Research Assignment Details; LAW
atgkd153
law00004_sgs22018.pdf
WARNING This material has been reproduced and communicated to you by or on behalf of Southern Cross University in accordance with section 113P of the Copyright Act 1968 (Act).
The material in this communication may be subject to copyright under the Act. Any further reproduction or communication of this material by you may be the subject of copyright protection under the Act.
Do not remove this notice.
Developed by Digital Resources
2018.2
2
Contents
Unit overview ............................................................................................................................................................................................... 6 About the writer................................................................................................................................................................................... 7 About the lecturer................................................................................................................................................................................ 8
Topic 1 Partnership .................................................................................................................................................................................... 9 1.1 Various business structures....................................................................................................................................................... 10 1.2 Partnership ................................................................................................................................................................................... 11 Partnership Acts................................................................................................................................................................................. 25
Topic 2 The Australian Constitution and corporate law and the administration of corporate law..................... 27 Changes to company law ................................................................................................................................................................. 27 2.1 Introduction ................................................................................................................................................................................. 27 2.2 The operation of the previous legislation............................................................................................................................... 28 2.3 The Australian Securities and Investments Commission (ASIC) .................................................................................... 31 2.4 Separate legal entity and limited liability ............................................................................................................................... 33 2.5 The difficulty of dealing with corporate groups: A statutory exception to the separate entity doctrine ................. 35 2.6 Corporate liability ....................................................................................................................................................................... 37
Topic 3 The creation of a company: Types of companies, promotion, formation and the company’s Constitution ................................................................................................................................................................................................ 38
3.1 Types of companies..................................................................................................................................................................... 38 3.2 Promotion and promoters......................................................................................................................................................... 42 3.3 Pre-registration contracts.......................................................................................................................................................... 43 3.4 Formation of companies............................................................................................................................................................ 44 3.5 Australian company number and company name............................................................................................................... 45 3.6 The company’s Constitution ...................................................................................................................................................... 46
Topic 4 The capacity of the company and its agents and the rights of its members .............................................. 51 4.1 Introduction ................................................................................................................................................................................. 51 4.2 Capacity of a company ............................................................................................................................................................... 51 4.3 Capacity of the agents of a company....................................................................................................................................... 54 4.4 The rights and remedies of members...................................................................................................................................... 56 4.5 The means of becoming a member of a company ............................................................................................................... 57 4.6 Members’ statutory rights ......................................................................................................................................................... 58 4.7 Remedies available to minority shareholders ....................................................................................................................... 60 Conclusion to Topic 4 ....................................................................................................................................................................... 66
3
Topic 5 Management ............................................................................................................................................................................. 67 5.1 The company secretary – appointment, role and responsibilities .................................................................................... 67 5.2 Definitions, appointment, removal and disqualification of directors ............................................................................. 68 5.3 Directors’ duties – duty of care, skill and diligence ............................................................................................................. 70 5.4 Directors’ general law duties – good faith and proper purpose and conflict of interest ............................................. 72 5.5 Directors’ statutory law duties – good faith and proper purpose and conflict of interest .......................................... 74 5.6 Executive officers: Role and responsibilities ......................................................................................................................... 75 5.7 Directors’ statutory obligations ................................................................................................................................................ 75 5.8 Directors’ statutory duties – insolvent trading ..................................................................................................................... 78 5.9 Civil penalties and compensation orders............................................................................................................................... 79 5.10 Criminal penalties .................................................................................................................................................................... 79 5.11 Ratification and exculpation of breaches of duty............................................................................................................... 79 Summary: Remedies for breach of duty ....................................................................................................................................... 80 5.12 The registered office.................................................................................................................................................................. 84 5.13 Meetings and proceedings ...................................................................................................................................................... 85 Conclusion to Topic 5 ....................................................................................................................................................................... 89
Topic 6 Financing the corporation .................................................................................................................................................. 91 6.1 Introduction ................................................................................................................................................................................. 91 6.2 Equity finance .............................................................................................................................................................................. 92 6.3 Debt finance of loan capital ...................................................................................................................................................... 99 6.4 Registration of security interests (formerly known as ‘charges’) .................................................................................... 102 6.5 Interests other than shares or debentures: Managed investment schemes................................................................... 104 6.6 Corporate fundraising in public companies ....................................................................................................................... 105 6.7 Current Australian policy on prospectuses ......................................................................................................................... 105 6.8 The capital maintenance doctrine ......................................................................................................................................... 114 6.9 Dividends .................................................................................................................................................................................... 116 6.10 Financial reports and audit ................................................................................................................................................... 117
Topic 7 Takeovers .................................................................................................................................................................................. 124 7.1 Introduction ............................................................................................................................................................................... 124 7.2 Takeovers .................................................................................................................................................................................... 124 7.3 Prohibition on acquisitions of more than 20 per cent ...................................................................................................... 126 7.4 Exceptions to section 606 ........................................................................................................................................................ 127 7.5 Off market bids .......................................................................................................................................................................... 128 7.6 On market bids .......................................................................................................................................................................... 128 7.7 Other relevant sections regarding takeovers....................................................................................................................... 128 7.8 Substantial shareholdings........................................................................................................................................................ 129 7.9 Share ownership tracing .......................................................................................................................................................... 130 7.10 Securities regulation............................................................................................................................................................... 131 Conclusion ........................................................................................................................................................................................ 131
LAW00004 Company Law
Contents | 4
Topic 8 Corporate insolvency .......................................................................................................................................................... 132 8.1 Introduction ............................................................................................................................................................................... 132 8.2 Corporate insolvency law reform .......................................................................................................................................... 133 8.3 The law on insolvency .............................................................................................................................................................. 134 8.4 Schemes of arrangement – Part 5.1 Corporations Act....................................................................................................... 134 8.5 Receivership and controllers – Part 5.2 Corporations Act................................................................................................ 137 8.6 Voluntary administration – Part 5.3A Corporations Act .................................................................................................. 140 8.7 Deed of company arrangement (DOCA) – Part 5.3A Corporations Act ...................................................................... 143 8.8 Liquidation – Winding up Part 5.4–6 Corporations Act................................................................................................... 145 8.9 Liquidators.................................................................................................................................................................................. 148 8.10 Recovery of assets ................................................................................................................................................................... 149 8.11 Proving and distributing the assets of the company ....................................................................................................... 151 8.12 Deregistration and reinstatement........................................................................................................................................ 151 Conclusion ........................................................................................................................................................................................ 154
LAW00004 Company Law
Contents | 5
Unit overview
Using this guide This Study Guide is designed, as the name suggests, to ‘guide’ you through the subject matter of the unit in a systematic and structured way, using features such as hierarchical headings, margin notes and bold font to highlight key concepts and terms.
We view the Study Guide as an active learning tool – that is, the learner is required to be active while studying and to interact with the learning material. Active learning is a key component for studying from a distance and an essential part of adult learning processes. For this reason, the Study Guide has been developed with adult learning principles in mind. This assumes that as an adult the learner wants to take control of his/her learning in a safe and secure environment and with the help of a learning facilitator – in this situation, the messages and directions in the Study Guide.
Aware that most external students study independently, the tasks and review activities in each topic provide the opportunity for you to monitor your learning progress. Generally, activities within the topic are designed to check your understanding of particular concepts while review activities at the end of topics are included to draw together related concepts and provide the opportunity to put theory into practice. All activities should be attempted as/when they appear. You are advised to attempt the activities independently before looking at the answers.
Throughout the Study Guide, you will be directed to specific activities – for example, when to read the textbook(s) or other supplied readings, when to attempt specific tasks and when to undertake self- assessment activities and/or review questions to check that learning is taking/has taken place. We use simple cues to represent the different things you need to do.
Read the material mentioned.
Prepare answers to questions posed or responses to statements made.
Note well: You need to attempt these activities before proceeding because they are designed to focus your thinking in a certain direction or allow you to check that learning has taken place. If you do not attempt them, you may find you have missed some fundamental point/concept/idea which we are using as a building block in subsequent teaching.
Here is a response to, or comment about, an activity you were set.
Reading
Activity
Feedback
6
Ponder the significance of something; assemble your thoughts about a specific statement or question.
Summary of important points/ideas/thoughts – usually appears at the end of a topic.
Learning objectives A list of learning objectives appears at the beginning of each topic. These are expressed in terms of anticipated outcomes. The objectives cover a wide range of aptitudes:
It is important to realise that recalling knowledge is a very small part of what is required in this course. Rote learning is not appropriate at this level of study. In this unit, you need to demonstrate higher-orders skills of analysis and application. The activities are included so that you incrementally acquire these important skills.
The content of each topic and the activities set should all relate to the objectives. You are advised to check your achievement against the objectives as you complete each topic.
About the writer For those who may not have met Jim Jackson, he says:
Do not let the weeks go by before you commence work, in my experience you will not catch up. This is a large unit and the workload is high. I believe the content is interesting, and especially relevant for modern society. I trust that you will enjoy this unit.
