years, were not paid out of capital, but out of profits, and the defendants are, in my opinion, under no liability whatever to repay the same, or any part. [Warrington and Scrutton LJJ delivered concurring judgments.]

[9.382]

1.

Notes&Questions

The Ammonia Soda case received a more favourable professional response: Even accounting opinion had at last approved of a legal decision, partly because of its undoubted lucidity (as compared with its predecessors) and partly because it “is likely to be convenient in practice”. It would often be a very great convenience if directors felt fully justified in declaring dividends out of profits earned as soon as a company has really “turned the corner”, and begun to make profits, instead of feeling compelled in the first instance to apply all profits made towards the making up of past losses. (B S Yamey (1941) 4 MLR 273 at 285).

By 1962, however, the Jenkins Committee in England was receiving evidence that the law should be changed to require that past revenue losses be eliminated before the profits of subsequent years become distributable. It accepted these views and recommended that a company’s revenue account be recognised as a continuous account: see Report of the Company Law Committee (Cmnd 1749, 1962), [341]. The recommendation was adopted in the United Kingdom in 1980. 2.

If a company makes a trading loss in the current year, may it declare a dividend against prior undistributed trading profits? See Re Hoare & Co Ltd [1904] 2 Ch 208. If so, what does this signify for the continuity of the revenue account under Australian law? On the steps required to capitalise distributable profits, see Glenville Pastoral Co Pty Ltd (in liq) v Commissioner of Taxation (Cth) (1963) 109 CLR 199 at 207-208.

3.

A smelting company operating on a large scale, for the convenience of its works, acquired the lease of some mines in order to supply its own ore instead of buying as required. The mines became flooded and the cost of pumping them out was prohibitive. The company therefore surrendered the leases, pulling down the blast furnaces and sold the cottages connected with them. The losses realised amounted to £200,000. Apart from this item the company shows a surplus from trading for the year. The directors wish to pay dividends out of current year profits. May they do so? See Bond v Barrow Haematite Steel Co [1902] 1 Ch 353 at 366-367.

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Lubbock v British Bank of South America [9.385] Lubbock v British Bank of South America [1892] 2 Ch 198 Chancery Division [A company sold certain of its assets for a surplus of £205,000 over the cost of their acquisition. The company’s balance sheet showed a surplus of assets over liabilities in the amount of £44,000. A shareholder complained that the profit from the sale was not distributable as a dividend.] CHITTY J: [201] The capital of the bank is intact, and the account shews it, and after providing for the capital, there remains a surplus which rightly goes to the profit and loss account. All that the company is required to do, by force of the Companies Act 1862 (UK) is, to keep its capital intact, and not to pay dividends out of its own capital; in other words, to keep that capital for its creditors, and any others who may be concerned therein. That mode of keeping the account is an excellent illustration of the right way to divide profit and loss. Taking the figures on this account, this sum of £44,000 is profit made, and profit available within the Act of 1862 for division among the shareholders, unless there is something in the articles which would prevent the directors, and prevent the company, from dividing the sum which thus stands to their credit. I say I have great difficulty in following the first portion of the argument for the plaintiff, because it was said that what was sold was part of the capital of the company, and that what came in over and above the £500,000 [viz, the amount shown in the balance sheet for liabilities] was an accretion to capital, [202] therefore it must be kept intact as part of the capital. That has, with great respect to the counsel who put forward this argument, nothing to do with the matter. The sale being an authorised sale, it is immaterial what is the thing sold.

[9.387]

Notes&Questions

In Australasian Oil Exploration Ltd v Lachberg (1958) 101 CLR 119 at 133, Dixon CJ, McTiernan and Taylor JJ said: [Counsel for the appellant] asserted that if a company engages in a transaction whereby it disposes, otherwise than in the course of its trading or business activities, of a single capital asset for a price in excess of the value at which that asset stands in its books, it may lawfully distribute the casual profit so made among its shareholders whatever the capital position of the company might otherwise be. This proposition was emphatically rejected by [the trial judge] and we agree with him in thinking that this is not the law. It is enough on this point to say that a company has no capital profits available for dividend purposes unless upon a balance of account it appears that there has been an accretion to the paid up capital.

See also Foster v New Trinidad Lake Asphalt Co Ltd [1901] 1 Ch 208 at 212-213.

Dimbula Valley (Ceylon) Tea Co Ltd v Laurie [9.390] Dimbula Valley (Ceylon) Tea Co Ltd v Laurie [1961] 1 Ch 353 Chancery Division [A company’s constitution provided that the company might resolve that any sum standing to the credit of any reserve account including share premiums “or any sum arising from any operation creating an excess of assets on capital account be capitalised and distributed by way of dividend”: art 140. The company took out a summons to determine whether it had power under the article to allot to shareholders shares credited as fully paid up by way of capitalisation of assets resulting from the revaluation (without realisation) of the capital assets. Preference shareholders opposed the capitalisation. Their counsel referred to the decision of the Court of Session (Scotland) in Westburn Sugar Refineries Ltd v Inland Revenue Commissioners [1960] TR 105.] BUCKLEY J: [371] [A]fter holding that the capitalisation having been of an increment in the value of fixed assets, the subject matter could not have been utilised in making a distribution within the meaning of the section, [the Lord President (Lord Clyde)] went on to say (at 107), as a separate [9.390]

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Dimbula Valley (Ceylon) Tea Co Ltd v Laurie cont. ground for his decision, that it would have been illegal for the company to have distributed the amount in question. After referring to a passage in Palmer’s Company Law (20th ed, 1959), p 645, which, for myself, I read as saying that by law an unrealised profit resulting merely from revaluation of fixed assets can be treated as a profit for dividend purposes, but that this is not normally to be regarded as a wise commercial practice, but which the Lord President seems to have interpreted otherwise, he said (at 107): I am of opinion that these observations are sound, and that particularly in the case of an appreciation, which is neither realised nor immediately realisable, it would be illegal to distribute the surplus. Lord Sorn said (at 109): “In my view, capital profits are not distributable until they are realised.” Founding himself on these observations Mr Sykes contends that a reserve fund resulting from a revaluation of fixed assets could not legitimately be distributed by way of dividend. Consequently, he says, it cannot legitimately be capitalised. It is [372] to be observed that art 140 provides that the capitalised sum is to be “appropriated as capital to and amongst the shareholders who would have been entitled thereto if the same had been distributed by way of dividend in the shares and proportions in which they would have been so entitled”. These words are common form in articles of this kind, and I think that it is correct to say that a capitalisation of this sort is in essence the declaration of a dividend combined with the application of that dividend on behalf of the shareholders entitled to participate in it in paying up shares to be allotted and issued to them in satisfaction of their rights of participation: see Hill v Permanent Trustee Co of New South Wales Ltd [1930] AC 720. As a general rule only that which could be distributed in dividends can be capitalised. Where the rights of various classes of shares to participate in profits differ from their rights of participating in a winding up, any other view or arrangement would lead to anomalous results. The exception to this general rule is that a sum standing to the credit of a share premium account or of a capital redemption reserve fund may not be distributed, except as provided by [the statute] but may be capitalised [under particular provisions]. The Court of Appeal has held that, if a share premium account is distributed with the sanction of the court, the distribution must be treated as though it were not a distribution of profit but a repayment of paid up capital: Re Duff’s Settlements [1951] Ch 923. A share premium account and a capital redemption reserve fund are, however, statutory creatures and these statutory provisions governing their distribution are of a special and artificial character. This exception to the general rule which I have formulated accordingly does not, in my judgment, in any way discredit the rule. If, therefore, the Court of Session was right in holding that a reserve fund constituted as a result of a revaluation of unrealised fixed assets could not legally be distributed, it would seem to me to follow that it likewise could not legally be capitalised. It has, I think, long been the generally accepted view of the law in this country (though not established by judicial authority) that, if the surplus on capital account results from a valuation made in good faith by competent valuers, and is not likely to be liable to short-term fluctuations, it may properly be capitalised: see Inland Revenue Commissioners v Thornton Kelley & Co Ltd [1957] 1 WLR 482. [373] … For myself, I can see no reason why, if the valuation is not open to criticism, this should not be so, or even why, in any case in which the regulations of the company permit the distribution by way of dividend of profit on capital account, a surplus so ascertained should not be distributed in that manner. After all, every profit and loss account of a trading concern which opens and closes with a stock figure necessarily embodies an element of estimate. The difference between ascertaining trading profits by, amongst other things, estimating the value of the stock in hand at the beginning and end of the accounting period, and ascertaining capital profits by comparing an estimated value of the assets with their book value, appears to me to be a difference of degree but not of principle. Moreover, if a company has fluid assets available for payment of a dividend, I can see nothing wrong in its using those assets for payment of a dividend, and at the same time, as a matter of account, treating that dividend as paid out of a capital surplus resulting from an appreciation in value of unrealised fixed assets. The proper balance of the company’s balance sheet would not be disturbed by such a course of action. The company would be left with assets of sufficient value to meet the commitments shown on the liabilities side of its balance sheet, including paid up share capital. A company is not required by law to keep any part of its assets in any particular form. I do 768

[9.390]

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CHAPTER 9

Dimbula Valley (Ceylon) Tea Co Ltd v Laurie cont. not say that in many cases such a course of action would be a wise commercial practice, but for myself I see no ground for saying that it is illegal.

Notes&Questions

[9.392]

1.

The decision in Dimbula Valley v Laurie has been followed in New Zealand and a cash distribution sustained against an unrealised accretion: Re NZ Flock and Textiles Ltd [1976] 1 NZLR 192. In the Supreme Court of New South Wales Needham J in Blackburn v Industrial Equity Ltd (1976) 2 ACLR 8 at 16 said: [I]f the question needed to be decided in these proceedings, I would [follow Buckley J in Dimbula Valley in preference to the Court of Session in Westburn Sugar Refineries v Inland Revenue Commissioners]. I would leave open the question whether a distribution of profit was permissible where it arose from a selective or incomplete revaluation of a company’s assets. In such a case, it may be that other assets shown in the accounts at book value would need to be devalued and such depreciation set against the appreciation of other assets revalued.

In Industrial Equity Ltd v Blackburn (1977) 137 CLR 567 at 580 Jacobs J said that “[i]t was accepted before this court [viz, the High Court of Australia] that the reasoning of Buckley J in Dimbula Valley (Ceylon) Tea Co Ltd v Laurie correctly stated the law”. Neither party sought, however, to rely upon the decision. It was accepted in Krecichwost v R [2012] NSWCCA 101 at [56]; see also Federal Commissioner of Taxation v Sun Alliance Investments Pty Ltd (in liq) (2005) 225 CLR 488 at [49], HNA Irish Nominee Ltd v Kinghorn (No 2) (2012) 88 ACSR 427; [2012] FCA 228 at [291] and QBE Insurance Group Ltd v ASC (1992) 8 ACSR 631 at 648-649. 2.

3.

Does the restriction expressed by the High Court in Australasian Oil Exploration Ltd v Lachberg (1958) 101 CLR 119 (see [9.387], Notes and Questions) apply to distributions against unrealised accretions to value? See further J Routledge & P Slade (2003) 23 C&SLJ 447.

Civil liabilities [9.395] The general law rule was that, if a dividend is paid otherwise than out of the profits of

a company, the directors who authorise the payment may be personally liable to pay the amount of the dividend to the company. 153 That rule is not wholly displaced by the revision of s 254T: see [9.355]. Second, payment of a dividend in contravention of s 254T, other than through the procedure for an authorised capital reduction, contravenes s 256D(1); a person who is involved in the company’s contravention of s 256D(1) (eg, by authorising the improper payment) contravenes s 256D(3), a civil penalty provision: s 1317E. They may also contravene s 180(1), the statutory duty of care. The person commits an offence if their involvement in the contravention of s 256D(1) is dishonest: s 256D(4). The company paying the dividend is not, however, guilty of an offence and the dividend is validly paid: s 256D(2). Third, as noted, directors may also be personally liable to compensate the company where the payment of dividends impairs the company’s solvency. The payment of a dividend is 153

Blackburn v Industrial Equity Ltd (1980) ACLC 40-604; Hilton International Ltd v Hilton [1989] 1 NZLR 442; Ammonia Soda Co v Chamberlain [1918] 1 Ch 266 at 292; Re City Equitable Fire Insurance Co Ltd [1925] Ch 407. [9.395]

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deemed to be the incurring of a debt for purposes of insolvent trading liability under s 588G(2); the debt is incurred when the dividend is paid or, if the company has a constitution that provides for the declaration of a dividend, when it is declared: s 588G(1A) (item 1). Breach of s 588G exposes the director to a civil penalty order under Pt 9.4B or, if the company goes into liquidation, to a compensatory order under Pt 5.7B Div 4: see [7.190]. [9.400]

Review Problem

A company both owns and leases land on which it operates a substantial banana plantation and a related amusement park for tourists. In January its directors resolve to pay an interim dividend to shareholders in an amount of $500,000. The interim accounts before the board disclose that the revenue from the sale of bananas and from the amusement park activities exceeded outgoings in the previous half year by $200,000. In the same period the company had sold a parcel of land at a profit over book value of $300,000. However, before the interim dividend could be paid, a cyclone strikes and heavy rain caused massive subsidence of the land on which the plantation and amusement park is situated. The damage was valued promptly at $1 million and insurance cover amounted only to $400,000. Further, with the additional expense and revenue loss consequent on the rains, the company incurs operating losses of $200,000 for the March quarter. In April the board is still anxious to make distributions, including the unpaid interim dividend. The accounts show that, three years earlier, the company’s freehold land and improvements (now affected by the rain damage) was re-valued upward by $300,000 which figure remains in the company’s accounts. Further, the company has carried forward trading profits of $100,000 from the previous financial year. What distributions may be made in April and at the end of the financial year on 30 June?

770

[9.400]

CHAPTER 10 Corporate Fundraising [10.10]

[10.30]

THE DISCLOSURE PHILOSOPHY OF NEW ISSUE REGULATION ....................................................... 772 [10.10]

The bases for regulation ............................................................................................... 772

[10.15]

Mandatory disclosure and its critics .............................................................................. 773

RECASTING THE STRUCTURE OF FUNDRAISING REGULATION ...................................................... 777 [10.35] [10.40] [10.50]

[10.55]

WHEN DISCLOSURE IS REQUIRED FOR INVESTORS ....................................................................... 781 [10.55] [10.60] [10.75]

[10.95]

[10.140]

[10.195]

The public offer concept .............................................................................................. 777 CLERP and the Financial Services Reform amendments ................................................. 778 Coverage of Chapter 6D: the definition of security ....................................................... 780 ASIC’s role and some foundational concepts ................................................................ 781 Sale offers that need disclosure .................................................................................... 782 Offers that do not need disclosure ............................................................................... 784

WHAT MUST BE DISCLOSED ......................................................................................................... 787 [10.95] [10.100]

The forms of disclosure document ............................................................................... 787 Prospectus content ...................................................................................................... 790

[10.120] [10.125]

Short form prospectuses .............................................................................................. 796 Profile statement content ............................................................................................. 796

[10.130] [10.135]

Offer information statement content ............................................................................ 797 Common defects in disclosure documents ................................................................... 798

THE PROCEDURE FOR OFFERING SECURITIES ............................................................................... 799 [10.140] [10.145] [10.150] [10.160] [10.165] [10.180]

The fundraising process in overview ............................................................................. Preparation of the disclosure document ....................................................................... Lodgment of the disclosure document with ASIC ......................................................... Holding the application money .................................................................................... Restrictions on advertising and publicity of securities offerings ..................................... Securities hawking .......................................................................................................

799 800 801 803 803 806

[10.185]

ASIC’s powers of enforcement, exemption and modification ........................................ 807

LIABILITY FOR THE CONTENTS OF DISCLOSURE DOCUMENTS .................................................... 809 [10.200]

Misleading or deceptive statements, omissions and new circumstances .............................................................................................................. 809

[10.202]

Fraud upon the market, reliance and the problem of causation .................................... 811

[10.205] [10.207] [10.210]

Defences to liability ...................................................................................................... 813 Due diligence process for assuring disclosure integrity ................................................. 815 Civil liability for misleading or deceptive conduct ......................................................... 816

[10.220]

Other remedies and liabilities with respect to fundraising under the Act ......................................................................................................................... 818

[10.225]

The rescission remedy with brief reference to tort liability for fundraising ..................... 818

[10.05] Corporations raise funds through the issue of their securities – shares, debentures and

options to subscribe for shares and debentures. These are major although not the only sources of corporate finance: see [9.35]-[9.40]; debt is also a major source of business finance for all company types but especially for smaller companies. They may do so by means of an initial public offering of securities when the company is first listed upon a securities exchange. Subsequent capital raising may be by a rights offer to existing holders of securities entitling [10.05]

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Corporations and Financial Markets Law

them to subscribe for new securities in proportion to their existing holdings, usually at a discount to the current market price of the security sufficient to induce subscription. The right to subscribe for new securities may be expressed to be renounceable in favour of another person (in which case it may have an economic value in itself and be sold upon the exchange) or non-renounceable, that is, exercisable only by the holder. Companies also raise new capital by the issue (or placement) of securities other than to existing holders. However, in the interest of protecting shareholders’ interests, stock exchange listing rules restrict the proportion of equity capital that may be raised by placement without shareholder approval: see [5.110]. For several reasons, the process by which corporations solicit investments in their securities has been a central concern of corporate regulation. What is offered, especially in the case of share capital, has an intangible, indeterminate and often speculative character. There are inevitably informational asymmetries between issuer and investor, whose degree varies with the particular security offered and financial sophistication of the group of investors to whom the offer is addressed. The consequence is the temptation upon issuers to withhold or misstate adverse information and to overstate or selectively disclose positive information and outlook. The consequences are not always discoverable by pre-investment investigation. Ultimately, capital raising will only succeed in an environment in which investors have confidence in the integrity of the fundraising process, whether founded upon legal, market or other mechanisms or some combination of them. On the other hand, excessively protective fundraising regulation imposes costs on capital raising that dispose corporations towards other means of meeting needs for finance, such as bank lending. The concern of this chapter is with the solicitation of investments in corporate securities. The chapter examines the foundations of the disclosure policy which underpins new issue regulation and the structure of regulation itself. It looks at when a disclosure document is required for an offering of securities, what must be disclosed and the procedure for offering securities. The disclosure policy underlying the capital raising provisions is predicated upon a complex of liabilities attaching to false or misleading statements in, or material omissions from, an offering document; these liabilities and the defences to them are examined together with the enforcement powers vested in ASIC.

THE DISCLOSURE PHILOSOPHY OF NEW ISSUE REGULATION The bases for regulation [10.10] The initial English companies statute adopted a disclosure philosophy for the

regulation of corporate registration and fundraising: see [2.55]. Under this policy, as the price of registration, the state adopts a limited interventionism by requiring disclosure as to specified matters perceived to be material to the judgment of potential investors. Beyond that, the state does not attempt any merits review of the efficacy or equity of the proposed venture or of the interests in it which are being offered to the public. 1 Australian regulatory policy with respect to new issues largely followed the English model. The United States experience, however, neatly demonstrates alternative approaches which might be taken. The Federal Securities Act 1933 (US) adopts the English disclosure policy although the Securities and Exchange Commission (SEC) has achieved considerable control over statements in a prospectus (the fundraising document) by its power to delay registration. 1

Brandeis’s is perhaps the most eloquent justification of this policy: “Publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants, electric light the most efficient policeman”: L D Brandeis, Other People’s Money (1914), Ch 5.

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[10.10]

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At the other end of the regulatory spectrum are the blue sky laws 2 of a minority of States which subject an offering to various merits tests, for example, by requiring the State regulatory agency to find that the terms of the issue are “fair, just and equitable”. The great majority of States, however, have taken an intermediate position by adopting the Uniform Securities Act drafted by Professor Louis Loss in 1954-1956. 3 In addition to the federal disclosure standard, the Act authorises the making of a stop order by the State agency against a prospectus on a finding of unreasonable selling expenses, promoters’ profits or options. The underlying theory is that these three areas would cover most of the classic abuses without the indefiniteness of the blue sky standard. 4 The United States securities legislation has been among the most significant and enduring achievements of the Roosevelt New Deal administration and has retained both its structure and wide political support. 5 The legislation inaugurated the distinct discipline of securities regulation as a complement to corporations legislation. 6 There are no fixed boundaries between the two areas and the precise division in each country will reflect differences in its legislative tradition and constitutional structure. In the United States the Securities Act 1933 (US) and the Securities Exchange Act 1934 (US) represent the principal exercise of federal legislative power with respect to corporations and securities since power over corporations rests principally with State legislatures. The 1933 Act is primarily concerned with the protection of investors in new issues of securities and the 1934 Act with secondary markets and their participants. In Australia companies legislation has long regulated primary distributions of securities while secondary markets have been regulated by statute only since 1970: see [2.80]. This distinction between primary and secondary distributions is reflected in the present treatment. This chapter is concerned with capital raising and Chapter 11 with the regulation of secondary markets. However, since the capital raising provisions of the corporations legislation are now expressed to apply to secondary as well as primary distributions of securities, the division between regulation and the two areas is no longer as neat as it had earlier been. Mandatory disclosure and its critics

Disclosure as an investor protection device [10.15] The principal motive for the passage of the United States Securities Act 1933 was the protection of investors in new capital raising. A congressional report in 1933 outlines some of the concerns that troubled legislators: During the post-war decade some $50bn of new securities were floated in the United States. Fully half or $25bn worth of securities floated during this period have been proved to be worthless. These cold figures spell tragedy in the lives of the thousands of individuals who invested their life savings, accumulated after years of effort, in these worthless securities. The 2

So named after a Kansas legislator in 1916 who feared that the greed of promoters from the financial centres of the northeast (principally New York) would lead them to “sell building lots in the blue sky in fee simple” to the honest, if financially unsophisticated, citizens of Kansas: quoted in L Loss, Fundamentals of Securities Regulation (2nd ed, 1988), p 8.

3 4

See Loss, pp 8-16 and L Loss, Securities Regulation (1961), Vol 1 pp 96-105. L Loss, Proposals for Australian Companies and Securities Legislation (1973) (report prepared for the Australian Government), p 17.

5 6

F H Easterbrook & D R Fischel (1984) 70 Va L Rev 669. The novelty lies more in the scope and system of regulation, rather than in the enterprise itself: securities regulation has been described as the “oldest branch of consumer protection after usury laws” (P Wood, Law and Practice of International Finance (1980), p 177). [10.15]

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flotation of such a mass of essentially fraudulent securities was made possible because of the complete abandonment by many underwriters and dealers in securities of those standards of fair, honest, and prudent dealing that should be basic to the encouragement of investment in any enterprise. Alluring promises of easy wealth were freely made with little or no attempt to bring to the investor’s attention those facts essential to estimating the worth of any security. High pressure salesmanship rather than careful counsel was the rule in this most dangerous enterprise. 7

Proponents of the mandatory disclosure requirement of the United States securities laws have argued that, without such disclosure, some issuers will withhold or misrepresent information material to investment decision, and underwriting costs and insiders’ benefits will rise to excessive levels. 8 They argue that there will be inadequate incentive for substantial voluntary disclosure and that public confidence in the integrity of securities markets will be at suboptimal levels. Mandatory disclosure coupled with an anti-fraud provision reduces the incidence of fraud, enhances the reliability of estimates of firm value and reduces the volatility of price swings. Risk minimisation enhances investor confidence and, accordingly, the level of investment through securities markets. The mandatory disclosure requirements for new issues under the 1933 Act and the continuous disclosure requirements of the 1934 Act have, however, drawn a considerable body of criticism. The first set of critics studied stock price movements both prior and subsequent to the 1933 and 1934 Acts and argued that the Acts had no significant effect upon the quality of securities distributed in primary and secondary markets. These studies adopt as a measure of the reliability of information disclosed to the market, and investor confidence in that information, the variability in price movements of the stocks studied relative to those of the stock market generally. Lower relative variability of new issue prices is indicative of a better informed market. Stigler compared the price history of new industrial stock offerings in 1923-1928 with those made in 1949-1955. 9 Although Stigler initially disputed any price enhancement, after recomputations following corrections for data errors, it emerged that, on average, the post-SEC price performance was superior in four of the five years. 10 While Stigler suggested that this outcome was explicable upon the basis that mandatory disclosure had excluded the riskier new issues from capital markets, 11 it is also consistent with the inference that mandatory disclosure had enriched the information fund available to investors. Another study challenged the benefits of the continuous disclosure requirements of the 1934 Act. Benston examined the stock price behaviour of two groups of companies listed on the New York Stock Exchange (NYSE), one group which had voluntarily disclosed sales figures and other information before being required to do so by the 1934 Act and another group which had done so only after it became compulsory. 12 Benston concluded that there were no significant differences in stock price variability post-1934 and that the mandatory 7

H R Report No 85, 73d Congress, 1st Sess (1933) quoted in J D Cox, R W Hillman & D C Langevoort, Securities Regulation: Cases and Materials (Little, Brown & Co, 1991), p 14; see also L Loss, Fundamentals of Securities Regulation (2nd ed, 1988), pp 25-35; L Loss & J Seligman, Securities Regulation (3rd ed, 1989), Vol 1 pp 25-26, 162-171; M E Parrish, Securities Regulation and the New Deal (1970); J M Landis (1959) 28 Geo Wash L Rev 29.

8

Seligman has marshalled substantial documentary evidence in relation to issuer misrepresentation and excessive compensation of underwriters and insiders in the period prior to 1933 and the chilling effect upon these practices of the 1933 Act. See J Seligman (1983) 9 J Corpn L 1. G J Stigler (1964) 37 J Bus 117.

9 10 11

See I Friend & E S Herman (1964) 37 J Bus 414 at 418. The data errors and issues of interpretation and methodology are canvassed in further exchanges at (1964) 37 J Bus 382 and (1965) 38 J Bus 106. (1964) 37 J Bus 117 at 122.

12

G Benston (1973) 63 Amer Econ Rev 132; see also (1969) 44 Accounting Rev 515.

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disclosure generated by the 1934 Act had secured little benefit to investors. The study was, however, challenged upon grounds of methodology and data interpretation and Benston’s results have been interpreted as supporting the conclusion that disclosures mandated by the 1934 Act enabled investors to estimate risk more accurately than under the prior regime of voluntary disclosure. 13 Further, it is not clear why, if only 62% of NYSE listed companies had voluntarily disclosed their sales figures (which elite group might be expected to reflect superior reporting practice), the information gains resulting from mandatory disclosure had not generally enhanced the information environment in which investment decisions were made.

The relevance of disclosure to investment decisions [10.20] A second line of attack upon mandatory disclosure is directed to the type of

information required to be disclosed. These critics complain that the focus of disclosure is upon historically based accounting data and that the SEC has inhibited disclosure of more useful information relating to future earnings and other projections touching the prospective dividend stream and capital appreciation of the stock. 14 The SEC has traditionally taken a cautious view with respect to disclosure of such soft information, partly because of a concern for investor vulnerability given the subjective or soft character of such information and partly out of a concern for the market manipulation opportunities which such disclosure creates. 15 There is also the problem in applying liability standards to forecasts and projections. 16 In 1979 the SEC introduced rule 175, providing a “safe harbour” for some predictions made by an issuer. The rule applies unless it is shown that the statement was made without reasonable basis or was not disclosed in good faith. 17 The rule has, however, a limited coverage. It applies to projections by publicly held corporations with respect to income, revenues and earnings per share, management’s plans for future activities and, within limits, failure of economic performance. It does not apply to predictions about many non-financial events such as timely completion of major projects. 18 A variant of this concern about the actual influence of disclosure upon investment decisions is prompted by events leading up to 2008 financial crisis. The concern is that the complexity of disclosure in relation to distributions of securities defeated the capacity even of sophisticated investors whose investment decisions were, in consequence, driven not by information disclosed but by other behavioural forces. Davidoff and Hill reflect on the collapse of the market for collateralised debt obligations (CDOs), structured asset-backed securities backed increasingly by lower ranked tranches of income from aggregated subprime home mortgages: An explanation of why sophisticated investors bought subprime securities in the volumes and on the terms they did despite the disclosure made is beyond the scope of this Article. We think … that in the case of CDOs in the period before the financial crisis, herd behavior and the incentive for money managers to seek to do no worse than their peers played a large part in driving the market. Once a money manager knows that his peers are buying an investment, his best strategy is to buy it too. At the time of the financial crisis, the herd behavior was to make macro bets on the housing market through CDOs without thorough attention to detail. Disclosure could still work as intended if those effectively leading the herd – those whose behavior was being copied – were strongly influenced by the disclosure. We think this is not 13

See I Friend & R Westerfield (1975) 65 Amer Econ Rev 467; J Seligman (1983) 9 J Corpn L 1 at 12-18; see also R J Gilson & R Kraakman (1984) 70 Va L Rev 549 at 637-638.

14 15 16 17

See, eg, H Kripke, The SEC and Corporate Disclosure: Regulation in Search of a Purpose (1973). See J D Cox (1986) 64 Wash ULQ 475 at 495-499 reviewing studies that corporate insiders systematically time their trading around earnings forecast announcements and thereby secure abnormal returns. See R C Clark, Corporate Law (1986), pp 752-756. Clark, pp 754-756.

18

This account of the rule’s scope is derived from Clark, p 755. [10.20]

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what typically occurred. … Our claim is simply that for sophisticated investors’ purchases of complex securities, including synthetic CDOs, disclosure mattered far less than we might want it to; improving disclosure therefore seems unlikely to make much of a difference. ... The foregoing account reveals an important contrast between the paradigmatic mechanism by which disclosure works, which is largely individual, and the more social and contextual mechanism we hypothesize. To overstate the case a bit, the former contemplates that somebody reviews information provided to them and makes a substantive assessment based on that information; the latter contemplates that the review and assessment may only be one part of an endeavor that takes into account many other things relating to the broader social context. Disclosure is importantly social. 19

This argument suggests that what is needed before reliance is placed on the cleansing power of disclosure is better understanding of how investors, especially sophisticated investors, take in and act on information disclosed.

Mandatory disclosure and market efficiency [10.25] A third school of criticism of mandatory disclosure argues that issuers have sufficient

incentive to make voluntary disclosure of price sensitive information to the market and that the mandatory rule therefore imposes a gratuitous and unnecessary burden. Thus, Easterbrook and Fischel argue: If disclosure is worthwhile to investors, the firm can profit by providing it … The firm controls all of its investments and can appropriate the full value of information. The firm that discloses more can sell its stock for more, indeed for as much more as the full value of all information. 20

Accordingly, firms have sufficient incentive to make comprehensive voluntary disclosure since that reduces the risk inherent in security investment and thereby the discount which investors will attach to new offerings. Disclosure is a bonding device (similar to management fiduciary obligations and the disciplines of capital and control markets discussed at [2.220]) which issuers and their management would voluntarily assume to align issuer and investor interests so that capital might be offered at a higher price and lower cost. High quality firms would protect their quality signal against mimicry by inferior firms by resort to reputation assurance devices. These would include the employment of investment banks and auditors who may lend their significant reputational capital, listing upon a securities exchange, substantial equity investment by insiders and commitments as to future dividend policy. 21 Like much of contract-based theory, its heuristic value depends upon possession of considerably more empirical information as to the mechanisms of stock market operation and efficiency than are available. On its own terms, it might be asked whether under a voluntary regime firms would have sufficient incentive to release bad news: are incentives based upon credibility assurance sufficient for this purpose? Second, it accords to management a considerable discretion as to the timing of price sensitive continuous disclosure, a discretion fraught with considerable opportunities for appropriation and manipulation. 22 Neither is it clear that, despite reputational bonding devices, the calculus of issuer self-interest protects sufficiently against the opportunity for “one-shot killings” in initial public offerings where the burden of investigation, and risk, lies with the investor. 23 19

S M Davidoff and C A Hill (2013) 36 Seattle University L Rev 599 at 631, 632.

20

F H Easterbrook & D R Fischel (1984) 70 Va L Rev 669 at 682-683.

21

These are some of the arguments developed by Easterbrook & Fischel (1984) 70 Va L Rev 669.

22

See, eg, the studies reviewed by J D Cox (1986) 64 Wash ULQ 475 at 495-499.

23

Clark, pp 757-758.

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Each of these schools of criticism raises perspectives or theories by reference to which the following treatment of the legislative, doctrinal and administrative material touching capital raising regulation may be assessed. 24

RECASTING THE STRUCTURE OF FUNDRAISING REGULATION [10.30] The fundraising provisions of the Act embody a regulatory framework whose basic

elements may be traced to the Companies Act 1862 (UK): see [2.60]. While the broad regulatory structure remains, requiring the issuer to make disclosure through a formal disclosure document, there have been fundamental changes to the traditional scheme of fundraising regulation. The public offer concept [10.35] Traditionally, the fundraising provisions applied only to offers or invitations to take

up securities made to the public or a section of the public. The public offer concept identified those solicitations that attracted regulatory protection through a registered offering document called a prospectus and the residual group of those essentially private distributions that were judged not to call for such protection. The public offer test is retained as the foundation of the fundraising regime in the United States and the United Kingdom although subject to detailed qualification and elaboration. It was abandoned in Australia in 1991. 25 The difficulties in its application are evident in Corporate Affairs Commission (SA) v Australian Central Credit Union 26 where the High Court indicated that an offer confined to a particular group may not be a public offer where there is some subsisting special relationship between the offeror and members of the group or some rational connection between the common characteristic of members of a group and the offer made to them. … [W]hether the group constitutes a section of the public … will fall to be determined by reference to a variety of factors of which the most important will ordinarily be: the number of persons comprising the group, the subsisting relationship between the offeror and the members of the group, the nature and content of the offer, the significance of any particular characteristic which identifies the members of the group and any connection between that characteristic and the offer. 27

In that case the credit union proposed to offer to its 23,000 members units in a property trust which owned the credit union’s administrative headquarters. Applying these criteria, the court held that, notwithstanding the size of its audience, the offers would not attract the prospectus provisions as a public offer. If, however, the offers were to be made to the much smaller group of employees of the credit union, a prospectus would probably have been required. The generality of these criteria and the uncertain adjustment they required promoted confusion

24

26

See further A R Rodier (1985) 23 U West Ont L Rev; C J Meier-Schatz (1986) 8 J Comp Bus & Cap Market L 219; J Azzi (1991) 9 C&SLJ 205; M Blair (1992) 15(1) UNSWLJ 177. The definition of an offer to the public is retained in s 82, essentially for purposes incidental to other provisions. (1985) 157 CLR 201.

27

Corporate Affairs Commission (SA) v Australian Central Credit Union (1985) 157 CLR 201 at 208.

25

[10.35]

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and evasion. 28 The policy foundations were also contentious: the public character of the audience relative to the offeror is not an exclusive indicator of the need for the protection that a prospectus provides. 29 When the Act discarded the public offer concept to define the reach of its fundraising regulation it substituted other criteria. The Act now prohibits offers of securities for issue that are made without a prospectus or other disclosure document, subject to limited exceptions: see [10.55]. Some offers of securities for sale are also affected. In consequence, a prospectus will now be required in some instances previously exempted as private offers of securities. CLERP and the Financial Services Reform amendments

The drivers of change [10.40] The amendments to corporations legislation made in 1991 brought significant

changes to fundraising regulation apart from discarding the notion of an offer to the public as the triggering requirement for issue of a prospectus. Among the other significant changes then effected were: • exceptions created from the general requirement for a disclosure document to be lodged where the offers of invitations were made to a category of sophisticated (or professional) investors (eg, banks, life offices, superannuation funds and financial institutions), offers or invitations of securities made in minimum amounts of $500,000 and for personal offers of invitations that did not exceed more than 20 persons in the preceding 12 months, and • the longstanding checklist of specific items required to be disclosed in a prospectus was replaced with a general disclosure standard expressed in terms of the information that investors and advisers reasonably require in order to make an informed decision about the financial position and prospects of the company and the rights attaching to the securities offered. With effect from 2000, legislation under the Corporate Law Economic Reform Program (CLERP) wrought further substantial changes to the fundraising provisions. They were driven by a concern for efficiency in corporate fundraising. The philosophy behind the CLERP reforms was stated thus: The primary function of prospectus disclosure is to address the imbalance of information between issuers of securities and potential investors. Prospectuses play an essential role in establishing and maintaining confidence in the capital market because they ensure that the market as a whole and individual investors are appropriately informed and are therefore able to assess the risks inherent in offers of securities. While investors will rely on a range of factors in determining whether to invest, such as the reputation of the fundraiser, prospectuses provide up-to-date information material to the investment decision. Given the important role of disclosure in the market, prospectus regulation must be efficient. Prospectuses should provide comprehensive, readily understandable information to investors and professional analysts and advisers alike. The cost of undertaking due diligence and preparing a prospectus cannot be justified unless, in practice, it facilitates informed investment decisions. The [Corporations] Law should promote the presentation of reader-friendly 28

29

778

See the accounts of abuses and malpractice in private placements in an earlier but not distant period in Senate Select Committee of Securities and Exchange, Australian Securities Markets and their Regulation (1974), Pt 1, Vol 1, Ch 10. Many of these so-called private placements were clearly public issues within the statutory definition. However, in the United States the public character of the solicited group is primarily assessed by reference to the needs of the audience group for the protection through information that would be provided by a prospectus: SEC v Ralston Purina Co 346 US 119 (1953). [10.40]

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information to each of the likely audiences for a prospectus. Retail investors do not generally require the same level of detail as professional analysts and advisers. These investors should not be discouraged from reading prospectuses due to their length and complexity. 30

These comments were in response to contemporary criticisms of the prospectus system: Prospectuses are often criticised for being too long and complicated and obscuring information of interest to investors. It is claimed that “[s]ome prospectuses do not inform investors adequately about the nature of the product on offer”. 31 Prospectuses for initial public offerings of shares in large companies are often approximately 100 pages long, and some are considerably longer. A recent study … on prospectuses for managed investments identified the following difficulties: • information was difficult to find; • the language used in the prospectus was too technical; • the presentation of data was unhelpful; and • information was absent from the prospectus or was inadequate for making a judgment. 32 Research commissioned by the ASIC indicates that most investors read prospectuses in some detail but have difficulty fully understanding them as a result of their length and complexity. 33 For their part, issuers frequently complain that they are forced to burden prospectuses with unnecessary information and that prospectus costs are too high. In 1996, fundraising costs equalled an average of 8.3% of the funds raised in a new listing on the ASX. In 1995, the figure was 11.2% and in 1994 it was 7.5%. 34 These figures are generally higher than costs incurred in, eg, the United States where research into equity capital raisings by corporations in the United States from 1990 to 1994 indicates that the direct costs of an initial public offering in that country average 7.1%. 35

In a survey made after the CLERP reform, 60% of respondents who owned shares directly used a stockbroker who provides an advisory service; only 27% had a financial planner. Newspapers were their most popular source of information before making an investment, followed by prospectuses; however, when asked about their most recent investment, the prospectus was ranked behind newspapers, investment magazines and brokers. Over half of the respondents spent between 30 minutes and one hour reading the prospectus for their most recent investment. Those who did not read the prospectus were deterred by its complexity. Readers of the prospectus were primarily interested in performance projections, details about the executive team and returns, in that order. When professional advisers were asked about the role of the prospectus in providing advice to clients, a majority rated it as either “very little”, a legal formality, an application form, a sales tool or at most a backup to the adviser. They said that most clients do not want to read or cannot understand the prospectus and rely upon the adviser to interpret the investment. 36 30

Fundraising: Capital raising initiatives to build enterprise and employment (Corporate Law Economic Reform Program Proposals for Reform: Paper No 2, 1997), p 11.

31 32 33

Financial System Inquiry Final Report, March 1997, p 265. Communication Research Institute of Australia, Report to Investment Funds Association and Australian Securities Commission: Developing a performance-based approach to prospectuses, March 1997, pp 13-14. ASIC, Prospectus Investor Survey Report, commissioned from Chant Link, 1994, pp 45-46.

34

Price Waterhouse, Annual Survey of Sharemarket Floats January-December 1996, February 1997, p 2.

35

Fundraising: Capital raising initiatives to build enterprise and employment (Corporate Law Economic Reform Program Proposals for Reform: Paper No 2, 1997), pp 12-13, citing I Lee & S Lochhead (1996) [Spring] Journal of Financial Research 9. Printing and distribution costs will also be high when issuers print a large number of prospectuses for broad distribution.

36

I M Ramsay, Use of Prospectuses by Investors and Professional Advisers (Centre for Corporate Law and Securities Regulation, University of Melbourne; 2003), pp 1-4. [10.40]

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Financial services reform and fundraising regulation [10.45] There are, of course, other forms of investment solicitation beyond corporate

fundraising. A wide variety of financial products other than corporate securities are routinely offered to retail and wholesale investors, including interests in managed investment schemes, superannuation products, insurance products, retirement savings accounts, deposit products and derivatives. Many of these financial products indirectly assist corporate fundraising since the funds that they raise are heavily invested in corporate securities. Related reforms with respect to financial services generally came into effect in 2002 with the Financial Services Reform Act 2001 (Cth). This introduced a single regulatory system for financial products and services that eliminated the distinct regulatory schemes that had developed largely independently of each other for products that were functionally comparable and often substitutable. It did so through the introduction into the Corporations Act of rules governing disclosure, the conduct of financial markets and the licensing of participants. Corporate fundraising by the issue of securities is regulated in Ch 6D through requirements for a disclosure document. Offerings of other financial products are regulated in Pt 7.9 through a product disclosure statement (PDS), the point-of-sale document that sets out the significant features of a financial product other than a security, including its risks, benefits and costs. 37 As with a disclosure document for corporate fundraising, the PDS is designed to help investors (or consumers) compare and make informed choices about financial products and services. In general, a retail client must receive a PDS before acquiring a financial product other than a security. The other provisions of Ch 7 apply generally to the regulation of financial markets, that is, the post-issue markets for financial products including corporate securities. They are discussed in Chapter 11 of this book. Coverage of Chapter 6D: the definition of security [10.50] The coverage of Ch 6D dealing with corporate fundraising is marked out by the

definition of securities where used in that chapter. In its use in Ch 6D and Ch 7, the term “security” is defined as a share, debenture, a legal or equitable right or interest in either, or an option to acquire, by way of issue, one of these interests: ss 761A, 700, 92(4). 38 So defined, it excludes interests in registered managed investment schemes whose distributions are governed by Pt 7.9. 39 Where reference to managed investments is necessary in Ch 7, express reference is made to managed investments in addition to the term “security”. The definition of security also excludes options over securities other than options with respect to unissued shares (that is, options to subscribe for such securities). Hence, offers of financial products such as warrants which rely upon put and call options (viz, to dispose of or acquire securities at a particular price, respectively) over issued shares do not fall within the definition of security. They are derivatives whose distributions are regulated under Pt 7.9. Corporate fundraising by way of rights issues is specifically regulated in Ch 6D: see [10.92]. Accordingly, the term security where used in Ch 6D does not include a right to acquire, by way of issue, a security within that definition: s 700(1). 37

There is an express exclusion of Pt 7.9 from applying to offers of securities: s 1010A(1); see also the definition of security discussed at [10.50].

38

In Ch 7 the generic terms “financial product” and “financial service” are used rather than “security” or another specific financial product; the term “financial product” specifically includes a security and an interest in a managed investment scheme along with other financial products in the broadly expressed definition: s 764A, Pt 7.1 Div 3.

39

However, the definition of security contained in s 92(3), which also includes managed investments and options over issued shares, applies to the continuous disclosure provisions in Ch 6CA and to those relating to takeovers in Chs 6 – 6C on the basis that the regulatory purposes of those provisions are served by their reach to those wider interests and that this can be achieved in a single set of provisions.

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[10.45]

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The provisions of Ch 6D are prescriptive and may not be waived or contracted out: s 703. They apply to offers of securities that are received in Australia, regardless of where any resulting issue, sale or transfer occurs: s 700(4).

WHEN DISCLOSURE IS REQUIRED FOR INVESTORS ASIC’s role and some foundational concepts [10.55] ASIC administers Ch 6D and, in doing so, undertakes four principal activities:

• reviewing disclosure documents and fundraising activity for compliance with the law; • taking regulatory action to prevent fundraising activity taking place without appropriate disclosure; • providing relief from the law where doing so produces a net regulatory benefit, or any regulatory detriment is minimal and is outweighed by the resulting commercial benefit; and • enforcing the law, for example, where the review of disclosure documents indicates contraventions of the Act prompting action to protect investors. 40 Where a company is seeking to list through an initial public offering (IPO) made under a prospectus, ASIC’s primary role is that of disclosure regulator. It reviews the prospectus to assess whether the information provided is sufficient and appropriately presented, and to ascertain whether there are any material omissions or inaccuracies. In doing so, it does not make a determination on the suitability of the company for listing or on the commercial merits of any particular offer although it may consider issues relevant to the merits of the offer in its efforts to ensure the disclosure in the prospectus is comprehensive and appropriately balanced, including in relation to the risks of the offer. In contrast, market operators such as the ASX oversee the listing standards they have adopted, and may grant or refuse admission at their discretion. For example, the ASX retains an absolute discretion in deciding whether or not to admit an entity to the official list and to quote its securities: ASX Listing Rules 1.19, 2.9 (see [9.30], [11.45]). This discretion may be exercised against an entity even though the entity otherwise satisfies each of the listing and quotation conditions specified in the listing rules. Where a company is seeking to list on a financial market, ASIC and the securities exchange will often perform their respective roles at the same time, liaising closely since the decisions made by each (by ASIC, about prospectus disclosure and by the ASX about listing) may affect the other’s performance of its functions. 41 There are some foundational concepts in Ch 6D. First, Pt 6D.2 Div 2 defines the offers of securities that require disclosure to investors under Ch 6D. An offer of securities for issue needs disclosure to investors unless it is exempted by s 708: s 706. (Exemptions under s 708 are discussed at [10.75]-[10.92].) However, an offer of securities for sale requires disclosure to investors only if disclosure is required by s 707(2), (3) or (5): s 707(1) (see [10.60]-[10.70]). 42 For the purposes of Ch 6D, offering securities for issue or sale includes inviting applications for the issue of or to purchase the securities: s 700(2). The distinction between issue and sale is therefore a fundamental one in this context. The term issue refers to creation of rights with respect to the security and the term sale to dealings with the security after its issue. 43 Issue is the creation of the security and sale is its transfer from one holder to another. Second, Ch 6D 40

ASIC Regulatory Guide 254.16 (Offering securities under a disclosure document).

41

ASIC, ASIC Regulation of Corporate Finance: January to June 2016 (Report 489), pp 8-9.

42

Fundraising regulation does not deal therefore with offers to purchase securities although such offers may be affected by Ch 6 as part of the regulation of the acquisition of corporate control: see Chapter 12 of this book.

43

See Re VGM Holdings Ltd [1942] Ch 235 at 240. An offer of options over unissued securities is an offer of those options, not of the underlying securities themselves: s 702(a). A note to the section indicates that, if a [10.55]

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makes repeated reference to persons offering securities; this term refers to the person who has the capacity, or who agrees, to issue or transfer the securities if the offer is accepted: s 700(3). The offeror will therefore, depending on the nature of the offer, be either the issuer or seller of the securities. Sale offers that need disclosure

Offers for off-market sale of securities by controller of the issuer [10.60] A disclosure document is needed for offers of securities for sale in three situations.

The first is where they are made by the controller of the company whose securities are being offered and those securities are not quoted on a securities exchange or, if quoted, are not offered for sale in the ordinary course of trading on that exchange (and none of the exemptions from disclosure in s 708 apply): s 707(2). 44 On-market sales made in the ordinary course of dealing are deemed to be adequately protected by the rules of the stock exchange and market mechanisms.

Offers for sale that amount to an indirect issue of securities [10.65] The second instance of offers of securities for sale that require disclosure is where the

securities are offered for sale within 12 months after their issue and the company issued the securities either with the purpose that the person to whom they were issued would sell or transfer them or the person to whom they were issued acquired them with the purpose of selling or transferring the securities and, in either case, no exemption arises under ss 708 or 708A: s 707(3). This provision seeks to prevent avoidance of the general requirement for a disclosure document in relation to offers of securities for issue. Without such a provision as this, securities might simply be issued to an intermediary and on-sold free of the disclosure obligation that attaches to offers of securities for issue. Indeed, it is a common practice, particularly in the United Kingdom, to issue shares to an underwriter with a view to distribution by on-sale rather than direct issue to investors. Securities are deemed to be issued or acquired with the purpose of sale if there are reasonable grounds for concluding that they were issued or acquired with that purpose (whether or not there may have been other purposes for the issue or acquisition); if any of the securities are subsequently sold, or offered for sale, within 12 months after issue, the purpose will be assumed to exist unless it is proved that the circumstances of the issue and the subsequent sale or offer are not such as to give rise to reasonable grounds for this conclusion: s 707(4). Section 707(4)(b) creates a rebuttable presumption that securities sold within 12 months of their issue were issued or acquired for the purposes of resale within s 707(3). To rebut this presumption, it is necessary to prove that the circumstances of the issue and subsequent sale were not such as to give rise to reasonable grounds for concluding that the securities were issued or acquired for that purpose. The relevant purpose under s 707(3) is the subjective end or object sought to be achieved by either the issuer when issuing the shares or by the subscriber when acquiring the shares; that purpose need not be their sole purpose. 45

44

disclosure document is needed for the option and there is no further offer involved in exercising the option, the issue or sale of the underlying securities on the exercise of the option does not need a disclosure document: s 702(a) (Note 1). The disclosure obligation with respect to options cannot be avoided simply by granting the option without offering it: s 702(b). However, the grant of the option will not require a disclosure document if no consideration is payable on the grant or the exercise of the option: s 708(15), (16), s 702(b) (Note 2). A note to the section confirms that the definition of control in s 50AA applies in this context.

45

ASIC v Axis International Management Pty Ltd (No 5) (2011) 81 ACSR 631 at [43], [44], [49].

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Amendments were introduced in 2004 which do not derogate from the primary antiavoidance intent of s 707(3) since they apply only where securities are not issued with the purpose of on-sale within s 707(3)(b)(i). 46 Their operation therefore is where the person to whom the securities were issued has the purpose of on-selling those securities within s 707(3)(b)(ii) but the original seller did not seek or intend this to happen. The amendments were intended to improve the practical operation of the placement market and secondary sale provisions in the Act on the basis that no further disclosure is required where investors have the benefit of information that is comparable to that provided in a prospectus. The amendments comprise two provisions dispensing from the disclosure requirement for offers for sale. The first applies where the issuer has provided adequate disclosure to the market that permits an on-sale by a holder of securities. The facility is available if the on-sale offer is for securities that are part of a class of securities that were continuously quoted throughout the preceding 3 months so that they are subject to the continuous disclosure requirements of Ch 6CA (see [11.125]) during that time; this exemption is subject to the further proviso that trading in that class of securities has not been suspended for more than five days in the preceding 12 months: s 708A(1), (5). Further, no on-sale can occur until a notice is provided to the stock exchange by the issuer under s 708A(6): s 708A(5). 47 This “cleansing” notice verifies to the market that the issuer has complied with its continuous disclosure and financial reporting obligations, and provides the market with additional information that ensures that investors through the on-sale receive information comparable to that found in a prospectus: s 708A(7), (8), and see [10.100] for information about the general disclosure standard. The notice must be corrected by a further notice if it is found to be non-compliant or false or misleading in a material particular: s 708A(10). ASIC may determine that there has been a contravention of a provision which precludes resort to the market notice procedure: s 708A(1)(c), (2). Offers for sale and sales made under a non-compliant cleansing notice may in appropriate instances be validated by judicial orders under s 1322(4) and market on-sellers relieved from civil liability in relation to their contraventions of s 727(1): see [10.140]. 48 Second, information may also be made available to investors through a prospectus for a retail issue of quoted securities that is more or less contemporaneous with offers of securities for on-sale such as through an institutional placement. The exemption permits purchasers from the on-seller to receive relevant information through a prospectus that, while not issued for on-sale, contains current information that relates to the same class of securities as those being on-sold: s 708A(11). Similar relief is provided to securities placed with underwriters or a person nominated by the underwriter in an underwriting agreement: s 708A(12).

Offers for sale that amount to an indirect off-market sale by controller of the issuer [10.70] The third instance of offers of securities for sale that require disclosure applies the

anti-avoidance provision in s 707(3) to sales that amount to an indirect off-market sale under s 707(2) by a company controller where no disclosure document was originally issued. (This failure to disclose might have occurred through simple non-compliance or because of an exemption under s 708.) A disclosure document is required for an offer of securities for on-sale within 12 months after their sale by a controller that falls within s 707(2) where the controller 46

47 48

The mere intention to list securities is not itself intended to signify the purpose on the issuer’s part of the securities being on-sold: Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill 2003, Explanatory Memorandum, [5.544]. Since responsibility for the notice rests with the issuer, an on-seller relying on a notice that does not comply with s 708A(6) does not contravene the Act: s 727(5). See, eg, Re Golden Gate Petroleum Ltd (2010) 77 ACSR 17. [10.70]

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sold the securities without disclosure under Pt 6D.2 and either the controller sold, or the purchaser acquired, the securities with the purpose of on-selling them (and no exemption arises under s 708): s 707(5). Section 707(3) is directed not merely to the first on-sale of shares, but to any subsequent resales. 49 If the securities are on-sold, or offered for on-sale within 12 months of their sale by the controller, the purposes are assumed to exist unless the seller or offeror proves otherwise: s 707(6). An exception is provided for offers for sale of securities that were not purchased with a view to resale where the securities are of a class that has been continuously quoted throughout the preceding 3 months provided that trading in that class of securities has not been suspended for more than five days in the preceding 12 months: s 708(1A), (5). Both the controller and the company whose securities are being sold must give the stock exchange a cleansing notice for release to the market similar to that required for the on-sales exemption. This exception is of a piece with exceptions granted with respect to on-sales and rights issues: see [10.65] and [10.92]; the original prospectus scrutiny and continuous disclosure requirements are considered to exact comparable disclosure. Offers that do not need disclosure [10.75] Exemptions are provided from the blanket requirement for a disclosure document for

offers of securities for issue and the narrower requirement for offers for sale. The exemptions fall into three groups. The first exemption is for issues or sales that result from personal offers of securities satisfying a rolling numerical cap of transactions and dollar value raised. The second group of exemptions is for offers made to professional, sophisticated or experienced investors. The third group is a cluster of miscellaneous exemptions. An exemption is also given for certain rights issues: s 708AA and [10.92]. In Re Golden Gate Petroleum Ltd, McKerracher J analysed the structure and underlying policy of the scheme of exemptions from disclosure: In summary, ss 708 and 708AA contain several exceptions to the general rule that offers of securities for issue need disclosure. These exceptions may be said to fall within one or more of the following general categories: (a) the public interest in commercial expediency in capital (fund) raising outweighs the public interest in disclosure: s 708(1), (2), (19), (20) and (21); (b) the person to whom the securities are to be issued is in a position to make an informed decision without disclosure: s 708(8), (10), (11), (12), (13), (14); (c) there is no consideration for the issue: s 708(15), (16); (d) the issue is part of a scheme of arrangement, deed of company arrangement or takeover (i.e., there will generally be other forms of disclosure): s 708(17), (18) and (19); or (e) disclosure similar to that provided in a prospectus has been provided by the body through compliance with the disclosure obligations under Pt 2M and continuous disclosure obligations under Ch 6: s 708AA. 50

The 20/12 exemption for personal offers [10.80] A disclosure document is not required if a person makes an unlimited number of

personal offers of securities that result in securities being issued or sold to 20 or fewer persons in a rolling 1 year period with no more than $2 million being raised in the period: 49 50

ASIC v Axis International Management Pty Ltd (No 5) (2011) 81 ACSR 631 at [40] (to confine the requirement to the first offer “would undermine the anti-avoidance effect of the section”). Re Golden Gate Petroleum Ltd (2010) 77 ACSR 17 at [26]. In the judgment, clauses (a)-(e) of paragraph [26] refer to s 707 instead of s 708 although the immediately preceding text, as quoted above, refers to s 708. That appears to be in error and references to s 708 have been substituted in the above quotation.

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s 708(1) – (7). This measure is intended to reduce the costs for small and medium business when making small-scale offerings. 51 The 20/12 exemption was previously expressed in terms of making up to 20 offers in 12 months. Limiting the exemption to offers rather than issues or sales was considered to be unduly restrictive and difficult to apply in practice (eg, it was found to be difficult to ascertain whether an offer had been made). Offers under the 20/12 exemption are limited to “personal” offers: s 708(1). This requirement seeks to prevent the exemption being abused by making offers to retail investors at large without proper disclosure in a disclosure document. An offer is a personal offer if it can be accepted only by the person to whom it is made and if the person is likely to be interested in the offer having regard to previous contact between or professional or other connection with the person making the offer, or because they have indicated that they are interested in offers of that kind: s 708(2). This latter measure allows offers to be made to self-designated small business investors (“business angels”) who have previously stated their interest in the offer, even though there had been no previous contact between the person making the offer and the prospective investor. Furthermore, by limiting the amount raised in any 12-month period to $2 million, a cap is placed upon the amount that may be raised from 20 investors; in calculating the amount raised on the issue of securities, regard must be had not only to the amount payable for the securities when they are issued but also to the amount payable under future calls upon partly paid shares or the exercise of an option or conversion right: s 708(7). Issuers seeking to raise larger amounts of capital are required to bear the costs of preparing a disclosure document. Securities issued or sold as a result of offers made under other exemptions are not counted towards the numerical cap: s 708(5)(a).

The professional, sophisticated and experienced investor exemptions [10.85] An exemption is extended to offers made to professional investors: s 708(11). A

professional investor is defined to include institutional investors (life offices, friendly societies and other bodies regulated by the Australian Prudential Regulation Authority (APRA)), the trustee of a superannuation fund with net assets of at least $10 million, another person who has or controls gross 52 assets of at least $10 million, a financial services licensee, a listed entity or its related companies, and an entity that carries on a business of investment in financial products, interests in land or other investments following public investment solicitations: s 9. A further exemption is allowed for offers of securities to investors if the minimum amount payable is at least $500,000: s 708(8)(a). This exemption relates to the amount invested and not the amount of the offer. Alternatively, the minimum figure may be satisfied if investors top up existing investments in securities of the same class to $500,000: s 708(8)(b). This sophisticated investor concession is made on the basis that it is consistent with a broader policy that allows offers to persons who are considered to have sufficient resources to obtain independent professional advice or who, because of the size of their potential investment, have sufficient leverage over the issuer to obtain the required information. To prevent avoidance problems that had arisen earlier, any moneys lent to the investor by the person offering the securities, or an associate, are not included when calculating the $500,000 minimum figure: s 708(9). From an issuer’s perspective, the CLERP review (see [10.40]) indicated that the threshold posed difficulties of finding investors willing to invest such large sums or because less than 51

This account of the rationale for the 2000 amendments draws upon the Corporate Law Economic Reform Program Bill 1999, Explanatory Memorandum.

52

MIS Funding No 1 Pty Ltd v Buckley (2014) 96 ACSR 691 at [68] (the phrase “at least $10 million” refers to gross assets rather than net assets). [10.85]

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$500,000 was sought by the issuer. Consequently, the CLERP amendments introduced two new categories of exemption which might be described as an experienced investor exception. First, investors may invest less than $500,000 if a qualified accountant certifies that they have net assets of at least $2.5 million or a gross income over the previous two financial years of at least $250,000: s 708(8)(c), reg 6D.2.03. Second, investors are able to invest less than $500,000 without a disclosure document if the offer is made through a financial services licensee who is satisfied on reasonable grounds that the person to whom the offer is made has previous experience in investing in securities which allows them to assess the investment (viz, the merits of the offer, the value of the securities, the risks involved in accepting the offer, their own information needs and the adequacy of the information given by the person making the offer): s 708(10)(a), (b). The licensee must give the person before or when the offer is made a written statement of its reasons for being satisfied as to those matters and the offeree must sign a written acknowledgment that they have not been given a disclosure document: s 708(10)(c), (d). This exemption was justified on the basis that making experience a proxy for sophistication allows issuers to offer securities to those who do not fit the threshold income and asset tests but are “sophisticated” because of their experience in investing in securities.

Miscellaneous exemptions [10.90] A further cluster of exemptions is available from the requirement for a disclosure

document, several of which relate to offers made to persons associated with the issuer body to which the offers relate in a way that displaces the need for protection through disclosure. The first exemption is for offers made to senior managers of the issuer or a related company, or their spouse, parent, child, brother or sister, or to a company controlled by one of these persons: s 708(12). A senior manager is defined as a person (other than a director or secretary) who makes, or participates in making, decisions that affect the whole or a substantial part of the business of the company or has the capacity to affect significantly the company’s financial standing: s 9. By reason of their knowledge of or influence in the company, senior managers and, indirectly, their family members are considered not to need investment protection through mandatory disclosure. Similarly, there are exemptions for • offers for issue of fully paid shares to existing shareholders under a dividend reinvestment plan or bonus share plan (s 708(13)); • offers for issue of debentures to existing debenture holders (s 708(14)); • offers of securities for issue or sale for no consideration (s 708(15)); 53 • offers made under takeover bids under Ch 6 and schemes of arrangement under Pt 5.1 (s 708(17) – (18)); and • offers made by an exempt body or public authority: s 708(19) – (21).

Rights issues exemption [10.92] An exemption is also provided to corporate issuers who raise capital by way of a

rights issue which meets certain conditions. A rights issue is an offer to all holders of a company’s securities to issue new securities in proportion to their existing holdings where the offer is made in the same terms to all holders (the offers may be renounceable in favour of others): s 9A. The disclosure exemption was introduced in 2007 on the basis that this form of fundraising was disadvantaged relative the private equity placement to institutional investors permitted under the sophisticated investor exception in s 708. That disadvantage was 53

An offer of options does not need disclosure provided that no consideration is payable either for the issue or transfer of the option or for the underlying securities on the exercise of the option: s 708(16).

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perceived to fall on smaller, retail investors. 54 Offers of securities under a rights issue do not require disclosure to investors if the securities are of a class of quoted securities and trading in that class has not been suspended for more than five days in the preceding 12 months: s 708AA(2). Investor protection is considered to be achieved through the original prospectus disclosure coupled with the continuous disclosure obligation upon listed companies. 55 Rights issues often occur in connection with significant transactions that have not been fully disclosed to the market, usually because the negotiations for the transaction have not been completed. 56 Accordingly, the company must give a “cleansing” notice to the stock exchange in the 24 hours before the rights issue is made which verifies to the market that the issuer has complied with its continuous disclosure and financial reporting obligations and provides the market with additional updating information. This notice must set out any information that has been excluded from a continuous disclosure notice as permitted by the listing rules of the stock exchange where that information is nevertheless information that investors and their professional advisers would reasonably require for the purposes of making an informed assessment of the assets and liabilities, financial position and performance, profits and losses and prospects of the company, and the rights and liabilities attaching to the securities the subject of the issue: s 708AA(1)(f), (7) – (11). 57 The notice must also state the potential effect of the rights issue on the control of the company and the consequences of that effect: s 708AA(8)(e). This disclosure is required since rights issues may lead to a shareholder or underwriter acquiring control of the company or significantly increasing their voting power. 58 Use of the rights issue exemption is precluded if ASIC determines that the company has contravened one of a number of provisions of the Act: s 708AA(1)(b), (3).

WHAT MUST BE DISCLOSED The forms of disclosure document

The choice of forms [10.95] The CLERP reforms introduced a wider range of disclosure documents, primarily

with a view to facilitating small and medium enterprise fundraising. 59 Four species of 54

Corporations Legislation Amendment (Simpler Regulatory System) Bill 2007, Explanatory Memorandum, [5.6].

55

Corporations Legislation Amendment (Simpler Regulatory System) Bill 2007, Explanatory Memorandum, [5.7]. Corporations Legislation Amendment (Simpler Regulatory System) Bill 2007, Explanatory Memorandum, [5.31]. The requirements for this notice are very similar to those for the notices that must be given by the on-seller of securities who relies on the exemption from disclosure in s 708A(1) and the controller making an indirect off-market sale of securities who relies upon the exemption from disclosure under s 708A(1A): see [10.65] and [10.70].

56 57

58

Corporations Legislation Amendment (Simpler Regulatory System) Bill 2007, Explanatory Memorandum, [5.32].

59

A new statutory regime was proposed in 2015 for crowd-sourced equity fundraising. Crowdfunding is the practice of funding a business, creative or non-profit project by raising funds (typically in small amounts) from a large number of people with an interest in its success. In its modern forms, it is typically promoted through an internet-based platform. The Corporations Amendment (Crowd-sourced Funding) Bill 2015 (Cth) proposed a regulatory framework to facilitate crowd-sourced funding (CSF) by small, unlisted public companies offering equity interests; its purpose is to stimulate innovative start-up and other small-scale enterprises. The Bill would provide new public companies that are eligible to crowd fund with temporary relief from reporting and corporate governance requirements and provide greater flexibility in the Australian market licence and clearing and settlement facility licensing regimes: see [11.30]. Specifically, the Bill would [10.95]

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disclosure document are identified in s 705 (set out below together with a brief description of their function and a guide to the provisions that specify their content, procedure, the liabilities attaching to them, and defences to liability). The prospectus is the standard full-disclosure document. If an offer of securities needs disclosure to investors under Pt 6D.2, a prospectus must be prepared for the offer unless s 709(4) allows an offer information statement to be used instead and this form is used for the fundraising. There are special content rules for the prospectus when it offers securities of the same class as those that were continuously quoted over the preceding 12 months: see [10.110]. A short form prospectus may be used for any offer by incorporating, by reference, the material contained in a prospectus lodged with ASIC. A profile statement is a facility that allows a brief document (the profile statement) to be sent out with offers rather than a full prospectus; the full prospectus must, however, be prepared and lodged with ASIC and made available to investors upon request: s 721(1A), (2), (3). A profile statement may be used only with ASIC’s consent: s 709(3). In practice, ASIC permits the use of a profile statement only in limited circumstances typically where the financial products offered are highly standardised and are subject to little variability within a product segment. Their use is primarily limited to offers of interests in managed investment schemes. An offer information statement may be issued instead of a prospectus for an issue (but not the sale) of securities of up to $10 million by a company, its related entities, its controller and the latter’s associates, and the company’s controlled entities (that is, sums raised by each of these bodies by means of an offer information statement are to be aggregated for the purposes of satisfying the $10 million cap): s 709(4). The company may raise several tranches of capital under an offer information statement provided the total raised during its life does not exceed $10 million. The limitation of $10 million is intended to accommodate the fundraising targets of small and medium enterprise. 60 Issuers seeking to raise larger amounts of capital are expected to bear the costs of prospectus preparation. In calculating the amount raised on the issue of securities, regard must be had not only to the amount payable for the securities when they are issued but also to amounts payable under future calls upon partly paid shares and the exercise of an option or conversion rights: s 709(5). Although ASIC’s approval is not required for the use of an offer information statement, it has the discretionary power to prevent abuse of the exemption by requiring aggregation of the transactions of a wider group of entities under s 740; this will affect the availability of the form if it exceeds the cap upon funds that may be raised under this form of disclosure document. Although there is a mandatory content for each type of disclosure document, there is also a body of common contractual material that is necessary for the making of offers as in any other form of written contract. Some provisions are fairly standard such as the price of the securities being offered and the period for which the offers will remain open and applications will be received. The right to extend the offer or to close early is often reserved in the offering

60

788

establish a CSF regime which would include eligibility requirements for a company to fundraise via CSF, including disclosure requirements for CSF offers; obligations of a CSF intermediary in facilitating CSF offers; the process for making CSF offers; rules relating to defective disclosure as part of a CSF offer; and investor protection provisions. The Bill lapsed when Parliament was prorogued for the 2016 Federal election; see also The Australian Government, Treasury, Crowd-sourced Equity Funding, Discussion Paper (2014); Corporations and Markets Advisory Committee, Crowd Sourced Equity Funding, Report (2014); G Walker, A Pekmezovic and A Walker (2016) 34 C&SLJ 243; T Ancev (2015) 33 C&SLJ 352; T W Wong (2013) C&SLJ 89. Corporate Law Economic Reform Program Bill 1998, Explanatory Memorandum, [8.6]. Use of an offer information statement is not formally limited to SMEs. Indeed, a proprietary company may not engage in fundraising which would require a disclosure document: s 113(3). This prohibition includes fundraising under an offer information statement. [10.95]

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document. There is no minimum period in which offers must remain open although there is a maximum offering period of 13 months for all offers that require a disclosure document. 61 The following table in s 705 shows what disclosure documents may be used if an offer of securities needs disclosure to investors under Pt 6D.2. It provides a signpost to other provisions in Ch 6D that affect each form of fundraising document.

TABLE 10.1 Types of disclosure document 1

2

3

4

Type prospectus The standard full-disclosure document.

short form prospectus May be used for any offer. Section 712 allows a prospectus to refer to material lodged with ASIC instead of setting it out. Investors are entitled to a copy of this material if they ask for it. profile statement Section 721 allows a brief profile statement (rather than the prospectus) to be sent out with offers with ASIC approval. The prospectus must still be prepared and lodged with ASIC. Investors are entitled to a copy of the prospectus if they ask for it. offer information statement Section 709 allows an offer information statement to be used instead of a prospectus for an offer to issue securities if the amount raised from issues of securities is $10 million or less.

Sections content [710, 711, 713] procedure [717] liability [728 and 729] defences [731, 733] content [712]

content [714] procedure [717] liability [728 and 729] defences [732, 733] content [715] procedure [717] liability [728 and 729] defences [732, 733]

Offers of simple corporate bonds [10.97] Offers of corporate bonds to retail investors generally require full prospectus

disclosure. In contrast, a listed issuer generally only requires a transaction-specific prospectus for offers of quoted shares, options over quoted shares and certain securities that are convertible into quoted shares: s 713. 62 However, under amendments made in 2014 with the objective of promoting trading of retail corporate bonds and the development of a strong retail bond market, a specific disclosure regime applies to offers of “simple corporate bonds”, which must be offered under a two-part simple corporate bonds prospectus. A “simple corporate bond” is a debenture with terms of issue that meet, and the offer of which meets, criteria set out in s 713A. These criteria include that the securities are or will be quoted on a prescribed financial market, and that the issuer is a body that has continuously quoted securities or is a wholly owned subsidiary of such a body that guarantees repayment of principal and interest. A two-part simple corporate bonds prospectus consists of: (a) a base prospectus with a life of three years, which must include general information about the issuer that is unlikely to change over the three-year life of the document (and that may be released in advance of an actual offer of simple corporate bonds); and (b) an offer-specific prospectus for each offer, which must include details of the offer and may update information contained in the base prospectus. Despite the terms “base prospectus” and “offer-specific prospectus”, neither document alone is taken to be a prospectus for the purposes of Ch 6D – rather, a two-part simple corporate 61

See s 711(16) (prospectus), s 715(3) (offer information statement) and s 714(2) (profile statement).

62

See also ASIC, Corporations (Offers of Convertibles) Instrument 2016/83; as to transaction-specific prospectuses, see [10.110]. [10.97]

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bonds prospectus is the combination of the base prospectus that covers the period during which the offer is made and the offer-specific prospectus for the offer. This combined document is a “prospectus” – and therefore a “disclosure document” – for the purposes of the Act: s 713B. The base prospectus and the offer-specific prospectus each have prescribed content (including prescribed financial ratios) and may incorporate by reference other material lodged with ASIC. 63 A streamlined specific disclosure regime applies to simple corporate bonds, including different expiry and lodgment requirements; there is also a streamlining of the general civil liability provisions for prospectuses and the defences available with respect to misleading and deceptive statements and omissions in disclosure documents. These changes are beyond the scope of this treatment; accordingly, the expressions “prospectus” and “disclosure documents” used in this chapter do not include offerings of simple corporate bonds to retail investors. Prospectus content

The general disclosure standard [10.100] The prospectus was the only form of disclosure document until the addition of the

offer information statement from 2000. Even where a short form prospectus or profile statement is used, a prospectus must be prepared and lodged with ASIC. The prospectus is still, therefore, the residual and primary disclosure document. If an offering of securities requires the lodgment of a disclosure document, it will involve a prospectus unless s 709(4) permits an offer information statement to be used instead: s 709(1). Disclosure in a prospectus must satisfy both a general disclosure standard and specific disclosure requirements. 64 The general disclosure standard requires a prospectus to contain all the information that investors and their professional advisers would reasonably require to make an informed assessment of the matters set out in a table. The prospectus must contain this information: (a) only to the extent to which it is reasonable for investors and their professional advisers to expect to find the information in the prospectus, and (b) only if a person whose knowledge is relevant (see s 710(3)): (i) actually knows the information or (ii)

in the circumstances ought reasonably to have obtained the information by making enquiries: s 710(1).

