Legal Solutions To A Contract Dispute And Breach Of Director's Duties Essay.

Issue: Contract Entered Into Prior Incorporation

Whether the contract between Bob and Computer Supply Pty Ltd. prior to the incorporation of Sunshine Scooter Art Pty. Ltd.  (“SSA”) was binding on SSA?

The principle well-settled in Australian and English law is that there cannot be valid ratification of a contract that has been made prior to incorporation in the name of agents or promoter.

It is not possible under equity for an unregistered company to be a party to a contract and neither can it ratify such a contract post its incorporation (Kelner v Baxter, [1866]). It was prior to the commercial contracts becoming prevalent that the rules with respect to ratification was established. One of the primary rules is that a contract cannot be ratified by a principle, unless at the time when the contract was being entered into the principal was in the position of entering into such a contract on its own behalf (Kelner v Baxter, [1866]). This means in case of a corporation a ratification is not a possibility unless at the date of the contract which is sought to be ratified the corporation was in existence.

The Corporations Act, 2001 section 124 provides that the company has the same legal capacity as that of an individual including the power of entering into an agreement and section 125 provides effectively that the act’s performance, including forming an agreement that is not within the power of the company under its constitution will not be invalid.  

A contract however, made by the company’s promoter on the behalf of the company but before the formation of the company cannot be enforced under company. However, under section 131(1) if the pre-registration contract is ratified within a period of time that is agreed and if there is no agreed period of time then within a reasonable period of time. Under section 131(2) however, if such a contract is not formed or ratified by the company then individual who was responsible for the formation of the contract on the behalf of the company may also be liable for the same.

In the given situation the contract was formed between  Bob and Computer Supply Pty Ltd. prior to the incorporation of  SSA (10th of August) on 4th of August, under equity such a contract cannot be enforced on the corporation further it cannot be ratified after the incorporation. Though under the Corporation Act 2001 ratification of the same is possible post incorporation however, since no such attempt was made for ensuring that the contract is ratified between SSA and Computer Supply Pty. Ltd. such a contract will not be binding on SSA and it is only with Bob that it would be considered to be binding.

Prior Incorporation: Contract

Position of Jana and Adrian is strong.

Whether the contract between Plastica Pty Ltd. entered in his capacity as the Director of SSA binding on SSA?

Where a director of a company enters into a contract on behalf of the company it is considered to be an act of the company. Section 126 of the Corporations Act, 2001 states that a person who is acting under implied or express authority of the company for contracting on behalf of or in the name of the company will be in the same manner as if the contract was being made by a natural person.

Doctrine of actual authority is in reference to the people, who by the virtue of their appointment in a said corporation have implied or express to act for or as the company.  When determining whether there is an actual authority with someone consideration has to be made of the position held by them in the company, whether any express actual authority has been granted to them, how the conduct of the company has been. In the case of Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd. the court opined (Diplock LJ) in this case that there was between the agent and the principal an actual authority based on the consensual agreement to when they were parties to alone. Thus if there is a contract that is entered pursuant to an actual authority contractual liabilities and rights are created between the parties (Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd., [1964]).

The second principle applicable is that of indoor management rule meaning thereby that a person who dealing in good faith with a company should be able to assume that it is within the powers and constitution that that the act is being done and is not bound to make inquiry with respect to the valid execution of the indoor management. Section 128 and section 129 are the indoor management rule’s statutory equivalent. It was in the case of  Royal British Bank v Turquand that this rule was recognized wherein it was opined by Jervis CJ that the parties which deal with the companies were bound to read the settlement deed and the statute however, were not bound to do anything more. People who are dealing with a company have requirements of its articles of association and memorandum a constructive notice but the irregularities with the indoor management does not affect them. (Royal British Bank v Turquand, [1856]).

Section 128 of the Act states that there is an entitlement to make assumptions so as to prevent a company from escaping its liability on the argument that there were certain formalities that had not been complied with. The only defence under this section is that such assumption cannot be made if at the time of assumption the party was aware of suspected that the assumption is not correct. It was opined in the case of Sofyer v Earlmaze Pty Ltd that it will be on the party who is seeking to disentitle the reliance on whom the proof will lie (Sofyer v Earlmaze Pty Ltd, [2005]). Assumption under section 128 as per section 129 can be made with respect to internal management rule and apparent/ostensible authority.

Validity of Contract between SSA and Computer Supply Pty. Ltd.

In the given scenario there is an actual authority that Bob had of entering into the contract as the Director of the company which was incorporated on 10th of August prior to entering into the contract with Plastica Pty Ltd. An assumption can be made by Plastica that the contract is entered into by the SSA since Bob as the director has actual authority for entering into the contract. Further under indoor management rule Plastica is not required to know the internal workings of the company, there is also no way that Plastica could have know that there existed a cap for entering into the contract as Bob was the director of the Company. SSA will be estopped from denying liability.

The position of Jane and Adrian is not very strong.

Whether there has been breach of director’s duties?

It was stated by Powell J in the case of Russell Kinsella Pty Ltd (in liq) v Kinsella that it is the duty of the director to refrain from exercising any of his powers in a manner so as to obtain either for themselves or for a third party a private advantage, or in order to achieve an object that is other than the power which has been vested in the director (Russell Kinsella Pty Ltd (in liq) v Kinsella, [1983]). It is the duty of the director under section 181 of the Corporations Act, 2001 (“Act”) to act in good faith and in the company’s best interest and for purposes that are proper (Black, 2017). This duty overlaps with the duty of director under equity to act for purposes that are proper, in good faith and in the interest of the company (Redmond and Brennan, 2013).

