Jack, Tom and Mary are executive directors of Photolab Ltd. Jack owns 8% of the shares, Tom 15% and Mary 7%. 15% of the shares are owned by 700 shareholders and the remaining 55% shares are owned by Photoproductions Ltd. Although Tom has never been formally appointed as managing director of the company, he has assumed that role and the other directors allow him to do so. The Board was aware that Tom’s business card described him as the managing director of Photolab Ltd. Often Tom entered into contracts on behalf of the company binding the company up to $1 million dollars without seeking the prior approval of the board. The company, however, always honoured these contracts.
Photolab Ltd is a subsidiary of Photoproductions Ltd. Tom is also a director of Photoproductions Ltd. On 5 April 2001, Tom entered into negotiations with Photoproductions Ltd, whereby it was agreed that Photolab Ltd would lend Photoproductions Ltd $1 million dollars interest free payable within three years. No security was taken with respect to this loan. Tom signed the loan contract as managing director “on behalf of Photolab Ltd”.
On 8 October 2002, Tom, believing that commercial rents were going to double in the next few months, renegotiated a 5 year lease over the premises the company was currently renting. In reaching this decision, Tom did not consult anyone nor did he read any relevant material to help him make an informed decision. Unfortunately, there was a downward trend in rentals and by December 2003, commercial rents had fallen by 10 % and were estimated to continue to fall by a further 10% over the next few months. When the board realized it questioned why he had done this, Tom said he just though it was the best thing to do, as he had a feeling rents were going to rise. The Board issued him with very specific directions that he was not to enter into any further contracts without first consulting them.
At a Board meeting in March 2004, the directors were becoming concerned about the company’s financial stability. It had lost one of its major clients to a competitor and they were worried that some of their other clients may follow. Mary suggested that perhaps an administrator should be appointed to provide an independent view of the company’s financial affairs. However, the Board voted against this arguing that the company had just been audited by Fred Smart, whose report had verified that Photolab Ltd was in a sound financial position.
Tom believed that for PhotLab to maintain a competitive market edge, it needed to invest in some of the newly available technology. In September 2003, he convinced the company to purchase a new developer for $180,000 to be paid by 4 equal payments over one year. On 4 April 2004, the company defaulted under the payment schedule. It appeared that the company was insolvent.
A) Was the contract made between Photoproductions Ltd and Tom, binding on Photolab Ltd? ( 6 marks)
B) Has Tom breached any of his duty as a director by entering into the loan contract with Photoproductions Ltd and/or the 5 year commercial lease? (8 marks).
C) If Tom has breached any of his director’s duty what actions can be taken against him and by whom? (6 marks)
D) Can a shareholder bring a personal action, and against whom – the company or the director- based on the facts of the question? Do you think there are grounds for a shareholder to bring derivative action? What remedies can be obtained both for personal and derivative action? (6+6+3=15 marks)
E) Does the agreement between Photolab Ltd and Photoproduction Ltd require the approval of shareholders? If so, why? (8 Marks)
F) If Photolab Ltd become insolvent because of the loan provided to Photoproductions Ltd, what liability, if any, have the directors for the company’s debts? Who can bring the action and what remedies are available? (7+5=12 marks)
Question 2 [15 MARKS]
In the above question [question 1] Fred Smart was the auditor of Photolab Ltd. Fred Smart’s wife owns 10% of the shares in Photolab Ltd. When Fred is conducting the audit he is concerned about the company’s accounts, in that the company has not kept proper financial records. He also cannot find any evidence that the company has maintained a register of its members or its charges. Tom tells him he will find them and give them to him but never does. The company tells Fred Smart that it intends to show his report to BigBank, as they wish to borrow $100,000 for expansion purposes. The company tells Fred that BigBank will not provide the loan, unless his report indicates that Photolab Ltd is financially stable. Fred provides the required report stating that in his opinion the company’s financial position is quite solid. On the basis of this, Bigbank lends Photolab Ltd the $100,000. Six months later, Photlab Ltd goes into liquidation.
i. Discuss whether Fred Smart has breached his statutory or common law duties.
ii. Has BigBank any right of action against Fred Smart? Provide reasons and support for your answer.
F. Chen is an accountant and he is skilled in preparing budgets and cash flow statements for new businesses. He is hired by four former University friends to prepare budgets and cash flows for a new company that is to be set up by these four friends. Chen goes to the printer and orders stationery for the new company and signs on behalf of the would be incorporated company. The new company, Comrades Pty Ltd, is formed, but it does not pay for the stationery ordered by Chen.
Who is liable to pay for the stationery? (7 marks)