Thus, the standard requires disclosure of information that passes the twin filters of investor and adviser need and reasonable expectation of inclusion in the prospectus. Such information must satisfy either of the further filters of actual knowledge or knowledge obtained by reasonable inquiry. The matters with respect to which such filters operate are specified in the following table. 65 Unlike the signposting table in s 705, this is an operative table in that it contains substantive provisions not contained elsewhere in Pt 6D.2. 63

64 65

790

For the content that must be included in a base prospectus, see s 713C and reg 6D.2.04 and, for the mandatory content of the offer-specific prospectus, see s 713D and reg 6D.2.05. For the key financial ratios relevant to the issuing body, see reg 6D.2.06. Section 713E governs the material which may be incorporated by reference, a provision similar to s 712 that applies to prospectuses and transaction-specific prospectuses. ASIC’s Regulatory Guide 228 (Prospectuses: Effective disclosure for retail investors) contains guidance on the preparation of prospectuses that satisfy the content requirement in s 710. The reference in the table and elsewhere in Ch 6D to interests in managed investment schemes was made redundant by the recasting of the definition of security from 2002 to exclude these schemes from its reach: see [10.50]. Curiously, these consequential amendments were not made. [10.100]

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TABLE 10.2 Prospectus content — general disclosure test 1

2

Disclosures Offer offer to issue (or transfer) shares, debentures or interests in a managed investment scheme

offer to grant (or transfer) a legal or equitable interest in securities or grant (or transfer) an option over securities

[operative] Matters • the rights and liabilities attaching to the securities offered • the assets and liabilities, financial position and performance, profits and losses and prospects of the body that is to issue (or issued) the shares, debentures or interests • the rights and liabilities attaching to: – the interest or option – the underlying securities

•

for an option – the capacity of the person making the offer to issue or deliver the underlying securities • if the person making the offer is: – the body that issued or is to issue the underlying securities; or – a person who controls that body; the assets and liabilities, financial position and performance, profits and losses and prospects of that body • if s 707(3) or (5) applies to the offer – the assets and liabilities, financial position and performance, profits and losses and prospects of the body whose securities are offered

In deciding what information should be included under s 710(1), regard must be had to: • the nature of the securities and of the issuer; • the matters that likely investors may reasonably be expected to know; and • the fact that certain matters may reasonably be expected to be known to their professional advisers: s 710(2). The second and third dot points, contained in s 710(2)(c) and (d), emphasise that disclosure will vary with the financial sophistication of the audience to whom the offers are addressed and their likely access to professional advice as well as the nature of the interests being offered. For example, an offering of non-renounceable rights to subscribe for additional capital in a company which is of the same character as that presently held (eg, offers to shareholders to subscribe for further ordinary shares) will be made in a quite different information environment than that which applies to a securities offering to a primarily retail audience even where the offering is part of the demutualisation of an association of which they are members (such as the AMP Society or NRMA) or in the public floats of the Commonwealth Bank, Telstra and the State government insurance offices. In these situations, familiarity with investment and access to financial advice cannot be assumed to moderate disclosure obligations under the general standard. For the purposes of s 710(1)(b), a person’s knowledge is relevant under the general disclosure standard only if they are one of the following: • the person offering the securities; • a director or proposed director of the corporation whose securities will be issued; • a person named in the prospectus as an underwriter of, or as a financial services licensee involved in, the issue or sale;

[10.100]

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• a person named in the prospectus with their consent as having made a statement that is either included in the prospectus or on which a statement made in the prospectus is based; or • a person named in the prospectus with their consent as having performed a particular professional or advisory function: s 710(3). The knowledge of this group of persons is the measure of the offeror’s actual or expected knowledge under s 710(1)(b). The group broadly replicates the group of persons who are exposed to civil liability for misleading statements, etc, in the prospectus although it also includes a person named as a financial services licensee involved in the issue or sale such as a stockbroker or investment bank performing advisory or other services. 66 This general standard does not expressly involve the concept of materiality. However, the concept of materiality is never far removed from decisions taken with respect to securities and the leading interpretation of the terms applied in the context of proxy solicitation appears a useful measure against which to test the general disclosure standard. In TSC Industries Inc v Northway Inc 67 the United States Supreme Court said: [t]he general standard of materiality that we think best comports with the policies of Rule 14a-9 [governing proxy solicitation] is as follows: An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. [M]ateriality [is] a requirement that “the defect have a significant propensity to affect the voting process”. It does not require proof of a substantial likelihood that disclosure of the omitted fact would have caused the reasonable investor to change his vote. What the standard does contemplate is a showing of a substantial likelihood that, under all the circumstances, the omitted fact would have assumed actual significance in the deliberations of the reasonable shareholder. Put another way, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the “total mix” of information made available.

This test was applied in the context of a director’s fiduciary obligation to individual shareholders in Coleman v Myers [1977] 2 NZLR 225 ([7.540]) at 334.

Specific disclosure obligations [10.105] The general disclosure test is augmented by specific disclosure obligations. These provisions extend earlier provisions and relate to the disclosure of interests and fees of persons involved in the offer and fees and benefits that may be derived under the fundraising process, and the disclosure of benefits received by related parties, promoters and securities advisors to the issue or sale. Thus, the prospectus must set out: • the terms and conditions of the offer (s 711(1)); • the nature and extent of the interests of persons identified in s 711(4) 68 in the past two years in the formation, promotion or property dealings with the company, or in the offer of securities (s 711(2)); • fees or benefits agreed to be paid to become a director of the issuer or for services provided by persons identified in s 711(4) for commission or services (s 711(3)); 66 67

The offeror and persons involved in a contravention of the prohibition upon misleading statements, etc, in the prospectus are also exposed to civil liability: see [10.200]. 426 US 438 at 449 (1976) per Marshall J.

68

That is, to any directors, proposed directors or promoters of the issuer, persons named in the prospectus as performing a function in a professional, advisory or other capacity in connection with the preparation or distribution of the prospectus, and an underwriter (but not a sub-underwriter) to the issue or sale, or a financial services licensee named in the prospectus as a financial services licensee involved in the issue or sale.

792

[10.105]

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• where the prospectus states or implies that the securities offered will be granted quotation on a stock market: either that the application for quotation has been successful, that it has been made or that it will be made within seven days after the date of the prospectus (s 711(5)); 69 • the expiry date of the prospectus (s 711(6)); 70 and • that it is lodged with ASIC which takes no responsibility for its contents: s 711(7). In common with other disclosure documents, the prospectus must state that no securities will be issued on the basis of the document after the expiry date specified in it; the expiry date must not be later than 13 months after the date of the prospectus: s 711(16). 71 The information in a disclosure document must be worded and presented in a clear, concise and effective manner: s 715A(1). Although contravention of s 715A(1) is not an offence, it will allow ASIC to make a stop order against distribution of the document: s 739(1)(a) and [10.150].

Special content rules for continuously quoted securities [10.110] There is a modified disclosure requirement for offers of continuously quoted securities that secure for the issuer or seller the benefits of the regular reporting and timely disclosure obligations under the continuous disclosure regime of Ch 6CA. Continuously quoted securities are securities that are in a class of securities that were quoted ED securities (see [11.130]) at all times in the 3 months preceding the prospectus and were subject to the continuous disclosure requirements of Ch 6CA without exemption during the preceding 12 months: s 9. On the basis that the market should already be sufficiently informed with respect to the securities being offered, the prospectus (commonly referred to as a transactionspecific prospectus) need address only the impact of the proposed offer and any relevant information previously exempted from disclosure. Accordingly, it must contain all the information investors and their professional advisers would reasonably require to make an informed assessment of: • the effect of the offer on the issuer;

• the rights and liabilities attaching to the securities offered; and • if the securities are options – the rights and liabilities attaching to the options themselves and the underlying securities. The prospectus must contain this information only to the extent to which it is reasonable for investors and their professional advisers to expect to find the information in the prospectus: s 713(2). The prospectus must also state that as a disclosing entity the issuer is subject to regular reporting and disclosure obligations and that copies of documents relating to it and lodged with ASIC may be obtained from an ASIC office: s 713(3). The prospectus must also either include a copy of, or inform offerees of their right to obtain, the issuer’s most recent financial report, half-year report and continuous disclosure notices lodged since the financial report with ASIC: s 713(4). Information about the offer must also be set out in the prospectus if it has been exempted from continuous disclosure in accordance with stock exchange listing rules and the information is necessary to meet the general prospectus disclosure standard 69

70

This statement has consequences for the issuer if the application is not made within 7 days or the securities are not admitted to quotation within 3 months of the disclosure document: ss 724(1)(b), 723(3); for provisions concerning the protection of the application money, see [10.160]. The prospectus must be dated with the date upon which it is lodged with ASIC: s 716(1).

71

See like time limits under s 715(3) (offer information statement) and s 714(2) (profile statement). [10.110]

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under s 710: s 713(5). ASIC may exclude a company for using this facility if it has breached financial reporting or continuous disclosure provisions during the previous 12 months: s 713(6). 72

Disclosure with respect to future prospects [10.115] The general disclosure standard in s 710(1) requires an informed assessment, among

other matters, of the “prospects” of the company whose shares are being offered. Does this require disclosure with respect to the issuer’s prospective financial information and forecasts of its future financial performance? A statement about a future matter will be misleading if its maker does not have reasonable grounds for making it: s 728(2). Does this requirement temper any expectations or obligations arising from the former provision? The provision in s 728(2) was introduced in 2000 to replace a provision that placed the onus of establishing the existence of reasonable grounds with respect to a future matter upon its maker. The Explanatory Memorandum for the Bill that introduced s 728(2) said that it was intended to: encourage the inclusion of material of potential use to investors without exposing issuers to liability for legitimate forecasting … [ensuring] that forecasts are made where there is a reasonable basis for them and not made on the basis of genuine but unreasonable beliefs of issuers. 73

This requires a distinction between “legitimate forecasting” and speculation, grounded in an objectively reasonable foundation rather than “genuine but unreasonable beliefs”. ASIC’s policy is that there is no general obligation to include prospective financial information in a prospectus; indeed, it should only be included where there are reasonable grounds for its inclusion; the decision to include it involves balancing “the information value (relevance) of what is disclosed against the likelihood that the information may be misleading (reliability). The two elements are interrelated”. The less reliable information is, the less relevant it becomes to investors, and the less likely it is that it should be included in the disclosure document. 74 ASIC’s “general test” of whether prospective financial information must be disclosed is whether the information is relevant to its audience and reliable; information is reliable if there is a reasonable basis for the disclosed information. 75 Information is not material to investors if it is “speculative or based on mere matters of opinion or judgment”. 76 As noted, a disclosure document should only include prospective financial information if there are reasonable grounds for its inclusion; otherwise it will be taken to be misleading: s 728(2). In ASIC’s view, the existence of “reasonable grounds” is determined objectively in light of all of the circumstances at the time of the statement, so that a reasonable person would view as reasonable the grounds for the statement. 77 To demonstrate reasonable grounds, an issuer must be able to point to some facts or circumstances existing at the time of publication of the information in the disclosure document on which the issuer in fact relied, which are 72

ASIC’s policy with respect to administration of this form of prospectus is contained in ASIC Regulatory Guide 66 (Transaction-specific disclosure).

73

Corporate Law Economic Reform Program Bill 1999, Explanatory Memorandum, [8.13].

74 75

ASIC Regulatory Guide 170.9 (Prospective financial information). ASIC Regulatory Guide 170.11 (Prospective financial information), citing GIO Australia Holdings Ltd v AMP Investment Insurance Ltd (1998) 29 ACSR 584. ASIC Regulatory Guide 170.11 (Prospective financial information), citing AAPT v Cable & Wireless Optus Ltd (1999) 32 ACSR 63. This and the GIO case concerned disclosure in takeovers but are considered by ASIC to state principles relevant to fundraising disclosure.

76

77

ASIC Regulatory Guide 170.16, RG 170.17 (Prospective financial information).

794

[10.115]

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objectively reasonable and which support the information. 78 ASIC lists the following factors that may amount to reasonable grounds for stating prospective financial information when: • the information relates to options on forward-sales contracts or leases that lock in future expenses and revenue; • the information is underpinned by independent industry experts’ reports and/or independent accountants’ reports; and • the information includes reasonable short-term estimates (not exceeding 2 years). 79 These factors are not necessarily conclusive; indeed, there may be other methods of establishing reasonable grounds. They are to be contrasted with prospective statements supported only by hypothetical assumptions, assertions without verifiable reasons and best estimates. ASIC gives the following non-exhaustive list of factors that do not, by themselves, establish reasonable grounds for prospective financial information in a disclosure document: (a) prospective financial information supported only by hypothetical assumptions (rather than reasonable grounds); (b)

statements by issuers asserting reasonable grounds for the inclusion of information, with no verifiable reasons to support such statements; and

(c)

statements along the lines of “this is the best estimate of the directors”. The test in s 728(2) requires that the grounds for prospective financial information be objectively reasonable. 80

The touchstone is the existence of an objectively reasonable foundation; however, the boundary between legitimate forecasting and mere speculation may involve delicate judgment. As regards disclosure, such prospective financial information as satisfies the reasonable grounds test must be provided that investors would reasonably require for the purpose of making an informed assessment about the financial product under s 710 (prospectus), s 714 (profile statement) or s 715 (offer information statement); this information may be misleading if presented in isolation from the assumptions and description of the methodologies used in its development. 81 Thus, investors should be given information to enable them to: (a) assess whether the prospective financial information is relevant and reliable (that is, to form their own view about how reasonable the grounds are for making the statement); and (b)

identify with certainty the facts and circumstances that support prospective financial information, as well as being able to demonstrate that the information is reasonable. 82

ASIC considers that prospective financial information in a disclosure document should be accompanied by: (a) full details of the assumptions used to prepare the prospective financial information; (b)

the time period covered by that information;

(c)

the risks that the predictions in the information will not be achieved; and

78

ASIC Regulatory Guide 170.24 (Prospective financial information), citing Sykes v Reserve Bank of Australia (1999) ATPR 41-699 per Heerey J at 42–902.

79 80 81

ASIC Regulatory Guide 170.26, RG 170.39 (Prospective financial information). ASIC Regulatory Guide 170.43 (Prospective financial information). ASIC Regulatory Guide 170.58 (Prospective financial information).

82

ASIC Regulatory Guide 170.59 (Prospective financial information). [10.115]

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(d)

an explanation of how the prospective financial information was calculated and the reasons for any departures from accounting standards or industry standards that investors would reasonably expect to be followed. 83

Short form prospectuses [10.120] In the years before the short form prospectus was introduced in 2000, ASIC had

permitted an “incorporation by reference” facility for securities offerings which were addressed to a retail audience. These included several offerings that were part of the demutualisation and privatisation process in the 1990s. For the issuer, the facility offered greatly reduced printing and distribution costs; for retail investors, the offering document might be made more readable and comprehensible, freed of the burden of detailed exposition of the offering. The full document was available to analysts and other users who chose to read it. The elements of this successful practice are expressed in the facility for the presentation of short form prospectuses. The primary purpose of a short form prospectus is to reduce the length of a prospectus and make it more useful for retail investors. Instead of setting out information that is contained in a detailed document lodged with ASIC, the short form prospectus simply refers to the document, effectively incorporating it by reference in the prospectus. The prospectus does not need to summarise each material fact in the document lodged with ASIC. However, the short form prospectus must identify the document which contains the information and inform people of their right to obtain a copy of the document free of charge during the application period of the prospectus: s 712(1), (5). The reference to the document must also include sufficient information about the contents of the document to allow offerees to decide whether they need to obtain a copy of the document. Where the issuer considers the information is primarily of interest to professional analysts or advisers or investors with similar specialist information needs, the prospectus must state this fact and describe the contents of the document: s 712(2). The document lodged with ASIC is deemed to be included in the prospectus (s 712(3)), thereby ensuring that the two documents taken together discharge the prospectus disclosure obligations and are subject to the general prospectus liability regime. Indeed, there is a broad licence given to the issuer who chooses to use a short form prospectus as to what to include in the prospectus and what to leave to the document lodged with ASIC. ASIC’s consent is not required for the use of the short form prospectus. Profile statement content [10.125] The goal of reducing the volume of material required for retail investors is advanced

also by the facility of profile statements. ASIC is empowered to allow the use of short profile statements in suitable industries. A profile statement may be used as the offering document if ASIC approves its use for offers of that “particular kind”; in addition a full prospectus must be lodged with ASIC: s 709(2). ASIC’s approval may specify additional information to be included in the profile statement beyond that specified in the Act: s 709(3). The mandatory content for a profile statement, well short of that for a standard prospectus, requires it to: • identify the issuer and the nature of the securities; • state the nature of the risks involved in investing in the securities; • give details of all amounts payable in respect of the securities (including any amounts by way of fee, commission or charge); and • state that the person receiving the profile statement is entitled to a copy of the prospectus free of charge, that a copy has been lodged with ASIC which takes no responsibility for its contents, and its expiry date: s 714. 83

ASIC Regulatory Guide 170.60 (Prospective financial information).

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[10.120]

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A person who acquires securities as a result of an offer that was accompanied by a profile statement is deemed to have acquired the securities in reliance upon both the profile statement and the prospectus for the offer: s 729(2). ASIC’s policy has been that profile statements are “intended to give investors the ability to make comparisons between similar products in suitable industries”; accordingly, it will “only approve the use of profile statements for an industry where [it has] a satisfactory basis for determining content requirements which would achieve the aim of promoting comparability between products in that industry”. 84 Historically, ASIC approved the use of profile statements only for offers of interests in certain kinds of managed investment schemes (see [10.45]); however, these offers are now made under a PDS in accordance with Ch 7 rather than a disclosure document under Ch 6D, for example, investor directed portfolio services and like schemes. As at April 2017, ASIC has not approved any uses for profile statements. 85 Offer information statement content [10.130] An issuer undertaking an offer of securities that requires a disclosure document

under Ch 6D may use an offer information statement instead of a prospectus where the amount of money to be raised by the issuer does not exceed $10 million, taking into account all other amounts previously raised by the issuer and its controlled or related entities under previous offer information statements: s 709(4). An offer information statement 86 is available only for an offer of securities for issue by a company, not offers for sale. ASIC’s consent is not required for its issue. A distinct and lower disclosure standard applies to offer information statements relative to the general disclosure standard. Disclosure obligations under an offer information statement are limited to the information that s 715(1) requires to be included in the statement. This is expected to be material information within the knowledge of the issuing company so that investigation and external inquiries are not expected to be undertaken to discharge the disclosure standard. 87 The statement must: • identify the issuer and the nature of the securities; • describe the issuer’s business; • describe what the funds raised by the offers are to be used for; • state the nature of the risks involved in investing in the securities; • give details of all amounts payable in respect of the securities including any amounts by way of fee, commission or charge; • state that a copy of the statement has been lodged with ASIC and that ASIC takes no responsibility for its contents; • state that the statement is not a prospectus and that it has a lower level of disclosure requirements than a prospectus; • state that investors should obtain professional investment advice before accepting the offer; and

84

ASIC Policy Statement 153 (Profile statements), [153.4] (replaced by ASIC Policy Statement 254 (Offering securities under a disclosure document)).

85

ASIC Regulatory Guide 254.116, RG 254.117 (Offering securities under a disclosure document).

86

For an empirical examination of early use of the facility see A Karl, A Kazakoff & L Chapple (2003) 21 C&SLJ 231.

87

This is reflected in an additional defence against liability for an offer information statement: s 732 and see also [10.205]. [10.130]

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• include a copy of a financial report for the issuer being a report for a 12-month period with a balance date within the last six months before the securities are first offered under the statement; the report must also be prepared in accordance with the accounting standards and be audited: s 715. Unlike a short form prospectus and a profile statement, there is no larger document lodged with ASIC. This explains the inclusion of warnings about the lower disclosure standard for these offers as opposed to a prospectus and the wisdom of obtaining professional advice before accepting the offer. These warnings are intended to make investors aware of the risks involved in this form of offering. The requirement for a recent audited financial report limits the utility of the form for those small and medium enterprises which have taken advantage of dispensations from financial reporting obligations. ASIC will generally not give relief from the financial reporting requirements for issuers that wish to take advantage of this form of fundraising. 88 Common defects in disclosure documents [10.135] ASIC has identified the following as the most common disclosure defects in

fundraising documents lodged with it. • The failure by companies to clarify how the funds would be applied in the event that the company failed to raise the amount originally sought where it was not underwritten and not subject to a minimum subscription condition. This was the most common defect. • Issuers skewing the balance of information in the prospectus by highlighting positive information in the first few pages of the prospectus while burying negative information in the back of the prospectus. • Lack of disclosure of the methodology used, and assumptions applied, for the valuation of options in the prospectus. There was also concern that the option valuation methodology used had not taken into consideration probability or discounting factors. • The inadequacy of financial information disclosed in the fundraising document, and a lack of disclosure in relation to other material information, usually the risks associated with the company’s current activities or a proposed venture. • The failure of issuers to include the assumptions upon which financial forecasts in the fundraising prospectuses were based. • Inadequate disclosure on borrowing limitations without which investors will have difficulty in making an accurate assessment of the risk/reward returns in the offer. • The inclusion of statements where companies implied that they would be seeking a listing on a financial market in the future. • Insufficient disclosure concerning key terms of material contracts in the fundraising document. • The existence of current material litigation not disclosed in the fundraising document. • Inadequate disclosure about past breaches of the Corporations Act such as failure to disclose that ASIC had obtained final orders in relation to an illegal fundraising conducted by the issuer. ASIC considered that this was information that investors and their professional advisers would reasonably require to make an informed assessment of whether to invest in the fundraising. 89 88

ASIC Regulatory Guide 254.111–254.114 (Offering securities under a disclosure document).

89

See ASIC Media Releases 21 July 2003 (03-231), 5 January 2004 (04-001), 6 January 2004 (04-002), 22 April 2004 (04-117).

798

[10.135]

Corporate Fundraising

[10.137]

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Review Problem

Ros is a brilliant young biotechnology researcher working in the field of human genome technology. Her university-based research team has developed a number of techniques for which she personally holds the intellectual property rights. She wishes to commercialise a number of these techniques. The research field in which she is working is at the leading edge of scientific development. The potential financial returns from successful commercialisation of research applications are enormous. However, only very few research innovations in Ros’s field are likely to make it through successfully to the product or services market. There are also acute problems in communicating the nature and quality of the underlying science and the specific risks to which a product or innovation is subject. Her brother Ben runs a venture capital firm which assists fledgling firms to tap into capital sources among the pool of investors that it has assembled. These comprise private equity investors and fund managers with an appetite for investment in “start-up” ventures. Ros proposes that a company be formed as the vehicle for fundraising, further research and for commercialisation of research outcomes. She plans to put all her financial resources into the company as equity, including through the sale to the company of intellectual property rights in exchange for the issue of shares. She will also take as low a salary as possible from the company with the major part of her compensation in the form of options over unissued share capital. She intends that the scientific research staff to be employed by the company, principally her current research team, will have a similar remuneration structure. However, Ros wishes to be able to dispose of some of her equity in about two years. Ros estimates that the company’s initial capital needs for the next three to five years are likely to be in the range of $4-7 million. A second tranche of capital will be needed at some stage in the future in a much greater amount if the initial obstacles to successful commercial development are overcome. Advise Ros as to the choice of fundraising devices for raising equity capital.

THE PROCEDURE FOR OFFERING SECURITIES The fundraising process in overview [10.140] There are three rules that almost invisibly underpin fundraising regulation. They are

best made explicit since one or two of them shape the procedure for offering securities. First, a person must not offer securities of an entity that does not exist if the offer would need disclosure under Pt 6D.2 if the entity did exist; this is so even if it is proposed to form or incorporate the entity: s 726. Second, a person must not make an offer of securities, or distribute an application form for an offer of securities, that needs disclosure under Pt 6D.2 unless a disclosure document for the offer has been lodged with ASIC: s 727(1). 90 Third, the goal of ensuring as far as possible that those who apply under the offer have received the disclosure document is a cornerstone concern of regulation. Thus, a person must not make an offer of securities, or distribute an application form for an offer of securities, that needs disclosure under Pt 6D.2 unless the offer or form is either included in the prospectus or accompanied by a copy of the prospectus: s 727(2). The same rule applies if both a prospectus and a profile statement are used for the offer or an offer information statement is used. This offence provision further sanctions the requirement that offers of securities for which a 90

The prohibition upon distribution of an application form is not confined to the owner or controller of the securities but extends, eg, to their agents; there is no requirement in s 727(1) of any knowledge on the part of the person distributing an application form that the offers need disclosure: ASIC v Axis International Management Pty Ltd (No 5) (2011) 81 ACSR 631 at [200], [201]. [10.140]

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disclosure document is being used must be made in, or accompanied by, that document: s 721(1)-(4). Intentional or reckless contravention of the latter requirement is itself an offence: s 721(5). Further, securities may only be issued or transferred in response to an application form that is believed to be included in or accompanying a disclosure document: s 723(1). The following table in s 717 summarises the separate steps that must be taken for an offer of securities that requires disclosure under Pt 6D.2; it also gives signposts to relevant provisions. The table identifies six distinct stages in the offering process.

TABLE 10.3 Offering securities (disclosure documents and procedure) 1

2

3

Action required Prepare disclosure document, making sure that it: • sets out all the information required

Sections 710 711 712 713 • does not contain any misleading or 714 deceptive statements 715 • is dated 716 and that the directors consent to the disclosure document. Lodge the disclosure document with 718 ASIC Offer the securities, making sure that the offer and any application form is either included in or accompanies: • the disclosure document; or

721

• a profile statement if ASIC has approved the use of a profile statement for offers of that kind.

4

If it is found that the disclosure 719 document lodged was deficient or a 724 significant new matter arises, either: • lodge a supplementary or replacement document under s 719; or • return money to applicants under s 724. 722

5

Hold application money received on trust until the securities are issued or transferred or the money returned.

6

Issue or transfer the securities, making 723 sure that: • the investor used an application form distributed with the disclosure document; and • the disclosure document is current and not materially deficient; and • any minimum subscription condition has been satisfied.

Comments and related sections Section 728 prohibits offering securities under a disclosure document that is materially deficient. Section 729 deals with the liability for breaches of this prohibition. Sections 731, 732 and 733 set out defences.

Subsection 727(3) prohibits processing applications for non-quoted securities for 7 days after the disclosure document is lodged. Sections 727 and 728 make it an offence to: • offer securities without a disclosure document • offer securities if the disclosure document is materially deficient. Subsection 729(3) deals with liability on the prospectus if a profile statement is used. The securities hawking provisions (s 736) restrict the way in which the securities can be offered. Section 728 prohibits making offers after becoming aware of a material deficiency in the disclosure document or a significant new matter. Section 730 requires people liable on the disclosure document to inform the person making the offer about material deficiencies and new matters. Investors may have a right to have their money returned if certain events occur (see ss 724, 737 and 738). Section 721 says which disclosure document must be distributed with the application form. Section 729 identifies the people who may be liable if: • securities are issued in response to an improper application form; or • the disclosure document is not current or is materially deficient Sections 731, 732 and 733 provide defences for the contraventions. Section 737 provides remedies for an investor.

Preparation of the disclosure document [10.145] Since the recasting of fundraising regulation and its successful use in the earlier

privatisation of the Commonwealth Bank in 1991, a more or less standard due diligence process has developed for initial public offerings of securities and other major new 800

[10.145]

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fundraisings. This involves the formation of a due diligence committee to identify all material required to be disclosed and oversee the process of verification of statements contained in a draft disclosure document prepared under the direction of the committee. The due diligence committee usually comprises representatives of senior management (often the chief executive and chief financial officer), the non-executive directors, the issuer’s lawyers, its financial adviser (often an investment bank), the underwriter to the issue, and any experts (eg, investigating accountants, geologists, etc). (The due diligence committee mechanism is discussed more fully at [10.207].) The draft disclosure document and report of the due diligence committee are submitted to directors of the issuer who must consent to the lodgment of the document with ASIC: s 720. By pooling information and so structuring the investigation and verification process, those liable for the prospectus’s contents garner the maximum protection available under the statutory defences: see [10.205]. The consents required for the several forms of offering document are shown in the following operative table contained in s 720. It applies also for supplementary or replacement disclosure documents: see [10.155].

TABLE 10.4 Consents required for lodgment of offering documents

1

2

3

4

Consents required for lodgment Type of offer Issue offers offer of securities for issue

[operative] People whose consent is required every director of the body every person named in the document as a proposed director of the body

sale offers (sale by controller) offer of securities for sale that needs a disclosure document because of s 707(2) sale offers (sale amounting to indirect issue) offer of securities for sale that needs a disclosure document because of s 707(3)

if seller an individual – that individual if seller a body – every director of the body

sale offers (sale amounting to indirect sale by controller) offer of securities for sale that needs a disclosure document because of s 707(5)

if seller an individual – that individual if seller a body – every director of the body if individual controls the body whose securities are offered for sale – that individual if body controls the body whose securities are offered for sale – every director of the controlling body

every director of the body whose securities are offered for sale if seller an individual – that individual if seller a body – every director of the body

Lodgment of the disclosure document with ASIC

Lodgment, post-vetting and stop orders [10.150] A disclosure document to be used for an offer of securities must be lodged with ASIC: s 719. A company or other person who wishes to offer securities may distribute the disclosure document immediately after it has been lodged with ASIC. However, a person offering non-quoted securities will not be allowed to accept an application for the issue or transfer of the securities until seven days after lodgment of the disclosure document with ASIC: s 727(3). ASIC may extend this exposure period to a maximum of 14 days. ASIC interprets the exposure period requirement as obliging offerors to make the disclosure document generally available during this period. This would generally involve posting it on an internet site that is accessible to the public and making it available upon request in print form. 91 The exposure period gives ASIC and the market an opportunity to consider the disclosure document before the commencement of subscriptions for the securities on offer. Where the disclosure document 91

ASIC Regulatory Guide 254.152 (Offering securities under a disclosure document). [10.150]

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Corporations and Financial Markets Law

is defective, the market may draw it to the attention of ASIC; alternatively, aggrieved parties may seek injunctive relief against the fundraising: see [10.220]. 92 The exposure period does not apply to the offering of quoted securities on the basis that these securities already have an established market price and are subject to the continuous disclosure regime of Ch 6CA and stock exchange listing rules. ASIC undertakes post-lodgment audits (“post-vetting”) of disclosure documents lodged with it but will examine a prospectus prior to lodgment only in exceptional circumstances. Post-vetting is undertaken both selectively and randomly and both during and after the exposure period. ASIC may seek access to the documentation prepared under the direction of the due diligence committee and its verification material. ASIC’s remedies, which underpin its enforcement powers, include the power to make stop orders and to require the lodgment of supplementary or replacement disclosure documents under threat of the exercise of the stop order power. ASIC may order that no offers, issues, sales or transfers of the securities be made while the order is in force if it is satisfied that information in a disclosure document is not worded and presented in a clear, concise and effective manner as required by s 715A or that an offer of securities under a disclosure document would contravene s 728: s 739(1). A disclosure document contravenes s 728 if it contains a misleading or deceptive statement, an omission of material required by the applicable disclosure obligation under ss 710 to 715, or a new circumstance has arisen which these provisions would have required to be included in the document if it had occurred prior to its lodgment with ASIC. ASIC may also make interim orders: s 739(3), (4). Indeed, interim orders are more frequent than stop orders. ASIC reports that most stop orders are made with the consent of the offering company after it has made the decision not to proceed with the particular prospectus rather than address a disclosure deficiency raised with it. 93 Usually an interim order will have been made first.

Supplementary or replacement disclosure document [10.155] If an offeror becomes aware of a misleading or deceptive statement, omission or new

circumstance as described that is materially adverse from the point of view of an investor, the person may lodge a supplementary or replacement document with ASIC: s 719. 94 The positive obligation to do so, rather than this licence, arises since it is an offence to continue making offers after the person has become aware of a misleading or deceptive statement, omission or new circumstance that is materially adverse; the lodgment of a supplementary or replacement document with ASIC correcting the deficiency allows offers to be resumed: s 728(1). Similarly, if the offeror becomes aware that information in the disclosure document is not worded and presented in a clear, concise and effective manner, they may lodge a supplementary or replacement document with ASIC (s 719(1A)); doing so pre-empts the exercise of ASIC’s stop power under s 739(1)(a). Lodging a supplementary or replacement document also prevents triggering of further obligations to return application money by reason of a misleading or deceptive statement, omission or new circumstance: s 724(1)(c), (d), (2), [10.160]. A supplementary or replacement document must state at its beginning that it is such and identify the disclosure document it supplements or replaces; a supplementary document must also identify any previous supplementary documents lodged with ASIC in relation to the offer and state that it is to be read together with the disclosure document it supplements and any previous supplementary documents: s 719(2), (3). If a supplementary or replacement 92

Corporate Law Economic Reform Program Bill 1999, Explanatory Memorandum, [8.68].

93 94

ASIC Media Release 21 July 2003 (03-231). The standard of materiality is not defined but it is likely that reference would be made in its application to the interpretation given to the term in TSC Industries Inc v Northway Inc 426 US 438 at 449 (1976) quoted at [10.100].

802

[10.155]

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document is lodged with ASIC, the disclosure document is taken to be the disclosure document together with the supplementary or replacement document for the purposes of the application of Ch 6D to events occurring after the lodgment: s 719(4), (5). Holding the application money [10.160] Several provisions protect the application money in the period before the securities

are issued or transferred to applicants. Thus, if a person offers securities for issue or sale under a disclosure document, they must hold the application money in trust for applicants until the securities are issued or transferred or the money is returned to the applicants: s 722(1). 95 If the application money needs to be returned, the person must return the money as soon as practicable: s 722(2). Four events trigger obligations on the part of the offeror either to return application money or to give applicants certain information coupled with the right to have their money returned. The first event arises where the disclosure document states that the securities will not be issued or transferred unless applications for a minimum number of securities are received or a minimum amount is raised; the offeror must not issue or transfer any of the securities until that condition is satisfied and, if it is not satisfied within four months, the repayment obligation is triggered: ss 723(2), 724(1)(a). The second event arises if a disclosure document states or implies that the securities are to be quoted on a financial market and an application for the admission of the securities to quotation is not made within seven days after the date of the disclosure document or the securities are not admitted to quotation within three months. In either case, an issue or transfer of securities in response to an application made under the document is void and the offeror must return the application money as soon as practicable: ss 723(3), 724(1)(b). The third instance arises where the offeror becomes aware that the disclosure document contains a misleading or deceptive statement or omits something required by ss 710 – 715 which in either case is materially adverse from the point of view of an investor: s 724(1)(c). The fourth event arises where the offeror becomes aware of a new circumstance that is materially adverse to investors. In these four situations, the offeror must either repay the application money received or, in the third and fourth instances, they may elect to give the applicants a supplementary or replacement prospectus that corrects the deficiency or changes the terms of the offer; in this latter case, the applicants have one month in which they may withdraw their application and be repaid: s 724(2), (3). If securities are issued to a person in contravention of s 724, the person has the right to return the securities and to have their application money repaid, even if the issuer is being wound up (s 737(1)); this right is exercisable by written notice given to the company within one month after the date of the issue (s 737(2)); if the issuer does not repay the money, its directors are personally liable to do so: s 737(3). If an application is received after the expiry date of a disclosure document, the offeror must either return the application money or give the applicant a new disclosure document and one month to withdraw the application and be repaid: s 725. Restrictions on advertising and publicity of securities offerings

General considerations [10.165] This panoply of investor protection might be set at naught if a securities offering

could be promoted independently through a process that bypasses the formal offering documents. Traditionally, company law has allowed advertising or promotion of a securities 95

A person offering non-quoted securities may not accept an application for the issue or transfer of the securities until seven days after lodgment of the disclosure document with ASIC: s 727(3); see [10.155]. [10.165]

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offering only after the prospectus has been lodged and then in a form limited to stating that a prospectus has been lodged and conveying a few key details about the offering. These rules were recast in 2000 on the basis that they were unduly restrictive and inadequately enforced. The principles that shape advertising regulation include the following considerations which for the most part may be found in the current scheme of regulation. • Regulation needs to guard against promotion that bypasses the disclosure document, protecting its intended function as the fulcrum of the investment decision or its primary basis, at least among retail investors. • A distinction needs to be drawn between advertising and publicity before, and that permitted after, the lodgment of the disclosure document. Since a prospectus is not then available to correct misconceptions, pre-prospectus advertising campaigns pose a particular danger of distorting investment decisions; once an investment decision is made, the influence of a subsequent prospectus is diminished. 96 • With respect to post-prospectus advertising, different considerations apply for quoted and unquoted securities. Unquoted securities offerings are more susceptible to manipulation through advertising campaigns since there is no informed market for the securities. For quoted securities, however, information about the issuer and its securities will already be available to investors through the exchange’s continuous disclosure rules and the market’s assessment of value will be reflected in their price. • Disinterested commentary and reporting on the offering serves a valuable information gathering function and assists price setting. • A reasonable accommodation needs to be set between the claims of genuine “image” or ambient advertising for a company and that which is primarily designed to promote a securities offering that it is making.

The general prohibition upon advertising [10.170] These principles are broadly expressed in current regulation. If a securities offering

does not require a disclosure document (eg, because it is covered by an exemption under s 708), there is no restriction under Pt 6D.2 upon its advertising or promotion. 97 However, an exception is made for offers protected by the exemption for small-scale offerings (viz, personal offers resulting in up to 20 issues or sales in 12 months: s 734(1) and [10.80]), presumably on the basis that the considerations that justify that exemption do not displace the investors’ need for advertising protection. A person must not advertise or publish a statement that directly or indirectly refers to a small-scale offer or intended offer: s 734(1). Otherwise, there is a general prohibition upon advertising subject to particular exceptions. Thus, if an offer or intended offer needs a disclosure document, a person must not advertise the offer or publish a statement that directly or indirectly refers to the offer or is reasonably likely to induce people to apply for the securities: s 734(2). (The exceptions for permitted advertising are discussed at [10.175].) In deciding whether a statement indirectly refers to an offer or is reasonably likely to induce applications for securities, regard must be had to whether the statement forms part of the normal advertising of a company’s products or services and is genuinely directed at maintaining its existing customers or attracting new customers for those products and services, whether it communicates information that 96

Fundraising: Capital Raising Initiatives to Build Enterprise and Employment (Corporate Law Economic Reform Program Proposals for Reform: Paper No 2, 1997), p 31.

97

Promotional statements are, however, subject to restrictions that apply to commercial communications generally such as the legal principles applicable to misleading or deceptive statements: see [10.210].

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materially deals with company affairs, 98 or whether it is likely to encourage investment decisions being made on the basis of the statement rather than on the basis of information contained in a disclosure document: s 734(3). This expresses the distinction drawn above between normal ambient advertising and prospectus promotion. (What inference should be drawn from the second of the three matters to which regard must be had, viz, that in s 734(3)(d)?) That distinction was blurred in the 1990s when the level and generality of ambient advertising appeared to increase dramatically just prior to some major retail fundraisings. Where a disclosure document has been lodged with ASIC, its dissemination will not contravene s 734(2) unless ASIC has made a stop order in relation to the offer: s 734(4). 99

Permitted advertising [10.175] The general prohibition upon advertising is subject to exceptions in respect of which

the person propounding a claim to their protection bears the evidential burden: s 734(2A) (note). The first applies in the period before the lodgment of a disclosure document for an offer of securities of a class already quoted on an exchange. For such offers advertising is liberally allowed provided that it includes a statement with the following prescribed matters: the identity of the issuer of the securities and the seller (if there is one); that a disclosure document for the offer will be made available when the securities are offered and when and where it will be available; that a person should consider the disclosure document in deciding whether to acquire the securities, and that anyone who wishes to acquire the securities will need to complete the application form that will be in or accompany the disclosure document: s 734(5)(a). Otherwise, advertising content for an offer of quoted securities is not regulated other than through the law relating to commercial communications, for example, through liability for misleading or deceptive statements: see [10.210]. However, if the prospective offer is for unquoted securities, pre-prospectus publicity is limited to statements (“tombstone statements”) that do no more than: • identify the offeror and the securities, and • state that a disclosure document for the offer will be made available when the securities are offered and that anyone who wants to acquire the securities will need to complete the application form that will be contained in or accompany the disclosure document: s 734(5)(b). 100 After the disclosure document is lodged, advertising and promotion is permitted without limitation beyond that arising from the restraint on misleading or deceptive conduct and the market offence provisions in Ch 7 provided that it includes a statement with the same content as that prescribed for advertising in the pre-lodgment period (see previous paragraph) including the statement that the offers of the securities are made in the disclosure document and that anyone wishing to acquire them must complete the application form in the document: s 734(6). This licence applies to offerings both of quoted and unquoted securities. There are several further exemptions from the general prohibition that are more specific. The advertising restrictions do not apply to notices lodged with a securities exchange, reports on the issuer’s general meetings, reports by the issuer that does not refer to the offer, news reports and disinterested media comment on the disclosure document, and disinterested reports about the issuer’s securities: s 734(7). The basis of these dispensations (which do not 98 99 100

This term is widely defined to include the promotion, formation, membership, control, business, trading and transactions of the company: s 53. ASIC’s Regulatory Guide 234 has detailed guidance for promoters of financial products and services, and for publishers of advertising for these products and services. The statement might also indicate how interested persons may arrange to receive a copy of the disclosure document: s 734(5)(b)(iv). [10.175]

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depend upon whether a prospectus has been lodged with ASIC) is the benefit flowing from genuine comment and media reporting of corporate affairs. Publishers are also protected for advertisements or statements published in the ordinary course of business of newspaper or magazine publishing or radio or television broadcasting where they did not know and had no reason to suspect that the publication would amount to a contravention: s 734(8). There is a further licence to circulate draft (or “pathfinder”) disclosure documents exclusively among those who would qualify as sophisticated, experienced or professional investors under s 708(8), (10), (11) whether or not the final document is intended to receive a wider distribution: s 734(9). This is often done with a view to setting a realistic offering price and finalising the contents of the disclosure document. Finally, ASIC has granted further relief from advertising restrictions for roadshow presentations and market research. Roadshow presentations are made by or on behalf of an issuer to analysts and other industry participants such as securities licensees, exempt dealers, exempt investment advisers and securities representatives. The issuer may also undertake market research to determine the number of disclosure documents that should be printed and to decide to whom the offer should be marketed and the type and extent of marketing to be done. 101 ASIC post-vets rather than pre-vets advertisements for compliance and its policy is to act only where the action would result in the market being drip-fed with selective information that is usually contained in the disclosure document or where it would discourage adequate analysis of the disclosure document by individual investors and result in investment decisions being made on the basis of the advertising campaign rather than the disclosure document. 102 Securities hawking [10.180] There has been a longstanding prohibition in companies legislation upon persons

going from place to place offering securities for subscription or sale. The prohibition derives from a recommendation of the Greene Committee in 1926. Subsequently, the Eggleston Committee in Australia expressed the rationale for the prohibition upon share hawking (as the practice was originally known) in these terms – The basis of the prohibition of share hawking is that as persons who are not experienced in business matters are unlikely to be able to form a reliable judgment as to the value of shares, it is undesirable that the law should permit them to be sold by door-to-door salesmen. Not only is it extremely difficult to establish exactly what representations were made to induce a person to subscribe for them, but in many cases, without actual misrepresentation of the facts, a salesman is able to paint such a glowing picture of the profits expected that the subscriber or buyer may find himself committed to a substantial expenditure on an investment that turns out to be worthless. The prohibition therefore represents a logical extension of the kind of protection that was sought to be given by the prospectus provisions. It was thought that if a prohibition was imposed against persons going from place to place offering shares for subscription or purchase, the ignorant investor could only be persuaded to subscribe if he were sent a written communication. 103

Following the CLERP amendments, regulation has been simplified to prohibit the offering of securities for issue or sale in the course of, or because of, an unsolicited meeting with another person or telephone call to another person (“cold calling”) unless the offer is exempted under s 736(2): s 736(1), (1A). (Why do you think other approaches such as mail and email are left unregulated?) The exceptions in s 736(2) apply in relation to sophisticated or professional investors or offers of listed securities made by telephone by a licensed securities dealer or an 101

ASIC Regulatory Guide 254.269–254.282 (Offering securities under a disclosure document).

102 103

ASIC Regulatory Guide 254.286–254.290 (Offering securities under a disclosure document). Company Law Advisory Committee, Sixth Interim Report (1972), [4].

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offer made to a client by such a dealer through whom the client has bought or sold securities in the last 12 months. If securities are issued or transferred to a person as a result of an offer that contravenes s 736, they may return the securities within one month after the issue or transfer; if they do so, they are entitled to be repaid the amount they paid for the securities: s 738. ASIC’s powers of enforcement, exemption and modification [10.185] Part 6D.4 grants ASIC specific enforcement powers in relation to corporate

fundraising. First, it may make stop orders if it is satisfied that • an offer of securities under a disclosure document lodged with it contains information that is not worded and presented in a clear, concise and effective manner; • an offer of securities would contravene s 728; or • an advertisement relating to securities is defective: s 739(1) and [10.150]. ASIC’s stop order power extends therefore to defective advertisements and publicity before and after the lodgment of a disclosure document as well as to offers of securities after lodgment of the disclosure document. An advertisement is defective if it makes a misleading or deceptive statement, omits material that is required, or makes a statement about future matters without having reasonable grounds for doing so: s 739(6) – (8). ASIC must hold a hearing and give a reasonable opportunity for an interested party to make submissions to it before making a stop order: s 739(2). An interim order may be made in some situations: s 739(3), (4). The limits upon the stop order power and the conditions for the exercise of the interim power are canvassed in Thompson v ASIC [10.190]. Second, ASIC is given broad anti-avoidance powers to require the aggregation of transactions of corporations that it considers are closely related so that the issue, sale or transfer of securities in one company is taken to be also the issue, sale or transfer of securities of the related companies: s 740. This provision has particular application to ceiling limits for offer information statements: see [10.95]. Third, ASIC possesses broad powers to exempt a person from a provision of Ch 6D or to declare that the Chapter applies to that person as if specified provisions were omitted, modified or varied in the manner that ASIC specifies: s 741(1). These powers are the counterpart to like discretionary powers with respect to takeovers and financial reporting: see [12.25] and [9.190]. They facilitate the application of detailed “black letter” rules. ASIC has released a regulatory guide outlining its policies on the exercise of discretionary powers with respect to fundraising. 104 Finally, ASIC may exercise enforcement powers of wider application such as those with respect to misleading or deceptive conduct under s 1041H and ASIC Act s 12DA and for remedial orders for contravention of provisions within Ch 6D under s 1324: see [10.220].

Thompson v ASIC [10.190] Thompson v ASIC (2002) 41 ACSR 456 Federal Court of Australia [The controllers of a company agreed to sell the whole of its share capital to another company (IMM). The sale was conditional on IMM successfully raising $6.5 million through the issue of ordinary shares. On 1 March, IMM lodged a prospectus with ASIC. On 2 April it advised the market through an ASX announcement that it had resolved to close the offer which had been oversubscribed. After this announcement ASIC advised the directors of IMM that it had received information which suggested that a third party had a prior claim in relation to a major asset of the company whose capital it was purchasing. The directors undertook not to process the issue of any shares pursuant to the offer while ASIC and the directors investigated the claim. After investigation, IMM’s directors concluded that that 104

ASIC Regulatory Guide 151 (Fundraising: Discretionary powers). [10.190]

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Thompson v ASIC cont. the claim was not sufficiently strongly based to be adverse to the interests of investors; however, on 8 April ASIC issued an interim order that no offers, issues, sales or transfers of securities be made by IMM since the offers would contravene s 728. The vendor of shares to IMM under the uncompleted sale sought review of ASIC’s interim order. The parties invited the court to proceed on the basis that no contractual relationship had been entered into between IMM and the persons who applied for shares under the prospectus.] BRANSON J: 29 In considering the proper interpretation of s 739, it is appropriate to start from the premise that the section is a provision designed for the protection of potential investors. It seems to me that its inclusion in the Act reflects an appreciation by the legislature that s 724 may provide ineffective protection to an applicant for securities where the relevant disclosure document contains a material misstatement or omission. It would therefore seem logical for the ambit of s 739 to be at least co-extensive with that of s 724. Further, in my view, the terms of s 739(1) indicate that the power given by s 739 to ASIC in respect of an offer of securities under a disclosure statement lodged with it is not intended to come to an end until it becomes impossible for any stop order made by ASIC to operate according to its terms. That is, until it is no longer possible for any relevant offers, issues, sales or transfers of the relevant securities to be made. In particular, the fact that a stop order made by ASIC reaches to “transfers” of securities is an indication that Parliament intended ASIC to be able to issue a stop order to prevent securities from being issued without regard to whether the offer in respect of those securities had closed. It would not, in my view, promote the purpose underlying the Act to adopt a construction of s 739 which left what could be a critical aspect of a fundraising process (ie the issue of securities after the close of the offer) beyond the power of ASIC to issue a stop order. Nor, in my view, would it promote the purpose underlying the Act if s 739 were construed in a way which would allow a person who has offered securities under a suitably worded disclosure document to close an offer during the life of an interim order under s 739(3) thus preventing the making of an order under s 739(1). I do not consider it appropriate to so construe the section (see s 15AA of the Acts Interpretation Act 1901 (Cth)). 30 It seems to me that the power given to ASIC by s 739(1) is intended to come into effect upon the lodging of the relevant disclosure document with ASIC and to continue until it is no longer possible for any of the things that a stop order may interdict to take place in respect of the offer to which that disclosure document relates. I conclude that the opening words of s 739(1) are intended to express in a short-hand way the requirement that ASIC be satisfied that an offer of securities made, or intended to be made, under a disclosure document lodged with ASIC is, was, or would be, an offer made in contravention of s 728. 31 To summarise, in my view, ASIC is authorised to act under s 739(1) of the Act where, and only where: (1)

A disclosure document (see s 705) in respect of an offer of securities (see s 700) has in fact been lodged with ASIC;

(2)

ASIC is satisfied that an offer of securities under that disclosure document would contravene s 728 in the sense that ASIC is satisfied that there is [a misleading or deceptive statement, the omission or new circumstance]; and

(3)

It remains possible for an order under the subsection to operate according to its terms in the sense that an offer, issue, sale or transfer of securities under the disclosure document lodged with ASIC may still be made.

32 However, even where ASIC is authorised to act under s 739(1), it must, before making any order other than an interim order, hold a hearing and give a reasonable opportunity to any interested people to make oral or written submissions to ASIC on whether an order should be made (see s 739(2)). Where ASIC considers that any delay in making a stop order pending the holding of a hearing would be prejudicial to the public interest, it may make an interim order under s 739(3). 33 I reject the submission of ASIC that ASIC may make an interim order under s 739(3) in circumstances in which it would not be authorised to make an order under s 739(1). That is, in circumstances in which it is not satisfied that an offer of securities under a disclosure document would 808

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Thompson v ASIC cont. contravene s 728 in the sense discussed above but in which it holds a suspicion falling short of satisfaction that the offer would contravene s 728. In my view, if the legislature intended that ASIC should be able to exercise, even on an interim basis, the significant power of intervention in fundraising given to it by s 739 in circumstances less restrictive than those provided for by s 739(1), it would have said so explicitly. This approach does not deprive the hearing required by s 739(2) of utility. As a result of evidence adduced at the hearing, or of submissions made to ASIC, ASIC may find its earlier satisfaction undermined, or, even if it continues to hold the necessary satisfaction, it may form the view that it would not be an appropriate exercise of its discretion under s 739(1) to make a stop order. 34 In my view, before ASIC may issue an interim order under s 739(3) it must: (1)

be authorised to act under s 739(1) (see [31] above);

(2)

have decided (subject to the outcome of the hearing under s 739(2)), to exercise the discretion given to it by s 739(1) in favour of making an order under s 739(1); and

(3)

consider that any delay in making an order under s 739(1) pending the holding of the hearing required by s 739(2) would be prejudicial to the public interest.

It was not suggested in this case that any of the above criteria was not satisfied at the time that ASIC made the order. [The application for review was dismissed.]

LIABILITY FOR THE CONTENTS OF DISCLOSURE DOCUMENTS [10.195] As noted, the disclosure policy shaping fundraising regulation requires disclosure

with respect to specified matters which are deemed material to investor judgment, and imposes civil and criminal sanctions for misstatements and omissions. These statutory sanctions supplement common law remedies derived from tort and contract. Their foundation is the structured system of liability and defences with respect to the content of disclosure documents contained in Pt 6D.3 Div 1. Amendments to the Act made in 2010 eliminate any restriction on the capacity of shareholders to recover damages against a company based on how they acquired the shares or whether they still hold the shares. 105 Shareholders may recover damages against their company: s 247E. However, all claims by shareholders in relation to the buying, selling, holding or otherwise dealing with shares rank equally with each other but are now postponed to other creditor claims: s 563A. Misleading or deceptive statements, omissions and new circumstances [10.200] The central liability provision around which the structure of civil and criminal

liability in Ch 6D is built is the prohibition in s 728(1) on the offering of securities under a disclosure document if it contains a misleading or deceptive statement, an omission of material required by the applicable disclosure obligation under ss 710 to 715, or a new circumstance has arisen which these provisions would have required to be disclosed if it had arisen before the document was lodged with ASIC. As regards future matters, a person is taken to make a misleading statement if they do not have reasonable grounds for making the statement: s 728(2). A person commits an offence if they contravene s 728(1) and the misleading or deceptive statement, the omission or new circumstance is materially adverse from the point of 105

These amendments reverse the effect of the High Court decision in Sons of Gwalia Ltd v Margaretic (2007) 231 CLR 160. [10.200]

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view of an investor: s 728(3). A person who suffers loss or damage because an offer of securities under a disclosure document contravenes s 728(1) may recover the amount of the loss or damage from a person referred to in the following table if the loss or damage is one that the table makes the person liable for; this is so even if the person did not commit, and was not personally involved in, the contravention (in that sense it imposes a form of positional liability): s 729(1). 106 Some persons are liable for misstatements, etc, only in limited portions of the disclosure documents (see item 5 in the table below). The persons named in the table will escape liability if they establish the elements of one or more of the defences applicable to the particular disclosure document: see [10.205].

TABLE 10.5 Right to recover compensation for loss or damage resulting from contravention 1 2 3 4 5

6

People liable on disclosure document These people … the person making the offer

[operative] are liable for loss or damage caused by … any contravention of s 728(1) in relation to the disclosure document each director 107 of the body making the offer if the any contravention of s 728(1) in relation to the offer is made by a body disclosure document any contravention of s 728(1) in relation to the a person named in the disclosure document with their consent as a proposed director of the body disclosure document whose securities are being offered any contravention of s 728(1) in relation to the an underwriter (but not a sub-underwriter) to the issue or sale named in the disclosure document disclosure document with their consent the inclusion of the statement in the disclosure a person named in the disclosure document with document their consent as having made a statement: (a) that is included in the disclosure document; or (b) on which a statement made in the disclosure document is based a person who contravenes, or is involved in the contravention of, s 728(1)

that contravention

This liability regime with respect to disclosure documents embraces the issuer company, its directors (including persons named as prospective directors) and, if they have consented to be named, underwriters, and those named in the document with their consent as having made a statement that is included in the document or on which a statement in the document is based. This latter group might include experts, auditors, bankers, solicitors and other persons assisting the issuer in relation to the issue. A person named in the table must notify the offeror in writing as soon as practicable if they become aware during the application period of a misleading or deceptive statement, omission or new circumstance in the disclosure document that is material in either case: s 730. There is a guide to the interpretation and application of the misleading or deceptive statement or omission standard in the extensive body of decisions based upon the prohibition on engaging in misleading or deceptive conduct formerly contained in trade practices legislation and now in s 18 of the Australian Consumer Law (at [10.210]). This prohibition is incorporated in the Act but not in relation to statements etc contained in a disclosure document where s 728 and its defences displace this ground of liability with respect to 106

A person who acquires securities as a result of an offer that was accompanied by a profile statement is taken to have acquired the securities in reliance on both the profile statement and the prospectus for the offer: s 729(2).

107 A note to the table indicates that this reference to a director includes a shadow director: see [7.40]. 810

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disclosure documents: see National Exchange Pty Ltd (ACN 006 079 974) v ASIC [10.230], Fraser v NRMA Holdings Ltd [6.120], and see [10.210]-[10.215] generally concerning civil liability for misleading or deceptive conduct. 108 “Fraud upon the market”, reliance and the problem of causation [10.202] Section 729(1) provides that a person who suffers loss or damage because an offer of

securities under a disclosure document contravenes s 728(1) may recover the amount of the loss or damage from a person referred to in the following table if the loss or damage is one that the table makes the person liable for. In that table, the issuer, directors and underwriter named in the document are made liable for loss or damage caused by any contravention of s 728(1) in relation to the disclosure document. Section 729 therefore appears to provide two tests for causation that must be satisfied before liability arises: the “because” and “caused by” tests. It is not clear, however, that there is any difference in substance between the two tests: in Caason Investments Pty Ltd v Cao it was assumed by the parties and accepted by the the Full Federal Court that the causal test was the same in both. 109 In that case the issue for decision was whether the causal requirement in s 729(1) includes a requirement of reliance by the plaintiffs on the disclosure document that is alleged to contravenes 728. The court held it is at least reasonably arguable that it does not, that is, that a market-based causation plea has reasonable prospects of success as a matter of law in Australia. In the United States, the “fraud on the market” doctrine is an accepted principle that relieves shareholders, usually in class actions, from having to prove direct reliance on misleading or deceptive statements. 110 The doctrine acts as a rebuttable presumption that the market price of shares traded on well-developed markets reflects all publicly available information – and hence any material misrepresentations – so that it can be assumed that an investor relied on public misstatements whenever he or she buys or sells stock at the price set by the market. 111 Australian law does not authorise such a rebuttable presumption; 112 on the other hand, no decision of the High Court or any intermediate Australian appellate court had, before Caason Investments, considered whether a standard of causation based on the effect of the contravention upon the market is sufficient for s 729 without actual reliance upon the prospectus. Edelman J explained this concept of market-based causation: A market based causation case is not a special sub-category of causation. It is, simply put, an example of indirect causation. One circumstance of market based causation … involves an alleged disclosure of misleading information to the market in a disclosure statement. That misleading information causes the listed price of securities being inflated which, in turn, causes an alleged loss because the investor purchases the securities at a higher price than he or she would otherwise have paid. 113

Caason Investments was an application for leave to appeal from a refusal to grant leave to amend a statement of claim to include pleading of “market-based”, as distinct from 108

See G North (2012) 30 C&SLJ 342; G North, Company Disclosure in Australia (Lawbook Co, 2013), ch 10; E Klotz (2015) 33 C&SLJ 451.

109 110 111 112

(2015) 236 FCR 322 at [152] per Edelman J (dissenting on procedural grounds only). Basic v Levinson 485 US 224 (1988); Halliburton Co et al v Erica P John Fund Inc 134 S Ct 2398 (2014); Note (2014) 128 Harv L Rev 291; M Legg, J Emmerig and G Westgarth (2015) 43 ABLR 448a. Re HIH Insurance Ltd (2016) 113 ACSR 318 at [41]. Johnston v McGrath [2007] NSWCA 231 at [38] per Young CJ in Eq (“[t]his doctrine has not (yet) been successfully invoked locally, and has been downplayed by Blanchard J in New Zealand in Boyd Knight v Purdue [1999] 2 NZLR 278 at 292 (CA). However, even if it has validity in Australia, the present case does not raise it”).

113

(2015) 108 ACSR 578 at [93]. [10.202]

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“reliance-based” causation. Edelman J dissented from the majority on the interpretation of the first instance decision but not on the legal issue of the causation requirement for claims under s 729. He said: First, and fundamentally, it is necessary to reiterate … that reliance is not a substitute for the essential question of causation: Campbell v Backoffice Investments Pty Ltd. 114 The usual manner in which the concept of causation is used is to describe a metaphysical relationship between an event and an outcome. The relevant event and outcome can be easily identified when considering whether a person suffered loss or damage because an offer of securities under a disclosure document contravenes s 728(1). The relevant event is the contravention of s 728(1). The relevant outcome is the suffering of loss or damage. As a matter of ordinary language, there is nothing in the word “because” that requires that the metaphysical causal relationship between the event and the outcome can only be proved by reliance by the appellants on a disclosure document. The concept of market based causation involves a causal relationship albeit one without reliance by the plaintiff investor on a disclosure document. The plea is that a misleading statement or omission in a disclosure document causes the market price for the securities to be inflated so that the investor purchases securities at a price which is greater than the investor would otherwise have paid. The investor then suffers loss including when the release of the omitted information or the correction of the misleading statements causes the market price of the securities to fall. None of these causal links requires the investor to rely on the disclosure document. It is at least arguable that as a technique of causation without reliance, market based causation is not unusual. A common example of causation without reliance is cases that involve misleading conduct by one trader which leads to customers being diverted from another trader. 115

Edelman J pointed to other reasons why it is arguable that reliance is not a necessary element of causation in s 729. Thus, s 729(1) permits claims in respect of alleged omissions, in relation to which the concept of reliance is “at best a strain of language”; there need be no sharp contrast between market-based causation and the more traditional reliance-based causation because both types of causation might be indirect; finally, the concept of market-based causation has not been expressly rejected in any Australian case and in some cases it has been allowed to proceed to trial or implicitly endorsed as arguable. 116 In Re HIH Insurance Ltd the absence of direct reliance on overstated financial accounts was held not to be fatal to an action by investors for loss sustained by contravention of the predecessor of s 1041H (misleading or deceptive conduct): if they purchased shares at a price set by a market which was inflated by the contravening conduct: the contravening conduct caused the market on which the shares traded to be distorted, which in turn caused loss to investors who acquired the shares in that market at the distorted price. In the absence of any suggestion that any of the plaintiffs knew the truth about, or were indifferent to, the contravening conduct, but proceeded to buy the shares nevertheless. I conclude that “indirect causation” is available and direct reliance need not be established. 117

That chain of causation is this: HIH released overstated financial results to the market; the market was deceived into a misapprehension that HIH was trading more profitably than it really was and had greater net assets than it really had; HIH shares traded on the market at an 114

(2009) 238 CLR 304 at 351 per Gummow, Hayne, Heydon and Kiefel JJ.

115

(2015) 108 ACSR 578 at [153]-[155].

116

117

(2015) 108 ACSR 578 at [156]-[158]; cf [59]-[62], [68] per Gilmour and Foster JJ (“[t]he text [of s 729(1)] does not refer to reliance. Accordingly, whilst reliance is a sufficient condition for establishing causation, it is not a necessary one”). (2016) 113 ACSR 318 at [77].

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inflated price; and investors paid that inflated price to acquire their shares, and thereby suffered loss. 118 Thus, the contravening conduct materially contributed to that outcome; it does not need actual reliance by an individual investor upon the misleading financial accounts – such reliance as exists was by the market as a whole. Of course, indirect causation still needs to be established since this reasoning proceeds on the assumption that the contravening conduct caused the market to be inflated: The plaintiffs must establish, by evidence and/or inference, that the contravening conduct distorted the market price so as to cause the shares to trade at an inflated price. In this case, whether the contravening conduct had the effect of inflating the market price of HIH shares is intertwined with the quantification of the plaintiffs’ damages, if any. 119

Defences to liability [10.205] There are several defences to criminal and civil liability arising under ss 728 and

729. First, a person does not commit an offence under s 728(3) and is not liable under s 729 for a contravention of s 728(1) because of a misleading or deceptive statement in a prospectus if they prove that they made all inquiries (if any) that were reasonable in the circumstances and, after doing so, believed on reasonable grounds that the statement was not misleading or deceptive: s 731(1). Similarly, there is no liability because of an omission from a prospectus in relation to a particular matter if they prove that they made all inquiries (if any) that were reasonable in the circumstances and, after doing so, believed on reasonable grounds that there was no omission from the prospectus in relation to that matter: s 731(2). This defence is commonly called the due diligence defence. It was to garner the benefits of these defences that the due diligence committee process (referred to at [10.145] and discussed at [10.207]) was created to identify the material required to be disclosed and to verify statements in the prospectus. The corresponding defence with respect to misleading or deceptive statements in or omission of a particular matter from an offer information statement or profile statement sets a lower standard of exculpation. In relation to these two disclosure documents, the defence is satisfied merely by proof that the person upon whom liability might fall did not know that the statement was misleading or deceptive or that there was an omission in relation to the matter: s 732. Knowledge rather than reasonable inquiry is the standard. This standard mirrors the reduced disclosure requirements for profile statements and offer information statements, in particular, the absence of any requirement for the issuer of an offer information statement to undertake reasonable inquiries before making its disclosure: see [10.125]-[10.130]. There are several other defences of general application. First, because all aspects of a disclosure document will not necessarily be within the expertise or knowledge of each person who may be potentially liable for its content, a person referred to in s 729(1) who places reasonable reliance on information provided by someone else will have a defence to criminal or civil liability arising from statements or omissions in relation to that information (the reasonable reliance defence): s 733(1). However, a company or natural person will not be able to rely on information provided by an employee or agent or, in the case of a company, its directors: s 733(1). 120 This exclusion is designed to prevent someone relying on what is effectively their own information. However, although a company may not rely on information supplied by its employees for the purpose of establishing a defence under s 733(1), it will be 118

(2016) 113 ACSR 318 at [75].

119

(2016) 113 ACSR 318 at [78]; see discussion in J Argent (2016) 34 C&SLJ 87; A Watson and J Varghese (2009) 32 UNSWLJ 948.

120

The exclusion is expressed so as not to prevent directors of the issuer from relying on information provided by company employees. [10.205]

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able to carry out due diligence through its officers and employees for the purpose of establishing the reasonable inquiry or belief defence under s 731. A person may also rely on someone who performs a particular advisory or professional function provided they are not an agent for some other reason: s 733(2). Again, the due diligence committee is structured so as to give participants, especially the directors of the issuer or seller, the full benefit of the right to rely upon information provided by others. Second, a defence is available to persons who are named in a disclosure document as a proposed director or underwriter or as making a statement included in the document if they publicly withdraw their consent to being named in that way: s 733(3). Third, a person has no liability because of a new circumstance that arises after the disclosure document was lodged if they prove that they were not aware of the matter: s 733(4). This defence will not protect an issuer whose employees or agents possess such information that is attributed to the company. There is little case law in Australia on the operation of the defences under ss 731 and 733 for liability arising from defective disclosure in a prospectus. In Reiffel v ACN 075 839 226 Ltd Gyles J quoted from the foundational US authority in Escott v Barchris Construction Corp, 121 that, in order to rely on the due diligence defence, it must be established the defendant: had, after reasonable investigation, reasonable ground to believe and did believe, … that the statements therein were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading. 122

Gyles J noted that, while the US authorities are of limited value because of the different statutory regimes, nonetheless, the statement “captures the essence”, of the duty of an expert otherwise liable in relation to a statement in a prospectus. Further guidance on standards of reasonableness for the inquiries supporting defences under ss 731 and 733 may perhaps be inferred from cases under the former Trade Practices Act 1974. In Universal Telecasters (Qld) v Guthrie a broadcaster sought to rely upon the defence that it “took reasonable precautions and used due diligence” in checking for misleading advertising. Bowen CJ said: While these are plain English words, which have to be applied as they stand, it appears to me that two responsibilities which Universal Telecasters would have to show it had discharged, in order to establish this defence, would be that it had laid down a proper system to provide against contravention of the Act and that it had provided adequate supervision to ensure the system was properly carried out. Universal Telecasters did institute a system and did provide for supervision. The mere fact that its system and supervision has proved inadequate to prevent error, does not necessarily establish that its system is defective. Even the best systems may break down due to human error. It is necessary to make a judgment about the system and the provision for supervision. 123

Failure by directors and other corporate officers to take reasonable steps to prevent contravention of s 728 may also breach their duty of care under s 180, for example, where it exposes the company to the risk of proceedings for contraventions of the Act: see [7.75]. In Re Sino Australia Oil and Gas Ltd (in liq), 124 declarations of contravention of s 180(1) were made against a director who (among other lapses) failed to confirm the accuracy of the statements contained in the prospectus by reading and understanding the documents himself before signing them. 121 122 123

283 F Supp 643 at [53] (1968). (2003) 45 ACSR 67 at [32]. (1978) 32 FLR 360 at 363.

124

[2016] FCA 934.

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Due diligence process for assuring disclosure integrity [10.207] As noted at [10.145], following its successful use in the privatisation of the

Commonwealth Bank in 1991, a more or less standard due diligence process has developed for initial public offerings of securities and other major new fundraisings. This involves the formation by the issuer of a due diligence committee to identify all material required to be disclosed and oversee the process of verification of statements contained in a draft disclosure document prepared under the direction of the committee. The due diligence mechanism is not a process prescribed in the Act; rather, it has emerged as a market practice to ensure that the prospectus is accurate and complete and to mitigate the risk of any future liability from a defective disclosure document. 125 It is structured with a view to capturing the protection provided by ss 731 and 733. Best practice when preparing a prospectus is to establish a committee to oversee and coordinate the IPO due diligence process. The due diligence committee is generally established by delegation of the issuer’s board of directors and reports periodically to the board on the conduct of the due diligence process. The members of the due diligence committee are usually directors (typically one executive and one non-executive director), legal advisers, investigating accountants, underwriters and lead managers. The due diligence committee is generally responsible for: (a) coordinating and reviewing the information gathering process from management and experts with a view that, by the end of the due diligence process, a complete and thorough understanding of all relevant facts is obtained and resolved before finalisation of the prospectus; (b) (c) (d) (e)

(f) (g)

(h)

determining the scope of the due diligence inquiries and agreeing on qualitative and quantitative materiality thresholds; identifying issues for investigation and disclosure in the prospectus; ensuring all potentially material issues identified during the course of the due diligence process are either appropriately disclosed in the prospectus or resolved as not material; ensuring there is adequate supervision at all stages of the due diligence process, including a system of continuing inquiry and monitoring after the prospectus has been lodged with ASIC; supervising the drafting of the prospectus and its verification; providing a final report to the board of directors that outlines the inquiries undertaken and enables directors to form the view that the disclosure in the final prospectus is complete and free from material misstatement; and documenting the due diligence process to provide evidence of the inquiries made and the basis on which opinions have been formed (including the retention of those materials). 126

ASIC’s view is that advisers and underwriters, as gatekeepers, play an important role in protecting investors, fostering fair and efficient capital markets, and creating and maintaining confidence in capital markets. The due diligence process is often driven by the legal advisers and ASIC places particular importance on their role in the process. 127 Adherence to best practice in due diligence is not universal. Between November 2014 and January 2016, ASIC conducted systematic reviews of the due diligence practices of 12 IPO 125

ASIC, Due diligence practices in initial public offerings (Report 484, 2016), [3].

126 127

ASIC, Due diligence practices in initial public offerings (Report 484, 2016), [36]. ASIC, Due diligence practices in initial public offerings (Report 484, 2016), [77]. [10.207]

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issuers, ranging from small to large offers, including a sample of offers from emerging market issuers. Key findings on due diligence processes adopted by these issuers were that: (a) issuers that demonstrated poor due diligence practices generally produced prospectuses with defective disclosure; (b) there was considerable variation in the due diligence processes for the reviews with small to medium-sized issuers generally adopting fewer due diligence processes; (c)

a number of issuers adopted a “box ticking” approach to due diligence rather than focusing on the disclosure in the prospectus; (d) in some instances certain directors had little involvement in the preparation of the prospectus before signing off on the document; (e) there were additional challenges for emerging market issuers resulting from foreign laws, language barriers and poor oversight of the inquiries conducted by foreign advisers; (f) there was an inconsistent quality of contribution from the parties involved in the due diligence process; and (g) a low-cost due diligence process may lead to delays and further work, and ultimately be more costly. 128 In all but one instance, the prospectus issuer was required to make corrective disclosure, or amendments to the offer terms, by issuing a replacement prospectus; one review resulted in the withdrawal of the offer, and another was subject to a final stop order. Civil liability for misleading or deceptive conduct

Ouster with respect to disclosure documents [10.210] It will be recalled that in Fraser v NRMA Holdings Ltd 129 an action was brought

claiming that statements contained in a prospectus involved misleading or deceptive conduct within s 52 of the Trade Practices Act 1974 (Cth). Relief was granted and, since no claim was brought under Pt 6D.3 Div 1, no question arose as to the availability of a defence under that Part. The decision prompted a review of the relationship between s 52 (to which there is no defence to liability), its then counterpart in the Act (whose relationship to the due diligence and other defences was uncertain) 130 and the fault-based liability regime in Pt 6D.3 Div 1. In this review the view prevailed that the Act contains a liability regime specifically tailored to prospectuses which should prevail over the more general strict liability standard which would otherwise effectively displace the prospectus liability regime. Accordingly, in 1998 the Act was amended to exclude s 52 from applying in relation to financial products and services and substituted s 1041H and s 12DA(1) of the ASIC Act, each of which is in similar terms to s 52 but applies only to financial products and services. 131 Both provisions, however, were excluded from applying to conduct that contravenes s 728: s 1041H(3)(a), (c); ASIC Act 128

ASIC, ASIC regulation of corporate finance: January to June 2016 (Report 489), [94]; ASIC, Due diligence practices in initial public offerings (Report 484, 2016), [43]-[74].

129

(1995) 127 ALR 543; see [6.120].

130

This provision was s 995 which was in the same terms as s 52 but did not formally exclude the latter section applying in relation to matters such as fundraising which are regulated by the Act. Possibly to avoid the argument that the defences in ss 731 – 733 might apply to an action founded on s 995, the action in Fraser v NRMA Holdings Ltd [6.120] was brought seeking orders under s 52 and not s 995.

131

Section 995 was then also repealed although continuing reference is still made to it in notes to ss 728 and 729. The decision to exclude s 52 from applying to financial products and services was justified on the basis, inter alia, that liability rules should not shift to fundraisers the investment risk properly accepted by investors in efficient securities markets. The argument was that strict liability rules such as those in s 52 are appropriate

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s 12DA(1A)(c). For this purpose, conduct contravenes s 728 even if the conduct does not constitute an offence, or does not lead to any liability, because of the availability of a defence. This establishes Pt 6D.3 Div 1 as the primary liability regime with respect to statements in or omissions from a disclosure document. 132 However, it leaves some residual potential application to corporate fundraising of the misleading or deceptive conduct remedy in s 18 of the Australian Consumer Law.

