Steve Jones is an entrepreneur with a variety of business interests. He learned of a gold deposit in Western Australia. Because he was anxious to exploit the opportunity, he flew to Perth on 6 July and entered into a contract to buy a drilling machine from Thor Mining Machinery Ltd, to be used to drill a test shaft. The contract specified that the drill would be delivered, and payment of the $ 125 000 price would fall due, on 30 July. He signed the contract as follows:
WA Gold Exploration Ltd was registered as a company by ASIC on 10 July, with Steve as 60% shareholder. He and the other shareholders met on 11 July, to elect a board of five directors. Steve himself was not elected to the board, because although he had originally discovered the opportunity, he had no experience in mining operations, and so did not want to be involved in day to day running of the company.
On 14 July, the board signed a contract to purchase a fleet of five ore trucks from Volvo Trucks (Australia) Ltd, costing a total of $ 500 000, to be delivered on 30 September. The board also established a sub-committee to determine the company’s technical needs, and on 25 July the board accepted the committee’s recommendation that the company buy a drill from United Mining Machinery Ltd for $ 100 000. The board also contacted Thor Mining Machinery Ltd and told it that it would not be taking delivery of the drill or paying for it.
Unfortunately, in mid-September it became clear that the gold deposit was not as large as hoped, and the board ceased trading on the basis that the company had only $ 400 000 in assets and had accumulated $ 2 million in liabilities. The company is therefore unable to pay for the trucks. Steve, who has personal assets of $ 1 million, has now been sued for breach of contract by both Thor Mining Machinery Ltd and Volvo Trucks (Australia) Ltd. Assume you are his legal advisor. Prepare advice for him citing full legal authority, as to what his legal position is.Question 2
Simon, George, Sara and Mary were all employed by different IT companies. However, they felt that they could do better if they went into business themselves. They pooled their available cash and drew up a partnership agreement, which stated that each partner had authority to enter into transactions on behalf of their firm, which they called Computer Solutions. The firm operates in Sydney and provides a service of storing data for customers. The agreement states that partners have authority to enter into contracts of up to $ 10 000, but that any contract for more than that must be approved unanimously by all partners.
George, Sara and Mary approach you for legal advice in relation to two transactions entered into by Simon, who had acted without referring back to the partners. One was for a 50GB hard-drive, bought by Simon on behalf of Computer Solutions, from Sunstar Computer Hardware Ltd, costing $ 15 000. The other was for a second-hand ute, costing $ 9 000, which Simon ordered for the firm from You Beaut Ute Ltd, on the basis that the partnership should branch into the freight business – an idea that the other partners had previously rejected. Sara had refused to accept delivery of both the hard drive and the ute and the partnership has been sued by both Sunstar Computer Hardware Ltd and You Beaut Ute Ltd. Give them legal advice, referring to statutory and case-law authority.
Whether Steve can be held personally liable to pay off the debts of WA Gold Exploration Ltd? Whether directors can be held liable for failing to identify the potential of gold exploration opportunity?
A corporation has a separate legal personality based on which its shareholders and directors cannot be held personally liable to pay off its debts. The companies in Australia are governed by the Corporations Act 2001 (Cth) which provides provisions regarding its incorporation and management. Due to its separate entity, the company can enter into a contract with third parties under its own name. It can also sue other parties and get sued by them in case of breach of contractual terms. Salomon v Salomon & Co Ltd (1897) AC 22 is a relevant case regarding the elements of a company. In this case, the company was operated by Salomon and his family, and Salomon was holding a major shareholding in the corporation as well. Later the corporation becomes insolvent, and its capital was used in paying off the debts of debenture holders, however, the unsecured creditors did not get anything. Salomon was a debenture holder in the corporation as well, and he received his share at the time of liquidation of the company. The unsecured creditors filed a suit against him by stating that the issuing of debentures was a sham as it was invalid. Based on which, the unsecured creditors argued that Salomon should be held personally liable to pay off their debts. The court rejected the arguments of unsecured creditors by providing that debentures were not a sham since it was properly documented.
Furthermore, the court provided that Salomon and the company have a separate legal entity and it did not have any effect that he holds the majority of shares in the company. Another good example was given in the case of Lee v Lee’s Air Farming Ltd (1961) AC 12 in which the court provided a similar judgement. In this case, a crop spraying company was incorporated by Lee. The court held that a shareholder could enter into a contract with the company in which he/she holds shares. Section 119 provides that a corporation comes it existence from the day it is registered, however, it can be held liable for contracts formed by promoters while acting on behalf of the company. Section 131 (1) provides that the corporation can terminate pre-incorporation contracts if it is specified within a reasonable time. Section 131(2) provides that the promoter can be held liable for breach of contract if the company did not comply with the terms of pre-incorporation contract which was formed by the promoter. The corporate veil protects actions of directors based on which they cannot be held liable for the decision taken by them. However, the court can lift the corporate veil to hold the directors liable for their actions. In Walker v Wimborne (1976) 137 CLR 1 case, the court provided that directors owe a fiduciary duty towards the company. Based on this duty, they have to ensure that they focus on achieving fulfilling the interest of the company rather than taking business decisions for personal benefits.