Reflect
Summary
knowledge: recalling information – for example, defining, naming, labelling; comprehension: interpreting information – for example classifying, describing, discussing, explaining, identifying;
application: applying knowledge – for example, applying, illustrating, interpreting, solving; analysing: breaking down knowledge into parts and showing the relationship among the parts – for example, analysing, calculating, comparing, contrasting, criticising, differentiating, examining;
synthesis: bringing together parts of knowledge to form a whole and building relationships for new situations – for example, constructing, creating, designing, preparing; and
evaluation: making judgments on the basis of certain criteria – for example, appraising, arguing, attacking, defending, evaluating, predicting.
I have completed much of my education as an external student, including all my primary school (at the Blackfriars Corrrespondence School run by the NSW Education Department) and my graduate Diploma in Education. I have experienced the best and worst in such courses and have particular empathy with external students.
I was the foundation Dean of the Southern Cross Law School and assumed that role in January 1993 on its establishment. My term finished in 1998, and I remained at the School of Law & Justice as a Professor of Law until 2010. I continue a connection with SCU as an Emeritus Professor.
My speciality in law is in the commercial and company law fields, with particular interests in trade practices, corporate management and insolvency law.
I have been teaching company law since 1976 and naturally have seen remarkable changes in the law in that time.
LAW00004 Company Law
Unit overview | 7
About the lecturer
Your unit assessor and lecturer is John Orr. John is the current unit assessor and lecturer in LAW00004 Company Law, LAW00527 Corporations Law and LAW00115 Equity & Trusts. John has close links with members of the accounting and legal professions engaged in corporate and insolvency practice. John’s major areas of teaching are in corporate law, equity, trusts and insolvency law.
John has taken a Bachelor of Human Movement Studies from the University of Queensland and a Bachelor of Laws with First Class Honours from SCU. John is a university medallist and was awarded an Australian Postgraduate Award to undertake research toward a PhD to examine the legal capacity of Australian universities.
John’s research interests are in higher education law, corporate and insolvency law and equity & trusts and include the fiduciary principle and unreasonable remuneration of corporate directors, the quality assurance and legal liability of Australia’s transnational education arrangements, the GATS and higher education, universities and liabilities for controlled entities, insolvency issues involving Australian universities, and corporate and commercial law liabilities and issues for universities, such as the ultra vires doctrine, shadow directors and the legal rights of Australian university members.
John Orr BHMS(UQ), LLB(Hon)(SCU)
LAW00004 Company Law
Unit overview | 8
Topic 1
Partnership
Objectives To successfully complete your study of this topic you will need to:
Important note on readings in this topic Note: The textbook is called the Corporations Law in Principle (Thomson Reuters). You should use the most recent edition. The current edition of this book is the 10th edition.
The chapters from Turner are:
Note that more detailed texts on partnership law are as follows:
Fletcher, K L, The Law of Partnership in Australia (LBC, 9th ed, 2007); and
Graw, S, An Outline of the Law of Partnership (LBC, 3rd ed, 2007)
Please note, you are not required to purchase a copy of Fletcher or Graw.
have an understanding of the law relating to partnership and the differences between partnerships, companies and sole traders;
be aware of the definition of partnership and be able to apply this to the resolution of factual issues; and
be able to describe and apply agency and partnership law in relation to: fiduciary duties between partners;
formalities for the creation of a partnership;
relationship of partners amongst themselves;
relationship of partners with third parties;
dissolution of partnership;
limited partnerships.
The 10th edition is referred to as the Textbook, 10th ed. The citation of this edition is Yogaratnam and Xynas, Corporations Law in Principle (Thomson Reuters 10th ed, 2016).
The earlier edition (9th edition) is referred to as Ciro & Symes. The citation of the 9th edition is Ciro, T and Symes, C, Corporations Law in Principle (Thomson Reuters 9th ed, 2013).
The Textbook, 10th ed, covers partnership law in Chapter 2 but this area will also supported by some chapters from Turner C and Trone J, Australian Commercial Law, 30th ed, Thomson Reuters, 2014 (Turner).
Agency – Chapter 13 Agency from Turner C and Trone J, Australian Commercial Law, 30th ed, Thomson Reuters, 2014, (available in the Bb folder).
Partnership – Chapter 26 Partnership, from Turner C and Trone J, Australian Commercial Law, 30th ed, Thomson Reuters, 2014, (available in the Bb Other Resources folder).
9
1.1 Various business structures
Textbook 10th ed, pp 32–64
In deciding the appropriate structure for a business many factors need to be considered. These include:
Here are some of the possibilities.
Sole traders A ‘sole trader’ or ‘sole proprietorship’ is a type of business that is owned and operated by one individual (a natural person). It is the most popular type of business structure in Australia. The sole trader operator receives all the profits and suffers all the losses and reports earnings on his or her income tax. Sole traders have unlimited liability and creditors can attack the operator’s personal assets to meet any shortfall owed in business.
Textbook 10th ed, pp 34–35
You will have noted that sole traders carry all the risk: of insolvency, of death, of insufficient managerial expertise or money.
Trading trusts Many businesses are traded through trusts. A trust is a fiduciary relationship where one person (trustee) is required to hold or invest property for the benefit of another person (beneficiary). The basic structure of a trust includes a ‘settlor’ who creates the trust and transfers assets to the trustee; the trustee holds legal title of trust assets but deals with it as a fiduciary strictly in accordance with the terms of the trust agreement (trust deed). A trust is set up for the benefit of beneficiaries. The beneficiaries hold the equitable title and derive the benefit, profit or advantage of the trust. A trust is not a separate legal entity.
Textbook 10th ed, pp 46–47
Textbook
taxation and superannuation implications;
size and potential growth and capital requirements;
who will own and control the organisation;
its capital needs;
the costs of setting it up;
how easy it will be to change to another entity or organisational structure later as the business evolves, for example, from sole trader to company, or from small proprietary company to public company;
who will bear the risk and the liability in case of failure; and
professional ethics or legal restrictions on organisational structure.
Textbook
Textbook
LAW00004 Company Law
Topic 1 Partnership | 10
Incorporated associations Legislation now exists in the states allowing the incorporation of certain groups of people who formerly may have chosen to incorporate under the Corporations Act but more likely would have simply operated as unincorporated associations with all the attendant risks of personal liability. Such organisations typically include some small sporting bodies and community organisations.
In New South Wales this incorporation can be achieved simply and cheaply under the Associations Incorporation Act 2009 (NSW). Limited liability is the major advantage, the major disadvantage is that such organisations must be not for profit, and in New South Wales they must also carry insurance.
Textbook 10th ed, pp 53–64
Joint venture An unincorporated non-partnership joint venture is based on contractual arrangements that form a relationship between two or more persons with a view of profit that falls short of the definition of a partnership; see Canny Gabriel Castle Jackson Advertising Pty Ltd and Fourth Media Management Pty Ltd v Volume Sales (Finance) Pty Ltd (1974) 131 CLR 321.
Textbook 10th ed, p 50
Partnership: Topic 1 This area is considered below.
Corporations: Topics 2–8 This will form the balance of study in this unit.
1.2 Partnership Partnership law in NSW is found in the Partnership Act 1892 (NSW) and ‘like similar Acts elsewhere in Australia and New Zealand, follows the model of the Partnership Act 1890 (Eng) drafted by Lord Lindley, often called “Lord Lindley’s Act’”: Williams v Nicoski & Anor [2003] WASC 131.
‘The existence of a partnership is determined by reference to the true contract and intention of the parties as appearing from all of the facts and circumstances relevant to the relationship of the parties’ …; Amadio Pty Ltd v Henderson (1998) 81 FCR 149, 172 cited in Momentum Productions Pty Limited v Lewarne [2009] FCAFC 30 per Spender, Jessup & Middleton JJ.
What is at the heart of a partnership… is the requirement that the persons concerned carry on business, in common, with a view of profit.
Textbook
Textbook
LAW00004 Company Law
Topic 1 Partnership | 11
You are required to read the following chapters from Turner and Chapter 2 of the textbook. The purpose of the readings is to provide a solid foundation from which you will be able to develop an understanding partnership law. It will be a valuable exercise for you to take time and familiarise yourself with the structure and content of the Partnership Act 1892 (NSW).
You should review the general principles of agency law prior to reading the chapter on partnership.
Re Chapter 13 – Agency from Turner C and Trone J, Australian Commercial Law, 30th ed, Thomson Reuters, 2014, (available in Bb/Other Resources).
Chapter 26 Partnership, from Turner C and Trone J, Australian Commercial Law, 30th ed, Thomson Reuters, 2014, (available in Bb/Other Resources).
Textbook 10th ed, pp 35–46.
