Legal Issues in a Case of Organic Wines Pty Ltd

Background

1.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 1st 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 2 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 1st 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.

Advise Raj and Alana:

A.Whether OW is bound by the supply contract with Seedy Vineyards given they believe that:

a. Priya has exceeded her authority to enter into such agreements; and

b. The agreement is in breach of the objects clause in OW’s constitution;

2.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 20th of June 2018, Miles agrees to buy 5% of Olive’s shares and they execute the agreement and transfer the shares. 3 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 1st of July 2018, Seedy Vineyards declares a dividend five-time higher than any of the dividends declared in the past three years.

Advise Olive:

A. 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

B.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.

Background

Whether the contract that is established amid Seedy Vineyards and Organic Wines Pty Ltd (OW) is valid in nature on the basis that: a) Priya does not have the authority to enter into contract; b) the object clause of Constitution of OW was violated?

The Corporation Act 2001 governs the actions of the company. Upon incorporation, a company acquires the status of an independent legal person legally and is held in Salomon v Salomon & Co Ltd. This separate legal entity status is governed by section 124 of Act which establishes that a company being an artificial legal person can enter into contracts with outsiders and its own members.

One of the most promising officers that act on behalf of the company is director which gets its recognition under section 9 of the Act. In Grimaldi v Chameleon Mining NL [2012] a person who even not appointed as director can be considered as a director if he is taking all the duties and care of a director. Many a times, the Managing Director is appointed under section 198C of the Act who are delegated with powers of the directors and the acts taken by them are binding on the company.

A company when is incorporated by a single person then it is a sole proprietorship. This company can be run by replaceable rule or constitution or both. The company is run by the provisions of the constitution. A company can set out its working in its object clause. Section 125 submits that a company can limit/restrict its activities through its object clause. Normally, an activity which is not as per the provisions are considered as void and a company should not honor the same. But, this is considered to be a hardship for the outsiders who act with the company directors considering in good faith that the actions must be within scope are within the object clause but in reality they are not. To protect their position, section 131 laid down according to which all contracts made by company in its independent capacity are valid irrespective of the fact whether they are within it outside the object clause and is held in Lion Nathan Australia Pty Ltd v Coopers Brewery Limited.

Every company director is authorized to carry out their actions within the authority that are assign/need to them by the company as they are the authorized representative of the company. Firstly, actual authority is the authority which is assumed by the directors either expressly or impliedly by the company and is held in Freeman & Lockyer v Buckhurst Park Properties (Magnal) Ltd, Secondly, when the authority is gained by the director not actually, but, some representation is made by the company itself in front of the third parties to make them believe that the director odes own the capacity to bind the company by their actions then, the directors gain an ostensible authority and the acts within such authority results in a binding contract amid the outsider and the company and is held in Hely-Hutchinson v Brayhead [1968].

Issue 1 - Organic Wines' Contract with Seedy Vineyards

This authority is established by Indoor management Rule held in Royal British Bank v Turquand wherein if the outsider can prove that the contract is made in good faith and on the assumptithat the agent does have the required authority then any contract is held to be valid provided that the outsider is not aware of any defect on the part of agents authority and is held in Crabtree-Vickers Pty Ltd v ADMAA Co Pty Ltd. This common law principle is established under section 128-129 of the Act and an outsider is allowed to make certain assumptions while making a contract with the agent of the company. As per section 127 if a document without company seal is signed by the director and company secretary then it is assumed that the document is valid.

A vineyard is operated by Alana and Raj. They form OW so that their children can be part of the business. The directors of the company are Alana, Raj and their son Jack. Carl was appointed as the company secretary.

The contract between Seedy Vineyards and OW can be held to be enforceable because of two reasons:

Firstly, Priya on 1^st February was appointed as managing director of the company, as per section 198C, a MD is held to dealing with the powers of a director that are delegated to her. The powers of Priya were limited in regard to any contract above $100,000 and she can only establish a contract beyond such valid by taking board approval. A contract was made by her wit Seedy Vineyards @ 500,000. Thus, she exceeded her power.

But, the contract was initiated by her by signing as MD and by Carl as Company secretary. Thus, by applying Section 127-129, it can be submitted that the contract was without common seal and thus Seedy Vineyards has reasons to believe that the people who are signing the document as the requisite authority provided Seedy Vineyards itself is acting in good faith.

So, by applying Indoor Management Rule and application of section 127-129, the contract is enforceable.

Secondly, it was specifically submitted by the constitution that Priya is not permitted to take contracts which it outside the activities that are mentioned the object cause. But she established a contract that was not within the activities mentioned in the clause. But, by applying the law of section 131, such violation of object clause is permissible.

Conclusion

Rule

Thus, the contract by Priya is binding in nature. Thus, the contract made by Priya is valid and OWW must honor the contract with Seedy Vineyards.

Whether the appointment clause made by Ted can be enforced by him and if yes, then, what remedies are available?

