Legal Advice For Two Business Scenarios

Scenario 1: Changing a Company's Constitution

Kody and Ryder met whilst studying together at USC and have just graduated. Together they have decided to go into business selling unique, hand-made crafts and other gifts online. They decided to start a company (which they want to register with the name “Incredible Gifts Pty Ltd”) to source, market and sell these products online.

Ryder, keen to get started, approaches Melanie, a well-known local craft artist. Ryder negotiates a 12 month contract with Melanie for the design and provision of a range of unique hand-made gifts, for sale exclusively by Incredible Gifts. The contract is signed by both parties on the 26^th April 2018 and provides for a monthly payment of $5,000.

When Kody and Ryder go to register Incredible Gifts Pty Ltd on the 2^nd of May 2018, they discover that the name has already been registered. As such, they register the company Astounding Gifts Pty Ltd instead. Kody and Ryder are listed as the two company directors, and Astounding Gifts enters into an employment contract with Salman to act as the company’s accountant. Kody and Ryder each hold 45% of the company’s shares and Salman is given a 10% shareholding.

On the 12^th of May 2018, Kody and Ryder convene their first directors’ meeting. Kody is pleased to hear that Ryder has already managed to sign the exclusive supply contract with Melanie and they begin paying the $5,000 per month.

On the 10^th of July 2018 Kody and Ryder find out that Salman has just accepted an accounting position with their competitor Incredible Gifts Pty Ltd and is trying to encourage Melanie to provide her hand-made gifts to Incredible Gifts instead. Kody and Ryder immediately call a members’ meeting and pass a resolution that alters Astounding Gift’s constitution to provide that directors may determine that the company can buy back shareholdings of less than 12% at their discretion.

Astounding Gifts also refuse to continue to pay Melanie the monthly payments.

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?

Chip-Eze Pty Ltd is a company involved in two business: the manufacture of potato crisps and other snack foods, which has been making a loss in the past few years, and the manufacture of frozen potato chips and other foods, which is reasonably profitable. The directors of the company are Michaela, Jordon and Marianne who each own 25% of the shares in the company. The remaining 25% of the shares are owned by five outside investors (Ayub, Saeed, Donte, Neeve and Faizah).

Chip-Eze have been having financial difficulties, with a number of outstanding payments to creditors—particularly the suppliers of the snack food side of the business. At a board meeting on the 1^st of August 2018, Michaela proposes a resolution to incorporate a separate company, Freeze Me Pty Ltd and to transfer the profitable frozen foods business to this company. The resolution is unanimously passed.

On the 10^th of August 2018, Freeze Me Pty Ltd is incorporated, the assets related to the frozen food business are transferred to it and all the customers and suppliers are updated with the new details.

On the 6^th of August, Jordon had been approached by Faizah who had asked if she could purchase additional shares in Chip -Eze Pty Ltd. Jordon agreed to sell her an additional 5% of the shares himself, and they completed the transaction on the 8^th of August.

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

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.

Part 1 A

The Corporation Act 2001 lays down the rules and regulation for registering as well as altering a company’s constitution. There are intricate procedures that needs to be followed to change the constitution. The constitution of a company binds the members of such company together, giving a feel to unity, while it also ties them together with the third parties with whom the company transacts. The constitution helps both parties to keep a clear picture of each other’s motto and purpose to operate. It also helps settle dispute between parties in case of a disagreement or breach of contract. Therefore, it is not only important to incorporate a constitution, it is also vital to amend it as per necessary requirement from time to time. Section 136 of the Corporation Act (CA) empower corporations to alter constitution as per necessity. Section 136(2) of CA states that, the company or its directors need to pass a special resolution for altering a company’s constitution. Section 136 (3) of the Act lays down the compliance rules that the company needs to abide by to alter the constitution. The directors may alter the constitution to add a certain clause to protect the best interest of the corporation.

It was held in the landmark case of Gambotto v WCP Limited, the court held that the directors cannot buy back shares of the minority shareholders by the way of changing the constitution. It was observed by the judges that such buying back shares from the minority shareholders through the trick of adding a clause to the constitution constitutes unethical and oppressive toward such minority shareholders. Alteration of the constitution for the inclusion of the provision of buying back shares is not permitted by the court unless the directors can show vital reasons for such inclusion, which is for the benefit of the corporation. The court would only allow such changes considering the position of the company, to save it from monetary injury or reputational issues. In Allen v. Gold Reefs of West Africa, the test of the duties of the directors towards protection of the minority shareholder. Lindley MR, stating that a director must exercise his duties not only as prescribed by law, but also ‘bona fide for the benefit of the company as a whole’ and it should not exceed its average standard of care, discussed it for the first time.