Residual application of the misleading or deceptive conduct remedy to corporate fundraising [10.215] The exclusion of ss 1041H and 12DA in relation to fundraising applies only to

conduct that contravenes s 728. This exclusion is therefore limited to statements in or omissions from a disclosure document. It does not affect other conduct in corporate fundraising which may fall within the prohibition in ss 1041H and 12DA in its application to other dealing in financial products: s 1041H(2)(a), (b)(i), (ii). 133 The prohibition potentially applies to statements made outside the prospectus which are not drawn from it, such as those made in advertisements or oral presentations such as roadshows, in the prior negotiations or in fundraising documents for and statements made in capital raising that do not require lodgment of a disclosure document because of exemptions under s 708. 134 There are good reasons why those statements should be subject to the strict liability standard where they are misleading or deceptive. Thus, in private equity and other exempted fundraising, it provides a liability regime and potential remedy where Pt 6D.3 Div 1 is silent, and does so through a liability standard that avoids positional or collective responsibility by applying only to those who actually engage in the misleading conduct. 135 Further, the rationale for the displacement of the strict standard where a disclosure document is lodged, namely, that the prospectus should be the primary source of information and issuers should be discouraged from departing from it or expanding upon statements made in it, has no application in this context. A person may recover loss or damage suffered by conduct that contravenes s 1041H by action against the person contravening the section or another person involved in the contravention: s 1041I(1). Recovery of loss or damage is subject to potential reduction for the damages that the claimant may recover where the claimant contributed to its loss through its failure to take reasonable care provided the defendant did not intend to cause the loss or damage and did not do so fraudulently: s 1041I(1B), Pt 7.10 Div 2A. 136 The claim is also subject to limitation under a State or Territory professional standards law that limits occupational liability in actions under s 1041H: s 1044B. to consumer protection where they impose liability on the person best placed to avoid the harm at the lowest cost; investment is distinct, however, from consumption since one of its inherent functions is allocating and pricing risk: Fundraising: Capital raising initiatives to build enterprise and employment (Corporate Law Economic Reform Program Proposals for Reform: Paper No 2, 1997), p 41. 132

Part 6D.3 Div 1 also displaces the counterpart provisions to s 52 contained in the State and Territory Fair Trading Acts; now s 18 of the Australian Consumer Law applies in each jurisdiction under those Acts: s 1041K.

133

Dealing is defined as applying for, acquiring, issuing, underwriting, varying or disposing of a financial product such as a security, issuing a financial product or publishing a notice in relation to a financial product: s 766C.

134

Where the representation is made with respect to a future matter, it will be misleading under s 1041H if its maker does not have reasonable grounds for making it: s 769C(1).

135

Yorke v Lucas (1985) 158 CLR 661 at 666.

136

The potential proportionate reduction by reason of the claimant’s contribution to its loss (an “apportionable claim”) applies only to recovery for claims under s 1041H for misleading or deceptive conduct and does not extend to claims based on conduct of a different kind: Selig v Wealthsure Pty Ltd (2015) 105 ACSR 552 at [37]. [10.215]

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The potential reach of this remedy, and indeed of the terms “misleading or deceptive” where used in relation to statements in disclosure documents throughout Ch 6D, is canvassed in National Exchange Pty Ltd (ACN 006 079 974) v ASIC [10.230] and, of course, in Fraser v NRMA Holdings Ltd [6.120]. The High Court has considered the meaning of the terms “misleading or deceptive” in the context of the continuous disclosure provisions in Forrest v ASIC ([11.43]). Other remedies and liabilities with respect to fundraising under the Act [10.220] There are other remedies and liabilities potentially arising with respect to fundraising

under the Act. Persons whose interests have been, are or would be affected by conduct that contravenes the Act may apply for an injunction to prevent fundraising based upon a non-complying disclosure document or other fundraising documents or statements that contravene s 1041H(1): s 1324. Orders for compensation for loss may also be sought under ss 1324(10) and 1325. Specific provisions in Ch 6D create offences for their breach. In addition to the specific prospectus liability provisions, the Act also imposes criminal liability in respect of certain breaches of its provisions relating to securities that are relevant to fundraising. Thus, liability may arise under s 1308 for false or misleading statements in documents lodged with ASIC and under the general market conduct provisions which impose liability with respect to false or misleading statements in relation to securities and fraudulently inducing persons to deal in securities. These apply to prospectuses as well as in other contexts. They are discussed at [11.145]-[11.195]. The rescission remedy with brief reference to tort liability for fundraising [10.225] Finally, the general law provides remedies to persons who have been misled by a

prospectus. The common law is primarily fault-based, allowing damages for deceit 137 or negligent misrepresentation although a misrepresentation which becomes a term of a contract also gives rise to a form of strict liability. The right of a member to obtain damages against their company depends upon whether they have rescinded or are entitled to rescind the contract of membership since a member may not seek damages against their company. 138 The remedy of rescission of the contract of allotment or sale of securities is generally available for a misleading disclosure document or other fundraising document without proof of fault. 137

Indeed, a major contributor to the development of the modern tort of deceit and, more relevantly here, to the statutory regime for prospectus liability, was the decision of the House of Lords in Derry v Peek (1889) 14 App Cas 337. A prospectus stated that the company was entitled under its incorporating Act to use steam power in its tramway operations, and not be forced to rely upon animal power. In fact, its right to do so was dependent upon the consent of the Board of Trade which was subsequently refused. An action for deceit against the directors brought by a subscriber to the prospectus failed on the basis that deceit requires proof of fraud, that is, that the false representation was made knowingly, without belief in its truth, or recklessly, careless whether it is true or false. This standard was not satisfied where the directors mistakenly believed that the Board’s consent would follow as a matter of course (at 374, 379). The decision prompted the development of the initial predecessor to the liability regime in Pt 6D.3. A New Zealand court has recently held that directors of an issuer did not owe a duty of care to investors who subscribed for shares in a prospectus: Houghton v Saunders [2014] NZHC 2229 at [711] (“[n]or are the circumstances of any relationship between the directors and other defendants, on the one hand, and the investors in the IPO on the other, such as to give rise to the prospect of a duty of care in tort being imposed”); the decision has been criticised for failure to recognise other judicial decisions that acknowledge that directors owe a duty of care to shareholders who purchase shares in an IPO: V Stace (2016) 34 C&SLJ 48.

138

Re Dividend Fund Inc (in liq) [1974] VR 451; Re Addlestone Linoleum Co (1887) 37 Ch D 191 at 206 per Lindley LJ (“a shareholder contracts to contribute a certain amount to be applied in payment of the debts and liabilities of the company, and that is inconsistent with his position as a shareholder, while he remains such, to claim back any of that money – he must not directly or indirectly receive back any part of it”).

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A person who has been induced to subscribe for securities by a material misrepresentation contained in a fundraising document may be entitled to rescind the contract and recover the consideration which has been given under it. The following notes briefly review the elements of the rescission remedy. They do not attempt a detailed treatment of topics covered in depth in works on tort and contract law. Several of these elements are common to the actions for deceit and negligent misstatement and accordingly, to avoid repetition, commonalties and points of departure between the tort and contract remedies are briefly noted here. Rescission will lie only in respect of a misrepresentation. A like requirement applies to actions for damages for fraudulent or negligent misrepresentation. An omission from a prospectus will not, of itself, suffice since the common law does not impose a general duty of disclosure of all material information in a prospectus. However, the omission will be actionable where it renders that which is contained in the prospectus false or misleading. The courts appear to be more willing to find that an omission (suppressio veri) amounts to a misrepresentation (suggestio falsi) where the shareholder is seeking rescission rather than damages where the omission must be characterised either as fraudulent or negligent. Thus, in an action for fraudulent misrepresentation it is said that: [t]here must … be some active misstatement of fact, or, at all events, such a partial and fragmentary statement of fact, as that the withholding of that which is not stated makes that which is stated absolutely false. 139

However, in an action for specific performance, approximating a rescission suit, a higher standard of disclosure has been required: Those who issue a prospectus holding out to the public the great advantages which will accrue to persons who will take shares in a proposed undertaking, and inviting them to take shares on the faith of the representations therein contained, are bound to state everything with strict and scrupulous accuracy, and not only to abstain from stating as facts that which is not so, but to omit no one fact within their knowledge the existence of which might in any degree affect the nature, or extent, or quality of the privileges and advantages which the prospectus holds out as inducements to take shares. 140

The misrepresentation must be of facts. A misstatement of opinion or intention does not per se found a right of rescission. However, a representation of fact may, in particular circumstances, be inferred in terms that the opinion or intention is honestly or even reasonably held. Such inferences will not be easily drawn. A similar rule applies to actions for fraudulent misrepresentation although a careless opinion or forecast may found an action for negligent misstatement. 141 The misrepresentation need not be made fraudulently or negligently for rescission to lie. An innocent misrepresentation will suffice for rescission but not, of course, for fraudulent or negligent misrepresentation. The misrepresentation must be addressed to a class of persons which includes the plaintiff and with the intention that the plaintiff will act upon it. This requirement applies equally to actions for negligence or deceit. While a prospectus is clearly addressed to would-be subscribers, difficult questions may arise with respect to liability for misstatements which induce the purchase of securities in a secondary trade. In Peek v Gurney a prospectus was held to be exhausted by the allotment of shares so that a subsequent purchaser was denied recovery 139

Peek v Gurney (1873) LR 6 HL 377 and 403.

140

New Brunswick & Canada Railway & Land Co v Muggeridge (1860) 1 Dr & Sm 363; 62 ER 418 at 381-382 (Dr & Sm) 425 (ER).

141

The classic instance in a prospectus context is Mutual Life and Citizens Assurance Co Ltd v Evatt [1971] AC 793. [10.225]

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for serious misrepresentations of fact which it contained. 142 However, in Andrews v Mockford, 143 a purchaser of shares on the stock exchange recovered damages for misrepresentation from a company promoter where his purchase was induced by postflotation publicity that was part of a single continuous fraud. More recent tort decisions also support an expansive interpretation of the audience to which a prospectus is addressed. 144 The misrepresentation must be material, that is, it must be capable of affecting the judgment of a person of reasonable prudence in such matters, in which case the plaintiff will succeed unless it is proved that he or she was not in fact so influenced. Gower suggests that the plaintiff may even succeed if they can persuade the court that they were induced by a statement that a reasonably rational person would discard as irrelevant “for fools are entitled to be protected against rogues; indeed, it is they who are most in need of protection”. 145 If fraud is proved, the person committing it perhaps may not be heard to say that the misrepresentation was immaterial. 146 The plaintiff must actually have been induced, at least partially, by the misrepresentation to subscribe for or purchase the securities, that is, there must be actual reliance. 147 It is no answer to the plaintiff that they might have avoided the loss flowing from their reliance on an objectively misleading statement if they had taken reasonable care: inducement to rely and actual reliance is sufficient. 148 If the securities in question are new securities allotted by the company to the plaintiff, or there is a contract to take up securities with the company, rescission may be available against the company. Allotment, whether by entry of the allottee’s name in the share register or issue of a share certificate, does not destroy the allottee’s right to rescind against the company. If, however, the plaintiff has purchased the securities on the stock exchange and a transfer is registered, the English decision in Seddon v North Eastern Salt Co Ltd 149 may bar rescission. For rescission to lie, it must be possible to restore the parties to their original position by rescinding the contract. The mere fact that the market price of the securities has fallen will not prevent restitution. Further, rescission will be upheld even where precise restitution is no longer possible provided that the court can, by the taking of accounts or other adjustments, achieve a practically just outcome between the parties and restore them substantially to the status quo. 150 It appears that the restitution rule will preclude rescission where the allottee has disposed of the securities, even where the allottee was unaware of her or his right to rescind. The allottee’s position may not be retrieved by the purchase and tender of an identical quantity of securities. Rescission is a discretionary remedy and may be lost or withheld in particular circumstances. Thus, the plaintiff must not have affirmed the contract after becoming aware of their right to

142 143 144

Peek v Gurney (1873) LR 6 HL 377. [1896] 1 QB 372. See, eg, Ross v Caunters [1980] Ch 297 and Yianni v Edwin Evans & Sons [1982] QB 438.

145

L C B Gower et al, Gower’s Principles of Modern Company Law (4th ed, 1979), p 376.

146 147 148 149

Smith v Kay (1859) 7 HLC 750; 11 ER 299 at 759 (HLC), 303 (ER). Andrews v Mockford [1896] 1 QB 372. Delmenico v Brannelly [2008] QCA 74. [1905] 1 Ch 326.

150

Alati v Kruger (1955) 94 CLR 216; see also Krakowski v Eurolynx Properties Ltd (1995) 183 CLR 563 at 586; Vadasz v Pioneer Concrete (SA) Pty Ltd (1995) 184 CLR 102 at 110.

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rescind, for example, by paying calls, accepting dividends or voting at company meetings. 151 The plaintiff must not be guilty of laches (delay) in rescinding. A delay of little less than two months in moving to rescind may be fatal. 152 Once a winding up of the company is commenced, the rights of creditors supervene and the rescission remedy is lost to a shareholder. 153

National Exchange Pty Ltd (ACN 006 079 974) v ASIC [10.230] National Exchange Pty Ltd (ACN 006 079 974) v ASIC (2004) 49 ACSR 369 Federal Court of Australia (Full Court) [National Exchange wrote to certain shareholders in Onesteel Ltd, most of whom had small holdings, offering to purchase their shares for $2 per share. The offer invited a comparison between this amount and the closing market price for the shares on the date of the letter ($1.93). However, a subsequent (and less prominent) part of the letter of offer provided that the purchase price was to be paid by 15 annual instalments payable on 3 September in each year, commencing on the following year. When this provision was taken into account, the actual value offered was substantially less than $2 per share. ASIC sought orders that this conduct contravened s 1041H(1). It was successful at first instance.] DOWSETT J: 18 In Campomar Sociedad Limitada v Nike International Ltd (2000) 202 CLR 45, the High Court reviewed many of the seminal cases associated with s 52 of the Trade Practices Act 1974 (Cth). That provision is similar in effect to subs 1041H(1) of the Act. Much of the decision in Nike concerned trademark legislation and is not relevant for present purposes. It is also not necessary that I address the facts of the case. For present purposes I need only consider [92–106] of the decision. The following propositions emerge: • Conduct will only be misleading or deceptive, or likely to mislead or deceive if there is a nexus between such conduct and any actual or anticipated misconception or deception. • In identifying such nexus regard must be had to the circumstances of the particular case, including the remedies sought. Section 52 of the TP Act does not confer any entitlement to a remedy for breach or anticipated breach. One must look elsewhere in the TP Act for such entitlement and construe the act as a whole. • In some cases, a representation may be made to identified individuals; in other cases the representation may be to the public at large or to a section thereof. In the former case the process of deciding whether or not the representation is misleading or deceptive or likely to be so may be “direct and uncomplicated”. In the latter case “the issue with respect to the sufficiency of the nexus between the conduct or the apprehended conduct and the misleading or deception or likely misleading or deception of prospective purchasers is to be approached at a level of abstraction not present where the case is one involving an express untrue representation allegedly made only to identified individuals”. … • When the representation is made to the public or to a section thereof, one must consider its effect upon an ordinary or reasonable member of the class in question. Although such class may include a wide range of persons, the ordinary or reasonable member will objectively be identified as having certain characteristics. In particular he or she can be expected to take reasonable care for his or her own interests and otherwise to behave reasonably. • It is necessary to inquire as to how a particular or anticipated misconception has arisen or may arise. In so doing, the Court will consider “the effect of the relevant conduct on reasonable members of the class”. 151 152

Elders Trustee and Executor Co Ltd v Commonwealth Homes and Investment Co Ltd (1941) 65 CLR 603; Scholey v Central Railway Co of Venezuela (1868) LR 9 eq 266n; Ex parte Briggs (1866) LR 1 Eq 483. Re Russian Ironworks Co (1867) LR 3 Eq 795.

153

Tennent v City of Glasgow Bank (1879) 4 App Cas 795; Re Dividend Fund Inc [1974] VR 451. [10.230]

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National Exchange Pty Ltd (ACN 006 079 974) v ASIC cont. • Conduct will only be misleading or deceptive or likely to mislead or deceive if the representee “labours under some erroneous assumption” or may be expected so to labour. Such an assumption or anticipated assumption may be obvious, predictable or fanciful. • In assessing the reactions or likely reactions of the ordinary or reasonable member of the class, the Court may decline to treat as reasonable, assumptions which are extreme or fanciful. The initial question which must be determined is whether the misconception or deception, alleged or anticipated, is properly attributable to an ordinary or reasonable member of the class. • The “question whether particular conduct causes confusion or wonderment cannot be substituted for the question whether the conduct answers the statutory description contained in s 52.” … Was the conduct misleading or deceptive or likely to mislead or deceive? 35 By reference to Taco Bell [Taco Company of Australia Inc v Taco Bell Pty Ltd (1982) 42 ALR 177 the trial judge] identified four steps in this inquiry, namely: • Was there a false representation? • What was the intention underlying the conduct in question? (His Honour identified correctly that intention to mislead was not essential but nonetheless was relevant to the inquiry.) • Was the conduct such as to lead to an erroneous assumption on the part of representees? • Did the conduct mislead or deceive or was it likely to do so, having regard to the behaviour of a reasonable representative of the whole class of representees? A false representation 36 National Exchange argues that one must read the offer documents as a whole. Whilst that proposition may be true in some senses, I consider that a document may be misleading even if a full and perfect understanding of its contents would not create that effect. … 38 Price is usually of pre-eminent importance in an offer to purchase property of any kind. Terms of payment might reasonably be treated by some people as being of subsidiary importance. An offeree would not normally expect that information as to payment would have the effect of substantially undermining the correctness of information found elsewhere in the document, particularly information as to a matter of pre-eminent importance such as price. The prominence of the invited comparison in the offer documents and the absence of any reference to deferred payment in the share transfer form would have further discouraged any such expectation. The offers were capable of being understood as offering a purchase price significantly in excess of the closing market price, with the tacit representation that there was nothing else in the document which would seriously undermine the validity of such comparison. That representation was false. Did National Exchange intend to mislead? 39 I am conscious of the traditional caution exercised by courts in determining whether or not a person deliberately intended to mislead. However, as his Honour indicated, it is impossible to imagine even the most unworldly of investors finding the offer attractive, given the arrangements for deferred payment of the purchase price. It is of some significance that National Exchange sent the vast majority of the offers to the holders of relatively small parcels of shares. Such persons, or some of them, could have been expected to pay less attention to the offers than they would if large holdings were involved. … [I]t is impossible to avoid the conclusion that National Exchange expected that some people might accept the two dollar offers without fully understanding them and tried to maximize the chances of uninformed acceptance. This view encourages me to infer that the offer was capable of being misleading or deceptive.

822

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National Exchange Pty Ltd (ACN 006 079 974) v ASIC cont. Erroneous assumptions 40 The two dollar offers invited the erroneous assumption that acceptance would yield two dollars per share to the offeree, or about seven cents more than would be derived from sale on the stock exchange. As I have previously pointed out, the amount of the benefit might need slight qualification. Nonetheless that was the substantial effect of the offers. The reasonable shareholder 41 The class of shareholder to whom the two dollar offers were addressed was dominated by small shareholders – persons who stood to receive amounts of less than $8,000. … 42 The format of the offer, particularly the heading and the information which appears under the subheading “Offer” would suggest to any reasonable person that the benefit to be derived from the offer was about $2 as compared to the market price of $1.93. No doubt, a sceptical shareholder would look for the “catch” but in my view, many reasonable shareholders would have been inclined to accept the offer at face value, assuming that conditions as to payment would be subsidiary and not such as significantly to reduce the value of the offer or the favorable comparison of it with the market price. It may be that many reasonable shareholders would, before finally accepting, have read the documents more closely and more critically. However I am satisfied that not every reasonable shareholder in the class would have done so. I conclude that the two dollar offers were likely to mislead or deceive reasonable offerees. The appeal should be dismissed. JACOBSEN and BENNETT JJ: 45 We have had the benefit of reading in draft the reasons for judgment of Dowsett J. We agree with his Honour’s conclusion that the appeal must be dismissed and, generally, with his reasons. We wish, however, to add some further observations. 46 The essential question in the appeal is whether the appellant has demonstrated error in the primary judge’s finding that a one-page offer document which, when read as a whole, was factually true, was nevertheless misleading. 47 The answer to this question is that, in our opinion, no error has been demonstrated because his Honour’s finding that the document created a misleading impression that the price was payable in full on acceptance was one which was open to him. Indeed, we agree with the conclusion which his Honour reached. 48 The principal ground of attack made by [counsel] for the appellant upon the judgment was that a document which is factually true cannot be misleading. He said that the document, containing only one page, should have been read in its entirety by the ordinary or reasonable shareholder who would then see that the offer was for payment by instalments. He submitted that the primary judge had fallen into error by misunderstanding and failing to apply the test of the ordinary or reasonable member of the relevant class stated by the High Court in Campomar Sociedad Limitada v Nike International Ltd (2000) 202 CLR 45 (“Nike”) at [102] – [105]. 49 It is well established that an offer which is literally true may nonetheless be misleading. It will be misleading or deceptive if it carries with it a false representation; see Hornsby Building Information Centre Pty Ltd v Sydney Building Information Centre Ltd, 140 CLR 216 at 227-228 per Stephen J. However, [counsel] submitted that this principle cannot apply where the statement is factually true. 50 In our opinion, no such distinction can be drawn. A document which, when read as a whole, is factually true and accurate may still be capable of being misleading if it contains a potentially misleading primary statement which is corrected elsewhere in the document but without the reader’s attention being adequately drawn to the correction. 51 The principle which applies to those cases is that the qualifying material must be sufficiently prominent or conspicuous to prevent the primary statement from being misleading … 52 As Mason J said in Parkdale Custom Built Furniture Pty Ltd v Puxu Pty Ltd (1982) 149 CLR 191 at 210-211 (“Puxu”): There may be situations where to exploit mistaken views of the public would contravene s 52 and would not be corrected by an inconspicuous accurate representation made in eg a concealed label or the “fine print” of a contract. [10.230]

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National Exchange Pty Ltd (ACN 006 079 974) v ASIC cont. 53 The striking feature of the [offer] document when read as a whole is the disparity between the impression created by the primary statement, namely that the offer is for payment in full on acceptance, and the true position stated in the qualification under which payment is to be made over 15 years. The primary statement is made in bold so as to emphasise it to the reader and it is repeated and reinforced in the comparative table. 54 The representation made in the table is that the shareholders will receive in cash in full on acceptance a premium of 7¢ over the closing price. The true position is that accepting shareholders make an interest free loan of the purchase price to the appellant over a period of 15 years. To describe it as a cheeky offer would be to understate the full import of the document. 55 Where the disparity between the primary statement and the true position is great it is necessary for the maker of the statement to draw the attention of the reader to the true position in the clearest possible way. 56 An analogy is to be found in cases dealing with exemption clauses. … 57 [Lord Denning’s] remarks in J Spurling Ltd v Bradshaw [1956] 1 WLR 461 were even more pointed. His Honour said at 466:… the more unreasonable a clause is, the greater the notice which must be given of it. Some clauses which I have seen would need to be printed in red ink on the face of the document with a red hand pointing to it before the notice could be held to be sufficient. 58 A similar approach is justified by the remarks of Stone J in one of the “asterisk cases”, ACCC v Signature Security Group Pty Ltd [2003] FCA 3; (2003) ATPR 41-908. Her Honour observed at [27] that the degree of prominence which must be given to a qualifying statement may well vary with the potential of the primary statement to be misleading and deceptive. 59 Although the primary judge did not refer to the disclaimer or asterisk cases, it seems to us that he took into account the question of whether the qualification was sufficiently clear and prominent to prevent shareholders from being misled. He appears to have done so … by making the finding that “a number of shareholders” would have formed a mistaken view about the offer by reason of the “general impression” of the offer document. 60 So long as his Honour did not apply the wrong test in identifying the persons who fell within the class of the ordinary or reasonable shareholders, we can see no error in the approach he took. The question was one of fact for the primary judge and we would not depart from his finding because we do not consider that the finding has been shown to be wrong … 61 It is not entirely clear whether his Honour applied the test of the hypothetical ordinary shareholder stated in Nike. He said … that it was difficult to identify the criteria for the ordinary member of a diverse group. He did not refer to the ordinary or reasonable shareholder in making his findings … Instead, he referred to “a number of shareholders” and the “general shareholding public” who would be likely to have been misled by the general impression of the document. It seems that the explanation for this is that he wrongly treated the case as one where the representation was made to identified individuals; see .au Domain Administration Ltd v Domain Names Australia Pty Ltd [2004] FCA 424 at [17]-[18]. 62 But even if his Honour failed to apply the correct test, we are not persuaded by the argument that the offer was not likely to mislead or deceive the ordinary or reasonable shareholder. The disparity between the primary representation and the qualification was so great that the warning was insufficient to draw the true position to the attention of the ordinary shareholder. 63 In coming to the view which we have reached, we have borne in mind that his Honour found … that the offer was deliberately composed to mislead shareholders of the company. As the primary judge said, no reasonable shareholder who read the payment terms and realised that the price was payable over 15 years would accept it. We agree with Dowsett J that his Honour was entitled to make this finding. Where there is a finding of intention to deceive, the Court will more readily infer that the intention has been effected; see Nike at [33]. 64 We agree with Dowsett J that price was likely to be of primary importance to the ordinary or reasonable shareholder. The bold statement in the heading that the offer was to purchase the shares 824

[10.230]

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National Exchange Pty Ltd (ACN 006 079 974) v ASIC cont. for $2 and the statement of the total offer price in the table conveyed a representation that the price was payable in full. Even if the ordinary or reasonable shareholder read the words “see payment terms”, he or she would not have expected those words to direct the reader to a statement which drastically altered the nature of the offer. This was an alteration which required not only a “red hand” but also the clearest possible words. Nothing short of a statement prominently made, as part of the heading or in the table, that the price was payable over 15 years would have been sufficient. We do not consider that the words “see payment terms” in the manner and form in which they appear in the table were adequate. 65 Moreover, we do not consider that the words directing the shareholders to consult an adviser if they did not understand the document were sufficient to remove the likelihood of misconception. This is because the words “see payment terms” would not have indicated to shareholders that there was something about which they might need financial or legal advice. The impression which was created by the heading, the table and the fact that it was a one page document was that it was a straightforward offer for cash on completion which did not require legal advice about the nature of the consideration that was payable. 66 Of course, s 1041H of the Corporations Act 2001 (Cth) is not intended to benefit those who fail to take reasonable care of their own interests; Puxu at 199 (Gibbs CJ), 209 (Mason J). However, as Gibbs CJ observed at 199, what is reasonable will depend on all the circumstances. The relevant circumstances included the inadequacy of the wording which directed the reader to the very substantial alteration in the terms of the offer. There was nothing unreasonable on the part of an ordinary or reasonable shareholder in failing to read that part of the document which stated that the offer was payable by instalments over a long period. … 67 [Counsel for the appellant] submitted that the primary judge erred in failing to consider whether a “significant proportion” of shareholders would have been likely to have been misled. … [Counsel] also pointed to a possible inconsistency between the remarks of Deane and Fitzgerald JJ in Taco Bell and the test of the ordinary or reasonable shareholder stated by the High Court in Nike. In a well-known passage in Taco Bell at 202, their Honours referred to the need to consider the question of whether conduct is misleading by reference to all those who come within the class including the astute and the gullible. 68 In Nike at [102] and [103] their Honours referred to the attribution of characteristics to the ordinary or reasonable members of the class and to the need to isolate the hypothetical member of the class who has those characteristics. The attribution is to be objective in order to allow for the wide range of persons who would, in fact, make up the class. It is also to allow for unreasonable reactions of members at either end of the spectrum which makes up the class. We see no difference between this approach and that which was contemplated by Deane and Fitzgerald JJ in Taco Bell. 69 Indeed, the same view seems to have been taken by Gibbs CJ in Puxu at 199 as follows:Although it is true, as has often been said, that ordinarily a class of consumers may include the inexperienced as well as the experienced, and the gullible as well as the astute, the section must in my opinion [be] regarded as contemplating the effect of the conduct on reasonable members of the class. … 72 Although the primary judge referred to “a number of shareholders”, it is sufficient that we have reached the view that the ordinary or reasonable members would be likely to have been misled.

[10.235]

Review Problem

Recall the Review Problem at [10.137]. Over the next few years, Ros raised substantial funds through a private placement involving a mixture of sophisticated and professional investors and a small-scale offering within s 708. However, she has now proceeded to a public float of [10.235]

825

Corporations and Financial Markets Law

her company and a stock exchange listing. The prospectus highlighted the success of past operations and projected a strong international market with multiple potential applications for a biotechnology process that the company has patented. However, Ros has been increasingly taken away from research into a management role as chief executive of the company although she has been reluctant to relinquish leadership of the research program. This reluctance has led to a major rift with her principal collaborators who have left to establish their own research and development company. They have unexercised options in Ros’s company but not in such amounts that persuade them to stay. They do not have contracts binding them to the company or precluding competitive work. Ros has been unable to replace them or to develop the further research that is needed for the timely application of patent rights. Projected contracts have failed to materialise and the company’s market price has fallen badly with poor publicity concerning the defections and lost contracts. Some investors who subscribed under the prospectus and others who had taken equity under the earlier private placement seek advice concerning their remedies.

826

[10.235]

CHAPTER 11 Financial Market Regulation [11.05]

[11.20]

[11.40]

[11.80]

[11.125]

[11.170]

[11.185]

DISCLOSURE AND MARKET EFFICIENCY ........................................................................................ 828 [11.10]

The Efficient Capital Market Hypothesis ........................................................................ 828

[11.15]

The concerns of this chapter ........................................................................................ 829

THE LEGAL STRUCTURE OF AUSTRALIAN FINANCIAL MARKETS .................................................... 829 [11.20]

Stock exchanges and stockbroking: the path to the present ......................................... 829

[11.25]

Australian financial markets .......................................................................................... 830

[11.30]

The development of financial market regulation ........................................................... 831

[11.35]

The licensing and supervision of financial markets ........................................................ 833

THE AUSTRALIAN SECURITIES EXCHANGE .................................................................................... 836 [11.40]

The changing character and environment of financial markets ..................................... 836

[11.45]

The foundations and functions of the ASX listing rules ................................................. 838

[11.50]

ASX Operating Rules .................................................................................................... 840

[11.60]

The status and enforcement of listing and operating rules ............................................ 841

ASIC’S INVESTIGATION AND INFORMATION GATHERING POWERS .............................................. 848 [11.80]

Overview of ASIC investigation and enforcement powers ............................................. 848

[11.85]

The power to conduct investigations ........................................................................... 849

[11.90]

Gathering information in aid of investigations .............................................................. 849

[11.95]

Fairness in the conduct of investigations ...................................................................... 851

[11.100]

The privilege against self-incrimination ........................................................................ 852

[11.105]

Legal professional privilege .......................................................................................... 852

[11.110]

Enforcement of the corporations legislation ................................................................. 853

CONTINUOUS DISCLOSURE ......................................................................................................... 855 [11.125]

Background to current regulation ................................................................................ 855

[11.130]

Continuous disclosure obligations ................................................................................ 856

[11.145]

Criminal sanctions ........................................................................................................ 871

[11.150]

Civil penalty consequences of contravention ................................................................ 873

[11.155]

Other civil remedies for contravention ......................................................................... 875

[11.160]

Infringement notices .................................................................................................... 875

[11.165]

Responding to an infringement notice ......................................................................... 877

SHORT SELLING ............................................................................................................................ 880 [11.170]

The merits and risks of short selling .............................................................................. 880

[11.175]

Legal regulation ........................................................................................................... 881

[11.180]

Remedies for breach .................................................................................................... 883

MARKET MISCONDUCT (APART FROM INSIDER TRADING) ........................................................... 883 [11.185]

The range of manipulative techniques .......................................................................... 883

[11.190]

The common law prohibition upon market manipulation ............................................ 884

[11.195]

Market manipulation through artificial price setting ..................................................... 885

[11.200]

False trading and market rigging .................................................................................. 887

[11.205]

Dissemination of information about illegal transactions ................................................ 888

[11.210]

False or misleading statements ..................................................................................... 888

[11.215]

Inducing persons to deal in securities ........................................................................... 889 827

Corporations and Financial Markets Law

[11.220] [11.225] [11.240]

Misleading or deceptive conduct ................................................................................. 889 Remedies for breach of the market misconduct provisions ........................................... 889

INSIDER TRADING ........................................................................................................................ 897 [11.240] [11.245]

The scope of the disclose or abstain requirement ......................................................... 897 Sanctions, remedies and relief ...................................................................................... 900

DISCLOSURE AND MARKET EFFICIENCY [11.05] This chapter introduces the markets for corporate securities and the legal and

industry controls governing their operations. Secondary markets bring together buyers and sellers for the trading which assures the liquidity of investments. Historically, they have done so through a central physical location which allows prompt dissemination of information about price levels and trading volumes. The availability of this information reduces the search costs for buyers and sellers and thereby enhances the liquidity of their investment. Liquidity through financial markets enables accurate pricing at the new issue stage through its assurance of transactional continuity in sufficient volumes that a single transaction will not distort the market price. Under economic theory, therefore, an efficient secondary market assists the primary market to allocate resources to their most highly prized applications. In another sense, the secondary market will be operationally efficient when its trading and settlement procedures are such as to minimise the transaction costs of participants. The Efficient Capital Market Hypothesis (ECMH) [11.10] Disclosure and the prevention of fraud and other forms of market misconduct have

been central planks of financial market regulation since the initial United States regulation in the 1930s ([10.10]) and the later Australia regulation: [2.75] and [11.30]. The theoretical foundation, albeit developed ex post, is supplied by the Efficient Capital Market Hypothesis (ECMH) which seeks to demonstrate that, in an efficient market, current stock prices reflect available information about financial products being traded so that prices reflect the aggregate judgment of traders as to underlying value. Information material to price is the oxygen of this judgment and its purity the assurance of market integrity and pricing function. The ECMH contemplates three tiers of market efficiency, reflecting differing levels of maturity of the mechanisms for summoning and ingesting information relative to the price of traded securities. 1 Under the ECMH a financial market exhibits weak form of efficiency in its trading activities if the current price of a stock reflects all information concerning historical prices for that stock. Future price movements are dependent on new information about the issuer or stock, and not upon constant market reappraisal of past information and assessments. The ECMH asserts that a market which exhibits semi-strong efficiency not only impounds instantaneously and imperceptibly into its price all historical information about a stock but also all current information about it that is publicly available. Again, only new information, not closer analysis of publicly available information, will affect future price movements. A market with strong form efficiency will exhibit even higher levels of information processing efficiency. In such a market, prices will incorporate all information, whether or not it is publicly available. The strong form level appears counter-intuitive since it would deny to any trader the capacity to outperform the market over time, even to groups such as corporate insiders with privileged 1

On the several mechanisms by which financial markets process information into price, see R J Gilson & R H Kraakman (1984) 70 Va L Rev 549; for the original exposition of market efficiency under the three forms of market efficiency, see E F Fama (1970) 25 J Fin 383. See generally on the efficiency, fairness and governance gains of mandated timely disclosure of listed company information G North (2014) 32 C&SLJ 560.

828

[11.05]

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CHAPTER 11

access to corporate information and demonstrated superior market returns. 2 The validity of the strong form of the ECMH in any market, as well as its regulatory implications (viz, that legal regulation is largely otiose, trumped by market dynamics), is contested. 3 Liquidity levels and trading volumes in a particular market together with information support, for example, through financial analyst research, will determine the level of overall market efficiency. That efficiency level may vary within a particular market such as Australian financial markets which are characterised by high levels of concentration among listed stocks by market capitalisation, turnover and analyst interest. 4 Pricing efficiency and logic are not always self-evident and there appears to be an apparent trading advantage available for astute early interpretation of new information. Nevertheless, the dependency of an efficient market in its price-setting function upon reliable and uncorrupted information has powerfully shaped financial market regulation. It is reflected in mandatory disclosure requirements – in periodic, timely (or continuous) and transactional disclosure obligations (the latter referring to the insider trading regime that requires insiders either to disclose or refrain from trading). Continuous disclosure and insider trading are considered here in the context of assuring investor protection and confidence in financial markets. Market manipulation, the enemy of market efficiency and investor confidence, is also examined in this chapter. The concerns of this chapter [11.15] These concerns with market efficiency and integrity mean that this chapter focuses

upon the corporate rather than the consumer protection aspects of financial market regulation. That is, it looks at the institutions and rules that protect the integrity of the markets upon which corporate securities are traded rather than the detailed provisions introduced into the Act in 2002 to protect consumers of (or investors in) a wide range of financial products of which corporate securities are but part. Accordingly, the focus is upon the regulation of the market for corporate securities in the general interest of investors and to assist its function in aiding capital formation, although a brief overview is provided of the scheme of financial services consumer protection. The chapter examines the legislative structure for the regulation of financial markets, with particular reference to the functions and powers of ASIC, the licenced market operators – principally the Australian Securities Exchange (ASX) – and ASIC’s investigation and enforcement powers. It then deals with the obligation of issuers of securities to ensure an informed market through continuous disclosure to the market of price sensitive information. Finally, it considers the assurance against market misconduct provided through the legal regulation of short selling, market manipulation and insider trading.

THE LEGAL STRUCTURE OF AUSTRALIAN FINANCIAL MARKETS Stock exchanges and stockbroking: the path to the present [11.20] We saw at [2.40] that by the last quarter of the 17th century an organised stock

market had been established in London with a professional group of “stock jobbers” and well settled mechanisms for dealings in shares. Periodic cycles of boom and bust were evident in the stock market even before the collapse of the South Sea Company and the passage of the Bubble Act in 1720. Indeed, in 1697 Parliament had passed “an Act to restrain the number and ill 2

See, eg, D Giivoly & D Palmon (1985) 58 J Bus 69.

3

The theory overall has a substantial body of critics although more from the legal than the finance academy: see, eg, L A Stout (1988) 87 Mich L Rev 613; D C Langevoort (1992) 140 U Pa L Rev 851; L A Stout (1997) 19 Cardozo L Rev 474.

4

See T E Headrick [1992] 1 Journal of the Securities Institute of Australia 2. [11.20]

829

Corporations and Financial Markets Law

practice of brokers and stock jobbers”. 5 In Australia stockbroking began as early as 1828 and stock exchanges were established in each of the capital cities in the period 1870 to 1890. The history and modern development of stockbroking and financial markets in Australia is outlined at [2.135]-[2.150]. By long tradition Australian stock markets operated through an order-driven or auction system where buy and sell orders were directly displayed to the market and a trade resulted where there was a price match. In contrast, some overseas markets are based on a quote-driven system where market makers stand continuously in the market as principals (that is, for their own account) quoting buy and sell prices. Advances in information technology have seen the displacement of physical markets by computer-linked financial markets. Thus, for the principal Australian market operator, ASX, the trading floors of the stock exchange have given way to automated trading systems which provide for computer-based matching of overlapping bids (for purchase) and offers (for sale) of securities at successive price levels, executed in the order in which they were entered into the system. The trading screen displays price limits and the quantities of bids and offers entered for each security and the details of recent trades in the security. Where bids and offers do not overlap, trades are effected by an operator entering a bid or offer at a matching price or by varying an existing bid or offer price so as to effect a price match. Orders are fed into the central computer through a network of terminals in stockbrokers’ offices. Execution of orders is all but instantaneous. Stockbrokers perform a wide range of functions in addition to their work in executing trading orders on behalf of clients. These include trading in financial products as principals, underwriting capital raisings, providing corporate advisory services in such areas as financing, mergers and acquisitions, and other expert services in relation to such transactions. In those activities they enjoy no monopoly although their access to the stock market frequently lends a competitive advantage over other providers of those services such as investment banks. Australian financial markets [11.25] Australian financial markets comprise distinct markets which may be grouped as

either exchange traded markets or over the counter (OTC) markets, the latter usually conducted by direct dealing between financial institutions and professional dealers. The turnover of OTC markets greatly exceeds that of exchange traded markets. OTC markets themselves comprise distinct markets such as foreign exchange markets, currency options, short and long dated debt instruments in the bond market, forward rate agreements, interest rate options and swaps. The exchange traded markets cover equities, futures (derivatives) and some debt. 6 ASX conducts the principal national market for securities trading together with markets for some derivative financial products such as equity options, warrants and futures contracts for share market indices. However, the principal national derivatives market is that conducted by the Sydney Futures Exchange which in 2006 became a wholly owned subsidiary of ASX. 7 The Sydney Futures Exchange retains a separate licence to operate a derivatives market. Its principal derivative markets are for interest rate products, equities and 5

8 & 9 Wm 3 c 32, quoted in L Loss, Fundamentals of Securities Regulation (2nd ed, 1988), p 1.

6 7

Major debt raisings by Australian corporations are usually made offshore in more liquid markets. The Sydney Futures Exchange began life in 1960 as the Sydney Greasy Wool Futures Exchange and until 1975 listed wool futures only. Commodity and currency futures followed, initially to enable traders and others exposed to foreign current movements to hedge their physical position against adverse price movements. Most derivative trading is now speculative rather than supporting primary production and international trade.

830

[11.25]

Financial Market Regulation

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commodities. 8 In a rebranding exercise, it is now called ASX 24 to mark its integration with the Australian Securities Exchange, called ASX. Several domestic and foreign financial markets are licensed to operate in Australia, ASX being the largest. Other exchanges include Chi-X, an alternative equity trading venue with institutional owners which opened in Australia in 2011, the Asia Pacific Stock Exchange (APX) and IR Plus, the latter targeting listings and investment in clean technology, renewable energy and biological science companies. The much older Stock Exchange of Newcastle, now called the National Stock Exchange of Australia or NSX, targets listings from small to medium sized entities and high technology companies. In 2005 NSX acquired the Bendigo Stock Exchange which traced its origins to the 1860s; the Bendigo Exchange was integrated into the NSX market. However, since ASX accounts for the great bulk of secondary market business and listings in Australia, the primary focus here is upon ASX (including reference to ASX 24 where relevant in the context) although some reference will also be made to Chi-X, ASX’s strongest emerging competitor. The development of financial market regulation [11.30] The Bubble Act of 1720 was an early form of financial market regulation. Its recitals

referred to “persons who contrive or attempt such dangerous and mischievous undertakings or projects, under false pretenses of public good, [who] do presume … to open books for public subscriptions, and draw in many unwary persons to subscribe therein towards raising great sums of money”. 9 Stockbrokers trading in unlawful securities were subjected to penalties. However, after this statute there was little legislative activity in the United Kingdom until the Financial Services Act 1986 (UK) introduced comprehensive regulation of investment business, including financial markets. In Australia financial markets were not regulated by statute until 1970. Futures markets were later brought within corporate regulation. Regulation of other financial products such as superannuation, life and general insurance, foreign exchange and banking products were regulated by legislation specific to the particular industry. The view was taken in the CLERP review in the late 1990s that convergence was occurring in relation to these products which was ill served by the existence of multiple regulatory regimes whose disparate levels of disclosure impeded consumer comparison between functionally equivalent products. 10 The Financial Services Reform Act 2001 (Cth) substantially recast Ch 7 of the Act to harmonise financial services regulation through a single system for financial products and services defined in functional terms rather than by reference to industry-specific characteristics. 11 Thus, the definition of a financial product commences with a broad general definition in terms of the key functions performed by financial products: a financial product is a facility through which a person makes a financial investment, manages financial risk or makes non-cash payments: s 763A(1). Each of these functions is itself elaborated in general terms: ss 763B, 763C, 763D. 8

9

For example, futures contracts are written with respect to major short and medium term interest rates (such as the 90 Day Australian Bank Accepted Bill Futures and Options and 3 Year and 10 Year Australian Treasury Bond Futures and Options); futures in fine wool, greasy wool and broad wool, in cattle and in coal enable producers to manage (hedge) their exposure to price volatility in those commodities. 6 Geo 1 c 18, s 18, quoted in Loss, p 2. An earlier example is the 1697 statute noted above entitled “An act to restrain the number and ill practice of brokers and stock jobbers.”

10

This followed a recommendation of the Wallis Committee, Financial System Inquiry Final Report (Commonwealth of Australia, 1997).

11

For a critique of this process from the perspective of regulatory theory and policy see A Corbett (1999) 22 UNSWLJ 506; D Kingsford Smith (2004) 22 C&SLJ 128. [11.30]

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The general definition is then clarified by a list of specific inclusions 12 and a list of specific exclusions. 13 For the most part Ch 7 regulates by reference to the terms “financial products” and “financial services” although the application of these broad concepts is refined in particular contexts to apply only to some subsets of products or services. Some portions of Ch 7 apply only to retail clients of financial service providers. Most financial products and services are captured by these broad definitions extending beyond securities such as shares, debentures and interests in managed investment schemes to include superannuation products, the investment components of life insurance, risk insurance, bank deposits, credit products that are not regulated by the National Credit Code, and foreign exchange derivatives. The “main object” of Ch 7 is to promote: (a) confident and informed decision making by consumers of financial products and services while facilitating efficiency, flexibility and innovation in the provision of those products and services; (b) fairness, honesty and professionalism by those who provide financial services; (c) fair, orderly and transparent markets for financial products; and (d)

the reduction of systemic risk and the provision of fair and effective services by clearing and settlement facilities: s 760A.

Translated into substantive content, that object contains at least four distinct elements. The first element concerns the structure of financial markets: • licensing of the financial markets themselves (Pt 7.2); • licensing of the facilities for the clearing and settlement of transactions upon those markets (Pt 7.3); • the imposition of ceilings upon the acquisition of voting power in a financial market licensee, reinforced by the power to disqualify persons from the management of a market operator who are not fit and proper persons for the role (Pt 7.4); and • the creation of compensation regimes for financial markets: Pt 7.5. The second element concerns the providers of financial services and imposes a single regime with respect to: • the licensing of financial services providers and their representatives such as securities dealers and investment advisers, futures brokers, life and general insurance companies and brokers, superannuation funds and deposit taking institutions (Pt 7.6); • disclosure obligations of financial services licensees and their representatives when providing financial services to retail clients (Pt 7.7); and • other conduct requirements for a financial services licensee (eg, dealing with client money and property; financial records, statements and audit): Pt 7.8. 14 The third element comprises uniform point of sale disclosure requirements for financial products through a product disclosure statement (PDS), ongoing disclosure and periodic 12

13 14

832

Specific inclusions include securities, derivatives, superannuation and retirement savings accounts, general and life insurance, deposit accounts, means of payment services such as smart cards and e-cash, and foreign exchange transactions other than pure money changing business: s 764A. Specific exclusions include health insurance, government insurance office operations, reinsurance and funeral benefits: s 765A. Major amendments were made with the Corporations Amendment (Future of Financial Advice) Act 2012 (Cth), including the best interest duty requiring financial planners and advisers to act in the best interests of clients and prefer the client’s interests in the event of conflict with those of the adviser, and bans on conflicted remuneration arrangements. The reforms follow the report of an inquiry into the collapse of Storm Financial and Opes Prime: Parliamentary Joint Committee on Corporations and Financial Services, Inquiry into Financial Products and Services in Australia (2009). [11.30]

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reporting requirements, and advertising restrictions applicable in each case only to dealings with retail clients: Pt 7.9. These requirements do not apply to corporate fundraising through the offering of securities (which offerings are subject to separate regulation under Ch 6D): s 1010A(1) and Chapter 10 of this book. The fourth element concerns Pt 7.10 which deals with market misconduct and other prohibited conduct relating to financial products and financial services. This includes forms of market manipulation, misleading or deceptive conduct, and insider trading. 15 These are longstanding provisions with respect to securities but are extended now to apply also to the broader category of financial products and services. As indicated, in view of the general concern of this book with corporations and financial markets law, the present focus is only upon those aspects of Ch 7 that directly concern regulation of the markets for corporate securities. Accordingly, treatment of the first three elements in this chapter is largely confined to the provisions governing the licensing of financial markets. The licensing and supervision of financial markets [11.35] Until 2010, powers with respect to the regulation of Australian financial markets

were shared between ASIC and the licensed market operators such as ASX, initially by virtue of longstanding market practice and later by the terms of the exchange’s market licence. ASX and other licensed market operators were responsible for the supervision of their own markets and market participants albeit with ASIC having broad oversight functions. This devolution of regulatory function to non-statutory bodies was justified by reference to perceived differences in institutional competencies, traditional responsibilities and the fundamental purposes of ASX and ASIC. In 2010 this co-regulation of financial markets was reshaped but not totally brought to an end. ASIC now has responsibility for supervision of domestic licensed financial markets and participants; market operators are responsible for ensuring that participants admitted to their markets comply with the market’s operating rules, including listing rules. The rationale for this fundamental change is discussed below after a further introduction to the development of exchanges and changing market structure: see [11.40]. The respective functions and responsibilities of ASIC and financial market operators in relation to listed companies are examined across this chapter. This section introduces the legal structure of financial market regulation in Australia with details elaborated in the immediately following sections. 16 Only the holder of an Australian market licence may operate a financial market such as that conducted by a stock exchange: s 791A. A financial market is defined as a facility through which offers or invitations to acquire or dispose of financial products are regularly made or accepted: s 767A. 17 The Minister may grant a market licence if satisfied that: • the applicant has adequate operating rules and procedures to ensure, as far as is reasonably practicable, that the market will operate as a fair, orderly and transparent market; • the applicant has adequate arrangements for operating the market, including arrangements for: 15

16 17

There are other provisions: miscellaneous provisions in Pt 7.12 and machinery provisions for title and transfer of securities and interests in managed investment schemes in Pt 7.11; these latter provisions are of general application and are not specific to financial services. On the background to and significance of the 2010 changes see J Austin (2010) 28 C&SLJ 444. The exception in s 767A(2)(a) for offers or invitations to acquire or dispose of financial products on the person’s own behalf, or on behalf of one party to the transaction only, is intended to exempt OTC markets from market licensing requirements: see Financial Services Reform Bill 2001, Explanatory Memorandum, [7.15]. [11.35]

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– handling conflicts between the commercial interests of the licensee and the need for the licensee to ensure a fair, orderly and transparent market; and – monitoring and enforcing compliance with the market’s operating rules; • the applicant has adequate clearing and settlement arrangements for transactions effected through the market if the Minister considers that the applicant should have such arrangements; and • no unacceptable control situation is likely to result if the licence is granted and no disqualified individual appears to be involved in the applicant: s 795B(1). 18 The general obligations upon a market licensee are expressed in like terms to those applying to the grant of the licence: s 792A. The market licensee must notify ASIC of breaches of or its inability to comply with these obligations and of other specified matters including the introduction of a new class of financial service, disciplinary action taken and significant contravention of its operating rules: s 792B. The Minister may vary, suspend or cancel an Australian market licence: ss 797A – 797C. Market operating rules, their content, status and enforcement are discussed at [11.45]-[11.50]. Five of the 16 licensed financial markets operating in Australia are overseas markets. ASIC does not directly supervise overseas financial markets licensed to operate in Australia on the basis that they are granted a licence to operate here under the protection of sufficiently equivalent regulation in their country of origin: s 795B(2). 19 A market licensee may self-list on the market’s official list: s 798C(1). The securities (financial products) of the self-listing licensee may be traded on the market if the listed entity enters into such arrangements as ASIC requires for dealing with possible conflicts of interest, and to ensure the integrity of trading in those securities: s 798C(2). Before self-listing, the market’s listing rules must provide for ASIC, instead of the market licensee, to make decisions and to take action in relation to the admission of the listed entity to, and its removal from, the market’s official list and the suspension or ceasing trading of its securities: s 798C(4). ASX was admitted to its official list in 1998 and its securities have traded since then on its own market. The resulting conflicts of interest contributed to the government’s decision to revoke the supervisory powers ASX then enjoyed over its own market: see [11.40]. ASIC is charged with supervising financial markets whose operators it has licensed under s 795B(1): s 798F. This involves ASIC monitoring the trading of financial products on domestic licensed financial markets (assuming ASIC’s erstwhile responsibilities and some of its staff and systems) and enforcing its market integrity rules as well as ASIC’s long standing functions under the market conduct provisions of the Act concerning continuous disclosure, short selling, market manipulation and insider trading. With the Minister’s consent (including to any amendments except in an emergency), ASIC may make rules (market integrity rules) that deal with the activities or conduct of • licensed markets and participants in those markets and • persons in relation to financial products traded on those markets: s 798G. ASIC, if it thinks it necessary or in the public interest, may give directions to suspend dealings in a financial product or class of financial products: s 798J. For example, ASIC might direct a broker to stop trading in a product where the dealings would lead to contravention of the Act or a market integrity rule, or would affect the integrity of the market; the direction is enforceable by the court: s 798J(4). Market integrity rules are legislative instruments and the rules are subject to Parliamentary disallowance: s 798G(1). ASIC has made detailed market 18 19

The licence may be granted subject to conditions (s 796A) and may be varied (s 796B), suspended or cancelled by the Minister in particular circumstances and by reference to particular criteria: ss 797B, 798A. Corporations Amendment (Financial Market Supervision) Bill 2010, Explanatory Memorandum, [2.10].

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integrity rules for the principal licenced markets with distinct bodies of rules for ASX and Chi-X markets. It has also made ASIC Market Integrity Rules (Competition in Exchange Markets) 2011 to even the playing field and so ensure fair competition between the ASX and Chi-X markets, eg, in relation to the clearing and settlement of market transactions in which ASX retains a monopoly through its licence to operate a clearance and settlement facility. Market operators and participants must comply with market integrity rules; breach of a market integrity rule attracts the civil penalty provisions: ss 798H, 1317E. Compensation orders may be made by a court where damage has resulted from the contravention of a market integrity rule although they may not be made against market operators on the basis that permitting claims of indeterminate amounts against those at the centre of the financial system would create systemic risk: s 1317HB(2). 20 ASIC may deal with breaches of the market integrity rules expeditiously by providing for a person to make a payment and/or undertaking to do something, such as instituting remedial measures or entering into a legally enforceable undertaking as an alternative to civil penalty proceedings: s 798K. The Corporations Regulations create sanctions through enforceable undertakings and infringement notices which may include the payment of a pecuniary penalty: Regulations Pt 7.2A. The market integrity rules and their statutory enforcement system are intended to parallel the largely non-statutory market supervision regime conducted before 2010 by ASX. 21 In further reflection of past structures and perhaps relative institutional capacity, in 2010 ASIC established a Markets Disciplinary Panel as a peer review body to make decisions about whether to issue infringement notices or accept enforceable undertakings for breaches of the market integrity rules. The panel’s members comprise people who currently hold senior roles in the markets; they are appointed by ASIC although the panel is designed to operate, as far as practicable, independently of ASIC. 22 The Act requires licensed market operators to monitor and enforce compliance with the market’s operating rules as a precondition to the grant of a market licence; these include the listing rules for the market, responsibility for which remains with the market operator: see [11.45]. In recognition of the potential for overlap and duplication in regulatory functions, ASIC has entered into memoranda of understanding with ASX and the Chi-X market operator for notification, information sharing and referral to enable the parties to discharge their respective functions and to co-ordinate compliance and enforcement. A degree of coregulation endures post-2010 – ASIC’s overall primacy in market supervision is the new norm but nuanced regulatory partnerships remain and are evolving.

20 21

Corporations Amendment (Financial Market Supervision) Bill 2010, Explanatory Memorandum, [2.20]. An empirical study of ASIC’s enforcement of market integrity rules from 2010-2014 found that, although ASIC has a range of enforcement options available when it considers there has been a contravention of market integrity rules, its enforcement has been restricted to infringement notices rather than seeking a pecuniary penalty under the civil penalty regime; this latter choice indicates that ASIC considers that the matters it has dealt with by way of infringement notice are less serious in nature: R Grayson Morison and I Ramsay (2015) 30 Aust Jnl of Corp Law 10. The great majority of infringement notices referred to remedial measures already implemented by the company to prevent recurrence of the breach.

22

The panel is non-statutory and the power to issue infringement notices and accept enforceable undertakings remains with ASIC. However, ASIC Commissioners delegate their functions and powers to members of a sitting panel so that they constitute a Division of ASIC and their decisions are decisions of ASIC; see ASIC Regulatory Guide 216 (Markets Disciplinary Panel) and ASIC Regulatory Guide 225 (Markets Disciplinary Panel practices and procedures). [11.35]

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THE AUSTRALIAN SECURITIES EXCHANGE The changing character and environment of financial markets [11.40] Listing upon a stock exchange confers four principal advantages for investors in and

the issuers of securities: • the assurance of liquidity that is provided by the public market for the securities; • the monitoring of trading in their securities; • the standard form governance and settlement rules adopted by the stock exchange which reduce the transaction costs of securities trading; and • the reputational signal which admission to the stock exchange list carries for potential investors in the company’s securities. 23 With the growth of other information markets and alternative reputation assurance mechanisms, stock exchanges no longer enjoy a natural monopoly with respect to these advantages. The advantages are principally secured through the listing and other operational rules adopted by the stock exchanges and ASIC’s market monitoring and intervention powers. Stock exchanges compete with each other as well as with other providers that seek to replicate their advantages by other means. In 2003, 76 overseas companies were listed upon ASX; they maintained listings on 22 other stock exchanges; at the same time 148 Australian companies had an overseas listing as well as their ASX listing, some of them multiple overseas listings. 24 In December 2012 some 96 foreign incorporated entities were listed on ASX. 25 A company does not need to have business operations in Australia before seeking listing here: foreign companies may seek Australian listing solely to access local capital sources for their domestic or global operaitons. Competition between stock exchanges is for companies’ primary listing. This is because index providers such as Standard & Poor’s which construct with the major stock exchanges indices of their listed companies (by size, sector, etc) generally allow a company to be included in an index for one stock exchange only. Inclusion in a stock exchange’s index means that many local investment institutions are effectively obliged to invest in the stock in proportion to its share of total market capitalisation (see [2.195]). With the largest investment community based in the United States, there has been a global pull upon major companies to the New York Stock Exchange (NYSE). In 2004, the leading Australian issuer, News Corporation, not only transferred its primary listing to the NYSE but incorporated a new holding company for the group in Delaware. Recently, a number of organisations have lodged Australian market licence applications for trading in ASX listed securities with ASIC. While well established in some other major jurisdictions, allowing multiple venues to trade in the same securities is a new development for Australia. An environment where multiple markets trade in ASX listed securities raises novel market supervision and surveillance concerns in an increasingly automated global trading system: Securities markets have experienced a dynamic transformation in recent years. Rapid technological advances and regulatory developments have produced fundamental changes in the structure of securities markets, the types of market participants, the trading strategies employed, the increase in the speed of trading and the array of products traded. Trading of securities has become more dispersed among exchanges and various other trading venues. The markets have become even more competitive, with exchanges and other trading venues 23 24

J Macey & H Kanda (1990) 75 Cornell L Rev 1007 at 1009-10. Australian Stock Exchange, Capital Raising Mechanisms in a Disclosure-based Market (Exposure Draft, 2003), [2.7], [2.8]. Seven of the largest Australian companies by market capitalisation listed on ASX also had an overseas listing ([2.9]).

25

ASX, Selected Securities of Foreign Incorporated Entities Quoted on ASX (December 2012) http:// www.asx.com.au/products/foreign-entity-data.htm.

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aggressively competing for order flow by offering innovative order types, new data products and other services, and through fees charged or rebates provided by the markets. Risks posed to markets by illegal or otherwise inappropriate conduct can be substantially increased by automation, as market participants have the ability to trade numerous products and enormous volume in fractions of a second. In addition, the speed at which trading occurs impacts the ability to monitor effectively markets in the traditional sense. Moreover, because trading has become more dispersed across multiple trading centers, it has become more difficult to monitor and trace orders and transactions. These developments have also posed challenges to regulators in conducting market analysis and surveillance, and in reconstructing important trading events. These developments have also posed challenges to regulators in conducting market analysis and surveillance, and in reconstructing important trading events. … The lack of uniformity in and cross-market compatibility of, audit trails may make detection of illegal or inappropriate trading activity carried out across multiple markets and multiple products more difficult. These differences may hinder the ability of regulators to view and regulate effectively trading activity across markets within a jurisdiction and within geographical zones. The absence of uniform order and transaction data may create regulatory gaps and provide incentives for market participants to conduct activities on markets where less regulatory data is collected on an automated basis. 26

Because of its pre-eminent position among Australian financial markets, attention here focuses upon ASX which is ranked in the top 10 of listed exchanges worldwide. In 1998 the stockbroker members of ASX voted to convert it from a mutual organisation of stockbrokers into a public company limited by shares, that is, a company conducted as an ordinary commercial enterprise to earn profits for distribution to shareholders as dividends. Those members became a very different group from the stockbrokers for whom membership of the stock exchange formerly gave access to practice as a broker on the stock exchange. ASX was simultaneously admitted to its own official list so that shares in ASX may be traded upon the stock market conducted by ASX itself along with those of other listed companies whose conduct ASX then supervised as market regulator. ASX was the first stock exchange to simultaneously demutualise and self-list although exchanges in other major financial centres soon followed. 27 ASX’s demutualisation and self-listing cast it in two roles simultaneously. The first was as a market operator with primary responsibility for routine market supervision supported by extensive regulatory powers over issuers and their officers; the second was as a commercial enterprise advancing the interests of its shareholders under the discipline of its own market (although not that of the market for corporate control in light of a 15% individual ownership cap). The inherent conflicts of interest were addressed by locating operational supervisory functions in a separate subsidiary which reported not to ASX management but to a separate ASX entity with majority independent membership. Further, ASIC became the designated listing authority for oversight of ASX’s self-listing. These arrangements did not assuage all concerns about conflicts of interest in market supervision and surveillance, especially in the light of applications received for Australian market licences for trading in ASX listed securities on other trading venues. Some applicants had major shareholders that are themselves large investment banks and brokers; potentially, ASX would perform supervisory functions, including investigation and disciplining, against the substantial shareholders of a competing

26

International Organization of Securities Commissions (IOSCO), Technological Challenges to Effective Market Surveillance Issues and Regulatory Tools, Consultation Report (CR12/2012, 2012), pp 1-2.

27

Other stock exchanges listed on their own markets include the London Stock Exchange, Deutsche Boerse, the Singapore and Hong Kong stock exchanges, and the Toronto Stock Exchange. [11.40]

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market operator. It would also be technically difficult for ASIC to monitor trading on a competitor’s market and detect misconduct there. These considerations underlay the transfer of market supervision functions to ASIC. 28 The foundations and functions of the ASX listing rules [11.45] Under the current arrangements, the Act requires licensed market operators to

monitor and enforce compliance with the market’s operating rules which are required as a precondition to the grant of a market licence: see [11.35]. Operating rules include the listing rules set by the exchanges, responsibility for the supervision of which has not been transferred to ASIC. They also include the detailed procedural and operating rules such as the ASX Operating Rules: see [11.50]. Responsibility for the supervision of the listing rules and other operating rules remains with the exchanges and has not been transferred to ASIC. Companies wishing to have their securities traded on ASX apply for admission to its official list and for quotation of their securities. ASX has promulgated listing rules governing admission to its official list and the conduct of companies whose securities are granted quotation. The ASX listing rules, which are part of its operating rules, are designed to promote a fair, informed and efficient market for quoted securities. The ASX listing rules specify prerequisites for admission of companies to the official list and for quotation of their securities. Further, they impose continuing obligations, particularly of disclosure, upon companies admitted to the list. Their general concern, shared with the market integrity rules, is to ensure a fair, orderly and transparent market for the securities that are granted quotation: see s 792A(a). Companies that are admitted to the official list bind themselves contractually to comply with the listing rules; that contractual obligation is reinforced by statutory provision for their judicial enforcement: ss 793B, 793C and [11.65]. The prerequisites for admission seek to ensure that companies enter the official list with adequate paid up capital which is sufficiently widely distributed to allow for the free play of market forces with respect to secondary trading. The prerequisites for quotation of securities impose requirements additional to those prescribed by the Act for the regulation of corporate fundraising. These prerequisites also seek to ensure a measure of equity among shareholders in the distribution of rights under the constitution of a listed company or terms of issue of the security. Thus, official quotation will generally only be granted to ordinary shares with voting rights and which confer equitable representation on shareholders as a body and any substantial section of them. The listing rules also contain numerous other provisions protective of the equity investment in quoted securities. These include provisions regulating new share and option issues, the making of calls, the election, interests and remuneration of directors, transactions with persons who are in a position to influence the company, capital reconstructions, takeovers and other changes in control or major activities of the listed company. The rules also require of listed companies timely disclosure of information necessary for an informed market for their securities. Companies must provide forthwith any explanations requested by the stock exchange and notify the stock exchange immediately of any information concerning the company or its subsidiaries necessary to avoid the establishment of a false market in the company’s securities or which would be likely to affect materially the price of those securities: see [11.125]. As the primary market regulator, ASIC conducts surveillance of market activity to identify unusual trades for investigation of possible insider trading, market manipulation or inadequate information disclosure. ASX enjoys wide discretionary powers over admission and quotation: the Introduction to the ASX listing rules states that “ASX has an absolute discretion concerning the admission of an entity to the official list”. If a company does not comply with the listing rules, its securities 28

Corporations Amendment (Financial Market Supervision) Bill 2010, Explanatory Memorandum, [3.6]-[3.12].

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may be suspended from quotation or it may be removed from the ASX official list. Its discretion with respect to their application is discussed at [11.60]. In 1990 ASX circulated a discussion paper canvassing opinion as to the desirable reach of its then co-regulatory role and the balance with its function as a market operator. As regards its primary role, ASX stated its position in these terms: A stock exchange is first and foremost a market place for trading in the securities of domestic and foreign issuers, and in derivatives based on those securities, and in the direct and indirect debt of public bodies. It brings together people with capital on the one hand (investors, including speculators) and people requiring capital on the other. The extent to which it attracts participants to the market is a measure of its efficiency. The ASX’s role is to provide and maintain a fair, efficient, well-informed and internationally competitive market for trading securities, so as to secure the confidence of investors and companies in the conduct of the market. 29

ASX identified four principles to which it considered its listing rules should give effect: (i) the listing and quotation principle; (ii) the market information principle; (iii) the regulatory principle; and (iv) the trading and settlement principle. The first, the listing and quotation principle, requires that a listed entity satisfy minimum standards of quality, size, operations and disclosure, and attract sufficient investor interest, if it is to participate in the market by having its securities traded. The securities, including the rights and obligations attaching to them, must be issued in circumstances which are fair to new and existing security holders. 30 ASX expressed the second, the market information principle, in these terms: The market must be advised by timely disclosure of any information which may affect security values or influence investment decisions, or in which security holders, investors and the stock exchange have a legitimate interest, or which is publicly disclosed elsewhere. It should be produced according to the highest recognised and acceptable standards and, where appropriate, should enable ready comparisons with other like information. The ASX regards the Listing Rules which flow from this principle as being fundamental to maintaining an informed market and, while there may be some argument that these rules could be prescribed by law, the ASX accepts the responsibility in the absence of another regulator. 31

The third – regulatory – principle has been overtaken by the transfer of supervisory powers to ASIC. ASX expressed the fourth, the trading and settlement principle, in these terms: All market transactions in the quoted securities of a listed entity must meet such requirements as give commercial certainty to fulfilment of the contractual obligations embodied in those transactions. This principle concerns all of the Listing Rules dealing with notice periods, meetings, new issues, dividends, calls, reconstructions and those rules governing settlements and transfer of securities. These rules ensure that trading in companies’ securities takes place in an orderly and efficient manner and that participants in the market accrue the benefits to which they are entitled. 32

The ASX listing rules now state the principles on which the listing rules are based as embracing the interests of listed entities, maintenance of investor protection and the need to protect the reputation of the market. These principles are now expressed as follows in the Introduction to the listing rules: Minimum standards of quality, size, operations and disclosure must be satisfied. 29 30 31

Australian Stock Exchange Ltd, The Role of the Australian Stock Exchange and its Listing Rules (Discussion Paper, 1990), paras 6-8. Australian Stock Exchange Ltd, [17]. Australian Stock Exchange Ltd, [22]-[23].

32

Australian Stock Exchange Ltd, paras 33-34. [11.45]

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Sufficient investor interest must be demonstrated to warrant an entity’s participation in the market by having its securities quoted. Securities must be issued in circumstances which are fair to new and existing security holders. Securities must have rights and obligations attaching to them that are fair to new and existing security holders. Timely disclosure must be made of information which may affect security values or influence investment decisions, and information in which security holders, investors and ASX have a legitimate interest. Information must be produced according to the highest standards and, where appropriate, enable ready comparison with similar information. The highest standards of integrity, accountability and responsibility of entities and their officers must be maintained. Practices must be adopted and pursued which protect the interests of security holders, including ownership interests and the right to vote. Security holders must be consulted on matters of significance. Market transactions must be commercially certain.

The Introduction also states that the listing rules themselves are to be interpreted: • in accordance with their spirit, intention and purpose; • by looking beyond form to substance; and • in a way that best promotes the principles on which they are based.

In summary, ASX offers a market for trading in securities. Trading takes place through market participants, the modern term for stockbroking firms, replacing the former nomenclature of member organisations that was itself displaced by ASX’s demutualisation. ASX Operating Rules [11.50] The second principal element of ASX’s operating rules required as a precondition to

the grant of a market licence is the body of detailed procedural and operational rules which in the case of ASX are called the ASX Operating Rules. (There is a distinction therefore between these “ASX Operating Rules” and ASX’s “operating rules”, the latter statutory term in s 795B(1) including, along with the ASX Operating Rules, the ASX listing rules.) The ASX Operating Rules are the body of regulations made by the stock exchange to regulate the conduct of securities business by market participants. While the ASX listing rules are concerned with product (that is, the securities traded upon the stock exchange), the ASX Operating Rules largely contain machinery internal to the stock exchange and its powers with respect to market participant organisations. They deal with the activities or conduct of the market and its participants, containing detailed rules for the machinery of stock exchange transactions and the conduct of market participants: participants’ access to the market, the products that may be traded, trading platform rules, monitoring compliance and sanctions against market participants.

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The status and enforcement of listing and operating rules

Suspension or removal from the official list [11.60] If a listed company breaches the listing rules, these rules empower the stock exchange

to suspend quotation of the company’s securities or remove the company from the official list. Indeed, there are judicial statements supporting the vigorous exercise of the removal power. In Kwikasair Industries Ltd v Sydney Stock Exchange Ltd 33 (decided in 1968) Street J in the Supreme Court of New South Wales said: In the context in which agreements are made for the listing of securities on the Stock Exchange Official List, there are obvious reasons in favour of the [Sydney Stock Exchange] Committee having the power of summary removal. In the absence of any term in an agreement fettering the Committee in the exercise of its power of summary removal, it would seem to be difficult to justify a right to remain on the official list such as to attract the protection of the Equity Court by way of injunction. Moreover, so long as the stock exchange continues in this community to discharge, with the acquiescence of the legislature, the important public duty expressed in its paramount and predominant object [viz, to promote and protect the interests of all members of the public having dealings on the stock exchange] the members of its committee should be left free to exercise honestly their powers of entry on or removal from the official list unencumbered by any prospect of their having to face a litigious investigation of the correctness of their decisions. The powers of the Committee in this regard are arbitrary; they are intended to be exercised summarily and fearlessly in protecting the public interest.

Suspension or removal from the official list may, however, be an inapt response to infringement of a listing rule since it may deny to holders a market for their securities and thereby compound the harm they have suffered. The Securities Industry Acts enacted by the Australian States in 1970 responded to this difficulty by providing for enforcement of stock exchange listing and market rules. That remedy, somewhat recast, appears in ss 793C and 1101B.

Judicial enforcement of the listing and other operating rules [11.65] The operating rules of a financial market are defined in the Act as the rules, including

the market’s listing rules, made by the market operator that deal with the activities or conduct of the market and its participants: s 761A. The contract between the market operator and a company admitted to its list binds the listed company contractually to comply with the operator’s listing rules; the force of this contract is augmented by s 793C(3), referred to below. The operating rules other than the listing rules are deemed to have legal effect as a contract under seal between the licensee and each participant in the market, and between participants inter se, under which each person agrees to observe the operating rules to the extent that they apply to them and to engage in conduct that they are required by the operating rules to engage in: s 793B(1). If there is an inconsistency between the operating rules of a financial market and the market integrity rules (see [11.35]), the market integrity rules prevail to the extent of the inconsistency: s 793B(2). ASIC must be given notice of any changes to the operating rules: s 793D. The Minister may disallow a change to the operating rules: s 793E. If a person who is under an obligation to comply with or enforce any of a licensed market’s operating rules (including the listing rules) fails to meet that obligation, an application to the Court may be made by: (a) ASIC; (b) the market licensee; 33

CCH Australian Securities Law Reporter, ¶20-700. [11.65]

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(c)

the operator of a clearing and settlement facility with which the licensee has clearing and settlement arrangements; or

(d)

a person aggrieved by the failure: s 793C(1).