Note: The links to the Partnership Acts in AustLII www.austlii.edu.au/ are as follows:
Partnership Act 1892 (NSW) http://www3.austlii.edu.au/au/legis/nsw/consol_act/pa1892154/
Partnership Act 1963 (ACT) http://www5.austlii.edu.au/au/legis/act/consol_act/pa1963154/
Partnership Act (NT) http://www5.austlii.edu.au/au/legis/nt/consol_act/p84a135/
Partnership Act 1891 (Qld) http://www5.austlii.edu.au/au/legis/qld/consol_act/pa1891154/
Partnership Act 1891 (SA) http://www5.austlii.edu.au/au/legis/sa/consol_act/pa1891154/
Partnership Act 1891 (Tas) http://www5.austlii.edu.au/au/legis/tas/consol_act/pa1891154/
Partnership Act 1958 (Vict) http://www5.austlii.edu.au/au/legis/vic/consol_act/p84a1958135/
Partnership Act 1895 (WA) http://www5.austlii.edu.au/au/legis/wa/consol_act/p84a1895135/
1.2.1 Formalities for the creation of a partnership
Chapter 26 Partnership, from Turner C and Trone J, Australian Commercial Law, 30th ed, Thomson Reuters, 2014
Reading
Reading
Textbook
Textbook
LAW00004 Company Law
Topic 1 Partnership | 12
In this reading you should have discovered:
Prohibition on large partnerships: note that s 115 of the Corporations Act 2001 (Cth) (http://classic.austlii.edu.au/au/legis/cth/consol_act/ca2001172) prevents the use of partnerships with more than 20 members unless formed under an Australian law. The regulations may specify a higher number for a particular kind of partnership; s 115(2). Regulation 2A.1.01 (http://classic.austlii.edu.au/au/legis/cth/ consol_reg/cr2001281/s2a.1.01.html) (size of partnerships or associations) Corporations Regulations 2001 (Cth) (http://classic.austlii.edu.au/au/legis/cth/consol_reg/cr2001281) specifies the following:
Kind of partnership or association Number
Actuaries, medical practitioners, patent attorneys, sharebrokers, stockbrokers or trademark attorneys
50
Partnerships or associations of the kind specified in sub-regulation (2) That is a partnership that has as its primary purpose collaborative scientific research; and includes at least one university; and at least one private sector participant.
50
Architects, pharmaceutical chemists or veterinary surgeons 100
Legal practitioners 400
(a) Accountants 1000
Note, however, that professional ethical and/or Code legal requirements may prevent some professional groups using a company to carry on parts or all of their business.
There are no special requirements for the creation of a partnership, it is therefore possible to have a partnership resulting from a purely oral arrangement. Existence of a partnership may be inferred from a course of dealings between the parties.
The very limited application of requirements for writing contained in modern equivalents of the Statute of Frauds.
Usually the contract of partnership will be contained in a written document called the partnership agreement. Where there is no such agreement or if the terms of the agreement are unclear regard will be had to the provisions of the Partnership Act. It is suggested that a partnership agreement should be drawn up because:
the terms of the agreement will then be quite clear; and
under the Income Tax Assessment Act existence of a partnership may be easier to prove.
The effect of business names legislation in various states. This generally requires registration of any name used for the partnership other than the actual name of the partners.
LAW00004 Company Law
Topic 1 Partnership | 13
1.2.2 The test for partnership
Partnership Act (NSW) Sections 1 and 2
Note, for convenience, provisions for the Partnership Act (NSW) are referred to in this guide. For the equivalent provisions in other Australia jurisdictions please see the ‘Comparative Table of Partnership Acts’ on pp 80 & 81 of the Textbook); and
Reading 1.1 Case Extract: Duke Group Ltd (in liq) v Pilmer (1999) 31 ACSR 213 Note: It is important that you read this extract, especially 11.3–11.9 and 12.1–12.6.
In your reading you must note the following:
Reading
The very first issue when confronted with a set of facts is to determine whether the relationship under review is a partnership or not. This issue is vital because if a partnership is found this will mean that the partners may be liable for the actions of other partners. We will address this issue later.
Basically, the principles to be applied in determining whether or not a partnership exists are contractual:
No doubt the question is, what is the true intent and meaning of the contract between the parties, and what is the true legal effect of the real transaction between them, which must be gathered from the whole instrument and not from a few words in it which may have been inserted for some purpose or other. Every word ought to have its weight and ought to be well considered.
— Re Megevand; Ex Parte Delhasse [1877–78] 7 ChD 511 per James LJ
The definition in s 1 of the Partnership Act
Partnership is the relation which exists between persons carrying on a business in common with a view of profit.
Please note that in this unit we will not be examining the concept of an incorporated limited partnership.
The rules for determining existence of partnership which are contained in Section 2 of the Act. Read these carefully. In regard to sharing of net profits, it was once thought, prior to Cox v Hickman (1860) 8 HL Cas 268, that if the parties did share, this was conclusive as to the existence of partnership. Note now s 2 (rule III) of the Act. As the decision as to the existence of a partnership may ultimately be one for the courts it is imperative that people, who do not wish a possible implication of partnership to be drawn from dealings between themselves, take steps to avoid arrangements such as the buying and selling of goods on a joint account with an ultimate divisibility of net profits. On this point refer to Canny Gabriel Castle Jackson Advertising Pty Ltd v Volume Sales (Finance) Pty Ltd [1974] HCA 22; (1974) 131 CLR 321. In this case a single financing venture was found by the High Court to constitute a partnership in circumstances where the parties provided that the deed was not a partnership.
LAW00004 Company Law
Topic 1 Partnership | 14
The first element: ‘A business must be carried on’ Traditionally this first element involves a discussion of the so called ‘continuity’ test from Smith v Anderson (1880) 15 ChD 247 per Brett J:
But such a test seems to have been rejected by the High Court in United Dominions Corp Ltd v Brian Pty Ltd [1985] HCA 49; (1985) 157 CLR 1 and the Partnership Act itself provides for a partnership for a single undertaking in s 32(b).
Note the significance of United Dominions Corp Ltd v Brian Pty Ltd in relation to the definition of partnership:
The second element: ‘In common’ In my view this is the most important issue in the test for partnership. It relates to the fact that partners are agents for each other and is the rationale for a partner’s liability for debts.
Miscellaneous aspects re existence of partnership: 321. Express disclaimer of partnership: if the test in s 1 of the Act is met a clause negating partnership in the agreement will not prevent the relationship being a partnership at law, though such a clause will be some evidence of the parties’ intentions. The overall rule to be applied in determining the existence of a partnership is that regard must be had to the true intention of the parties as appearing from all the facts of the particular case. If the real effect of the agreement is to create a partnership the parties cannot escape the consequences of that relationship by an express declaration that they are not to be regarded as partners, nor be liable as such.
322. Note that a finding of partnership is not the only way liability for debts can be created. Liability can exist under:
Under s 14 of the Act liability may arise by ‘holding out’ even if the relationship between the parties is not one of partnership.
agency lawa. partnership by estoppel = partnership by holding out, see s 14.b.
The three elements in s 1 of the Partnership Act which are now considered in more detail:
The expression carrying on implies a repetition of acts and excludes the case of an association formed for doing one particular act which is never to be repeated. That series of acts is to be a series of acts which constitutes a business.
it is now clear that a partnership can exist for a single venture; terminology such as ‘Joint Venture’ will not prevent a relationship which meets the partnership test from becoming a partnership; see Canny Gabriel Castle Jackson Advertising Pty Ltd v Volume Sales (Finance) Pty Ltd [1974] HCA 22;
but is there now a new form of business operation in Australia that is: the ‘joint venture’? This had been the finding in the case when it was in the New South Wales Court of Appeal, however, the High Court simply relied on partnership law in reaching its findings.
LAW00004 Company Law
Topic 1 Partnership | 15
Note the quotes that follow:
This existence of mutuality does not mean that partners have to share equally in management or profits.
The third element: ‘With a view of profit’ Profit is closely related to the ‘carrying on of a business’ and is thus useful to exclude those organisations operating without a profit motive: for example charitable bodies, some clubs or sporting organisations.
These are relatively easy to distinguish but more difficult issues arise in relation to agreements which arrange for the sharing of product. For example many mining and oil production ventures are based on contracts providing that:
These relationships are known by various names including joint production agreements, joint operating agreements, joint ventures or any other name the parties chose to give them.
One important legal issue in such relationships is whether ‘profit’ in s 1 means ‘gain’ or ‘accounting profit’? This issue has not been authoritatively determined, however in United Dominions Corporation Pty Ltd v Brian Ltd [1985] HCA 49 at [7] Dawson J said:
This judge is suggesting that such relationships are not partnerships, but his comments are obiter.
If liability arises in such ventures through agency law a resolution of the partnership issue becomes less important. It is contended that very often agency will be found to exist in these agreements, even though one of the venturers might be an undisclosed agent.
