Legal Issues Involving Organic Wines Pty Ltd & Seedy Vineyards Pty Ltd

Background of Organic Wines Pty Ltd and Seedy Vineyards Pty Ltd

Raj and Alana have owned a vineyard and winery in South Australia for many years. In 2010 they decided that they wanted to make provision for including their children in the business in the future. As such, they incorporated the company Organic Wines Pty Ltd (“OW”) and transferred the vineyard and winery to the company. They then asked a solicitor friend of theirs, Ted, to draft the company’s constitution.

Because of their desire for the company to continue their practice of organic farming and wine production, Raj and Alana asked Ted to include an ‘objects clause’ in the constitution which restricted the activities of the corporation to the organic framing of grapes, the production of organic wines and any related and incidental activities. When drafting the constitution Ted included this clause, along with a clause appointing himself as the company’s solicitor and stating that he could only be dismissed for misconduct. Ted received an allotment of 5% of the shares in the corporation as consideration for drafting the constitution.

Up until 2016, the board of OW was made up of Raj, Alana and their son Jack (who is also the company’s Chief Financial Officer). In January 2016, Raj and Alana’s daughter Priya moved back from Melbourne after finishing her university studies. Raj and Alana were wanting to step back from the business and allow their children to have a more active role. On the 1^st of February 2016, Priya was appointed to the position of Managing Director of OW for a period of two years. The board did not formally reappoint Priya as Managing Director after 1 February 2018, but she has continued to act in that position. In February 2018, Priya arranged for the appointment of Carl, a recently admitted solicitor and her current boyfriend, as company secretary of OW.

One of the terms of Priya’s appointment, which were set out in a contract between her and OW, included a restriction to the effect that she was not to commit the company to any transactions in excess of $100,000 without approval by the Board of Directors. Priya had been looking at ways of expanding the business, and has been discussing potential supply agreements with Bob Murphy’s, a large national liquor supplier. However, in order to increase production sufficiently OW would need to purchase additional grapes from other vineyards.

In June 2018, Priya negotiated an agreement for the supply of grapes from Seedy Vineyards Pty Ltd, for the value of $ 500,000. Seedy Vineyards use a range of pesticides on their grapes and have not subscribed to any principles of organic farming. On the 1 ^st of July, Priya signed the contract as managing director along with Carl as company secretary.

On the 5th of July, Priya notified Ted that his services are no longer required by OW, as they now have sufficient legal expertise with the appointment of Carl.

When Jack receives the first invoice from Seedy Vineyards requesting payment, he raises the contract with Raj and Alana who are not pleased. They both call Ted for advice, but he says that he has been dismissed from his role and is about to bring an action against the company for breach of contract.

1. Whether OW is bound by the supply contract with Seedy Vineyards given they believe that:
   
   
   1. Priya has exceeded her authority to enter into such agreements; and
   2. The agreement is in breach of the objects clause in OW’s constitution;

1. Whether Ted can enforce the clause in the constitution appointing him as company solicitor and what type of remedy would be applicable.

The directors of Seedy Vineyards Pty Ltd are Karim and Miles, who each also own 45% of the company’s shares. The remaining 10% of the shares are owned by Olive. Whilst Seedy Vineyards has had a number of customers, their profits have not been significant and therefore they have not regularly paid dividends. As such, Olive has been trying to sell her shares.

Karim and Miles want to retain control of the shareholding, but have generally refused to purchase Olive’s shares because of a lack of funds. However, on the 20^th of June 2018, Miles agrees to buy 5% of Olive’s shares and they execute the agreement and transfer the shares.

At the same time, Olive also managed to secure a sale of her remaining 5% of the shares to Priya. However, after completing the sale contract, Karim and Miles refuse to register the transfer of shares. Karim then offers to buy the shares at 10% less than the price Priya was paying.

After the transaction with Organic Wines is finalised on the 1^st of July 2018, Seedy Vineyards declares a dividend five-time higher than any of the dividends declared in the past three years.

1. Whether Karim and Miles have breached s181 of the Corporations Act2001 (Cth) or their equivalent equitable duties by refusing to register the transfer of shares and what penalties or remedies might be applicable; and
   
   
2. Whether she has an action against Miles for a breach of directors’ duties for his purchasing the shares without telling her of the improved prospects of the company.

