Legal Analysis: Company Constitution And Expropriation Of Shares Essay.

Advise:

1. Salman, what the process for altering a company constitution is, and whether she can prevent the inclusion of the clause allowing the directors to expropriate her shares?
2. Melanie, what recourse, if any, she has for the non-payment of her monthly payments for the remainder of her 12 month contract?

Upon application by creditors who had not been paid, the court orders that a liquidator be appointed and Chip-Eze Pty Ltd be wound up in insolvency. Archibald is then appointed as liquidator.

Advise:

1. Archibald whether the directors of Chip-Eze Pty Ltd have breached s181 of the Corporations Act 2001 (Cth) or their equivalent equitable duties and what penalties or remedies might be applicable; and
2. Faizah whether she has an action against Jordon for breach of directors’ duties for selling her the shares in Chip-Eze Pty Ltd just before it was going into liquidation.

As noted in the course outline, the assessment criteria for this assessment task are:

1. Demonstration of knowledge of the law, as evidenced by accurate statement of relevant legal principles;
2. Demonstration of understanding of the law, as evidenced by cogent and coherent application of legal principles to the fact situation as stated;
3. Demonstration of requisite academic communication skills, as evidenced by logical structure of arguments, appropriateness of conclusions, accuracy of citations (legal referencing) and academic referencing and use of accurate and appropriate expression.

In terms of addressing the assessment criteria:

• In order to demonstrate knowledge of the law for this assignment, you need to state the relevant legal principles accurately and reference them appropriately by citing case law and legislation;
• In order to demonstrate understanding of the law, you need to apply the relevant legal principles to the facts of the case study in order to reach a conclusion;
• You need to adopt a logical structure (it is recommended you use headings), avoid spelling and grammatical errors (see further under ‘Structure and Style’ below) and present your arguments in a coherent and convincing manner. Note that the use of footnotes is the required method of referencing for legal writing (you can use the ‘Insert > Footnote’ function in Word). The following guidelines stem from the criteria stated above:
• It is not enough to discuss the facts in a general way without reference to legal principle/s.
• It is not enough to state relevant legal principles without explicitly applying those principles to the facts.
• Statements of legal requirements/ principles must be accurate. Use of your own words is encouraged but must convey the substance (meaning of) the legal principle/s.
• Merely reproducing the facts given in the problem will not attract marks. This problem commonly occurs in written introductions, where it would appear that the writer is not sure where to start.

Powers and Limitations of Company Constitution

The constitution of a company is a legal document that is drafted either before or after the registration process is through. The constitution is a legal framework, among the roles of the constitution, the documents delegates’ duties to the company directors and other officers meant for the operational purposes and the internal management of the institution. The constitution of a business covers the powers, rights, and duties of the firm, the executives, the board, and those of the different shareholders. It is a pact between the firm and its members, company and its secretary, the organization and each director, and amongst the company members. A company cannot limit its statutory powers to change its constitution and the constitution cannot have a statute that bars the company from making any changes to the constitution, as such, restrictions or provisions would be void. The Corporations Acts and the common law however shields the company’s shareholders from the variations or annulment of class rights, various amendments to provisions of a firm’s constitution that have the impact of expropriating the shares of the minority or rights ascribing to those shares; and revisions to precise provisions of the firms constitution. In the case Salman vs. Astounding Gifts Pty. Ltd, the case subjects itself to the provisions of the Corporations Act 2001 (CTH) with specific regards to the expropriation of shares.

Expropriation of shares

The high court of Australia turned the tide of corporate power in favor of the minority shareholders. The victory in the Gambotto case was termed significant as the court initiated a mechanism of stringent rules aimed at measuring the validity of the alterations of the company constitution. The case ruling represented an interfering method which traditional law courts had been hesitant to embrace in the corporate environment. However, it is important to note that the court has limited powers in regards to the best interests of the company; Latham CJ stated that, “it is not for the court to impose upon a company the ideas of the court as to what is for the benefit of the company…” The same was applied in the English court of Appeal in the case Shuttleworth v Cox Bros Ltd (1927) 2KB 9, here the court refused to impose its views as to whether an amendment to the company constitution was aimed to benefit the company.

