Breach Of Director Duties - Case Study Essay.

1.Write an explanation in preparation for this meeting, setting out what the duties of directors are under s.180(1)of the Corporations Act, explaining the effect of s.180(2) and assessing whether any of the directors may have breached their duties under this section.

2.Explain to Lana, Rik and Patel whether Fruut can be forced to keep leasing the new premises for the three year term.

Definition of a Director under Section 9

The key issue of this case revolves around the possible breach of director duties’ covered under section 180(1) of the Corporations Act, by the directors of the company, and the possible defence available under 180(2) of the Corporations Act.

Corporations Act, 2001 is the legislation which has to be followed by all the companies working in Australia, unless otherwise exempted. This legislation provides the different aspects of company like the constitution/ replaceable rules, shares, director duties, and other major provisions. Under section 9 of this legislation, the definition of a director has been given. This section provides that any person who acts in the position of a director, or where the company is used to acting as per the wishes or instructions of such person, the person would be deemed as a director of such company, even when not specifically named so.

In Australian Securities Commission v AS Nominees Ltd it was held that the true source of decision making and holding the personal liable for decisions was the reason for holding such individuals as director of the company. Where a person undertakes management functions which typically a director of company undertakes Chameleon Mining NL v Murchison Metals Ltd would make such person a director of the company. Similar findings were given in Deputy Commissioner of Taxation v Austin. 

A shadow director and a de facto director have the same duties and responsibilities as a general director of a company has. Part 2D.1 of the Corporations Act specifically covers the duties of directors. Of the duties covered under this section is the civil obligation of care and diligence as is covered under section 180 of this act. As per section 180(1) of the Corporations Act, the directors of the company are under a civil obligation of using their powers and fulfilling their duties in a manner as a reasonable person holding their office in similar situation and faced with similar issue would use. In case the provisions covered under this sub-section are not fulfilled, the director would have to bear the penalty provisions covered under section 1317E of this act. This allows the Court to make a Declaration of Contravention against the director; pursuant to which the ASIC can apply for a disqualification order against the director based on section 206C of this act, or to apply for pecuniary penalties as are provided under section 1317G of this act. In AWA Ltd v Daniels, it was clarified that the court takes into consideration the subjective elements of position which the director held in the specific situation of the particular company when they make the decision of the contravention of duty covered under this section.

Duties of a Director under Part 2D.1

Section 180 not does come with civil penalty provisions alone, it also offers defence in needful cases to the directors. Section 180(2) covers the business judgement rule, which provides that a director would not be in breach of subsection (1) where they make the decision on the basis of business judgment rules. These rules provide that the decision by the director has to be made on the basis of making judgment in good faith for proper purpose, director lacking personal interest in the judgment’s subject matter, director informs himself/ herself regarding the judgment’s subject matter, and the director rationally does believe that the judgment being undertaken is in the company’s best interest.

The directors need to consider a lot of factors in order to use this section as their defence. They have to show that they took time in reviewing the information available to them, their confidence in consideration of the particular matter, and the nature of demand which required attention and the business of company. In Australian Securities and Investments Commission v Rich, Austin J provided that in order to fulfil section 180(2) there was a need for the director to inform themselves on the judgment’s subject matter to such an extent which in their view was reasonably appropriate. People’s Department Store Inc v Wise clarifies that this does not only involve what the director knew, but what such a director should have known.

In the present case study, there is a need to firstly clarify on the individuals who can be deemed as the director of Fruut Pty. Ltd. Company. It is clearly provided in the case study that Rik and Patel are the directors and shareholders of Fruut Pty. Ltd. Company. The status of Lana needs to be analysed here. Here, there is a need to analyse the work done by Lana and the role she played in the company. Applying section 9 here, Lana although has not been named as the director of the company, does perform the roles of a director, as would any director of such company would. This can be established through application of case laws. 