After giving the applicant and the person against whom the order is sought an opportunity to be heard, the Court may make an order giving directions about compliance with, or enforcement of, the operating rules to the person against whom the order is sought or its directors, if it is a corporation: s 793C(2). A corporation that is, with its acquiescence, included in the official list of a licensed market, or an associate of such a corporation, is taken to be under an obligation to comply with the operating rules of that market to the extent to which those rules purport to apply to the body corporate or associate: s 793C(3). An associate of a corporation is defined to include in this context a related company and a director or secretary of the corporation or of a related company: s 11. If a corporation fails to comply with or enforce provisions of the operating rules of a licensed market, a person who holds financial products of the corporation that are able to be traded on the market is taken to be a person aggrieved by the failure: s 793C(5); there may be other circumstances in which a person may be aggrieved by a failure for the purposes of this section: s 793C(6). Further, where a person has contravened a provision of the operating rules of a market or is about to do so, the Court may make one or more of an extensive range of orders on application by ASIC, a market licensee, or of a person aggrieved by an alleged contravention: s 1101B. Several questions arise from these provisions. First, when is a person under an obligation to comply with or enforce a provision of a market’s operating rules? The original form of s 793C did not expressly require persons to comply with the listing rules in the manner of s 793C(3); the provision was interpreted as imposing no obligation of compliance with the rules and as operating only upon an obligation arising independently of the section itself. An unlisted company was not, therefore, subject to any relevant obligation. 34 Indeed, under this provision a listed company would not be subject to an obligation of compliance if it had obtained listing without making a contractual commitment to comply with the relevant listing rule. 35 The deemed obligation to comply with the listing rules applies only to the extent that those rules purport to apply to the person in question: s 793C(3). In Hillhouse v Gold Copper Exploration NL (No 3), the court held that directors of a listed company are not, by dint of their office and the deemed compliance obligation in s 793C(3), under any personal obligation to comply with a listing rule that does not in its terms impose an obligation upon them but only upon their company. 36 The court noted that s 793C(3) (its then counterpart was in the same terms) referred to the listed company and the associates in the alternative so that the company’s obligation to comply with the rule is not placed upon the directors and vice versa. However, following this decision, s 793C(2) was introduced to enable the Court to make orders against directors of a company that is under an obligation to comply with a rule even though those directors are not personally obliged by the rule. That provision does not in its terms expand the scope of the directors’ obligation to comply, whether arising from contractual stipulation or the effect of s 793C(3), merely their amenability to judicial order. Similarly, it is not expressed to apply in reverse, that is, to make a listed company amenable to an order for compliance with a listing rule that in its terms binds directors only. 34 35 36

Designbuild Australia Pty Ltd v Endeavour Resources Ltd (1980) 5 ACLR 610; Repco Ltd v Bartdon Pty Ltd [1981] VR 1; NCSC v Industrial Equity Ltd (1981) 6 ACLR 1. As, eg, in Designbuild Australia Pty Ltd v Endeavour Resources Ltd (1980) 5 ACLR 610 at 634-635. Hillhouse v Gold Copper Exploration NL (No 3) (1988) 14 ACLR 423. It will be unusual, although not impossible, for the stock exchange’s market rules (as distinct from its listing rules) to be invoked against directors since they mostly concern the mechanics of market transactions.

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One difficulty in defining the effect and reach of the ASX listing rules flows from their peculiar function and the consequent attitude towards them traditionally adopted by ASX and its predecessors. Thus, under the heading “Application of the listing rules”, the Introduction to the ASX listing rules makes the following statement that is consistent with the longstanding practice of Australian stock exchanges: ASX has an absolute discretion concerning the admission of an entity to, or its removal from, the official list and the quotation or suspension of its securities. ASX also has discretion whether to require compliance with the Listing Rules in a particular case. In exercising its discretion, ASX takes into account the principles on which the Listing Rules are based. ASX may also waive compliance with a listing rule, or part of a rule, unless the rule in question says otherwise. The Listing Rules necessarily cast a wide net. However, ASX does not want to inhibit legitimate commercial transactions that do not undermine the principles on which the Listing Rules are based.

ASX’s express reservation of discretion with respect to enforcement of its listing rules, and its primary concern for underlying principles rather than the letter of the rules (see [11.45]), discourage a literal approach to their interpretation and the assumption that they apply prescriptively. In Bateman v Newhaven Park Stud Ltd, it was argued that ASX’s views as to the construction of its listing rules were “essentially beside the point” and that, in the absence of a specific waiver by ASX, the listing rules should take effect according to a proper construction of their terms. However, Barrett J discouraged [a]n uncompromisingly literal approach of this kind [as being] … at odds with the nature and intent of the listing rules. … I do consider to be of continuing relevance and validity the … observations [viz, of Young J in Fire and All Risk Insurance Ltd v Pioneer Concrete Services Ltd (1986) 10 ACLR 760 (see [11.70]) that “one falls into error if one treats the requirements of the listing requirements as a technical document for construction in the same way as a statute”]. I also consider to continue to be valid today in relation to the listing rules the comment of Brinsden J in Harman v Energy Research Group Australia Ltd (1985) 9 ACLR 897 that the discretions there reserved by the stock exchange to itself mean that the obligation to comply with the listing rules to which a listed company is subject may be seen, in reality, as “an obligation to comply with such of the listing requirements as the Stock Exchange in its discretion has required the company to comply with”. 37

Another way of expressing this question is to ask whether the provisions relating to the legal effect and enforcement of listing rules have any significance for contractual dealings by listed companies inter se. Alternatively, despite the broad terms of ss 793B and 793C, are they essentially provisions in aid of stock exchange enforcement of its listing rules? In Quancorp Pty Ltd v Macdonald the court said it was quite unable to perceive any basis upon which a declaration [that the actions of directors were void as being in breach of one of the listing rules] could be made in proceedings to which the ASX was not a party. … The sole remedy for a party complaining of a breach of the rule is to apply to the ASX. If the ASX considers that there has been a breach it is then empowered to require the party in default to take corrective action of one of the kinds set out in the rule. … If, contrary to my view, it was arguable that, if the ASX did not require corrective action to be taken, an aggrieved party could claim other relief, it would be necessary to plead and prove, not only the breach of the rule, but also the failure of the ASX to require the directors and [company] to take corrective action set out in [the] Listing Rule. Absent such proof the Court would not be entitled to declare the actions void. 38 37 38

Bateman v Newhaven Park Stud Ltd (2004) 48 ACSR 454; [2004] NSWSC 392 at 457 (ACSR) at [10], [11], [12]. Quancorp Pty Ltd v Macdonald (1999) 32 ACSR 50; [1999] WASCA 33 at 55-56 (ACSR), at [23], [25], [26]. [11.65]

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The status and enforceability of listing rules is canvassed in FAI Insurances Ltd v Pioneer Concrete Services Ltd (No 2) at [11.70].

FAI Insurances Ltd v Pioneer Concrete Services Ltd (No 2) [11.70] FAI Insurances Ltd v Pioneer Concrete Services Ltd (No 2) (1986) 10 ACLR 801 Court of Appeal of the Supreme Court of New South Wales [In December 1982 Ampol (a subsidiary of Pioneer) acquired the petroleum business of Total. Part of the transaction involved the issue to Total of redeemable preference shares in Ampol. These shares could be redeemed in the “shorter period” between 1984 and 1986 or in a “longer period” between 1986 and 1988. If they were redeemed in the shorter period, Total was obliged to invest the proceeds in shares in Pioneer which was in turn obliged to allot the shares. The transaction was publicly announced. Total decided to redeem the shares within the shorter period and became entitled to have the Pioneer shares allotted to it. By April 1986, before the allotment had been made, Total had disposed of its rights in favour of several investment institutions. On 29 May 1986 FAI announced its intention to make takeover offers for Pioneer shares to increase its holding from 17% to 67 per cent. Its bid price was to be $2.75 cash for ordinary shares. On 2 June 1986 Pioneer allotted 41 million shares to the institutions which had acquired Total’s rights. The issue was made for $2.45 per share. On 12 June 1986 the Sydney Stock Exchange (on which Pioneer was listed) granted quotation to the 41 million shares. FAI commenced proceedings to have the allotments set aside. It claimed that the allotments were in breach of the listing requirements, as the rules were then called, and that the predecessor to s 793C gave the listing requirements statutory force. It sought orders for rectification of Pioneer’s register under the counterpart of s 175. The listing requirement which FAI alleged Pioneer had infringed was r 3R(3) which provided that where a listed company receives notice of a takeover offer it will not issue shares for a period of three months unless the issue is approved by the company in general meeting, made pro rata to existing members or had been notified to the exchange prior to receiving notice of the bid. At first instance, Young J held that the allotments infringed r 3R(3). Nonetheless (for reasons outlined by Kirby P below), he declined to make interlocutory orders restraining the disposal of the shares. FAI sought leave to appeal. References to the Act have been substituted in the following extracts; relevant differences in their terms are noted by emendations below concerning the wider group of persons who may seek orders under s 1101B.] KIRBY P: [809] Young J was prepared to conclude that the claimants were “persons aggrieved” within the section. So do I, no contrary submission having been pressed upon the court. However, his Honour concluded, for a number of reasons, that the section was inapplicable to the facts in this case, even if all of the facts alleged were proved by FAI. His Honour contrasted s 793C with s 1101B. There are larger powers under the latter section by which the court may make necessary and appropriate orders to cure problems arising from the contravention of the listing rules of a securities exchange. His Honour held that if s 793C were to be construed to have the wide and protective effect urged by FAI, it would needlessly overlap with s 1101B in a way that ought not to be imputed to the legislature. Significantly, the powers of the court in [the predecessor to s 1101B] may be invoked only by the NCSC or a securities exchange. [Wider standing rights are now granted under s 1101B.] Operation of the section cannot be secured by proceedings brought by “a person aggrieved”, as may be the case under s 793C. Accordingly, in the scheme of the legislation, Young J held that s 1101B was enacted to give the court power to make orders in the event of contravention of listing requirements, including orders which might affect any person. His Honour held that s 793C on the other hand, existed only to empower the making of orders against the listed company and associated persons to give effect [810] to listing requirements. Upon this view s 793C was not available to cure breaches of listing requirements which had occurred. These were “unremediable”, because no further orders could be made under the section which would ensure that any directions made were complied with. Such 844

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FAI Insurances Ltd v Pioneer Concrete Services Ltd (No 2) cont. breaches, if they were to be addressed at all, had to be dealt with extracurially by the relevant securities exchange or raised in proceedings under s 1101B. By the terms of that section, the court’s protection could only be invoked on the initiative of the Commission or a securities exchange. … The court has not, in this interlocutory appeal, heard full argument concerning the meaning to be ascribed to s 793C. However, at this stage for a number of reasons I would not be inclined to accede to the limited construction favoured by Young J. [811] First, the words “compliance with, observance or enforcement or giving effect to those … listing rules” in s 793C are words of very wide purport. The word “enforcement” may be apt, as may the words “giving effect to”, to include the contemplation of the making of complex orders which are designed to ensure so far as can be secured, compliance, relevantly, with the listing rules of the securities exchange, even if that compliance incidentally affects the rights of third parties. Second, there is an inescapable overlap between ss 793C and 1101B, despite his Honour’s pains to avoid a construction which involves overlap of the provisions. The intersection of the provisions arises by reason of the reference in each to the powers of the Commission and of the securities exchange to take steps following contravention of (s 1101B) or non-compliance with, non-observance of, non-enforcement of, or failure to give effect to (s 793C) the listing requirements. One important difference between the sections lies in the standing which is accorded to the “person aggrieved” by s 793C but not by s 1101B. Section 793C is a beneficial, protective provision. By virtue of these additional words, s 793C should not be given a narrow construction. The fact that a “person aggrieved” may initiate proceedings under s 793C suggests the possibility that the section contemplated remedial action which might affect third party rights such as are likely to be raised by the typical concerns of such persons aggrieved about non-compliance with the listing requirements. Third, his Honour has taken too narrow a view of the purpose and operation of s 793C. His references to the listing requirements as being a “flexible set of guidelines for commercial people to be policed by commercial people … [which] are never intended to be inflexible rules but rather principles to be administered and applied by an expert body in accordance with the prevailing ethos of those chosen to administer them”, undervalues the special statutory status now accorded to them by both ss 793C and 1101B. Section 793C(2) deems, inter alia, persons “associated with a body corporate” to be “under an obligation to comply with, observe and give effect to the listing requirements”. Accordingly the net of the potential remedial operation of the section is cast more widely than would have been necessary if the section had been simply addressed to the obligation of companies to comply with the listing requirements of a securities exchange. The terms of s 793C(2) provide another indicium of the legislative intention to afford a wide facility to courts to frame orders which secure compliance with those listing requirements. Fourth, and most importantly, the power conferred to make orders giving directions is not limited by its terms to a power to direct compliance with, etc … the listing requirements. It is expressed more widely, in two important ways. The power is not confined by the language of the subsection to make orders against the person who is under the obligation to comply with the listing rules, as it might easily have been. The subsection does not state that the order may only be made against “that person”, that is, the person referred to in the opening words of the subsection. Instead it refers to “the person against whom the order is sought”. This language suggests the contemplation of an order against persons other than the person who is under the obligation, the non-compliance with which activates the operation of s 793C. As well, the order contemplated may be “concerning compliance”. The use of the wide word of connection “concerning” is a further indication of a possible operation of the section upon third parties, such as the allottees and a securities exchange. The only requirements of the subsection are that the order must be sought against the person and that person must be given an opportunity of being heard. [812] Finally, the construction of s 793C urged by the claimants has an additional attraction. Making due allowance for the discretion of the court, which is assured by the terms of s 793C, it permits the protective intervention of the court to ensure that breaches of listing requirements, which, for whatever reason, are not pursued by the Commission or a securities exchange, can be brought to notice of the court by a person aggrieved. That facility provides an appropriate protection, including [11.70]

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FAI Insurances Ltd v Pioneer Concrete Services Ltd (No 2) cont. to the public interest which may be or become involved in suggested breaches of the listing requirements of a securities exchange. Making every allowance for the commercial considerations to which Young J referred and for the “absolute discretion” reserved to the securities exchanges by the foreword to the official listing requirements, the overall scheme of [Ch 7 of the Act], as enacted by the Parliament, appears to be one which elevates the listing requirements to a statutory importance which they did not previously have. They are now more than the private rules of a private body. By s 793C, as by s 1101B of the [Act], they are given statutory significance, doubtless in recognition of the fact that they necessarily affect large transactions, potentially involve the movement of very considerable funds and concern the public interest as well as the private interests of shareholders. Although the considerations to which Young J referred can properly be taken into account in the exercise of the court’s discretion to grant or deny relief under the section, they are not, in my view, reasons for giving a narrow construction to the power which the legislature has conferred on the court by the provisions of s 793C. It is not necessary at this stage of the proceedings to express a concluded view on the precise scope of that power. Suffice it to say that I am not content to hold that the power is as narrow as the opponents urged and as Young J found. STREET CJ: [805] I incline to the view that [Young J adopted] too restrictive a statement of the range of jurisdiction under s 793C. It may, in some circumstances, overlap with s 1101B although the range of remedies under s 1101B is considerably wider. I hesitate to confine s 793C to jurisdiction to giving directions which will bring about compliance with the listing requirements. This is a gloss not specifically within the terms of s 793C and there may well be cases where the court’s jurisdiction could properly and usefully be more extensively exercised. Again, an irremediable breach does not necessarily close off the exercise of the court’s jurisdiction. I prefer to leave this particular aspect at large, but in a case such as the present I do not consider that the jurisdiction extends [806] to ordering rectification of the register so as to take off the names of third to the 21st opponents. As Young J correctly held that s 793C did not authorise the substantive relief sought by the claimants, I see no justification for granting leave to appeal from Young J’s order discharging the interlocutory injunction. There are, however, other matters upon which I consider it desirable to make some observations. Young J expressed his opinion upon the operative significance, in a general sense, of the listing requirements of the Sydney Stock Exchange. His Honour said in that regard: One falls into error if one treats the requirements of the listing requirements as a technical document for construction in the same way as a statute. To my mind the listing requirements are a flexible set of guidelines for commercial people to be policed by commercial people. They are in the same category as guidelines or standards laid down by administrative bodies who are administering an Act of Parliament. These guidelines or standards are never intended to be inflexible rules, but rather principles to be administered and applied by an expert body in accordance with the prevailing ethos of those chosen to administer them. Whilst I recognise the importance of enabling the stock exchange to impose requirements upon listed companies according to ordinary and proper commercial standards, ss 793C and 1101B confer on the court jurisdiction to underwrite the binding nature of the stock exchange rules. The obligation to comply with them is expressly imposed by s 793C(2) and the jurisdiction conferred by s 793C(1) and by s 1101B(1) imposes upon the court a complementary responsibility to hold itself ready, in appropriate cases, to underwrite and enforce that binding significance. It is of course apparent that some of the rules, by their very nature, are not capable of being enforced in terms. This may flow from the generality of their expression, the subject matter with which they purport to deal, or from some other consideration rendering it impracticable or undesirable for the court to intervene. Others of the rules, however, are clearly such as to attract the exercise of the court’s jurisdiction in appropriate cases. The only generality regarding the rules that can safely be made is that the legislature, in these two sections, has plainly indicated that they are to be binding and enforceable. The stock exchange itself has available to it the sanction of delisting for disregard of the rules. The 846

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FAI Insurances Ltd v Pioneer Concrete Services Ltd (No 2) cont. court has a more widely ranging jurisdiction. In the case of both the stock exchange and the court, however, the question of whether or not the particular situation calls for intervention is ultimately a matter of discretion. Returning to the case in hand, the breach of r 3R(3) does not in itself entitle the claimant to the rectification that it seeks. There is thus no occasion justifying, merely on the ground of this breach, the grant of interlocutory relief pending the final determination of the proceedings. The breach can, however, possibly have significance in a more broadly based challenge such as [counsel for FAI] foreshadowed [namely, that the Pioneer directors were in breach of their fiduciary duties in making the allotments. This challenge] involve[s] consideration, amongst other [807] matters, of the history of the present share issue with a view to ascertaining whether or not the decision of the directors to issue shares was tainted by collateral considerations. Breach of r 3R(3) could be a factor to be weighed within this general topic even though it does not, as Young J correctly held, in itself provide a basis for substantive relief sought by the claimant. [Street CJ and Kirby P concluded that interlocutory relief should be granted to preserve the status quo pending a fresh decision at first instance on the wider ground of challenge. Samuels JA dissented. He said (at 814-815): I do not consider that s 793C(1) … will do the work which the claimants require of it. I am not persuaded that it authorises the court to divest third party rights, even those acquired by dint of a breach of the listing rules. This is not the occasion for discussion of the view expressed by Young J about the construction and effect of the listing requirements or of the influence which they might have upon the construction of s 793C. I reserve my opinion upon these points. But I am by no means persuaded that the learned judge’s ultimate conclusion concerning the scope of s 793C and his manner of reaching it by comparison with s 1101B are other than correct.]

[11.75]

1.

2.

3.

Notes&Questions

Why did Street CJ refuse to grant rectification under s 175 for breach of the listing rule? If it had been shown that the allottees had been aware that Pioneer had allotted the shares in breach of the listing rule, might the rectification order have been made? What operation do ss 793C and 1101B have apart from supplementing the market operator’s powers of enforcement of its rules? Do, and should, the provisions provide a remedy for review of the stock exchange’s decisions with respect to enforcement of the rules? In light of the standing and remedies that are granted for their breach and the requirements for Ministerial approval and disallowance of their amendment, should the listing rules be considered as performing a quasi-legislative function rather than as private contractual supplements?

[11.77]

Review Problem

Mates Ltd is listed on ASX. It proposes to make a substantial cash loan to a joint venture company in which the spouse of Mates’ chairman holds half the equity. There is evidence to suggest that the Chairman may vote at the directors’ meeting to approve the transaction. Mates Ltd does not propose to consult its shareholders over the transaction as required by ASX under LR 10.1 as a transaction with a person in a position of influence with the company. What action might ASX take if the directors persist in their refusal to hold a meeting of [11.77]

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disinterested shareholders and if the Chairman votes at board level? What remedies might an independent shareholder have if ASX declines to take action itself or grants a waiver from compliance with the applicable listing rules?

ASIC’S INVESTIGATION AND INFORMATION GATHERING POWERS Overview of ASIC investigation and enforcement powers [11.80] This section introduces ASIC’s extensive powers of investigation and information

gathering. 39 These powers are not limited to the exercise of functions under Ch 7 of the Act. ASIC receives complaints from many informal sources. Of course, complaints may be made to other bodies such as ASX although its responsibilities are limited to listed companies and its sanctions are constrained by their contractual foundation and limited statutory supplements. ASIC is the principal complaints handling body by reason of its statutory responsibilities and the powers given to it under Pt 3 of the ASIC Act. 40 (In this section the bulk of statutory references will be to the ASIC Act rather than the Corporations Act. Accordingly, for convenience, references to the Corporations Act will be denoted by the prefix “CA” and those to the ASIC Act will be shown with the prefix “ASICA”.) The exercise of these statutory powers enables ASIC to gather information which it may use to launch criminal, civil or administrative proceedings for relief, remedy or other sanction. As noted, these powers are not limited in their application to the financial market provisions of Ch 7 but apply to the generality of provisions of the Act. However, many complaints received by ASIC or investigations made upon its own initiative (eg, following media reports) will not involve the exercise of formal powers under Pt 3, unless informal investigation indicates the need for more formal inquiry and the exercise of coercive powers granted to the agency under Pt 3. An investigation conducted under investigative powers conferred by ASICA Pt 3, Div 1 has significance not only for the coercive powers of information gathering which its commencement triggers but for the range of proceedings which may be founded upon the mere fact of that commencement or upon evidence obtained during the investigation. First, where as the result of an investigation it appears to ASIC that a person may have committed an offence against the corporations legislation 41 and ought to be prosecuted for the offence, ASIC may initiate a prosecution: ASICA s 49(1), (2). ASIC may require a person (other than the defendant and her or his lawyer) who it reasonably believes can give information relevant to a prosecution to provide assistance: ASICA s 49(3), (4). Second, where, following an investigation or examination under Pt 3, it appears to ASIC to be in the public interest for a person to sue for damages for misconduct committed in connection with a matter to which the investigation or examination related, or for the recovery of the person’s property, ASIC may commence such proceedings in the person’s name: ASICA s 50. Third, the fact that an investigation has been initiated permits ASIC to seek protective orders: CA s 1323. Fourth, ASIC may release a record of an examination conducted under ASICA Pt 3, Div 2 to a lawyer conducting or proposing civil proceedings on behalf of another party: ASICA s 25(1) and [11.90]. Fifth, the commencement of an investigation confers standing to seek other statutory remedies of wider 39

See further V Comino (2016) 34 C&SLJ 360; T Middleton (2004) 22 C&SLJ 503; J B Kluver, “ASIC Investigations” in Australian Corporation Law Principles and Practice (LexisNexis looseleaf service), [15.1.0005] et seq; J P Longo (1991) 8 Aust Bar Rev 163; A J McHugh & S Stern (1991) 3 Current Issues in Criminal Justice 63.

40

ASIC has other coercive powers of information gathering. Thus, it may seek court orders for public examination of corporate officers under CA, s 597. However, since the Commission’s principal investigative powers are contained in ASICA, Pt 3, attention is confined to those provisions.

41

The term “corporations legislation” is defined as the Corporations Act and the ASIC Act: ASICA s 5(1).

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application: see, eg, CA s 464(1). Sixth, statements made at an examination are admissible against the examinee in criminal proceedings, subject to protective provisions relating to self-incrimination and legal professional privilege: ASICA s 76 and [11.100]-[11.105]. The report of the investigation itself is admissible in civil proceedings as prima facie evidence of facts and matters disclosed: ASICA ss 81 – 83. These elements of ASIC’s investigation and enforcement powers are examined in the following paragraphs. The power to conduct investigations [11.85] Part 3 Div 1 of ASICA contains the sources of ASIC’s power to conduct investigations.

First, ASIC may make such investigation as it thinks expedient for the due administration of the corporations legislation where it has reason to suspect that there may have been committed a contravention of that legislation or of another law either concerning the management or affairs of a corporation or which involves fraud or dishonesty and relates to a corporation or managed investment scheme: ASICA s 13(1). Second, ASIC may make such investigation as it thinks appropriate where it has reason to suspect a contravention of a relevant previous law: ASICA s 13(2). Third, ASIC may investigate misconduct referred to in reports by liquidators or receivers under CA ss 533 and 422 for possible prosecution: ASICA s 15. Each of these investigative powers is exercisable on ASIC’s initiative. In addition, the Minister may direct ASIC to investigate certain matters where the Minister considers that such investigation is in the public interest: ASICA s 14(1). These matters are very broadly drawn and do not require the formation of a suspicion as to contravention of the corporations legislation: ASICA s 14(2). ASIC must comply with a ministerial direction to undertake such an investigation: ASICA s 14(3). At the end of an investigation initiated by the Minister, ASIC is required to prepare a report about the investigation (ASICA s 17(2)) and may elect to do so upon completion of other investigations under the division: ASICA s 17(1). ASIC is obliged, however, to prepare an interim report when in the course of any investigation it forms the opinion that a serious contravention of a law has been committed, that the preparation of an interim report would assist the preservation or prompt recovery of property or that there is an urgent need for amendment to the corporations legislation: ASICA s 16(1). Reports are to be made available to the Minister and may also be given to Commonwealth law enforcement agencies: ASICA s 18(1), (2). The Minister may publish a report: ASICA s 18(4). 42 Gathering information in aid of investigations [11.90] Divisions 2, 3 and 4 of Pt 3 of ASICA contain provisions enabling ASIC to gather

information relevant to an investigation under Div 1. Under Div 2 ASIC may require a person to give all reasonable assistance in connection with an investigation and to appear before an inspector for examination upon oath and to answer questions: ASICA s 19(2). The examination power may be exercised only where ASIC, on reasonable grounds, suspects or believes that a person can give information relevant to an investigation: ASICA s 19(1). An inspector may require an examinee to answer any question put to them which is relevant to matters under investigation: ASICA s 21(3). The examination takes place in private: ASICA s 22. The inspector may require an examinee to sign a record of the examination: ASICA s 24(2)(a). The examinee is entitled to a copy of the written record, subject to conditions imposed by the inspector: ASICA s 24(2)(b). 42

The obligations of the NCSC where it proposed to publish a report of its investigation under express powers were discussed in National Companies and Securities Commission v News Corp Ltd (1984) 156 CLR 296 at 324-326. The NCSC did not enjoy any immunity from defamation liability. [11.90]

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ASIC may give a copy of a record of the examination to another person’s lawyer if it is satisfied that the person whom they represent is carrying on or contemplating in good faith a proceeding in respect of the matter to which the examination relates: s 25(1); this record of the examination may only be copied or communicated in connection with such proceedings: s 25(2). 43 ASIC may also give another person a copy of a written record of the examination subject to such conditions as it imposes: s 25(3). The power to release information acquired under examination is, however, limited by the duty of confidentiality imposed by s 127(1); ASIC may, however, share information obtained in connection with the performance of any of its functions (including but not limited to the examination power) with other governments, agencies and disciplinary bodies as an exception to the general principle of confidentiality in such information: s 127(1A)–(5A). Subject to these permitted uses, ASIC’s power to release is qualified by protection of the examinee’s confidentiality in the information disclosed in an examination: A person who obtains information in exercise of the powers conferred by s 19 of the Act comes under a statutory duty of confidence with respect to the information thus obtained. It is therefore important to ascertain the purposes for which such information can be legitimately used or disclosed. In the first place, the power conferred by s 19 of the Act to require a person to appear for examination and to answer questions is conferred for the purpose of obtaining “information relevant to a matter that [ASIC] is investigating, or is to investigate, under Division 1” of Pt 3 of the Act. So the information acquired by conducting a s 19 examination may be used for the purposes of such an investigation. In addition, s 127(3) authorises disclosure of otherwise confidential information by, inter alia, the members and staff members of [ASIC] for the purposes of performing the official functions of the person making the disclosure. As investigations are but some of the functions of [ASIC] (most of which are prescribed by Pt 2 of the Act) the Act contemplates that information acquired on examinations under s 19 may be used and disclosed for the purpose of the performance or exercise of any of the functions of [ASIC]. Then, certain purposes other than the performance of the functions of [ASIC] are approved by [s 127(1A)–(5A)]. Information obtained in exercise of the powers conferred by s 19 may therefore be used or disclosed for the purpose of the performance of any of the functions of [ASIC] and for any of the purposes mentioned in [s 127(1A)–(5A)]. But for no other purpose. 44

Transcripts of ASIC’s examinations of directors were given to a company’s receivers for the purpose of enabling them to determine whether to bring proceedings against those directors; this disclosure was judged to be a proper use of the information for the purpose for which it was obtained. 45 In determining whether it should release copies of records of interview, ASIC considers whether any of its enforcement requirements (such as a current or future

43

The conflicting public (as well as private) interests affecting disclosure of records of s 19 examinations are discussed in E Rumble (2014) 32 C&SLJ 44.

44 45

Johns v Australian Securities Commission (1993)11 ACSR 467 at 475 per Brennan J. Gothard v Fell (2012) 88 ACSR 328. In AWB Ltd v ASIC [2008] FCA 1877 a challenge to ASIC’s proposed disclosure of information from s 19 examination to the Australian Federal Police was dismissed notwithstanding that legally privileged information had been given to ASIC by examinees who were not holders of the privilege: see [11.105]. In R v OC (2015) 108 ACSR 80 the court rejected an application for a temporary stay of criminal proceedings against an examinee made on the grounds that the prosecution team included persons who had direct or derivative access to the transcript of the examination which included matters, the proof of which were necessary to sustain the charge. The court held that, since ASIC’s functions include prosecution of contraventions such as those in the instant case, making the transcript available to those conducting the prosecution was within its functions.

850

[11.90]

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investigation, prosecution, civil proceedings or administrative action) would be jeopardised by the release of the records and whether other persons might be adversely affected by the release. 46 Division 3 confers upon ASIC compulsive powers to inspect books, a term broadly defined to include any document or record of information: ASICA s 5(1). First, ASIC may inspect without charge any books required to be kept under the corporations legislation: ASICA s 29. (This power may be used for any function of ASIC and not merely for purposes of an investigation under Pt 3.) Second, for the purposes of an investigation under Div 1, ASIC may require the production of any other books about the affairs of a corporation or managed investment scheme: ASICA ss 28(d), 30 – 33. 47 The power in relation to the production of books includes the power to inspect and make copies or extracts, to make use of the books in proceedings and to retain any of the books for as long as is necessary: ASICA s 37. Where ASIC has reason to suspect that there may be books which have not been produced as required, it may obtain a search warrant and seize books: ASICA ss 35, 36. Division 4 empowers ASIC to obtain information from persons carrying on a financial services business, who deal in financial products or whom ASIC believes are in a position to give information about the activities or position of such a business or provider: ASICA ss 41 – 43. These coercive powers may be used for the purposes of a Div 1 investigation as well as for the purposes of other functions under the corporations legislation generally and cognate legislation: ASICA s 40(a) – (c). Particular powers are also subject to specific limitation upon their exercise: see ASICA s 43(1), (4). Disclosures made pursuant to Div 4 requirements take place in private and the communications are protected from disclosure: ASICA s 47. Fairness in the conduct of investigations [11.95] Investigation provisions reflect an adjustment between the conflicting values of

expeditious information gathering and traditional concerns for the protection of the individual against the exercise of coercive state power. (What significance has the dual character of ASIC, as both a corporate and financial market regulator, for this adjustment?) Several provisions in Pt 3 protect persons who are subject to its investigation and examination powers. The first imposes an obligation of fairness in the conduct of investigations. A notice under s 19(2) requiring a person to appear for examination must state the general nature of the matter under investigation and set out the examinee’s rights to legal representation under s 23(1): ASICA s 19(3). 48 The examinee is entitled to have a lawyer present during the examination and to address the inspector and examine the examinee about matters the subject of the examination: ASICA s 23(1). Similar provisions apply to compulsory disclosures under Div 4: ASICA s 48. There is no express obligation imposed upon ASIC (unlike its predecessor) to observe the rules of natural justice (or procedural fairness) in the exercise of its investigative powers. The provisions relating to notices and legal representation make some limited provision in this regard. 46

ASIC Regulatory Guide 103.18 (Confidentiality and release of information).

47

The power to compel production is are not confined to investigations under Pt 3 Div 1 and may be employed in the performance or exercise of any of ASIC’s powers and functions under the corporations legislation, to ensure compliance with it or in relation to an alleged or suspected contravention of the legislation or another law concerning corporate management or involving fraud or dishonesty in relation to a corporation or financial products: s 28(a) – (c).

48

The standard of disclosure required by s 19(3)(a) may not be very exacting. A notice which merely stated that it was “[i]n relation to an investigation of [the company]” was held to be deficient only in so far as it did not set some temporal boundaries and that the investigation was confined to a particular takeover transaction: Australian Securities Commission v Graco (1991) 5 ACSR 1 at 8-9. [11.95]

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The privilege against self-incrimination [11.100] The Act expressly removes the common law right to refuse to give information,

produce a book or sign a record of examination upon the ground that to do so may tend to incriminate the person or make them liable to a penalty: ASICA s 68(1). Where, however, before making an oral statement giving information or signing the record, a natural person 49 claims that the disclosure or signing is self-incriminatory, the incriminating words and signing are inadmissible in any criminal proceedings against the person other than for perjury and in civil proceedings for the imposition of a penalty: ASICA s 68(3). (As noted at [11.80], subject to this exception and that relating to legal professional privilege (see [11.105]), statements made at an examination are admissible against the examinee in criminal proceedings and the report of the investigation is admissible in civil proceedings as prima facie evidence of facts and matters disclosed: ss 76, 81–83.) Until 1992, s 68(3) extended this use immunity to exclude any evidence discovered as a result of those words and documents (the derivative use immunity). In 1992, s 68(3) was recast to remove the derivative use immunity in relation to witnesses who give evidence under compulsion in Div 1 investigations. 50 The amendments also denied to corporations the immunity which now protects natural persons only. Legal professional privilege [11.105] By express provision, in a Pt 3 investigation a lawyer to whom a requirement to give

information or produce a book is addressed may refuse to comply with the requirement where it would involve disclosing a privileged communication made by, to or on behalf of the lawyer (that is, within the scope of the general law doctrine of legal professional privilege) unless the person to, by or on behalf of whom the communication was made consents to the lawyer complying with the requirement: ASICA s 69(1), (2). However, the lawyer who refuses to comply must disclose particulars identifying the source of the communication or the book: ASICA s 69(3). However, no provision is made in the legislation for the situation where the examinee or other person to whom the requirement for disclosure or production is addressed is not a lawyer, even if the communication sought would be within the scope of the general law doctrine of legal professional privilege. Although it has not issued a regulatory guide on the

49

The limited immunity no longer extends to a corporation which is also precluded from claiming the privilege against self-incrimination in any criminal proceedings under the Corporations Act: s 1316A.

50

The removal of the derivative use immunity was justified upon the basis that it placed an excessive burden on the prosecution to prove beyond reasonable doubt the additional fact that any item of evidence had not been obtained as a result of information the subject of the use immunity: Corporations Legislation (Evidence) Amendment Bill 1992, Explanatory Memorandum. The amendment implemented the recommendations of the Joint Statutory Committee on Corporations and Securities established under the ASIC Act, s 241: see Use Immunity Provisions in the Corporations Law and the Australian Securities Commission Law (1991). The Commission had argued before the Committee that the derivative use immunity required the Commission to anticipate the likely outcome at the outset of an investigation and, in particular, whether it was likely to lead to civil or criminal remedies. In some cases, this prompted the Commission to concentrate on civil proceedings and to abandon any prospect of criminal proceedings from the outset since coercive disclosures under its examination process would effectively preclude admission of evidence in later criminal proceedings. Alternatively, where the prospect of criminal proceedings was to be kept alive, the Commission was forced to structure its investigation so as not to rely upon examinations (ie, to rely upon documentary evidence) for fear that the examinee might invoke the immunity provisions and then make disclosures or produce documents which render inadmissible any evidence obtained through them. In consequence, it was argued, timely preservative action might be delayed, investigations were prolonged and the coercive powers of examination and document production became self-defeating, a “poisoned chalice” (in the words of one witness): pp 14, 27; see also P M Wood [1990] 1 Comm LQ 21.

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[11.100]

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subject, ASIC has asserted, when issuing notices to produce, that recipients who are not lawyers are not excused by the doctrine of legal professional privilege from the obligation to produce documents. 51 Enforcement of the corporations legislation [11.110] ASIC is directed, through the statement in ASICA of the objects for which it must

strive, to take whatever action it can and is necessary in order to enforce and give effect to the corporations legislation: ASICA s 1(2)(g). That enforcement responsibility may be discharged through criminal prosecutions or by civil proceedings to which ASIC is a party, in which it intervenes or which it assists by providing information derived from the exercise of its investigative powers. This section examines those enforcement options.

Criminal prosecution [11.115] ASIC may commence and conduct criminal prosecutions for breach of the

corporations legislation: ASICA s 49 and CA s 1315. Under guidelines established by ASIC and the Commonwealth Director of Public Prosecutions (DPP), responsibility for prosecution initiative and conduct is assigned to the DPP except for minor regulatory offences. Further, under those guidelines matters will not be referred to the DPP for criminal prosecution until ASIC has taken civil recovery action, which action is to be disposed of as quickly as possible. 52 It will be apparent that there is a tension between the claims of criminal prosecution and civil enforcement action as a response to particular conduct since legal doctrines relating to contempt, abuse of process and stay of proceedings have potential application to concurrent civil and criminal proceedings. Against the deterrent value of criminal proceedings must be weighed the benefits of immediate preservation and recovery of property for the benefit of shareholders and creditors. The adjustment of those sometimes competing claims reflects judgment within ASIC from time to time as to the relative strength of particular sanctions and institutional capacities. 53

Civil proceedings initiated by ASIC [11.120] There are numerous bases for civil enforcement proceedings to be commenced by

ASIC. Some are protective in the sense that they permit ASIC to take action to exclude individuals from participation in corporate management or from provision of financial services. Other civil enforcement powers are directed towards the preservation of corporate property or its recovery for the benefit of those with an interest in the capital fund. These remedies complement those available to directors, individual shareholders and creditors, and external administrators such as liquidators and receivers. 54 There are several bases upon which ASIC may commence legal proceedings to preserve corporate assets which are in jeopardy of dissipation, waste or improper removal. General law remedies include a Mareva injunction to prevent assets being put beyond the reach of court 51

See G Healy & A Eastwood (2005) 23 C&SLJ 375 at 376; T Middleton (2004) 22 C&SLJ 503 at 528; T Middleton (2008) 30 Aust Bar Rev 282 at 297-302.

52

See A G Hartnell, “Regulatory Enforcement by the ASC; An Inter-relationship of Strategies” (unpublished paper, 3 March 1992), p 10.

53

Part of this calculus of choice is, of course, the length, cost and complexity of corporate fraud trials. For a review of some measures taken or proposed to ameliorate such difficulties, see M Weinberg (1992) 1 J Judicial Admin 151.

54

For a comprehensive review of civil enforcement remedies available to ASIC see J B Kluver, “ASIC Enforcement” in Australian Corporation Law Principles and Practice (LexisNexis looseleaf service), [15.2.0005] et seq. For an empirical study of ASIC enforcement activities and outcomes, see H Bird et al, ASIC Enforcement Patterns (Centre for Corporate Law and Securities Regulation, University of Melbourne; 2003). [11.120]

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Corporations and Financial Markets Law

process. 55 Two provisions confer preservation remedies of wide application. 56 First, ASIC may seek a wide range of preservation orders, including the appointment of a receiver, following an investigation under ASICA Pt 3, Div 1, a prosecution that has been begun or civil proceedings commenced under the Corporations Act: CA s 1323. The remedy may be important to freeze assets in the face of the apprehended removal of property and may be granted on ex parte application. 57 In deciding whether it is “necessary or desirable” to grant relief under the section, the court is concerned with the protection of the interests of persons who may have claims against the company, such as investors; the judicial function under s 1323 is essentially one of risk assessment and management. 58 The section is auxiliary to the investigation, prosecution or civil proceeding which provides access to it. Second, ASIC may obtain an injunction to restrain conduct which is or would be a contravention of the Corporations Act or ancillary to such a contravention, or seek a mandatory injunction: CA s 1324. An award of damages may be made in lieu of or in addition to the grant of an injunction: CA s 1324(10). Several provisions in the Corporations Act permit ASIC to seek legal orders for recovery of property on behalf of individuals or a company. Thus, standing is expressly conferred upon ASIC to seek orders for the recovery of compensation or damages for contravention of a civil penalty provision: CA s 1317J. ASIC may seek a wide range of restitutionary orders with respect to contravention of provisions relating to fundraising and market misconduct: CA s 1325. The investigation may permit ASIC to approve a person to apply for an order with respect to oppressive or unfairly prejudicial conduct: CA s 234(e). ASIC is also empowered to bring an action in the name of a company (without its consent) or an individual where, as a result of an investigation or record of examination, it considers it to be in the public interest to do so: ASICA s 50. 59 Further, in two respects ASIC is able to assist litigants without assuming primary enforcement responsibility. The first is through its capacity to communicate to actual or potential litigants information acquired through the exercise of its investigative powers (see [11.80]); further, ASIC may also intervene in any legal proceedings relating to a matter arising under the Corporations Act: CA s 1330. 60 As part of its enforcement strategy, ASIC may also accept an enforceable undertaking from a person or entity in connection with a matter in relation to which it has a function or power under the ASIC Act, including the corporations legislation: s 93AA(1). 61 Enforceable undertakings are an alternative to civil litigation or administrative action or referral to an external body such as the Takeovers Panel. ASIC’s policy is to use an enforceable undertaking only if it considers it will provide a more effective regulatory outcome than non-negotiated 55

For an instance of a Mareva injunction being granted pending determination of statutory proceedings for preservative orders, see Corporate Affairs Commission v Glauber Co Ltd (1985) 3 ACLC 492.

56

Neither power is exclusive to ASIC and may be invoked by an aggrieved person (s 1323) or one whose interests are affected by the contravention: s 1324. See, eg, Connell v National Companies and Securities Commission (1990) 8 ACLC 70.

57 58

ASIC v Burke [2000] NSWSC 694 at [6]; ASIC v Burnard (2007) 64 ACSR 360 at 365; ASIC v Carey (2006) 57 ACSR 307 at [26].

59 60

See T Johnson (2015) 33 C&SLJ 528 concerning problems of interpretation and constitutional validity. The broad criteria by reference to which ASIC decides whether to intervene are whether intervention is of strategic regulatory significance; whether the benefits of intervention outweigh the costs of doing so; whether issues specific to the case warrant intervention; and whether alternatives are available, including appearing as amicus curiae or taking action itself: ASIC INFO 180 (ASIC’s approach to involvement in private court proceedings).

61

See H Bird, G Gilligan and I Ramsay (2016) 34 C&SLJ 493; M Nehme (2008) 26 C&SLJ 147; M Nehme (2005) 18 Aust Jnl of Corp Law 68.

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[11.120]

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administrative or civil sanctions. 62 Enforceable undertakings have the potential advantage for the regulator of achieving an outcome fashioned to address its perceived concerns, eg, by a corporation adopting an internal compliance or training regime or correcting previous false or misleading disclosures; their utility depends on whether they provide a cost-effective alternative to litigation, producing a swift result that compensates persons who have suffered loss or damage as a result of the contravention or alleged contravention of the law. 63 ASIC will not accept an enforceable undertaking that is given in confidence; its subject and terms are accessible on the enforceable undertaking register that ASIC maintains and makes available to the public. 64 The undertaking may only be withdrawn or varied with ASIC’s consent: s 93AA(2). If ASIC considers that the undertaking has been breached it may apply to the Court for an order: s 93AA(3). If the Court is satisfied that an undertaking has been breached, it may make an order directing compliance with the undertaking, payment to the Commonwealth of any financial benefit that the promisor has derived from the breach or of compensation for loss suffered by any person from the breach, or any other order that the Court considers appropriate: s 93AA(4). 65

CONTINUOUS DISCLOSURE Background to current regulation [11.125] Stock exchange listing rules require timely disclosure by listed corporations of major

new developments or changes in its financial condition, performance or outlook which are not publicly available and which would be likely to affect its stock price if disclosed to the market. This disclosure obligation complements the periodic disclosure obligations with respect to financial reporting, the transaction specific disclosure under fundraising regulation and the “disclose or abstain” regime for insider trading. In the early 1990s ASIC expressed the view that the stock exchange’s enforcement of its continuous disclosure rules was uneven and that flagrant breaches of the rule had led to an inadequately informed market. In 1991 the statutory advisory committee recommended the strengthening of corporate disclosure by the creation of a new class of disclosing entity which would be required to lodge half-yearly financial reports in addition to annual reporting obligations: see [9.120]. The option of mandatory quarterly reporting by public issuers was rejected in favour of statutory backing for stock exchange listing rules requiring disclosing 62

ASIC Regulatory Guide 100.18 (Enforceable undertakings)

63

ASIC Regulatory Guide 100.19 (Enforceable undertakings).

64

ASIC Regulatory Guide 100.43-100.46 (Enforceable undertakings). However, certain information will be withheld from public inspection if the promisor seeks it and ASIC is satisfied that it is commercial in confidence, that the information consists of personal details of an individual or that its release would be against the public interest (RG 100.44).

65

The Senate Economics References Committee Report Performance of the Australian Securities and Investments Commission (2014) was critical of ASIC’s enforcement record and particularly its reliance upon enforceable undertakings. The Committee recommended that, when considering whether to accept an enforceable undertaking, ASIC require stronger terms, particularly regarding the remedial action that should be taken to ensure that compliance with these terms can be enforced in court; require a clearer acknowledgment in the undertaking of what the misconduct was; as its default position, require that an independent expert be appointed to supervise the implementation of the terms of the undertaking; and consider ways to make the monitoring of ongoing compliance with the undertaking more transparent with a view to enforcing compliance by court action if necessary (Recommendations 24 and 25). In the Government’s response to the report, it noted that ASIC has committed to greater transparency in public reporting on the outcomes of enforceable undertakings and these processes are currently being designed (October 2014). In 2016 the Australian Government appointed an ASIC Enforcement Review Taskforce to examine the adequacy of ASIC’s enforcement regime to deter misconduct and foster consumer confidence in the financial system. [11.125]

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entities to disclose any material information immediately to the market. 66 In response, the predecessor to Ch 6CA was introduced into the Corporations Act in 1994; it also provided a parallel disclosure obligation and procedure for unlisted disclosing entities. Its effect is to create a legal structure of a shared regulatory role with respect to listed companies under which ASX specifies continuing disclosure requirements and monitors compliance with them and ASIC takes enforcement responsibility with respect to breaches. For unlisted disclosing entities, the Corporations Act specifies the disclosure obligations and ASIC has responsibility for monitoring compliance with and enforcement of those statutory obligations. However, concerns continued to be expressed as to the adequacy of sanctioning and ASIC’s enforcement powers, and the need to create an improved culture of compliance and equal access by investors to price sensitive information. 67 In 2002 the continuous disclosure provisions were included among the new group of civil penalty provisions, the financial services civil penalty provisions: see [7.60]. In 2004 the continuous disclosure regime in Ch 6CA was further strengthened in three respects: • by the general increase in the maximum pecuniary penalty a court may impose following a declaration of contravention of a financial services civil penalty provision; • by allowing ASIC to seek civil penalties against individuals involved in contraventions such as directors, managers and, potentially, professional advisers (see [11.150]); and • by giving ASIC power to issue an infringement notice for alleged contraventions of the continuous disclosure provisions: see [11.160]-[11.165]. Continuous disclosure obligations

The core obligations in outline [11.130] The statutory continuous disclosure obligation applies only to disclosing entities. An

entity is a disclosing entity if it has issued “ED securities”, the term signifying an enhanced disclosure obligation upon their issuer. At the core of this group are the securities of a listed entity that have been granted quotation upon a prescribed financial market such as that operated by ASX: ss 111AD, 111AE(1), (1A). However, the definition of ED securities also 66

67

856

Companies and Securities Advisory Committee, Report of an Enhanced Statutory Disclosure System (1991), pp 9-10; see further on the committee’s proposals M Blair (1992) 2 Aust Jnl of Corp Law 177 and (1992) 15(1) UNSWLJ 54; see also Australian Securities Commission, Enhanced Statutory Disclosure System: A Response to the Companies and Securities Advisory Committee Report (1992), p 8. Statutory supplementation reflects the stock exchange’s limited remedies with respect to enforcement of its listing rules under ss 793C and 1101B: see [11.65]. Quarterly reporting is the model adopted in the United States, coupled with a limited form of continuous disclosure that does not have statutory backing: see A Cassidy & L Chapple (2003) 15 Aust Jnl of Corp Law 81. Quarterly financial reporting has been criticised for its effect of focusing investor attention upon short term financial performance. Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill 2003, Explanatory Memorandum, [4.218], [4.219]; some of the incidents that prompted these concerns are canvassed in G Golding & N Kalfus (2004) 22 C&SLJ 385 at 408-412; on the development of Australian regulation of continuous disclosure and ASIC’s role, see M Bloch, J Weatherhead & J Webster (2011) 29 C&SLJ 253; G North (2010) 28 C&SLJ 331 (arguing that regulators need to place greater emphasis on compliance with, and enforcement of, the periodic and continuous disclosure obligations); M Welsh (2009) 23 Aust Jnl of Corp Law 206 (testing correspondence between regulatory enforcement of and compliance withcontinuous disclosure obligations); G North (2011) 29 C&SLJ 394 (examining “empirical uncertainties” in continuous disclosure regulation); G North, Company Disclosure in Australia (Lawbook Co, 2013), ch 8; D McFarlane (2015) 33 C&SLJ 7 (the materiality threshold to continuous disclosure); S Lombard and J Viven (2014) 32 C&SLJ 419 (interaction between continuous disclosure obligations under corporate law and contract law’s obligations of disclosure under good faith doctrines); G North (2013) 28 Aust Jnl of Corp Law 233 (critical appraisal of ASX Guidance Note 8 to ASX Listing Rule 3.1); N Bentley (2016) 34 C&SLJ 567 (appraising the mixture of public and private enforcement of the continuous disclosure law). [11.130]

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includes other securities in which there is a wider investment interest arising from the circumstances of their issue and extent of their distribution. 68 A disclosing entity is a listed disclosing entity if all or any ED securities of the entity are quoted ED securities; other disclosing entities are unlisted disclosing entities: s 111AL. The statutory disclosure obligation applies to a listed disclosing entity if the listing rules require it to notify the market operator of information about specified events or matters as they arise for the purpose of the operator making that information available to participants in the market: s 674(1). Such a rule is contained in ASX listing rule (LR) 3.1 which provides: Once an entity is or becomes aware of any information concerning it that a reasonable person would expect to have a material effect on the price or value of the entity’s securities, the entity must immediately tell ASX that information. 69

The obligation upon the listed entity under the listing rule to notify the stock exchange is reinforced by a statutory obligation upon the entity to make that disclosure where two conditions are satisfied with respect to the information: • the information is not generally available; and • it is information that a reasonable person would expect, if it were generally available, to have a material effect on the price or value of the entity’s ED securities: s 674(2). These conditions are discussed at [11.135] and [11.140]. ASX provides the following examples of information that would require disclosure by a listed company under LR 3.1: • a transaction that will lead to a significant change in the nature or scale of the company’s activities; • a material mineral or hydro-carbon discovery; • a material acquisition or disposal; • the granting or withdrawal of a material licence; • the entry into, variation or termination of a material agreement; • becoming a plaintiff or defendant in a material law suit; • the fact that the company’s earnings will be materially different from market expectations; • the appointment of a liquidator, administrator or receiver; • the commission of an event of default under, or other event entitling a financier to terminate, a material financing facility; • under subscriptions or over subscriptions to an issue of securities; • giving or receiving a notice of intention to make a takeover; and 68

Thus, the term “ED securities” includes, in addition to quoted securities, securities continuously held by at least 100 persons the circumstances of whose issue were such as to require a higher level of investor protection through lodgment of a disclosure document (ss 111AF, 111AFA), securities issued as consideration for an acquisition under a takeover bid or Pt 5.1 scheme of arrangement and continuously held by at least 100 persons (s 111AG) and debentures issued in circumstances that required the borrowing corporation to appoint a trustee: s 111AI.

69

For the purposes of LR 3.1, a company becomes aware of information if, and as soon as, an officer of the entity has, or ought reasonably to have, come into possession of the information in the course of the performance of their duties: LR 19.12 (definition of “aware”); ASX Guidance Note 8, Continuous Disclosure: Listing Rules 3.1-3.1B, [4.1]. The officer’s acquisition of such information may not only trigger an obligation on the part of their company to disclose the information to ASX but the individual will also be under a personal obligation not to trade in securities whose value would be affected by such information: see [11.240]. [11.130]

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• any rating applied by a rating agency to the company or its securities and any change to such a rating. 70 For unlisted disclosing entities, the Corporations Act itself supplies the primary continuous disclosure obligation which requires it, as soon as practicable, to lodge a document with ASIC containing the information: s 675(1)(b). 71 This obligation arises in the same circumstances as those that, apart from the listing rule, trigger the disclosure obligation of listed disclosing entities, that is, where the entity becomes aware of information that is not generally available and which a reasonable person would expect, if it were generally available, to have a material effect on the price or value of the entity’s ED securities: s 675(2). 72 Under memoranda of understanding between ASIC and the market operators, ASX and Chi-X, ASIC will notify the exchanges of suspected breaches of the listing rules relating to continuous disclosure for review by the exchanges and discussion with the listed entity. This reflects the regulatory division of function under which the exchanges have primary responsibility for monitoring and enforcing compliance with the disclosure requirements of their listing rules and ASIC has responsibility for enforcing the statutory disclosure obligation in s 674. Where an exchange suspects a significant contravention of its operating rules (including its listing rules) or the Act, it must refer the matter to ASIC as soon as practicable for further investigation and possible civil enforcement or criminal prosecution: s 792B(2)(c).

When information is generally available [11.135] Disclosure of information is not required if the information is “generally available”.

For the purposes of s 674, information is defined as generally available where it (a) consists of readily observable matter (s 676(2)(a)); (b)

has been made known in a manner which would, or would be likely to, bring it to the attention of persons who commonly invest in securities of a kind whose price or value might be affected by the information and, since it was made known, a reasonable period of time for it to be disseminated among such people has elapsed (s 676(2)(b)); or

(c)

consists of deductions, conclusions or inferences drawn from the readily observable matter (s 676(2)(a)) or from information made known in the manner described in s 676(2)(b) whether or not the reasonable dissemination time has passed in relation to the latter information: s 676(3). In Grant-Taylor v Babcock & Brown Ltd the Full Federal Court held that the first limb of the test in s 676(2)(b) does not involve a consideration of whether the market has had a reasonable time to absorb the information. It noted that the term “readily observable matter” in relation to insider trading was not defined in the Act but pointed to extrinsic material relating to analogous provisions proscribing insider trading which explained the expression as “facts directly observable in the public arena”: Whether information is “readily observable matter” is a question of fact to be determined objectively and hypothetically. It does not matter how many people actually observe the relevant information; information may be readily observable even if no one has observed it. … 70

ASX Listing Rule 3.1 (Notes).

71

The obligation applies also to a listed disclosing entity which is listed on a financial market whose listing rules do not contain a counterpart to ASX LR 3.1: s 675(1)(a). Exceptions apply for information required to be included in a supplementary or replacement disclosure document in relation to the entity: s 675(2)(c) and [10.155]. ASIC Regulatory Guide 198: (Unlisted disclosing entities: Continuous disclosure obligations) promotes and regulates the use of corporate websites as vehicles for communication with investors, the site where investors would expect to find important information relating to investment decisions.

72

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The test of whether material is readily observable is not whether the particular matter was actually observed but whether it could have been observed readily, meaning easily or without difficulty. 73

The definition in s 676 is in identical terms to that applying in relation to insider trading (s 1042C): see [11.240]; the meaning of “readily observable matter” is discussed in R v Firns [11.255]. In Grant-Taylor v Babcock & Brown Ltd the Full Court did not consider whether the expression “generally available” carries the same meaning as in the insider trading context. It is possible that differences in the underlying policy mix between continuous disclosure law and insider trading regulation may indicate that identical interpretations need not apply in the two contexts. The obligation not to trade with inside information does not depend upon its possessor having any connection to the corporation for whose securities that information is price sensitive: the “insider” might be a stranger who simply overheard a conversation in a lift, for example: see [11.240]. Further, in deciding whether information is generally available in the insider trading context, considerations favouring fairness or equality of access contend with those that encourage individual resourcefulness through quick deduction as to likely price impact of information. However, in the continuous disclosure context, the information triggering the disclosure obligation will, of its nature, usually derive from the company and its officers although it need not be limited to information generated by or sourced from within the company. 74 Additionally, the policy favouring prompt public disclosure of price sensitive information is offset by a quite different concern that premature disclosure of incomplete or indefinite matters may mislead. These differences might well lead in some instances to a more restrictive interpretation of “generally available information” in the continuous disclosure context where it rests on deductions or inferences from information in respect of which a reasonable time for its market dissemination has not passed, and even perhaps where it depends upon whether some information is properly described as a readily observable matter. A court may be less inclined to treat such information as being generally available.

Material effect on price or value [11.140] For the purposes of ss 674 and 675, a reasonable person is taken to expect information to have a material effect on the price or value of ED securities if the information would, or would be likely to, influence persons who commonly invest in securities in deciding whether to acquire or dispose of the ED securities: s 677. In Grant-Taylor v Babcock & Brown Ltd the Full Federal Court considered that “a purposive approach might suggest giving a broader reading of s 677, given its protective purpose, and a narrower reading to s 676 which in a sense is part of an ‘exclusion’ (using that term informally)”. 75 A like definition to s 677 applies in the insider trading provisions although there, unlike here, the definition is expressed to apply “if (and only if)”: s 1042(D); see [11.240]. For purposes of insider trading regulation, the term “information” is defined to include matters of supposition and other matters that are insufficiently definite to warrant being made known to the public and matters relating to the intentions, or likely intentions, of a person: s 1042A. The term “information” is not defined in Ch 6CA and its underlying policy may not require so broad an interpretation in particular contexts. In most instances, the question of materiality for the purposes of the statutory disclosure obligations under ss 674 and 675 will be assisted, indeed, supplanted, by the deeming provision in s 677 which does not 73

(2016) 113 ACSR 362 at [119].

74

ASX Guidance Note 8, Continuous Disclosure: Listing Rules 3.1-3.1B, [4.1]. Another nexus is that the information need “concern” the company.

75

(2016) 113 ACSR 362 at [112]. [11.140]

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require that the information should have a “material” effect on the share price. Rather, the effect of the section [is] to obviate the need to address the question of whether a reasonable person would be taken to expect a “material” effect on price to be produced by deeming that question to be answered in the affirmative if the information would, or would be likely to, influence persons who commonly invest in the relevant securities in deciding whether or not to subscribe for, or buy or sell those securities. 76

Although theoretically feasible, it is difficult to envisage instances where information might require disclosure for purposes of the materiality standard in s 674 despite not being likely to influence investors within the s 677 standard. 77 Although s 677 is not in terms expressed to apply for the purposes of the listing rules such as ASX LR 3.1 (as distinct from the statutory disclosure obligation in s 674), ASX treats it as applicable to the listing rule also in determining what needs to be disclosed as “market sensitive information”, its shorthand term for disclosure under LR 3.1. 78 But at the same time, ASX considers that the word “influence” carries its own connotation of materiality: In ASX’s view, to trigger section 677, the information in question must be of a character that would, or would be likely to, influence persons who commonly invest in securities to make a decision to acquire or dispose of an entity’s securities and not merely play some minor and immaterial role in such a decision. 79

ASX interprets the reference to persons who commonly “invest in” securities as a reference to persons who commonly buy and hold securities for a period of time, based on their view of the inherent value of the security. In ASX’s view, it therefore does not include traders who seek to take advantage of very short term (usually intraday) price fluctuations and who trade into and out of securities without reference to their inherent value and without any intention to hold them for any meaningful period of time. 80

In Grant-Taylor v Babcock & Brown Ltd the Full Federal Court considered that “it is apparent that in s 677 the expression ‘commonly invest in securities’ is broader than the expression ‘commonly invest in securities of a kind …’. So, for s 677 the class is not confined to listed securities. Moreover, it is not confined to the type of security or company involved, whether as to size or sector. Contrastingly, s 676 is narrower and looks at the type of securities in question”. 81 In that case, the primary judge construed the expression in s 677 to mean “persons who ordinarily or usually invest in listed securities [excluding] self-funded retirees who, from time to time, (perhaps between games of bingo) play the stockmarket”. However, a wider conception of the phrase was adopted by the Full Federal Court: The phrase “commonly invest in securities” in s 677 is not limited to shares in the type of company in question. Both the text and context of s 677, including the contrast with the language in s 676, point against that construction. … But we depart from the primary judge’s approach in two other respects. First, his Honour confined the phrase in s 677 to listed securities. But in our view, the text does not provide that limitation and nor does the context require it. Second, his Honour confined the phrase to those who “ordinarily or usually” invest in listed securities. But in our view, if the phrase is looking at the matter from a class perspective (as we think it does), it would embrace both the frequent 76 77

Jubilee Mines NL v Riley (2009) 226 FLR 201 at [34]. Jubilee Mines NL v Riley (2009) 226 FLR 201 at [59].

78 79 80

ASX Guidance Note 8, Continuous Disclosure: Listing Rules 3.1-3.1B, [4.2]. ASX Guidance Note 8, Continuous Disclosure: Listing Rules 3.1-3.1B, [4.2], fn 20. ASX Guidance Note 8, Continuous Disclosure: Listing Rules 3.1-3.1B, [4.2].

81

(2016) 113 ACSR 362 at [110].

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investor and the infrequent investor such as a self-funded retiree. Moreover, the class would embrace both the sophisticated investor and the unsophisticated investor including those who may have an occasional interest in investing. 82

The materiality (or influence) standard poses inherent difficulties because it requires listed companies to predict how investors will react to particular information when disclosed. This exercise is both hypothetical and predictive. 83 These difficulties are often compounded by the need for quick decision with respect to disclosure. Difficulties especially arise where facts evolve over time so that it is uncertain when the maturity of corporate plans, the contingencies to which they are subject, the likelihood of loss, or the effect of related developments become sufficiently certain to require disclosure. Issues of materiality also arise with respect to less gradual developments. It is apparent that the boundary fixed by the materiality test is not drawn with quantitative precision. Thus, in Flavel v Roget, O’Loughlin J said: Much will depend upon the identity of the particular company; what one company should advise the Stock Exchange might not have to be advised by a second company; what should be advised by a company at one stage in its career might not have to be advised at another stage of its career because of changed circumstances. 84

ASX offers this guidance to company officers: (1) Would this information influence my decision to buy or sell securities in the entity at their current market price? (2) Would I feel exposed to an action for insider trading if I were to buy or sell securities in the entity at their current market price, knowing this information had not been disclosed to the market? 85

If the answer to either question is “yes”, ASX says that should be taken to be a cautionary indication that the information may well be market sensitive and, if it does not fall within the carve-outs from disclosure in LR 3.1A, may need to be disclosed to ASX under LR 3.1.

Listing Rule 3.1A – the exceptions to immediate disclosure [11.141] Express carve-outs from disclosure in the listing rules therefore assist. The terms of

the stock exchange listing rules are crucial since the statutory disclosure obligation in s 674 only applies where the listing rule requires disclosure to the exchange. ASX LR 3.1A excludes information from the disclosure obligation. Listing rule 3.1 does not apply to particular information while each of the following requirements is satisfied in relation to the information: 3.1A.1 One or more of the following applies: • It would be a breach of a law to disclose the information.

82

83 84 85

(2016) 113 ACSR 362 at [115], [130], [131]. Referring to the expression where used in s 676(2)(b), the Court added: “We are of the view that the expression ‘persons who commonly invest in securities’ is a class description. First, the plural ‘persons’ is used in contradistinction to the singular ‘a reasonable person’ in s 677. Secondly, to treat this as a class description avoids distinctions dealing with large or small, frequent or infrequent, sophisticated or unsophisticated individual investors. Such idiosyncratic distinctions are made irrelevant if one is looking at a class of investors. There is no reason to confine ‘likely to influence persons ...’ to the sophisticated. The unsophisticated also need protection. Likewise the small investor and likewise the infrequent investor. But not the irrational investor. Thirdly, in the context of s 676, the question is whether the information has been made known to the relevant class, albeit that the class may be narrower than for s 677. We accept that the phrase does not use the express language of ‘class’, but in using the plural ‘persons’, the legislature appears to be generalising to a group description”. In this respect it mirrors the inquiry under s 1041E as to whether a false or misleading statement is likely to induce share dealings: James Hardie Industries NV v ASIC [2010] NSWCA 332 at [242]; see [11.210]. Flavel v Roget (1990) 1 ACSR 595 at 602–603. ASX Guidance Note 8, Continuous Disclosure: Listing Rules 3.1-3.1B, [4.2]. [11.141]

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• The information concerns an incomplete proposal or negotiation. • The information comprises matters of supposition or is insufficiently definite to warrant disclosure. • The information is generated for the internal management purposes of the entity; or • The information is a trade secret; and 3.1A.2 The information is confidential and ASX has not formed the view that the information has ceased to be confidential; and 3.1A.3 A reasonable person would not expect the information to be disclosed.

The carve-outs operate only when each of the three requirements is satisfied; a helpful way of viewing the provision is that the five exceptions in LR 3.1A.1 are engaged only if the information in question is also confidential and a reasonable person would not expect it to be disclosed. 86 As regards LR 3.1A.3, ASX’s previous guidance note had stated that a reasonable person would not expect information to be disclosed if the result would be unreasonably prejudicial to the company; this was deliberately removed in 2013 on the basis that “it no longer reflects the expectations of regulators and the market”. 87 ASX considers LR 3.1A2 to have two distinct components: (1) the information must be confidential and (2) ASX must not have formed the view that the information has ceased to be confidential. ASX treats information as confidential for LR 3.1A.2 if it is “secret”, that is, if • it is known to only a limited number of people; • the people who know the information understand that it is to be treated in confidence and only to be used for permitted purposes; and • those people abide by that understanding. 88 Whether information has the quality of being confidential is a question of fact, not one of the intention or desire of the company. Accordingly, even though a company may consider information to be confidential and its disclosure to be a breach of confidence, if it is in fact disclosed by those who know it, then it is no longer secret and ceases to be confidential information for the purposes of this rule. 89 This applies even though the company has entered into confidentiality arrangements and/or the information has come from another source. If the secret is “out”, confidentiality is lost and disclosure needs be made if LR 3.1 requires it. If there is a sudden and significant movement in market price or traded volumes which can fairly be attributed to information about a particular matter ceasing to be confidential, ASX is likely to form the view that the information has ceased to be confidential in the absence of another credible explanation and require its disclosure. 90 86

87 88 89

The current form of LR 3.1A reverses the previous order of the exceptions to de-emphasise the “reasonable person” test, seeking to convey that this is a last order, not a first order, requirement for information to be immediately disclosed. ASX, Review of ASX Listing Rules Guidance Note 8: Continuous Disclosure: Listing Rules 3.1-3.1B (17 October 2012), [17]. ASX Guidance Note 8, Continuous Disclosure: Listing Rules 3.1-3.1B, [5.8]. ASX Guidance Note 8, Continuous Disclosure: Listing Rules 3.1-3.1B, [5.8]. It is ASX policy that, whatever the information, and however much it might otherwise have been reasonable not to disclose it, the information ceases to be confidential and should be released to the whole market once it becomes known to any part of the market. ASX considers that an entity may give information to third parties in the ordinary course of its business and continue to satisfy LR 3.1A.2 provided it retains control over the use and disclosure of the information. It would be likely to consider that information has ceased to be confidential if it becomes known either selectively or generally, inadvertently or deliberately, in circumstances where the entity does not retain control over its use and disclosure.

90

ASX Guidance Note 8, Continuous Disclosure: Listing Rules 3.1-3.1B, [5.8].

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There may be circumstances where the requirements of LR 3.1A appear to be satisfied, but ASX nonetheless considers there is or is likely to be a false market in the entity’s securities; in this case, it will ask the entity to give it information to correct or prevent a false market and the entity must do so: LR 3.1B. One particular application arises in respect of market rumours or speculation, especially when the market moves in a way that appears to be referable to the rumour or speculation; instances might relate to merger or takeover speculation or price movements unrelated to the company’s earnings announcements. 91 In these situations, ASX will ask the company for information or clarification to ensure that the market remains properly informed or to correct or prevent a false market in the company’s securities. 92 Another sensitive area concerns briefings with market analysts. ASX and ASIC recommend that companies have a procedure after briefings and discussions with analysts to review whether any price sensitive information has been inadvertently disclosed; if so, they should announce it immediately through the stock exchange and then post it on the company’s website. Slides and presentations used in briefings should be given to the stock exchange for immediate release to the market and be posted on the company website. 93 In answering analysts’ questions, ASIC recommends that companies only discuss information that has been publicly released through the stock exchange; if a question can be answered only by disclosing price sensitive information, the company should decline to answer or take it on notice and announce the information through the stock exchange before responding to the analyst. 94 The decisions in Jubilee Mines v Riley [11.142] and Forrest v ASIC [11.143] elaborate legal principles governing the continuous disclosure obligations, although Forrest was decided by reference to the misleading and deceptive conduct provisions in s 1041H: the Forrest decision valuably reminds us of the breadth of their reach to corporate disclosure. In addition to these decisions, reference should also be made to ASIC’s action against the James Hardie directors and executives for failing to disclose to the market the separation from the corporate group of the former Australian parent company, JHIL, and the gratuitous cancellation of partly-paid shares in the new parent JHI NV held by JHIL; the issue of these shares imposed a contingent liability of $1.96 billion on the new parent which might answer any claim against the parent for the asbestos liabilities of the former subsidiaries earlier transferred to a separate foundation: see [9.265] and [4.127], n 7. The NSW Court of Appeal upheld the trial judge’s findings of the materiality of this information for the purposes of s 674: The test under s 674 is an objective test, determined ex ante the relevant event which requires disclosure. That the party with the obligation to disclose might convince itself that information would not be expected to have a material effect on the price or value of its securities, does not answer the question whether the material was disclosable as required by s 674.

91

ASX may also form the view in these circumstances that the information has ceased to be confidential under LR 3.1A.

92

ASX Guidance Note 8, Continuous Disclosure: Listing Rules 3.1-3.1B, [6.4], [6.5]. Where an entity advises ASX that it needs time to prepare an announcement to the market, ASX usually suggests that the entity also request a trading halt in its securities.

93

ASX Guidance Note 8, Continuous Disclosure: Listing Rules 3.1-3.1B, Annexure C, quoting ASIC, Regulatory Guide 62 (Better disclosure for investors), [8]. ASX Guidance Note 8, Continuous Disclosure: Listing Rules 3.1-3.1B, Annexure C, quoting ASIC, Regulatory Guide 62 (Better disclosure for investors), [9]. In responding to analysts’ questions on financial projections and reports, ASIC says that companies should confine comments to errors in factual information and underlying assumptions and avoid any suggestion that the company’s, or the market’s, current projections are incorrect: “The way to manage earnings expectations is by using the continuous disclosure regime to establish a range within which earnings are likely to fall. Publicly announce any change in expectations before commenting to anyone outside the company” (Better disclosure for investors, [10]).

94

[11.141]

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Although JHINV considered that the prospect of JHIL becoming liable for asbestos claims was remote, there was a significant body of evidence that supported his Honour’s finding that JHINV’s connection with asbestos was having a negative effect on JHINV’s financial position in the market place. … Underscoring the concerns expressed in this material was the possibility that JHIL might be found liable for claims on the basis of the principles in Wren, that claims in the secondary market might be sheeted home to JHIL and that liability of some kind might be legislatively imposed. Senior counsel accepted that if there was a prospect of any of those risks coming home, JHINV could come under a financial obligation. That obligation was to pay up to $1.96 billion, should JHIL find itself in a position that required it to call on the partly paid shares. The effect of the transfer of JHIL out of the James Hardie Group was to completely dispose of that liability for no cost. Given JHINV’s acceptance that evidence was not required to demonstrate the significance of eliminating a contingent liability of that order, we do not consider anything more needs to be said on this. Accordingly, there is no basis to disturb his Honour’s finding as to the materiality of this aspect … and that breach of s 674 … had been established. 95

Jubilee Mines NL v Riley [11.142] Jubilee Mines NL v Riley (2009) 226 FLR 201 Court of Appeal, Supreme Court of Western Australia [Jubilee was a small listed gold exploration company that was seeking to transition to a gold producing company. That was to be achieved by the purchase of the Bellevue gold mine which would render a gold project on its tenements viable. In 1994 the appellant received information from a neighbouring tenement holder WMC about the results of drilling that WMC had mistakenly carried out on the appellant’s tenement known as McFarlanes Find. The results showed nickel sulphide dissemination at great depths. Crossley, the managing director, and Cooke, a geologist, who had the daily management of Jubilee at the time decided against further exploratory drilling on the grounds that Jubilee’s focus was on gold and its cash resources were limited. WMC’s drilling results were not communicated to the market then. In June 1996, following a change in board composition introducing personnel with experience and interest in nickel exploration, a cash injection from a new share issue and a further meeting with WMC, Jubilee decided to undertake exploratory drilling on McFarlanes Find. Jubilee announced the earlier WMC drilling results to the ASX and its intention to undertake further exploratory drilling on McFarlanes Find. Riley, a former shareholder in Jubilee, claimed compensation on the grounds that, had disclosure been made in 1994, he would have been influenced to retain his shares and sell later at a higher price. Jubilee appealed from the decision of a master of the Supreme Court of Western Australia to award damages to Riley. In the following extracts, references to ss 674(2) and 677 are substituted for their then contemporary counterpart provisions.] MARTIN CJ: [52] Perhaps surprisingly, neither the parties, nor the researches of the court have been able to identify any decisions dealing with [the counterpart to s 674]. … [54] It is therefore necessary to approach the proper construction and effect of the relevant legislative provisions essentially by reference to the natural and ordinary meaning of the language used, construed in light of the evident purpose of the legislation, with such limited assistance as the extrinsic materials to which I have referred can provide. … [59] [Concerning s 677] in practical terms, it is very difficult to envisage a circumstance in which a reasonable person would expect information to have a material effect on the price or value of securities if the information would not be likely to influence persons who commonly invest in those securities in deciding whether or not to subscribe for, or buy or sell them. The price of securities quoted on a stock exchange is essentially a function of the interplay of the forces of supply and demand. It is therefore difficult to see how a reasonable person could expect information to have a material effect on price, if it was not likely to influence either supply or demand. Rather, on the face of it, the scope of 95

James Hardie Industries NV v ASIC [2010] NSWCA 332 at [546]-[548].

