Discussing The Deadlock In The Company Due To Class Shares Dispute

Background of the case

Discuss About The Deadlock Because Resulting Class Of Shares.

A personal relationship (de facto married relationship) exists amid the respondent (Mrs Wallington ) and the second appellant (Mr Nikola Kokotovich). The respondent used to work for the 2^nd respondent for more than 20 years. During this period the appellant also helped the 2^nd respondent in his form business, like, she wrote up books, prepare quotations and ether administrative works. She also supplied money to the business. However, dispute is incurred amid the two.

In 1972, the 2^nd respondent decided that he will incorporate a business and thus he formed two companies, that is, Kokotovich Constructions Pty Limited (1^st Appellant) and N. K. Plant Hire Pty Limited.

It was contended by the 2^nd appellant that when the company was formed then the same was always intended to be in his control and direction. On 13 May 1992, the 1^st appellant held an extra general meeting and a notification is send to the respondent wherein it was established that the company is willing to remove the respondent from the posts of director plus company secretary.

On 10^th December 1992, the 2^nd appellant intends to issue 9,795 one dollar shares in the 1^st company.

On 21 December 1992, summons is filed by the respondent in Equity Division of the Supreme Court of New South Wales wherein she desires that the 1^st appellant company must be wound up and sought that:

1. the allotment made on 10^th December 1992 must be construed as invalid;
2. to validate the allotment of shares made on 30^th October 1972 under section 194 of the act;

• That the 1^st appellant company must be round up.

The main issue that was raised was whether the appellant company should be wound up?

When the first shareholders meeting was conducted, then, both the plaintiff and the defendant has passed a resolution wherein deeming of 5 shares to be allotted as per section 54 of the companies Act 1961. But the deeming process only takes place when there has been a subscription for the shares in question. The court held that the allotment of class A shares falls within the provisions of the section as the shares were subscribed. But the other three shares were not allotted following a subscription and thus do not fall within the provisions of the section. The court submitted that when the shares are to be allotted then it is necessary that apart from subscription, there must be an application by the shareholders and a director’s resolution to allot the shares is needed. But, this procedure is not followed. Thus, section 54 of the act was violated.

Contentions in the court

It is found that the 2^nd appellant has violated is fiduciary duty by issuing shares which has hampered the voting rights and powers of the respondent and the acts are considered to be oppressive in nature.

Young J ordered the winding up of the 1^st appellant company and an official liquidator must be appointed who carry out the winding up process. However he stayed the order and gave opportunities to the parties to resolve the conflict by negotiations.

Supreme court of New south Wales

The plea was rejected with costs.

Young J analyzed that there were four issues that were involved. That is:

1. To analyze the person who is holding the shares in the first defendant company?

It was contended by the plaintiff that there was a moral partnership that existed amid her and the defendant. That is, though the plaintiff is not contributing anything in business but her contribution in the operation and the formation is significant and thus she is entitled to be having stake in the company. Her moral claims were recognized by the defendant and thus shares are issued in her name. Whereas the defendant submitted that the shares were allotted to her in order to comply with the legal formalities.

Young J submitted that the evidence laid down by the plaintiff to support her arguments are more reliable than the evidence that are aid by the defendant. Thus, the plaintiff does have beneficial interest not because she contributed financially but the emotional relationship she shares with the 2^nd respondent and the time she spent in the company.

1. Should any order be made rectifying the initial allotments?

The plaintiff has asked that the invalidated issue of shares in 1972 must be validated as per section 194 of the Act. However, the defendant submitted that of the shares allotment is validated then it will be unfair and not equitable for him. However, the  court rejected the argument of the defendant and submitted that the court is empowered to validate any order if it thinks just and equitable. The court submitted that section 194 must be applied when because of some technical fault a bona fide transaction is flawed and quoted Millheim v Barewa Oil and Mining NL [1971].

The judge submitted that a validation order must be made in order to clear the flaw that kept on lingering for 20 years. The court validated the C and B class of shares.

Young J reviewed the Articles of Association of the company and relied on the decision of Whitehouse & Anor v Carlton Hotel Pty Ltd and submitted that there was no technical defect that can be assumed on the part of the defendant while catering his power as governing director. He further submitted that the main reason of the allotment of December 1992 was nit to raise money but to make sure that no proprietary right must be acquired if any by the plaintiff become redundant. Thus the allotment was set aside by the court.

1. Can the company be dissolved?

Issues raised

Various statutory basis was analyzed prior deciding whether the company must be wound up.

1. Section 260 of the law – Section 260 of the law lays down provisions under which the company can be wound up on the grounds of oppression. section 260 submits that no winding up order must be made if such an order results in causing unfairly prejudice to the oppressed member or members. However, in the given case, the action is in itself brought by the oppressed member thus the qualification is not required.
2. Section 461- winding up on the ground of just and equitability. The appellant submitted that the management cannot be oppressive as the same was carried out by the appellant himself. But the argument was rejected. Young J submitted that a winding up order was a good way to resolve the conflicts that exists.

The appeal lies at the Supreme Court and is heard by Priestley JA; Kirby ACJ and Handley JA.

