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Enforcing the Company Constitution

Discuss about the Hypothetical for Positive Life Assurance Co Ltd.

The first issue is whether Max can enforce the clause in the Company Constitution that makes him solicitor and the type of remedy that he would need to seek if he could. The second issue is whether Max can prevent the inclusion of the clause that allows the directors to expropriate his shares notwithstanding the fact that the directors have passed a special resolution.

Section 140 of the Corporations Act 2001[1] provides that the constitution of a company has the effect of forming a contract under seal between the company and each member; the company and its directors and company secretary; and between the members. The effect of the above law, contractually, is that it is limited to those situations above. In other words, no common law rights are conferred upon any other person apart from the ones mentioned in the Act above. The authoritative deciding of Eley v Positive Life Assurance Co Ltd[2] clearly illustrated this fact. In that case, Eley’s appointment under the Company Articles was as solicitor for life. Later, he became a member of the company and was removed from being the company solicitor. He sued the company for breach of contract and the Court held that the constitution of the company conferred upon him no other rights other than those of being a member and since those rights were not affected, there was no breach. This view was further asserted in the case of Hickman v Kent or Romney Marsh Sheep-breeders Association[3] where the court held that the articles have the effect of forming a contractual relationship between the members and the company.

Section 136 of the Corporations Act outlines the procedure for amending or repealing a company’s constitution and provides that the same can only be done by special resolution (s.136(2)). This was the position maintained by the English Court of Appeal in the authoritative pronunciation of Allen v Gold Reefs of West Africa Ltd.[4] It is important to note that under the Common Law, any alterations to the company constitution must be for the benefit of the company as a whole and must be bona fide. The Court authoritatively pronounced itself on this matter. In the case of Gambotto v WCP Ltd[5], the court held that in cases that involve an actual or effective expropriation of shares by the majority in order to compulsorily acquire the shares of the minority is oppressive conduct that necessarily lies beyond the scope of the contemplated aims of the power to amend articles. In ascertaining whether the alteration is valid, the courts will examine if the expropriation is valid or effective. The burden of proving a challenge to an alteration is on the person bringing the claim to show that the majority of the persons that voted for the change acted beyond their powers. The case of Brown v British Abrasive Wheel Co Ltd[6] was to the effect that the move by the majority shareholders to compulsorily acquire the minority shareholders was denied by the Court.

Preventing Expropriation of Shares

Section 136 of the Corporations Act allows shareholders to bring derivative actions against directors who are perceived to have breached their statutory duties. Section 236 to 242 provide for the procedure for bringing derivative actions.  

The appointment of Max as a company solicitor by the company constitution had the effect of creating a contractual relationship between him and the company by virtue of section 140 of the Corporations Act. That relationship is as between the company and Max as a member and not as solicitor. Although there was a special resolution by the directors, Max has a legal avenue through which he can challenge the decision to include a clause that expropriates his shares. This is by virtue of section 136 and the cases discussed in the foregoing. The onus is on Max to institute legal proceedings against the directors and to show that their actions were not within the objects of the powers to amend the articles.

Max’s ability to enforce his constitutional appointment as solicitor is limited to him as a member. Therefore, Max cannot enforce the clause in the constitution that makes him solicitor. Also, Max can prevent the inclusion of the clause allowing the directors to expropriate his shares.  

The issue is whether the directors have issued their equitable and/or statutory duties to AB and the remedies that apply.

The general rule is that the duties owed by directors are to the company as opposed to individual shareholders. This was the holding in the cases of Percival v Wright[7] and Allen v Gold Reefs of West Africa Ltd[8]. Section 181 of the Corporations Act 2001 imposes upon company directors the duty to act in good faith for the best interests of the company and in good faith. The courts have held that the obligation of acting in good faith and the duty of acting for a proper purpose are two separate duties in case of Bell Group Ltd (in liq) v Westpac Banking Corporation.[9] Santow, J., in the case of ASIC v Adler[10], stated that under section 181, a director is under a fiduciary obligation against promoting a personal gain where there is a possibility that they will conflict with the interests of the company. In assessing whether there is a reasonable and real risk that a conflict may possibly arise, the position of a reasonable person faced with similar circumstances is adopted.[11] However, a director is permitted to act on personal interest where he has not relieved himself of the personal interest provided that the personal interest was for the overall bona fide good of the company or for promotion of fairness.[12] Where a director is in a position of influence and power, merely disclosing the conflict between duty and interest and not voting is not enough to amount to fiduciary responsibility. Such a director must exercise such power to prevent that transaction.[13] Beyond disclosure, the action that a director is required to take is dependent on factors such as the degree of the director’s involvement in the transaction and the seriousness of the likely outcomes for the corporation.[14]

Directors' Duty to Act in Good Faith

The general rule with respect to good faith is that directors must act upon their mandate bona fide in that which they deem as being within the interests of the company.[15] The test of honesty is objective as opposed to subjective, which is insufficient.[16]

