Shareholder agreement and replaceable rules
Cotton Limited holds 89.5% of the shares in Satin Co Limited. The remaining shares are held by Silk and several other small investors. The Board of Satin wants the company to become a wholly owned subsidiary of Cotton Limited as they expect this will result in both taxation benefits and a saving on accounting fees and administration charges of about $230,000. Cotton Limited offers to buy the shares held by Silk and other minority members but they refuse. Arrangements are made to hold a members meeting to pass a resolution changing the constitution of Satin by inserting a new clause 53 “any member entitled to 80% or more of the issued shares may compulsorily acquire all the remaining shares”. Silk and other minority members receive written notice of the company meeting together with a proxy form and a valuation certificate stating the shares were worth $2.50 each. Although the offer is fair Silk does not want to sell her shares and wants to start legal action to prevent the proposed alteration to the constitution.
Discuss whether she may succeed in her action.
Would your answer be different if the real reason for compulsorily acquiring the shares from Silk was that she discovered operating a business in competition with Satin Co and was using information gained as a member to take away some of Satin’s business?
The Constitution of the company and the replaceable rules applying to such a company are considered as a contract that exists between the company and its members as well as a contract present between the company and its directors and the company secretary. At the same time, the Constitution of the company can also be considered as a contract existing between a member of the company and all other members. According to this contract, each person agreed to abide by as well as perform in accordance with the Constitution of the company and the replaceable rules that apply in such a case. As a result, from the very beginning, a shareholder agreement is present between all the shareholders related with the matters that have been mentioned in the Constitution of the company and also regarding the replaceable rules applying to the company. In this way, any modification or displacement results in a contractual variation and as a result, the shareholders can sue for any breach of contract by the company or by other shareholders. The shareholder agreement can be resorted to in order to do several things. However the most common things are the maintenance of status quo (balance of power), maintaining the particular structure, dealing with succession issues, providing compulsory acquisition of shares in some cases and trying to clarify the role of management as compared to the shareholders. Generally, it has been seen that almost at all levels of authority, the rule which prevails is the role of majority therefore, the main purpose of shareholder agreement is to prevent any excesses that may be committed by the majority.
Shareholder agreements have been accepted by the courts as being facilitators of small groups of investors in helping to avoid the consequences of the general principle of the majority rule. The meaning of the term, controlling majority is that the majority members, who generally comprise the majority shareholders or the persons having the ability to control the company by voting rights. As a result, these members are known as the controlling members. However, it is the duty of the controlling members to consider the interests of the minority members of the company as well. For example, the Court has stated in Allen v Gold Reefs of West Africa Ltd.that the power to alter company's Constitution can be exercised by the majority members in the general meeting only for the benefit of the whole company and also by considering the interests of the minority shareholders also. On the other hand, the court adopted somewhat different approach Gambotto v W.C.P. Ltd.when it was stated by the court that the Constitution of the company can be altered by the members who are in majority however it is required that these alterations it should not be oppressive nature or should not go beyond the contemplative purpose of powers that have been defined in the company's Constitution. Another significant example that can be used to explain the basic concept of the rights of the minority shareholders is the case titled Cook v Deek. This case explains the remedies that are available to the minority shareholders if the directors of the company have breached their fiduciary duties and if the directors have diverted a corporate opportunity towards themselves or their associates.
Meaning of controlling majority and their duty towards minority members
There is a common law duty of the controlling members towards the minority members and that was established by the court in Allen v Gold Reefs of West Africa (1900). As a result, while passing resolutions in the general meetings, certain fiduciary duties are owed by the majority members towards the minority members. In this regard, it is required that the majority members should exercise their powers bona fide and for the benefit of the whole of the company which includes all the members of the company. On the other hand if the personal rights of the members of the company are infringed, such members can take action under the common law as well as under the Constitution of the company and the replaceable rules that apply to the company. At the same time, such members can also take action under the Corporations Act, 2001 (Cth) and any separate contract that may be present between the members and the company. When an attempt is made to ask an ordinary resolution in the general meeting, where it is required by the Constitution of the company or by the Corporations Act that the passing of a special resolution may result in a procedural irregularity and therefore, it can be considered as invalid if it has caused substantial injustice.
On the basis of the above mentioned discussion, it can be set in the present case that an attempt is being made by the majority to amend the Constitution of the company by inserting a new clause that provides a power to the member who controls 80% or more shares of the company to acquire compulsorily all the other shares of the company. In this way, if Silk and other minority members of the company can establish that the action taken by Cotton Limited is not bona fide and it amounts to oppressive conduct, Silk and other minority members of the company can take action under the Corporations Act as well as under the common law. These members can succeed in the action if they are able to establish that the action taken by the majority is oppressive for them.
