Legal analysis of two Pty Ltd companies.

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 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;
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.

Background

i. Whether OW is bound by the supply contract with Seedy Vineyards given that

a. Priya has exceeded her authority

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

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

When any company is formed then it is an artificial legal personal in law (Salomon v Salomon & Co Ltd. As per section 124 of the Corporation Act 2001, a corporation is independent and has the power to make contracts on its own behalf. As per section 9, the director is the officer who is appointed at such position including de factor and shadow director (Deputy Commissioner of Taxation v Austin. As per section 198C the Managing Director is the person who acts like a director and is authorized with such powers.

Now, when a company is not a sole proprietor, then, it must be governed by the replaceable rules or by constitution or by both. When a constitution is formulated, then, one of the clauses that was made part of the contract was the object clause. The object clause defines and restricts the activities of the business. Before 1983 any acts beyond the object clause is not enforceable against the company (Ashbury Railway Carriage & Iron Co v Riche. However, as per section 131, it was held that no contract can be held to be invalid on the ground that the same is outside the object clause of the constitution and is binding on the corporation under section 125 of the Act.

Now, as per section 140, the relationship amid the constitution and its members is held to be contract, that is, Company and each member, Company and each officer, Members and each other member. A company has the power to take action against the member if the member does not comply with the provisions (Hickman v Kent or Romney Marsh Sheep-Breeders Association [1915]). Likewise, the members are also entitled to take action if the corporation does not comply with the provisions of the constitution (Andres v Queensland Racing Ltd. However, the members can take action against those rights which are conferred upon them as a member and not otherwise (Pender v Lushington and Wood v Odessa Waterworks. However in Eley v Positive Government Security Life Assurance, it was held that rights that arise not as a member cannot be enforced against the company.

Issues

Now, the directors are authorized to represent a corporation The rights that are possessed are:

i. Actual – The authority that is granted to the directors expressly (Freeman & Lockyer v Buckhurst Park Properties (Magnal) Ltd)

ii. Ostensible - The authority that is assumed by the director when some overt act is undertaken by the company which makes an outsider believe that the director does possess the requisite authority and has the ability to bind the company. Thus, as per Hely-Hutchinson v Brayhead [1968] contract made under ostensible authority is binding on the company. However, the outsider who is dealing with the officer must be acting in honesty and without knowledge of the defect (Crabtree-Vickers Pty Ltd v ADMAA Co Pty Ltd.

Also, when the outsider is acting with the agent on the pretext that the agent does possess the requite authority then the contract with such agents are binding by applying the rule of indoor management as held in Morris v Kanssen and Royal British Bank v Turquand. This rule is enshrined under section 128 and section 129 of the Act.

Now,

Issue 1

Raj and Alana have owned a vineyard/winery in South Australia. In 2010 they decided to include their children in the business so they incorporated Organic Wines Pty Ltd (“OW”) and transferred the vineyard/winery to the company. Until 2016, the company comprises of a board are Raj, Alana, Jack (son and Chief Financial Officer). In February, se appointed Carl as company secretary of OW.

OW is bound by the supply contract with Seedy Vineyards mainly because:

i. Priya has not exceeded her authority to enter into agreements. On 1^st February, Priya (daughter) was made the managing director for two years. She was not formally appointed but was carrying the duties of a managing director. A restriction was imposed on her that she was not to commit the company to any transactions in excess of $100,000 without approval by the Board. But, In June 2018, she negotiated a contract with Seedy @ $500,000. On the 1st of July, she signed the contract as managing director along with Carl as company secretary.

Now, if Seedy has established a contract with the agent (Priya) in good faith then such contracts are binding by applying the rule of indoor management.

Also as per section 128 and section 129 an assumption can be raised that Priya has the right to make contract on behalf of OW as the contract was signed by Priya as managing director and by Carl as the Company Secretary.

Rules and Analysis

ii. The agreement is not in breach of the objects clause in OW’s constitution. A company constitution was drafted by Ted. The company was dealing in organic farming and wine production. However, as pet section 125 of the Act, an activity which is outside the scope of the object clause of the company will not render the transaction void.

A clause was made part of the constitution wherein Ted has appointed himself as the solicitor of specifying that he could only be dismissed for misconduct. 5% shares are granted to him as a consideration for drafting the constitution. On the 5th of July, Priya notified Ted that his services are no longer required and appointment Carl.

Ted cannot enforce the clause in the constitution appointing him as company solicitor, mainly because as per section 140, Ted can only sue the company provided his rights as member are violated. However though Ted was having 5% shares but by removing him from the post of the solicitor does not hamper his rights as a member.

