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Remedies for Avoiding Conflicts of Interest

Describe about the Conflict Management for Actual Decision Making.

1. The various remedies whereby the conflict of interest could be avoided by the members are highlighted below.

Disclosure of the underlying conflict of interest in a given situation to the fellow members so that the others are not influenced and can maintain a partial stance.

In situations where a potential conflict of interest may be avoided, the member must not act as an influencer or decision maker and seem to minimise direct or indirect participation in deliberations and actual decision making.

Advantages of Partnership

Capital – Due to the nature of the business, the partners will fund the business with start up capital. This means that the more partners there are, the more money they can put into the business, which will allow better flexibility and more potential for growth. It also means more potential profit, which will be equally shared between the partners.

Flexibility – A partnership is generally easier to form, manage and run. They are less strictly regulated than companies, in terms of the laws governing the formation and because the partners have the only say in the way the business is run (without interference by shareholders) they are far more flexible in terms of management, as long as all the partners can agree.

Shared Responsibility – Partners can share the responsibility of the running of the business. This will allow them to make the most of their abilities. Rather than splitting the management and taking an equal share of each business task, they might well split the work according to their skills. So if one partner is good with figures, they might deal with the book keeping and accounts, while the other partner might have a flare for sales and therefore be the main sales person for the business.

Decision Making – Partners share the decision making and can help each other out when they need to. More partners means more brains that can be picked for business ideas and for the solving of problems that the business encounters.

Disagreements – One of the most obvious disadvantages of partnership is the danger of disagreements between the partners. Obviously people are likely to have different ideas on how the business should be run, who should be doing what and what the best interests of the business are. This can lead to disagreements and disputes which might not only harm the business, but also the relationship of those involved. This is why it is always advisable to draft a deed of partnership during the formation period to ensure that everyone is aware of what procedures will be in place in case of disagreement and what will happen if the partnership is dissolved.

Advantages of Partnership

Agreement – Because the partnership is jointly run, it is necessary that all the partners agree with things that are being done. This means that in some circumstances there are less freedoms with regards to the management of the business. Especially compared to sole traders. However, there is still more flexibility than with limited companies where the directors must bow to the will of the members (shareholders).

Liability – Ordinary Partnerships are subject to unlimited liability, which means that each of the partners shares the liability and financial risks of the business. Which can be off putting for some people. This can be countered by the formation of a limited liability partnership, which benefits from the advantages of limited liability granted to limited companies, while still taking advantage of the flexibility of the partnership model.

Taxation – One of the major disadvantages of partnership, taxation laws mean that partners must pay tax in the same way as sole traders, each submitting a Self Assessmenttax return each year.

Profit Sharing – Partners share the profits equally. This can lead to inconsistency where one or more partners aren’t putting a fair share of effort into the running or management of the business, but still reaping the rewards. 

2. A legal concept that separates the personality of a corporation from the personalities of its shareholders, and protects them from being personally liable for the company's debts and other obligations. This protection is not ironclad or impenetrable. Where a court determines that a company's business was not conducted in accordance with the provisions of corporate legislation (or that it was just a façade for illegal activities) it may hold the shareholders personally liable for the company's obligations under the legal concept of lifting the corporate veil. In this regard Section 588G and 588V are significant which tend to place responsibility of insolvency on the directors of the company and holding company respectively provided if some necessary conditions are satisfied.

3. Piercing the corporate veil or lifting the corporate veil is a legal decision to treat the rights or duties of a corporation as the rights or liabilities of its shareholders. Usually a corporation is treated as a separate legal person, which is solely responsible for the debts it incurs and the sole beneficiary of the credit it is owed. Common law countries usually uphold this principle of separate personhood, but in exceptional situations may "pierce" or "lift" the corporate veil.

A simple example would be where a businessman has left his job as a director and has signed a contract to not compete with the company he has just left for a period of time. If he sets up a company which competed with his former company, technically it would be the company and not the person competing. But it is likely a court would say that the new company was just a "sham", a "cover" or some other phrase and would still allow the old company to sue the man for breach of contract.