1. Whether OW is bound by the supply contract with Seedy Vineyards  

After going through the facts that have been given in this question, the issue arises regarding the contract created by Priya with Seedy Wineyards Pty Ltd for supply of grapes at the price of $500,000. It is worth mentioning that Seedy uses a lot of pesticides, and they don't follow organic farming. However, there is a clause in the constitution of OW, which provides that the company would be restricted to activities of organic farming of grapes. Therefore the question arises if this contract is binding against the company.

For dealing with the situation that has been mentioned in this question, the indoor management rule has been described by the common law. The court came up with this rule in Turquand's case. According to this rule, the law allows the third-party to make an assumption that all the internal rules of the company have been complied with, unless other party had actual knowledge of the noncompliance of these rules. The Corporations Act, 2001 also adopted these rules. As a result, sections 128 and 129 provide that any person, while dealing with the Corporation can make certain assumptions regarding such transaction. The assumptions are present in s129 and they deal with the internal procedures that have to be followed by the corporations. 

But it needs to be noted that the other party cannot make such assumption under the law if such party.The third party cannot rely on the assumption if it has knowledge or reason to suspect that the assumption was not correct. Hence, while dealing with the Corporation, the third-party is allowed by the law to make an assumption according to which the rules concerning the internal management of the Corporation are complied with. In the same way, it may be assumed by the third-party that any officer is appointed according to the rules of the company. Similarly, when a document is purported to be signed by a director of the company, it can be assumed that such person has signed according to the Constitution of the company. Therefore even if the indoor management rule is not available but the assumptions that can be made under this rule are still available under section 129. Sections 128 to 130 deal with the assumptions that may be made by third parties while entering into transactions with the company (Jordan, 1997). It should also be mentioned that these provisions are not the same as the provisions that have been laid down by the law of agency. The objective test that is applicable in such cases is present in s128(4). This test can be used to see if the third party had knowledge or reason to doubt the correctness of these assumptions.

The Issue of the Supply Contract with Seedy Vineyards Pty Ltd

After going through the above-mentioned rules, it can be stated that in this case Priya was formally appointed managing director of OW for a period of two years however, after this period she was not formally re-appointed but she continued to work as the managing director. But in this case, Seedy was aware of the fact that Priya had exceeded his authority to enter the contract and at the same time, the company also new regarding the breach of objects clause of OW. The objects clause of OW clearly mentions that company's activities will be limited to organic farming of grapes and producing organic wines. As a result, this contract is not enforceable against OW.

It can be stated in the end that the contract created by Priya with Seedy, cannot be enforced against OW

2. Whether Ted can enforce the clause in the constitution appointing him as company solicitor and what type of remedy would be applicable.

The issue in this question is related with the enforceability of a clause mentioned in the Constitution of OW according to which Ted cannot be removed as the solicitor of the company except in case of misconduct.

The law that is applicable in such cases provides that the company's constitution has to be treated as a statutory contract that is formed between the company and its members. However, there has been a lot of controversy and confusion regarding this contract. The main issue of contention is the question if such contract is enforceable by the members of the Corporation for the purpose of making sure that any right granted to them in some other role can be enforced by them against the company. Section 140, Corporations Act also provides that the Constitution is a contract formed between the company and its members, directors and the members themselves. At the same time, the Constitution can be varied by passing a special resolution. The resolution has to be passed by the shareholders of the company in its general meeting.

On the basis of the facts that have been given in this question, the case of Eley v Positive Government Security Life Assurance Co Ltd. needs to be discussed. The brief facts of this case are that the constitution of the company provided that Mr. Eley was going to continue as the solicitors of the Corporation for his life. Later on, he also became a member of the company. After some time it was decided by the company that Mr. Eley should be removed from his position as the company's solicitors. Even if he was a member but he decided to take action against the company in his capacity as the solicitor. The action was taken to enforce the articles of incorporation with provided that he cannot be removed as company's solicitors. Hence, the court arrived at the conclusion that the articles of the company cannot be considered as a contract that was present between company and Mr. Eley in his capacity as the solicitor. According to the court, it was not possible to enforce this provision as a solicitor. On the other hand, Mr. Eley was trying to enforce this provision as a solicitor and not as a member of the company. The decision given in Browne v La Trinidad also reinforced this decision.

Enforcebility of the Clause Appointing the Solicitor in Organic Wines Pty Ltd's Constitution

Under these circumstances, it can be said that in the present case, if Ted is willing to enforce a clause of the Constitution with provided that he cannot be removed as company's solicitors unless in case of misconduct, such action cannot succeed. Although the company's constitution is a contract formed between the company and its members, but it can be enforced by the members in their capacity as company's member and not in any other capacity. Hence, in this case, the action taken by Ted is not likely to succeed.