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Jubilee Mines NL v Riley cont. information which would, or would be likely, to influence persons who commonly invest in securities in deciding whether or not to subscribe for, or buy or sell those securities is potentially wider than information which a reasonable person would expect to have a material effect on price or value, because there is no specific requirement of materiality in the former requirement. Grounds 2 and 3 [85] These grounds are conveniently considered together, as they involve essentially the same issue. Ground 2 alleges that if Jubilee had notified the ASX of the data received from WMC in September or October 1994, it would also have been obliged to notify the ASX that: (a)

in the opinion of its geologist, the intersected mineralisation, which was found in only one hole of six drilled, was too deep, too low a grade and too small to be of any interest; and

(b)

Jubilee had no current intention of carrying out any exploratory drilling on the tenement in the foreseeable future because of: (i) the view of its geologist and managing director as to the lack of significance in the drilling results; (ii)

its preoccupation with gold exploration; and

(iii)

its lack of funds.

[86] Ground 3 asserts that when regard is paid to the additional material which Jubilee would have disclosed together with the WMC drilling data, the information as a whole was not information which was likely to have influenced persons who commonly invest in securities in deciding whether or not to buy or sell shares in Jubilee … Preliminary observations [87] There are a number of preliminary observations appropriately made in relation to these grounds. The first is that the evident purpose of each of the listing rule and the relevant statutory provisions is to ensure an informed market in listed securities. Put another way, the legislative objective is to ensure that all participants in the market for listed securities have equal access to all information which is relevant to, or more accurately, likely to, influence decisions to buy or sell those securities. It would be entirely contrary to that evident purpose to construe either the listing rule or the statutory provisions as countenancing the disclosure of incomplete or misleading information. [88] The next relevant general observation is that the ultimate determination of the ambit of the information appropriately disclosed, on the proper construction of the listing rule and the statutory provisions, was essentially a determination for the master drawing upon the facts established by the evidence. If the proper conclusion from the facts established by the evidence is that disclosure of the information gained from WMC without disclosure of the surrounding circumstances would have been incomplete or misleading, it would be wrong to award damages on the basis that Jubilee had failed to comply with its obligations in that way. [89] The final general observation appropriately made is that the obligations imposed by the Listing Rules and the relevant statutory provisions are limited to the disclosure of information. The obligations do not extend to include, eg, making business decisions which might or even should be made as a result of the receipt of the information. At points in the argument advanced on behalf of Mr Riley, and in the master’s reasons, it seems to be supposed that if Jubilee should have attached greater significance to the drill hole data it received and should have immediately undertaken exploratory drilling (perhaps by raising funds to enable that to occur), it was somehow a breach of the continuous disclosure provisions for Jubilee not to announce and take that course. Plainly, the obligations of continuous disclosure do not go that far. [90 Jubilee can only have been obliged to disclose information which it had or ought to have had. The latter expression cannot be construed as extending to information arising from business decisions which Jubilee had not made – such as the decision to undertake exploratory drilling. Jubilee’s obligations of disclosure must be assessed having regard to the totality of relevant information. It follows that if, for whatever reason (including flawed reasons), Jubilee had no current intention of [11.142]

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Jubilee Mines NL v Riley cont. undertaking exploratory drilling on the tenement, and that intention was relevant to the assessment of the extent to which provision of the drill hole data provided by WMC would be likely to influence those who commonly invest in securities in deciding whether or not to buy or sell Jubilee’s shares, Jubilee’s obligations of disclosure must be assessed in that light. … [93] To the extent that it is possible to infer from the master’s reasons the view which he took in relation to the actual intention of Jubilee in 1994, it seems reasonable to infer that he concluded that Jubilee had no intention of undertaking exploratory drilling in the foreseeable future. That inference can be drawn from the numerous references in his reasons to Jubilee’s constrained financial position in 1994, and to its primary focus being upon gold exploration … [94] In short, the master found that neither Mr Cooke, nor Mr Crossley, appreciated the significance of the information provided by WMC. Mr Riley has not challenged that finding. However, it is a finding which leads inevitably to the conclusion that, as a matter of fact, Jubilee had no intention of undertaking exploratory drilling on the McFarlanes Find tenement in 1994. … [108] … Even when further funds were realised during 1995, no exploration work was undertaken on the McFarlanes Find tenement. No decision to undertake exploratory drilling on McFarlanes Find was made until June 1996, when further funds had been realised and there had been a change in board composition introducing personnel with experience and an interest in nickel exploration, and following a further meeting with WMC. [109] [The court concluded] that the master was assessing Jubilee’s disclosure obligations by reference to business decisions that he considers that the company might or should have made based on a proper appreciation of the information it had received. However, the undeniable fact is that the company did not make such a business decision and its obligation of disclosure fell to be assessed by reference to its actual intentions, not its supposed intentions. … [122] The master took the view that the issue posed by s 677 … was to be addressed by reference to those who commonly invest in securities of the kind in question – that is, the shares of junior mining explorers. He concluded that those persons were traders looking to derive profit from an increase in the share price, rather than longterm investors seeking dividend terms. Neither party has challenged that aspect of the master’s decision in this appeal. [123] Looking at this issue from the perspective of such a trader, as the master found, the relevance of the WMC drill hole information lay in its revelation of the prospectivity of the tenement. Following the announcement of such data, the prospect of gain for such a trader would lie in the possibility that further exploratory work would prove up the preliminary data, resulting in an increase in the price of the shares, which could then be sold at a profit. On that hypothetical scenario, if the announcement of the drill hole data was accompanied by a statement to the effect that the company had no current intention of undertaking exploratory work, and lacked the financial capacity or the inclination to do so, the hypothetical scenario of gain would appear, to such a trader, to be most unlikely or improbable, at least in the foreseeable future. Accordingly, doing the best one can to stand in the shoes of the hypothetical investor nominated by s 677, and taking into account the evidence of [expert witnesses and Riley himself], I conclude that an announcement by Jubilee of all relevant information pertaining to the WMC drill hole data would not, or would not have been likely to, influence persons who commonly invest in securities in deciding whether or not to buy or sell its shares. It follows that s 677 did not operate to require Jubilee to disclose any information relating to the data provided by WMC until June 1996, when it made such disclosure. [124] As I have observed above (at [58]), s 677 is not, theoretically at least, the only means by which it can be concluded that a reasonable person would expect the information, if made available, to have a material effect on the price or value of Jubilee’s shares. However, in the circumstances of the present case, once it is concluded that disclosure of all relevant information would not have influenced persons who commonly invest in securities in deciding whether to buy Jubilee’s shares, it is impossible to see any other basis upon which it could be concluded that a reasonable person would expect disclosure of that information to have a material effect on the price of Jubilee’s shares.

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Jubilee Mines NL v Riley cont. [125] It follows that ground 3 should be upheld. The master should have concluded that, when all relevant information was taken into account, Jubilee was under no obligation to make disclosure following receipt of the information from WMC, at least and until it altered its position and decided to undertake exploratory drilling work, at which time disclosure was in fact made. [Le Miere AJA agreed with the Chief Justice. McLure JA also allowed the appeal in a separate judgment.]

Forrest v ASIC [11.143] Forrest v ASIC [2012] HCA 39 High Court of Australia [Fortescue entered into agreements with three Chinese state-owned entities to build, finance and transfer the railway, port and mine components of its proposed Pilbara Iron Ore and Infrastructure Project in Western Australia. Each of the agreements was headed “Framework Agreement” and was four pages long. Each agreement recorded that it was to become binding upon approval by the parties’ respective boards and that the parties were jointly to agree and develop further general conditions of contract at a later date. The parties’ boards approved the agreements. Fortescue and Forrest, as its chairman and chief executive, then made public statements that Fortescue had entered into a “binding contract” with each of the Chinese entities to build, finance and transfer the relevant construction works. ASIC commenced proceedings alleging that, because the agreements would not be enforceable under Australian law, Fortescue had engaged in misleading and deceptive conduct within s 1041H when claiming that the agreements were “binding” and that Fortescue and Forrest had contravened s 674 by not correcting the false or misleading information. It also alleged that Forrest had failed to discharge his duties as director of Fortescue with the degree of care and diligence required by s 180(1). ASIC’s claims were dismissed at trial in the Federal Court. The Full Court, however, allowed ASIC’s appeal. The Full Court concluded that, because the agreements would not be enforceable under Australian law, it was misleading to describe them as “binding”. Special leave was granted to appeal to the High Court.] FRENCH CJ, GUMMOW, HAYNE AND KIEFEL JJ: [24] As explained in this Court, ASIC’s case was that the impugned statements conveyed facts which ASIC said were not true. If that was ASIC’s case, the reference to Fortescue’s state of knowledge was unnecessary and inappropriate. The allegation served only to distract attention from two questions critical to ASIC’s misleading or deceptive conduct case: first, what ASIC alleged that the impugned statements conveyed to their intended audience; and second, whether what was conveyed was misleading or deceptive or likely to mislead or deceive. [31] These reasons now turn to the determinative issue in the appeal: what did the impugned statements convey to their intended audience when they said that the parties to each framework agreement had made a “binding contract”? A “binding contract” [32] Three possibilities must be considered: first, that the statements conveyed a message about what the agreements said; second, that they conveyed some message about “legal enforceability”; and third, that they conveyed a message which was a mixture of elements drawn from the first two possible constructions of what was said. It is the first possibility that is decisive of these appeals: the statements conveyed to their intended audience what the parties to the framework agreements had done and said they had done. [33] As has already been noted, ASIC’s argument in this Court hinged on the proposition that the impugned statements conveyed to their intended audience a view about the legal enforceability of the framework agreements. ASIC sought to describe what was conveyed as a matter of fact, submitting that “the words ‘agreement’ or ‘binding agreement’ convey that it is an agreement containing all of the essential elements that would constitute a contract under Australian law”.While it is to be doubted [11.143]

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Forrest v ASIC cont. that the proposition which ASIC identified is accurately, or at least sufficiently, described as a statement of “fact”, it is ultimately unprofitable to attempt to classify the statement according to some taxonomy, no matter whether that taxonomy adopts as its relevant classes fact and opinion, fact and law, or some mixture of these classes. It is necessary instead to examine more closely and identify more precisely what it is that the impugned statements conveyed to their audience. [34] It is convenient to begin that examination by noticing how the Full Court dealt with the issue. The Full Court concluded, first, that the impugned statements “would have been understood as conveying the historical fact that agreements containing terms accurately summarised in the announcements had been made between the parties”. Second, regardless of the subjective intentions of the parties, the question of whether the parties had made contracts of the kinds described was to be determined by taking an objective view of the agreements. Third, objectively assessed, the agreements would be held by an Australian court to be incomplete, because they did not provide for the subject matter, scheduling and price of the work to be done or any mechanism for determining those matters. And fourth, because the Full Court concluded that the agreements were incomplete in these respects, it was misleading or deceptive, or likely to mislead or deceive, to describe them each as a “binding contract”. [35] The critical step taken by the Full Court was from the first to the second. The Full Court did not conclude that the impugned statements had not accurately summarised what the framework agreements said. Rather, the Full Court moved from the identification of what the impugned statements conveyed about what had been said and done by the parties (properly described as matters of “historical fact”) to an examination of the legal consequences that were to be attached to what those parties had said and done. The Full Court took this step on the basis that the examination of that question was necessary in order to decide whether what was said and done amounted to the making of “contracts”. That is, the Full Court treated the references in the impugned statements to the parties having made a “binding contract” as conveying more than the message that the parties had made an agreement which they described as a “binding contract”. Importantly, the Full Court treated the references to “binding contract” as conveying more than the message that the parties had made an agreement which the commercial community (or some relevant section or sections of it, such as “investors”) would describe in the terms Fortescue had used in its statements. And critically, the Full Court assumed that the impugned statements conveyed the message to the intended audience that the parties had made what an Australian court would decide to be a “binding contract”.That is, the Full Court found, in effect, that it would be (and in this case was) misleading or deceptive or likely to mislead or deceive to say that the parties to the framework agreements had made “binding contracts” unless the parties had made bargains that could be and would be enforced by action in an Australian court. [36] There are at least two difficulties in the Full Court’s analysis. Both stem, ultimately, from the need to identify the intended audience for the impugned statements and the message or messages conveyed to that audience. The intended audience can be sufficiently identified as investors (both present and possible future investors) and, perhaps, as some wider section of the commercial or business community. It is not necessary to identify the audience more precisely. When that audience was told that Fortescue had made binding contracts with identified Chinese state-owned entities, what would they have understood? [37] Would they, as the Full Court assumed, ask a lawyer’s question and look not only to what the parties had said and done but also to what could or would happen in a court if the parties to the agreement fell out at some future time? Or would they take what was said as a statement of what the parties to the agreements understood that they had done and intended would happen in the future? The latter understanding is to be preferred. [38] The Full Court’s conclusion hinged on the use of the word “contract” or “agreement” in each of the impugned statements. The Full Court assumed that, by using one or other of those terms, the impugned statements conveyed to their intended audience a message about the legal quality (as determined by reference to Australian law) of the contract or agreement referred to in the relevant communication. And the relevant legal quality was identified as future enforceability in the event of a 868

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Forrest v ASIC cont. dispute between the parties. That is, the Full Court assumed that the words “contract” and “agreement” necessarily conveyed a message about legal enforceability in an Australian court. But that is too broad a proposition. First, it is necessary to examine the whole of the impugned statements to see the context in which reference was made to the making of a contract or agreement. Second, it is necessary to undertake that task without assuming that what is said must be put either into a box marked “fact” (identified according to whether an Australian court would enforce the agreement) or into a box marked “opinion” (identified according to whether the speaker thought that Australian court could or would enforce the agreement). [39] There was no evidence led at trial to show that investors or other members of the business or commercial community (whether in Australia or elsewhere) would have understood the references in the impugned statements to a “binding contract” as conveying not only that the parties had agreed upon what they said was a bargain intended to be binding, but also that a court (whether in Australia or elsewhere) would grant relief of some kind or another to one of the parties if, in the future, the opposite party would not carry out its part of the bargain. [40] The very words of the impugned statements made two points abundantly clear. First, there can be no doubt that the impugned statements conveyed to their intended audience that the parties had made agreements. Second, there can be no doubt that the impugned statements conveyed what the parties to the framework agreements had said in those agreements. And the provisions of the framework agreements showed (and ASIC expressly accepted at trial) that the parties intended their agreements to be legally binding. [41] In argument in this Court, ASIC disclaimed any special reliance upon the use of the word “binding” as a description of the agreements that had been made. Consistent with the reasoning of the Full Court, the weight of ASIC’s argument in this Court was placed on the proposition that “the words ‘agreement’ or ‘binding agreement’ convey that it is an agreement containing all of the essential elements that would constitute a contract under Australian law” (emphasis added). That is, ASIC submitted that, despite the parties’ stated intention to make a legally binding contract, it was misleading or deceptive or likely to mislead or deceive to announce to investors, or some wider business or commercial audience, that the parties had made a contract (or binding contract) unless the agreement they had made would withstand legal challenge in an Australian court. [42] The validity of that proposition must be determined assuming that the parties stated intention of making a legally binding agreement was genuinely shared by them. ASIC did not establish its allegation that Fortescue did not believe that the framework agreements were binding. That allegation was rejected at trial and the trial judge’s findings on that issue were not set aside on appeal to the Full Court. [43] Once it is accepted, as it must be, that the parties genuinely intended to make a legally binding agreement, the breadth of ASIC’s submission (and the Full Court’s conclusion) becomes apparent. For the submission was that, although the impugned statements accurately recorded that the parties to each framework agreement had made an agreement which said that the bargain was, and was intended by the parties to be, legally binding, the impugned statements were misleading or deceptive or likely to mislead or deceive because they also conveyed to their intended audience a larger message. This was that the agreements the parties had made were not open to legal challenge in an Australian court. That broader proposition should not be accepted. The impugned statements conveyed to their intended audience what the parties to the framework agreements had done and said they had done. No further message was shown to have been conveyed 96 to an “ordinary or reasonable” member of that audience. [44] There is a second and no less fundamental difficulty in adopting the Full Court’s analysis. The Full Court’s conclusion that the agreements were incomplete and for that reason unenforceable, and ASIC’s argument in this Court in support of that conclusion, assumed that the legal character or effect of the framework agreements was to be determined by Australian domestic law. That assumption was not justified. 96

Campomar Sociedad, Limitada v Nike International Ltd (2000) 202 CLR 45 at 86-87 [105]. [11.143]

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Forrest v ASIC cont. [45] The intended audience for the impugned statements would have recognised from the very content of the statements that the agreements to which they referred had important international features. Although it may readily be assumed that many, perhaps most, in that audience had some immediate association with Australia or the Australian share market, it by no means follows that such an audience would have understood the impugned statements as inviting any attention to what the courts of Australia could or would do if a party to one of the agreements did not perform its part of the bargain. [46] The framework agreements related to infrastructure that would be constructed in Australia for use by one or more Australian companies. But as the impugned statements made plain, the work referred to in the framework agreements was to be done by companies that were state-owned entities of a foreign government – the People’s Republic of China, and indeed, the agreements were executed at signing ceremonies held in Beijing. No consideration was given, at any point of the Full Court’s analysis, to the significance, if any, of the fact that the counterparty to Fortescue in each agreement was a foreign state-owned entity. More significantly, the agreements contained neither a choice of law nor a choice of forum clause. The only provision in the agreements relating to the question of applicable law provided that the relevant agreement “will conform with all relevant Australian and Chinese laws and regulations” and that “[a]ny difference that may exist will be negotiated in good faith and will not impact the effectiveness of the other clauses”.Yet no consideration was given, at any point of the Full Court’s analysis, to what law governed the agreements. [47] Both the place of the signing ceremonies and the status of Fortescue’s counterparties as state-owned entities point to the real and lively possibility that the formal and essential validity of the agreements might be governed by the law of the People’s Republic of China, not Australia. It would have been neither extreme nor fanciful for those who read or heard the impugned statements either to consider the possibility or even to assume that the law of the People’s Republic of China governed the agreements. And regardless of whether questions about the validity of the framework agreements were governed by the law of Australia, there was an immediate question of the manner and extent of enforceability presented by the fact that Fortescue’s counterparties were state-owned enterprises. In Australia that question would be governed by the Foreign States Immunities Act 1985 (Cth), but no attempt was made by any party to explore whether there may have been some relevant and applicable Chinese law. [48] It is, however, necessary to bear firmly in mind that the impugned statements were made to the business and commercial community. What would that audience make of the statement that Fortescue had made a binding contract with an entity owned and controlled by the People’s Republic of China? [49] It is surely relevant to ask whether the public expression of acceptance by such a state-owned entity of what were described as “binding” obligations may not have been a much more powerful spur to performance of its obligations than any possible legal action instituted by Fortescue. Again, for that audience to form such an understanding would be far from “extreme or fanciful” 97. But these issues were not explored, because the Full Court and ASIC incorrectly assumed, rather than demonstrated, that an inquiry into the “effect” of the agreements required an inquiry into their legal effect under Australian law. [50] Instead, the central tenet of ASIC’s case was that the impugned statements conveyed a message to their intended audience (a) that, in the words of ASIC’s statement of claim, it was “practicable to force” the counterparties to perform their part of the bargain and (b) that whether it was “practicable to force” performance was to be determined according to the same principles as would be applied to an agreement for the sale of a suburban block of land or the construction of a house in suburban Australia. ASIC established neither of those propositions. The impugned statements conveyed to their intended audience what the parties to the framework agreements said they had done – make agreements that they said were binding – and no more. ASIC did not demonstrate that members of the intended audience for the impugned statements would have taken what was said as directed in 97

Campomar Sociedad, Limitada v Nike International Ltd (2000) 202 CLR 45 at 86-87 [105].

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Forrest v ASIC cont. any way to what the parties to the agreements could do if the parties were later to disagree about performance. ASIC did not demonstrate that the impugned statements conveyed to that audience that such a disagreement could and would be determined by Australian law. And given that the impugned statements did accurately convey what the parties to the framework agreements had said in those agreements, it would be extreme or fanciful for the audience to understand the impugned statements as directing their attention to any question of enforcement by an Australian court if the parties later disagreed. Such an extreme or fanciful understanding should not be attributed 98 to the ordinary or reasonable member of the audience receiving the impugned statements. [51] It is, then, not to the point to observe, as the Full Court did and as ASIC sought to emphasise in this Court, that the framework agreements did not fix either the work to be done or a price for the work to be done with any greater particularity than the list of items recorded in the framework agreements. [52] Nor is it necessary to decide whether, as Fortescue and Mr Forrest submitted, the framework agreements did provide for mechanisms by which those matters could be determined. It is enough to say that, contrary to the arguments of Fortescue and Mr Forrest, the better view would appear to be that cl 1.2 of the framework agreements did not provide such a mechanism. That clause, on its more natural construction, provided only that Fortescue would have the opportunity (with the cooperation of its counterparty) to conduct its own “[i]ndependent review of the schedule and value of the Works” which, as cl 1.1 expressly provided, the parties were to “jointly develop and agree”. … [59] It is … unnecessary to give separate consideration to the “likely to mislead or deceive” limb of s 1041H. In the Full Court, Emmett J expressly based his reasons on this ground. His Honour concluded that the statements “were, at least, likely to mislead or deceive an ordinary and reasonable member of the investing public who read the [impugned statements]”.But the inquiry into how an ordinary or reasonable member of the intended audience would receive a message is of its nature hypothetical. That inquiry is therefore apt to answer both whether conduct is misleading or deceptive and whether it is likely to mislead or deceive. Separate consideration of this limb of s 1041H is therefore not necessary once it is decided that an ordinary or reasonable member of the audience would not have understood the impugned statements to have conveyed anything other than what the parties did and intended, and that the statement made about those matters was neither misleading nor deceptive. [61] … Once it is decided that Fortescue’s statements that it had made binding contracts were not misleading or deceptive or likely to mislead or deceive, it is not to be supposed that, despite Fortescue lawfully making those statements, the continuous disclosure requirements nonetheless required Fortescue to tell the market that the agreements were not binding contracts. [In a separate judgment, Heydon J also allowed the appeal.]

Criminal sanctions [11.145] It is an offence for a disclosing entity to contravene its disclosure obligations under

s 674(2) (listed disclosing entities) or s 675(2) (unlisted disclosing entities): s 1311(1), (2) and Sch 3 items 229A, 229C. The Criminal Code Act 1995 (Cth) (Criminal Code) applies to an offence for breach of those provisions: s 678. No fault element is specified in Ch 6CA; however, since the physical element of the offence consists of conduct, the default fault element would appear to require proof of intention or recklessness with respect to the physical elements of the offences: Criminal Code, s 5.6. 99 If intent or recklessness is a fault element in relation to the physical element of an offence, it must be attributed to the corporation that 98

Campomar Sociedad, Limitada v Nike International Ltd (2000) 202 CLR 45 at 86-87 [105].

99

Recklessness applies as the default fault element where the physical element of the offences consists of a circumstance or result: Criminal Code, s 5.6(1). This may apply with respect to the element of possession of [11.145]

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expressly, tacitly or impliedly authorised or permitted the commission of the offence: Criminal Code, s 12.3(1). The means by which corporate authorisation or permission may be established include by proof that: (a) the board of directors intentionally, knowingly or recklessly carried out the relevant conduct, or expressly, tacitly or impliedly authorised or permitted the commission of the offence; (b) a high managerial agent of the corporation intentionally, knowingly or recklessly engaged in the relevant conduct, or expressly, tacitly or impliedly authorised or permitted the commission of the offence; (c) a culture existed within the corporation that directed, encouraged, tolerated or led to non-compliance with the provision; or (d) the corporation failed to create and maintain a corporate culture that required compliance with the provision: Criminal Code, s 12.3(2). A high managerial agent is an employee, agent or officer of the corporation with duties of such responsibility that their conduct may fairly be assumed to represent the corporation’s policy: Criminal Code, s 12.3(6). Conduct by a high managerial agent of the corporation will not be treated as corporate authorisation if the corporation proves that it exercised due diligence to prevent the conduct, or the authorisation or permission: Criminal Code, s 12.3(3). Corporate culture is defined as an attitude, policy, rule, course of conduct or practice existing within the corporation generally or in the part of it in which the relevant activities take place: Criminal Code, s 12.3(6). Factors that are relevant in determining whether or not a corporate culture existed that supported compliance with continuous disclosure obligations include: (a) whether authority to commit an offence of the same or a similar character had been given by a high managerial agent of the corporation; and (b) whether the employee, agent or officer of the corporation who committed the offence believed on reasonable grounds, or entertained a reasonable expectation, that a high managerial agent of the corporation would have authorised or permitted the commission of the offence: Criminal Code, s 12.3(4). Accordingly, it is common for listed companies to establish formal procedures (or compliance systems) to identify situations that might require disclosure, supported by appropriate training and line authority for decision making. ASIC recommends that companies nominate a senior officer to have responsibility for • ensuring compliance with continuous disclosure requirements; • overseeing disclosure of information to the stock exchange, analysts, brokers, shareholders, the media and the public; and • educating directors and staff on the company’s disclosure policies and procedures and raising awareness of the principles underlying continuous disclosure. 100 Under ordinary principles of accessorial criminal responsibility, directors and managers of disclosing entities may be exposed to personal criminal liability for contraventions by their company of the continuous disclosure obligations in which they participate or are otherwise

100

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information which is not generally available and which satisfies the materiality standard with respect to price or value; the element of failure to notify the stock exchange would, as conduct, engage the intention standard: Criminal Code, s 5.6(1); see Golding & Kalfus at 393-394. ASIC Regulatory Guide 62 (Better disclosure for investors), [3]. ASX requires listed companies to appoint a senior officer to be responsible for communications with it with respect to the company’s obligations under the listing rules: LR 1.1, condition 12 and LR 12.6. [11.145]

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complicit. 101 These principles are not elaborated in Ch 6CA in the manner that the principles of accessorial liability are in their application to the consequences of contravention under the civil penalty regime: see [11.150]. It is an offence for an officer or employee of a corporation who gives or authorises the giving of information to the operator of a financial market relating to the affairs of the corporation knowing it is false or misleading in a material particular or that it omits something which renders the information misleading in a material respect: s 1309(1). A like offence applies where the knowledge element is not satisfied but the officer or employee did not take reasonable steps to prevent the information being false or misleading: s 1309(2). Several of the market offence provisions in Pt 7.10 are potentially applicable to false or misleading statements made to a stock exchange in purported discharge of continuous disclosure obligations, eg, ss 1041E (false or misleading statements made knowingly or recklessly and which are likely to induce dealings in financial products) and 1041F (inducing another to deal in financial products by making a statement where the maker knows, or is reckless as to whether, the statement is misleading, false or deceptive or by a dishonest concealment of material facts): see [11.210] and [11.215]. Civil penalty consequences of contravention [11.150] The continuous disclosure obligations in ss 674(2) and 675(2) are expressed to be

financial services civil penalty provisions: ss 1317E(1), 1317DA. Sections 674(2) and 675(2) do not specify any fault element. The default fault provisions of the Criminal Code do not, of course, apply to civil penalty provisions; accordingly, if no fault element – intention, knowledge, recklessness or negligence – is specified for a civil penalty provision, it offers reduced elements and a lower standard of proof relative to a criminal prosecution with respect to that conduct or circumstances if it also constitutes an offence. The existence of a proper compliance system and a culture of compliance with respect to continuous disclosure obligations will not of themselves protect a corporation from liability for contravention of these civil penalty provisions under Pt 9.4B. Such a compliance system and culture will, however, be relevant in an application for relief from liability on the basis that the person acted honestly and, having regard to all the circumstances, ought fairly to be excused for the contravention: s 1317S. An individual who is involved in a contravention of ss 674(2) or 675(2) contravenes ss 674(2A) and 675(2A) which latter provisions are themselves financial services civil penalty provisions: ss 1317E(1), 1317DA. Accordingly, persons such as a director or manager of or professional adviser to a disclosing entity may be exposed to personal civil liability under Pt 9.4B. The provision was introduced in 2004 on the basis that the prospect of financial penalties being imposed on individuals would operate as a more credible and effective deterrent than financial penalties imposed on the entity alone. 102 An individual is involved in a contravention if, and only if, the person aids, abets, counsels, procures or induces the contravention, is knowingly concerned in or party to the contravention, or conspires with others to effect the contravention: s 79. The intention of the provisions is to embrace individuals with “real” involvement in a contravention of the continuous disclosure provisions, requiring “some form of intentional participation and actual knowledge of the essential elements of the contravention”. 103 While this application of s 79 in the context is

101 102 103

Criminal Code, s 11.2 (liability for person who “aids, abets, counsels or procures the commission” of an offence). Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill 2003, Explanatory Memorandum, [5.450]. Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill 2003, Explanatory Memorandum, [5.447]. [11.150]

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supported by decisions under general law civil accessorial liability, 104 some dicta assume that a lower standard of active participation is sufficient for liability. 105 Proximity to the decision, with respect to the disclosure decision, increases the probability of exposure to accessorial liability; since there is no positional liability - liability by reason only of holding office as a director, compliance officer, etc - with respect to continuous disclosure, the imposition of accessorial liability might therefore be thought to provide an incentive to corporate officers and advisers to distance themselves from involvement in the disclosure decision. Accordingly, a due diligence defence was added in 2004 together with the introduction of accessorial responsibility for continuous disclosure. An individual said to be involved in a contravention by a disclosing entity has a defence against liability if they prove that they (a) took all steps that were reasonable in the circumstances to ensure that the entity complied with its continuous disclosure obligations and (b)

after doing so, believed on reasonable grounds that the entity was complying with its obligations: ss 674(2B), 675(2B).

The defence is in broadly similar terms to the due diligence defence for prospectuses contained in s 731: see [10.205]. It reinforces the incentive under criminal sanctions, particularly those relating to authorisation from the culture of an organisation (see [11.145]), to establish compliance systems to identify information or developments that might require disclosure and ensure that the entity’s obligations with respect to it are properly assessed. Paragraph (a) encompasses the assessment whether particular information needs to be disclosed to the stock exchange; the reference to reasonable steps “in the circumstances” is intended to refer to all the conditions surrounding the entity’s compliance with its continuous disclosure obligation, including the circumstances of the person taking the steps and their role in the entity, and of the entity itself as well as the nature of the information. 106 The defence does not in terms cover the situation where, eg, a corporate compliance officer, other manager or individual board member considers that disclosure should be made to the stock exchange with respect to information but is overruled or outvoted. In this situation the dissenting individual will not have the protection of the due diligence defence since they will lack the belief in the corporation’s compliance required by para (b). However, they would appear to escape personal liability on the ground that they are not “involved” in any contravention by their company. 107 If a court makes a declaration of contravention of the provisions against a disclosing entity or an individual involved in its contravention, it may make

104 105

106 107

874

See, eg, Yorke v Lucas (1985) 158 CLR 661 at 667 (requiring “intentional participation” which rests upon “knowledge of the essential matters” that go to make up the breach); NRMA v Morgan (1999) 31 ACSR 435. Heydon v NRMA [2000] NSWCA 374 at 336, 436 (advice by solicitors with respect to the content of a disclosure document under Ch 6D would involve them in contravention by the issuer); see Golding & Kalfus at 397-398 and A Zandstra, J Harris & A Hargovan (2008) 22 Aust Jnl of Corp Law 51 (arguing that greater use should be made of accessorial liability for continuous disclosure contraventions). Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill 2003, Supplementary Explanatory Memorandum, [4.85]. That is the view expressed in the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Bill 2003, Supplementary Explanatory Memorandum, [4.87]. The possible burden of continuing advocacy of the contrary position by the dissenting individual that might be necessary for the parallel defence to insolvent trading would not seem to be present here by reason of underlying policy differences deriving from the distinct contexts. The question arises, however, whether it is necessary for the defence to press for reconsideration of a decision not to disclose by a higher authority within the organisation such as the chief executive or board: see [7.185]. [11.150]

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• if the contravention is serious or materially prejudices the interests of acquirers or disposers of the corporation’s financial products or the corporation itself, a pecuniary penalty order of up to $200,000 for an individual or $1 million for a corporation (s 1317G(1A), (1B)) 108; and • a compensation order: s 1317HA. 109 Potentially, the quantum of a compensation order with respect to non-compliance with continuous disclosure obligations might be very large since investors might argue that they acquired or disposed of securities in reliance upon the corporation’s existing disclosure to their disadvantage; it is an interesting question as to whether those who did not trade but argue that they would have done so if proper disclosure had been made might also recover compensation. 110 Other civil remedies for contravention [11.155] Other civil remedies apply in relation to contraventions of ss 674(2), (2A), 675(2),

(2A). These include injunctive remedies or damages in lieu in respect of conduct that contravenes the Act (s 1324), a wide range of remedial orders in respect of conduct that contravenes Ch 6CA (s 1325) and remedies for misleading or deceptive conduct in relation to a financial product: ss 1041H(1), (2) and 1041I; see [10.215]. Court orders for the enforcement of the listing rules may also be sought under ss 793C and 1101B: see [11.65]. Court orders may also be made against a person for the disclosure of information or publication of advertisements where the Court is satisfied that they have engaged or been involved in conduct contravening a provision of Ch 6CA: s 1324B. Infringement notices

Procedural steps [11.160] In 2004, Pt 9.4AA was introduced to permit ASIC to issue an infringement notice 111

to a disclosing entity for an alleged contravention of its continuous disclosure obligations as an alternative to proceedings for a civil penalty under Pt 9.4B: s 1317DAB(1). (The facility does not apply to involvement by individuals in an alleged contravention by the entity.) The infringement notice facility was introduced to remedy a significant gap on the current enforcement framework by facilitating the imposition of a financial penalty in relation to relatively minor contraventions of the regime that would not otherwise be pursued through the courts and in relation to which ASIC considers a relatively small financial penalty would be justified. The capacity to issue an infringement notice would 108

As in ASIC v Southcorp Ltd (No 2) (2003) 130 FCR 406 (approval of joint recommendation by the company and ASIC under settlement between them of a pecuniary penalty of $100,000 for selective distribution of price sensitive information to analysts that had not been communicated to ASX; the then maximum pecuniary penalty for a corporation was $200,000).

109

The person involved is not, however, subject to a disqualification order under s 206C since the power to make the order arises only upon contravention of a corporation/scheme civil penalty provision: see [5.230].

110

GPG (Australia Trading) Pty Ltd v GIO Australia Holdings Ltd (2001) 117 FCR 23 (recovery of compensation by an investor who acquired shares on the faith of financial reporting by a listed company that was misleading and deceptive within the former Trade Practices Act 1974, s 52 (now s 18 of the Australian Consumer Law; it was unnecessary to determine whether the company had breached its disclosure obligations under Ch 6CA).

111

See, on ASIC’s use of the infringement notice regime, I Ramsay (2015) 33 C&SLJ 196 (reporting that 48% of ASIC’s continuous disclosure enforcement actions are undertaken by way of infringement notices; that small capitalisation companies are those most likely to receive an infringement notice; companies in the resources industry tend to receive the most infringement notices); A Desai & I Ramsay (2011) 39 Aust Bus L Rev 260; R Langley (2007) 25 C&SLJ 439; M Welsh (2007) 25 C&SLJ 315; J Coffey (2007) 20 Aust Jnl of Corp Law 301; M Nehme, M Hyland & M Adams (2007) 21 Aust Jnl of Corp Law 112. [11.160]

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also allow ASIC to signal its views concerning appropriate disclosure practices to listed entities more effectively than through court action alone. 112

ASIC may issue an infringement notice if it has reasonable grounds to believe that a disclosing entity has contravened ss 674(2) or 675(2): s 1317DAC(1). Before doing so, a number of steps will or must be followed. 113 First, where a possible breach is identified, ASIC will conduct an investigation using its compulsory powers; if ASIC considers that the issue of an infringement notice may be an appropriate result, it will brief an internal delegate who has not been involved in the investigation to determine whether there has been a breach. 114 The next step is for a hearing notice to be issued, giving the disclosing entity a written statement setting out its reasons for believing that the entity has contravened ss 674(2) or 675(2) and giving a representative of the entity the opportunity to appear at a private hearing before ASIC and give evidence and make submissions to ASIC in relation to the alleged contravention: s 1317DAD(1). Any evidence or information that the entity’s representative gives ASIC under this provision is not admissible in evidence against the entity in any proceedings: s 1317DAD(4). After the hearing, an infringement notice may be issued and served. In deciding whether or not to issue a notice, ASIC looks to the seriousness of the alleged breach and the stock exchange’s views where the entity is listed. 115 Among other matters, the infringement notice must give details of the alleged contravention by the entity and, in the case of a listed entity, may specify information that the entity must notify to the stock exchange in accordance with its listing rules; for unlisted disclosing entities, it may require it to lodge a document with ASIC containing specified information: s 1317DAE(1). It must also specify the applicable penalty: s 1317DAE(1)(g). The penalty varies with the market capitalisation of the entity: • $100,000 for a Tier 1 entity (market capitalisation over $1,000 million); • $66,000 for a Tier 2 entity (market capitalisation between $100 million and $1, 000 million); and 112

Minister for Justice and Customs, A Guide to Framing Commonwealth Offences, Civil Penalties and Enforcement Powers, February 2004, p 45, quoted in Parliamentary Joint Committee on Corporations and Financial Services, CLERP (Audit Reform and Corporate Disclosure) Bill 2003 (Part 1, 2004), [6.27]. The introduction of the infringement notice facility was prompted by some notable instances of failure of disclosure: see Golding & Kalfus at 408-412; it was also strongly opposed on the grounds of the constitutionality of the measure, the apparently conflicting functions assigned to ASIC of investigation and adjudication, role overlap and confusion between ASIC and ASX, and the inappropriateness of the facility in view of the complexity and subjectivity of the disclosure obligation: see Parliamentary Joint Committee on Corporations and Financial Services at [6.31] and Ch 6 generally. The Parliamentary Joint Committee recommended that the Advisory Committee review the operation of the infringement notice provisions after two years and that they be subject to a three-year sunset clause: [6.134]–[6.135]. The Government did not accept the latter recommendation.

113

The 10 distinct stages in the infringement notice process are outlined in ASIC, Continuous disclosure obligations: infringement notices (2004).

114

The delegate would be a member of ASIC to whom it has delegated the power to hold hearings: Parliamentary Joint Committee on Corporations and Financial Services, at 6.109. This procedure is intended to address concerns about the coincidence of investigative and adjudicatory functions in ASIC. In determining seriousness, ASIC considers the impact of the alleged breach on the market for the entity’s securities, the materiality of the information the subject of the alleged breach, whether the breach was negligent, reckless or intentional, the adequacy of the entity’s internal controls, whether the entity sought and followed professional advice, and the corrective steps it has taken: ASIC, Continuous disclosure obligations: infringement notices, [10]. If the entity is listed, ASIC must also consult with ASX before giving the entity the statement of reasons, presumably as a caution against precipitate action and to secure the benefits of its perspective as the market operator: s 1317DAD(2). ASIC is not bound by ASX’s views. In determining whether to issue an infringement notice to a listed entity, ASIC must also have regard to any guidelines issued by the stock exchange relating to its continuous disclosure requirements: s 1317DAD(4).

115

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• $33,000 for a Tier 3 entity (market capitalisation below $100 million): s 1317DAE(2), (6). 116 The compliance period for an infringement notice is 28 days subject to extension by ASIC for another 28 days: s 1317DAH. A disclosing entity complies with the notice by paying the penalty and remedying any inadequate disclosure specified in the notice. The entity may also make representations to ASIC seeking the withdrawal of the notice: s 1317DAI. Responding to an infringement notice [11.165] An entity which elects to comply with an infringement notice does so without

admissions: it will not, for that reason only, be regarded as having contravened the disclosure provisions or committed an offence constituted by the conduct specified in the notice: s 1317DAF(1) – (4). The advantage it derives from doing so is that criminal or civil proceedings may not be started or continued against it in relation to the alleged contravention specified in the notice or an offence constituted by the same conduct: s 1317DAF(5). 117 The infringement notice is not, however, intended to interfere with the rights of individuals affected by the entity’s conduct. Accordingly, an exception applies for compensation proceedings for loss or damage suffered under ss 1317HA, 1041H or otherwise, for enforcement of stock exchange listing rules under ss 1101B or 793C, and public interest proceedings under ASICAs 50 relating to the alleged contravention specified in the notice: ss 1317DAF(6), 1317DAA(1). If an entity elects to comply with the notice, ASIC is also restricted in its use of publicity in relation to the fact of compliance: it may publish details of the entity’s compliance with the notice which details are limited to an accurate summary of the notice including the name of the entity, the amount of the penalty and the conduct specified in the notice; in the entity’s interest, it must also state that the entity has complied with the notice, that compliance with the notice is not an admission of guilt or liability, and that the entity is not regarded as having contravened the provision specified in the notice: s 1317DAJ(1) – (3). ASIC must not otherwise publish details of the notice or the entity’s compliance with it: s 1317DAJ(4). 118 If the entity fails to comply with an infringement notice within the period specified, ASIC may not enforce the notice against the entity. Instead, it must decide whether to take court proceedings in relation to the alleged contravention; having issued an infringement notice and not withdrawn it, it is limited in the proceedings it may then initiate. First, it may commence proceedings against the entity under Pt 9.4B; as noted (at [11.150]), the upper level of pecuniary penalty orders that may be made under Pt 9.4B is considerably higher than the penalties applying under an infringement notice. Second, if the entity fails to notify the stock exchange of any information that is specified in the notice or, in the case of an unlisted disclosing entity, fails to lodge any required document with ASIC, ASIC may commence proceedings for a disclosure order under s 1324B: s 1317DAG(1), (2). In these proceedings, it will need to establish its claim to the remedy it seeks without the benefit of any presumptions or evidentiary advantage arising from the issue of the notice. No other civil and no criminal proceedings may be started or continued against an entity which fails to comply with an 116

A Tier 2 or Tier 3 entity is elevated to a higher tier for purposes of the quantum of penalty if it has been convicted of an offence, subject to a civil penalty order or breached an enforceable undertaking given to ASIC, in either case in relation to a contravention of ss 674(2) or 675(2): s 1317DAE(3).

117

ASIC may, however, recover the costs of its investigation under ASIC Act s 91: s 1317DAF(7).

118

However, ASIC may also publish a copy of the notice in the [Government] Gazette together with statements that the entity has complied with the notice, that compliance is not an admission of liability, and that the entity is not regarded as having contravened the disclosure provision specified in the notice: s 1317DAJ(2). It is not prevented from publishing information on an aggregate and anonymous basis such as the number of infringement notices issued and their outcomes. [11.165]

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infringement notice in relation to the alleged contravention specified in the notice or an offence constituted by the same conduct: ss 1317DAG(3), 1317P(2). However, the same exception applies as for an entity that elects to comply with a notice, namely, for compensation and enforcement proceedings by parties affected by the conduct the subject of the notice: ss 1317DAG(4), (5), 1317DAA(1). The decision to issue an infringement notice has enforcement implications for ASIC since, if the entity fails to comply with it, ASIC is prevented from commencing criminal proceedings against the entity and its civil remedies are limited to those under Pt 9.4B and s 1324B. 119 Of course, ASIC may only issue the notice if it has reasonable grounds to believe that a disclosing entity has contravened ss 674(2) or 675(2); accordingly, it will have already committed considerable investigative resources to the matter. Whether or not the entity complies with the notice, ASIC is not limited in the proceedings that it may take against persons involved in the entity’s contravention of its continuous disclosure obligations. For an entity which has received an infringement notice, the calculus of choice is perhaps more complex. The following considerations might favour compliance with a notice even where the entity does not consider that disclosure is or was required: • it brings to an end the threat of civil or criminal proceedings by ASIC in relation to the matter the subject of the notice; • the quantum of the penalty will be minor relative to the costs of contesting the issue with ASIC and the possible pecuniary penalty that might be imposed under s 1317HA; • compliance is not an admission of liability; • a corporate entity is protected against adverse ASIC determinations under ss 708A(2) (sale offers that do not need disclosure: see [10.65]) and 713(6) (special prospectus content rules for continuously quoted securities: see [10.110]); and • ASIC may make limited reference only to the notice and compliance with it in publicity, qualified further by the requirement to state that the entity’s compliance is not an admission of guilt or liability and that the entity is not regarded as having contravened the provision specified in the notice; if ASIC commences proceedings against the entity following failure to comply with the notice, ASIC will publish that fact. For the entity itself, the following factors weigh against compliance with the notice: • the general character of the disclosure obligation under the listing rule and the materiality standard mean that complex issues will arise with wide scope for subjective differences in interpretation as to their application in particular cases; compliance with the notice may cut powerfully against judgment and instinct in some instances; • there will inevitably be some reputational cost arising from compliance with a notice especially for larger corporations with significant profiles in investment and consumer markets; • the fact that ASIC issues and does not withdraw the notice itself limits the enforcement proceedings that ASIC might bring in relation to the matter; • compliance will not protect the entity’s officers from proceedings with respect to their involvement in the matter the subject of the notice; 120 and • compliance will not protect the entity against compensation proceedings brought by those affected by the conduct the subject of the notice. 119 120

However, ASIC will also be able to recover the costs of its investigation under ASICAs 91 and accept an enforceable undertaking under ASIC Acts 93AA. In practice, the entity might be expected to seek to have this matter covered in its representations to ASIC.

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In a study of ASIC’s enforcement of the continuous disclosure laws, Ian Ramsay found that 48% of ASIC’s enforcement actions were undertaken by way of infringement notice: [I]t can be seen, based on the data collected for this note, that ASIC does not engage in heavy enforcement action for alleged contraventions of the continuous disclosure laws. In other words, it does not make extensive use of criminal sanctions and only limited use of civil sanctions. This is different to some other laws ASIC enforces where ASIC does make extensive use of criminal sanctions. An example is ASIC’s enforcement of the insider trading laws where 92% of ASIC’s enforcement actions are criminal and only 8% civil. Instead of making extensive use of criminal and civil actions to enforce the continuous disclosure laws ASIC uses lower level sanctions, in particular, infringement notices. There is an important question why this is the case given that criminal actions can provide the strongest deterrence signal. Several possible reasons can be proposed. First, infringement notices have benefits for ASIC. They allow ASIC to issue a sanction (a monetary penalty) but without the need to commence court proceedings and without the need for ASIC to establish liability or for the company to admit liability. In addition, ASIC views the payment of an infringement notice as an enforcement win, even though there is no admission of liability by the company. A second possible reason why ASIC favours infringement notices, relates to sensitivities around continuous disclosure. If the contexts of prospectus disclosure and continuous disclosure are compared, in the former context, it is expected the company and its advisers will undertake appropriate due diligence to ensure the disclosures made in the prospectus are accurate. Companies are expected to take the time necessary to ensure accurate disclosure in the prospectus. Companies do not have the same luxury of time when it comes to continuous disclosure. When a company becomes aware of information that a reasonable person would expect to have a material effect on the price or value of the company’s securities, then the company must immediately disclose the information. Some continuous disclosure litigation has involved companies close to insolvency. This is a time when the directors, under typically significant time constraints, are grappling with the demands of creditors while endeavouring to comply with continuous disclosure obligations regarding the changing financial status of the company. There can also be sensitivities regarding when a company should disclose information about a proposed takeover and when confidential information is no longer confidential so that it needs to be disclosed. Therefore, ASIC’s use of lower level sanctions might be a recognition of the challenges facing directors and senior executives in these situations. 121

[11.168]

Review Problems

1. Midas Ltd is a listed company which has been successfully operating a major international casino in Australia for several years. At the end of September, management accounts show a substantial loss due in part to decline of trading revenue and significant losses from gambling transactions with several high rollers. In early November, internal reports show that the company is in breach of the debt-to-equity ratios imposed as a condition of its casino licence. In December the chief executive of the company enters into a settlement with the gaming licensing board in the United States jurisdiction where he had been in charge of a major casino that had lost its licence because of Mafia influence in its operations. If that settlement is disclosed to the local gaming regulator, it may jeopardise the casino’s licence. An influential financial journalist who approaches the company with rumours of gaming losses is told that they are untrue and that revenues are strong. He writes a positive story. The expectations of board and management that the revenue and gaming losses will self-correct prove unfounded; when half-year results are released, the company’s stock price declines sharply. It falls even further later when another journalist learns of and reports the chief executive’s settlement in the US. Investors who bought after the favourable story seek advice as to whether they may recover losses. 121

I Ramsay (2015) 33 C&SLJ 196 at 203. [11.168]

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2. Limping Ltd, a listed mining company, has long been the subject of takeover rumours but no bidder has come forward until Yodel Ltd, a Swiss company, approaches the board to explore confidentially an agreed merger. After three weeks of negotiations, the two parties have been unable to agree on a price to put to Limping shareholders. Noting a sudden increase in Limping’s stock price, ASX queries the company which says that it has no announcement to make and “cannot explain it”. Limping’s directors become more confident that Yodel will increase its bid if they hold out long enough especially since Limping’s rising share price is putting pressure upon Yodel to increase its bid price if it wishes the merger to proceed. Agreement is reached and announced immediately to ASX. ASIC and ASX receive complaints from those who sold Limping shares before the bid was announced at a premium of 10% to the stock’s price.

SHORT SELLING The merits and risks of short selling [11.170] Short selling refers to a transaction where speculators 122 sell securities which they

do not own, anticipating that the price of those securities will fall and that they will be able to retrieve their position by a subsequent purchase at a lower price and a consequent profit. 123 Although the practice was held to be lawful as early as 1838, the practice has a manipulative potential within financial markets that has prompted regulation which permits only a limited and conditional short selling of securities. The benefits which it is claimed that short selling may bring to the efficient operation of a financial market include: • by increasing the total trading volume, it contributes to the continuity, depth and liquidity of the market for the securities; • short sellers act as agents of price discovery and potentially smooth market bubbles; • levelling out fluctuations in market prices, eg, by acting as a moderating force when the price of a security or of the market generally experiences an undue fall; and • it aligns Australian markets with practices of the principal overseas markets. 124 On the other hand, unregulated short selling is fraught with dangers: • short selling may accelerate a market price decline, either in the particular stock short-sold or in the market generally, if the pressure upon the stock price from short sales is markedly greater than the price effects of the short sellers “covering” their position through subsequent purchases or if the velocity of price decline triggered by shorting itself causes potential buyers to stand back from the market because of uncertainty as to its basis or contributes to panic sales by “long” holders (disorderly market concerns); 125 122

Other motives include hedging a long position (ie, to offset the effects of an anticipated price decline in a security which the holder does not wish to dispose of). Tax considerations, particularly those relating to capital gains tax, also play a role. Some fund managers, typically called hedge funds because of their trading strategies and sophisticated investor group, employ short selling as an “active” (ie, aggressive) trading strategy.

123 124

Hibblewhite v McMorine (1839) 5 M & W 462; 151 ER 195. Australian Associated Stock Exchanges and National Companies and Securities Commission, Joint Exposure Draft on Proposed Amendments to AASE Member Stock Exchanges Business Rules to Facilitate Short Selling in Approved Securities Made Public Securities Quoted on Australian Stock Markets (1985), [1].

125

ASIC, Short selling: Post-implementation review (Report 302, 2012), [22].

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• the creation of false markets as, eg, where short sellers are unable to cover their position because of a market corner by an investor who anticipates the shorters’ positions; 126 • short selling creates incentives for “rumourtrage”, the spreading of negative rumours about a company, since these rumours assist the share price fall that enables the seller’s profits; • the risk to investors who speculate on margin, that is, without having to put up funds to match their effective investment; 127 in 2008 there were concerns that short selling was driven in some cases by expectations that a price fall in some companies’ shares would force their executives who had subscribed for large shareholdings on margin to sell and so accentuate the downward spiral; 128 and • the risk of settlement failure by a broker who is unable to settle a short sale made on its own behalf or for a client, triggering the risk of systemic settlement failure in view of the multiple transactions that brokers execute daily, their individual liability under stock exchange rules for settlement of client transactions and the consequent concern of all for the solvency of each broking firm. Legal regulation [11.175] Concern for these dangers led to a statutory ban upon short selling (except for some

technical exceptions) in the early 1970s. Gradually, these exceptions were expanded to permit “scrip arranged” or “covered” short sales and the “naked” short selling of approved securities: • scrip arranged or covered short sales: where a person sells securities where they have in place a scrip borrowing arrangement that gives them a “presently exercisable and unconditional right to vest” securities of the same amount in the buyer at the time of sale (s 1020B(2)) • naked short sales: where the seller has no such arrangement in place at the time of sale and therefore no “presently exercisable and unconditional right to vest” securities in the buyer. Naked short selling was prohibited in Australia following the 2008 stock market break. Under the facility earlier contained in the Act, ASX had declared certain quoted securities identified in its market rules to be approved securities. These comprised the equity securities with the largest market capitalisation and highest turnover volumes, comprising approximately 20% of stocks listed on ASX. The 2008 prohibition on naked short selling was explained in these terms: Various concerns have been expressed in relation to naked short selling. Transactions of this nature may have a higher risk of settlement failure (because the seller does not have a presently exercisable and unconditional right to vest the products at the time of sale). They may also distort the operation of financial markets by causing increased price volatility and potentially facilitating market manipulation. In addition, the perceived activity of naked short sellers is likely to damage market confidence particularly among retail investors. For these reasons, naked short selling has the potential to damage the integrity of Australian financial markets. 129

The other major amendment made at this time was to strengthen the disclosure regime with respect to covered short sales. Disclosure obligations are discussed at [11.177]. 126

As occurred in Osborne v Australian Mutual Growth Fund [1972] 1 NSWLR 100.

127 128

Australian Associated Stock Exchanges and National Companies and Securities Commission, [6.2]. ASIC, Short selling: Post-implementation review (Report 302, 2012), [25].

129

Corporations Amendment (Short Selling) Bill 2008, Explanatory Memorandum, [3.4]. Similar bans on naked short sales were introduced or reinforced in 2008 in other countries with developed securities markets. [11.175]

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Scrip arranged (or covered) short selling [11.176] The only permitted form of short selling is scrip arranged (or covered) short selling.

Scrip arranged short selling may only be effected by a person who is not an associate of the corporation whose securities are traded. 130 To effect a scrip arranged short sale, the seller must have at the time of the short sale a “presently exercisable and unconditional right” to vest the securities in the buyer: s 1020B(2). It is also sufficient if the seller has, before the time of sale, entered into a contract to buy the securities and has the right to have those securities vested in them conditional only upon payment of consideration for the purchase or receipt of a proper instrument of transfer or title documents to the securities: s 1020B(4). ASIC interprets the “time of sale” to refer to the time when the offer for sale is placed, and not the time of settlement of the sale transaction. Arrangements must be made for delivery of covering scrip within three business days of the sale (stock exchange rules require settlement of transactions within three business days (T+3)). In covered short sales this is commonly done by a standard agreement called a stock lending agreement, often with an institutional shareholder which takes a fee for the loan of the securities. Under the standard agreement, the borrower is under a contractual obligation to return the same or an identical number of securities to the lender at a specified date or on demand. Delivery of securities may simply involve a custodian holder transferring securities from one account holder to another under the terms of the lending agreement. Often the lending agreement is expressed as an agreement for the sale of the securities with an obligation to re-sell the same number of securities at a specified time to the “lender”. 131

Disclosure of short sales [11.177] During the stock market break in 2008, when it became evident that sales

underpinned by lending agreements where beneficial title is transferred were widely considered not to be short sales requiring disclosure, the Commonwealth Government announced its intention to introduce legislation to clarify that covered short sales, even where title passes under a lending agreement, must be disclosed. It thought that uncertainty surrounding the actual level of short selling, a consequence of non-disclosure of covered sales, was resulting in rumour and speculation in the market: The current degree of uncertainty surrounding the activity of covered short sellers in Australian securities is having a significant impact on Australian capital markets. Currently, when a security experiences a significant decline in price, it is unclear whether this is attributed to short selling activity or other factors, which is resulting in considerable rumour and speculation regarding short selling activity and potentially adding to price volatility. Speculation regarding the level of short selling activity in Australian securities is also having broader market implications. Confidence in the market, particularly among retail investors, is likely to be damaged as investors express concern about the perceived activity of short sellers in the market. A fall in market activity, and investor confidence about the integrity of Australian capital markets, will make it more difficult for companies to raise additional capital leading to an increase in the companies overall cost of capital and a fall in investment activity. 132

130 131

As to the definition of associate, see Pt 1.2, Div 2. Directors of the issuer and its related companies may not, therefore, short sell under this exception: s 11. For close analysis of the legal character of a securities lending agreement see Beconwood Securities Pty Ltd v ANZ Banking Group Ltd (2008) 66 ACSR 116.

132

Exposure Draft of the Corporations Amendment (Short Selling) Bill 2008, Commentary, [22].

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The Government’s intention was not to prohibit or discourage covered short selling but to increase transparency with respect to it by requiring disclosure of all such sales to the selling brokers and the stock exchange. 133 This intention is given effect in the enhanced disclosure requirements contained in Pt 7.9 Div 5B. There is a tiered set of reporting obligations under the Div 5B. First, short sellers must advise their executing broker when the sale is a covered short sale: s 1020AB. (This applies regardless of whether the seller is inside or outside Australia: s 1020B(2).) To bolster client disclosure, the broker must also ask a client, before making the sale, whether the sale is a covered short sale, and keep a written record of the answer: s 1020AE. This obligation is to ensure that clients, particularly overseas clients, understand their obligations to report short sales. Second, the broker must report the disclosed covered short sale to the ASX together with any short sales they make as principal (that is, on their own behalf): s 1020AC. Third, ASX must publicly disclose reported short sale information: s 1020AD.

ASIC’s powers to suspend or prohibit short selling [11.178] In September 2008, concerned that “recent global market conditions, coupled with

extensive short selling of stocks, particularly financial stocks, may be causing unwarranted price fluctuations”, ASIC prohibited naked and covered short selling for specified periods under its then power. 134 In the legislation that later prohibited naked short selling, ASIC’s general exemption and modification power was amended to clarify that it included power to suspend, prohibit or limit short selling in any form as well as transactions with a substantially similar market effect: s 1020F. Remedies for breach [11.180] Breach of the core prohibition in s 1020B(2) is a criminal offence: s 1311(1), (2), Sch 3, item 300C. (Breach of provisions in Ch 7 is criminally sanctioned only if a penalty is imposed in Sch 3: s 1311(1A).) A transaction which is in breach of the prohibition is nonetheless valid in view of the general provision that failure to comply with a requirement of Ch 7 does not affect the validity or enforceability of the transaction: s 1101H(1). However, ASIC or the other party to a non-complying short sale (the latter as a person aggrieved by the contravention) might seek court orders under s 1101B including orders declaring the contract void or voidable: s 1101B(4)(h). 135 Alternatively, ASIC, ASX and the other party to the short sale might seek injunctive relief under s 1324 or damages in lieu.

MARKET MISCONDUCT (APART FROM INSIDER TRADING) The range of manipulative techniques [11.185] Part 7.11 contains provisions relating to market misconduct and other forms of

prohibited conduct in relation to financial markets. 136 The provisions apply to market participants generally, irrespective of whether they are providers of financial products licensed under Ch 7. This section considers some forms of market misconduct and other forms of 133

Exposure Draft of the Corporations Amendment (Short Selling) Bill 2008, Commentary, [23]-[24], [26]-[27], [47].

134 135

ASIC Media Release 08-210: ASIC extends ban on covered short selling, 21 October 2008. Where the contravention is of the ASX market rules, ASX might also seek orders under s 1101B(1)(b).

136

See V Goldwasser, Stock Market Manipulation and Short Selling (Centre for Corporate Law and Securities Regulation, University of Melbourne; 1999), Ch 1; A F H Loke (2007) 21 Aust Jnl of Corp Law 22; Loss, pp 645-651; R Deutsch (1983) 1 C&SLJ 142; A Kedzior (1988) 11 Adel LR 32; A Black (2011) 29 C&SLJ 313 (examining ASIC’s enforcement record with respect to market misconduct). [11.185]

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prohibited conduct; the following section deals with insider trading, one of the most common forms of misconduct and one with a more highly elaborated body of regulation. Market misconduct and manipulation are the enemy of market efficiency and investor confidence. They may take many forms. ASX has identified some principal techniques and their Runyonesque labels: 137 • “Hype and dump”: talking up the price of stock, using false or exaggerated reports, rumours, brokers’ recommendations, etc. Once the price has risen, the stock is dumped. The antithesis can be known as “slur and slurp” and occurs when the price of a stock is talked down, allowing the manipulator to buy shares at lower prices. • “Pump and dump”: entering into transactions at successively higher prices, giving the appearance of real activity by investors, then “dumping” or selling them at the artificially inflated price. • “Ramping” or “marking (up) the close”: either placing a bid or purchasing a parcel at or near the close of trading which changes the closing price (the bid is often dropped next morning or a day-only bid is used). This is also called “painting the tape” or “window dressing” and may be used to push share prices lower. • “Window dressing” or “ramping”: used by institutional investors to allow valuation at desired prices. • “Churning”: the manipulator acquires a holding of shares and then places both buy and sell orders either through one broker or several in order to create an impression of large turnover. These orders are usually placed at progressively higher prices. The technique is also called “pass the parcel”. • “Pools”: a group of manipulators who trade shares back and forth between themselves, usually through one broker, thereby raising volumes and creating other investor interest. The technique is similar to “churning” and “pass the parcel”. • “Short squeeze”: purchasing a significant amount of short-sold stock, “cornering” the market in order to force short sellers to purchase shares to cover their short positions at successively higher prices, thereby increasing the stock price. • “Matched orders” or “pre-arranged trades”: that is, associated parties entering purchase or sale orders knowing that an associate has entered a corresponding order. • “Wash sales”: purchase and sale orders placed at the same time where beneficial ownership does not change. 138 The common law prohibition upon market manipulation [11.190] The common law took a firm stand against the mischief of interfering with the free

public market for securities. Thus, in R v de Berenger 139 a charge of conspiracy to raise the price of public securities was brought against individuals who had executed a ruse to announce the defeat of Napoleon in February 1814 and the capture of Paris by English forces. The scheme involved dressing one member of the group in military uniform and scattering French coins along the road from Dover to Winchester. 140 As the stock market rose on this 137

Australian Stock Exchange Ltd, Circular to Member Organisations, 21 June 1990.

138

139

Other techniques include a “run” where a group manipulates trading in a security by its own activity, including the promotion of rumours, misleading statements, etc. For discussion of manipulative practices employed during the Poseidon mining boom of the late 1960s, see Australian Securities Markets and their Regulation (1974), Pt 1, Vol 1, Ch 8. (1814) 3 Maule & S 67; 105 ER 536.

140

There is a graphic account of the scheme in Loss, pp 845-847.

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good news, the conspirators sold their holdings at substantial profit. They were convicted. As explained by Lord Ellenborough, the essence of their offence was the manipulation of an open market: A public mischief is stated as the object of this conspiracy; the conspiracy is by false rumours to raise the price of the public funds and securities; and the crime lies in the act of conspiracy and combination to effect that purpose, and would have been complete although it had not been pursued to its consequences, or the parties had not been able to carry it into effect. The purpose itself is mischievous, it strikes at the price of a vendible commodity in the market, and if it gives it a fictitious price, by means of false rumours, it is a fraud levelled against all the public, for it is against all such as may possibly have anything to do with the funds on that particular day. It seems to me also not to be necessary to specify the persons, who became purchasers of stock, as the persons to be affected by the conspiracy, for the defendants could not, except by a spirit of prophecy, divine who would be the purchasers on a subsequent day. The excuse is, that it was impossible they should have known, and if it were possible, the multitude would be an excuse in point of law. But the statement is wholly unnecessary, the conspiracy being complete independently of any persons being purchasers. I have no doubt it must be so considered in law according to the cases. 141

By the end of the 19th century, the concept of market interference was extended to manipulation by trading alone, without accompanying rumours and misinformation. 142 General law prohibitions were strengthened by statutory prohibitions upon manipulative activities with the Securities Industry Acts of 1970. Their prohibitions are now contained in Pt 7.10 Div 2. Regulation is now effected by reference to financial products rather than securities, the focus prior to 2002. The distinct offences in Div 2 do not operate in separate watertight compartments where any given set of facts might constitute only one of the offences prescribed. This matter is “put beyond doubt” by s 1041J which provides that, subject to any express provision to the contrary, the various sections in Div 2 have effect independently of each other, and that nothing in any of the sections limits the scope or application of any of the other sections. 143 Market manipulation through artificial price setting [11.195] One set of statutory prohibitions is upon trading activity which manipulates market

prices. 144 Thus, a person must not take part in or carry out a transaction, or two or more transactions, that have or are likely to have the effect of creating or maintaining an artificial price for trading in financial products on a financial market: s 1041A. 145 The prohibition posits the distinction between the real and the artificial price for the security and enjoins transactions – manipulative rather than real investment transactions or speculative trading – that create that artificial price. An instance might include buying securities to move the price for extraneous purposes such as to spoil a takeover offer for the stock by purchases above the bid price or to establish a market price by purchases that would enable the purchaser to offload a holding at that artificially elevated price. The prohibition has been extended by elimination of the element of inducing others to deal in those securities that was contained in predecessor provisions. The requirement that the price effect be “likely” has been held, in 141

(1814) 3 Maule & S 67; 105 ER 536 at 72-73 (Maule & S), 538 (ER).

142

Scott v Brown Doering McNab & Co [1892] 2 QB 724; Loss, pp 847-848.

143

DPP (Cth) v JM (2013) 94 ACSR 1 at [64].

144 145

Hui Huang (2009) 27 C&SLJ 8 (arguing that the intent element is still to be implied into the law). The prohibition in this and the other market misconduct prohibitions is upon dealing in financial products on a financial market operated in Australia. This does not affect dealings in OTC markets where parties trade as principals: see [11.25]. [11.195]

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relation to s 1041E (see [11.210]) to require only that the likelihood be a “real and not remote chance” regardless of whether it is more or less than 50% probability. 146 The second limb of the prohibition is upon transactions with the effect of maintaining stock prices at an artificial level. It has been common in the United States and United Kingdom markets to allow some regulated degree of price stabilisation in initial public offerings. Permitted price stabilisation activities typically involve purchases or sales by underwriters and their broker. From 2000 ASIC has formally permitted post-issue price stabilisation by allowing an underwriter to take an option from the issuer over 15% of the offering and to moderate an imbalance between supply and demand post-issue by on-market purchases or, in a heated market, sales following the exercise of options. 147 Recent decisions have interpreted “artificial price” in s 1041A consistently with the interpretation of “false or misleading appearance of active trading” in s 1041B (see [11.200]). In ASIC v Soust Goldberg J held that: Having regard to the context in which the expressions “artificial price” and “false or misleading appearance” [in s 1041B(1)] appear, I consider that the expression “artificial price” in s 1041A connotes a price created not for the purpose of implementing or consummating a transaction between genuine parties wishing to buy and sell securities, but rather for a purpose unrelated to achieving the outcome of the interplay of genuine market forces of supply and demand. I consider that the reasoning of Mason J in North v Marra Developments Ltd (see [11.230]) in relation to the creation of a false or misleading appearance of active trading and the creation of false or misleading appearance with respect to the market for, or the price of, securities is equally applicable to the creation of an artificial price for trading in securities. That is to say, the reasoning applies to ss 1041A and 1041B(1)(b). It is fundamental to the working of the free market forces of securities exchanges such as the ASX Ltd that buyers are concerned to buy securities at the lowest possible price and sellers are concerned to achieve the highest possible price. Any different approach to the price for which securities are traded is a distortion of the interplay of the open market forces of supply and demand. A consideration of the scope of s 1041A is complicated by the fact that the section has a heading “Market Manipulation”. Section 13(3) of the Acts Interpretation Act 1901 (Cth) provides that headings to sections do not form part of the Act. It is therefore necessary to be careful in equating the act of creating an artificial price for shares or securities with manipulation of the market. 148

In DPP (Cth) v JM, in a unanimous judgment, the High Court said that “market manipulation is centrally concerned with conduct, intentionally engaged in, which has resulted in a price which does not reflect the forces of supply and demand”. 149 The court quoted from Mason J in North v Marra Developments Ltd (see [11.230]) concerning s 1041B: The section seeks to ensure that the market reflects the forces of genuine supply and demand. By “genuine supply and demand” I exclude buyers and sellers whose transactions are undertaken for the sole or primary purpose of setting or maintaining the market price. (emphasis added) 150

Concerning the interpretation of “artificial price” in s 1041A, the High Court in DPP (Cth) v JM said: 146

James Hardie Industries NV v ASIC [2010] NSWCA 332; (2011) 81 ACSR 1 at [183], [184] (NSWCA); see contra, in relation to s 1041B, ASC v Nomura International Plc (1998) 29 ACSR 473 at 561 (greater than 50% chance required).

147 148 149

See A Trichardt (2003) 21 ACSR 26, 75. ASIC v Soust [2010] FCA 68 at [90]-[92]. (2013) 94 ACSR 1 at [70].

150

(2013) 94 ACSR 1 at [70].

886

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The forces of “genuine supply and demand” are those forces which are created in a market by buyers whose purpose is to acquire at the lowest available price and sellers whose purpose is to sell at the highest realisable price. The references in s 1041A to a transaction which has, or is likely to have, the effect of creating an “artificial price”, or maintaining the price at a level which is “artificial”, should be construed as including a transaction where the on-market buyer or seller of listed shares undertook it for the sole or dominant purpose of setting or maintaining the price at a particular level. It is, however, important to emphasise that whether there are other kinds of transaction which have the effect of creating or maintaining an artificial price in a market for listed shares is not [here] decided. The price that results from a transaction in which one party has the sole or dominant purpose of setting or maintaining the price at a particular level is not a price which reflects the forces of genuine supply and demand in an open, informed and efficient market. It is, within the meaning of s 1041A, an “artificial price”. The offer to supply or acquire of the kind described is made at a price which is determined by the offeror’s purpose of setting or maintaining the price. It is not determined by the offeror’s purpose, if buying, to minimise, or, if selling, to maximise, the price paid, and it is not determined by the competition between other buyers whose purpose is to minimise the price and other sellers whose purpose is to maximise the price. If the offer results in a transaction, that is a transaction which can be characterised as at least likely to have the effect of creating or maintaining an artificial price for trading in the shares. Because s 1041A prohibits transactions which are likely to have that effect, it is not necessary to demonstrate, whether by some counterfactual analysis or otherwise, that the impugned transactions did create or maintain an artificial price. It is sufficient to show that the buyer or seller set the price with the sole or dominant purpose described. 151

If a transaction is made for the sole or dominant purpose of setting or maintaining a price for listed shares, it is not necessary to proffer additional proof that the impugned transactions affected the behaviour of genuine buyers and sellers in the market in order to demonstrate that the transactions had, or were likely to have, the effect of creating or maintaining an artificial price. This is because market participants are entitled to assume that the transactions are made between genuine buyers and sellers, and are not made for the purpose of setting or maintaining a particular price; transactions made with such a purpose have, or at least are likely to have, the effect of setting or maintaining an artificial price for the shares in question. 152 Further, proof of a sole or dominant purpose is not a separate element of the offence of market manipulation but one way of demonstrating that the impugned transaction was at least likely to have the effect of setting or maintaining an artificial price. The court did not consider by what other ways that effect or likely effect might be established. 153 False trading and market rigging [11.200] There are further prohibitions upon conduct that involves false trading or market

rigging. 154 The first involves the creation of a false or misleading appearance of active trading and includes “pools” and “churning”: see [11.185]. Conduct (including by omission) is prohibited which has or is likely to have the effect of creating a false or misleading appearance of active trading in financial products on an Australian financial market or with respect to the market for, or the price for trading in, financial products on such a market: s 1041B(1). A person is taken to have created a false or misleading appearance of active trading if they: (a) enter into or carry out a transaction of acquisition or disposal of any of those financial products that does not involve any change in the beneficial ownership of the products; 151

(2013) 94 ACSR 1 at [71]-[73].