The issues were resolved by the court:

1. To analyze the person who is holding the shares in the first defendant company?

Whether the Respondent have acquired any kind of beneficial interest in the company is dependent upon the intention of the 2nd appellant, the person who has paid the purchase price (Calverly v Green (1984) and Muschinski v Dodds (1986) . The intention of the 2^nd appellant can be gathered from his acts /declaration made  before or immediately after the shares are acquired.

The appellant contended that considering the legal principal above, there was nothing that shows that the appellant is having any intention to have any beneficial interest to the respondent even considering the de facto relationship they are sharing. The appellant contended that there is a resulting trust as the shares that are hold by the respondent were mainly in the name of the appellant.

But, the court reaffirmed the finding of the primary Judge and contended that Young J was right in holding that the respondent is having beneficial interest which is supported by the intention of both the parties. That the evidences that are laid down by the respondent is supported by witnesses (Mr Bullivant). Thus, the presumption of a resulting trust in favor of the 2^nd appellant is negated on account that the respondent has a beneficial interest in the company. The court also submitted that no constrictive trust should be established in favor of the appellant merely on the ground of fairness. 

1. Should any order be made rectifying the initial allotments?

If the court does not intend to validate the initial allotments, then, the only valid shares that exists are the A class shares. But, if the same is done then there will a deadlock in the company as no shareholder can exercise power one over another.

The court confirmed the validation order made by the Young J mainly because:

1. The court rejected the argument of the appellant, that is, the case does not fall within the provisions of section 194 of the Law as there was no purported allotment. He contended that the acts of the parties on 30^th October 1972 wherein 5 shares were deemed to have been allotted cannot be considered as allotment or issue of shares, rather, the resolution was only a declaration. However, the court rejected these contentions and submitted that section 194 has the applicability. The court submitted that the parties intend to form a company with a share structure and which is considered to be a purported allotment of shares.
2. The court rejected the argument of the appellant that the young J has not exercised his discretionary powers appropriately. He contended that the discretionary power should only be used when the validating order of the shares is non contentious considering public policy ground in consideration (Re Swan Brewery (No 2)(1977-1978). Also the shares of the respondent were forgotten shares with no dividends, no voting rights and no transferability, no funds were taken for the acquisition of shares.

The contentions were rejected and it was held that the respondent and substantial and real interest in the company. The shares that are granted to her were against her involvement in the setting up and continuation of the company (Swiss Screens (Australia) Pty Ltd & Anor v Burgess & Ors (1987) 5 ACLC 1,076.

1. Whether the December 1992 allotment is valid?

The appellant submits that the 1992 shares are allotted validly. He submitted that the governing director (the 2^nd appellant) does not own any kind of fiduciary duty as per the MOU and AOA of the company. Also, the allotment was not made for any kind of improper purpose. Also, if the allotment was considered to be the violation of the fiduciary duty then the same can be rectifies under the general meeting of the company.

Resolution of the deadlock

However the courts have established that the directors are obligated to comply with their fiduciary duty in every scenario. The director must comply with their powers in the manner in which the same are delegated to them and with proper purpose.

However, if the fiduciary duty needs to be modified then a specific provision must be made part of MOU or AOA of the company.

But considering the present case no modification in the fiduciary duty of the 2^nd appellant is made in MOU or AOA of the company. Rather, the fiduciary duty upon the 2nd appellant is not comply with by him as the main reason for the issue of shares was to dilute the shareholding power of the respondent and the value of her interest and the same must be considered as the dominant purpose. Also, the issue of shares cannot be rectified in the general meeting as it results in deadlock because resulting only in A class of shares.

1. Can the company be dissolved?

The court ordered that the company must be wound up. Though it is a strong step but in order to curb oppression and the animosity that exist amid the parties it is necessary that the company must be wound up.

After analyzing the decision that is laid down in the present case, it is submitted that the courts are found to be willing to wound up the company if the acts of the directors of the company are such that they consider their own interest over the interest of the other members of the company. The directors are held to be in fiduciary duty that they must comply with all the time unless and until the duty is modified with the help of the AOA or the MOU.

Conclusion

Thus, the decision under Kokotovich Constructions Pty Ltd v Wallington is a landmark decision. It gives a strong impression that the duties of the company director must be comply with in each and every scenario. No excuse can be made and the directors of the company cannot shed away with their duties both under common and statutory law. If any company director does not wish to comply with their duties, then, the courts are not reluctant and are willing to dissolve the company.

References

Calverly v Green (1984) 155 CLR 242 at 246, 258;

 Muschinski v Dodds (1986) 160 CLR 583 at 589-590

Millheim v Barewa Oil and Mining NL [1971] WAR 65

Kokotovich Constructions Pty Ltd v Wallington (1995) 13 ACLC 1113 (NSW Court of Appeal);

Re Swan Brewery (No 2) (1977-1978) CLC ¶40-450;

Swiss Screens (Australia) Pty Ltd & Anor v Burgess & Ors (1987) 5 ACLC 1,076

Whitehouse & Anor v Carlton Hotel Pty Ltd (1987) 5 ACLC 421;