McLelland J held that such alteration of constitution would be fair if it is ’bona fide for the benefit of the company as a whole’. Citing Peter’s American Delicacy Co v. Health, His Honour stated that this test of good intention and purpose is not conclusive, as the interest of different classes of shareholders needs to be taken into account.

While, the minority shareholders need to highlight the fact that the directors intend to incur personal gain out of such alteration of constitution to stop the directors from making such changes. The aggrieved party needs to cite to the court that the corporation has not followed the prescribed way of making the amendments, which involve holding special resolution meetings that includes the vote of the minority shareholders as well. However, it requires the vote of 75% of the shareholders and does not include the ones below 11%.

The Process to Alter the Constitution of a Company

In this case, Kody and Ryder holds 90% of the shares together, which gives them the authority to pass a special resolution and alter the constitution without involving Salman who only holds 10% of the shares in the company.

Since the two directors hold 90% of the shareholding in the company, therefore they have the power to change the constitution for the interest of the company when they found out that Salman was consorting with a competitor company. Under section 136 and 136 (2) of CA, the directors have the authority to exclude Salman and make the necessary changes to insert the clause of buy back shares of the minority shareholder, holding shares below 10%. Thus as per the provision of the CA, it was not illegal or unethical on Kody and Ryder’s part to make the amends. Such act of alteration saved the company from material loss and injury.

The intention of the directors are however, inquired into by the court of law for it is likely to be collusive and malicious in most cases. The directors are generally found to be making changes for their personal gains, injuring the minorities. However, in this case, Kody and Ryder followed the letters of the law to save the company from the malicious intentions of Salman. Salman was working for the competitor company as an accountant and inducing Melanie to work for that company as well. This is unethical and illegal on her part, which is substantial enough to disqualify her eligibility to sue Astounding Gifts Pty Ltd or its directors. Therefore, Salman cannot prevent the inclusion of the clause of buy back shares for her own collusive conduct.

Provisions for pre-registration contract

Pre-registration contracts are subject to ratification. The Corporation Act 2001 provides for the provision of the pre-registration contracts and their ratification by the parties to the contract. After such contracts have been signed, it is compulsory for the parties to perform it. Section 131(2) of the Act entitle the parties to execute the contract and reap its benefits as well, following the procedural requirements though. A formal ratification of the pre-registered contract is a mandate under section 131(2), which requires the parties to ratify such contract within a mutually agreed date or a reasonable period after the corporation is registered. The party that fails to ratify it is liable to pay compensation to the other on non-performance of the contract. Section 131(3) of CA directs the compensating party to pay the damages in full at one time or in installments for a certain period.

Even though the statute says that pre-registration contracts are legally binding, yet various precedents exists that relieve parties from further execution after the company comes into existence, as they consists of extinguishing clauses incorporated in such pre-registration contracts.

In this case, Astounding Gifts Pty Ltd had entered into a pre-registration contract with Melanie, which they fail to ratify even after the company was registered. On the other hand, Melanie have breach the contract with Astounding Gifts Pty Ltd of supplying her work to them, instead she supplied them to its arch competitor. Therefore, it can be held that both parties have breach their duties to perform the contract differently. Astounding Gifts Pty Ltd will be liable to pay Melanie her share of monthly remuneration and other damages for not ratifying the contract. While Melanie can be held liable to compensate the company for breach of contract. The company will be liable to pay her wholly at a go or partly from time to time as per Melanie’s claim for violating the provision laid down in section 131 of the Corporation Act. The company can bring charges against Melanie to pay damages.

Advice for Salman

Bibliography

Corporation Act 2001 (Cth)

Gambotto v WCP Limited [1995] HCA 12

Peters' American Delicacy Company Limited v Heath [1939] HCA 2

Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656

Re National Motor Mail Coach Co., 77 L. J. 790 (1908)

Part 2A

Breach of director’s duty under Corporation Act 2001

Common law lays down the moral duties of an employer toward his employees. These general duties are common to any kind of institution. While statutory legislations shapes the unwritten common law principles and incorporate them as codified rules and regulations for modern day usage. Section 181 of the Corporations Act 2001 states the duties of the director and other officers in a corporation. The directors are supposed to abide by the provisions laid down in this section and execute them accordingly. As per this section, the directors are meant to execute their duties in ‘good faith’. While Section 181 (1) of CA directs the officers and directors of the corporation to act reasonably with due ‘care and diligence’. Violation or breach of the prescribed duties would result to penalty of the director responsible for such breach. Section 1317E of CA lists down penalties for several types of breach and violation of duties by directors and officers under the Corporations Act 2001.

In ASIC v Adler, the directors were held liable to breach the following provisions under the CA:

• Section 180: It lays down the duty of the director to execute his duties with care and diligence.
• Section 181: it asks the director to carry out his duties bona fide.
• Section 182: refrains the director to misuse their position.
• Section 183: refrains director to use the information received by way of his position as a director in an inappropriate way.
• Section 206A: lays down the duties of the director regarding his financial responsibility toward the corporation.