For years, there have being considerable tension amidst the majority and the minority shareholders due to the general exercise of the significant power controlled by the majority. Normally, the minority shareholders are placed on a situation of a weaker position as compared to the majority. The main issue of concern is the decisions made at general meetings where in most cases the minority shareholder are coerced to accept the decisions made to favor the majority shareholders especially where related to the amendment of the company’s constitution. Over the years, through the legal system restrictions to the majority shareholders have been effected. The canon of fraud on the minority shareholders was employed to access whether fraud against the minority had taken place; it was the prerequisite measure of the majority to act bonafide in the best interest of the business and not themselves.

Expropriation of Shares: Gambotto Case

Gambotto v WCP Ltd (1995) 182 CLR 432

99.7% of the shares of WCP ltd were controlled by Industrial Equity. Gambotto was a minority shareholder in WCP Ltd. Industrial Equity intended to change the ownership structure of WCP by making it a wholly owned subsidiary in order to attain savings through taxes and administrative costs. IEL proposed to purchase 50590 shares from Mr. Gambotto and Ms Eliana Sandri who were the minority shareholders. The notice of meeting also contained information regarding the financial assessment of shares owned by WCP Ltd prepared by the accounting department. The offer price to purchase the shares was valued at a premium. The minority shareholders filed a legal suit arguing that the amendments were invalid, as they were not done in good faith.

The court held that the constitutional amendment was invalid rejecting Allen’s test of bona fide and in the interest of the firm as a suitable test for evaluating modifications in the constitution. The court held that for such an amendment conferring upon the majority shareholders powers to expropriate powers of the shareholders must first satisfy the following; it is for an appropriate purpose and not meant to oppress the minority shareholders. The court further held that the process require complete disclosure of key information, an autonomous assessment of the value of the shares by an expert, and imbursement of the shareholding at market value. Expropriation is only allowable because minority has continued shareholding would be injurious to the firm. Other grounds include where the minority shareholder is in direct competition with the firm, and by the act of expropriation the company would be in a position conform with the principles governing the principal business is involved in, or where the expropriation would be to safeguard the interests of the firm.

According to the Corporations Act 2001 sect. 136, a company is allowed to implement a constitution before or after the company is registered. When embraced prior to the registration process, all members must in form of writing agree to the terms set forward by the constitution. In a case where the adoption of the constitution comes after the registration process, a special resolution of the adoption is passed. Section 136 (2) of the Corporations Act states where the constitution has a provision governing modifications, the amendments must foremost comply with the required provisions prior to making any changes. Such additional requirements can be negotiated by the minority as a means to offer some form of protection from resolutions made by the majority shareholders bearing extensive financial consequences. As such, these requirements make it difficult for majority shareholders to amend the constitution.

The high court in the Gambotto case established a two-part test as a measure to determine whether the alterations of the company constitution allowing expropriation of shares are valid. The validity of the tests is based on whether it was done for a proper purpose and that the aim of the amendment was not to oppress them minority shareholders. The proposed clause by Kody and Ryder is a provision allowing the majority shareholders to forcefully acquire shares from minority shareholders not controlling more than 12%. Salman has just accepted an accounting position with a competing firm and is already encouraging Melanie to provide her hand-made gifts to the competitor, hence the clause was meant to protect the interests of Astounding Gifts Pty Ltd. Based on the ruling in Gambotto case, the court held that expropriation was only applicable where;