Acting in the best interests of a company denotes the corporators as an entire body and not a company as a distinct commercial entity separate from corporators as was the position in Greenhalgh v Arderne Cinemas Ltd.[17] The duty also requires that the creditors’ interests be considered. This was the position in the case of Spies v The Queen.[18] Although the company’s interests and those of its shareholders are usually similar, in circumstances where that is not the case, it seems that those of the shareholders come first. In the case of Darvall v North Sydney Brick & Tile Co Ltd[19], Hodgson, J affirmed the above position and further stated that directors may also act in the best interests of the company even though it is not within the short term interests of the members. The duty owed to shareholders as a group does not necessarily mean the same thing as that owed to individual shareholders as was seen in Percival v Wright. In some instances, however, the courts have held that specific shareholders are owed this duty. This was held, for instance, where the director of a family company withheld confidential information and stood to make profits out of the business deal as was the case in Coleman v Myers.[20]  Courts have further noted that directors may well be shareholders, either preference or ordinary, and it would be impractical to invalidate their actions just because of this fact Mills v Mills at page 164. The courts tested the standard of good faith in the case of Howard Smith Ltd v Ampol Petroleum Ltd[21], which involved a takeover. The Privy Council found the directors to be in breach of that duty since if they had acted in good faith, their decision would not be impeachable by the courts. Accordingly, a decision that is performed by directors in good faith and for relevant purposes is not open for review by the courts as was the case The Bell Group Ltd (in liq) at  paragraph 4426.[22]  

Directors’ duty to act for a proper purpose means that they must act within the purpose that was conferred to them. Directors, in the exercise of their powers, must not allow themselves to be found in a position where they are in a conflict or where their powers are restrained. In determining the purpose for which directors exercised a power, courts identify the directors’ substantial purpose that caused the directors to make a particular decision as was held in Bell IXL v Life Therapeutics Ltd.[23] Where shares are being allotted and it is found that the said allotment was made for a purpose that was impermissible. In such a circumstance, it is immaterial if rights are issued to a third party, the same will be voidable. The case of Howard Smith Ltd v Ampol Petroleum Ltd involved a company’s directors that issued shares for the purpose of assisting a takeover by blocking the majority shareholders that was in existence. The Privy Council held that the directors were in breach of their duty of good faith towards the company by purporting to destroy the existing majority shareholding to create a new one.

Remedies for Breach of Duty

Section 180 requires directors to exercise care and diligence. It creates the business judgement rule that requires directors to make decisions to take or not to undertake actions regarding matters relevant to the operations of the business of a company (s. 180 (3))

It is clear that AB was undergoing challenges especially since there had been a market shift and the competition was high. Also, there is an eminent takeover. It is clear that the move by the company directors was done for the company’s best interests and for the proper purpose. Some degree of reasonable care and diligence is also discernible.The directors are not in breach. 

Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch D 656

ASIC v Adler [2002] NSWSC 171

ASIC v Maxwell [2006] 59 ACSR 373

Bell Group Ltd (in liq) v Westpac Banking Corporation (no 9) [2008] WASC 239

Bell IXL v Life Therapeutics Ltd [2008] FCA 1457

Brown v British Abrasive Wheel Co Ltd [1919] 1 Ch D 290

Coleman v Myers [1977] 2 NZLR 255

Corporations Act 2001 (Cth), Australia

Darvall v North Sydney Brick & Tile Co Ltd (1988) 6 ACLC 154

Eley v Positive Life Assurance Co Ltd [1876] 1 Ex D 88

Fitzsimmons v R (1997) 23 ACSR 355

Gambotto v WCP Ltd (1995) 16 ACSR 1

Greenhalgh v Arderne Cinemas Ltd [1951] Ch 286

Hickman v Kent or Romney Marsh Sheep-breeders Association [1915] 1 Ch D 881

Howard Smith Ltd v Ampol Petroleum Ltd [1974] AC 821 

Mills v Mills (1938) 60 CLR 150

Percival v Wright [1902] 2 Ch 421

Permanent Building Society (In Liq) v McGee (1993) 11 ACSR 260

Permanent Building Society (in liq) v Wheeler (1994) 14 ACSR 109

Phipps v Boardman [1967] 2 AC 46

Re Smith and Fawcett [1942] 1 All ER 542

Spies v The Queen (2000) 201 CLR 603

The Bell Group Ltd (in liq) v Westpac Banking Corporation (No 9) [2008] WASC 239

[1] Corporations Act 2001 (Cth)

[2]  [1876] 1 Ex D 88

[3] [1915] 1 Ch D 881

[4] [1900] 1 Ch D 656

[5] (1995) 16 ACSR 1, at 8

[6] [1919] 1 Ch D 290

[7] [1902] 2 Ch 421

[8] [1900] 1 Ch D 656, at 104

[9] [2008] WASC 239, at 4456

[10] [2002] NSWSC 171, at 735

[11] Phipps v Boardman [1967] 2 AC 46, at 124

[12] Mills v Mills (1938) 60 CLR 150, at 164-165

[13] Permanent Building Society (In Liq) v McGee (1993) 11 ACSR 260, at 239

[14] Fitzsimmons v R (1997) 23 ACSR 355, at 258

[15] Re Smith and Fawcett [1942] 1 All ER 542

[16] Permanent Building Society (in liq) v Wheeler (1994) 14 ACSR 109, at 137

[17] [1951] Ch 286

[18] 201 CLR 603

[19] (1988) 6 ACLC 154

[20] [1977] 2 NZLR 255

[21] [1974] AC 821 

[22] The Bell Group Ltd (in liq) v Westpac Banking Corporation (No 9) [2008] WASC 239

[23] [2008] FCA 1457

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