In Hutton v. West Cork Railway Co, it was observed by the court that the directors have limitation to spend fund of the company for the benefit of non-shareholders. The court ascertained this case on the basis of the fact that an insolvent company still holds certain duties towards the employees.

In Australian Metropolitan Life Assurance Co Ltd v Ure, it was observed that the directors have discretion to choose parties for the legit transfer of shares of the corporation.

Therefore, the provisions for the director’s duty and the breach of such duty laid down in the Corporation Act is to be followed by the directors to avoid the violation of such provisions and thereafter attract penalty.

Chip-Eze Pty Ltd had two sections of its business, one dealing with making potato crisps and other snacks while the other dealt with the manufacture of frozen potato chips. It formed a new company and transferred its substantial assets to such company as it suffered a heavy loss in its potato crisps business while made profit in the frozen potato chips venture. They named the new venture as Freeze Me Pty Ltd. It is quite clear that the company indulged into such a substantial change for it had a huge credit amount due to several creditors due to the loss sustained in the potato crisps business. They severed the business from its previous transaction route to evade the creditors. However, in Bell Group Ltd v Westpac Banking Corporation, it was held that the financers put risk while investing in a corporation and they intend to incur profit out of such engagement. Therefore, it is the duty of the director to act accordingly so that such risk of the financer is not wasted. Thus, the attempt to evade liabilities and loss suffered from previous business would not let the directors escape the clutch of legal obstacles. In such cases, the directors cannot take the defense of protecting the corporation from probable injury, as it would be intended that a company could not exist by defrauding the claim of its creditors. It would held as an offense under civil law, law of tort as well as under the Corporation Act to escape the credits a company needs to pay to its creditors. Under section 1317E of CA, the guilty directors would be liable to pay damages to the creditors.

Therefore, it is advised to Archibald to liquidate the new company in his capacity as the official liquidator appointed by the court. Archibald must penalize the company for evading the creditors of their rightful claim over her investments. Under the section 1317E, the directors would be penalized that involves a monetary compensation that might extend up to $200000 or the directors may be banned from their respective positions.

Determination whether as to the directors hold liability towards individual Shareholder

The directors of a company is vested with several duties and responsibilities under the Corporations Act, yet they are not liable to execute duties pertaining to individual shareholders. They are only supposed to carry out responsibilities toward the company and not to any one in particular. In the case of Percival v. Wright, it was held that the directors cannot be held responsible or dutiful towards individual shareholder. It was observed that a director has the right to buy back share from a shareholder when such shareholder wants to sell off his part and therefore puts trust upon such director. The director is not under any obligation to let the shareholder know about the probable liquidation of the company while buying the shares back from an individual shareholder. Nonetheless, it is to be looked after that the director does not possess any personal interest or coerce a shareholder to sell his part. In addition to, it is to be made sure that the shareholder selling his share must be vulnerable and thus puts his trust on the director.

However, this observation was overruled in Coleman v Myer. In this case, it was held that on certain circumstances the director must execute specific responsibility toward individual shareholders. More so, it is to be followed when it is clearly seen that such shareholder puts a sense of trust over the director to buy back his part of shares. The court held that the directors are liable to disclose information to the individual shareholders about the corporation, which are significant for the transfer of such shares. It is solely due to the trust that an individual shareholder might hold upon a director.

Section 588G of the Corporation Act 2001 refrain the directors from carrying out insolvent trading for such illegal trading would penalizes the directors.

It is alleged by Faizah that Jordon had breached his duty as a director. However, it is not clear whether Jordon had any duty towards Faizah on the first place. Jordon bought the shares that Faizah offered to sell not knowing the fact that the company was on the verge of liquidation. In this case, it cannot be established that Faizah had put trust on Jordon for some serious issue that she was going through when she offered such transfer. In no way can it be proved that she was in a vulnerable condition. Therefore, following the rule of Percival v Wright, it can be said that it was no wrong on Jordon’s part to disclose the fact of the company’s winding up. Charges Therefore, Faizah cannot bring charges upon Jordon or any other director that they have infringed their duty in the capacity of a director.

Australian Metropolitan Life Assurance Co Ltd v Ure [1923] 33 CLR 199

Australian Securities and Investments Commission v Adler [2002] NSWSC 171

Bell Group Ltd v Westpac Banking Corporation (No 9) [2008] WASC 239

Coleman v Myers [1977] 2 NZLR 225

Corporation Act 2001 (Cth)

Hutton v West Cork Railway Co [1883] 23 Ch D 654

Percival v Wright [1902] 2 Ch 401