Polyester is a director of Style Pty. Limited involved in making women’s clothing. Has she breached any duties under the Corporation Act in the following situations?
Situation 1. She arranges with the company’s bank to transfer an amount of $65,000 from the company account into a personal bank account held by her in her own name. She uses the funds to finalise some outstanding personal debts.
Situation 2. As a director she receives information that the company is in a serious financial position. She arranges to transfer a larger amount of the assets of the company over a new proprietary company that she formed with the intention of caring on the same business.
Situation 3. Contrary to a resolution of the Board and notwithstanding established business practice that limits credit to $20,000 she allows a trade debtor (who has a history of bad debts) to exceed its credit limits by $25,000. The debtor fails to pay the outstanding amount of $45,000. Can she rely on the business judgment rule in this situation?
Legal remedies available to minority shareholders
Situation A: it appears in the present case that several fiduciary duties have been breached by Polyester. These duties included the duty to avoid conflict of interest, duty not to make secret profit and the duty of the director of the company not to seek personal benefits. At the same time, it can also be said that Polyester has acted for an improper purpose because she was motivated by the desire to derive personal benefit and at the same time, cause a detriment to the company. In this regard, the law provides that the directors of companies should not use the property of the company for their personal gain. Whenever the property of the company is used by a director for personal use without the permission of the company, the fiduciary duty of the director is breached. It needs to be noted at this point that for the purpose of this rule, the trade secrets as well as the intellectual property of the company are included in the term property. At the same time, the directors of the companies have also been restrained from making secret profits. In this regard sections 181, 182 and 183 of the Corporations Act prescribed statutory provisions that are equivalent to the fiduciary duties of the directors to act in good faith, for a proper purpose and in the best interests of the company and at the same time to avoid conflict of interest and make no secret profits.
Situation B: all the directors of companies are required to act in good faith and in the interests of the company. Similarly, the directors should take for proper purpose and at the same time avoid any conflicts of interest. Similarly, the directors should use discretion while performing the business of the company. Like the partners, trustees and agents, the directors of the company also owe fiduciary duties towards the person who can be easily harmed and is vulnerable.In the same way, it is also the fiduciary duty of the directors of companies not to make a secret profit and act for proper purpose. On the other hand, in the present situation, this city has been violated by Polyester when a large number of assets of the company were transferred by her when the company was facing financial difficulties. She transferred these assets to a new proprietary company that was owned by Polyester and as a result, it can be said that she had breached her duties as the director of the company.
Situation C: The duty to act with care and diligence while performing companies business has also been imposed on the directors. The basic test that can be used in such a case was provided by the court in City Equitable Fire Insurance Co Ltd. Therefore, the court stated in this case that the directors of the company are required to exercise the degree of skill and diligence that amounts to reasonable care that can be expected from any ordinary person under same circumstances if the business was owned by such a person. However in this regard, it needs to be noted that the test provided in this case was only a subjective test added to relied on the individual knowledge, skill and experience of the directors. As a result, an objective test was introduced by the Corporations Act, 2001. In the same way, the more the duty of care and diligence of the directors of the companies has undergone a change made the change that took place in the expectations of corporate responsibility. For example, in the present case, Polyester had acted against the resolution of the board as well as contrary to the established business practice when she allowed the debtor to exceed the credit limit by $25,000.
At the same time, Polyester cannot rely on the business judgment rule as provided by the Corporations Act, 2001 in section 180(2) as a defense that is available to the officers of the company if they are complying with their duties mentioned in section 180(1) in case the below mentioned conditions are satisfied. Therefore, it is required that the business judgment should have been made in good faith and for proper purpose. It is also require that the officer should not have any material personal interest in it. Similarly the officer is also required to inform himself or herself regarding the subject matter as well as it is also required that they should rationally believe that their judgment is in the best interests of the company. Due to the reason that these conditions were not satisfied in the present case, Polyester cannot rely on the business judgment rule.
Cassidy J, (2000) ‘Divergence of Duty of Care in United States and Australia’ 28 Australian Business Law Review 180
Goldman D, (2005) ‘Directors Beware! Creditor protection from insolvent trading’ 23 Company and Securities Law Journal 216
Kirby J, (2004) ‘The History and Development of the Conflict and Profit Rules in Corporate Law — A Review’ 22 Company and Securities Law Journal 259
Sivehla J, (2006) ‘Directors’ Fiduciary Duties’ 27 Australian Bar Review 192
Allen v Gold Reefs of West Africa Ltd (1900) 1 Ch 656
City Equitable Fire Insurance Co Ltd  Ch 407
Cook v Deek (1916) AC 554
Gambotto v WCP Ltd (1995) 13 ACLC 342
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