So, the contract amid Seedy and OW is valid. Ted cannot sue the company for his termination as none of his member’s rights are violated.

Whether Karim and Miles have breached s181 of the Corporations Act 2001 any other equivalent equitable duties by refusing to register the transfer of shares and what penalties or remedies might be applicable;
Whether Olive 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?

A corporation has an individual personality in law. The acts of the officers are in company name (Salomon v Salomon & Co Ltd.

Now, directors are the most important officers as they are concerned with the activities of the company. However, there are various responsibilities that are allocated to the director the non compliance of which may results in penalties.

i. Section 181 (1) of the Act submits that officers and directors must carry out their duties for proper purposive and in company interest.

In Australian Metropolitan Life Assurance Co Ltd v Ure it was held that the refusal to register the transfer of shares by the director is nothing but the abuse of power and thus is in breach of section 181 of the Act as the actions are not carried out for the proper purpose of the company. whether the proper purpose is attained or not must be gathered by surrounding circumstances and is held in Hindle v John Cotton Ltd:

The best interest must be considered as to what the directors think and not what the court thinks and is held in Re Smith & Fawcett Ltd and The Bell Group Ltd v Westpac Banking Corporation (no 9). The acts of the directors must be judged both objectively and subjectively and is held in Westpac Banking Corp v Bell Group Ltd (No 3).

Conclusion

The duty is considered to be violated if the director acts in a manner which no rational director would have acted in the similar situation and is held in ASIC v Adler and Hutton v West Cork Railway Co .

ii. Section 191-195 of the Act signifies that the directors must act so that there is no conflict of interest and if there is disagreement of interest then the interest of the corporation must be given preference and is held in Aberdeen Railway Co v Blaikie Bros.

iii. Section 182 and section 183 of the Act signifies that the directors must not misuse their position and information for their own benefit and detrimental to the company and is held in Kwok v R and R v Byrnes.

iv. A director owns a duty to the individual shareholders and must not indulge in any action that is determinate to the interest of such shareholders. Any such act is the breach of directorial duty and is held in Coleman v Myers. Various factors are considered such as whether the shareholder is relying on the information or advice of the directors which establishes a fiduciary duty towards the shareholders and is held in Brunninghausen v Glavanics. Also, no director must act in such manner which gave preference to their own personal interest keeping aside the significance of the corporation as a whole and the shareholders of the company.

Violation of section 181-183 of the Act imposes fine of $200,000, compensation, disqualification under section 206 (C) of the Act ;
If the duties are breaches recklessly then imprisonment of five years can also be imposed.

Now,

Karim and Miles are the directors of Seedy Vineyards Pty Ltd. They are also the shareholders with 45% shares each. Olive holds that remaining 10% shares. The profits of Seedy are not very significant and are not able to pay its regular dividends. Olive is willing to sell her shares. In order to retain the control of the Seedy both Karim and Miles want to purchase shares of Olive but are not able to do so as they does not have the required funds.

But, on 20^th June 2018, Mile was willing to purchase 5% shares of Olive and thus an agreement is established for the same amid the two. 5% of the Olive shares were also purchased by Priya. But, after the sale of the shares of Olive, both Karim and Miles refuse to register the shares of Olive. At this time Karim offers to buy the shares at 10% less than the price Priya was paying.

It is submitted that at this time Karim and Miles are in violation of section 181 (1) of the Act. As per Australian Metropolitan Life Assurance Co Ltd v Ure refusal to register the transfer of shares by the director is abuse of power and are the actions that are not carried out for the proper purpose of the company.

Also, section 191-195 of the Act are violated because, Miles and Karim are giving preference to their own interest by not registering the shares over the interest of the company

Its found that after the transaction with Organic Wines is finalized 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.

It is submitted that Miles and Karim are in violation of their fiduciary duties that they own towards the individual shareholders. By, not disclosing the true position of the company this duty was violated as held in Brunninghausen v Glavanics.

Also, section 182 and 183 are violated as Miles and Karim has used their position and information in their on benefit and to the detrimental to the company. The dividend is disclosed after the sale of shares by Olive and thus there is clear breach.

Thus, section 181, 182, 183, 191-195 and fiduciary duties are violated by Karim and Miles and thus penalties under both civil and criminal law must be imposed.

References

Books/Articles/Journals

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

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

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

McLaughlin, Susan , Unlocking Company Law, (Routledge, 2013)

Case laws

Andres v Queensland Racing Ltd (2009) 74 ACSR 538.

ASIC v Adler [2002] NSWSC 171

Australian Metropolitan Life Assurance Co Ltd v Ure (1923) 33 CLR 199.

Ashbury Railway Carriage & Iron Co v Riche (1875) LR 7 HL 653.

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