1. Proper purpose: proper purpose was meant to prevent the company from suffering significant detriment or harm. The court gave two examples for establishing proper purpose; the minority shareholders are competing with the company or the expropriation is necessary to ensure that the company continues to comply with the law governing the company key business. As such, expropriation was justified in the case where the actions of shareholder were seen as competing with the company. Salman controls 10% of the shares in Astounding Gifts Pty Ltd and by accepting the accounting position in a company that was in direct competition with Astounding Ltd and further pursuing Melanie to provide his new employer with the same services she provided his former employer would be detrimental to his previous employer, Astounding Gifts Pry Ltd.
2. Fairness: fairness based on the Gambotto case ruling involved the majority shareholders revealing all the significant information pertaining the amendment of the constitution. Furthermore, the share price of the share should either be at market value or at a premium. Seeking the court intervention to stop an oppressive conduct, the plaintiff must prove that the amendment was unfairly prejudicial. In the case Wayde v NSW Rugby League Ltd (1985) 180 CLR 459to determine fairness is an objective test, the plaintiff must prove that the director’s actions were not justified. The directors decision to expropriate the shares was justified based on Salman’s’ actions.

Amending the Company Constitution: Corporations Act 2001

Since there were no additional requirements that were to be met before amendments of the constitution were made, both Kody and Ryder controlled 90% of the shares meaning that they met the required threshold of 75% to pass resolution to amend the company constitution, meant that the amendments were binding. Moreover, Salman actions were in the best interest of his new employer and in this case formed the basis of a conflict of interest. Kody and Ryder being the majority shareholders had the right to expropriate his shares as his actions contravened those of an officer of a registered company.

Therefore, Salman has no legal redress in a court of law for the expropriation of Salman’s’ shares was in the best interest of Astounding Gifts Pty Ltd and was meant to further protect their principal business.

Question 1B

Astounding Gifts Pty Ltd. can argue that the contract between the company and Melanie is non-existent because it was entered before the registration of the name Astounding Gifts. When entering the contract, the company was meant to be registered as Incredible Gifts Pty Ltd. The court can be called in to determine the validity of the contract. For a period, Astounding Gifts Pty has being remitting $5,000 for the exclusive rights, which in essence ratifies the pre-registration contract. In this case, this can be an implied contract effected when payment is made for the purchase of the goods as determined in the case Aztech Science Pty Ltd v Atlanta Aerospace (Woy Woy) Pty Ltd.

Proving whether a party to the contract has indeed breached the contract can prove to be difficult mainly because of the initial wording of the contract. Under normal circumstances it is the party’s’ to the contract who agree on the terms of the contract. Australian common law recognizes four types of breaches that include; material breach, minor breach, anticipatory breach, and actual breach. Where there is a breach of a contract, the afflicted parties can claim remedies including damages that will place them in the same position if the terms of the contract were fulfilled. This was an anticipatory breach, Astounding Gifts refused to continue paying Melanie for the remaining term as per the contract. In exchange for her unique handmade gifts, she was to be paid $5,000 monthly for a period of twelve months. In the case Robinson v Harman (1848) 1 Ex Rep 850, the court ruled that,

“The rule of the common law is that where a party sustains loss by reason of a breach of contract, he is, so far as money can do it to be placed in the same situation, with respect to damages, as if the contract had been performed.” Melanie can seek remedy in terms of damages from Astounding Gifts Pty Ltd. for she had not failed to fulfil terms of the contract by talking to Salman offering her an opportunity to sell her products to Gifts Pty Ltd unless it was explicitly stated that she was forbidden from engaging with competitors. The amount of damages will be based on the ruling in the case Commonwealth of Australia v Amann Aviation Pty Ltd (1991) 174 CLR 64 the court ruled that the afflicted parties should be placed in a similar situation to what it would have been if the contractual obligations were fulfilled.

Application of Expropriation of Shares

Question 2

Corporations Act 2001

The framework governing the duties of the director is that, as a director one must conform to the Corporations Act 2001. Section 181 of the Corporations Act executes a civic requirement on directors plus relevant officials in an organization to implement their powers and discharge their duties in good faith, in the best interests of the corporation and for a proper purpose. The failure of a director to execute their duties, the director is open for civil or criminal or a hybrid of the two offences. When discharging their duties, directors and other officials recognized by the Corporations Act must do so in good faith, their action must be in the best interest of the company, and be done for proper purposes.