Cox v Hickman (1860) 11 ER 431 where Lord Wensleydale noted:
The law as to partnership is undoubtedly a branch of the law of principal and agent; and it would tend to simplify and make more easy of solution, the questions which arise on this subject, if this true principle were more constantly kept in view… A man who allows another to carry on trade, whether in his own name or not, to buy and sell and to pay over all the profits to him, is undoubtedly the principal, and the person so employed the agent, and the principal is liable for the agent’s contracts in the course of his employment. So if two or more agree that they should carry on a trade, and share the profits of it, each is a principal, and each is an agent for the other, and each is bound by the other’s contract in carrying on the trade, as much as a single principal would be by the act of an agent, who was to give the whole of the profits to his employer. Hence it becomes a test of the liability of one for the contract of another, that he is to receive the whole or a part of the profits arising from that contract by virtue of the agreement made at the time of the employment. I believe this is the true principle of partnership liability. Perhaps the maxim that he who partakes the advantages ought to bear the loss, often stated in the earlier cases on this subject, is only the consequence not the cause, why a man is made liable as a partner.
In Birtchnell v Equity Trustees Executors & Agency Co Ltd [1929] HCA 24; (1929) 42 CLR 384, Justice Dixon of the Australian High Court commented in relation to partners:
The relation is based, in some degree, upon a mutual confidence that the partners will engage in some particular kind of activity or transaction for the joint advantage only. In some degree it arises from the very fact that they are associated for such a common end, and are agents for one another in its accomplishment.
the relationships are not partnerships, and
product, for example, the ore or the oil is to be split in some predetermined share.
Perhaps in this country, the important distinction between a partnership and a joint venture is, for practical purposes, the distinction between an association of persons who engage in a common undertaking for profit and an association of those who do so in order to generate a product to be shared among the participants. Enterprises of the latter kind are common enough in the exploration for and exploitation of mineral resources and the feature which is most likely to distinguish them from partnerships is the sharing of product rather than profit. It is, however, unnecessary to pursue that matter here.
LAW00004 Company Law
Topic 1 Partnership | 16
1.2.3 Fiduciary duties between partners
Chapter 26 Partnership, from Turner C and Trone J, Australian Commercial Law, 30th ed, Thomson Reuters, 2014; and
Partnership Act ss 28, 29 and 30
Also note s 24 and ss 32–35 in this context. We will cover this latter group of sections later.
We will also deal with the concept of fiduciary duties in Topic 5 in relation to directors’ obligations as fiduciaries. The principles are the same, only the context is different.
A fiduciary is ‘someone who has undertaken to act for or on behalf of another in a particular matter in circumstances which give rise to a relationship of trust and confidence. The distinguishing obligation of a fiduciary is the obligation of loyalty. The principal is entitled to the single-minded loyalty of his [or her] fiduciary. The core liability has several facets. A fiduciary must act in good faith… must not make a profit out of his [or her] trust; … must not place him[or her]self in a position where his [or her] duty and his [or her] interest may conflict; … must not act for his [or her] benefit or for the benefit of a third person without the informed consent of his [or her] principal. This is not intended to be an exhaustive list, but it is sufficient to
Activity 1.1
Barry carries on business as a window dresser. He employs Bruce to assist him. After some years Barry finds that Bruce is such a good friend and an excellent employee that he, with Bruce’s full approval, promises to pay Bruce in addition to his salary, a 1/2 share of all future profits made. In the event of insolvency of the business would Bruce be liable to contribute? Would your answer differ if:
instead of being a window dresser, Bruce had acted as agent for Barry in obtaining new contracts? or
a.
if Barry, at the time he promised to pay a 1/2 share of future profits, had ceased paying Bruce a salary?
b.
1.
B and C owned a block of flats as tenants in common. The letting of the flats was handled by H Estate Agency who paid all outgoings in connection with the flats, including maintenance costs, and forwarded the net proceeds to B and C monthly. B and C shared these receipts equally. Unbeknown to C, B arranged with D to supply and lay new carpet in two of the flats. D has been unable to obtain payment from B and seeks your advice on taking action against B and C jointly. Advise D.
2.
Is it essential to the existence of partnership that all partners participate to some extent in profits? Is the following a partnership? A, B and C have an agreement which, for tax reasons, provides that profits are to be shared so that A gets 60%, B gets 40% and C nothing.
3.
If three people establish a factory to make widgets and decide that rather than selling the widgets jointly they would each be entitled to 5000 widgets per year would this be a partnership? Assume the parties share equally the costs of production of widgets.
4.
What is the difference, if any, between a joint venture and a partnership?5.
Reading
LAW00004 Company Law
Topic 1 Partnership | 17
indicate the nature of fiduciary obligations’; Bristol and West Building Society v Mothew [1998] Ch 1 per Millett LJ at 18A; see also Hospital Products Ltd v United States Surgical Corporation [1984] HCA 64 per Mason J at [68] to [70], [84] and [86].
In your reading you should have noted:
1.2.4 Operation of partnerships
Relationship of partners amongst themselves
Chapter 26 Partnership, from Turner C and Trone J, Australian Commercial Law, 30th ed, Thomson Reuters, 2014; and
Partnership Act ss 5, 19, 20, 21, 22, 23, 24, 25
Note especially:
The strength of the fiduciary relationship in partnership, once the subject matter of the partnership relationship is determined. As we have seen this element itself is critical to the establishment of partnership, it being difficult to conceive of a situation where a fiduciary relationship was absent yet the court could find partnership. In Birtchnell v Equity Trustees Executors & Agency Co Ltd [1929] HCA 24; (1929) 42 CLR 384 Justice Dixon commented on the nature of the fiduciary relationship:
The relation between partners is, of course, fiduciary. Indeed, it has been said that a ‘stronger case of fiduciary relationship’ cannot be conceived ‘than that which exists between partners. Their mutual confidence is the life blood of the concern. It is because they trust one another that they are partners in the first instance; it is because they continue to trust one another that the business goes on’ per Bacon VC, Helmore v Smith (No 1) (1886–7) 35 Ch D 436 at 444.
The relation is based, in some degree, upon a mutual confidence that the partners will engage in some particular kind of activity or transaction for the joint advantage only. In some degree it arises from the very fact that they are associated for such a common end, and are agents for one another in its accomplishment. Lord Blackburn found in this consideration alone sufficient reason for the fiduciary character of the partnership relation: Cassels v Stewart (1881) 6 AC 64 at 79.
The fiduciary duty includes these propositions: a partner must not withhold business opportunities from firm (within its scope); and
a partner must avoid conflicts or possible conflicts of interest.
Partnership Act ss 28, 29, 30 set out some fundamental principles re accounts, accountability for profits, and competition. Section 30 imposes a duty not to compete. Note that the restriction is in relation to business of the same nature as that of the firm. Section 30 does not change the common law or statutory rules relating to restraint of trade.
Reading
The operation of s 19 of the Act which allows variation of the terms of a partnership agreement by mutual consent. The section seems to provide that variation does not have to be in the same form as the original agreement.
LAW00004 Company Law
Topic 1 Partnership | 18
1.2.5 Relationship of partners with third parties
Chapter 26 Partnership, from Turner C and Trone J, Australian Commercial Law, 30th ed, Thomson Reuters, 2014; and
Partnership Act ss 5–18
In your reading these issues are of particular importance:
A major source of possible argument between partners may arise in relation to partnership property (both real and personal). Though disputes as to ownership can be avoided by clear agreement on formation, or at the time of introduction or use of the property in the business, such agreement will often be lacking. The Act deals with partnership property in ss 20, 21 and 22. The High Court decision in Harvey v Harvey [1970] HCA 11; (1970) 120 CLR 529 highlights the problems that can arise in this area. In Harvey an argument arose as to which partners obtained the benefit of improvements to land owned by one of the partners. On the facts the High Court held that the improvements belonged to the partner who owned the land. Note also Canny Gabriel (discussed above) in relation to the concept of equitable interests in partnership property. See also Kelly v Kelly (1990) 92 ALR 74.
Section. 20(1) of the Partnership Act (NSW) defines partnership property. All disputes relating to property will be overcome by a carefully drawn up partnership agreement which provides for various circumstances.
The very important rules contained in s 24 of the Act governing the interests of partners in the partnership property and their rights and duties in relation to the partnership. Note that these rules are expressly stated to be subject to any agreement expressed or implied between the partners.
Section 31: This section should be contrasted to s 24(1)(7). Thus while a new partner cannot be introduced unless the consent of all other partners is obtained (this is subject to agreement to the contrary), it is possible for a partner to assign his share under s 31. But note the restricted rights obtained by the assignee of such a share. If the consent of the other partners was obtained the assignee could be admitted as a partner, either at the time of the assignment or at some later state.
The various issues canvassed in the above notes and references relating to partners rights and duties inter se stem basically from the theory that partnership law is simply an extension of agency law.