Based on Chameleon Mining NL v Murchison Metals Ltd and Deputy Commissioner of Taxation v Austin, the functions of management undertaken by Lana would have to be analysed. In the case study, it is clear that Lana takes part in the management of the company as she usually attend the meetings of the boards, so as to help the others in making the difficult decisions. Further, she also provided guarantee for the loan for business to the bank. Apart from this, the applicability of Australian Securities Commission v AS Nominees Ltd requires the true source of decision making to be analysed for holding Lana personally liable for decisions. Her participation in board decisions would fulfil this aspect as well. Thus, Lana would be deemed as a director in this case as per definition covered under section 9 of the governing act. Further, she would have the same duties and responsibilities as Rik and Patel.

Application of Business Judgement Rule as a Defence

As a result of the business being affected, a business decision was undertaken by Rik regarding moving the business to another place. Rik informs of this decision to Patel and Lana and provides that moving would solve the hardships being faced by the business. Section 180(1) of the Corporations Act required this decision to be made in a careful and diligent manner by the directors of the company. They had to cross reference and check regarding the feasibility of idea. Lana and Patel particularly had to analyse the feasibility of moving to another location, instead of merely relying on the information provided by Rik. A reasonable director in place of Lana and Patel would have conducted the proper analysis to reach this decision. Applying the case of AWA Ltd v Daniels in the present instance, the subjective element of position held by Lana and Patel would show that they were in breach of section 180(1) of the Corporations Act. This is because they failed in raising questions to Rik on the proposed lease. Further, they went ahead with this decision even when Lana felt that Rik should not have signed the lease without consulting with the other directors as this left the other directors with no choice. Yet, she did not do anything to let Rik know of the same. Thus, owing to the lack of care and diligence in the work of the directors, they would be in breach of the quoted section.

The business judgment rule can be relied upon by Lana and Patel, but there are high chances of this defence failing for them. Section 180(2) of the Corporations Act required Lana and Patel to make the decision of shifting to new place on the basis of good faith. Here, Lana clearly lacked the faith in this decision. Both the directors lacked personal interest in the decision of shifting to new place, so this point is fulfilled. Both Patel and Lana failed in informing themselves regarding the subject matter of decision of shifting to new place, raised no questions and conducted no feasibility of this proposed decision. Most importantly, Lana did not believe that the judgment was in best interest of the company, which breached the basic essence of this entire defence. Lana and Patel failed in taking the time to review the proposal being put in front of them, they held no confidence in the particular matter, despite the fact that this matter required proper attention to be given due to the nature of decision.

Concept of Separate Legal Entity

Applying the case of Australian Securities and Investments Commission v Rich, Lana and Patel failed in informing themselves regarding the judgment’s subject matter to such an extent which in their view was reasonably appropriate. This does not require that Lana and Patel knew that there could be a problem of feasibility of this plan, but as directors they should have known about the same, based on People’s Department Store Inc v Wise. So, the business judgment rule defence would not be available to the directors.

Rik however conducted proper research for new place and thus would be able to use this defence. Moreover, a case of breach would not be present for him as he did deploy care and diligence in his work. 

Conclusion

Hence, on the basis of this discussion, it can be concluded that Lana and Patel breached section 180(1) and the defences under section 180(2) would not be available to them.

The key issue of this case revolves around the possibility of Lana, Rik and Patel forcing Fruut Pty. Ltd. to keep the new premises.

A company is deemed as a separate legal entity in the eyes of law. Section 124(1) of the Corporations Act provides that a company holds the legal capacity and the powers which an individual has both in and out of its jurisdictions. The meaning of this is that the company is a separate legal entity from other individuals and businesses. The concept of separate legal entity was brought in through the case of Salomon v Salomon & Co Ltd. As a result of this concept, the debts of the company are its own and the assets purchased in the name of the company are of the company. Such assets do not belong to any director or shareholder, despite the shareholders holding 100% of the company shares. So, the company is the legal owner and has the ownership rights to such property. Macaura v Northern Assurance Co Ltd is a leading example of a company holding the property of it, separate from the property of company members.