A contract made by a company is enforceable with its own members, officers and amid members and is held in section 140 of the Act. So violation of contract terms by officers and members will hold them liable and the company can sue them and vice versa and is held in (Hickman v Kent or Romney Marsh Sheep-Breeders Association.

But, the members have the right to bring an action under breach of contact only when the breach is made of their rights as member. If any rights are violated by the company then the same is not violation of section 140 of the Act and is held in Eley v Positive Government Security Life Assurance.

Ted drafted the constitution and he himself appointed him as a company solicitor he was also the shareholder of 5% Ted is only allowed to be removed from his position provided he acted in a misconduct manner. But, he was removed from the position not on account of misconduct.

It is submitted that Ted has no right to sue the company for his removal because by removing from the post of solicitor his member rights are not hampered. There is no application of section 140 and the removal is binding on Ted.

Conclusion

Ted removal is valid and he cannot sue the company for his removal.

Whether section 181 of the Act or other directorial duties are violated by Karim and Miles when they refuse to register the transfer of shares of Olive?

A company acquires the status of an independent legal person legally and is held in Salomon v Salomon & Co Ltd. The directors are the fuctioneers of a company. But the 2001 Act has imposed duties on the directors and if not comply with the consequences can be faced.

The duty of care and diligence is crafted under section 181 of the Act. The directors/officers are obligated to carry their conduct with all diligence and care to achieve company interest and the acts must be for proper purpose and is held in Australian Metropolitan Life Assurance Co Ltd v Ure. For instance, if the director does not register the share transfer then it is breach of section 181. The test is objective in nature and must be analyses from the point of view of the court and not the director himself and is held in and The Bell Group Ltd v Westpac Banking Corporation (no 9). The acts that are carried out by the director of the company must be analyzed by comparing the same with the acts of a resonate prudent man have taken in the similar situation and is held in ASIC v Adler.

Issue 2 - Transfer of Shares in Seedy Vineyards Pty Ltd

Another duty that every company director must care of is under section 191-15 of the Act which submits that when a director carries out his acts then the interest of the company must prevail over the directors personal interest and is held in Aberdeen Railway Co v Blaikie Bros .

Seedy Vineyards Pty Ltd is directed by Miles and Karim both of them are holding 45% shares. 10% are hold by Olive. The company was not moving financially well and considering the fact Olive intends to sell his shares to Miles. Later on 20^th June 2018, Miles agreed to buy the 5% shares of Olive and a contract was made. The other 5% were taken by Priya but then Karim agreed to buy the shares that Olive is intending to gave it to Priya and they refuse to register share transfer.

So, there is clear violation of section 181 as denial of register of share transfer is not allowed as per Australian Metropolitan Life Assurance Co Ltd v Ure. Both the directors are misusing their position and are securing their own interest over the company and thus section 191-195 is violated.

Conclusion

Since section 181 and section 191-195 are violated so the parties must face consequences for the same and penalties compensation and disqualification can be carried on.

That shares are purchased by Miles from Olive knowing the fact that the company is improving, so, are there any duties that are breached?

Section 182 submits that when a director is posited at his place then he must not act in such a manner so that he take advantage of his position for his own benefit and for the disadvantage of the company. Section 183 submits that when a director is posited at his place then he must not act in such a manner so that he take advantage of his information gathered by him for his own benefit and for the disadvantage of the company and is held in R v Byrnes.

Also, the director must make sure that he must act in such a manner so that no shareholders interest must be hampers. The director must make sure that all the creditors and shareholders should be secured in the best possible manner. If the director does not have adequate advice to the shareholder known the fact that the shareholder is relying on his advice then it is an act of breach and is held in Brunninghausen v Glavanics.

If the director does not comply with his duties then he can be imposed with compensation, fines or disqualification. Criminal penalties of 5 years jail or fine or both can be imposed.

On 1^st July 2018, a deal was made with Organic Wines. It is after the said deal that divided is declared by the company which is much higher in comparison with the dividends that are declared previously. By, declaring dividends of such high value immediately after the deal with Organic Wines shows that the directors, that is, Miles and Karim are not acting in good faith and thus have breached their duty of good faith. As per Brunninghausen v Glavanics by not relieving the true position of the company, the directors have violated their duty and misuse their position and information thereby violation section 182-183 of the Act.

Conclusion

So, several duties are violated by the directors of the company so, penalties must be imposed on them.

Reference List

Books/Articles/Journals

Cassidy, Julie, Concise Corporations Law, (Federation Press, 2006)

Judge, Stephen , Business Law, (Macmillan Education UK, 2009);

Tomasic, et. Al, Corporations Law in Australia, Federation Press.

Mäntysaari, Petri , Comparative Corporate Governance: Shareholders as a Rule-maker, (Springer Science & Business Media, 2005)

Case laws

ASIC v Adler [2002] NSWSC 171;

Australian Metropolitan Life Assurance Co Ltd v Ure (1923)

Aberdeen Railway Co v Blaikie Bros (1854) 1 Macq 461.