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Corporations Law: Satin Co.Ltd And Cotton Ltd

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Questions:

Question 1:
 
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?
 
Question 2:

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?

 

 

Answer:

1. In the present case, while 89.5% of the shares in Satin Co. Ltd. are being controlled by Cotton Ltd and the rest of the shares of the company are held by Silk and some other small investors. Now the board of Satin Co wants to make the company a wholly-owned subsidiary of Cotton. The purpose behind this move is expected tax benefits and also a saving in administration charges and accounting fee worth $230,000. An offer was made by Cotton Ltd to purchase the shares of the minority shareholders however they refused the offered. As a result, the majority decided to pass a resolution and change the constitution of the company with a view to insert a new clause number 53 according to which any member who has more than 80% shares of the company will have the power to compulsorily acquired the rest of the shares. The question that needs to be decided in this case is if the conduct amounts to oppressive conduct and what are the remedies that are available to Silk and other minority shareholders of Satin Co Ltd.;

The Corporations Act, 2001 (Cth) provides a number of rights to the shareholders. In this regard, a distinction has also been made between majority and the minority shareholders of the company. The reason is that some extra rights and remedies have been provided to the minority shareholders because it is considered that the position of the minority shareholders in the company is vulnerable. Among the remedies provided to the minority shareholders, there are the remedies of minority oppression, injunction, winding up order and statutory derivative action. Section 232, Corporations Act, 2001 provides a remedy for minority oppression. However, the shareholders also have certain personal rights, apart from these remedies that can also be pursued by them. On the other hand, the purpose of the remedy for minority oppression is to provide the minority shareholders of the company with an enforceable remedy against any prejudicial conduct to the interest of these shareholders. Oppressive conduct, in context of shareholder remedies can be described as the conduct that is prejudicial or unfair towards the minority shareholders.  A number of remedies have been provided to the minority shareholders in case these shareholders are facing oppressive conduct by the majority. It needs to be noted in this regard that the oppressive conduct includes any modification made in the Constitution of the company by the majority. Similarly, other examples of oppressive conduct can be the purchasing of the shares of the members, injunction, appointment of manager or receiver, regulating the affairs of the company and a winding up order.

In the present case also, the board of Satin has decided to amend the Constitution of the company and introduce a clause according to which, any person who has 80% or more shares of the company will have the power to compulsorily acquire the shares of other minority shareholders.

In view of the above discussion, it can be said that the above-mentioned statutory remedies can be used by the minority shareholders in case the rights of these shareholders are being infringed. The purpose of providing the statutory remedies to the minority shareholders is to overcome the problems that were related with common law. In case of the oppression remedy, relief can be sought by the minority shareholders of the company against the persons controlling the company. In this way, the directors of the company and the majority shareholders as well as the company itself can also be included in such persons against whom the minority shareholders can seek a remedy in case of oppression. This remedy can be used by the minority shareholders for any issue related with the way the affairs of the company are being conducted and also regarding any proposed or real act or omission or in case of a resolution or proposed a resolution that has been made by the majority shareholders of the company and when such conduct can be considered as oppressive or is prejudicial to the minority shareholders or discriminates against them.

As a result of the above said discussion, it can be said that Silk and other minorities shareholders of Satin Co Ltd can be prejudicially affected by the conduct of the majority in Satin Co with the introduction of a new clause in the Constitution of the company which gives the power to the party holding the majority shares to compulsorily acquire the shares of other members. The reason is that in such a case, the minority shareholders of Satin Co., including Silk can claim to be facing oppressive conduct. As a result the remedy for minority oppression that has been provided by the Corporations Act can be availed by these shareholders including Silk and as a result, it can be said that in this case Silk may be successful in action against the majority shareholders of Satin Co. however if it is found that Silk is operating a business that is in direct competition with Satin Co and Silk had been using the information that she received as a member of Satin Co to take away some business of Satin, the remedy may not be available to Silk.