The effect of s 5 (considered in detail below): Some of the duties of partners to each other are akin to the duty of a trustee to his beneficiary. Hence partners have a duty to take care of partnership property and to keep proper accounts. Partners, like trustees are not entitled to profit from their position to the detriment of the other partners.
Reading
The liability of partners to third parties is based on agency law. Section 5 of the Act codifies these common law agency principles in a partnership context. Note also s 9.
LAW00004 Company Law
Topic 1 Partnership | 19
The following chart may provide assistance in interpreting s 5 of the Act.
Consider the following quote from Baird’s Case: (1870) L.R. 5 Ch App 725 which puts the liability of partners to outsiders in context:
Ordinary partnerships are essentially, in kind, and not merely in the magnitude of the partnership or in the number of the partners, different from joint stock companies. Ordinary partnerships are by the law assumed and presumed to be based on the mutual trust and confidence of each partner in the skill, knowledge and integrity of every other partner. As between the partners and the outside world, (whatever may be their private arrangements between themselves), each partner is the unlimited agent of every other in every matter connected with the partnership business, and not being in its nature beyond the scope of the partnership. A partner who may not have a farthing of capital left may take money or assets of the partnership to the value of millions, may bind the partnership by contracts of any amount, may give the partnership acceptances for any amount, and may even involve his innocent partners in unlimited amounts for frauds which he has craftily concealed from them.
Liability under ss 5 and 9 will depend on a number of factors: The transaction must be within the scope of the business carried on by the partnership. This will always be a question of fact to be decided by the court. Note the decisions on this issue in Polkinghorne v Holland (1934) 8 ALJ 140 and in National Commercial Banking Corp. of Australia v Batty (1986) 160 CLR 251. You may also consider Mann v Darcy [1968] 2 All ER 172.
In Bank of Australasia v Breillat (1847) 6 Moo 152: 13 ER 642 Lord Brougham stated:
In non-trading partnerships, the courts have not been prepared to interpret the implied powers so widely.
… if the partnership is of a general commercial nature he (a partner) may pledge or sell the partnership property, he may buy goods on account of the partnership, he may borrow money, contract debts, and pay debts on account of the partnership, he may draw, make, sign, endorse, accept, transfer, negotiate and procure to be discounted promissory notes, bills of exchange, cheques and other negotiable paper in the name of and on account of the partnership.
1.
The transaction must be carried on in the usual way. See Goldberg v Jenkins (1889) 15 VLR 36
2.
If the partner who carried out the transaction has in fact no authority to act for the firm (eg by an express limitation in the partnership agreement) then the firm will still be liable provided that the third party:
Note carefully that an express limitation on a partner’s authority will not necessarily prevent the firm being liable if the partner in breach of the agreement exceeds the authority. It will however give the other partners rights against the partner acting in breach of his authority.
did not know of the limitation; ora. knew or believed that the partner involved in the transaction was a partner.b.
3.
Other sections relevant to liability to third parties include ss 6–18. Consider: the difference in liability between contract (s 9) and tort (s 10);1. the effect of s 14 of the Act; and2. section 7 dealing with the use of the firms credit for private purposes.3.
LAW00004 Company Law
Topic 1 Partnership | 20
Tests in s 5 of the Act
1.2.6 Dissolution of partnership
Chapter 26 Partnership, from Turner C and Trone J, Australian Commercial Law, 30th ed, Thomson Reuters, 2014; and
Partnership Act ss 32–44
You should have:
Reading
noted that a partnership may be dissolved by agreement between the partners or by a court. Where there is a partnership agreement the method by which the partnership may be dissolved is usually specified therein. Where there is no agreement between partners on dissolution the Partnership Act provides rules for dissolution: ss 32–35;
analysed the various grounds on which a court can order a dissolution. Some of these grounds correspond to provisions in the Corporations Act;
noted that s 35(f) provides for a discretion in the court to order a winding up when it is just and equitable to do so;
realised that were a partnership is to be dissolved, the business is carried on only so far as may be necessary for the purpose of winding up the partnership; and
considered the sections relating to the liability of a retiring partner who may continue to be liable for debts of the firm unless he/she takes action to protect himself/herself from liability: s 36, and see also s 14.
LAW00004 Company Law
Topic 1 Partnership | 21
1.2.7 Limited partnerships
Chapter 26 Partnership, from Turner C and Trone J, Australian Commercial Law, 30th ed, Thomson Reuters, 2014; and
Partnership Act ss 49–81
In your reading note those states which have limited partnership legislation and the nature of the liability imposed on general and limited partners, and the advantages and disadvantages of this form.
In April 2004 the NSW Partnership Act was amended to introduce a new form of partnership, the incorporated limited partnership, which unlike other partnerships is a separate legal entity: s 53; and has the powers of a body corporate: s 53A. A written partnership agreement is required: s 53B. Under s 53D incorporated limited partnerships may only be registered for venture capital activities. Accordingly this concept neatly crosses the boundaries between partnership law and corporations law.
A detailed study of incorporated limited partnerships is beyond the scope of this unit.
Reading
LAW00004 Company Law
Topic 1 Partnership | 22
Activity 1.2
A and B are partners in a newsagency business. C, a wholesale stationer, is friendly with A and offers her 5% commission on all purchases made by the partnership. C pays this commission to A by cheque, monthly, and A deposits it in her personal account. Sometime later B discovers the arrangement. Advise B.
1.
R and S contribute $40 000 and $60 000 respectively as capital to a business. They do not have a written partnership agreement. At the end of the first year they have a profit of $10 000 and S insists that his share of the profits should be $6000. Advise R.
2.
Husband (H) and wife (W), own and operate a cafe business. They have no written partnership agreement, and both work together in running the business for a number of years. They then have a violent argument and H refuses to allow W to enter the cafe premises. W employs X, an accountant, to investigate the accounts of the partnership, but H refuses to allow her access to the partnership books. W seeks your advice on her rights. Advise her.
3.
A, B and C are in partnership as produce merchants. In the course of her duties as a partner A has an opportunity of buying a quantity of grain at a cheap price. In order to finalise the transaction she pays with a cheque for $20 000 drawn on her personal account. When they learn of A’s purchase, B and C decide that the grain is unsuitable for the partnership business, and refuse to reimburse A. This they can enforce because all cheques drawn on the partnership bank account require the signatures of two partners. Advise A of her rights.
4.
What is ‘Partnership Property’ within s 20 of the Partnership Act (NSW)? Discuss the importance of distinguishing partnership property from other property of the partners.
5.
LAW00004 Company Law
Topic 1 Partnership | 23
Wilson, Bartley and Hickey are three members of Canonbury Leagues Club. Whilst attending the Club on 1 February, 2015, the three men decided to leave their present jobs and jointly attempt to earn a living by purchasing parcels of land, subdividing them and then reselling at a profit. Bartley has had experience in the buying and selling of land and it is agreed verbally between the three men that Bartley would be the manager of the business on their behalf, but that all three members of the business would have equal rights in decisions which concerned the business and would incur equal liability. The three men commenced business under the name of WB & H Company. No formal written agreement is ever entered into by the three men. Now answer, discussing relevant cases and principles of law, parts (a) and (b) below, each of which concerns a different set of circumstances arising from the above facts.
What rights, if any, do X Suppliers Pty Ltd, Y Finance Pty Ltd and Z Rent-a-Cars have with respect to the money still owing them? Include in your answer a discussion on whether these three business creditors have any claim against the personal assets of Wilson, Bartley and Hickey and if so illustrate in what manner.
On 1 January 2016 it becomes known to Wilson and Hickey that Bartley has used some of the working capital of the business to buy himself a boat solely for his own private use from Boating House Pty Ltd Bartley still personally owes Boating House Pty Ltd the sum of $20 000 for the boat. Boating House Pty Ltd has never had any dealings with WB & H Company and, in fact, does not even know of its existence. Discuss the nature of the relationship, if any, between the three men. What rights, if any, do Wilson and Hickey have against Bartley? What rights, if any, does Boating House Pty Ltd have against the business in respect of the $20 000 still owing on the boat? Include in your answer a discussion as to whether or not the business can be dissolved.
a.
It became apparent on 1 January 2016 that the business was operating at a loss because there had been a drastic decline in the economy. The total assets of the business on the 1 January, 2016, including profits made during its operation, amount to $400 000. The total debts of the business are as follows:
Wilson’s private assets total $150 000 and his private debts total $50 000.
Bartley’s private assets total $130 000 and his private debts total $30 000.
Hickey’s private assets total $200 000 and his private debts total $100 000.
to X Suppliers Pty Ltd the sum of $300 000i. to Y Finance Pty Ltd the sum of $200 000ii. to Z Rent-a-Cars the sum of $200 000.iii.
b.
6.