Disadvantages of Partnership

In this context, section 588G and 588 V of the Corporations Act 2001 assume significance. Section 588 imposes a duty upon directors to prevent a company from engaging in insolvent trading and leads to breach of duty in case such a debt is assumed by the director acting in negligence or fraud. Similarly, Section 588V creates the liability for the holding company when the following conditions are satisfied.

the company was a holding company of the subsidiary at the time the debts were incurred by the subsidiary; and

the subsidiary was insolvent when it incurred the debts; and

at the time there were reasonable grounds for suspecting insolvency; and

the holding company or at least one of its directors were aware of the grounds for suspecting insolvency, or “having regard to the nature and extent of the corporation’s control over the company’s affairs and to any other relevant circumstances”, it was reasonable to expect the holding company or one of its directors to be aware of the grounds for suspecting insolvency; and

that time is at or after the commencement of this Act.

4. The following are the major differences between debt and equity:

Debt is the company’s liability which needs to be paid off after a specific period. Money raised by the company by issuing shares to the general public, which can be kept for a long period is known as Equity.

Debt is the borrowed fund while Equity is owned fund.

Debt reflects money owed by the company towards another person or entity. Conversely, Equity reflects the capital owned by the company.

Debt can be kept for a limited period and should be repaid back after the expiry of that term. On the other hand, Equity can be kept for a long period.

Debt holders are the creditors whereas equity holders are the owners of the company.

Debt carries low risk as compared to Equity.

Debt can be in the form of term loans, debentures, and bonds, but Equity can be in the form of shares and stock.

Return on debt is known as interest which is a charge against profit. In contrast to the return on equity is called as a dividend which is an appropriation of profit.

Return on debt is fixed and regular, but it is just opposite in the case of return on equity.

Debt can be secured or unsecured, whereas equity is always unsecured.

5. Yes, ASIC has the authority to undertake both civil and criminal penalty against the defaulting directors.

Piercing the Corporate Veil

Criminal actions are usually referred to the Department of Public Prosecutions, or DPP, to conduct the prosecution. Under this arrangement, ASIC is obliged to provide to the DPP all material it has gathered that may be relevant to the defendants' defence in a criminal trial. However, the regulator will sometimes prosecute minor regulatory infractions of the law itself. This has led to speculation that ASIC prefers to bring civil proceedings it can undertake itself, rather than criminal ones it must hand over to the DPP, in matters where both are available. The regulator has strenuously denied these claims. 

Civil action can lead not just to penalties, but also to court orders for injunctive relief, corrective action, compensation, and drastically, the winding up of insolvent companies. Because ASIC can bring criminal proceedings for conduct for which it has already obtained a criminal penalty (section 1317P Corporations Act), it will occasionally take civil action as an interim protective measure, while investigation of possible criminal matters is still on foot.

Some of the relevant cases where such actions have been prompted by ASIC against directors are given below.

  • ASIC v Vizard (2005) 54 acsr 394
  • ASIC v Rich & Ors (2003) 44 ASCR 341
  • ASIC v Vines [2006] NSWSC760.

6. In the given case, ASIC demanded that certain documents be furnished by the defendants in relation to an ongoing investigation but a waiver by granted in this regard by the honourable judge who himself vetted the documents submitted by the defendant and ruled that the company itself is carrying an investigation against the culprit firm and disclosing of the documents related to the ongoing investigation to ASIC would disclose the name of the informers and other confidential information which would impair ASIC’s ability to extract reliable data from the culprit firm.

The relevant rule which acts as a guide is stated below.

"Sankey v Whitlam establishes that when one party to litigation seeks the production of documents, and objection is taken that it would be against the public interest to produce them, the court is required to consider two conflicting aspects of the public interest, namely whether harm would be done by the production of the documents, and whether the administration of justice would be frustrated or impaired if the documents were withheld, and to decide which of those aspects predominates. The final step in this process - the balancing exercise - can only be taken when it appears that both aspects of the public interest do require consideration - i.e., when it appears, on the one hand, that damage would be done to the public interest by producing the documents sought or documents of that class, and, on the other hand, that there are or are likely to be documents which contain material evidence. The court can then consider the nature of the injury which the nation or the public service would be likely to suffer, and the evidentiary value and importance of the documents in the particular litigation.”

Differences between Debt and Equity

7. The company itself can bring a claim against the erring director if it can show that it has suffered some loss. If the director has made some personal profit, they can be required to surrender the gain to the company. A contract or other arrangement entered into by the director in breach of a duty will be void, though it may be open to the company to ratify the agreement if it wishes to do so.

