Provisions For Constitution Alterations, Pre-registration Contracts, And Director Duties Under The Corporation Act 2001 Are Essay-worthy.

A. Amaya, 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?

B. Gracey, what recourse, if any, she has for the non-payment of her monthly fee for the remainder of her one year contract?

A. Lily-Mae whether the directors of Drink It Up 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

B. Dhruv whether he has an action against Kristofer for breach of directors’ duties for selling him the shares in Drink It Up Pty Ltd just before it was going into liquidation.
 

Alterations to a Company's Constitution under Section 136

A.Constitution of a company: its alternation, procedure for alternation and limitations:

The Corporation Act 2001 (CA) lays down the provisions for the inclusion of a constitution for every company. It also lays down the provisions for making additions and alternations to such constitution as well. The constitution of a company is the instrument that holds the members together, along with the third parties too. The procedure to amend or alter the constitution under the CA 2001 is laid down in section 136.

Section 136(2) of the Act states that constitution of an organization or a company can be changed by way of passing a special resolution. While section 136(3) states that, such alteration of the constitution would not have any effect unless the necessary procedures specified in this section has been complied with. Section 136(4) further mentions that the company is eligible to alter the constitution, unless a contradictory provision is laid down in the constitution itself.

Nevertheless, in Gambotto v. WCP Limited, it was held that the action of the shareholder in relation to alter the constitution to buy back shares of the minority shareholders was struck down by the court. It was held by the court that alteration of the constitution to buy back minority shareholder’s share would be unfair and oppressive unless there is a special purpose. It was cleared out by the court that such alteration of the constitution is permissible when the action of the minority shareholders are corrosive to the company or such minority shareholders compete with the company. However, such modification is unjust and non-permissible if it is proven that the majority shareholders are giving effect to it for their personal gains.

Legality of the alteration done by Oh My Pty Ltd

Under Section 136 of the CA 2001, a special resolution is required for the alternation of the constitution, which requires 75% of the shareholders to hold a voting procedure to ratify such alteration. Here, in the company Oh My Pty Ltd, the two directors hold 90% of the shares, which makes them eligible to hold a special resolution in order to alter the constitution of the company under section 136(2). Additionally, section 136(3) and 136(4) does not lay any hindrance in the way of amending the constitution of the company, along with the fact that the shares that are bought back belongs to a minority shareholder who holds less than 11% shares in the company. Hence, as per the provisions of the Corporation Act 2001 the alteration stands just and valid. 

Pre-registration Contracts under Section 131

However, if it is judged from the point of view laid under Gambotto v. WCP Limited, the intention of the majority shareholders behind such alteration needs is to be highlighted. It is to be understood that although the intention of the majority shareholders speaks for personal gain and portrays oppression and injustice to Amaya, yet it is proven that Amaya was working for a competitor company, which defeats the principle stated in the Gambotto case. Amaya has been influencing Gracey to sell her podcasts to the competitor company as well, along with working for the competitor company herself while working with Oh My Pty Ltd. Therefore it can be clearly seen that Amaya is competing with her own employer and so the alteration of the constitution pertaining to the buying back of her shares was just, reasonable and valid.

B.Pre-registration Contracts

Section 131 of the Corporation Act 2001 lays down the rules for contracts and agreements, which are entered into before the company is registered. Section 131(1) of the Act states that when a company enters into a contract before it was registered, then the company is required to abide by such contract and work accordingly. The parties to the contract is entitled to derive the benefits of such contract unless otherwise directed. Provided, such pre-registration contract is ratified within the specified time or within a reasonable period after the company is registered. However, Section 131(2) says that a person will be required to compensate the company regarding the contracts entered before registration if the company has not ratified such contract within the specified time or reasonable time or if such company fails to register itself. The amount that has to be compensated by the person would equal the amount, which the company was supposed to pay if the contract was ratified and then not performed. However, if the court sees that the company is not ratifying the contract or has substituted it, then the court has the power to bring in any action that it believes to be appropriate in such situation under Section 131(3). The court may order the person to pay all or part of the compensation or return the goods or services received in lieu of such contract. Section 131(4) states that the court may direct a person who has failed to act wholly or partly according to the contract entered into before the registration of the company, to pay in whole or in part, the compensation required to be paid.

Director Duties as per Section 181

Defense available to Gracey

Huw had entered into a contract with Gracey according to which Gracey was supposed to supply weekly podcasts to Oh My Pty Ltd in exchange of $4000 per month. It was contracted before the company was registered. The contract was signed between Gracey and the company when it was named as ‘Gosh Pty Ltd’, which was later changed to Oh My Pty Ltd due to unavailability of the previous name. Therefore, it is implied that under section 131 of the CA 2001 the company is liable to perform the contract as per the agreement and was required to ratify the contract within a reasonable time after it was registered; the company however failed to comply with either of these criteria.

Therefore, as Huw had entered into a contract with Gracey on behalf of the company, so Huw would be liable to compensate Gracey due to non-ratification and. non-performance of such contract under Section 131(2). Additionally, the court may direct the company to pay the compensation wholly or in parts if Gracey makes a claim for it under Section 131(3). Lastly, Section 131(4) empowers the court to direct the company to compensate Gracey if it is established that the company ratified the contract yet breached it. 