LAW00004 Company Law
Topic 1 Partnership | 24
Partnership Acts Below are links to States and Territories Partnership Acts
Partnership Act 1892 (NSW) http://www3.austlii.edu.au/au/legis/nsw/consol_act/pa1892154/
Partnership Act 1963 (ACT) http://www5.austlii.edu.au/au/legis/act/consol_act/pa1963154/
Partnership Act (NT) http://www5.austlii.edu.au/au/legis/nt/consol_act/p84a135/
Partnership Act 1891 (Qld) http://www5.austlii.edu.au/au/legis/qld/consol_act/pa1891154/
Partnership Act 1891 (SA) http://www5.austlii.edu.au/au/legis/sa/consol_act/pa1891154/
Partnership Act 1891 (Tas) http://www5.austlii.edu.au/au/legis/tas/consol_act/pa1891154/
Partnership Act 1958 (Vict) http://www5.austlii.edu.au/au/legis/vic/consol_act/p84a1958135/
Marge, Maree and Myrtle operate a trucking partnership. Marge, who has little idea of how to run a business, has performed the following acts without the knowledge of the other partners.
She has mortgaged two trucks, and a block of land owned by the firm, to secure a loan of $50 000. This money has been used by the firm.
a.
She has purchased on credit in the firm’s name: Christmas presents for Maree and Myrtlei. 2000 new tyres for the firm’s fleet of seven trucks.ii.
b.
She has employed four new drivers. It transpires however that two of these have never driven a truck before, and the other two suffer from regular blackouts.
c.
She has drawn several partnership cheques to pay for her groceries. To what extent are
Could Marge be expelled from all future participation in partnership management?
Maree and Myrtle liable, ori. Marge liable to Maree and Myrtle with respect to the above?ii.
d.
7.
Discuss the truth or falsity of the following statements: A partner may not assign his portion of the business.a. Partnership property is the equivalent of property used in a firm’s business.b. A provision in a partnership agreement providing that all management disputes are to be decided by majority vote is invalid.
c.
The relationship of partners inter se is one of uberrimae fidei.d. Partners may not expel any other partner.e. A partnership agreement which provided that a particular partner was to be liable for all the debts of the firm would be void ab initio.
f.
Retiring partners are liable for all debts of the firm incurred in the twelve month period following their retirement, but have no claim to profits made after their retirement.
g.
A court will automatically order dissolution of a partnership if a partner commits an act of bankruptcy.
h.
8.
Under what circumstances is unanimity in voting required in partnership decisions? See ss 19, 24(1)(7), 24(1)(8) and 25.
9.
LAW00004 Company Law
Topic 1 Partnership | 25
Partnership Act 1895 (WA) http://www5.austlii.edu.au/au/legis/wa/consol_act/p84a1895135/
LAW00004 Company Law
Topic 1 Partnership | 26
Topic 2
The Australian Constitution and corporate law and the administration of corporate law
Changes to company law Company law rarely stands still. For a list of amendments to the Corporations Act 2001 (Cth) go to the following URL at Australian Government Attorney-Generals Department, Comlaw:
http://www.comlaw.gov.au/Series/C2004A00818 (accessed 05 May 2017)
See also the list of corporate law reform at the following URL:
http://www.uclaw.com.au/law-reform/ (accessed 05 May 2017)
Note that discussion papers, reports and reviews are important secondary sources for your studies.
See also the list of recent changes to the Corporations Act 2001 (Cth) and recent reports and discussion papers in Textbook 10th ed – Preface & Table 1.1, pp 8–12.
Objectives To successfully complete your study of this topic you will need to:
2.1 Introduction
Textbook 10th ed Chapter 1, pp 2–8
have an understanding of the context of Australian corporations law and of the historical development of the company;
understand the decision in NSW v The Commonwealth [1990] HCA 2 and s 51(xx) of the Australian Constitution; see https://www.aph.gov.au/About_Parliament/Senate/Powers_practice_n_procedures/ Constitution and be aware of the implications of this case for the administration of corporate law;
be able to describe the present system of corporate law administration in Australia; and
have considered in detail the decision in Salomon v Salomon and its implications for the separate legal entity and limited liability doctrines.
Textbook
27
In this reading I want you to gain an understanding of what a company is, prior to our detailed study of the administration of company or corporate law in Australia. The terms company and corporation will be used interchangeably except where a distinction is drawn in these materials or in the Act.
Small Business Guide, Part 1.5 Corporations Act 2001 (Cth)
Students should read the small business guide, Part 1.5 Corporations Act 2001 (Cth). Part 1.5 provides a summary of the main rules in the Corporations Act 2001 that apply to small proprietary companies limited by shares. This type of company is the most common type used by small business. The guide gives a general overview of the Corporations Act as it applies to small proprietary companies and directs readers to the operative provisions in the Corporations Act.
2.2 The operation of the previous legislation
Textbook 10th ed, Figure 1.1, p 3
2.2.1 The 1978 Commonwealth Scheme for Co-operative Companies and Securities Industry Legislation
Textbook 10th ed, p 4
On 22 December 1978, the Commonwealth and all State Governments entered into an agreement for the uniform application and administration of company law and the law relating to the securities industry throughout Australia.
Reading
Textbook
Textbook
LAW00004 Company Law
Topic 2 The Australian Constitution and corporate law and the administration of corporate law | 28
The objectives of this earlier scheme are stated in the preamble to this agreement between the Commonwealth and State Governments:
The resultant 1981 Companies Code attempted to embody these principles.
2.2.2 The constitutional position
Textbook 10th ed, pp 3, 5–7
In the 1980s the High Court handed down a number of significant decisions in the interpretation of the ‘external affairs’ power (s 51 placitum xxix) of the Australian Constitution – for example, the Franklin Dam case. The court exhibited an expansive view of Commonwealth power and it was generally assumed that this expansionist approach would also be applied to s 51 placitum xx (‘Foreign corporations, and trading or financial corporations formed within the limits of the Commonwealth’).
Consequently, in 1989, the Commonwealth Government introduced three major pieces of legislation concerning corporate regulation into Parliament:
The effect of this legislation, if valid, would have been to create a single national jurisdiction for corporate regulation based on Commonwealth constitutional power.
Apart from the transitional provisions of the ASC Act, none of this legislation was proclaimed. A number of State governments launched an action in the High Court questioning the constitutional validity of parts of the Corporations Act. In February 1990, the High Court handed down its decision in NSW v The Commonwealth [1990] HCA 2; (1990) 3 ACSR 137 (the Corporations Case) which held that certain key provisions in this legislation were invalid.
Whereas –
A. It is generally acknowledged in the interests of the public and of persons and authorities concerned with the administration of the laws relating to –
companies, anda. the regulation of the securities industry, that there should be uniformity both in those laws and in their administration in the States and Territories of Australia in order to promote commercial certainty and bring about a reduction in business costs and greater efficiency of the capital markets and that the confidence of investors in the securities market should be maintained through suitable provisions for investor protection;
b.
B. The Governments of the Commonwealth and of the States of Australia are agreed that such uniformity will be achieved by establishing and implementing a co-operative scheme the objectives of which are to ensure that –
the legislation relating to the scheme is, and continues to be, uniform through Australia at all times,a. the legislation is administered on a uniform basis,b. the Commonwealth and the States are able to co-operate with each other in regard to the matters to be provided in the legislation and the way in which the legislation is administered,
c.
the legislation is capable of effective administration throughout Australia with the minimum of procedural requirements and is so administered, and
d.
changes in the legislation are proposed for consideration as appropriate from time to time and amendments made when the need for reform arises.
e.
Textbook
The Corporations Bill;1. The Australian Securities Commission Bill; and2. The Close Corporations Bill.3.
LAW00004 Company Law
Topic 2 The Australian Constitution and corporate law and the administration of corporate law | 29
Note the history of company law, including the corporations power, is well represented in the joint judgment of Gleeson, CJ, Gummow, Hayne, Heydon and Crennan JJ in New South Wales v Commonwealth [2006] HCA 52 http://www.austlii.edu.au/au/cases/cth/HCA/2006/52 (accessed 05 May 2017).
2.2.3 The previous scheme
Textbook 10th ed, p 4
Each State had enacted similar provisions to those contained in ss 1 to 81 of the Commonwealth Act. The content of these State and Territory versions of the ‘covering clauses’ contained, inter alia, provisions allowing cross-vesting of court jurisdictions, the application of provisions relating to offences contained in the Corporations Law as if they were offences under State law, conferral of power on the ASIC and the Federal police and the application of Commonwealth administrative law.
This was described in the Explanatory Memorandum to the Corporations Legislation Amendment Bill 1990:
However these noble ambitions were thwarted by the High Court decision in Re Wakim Ex parte McNally [1999] HCA 27 which struck down the cross vesting jurisdiction.
The intention behind the legislative scheme was to create a de facto national regulatory program.
The result of adopting this approach to corporate regulation was that each State adopted the Corporations Law as defined in the Commonwealth statute and, accordingly amendment in each jurisdiction became unnecessary. A similar approach was adopted in relation to the Corporations Regulations. The desire to develop a national system of regulation was reflected within the State Acts by the adoption of single terminology – that is, ‘the Corporations Law.’