2. Advise Olive:

1. Whether Karim and Miles have breached s181 of the Corporations Act

Section 181 of the Corporations Act is related with the duties of the directors. This particularly requires that the directors should act in good faith. In order to consider a duty has been fulfilled by the directors, inquiry has to be made regarding the beliefs, intentions and the motive of the directors. It also needs to be seen that the director should give preference to the interests of the corporation. At the same time, it can be stated that the particular directors liable for the breach of duty prescribed by section 181 in case the director uses its discretion in order to achieve a personal advantage or to provide a benefit to some other party or for the purpose of causing a loss to the company. Hence, in view of this duty, the director should always act honestly and give preference to the interests of their corporation. At the same that it is required that it should be honestly believed by the directors that the action taken by them is in the interest of their company. Such decision can be initiated as a result of the breach of two other elements of the duty. Each of these elements has objective content. According to the circumstances of it is required that the directors should exercise the powers only for the purpose for which the powers that granted (Goddard, 1998). Consequently, the decision taken by the directors may be invalidated by the courts in case the main purpose behind the decision is such that the court may consider to be beyond those decisions for which the power has been given to the director in order to legitimately exercise it or if it can be stated that the decision was not beneficial for the corporation.

In the present case, the facts suggest that Karim and Miles may be liable for the breach of their duties, particularly the duty imposed by section 181. The reason behind this conclusion is that in the present case, both these directors have taken the decision according to which they have refused to register the transfer of shares. Their intention was that these shares will be purchased by them later on at a lesser price. Although it is within the power of the directors to refuse to register the transfer of shares, but it hasn't provided by section 1071F of th

2. Whether she has an action against Miles for a breach of directors’ duties for his purchasing the shares without telling her of the improved prospects of the company

There are several duties that have been imposed on the directors by the common law, statutory law and also by company's constitution. One of these duties requires that the directors should refrain from acting for an improper purpose. This includes the cases where the directors ask for the purpose of gaining a personal benefit. Among these duties, it is mentioned in section 181 that the directors should always act in good faith while acting on behalf of the corporation. Consequently it is very significant that the directors use their powers and discharge their duties in good faith and for proper purpose. Similarly, it has been mentioned in section 182 that the directors are bound by the duty which requires them not to use their position in properly. The result is that the position of the directors should not be used for an improper purpose. As a result, the position held by the directors should not be used by them for getting your personal benefit or for causing any loss to the company. On the other hand, if a director is found to be in breach of this provision, and being involved in conduct with the intention of receiving your personal benefit or to cause any loss to the company, it does not matter if such benefit or loss has been caused or not. Another significant duties imposed by section 183. This section requires that any information received by the directors should not be used improperly. The improper use of the information received by the directors as a result of the position in the company takes place when the directors have used such information for the purpose of receiving a personal benefit or rather the quality loss to the company. It will be resumed by the law that a particular director has violated the provisions of section 183 if the director is found to be involved in conduct with a view to achieve personal advantage or for causing loss to the corporation although the benefits or the loss has not been caused.

Therefore it is clear that in this case Miles had breached his duty, which has been imposed on the directors of the company. The reason behind this conclusion is that the conduct of Miles took place for the purpose of receiving a personal benefit. This benefit was present in the form of purchasing the shares at a very low price particularly when the prospects of the company were likely to improve soon.

H A J Ford and R P Austin, Ford and Austin’s Principles of Corporations Law (Butterworths, 7^th ed, 1995) 262

H A J Ford, Principles of Company Law Butterworths, 2^nd ed, 1978, 345

John H Farrar and Brenda Hannigan, Farrar’s Company Law, Butterworths, 4^th ed, 1998, 382

R P Austin and I M Ramsay, Ford’s Principles of Corporations Law, LexisNexis Butterworths, 15^th ed, 2013, 432

Case

Royal British Bank v Turquand (1856) 6 E&B 327

Eley v Positive Government Security Life Assurance Co Ltd (1875) 1 Ex D 88

Sons of Gwalia Ltd v Margaretic (2007) 232 ALR 232

Borland’s Trustee v Steel Brother & Co Ltd [1901] 1 Ch D 279

Pender v Lushington (1877) 6 Ch D 70

Legislation

S 129, Corporations Act, 2001 (Cth)

S181, Corporations Act, 2001 (Cth)

S183, Corporations Act (Cth)