A.Duties of the Directors

Directors have been given various duties under the Corporation Act 2001 and under Common Law, which can be categorized as general duties and statutory duties. The Directors are bound to carry out their duties entrusted upon them and act in good faith as per the Common Law which is vital for the welfare of the company. The unwritten principles of the Common law have been given shape by way of a legislation. The Corporation Act 2001 under Section 181 lays down these duties of the Directors prescribed by the Common Law.

Provisions for Directors’ Duty under the Corporation Act

Section 181 of the CA 2001 lays down the duties of the Directors and officers and direct them to act in good faith. Section 181(1) requires the Directors and other officers to make use of the powers and discharge their duties and responsibilities accordingly for the best interest of the company. Violation of Section 181(1) attracts civil penalty laid down under Section 1317E of the same Act.

In case of ASIC v. Adler, several breaches of duties by Director’s have been pointed out by the court. It was held by the court that the Directors had breached their duties under section 9 that lays down the definition of a director’s duty. Along with, section 180 that speaks for the duty of the Director to act with diligence and car, section 181 stating the duty of the Director to act in good faith; Section 182 that lays down the provisions for misusing one’s position, Section 183 dealing with duty not to misuse information and Section 260A discussing about financial assistance. While in Hutton v. West Cork Railway Co it was held that the power of a Director to spend company fund for non-shareholder’s benefit must be put under certain limitations. This case was decided on the light of a company’s insolvency pertaining to its employees. In Australian Metropolitan Life Assurance Co Ltd v Ure, it was held that the Directors must exercise their discretionary power to refuse transfer of share for a legitimate and rational reason, like refraining a bankrupt person to become a member, shareholder or enter into a contract with company. 

Cases like ASIC v. Adler and Bell Group Ltd v Westpac Banking Corporation

Drink It Up Pty Ltd: Breach of Director’s duty

In the given case, it has been told that the beverage company Drink It Up Pty Ltd has come up with the idea of forming a new company as they had major losses pertaining to their fruit juice business while made remarkable profit on the spring water business. They shifted all their assets to the spring water business, forming a new company named H20 Pty Ltd. It was done in this manner to escape financial complexities that the company had to face due to the heavy losses it suffered from the fruit juice business. This clearly implies that the Directors of the company is making such arrangements to escape from the clutch of its creditors. As held in Bell Group Ltd v Westpac Banking Corporation, financers take up huge risks while providing finances to companies and therefore it is the duty of the directors to act in good faith for the best interest of the company. It is the duty of the director to act for a proper purpose relating the interest of the company. Thus, the decision of Directors of Drink It Up Pty Ltd to divide its trade for improper purpose, wound up its old business and move all asset to the new company, H20 Pty Ltd  cannot be considered just, rational and for the best interest of the company. It clearly violates Section 181 of the Corporation Act and will be held liable under section 1317E to pay fine which may extend up to $200000 or maybe disqualified from the post of Director under section 206C of the same Act.

B.Duty of the Director toward Individual Shareholders

The directors do not hold any general duty towards the individual shareholders. It was so held in Percival v. Wright that the Directors only hold duty towards the company as a whole and not to an individual shareholder. It is not wrong on the Director’s part to buy shares from shareholders who desired to sell their shares before the company was sold out. It was held by the court that this does not amount to a breach of duty on the Director’s part as they are not liable to meet any responsibility toward individual shareholders.

While the judgment delivered in Percival v. Wright was not observed in Coleman v Myer. In this case it was held by the court that the Directors in certain circumstances hold liability to the individual shareholders as well. It was directed by the court that the director hold fiduciary duties towards the individual shareholders and for the purpose of which they are liable to disclose the facts regarding a specific offer for the individual shareholders to know before executing the transaction as such disclosure can change the approach and action of such shareholders. In several other case, it has been held by different courts that the Directors have duties towards individual shareholders, in cases where the Director is required by the demand of the situation to serve a bigger and greater duty towards the individual shareholders. It is to be made sure that the Directors are trusted by such shareholders in acute need to sell his portion of shares or for some other purpose.

In addition to the duties that the Directors hold towards the company and the shareholder, they are also under the obligation not to carry out business when the company is insolvent. Section 588G of the CA 2001 clearly specifies that a Director is refrained from carrying out any insolvent trading and in doing so, they can be held liable personally for the losses suffered by the financer. 

Kristofer’s Breach of Duty

The dilemma regarding Kricstofer’s breach of  Director’s duty depends on the fact whether Kristofer had any duty towards Dhruv individually. The facts of Percival v Wright matches with the situation of this case therefore the judgment of Percival v Wright can be applied in this case as well. In the given case, the shareholders desired to sell their shares at a lower price before the company is sold out as that would make the price of the shares much higher. Thus, pinning on the judgment of Percival v Wright, it can be concluded that Kristofer had no duty towards Dhruv who was an individual shareholder. However, there is exception to the general rule which has been established in several cases like Coleman v Myers. Although it is clear that such exception is applied only when it is observed that such individual shareholders is vulnerable and depends largely on the directors with his shares in the company. In the given problem, it can be clearly observed that Dhruv had no such vulnerability or dependence on kristofer regarding his shares in the company. Therefore, the exceptional rule to the general principle does not stand in this scenario and Kristofer is in no way responsible to make Dhruv aware of the fact that the company is soon to be bankrupt. 

ASIC v Adler [2002] NSWSC 171

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

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

Corporation Act 2001 (Cth)

Gambotto v WCP Limited [1995] HCA 1