2.2.4 The present scheme
Textbook 10th ed, pp 6–7
The complexities and legal difficulties under the previous cooperative scheme have been over-come by the States referring company law power to the Commonwealth for a five year period.
Reading
Parts 1–12 (ss 1–81) contained provisions which applied Part 13 of the Act, ‘the Corporations Law’, to the Australian Capital Territory. The provisions also dealt with some aspects of enforcement and administration.
a.
Part 13 (s 82) enacted ‘the Corporations Law’. These provisions constituted the substantive law to be applied. Each State then passed application legislation adopting ‘the Corporations Law’.
b.
The State legislation will also provide for the ‘federalising’ of matters arising under State and Northern Territory laws and the conferral of powers on the ASC and Commonwealth law enforcement and administrative law bodies. The State legislation will also provide complementary legislation for the cross-vesting of civil and criminal jurisdiction for matters arising under the Corporations Law.
Textbook
LAW00004 Company Law
Topic 2 The Australian Constitution and corporate law and the administration of corporate law | 30
In 2004 the relevant Ministers at the Ministerial Council for Corporations, endorsed a five-year extension to the current references of corporations and related power from the States to the Commonwealth. The arrangements commenced in 2001, and were due to expire in 2006. The agreement extended the arrangements until 2011. Not surprisingly the period of reference was extended to 2016 and further extended to 2021.
Source: http://www.legislation.nsw.gov.au/regulations/2016-319.pdf (accessed 05 May 2017).
2.3 The Australian Securities and Investments Commission (ASIC) See: http://www.asic.gov.au (accessed 05 May 2017).
Textbook 10th ed, pp 15–21
In Australian Securities and Investments Commission v West & Anor [2008] SASC 111 Justice Gray at 6 noted the following:
ASIC serves the important public interest function of securing compliance with the legislation it regulates.
As was observed by Finn J in Australian Securities Commission v AS Nominees Ltd [[1995] FCA 1663; (1995) 62 FCR 504 at 530]:
The name of the body administering company law was changed by the Corporate Law Review Act 1998 (CLRA) from the Australian Securities Commission (ASC) to the Australian Securities and Investments Commission (ASIC).
The role of the ASC (the former name of ASIC) was explained in the Explanatory Memorandum to the Corporations Bill 1989:
Textbook
ASIC is a statutory body corporate constituted pursuant to section 8 of the Australian Securities and Investments Commission Act 2001 (Cth). ASIC’s functions and powers are conferred under the corporations legislation, defined in section 5 of the Australian Securities and Investments Commission Act to mean the Australian Securities and Investments Commission Act and the Corporations Act 2001 (Cth), and are also conferred under agreements or arrangements with States and Territories. [See section 11 ASIC Act]
As a matter of obligation in our system of government the ASC, like all other agencies of government, is required to act in the public interest within its sphere of responsibility…
The ASC will be an independent statutory Commission with the same sort of discretionary powers which the NCSC now has. It will be responsible for the day-to-day administration of scheme legislation and will report directly to the responsible Commonwealth Minister and through the Minister to the Commonwealth Parliament.
The ASC will be more independent of political interference than the NCSC. The Ministerial Council has the capacity to give a direction to the NCSC in respect of particular cases. The ASC will not be subject to any such influence from Government.
The ASC will also have a policy role. The Bill provides that if in the course of performing its functions or exercising its powers the ASC encounters problems which, in its opinion, require a national scheme law to be amended it will be able to advise the Minister accordingly.
LAW00004 Company Law
Topic 2 The Australian Constitution and corporate law and the administration of corporate law | 31
The Australian Securities and Investment Commission (ASIC) is an independent Commonwealth government body and is Australia’s corporate, markets and financial services regulator. ASIC is set up under the Australian Securities And Investments Commission Act 2001 (Cth) (ASIC Act), and carries out most of its work under the Corporations Act.
ASIC regulates Australian companies, financial markets, financial services organisations and professionals who deal and advise in investments, superannuation, insurance, deposit taking and credit.
As the corporate regulator, ASIC is responsible for ensuring that company directors and officers carry out their duties honestly, diligently and in the best interests of their company.
As the markets regulator, ASIC’s role is to assess how effectively ‘authorised financial markets’ are complying with their legal obligations to operate fair, orderly and transparent markets. ASIC also advises the minister about authorising new markets.
As the financial services regulator, ASIC’s role is to license and monitor financial services businesses to ensure that they operate efficiently, honestly and fairly. Financial service businesses typically deal in superannuation, managed funds, shares and company securities, derivatives and insurance.
ASIC also has powers to protect consumers against misleading or deceptive and unconscionable conduct affecting all financial products and services, including credit.
(Source: The Australian Securities & Investment Commission (ASIC), http://www.asic.gov.au/asic/asic.nsf/ byheadline/Our>+role?openDocument (accessed 05 May 2017).)
LAW00004 Company Law
Topic 2 The Australian Constitution and corporate law and the administration of corporate law | 32
2.4 Separate legal entity and limited liability
2.4.1 Characteristics of a company as a legal entity
Textbook 10th ed, pp 85, 98–103
This reading, including the cases contained therein, is fundamental to your understanding of what a company is. Some of the key elements are included below. You should pay particular attention to the liability of a holding company for the debts of its subsidiary, an area which still generates much litigation.
The concept of a corporation as a separate legal entity has been developed by the common law over a considerable period. In creating this concept the common law has attached rights, duties and obligations to a corporation in the same manner as they would be attached to a natural person. In other words the law has given a personality to the corporation, so that the corporation (and not the persons comprising it) acquire rights and obligations which will be upheld or enforced by the law. In this respect the law has recognised two
Activity 2.1
What are the major stages in the development of English and then Australian company law?1. Describe the political and legal alternatives facing the federal government immediately after the decision in NSW v The Commonwealth was handed down. Could the government have proclaimed the balance of the legislation? Was this a good decision?
2.
If the decision in NSW v The Commonwealth had gone the other way, would the federal government then have had sufficient power to regulate all companies in Australia?
3.
What powers have been referred to the Commonwealth in relation to company law? How has this been done?
4.
Using the Index to the Australian Corporations Legislation, what are the statutory provisions in relation to:
the qualifications needed to be registered as an auditor;
the power of ASIC to examine records and books of a corporation;
the definition of a small proprietary company?
5.
A client approaches you for advice. She is a company director who is concerned that her financial interests may be coming into conflict with her duty as a director. Using the Table of Provisions of the legislation, what portion of the Corporations Act deals with the duty of directors to disclose conflict of interests? Can you provide a specific section?
6.
Again using the Table of Provisions, what portion of the Corporations Act deals with substantial shareholdings? Can you provide specific relevant sections detailing what a substantial shareholding is, and what must be done to comply with the Corporations Act?
7.
Your client asks you how much ASIC will charge her to lodge an application for registration as an auditor and whether there is a prescribed form she has to fill in. Can you answer her from the Act? It turns out that your client went to Southern Cross University. Is that University a prescribed University for the purposes of s 1280(2)(a)(ii) of the Corporations Act?
8.
Textbook
LAW00004 Company Law
Topic 2 The Australian Constitution and corporate law and the administration of corporate law | 33
types of corporation – corporation sole and corporation aggregate. For present purposes the corporation aggregate only is important. A corporation aggregate is given recognition by the law when it is created by a means accepted by the law. A company created under the Corporations Act is a corporation aggregate which is given statutory recognition by that Act.
In the development of the common law with respect to corporations certain principles have emerged which relate to corporations generally.
Summary
These principles may be summarised:
2.4.2 Lifting or piercing the corporate veil
Textbook 10th ed, pp 103–107
The law recognises a corporation as a distinct legal entity, having a separate existence and a corporate personality of its own, quite apart from the members who comprise it. One of the very important cases on this principle is Salomon v Salomon & Co. Ltd [1897] AC 22. You should also note a modern application of this principle, the case of Lee v Lee’s Air Farming Ltd [1961] AC 12.
A corporation has a continuity of existence, sometimes called perpetual succession. It remains a corporation, until wound up, even though the members of the corporation may change continually.
A corporation can sue or be sued by its corporate name, which overcomes the difficulties of representative forms of action encountered with unincorporated associations – for example, a cricket club. Under the rule in Foss v Harbottle (1843) 2 Hare 461; 67 ER 189 the corporation is prima facie the only proper plaintiff in proceedings to redress a wrong done to the corporation. In other words, individual members of a corporation cannot take action individually where such right of action is with the corporation.
Example: If a director of a company improperly uses his position for personal gain, the company must bring the action against him, not the individual shareholders. There is little likelihood of the directors taking action against themselves, consequently the company in general meeting has the power to commence or reject the suit. The action is still however brought in the name of the company.