Under section 182 of the Act to not misuse the position that the director has in the company and this section in equity reflects the fiduciary relationship of the director. A traditional status based fiduciary relationship exists between the director and the corporation (Hospital Products Ltd v United States Surgical Corp, [1984]). In the case of Westpac Banking Corporation v The Bell Group Ltd (in liq) (No 3) it was opined that the directors are required to act in good faith and in the interest of the company for the purposes that are proper (Westpac Banking Corporation v The Bell Group Ltd (in liq) (No 3), [2012]). It was opined in the case of  Coope v LCM Litigation Fund Pty Ltd that (Coope v LCM Litigation Fund Pty Ltd, [2016]):

Position of Jana and Adrian

“ A conflict arises if there is a real and sensible possibility that the personal interests of the fiduciary divide the loyalty of the fiduciary with the result that he or she could not properly discharge their duties to the beneficiary. …”

A contravention of director’s statutory duty under section 181 and section 182 of the Act involves a concurrent breach of the duties director under equity. There is a range of criminal and civil liabilities under the act on the director of the company (Dietrich and Middleton, 2006). The civil liability arise with the breach of section 181 and section 182 in the given situation. It can either give rise to civil liability by ASIC or the company.

It is required under section 588G(3) that it is the duty of the director to ensure that insolvent trading is avoided, it is required under this section that a debt must be incurred, the individual is director of the company at the time the debt is incurred and the company insolvent or becomes insolvent due to the debt (Redmond and Brennan, 2013). The person at the time when the debt occurred was aware that the company was insolvent or would become insolvent.

The reasonably ground for suspecting that there is insolvency section 588G(1)(c), it was opined in the case of Queensland Bacon Pty Ltd v Rees (1966) “Suspicion that something exists is more than a mere idle wondering whether it exists or not” (Queensland Bacon Pty Ltd v Rees, [1966]). It is not essential under section 588G(2) that the director is aware of the insolvency of the company but there should be reasonable grounds for suspecting such insolvency.

The breach of this abovementioned section is a provision of civil penalty and the Australian Securities and Investment Commission (ASIC) one the declaration is made seek a penalty that is pecuniary. An order under section 1317E of the Act can be brought issuing declaration for order for pecuniary penalty or for disqualifying the person who managing the corporation (Harris, 2008).

An action can be brought in the given scenario under breach of director’s duty under section 181 and section 182 and the corresponding law  of equity. The directors were required to act in good faith and in benefit of the company with no conflict of interest, however, an assumption can be made from the facts that there was a conflict of interest in giving the Stores giving guarantee for the debts of Holdings and Manufacturers, and that the decision was not taken in the best interest of the company. Further the directors allowed insolvent trading of the company as the overdraft facilities exceeded their limits, it would have reasonable to assume that any reasonable director in the place would have been aware that exceeding of overdraft in financial constraints may lead to insolvency or that the company is already insolvent. An order for pecuniary damages or disqualification of the directors can be brought against the company.

A strong case can be brought by Karen in the given situation.

References

Black, J. (2017). Some parallel duties and remedies in equity and corporations law ; Paper delivered to the New South Wales Bar Association Sydney CPD Conference. [online] www,supremecourt.justice.nsw. Available at: https://www.supremecourt.justice.nsw.gov.au/Documents/Publications/Speeches/2017%20Speeches/Black_20170325.pdf [Accessed 17 Sep. 2017].

Clark, J. (2013). Australian Contract Law. [online] Australiancontractlaw.com. Available at: https://www.australiancontractlaw.com/law/formation-capacity.html [Accessed 17 Sep. 2017].

Coope v LCM Litigation Fund Pty Ltd [2016]NSWCA 37; 333 ALR 524.

Corporations Act.

Dietrich, J. and Middleton, T. (2006). Statutory remedies and equitable remedies. Australian Bar Review, Lexis Nexis.

Duncan v Independent Commission Against Corruption [2016]NSWCA 143.

Freeman and Lockyer v Buckhurst Park Properties (Mangal) Ltd. [1964]2 QB 480.

Harris, J. (2008). Relief from Liability for Company Directors: Recent Developments and Their Implications. University of Western Sydney Law Review, 12(1), p.152.

Hayne, K. (2014). Directors' Duties and a Company's Creditors. Melbourne University Law Review, 38(2), p.795.

Hospital Products Ltd v United States Surgical Corp [1984]HCA 64.

Kelner v Baxter [1866]LR 2 CP 174.

Queensland Bacon Pty Ltd v Rees [1966]HCA 21.

Redmond, P. and Brennan, F. (2013). Corporations and financial markets law. 6th ed. Law Book Corporation.

Royal British Bank v Turquand [1856]6 E&B 327.

Russell Kinsella Pty Ltd (in liq) v Kinsella [1983]4 ACLC 215.

Sofyer v Earlmaze Pty Ltd [2005]ANZ Conv R 130.

Westpac Banking Corporation v The Bell Group Ltd (in liq) (No 3) [2012]WASCA 157.