Scenario One: Alteration of Company Constitution Process
1.The facts reveal that,
Ryder and Kody graduated from USC. After their graduation they decided to carry on unique handmade craft business and selling other gifts online. They decided to name their company as Incredible Gifts Pty Ltd. Ryder approaches Melanie a famous craft artist and enters into a twelve months contract with Melanie for designing of unique range of hand-made gifts and for selling them exclusively to his company i.e. Incredible Gifts on 26th April 2018.The monthly payment for the contact was decided to be $5,000.
But when Ryder and Kody went to register company by name “Incredible Gifts Pty Ltd” on 2nd of May 2018 they came to know that the said name had already been registered by some other person. Hence they registered a company with name Astounding Gifts Pty Ltd.
Ryder and Kody became two directors of company with 45% of shares each with them and rest 10% with Salman with whom they had entered into an employment contract to act as an accountant. On their first director meeting on 12th of May 2018 Kody was pleased to hear that Ryder has already signed a supply contract with Melanie and agreed and begin paying $5,000 per month to him. But on 10th of July 2018 they found out that Salman had accepted job with their competitor and is encouraging.
Melanie to sell her handmade gifts to Incredible Gifts the competitor of Astounding Gifts Pty Ltd Ryder and Kody called up a members meeting and passed a resolution that alters Astounding Gift’s constitution which stated that the directors may determine that the company can buy back shareholdings of less than 12% at their discretion. They also refused to pay Melanie in future as regard to her monthly payments.
Now, the first concern that is raised is to explain Salman the process for altering a company constitution and whether she can prevent the inclusion of the clause allowing the directors to expropriate her shares?
It is first important to explain to Salman that a company is registered in Australia as per the guidelines laid down by Australian Securities and Investment Commission (ASIC) and has to function as per the legislation, The Corportaion Act 2001.
A compnay when incorporated has its own seprerate legal entity and existance and is authenticated under section 124 of Corporation Act. This statutiry priciple is achived by applying the ruling of Salomon v A Salomon and Co Ltd wherein it is stated that a company upon its formation becomes a separate legal person and acts in its own name different from the persons who are managing it, that is, officers and directors. In Lee v Lee’s Air Farming it was held that a company can enter into contracts in its own name, it has the capacity to acquire properties and can sue a third party in its own name.
Scenario Two: Directors’ Breach of Duties
A company functions own its own rules formulated by it as per its constitution or it can also follow the rules mentioned in the Corportaion Act 2001 (section 141 – Replaceable Rules) or it can also follow both.
Now, as per section 136, a company may adopt a constitution for its working. Also, as per section 136 (2), the shareholdes of a company are given power by which they can change the constitution of their compnay. This can be done if a special resolution to that effect is passed by its shareholders in a special meeting with 75% of the shareholders voting in favor of the alteration of the company. The alteration is binding on all the shareholders of the compnay if the said procedurev is followed. It is held in Arakella Pty Ltd v Paton (No. 2) , that the alteration of the constitution should be done with bona fide intention.
Now, as per the given situation Salman does not has majority of 75% voting power so she will not be able to do anything. As per section 136 of the Corportaion Act, Ryder and Kody have the majority of 90% shares so they can take recourse under section 136 (2) of the Corportaion Act and thus can bring alteration to the constitution. The alteration is bought to expriorate the shares of the Salman and this alteration is considered to be valid as per section 136 (2) of the Act. this is so because, any alteration by majority is binding on the shareholders of the company and is also analyzed in Australian Fixed Trusts Pty Ltd v Clyde Industries Ltd.
But, as per section 246B if the alteration by majority leads to expropriate of shares of minority class of shareholders, then, such alteration can be considered to be invalid as per law. In the leading case of Gambotto v WCP Ltd, the court simply held that when the minority is acting not in the interest of the company by competing with the company or the presence of the minority is hampering the company, it is then only section 246B can be applied by the majority shareholders. This ruling was initially also analyzed in Greenhalgh v Arderne Cinemas Ltd (No 2) and Bundaberg Sugar Ltd v Isis Central Sugar Mill Co Ltd.
so, as Salman was involved with competitor Incredible Gifts Pty Ltd as he took the position of the account in the said company and further she was also persuading Melanie to sell items to the competitor of Ryder and Kody, thus, her acts are in the company interest and it is justified to apply section 246B.
Salman can only prevent the application of section 246B when she can portray that the acts are not carried in the best interest of the company and is dealt to hamper the class rights of the minority shareholders.
Hence Ryder and Kody can lead to expropriate of shares of Salman as it is appropriate as Salman is acting against the company.
Now, it is important to consider, whether Melanie can claim for monthly payments for the remainder of her 12 month contract from Ryder and Kody?
