ACC220-Law Of Business Associations

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 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. Priyahas exceeded her authority to enterinto such agreements;  and
b. The agreement is in breach of the objects clause in OW’s  constitution; 

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

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. 

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 Act  2001 (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. 

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

In this question, Priya entered into a contract for the supply of grapes from Seedy Wineyards Pty Ltd for $500,000. However it needs to be noted that Seedy uses a wide range of pesticides on the grapes and they do not follow the principles of organic farming. On the other hand, a clause is present in the Constitution of OW. According to which the activities of the company will be restricted to organic farming of grapes.

In order to deal with the situations mentioned above, the common law has introduced the indoor management rule. This rule was provided by the court in Turquand's case. It was provided by this rule that it is available to the third-party presumed that all the internal rules concerning the management of the company are complied with unless the other party has actual knowledge regarding the non-compliance of such rule. Later on these provisions are also major part of the Corporations Act, 2001. Hence, it has been provided by section 128 and 129 that any person who is dealing with the company, is allowed by the law to make certain assumptions related with such dealings. These assumptions have been mentioned in s129, and they are related to internal procedures of the company to be complied with.

However, the other person is not allowed by the law to make such an assumption if the third party has the knowledge or reason to suspect that such an assumption was not true. In this way, when a third party is dealing with the Corporation, the person is allowed by the law to assume that all the rules related with the internal procedures of cooperation have been complied with. Similarly, the third-party may also assume that any particular officer has been appointed in accordance with the constitution of the company. In the same way, a document that is purported to be signed by the director can be assumed to be signed in accordance with the company's constitution. The result is that the end of management tools is not applicable any longer, but the assumptions that have been mentioned in this rule are also mentioned in s129. The provisions of Corporations Act, ranging from Ss 128 - 130 provide the assumptions that are available to third-party companies while dealing with a Corporation. It is worth mentioning that these provisions are apart from the provisions prescribed by the law of agency. The objective test that has to be applied in this type of cases is mentioned in s128(4) for the purpose of seeing if the third-party knew or had reason to suspect regarding the correctness of such assumption.

In the present case, Priya had been formally appointed as the managing director of OW for a period of two years but after an initial appointment, she was not formally been appointed as the managing director of the company by the board. However there are reasons to believe that Seedy knew regarding the fact that Priya had exceeded her authority when entering into the contract and moreover they were also aware of that agreement created by Priya was in breach of the objects clause of OW. In the objects clause of the company, it has clearly mentioned that the activities of OW will be restricted to organic farming of grapes and production of organic wines. In this case it can be concluded that OW is not bound by the contract created by Priya with Seedy.

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

In this case, Ted, a solicitor friend of Raj and Alana was asked by them to draft the constitution of the company. While doing so, Ted included a clause in the constitution of the company according to which she was going to remain as the solicitor of the company and it would be dismissed only for misconduct. Later on, Priya arranged for the appointment of Carl, was recently admitted solicitor and also her boyfriend, as the company secretary of OW. A notice has been served to Ted by Priya informing that OW does not require the services of Ted anymore. Under these circumstances, the issue arises if Ted can enforce the laws of the Constitution according to which we cannot be dismissed except in case of misconduct.

According to the law, the Constitution of the company is considered as a statutory contract that has been created between the company and the members of the company. However, this contract has remained the subject of much controversy and confusion for the last several decades. The main controversies related with the question if the contract can be enforced by the members of the company in order to ensure that the right associated with them in another role, can be enforced by them. The constitution of the company has been provided contract enforced by s140, Corporations Act. According to this section, the constitution of the company has to be considered as a contract concluded between company and each member of the company, as well as the company and its directors, the music during and between the members of the companies themselves. It is possible to vary the constitution of the company by passing a special resolution by the members of the company in a general meeting.

The leading case related with the above-mentioned facts is that of Eley v Positive Government Security Life Assurance Co Ltd. In this case, it was provided by the Constitution of the company that Mr. Eley will remain the solicitor of the company. However, later on, the company decided against employing Mr. Eley as the solicitor of the company.. However, he was a member of the company but he decided to bring action in his capacity as the solicitor to enforce the articles of the company. Under these circumstances, it was the decision of the courts that the articles of the company did not result in a contract created between Mr. Eley and the company. In the opinion of the Court, the provision cannot be enforced in such a way. The reason was that Eley was trying to enforce the provision in his capacity as a solicit and not in his capacity as the member of the company. Later on, this decision was further supported by the decision given in Browne v La Trinidad.