Another law which can be applied in the present instance is agency law. Agency law dictates that for the acts done by the agent, which is the directors in present instance, the principle, which is treated as company in present instance, is liable to the third party. So, where the act is undertaken by the director of company on behalf of company, the company would be liable. In context of agency law, a key aspect is authority given to the agent, which can be express, implied or apparent. In nearly all the cases, the principle is held liable, despite the agent not been given specific permission or authority for doing something. This is because the third party cannot be made liable for the agent having or not having the authority to indulge in certain actions, when it is apparent or implied that the agent holds the required authority.

Agency Law

Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd is a leading case in this context. In this case, the company secretary indulged in certain acts on behalf of the company, which the other directors were aware of. As a result of this, the court made the company liable for the unpaid architectural fees based on the applicability of agency law, making the principle liable for acts of the agents. Devren Pty Ltd v Old Coach Developments Pty Ltd and Ors is a similar case, where the company was made liable for acts undertaken by Claire despite Claire lacking express authority. The presence of apparent authority made the company liable despite the fact that Claire was not a director of the company.

However, there are cases, where the court can look beyond the corporate veil of the company, and pierce it, to make the parties behind a particular action, liable for their acts. An example of this is the case of CSR Ltd v Young. 

In the present case study, the lease for the new place was signed by Rik on behalf of Fruut Pty. Ltd. It is already clarified that a company is separate from the people running its affairs based on Salomon v Salomon & Co Ltd. This means that the lease which Fruut Pty. Ltd. entered into would be its own and the company would have to abide by it, despite it being signed by one of its directors. This can further be substantiated on the basis of Macaura v Northern Assurance Co Ltd, which would mean that despite Rik signing the lease, the lease would be that of Fruut Pty. Ltd.

Apart from the application of separate legal entity concept, there is a need to apply the agency law here as well. The directors can be deemed as the agent of the company as they work on behalf of the company and the company becomes liable for the acts which the directors conduct on its behalf. This is true not only for the directors, but also for any person working on behalf of the company, as per Devren Pty Ltd v Old Coach Developments Pty Ltd and Ors. The most important reason for holding the company liable in this case stems from the applicability of Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd. Applying this case in present instance, Lana and Patel were aware of the lease signed by Rik and stayed mum on it. The awareness of the other directors would bind Fruut Pty. Ltd. with this lease. Here, Lana can try to make the lease unenforceable by getting the corporate veil pierced by the court, but there are no facts given in the case study to support the success of this claim.

Conclusion

Hence, on the basis of this discussion, it can be concluded that Fruut Pty. Ltd. can be forced to keep leasing the new premises. 

Articles/ Books/ Journals

Bennett H, Principles of the Law of Agency (Bloomsbury Publishing, 2014)

Cassidy J, Concise Corporations Law (The Federation Press, 5^th ed, 2006)

Munday R, Agency: Law and Principles (Oxford University Press, 2010)

Cases

Australian Securities and Investments Commission v Rich (2009) 236 FLR 1

Australian Securities Commission v AS Nominees Ltd (1995) 13 ACLC 1822

AWA Ltd v Daniels (1992) 7 ACSR 759; 10 ACLC 933

Chameleon Mining NL v Murchison Metals Ltd [2010] FCA 1129

CSR Ltd v Young [1998] Aust Tort Reports 81-468

Deputy Commissioner of Taxation v Austin (1998) 16 ACLC 1555

Devren Pty Ltd v Old Coach Developments Pty Ltd and Ors [2015] QSC 53

Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd [1964] 2 QB 4

Macaura v Northern Assurance Co Ltd (1925) AC 619

People’s Department Store Inc v Wise [2004] 3 SCR 461

Salomon v Salomon & Co Ltd (1897) AC 22

Legislation

Corporations Act, 2001 (Cth)

Others

PwC, A guide to directors’ duties and responsibilities for non-listed public companies and proprietary companies in Australia (2008) <https://etraining.communitydoor.org.au/pluginfile.php/608/course/section/95/GuideDirectors_Apr08.pdf