Re Smith and Fawcett Ltd. [1942] Ch 304

As per Article 10, the directors were at liberty to refuse to register shares. When Mr. Fawcett, a director of the company, died; the remaining director, Mr. Smith refused to register and transfer the shares of the dead director to his executioner. Mr. Smith opted to sell some of the shares whereas the remaining shares were transferred to the executors of the will. Lord Greene ruled in favour of Mr. Smith stating that his actions were appropriate and within his mandate as a remaining director. The actions of the director were free from the court intervention, director must exercise their powers on their discretion based on what they and not the court decides as the best interest of the company.

Application in the case law

Determining what is in the best interest of the company is at the director’s discretion and not a court mandate. Based on the expectations of the directors as stated in the Corporations act (2001), they must act in good faith, best interest of the company and for proper purposes; if their intentions are genuine and they justly believe that, what they are doing truthful for the company, directors are safeguarded from accusation that they would have done something differently. The directors of Chip Eze Pty Ltd. satisfied the three legal mandates set out in the Corporations Act by incorporating a new company Freeze Me Pty Ltd to cater for the profitable frozen foods business. By doing so, they protected the interests of all stakeholders in Chip Eze Ltd. shielding them from the consequences meant for the unprofitable manufacture of potato crisps and other snack foods. The shareholders were shielded from loss after the winding up of Chip Eze Pty Ltd. As a director, one must take relevant steps to help reduce losses to the creditors in case the business became bankrupt.

Question 2B

Faizah

The case of Faizah is unique, she is an existing shareholder to Chip-Eze Pty Ltd and in the meeting to split Chip Eze into two, the resolution was voted for unanimously. She was aware of the financial status of Chip-Eze and was aware of the factors that led to the removal of the more profitable unit to be registered as an independent company from Chi Eze. She still went ahead to approach Jordon to sell her additional 5% of his shareholding. Jordan had the right to sell some or all his shares to whoever he chose, but by the fact that he was a director he was further required to reveal the sale to other directors. When trading with shares, directors are supposed to seek authorization from the company secretary as a measure to ensure that the one intending to purchase or sell their shares does not have any information that is not known by the public. The agency of a director gives rise to the status fiduciary. In regards to fiduciary, there are two areas of concern which include the particular relationship out of which the duty arise and the content and proper performance of the duty. However, the fiduciary duty is owed to the company and the company alone, which means that, the directors do not owe any duty to the individual members.

In Coleman v. Myers one of the key issues was the non-disclosure of material information. In the case the court held that the directors duty are owed to the company does not stop them from having fiduciary duties to the shareholders provided there is an agency relationship or a very specific relationship giving rise to fiduciary duties. I would argue that for anyone intending to make any purchase additional shares in a company where one is already a shareholder means that one has already performed due diligence on the financial position of the company.

Faizah decision to purchase additional shares in what remained to be a poorly performing company instead of additional shares in the newly formed company can be argued as a decision made out of ignorance. Based on the position held by Faizah, he was aware of the prevailing situation. Despite Jordan owing a fiduciary duty towards Faizah, Faizah was ignorant of the prevailing situation since the information to split the company was agreed by the directors meaning there was a circular to show the progress and procedures to safeguard the profitable unit. Hence, Jordan cannot be blamed for selling her shares of a company that was headed for liquidation hence she had no legal redress against Jordan.

References

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(Commonwealth of Australia), 2012a. Volume 1,

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Commonwealth of Australia v Amann Aviation Pty Ltd (1991) 174 CLR 64

Corporations Act 2001 sect 136

Corporations Act 2001 sect 181

Gambotto v WCP Ltd (1995) 182 CLR 432

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Parliament of Australia, C., 2018. Chapter Four - Directors’ duties. URL https://www.aph.gov.au/Parliamentary_Business/Committees/Joint/Corporations_and_Financial_Services/Completed_inquiries/2004-07/corporate_responsibility/report/c04 (accessed 9.12.18).

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Re Smith and Fawcett Ltd. [1942] Ch 304

Robinson v Harman (1848) 1 Ex Rep 850

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