152 153

(2013) 94 ACSR 1 at [74]. (2013) 94 ACSR 1 at [76]; see valuable discussion at E Armson (2014) 32 C&SLJ 146.

154

See E Armson (2009) 27 C&SLJ 411 (canvassing problems with the false trading and market rigging provisions earlier identified by Treasury). [11.200]

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this occurs if a person who had an interest in the financial products before the acquisition or disposal, or an associate, has an interest in them after the acquisition or disposal or (b)

make an offer to acquire or to dispose of financial products at a specified price when the person has made or knows that an associate has made or proposes to make the counterpart offer for the same number, or substantially the same number, of those financial products at a price that is substantially the same: s 1041B(2), (3). “Wash sales” (see [11.185]) are typical instances of conduct within the latter prohibition. The reach of these prohibitions is discussed in North v Marra Developments Ltd [11.230] and Fame Decorator Agencies Pty Ltd v Jeffries Industries Ltd [11.235]. A related prohibition is against artificially maintaining trading prices: a person must not enter into, or engage in, a fictitious or artificial transaction or device if it results in the price for trading in financial products on an Australian financial market being maintained, inflated or depressed, or in fluctuations in the price for trading in financial products on the market: s 1041C(1). In determining whether a transaction is fictitious or artificial, it is not conclusive that the transaction is, or was at any time, intended by its parties to have effect according to its terms: s 1041C(2). Examples of conduct within the section include the conduct of de Berenger (see [11.190]) and “painting the tape” and “window dressing”: [11.185]. Dissemination of information about illegal transactions [11.205] Another group of prohibitions is upon the dissemination of information which is

likely to mislead the market. The prohibitions take several forms. The first prohibition further sanctions the manipulative practices outlined above by prohibiting the dissemination of information by interested parties about their likely effect upon stock prices. The prohibition applies to the circulation of information to the effect that the price for trading in financial products on an Australian financial market will, or is likely to, rise or fall, or be maintained, because of a transaction, or other act or thing done, in relation to those financial products if: • the transaction, or thing done, constitutes or would constitute a contravention of ss 1041A, 1041B, 1041C, 1041E or 1041F; and • the person or an associate has entered into such a transaction or done such an act or has or may receive a benefit for circulating the statement or information: s 1041D. False or misleading statements [11.210] Other prohibitions have wider application than to trading on financial markets.

They include the prohibition upon statements or information which are false in a material particular or materially misleading and which are likely to induce persons to apply for or dispose of financial products or to have the effect of increasing, reducing, maintaining or stabilising the price for trading in financial products on a financial market, when the person making the statement either does not care whether the statement is true or false or knows, or ought reasonably to have known, that the statement is false in a material particular or materially misleading: s 1041E(1). The “pump and dump” technique referred to at [11.185] is an instance of conduct to which this prohibition is directed. In James Hardie Industries NV v ASIC the NSW Court of Appeal considered an oral presentation and slideshow which the Hardie chief executive had made to several investment institutions. The slides were later made publicly available through the ASX market information platform. The slides contained the statement that “future [asbestos] claims [were] separated and fully funded”: see [7.80]. The court upheld the primary judge’s finding that the statement was misleading within s 1041E: these statements, intended for release to the public 888

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would be likely to convey to the reasonable member of the class that there was a proper and supportable basis for making the statements. 155

For a contravention of s 1041E, ASIC need establish that these materially misleading statements were likely to induce persons to dispose of or acquire JHINV shares or have the effect of reducing, maintaining or stabilising its share price. (Section 1041E does not require proof of actual inducement.) The Court of Appeal held that, for the purposes of ss 1041E and 1041H, the word “likely” means “real and not remote chance”, regardless of whether that chance is less or more than 50%. 156 The Court of Appeal acknowledged that “the exercise required of the court by s 1041E is both hypothetical and predictive [and while] the court may have regard to the market reaction [that reaction] is not conclusive of the question”. 157 The Court concluded that [a]s a matter of common sense, the representations [made by posting the slides on the ASX market information platform] would likely induce persons to acquire JHINV shares and would also have the effect of maintaining or stabilising the share price. After all, an objective of JHINV’s investor relations program … was to reduce share price volatility. 158

However, the oral presentation and slideshow to the “select and sophisticated” professional investors were not likely to have the relevant inducing effect since as a matter of their own professional responsibilities to clients [they] would analyse and further research information they received before acting upon it. It would be expected that persons in their position would be likely to have some resilience to persuasion solely on the basis of a 1 hour presentation. 159

Inducing persons to deal in securities [11.215] A person must not in Australia induce another person to deal in financial products

by making or publishing a statement, promise or forecast if the person knows, or is reckless as to whether, the statement is misleading, false or deceptive, or by a dishonest concealment of material facts: s 1041F(1). Dishonesty is measured according to the standards of ordinary people and known by the person to be dishonest according to the standards of ordinary people: s 1041F(2). This prohibition has its primary corporate law application in relation to fundraising; it is discussed in Chapter 10. Misleading or deceptive conduct [11.220] A person must not in Australia engage in conduct, in relation to a financial product

or a financial service, that is misleading or deceptive or is likely to mislead or deceive: s 1041H(1). This includes dealing in a financial product such as by issuing a financial product or publishing a notice in relation to a financial product: s 1041H(2). The prohibition is discussed in relation to fundraising at [10.215] and, in relation to the predecessor provision, Fame Decorator Agencies Pty Ltd v Jeffries Industries Ltd [11.235]. Remedies for breach of the market misconduct provisions [11.225] Breach of each of the prohibitions in ss 1041A – 1041G is expressed to be an

offence. Sections 1041A – 1041D are also civil penalty provisions and are therefore sanctioned under Pt 9.4B: s 1317E. In addition, a person may recover loss or damage suffered by conduct 155

[2010] NSWCA 332; (2011) 81 ACSR 1 at [173] (NSWCA).

156 157

[2010] NSWCA 332 at [184], [183]; citing, inter alia, Boughey v R (1986) 161 CLR 10 at [15]. [2010] NSWCA 332 at [242].

158

[2010] NSWCA 332 at [245].

159

[2010] NSWCA 332 at [342]. [11.225]

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that contravenes ss 1041E – 1041H by action against the person contravening the section or another person involved in the contravention: s 1041I(1). 160 Civil recovery does not depend upon conviction for an offence. A transaction which breaches one of the prohibitions is nonetheless valid in view of the general provision that failure to comply with a requirement of Ch 7 does not affect the validity of enforceability of the transaction: s 1101H(1). However, where a person has contravened a provision of Ch 7, another law relating to dealing in financial products or providing financial services or a provision of the operating rules of a licensed market, ASIC 161 may seek a wide range of judicial orders including orders • restraining acts in relation to financial products or financial services; • giving directions about complying with a provision of the operating rules; • restraining a person from acquiring, disposing of or otherwise dealing with any financial products; • restraining a person from acquiring, disposing of or otherwise dealing with any financial products; or • declaring a contract relating to financial products or financial services to be void or voidable: s 1101B. Thus, the purchaser under a non-complying short sale of approved securities, as a person aggrieved by the contravention, might seek orders declaring the contract void or voidable: s 1101B(4)(h). 162 Alternatively, ASIC, ASX and the other party to the short sale might seek injunctive relief under s 1324 or damages in lieu: s 1324(10).

North v Marra Developments Ltd [11.230] North v Marra Developments Ltd (1981) 148 CLR 42 High Court of Australia [The appellant stockbroking firm sued for remuneration alleged to be due to them in connection with advisory services on the capital reconstruction of the respondent which involved a merger with another company. The respondent denied liability for payment upon the basis that the contract for services was illegal and unenforceable since one of its terms required the appellant to support the price of the shares of the respondent on the stock market by purchases made upon their house account. Such price support, it was held at first instance and in the New South Wales Court of Appeal, involved a contravention of the then counterpart of s 1041B. This earlier provision had defined the prohibited act as one which is “calculated” to create the relevant appearance.] MASON J: [58] The relevant prohibition in the section is against creating, or causing to create, or doing anything which is calculated to create, “a false or misleading appearance with respect to the market for, or the price of, any securities”. In terms the statutory prohibition is directed against activity which is designed to give the market for securities or the price of securities a false or misleading appearance. In this setting, “calculated” means “designed” or “intended” rather than “adapted” or “suited”. It is not altogether easy to translate the generality of this language into a specific prohibition against injurious activity, whilst at the same time leaving people free to engage in legitimate commercial activity which will have an effect on the market and on the price of securities. Purchases or sales are often made for indirect or collateral motives, in 160

Recovery of loss or damage is subject to potential reduction for the proportionate liability of the claimant where the defendant did not intend to cause the loss or damage and did not do so fraudulently: s 1041I(1B); Pt 7.10, Div 2A. The claim is also subject to limitation under a State or Territory professional standards law that limits occupational liability in actions under s 1041H: s 1044B and see [10.215].

161

And, in the case of an alleged contravention of the operating rules of a financial market, a person aggrieved by the alleged contravention: s 1101B(1)(d).

162

As in NCSC v Monarch Petroleum NL [1984] VR 733 where sales made after a forged letter was sent to the stock exchange which had the effect of raising prices were declared void.

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North v Marra Developments Ltd cont. circumstances where the transactions will, to the knowledge of the participants, have an effect on the [59] market for, or the price of, shares. Plainly enough it is not the object of the section to outlaw all such transactions. It seems to me that the object of the section is to protect the market for securities against activities which will result in artificial or managed manipulation. The section seeks to ensure that the market reflects the forces of genuine supply and demand. By “genuine supply and demand” I exclude buyers and sellers whose transactions are undertaken for the sole or primary purpose of setting or maintaining the market price. It is in the interests of the community that the market for securities should be real and genuine, free from manipulation. The section is a legislative measure designed to ensure such a market and it should be interpreted accordingly. I agree with Hope and Samuels JJA [in the Court of Appeal] in rejecting the suggestion that the section strikes only at fictitious or colourable transactions. Transactions which are real and genuine but only in the sense that they are intended to operate according to their terms, like fictitious or colourable transactions, are capable of creating quite a false or misleading impression as to the market or the price. This is because they would not have been entered into but for the object on the part of the buyer or of the seller of setting and maintaining the price, yet in the absence of revelation of their true character they are seen as transactions reflecting genuine supply and demand and having as such an impact on the market. When purchases have been made of shares in a company at or about a particular level for the purpose of setting and maintaining a market price for those shares there is a breach of the statutory prohibition. At the very least purchases have then been made which are calculated to create “a false or misleading appearance with respect to the market for, or the price of” the shares. In reality the purchases are calculated to create a false market or false price. The false or misleading appearance is that the market, in the absence of any disclosure that a market support operation is on foot, appears to be real or genuine, there being no overt sign of market support or manipulation. In passing I note that it is enough to breach the section that the activities are calculated to create a false or misleading appearance. It is not necessary that they do in fact create that appearance … The question then is whether the contravention of the section results in an illegality so as to prevent the appellants from recovering [60] their remuneration. On the inferences drawn by the Court of Appeal the original agreement between the parties was one which from its inception contemplated the possibility of a breach of s [1041B] as a means of executing the scheme which the parties agreed should be carried into execution. As events fell out what was a contemplated possibility became an actuality – the appellants carried out their part of the contract by contravening [s 1041B]. It makes no difference that Marra acquiesced in what was done. The appellants’ performance of the agreement involved an illegality and the agreement itself envisaged this as a possibility. The appellants fail, not because the agreement on which they sue is avoided by s [1041B], but because the performance on which they rely involved illegal conduct. The consequence is that the claims based upon the account stated and the second agreement must also fail. Quite apart from contravention of s [1041B], the inferences drawn establish that the appellants’ claim was affected by common law illegality. The appellants’ claim for remuneration was based on the commission of fraudulent conduct, the making of statements which were and were known to be misleading with a view to deceiving the Scottish shareholders. A claim for remuneration for fraudulent conduct is defeated by the illegality principle. The general principle was expressed by Lindley LJ in Scott v Brown Doering McNab & Co ([1892] 2 QB 724 at 728-729) in these terms: In this case the correspondence put in evidence by the plaintiff in support of the claim he made at the trial shews conclusively that the sole object of the plaintiff in ordering shares to be bought for him at a premium was to impose upon and to deceive the public by leading the public to suppose that there were buyers of such shares at a premium on the Stock Exchange, when in fact there were none but himself. The plaintiff’s purchase was an actual purchase, not a sham purchase; that is true, but it is also true that the sole object of the purchase was to cheat and mislead the public. Under these circumstances, the plaintiff must look elsewhere [11.230]

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North v Marra Developments Ltd cont. than to a court of justice for such assistance as he may require against the persons he employed to assist him in his fraud, if the claim to such assistance is based on his illegal contract. As the fraud and illegality (common law and statutory) was a contemplated means of performing the contract and became an integral element in the appellants’ performance of the contract there is no basis for treating the fraud and the illegality as collateral only [61] or fraud as severable from the remainder of the work undertaken by the appellants. [MURPHY and WILSON JJ agreed with Mason J.]

Fame Decorator Agencies Pty Ltd v Jeffries Industries Ltd [11.235] Fame Decorator Agencies Pty Ltd v Jeffries Industries Ltd (1998) 28 ACSR 58 Court of Appeal of the Supreme Court of New South Wales [The facts of the case are summarised by Gleeson CJ in the extract below. The extract includes updated references to the statutory provisions.] GLEESON CJ: [59] This appeal, from a decision of Cohen J in the Equity Division, raises questions as to the meaning and effect of ss 995 [1041H] and 998 [1041B] of the Corporations Law … [The substitution of s 1041H for s 995 and s 52 of the Trade Practices Act 1974 (Cth), now s 18 of the Australian Consumer Law is discussed at [10.210].] Cohen J held that two share transactions, both being sales of shares in Jeffries Industries Ltd (Jeffries) on 28 April 1995, contravened ss 995 [1041H] and 998 [1041B] of the Corporations Law, and made declarations accordingly. The appellant, Fame, challenges that finding and seeks to have the declarations set aside. ASC supports the finding and seeks to maintain the declarations. … Jeffries is a public company. Its shares are listed on the Stock Exchange. Fame has at all material times held shares in Jeffries. Mr J F O’Halloran, who principally controls the business of Fame, was formerly the chairman of directors of Jeffries. He had ceased to hold that position by April 1995. In addition to a substantial parcel of ordinary shares in the capital of Jeffries, Fame, in 1995, held converting preference shares. The conversion date, on which those shares were to be converted to ordinary shares, was 4 February 1999, but the articles of association of Jeffries provided that conversion might be accelerated in certain circumstances. One such circumstance is presently relevant. If, prior to the completion date, Jeffries failed to pay a certain specified dividend on a particular date, then each holder of a converting preference share had a right to accelerate the conversion date in respect of all or some of the holder’s preference shares. In that event, the number of ordinary shares to be allotted upon conversion was to be determined in accordance with a formula. It suffices for present purposes to say that one of the elements of that formula was the weighted average sale price of all fully paid ordinary shares in Jeffries sold on the stock exchange during the 20 trading days immediately prior to the conversion date. The lower the average sale price of ordinary shares during that period of 20 trading days, the greater would be the number of ordinary shares to be allotted to a preference shareholder upon conversion. On Thursday 27 April 1995 Mr O’Halloran became aware that the directors of Jeffries intended to announce on the following day, Friday 28 April 1995, that there would be no dividend paid for the converting preference shares for the period ended Sunday 30 April 1995. That would trigger the accelerated conversion provisions. The shares in Jeffries were thinly traded, and sales were infrequent. This rendered the market susceptible to manipulation. In March 1995 there was a placement of 1.45 million shares, and during that month there were sales on the stock exchange of about 755,000 ordinary shares at prices ranging from 25c to 35c each. From the beginning of April, 40,000 shares were sold on the stock exchange, at prices ranging from 35c to 50c. During the morning of 28 April there was a sale of 5000 shares at 45c. Mr O’Halloran contacted his stockbroker, Mr Powell, on 27 April and again on 28 April. There were some differences between the evidence of Mr O’Halloran and that of Mr Powell about those 892

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Fame Decorator Agencies Pty Ltd v Jeffries Industries Ltd cont. communications, but the differences were not [60] regarded by Cohen J as material. They discussed the possible sale by Fame of a substantial number of shares in Jeffries. As they acknowledged, they both understood that, for reasons related to the possible conversion of preference shares, it was in the interests of Fame that the average sale price of ordinary shares, over the period up to and including 28 April, be minimised, thereby increasing Fame’s entitlement on conversion of its preference shares. There was evidence as to the method of operation of the Stock Exchange Automated Trading System (SEATS). Under that system brokers place on record offers to buy, and offers to sell, shares. When an offer to buy is matched with an offer to sell, a trade takes place. Brokers have computer access to the information which records offers and trades. As the evidence in the present case demonstrated, brokers sometimes make an offer to buy, or an offer to sell, at a price substantially different from the current market price, leaving such offer to stand in the hope that at some future time changes in market circumstances will result in its acceptance. If, at any given time, there are in existence a number of offers to buy shares in a company at various prices, then a seller who is willing to trade must accept the offers to buy in descending sequence until the shares available for sale have been exhausted, or there is no longer a willingness to sell at a price matching an outstanding offer. According to Mr Powell, at about midday on 28 April he informed Mr O’Halloran of the details of the various offers to buy shares in Jeffries which were current at that time. These were as follows: 31 March 1995 30 March 1995 28 March 1995 30 March 1995 27 March 1995 21 March 1995 9 March 1995 9 March 1995

28,000 shares 5000 shares 10,000 shares 10,000 shares 20,000 shares 6000 shares 20,000 shares 250,000 shares

@ 35c @ 30c @ 28c @ 28c @ 26c @ 25c @ 14c @ 13c

The dates listed above are the dates on which the offers to buy, or bids, were entered in the system. According to the SEATS system, if Fame wished to sell shares in Jeffries it was required to accept those bids in the sequence listed above. Trading opens at 10 am and closes at 4 pm. It was agreed between Mr Powell and Mr O’Halloran that they would have a further conversation later in the afternoon of 28 April. It was also agreed that if, by that time, there was no change in the market, Mr O’Halloran would instruct Mr Powell to sell 170,000 shares in Jeffries down to a price of 13c, and that the sales would be left until as late as possible, just before the close of the market. At 3.52 pm on 28 April there was a further telephone conversation in which it was agreed between Mr O’Halloran and Mr Powell that Mr Powell would sell 170,000 shares down to 13c. In the result, Fame accepted all the outstanding offers to buy Jeffries shares at prices of 35c, 30c, 28c, 26c, 25c and 14c. Fame also accepted offers to buy 74,000 shares at 13c, and there was, additionally, the sale of an odd lot parcel of [61] 1000 at 26c. The offer to buy 20,000 shares at 14c had been placed by Cameron Securities. Mr Cameron gave evidence that, when he placed the bid, the market price was 35c. He said in his evidence: I didn’t really think, in my wildest dreams, that anyone would sell them at 14, but if you’re not there you don’t get them. Sometimes it happens. In this case it happened. The bid, or offer to buy 250,000 at 13c, had been placed by James Capel. There was no evidence from any member of that organisation. There was no evidence or suggestion of any collusion between Fame and either Cameron Securities or James Capel. The transactions which occurred on 28 April excited official interest, and an investigation was undertaken. Disputes arose between Jeffries and various persons as to the significance of those [11.235]

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Fame Decorator Agencies Pty Ltd v Jeffries Industries Ltd cont. transactions in relation to the conversion of preference shares. For the purposes of this appeal it is unnecessary to go into the detail of those disputes, or their outcome. The sole question with which we are concerned is whether Cohen J was right to conclude that the sales of 20,000 Jeffries shares at 14c and 74,000 Jeffries shares at 13c involved contraventions of ss 995 [1041H] and 998 [1041B] of the Corporations Law. ASC argued that all of the sales by Fame on 28 April 1995 contravened ss 995 [1041H] and 998 [1041B] but … regarded it as unnecessary to pursue its cross-appeal in support of that contention. At first instance, Mr O’Halloran gave evidence in explanation of his conduct. He sought to persuade Cohen J that, in placing the selling orders on 28 April, he was acting under pressure of a need to obtain quick cash to satisfy certain financial commitments. His evidence was disbelieved. No attempt has been made to challenge Cohen J’s findings of fact. Cohen J found that Mr O’Halloran had funds available to enable him to pay any urgent debts, and there was no reason, arising out of any need for cash, for him to sell so many shares in Jeffries at such a low price. Cohen J said that the only conclusion that could be drawn was that Mr O’Halloran deliberately sold at least the last 94,000 shares on 28 April at a price well below the previous sale prices in order to create an artificially low figure for purposes of the conversion calculation to be made in respect of the preference shares. All of the offers to sell made by Mr O’Halloran on behalf of Fame were made within about three minutes of the close of trading on 28 April 1995. That was an aspect of the transactions which had previously been arranged between Mr Powell and Mr O’Halloran. The apparent purpose was to foreclose the possibility that, in response to the placing of selling orders, additional buyers would come into the market offering to purchase shares in Jeffries at prices above the figures of 14c or 13c. That is exactly what happened on the next trading day, which was the Monday of the following week. On that day the market price of shares in Jeffries recovered to a figure well in excess of 14c. Mr O’Halloran’s objective was unusual. He was setting out to achieve a sale of a substantial number of Fame’s shares in Jeffries, not at the highest possible price, but at the lowest possible price. This would be to the ultimate financial advantage of Fame, because a depressed market price for Jeffries shares would, by reason of the conversion formula, result in the potential acquisition of an increased number of ordinary shares upon conversion. The question for this court to decide is whether, on the facts as found by Cohen J, there was a contravention of s 995 [1041H] and/or s 998 [1041B] of the Corporations Law. Senior counsel for the appellant submitted that there was nothing misleading [62] about what occurred, and no form of market manipulation involved. There was, he acknowledged, conduct intended to take opportunistic advantage of the market situation which existed on 28 April, but that situation had not been created by the appellant or by any person acting in collusion with the appellant. All that the appellant did, acting in its own financial interests, was to accept the various offers to buy shares in Jeffries which had been placed in the market prior to 28 April and were still in place. The appellant went into the market immediately before the close of trading on 28 April, and simply mopped up all the current offers to buy at the current offer prices. The sales were all arm’s length transactions. The vendor met the market, and the fact that, for its own reasons, it suited the vendor to accept, for some of its shares, a lower price than might well have been obtained if it had acted differently, is immaterial. It is convenient to deal first with s 998 [1041B], which relevantly provides: 998(1) A person shall not create, or do anything that is intended or likely to create … a false or misleading appearance with respect to the market for, or the price of, any securities. This provision is the current Australian counterpart of … ss 9(a)(i) and 10(b) of the Securities Exchange Act 1934 (US) and r 10b-5 made pursuant to s 10(b). (For an examination of United States authorities on the corresponding legislation: see A Black, “Regulating Market Manipulation: Sections 997-999 of the Corporations Law” Australian Journal of Law, vol 70 No 12, 1996, pp 987-1010.) In North v Marra Developments Ltd (1981) 148 CLR 42; 37 ALR 341; 6 ACLR 386, a case concerning s 70 of the Securities Industry Act 1970 (NSW) Mason J said, at CLR 58-59 [see [11.230]]: 894

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Fame Decorator Agencies Pty Ltd v Jeffries Industries Ltd cont. In terms the statutory prohibition is directed against activity which is designed to give the market for securities or the price for securities a false or misleading appearance … It is not altogether easy to translate the generality of this language into a specific prohibition against injurious activity, whilst at the same time leaving people free to engage in legitimate commercial activity which will have an effect on the market and on the price of securities. Purchases or sales are often made for indirect or collateral motives, in circumstances where the transactions will, to the knowledge of the participants, have an effect on the market for, or the price of, shares. Plainly enough, it is not the object of the section to outlaw all such transactions. It seems to me that the object of the section is to protect the market for securities against activities which will result in artificial or managed manipulation. The section seeks to ensure that the market reflects the forces of genuine supply and demand. By “genuine supply and demand” I exclude buyers and sellers whose transactions are undertaken for the sole or primary purpose of setting or maintaining the market price. The concluding sentence is directly in point in this case. Mason J went on to reject the suggestion that s 70 struck only at fictitious or colourable transactions. This approach accords with United States authority on similar legislation, where a price reflecting basic forces of supply and demand working in an open, efficient and well-informed market, is contrasted with an artificial price resulting from manipulative conduct: see eg, Cargill Inc v Hardin 452 F 2d 1154 (1971); Freeman v Laventhol & Horwath 915 F 2d 193 (1990). Section 998 [1041B] aims to preserve the integrity of the share market. Markets, in reflecting the interaction of forces of supply and demand, may suffer from a variety of imperfections, including mismatches of information, without such imperfections destroying their integrity. However, the conduct of a seller of [63] thinly traded shares, calculated to effect sales at the lowest, rather than the highest, obtainable price, and timed so as to deflect the possibility of some purchasers bidding up the price, had both the purpose and effect of creating, temporarily, an artificial market and price. There is a difference between the market and the individual buyers who had current bids immediately before the close of trading on 28 April 1995. The effect of Fame’s conduct upon the market for shares in Jeffries, and the market price, was not merely incidental. The central object of such conduct was to influence the market price. As Mason J acknowledged in North, in individual cases there may be difficulty in determining whether the conduct of a buyer or a seller, unless fully disclosed, falsifies the assumptions upon which a market operates, and damages the integrity of the market. In the present case, however, Cohen J was right to conclude that both the purpose and the effect of Fame’s conduct was to create an artificial market price for shares in Jeffries and that such conduct contravened s 998 [1041B]. I turn to s 995 [1041H], which relevantly provides: 995(2) A person shall not, in or in connection with: (a) any dealing in securities; … engage in conduct that is misleading or deceptive or is likely to mislead or deceive. … (4) Nothing in the following provisions of this Part … shall be taken as limiting by implication the generality of subsection (2). The parliamentary history of the legislation shows that this provision was inspired by s 52 of the Trade Practices Act 1974 (Cth). It was regarded as desirable that, although s 52 may have applied to some cases of dealing in securities, there should be a similar provision having as its focus conduct in relation to securities. Much of the case law which has developed around s 52 will apply also to s 995 [1041H]. There is a substantial degree of overlapping between s 995 and the following provisions, and subs (4) prevents any reading down by implication from those provisions. The section was described in the explanatory memorandum to the bill when it was introduced as “a general ‘catch all’ provision”. [11.235]

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Fame Decorator Agencies Pty Ltd v Jeffries Industries Ltd cont. The expression “in, or in connection with” means that the section is not restricted to conduct which amounts to, or is part of, a dealing in securities. In the present case, Cameron Securities and James Capel were not misled or deceived, and they have no complaints to make about the conduct of Fame. The offers to sell shares to Cameron Securities and James Capel, or, more accurately, the acceptances of their offers to buy, and the resulting contracts of sale and purchase did not, in themselves, considered in isolation, involve misleading or deceptive conduct. They had, and were intended to have, the legal effect which all parties to the dealings wished to achieve. However, the conduct of Fame in connection with the sales was, for the reasons given above in relation to s 998 [1041B], likely to mislead or deceive third parties who were interested in the market for shares in Jeffries, who were entitled to assume that market prices reflected the genuine interaction of forces of supply and demand, and who would not have expected that the seller on 28 April 1995 was seeking to sell to the lowest bidders and eliminate the possibility of a higher bidder emerging. [64] The finding of a contravention of s 995 [1041H] was also correct. The appeal should be dismissed with costs. PRIESTLEY JA: The facts of this appeal are set out in the Chief Justice’s reasons. On the facts it is my opinion the appeal should be upheld. The appellant is a company whose actions were decided on and carried out by Mr O’Halloran. For simplicity, I will refer to him as the appellant. The appellant took the market as he found it. By “market” for the purposes of this case I mean the place where shares in Jeffries Industries Ltd (Jeffries) could be bought and sold together with the sum of publicly available information relevant to buyers and sellers of those shares. The appellant did nothing in that market beyond selling shares in a way and for prices publicly on offer to any holder of those shares who wished to sell at those prices. His sales began after 3.52 pm on Friday 28 April 1995 and ended by 4 pm. At the close of trading the market price had fallen. On Monday 1 May 1995, the next day of market trading, the price rose. An observer of the events of the last eight minutes of trading on the Friday who understood the full publicly available facts relevant to Jeffries’ shares would not have been deceived about the market price of those shares by what happened during those eight minutes. What happened in the market happened because of the market’s own mechanism. The appellant did nothing to that mechanism other than accept offers, made in accordance with market rules, to buy shares in Jeffries at set prices. The appellant had nothing to do with those offers being on foot. Anyone who knew how to find out what offers were on foot could get the information in a moment. Similarly, knowledge of the situation Jeffries had created, quite independently of the appellant, concerning its converting preference shares was publicly available. In doing what he did, the appellant was acting upon his own view of what would be to his advantage, on publicly available information, by selling shares in accordance with known market procedures, in circumstances which he had had no part in producing. This is the mainspring of ordinary market behaviour. In acting for his own advantage the appellant’s purpose was not to create a false or misleading appearance with respect to the market for, or the price of, Jeffries shares; nor in my opinion did he in fact do so. His purpose was to bring about a close of market price which would be to his advantage when Jeffries did the calculation required by its conversion formula. On the same facts he in my opinion engaged in no conduct which was misleading or deceptive, or likely to mislead or deceive any person aware of the publicly available facts. The absence of any misleading effect of his conduct seems to me to be demonstrated by what actually happened in the market. There were no sales at the close-of-market price of 28 April, other than the appellant’s. The next market day, sales were at higher prices. The unique combination of circumstances at the time the appellant sold his shares could not have been foreseen by Jeffries and brought about a situation to Jeffries’ disadvantage. This was not due to 896

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Fame Decorator Agencies Pty Ltd v Jeffries Industries Ltd cont. anything done by the appellant. Jeffries had created the arrangement upon which the market procedures then worked. “He that diggeth a pit shall fall into it.” Jeffries made the rules about its converting shares. The appellant took advantage of them, as anyone else who held 170,000 ordinary shares in Jeffries could have done if that holder, because of a simultaneous holding of converting preference shares, thought it advantageous to do so. [65] I do not see how the appellant, doing nothing more than sell shares in accordance with market procedures, without collusion, connivance, prearrangement or even communication with any other person than his agent fell within the words either of ss 995 [1041H] or 998 [1041B] of the Corporations Law. The appellant himself appears to have thought he was doing something shady, or at least that others might think shady: he told a cover story for his need for the proceeds of the sale of the shares which Cohen J found was false, and “the wicked flee when no man pursueth”. However, whatever the appellant’s motivation for his cover story, which to my mind is the only point in this case against him, what he did was in my opinion lawful and not in breach of either of the two sections relied on against him. The difficulty in coming to any other conclusion is illustrated by the appellant’s sales of shares for 28c, 26c and 25c. Cohen J held these sales not in breach of the sections. How could the conduct of a seller of shares, “doing nothing more than accept lawful standing offers to buy”, be not prohibited in accepting one offer at 25c and the next moment prohibited in accepting another offer at 13c? In my opinion the appeal should be upheld with costs and the declarations made by Cohen J set aside. POWELL JA: I agree with Gleeson CJ. [Special leave to appeal to the High Court was refused on the basis that “[the] case turns essentially on a question of fact about which opinions might be divided, as in the Court of Appeal.”]

INSIDER TRADING The scope of the disclose or abstain requirement [11.240] Insider trading 163 is the most widely known (and, perhaps, practised) form of

market abuse. ASX has identified the following principal types although several others might be chosen with equal cogency. 163

A Black (2011) 29 C&SLJ 313 (examining ASIC’s enforcement record with respect to insider trading); G North (2011) 25 Aust Jnl of Corp Law 209 (exploring “legislated astigmatism” in insider trading policy objectives and Henry Manne’s intellectual foundations for libertarian approach); M J Duffy (2009) 23 Aust Jnl of Corp Law 149 (continuing problems of proof); J Overland (2010) 24 Aust Jnl of Corp Law 266 (mens rea requirement for corporate liability for insider trading). On the origins and bases of insider trading regulation see Loss, pp 723-738; R C Clark, Corporate Law (1986), pp 264-283; J D Cox (1990) 12 Syd L Rev 456. The general literature of insider trading regulation is voluminous. For significant writing of relevance to the policy foundations of Australian regulation see Corporations and Markets Advisory Committee, Insider Trading Report (2003); Companies and Securities Advisory Committee, Insider Trading (Discussion Paper; 2001); House of Representatives Standing Committee on Legal and Constitutional Affairs, Fair Shares for All: Insider Trading in Australia (Griffiths Report; 1989); P Anisman, Insider Trading Legislation in Australia: An Outline of the Issues and Alternatives (1986); A Black (1992) 15(1) UNSWLJ 215 and (1988) 16 MULR 633; R Tomasic, Casino Capitalism?: Insider Trading in Australia (1991); on the interpretation and application of the present regulation see J Overland (2016) ABLR 256 (reviewing the requirement of “possession” of inside information); J Overland (2015) 33 C&SLJ 317 (deterrence and penalties); J Overland (2014) 32 C&SLJ 353 (materiality of information); J Overland (2013) 31 C&SLJ 189 (the scope of inside information); J Overland (2006) 24 C&SLJ 207; A Jacobs (2005) 23 C&SLJ 231; D Pompilio (2007) 25 C&SLJ 467; M Chang, R Hillman & I Watson (2005) 23 C&SLJ 165. [11.240]

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• Classic insider trading: when a director or other corporate insider (or their associates) buys or sells securities in the company before the release of a price-sensitive announcement. • “Front running”: when a broker, knowing that a client has a large or market-sensitive order, puts through a transaction on the broker’s or another client’s behalf, thus benefiting from the pre-warning. • “Scalping”: trading prior to the release of a research report. • “Piggy-backing”: when a broker, after observing a series of transactions of a client who has a high degree of trading success, repeats their investments for the broker or clients. This practice is similar to front-running but occurs after the transactions of the client have been completed. • “Inside market information”: when a broker disseminates information that certain trading activity is occurring or is about to occur which will cause a price change. Again, the technique is similar to “front running”. 164 Insider trading has been the subject of specific legal regulation in Australia since the securities industry legislation of 1970, in mark of its contribution to the stock market boom of the late 1960s: see [2.80]. The complementary proscriptions in ss 182 – 183 upon company officers making improper use of information of position have an even longer history. Each provides for a criminal sanction coupled with a civil compensation remedy: see [7.500]. In 1991, following a parliamentary review resulting in the Griffiths Report, 165 the insider trading provisions were substantially recast to adopt a “parity of information” approach over the earlier model that looked to the whether the insider’s informational advantage was obtained through a connection to the company whose securities were traded. The provisions are now contained in Pt 7.10 Div 3. The principal change was to “alter the focus of the prohibition from the connection which a person had with a corporation to the use of certain information”. 166 The change was made by deleting the requirement for a connection between the person in possession of inside information and the company to which the information relates. Although the offence is called insider trading and the information in question is referred to in the Act as “inside information”, the person who possesses the information in question need not be a corporate insider in any sense: “[a]lthough the offence … may sometimes be referred to as an offence of ‘insider trading’, it is more accurately described, in the words of the heading of the section, as ‘Prohibited conduct by [a] person in possession of inside information’. … Noticeably absent from these provisions [is] any requirement that the information in question come from within the corporation the securities of which were the subject of the prohibition”. 167 Instead, Div 3 prohibits any person in possession of “inside information” using it to trade in or subscribe for securities of the company, however the information was acquired. Inside information is simply defined in terms of the perceptions of a reasonable person as to the information’s price significance: a person (the insider) is prohibited from trading in financial products 168 such as securities while knowingly in 164 165

Australian Stock Exchange Ltd, Circular to Member Organisations, 21 June 1990. House of Representatives Standing Committee on Legal and Constitutional Affairs, Fair Shares for All: Insider Trading in Australia (Griffiths Report; 1989); the Griffith Committee was animated by the objective expressed by the Campbell Committee inquiry into the Australian financial system in 1981 that “securities markets operate freely and fairly, with all participants having equal access to relevant information”: Australia, Committee of Inquiry Into the Australian Financial System, Australian Financial System: Financial Report of the Committee of Inquiry (1981), [21.118].

166 167

Mansfield v The Queen [2012] HCA 49 at [36] per Hayne, Crennan, Kiefel and Bell JJ. Mansfield v The Queen [2012] HCA 49 at [22] per Hayne, Crennan, Kiefel and Bell JJ.

168

The prohibition is expressed to apply to “Division 3 financial products”, a term defined to include securities and (inter alia) any other financial products that are able to be traded on a financial market: s 1042A.

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possession of information that is not generally available and, if it were generally available, a reasonable person would expect it to have a material effect on the price or value of particular financial products: ss 1043A(1), 1042A (definition of inside information). 169 The insider is also prohibited from communicating inside information to another person (commonly called a tippee) if they know or ought reasonably to know that the tippee would or would be likely to apply for, acquire or dispose of a financial product or procure another person to do so: s 1043A(2). Information 170 is defined as being generally available where it (a) consists of readily observable matter (s 1042C(1)(a)); (b) has been made known in a manner which would, or would be likely to, bring it to the attention of persons who commonly invest in securities of a kind whose price or value might be affected by the information and where a reasonable period of time for the dissemination of information has elapsed (s 1042C(1)(b)); or (c) consists of deductions, conclusions or inferences drawn from the readily observable matter or information made known in the manner described whether or not the reasonable dissemination time has passed in relation to the latter information: s 1042C(1)(c). Information within the prohibitions need not be true: The word “information” in its ordinary usage is not to be understood as confined to knowledge communicated which constitutes or concerns objective truths. Knowledge can be conveyed about a subject-matter … and properly be described as “information” whether the knowledge conveyed is wholly accurate, wholly false or a mixture of the two. The person conveying that knowledge may know or believe that what is conveyed is accurate or false, whether in whole or in part, and yet, regardless of that person’s state of mind, what is conveyed is properly described as “information”. 171

The inclusion within the definition of “information” of “matters of supposition”, “other matters that are insufficiently definite to warrant being be made known to the public” and “matters relating to the intentions or likely intentions of a person” confirm that “information” in Div 3 is not to be read as confined to matters shown to be true. 172 The effect of s 1043A is to create a class of persons who, by reason of an informational advantage (viz, their possession of “inside information”), are prohibited from trading. It is not necessary that there be any causal connection between possession of the information and the decision to trade the securities; a sale prompted by an innocent or legitimate motive does not relieve the seller from the prohibition. 173 Similarly, if a person possesses information that he knows is not generally available and is price sensitive, the prohibition on trading will apply whether or not he consciously brings to mind that information and its nature at the time he makes a decision to trade in shares. The reason for the alternative between “knows” and “ought to know” is not to deal with lapses of memory or a failure to recall the true nature of the information possessed but to deal with the situation where 169

A reasonable person would be taken to expect information to have a material effect on the price or value of particular financial products if (and only if) the information would, or would be likely to, influence persons who commonly acquire financial products in deciding whether or not to acquire or dispose of the particular financial products: s 1042D. The financial products (securities, in this context) need not be those to which the information directly relates.

170

Information includes matters of supposition and other matters insufficiently definite to warrant being made known to the public and matters relating to the intentions, or likely intentions, of a person: s 1042A; see further K Kendall & G Walker (2006) 24 C&SLJ 343.

171 172

Mansfield v The Queen [2012] HCA 49 at [29]. In Mansfield the relevant information upon which the defendant acted was wholly false. Its materiality was to be decided at a new trial. Mansfield v The Queen [2012] HCA 49 at [32].

173

R v Farris (2015) 107 ACSR 26 at [173]. [11.240]

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a person possesses inside information and fails to appreciate that it is not generally available or price sensitive where the objectively available circumstances should have led them to that conclusion. 174

Further, if a person possesses inside information, it does not matter to liability that she or he was not consciously aware of that information when placing a buy or sell order: A person possesses information that is in his memory even when he is not consciously thinking of it. The knowledge element in s 1043A(1)(b) relates to the act of possession not to the point of sale. It requires that the person know or ought to know that the information he possesses has a certain quality. That is, the person is aware or ought to be aware that the information is price sensitive and not generally available at the time he acquires it or at some point thereafter and before he trades. 175

These basic prohibitions are amplified in satellite provisions defining the breadth of its proscriptions, including provisions defining the extent of attributed knowledge within corporations and partnerships (ss 1042G and 1042H), and permitted exceptions including those for • information barriers (commonly called Chinese walls) constructed within corporations and partnerships that limit information flows within an organisation (ss 1043F, 1043G); • underwriters applying for securities under an underwriting agreement or disposing of them under the underwriting agreement (s 1043C); • knowledge of a person’s own intentions or activities which knowledge falls within the definition of information under s 1042A (s 1043H); and • transactions by a financial services licensee on behalf of a client in circumstances where a Chinese wall prevented prohibited information flows within the organisation: s 1043K. 176 The insider trading prohibition in Pt 7.10 Div 3 calls for a choice between disclosure of information that gives a person a risk advantage in financial transactions or abstention from trading. The policy underlying Div 3 clearly draws upon several notions, primarily that of fairness through equality of access to information in financial transactions. However, the policy is qualified, eg, in the licence extended to deductions or inferences under s 1042C(1)(c). In his discussion of the competing theories underlying Div 3, Mason P in R v Firns [11.255] referred to what he called “legislated astigmatism” (at [53]) in the blurring of the equal access policy through the exception for deductions or inferences under s 1042C(1)(c) and the “ambiguous embrace of the market fairness/‘equal access’ and market efficiency theories” (at [45]). Sanctions, remedies and relief

Criminal sanctions and defences [11.245] The prohibitions in s 1043A(1) and (2) are criminal offences: s 1311 and Sch 3,

items 311C and 312A. In a criminal prosecution, the onus is upon a defendant who seeks to rely upon one of the exceptions contained in ss 1043B – 1043K to establish its elements, and not upon the prosecution to prove the non-existence of facts or circumstances which, if they existed, would preclude a contravention: s 1043M(1). In a prosecution for an offence based 174

R v Farris (2015) 107 ACSR 26 at [174].

175 176

R v Farris (2015) 107 ACSR 26 at [175]. The efficacy of such information barriers within financial services conglomerates, to prevent insider trading and multiple conflicts of interest with client duties, is much contested: see A F Tuch (2013-2014) 39 J Corp L 563.

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upon s 1043A(1), because the person entered into, or procured another person to enter into, a transaction or agreement at a time when certain information was in the defendant’s possession, it is a defence if the information came into the defendant’s possession solely as a result of the information having been made known as mentioned in s 1042C(1)(b)(i) (that is, the information would have been generally available if the reasonable dissemination period had elapsed): s 1043M(2)(a). It is a further defence if the other party to the transaction or agreement knew, or ought reasonably to have known, of the information before entering into the transaction or agreement: s 1043M(2)(b). For the purposes of this defence, a corporation ought reasonably to know something that an officer ought reasonably to know (s 1042G(1)(d)); a similar presumption applies for members of a partnership with respect to matters that a member or employee of the firm ought reasonably to know: s 1042H(1)(d). Like defences apply to a prosecution for an offence based upon s 1043A(2): s 1043M(3).

Civil remedies and relief [11.250] A transaction which is in breach of s 1043C(1) or (3) is nonetheless valid in view of

the general provision that failure to comply with a requirement of Ch 7 does not affect the validity or enforceability of the transaction: s 1101H(1). The prohibitions in s 1043A(1) and (2) are also sanctioned as civil penalty provisions: s 1317E(1). Accordingly, the Court may make a declaration of contravention under s 1317E(1), impose a pecuniary penalty under s 1317G(1A) and, with respect to damage that resulted from the contravention, a compensation order against persons who contravene the provisions or are involved in a contravention within s 79: s 1317HA(1). In proceedings under Pt 9.4B with respect to a contravention of s 1043A(1) or (2), the court may relieve a person from liability if it appears to the court that the circumstances in any of ss 1043B – 1043K applied (s 1043N(a)) or the circumstances that would amount to an defence to a prosecution under s 1043M(2) or (3) applied: s 1043N(b) and (c). Unlike the application of s 1043M in criminal proceedings, relief from civil liability under s 1043N is discretionary. The general compensation remedy in s 1317HA is elaborated and extended 177 by specific provisions with respect to conduct that contravenes s 1043A(1) where the insider knows or is reckless as to whether information is inside information: s 1043L(1). 178 (In this context, the recklessness limb replaces that in s 1043A(1)(b), viz, that the insider ought reasonably to know that the information is inside information; this limb applies where actual knowledge is either absent or cannot be proved.) This specific remedy permits recovery of compensation in several circumstances. The first applies where the insider applied for, or procured another person to apply for, financial products; the issuer of the products may, by action under s 1317HA, recover as compensation for damage suffered by the issuer the amount (if any) by which the application price fell short of the then likely market price of the financial products if the inside information had been generally available: s 1043L(2). The issuer may recover against the insider, the tippee or any other person involved in the contravention. 179 Like recovery may be made by a person who disposes of financial products to an insider or tippee (s 1043L(3)) or who acquires them from an insider or tippee, in either case where they did not possess the inside information: s 1043L(4). In addition to its compensation remedy under s 1043L(2), an issuer may also recover as compensation for damage it has suffered the amount which the seller to or purchaser from the insider or tippee might recover under s 1043L(3) or (4): s 1043L(5). If it considers that it is in the public interest to do so, ASIC may also bring an 177

Any right of action under s 1043L is in addition to that under s 1317HA: s 1043L(10).

178

The recklessness of corporate officers and of members or employees of partnerships is attributed to the corporation and to members of the partnership, respectively: s 1042G(1)(c).

179

The issuer does not appear to be disqualified from recovery by its possession of the inside information. [11.250]

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action under s 1043L(2) or (5) in the name and for the benefit of the issuer: s 1043L(6). The Court may relieve the person wholly or partly from liability under s 1043L if it appears that the information came into the insider’s possession solely as a result of the information having been made known as mentioned in s 1042C(1)(b)(i) (that is, the information would have been generally available if the reasonable dissemination period had elapsed): s 1043L(7). If it finds that a contravention of s 1043A has occurred, the Court may, in addition to any other orders, make such order as it thinks just, including orders restraining the exercise of rights attached to financial products, restraining their issue or acquisition, directing their disposal, cancelling agreements for their acquisition or disposal, vesting them in ASIC or cancelling an Australian financial services licence: s 1043O. In ASIC v Petsas, the first instance of civil penalty proceedings for insider trading, the court referred to [the] good reasons why parliament and enforcing authorities are moving towards the use of civil sanctions (such as injunctions, forfeiture, restitution and civil fines) in preference to criminal sanctions especially in the regulatory sphere, regardless of whether the proscribed conduct is regarded as essentially criminal. The main reason for the move is that proceedings that are “civil” in nature are likely to be cheaper and more efficient than criminal proceedings. Civil proceedings are cheaper and more efficient because the rules of evidence are less strict, the protections afforded to defendants are not as great and the level of certainty required to secure a conviction (the standard of proof) is lower. There is another benefit derived from the use of civil proceedings. If there is a greater likelihood of obtaining a conviction, enforcing authorities may be more inclined to take action in doubtful, or potentially doubtful, cases. 180

Finkelstein J had to address the issue of how the sentencing judge should go about determining an appropriate civil penalty “for an essentially criminal offence”: What is a judge to do when he (or she) is required to impose a civil remedy (eg, a fine) when on the same facts in a criminal court the very same offender would have been imprisoned? Should the judge attempt to achieve an equivalence? Alternatively, should the judge simply ignore the fact that on another day before a different judge the offender would have been incarcerated? Or is there something in between? 181

The court made a compensation order in favour of the counterparties to the insider transactions and imposed pecuniary penalties whose quantum was assessed by reference to a number of factors including “the seriousness of the offence, the size of the profit made, the fact that the offence was committed with the sole object of making a profit, the fact that if this case had been prosecuted criminally a jail sentence would have been imposed and the need to make it clear to others that this kind of crime will not be allowed to pay even if prosecuted in a civil trial”. 182 The court assumed that imprisonment was not presently available as a sanction, and did not refer to the technical possibility that ASIC might later bring a criminal prosecution in respect of the same conduct: s 1317P(1). If the defendants had first been prosecuted for their conduct and convicted, civil proceedings might not be then brought with respect to substantially the same conduct: s 1317M. 183 180

ASIC v Petsas [2005] FCA 88 at [2].

181

ASIC v Petsas [2005] FCA 88 at [3].

182

ASIC v Petsas [2005] FCA 88 at [18].

183

See V Lei and I Ramsay, Insider Trading Enforcement in Australia (7 November 2014). Available at SSRN: https://ssrn.com/abstract=2520334; L Bromberg, G Gilligan, J Hedges and I Ramsay, Sanctions Imposed for Insider Trading in Australia, Canada (Ontario), Hong Kong, Singapore, New Zealand, the United Kingdom and the United States: An Empirical Study (30 June 2016). CIFR Paper No 117/2016. Available at SSRN: https://ssrn.com/abstract=2817172.

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R v Firns [11.255] R v Firns (2001) 38 ACSR 223 Court of Criminal Appeal of the Supreme Court of New South Wales 184 [Carpenter was an ASX listed Australian company. Its main business was holding exploration licences in Papua New Guinea through wholly owned subsidiaries. One licence was adversely affected by a regulation purportedly made under the Mining Act 1992 (PNG). The subsidiary challenged the validity of the regulation and, having failed at first instance, appealed to the Supreme Court of Papua New Guinea. The appeal was heard in October 1994 in open court, and judgment was reserved. On Friday 28 July 1995, at about 9.30 am the judgment was handed down in open court in Port Moresby, upholding the appeal and declaring the regulation invalid. Carpenter’s general manager Kruse and a solicitor from the firm representing it in Papua New Guinea were present. At 9.40 am the news was telephoned to Hill, the chairman of directors, who telephoned his fellow directors, beginning with Mr Firns Senior who telephoned the news to his son, the appellant, in Brisbane at about 10.08 am. Shortly before 10.27 am the appellant phoned a Brisbane stockbroker and purchased 400,000 Carpenter shares at 21/2 cents in his wife’s name. He identified himself as “Ken Wiggins”, his wife’s maiden name (Ken was his forename). The appellant also arranged for the purchase of a further 338,000 shares at 3 cents each in favour of a friend. (In mid August the two parcels of shares were sold at prices between 9 and 12 cents.) ASX was not notified of the successful judgment until about 1.30 pm on 28 July, and then by an unrelated party. Newspaper reports of the decision appeared in Papua New Guinea on Monday 31 July and in Australia on 1 August. Ken Firns was convicted in the District Court on two charges involving prohibited conduct by a person in possession of inside information under the predecessor of s 1043A(1). Kruse was also tried separately on the same facts but was acquitted. Firns appealed. The issue upon Firns’s appeal was whether the information used by the appellant was “generally available” in the sense that it consisted of “readily observable matter” at the time the appellant purchased the shares. Firns also argued that the jury were misdirected when they were told that the issue was whether the Supreme Court of Papua New Guinea decision was readily observable in Australia when it was acted upon. In the extract below, references to statutory provisions have been updated; any relevant differences in their terms are noted.] MASON P: [26] The Crown alleged that the information about the Papua New Guinea judgment was information that was not generally available until after the ASX was first notified, which was about 1.30 pm on 28 July 1995. That notification was made at the Perth branch of the ASX by an unrelated company interested in the judgment. By that stage the purchases referred to in the indictment had been effected. … Elements of the offences … [30] The offences charged had six broad elements: 1. The accused possessed information;

2.

“Information” is defined in s 1042A. It was proved that the appellant received information about the Supreme Court judgment through his father. that was not generally available; This is the critical point in the appeal.

3.

if the information were generally available a reasonable person would expect it to have a material effect on the price or value; Section 1042D provides a relevant definition. It is not seriously disputed that the news of the favourable judgment that was used by the appellant constituted information which a reasonable person would expect to have a material effect on the price of Carpenter’s shares.

184

See also the discussion of Firns and related prosecutions in G R Walker (2000) 18 C&SLJ 213. [11.255]

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R v Firns cont. 4.

of securities of a body corporate [now “relevant Division 3 financial products”]; There is no issue on this account.

5.

the accused knows or ought reasonably to know (i)

that the information is not generally available; and

(ii)

if it were generally available, it might have a material effect on the price or value of those securities.

There was ample evidence of this aspect of mens rea, which the jury obviously accepted. The appellant knew that the information he obtained from his father would have a material effect on the price of the Carpenter shares and that it had been passed on to him in advance of any announcement to the public … 6.

the accused (whether as principal or agent) purchased the securities (count 1); or the accused procured a third person to purchase the securities (count 2). These elements of the offences were clearly proved to the satisfaction of the jury.

… [34] As regards s 1042C(1)(a) (“readily observable matter”), Judge Sides held that the words mean readily or easily noted or noticed or perceived: and that perception is not limited to sight perception. He concluded nevertheless that the announcement of the Supreme Court decision in open court in Port Moresby did not establish that the judgment was “readily observable”. When he summed up to the jury, Judge Sides told them that par (a) meant that the Crown had to establish beyond a reasonable doubt: … that the material or information was not easily noticed or perceived by any of our senses by someone who was within Australia. In the context of this case that means that the information about the outcome of the appeal in the Supreme Court of Papua New Guinea was not easily noticeable or not easily perceived by those in Australia. (emphasis added) [35] Judge Sides correctly told the jury that the Crown had to negative beyond reasonable doubt both of the propositions contained in CApars (a) and (b) of s 1042C(1). Par (b) is not in issue in this appeal. … The legislative purpose(s) of the prohibition [40] There is lengthy philosophical debate about the object of prohibiting insider trading. Because of this, care needs to be taken to ensure that a judge does not unconsciously read his or her own philosophy into the enactment and then use it as the basis for construing the enactment consonant with that philosophy. The need for caution is heightened in light of the conflicting signals in the extrinsic material and recognition that one is dealing with a serious criminal offence (cf Chew v The Queen (1992) 173 CLR 626 at 632). Classical theories of statutory interpretation endorse a liberal interpretation of provisions designed to protect classes of vulnerable people such as investors and consumers. On the other hand criminal statutes are construed strictly having regard to the common law’s concern for the liberty of the subject. [41] The Explanatory Memorandum that accompanied the Corporations Amendment Bill 1991 explained that the legislation arose out of the Report of the House of Representatives Standing Committee on Constitutional and Legal Affairs, Fair Shares for All: Insider Trading in Australia, AGPS, Canberra, 1989 (the Griffiths Report). The Committee is usually referred to as the Griffiths Committee, after its chairman, Alan Griffiths MP. [42] Various theories have been offered as a basis for prohibiting insider trading and, conversely, in defence of insider trading … [43] The Griffiths Committee pointed out that the theories that have been offered as a basis for prohibiting insider trading include the concepts of: • fairness, ie market participants should have equal access to the relevant information from the company which issues the securities; 904

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R v Firns cont. • fiduciary duty, ie a person who holds a position of trust should not make a personal profit from that position without the informed consent of the beneficiaries; • economic efficiency, ie insider trading is damaging to the integrity of the financial market; and • corporate injury, ie insider trading injures the company which issued the securities, the shareholders in the company and investors who deal with insiders. [44] Alternative theories have, however, been expressed in defence of insider trading. Professor Henry Manne has suggested that insider trading is beneficial on the grounds of enhancing market efficiency, since trading by insiders sends signals to the market which help move the price of securities towards their real value, thus bringing about a better informed and more efficient market (H Manne, “In Defence of Insider Trading” (1966) 43 Harvard Business Review 113). [45] The legislative history suggests that Parliament left the courts with a scheme embodying the ambiguous embrace of the market fairness/“equal access” and market efficiency theories. [46] The [last but one] predecessor of Division 3 was s 128 of the Securities Industry Code. In Hooker Investments Pty Ltd v Baring Bros Halkerston & Partners Securities Ltd (1986) 10 ACLR 462 at 464, Young J said that one approached s 128: … with the idea that it is directed to people who are trading in the market place and are involving themselves in a transaction where a price could be affected by information and the purpose of the Act is to prevent one person having an unfair advantage from another. [47] These comments were endorsed in the Court of Appeal in that case (Hooker Investments Pty Ltd v Baring Bros Halkerston & Partners Securities Ltd (1986) 5 NSWLR 157 at 163). In Exicom Young J repeated his comments and applied them to s 128’s successor, s 1043A of the Corporations Act. He found that the transaction in Exicom fell outside s 1043A because it was not: … a situation where an insider [was] making use of information in a market to gain an advantage over an outsider (at 410). [48] One finds clear statements in the Griffiths Report that the basis for regulating insider trading was the need to guarantee investor confidence in the integrity of the securities markets (see eg at §5.3.9). The Committee endorsed the principles adopted in 1981 by the Committee of Inquiry into the Australian Financial System (the Campbell Committee) where it was stated that: The object of restrictions on insider trading is to ensure that the securities market operates freely and fairly, with all participants having equal access to relevant information. Investor confidence, and thus the ability of the market to mobilise savings, depends importantly on the prevention of the improper use of confidential information. … [49] In the Explanatory Memorandum the following appears (emphasis in original): 307. Some commentators have suggested that regulation of insider trading is not necessary, as insider trading enhances the efficiency of the securities market through the faster dissemination of information. The Government’s policy view is, however, that it is necessary to control insider trading to protect investors and make it attractive for them to provide funds to the issuers of securities, for the greater and more efficient development of Australia’s resources. The effects of insider trading on investor confidence are regarded as outweighing any efficiencies arising from the faster dissemination of information which some commentators allege would accrue if insider trading were decriminalised. [50] On this approach, equality of access to the relevant market is the critical factor. Under this theory, restrictions on insider trading are designed to ensure that the market operates fairly, with all participants having equal access to relevant information. The playing field is to be levelled. The derived concept of precluding “unfair advantage” was adopted by Young J and the Court of Appeal in the passages set out above. [51] This is all very well in providing insight into one aspect of the general philosophy underlying Division 3. And it is reflected in s 1042C(1)(b). However, the appellant was not charged with making “unfair” use of information relevant to the value of Carpenter shares. And the Crown had to negative both arms of s 1042C(1) to secure a conviction. [11.255]

905

Corporations and Financial Markets Law

R v Firns cont. [52] The critical element of the offences charged was the requirement that the Crown prove that the information was not generally available, as that term is defined in s 1042C. The vital issue in this appeal is whether the information used by the appellant was “generally available” in the sense that it consisted of “readily observable matter” at the time when the appellant effected (count 1) and procured (count 2) the two purchases before 11am on 28 July 1995. [53] The language of the statutory definition of “generally available” [in s 1042C] and the drafting history of that definition demonstrate that the Griffiths Committee’s clear vision of an underlying policy of promoting fairness in the market through equal access to information became badly blurred in the legislative process. This did not happen through oversight, although it is possible that different participants in the legislative process concentrated on one factor to the exclusion of the other or persuaded themselves that two essentially conflicting policies could be brought into sharp focus at the point of statutory definition. Regrettably for the courts at least, this has not happened. The result has been a form of legislated astigmatism because the attempt to converge essentially incompatible policy goals has produced a patchy blurring of the image (cf definition of astigmatism in Penguin New English Dictionary: “a defect of an optical system, eg a lens of the eye, in which rays from a single point fail to meet in a focal point, resulting in patchy blurring of the image”.) [54] In the following paragraphs I seek to demonstrate why the statutory definition of “generally available” focusses in opposite directions and why in my opinion the market fairness/“equal access” paradigm cannot be invoked as the sole basis for interpreting the criminal offence with which this appeal is concerned. [55] The Griffiths Committee had recommended that the concept of general availability should be defined in the legislation. However, the definition proposed by the Committee was narrower than that later enacted. The difference is of significance, as are the reasons. The Committee stated: 4.5 Availability of information 4.5.1 Relevant to determining the type of information covered under the insider trading provisions, it was argued in some submissions that the concept of general availability lacks precision and should be replaced by a provision which indicates the manner of disclosure and ensures that the information is likely to be available to the ordinary investor. It was suggested that such a provision could specify a reasonable waiting period for the information to be absorbed. 4.5.2 LCA [Law Council of Australia] noted that, in the United States, the American Law Institute’s proposed Federal Securities Code has moved towards the specification of precise times from the release of information to the time when it can be regarded as sufficiently absorbed by the market that insiders are free to trade. For example, LCA indicated that it considered unsatisfactory that an insider should be able to leave a press conference and go straight to the telephone and start buying stock before the market has had sufficient time to absorb the information. 4.5.3 However, on the grounds of market efficiency, there was opposition to the proposal that there be specification of precise times between release and absorption of information. AMP argued: … if we were to wait until every investor had an opportunity to assess information we would be forced to suspend stocks every time there was a news release. 4.5.4 AMP suggested that the interests of the private sector are best served by allowing market professionals to have instant access to information, so as to produce a properly priced security, thereby reducing the opportunity for insider trading. 4.5.5 While acknowledging that the absence of a time rule may disadvantage small investors vis a vis market professionals, the NCSC indicated that any arbitrary period is likely to be unrealistically long in some cases and penalise the diligent. Conclusions 4.5.6 The Committee reiterates its view that any concept which is fundamental to the operation of the legislation must be expressed in clear and practical terms. As the term 906

[11.255]

Financial Market Regulation

CHAPTER 11

R v Firns cont. “generally available” is critical in determining whether insider trading has occurred, uncertainty about its application indicates a need to clarify the concept. 4.5.7 It is clearly compatible with the intent of the legislation if an insider gains an advantage from the dissemination of inside information before the market has had a reasonable time to absorb that information. Accordingly, the concept of general availability should be defined by providing that the information should be available to a reasonable investor, and by requiring a reasonable time period for the dissemination of the information. In addition, guidelines should be issued by the regulatory agencies on appropriate methods for disclosure of information. 4.5.8 However, the Committee is opposed to incorporating a fixed time period within the legislation, as this may well impact on the efficient operation of the securities markets and may penalise individual initiative and diligence. Instead, the given circumstances of a case should be taken into account when deciding whether the time frame involved was reasonable. Recommendation 4 4.5.9 The Committee recommends that, for the purposes of the insider trading provisions, information be defined as generally available where it is disclosed in a manner which would, or would be likely to bring it to the attention of a reasonable investor, and where a reasonable period of time for the dissemination of the information has elapsed. [56] Had this recommendation been adopted, s 1042C(1) would have contained par (b) (or something similar), but not par (a) and perhaps not s 1042C(1)(c). Yet Parliament chose to include these additional and alternative means of establishing that information was “generally available”. In doing so, the legislation effectively undermined the policy objective stated in §4.5.7 of the Griffiths Committee Report. The Explanatory Memorandum explained the drafting of s 1042C in the following terms: Section 1042C – Information generally available Background 325. The Committee recommended that information be defined as “generally available” where it is disclosed in a manner which would be likely to bring it to the attention of a “reasonable investor”, and where a reasonable period of time for the dissemination of the information has elapsed. 326. Concern was expressed that in consequence of the adoption of this definition in the exposure draft, information directly observable in the public arena would not be regarded as generally available, as it has not been “made known”. It was considered that a person could be liable for insider trading where he/she traded in securities on the basis of, for example, an observation that the body corporate had excess stocks in a yard. This was not the intention of the provisions. 327. Further, although it was not intended that the provisions would regard as inside information such things as deductions and conclusions which investors, brokers or other market participants may make based on independent research of generally available information, a number of submissions considered that this intention was not reflected in the provisions. Proposed amendment 328. Proposed section 1042C is a reflection of the Committee’s recommendation in relation to generally available information. For information to be generally available, subsection 1042C(1) requires either that it: • consist of readily observable matter, ie facts directly observable in the public arena (subparagraph (a)); or • be made known in a manner that would, or would be likely to, bring it to the attention of persons who commonly invest in securities of bodies corporate of a kind whose price or value might be affected by the information. This provision is intended to define the term “generally available” in terms appropriate to closely held and unlisted companies as well as listed [11.255]

907

Corporations and Financial Markets Law

R v Firns cont. companies with dispersed shareholdings. It would not be sufficient for information to be released to a small sector of the investors who commonly invest in the securities. The information must be made known to a cross section of the investors who commonly invest in the securities; and • a reasonable period of time has elapsed for the information to be disseminated. This provision is designed to prevent an insider, who is aware of information prior to its release, getting an unfair head start on other market participants, not to require an embargo on trading of such duration that it constitutes an impediment to the efficient operation of the market (subparagraph (b)). 329. Proposed subsection 1042C(1)(c) makes it clear that information is also generally available if it consists of deductions, conclusions or inferences based on, separately or in combination, readily observable matter and information that has been made known within subparagraph (1)(b)(i). [57] Both the Committee and the Parliament were concerned not to “penalise individual initiative and diligence” (Committee Report at §4.5.8). However, both Committee and Parliament rejected a bright line definition. And Parliament went further in recognising that, for some types of information, cleverness, swiftness and efficiency are to be encouraged. The Committee’s call for drafting clarity was also ignored with the insertion of the opaque words “readily observable matter”. [58] These policy and drafting decisions left the courts with a difficult interpretative task [with respect to] … the conflicting goals embedded in the essentially two-pronged definition of “information generally available”. [59] One commentator has observed that: Insider trading is a curious animal: there are many more journal articles discussing what it should be than reported cases of what it is. We all think we know what it is, yet defining it in the clear language required of a statutory provision with criminal liability attached has proved problematic. Most people agree that it is undesirable, yet there is still debate on precisely why it should be so from a philosophical perspective. (Michael Gething, “Insider Trading Enforcement: Where are we now and where do we go from here?” (1998) 16 Companies and Securities Law Journal 607.) [60] Since one way of establishing that information is generally available is to show that “it consists of readily observable matter”, Division 3 has, I believe, partially and indirectly endorsed the economicefficiency paradigm as one of the goals of insider trading prohibition. Of course, this casts little light upon whether or not conduct like that of the appellant contributes to such efficiency. … [68] The Corporations Act does not define “readily observable matter”. The drafting history and the opening words of par (b) shows that the generality of the words in par (a) are not to be limited by par (b). What also emerges clearly from a comparison between pars (a) and (b) of s 1042C is that in par (a) the legislature deliberately held back from placing information under an embargo until the lapse of a fixed time or even a reasonable time from some fixed point of actual disclosure. Paragraph (a) was inserted as an alternative in order not to penalise the efficient, the speedy or the diligent – at least to the degree encompassed by the opaque “readily observable matter”. [69] In R v Hannes [2000] NSWCCA 503 the trial judge had spoken of availability “in the marketplace”. She did not elaborate upon the words “readily observable matter”, describing them as “reasonably plain English”. The appellant in Hannes submitted that the jury should have been given directions as to the persons to whom and the manner how the matter in question should be readily observable. It was suggested that the jury should have been told that the matter need only have been readily observable to the public at large; and that the matter had to be “easily able to be perceived by the senses in some way”. Spigelman CJ (with whom Studdert J and Dowd J agreed) observed (at [262]-[263]) that, if par (a) was that wide, the trial judge’s directions allowed the jury to proceed thus. If they proceeded on some narrower basis, then that was unnecessarily advantageous to the appellant, Hannes. The Chief Justice concluded that “these plain English words” required no elaboration on the trial judge’s 908

[11.255]

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CHAPTER 11

R v Firns cont. part. I do not read these remarks as indicating that it may never be appropriate to give the jury further guidance as to the scope and application of par (a). The facts of Hannes and the issues fought at trial simply required nothing further. [70] Section 1042C(1)(a) does not define the class of persons by whom the matter is to be “readily observable”. They cannot be confined to existing shareholders or even existing traders of shares on ASX. In any event, the latter class is a very wide one since traders in Australian-listed shares are not confined to Australians, no matter how the latter term is defined. 71 I do not understand the parties to disagree with Sides DCJ’s direction that perception is not limited to sight perception. He told the jury that “observable”: extends beyond the concept of seeing something with the eye and it includes what can be perceived or what is capable of being noticed. Thus the word “observable” extends beyond the use of our visual sense, for example it would include as well the use of the olfactory senses that is smell, or the auditory senses that is hearing, or the tactile senses that is feeling. In other words people who are visually challenged are not excluded from this concept. Thus “observable” means something that is capable of being noticed or perceived. It is not, however, a question of whether something is easily able to be obtained or is easily available. [72] This exposition appears to confine observability to the capacity to be perceived through direct use of the unaided human senses. Such a direction will be sufficient in some situations, but it may at once be too broad and too narrow. [73] Sometimes information will consist of matter that is directly visible yet it may not be “observable”, at least not “readily” so. Examples would be a message which is widely published yet encrypted or a gold nugget lying in a remote corner of a desert. Judge O’Reilly referred to the “public arena” in Kruse (par 32 above). It was the Explanatory Memorandum that glossed s 1042C(1)(a)’s “readily observable matter” as “facts directly observable in the public arena” (see at par 328). Such a concept may be helpful in some contexts but my example of the published encrypted message shows that it cannot be taken too far. [74] At other times a direction that confined the jury to perceptibility by the unaided human senses will be too narrow. The present case is an example. [75] Some information has the capacity to generate its own dissemination. Its initial disclosure may be limited, yet the type of information involved and the initial group of persons to whom it is disclosed may ensure that it gets abroad. One would expect share-sensitive information despatched to ASX to have this capacity (cf Kinwat Holdings Pty Ltd v Platform Pty Ltd (1982) 6 ACLR 398, 1 ACLC 194). [76] Here the information embodied in the Supreme Court judgment was available, understandable and accessible to a significant group of the public, ie those present and capable of being present in court in the ordinary course. (I am leaving aside for the moment the issues raised by the venue being in Port Moresby as distinct from Sydney.) The judgment was readily observable to this class. [77] For the purposes of par (a) it does not matter how many people actually observe the relevant information. Nor is par (a) concerned with the time that is likely to elapse between the information becoming “readily observable” and when it was in fact observed. Information may be readily observable even if no one observed it. [78] Even if ready observability were to be limited to perceptibility by the unaided human senses, the published judgment of a Supreme Court is readily observable. A fortiori if, as I believe to be the case, one is not confined to the unaided human senses. Since the demise of the pony express and semaphore and the advent of telephone, telex, facsimile, television and the internet we have come to observe information immediately yet indirectly. Our human senses are engaged, but with the aid of modern means of telecommunication. Absent statutory clarification or restriction, there will be cases where failure to advert to this modern reality skews the true scope of par (a) despite emphasis on the modifying adverb “readily”. [11.255]

909

Corporations and Financial Markets Law

R v Firns cont. [79] The appellant challenges the direction that it is the ready perceptibility “by those in Australia” that is in issue. I agree with the appellant that this limitation is not an explicit or implicit part of the statutory definition. In my view, the words added by his Honour significantly altered the statutory offence, to the detriment of the appellant. [80] It may be granted that the protection of fair trading in the Australian sharemarket is the primary focus of the legislative scheme (see Hooker Investments Pty Ltd at 163 (CA)). Non sequitur that the market is viewed as located solely in Australia or that parties protected are those who are “within Australia” or “in Australia”. After all, a large proportion of investors in Australian corporations are non-Australians; and a considerable proportion of the shares listed on the ASX are shares of foreign corporations. Division 3 is not confined to protecting the interests of resident Australian investors or dealings in Australian shares. [81] There is a further difficulty with the direction that ready observability is to be tested from the stance of a hypothetical person “within Australia”. I have already touched upon it. The direction suggests or infers that the readiness of the perceptibility is also to be judged from the viewpoint of individuals located in Australia using their natural senses but without regard to modern methods of telecommunication. The unelaborated direction referring to “those in Australia” carries the seeds of miscarriage when it is recognised that television, the internet (including e-mail) and other means of telecommunication such as the phone and fax are part and parcel of how Australians generally and investors in particular readily perceive events. [82] A sudden crisis in the Middle East may have an immediate impact upon the value of Australian oil shares. That crisis may generate immediate coverage through a cable television provider such as CNN and/or it may be objectively of such a nature that one would expect people to jump on to the telephone, facsimile or e-mail to communicate price-sensitive information almost instantaneously. If the crisis occurs in the dead of the Australian night but during prime time in the United States of America the information is only not readily observable if one reads “in Australia” into the statute and then construes those words in a manner divorced from the realities of the modern world of global telecommunication. [83] The words “readily observable matter” raise a jury issue par excellence. In many contexts judicial gloss of the words would be inappropriate and potentially dangerous (see R v Holden [1974] 2 NSWLR 548 at 551, Hannes at [272]-[273]). Here the “within Australia” qualification (without explanation or elaboration) created a significant risk that the jury could proceed to conviction by inappropriate reasoning. The addition of the words “by those in Australia” certainly confined the inquiry too narrowly, to the significant disadvantage of the appellant. [84] The risk was exacerbated by the failure to alert the jury to the role of telecommunications in how Australian and other investors “readily” observe events. The latter task is a difficult one and I do not wish my remarks about them to be treated as a categorical exegesis of this obscure provision. Every summing-up is to be tested in its factual context. … [94] The appeal should be upheld, the conviction quashed and an acquittal entered. [HIDDEN J agreed with MASON P. CARRUTHERS AJ dissented, holding that “[t]he issue whether the Crown had negatived beyond reasonable doubt that the successful outcome of the PNG Supreme Court litigation for Carpenter was readily observable material at the time the relevant shares were purchased was properly left to the jury for their consideration. In my view the direction which his Honour gave to the jury, as quoted above, was correct. In the light of the evidence, the jury’s finding in favour of the Crown on that issue was open, if not predictable” ([126]).]