 

2. A number of duties have been imposed on the directors. These duties have been imposed by the common law and also by the Corporations Act, 2001. The duties imposed by the common law includes the duty of care and diligence, to a bona fide, the duty not to act for improper purpose, duty to retain discretion, duty to avoid conflicts of interest and duty of the directors not to abuse corporate opportunities. At the same time, there are certain statutory duties of the directors that have been prescribed by the Corporations Act. These duties include the duty of good faith, duty of care and diligence including the business judgment rule, duty not to trade while insolvent, not to make improper use of information, not to make improper use of the position of the directors and certain other duties related with financial reporting. These duties need to be applied to the below mentioned situations in order to decide if the duties prescribed by the corporations act have been breached in this case or not.

Situation 1

the Act provides that the directors should not use their position for an improper purpose. In this regard, improper purpose can include receiving an advantage by the director or defeating the voting power of the shareholders of the company by creating new majority. In this regard, an objective test needs to be applied in order to decide if the director has used his or her power for an improper purpose or not. For example, in case money has been borrowed, the substantiality of the alleged need to borrow money can be considered. Similarly if the power of the director has been used for an improper purpose, the company can declare such an action as being void. Section 181 of the Act prescribes the duty of good faith that needs to be followed by the directors.[11] In the present case, it can be said that as a director of Style Pty Ltd., Polyester has breached her duty as the director of the company when she arranged a transfer of $65,000 from the account of the company to a personal account and used this money for dealing with some personal debt.

Situation 2

The Act also prescribes the duty of the directors according to which they should not make improper use of their position. Therefore, the position of the director should not be used improperly with a view to gain advantage or to cause a detriment to the company. Therefore a director can be considered as liable for the breach of this duty that has been prescribed by s182 of the Act in case the director of the company is involved in conduct with a view to obtain improper advantage.[12] In this regard, it is immaterial if such advantage has taken place in reality or not.[13] Therefore when the director knows the unstable financial condition of the company and continues to act in this way, it can be considered that the duty prescribed by s182 has been breached by the director. Therefore in the present case, it can be said that Polyester has breached her statutory duty to act in good faith and in the interests of the company.

Situation 3

The Corporations Act also imposes a duty on the directors and other officers of the company got into which they should exercise the powers and discharge the duties with care and diligence. This duty has been prescribed by section 180 of the Act. The care and diligence that the directors should exercise should be of the same level as would have been exercised by any other reasonable person. Therefore it is the duty of the directors to satisfy the duty of care and diligence that has been imposed by them on the statute while exercising a particular business judgment. However in order to avail the defense provided by the business judgment rule, it is required that the judgment should be exercised in good faith, director should not have any personal interest in its subject matter and at the same time, the director should inform himself or herself regarding the subject matter of such judgment to the extent that is considered appropriate and at the same time, it must be rationally believed by the director that the business judgment is in the best interests of the company. As the above mentioned the conditions do not appear to be fulfilled in the present case, Polyester cannot use the defense provided by the business judgment rule and she can be held liable for breach of her statutory duty.

 

References

Baxt, R., and Fletcher, K.L., Fridman, S., 2008. Corporations and Associations Cases and Materials on, Butterworths, Australia, 10th edition

Ciro T, Symes C, 2009. Corporations Law in Principle LBC Thomson Reuters, Sydney, 8th edition

Davenport, S and Parker D, 2012, Business and Law in Australia, Thomson Reuters

Fitzpatrick, Synes, Veljanovski, Parker, 2011. Business and Corporations Law; LexisNexis 1st edition

Hanrahan, P., Ramsay I., Stapledon G., 2010, Commercial Applications of Company Law, CCH 11th edition

Pentony, Graw, Lennard & Parker, 2011, Understanding Business Law 4th ed Butterworths.

Case Law

Allen v Gold Reefs of West Africa Ltd (1900) 1 Ch 656

Australian Trade Commission v WA Meat Exports Pty Ltd (1987) 11 ALD 52

AWA Ltd v Daniels (1992) 7 ACSR 759

Gambotto v WCP Ltd (1995) 13 ACLC 342

Granby Pty Ltd v FCT (1995) 129 ALR 503

R v Byrnes (1995) 130 ALR 529

Statewide Tobacco Services Ltd v Morley (1990) 2 ACSR 405

Wayde v Rugby League Ltd (1985) 3 ACLC 799

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