The company may also seek:

an injunction to stop the director from carrying out or continuing with the breach;

damages by way of compensation where the director has been negligent;

restoration of the company’s property;

the rescinding of a contract in which the director had an undisclosed interest.

Claims by a company are often retrospective, brought by members of the existing board against their predecessors.

Also, shareholders may also initiate action against the erring directors. For this, a shareholder dissatisfied with a board’s lack of action against an errant director must issue a claim in the name of the company and request the court’s permission to take it forward. A successful shareholder will be allowed to pursue the claim (with the company footing the bill), but the court has a wide discretion to adjourn the case to gather evidence from the company itself. An unsuccessful shareholder risks paying the other parties’ costs and an order restraining further action

8. Receivership functions

Receivership is an extraordinary remedy, the purpose of which is to preserve property during thetime needed to prosecute a lawsuit, if a danger is present that such property will be dissipated orremoved from the jurisdiction of the court if a receiver is not appointed. Receivership takes placethrough a court order and is utilized only in exceptional circumstances and with or without theconsent of the owner of the property.

Defacto directors

De facto directors typically fall into one of the following three categories: (i) persons who are properly elected but lack some qualification under the relevant company law that disqualifies them from legally being directors; (ii) former directors whose term of office has expired but who have continued to act as directors; or (iii) those who simply assume the role of director without any pretense of legal qualification.

One of the most often-cited definitions of a de facto director is in the case of Re Hydrodam (Corby) Ltd., [1994] 2 B.C.L.C. 180. The Courts have recently had the opportunity to address the test for de facto directors. In the English case ofElsworth Ethanol v. Ensus, [2014] EWHC 99, the Court confirmed that there is no single test, but listed some of the non-exhaustive factors that should be considered in order to determine if an individual is a de facto director:

Whether an individual (the putative de facto director) was acting with one or more "true directors" on an equal footing in directing the affairs of the corporation;

Whether there was a holding out by the company of the individual as a director;

Whether the individual used the title of director; and

Whether the individual was part of the corporate governing structure, being the system by which the company is directed and controlled.

The major disability in relation to the company is that it that it requires agents in the form of management to run the business. The company even though is a legal structure but cannot take any decisions on the own. Further, the agents of the owners  have a liability for the action of the employees even if they act in  bad faith as the interest of the third party is paramount.

Vicarious liability

Vicarious liability is a legal doctrine that assigns liability for an injury to a person who did not causethe injury but who has a particular legal relationship to the person who did act negligently. It is alsoreferred to as imputed Negligence.  Ordinarily the independent negligence of one person is not imputable to another person. In context of a company, it implies that the implications of the act of the employees would have to be borne by the employer or the firm for which the employee was acting as a agent irrespective of the fact whether the employee was acting in congruence to the instructions given by the company or not.

Corporate Liability

The legal responsibility of a corporation for criminal actions, or the failure to act in some cases, committed by the company's employees. If the actions were done for the benefit of the company, are a result of negligence or if they occurred due to a lack of responsible management by the company, the corporation can be prosecuted and punished.

Duty of care of directors

Directors are required to exercise their power with competence (or skill) and diligence in the best interests of the corporation. They owe what is called a "fiduciary duty" to the corporation. The duty is a "fiduciary" duty because the obligation to act in the best interests of the corporation, at its core, is an obligation of loyalty, honesty and good faith. Modern corporations statutes governing business corporations provide a concise formulation of the fiduciary obligation owed by directors.

Directors' fiduciary duties can be divided into two main branches:

Duty of care and duty of loyalty

The duty of care imposes on directors a duty of competence or skill - i.e., a requirement to act with a certain level of skill; and a duty of diligence. The duty of skill and diligence must be performed to a certain "standard of care".

In the Australian context, there are a plethora of duties that are bestowed on directors such as Section 180, 181, 184, 588G etc.

Cores and Statutes

It refers to the combination of the common law which is the core and the statute law which are to be deployed in a particular situation and matter so that a holistic picture emerges of the underlying situation which considers the host of underlying issues which may not be addressed by either one of the above.

Member Remedies

These are the remedies that are available to the members so that they can safeguard their legal and valid interests. One of the remedies available is against oppression which is particularly useful for minority shareholders especially since the board is dominated by the major shareholders but even minority shareholders to initiate debates and enquire about a particular aspect of the company.

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