[11.260]

Review Problems

1. Albert, the managing director of a public but unlisted company, is approached by a group of shareholders who are dissatisfied with the company’s performance. They ask him for 910

[11.260]

Financial Market Regulation

CHAPTER 11

help in finding a buyer for their shares. After Albert agrees to do so, negotiations commence for the sale of the company’s principal operating subsidiary for a price well above its book value. Albert then offers to purchase the shares of the dissatisfied shareholders who have approached him, at a slight premium above the last known sale price. They happily accept. Would the position be different if Albert was a majority shareholder but not a director? See Brunninghausen v Glavanics (1999) 32 ACSR 294 at [58], quoted at [7.535] and Allen v Hyatt (1914) 30 TLR 444 referred to in Coleman v Myers [7.540]. 2. Bernice and Noel are directors of a family company which has a cluster of long accumulated assets and underperforming businesses. The assets and businesses have been accumulated over several generations of the family and are managed, with varying degrees of efficiency, by representatives of different branches and generations of the family. Such central management and control as exists has fallen to Noel and Bernice as the most able and experienced family members. They wonder whether more modern business methods and disciplines might not increase financial returns dramatically. They buy out other members, initially from their own resources but latterly with bank funds. They acquire almost all the equity, sell off unproductive assets and quickly retire the acquisition funding. Some of their children later complain that they sold their shares too cheaply to their parents. Advise them. Recall Coleman v Myers [7.540]. 3. Charles is a non-executive director of Ulysses Ltd, a company listed on ASX which markets a fragrance for men. Board papers contain a report from the research department that an ingredient in the fragrance’s manufacture has been linked in the US with a singularly unpleasant skin condition. The company’s shares are trading at about $2.60. Charles rings his broker immediately directing him to sell his Ulysses holdings “at best” promptly. The sale order is matched by the ASX automated trading system with a buying order emanating from a client who had instructed her broker to buy “up to $2.70”. Shares in Ulysses are actively traded. After the board meeting in the following week, a press conference is called by the managing director to announce that the fragrance has been withdrawn from sale. The company’s share price declines to $1.50. Discuss the legal consequences that Charles’s conduct might trigger. 4. (This and questions 5 to 7 deal with alternative courses of action which Charles may take. Discuss the legal ramifications of each course of action.) Instead of selling immediately he reads the research report, Charles instructs his broker to sell his Ulysses shares 30 minutes after the conclusion of the press conference. He sells for $2.00. 5. Charles is troubled by what he reads in the board papers. He consults his doctor for stress, and explains his dilemma. The doctor prescribes a sedative and immediately instructs his broker to sell his own holdings in Ulysses. Charles does not sell. 6. Charles and his wife are watching their daughter’s netball team playing on a Saturday morning. Charles outlines his concerns about the report to his wife. They agree that they should not sell their shares. Their conversation is overheard by another parent who purchases put options on the following Monday. 7. Charles does not sell any of his own shares. However, he tells his son to stop using the fragrance, and his wife and parents to liquidate their Ulysses holdings. 8. (This and questions 9-12 consider other situations. Please consider the legal implications and consequences of each.) Charles is a partner in an incorporated investment planning consultancy. He has given formal notice to his fellow directors of his directorship with Ulysses and it is agreed that he will not advise clients with respect to Ulysses and that he shall not communicate any confidential information concerning Ulysses within the [11.260]

911

Corporations and Financial Markets Law

9.

10.

11.

12.

13.

912

consultancy. The constraint has always been respected. At the same time as Charles is selling shares in Ulysses (see n 3 above) a fellow director is advising a client of the firm to acquire a substantial parcel of the shares for his portfolio. Would the legal position be different if the consultancy were a partnership? Deidre writes a column of investment analysis for a weekly national business magazine. It is widely read, highly regarded and often has price impacts upon securities which are subject to her analysis. She frequently trades in advance of her report, selling (or short selling) securities which will be subject to a scathing report and buying those upon which she will heap praise. She sells Ulysses shares in advance of a report which accuses the market of faddishly overpricing stocks of companies manufacturing “green or new age products”. She singles Ulysses out for special mention. Would it matter that her magazine was happy for her to take a modest and discreet profit from “front-running” her reports? While this understanding was never made explicit, it was reflected in the very modest compensation which she received as an independent consultant for her weekly report. Deidre is also a Professor of Finance at a major university. Her secretary, who types the text of Deidre’s report for transmission to the magazine (see n 9), is interested in the securities market and is astute as to the likely price effects of particular reports. She short sells Ulysses shares prior to publication. Deidre is unaware of her activities. Three Ulysses directors take the lift to the board meeting at which the adverse R & D report is to be discussed. Each is agitated and an astute bystander in the lift overhears their conversation, discerns its drift, notices that they get out at the Ulysses office and hastens to sell his Ulysses shares. The research chemist who prepared the report for the Ulysses board accidentally leaves a copy of the report upon the bus that she takes to work. The next occupant of the seat reads the report and buys put options over Ulysses shares. Recall the review problems at [10.137] and [10.235]. After Ros’s firm has listed on ASX and before its loss of key staff and price decline, Ros circulates an information memorandum for a private debt issue among the group of investors introduced by her brother, Ben. In the course of this distribution, a private investor who has invested in other biotechnology start-up ventures promoted by Ben, reads about Ros’s research and its potential applications. This causes him to reassess the probable life cycle of a number of other commercialisation projects in which he has invested under earlier fundraisings, not all of them through Ben. He decides to dispose of several of these investments (mostly in quoted securities) and invest the proceeds in Ros’s start-up. The investor is particularly careful and astute even by the standards of specialist venture capital investors. Indeed, he is the only one who makes the scientific connection between Ros’s research work and its likely impact upon the value of the other investments. Is there any breach of the Act here and, if so, with what remedies?

[11.260]

CHAPTER 12 Takeovers [12.05]

[12.50]

THE CONTEXT OF TAKEOVER REGULATION .................................................................................. 914 [12.05]

The several means of effecting transfers of corporate control ....................................... 914

[12.10]

Why do takeovers occur? ............................................................................................. 915

[12.15]

The principles shaping Australian takeover regulation ................................................... 916

[12.20]

The structure of Australian takeover regulation ............................................................. 919

[12.25]

The Takeovers Panel ..................................................................................................... 920

[12.30]

The Panel’s jurisdiction and powers .............................................................................. 921

PROHIBITED ACQUISITIONS OF RELEVANT INTERESTS IN VOTING SHARES ......................................................................................................................................... 930 [12.50]

The core prohibition upon acquisitions ........................................................................ 930

[12.80]

Relevant interests in securities ...................................................................................... 937

[12.130]

EXCEPTIONS TO THE PROHIBITION UPON ACQUISITIONS OF RELEVANT INTERESTS ................... 953

[12.135]

TAKEOVER OFFERS ........................................................................................................................ 958

[12.185]

[12.135]

The two species of takeover bid and the prohibition on bluffing bids ........................... 958

[12.140]

Market bids .................................................................................................................. 960

[12.145]

Off-market bids ............................................................................................................ 961

[12.150]

Conditions in off-market bids ....................................................................................... 961

[12.155]

The consideration for the offer, and the regulation of collateral benefits and escalators .............................................................................................................. 962

[12.160]

Variation of the terms of offers ..................................................................................... 962

[12.170]

Withdrawal of offers ..................................................................................................... 963

[12.175]

Lock-up devices ........................................................................................................... 964

CONDUCTING THE TAKEOVER BID ............................................................................................... 968 [12.185]

Takeover procedure ..................................................................................................... 968

[12.190]

Off-market bids ............................................................................................................ 968

[12.195]

The scope of bidder and target disclosure obligations .................................................. 972

[12.215]

Liability for misleading or deceptive statements etc in takeover documents .................. 977

[12.220]

Disclosure of substantial shareholdings ........................................................................ 978

[12.240]

FRUSTRATING ACTION BY TARGET COMPANIES ............................................................................ 986

[12.250]

COMPULSORY ACQUISITION AND BUY-OUT OF MINORITIES ....................................................... 999 [12.250]

The scheme of compulsory acquisition and buy-out ..................................................... 999

[12.255]

Compulsory acquisition and buy-out following takeover bids ....................................... 999

[12.275]

General compulsory acquisition and buy-out powers ................................................. 1004

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Corporations and Financial Markets Law

THE CONTEXT OF TAKEOVER REGULATION The several means of effecting transfers of corporate control [12.05] In common parlance the word “takeover” refers to the process of gaining control of a

company (the target) by bidding under a formal process for sufficient shares to achieve that end. 1 However, a takeover by formal offers for shares in the target company is but one way of acquiring control of a business and a variety of other means is available, particularly when the attempt is not contested or resisted. First, a common form of transfer for small business, is the purchase of assets, business and undertaking of the company – Australian corporate law does not recognise a doctrine of successor liability so that the purchaser may avoid being visited with unwanted liabilities provided that sufficient assets are left in the vendor corporation to avoid insolvency. However, stamp duty may be higher and there will be no carry forward of tax losses of the target, often a desired outcome. Second, it is becoming increasingly common for takeovers to be effected by means of a scheme of arrangement under Pt 5.1, often coupled with a selective capital reduction: see [9.230]-[9.235]. Schemes of arrangement have been used in Australia to effect change in control transactions for over 40 years. 2 This is only one of several purposes for which the scheme mechanism may be used and is accordingly often referred to as a transfer scheme: see [9.235]. Thus, shareholders in a target company might vote to approve a scheme that would see their shares transferred to the bidder, or cancelled so that only the bidder’s shareholding in the target remained, in either case for cash or a non-cash consideration, the latter often in the form of the bidder’s own securities. The scheme process is within the control of the target – the scheme is an “arrangement” between a target company and its members – and will only be instigated with the support of the target’s board who will negotiate the terms of sale for shareholders to consider in general meeting. 3 The shareholder consent thresholds for a scheme (75% by value and 50% by number (see [9.235])) are lower than those for the exercise of compulsory acquisition powers under takeover offers; the scheme mechanism also offers the certainty of either of two outcomes, acceptance or rejection, with no unsatisfactory intermediate outcome. 4 However, the process is a less flexible one than a takeover so that a bidder using this process faces the risk of being outmanoeuvred if another bidder emerges to create an auction for the company. The scheme process is also more suited to a cool takeover market when target directors consider that an auction for control of their company is unlikely 1

See generally on takeover regulation I Renard & J G Santamaria, Takeovers and Reconstructions in Australia (Butterworths, looseleaf service); D D McDonough, Annotated Mergers and Acquisitions Law of Australia (3rd ed, Lawbook Co., 1999); R P Austin & I M Ramsay, Ford, Austin and Ramsay’s Principles of Corporations Law (16th ed, 2015), Ch 23; R Levy, Takeovers: Law and Strategy (LBC Information Services, 1996); for United Kingdom material on takeovers, see M A Weinberg, M V Blank & A L Greystoke, Weinberg and Blank on Take-overs and Mergers (5th ed, Sweet & Maxwell, 1989); R Finbow & N Parr, UK Merger Control: Law and Practice (Sweet & Maxwell, 1995); Sir Alexander Johnston, The City Take-over Code (Oxford UP, 1980). For valuable United States writing on takeover, their wider environment and issues, see J C Coffee, L Lowenstein & S Rose-Ackerman (eds), Knights, Raiders and Targets: The Impact of the Hostile Takeover (Oxford UP, New York, 1988); D C Bayne, The Philosophy of Corporate Control: A Treatise on the Law of Fiduciary Duty (Loyola UP, Chicago, 1986).

2

4

See Re Castlereagh Securities Ltd [1973] 1 NSWLR 624; Lionsgate Australia Pty Ltd v Macquarie Private Portfolio Management Ltd (2007) 62 ACSR 522 at [38]; T Damian and A Rich, Schemes, Takeovers and Himalayan Peaks: The Use of Schemes of Arrangement to Effect Change of Control Transactions (3rd ed, 2013), p 545. Such a scheme of arrangement only binds the company and its members; accordingly, the modern practice in transfer schemes is for the bidder/acquirer to execute a deed poll at the first court hearing so as to give the target company and its members contractual rights against it: see Toal v Aquarius Platinum Ltd [2004] FCA 550 at [49]-[50] per French J. This degree of certainty may be very attractive also to the bid’s financiers.

914

[12.05]

3

Takeovers

CHAPTER 12

and that shareholders’ interests are best served by their co-operating in the scheme process. In some cases control might also be transferred simply through a selective capital reduction, although in a company with a significant number of shareholders the binding effect of a scheme or compulsory acquisition will usually be necessary to achieve the control transfer. ASIC has gatekeeper functions where the scheme process is being used to effect a takeover that might have been made under Ch 6: s 411(17). ASIC’s policy is that shareholders should receive equivalent, although not necessarily identical, protection whether the acquisition is made by a scheme, capital reduction or takeover. If equivalent protection is provided, ASIC does not favour one form of control transfer over another. 5 Thirdly, a form of de facto control transfer may also be effected by the simple expedient of seeking control of the board through election of supportive directors using proxy solicitation for voting in general meeting. However, this form is rare, partly because of the benefits of board access to the proxy process and incumbency generally, the claims of rational shareholder apathy, and because of the feeling that control acquisition should be paid for, even that control which is not rooted in majority legal ownership. The crucial issue in takeovers is corporate control. When the chosen means is the acquisition of shares, a holding of significantly less than 50% may be sufficient; this may be so, for example, where the remaining shares are widely held by independent persons and the acquirer wishes to do no more than control the business operations of the target. On the other hand, if there are major interest groupings within the remaining shareholders, or if the acquirer intends to change the character of the target in some significant way as, for example, by integrating it with its other operations, nothing less than full ownership may be required. In such situations, there are other relevant measures of control, such as entitlement to or the enjoyment of: • 75% of the voting shares which ensures the ability to secure passage of a special resolution unless the holder is disenfranchised on a particular issue and subject always to oppression doctrines and other minority shareholder protection remedies; • 50% of the voting shares plus one which entitlement ensures the like ability to secure the passage of ordinary resolutions; • such lesser shareholding as will be practically sufficient to secure passage of an ordinary resolution in a general meeting of members of the company in most circumstances (de facto control); • boardroom control, where a majority of directors are prepared to act in accordance with the wishes of a particular shareholder or group; and • control as measured by reference to a wider and more fluid standard through the capacity to determine the outcome of decisions about the financial and operating policies of the entity under, for example, accounting standards requiring consolidation of company financial statements: see [9.130]. 6 Why do takeovers occur? [12.10] What are the reasons for takeovers? 7 Why does a bidder pay a premium above

market price for control of a company? Several reasons are often assigned. Takeovers permit 5

6 7

ASIC Regulatory Guide 60.7 (Schemes of arrangement – s 411(17)). Some commentators query whether transfer schemes offer sufficient protection for shareholders, particularly in view of ASIC’s interpretation of and policy role adopted under s 411(17): see J Mignone (2016) 30 Aust Jnl of Corp Law 259 and J S Humphrey (2014) 32 C&SLJ 473. R P Austin & I M Ramsay, Ford, Austin and Ramsay’s Principles of Corporations Law (16th ed, 2015), Ch 23. See further on the causes and benefits of takeovers, R C Clark, Corporate Law (1986), pp 533-546; P Dodd, “Corporate control: what are the issues?” in Takeovers and Corporate Control: Towards a New Regulatory [12.10]

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Corporations and Financial Markets Law

the derivation of gains from superior management of target company assets: allocative efficiency gains are achieved if assets of a company are managed by those who can extract the greatest value from them; such managers will pay the highest price for those assets and the performance gains of this monitoring and acquisition are shared among shareholders of the target company and the bidder generally. This assumes constant monitoring of managerial performance of each company by managers of other companies; this disciplinary process, the market for corporate control, is asserted to be a significant accountability mechanism to ensure performance by managers: see [2.195]. However, there are major limitations upon its disciplinary effect: it is a blunt instrument since a bid for full ownership or control of a company simply to change its managers is a drastic measure, very expensive, difficult, and often belated. A second explanation is in terms of the benefits to the bidder’s managers in terms of increased power, status and prestige, and group size, with the latter perhaps working to inhibit a hostile bid for the company. A third explanation is in terms of the opportunistic gains to the bidder. Here it may be necessary to distinguish between what might be called looting (eg, a bid for less than full ownership of the company that is intended to be profitable through the oppression of minorities and the depletion of target assets through transfer to the bidder at an undervalue) and rational liquidation such as through a “bust up” takeover where the target is broken up and its assets disposed of. Such a step is not necessarily harmful to the economy although it is likely to be harmful to employees, suppliers and to the local communities in which the company operates or draws staff. 8 The principles shaping Australian takeover regulation [12.15] Takeovers are a significant feature of corporate life although the hostile takeover

emerged only in the 1950s, initially in the United States. Since the 1960s the incidence of takeover activity in Australia has fluctuated between periods of hyperactivity and those of relative dormancy. This period has seen the progressive introduction of ever more detailed takeover regulation through legislation, now found in Chs 6, 6A, 6B and 6C of the Act (here called compendiously from time to time “the takeovers Chapters”). Its scope extends beyond transactions within the common idea of a takeover bid made for all the shares in a company to other acquisitions of interests in voting shares that are not intended to be part of a takeover bid. Further, there are other bodies of legislation that may affect the conduct of particular takeovers whether by reference to the character of the target, 9 of the bidder 10 or its anti-competitive effects. 11 The present focus, however, is upon corporate law aspects and those arising under the takeovers Chapters.

8 9

Environment (Centre for Independent Studies, 1987), pp 3-16; S Bishop, P Dodd & R R Officer, Australian Takeovers: The Evidence 1972-1985 (Centre for Independent Studies, 1987); P Dodd & R R Officer, Corporate Control, Economic Efficiency and Shareholder Justice (Centre for Independent Studies, 1986); G A Jarrell, A Poulson & J Pound, “Regulating hostile takeover activity: an interpretive history of the US experience” in Takeovers and Corporate Control: Towards a New Regulatory Environment (Centre for Independent Studies, 1987), pp 19-36; O E Williamson, “Mergers, acquisitions and leveraged buyouts: an efficiency explanation” in L A Bebchuk (ed), Corporate Law and Economic Analysis (1990), ch 1; J C Coffee, L Lowenstein & S Rose-Ackerman (eds), Knights, Raiders and Targets: The Impact of the Hostile Takeover (1988), chs 11-17, 20-24; J C Coffee (1984) 84 Col L Rev 1145; J C Coffee, “Shareholders Versus Managers: The Strain in the Corporate Web” in J C Coffee, L Lowenstein & S Rose-Ackerman (eds), Knights, Raiders and Targets: The Impact of the Hostile Takeover (1988), pp 77-81 (see also pp 81-115 together with comments by V Brudney (pp 150-154) and M A Eisenberg (pp 155-158)). See R C Clark, Corporate Law (1986), pp 533-546.

10 11

For example, under the Broadcasting Services Act 1992 (Cth) (broadcasting and media companies) or the Financial Sector (Shareholdings) Act 1998 (Cth) (banks and insurance companies). Foreign Acquisitions and Takeovers Act 1975 (Cth) (consent required for acquisitions by foreign interests). Competition and Consumer Act 2010 (Cth), s 50.

916

[12.15]

Takeovers

CHAPTER 12

When the Uniform Companies Act was enacted in 1961 it included only two sections dealing directly with takeovers. Notorious avoidance of those sections led to the publication in 1969 of the Second Interim Report of the Company Law Advisory Committee (the Eggleston Committee), Disclosure of Substantial Shareholding and Takeover Bids. This report contained numerous proposals for reform that have continued to be highly influential in Australian takeover regulation. As a result, a so-called Takeover Code was introduced in 1971 with 25 new sections inserted into the Act. In the following three decades that legislation was regularly reviewed and was substantially recast under the CLERP process with effect from 2000. These changes did not, however, displace the principles adopted in 1969 by the Eggleston Committee on the policy objectives of takeover regulation (now known as the “Eggleston principles”): We agree with the general principle that if a natural person or corporation wishes to acquire control of a company by making a general offer to acquire all the shares, or a proportion sufficient to enable him to exercise voting control, limitation should be placed on his freedom of action so far as is necessary to ensure: (i) that his identity is known to the shareholders and directors; (ii) that the shareholders and directors have a reasonable time in which to consider the proposal; (iii) that the offeror is required to give such information as is necessary to enable the shareholders to form a judgment on the merits of the proposal and, in particular, where the offeror offers shares or interests in a corporation, that the kind of information which would ordinarily be provided in a prospectus is furnished to the offeree shareholders; (iv) that so far as is practicable, each shareholder should have an equal opportunity to participate in the benefits offered. 12

These principles have had a profoundly shaping effect upon Australian takeover law, explicitly through their inclusion in the statement of the purposes of Ch 6, namely, to ensure that the acquisition of control over listed companies or those with more than 50 members takes place in an efficient, competitive and informed market and that conditions corresponding to the four Eggleston principles are satisfied whenever a person would acquire a substantial interest in the company: s 602. 13 They are also incorporated throughout the whole of the takeovers Chapters and particularly in the jurisdiction and powers of the Takeovers Panel (see [12.25]). The first three principles are essentially concerned with the bid process and protection against crude forms of coercion or deception. The fourth principle asserts the claims of distributive justice, in the sense of fair or equal treatment of target shareholders, against those of allocative efficiency. At the base of most systems of takeover regulation is the question whether corporate control is treated as a corporate asset: do the transferors of a controlling block of shares owe fiduciary-type obligations to the company for the premium they receive? If not, what adjustments are to be made in the interests of the minority? Where, as in Australia, an equal opportunity to participate in transfer of control is accorded to all shareholders, the rationales are usually expressed in terms of: • the danger of unfair treatment of minorities under a new controller; • recognition of the opportunity for the purchaser of control to acquire the business at an undervalue, partly financed by the depression in the value of minority interests caused by the control transfer; and • the right to participate in the sale of control as part of the investment expectation of all shareholders. 12

Company Law Advisory Committee, Second Interim Report (1969), [16].

13

An additional condition refers to an appropriate procedure being followed as a preliminary to compulsory acquisition of securities under Pt 6A.1 (see [12.255]). [12.15]

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Corporations and Financial Markets Law

Arguments against the equality principle favour reliance upon market controls over legal regulation in view of the latter’s assumed chilling (or stifling) effect on bids and the disciplinary effect of the market for corporate control – it is better for the pie to be bigger even if it is unequally divided. 14 The CLERP review of takeover regulation outlined the merits and costs of the fourth of the Eggleston principles – the equal opportunity to participate in the premium paid for control – in these terms: Without the equal opportunity principle, there could be differential treatment of shareholders. Control could pass without some shareholders having any opportunity to sell their shares at the likely higher price. In addition, the change in control could result in a reduction in the market value of the shares, depressing the price which minority shareholders could receive. A bidder could acquire control of all of the business and assets of the target at a price significantly less than the full value of the target. This would particularly be the case in a partial on-market bid where the bidder bought sufficient shares to deliver control in a short time period. The risk of becoming a minority shareholder unable to sell their shares at the pre-takeover price or receiving lower returns from a new purchaser of control may be able to be minimised through an investor diversifying their funds between different companies or assets. However, from an investor’s perspective this would be a second best alternative to the equal opportunity principle as, in practical terms, diversification can be difficult to achieve without incurring substantial costs, especially if the investor does not have liquid investments. Alternatively, investors could move to managed investments, leading to less direct investment in the capital market. The equal opportunity principle potentially creates higher costs for market participants, reducing incentives to engage in takeover activity. … Under the equal opportunity principle, the total consideration paid by the bidder could increase as a result of the need to make offers to all shareholders instead of those necessary to obtain control. Making the offer price sufficiently attractive to larger shareholders may also increase the total consideration paid. Alternatively, the principle could result in a lower premium obtainable by controlling shareholders, where the bidder decides to pay the same total premium and distribute it amongst all target shareholders. Controlling shareholders in the target may consequently receive a smaller percentage of the premium than that reflecting the control inherent in a large shareholding. In this respect, the current law allows holders of smaller parcels of shares to gain a windfall, free-riding on the endeavours of controlling shareholders. However, it is likely that the effect of the equal opportunity principle is already taken into account by shareholders when acquiring control parcels. 15

Although other regimes encourage equal treatment of shareholders to varying extents, Australian takeover law is distinctive, possibly unique, in the weight accorded to the equal opportunity principle. It is one of the cornerstone principles shaping Australian takeover regulation. 14

15

918

Some also argue that the external costs generated by takeovers and borne by stakeholders (such as the loss of employment and the impact of plant closures upon local communities) are not adequately addressed by the shareholder-protective focus of corporate law. The rationales for and utility of takeover regulation are discussed further in R C Clark, Corporate Law (1986), pp 478-480, 491-498; J C Coffee (1985) 3 C&SLJ 216; Companies and Securities Law Review Committee, Report on the Take-over Threshold (1984), [73]-[113]; Companies and Securities Law Review Committee, Report to the Ministerial Council on Partial Take-over Bids (1985); Companies and Securities Law Review Committee, Partial Take-over Bids (Discussion Paper No 2, 1985); D C Bayne SJ, The Philosophy of Corporate Control: A Treatise on the Law of Fiduciary Duty (Loyola UP, Chicago, 1986). As for the legal response to the coercive effect of takeover bids, see J C Coffee (1985) 3 C&SLJ 216 at 227-229. Takeovers: Corporate control: a better environment for productive investment (Corporate Law Economic Reform Program Proposals for Reform: Paper No 4, 1997), pp 14-16; see also J Mayanja (2000) 12 Aust J Corp L 1; J Mannolini (1996) 14 C&SLJ 441. [12.15]

Takeovers

CHAPTER 12

The structure of Australian takeover regulation [12.20] The broad structure of Australian takeover regulation, sitting on top of the Eggleston

principles, is comprised of the following principal elements: • the takeover threshold of 20% of voting shares (s 606(1); [12.50]) beyond which acquisitions are prohibited except by takeover offer (by either of two types, the off-market bid or market bid) or permitted exceptions ([12.130]); the takeover threshold is intended to stop persons short of the point where they may exercise de facto control of the company and require them to proceed across that threshold only in a manner that satisfies regulatory goals, usually by formal takeover bid; • mandatory disclosure obligations in bids that are articulated to the prospectus standard of disclosure, at least where the consideration offered is in the form of corporate securities (s 636(1)(m); [12.195]); • liabilities for misstatements are articulated with the regime applying under the fundraising and financial services provisions ([12.215]); • Ch 6 applies also to the acquisition of interests in listed managed investment schemes; • compulsory acquisition of minorities is permitted subject to safeguards (Ch 6A; [12.250]); • the grant of remedial and other powers of the Court in relation to breaches of Ch 6 (ss 1325A – 1326)); • ASIC may exempt from and modify the takeover provisions (Pt 6.10 Div 1); • since 2000 a central role has been assigned to the Takeovers Panel (Pt 6.10 Div 2) including – the power to declare unacceptable circumstances: the provision enjoins respect for the spirit as well as the letter of the Eggleston principles and – the ouster of tactical litigation in favour of the Panel playing an almost exclusive role in takeover dispute resolution; and • mandatory disclosure of information concerning the acquisition of substantial shareholdings 16 in and the tracing of beneficial ownership of listed companies (Ch 6C; [12.220]). There is a variety of alternative institutional structures for regulation of takeovers, with the United Kingdom, Hong Kong, Singapore, India, Ireland, New Zealand, Switzerland and South Africa as well as Australia preferring a market-based statutory takeovers panel over the courts for the resolution of takeover disputes. 17 In the United States, federal law is essentially disclosure based while much State law is primarily concerned with protection of nonshareholder interests including management, employees and local community interests in takeovers; that is not the case with Delaware where many major corporations are incorporated. In the United States there is a relatively greater freedom for both bidder and target management, and auctions for corporate control tend to be easier and more common. There is 16 17

Defined as 5% of voting shares (s 9); changes in the entitlements of substantial shareholders must be reported on a timely basis in the interests of an informed market for the securities. On comparative approaches to takeover regulation, see I Ramsay (2015) 33 C&SLJ 341 (evaluating the respective merits of the resolution of takeover disputes by a takeovers panel and the courts using data from Australia and the United States, and concluding that a takeovers panel can provide a superior forum to the courts for resolving these disputes); E Armson (2014) 29 Aust Jnl of Corp Law 295; P Frazer, “The Regulation of Takeovers in Great Britain” in J C Coffee, L Lowenstein & S Rose-Ackerman (eds), Knights, Raiders and Targets: The Impact of the Hostile Takeover (1988), pp 436-444; G A Jarrell, A Poulson & J Pound, “Regulating Hostile Takeover Activity: An Interpretive History of the US Experience” in Takeovers and Corporate Control: Towards a New Regulatory Environment (Centre for Independent Studies, 1987), pp 19-36; K J Hopt (2002) 15 Aust Jnl of Corp Law 1. [12.20]

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no direct counterpart to the equality of opportunity principle. The contest between bidder and target sometimes becomes a Hobbesean struggle, showing nature red in tooth and claw. 18 In the United Kingdom there is a requirement to act through licensed professional advisers who are repeat players in the takeover process and there are also tighter market controls over the sources of funding for takeover bids. The main financial institutions are parties to the Code on Takeovers and Mergers and are subject to the jurisdiction of its Panel which is interventionist and exercises strong sanctions, albeit less reliant upon legal powers than in Australia. There are similar principles of equality of opportunity as in Australia although without the same takeover threshold; instead there is provision for a mandatory follow-on bid by one who acquires 30% of voting shares of a company; partial bids require Takeovers Panel approval under the Code. The Takeovers Panel

History of the Panel [12.25] The Corporations and Securities Panel was established in 1991; in 2000 it was retitled

the Takeovers Panel 19 to reflect the popular usage that had developed in the 1990s. Its original purpose was to intervene on the initiative of ASIC where parties to the acquisition of a substantial interest in a company engaged in conduct which was seen to offend the spirit but perhaps not the letter of takeover regulation. It was empowered to make a declaration and appropriate orders where it was satisfied that unacceptable circumstances had occurred in relation to the acquisition and that it was in the public interest to make the declaration. The concept of unacceptable circumstances was framed by reference to the Eggleston principles. Before 1991, the power to make such declarations had been vested in the predecessor to ASIC. The Panel was created and the role transferred to it so as to separate the functions of adjudication from those of investigation. The Panel was, and is, composed of persons with substantial takeover experience either as director, investment banker, accountant, securities adviser or lawyer. Members are appointed by the Governor-General: ASIC Act s 172. ASIC referred only four matters to the Panel in the 1990s, the low number possibly reflecting the inhospitable reception given to its initial references. However, the 2000 amendments were framed so as to place the Panel at the centre of takeover dispute resolution. In addition, the Panel may review the exercise by ASIC of its exemption and modification powers with respect to takeovers and the disclosure of ownership of listed companies: CA s 656A(1). This function had previously been vested in the Administrative Appeals Tribunal. 18

See the fascinating accounts in B Burrough & J Helyar, Barbarians at the Gate: The Fall of RJR Nabisco (Jonathon Cape, 1990); A Fleischer, G C Hazard & M Z Klipper, Board Games: The Changing Shape of Corporate Power (Little, Brown & Co, 1988) and, on the new sources of finance that drove the 1980s takeover boom, C Bruck, The Predators’ Ball (Information Australia Group, 1988).

19

See B Dyer & M McDonald, “Why Was the Takeovers Panel Established?” in I Ramsay (ed), The Takeovers Panel and Takeovers Regulation in Australia (2010), ch 3; M Hoyle, “An Overview of the Roles, Functions and Powers of the Takeovers Panel” in Ramsay, op cit, ch 2; for empirical and other studies of the Panel’s operation see Ramsay, op cit; J G Hill & R P Austin (eds), The Takeovers Panel After 10 Years (2011); E Armson (2006) 34 ABLR 105; E Armson (2005) 27 Syd L Rev 665; C Miller, R Campbell & I M Ramsay, The Takeovers Panel – An Empirical Study (Centre for Corporate Law And Securities Regulation, 2006); Chant Link & Associates, A Report on Stakeholder assessment of the Takeovers Panel (2006 at http://www.takeovers.gov.au) (findings from research commissioned by the Takeovers Panel to explore stakeholder feedback on its performance over its first six years of operation); N E Calleja, The New Takeovers Panel – A Better Way? (Takeovers Panel, CCH and Centre for Corporate Law and Securities Regulation, University of Melbourne, 2002); see also E Armson (2004) 28 Melb U L Rev 565 (exploring the essential character of the Panel, as commercial body or quasi-court); E Armson (2005) 5(2) Journal Corporate Legal Studies 401 (comparing Australian and UK models of takeover dispute resolution).

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[12.25]

Takeovers

CHAPTER 12

The Panel is central to Ch 6 because it is assigned a virtually exclusive dispute resolution role with respect to takeovers. The Panel’s role is to the exclusion of the jurisdiction of courts to make orders for breaches of the duties of target company directors as well as of the provisions of the takeovers Chapters. The importance of the Panel in the regulation of takeovers can scarcely be overstated. The principal function of the Panel, apart from its review of ASIC decisions whether or not to exempt or modify the takeovers provisions in a particular case, arises from its power to declare circumstances in relation to a company to be unacceptable circumstances. Simply stated, unacceptable circumstances are the mischief that the takeovers Chapters seek to overcome. How is that charismatic idea actualised? That is the project at the core of takeover regulation. Its exposition commences with the Takeovers Panel’s jurisdiction and powers. 20 The Panel’s jurisdiction and powers [12.30] The Panel may declare circumstances in relation to the affairs of a company (defined

broadly in s 53 21) to be unacceptable circumstances whether or not they constitute a contravention of the Act: s 657A(1). The Panel may only declare circumstances to be unacceptable circumstances if it appears to the Panel that the circumstances (a) are unacceptable having regard to the effect that the Panel is satisfied that the circumstances have had, are having, will have or are likely to have 22 on the control, or potential control, of the company or another company or the acquisition, or proposed acquisition, by a person of a substantial interest in the company or another company; 23 or (b) are otherwise unacceptable (whether in relation to the effect that the Panel is satisfied the circumstances have had, are having, will have or are likely to have in relation to the company or another company or in relation to securities of the company or another company) having regard to the purposes set out in s 602; or (c) are unacceptable because they constituted, constitute, will constitute or are likely to constitute a contravention of a provision of the takeovers Chapters or gave or give rise to, or will or are likely to give rise to, a contravention of a provision of those Chapters: s 657A(2). The term “substantial interest” as used in s 657A(2)(a) was not defined or elaborated in the Act before 2007. 24 Recent decisions concerning the use of equity derivatives in takeovers then 20

See T Bednall & V Ngomba (2011) 29 C&SLJ 355 (examining ASIC’s involvement in Takeover Panel matters and its impact on takeovers regulation and practice).

21

And applied to s 657A by virtue of reg 1.0.18 which declares s 657A to be a prescribed provision to which the definition in s 53 applies.

22

The apparent prolixity in the specification of tenses in the three paragraphs of this sub-section is to address concerns arising from decisions indicating that the Panel “may not be able to act to prevent the effects of unacceptable circumstances (even if clearly apprehended), but rather, may need to wait until those effects, and the consequent harm, have actually occurred”: Corporations Amendment (Takeovers) Bill 2007, Explanatory Memorandum, [1.5].

23

The premise upon which the exercise of power is predicated is that the Panel is satisfied with respect to the effect that the circumstances are having (etc) on control of the company (etc). The Panel needs to make a determination that it is satisfied with respect to that effect before it considers whether it appears to the Panel that the circumstances are unacceptable: see Glencore International AG v Takeovers Panel (2005) 54 ACSR 708 at [39]. This case was decided with respect to s 657A(2) as it was before the 2007 amendments although those amendments do not affect the sequential character of the decisions that the Panel needs to make. In Elders IXL Ltd v NCSC [1987] VR 1 at 18 Marks J said that “[a]t the very least, in my opinion, [a substantial interest] must be understood in the context of the Takeover Code. It may well be that its meaning cannot be defined by reference to a stated percentage or a minimum percentage, but that the question as to what is or

24

[12.30]

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Corporations and Financial Markets Law

indicated that the developing interpretation of the term might “prevent the Panel from being able to deal with new and developing interests and tactics in relation to takeovers”. 25 Accordingly, provision was made in the Act, not by way of definition of the term but to unfetter its interpretation: a reference to a substantial interest is not to be read as being limited to an interest that is constituted by a relevant interest (see [12.80]) or a legal or equitable interest in securities or a power or right in relation to a company or its securities: s 602A(1). The Explanatory Memorandum adds that “[i]t is not intended that every involvement with a company … will be a substantial interest. By way of example, people will not have a substantial interest in a company merely because they are employees of the company, or supply goods or services to the company, or are someone to whom the company supplies goods or services.” 26 A new s 657A(2)(b) was inserted in 2007 to give the Panel jurisdiction to declare circumstances unacceptable having regard to the purposes of Ch 6 of the Act set out in s 602. This was described as a significant change, designed to ensure the Panel can address circumstances which impair those purposes, without having to also establish either a contravention of the Act or an effect on control or potential control of a company or on the acquisition or proposed acquisition of a substantial interest in a company. The intention is to give the Panel a wider power to give effect to the spirit of the Act. The purpose of the words in brackets in the new paragraph [reproduced above] is to ensure that the Panel can make a declaration of unacceptable circumstances in relation to the affairs of one company, being the company referred to in s 657A(1), where the effect of the unacceptable circumstances relates to or is primarily manifest on another company or the securities of either company. 27

The Panel may only make a declaration, or only decline to make a declaration, if it considers that doing so is not against the public interest after taking into account any policy considerations that the Panel considers relevant: s 657A(2). In exercising its powers to make a declaration, the Panel must have regard to the purposes set out in s 602, other provisions of Ch 6 and the rules made by the Panel under s 658C; in addition, it may have regard to any other matters it considers relevant: s 657A(3). In having regard to the purpose set out in s 602(c), the Panel must take into account the actions of the directors of the company whose securities are the subject of the acquisition or proposed acquisition, including actions that caused the acquisition not to proceed or contributed to it not proceeding: s 657A(3). This latter provision specifically includes the conduct of the target directors within the scope of the Panel’s powers to make a declaration of unacceptable circumstances, and confirms that the power is not focused exclusively on the acquisition of securities alone. The Panel’s jurisdiction does not therefore depend upon a formal takeover offer having been made for shares in the company but is engaged by some lesser acquisition or transaction is not a ‘substantial interest’ for the purpose of the subsection is to be determined according to the circumstances of a particular case. But its meaning in a particular case must attach to a step in the direction of takeover or change in corporate control. It is not to be considered in a vacuum as relating solely to size. The size must have relationship to a threat or potential threat to the stability of corporation control.” In that case, the acquisition in question was not shown to relate to the contested takeover but was found to be “merely a purchase of shares”. 25

26

Corporations Amendment (Takeovers) Bill 2007, Explanatory Memorandum, [1.5]; see Glencore International AG v Takeovers Panel (2005) 54 ACSR 708 and Glencore International AG v Takeovers Panel (2006) 56 ACSR 753. Corporations Amendment (Takeovers) Bill 2007, Explanatory Memorandum, [3.5]. The definition also provides for regulations to specify that particular interests may constitute or do not in themselves constitute substantial interests. This provision should allow any future uncertainty about the application of the term to particular situations to be addressed ([3.6]).

27

Corporations Amendment (Takeovers) Bill 2007, Explanatory Memorandum, [3.8].

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affecting either potential control or acquisition of a substantial interest in a company. Thus, Greenwood J said in Palmer Leisure Coolum Pty Ltd v Takeovers Panel: Section 657A does not operate only in the circumstances of a takeover bid. It contemplates circumstances which might be unacceptable having regard to the effect that the Panel is satisfied the circumstances have had, are having, will have or are likely to have on the control, or potential control, of the company or the acquisition or proposed acquisition, by a person of a substantial interest in the company. 28

An application may be made for a declaration from the Panel by the bidder, target, ASIC or any other person whose interests are affected by the relevant circumstances: s 657C(2). Following the making of a declaration that circumstances are unacceptable, the Panel may make any order, including a remedial order, 29 that it thinks appropriate with a view to • protecting the rights of persons whose interests have been, are being or will be or are likely to be affected by the unacceptable circumstances; or • ensuring the bid proceeds (so far as possible) in a way that it would have proceeded if the circumstances had not occurred: s 657D(2). It may not, however, make an order directing compliance with a requirement of the takeovers Chapters (s 657D(2)). It must not make an order if it is satisfied that the order would unfairly prejudice any person: s 657D(1). These provisions often involve the balancing of conflicting interests: [The Panel] must weigh the object of protecting rights or interests of any person affected by the relevant circumstances against the prejudice to any person that would flow from the making of an order, in order to determine whether that prejudice would be unfair. It was incumbent upon the Review Panel to make a determination as to whether any prejudice to [the bidder] was unfair, having regard to the extent of protection of the rights or interests of persons that would be afforded by the proposed order. That would have required, in the present case, the identification of persons whose rights or interests were affected by the non-disclosure, the appropriate order to protect those rights or interests and the prejudice that would be suffered by [the bidder] by reason of the proposed order. 30

Chapter 6 continues to have a detailed black-letter specification with respect to the content, procedure and conduct of bids. Ultimately, however, disputes with respect to takeovers are determined by a body which must act by reference also to the augmented Eggleston principles contained in s 602. The role of the Panel is not to determine what rights and liabilities arise from the terms of the takeovers Chapters and then give effect to them, as a court might do if it were seized of the Panel’s jurisdiction (which would inevitably be more narrowly cast). Thus, in Re Pinnacle VRB Ltd (No 8), the Panel said: The function of the courts is to determine what rights and liabilities exist and to enforce them. The function of the Panel, by contrast, is to find out the existing state of affairs (including existing rights and liabilities). Then, where it considers it appropriate, to make orders within the powers given to it by the law changing that state of affairs thus creating a new set of rights and obligations rather than purporting to enforce existing ones. Significantly, the Panel has only those powers conferred on it by the statute: [it has] no common law, equitable, or other jurisdiction. 31 28

(2016) 110 ACSR 425 at [235].

29 30

Remedial orders include orders preventing a person from acquiring or voting securities, directing a person to dispose of securities or vesting securities in ASIC (s 9). Glencore International AG v Takeovers Panel (2005) 54 ACSR 708 at [52].

31

Re Pinnacle VRB Ltd (No 8) (2001) 39 ACSR 55 at [37]. [12.30]

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In Attorney-General (Commonwealth) v Alinta Ltd, the High Court allowed an appeal from the decision of the Full Federal Court which had declared that the predecessor of s 657A(2)(c) (as it existed prior to the 2007 amendments) was invalid for purporting to confer the judicial power of the Commonwealth upon the Panel. The High Court unanimously rejected this decision. The bases for the High Court’s decision are indicated by Kirby J: First, whilst policy choices are inevitably involved in many decisions made in the courts, the broad policy criteria that the Act requires the Panel to address in discharging its functions are such as to be more appropriate to, and characteristic of, an administrative decision than a judicial decision. Thus, the criteria are stated in wide and substantially open-ended terms. Those terms go beyond the language in which judicial decision-making functions are typically conferred. This is not a conclusive point. But it is the right place to start in appreciating the essential character of the governmental functions involved in this case. They are not inherently judicial. Secondly, the limitation on the commencement of court proceedings, which weighed so heavily for the majority in the Full Court, is temporary, not permanent. … Thirdly, the width of the Panel’s powers makes it clear that it is expected that the Panel, by its decisions, will create new rights and obligations and not simply determine conclusively (as a court might do) controversies over past suggested contraventions of the Act. Fourthly, contrary to the conclusion of the majority in the Full Court, the determination by the Panel of the rights and obligations of the contesting parties under s 657A(2)(b) of the Act remains no more than a “basis for determining what rights and obligations should be created in the future”. The Attorney-General of the Commonwealth correctly submitted that the decision by the Panel was a “criterion or factum” by reference to which legal norms are imposed and remedies provided for their enforcement. In every case it remains for the Panel to conclude whether or not the circumstances are “unacceptable”. For that conclusion to be reached, more is required than proof of a contravention of the Act, although in particular cases such proof may, in practice, be sufficient to result, without much more, in a conclusion of unacceptability. Fifthly, care has been taken in drafting the provisions of the Act to avoid any suggestion that the Panel enforces its own orders. It is left to the courts to make orders to ensure compliance with the Panel’s determinations. Necessarily, this involves the court concerned in a judicial decision, not a mere formality. 32

As noted, the Panel may declare circumstances in relation to the affairs of a company to be unacceptable circumstances whether or not they constitute a contravention of the Act: s 657A(1). In many instances the Panel’s powers will be invoked in circumstances where some issue of contravention of Chs 6, 6A, 6B or 6C is alleged. In Attorney-General (Commonwealth) v Alinta Ltd, Kirby J said: In every case it remains for the Panel to conclude whether or not the circumstances are “unacceptable”. For that conclusion to be reached, more is required than proof of a contravention of the Act, although in particular cases such proof may, in practice, be sufficient to result, without much more, in a conclusion of unacceptability. 33

Similarly, Hayne J said: Contravention of a provision of one of the specified Chapters of the Corporations Act may provide the footing for that conclusion but it must appear to the Panel that the circumstances merit the description “unacceptable”. … It may be accepted that the word “unacceptable” may readily be applied to most, perhaps all, contraventions of provisions of the kind found in Chs 6, 6A, 6B and 6C of the Corporations Act. The first observation, that the Panel must conclude that the word “unacceptable” can properly be attached to a contravention, may therefore be of little moment. But even if that is so, the second and third observations reveal that the Panel’s task is not completed by deciding 32 33

Attorney-General (Commonwealth) v Alinta Ltd (2008) 64 ACSR 507 at [40]-[44] (footnotes omitted). Attorney-General (Commonwealth) v Alinta Ltd (2008) 64 ACSR 507 at [43].

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that there has been a contravention of one of the relevant provisions. The Panel must make a declaration or decline to do so if it considers that doing that is not against the public interest after taking into account any policy considerations that the Panel considers relevant (s 657A(2)), and in exercising its powers under s 657A the Panel may have regard to any matters (in addition to those specified in s 657A(3)(a)) that it considers relevant.” (original emphasis) 34

Crennan and Kiefel JJ put it slightly more strongly: Sub-section (1) of s 657A provides a power, expressed in non-obligatory terms (“may declare”), to make a declaration that the affairs of a company are unacceptable. The purpose of subs (2) is to provide for the occurrences which may constitute unacceptable circumstances. Paragraph (a) requires an opinion, on the part of the Panel, about the effect of the circumstances on the company. Paragraph (c) requires only that the Panel be satisfied that there has been a contravention. The paragraph treats a contravention as synonymous with unacceptable circumstances. The circumstances are unacceptable “because” they constitute or give rise to a contravention of the Chapters. 35

Decisions of the Panel extracted in this chapter indicate the manner of the exercise of its powers as it responds to the breadth of its jurisdiction across the full range of takeover activity. The Panel has issued Guidance Note 1 concerning its powers with respect to unacceptable circumstances; it provides a guide to the interpretation of these powers and the factors conditioning their exercise: see [12.45]. This is one of a number of guidance notes that the Panel has issued with respect to the exercise of its powers and jurisdiction.

Jurisdictional boundaries between the Panel, Court and ASIC [12.35] It is in the context of the extensive jurisdiction given to the Panel 36 that the

prohibition upon court proceedings during the bid period is effected. 37 Litigation to challenge a hostile takeover bid for contravention of the counterpart of Ch 6 proved to be a relatively inexpensive (if often temporary) “show stopper” from the 1980s. From 2000, once a takeover bid has been proposed or commenced, only ASIC, the Minister or another public authority of the Commonwealth or State may commence court proceedings in relation to the bid until the end of the bid period: s 659B(1). 38 The enjoined court proceedings (“court proceedings in relation to a takeover bid or proposed takeover bid”) include court proceedings to challenge the bid or to enforce an obligation imposed by Ch 6: s 659B(4). Court proceedings that are commenced before a takeover bid is proposed may be stayed by a court until the end of the bid period if they relate to a takeover bid or would have a significant effect upon its progress: s 659B(2), (3). Upon its own initiative, the Panel may refer a question of law arising in takeover proceedings to the Court for decision (s 659A); however, under the Panel’s practice since 2000, such action is wholly exceptional. 34 35

Attorney-General (Commonwealth) v Alinta Ltd (2008) 64 ACSR 507 at [81]-[82]. Attorney-General (Commonwealth) v Alinta Ltd (2008) 64 ACSR 507 at [162]. Note that the reference to s 657B(2)(b) in the judgment has been altered to refer to the now current provision, namely, s 657B(2)(c).

36

See R P Austin, “The Courts and the Panel” in J G Hill & R P Austin (eds), The Takeovers Panel After 10 Years (2011), pp 131-146; T Damian, “The Courts and the Panel - A Commentary”, in Hill & Austin, pp 146-156.

37

The bid period is defined for an off-market bid (the principal bid type) as the period starting when the bidder’s statement is given to the target and ending when offers under the takeover bid close: s 9 (definitions of bid period and offer period). For a market bid, it starts when the bid is announced to the stock exchange and ends when offers close. The Federal Court has held that s 659B(1) makes it clear that a private litigant cannot bring court proceedings in relation to a takeover bid before the end of the bid period, including those seeking judicial review under the Administrative Decisions (Judicial Review) Act 1977 (Cth) of ASIC’s refusal to accept takeover bid documents for lodgment; the object of the provisions is to make the Panel the main forum for resolving disputes about bids until the bid period has ended: St Barbara Mines Ltd v ASIC (2001) 37 ACSR 92.

38

[12.35]

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Accordingly, any court proceedings after the commencement of a bid for a criminal prosecution, damages, or relief from liability for contravention of the Act may not be brought until after the conclusion of the bid period unless they are taken by ASIC, the Minister or other public authority. The stay of proceedings extends beyond proceedings for contravention of the Act to proceedings under other Commonwealth and State laws and the general law (that is, common law and equity): s 659B(4). If the Panel refuses to make a declaration of unacceptable circumstances in relation to conduct but a court subsequently finds that the conduct contravenes the corporations legislation, the Court is limited to the following orders: • that a person is guilty of an offence and impose a penalty; • for payment of damages, an account of profits or pecuniary penalty; • for relief from liability; or • to cure irregularities in company proceedings and action: s 659C. These orders do not permit the Court to affect the shape or outcome of the takeover transaction. However, courts continue to exercise jurisdiction in relation to shareholder grievances concerning compulsory acquisition of their shares following a successful bid (see [12.250]) and under other express powers such that to make orders, including remedial orders, if a person contravenes a provision of the takeovers Chapters: s 1325A(1). While the exercise of these powers will generally be displaced in favour of the Panel when a takeover bid has been made, the core prohibition in Ch 6 is so broadly cast as to apply to other transactions that are not intended to be a takeover in the usual sense of the term, much less involve the making of takeover offers. 39 Despite the breadth of the privative clause, viz, enjoining “court proceedings in relation to a takeover bid or proposed takeover bid”, and the scope of unacceptable circumstances, the boundaries between the respective jurisdictions of the Court and Panel are less than precisely drawn. This is particularly the case in relation to the exercise of powers and remedies under other parts of the Act which might also engage the Panel’s jurisdiction. The Panel is cautious in relation to the exercise of jurisdiction in possible competition with that of the Court. 40 Further, the privative clause is not a blanket exclusion of court proceedings by private parties affecting takeovers. Thus, in Lionsgate Australia Pty Ltd v Macquarie Private Portfolio Management Ltd the Court accepted jurisdiction to hear a suit by a bidder for enforcement of a pre-bid acceptance agreement, even though the obligation to sell under the agreement was triggered by the making of the bid itself. The Court held that this nexus with the bid was merely “accidental” to the subject matter of the agreement and that the contractual interpretation and enforcement proceedings were not “proceedings in relation to [the bid] or a document prepared under [Ch 6]”. This was so even though it had not been demonstrated that the Panel would lack the power to entertain an application in relation to the dispute before the Court. 41 Most significantly perhaps, the Federal Court may grant constitutional writ relief in respect of a Panel decision affected by jurisdictional error: “if it be established that the Panel identified a wrong issue, asked a wrong question, ignored relevant material or relied on irrelevant material in such a way as affected the exercise of power conferred by ss 657A and 657D or exercised a power predicated on a finding on a relevant matter without making a

39

See, eg, Flinders Diamonds Ltd v Tiger International Resources Ltd (2004) 88 SASR 281 and [12.100].

40 41

See, eg, Re Richfield Ltd [2003] ATP 41. Lionsgate Australia Pty Ltd v Macquarie Private Portfolio Management Ltd (2007) 62 ACSR 178.

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finding on that matter.” 42 That jurisdiction has been rarely invoked since the Panel was restructured, and effectively reborn, in 2000. 43 Oversight of the conduct of takeovers is thus shared between ASIC and the Panel with the Panel also given a review role in relation to ASIC’s powers to exempt from or modify the takeover provisions. The Panel has expressed its policy with respect to review of ASIC decisions thus: The Panel’s approach to reviewing an ASIC decision is guided by the following considerations: a. review proceedings are a de novo consideration on the merits b. the relevant ASIC policy and whether it was applied. If the Panel comes to the same conclusions as ASIC on what policy to apply and how to apply it, then normally ASIC’s decision would be affirmed c. whether there is any reason why ASIC’s policy should not be applied. The Panel, as a specialist review body, may have more scope to review the underlying policy, but persuasive reasons would be needed not to apply established ASIC policy (particularly if arrived at after public consultation) d. the legislative policy of Chs 6 or 6C e. the Panel’s own policies and rules and f. the desirability of consistency and certainty in decision-making. 44

As will be seen, ASIC is not given the same extensive gatekeeper powers as its predecessor once enjoyed over takeovers; for example, takeover documents do not need to be registered by ASIC but merely lodged with it. Nonetheless, most takeover bids require ASIC to exercise its exemption or modification powers in some minor technical respects at least. However, ultimately it is the Panel that possesses the final determinative role in relation to most aspects of takeover conduct and the resolution of takeover disputes.

Panel procedure [12.40] Most applications to the Panel are made by a party to the takeover bid or connected

transaction, whether as target, bidder or one of a number of rival bidders; it is rare for an application to be made by shareholders in the target or bidder. A panel of three members considers each application. Panel proceedings are to be conducted in a manner that is as fair and reasonable, timely and with as little formality as the legislation permits. 45 Usually, the Panel does not hold hearings 46 and proceedings before it are dealt with by written submissions often sent by email under tight timetables. 47 Pleadings are not used; instead, if the Panel decides to conduct proceedings in relation to an application, the Panel executive issues a brief to interested parties and ASIC which identifies relevant issues and calls for responses on the facts and proposed remedies. 48 The Panel therefore drives the process more than a court might. The Panel also tends to be more concerned to correct a situation affected by 42

Glencore International AG v Takeovers Panel (2005) 54 ACSR 708 at [34].

43

44

The experience with judicial review of Panel decisions and the 2007 amendments which strengthen the Panel’s position are discussed in E Armson, “Judicial review of Takeover Panel decisions” in I Ramsay (ed), The Takeovers Panel and Takeovers Regulation in Australia (2010), p 177. Takeovers Panel, Guidance Note 2: Reviewing Decisions, [10].

45

ASIC Regs, reg 13.

46

However, the Panel may conduct a conference to clarify matters arising from documents, resolve inconsistent statements or to inform itself on matters relating to the proceedings: ASIC Regs, reg 35. Subject to extension by court order, the Panel must make a declaration within three months after the circumstances occurred or one month after the application was made: CA s 657B.

47 48

ASIC Regs, regs 20, 21. [12.40]

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unacceptable circumstances than to punish those responsible for them, consistently with its direction to ensure that the bid proceeds so far as possible in a way that it would have if the unacceptable circumstances had not occurred: s 657D(2). The rules of procedural fairness apply to the extent that they are not inconsistent with the takeovers legislation applicable to the Panel. 49 Procedural fairness (or natural justice) does not require the Panel to hold an oral hearing before making adverse findings on the credit of participants. 50

Takeovers Panel, Guidance Note 1: Unacceptable Circumstances [12.45] Takeovers Panel, Guidance Note 1: Unacceptable Circumstances (Fifth Issue: 21 September 2010) http://www.takeovers.gov.au (most footnotes omitted) What are unacceptable circumstances? 17. There is no definition of unacceptable circumstances. Based on the wording of s 657A, the Panel’s ability to make a declaration of unacceptable circumstances is broad. 18. The power extends beyond takeover bids to other control transactions. Examples: 1. rights issues and equity placements 2. buy-backs and other reductions of capital 3. resolutions to approve acquisitions of shares 4. compulsory acquisition 5. schemes of arrangement 6. reverse takeovers. … 20. In 1998, when s 657A was proposed, Parliament said: The Panel’s jurisdiction to make a declaration of unacceptable circumstances will not depend upon the existence of a general offer to shareholders under a takeover bid. Instead, its discretion will extend to circumstances involving an acquisition of a substantial interest in, or control of, a company (proposed paragraph 657A(2)(a)). In making a declaration of unacceptable circumstances, the Panel must have regard to the spirit of the takeover rules in section 602 in deciding whether the circumstances are unreasonable and whether it is in the public interest to make the declaration (proposed subsection 657A(2)). 21. A broad interpretation allows the Panel to fulfil the role envisaged by s 659AA as the main forum for resolving disputes about a takeover bid. 23. In Alinta, which concerned in part whether s 606 had been contravened, it was said in the High Court: … The declaration is a statement of the Panel’s conclusion that, having regard to the circumstances created by the contravention and to the public interest, it considers something needs to be done about those circumstances. They are “unacceptable” in the sense that they cannot remain as they are and that they require consideration to be given to the orders that may be made under s 657D…. 24. The existence of unacceptable circumstances does not depend on conduct or intention. Typically the Panel considers the effect of the circumstances on persons and the market in the light of the principles in s 602. 25. Unacceptable circumstances may arise whether or not there is also a breach. Examples involving possible unacceptable circumstances: 49 50

ASICA s 195(4). Tinkerbell Enterprises Pty Ltd v Takeovers Panel [2012] FCA 1272 at [104]-[111].

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Takeovers Panel, Guidance Note 1: Unacceptable Circumstances cont. 1. contravention of s 606 2. contravention of a provision mentioned in s 612 3. contravention of ss 636(1) or 638(1) - disclosure 4. contravention of a timing provision (even minor) if persons may have changed their position in reliance on compliance with the provision 5. contravention of ss 636(3) or 638(5) – consent Section 602 … 32. Section 602 sets out the purposes of Chapter 6. There is overlap between some of the principles. They are to ensure that: a. the acquisition of control over voting shares takes place in an efficient, competitive and informed market. Examples involving possible unacceptable circumstances: 1. information deficiency 2. a false market in securities the subject of a bid 3. the lockout of rival bids 4. departure from a ’truth in takeovers’ statement 5. failure to have (and maintain) a reasonable basis to believe you will be able to pay the cash component offered in a bid 6. failure to issue consideration securities 7. the refusal to reverse transactions entered in error and promptly notified 8. excessive broker handling fees 9. uncertainty concerning the effect of conditions of a bid 10. uncertainty about whether a bid will be made and its terms 11. an agreement taking a person’s interest over 20% that restrains disposal of shares in reliance on s 609(7) and the restraint is not lifted should the “acquirer” announce a takeover or scheme before shareholder approval or an ASIC exemption has been obtained 12. excessive break fees. b. the holders of shares and the directors: i. know the identity of a person who proposes to acquire a substantial interest ii. have a reasonable time to consider the proposal and iii. are given enough information to enable them to assess the merits of the proposal Examples involving possible unacceptable circumstances: 1. failure to provide information under ASX Listing Rules or ss 643, 644 or 630 2. failure to comply with substantial holding notices and tracing notices under Chapter 6C 3. failure to disclose the intentions of the bidder concerning future relations between the target and the current shareholders of a co-operative 4. using reports for a different purpose than intended 5. failure to provide the qualifications of the person who prepared a report 6. failure to disclose the basis of comparison between a bid price and “comparable” transactions 7. use of “inside” information (which may also breach the insider trading provisions) [12.45]

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Takeovers Panel, Guidance Note 1: Unacceptable Circumstances cont. 8. a change of control, or a material effect on control by an issue of shares as consideration for a bid, that either disenfranchises shareholders or does not meet the policy of Chapter 6 (even if strictly it satisfies item 4 of s 611 – acquisitions that result from acceptance of a bid). 51 c. as far as practicable, the holders of shares in the relevant class all have a reasonable and equal opportunity 52 to participate in any benefits accruing to holders through any proposal under which a person would acquire a substantial interest. This does not require that all transactions provide a premium to the existing market or be equally attractive to all shareholders. Examples involving possible unacceptable circumstances: 1. maximum acceptance conditions 2. uncommercial pricing of a rights issue 3. deflating the price for shares that are the subject of the bid 4. frustrating a bid 5. brokers sharing broker handling fees with clients 6. unreasonable effects of a share buy-back 7. a target’s associate acquiring the target’s shares as a defence to a bid, then obtaining a benefit such as a material trading arrangement with the target or an interest in the target’s assets 8. a rights issue not affording genuine accessibility to its benefits to all shareholders 9. a collateral benefit d. an appropriate procedure is followed as a preliminary to compulsory acquisition. Example involving possible unacceptable circumstances: 1. a bid which satisfies the preconditions to compulsory acquisition only because of acquisitions which did not reflect an arms-length approval of the bid terms.

PROHIBITED ACQUISITIONS OF RELEVANT INTERESTS IN VOTING SHARES The core prohibition upon acquisitions

The takeover threshold [12.50] The central provision in Australian takeover regulation, that gives technical effect to

the regulatory goals, is contained in s 606(1): A person must not acquire a relevant interest in issued voting shares in a company if: 51

Gloucester Coal 01 [2009] ATP 6; Gloucester Coal 01R [2009] ATP 9. A reverse takeover may also offend the principles in s 602(a) and (c). It may “lock up” the bidder and adversely affect competition. The Panel takes into account whether the transaction is subject to the approval of bidder shareholders (relief from s 629 can be sought from ASIC if necessary) and/or is subject to a condition that allows a superior proposal to be considered by those shareholders. A “superior proposal” condition, however, if it depends on the opinion of, or an event controlled by, the bidder or an associate is void (s 629) so should be drafted in objective terms.

52

Reasonable opportunity means that holders have adequate time to consider a proposal and respond to it and are not exposed to pressure tactics. Equal opportunity means equal value, not identical dealing. Opportunity may be direct (eg, selling shares) or indirect (eg, voting on a transaction under s 611 item 7: some aspects of this were considered in PowerTel Ltd (No 1) [2003] ATP 25).

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(a) the company is: (i) a listed company; or (ii) an unlisted company with more than 50 members; and (b) the person acquiring the interest does so through a transaction in relation to securities entered into by or on behalf of the person; and (c) because of the transaction, that person’s or someone else’s voting power in the company increases: (i) from 20% or below to more than 20%; or (ii) from a starting point that is above 20% and below 90%.

However, the person may acquire the relevant interest under one of the exceptions set out in s 611 without contravening s 606 (see [12.130]): s 606(1A). The prohibition acts as a takeover threshold, stopping anyone crossing its barrier of 20% of voting power by share acquisition unless they do by means of one or more of the sanctioned paths each of which pays its respects to the Eggleston principles. The principal exemptions are for formal takeover offers. If a person has already crossed the 20% threshold, they may increase their holding only by one of the exceptions such as the creep rule allowing acquisitions of shares that increase voting power by no more than 3% in six months. To prevent evasion of the threshold, some of the elements of the prohibition are widely cast, particularly those relating to the notion of the acquisition of shares expressed through the concept of a relevant interest in securities. Acquisitions which increase the voting power of a person whose voting power already exceeds 90% are not regulated by s 606 since there is no question of control passing or being entrenched under these transactions. Further, this person may be entitled or even required to acquire the remaining securities of the company in which they do not have a relevant interest: see [12.250]. A like prohibition applies to the acquisition of a legal or equitable interest in securities of a company if, because of the acquisition, another person acquires a relevant interest in issued voting shares in a listed company and someone’s voting power in the company crosses the 20 threshold or, if it was above the threshold before the acquisition, increases in the range from 20 to 90%: s 606(2). Offers or invitations to do acts that would contravene s 606(1) or (2) are also enjoined: s 606(4). Attention will be focussed here upon s 606(1) since it is unlikely that s 606(2) has much (if any) independent operation outside the situation where a person acquires the legal title to a voting share as bare trustee for another. 53

Issued voting shares [12.55] The prohibitions in s 606(1) and (2) draw upon terms and concepts that are

explicated elsewhere in the Act. Thus, a “person” means a natural person as well as a corporation: Acts Interpretation Act 1901 (Cth), s 2C. A “company” is defined as a company incorporated under the Act or a predecessor statute: s 9. The prohibition does not apply therefore in respect of acquisitions of shares in companies incorporated outside Australia; however, it may apply to local or overseas transactions in shares in foreign companies that operate to produce the downstream acquisition of shares in an Australian company by reason of the deeming provisions with respect to the acquisition of a relevant interest (see [12.80]). 54 The core prohibition is upon the acquisition of a relevant interest in issued voting shares in a company. The concept of a relevant interest is more complex and will be considered shortly, 53

The acquisition of a legal interest as bare trustee is not the acquisition of a relevant interest (s 609(2)) and accordingly s 606(1) is not engaged. Can you identify another situation where s 606(2) operates independently of s 606(1)?

54

See, eg, NCSC v Brierley Investments Ltd (1988) 14 NSWLR 273 (see extract at [12.115]). [12.55]

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at [12.80]. The prohibition applies to the acquisition of issued voting shares. Only the acquisition of issued shares is affected, not the acquisition of interests in or options with respect to unissued share capital (see below, however, with respect to the exercise of options over unissued shares and of conversion rights ([12.95])). Voting shares are defined as shares which confer voting rights beyond the limited circumstances specified in the definition in s 9 (viz, a right to vote while a dividend is unpaid or on a proposal to reduce share capital, approve the terms of a buy-back agreement, that affects the rights attached to the share, to wind the company up or to dispose of the whole of the company’s undertaking). These voting rights are those that might be common to preference shares. However, if voting rights are more extensive than these rights, the share is a voting share even though it appears in all other respects to be a standard preference share. There is no formal carve out for preference shares as such. The takeovers Chapters apply also to the acquisition of interests in a listed managed investments scheme as if the scheme were a listed company and interests in the scheme were shares in the company: s 604. Accordingly, reference is made throughout the takeovers Chapters to interests in a managed investments scheme. They are, however, generally elided from discussion here in view of the focus upon companies and their securities.

Defining the affected companies [12.60] The prohibition in s 606(1) is contravened if each of four elements is satisfied. The

first is that the company whose voting shares are being acquired must be either a listed company or an unlisted company with more than 50 members: s 606(1)(a). However, as a note to the section explains, if the acquisition of relevant interests in an unlisted company with 50 or fewer members leads to the acquisition of a relevant interest in another company that is an unlisted company with more than 50 members, or a listed company, the acquisition is caught by s 606 because of its effect on that other company; as to such downstream acquisitions, see [12.80]. Otherwise, however, acquisitions of shares in companies with 50 or fewer members do not engage the prohibition.

A transaction in relation to securities entered into by or on behalf of the acquirer [12.65] The second element of a contravention of s 606(1) is that the acquisition must occur

through a transaction in relation to securities entered into by or on behalf of the person acquiring the shares. This element has a narrowing function in that it confines the operation of the broadly expressed prohibitions to transactions based on consensual arrangements relating to securities, albeit not necessarily those of the particular company whose securities are the explicit subject of the arrangement (a reference to downstream acquisitions again (see [12.80])). The phrase “transaction in relation to securities” is defined to refer to (a)

entering into, or becoming a party to, a relevant agreement in relation to the shares or securities; or

(b) exercising an option to have the shares or securities allotted: s 64. A relevant agreement referred to in para (a) is broadly defined as an agreement, arrangement or understanding, formal or informal, with or without any legal force: s 9. It is a term of central importance in takeover regulation which seeks to extend its reach to understandings with respect to shares that often are not in their creators’ interests to formalise in view of their consequences under the takeovers Chapters. (Perhaps the poet Milton anticipated the problems of takeover regulation in the 17th century when he referred in L’Allegro to “nods, and becks, and wreathed smiles”.) They are understandings buttressed by self-interest and sometimes expressed in little more than nods and winks. What is essential for a relevant 932

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agreement is a meeting of minds 55 and some degree of mutuality of purpose, not simply identical intentions independently held; it does not matter that the parties are free to act inconsistently with the mutual understanding. 56 In Perpetual Custodians Ltd v IOOF Investment Management Ltd Leeming JA said: An arrangement or understanding is something which falls short of a formal agreement, but still presupposes an informal consensus between parties. There must be a “meeting of minds” as to what will be done in the future. A mere expectation is not sufficient, even if that expectation is brought about by the other party. 57

The transaction that satisfies this second requirement will usually be a transaction in relation to shares. However, the term “security” is used rather than “shares” since expanded definitions of other terms embrace acquisitions of securities other than shares that result in a deemed acquisition of particular shares. Ordinarily, however, the relevant acquisition will be of voting shares rather than other securities. The term securities is defined for purposes of the takeovers Chapters in s 92(3) to mean shares, debentures, interests in registered managed investment schemes, legal or equitable rights or interests in shares, debentures or interests in managed investment schemes, and options to acquire any of these securities whether by way of issue or transfer. It excludes derivatives (such as futures contracts with respect to shares) and market traded options: s 9. The apparent rationale for these exclusions is that while trading in these markets may enable the accumulation of a proxy for a stake in another company (that is, the non-proprietary equivalent of such a stake), it has no actual effect upon control of the target.

Voting power in a company [12.70] The third element of the prohibition in s 606(1) applies where, because of the

acquisition, a person’s voting power in the company crosses the 20% threshold or, if it was above the threshold before the acquisition, increases in the range from 20 to 90%. The concept of a person’s voting power in a company is defined in s 610(1) by the following formula: Person’s and associates’ votes x 100 Total votes in body corporate

where: “person’s and associates’ votes” is the total number of votes attached to all the voting shares in the company that the person or an associate has a relevant interest in, and “total votes in body corporate” is the total number of votes attached to all voting shares in the company.

A note to the subsection indicates that even if a person’s relevant interest in voting shares is based on the control they possess over disposal of the shares (rather than control over voting rights attached to the shares), their voting power in the body corporate is calculated on the basis of the number of votes attached to those shares. The number of votes attached to a voting share is the maximum number of votes that can be cast in respect of the share on a poll on the election of a director or (in lieu of shareholder voting on such election) on the adoption or amendment of a constitution: s 610(2). 55

“There has to be a meeting of minds. If you open the door of a cage and all the mice leap [in] and head for the cheese, that does not mean they have an understanding”: Gleeson CJ in argument in Rural Press Ltd v ACCC [2003] HCATrans 291.

56

The core requirement is that of the underlying understanding since there is unlikely to be an agreement or arrangement independently of the existence of at least an understanding among those involved: Adsteam Building Industries Pty Ltd v The Queensland Cement and Lime Co Ltd (No 4) (1984) 2 ACLC 829 at 832.

57

[2013] NSWCA 231 at [70]. [12.70]

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Transactions between associates that would not increase a person’s voting power under the formula in s 610(1) are captured by s 610(3); otherwise, associates would be at liberty to dispose of voting shares between each other without engaging s 606 since that would not increase the voting power of the acquirer. This reflects the fact, as the following discussion indicates, that the factors that make a person an associate of another do not necessarily give them a relevant interest in the other’s shares.

The definition of associate [12.75] The definition of voting power draws upon that of an associate. An associate of a

person (the primary person) for purposes of the takeovers Chapters is defined as: (a)

if the primary person is a company, the entity or entities that control it or which it controls and entities under common control with it, determined in each case by reference to the broad definition of control in s 50AA;

(b)

a person with whom the primary person has, or proposes to enter into, a relevant agreement for the purpose of controlling or influencing the composition of the board or the conduct of the affairs of another company;

(c)

a person with whom the primary person is acting, or proposing to act, in concert in relation to the affairs of another company: s 12(2). Regulation 1.0.18 declares that the definition of the affairs of the company in s 53 applies to s 12(2)(b) and (c). The first definition of associate in s 12(2)(a) embraces controllers and controlled entities. The concepts underlying the second and third definitions – “relevant agreement for the purpose of control or influence” (s 12(2)(b)) and “acting in concert”(s 12(2)(c)) – overlap significantly. 58 Similar but not identical provisions are contained in s 15. The effect of s 15 and its relation to the limbs of s 12(2) is not entirely clear since s 15 appears to countenance the possibility that a person might be an associate under that provision who is not caught by s 12(2). 59 In particular, s 15(1)(c) applies where a person is or proposes to become associated with another “in any other way”, untethered from the requirements in s 12(2)(b) of a relevant agreement and the purpose of controlling or influencing board composition or company affairs. In Perpetual Custodians Ltd v IOOF Investment Management Ltd, Leeming JA considered that: to the extent that s 15(1)(c) expands the concept of “associate” at all, it does so by relaxing questions of timing and formality. The definition in s 15(1)(c) includes within the class of associates a person with whom the primary person “is, or proposes to become, associated, whether formally or informally, in any other way”. To my mind there is much to be said for the proposition that just as s 15(1)(a) in no way enlarges the class of “associates” in s 12(2)(c), so too s 15(1)(c) adds nothing to s 12(2)(b) or (c) even if it applies so as to override the necessity and sufficiency of the conditions in that subsection. That it adds nothing is apparent once it is broken down into its constituent parts. On its face, it has a present and a future-looking operation. The present operation extends the “associate” reference to persons with whom the primary person is associated, whether formally or informally, in any other way. But s 12(2)(b) and (c) proceed on the basis that formal or informal associations are sufficient: the references to “relevant agreement” in s 12(2)(b) pick up informal agreements and understandings and arrangements, and acting in concert in s 12(2)(c) likewise may be effected formally or informally. The future-looking operation of s 15(1)(c) is 58

CMI Ltd 01R [2011] ATP 5 at [33]-[34].