Normally whenever companies are formed then there are contractual relationship which are established before its incorporation and such contractual (pre registration contracts) have no relevant in common law and is authenticated in the leading case of Kener v Baxte.
As per section 131 of 2001 Act, the pre regoistration contracts are valid in case they are ratified after the formation of the compnay by the compnay itslef and is analsued in Aztech Science Pty Ltd v Atlanta Aerospace (Woy Woy) Pty Limited. These contrcats to be valid must be between the representaive of the compnay and the outsider before the registration of the compnay, and the said contracts are approved by the comoany upon its regitsration and is held in Commonwealth Bank of Australia vs. Australian Solar Information Pty Ltd. A contract by a company which later on changes its name does not categorize as a pre registration contract. In case the ratified contract is not abide by the compnay, then, it is said to be breached.
Now, the law is applied and it is submitted that Ryder and Melanie entered into contract on 26th April 2018 with Incredible Gifts a company yet to come into existence but Incredible Gifts name was already taken so the new company was formed in the name of Astounding Gifts Pty Ltd that came into existence on 2nd of May 2018. The new company then ratified the contract with Melaine on 12th May 2018 hence as per section 131 of the Corporation Act 2001 the contract became valid.
Hence Ryder and Melanie are bound to Melaine as they had ratified the contract with Melaine in a meeting on 12th May 2018 and thus must pay the payments that are due to Melaine.
2.In the present section, an analysis is drawn to the duties of the directors and the circumstances when they are considered a violated. The facts submit that a company (Chip-Eze Pty Ltd) is incorporated and is mainly dealing in the manufacturing process of the potato chips. There are three directors of the company who are holding twenty five percentages of the shares of the company, namely, Jordon, Michaela and Marianne. The rest twenty five percentages of shares are hold by other shareholders one of whom was Faizah. One of the businesses (frozen chips) is running into loss and the company financial position was not such that they can pay to its creditors and suppliers. On 1st August 2018, the directors called the meeting and a resolution is passed wherein they decided to incorporate Freeze Me Pty Ltd wherein the business which is running in profit should be transferred to the new company. The new company is made on 10th August 2018 and the business is transferred and the information is provided to all the intending parties. The only business that is left to the company is its non-profitable business and is thus not able to pay its creditors. Considering the situation, a liquidator (Archibald) is appointed.
Thus, there are two important concerns are now analyses.
It is important to understand whether the company directors are in contravention of section 181 of the Act and any other directorial duties. What are the liabilities that can be imposed for the breach?
Once a company is registered, then it is regarded as a separate person in law. In the leading case of Salomon v A Salomon and Co Ltd (1897) the law is settled that is, a registered company is regarded as am artificial personnel which has its own existence in law and has the capacity to sue or be sued, hold property, etc. In the leading case of Lee v Lee’s Air Farming Ltd the court held that in any company the position of the officers is distinct from the company and a company officer and also become the employee of the company at the same time. The acts of the officers are carried in company’s name and are not held personally liable for the same.
Since the company does not have mind of its own thus it needed officers for its working. Section 9 of the Act has given recognition to the directors of the company who are the first officers of the company. They are allocated with the duty to act on behalf of the company and are held in section 198A of the Act. The legisltaion has casted few respnsibilties on the directors so that there is no abuse of power. The prime responsbilitie includes:
Section 181 of the Act – Every director of the comoany must act in good faitha and with hoinesty for the company benefit and for the adequate purpose of the company. In Hutton v West Cork Railway Co it was held that whether the duty is breached is to be assessed in objective manner, that is, judged from the point of view of the court and not from the point of view of the directors. In Imperial Hydropathic Hotel Company Blackpool v Hampson if the court believes that the directors have not acted in good faith then there is violation. If the acts of the director fall short of what a reasonable man will act in the given situation, then, there is breach of duty and is held in ASIC v Adler.
Section 191-915 of the Act – Another important duty that a company director must compaly is that whenever there is conflict amid the interest of the director with that of the company then it is the interest of the comoany that muist prevail and is held in Westpac Banking Corp v Bell Group Ltd (No 3). It is the duty of the director to avoid any kind of conflict of interest and if conflict incurs then it must be resolved in favor of the company.
Duty to avoid illegal phonix activity – When any director indulges in any act with the motive to defraud the creditors and to make an attempt so that no payment is made to them them such activities are not permitted.
Considering the facts,
The company has three directors and the company itself being the artificial person, it is the duties of the directors to act in the best interest of the company with good faith (section 181 of the Act).
Now, the directors of the company intentionally in order to cheat the creditors and the suppliers formulated a new company and sold the profitable business to the new company. Thus, these acts are totally carried out not in good faith and not in the interest of the company as the interest of the company also includes the interest of the shareholders and creditors. So, there is complete breach of section 181 on the part of the directors.