In this case, Steve Jones entered into a contract with Thor Mining Machinery Ltd on behalf of WA Gold Exploration Ltd. The contract was formed on 6th July, and the company comes into existence on 10th July. However, the company is bound by the terms of this contract as given under section 131 (1). The corporation has the right to terminate this contract within a given time and decided to dismiss this contract on 25th July. Since the delivery date was 30th July, the company can end this contract without paying any fee to Thor Mining Machinery Ltd. Moreover, directors failed to take appropriate care while taking business decisions, however, they did not breach their fiduciary duty since they did not take the decision for personal benefits or causing harm to the company, thus, they are not liable towards the creditors (Walker v Wimborne). Furthermore, the Australian corporate law gives importance to the contractual liability of pre-incorporation contract based on which Steve can be held personally liable by Thor Mining Machinery Ltd because he entered into a contract on behalf of the company which was rejected by the company as given under section 131(2).
In conclusion, Steve can be held personally liable to pay off the debts of WA Gold Exploration Ltd because he formed the contract for the company which was rejected, thus, Thor Mining Machinery Ltd can hold him personally liable under section 131(2). Directors did not act outside their authority, and they did not breach their fiduciary duty, thus, they cannot be held liable as well. The company can cancel its contract with Thor Mining Machinery Ltd based on section 131 (1), and it has to repay the debts of other organisations.
Whether the partnership is bound by the contract formed by Simon who acted without consulting with other partners? Whether other partners have any remedy again Simon?
Partnership is formed based on an agreement between two or more parties who decided to run a business together. The Partnership Act 1892 (NSW) provides provisions which govern the operations of the partnership. Partners have unlimited liability in the partnership, and they are jointly and severally liable for the debts of the business. The business did not have a separate legal entity based on which partners are liable to repay its debts. Section 1 provides that certain elements must be fulfilled to form a partnership which includes the relationship between parties, carrying on the business in common and the objective of the business is to generate profit. A relationship between partners must be formed in order to carry out the operations of the business as given in Smith v Anderson (1880) 15 Ch D 247 case. Sharing of profit is a key element of partnership, however, only sharing the profits did not constitute a partnership between parties as given under section 2 (2). In Cox v Coulson (1916) 2 KB 177 case, the court provided that a partnership exists between partners even if the business suffered from loss.
Partners can terminate the partnership business at their will, and it did not have perpetual succession based on which it can be terminated after the death of any of the partners. The profits and losses of the business are shared by the partners between themselves equally unless specified otherwise in their partnership agreement as given under section 24 (1). Furthermore, section 24 (5) presumed that all partners are involved in the decision-making process in the partnership unless an agreement has formed between parties regarding contrary. Furthermore, section 24 provides that partners take business decisions of the partnership based on majority of votes. Partners have fiduciary duty towards each other since they act as the agent for the business, and they can bind other partners into legal liabilities based on their actions. Section 29 restricts partners from making secret profits in the business as given in the case of Britchnell v Equity Trustee, Executors & Agency Co Ltd (1929) 42 CLR 384.
Furthermore, section 5 (1) of the act provide that each partner has implied authority based on which they can act as the agent on behalf of the enterprise. However, this provision applies only when the partner is acting within the ordinary course of business; here the principle of ostensible authority applies. Actions are taken outside the course of business only binds other partners if they are taken based on special express authority on the partner. Section 12 provides that partners are jointly and severally liable and third party can hold them liable for their debts. In Polkinghorne v Holland & Whitington (1934) 51 CLR 143 case, the court provided that all partners are liable to the torts of a partner which is committed while acting during the ordinary course of business. Section 8 provides that the third party cannot hold the partnership liable for the action of a partner if he/she knew about an internal contract between partners which limits their authority as given in Mercantile Credit Ltd v Garrod (1962) 3 All ER 1103 case.
Simon acted outside his authority while purchasing 50GB hard-drive for the business. Although it was an ordinary course of business, however, based on the internal agreement between partners, they agreed not to invest more than $10,000 without consulting with other partners. However, Sunstar Computer Hardware Ltd did not know about the internal contract of partners based on which it can hold the partnership and other partners liable for the actions of Simon (Polkinghorne v Holland & Whitington). On the other hand, the decision of purchasing a second-hand Ute is outside the ordinary course of business. Simon decided to purchase the Ute without consulting with other partners. He also acted outside his authority since other partner rejected this idea before, thus, only Simon is liable towards You Beaut Ute Ltd. Furthermore, Simon breached his fiduciary duty and internal agreement with partners by purchasing 50GB hard-drive, thus, other partners can hold him liable and demand compensation from him.
In conclusion, the partnership is liable towards Sunstar Computer Hardware Ltd because the actions of Simon were within the ordinary course of business and the company did not know about the internal agreement between parties. Simon is solely liable towards You Beaut Ute Ltd since he acted outside his authority and ordinary course of business. Moreover, other partners have a remedy against Simon, and they can demand compensation because he breached his fiduciary duty and breached the terms of the internal agreement.
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