59

Perpetual Custodians Ltd v IOOF Investment Management Ltd [2013] NSWCA 231 at [59] per Leeming JA. Further, the definition in s 12(2) is expressed to apply “for the purposes of the application of the associate reference to the designated body [viz, a company]”; s 15 is expressed to apply more generally, “in respect of the matter to which the associate reference relates”.

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expressly picked up by “proposes to enter into” in s 12(2)(b) and “proposes to act” in s 12(2)(c). It is not necessary to explore whether s 15(1)(c) adds anything to s 12(2)(a), upon which the [plaintiff] placed no reliance. Moreover, in its application to the facts of this appeal, nothing turns on the timing or the informality of the alleged association. Only if it did could the expansive words of s 15(1)(c) make a difference, and only then would it be necessary to attempt to reconcile its apparent conflict with the necessary and sufficient conditions provided for in s 12(2). 60

The Takeovers Panel points to the breadth and generality of the s 12 definition: Section 12 does not … require that the agreement or concerted action relate expressly to shares in any way, or to the exercise of votes attached to shares. Rather, the legislature has decided to aggregate the voting power of people who are cooperating in ways which might be advanced by the use of such power. 61

ASIC interprets s 12(2) as grouping together people who have a common purpose of controlling a company and ensuring that the persons are not treated as acting independently of persons with whom they are in fact co-operating. Accordingly, ASIC has modified the associate reference in s 12(2)(b) and (c) by class order to make it clear that the parties to a relevant agreement are not associates merely because the agreement contains a provision giving a person the right to dispose of securities in a company or to control the exercise of the power to dispose of the securities. 62 That consequence would flow from the breadth of the concept of a relevant interest in shares that has been adopted to protect the takeover threshold (see [12.80]). The disposal right does not necessarily mean that they have a common purpose with respect to corporate control – the parties may not be seeking to achieve any more together than simply to acquire and dispose of securities. 63 The intrinsic character of the associate concept presents an unusually difficult challenge in legal formulation. The phrase “acting in concert” connotes “knowing conduct the result of communication between parties and not simultaneous actions occurring contemporaneously.” 64 In Perpetual Custodians Ltd v IOOF Investment Management Ltd Stevenson J at first instance said that in order that two parties act “in concert”: (a) there must at least be an understanding between them as to their common purpose of object; a mere coincidence of separate acts is insufficient; (b) there must be some knowing conduct the result of communications between parties and not merely simultaneous actions occurring contemporaneously; (c) there must be an understanding between the parties as to a common purpose of object; (d) there must be contemporaneity and community of purpose; (e) a concurrence of views about the merits of a particular resolution proposed by another person is not sufficient; and (f) the understanding between the parties as to the common purpose or object must be consensual and there must be some adoption of it. 65 60 61

[2013] NSWCA 231 at [120]-[121]. National Foods Ltd [2005] ATP 8 at [57].

62

ASIC Regulatory Guide 5.146 (Relevant interests and substantial holding notices). Without the class order, parties would have a relevant interest not only in the securities the subject of the disposal right but all securities held by the other party. The person with the disposal right retains their relevant interest in the securities but the parties are not thereby associates of each other by reason solely of the disposal right.

63 64 65

ASIC Regulatory Guide 5.148 (Relevant interests and substantial holding notices). Bank of Western Australia Ltd v Ocean Trawlers Pty Ltd (1995) 16 ACSR 501 at 524. (2013) 91 ACSR 530 at [102] (citations omitted); this statement was approved and applied on appeal: Perpetual Custodians Ltd v IOOF Investment Management Ltd [2013] NSWCA 231 at [103] per Leeming JA with whom McColl and Gleeson JJA agreed. [12.75]

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Of themselves, family relationships will not friendships or professional relationships. 66 In that the counterpart to s 12(2)(b) extended non-reflexively, merely by a proposal in the communicated to another. This was rejected:

establish an association, much less personal Elders IXL Ltd v NCSC the regulator argued to an association established unilaterally or mind of one person not yet, perhaps never,

The purpose of the Code is to regulate takeover activity. The purpose of [the section] is to identify the size of a relevant shareholding for the purposes of the restriction imposed by [s 606]. Necessarily, [the section] is concerned with real combinations and real aggregations which, one way or another, truly exist. It is not concerned to fantasise combinations by adding to a holding that of another person, who has no real connection, potential or otherwise, with the first. … In summary, the Code is to be understood as dealing with combinations of persons which might fairly be regarded as in existence, no matter what arrangement or device is employed to disguise the fact of combination. Thus, the admittedly wide words of [the section] are to permit a finding, from the known facts and circumstances, that a combination as a matter of probability exists, notwithstanding it is hedged about with all manner of devices for concealment. It must be emphasised, however, that such a finding must be truly available and not the product of mere suspicion or prejudice. 67

As with that of a relevant agreement with which the concept of association is inevitably linked, the intrinsic character of an association and the breadth of the statutory language present unusual problems of detection and proof since the evidence for an association will often be circumstantial and depend upon inference. In Dromana Estate 01R, the Panel said that “[i]ssues of association frequently need to be decided on the basis of inferences from partial evidence, patterns of behaviour and a lack of a commercially viable explanation for the impugned circumstances”. 68 In Adsteam Building Industries Pty Ltd v The Queensland Cement and Lime Co Ltd (No 4), McPherson J said: I cannot see that it is possible for persons to “act in concert” towards an end or object, or even simply to act in concert, unless there is at least an understanding between them as to their common purpose or object. The expression in question evokes the notion of joint actors, or perhaps even joint tortfeasors, as to which it is settled that there must be “concerted action to a common end” … A mere coincidence of separate acts is insufficient. If such an understanding does exist, it is extremely unlikely that the plaintiffs will be in a position at trial to adduce direct evidence that the defendants arrived at it. That is to say, it is improbable in the extreme that they will be able to prove that the understanding alleged was arrived at on a particular day or days, or between identified individuals acting on behalf of named companies, etc. … The law is by no means without experience of cases of this kind. Cases of criminal conspiracy are the most obvious example. Direct evidence to prove the making of an agreement to carry out an unlawful purpose is rarely available to the prosecution in such cases. As has repeatedly been said, in those cases proof of conspiracy almost invariably rests upon inference deduced from acts of the parties done in pursuance of the apparent common purpose. 69

In Viento Group Ltd, the Panel said: Before the Panel will conduct proceedings on the issue of association, there must be a sufficient body of material demonstrated by the applicant, together with inferences (eg from partial 66

67

Bateman v Newhaven Park Stud Ltd [2004] NSWSC 566; (2004) 49 ACSR 597; Elders IXL Ltd v NCSC [1987] VR 1 (deemed irrelevant that two persons had “a friendly relationship”, that their two companies were part sponsors of a sporting event and they were directors of the same football club). Elders IXL Ltd v NCSC [1987] VR 1 at 15.

68

Dromana Estate Ltd 01R [2006] ATP 8 at [25].

69

Adsteam Building Industries Pty Ltd v The Queensland Cement and Lime Co Ltd (No 4) (1984) 2 ACLC 829 at 832, 833.

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evidence, patterns of behaviour and a lack of a commercially viable explanation) that might be drawn, to support the Panel conducting proceedings. … Circumstances which are relevant to establishing an association include: (a) a shared goal or purpose (b) prior collaborative conduct (c) structural links (d) common investments and dealings (e) common knowledge of relevant facts and (f) actions which are uncommercial. 70

However, a person is not an associate of another merely because of the following: • advice given to or acts on behalf of the primary person in the proper performance of professional functions or a business relationship; • specific instructions given to a dealer in financial products to acquire such products on the primary person’s behalf in the ordinary course of its business; • the sending, or the proposal to send, takeover offers; and • the appointment of a proxy to vote at a company meeting unless valuable consideration has been given for the proxy: s 16. Association in itself does not contravene s 606 but may lead to contravention of the substantial shareholding provisions by reason of the aggregation of relevant interests. 71 Questions of contravention of s 606 only arise when a person acquires a relevant interest in voting shares through a transaction in relation to securities and, because of the transaction, a person’s voting power crosses the 20% voting threshold or increases beyond the protection of an exemption. The final element of the s 606 prohibition is the concept of a relevant interest; it is to that which we now turn. We shall see that the events that trigger association do not necessarily, although they may sometimes, create a relevant interest in shares: see [12.100]. The two concepts are linked but not identical either in their terms or function. Each contributes to the architecture of s 606. Relevant interests in securities

The extended definition [12.80] The fourth core prohibition of s 606 is upon the acquisition of a relevant interest in

issued voting shares, a prohibition giving effect to the core idea of regulating the transfer of corporate control so that all shareholders have the opportunity to participate equally in the premium being offered for control. However, if the prohibition upon acquisitions of voting shares might be avoided by acquiring rights short of legal or equitable ownership that nonetheless conferred effective control over the shares, that would open easy opportunities for evasion of the control threshold that s 606 creates. Accordingly, a more complex notion is required, expressed in that of a relevant interest in securities. Two sets of rights with respect to a security are selected as marking their essence for the purpose of identifying control with respect to the shares: voting and disposal rights. Thus, a person is deemed to have a relevant interest in securities if one of the following indicia applies: 70

71

Viento Group Ltd [2011] ATP 1 at [26], [119]; see also Mt Gibson Iron Ltd [2008] ATP 4; CMI Ltd [2011] ATP 4; World Oil Resources Ltd [2013] ATP 1; Winepros Ltd [2002] ATP 18 at [27] (often establishing an association requires the Panel “to draw inferences from patterns of behaviour, commercial logic and other evidence suggestive of association”). Coopers Brewery Ltd 03R [2005] ATP 23; Coopers Brewery Ltd 04R [2005] ATP 24. [12.80]

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• they are the holder of the securities; • they have power to exercise, or control the exercise of, a right to vote attached to the securities; or • they have power to dispose of, or control the exercise of a power to dispose of, the securities (s 608(1)). It does not matter how remote the relevant interest is and how it arises: s 608(1). Power or control is widely extended to include that which is indirect, implied or informal, exercisable through or in breach of a trust, agreement or practice, alone or jointly with someone else, or is subject to restraint. It need not be related to a particular security: s 608(2). In TVW Enterprises Ltd v Queensland Press Ltd two shareholders in The Herald and Weekly Times Ltd (Herald) exchanged letters signed by the chairman of directors of each company undertaking, if called upon by the other to do so, to enter into an agreement in the terms of that attached to the correspondence. That agreement, once executed, would confer a right of pre-emption in favour of either party in relation to the Herald shares held by the other should either wish to sell those shares. The right was a right of pre-emption as distinct from an option to purchase; the pre-emptive procedures provided that a party proposing to sell any of its shares would first give the other a notice specifying the transfer shares and sale price. The notice was to constitute an offer for the sale of the transfer shares at the sale price; the party receiving the notice would have 90 days in which it might purchase at the nominated sale price. O’Bryan J held that the conditional offer, once accepted, constituted an enforceable agreement. He added: In my opinion if a person has power to exercise some true or actual measure of control over the disposal of voting shares in a company then that person has a relevant interest. …. I am unable to accept [the] submission that “control” in [s 50AA] should be construed to mean “complete control”, “effective control” or “actual control”. … I agree in the words of Beach J [in Re Kornblums Furnishings Ltd [1982] VR 123] that “some true or actual measure of control over either, the right to vote attached to a share or, over the disposal of that share gives rise to a relevant interest”. Such a conclusion is consistent with the ordinary meaning of control and not unduly restrictive. The literal meaning of “power” is, “the ability to do or act”; “control, influence, ascendancy” (Oxford Dictionary). Were one to construe power to mean “full and adequate power” one would unduly restrict the ordinary meaning of the power, in my opinion. 72

O’Bryan J held that each shareholder had, by the exchange of correspondence, a relevant interest in each other’s shares in Herald. This conclusion flowed since the letter exchange gave each party power “to exercise some true or actual measure of control” over the exercise of voting rights and the disposal of the other’s shares – the agreement created by the exchange of letters implied a restriction upon disposal inconsistent with the pre-emption rights and the draft agreement, once executed, would operate to control the exercise of the right to vote attached to the shares. 73 A person may acquire a relevant interest in securities other than through direct acquisition of rights with respect to these securities. First, a person (including a company) is deemed to have a relevant interest in any securities in which a company has a relevant interest where the person’s voting power in the company is above 20%: s 608(3)(a). (The acquisition of a relevant interest in the shares in the downstream company is commonly called a “downstream acquisition”.) This downstreaming provision deems control to arise from the fact of this level of voting power; however, it recognises the danger of multiplying the assumption by applying it serially. Therefore, the deeming does not apply to a relevant interest that the company has in 72 73

[1983] 2 VR 529 at 542-543. [1983] 2 VR 529 at 543-544.

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the securities merely because of the operation of s 608(3)(a) in respect of its voting power in another company. That is, s 608(3)(a) does not operate successively upon immediately adjacent shareholdings to give one company a deemed relevant interest in another company by virtue of two layers of interposed shareholdings. Thus, in the following example s 608(3)(a) would deem A to have a relevant interest in B’s shareholding in C but not (on the basis of these shareholdings alone) in C’s shareholding in D. Similarly, B, but not A, would be deemed to have a relevant interest in C’s shareholding in D.

Second, a person (including a company) is deemed to have a relevant interest in any securities in which a company that it controls has a relevant interest: s 608(3)(b). The definition of control for this purpose is similar to that contained in s 50AA, namely, the capacity to determine the outcome of decisions about the company’s financial and operating policies; this capacity is measured by the practical influence the person can exert (rather than the rights they can enforce) and takes account of any practice or pattern of behaviour affecting the company’s financial or operating policies even if it involves a breach of an agreement or trust: s 608(4), (5). However, a person does not control the company merely because they and an entity that is not an associate jointly have the capacity to determine the outcome of decisions about its financial and operating policies; neither does a person control a company merely because of a capacity they have if they are under a legal obligation to exercise that capacity for the benefit of someone else or, in the case of a company, someone other than its members: s 608(6), (7). In the following example, what factors might determine whether W would have a relevant interest in Y’s holdings in Z?

The operation of these rules may result in a company having a relevant interest in its own securities: s 608(9). In the above examples, in what circumstances might A or W be deemed to have a relevant interest in shares in itself? What might the consequence of such an interest be?

Anticipatory relevant interests [12.85] A further provision prevents the artificial suspension of existing control relationships; it does so by anticipating the performance of executory agreements and exercise of rights through a “relation back” rule. Thus, if at a particular time each of these conditions are satisfied: (a) a person has a relevant interest in issued securities; (b) the person (whether before or after acquiring the relevant interest) (i) enters into an agreement with another person with respect to the securities; (ii) gives another person an enforceable right, or is given an enforceable right by another person, in relation to the securities (whether the right is enforceable presently or in the future and whether or not on the fulfilment of a condition); or (iii) grants an option to, or is granted an option by, another person with respect to the securities; and [12.85]

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(c)

the other person would have a relevant interest in the securities if the agreement were performed, the right enforced or the option exercised

the consequence is that the other person is taken to have immediately a relevant interest in the securities, and not merely from the later time of performance, enforcement or exercise: s 608(8). Examples include a conditional agreement for sale of shares and the grant of a call option over a parcel of shares: in the latter case, the taker has a relevant interest in the shares from the time of the grant and not merely the exercise of the option. The provision operates, however, only with respect to issued shares, and does not apply to agreements concerning or options over unissued share capital.

Interests outside the concept of a relevant interest [12.90] In a variety of situations that might otherwise attract the definition of relevant

interest, specific exclusions are granted from the definition: s 609. These include interests arising from: • moneylending and other financial accommodation in the ordinary course of business and on ordinary commercial terms (s 609(1)); • acting as a bare trustee of a trust (that is, a trustee with no equitable interest in the trust) if a beneficiary under the trust has a relevant interest in the securities because of a presently enforceable and unconditional right of the kind referred to in s 608(8) (s 609(2)); 74 • a financial services licensee holding securities on behalf of someone else in the ordinary course of financial services business (s 609(3)); • the grant of a revocable proxy for a single company meeting for which no consideration is given (s 609(5)); • a market traded option over securities or the right to acquire the securities given by a derivative until the time when the obligation to make or take delivery of the securities arises (otherwise s 608(8) would create a relevant interest from the grant of the option or contract) (s 609(6)); • the grant of pre-emptive rights under a company’s constitution (s 609(8)); 75 and • appointment as director of a company where the company has a relevant interest in securities (s 609(9)). 76

When the acquisition of a relevant interest occurs [12.95] The central prohibition in s 606 is upon a person acquiring a relevant interest in

voting shares. The term “acquire” is not defined in the Act. However, it is clear that it includes acquisition by subscription for, as well as purchase of, shares. It also includes obtaining a 74 75

A note to s 609(2) indicates that it will often apply to a person who holds securities as nominee for another. In the absence of such an exemption the acquisition of a single share by someone who had no interest previously would see their voting power increase from zero to 100%; subsequent acquisitions would not be affected by s 606 since each shareholder would have a relevant interest in all shares in the company; effectively admission to membership would involve a contravention but there would then be no further application for s 606; neither of these situations is sustainable in terms of the policy in s 602: North Sydney Brick and Tile Co Ltd v Darvall (1986) 5 NSWLR 681 at 683, 689-691.

76

The provision displaces the interpretation placed upon s 608(1) that, because the board of directors collectively has power with respect to securities in which the company has a relevant interest, each director has the like power, and therefore the like relevant interest, individually: Clements Marshall Consolidated Ltd v ENT Ltd (1988) 13 ACLR 90; but see Zytan Nominees Pty Ltd v Laverton Gold NL (1988) 14 ACLR 524 (adopting the view expressed in s 609(9)).

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relevant interest in securities through the deemed relevant interest under s 608(3) if that arises as a result of a transaction entered into in relation to securities: Edensor Nominees Pty Ltd v ASIC [12.120] at [17], [34]-[35]. In two situations where a gap in coverage would otherwise occur, a person is deemed to acquire a relevant interest in voting shares for the purposes of s 606(1), namely, where (a) securities in which the person already has a relevant interest become voting shares in the company, or (b) there is an increase in the number of votes that may be cast on a poll attached to voting shares that the person already has a relevant interest in: s 606(6). Instances arise where a person exercises a right to convert non-voting preference shares or debentures into ordinary shares with voting rights (para (a)) and where a holder pays up partly paid shares with limited votes and this leads to an increase in the number of votes attached to the shares (para (b)).

Application to corporate governance initiatives [12.100] The prohibition in s 606(1) is expressed to apply to transactions wider than those preparatory to the making of takeover offers and may include those that concern the governance, affairs and board control of a company without any proposal to purchase further shares in it. Investors with a shared concern in such issues may become associates or be regarded as having entered into a relevant agreement for the purposes of the takeover or substantial holding provisions; their conduct may also give rise to unacceptable circumstances. This is because those provisions are concerned not only with the power of individual investors in relation to the voting and disposal of shares in companies but also with the aggregated voting power of groups of investors who are either related or associated with each other in relation to some aspect of the company’s affairs. 77 Thus, in Flinders Diamonds Ltd v Tiger International Resources Ltd two shareholders reached an understanding to remove the incumbent directors of Flinders and to replace them with their own nominees. This was part of a plan for one of them to become the managing director of the company. For this purpose one shareholder had in accordance with the understanding requisitioned a general meeting of Flinders. The court held that the agreement between them breached s 606 since they had the capacity between them to control more than 20% of the company. The understanding between them breached s 606(1) since [they] had resolved upon a plan to replace the board of Flinders. That of itself is not sufficient to constitute a breach of s 606. Something more than that each had a common intention to bring about the desired result is required. … [They] had an understanding that they would vote collectively the shares in Flinders held by [each] … The evidence clearly established that [they] had an understanding as to the means by which they proposed to achieve their common goal of spilling the board of Flinders. To that extent, they were also acting in concert to achieve that end. 78

The exception in s 609(5) did not save them because their understanding with respect to the grant of an irrevocable proxy extended beyond the single requisitioned meeting. The order made is discussed at [12.105]. In Resource Generation Ltd, Resource Generation (RES) applied for a declaration of unacceptable circumstances in relation to its own affairs. The application concerned, among other things, the failure to disclose an alleged association between three RES shareholders two of whom were members of a debt club seeking to provide new project financing to the 77 78

ASIC Regulatory Guide RG 128.7 (Collective action by investors). Flinders Diamonds Ltd v Tiger International Resources Ltd (2004) 88 SASR 281 at [35], [37]. [12.100]

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company. One of the shareholders (Altius) had requisitioned a general meeting to change the composition of the RES board. The Panel considered that two of them (Noble and Altius) were associated for the purpose of controlling or influencing the composition of the RES board, and made a declaration of unacceptable circumstances and ordered disclosure. Having found an association between Noble and Altius, the Panel considered whether Noble and Altius acquired a relevant interest in each other’s RES shares by virtue of their entering into a relevant agreement to each vote their shares in favour of the resolutions at the requisitioned meeting. RES submitted that the evidence upon which the Panel was minded to find an association established a voting agreement and submitted that it would be illogical for the Panel to infer that Noble and Altius had a relevant agreement for the purpose of influencing the composition of RES’s board but not a relevant agreement as to the voting of their RES shares at the requisitioned meeting. The resolutions to be voted on at the requisitioned meeting, RES submitted, were directed precisely at the composition of the board. The Panel disagreed: We do not think there has been a contravention of s 606 here. Unlike Flinders Diamonds, we consider there is insufficient evidence to find that Noble or Altius had a voting agreement in relation to their RES shares. In most cases, parties forming a proposal for controlling or influencing the composition of a board will also enter into a voting agreement. It is, as RES submitted, a logical corollary of a shared goal such as board composition that the agreement, arrangement or understanding would extend also to seeing it implemented. It would not seem to us to require very much evidence to establish that the agreement, arrangement or understanding went as far as a voting agreement, and indeed it might be a relatively easy inference to draw from surrounding circumstances. However, we have the unusual case before us. The evidence is not sufficient in our view to permit the taking of the next step. In our view, as ASIC RG 128 seeks to establish, collective action is to be encouraged for proper corporate governance purposes. The Panel does not seek to limit the ability of major security holders to exercise voting power in whatever way they choose. It is only, for example, when collective action binds them to other major holders by virtue of a relevant agreement, or where there are further accumulations of securities, that unacceptable circumstances are likely to occur. On the evidence available to us in this matter, the proposal for controlling or influencing the composition of the board of RES involved, at least in the end, replacing the existing board. A majority of the appointees proposed for the board, it appeared, were independent of Noble and Altius. Save for non-disclosure of the association, this would be an example of the type of collective action that would be unlikely to give rise to unacceptable circumstances. This case illustrates a wider point in the context of debt clubs and other debt “work-outs”. The relationship between debt and equity providers can become blurred when members of the club and their associates hold in excess of 20% of the underlying equity and/or when they seek support from other security holders. In our view, it is up to the individual debt providers to ensure that their communications and actions do not overstep the mark. 79

In Re Online Advantage Ltd the question arose with respect to an agreement for the sale of shares in a company that carried with it the vacation of some board positions in favour of the purchaser. The Takeovers Panel said: In general, it does not offend against the policy of section 602 for people to buy and vote shares in a company, even if by doing so they change the policies of the company and frustrate the intentions of previous directors and shareholders, provided they do not do so in ways which contravene section 606 or otherwise represent combinations to purchase a block of over 20% of the votes, directly or indirectly. 79

Resource Generation Ltd [2015] ATP 12; affirmed upon review: Resource Generation Ltd 01R [2015] ATP 13. On the application of Ch 6 to recapitalisation proposals see Billabong International Ltd [2013] ATP 9 and A Colla (2013) 31 C&SLJ 531.

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Nor is it offensive for like-minded shareholders to vote the same way (including to replace a board), if each of them votes in that way because they see it as in their interest as a shareholder to vote in that way, and they do not vote together because they have entered into an understanding, affecting 20% or more of the votes, to exercise joint control over the company. After all, resolutions are put to a vote just so that shareholders can resolve disputed questions by majority, according to their perception of their respective interests. Despite these principles, in our view, it is unacceptable for one person (or a group acting together) to acquire control of a company by buying from another group an influential block of shares (which might be less than 20% of the votes) and having that group deliver them control of the board, by appointing a majority of directors to fill casual vacancies, without the minority participating by being made offers to acquire their shares on the same terms or having the opportunity to consent to the transaction. The support of the board can magnify the influence which a modest block of shares can exercise in an open register, and that influence can in turn entrench the board. The overall effect could amount to the purchase of control from some only of the shareholders in the company, contrary to the policy of section 602. 80

The reach of the prohibition in s 606 through the extended definition of relevant interest has a potentially significant impact upon collective action that shareholders, institutional investors particularly, might wish to take in relation to the affairs of portfolio companies. ASIC’s policy with respect to whether unacceptable circumstances exist and enforcement action is warranted will depend on whether it appears to ASIC that the conduct has a control purpose and effect, rather than simply promoting good corporate governance. 81 ASIC has provided the following illustrative examples of conduct where collective action by investors is unlikely to constitute entry into a relevant agreement resulting in the acquisition of a relevant interest or triggering an associate relationship or unacceptable circumstances • holding discussions or meetings about voting at a specific or proposed company meeting; • discussing issues about the company, including problems and potential solutions; • discussing possible matters to be raised with the company’s board; • discussing and exchanging views on a resolution to be voted on at a meeting; • disclosing individual voting intentions on a resolution; • recommending that another investor votes in a particular way provided no undertaking or agreement to follow the recommendation or act in a particular way is obtained; or • making representations to the company’s board about the company’s policies or particular actions that the company might consider taking 82 provided each investor is not bound to act in a certain way and retains its own discretion in terms of approach on an issue. 83 80 81

Re Online Advantage Ltd [2002] ATP 14 at [54]-[56]. ASIC Regulatory Guide 128.45 (Collective action by investors).

82

Provided that the investors are not pursuing agreed joint proposals about the company; in that case, they may become associates. Representations accompanied by overt threats of collective or coordinated exercise of rights attached to shares can raise concerns that the investors have acquired relevant interests in each other’s shares through a relevant agreement.

83

ASIC Regulatory Guide 128, Table 1 (Collective action by investors). A potential problem may arise for investment institutions seeking to discharge their responsibility to prevent or mitigate human rights abuses to which they are linked by their investment. The United Nations Guiding Principles on Business and Human Rights summon investors to exercise and build influence through collective action if individual action is insufficient to prevent or mitigate the harm: see [2.247]. The prohibition in s 606 and ASIC’s Regulatory Guide are framed without advertence to investor discharge of the responsibility to respect human rights. Investor action in discharge of the responsibility is unlikely to offend takeover policy but nonetheless may expose actors to serious sanctions in some situations; the fit between the two bodies of regulation requires attention: see P Redmond (2016) 31 Aust Jnl of Corp Law 3 at 39-41. [12.100]

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ASIC also gives these examples of conduct where collective action by investors is more likely to constitute entry into a relevant agreement resulting in the acquisition of a relevant interest or triggering an associate relationship or unacceptable circumstances: • jointly signing with other investors a s 249D notice requisitioning a general meeting to consider a resolution relating to board composition or the company’s affairs or a s 249N notice to similar effect; • formulating joint proposals relating to board appointments or a strategic issue; • accepting an inducement to vote or act in a specific way; • agreeing on a plan concerning voting; or • limiting their freedom to vote (eg, by granting another investor an irrevocable proxy). As regards the first dot point, ASIC considers that joint signing in these circumstances is likely to involve entry into a relevant agreement and accordingly for these investors to be considered associates. If accompanied by an understanding about the exercise of voting rights, it will also result in the acquisition of a relevant interest. As regards the second dot point, ASIC takes the view that this conduct is likely to indicate that there is an understanding between the investors on a particular matter relating to the affairs of the company which amounts to a relevant agreement or acting in concert and these investors being considered associates. As regards the third dot point, ASIC considers that this conduct is likely to constitute entering into a relevant agreement and for these investors to be considered associates. In addition, it may give a person control over the votes attached to shares or interests, resulting in the acquisition of a relevant interest by that person. 84

Consequences of contravention of s 606 [12.105] A transaction is not invalid merely because it involves a contravention of s 606:

s 607. However, the Court may make a wide range of remedial orders for contravention including the divestiture of shares although, where a takeover bid is made, its jurisdiction is displaced in favour of that of the Panel until after the bid period: s 1325A and [12.35]. In Flinders Diamonds Ltd v Tiger International Resources Ltd the contravention did not involve a takeover bid and so no question of the court’s jurisdiction arose. The court identified and applied these principles in framing the remedy for breach: (a) One of the primary objectives of Chapter 6 is to ensure that the acquisition of shares in listed companies takes place in an efficient, competitive and informed market. In the context of this action that principle translates to the objective of ensuring the transparent exercise of voting rights, so that control of the corporation cannot be exercised other than in accordance with rights attached to the shares beneficially held and without full disclosure of the nature and extent of that beneficial interest. (b) The orders to be made in respect of a contravention are, in general, remedial rather than punitive. The discretionary power to make such orders as the court thinks appropriate, although conferred in very wide terms, has been construed as a power to make orders which advance the principal objectives of the statutory scheme. (c) It is relevant to have regard to the seriousness of the contravention and of the consequences which flow from it. (d) Orders that ensure that those who contravene the provisions do not enjoy the benefits of their contravention or orders which render their efforts fruitless are within the objects of the statutory scheme. 84

ASIC Regulatory Guide 128 Table 2 (Collective action by investors).

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(e) The exercise of the court’s discretion requires it to consider the range of possible remedies and select the appropriate one in the circumstances of the case. While orders made in respect of a contravention are generally remedial rather than punitive, in considering whether an order is unfairly prejudicial and whether the court should exercise its power in a particular case, it is appropriate to take into account the degree of culpability of persons whose interests are affected by the orders, including whether those persons have acted dishonestly or in a manner that can be characterised as reckless. 85

The vice in the defendants’ conduct (see [12.100]) was not that they sought to change the composition of the board but that they did so by means of secret understandings as to voting. 86 The court ordered that each of the defendants be restrained from giving effect to their understanding with respect to shares held by the other. It set aside the divestiture order made by the primary judge who had directed that their shares be sold by ASIC. 87 These principles and rules are applied in the following case extracts. NCSC v Brierley Investments Ltd [12.115] examined notions of control and power that satisfy the standard for relevant interests. Edensor Nominees Pty Ltd v ASIC [12.120] dealt with a sophisticated arrangement that was argued to create an association without the acquisition of a relevant interest in the associate’s shares. It was decided shortly before the Panel’s extended jurisdiction commenced in 2000. Re Taipan Resources NL [12.125], an early decision of the Panel, dealt with a contravention of s 606(1) and fashioned appropriate orders.

NCSC v Brierley Investments Ltd [12.115] NCSC v Brierley Investments Ltd (1988) 14 NSWLR 273 Supreme Court of New South Wales [This case concerned the acquisition by Brierley Investments Ltd (BIL) of a 30% interest in the company Rainbow. Both are New Zealand-incorporated companies and the transaction occurred in New Zealand where it was not prohibited under local law. ASIC’s predecessor sought a declaration that this transaction was the acquisition of shares in Woolworths, incorporated in New South Wales, in contravention of the contemporary counterpart of s 606(1). The relationships between the companies and BIL’s interest in Woolworths through IEL are shown in the following diagram taken from Butterworths Corporations Law Bulletin 1988, [382].

85 86 87

Flinders Diamonds Ltd v Tiger International Resources Ltd (2004) 88 SASR 281 at [63], quoting principles adopted and summarised by Merkel J in ASIC v Terra Industries Inc (1999) 163 ALR 122 at [97]. They also breached obligations to disclose changes in substantial shareholdings under Ch 6C since Flinders was a listed company: see [12.220]. Flinders Diamonds Ltd v Tiger International Resources Ltd (2004) 88 SASR 281 at [81], [83]. [12.115]

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NCSC v Brierley Investments Ltd cont.

There were two shares only in Redgate, one each registered in the name of Briggs and Townley, members of a Darwin law firm. By a deed each granted a call option to Diatribe to sell to Diatribe any of the shares in Redgate held by him for a price of $1, on one week’s notice, the purchase to take place within two business days thereafter. At all material times, the shares in Diatribe were owned, as to two “D” class shares, by a New Zealand company called Setar Five and, as to the other shares, equally by Conference and Progen, both New Zealand companies. The directors of Diatribe were Darvell and Young, New Zealand solicitors. The articles of Diatribe gave the holder of the “D” shares the exclusive right to appoint and remove directors of Diatribe. However, the only shareholders and directors of Setar Five were Darvell and Young. Furthermore, the annual return for Setar Five dated 19 June 1987 was lodged by Rainbow. ASIC argued that Rainbow had a controlling interest (the then measure of a relevant interest) in Stanley Park because it had an interest through the numerous interposed companies that necessarily gave it indirect control. Secondly, it argued that such a controlling interest might be found by the successive application of the control test corresponding to s 608(3)(b) although without the present expansive notions of control under s 608(4) and (5). Thirdly, it argued that the court could infer that, as a matter of fact, Rainbow had power to control the exercise of the right to vote attaching to Stanley Park’s shares in Woolworths and/or power to exercise control over the disposal of such shares.] HODGSON J: [287] As regards the first approach, … in my view, on the balance of probabilities, at material times, Rainbow did have a factual power to control Stanley Park … in my view, this fact is proved in the appropriate way on the balance of probabilities. [288] In my view it is clear, when one looks down the whole chain of companies between Rainbow and Stanley Park, that there is no commercial interest anywhere in this chain which is independent of 946

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NCSC v Brierley Investments Ltd cont. Rainbow, except for such interests as may be associated with the shares in Progressive which are held by persons other than Rainbow. Those shares amount to 49% of Progressive, of which about 14% were, at material times, held by BIL and were to be transferred to Rainbow pursuant to the transactions in question. It is clear in my view that the holding of this minority of shares in Progressive would not prevent Rainbow having power to control Stanley Park. So far as concerns the two claimed breaks in the chain, in my view the absence of any independent commercial interest at these points is clear. The company, Setar Five, which had power to appoint directors of Diatribe, was at material times a company whose only shareholders and directors were two solicitors, who were also directors of Diatribe. The annual return of Setar Five was lodged by Rainbow. Control over Diatribe could, if necessary, be assumed by the other shareholders of Diatribe, by having a meeting called to effect appropriate changes in the articles of Diatribe. From these circumstances, I infer a factual control of Diatribe by Conference and Progen, even though, in terms of enforceable legal rights, it could be said that Conference and Progen had only a potentiality to obtain control. So far as concerns the control of Redgate, again it seems clear to me that Messrs Briggs and Townley had no independent commercial interest, and would, as a matter of commercial practice, act on the instructions of Diatribe or those who control Diatribe. Messrs Briggs and Townley were two members of a firm (whether of accountants or solicitors or some other business, I do not know) in Darwin. By reason of the call option it is clear that they had nothing other than a nominal commercial interest in Redgate, and they were bound by the call option to transfer the shares in Redgate (which must be of very considerable value) for nominal consideration. Furthermore, it seems clear that if necessary, legal control of Redgate could have been obtained by Diatribe by exercise of the call option. In those circumstances, I infer a factual control of Redgate by Diatribe and (in turn) by those who control Diatribe, notwithstanding that there may only be a potentiality so far as legally enforceable rights are concerned. Having found that Rainbow, as a matter of fact, had power to control Stanley Park, the next question is whether it had a “controlling interest” in Stanley Park. Although I accept that in many contexts “interest” means proprietary interest, I do not think a “controlling interest” within … the Acquisition Code needs to be a proprietary interest … I think that in ordinary language, Rainbow can be said to have had an indirect interest in Stanley Park, and I think that indirect interest was such as to give Rainbow control of Stanley Park; and accordingly, in my view, Rainbow did, at material times, have a controlling interest in Stanley Park. Then, applying [s 608(3)(b)], Rainbow had, at material times, the power to exercise the right to vote attaching to Stanley Park’s shares in Woolworths, which Stanley Park itself had. I turn now to the second way in which the plaintiff put its case on this aspect … The main difference here from the first way is that at various [289] intermediate points in the chain, a controlling interest is alleged, so that [s 608(3)(b)] can be applied. That is, it is not alleged as a matter of fact that there is direct control from Rainbow to Stanley Park, but rather that power to control should be deemed by virtue of a number of applications of [s 608(3)(b)]. I am prepared to infer that Rainbow had a controlling interest in Diatribe, and it is clear that Redgate had a controlling interest in Turaro, which in turn had a controlling interest in Stanley Park. The main question on this approach is whether Diatribe had a controlling interest in Redgate. On the whole, … I think Diatribe’s interest in the call option, whether or not it can strictly be regarded as a proprietary interest in Redgate, can be considered a controlling interest, because it is in ordinary language an interest in Redgate, and for the reasons given earlier, it did give factual control. Accordingly, on this basis also, I think that Rainbow is deemed by successive applications of [s 608(3)(b)] to have had, at material times, the same power in relation to Stanley Park’s shares in Woolworths as Stanley Park itself had. As regards the third approach, for the same reasons as referred to in relation to the first approach, I am prepared to infer that as a matter of fact, Rainbow, at material times, had power to control the exercise of the right to vote attached to Stanley Park’s shares in Woolworths, and also to exercise control over [12.115]

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NCSC v Brierley Investments Ltd cont. the disposal of those shares. This is purely an inference of fact, based especially on the nature of the connections between Rainbow and Stanley Park, and the absence of any outside commercial interest, apart from the minority shares in Progressive.

Edensor Nominees Pty Ltd v ASIC [12.120] Edensor Nominees Pty Ltd v ASIC (2002) 41 ACSR 325 Federal Court of Australia (Full Court) [On 12 January 1999 Yandal Gold served on Great Central Mines Ltd, an ASX listed company, a takeover offer for all the shares on issue in Great Central. The offer was pitched at $1.50 per share. Yandal Gold was a wholly owned subsidiary of Yandal Gold Holdings the shares in which were owned as to 50.1% by Edensor and as to 49.9% by Normandy Consolidated Gold. On the previous day, 11 January, Yandal Gold, Yandal Gold Holdings and the Normandy Group had entered into a shareholders agreement in relation to the takeover offer. Edensor held 12.56% of Great Central voting shares and Normandy Mining Holdings held 27.81%. The shareholders agreement provided for the participation of Edensor and the Normandy Group in many matters, including the conduct of the proposed bid, the shareholding structure and membership of the boards of directors of Yandal Gold Holdings and Yandal Gold, dividend policy, the composition of and voting on the board of directors of Great Central and the financing of the bid by way of a loan facility with Chase Manhattan Bank. The Chase facility was a $285 million syndicated term debt facility in which Chase acted as agent for and with other lenders financing the bid. Under the facility Normandy and Edensor were liable to repay the debt and interest, but Edensor was not liable to Chase if it defaulted. In that event Normandy was to have recourse only to Edensor’s shares in Yandal Gold Holdings. If Edensor defaulted when the loan was due for repayment, or before that date, it was to bear no risk of loss but was to be entitled to receive 90% of the value of its shareholding in Yandal Gold from Normandy. This feature of the agreement was described in the judgment as Edensor’s “carried interest”. A consequence of the shareholders agreement was that all parties to it became associates of each other and entitled to relevant interests in the shares in Great Central held by the other parties. Hence, on 11 January 1999 Edensor’s entitlement to a relevant interest in shares in Great Central increased from 12.56% to 40.37% and the Normandy Group’s entitlement increased from 27.81% to 40.37%. On that day Yandal Gold and Yandal Gold Holdings held no shares directly in Great Central, but their entitlement to a relevant interest in Great Central shares likewise became 40.37%.

Yandal Gold’s takeover offers were conditional on it becoming entitled to 90% of the shares in Great Central and not less than three quarters of the offerees accepting the offers, thereby entitling Yandal Gold to compulsorily acquire the remaining shares under the Act. The bidder’s statement recorded 948

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Edensor Nominees Pty Ltd v ASIC cont. that Edensor and Normandy Mining Holdings had informed Yandal Gold that they would not accept the offers applicable to their holdings. By June 1999 Yandal Gold had become “entitled” to – we would now say that its voting power was – 94.37% of the shares in Great Central and moved to compulsorily acquire the holdings of those who had not accepted the offers. ASIC commenced proceedings alleging that the shareholders agreement contravened s 606(1). It alleged a further contravention arising from entry into what were referred to as the “non-acceptance agreement” and the “retention agreement”, informal agreements, arrangements or understandings between the parties to the shareholders agreement that were not intended to be legally binding to the effect that Edensor and Normandy Mining Holdings would not accept the takeover offers and would retain their shares for the purpose of the bid. The primary judge held that there had been breaches of the counterpart to s 606. Among other orders the judge ordered that Edensor pay ASIC $28.5m for distribution on a pro rata basis to the shareholders in Great Central who had accepted the offers and had not exercised their entitlement to withdraw their acceptances or whose shares had been acquired by Yandal Gold under the compulsory acquisition provisions. This payment was to disgorge and redirect to them the benefit that Edensor had obtained as carried interest under the funding arrangements for the bid. The case was decided under the provisions of the Act as they stood before the 2000 amendments. Statutory references have been amended to substitute those of their current counterparts; some changes in statutory nomenclature have also been made. The concept of entitlement to a relevant interest in voting shares was replaced with that of voting power in 2000.] HILL, SUNDBERG and MANSFIELD JJ: [14] [T]he primary judge concluded that … the present case is one in which the Court can imply or infer from the circumstances and the conduct of the parties … that the “bid structure agreement”, as alleged by ASIC, was entered into between Mr Gutnick [for Edensor] and Mr de Crespigny [for Normandy Group] and I reject … evidence that no such “agreement” was entered into. I am also satisfied that the “agreement” was an informal and unenforceable arrangement or understanding between Edensor, Normandy Mining Holdings and Yandal Gold (which was effectively controlled by Normandy and Edensor) to the effect that Edensor and Normandy Mining Holdings would not accept Yandal Gold’s takeover offer for their shares in Great Central Mines and that each would retain those shares for the purposes of the bid to enable compulsory acquisition of the shareholdings that were not sold into the takeover bid. [15] Before it could be concluded that there had been a contravention of s 606 by reason of the bid structure agreement, it was necessary to determine whether that agreement conferred power on the parties to it to exercise control over the disposal of the shares held in Great Central by Normandy Mining Holdings and Edensor (s 608(1)). The primary judge was of the view that although the power to exercise control may be informal, indirect and unenforceable (s 608(2)), there must be some true or actual measure of control that is not minor, peripheral, or merely hypothetical, theoretical or notional. See, for example, TVW Enterprises Ltd v Queensland Press Ltd [1983] 2 VR 529 at 542-543. His Honour concluded that while the non-acceptance element of the arrangement or understanding standing alone might not involve a true or actual measure of control over the disposal of shares, that element in company with the retention element plainly did. … Accordingly, pursuant to a “relevant agreement” each of Yandal Gold, Normandy Mining Holdings and Edensor acquired the power to exercise control over the shareholdings of Normandy Mining Holdings and Edensor and therefore acquired a relevant interest which was: • in respect of Yandal Gold – in 40.37% of the shares in Great Central Mines being the shares held by Normandy Mining Holdings and Edensor; • in respect of Edensor – in an additional28.81% of the shares in Great Central Mines being the shares held by Normandy Mining Holdings; • in respect of Normandy Mining Holdings – in an additional 12.56% of the shares in Great Central Mines being the shares held by Edensor. [12.120]

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Edensor Nominees Pty Ltd v ASIC cont. Since each of those acquisitions was an acquisition … as a result of a transaction, namely the bid structure agreement (s 64) entered into by or on behalf of Yandal Gold, Normandy Mining Holdings and Edensor in relation to the shares held by Edensor and Normandy Mining Holdings in Great Central, the primary judge held that ASIC had made out its case of a contravention of s 606 by reason of the bid structure agreement. [16] The primary judge rejected the submission that to find that the non-acceptance and retention agreements had been made would be inconsistent with clause 1.5 of the shareholders agreement [that neither would have a relevant interest in the shares in Great Central that the other party had]. … The primary judge said: Whilst I accept that the clause is intended to operate according to its terms, in my view the clause does not answer the case put by ASIC of an informal and unenforceable arrangement or understanding which is a “relevant agreement” as defined in s 9. The clause provides for the legally enforceable obligations that are to operate as between the parties to the agreement and is not concerned with, nor can it touch upon, unenforceable “obligations” such as those that I have found were the subject of the bid structure agreement. Such “obligations” may not only be unenforceable, they may be such that the parties are free to withdraw from or act inconsistently with them notwithstanding their adoption of those obligations … Whilst the clause can be relevant to the legally enforceable obligations in any “relevant agreement”, it cannot operate to negative unenforceable “obligations” or a finding of a “relevant agreement” based on, and inferred from, the totality of the evidence before the Court. [17] There was no dispute that by reason of the shareholders agreement Edensor, Normandy Consolidated Gold, Yandal Gold Holdings and Yandal Gold were deemed by s 608 to have relevant interests, which each increased to 40.37%, in shares in Great Central, and that these increases occurred in a manner not provided for in Ch 6 of the Act. Before the primary judge the bidders contended that the increased relevant interests were not acquired in contravention of s 606. They submitted that on its proper construction, in order that a person acquire a relevant interest, he must obtain the title to, or dominion over, the actual relevant interest said to be acquired. Thus a “deemed” relevant interest cannot be acquired. His Honour rejected this argument. … … Reasoning on the appeal Bid structure agreement … [26] We are in as good a position as the primary judge to determine whether the proper inference to draw from the facts found ([12] and [14]) is that the non-acceptance agreement and the retention agreement were made. On the primary judge’s findings we would infer that the non-acceptance agreement was made. … [33] … The primary judge appears to have accepted that while the non-acceptance agreement standing alone might not involve some true or actual measure of control over the disposal of shares, the two agreements together did. Edensor contended that this conclusion was inconsistent with the finding that the retention agreement was unenforceable. We do not agree. What his Honour said was that there must be some true or actual measure of control “(that is, in the context of the extended meaning of ‘control’ provided for in s 608)”. Control can be indirect and exercisable by means of unenforceable agreements and practices. Where what is involved is an unenforceable arrangement or understanding, the question whether some true measure of control exists must be determined on the assumption that the parties act in accordance with, rather than contrary to, their arrangement or understanding. … In our view the primary judge correctly found that the non-acceptance and retention agreements were in breach of s 606.

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Edensor Nominees Pty Ltd v ASIC cont. Shareholders agreement [34] Depending on its context the word “acquire” may mean to gain title or ownership of something or simply to obtain something. This is reflected in the meanings given in the Oxford English Dictionary: 1.

To gain, obtain or get as one’s own, to gain the ownership of (by one’s own exertions or qualities) …

2. To receive, or get as one’s own (without reference to the manner), to come into possession of. In s 606 of the Act the word is used in relation to a relevant interest in shares. The section is not limited to acquisitions of shares, where the context would suggest the giving of title to or ownership of the shares. A relevant interest in a share is a power to vote in respect of the share or a power to dispose of the share: s 608(1). A power to dispose of a share includes a power to exercise control over the disposal of the share … power or control can be direct or indirect, or can be exercised as a result of agreements and practices whether enforceable or not: s 608(2). Section 608(2) provides that it is immaterial whether or not the power to vote or to dispose of the share is implied, informal, cannot be related to a particular share or is remote. In that context, the natural meaning of “acquire” is simply to obtain a relevant interest, which may be an actual or a deemed relevant interest. [35] For the above reasons, which are essentially those given by the primary judge, we are unable to accept the meaning of “acquire” in s 606 advanced by Edensor. … [39] We thus agree with the primary judge that as a consequence of the shareholders agreement Yandal Gold, Yandal Gold Holdings, Edensor and Normandy Consolidated Gold Holdings obtained, and thereby acquired, relevant interests in shares in Great Central in contravention of s 606. [The appeal was dismissed. The High Court refused special leave to appeal from the decision of the Federal Court.]

Re Taipan Resources NL (No 9) [12.125] Re Taipan Resources NL (No 9) [2001] APT 4; (2001) 38 ACSR 111; Takeovers Panel 17 April 2001 [On 12 October 2000 St Barbara acquired 4 million fully paid shares in Taipan, an ASX listed company, representing 1.28% of its voting shares. While St Barbara’s relevant interest in Taipan is not reported, it is assumed to be below 20% at all relevant times. Strata’s voting power in St Barbara exceeded 20 per cent; accordingly, in view of s 608(3)(a), Strata’s voting power in Taipan thereby increased from 19.42% to 21.28%t. Strata lodged notice under s 671B (substantial holding information) indicating that it had acquired a relevant interest in the 4 million shares acquired by St Barbara. On 21 December, St Barbara announced that it would make a mixed cash and scrip bid for Taipan. On 2 January, Troy made an off-market bid for Taipan shares which it had previously announced. Troy applied to the Panel for a declaration of unacceptable circumstances, primarily in relation to St Barbara’s acquisition of Taipan shares on 12 October (“the Primary Acquisition”). It was not argued that that any of the exceptions in s 611 applied to the Primary Acquisition.] [1] The panel in this matter is constituted by Professor Ian Ramsay (sitting President), Denis Byrne (sitting Deputy President) and Trevor Rowe. … [38] Section 606 is one of the cornerstone provisions of Ch 6 of the Act. It provides that, except in certain circumstances, a person must not acquire interests in a listed company if that person’s interests, aggregated with those interests of associated persons, would exceed 20% of the listed company. It is critical that this prohibition is complied with in order for the acquisition of control over a listed company to take place in an efficient, competitive and informed market in accordance with the other provisions of Ch 6. A contravention of section 606 will therefore, by its very nature, generally be contrary to the principles set out in section 602. [12.125]

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Re Taipan Resources NL (No 9) cont. [39] St Barbara submitted that any contravention of section 606 by St Barbara as a result of the Primary Acquisition was a technical breach and would not have amounted to unacceptable circumstances because: (a)

the circumstances would not be unacceptable having regard to the control, or potential control, of Taipan;

(b)

the acquisition did not cause Strata to acquire a more substantial interest in Taipan;

(c)

the contravention would not have offended the policy objectives of Ch 6 of the Act set out in section 602; and

(d)

the contravention would be technical, minor and resulted in no legal or commercial mischief, and in any event St Barbara has now made an off-market takeover bid for all the shares in Taipan.

[40] We do not agree with St Barbara’s submissions for the following reasons: (a)

the circumstances are unacceptable having regard to the acquisition, or proposed acquisition, of a substantial interest in Taipan because St Barbara acquired voting shares in Taipan in breach of the Act;

(b)

under subsection 608(3), Strata had a larger substantial interest in Taipan as a result of the Primary Acquisition;

(c)

… the contravention was contrary to the policy objectives set out in section 602;

(d)

the fact that a contravention may be of a technical nature does not mean that it ought to be excused – section 606 is a technical provision and parties will often be deemed to have interests in shares that are held by other parties;

(e)

we do not consider that a contravention involving 1.28% of the voting power of Taipan can be characterised as “minor” in this case when the control of Taipan is being closely contested;

(f)

the fact that St Barbara has subsequently made a takeover bid for Taipan does not adequately remedy the breach of section 606 where control of Taipan is being contested; and

(g)

St Barbara did not sell down its interest in Taipan or otherwise seek to remedy the breach.

[41] In deciding to make a declaration of unacceptable circumstances in relation to St Barbara’s contravention of subsection 606(1), we also had regard to the following matters that we considered relevant: (a)

by notice dated 11 August 2000, Strata informed St Barbara that its voting power in St Barbara had increased from 19.51% to 22.51% and therefore St Barbara should have been aware that Strata’s voting power in Taipan would increase as a result of the Primary Acquisition by virtue of the operation of subsection 608(3);

(b)

the shares acquired by St Barbara in the Primary Acquisition were voted at St Barbara’s direction in favour of a resolution to approve a merger between Taipan and St Barbara at the meeting of Taipan shareholders held on 12 October 2000;

(c)

St Barbara made the Primary Acquisition at a time when control of Taipan was being contested between Troy and St Barbara;

(d)

as a result of the Primary Acquisition, St Barbara gained an unfair tactical advantage over Troy in so far as it acquired more Taipan shares than it was permitted to do under the Act; and

(e)

the shares were acquired for 9.25 cents each, which was higher than the price offered under St Barbara’s takeover bid at the time of our decision.

[42] We also note that Strata’s voting power in Taipan was diluted to less than 20% after the Primary Acquisition as a result of an issue of 15 million fully paid shares by Taipan on 13 December 2000. However, this does not affect our decision that unacceptable circumstances existed because of St Barbara’s contravention of section 606 on 12 October 2000. [43] It will often be appropriate for the Panel to make a declaration in cases such as this even if the voting power of the relevant party has subsequently decreased to less than 20%. This is because the 952

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Re Taipan Resources NL (No 9) cont. contravention by itself constitutes unacceptable circumstances having regard to the policy objectives set out in section 602. However, it may be relevant in these circumstances for the Panel to take any subsequent decrease in voting power into account in determining appropriate orders to make under section 657D. [44] Having regard to the matters set out above, we consider that it would be against the public interest for the Panel to decline to make a declaration in this case. [45] St Barbara submitted that it would be against the public interest for the Panel to make a declaration of unacceptable circumstances because St Barbara has made a takeover bid for all of the shares in Taipan. We do not agree with this submission. In this case, St Barbara did not make its takeover bid for Taipan until more than four months after the Primary Acquisition occurred and the cash consideration offered under its takeover bid was less than the price paid for the Taipan shares that it acquired through the Primary Acquisition. [46] We therefore decided on 9 March to make a declaration of unacceptable circumstances under section 657A in relation to the Primary Acquisition by St Barbara. [The Panel made an order that 2,751,462 fully paid ordinary shares in Taipan held by St Barbara (the number of shares by which Strata’s voting power exceeded 20% as a result of the Primary Acquisition) vest in ASIC to be held on a trust for sale off-market by tender to the highest bidder. Troy made a number of residual allegations which the Panel said were based on inconclusive circumstantial evidence regarding various alleged associations between St Barbara, Strata and various other parties. The Panel did not consider it appropriate to conduct an extensive investigation into allegations that were not substantiated to some material extent by the application itself. The Panel invited ASIC to enquire into these allegations and to advise the Panel of any evidence that it uncovered relevant to them. ASIC reported back that there was insufficient evidence to warrant further investigation. On this basis the Panel confirmed its decision not to consider the residual allegations.]

EXCEPTIONS TO THE PROHIBITION UPON ACQUISITIONS OF RELEVANT INTERESTS [12.130] Part 6.2A provides for a series of exceptions to the prohibitions in s 606(1) and (2),

permitting an acquisition that crosses the takeover threshold or an increase in voting power for one who has already passed it. Thus, s 611 sets out exempt acquisitions including • an acquisition that results from acceptance of an offer under a takeover bid (item 1); • permitted on-market purchases during the bid period (items 2 and 3); • acquisitions resulting from acceptance of offers under a takeover bid if the voting shares are included as part of the consideration in the offers under the bid (item 4); • acquisitions resulting from exercise of the powers under a charge taken in the ordinary course of business by a financier (item 6); • acquisitions that have been approved by a resolution passed at a general meeting of a company following full disclosure and voting disqualification of the intended acquirer and its associates (item 7); • creeping acquisitions of no more than 3% over a six months period (item 9); • acquisitions through permitted rights issues, dividend reinvestment plans or a will (items 10, 11 and 15); 88 88

On the meaning of rights issue see s 9A and [10.92]. The exemption for rights issues is a particularly sensitive topic with multiple applications made to the Panel alleging that a proposed rights issue would have an effect [12.130]

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• downstream acquisitions resulting from the acquisition of relevant interests in voting shares in a listed company (item 14); and • acquisitions resulting from a compromise or arrangement approved by the Court under Pt 5.1 or under an authorised share buy-back (items 17, 18 and 19): s 611. The exceptions contained in items 1 to 4 will be lost if the bidder contravenes one or more of the provisions of Ch 6 designated in s 612, namely, the requirements in ss 618 (full or proportionate bid), 619 (offers must be the same), 621(3) (minimum price), 624(1) (minimum offer period), 625 – 630 (as to the offer conditions), and items 2, 3 and 6 in the table in 633(1) (procedural steps for off-market bids) or items 3, 4 and 6 in the table in 635 (procedural steps for market bids). These provisions are thereby designated as the core or fundamental provisions of Ch 6 non-compliance with which disqualifies the bidder from the licence of the exception. However, ASIC may grant case-by-case relief against the effect of s 612 where the contravention is inadvertent or beyond the bidder’s control. 89 The exception in item 1 appears to apply not only to direct acquisitions but also to downstream acquisitions, that is, deemed acquisitions of a relevant interest in another company which the target company controls or in which it has voting power of more than 20%. 90 Literally read, it would render item 14 redundant in relation to upstream acquisitions to which it is expressed to apply (viz, in listed companies) since it offers a wider exception. However, ASIC’s policy has been that if the downstream acquisition is not merely incidental to the upstream acquisition, it is dangerous for a bidder to rely upon the protection of item 1 since it will invite consideration as to whether unacceptable circumstances exist. 91 This issue is considered further in this paragraph when discussing item 14. The licence contained in items 2 and 3 to purchase shares and convertible securities on-market 92 during the bid period free of the prohibitions in s 606 may provide significant tactical advantage for a bidder particularly when spoilers seek to defeat or frustrate the bid’s chances of success by market transactions. The exceptions are subject to conditions which limit this licence to offers for all the shares in the bid class, being offers that are either unconditional or where bid conditions are limited to the major externally induced events (“prescribed occurrences”) specified in s 652C(1) or (2) (see [12.150]). If the bidder pays a higher price under these purchases, that will automatically vary the consideration offered under the bid or under existing contracts arising from prior acceptance of offers under the bid: s 651A. The licence will be lost if one of the core takeover provisions designated in s 612 is contravened. A bidder who relies upon item 2 or 3 to make on-market purchases will not be entitled to exercise voting rights attaching to those shares if the bid is an off-market bid and the bidder fails to send offers under the bid within 28 days after giving the bidder’s statement to the target: s 613. This prevents a form of “bluffing” announcement which provides pro tem cover for on-market acquisitions that would otherwise offend s 606. Item 7 effectively allows shareholders to waive the protection of Ch 6 but only upon the disinterested and informed vote of members. That approval must be given in advance of the acquisition by ordinary resolution in which, in the case of an acquisition by the issue of shares,

89

upon corporate control that offends s 602 principles; this is particularly so where the rights issue is highly dilutive and non-renounceable. Recent decisions and policy are discussed in E Armson (2012) 30 C&SLJ 405; see further R Philip (2005) 23 C&SLJ 426; K Butler & P von Nessen (2005) 18 Aust J Corp L 148. The Takeovers Panel has issued Guidance Note 17: Rights Issues. ASIC Regulatory Guide 9.558 (Takeover bids).

90

The deemed acquisitions arise by reason of s 608(3)(a) and (b): see [12.80].

91

ASIC Regulatory Guide 71.22-71.25 (Downstream acquisitions) although ASIC acknowledges that “there are different views on this issue” (at RG 71.24).

92

Defined as a transaction on a prescribed stock exchange such as ASX and made in the ordinary course of business: s 9.

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no votes are cast in favour of the resolution by the person proposing to make the acquisition and their associates and, where the acquisition is by purchase of shares, the persons from whom the acquisition is to be made and their associates. The members of the company must be given all information that is known to the person proposing to make the acquisition or their associates, or known to the company, that is material to the decision on how to vote on the resolution including: (i) the identity of the person proposing to make the acquisition and their associates; (ii) the maximum extent of the increase in that person’s voting power in the company that would result from the acquisition; (iii) the voting power that the person would have as a result of the acquisition; (iv) the maximum extent of the increase in the voting power of each of that person’s associates that would result from the acquisition; and (v) the voting power that each of that person’s associates would have as a result of the acquisition. Where the company has voting power in another company of more than 20%, shareholder approval will be required from both companies by reason of the deemed acquisition of a relevant interest in both companies. 93 Although item 7 requires approval by ordinary resolution only, where the approving company is stock exchange listed and the acquisition involves the issue of shares to related parties or others whom the ASX considers to be persons in a position of influence in the company, the special approval mechanism involving independent expert advice must also be satisfied: see ASX Listing Rule 10.11. 94 The creep exception in item 9 permits an acquisition if throughout the six months before the acquisition that person, or any other person, has had voting power in the company of at least 19% and as a result of the acquisition, none of the persons referred to would have voting power in the company more than three percentage points higher than they had six months before the acquisition. The six months requirement ensures that the market is informed of the person’s initial positioning just below the control threshold, supported in the case of a listed company by compulsory disclosure to the market of the holder’s interests under Ch 6C. The exception imposes a continuous rolling cap upon acquisitions of 3% looking back over the past six months. The exception is not cumulative with the other exceptions but independent and freestanding, allowing major holders to increase, gradually and transparently, their relevant interests in voting shares without making a takeover bid. In media commentary ASIC has pointed to the potential under this exemption for a shareholder to acquire a controlling stake without making a formal takeover bid. A Treasury scoping paper comments: A creeping acquisition may potentially allow an acquirer to avoid paying a takeover premium, or to pay a smaller premium. If there is no formal takeover bid, shareholders in the target company may not have an equal opportunity to participate in the transaction and receive any premium that is paid. If the acquirer does not make a formal bid or acquire control in another permitted fashion (eg, via a scheme of arrangement or other transaction approved by target shareholders), the market may be uncertain as to the details of the proposed acquisition, such as the stake the 93

94

Consider which of the following, and in what circumstances, will be disqualified from voting upon the approval motion in the downstream company: the acquirer of shares in the upstream company, the vendor of those shares (if any) and the upstream company itself. An understanding or agreement that is conditional on a resolution being passed under item 7 does not create a relevant interest in securities if it does not confer any control over, or power to substantially influence, the exercise of a voting right attached to the securities and does not restrict disposal of the securities for more than three months from the date of the agreement; otherwise, a relevant interest in the securities is acquired only when the approval resolution is passed: s 609(7). [12.130]

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acquirer ultimately intends to take and what they intend to do when they have control of the company’s assets. This makes it difficult for the target company board to assess the acquisition and make recommendations to shareholders. However, the 3% allowance may contribute to an efficient capital market by facilitating capital raising and otherwise ensuring liquidity in a company, as it allows holders of large stakes in a company to trade in that company’s shares. 95

An acquisition is also exempted if it results from another acquisition of relevant interests in voting shares in a company that is listed on a prescribed stock exchange: s 611 (item 14). This exemption applies where one company (Co 1) holds more than 20% of the voting power in another company (Co 2). An acquisition of voting shares in Co 1 which crosses the 20% threshold in that company will automatically result in a downstream acquisition in Co 2 which crosses the takeover threshold for that company by virtue of s 608(3)(a) (see [12.80]). If the threshold crossing in Co 1 is sanctioned by another exemption, the deemed downstream acquisition in Co 2 will not offend s 606 if Co 1 is a listed company on a prescribed stock exchange. The exception prevents the construction of takeover defences through the acquisition of strategic parcels of shares in other companies such as Co 1 has in Co 2. 96 Where Co 1 is not a listed company, ASIC does not consider that a downstream acquisition will be exempt merely because an exemption other than item 14 (eg, that in item 1) applies to the upstream acquisition; it bases this view on the existence of a separate express exemption for downstream acquisitions in item 14 although it acknowledges “that there are different views on this issue”. ASIC may take regulatory action against an acquirer who cannot rely on item 14 and seeks to rely on another exemption in relation to a downstream acquisition, including an application to the Takeovers Panel for a declaration of unacceptable circumstances. 97 [12.132]

Review Problems

1. T Ltd is listed on ASX. A Ltd wishes to acquire Harry’s 2% holding in T. May it do so without offending s 606 in view of the following beneficial holdings in T? A Ltd (10%); Abigail, a non-executive director of A Ltd (2%); B Ltd of which Abigail is an executive director (1%); C Ltd (3%; A Ltd’s voting power in C Ltd is 21%; D Ltd (5%t; A Ltd’s voting power in D Ltd is 51%); F Ltd (3%; A Ltd has a 25% interest in G Pty Ltd which has voting power of 22% in F Ltd). Would it make any difference if • A Ltd took a call option over Harry’s shares rather than purchased them; • T Ltd had a 40% interest in H Pty Ltd; or • Harry’s interest in T Ltd comprised (i) options over unissued shares or (ii) convertible debt securities? 2. Bidder Ltd, Healthy Ltd and Target Ltd operate private hospitals. Each is listed on ASX. The founders of Bidder and Healthy, their respective managing directors, Betty and Larry, have always been friendly. About ten years ago, in anticipation of greater co-operation in their operations, Bidder and Healthy made an investment in each other of 21% of the voting power in each company. Bidder and Target have 95

Treasury, Takeover Issues – Treasury Scoping Paper (2012), pp 1-2.

96

Legal Committee of CASAC, Anomalies in the Takeover Provisions of the Corporations Law (1994), p 29.

97

ASIC Regulatory Guide 71.22-71.25 (Downstream acquisitions). In an earlier, now superseded, guidance ASIC indicated that this would be so where the downstream acquisition is not merely incidental to the upstream acquisition such as when shares in the downstream company form a substantial portion of the assets (in most circumstances, over 50%) of the upstream company or control of the downstream company is one of the main purposes of the upstream acquisition: ASIC Regulatory Guide 171.41, 171.49 (Anomalies and issues in the takeover provisions) (superseded).

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cross-investments with 5% of each other’s voting power and Healthy holds an interest in Target of 5% of its voting power. Fifteen years ago Bidder and Target jointly formed Delta Ltd to import and supply equipment and supplies to Australian private hospitals; it is an unlisted company with about 70 investors including Bidder and Target who each hold 25% of Delta’s capital. Betty holds 40% of Bidder’s voting shares. She also has a personal investment in Target which represents 2% of its voting power. Bidder’s board wishes to acquire control of Target so that it may integrate its operations with its own to achieve economies of scale, perhaps closing or relocating some hospitals so that a national operation can be established. It will do so through an off-market bid. Betty realises that Larry values his independence and would be unlikely to agree to a merger with Bidder. Accordingly, Betty wants Bidder to bid for Target alone but has canvassed her plans with Larry on a confidential basis, offering the assurance of informal consultation with Larry on the shape of future reorganisation of the merged operations after a successful bid for Target. Larry is not entirely happy with Bidder’s plans but indicates that in consideration of this assurance of consultation, Healthy will not bid for Target in competition with Bidder nor sell its shares to a competing bidder if one emerges unless that second bid is demonstrably more attractive than Bidder’s. Larry has a personal ambition to be President of the international federation of hospital industry associations. In the context of discussing the proposed bid for Target, Betty offers her active support for Larry’s campaign for office; Betty carries considerable influence in the federation and would be a credible candidate for the office herself. Target has been unprofitable for several years and is heavily indebted to Lender Inc, a US private hospital operator which also holds 25% of its ordinary capital, the largest single stake in Target. Target’s indebtedness to Lender is secured by a floating charge over all of its assets. Through an intermediary investment bank, Betty has had confidential preliminary discussions with Lender as to the circumstances and terms upon which it would dispose of its shareholding in Target. Lender has indicated that it would sell its stake to Bidder only if Bidder would guarantee the repayment of Target’s debt within two months of gaining control. In view of Target’s poor financial circumstances and the possibility even of insolvency, Lender indicates that it is willing to accept a discount of 5% on its debt as part of the total retirement of its investment in Target. Through its intermediary, Bidder has indicated that this would be acceptable to it. It would like to have Lender commit to acceptance of its bid as quickly as possible. Lender also holds unsecured notes issued by Target with a face value of $2.5 million, convertible at the option of Lender into ordinary share capital in defined amounts at specified future times. Lender also holds redeemable preference shares in Target that have limited voting rights. It is anxious to dispose of both these interests also. Advise Betty with respect to pre-bid strategy. She also wishes to increase Bidder’s shareholding in Target by market purchases so that it will be in a stronger position when it announces its off-market bid.

[12.132]

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TAKEOVER OFFERS The two species of takeover bid and the prohibition on bluffing bids [12.135] Takeover bids must be made for securities within a particular class; similarly,

compulsory acquisition and buy-out rights operate on securities within a particular class only: s 605(1). Accordingly, separate bids will need to be made for securities in distinct classes. 98 Chapter 6 provides for two types of takeover bid: • an off-market bid (for quoted or unquoted securities), and • a market bid (available only for quoted securities): s 616(1). For both species of bid, Ch 6 operates essentially as a supplement to the law of contract which primarily governs the offers made by the bidder to acquire voting shares in the target company and the resulting obligations between the parties. Chapter 6 interferes with the bidder’s contractual freedom as well as its freedom to make acquisitions generally. In both instances it does so in the interests of securing the goals identified in s 602. A person must not publicly propose to make a takeover bid for securities in a company but fail to make offers for the securities under a takeover bid within two months of the announcement; the terms and conditions of the bid must be the same as or not substantially less favourable than those in the public proposal: s 631(1). The Court may order the person to proceed with the bid: s 1325B. Second, a person must not make a bluffing bid, that is, publicly propose to make a takeover bid if they know the proposed bid will not be made or are reckless as to whether it will be made, or are reckless as to whether they will be able to perform their obligations if a substantial proportion of the offers is accepted: s 631(2). Contravention of each provision is a criminal offence, the former being a strict liability offence: s 1311(1); Sch 3, items 182, 183; s 631(1A). The Eggleston Committee expressed the vice to which the prohibition in s 631(2) is addressed and the purpose of the restriction: “Bluffing”offers: It has been suggested to us that the very existence of the provisions requiring notice of intention to make an offer affords a method by which an unscrupulous person may defeat a take-over offer or run up the price by announcing his intention to make an offer without having any such intention. It has been suggested that some form of security might be required as evidence of good faith. We see practical difficulties in making such provision, but we think it should be an offence to make a take-over offer, or to give notice of intention to do so without having any real intention of doing so, or without having any reasonable or probable grounds of expectation of being able to provide the consideration for the offer or proposed offer. It would often (but not always) be difficult to prove the offence, but the existence of such a provision would, we think, discourage the making of irresponsible announcements which could have the effect of creating a false market. In making this recommendation we are not so much concerned with offerors who may find that as a result of a bluffing statement they have been induced to pay more than their first offer. Presumably they will not pay more than the shares are worth to them. We are, however, concerned that a bluffing statement may be used to defeat a genuine take-over bid, or to create a false market where no take-over bid is in fact contemplated by anyone. 99

In ASIC v Mariner Corp Ltd Beach J rejected ASIC’s submission that the test in s 631(2)) is objective, so that the prohibition is breached if the proposer ought to have been aware of the risk that it would not be able to perform its obligations if a substantial proportion of the offers under the bid is accepted. The judge held that a subjective test of recklessness applies, whether 98 99

However, securities will not be in different classes merely because some are fully-paid and others are partly-paid or different amounts are paid up or remain unpaid on the securities: s 605(2). Company Law Advisory Committee, Second Interim Report (1969), [37].

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the applicable test is that of the Criminal Code Act 1995, s 5.4 or the common law subjective meaning; in either case, it requires an awareness of the risk and a conscious disregard or indifference to that risk. 100 Accordingly, the prohibition applies only in “egregious circumstances, namely where the potential bidder had no genuine intention to follow through (including where it had not turned its mind to its resultant potential obligations)”. 101 Beach J accepted that “there may be a case where recklessness in a subjective sense may be established where a defendant deliberately chose not to inform himself of the risk”. 102 As regards the condition that a “substantial proportion of the offers is accepted”, Beach J said: Generally, what seems to have been assumed, implicitly, by the legislature is that “a substantial proportion of the offers”, if accepted, would deliver “a substantial proportion of the shares” the subject of the bid. That assumption is good if the shareholder spread has the pattern of each shareholder having the same number of shares. But of course that is not the reality. Why then did the legislature refer to “offers” rather than “shares”? This is unclear, but it may be just a function of the context of s 631 where bids and offers were the functional concepts being dealt with. … Assuming in ASIC’s favour that “substantial” means sizeable or large, and also assuming that the word “offers” is in effect looking through to the shares (so that, say, 50% of the offers informally equates to 50% of the shares), what is “substantial proportion” signifying? What is too low a percentage to constitute “substantial proportion”? What is too high? It is invidious to talk of a quantitative measure. The legislature has not seen fit to use a percentage or to say “majority”. It has left the concept unclear. I am compelled to take a practical approach which is not inconsistent with but embraced by the language of the text. Not without some hesitation, I propose to adopt a “no less than” approach of saying that whatever “substantial proportion” means, it ought not to embrace less than 50% of the shares that are anticipated to be the subject of the offers to be dispatched. 103

In that case, Mariner announced to the ASX a proposed off-market bid for a listed company Austock whose market capitalisation, it judged, did not reflect its true value if its component