Further, section 191-195 of the Act is also violated because by establishing the new company and transferring the profitable business to the new company the directors have secured their own interest at the cost of the company (its creditors and suppliers). So, the self interest is given importance over the interest of the company.
Also, the director’s acts are to cheat the creditors by selling the profitable business to the new company, thus, the acts are illegal phoenix activities.
Thus, in this situation, the directors can be imposed with $200,000 and can also be disqualified.
The facts also reveal that,
On 6th August, Jordon has a conversation with Faizah. Faizah is interested in buying the shares in the company to which Jordon affirmed.
Now, the main concern that is raised is whether Jordon has contravened any directorial duty when he sold the shares of the company to Faizah?
Now, apart from the duties of good faith, avoiding conflict of interest and avoidance of illegal phoenix activity, there is yet another duty that every director must company, that is, section 180 of the Act.
As per section 180, no director must act without adequate diligence and care and the acts must be with adequate purpose and in the interest of the company and no acts must be carried which are to bring personal gain at the cost of the company and its shareholder sand is analyzed in Daniels v AWA Ltd. The duty to act with care and diligence us also extended to the shareholders and any action that will hamper the shareholders interest is not permitted and is held in Coleman v Myers.
But, if the director can establish that the acts that are carried out by him with all good faith and knowledge and adequate expertise, then, he can protect him under section 180 (2) (Business judgment rule).
Further, when a director is appointed at his post then there is various information that are gathered by him. It is the duty of the director that he must not act in any manner so that he misses his position or the information that is received by him and is held under section 182-183 of the Act.
Now, Faizah approached Jordan to buy the shares in the company, Jordan is aware that they are selling the profitable business to the new company and the only business that is left to the company is the business which is running in loss. Knowing the fact the same was not communicated to Faizah. Thus, the acts are not in the interest of the shareholder and thus section 180 is violated.
Also, Jordon knowing the company information uses the same for his own benefit, thus, he mis-uses his position and the information, thus, there is breach of section 182-183 of the Act.
Reference List
Books/Articles/Journals
Cassidy, Julie, Concise Corporations Law, Federation Press, 2006.
Dermansky, Patricia , Should Australia Replace Section 181 Of the Corporations Act 2001 (Cth) With Wording Similar to Section 172 of the Companies Act 2006 (UK)?, < https://law.unimelb.edu.au/__data/assets/pdf_file/0003/1709832/60-Should_Austalia_replace_s181_of_the_Corporations_Act3.pdf>.
James, Nicholas, Separate Legal Personality: Legal Reality and Metaphor, Bond Law Review, Volume 5, Issue 2 Article 6. < https://epublications.bond.edu.au/cgi/viewcontent.cgi?article=1081&context=blr>.
Latimer, Paul, Australian Business Law 2012, CCH Australia Limited, 2012.
McLaughlin, Sue, Unlocking Company Law, Routledge, 26-Apr-2013 .
Case laws
Aztech Science Pty Ltd v Atlanta Aerospace (Woy Woy) Pty Limited (2004).
Arakella Pty Ltd v Paton (No. 2) [2004] NSWSC 605.
Australian Fixed Trusts Pty Ltd v Clyde Industries Ltd (1959) 59 SR (NSW) 33.
ASIC v Adler [2002] NSWSC 171.
Bundaberg Sugar Ltd v Isis Central Sugar Mill Co Ltd [2006] QSC 358.
Commonwealth Bank of Australia vs. Australian Solar Information Pty Ltd (1987).
Commissioner of Taxation v BHP Billiton Ltd [2011].
Coleman v Myers [1977] 2 NZLR 225.
Daniels v AWA Ltd (1995) 13 ACLC 614.
Deputy Commissioner of Taxation v Austin (1998) 28 ACSR 565 and Standard Chartered Bank of Australia Ltd v Antico (1995) 18 ACSR 1.
Gambotto v WCP Ltd (1995) 182 CLR 432
Greenhalgh v Arderne Cinemas Ltd (No 2) [1946] 1 All ER 512.
Howard Smith Ltd v Ampol Petroleum Ltd [1974]AC 821.
Hutton v West Cork Railway Co (1883) 23 Ch D 654.
Imperial Hydropathic Hotel Company Blackpool v Hampson (1882) 23 Ch D 1.
Kelner v Baxter (1866) LR 2 CP 174.
Lee v Lee’s Air Farming [1961] AC 12.
R v Byrnes (1995).
Salomon v A Salomon and Co Ltd (1897).
Westpac Banking Corp v Bell Group Ltd (No 3) [2012] WASCA 15
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