In the present case also, if Ted wants to enforce a clause of the Constitution of the company, according to which he cannot be removed from the post of the solicitor of the company except in case of misconduct, in his capacity as a solicitor, it cannot be allowed by the law. The Constitution of the Corporation is a contract created between the company and its members. Therefore, Ted can enforce the laws only as a member of the company.

2.Advise Olive:

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

According to section 181, the directors of the company are bound by a duty to act in good faith. While applying this duty to the directors, the inquiry as to consider the intentions, beliefs and motive of directors and if they have given primacy to the interests of the company has to be made. On the other hand, a director can be held liable for the breach of this duty if the director has used his or her discretion of the powers for the purpose of achieving a personal advantage or to confer benefit on a third party, shareholder or class of shareholders or cause loss to the company itself. In this way, it is the duty of the directors to act honestly and in the interests of the company. It is necessary that the directors should honestly believe that the particular action is in the interests of the company. However such decision can be initiated by breach of the other two elements of the duty, each one of which have objective content. Under these circumstances, the director required to exercise their powers for the purpose for which such powers have been granted to them. As a result, the courts may invalidate the decisions taken by the directors where the motivating purpose behind such decision is one which allows the court to consider as beyond those decisions for which the power conferred to the directors may be legitimately exercise or if the decision is not for the benefit of the company.

After going through the facts of this question, it can be stated that Karim and Miles can be held liable for the breach of the duties imposed on them by section 181. The reason is that in this case, Karim and Miles have taken the decision to refuse to register the transfer of shares so that they may purchase these shares later on at a lesser price. In this way, it can be stated that these two directors of OW have not acted in good faith. In such a case, s1071F, Corporations Act provides that if the directors of the company refuse all failed to register the transfer of shares, such party may apply the court seeking an order under this section.

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

Duties are being prescribed for the directors in Australia by the common law, said the law and also by the Constitution of the Corporation. In this regard, the, law provides that it is the duty of the directors that they should work to ask for an improper purpose. This includes obtaining your personal advantage, by the directors or debating the voting power of the present shareholders by creating new majority. Among the statutory duties of the directors, s181 describes the duty to act in good faith. The result is that the directors of the corporation should use their powers and discharge their duties in good faith and for a proper purpose. At the same time, it has been prescribed by section 182 that it is the duty of the directors that they should not make improper use of their position. Consequently, the directors would not use their position improperly for achieving your personal advantage or for someone else or, in order to cause loss to the company. Any director who breaches the provisions of this section by involving in conduct with the intention and purpose of achieving your personal advantage or for causing a loss to the company, it is immaterial if such benefit all loss was caused in reality or not. Similarly s183 imposes a duty on the directors according to which they should not improperly use the information received by them as a result of their position in the company. Therefore, when a director receives any information due to the result of their position, such directors should not use the information in properly in order to achieve a personal advantage or to cause a loss to the company. It will be considered by the law that the director has breached section 183 with the director is involved in conduct with the intention of achieving your personal advantage or to cause loss of the company even if such benefit or advantage has not taken place in reality.

In the present case, if Miles had failed to inform Olive regarding the improved prospects of the company and purchase her shares at a lesser price, it can be stated that Miles is responsible for the beach of his duties as the director of OW. The reason is that in this case, Miles was involved in conduct the review to achieve a personal advantage for him. The advantage was to purchase her shares at a lesser price even if he was aware of the improved prospects of OW

References

Cheffins, B.R., 1997, Company Law: Theory, Structure and Operation, Oxford, Clarendon Press

Clarke, P. and Clarke, J., 2016, Contract Law, Commentaries, Cases and Perspectives, 3^rd Edition, Oxford University Press

Goddard, D., 1998, ‘Company Law Reform — Lessons from the New Zealand Experience’ 16 Company and Securities Law Journal 236

Jordan, C., 1997, ‘Towards a Commonwealth Model of Companies Law’ in Fiona Macmillan Patfield (ed), Perspectives on Company Law: 2  289

Khoury, D. and Yamouni, Y., 2010, Understanding Contract Law, 8^th Edition, LexisNexis Butterworths

Swanston, J., 1981, ‘Discharge of Contracts for Breach’, 13(1) Melbourne University Law Review 69

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

Legislation

S 129, Corporations Act, 2001 (Cth)