The acts of the corporation bind the corporation alone, and not the individual members. A member of a corporation incurs no personal liability in respect of a contract entered into by a corporation, other than his/her agreed liability to the corporation itself.
A member of a corporation may enter into transactions with the corporation: Lee v Lees Air Farming Ltd [1961] AC 12.
Property belongs to the corporation and not to its members. Thus the members have no legal or equitable interest in the property of the corporation: Macaura v Northern Assurance Co Ltd [1925] AC 619.
The above statements could perhaps be simply restated as one, a company is a separate legal entity. There are however exceptions or limits to the extent of this doctrine.
Textbook
LAW00004 Company Law
Topic 2 The Australian Constitution and corporate law and the administration of corporate law | 34
The following ‘statements of principle’ relating to the modes of piercing the corporate veil was accepted by Einstein J in Idoport Pty Limited v National Australia Bank Limited [2004] NSWSC 695 [144]:
See also McConnell Dowell Constructors (Aus) Pty Ltd v Gas Transmission Services WA (Operations) Pty Ltd & Ors [2007] VSC 301 (Habersberger J) especially at paras 20–27.
2.5 The difficulty of dealing with corporate groups: A statutory exception to the separate entity doctrine
Textbook 10th ed, pp 108–114
The expression ‘lifting the corporate veil’ ‘means that although whenever each individual company is formed a separate legal personality is created courts will on occasions look behind the legal personality to the real controllers’; Pioneer Concrete Services Limited v Yelnah Pty Ltd (1986) 5 NSWLR 254, Young J at 264.
There is no common, unifying principle, which underlies the occasional decision of courts to pierce the corporate veil. Although an ad hoc explanation may be offered by a court which so decides, there is no principled approach to be derived from the authorities: Briggs v James Hardie & Co Pty Ltd (1989) 16 NSWLR 549 at 567, per Rogers A-JA.
The cases merely provide instances in which courts have on the facts refused to be bound by the form or fact of incorporation when justice requires the substance or reality to be investigated: see Theosophical Foundation Pty Ltd v Commissioner of Land Tax (1966) 67 SR (NSW) 70.
When one company is found to be the agent of an individual, it is often said that the corporate veil has been pierced. Strictly speaking this may not be true. A finding that one party is the agent of another does not require a disregard of the separate entity. It merely imputes the acts of one party to another under normal agency principles.
There may be cases where the court will ‘pierce’ the corporate veil, not because it considers it just to do so, but because special circumstances exist indicating that it is a mere facade concealing the true facts. In identifying what is a mere facade, the motive of those behind the company will be relevant. The court will go behind the status of the company as a separate legal entity distinct from its shareholders, and will consider who are the persons, as shareholders or even as agents, directing and controlling the activities of the company: see Merchandise Transport Ltd v British Transport Commission [1961] 3 All ER 495 at 517, 518; see generally Halsbury’s Laws of England, Volume 7(1) at [93].
In these circumstances, the corporate veil may be ‘pierced’ so as to attribute rights or duties to the member as a principal: see generally Ford, Austin and Ramsay’s Principles of Corporations Law 16th ed at [4.250].
Textbook
LAW00004 Company Law
Topic 2 The Australian Constitution and corporate law and the administration of corporate law | 35
Liability of holding company under common law The separate legal entity doctrine applies to companies in a group. The following principles were adopted by Habersberger J in McConnell Dowell Constructors (Aus) Pty Ltd v Gas Transmission Services WA (Operations) Pty Ltd & Ors [2007] VSC 301 at 20–27.
Note also the report by Corporations and Markets Advisory Committee (CAMAC), Corporate Groups (May 2000) http://www.camac.gov.au/ (accessed 05 May 2017).
Liability of holding company under s 588V
Summary A holding company will be liable for debts of a subsidiary incurred in the circumstances set out in s 588V.
The holding company is liable where:
The liquidator may recover from the holding company compensation for any resultant loss. Proceedings must be taken within six years after the beginning of winding up: s 588W.
A holding company may rely on defences provided by s 588X (similar to s 588H defences).
… it can scarcely be contended that [the Companies Act] operate[s] to deny the separate legal personality of each company in a group… in the absence of contract creating some additional right, the creditors of … a subsidiary company within a group, can only look to that company for payment of their debts. They cannot look to… the holding company, for payment…; Industrial Equity Limited v Blackburn [1977] HCA 59; (1977) 137 CLR 567 per Mason J (as he then was) at 577.
The proposition that a company has a separate legal personality from its corporators survived the coming into existence of the large numbers of fully owned subsidiaries of companies and their complete domination by their holding company: … There was continued adherence to the principle recognised by Salomon, notwithstanding that for a number of purposes, legislation recognised the
existence of a group of companies as a single entity …[and] the court maintain[s] the strict separation between a subsidiary and a holding company. … In the result, as the law presently stands, in my view the proposition advanced by the plaintiff that the corporate veil may be pierced where one company exercises complete dominion and control over another is entirely too simplistic. The law pays scant regard to the commercial reality that every holding company has the potential and, more often than not, in fact, does, exercise complete control over a subsidiary; Briggs v James Hardie & Co Pty Ltd (1989) 16 NSWLR 549 per Rogers AJA at 576C–577D.
it is the holding company at the time the subsidiary incurred the debt; and
the subsidiary company is insolvent at that time (or becomes insolvent); and
at the time there are reasonable grounds for suspecting that the subsidiary company is insolvent; and
the holding company or one or more of its directors is or are aware that there are grounds for suspecting the subsidiary company is insolvent; or
having regard to the nature and extent of the holding company’s control it is reasonable to expect that the holding company (or a director) would be so aware.
LAW00004 Company Law
Topic 2 The Australian Constitution and corporate law and the administration of corporate law | 36
2.6 Corporate liability
Textbook 10th ed, generally Chapter 7
Although difficulties exist in determining corporate liability there are a number of areas that may give rise to liability for companies and their officers including:
This is the end of Topic 2. In Topic 3 we examine the company formation process.
Activity 2.2
Analyse the decision in Salomon v Salomon and the exceptions to the rule that emerge from this case. Is the decision a travesty or is it fundamental to corporate capitalism?
What are the exceptions to the principle from this case?
1.
A holding company is generally liable for the debts of its subsidiary and always liable if the subsidiary is 100% owned. Discuss the accuracy of these statements.
2.
What principles guide the liability of a company for crimes and torts? Explain the significance of Tesco Supermarkets v Nattrass (Textbook 10th ed, pp 207–208; Ciro & Symes, pp 141–142).
3.
Textbook
liability in negligence (including a failure to exercise reasonable care);1. vicarious liability (for acts of your employees);2. liability to employees;3. liability under legislation; Corporations Act (for example directors liability); note also the privacy legislation; and
4.
criminal liability. The criminal liability for company officers (especially regarding corporate manslaughter) has been a contentious issue in recent years and has given rise to a great deal of discussion and reports. See for example the report by Corporations and Markets Advisory Committee (CAMAC) Personal Liability for Corporate Fault (September 2006) http://www.camac.gov.au (accessed 05 May 2017) and check ‘reports’.
5.
LAW00004 Company Law
Topic 2 The Australian Constitution and corporate law and the administration of corporate law | 37
Topic 3
The creation of a company: Types of companies, promotion, formation and the company’s Constitution
Objectives To successfully complete this topic you will need to be able to:
Unlike partnerships, corporations are created by statute. The Act sets out the various types of corporations that are allowed and the method by which a corporation is brought into existence. One important document which must be written as part of this process is the corporate Constitution, previously known as the memorandum and articles. The people who create the company are known as its promoters. If they do not carry out their tasks in accordance with the common law and the statute, they will be liable to the company for breach of their fiduciary duties. These matters are the basis of discussion in this topic.
3.1 Types of companies Before promoters set about forming a company they must be aware of the particular type of company best suited to their needs. The Act provides for a number of different types of corporations. In your reading you should identify these, noting their uses.
Textbook 10th ed, pp 64–72
Classifications Corporations under the Act may be classified as:
differentiate clearly between types of companies, and be aware of their characteristics and uses;
define what a promoter is;
discuss the problems facing promoters in company formation and in particular those relating to pre- incorporation contracts;
recognise the duties owed by company promoters;
indicate the basis for formation of companies and describe the formation process for proprietary and public companies;
be able to recognise the corporate Constitution, be aware of information contained in it and the important role it plays in corporate life; and
describe the rules relating to alteration of the corporate Constitution.
Textbook
38
1. Limited companies See ss 112, 117(2)(k)(l) and Pt 5.6 Div 1 and 2.
The liability of a member is limited to the amount the member has agreed to invest in the company. This may be effected by:
Note the obligation by the member to the company is recognised as an enforceable contract, and as such is a debt which may be sued for by the company: ss 515, 527 and the definition of contributory in s 9.
2. Unlimited companies The financial liability of members is not protected, and they can be called upon to contribute to the limit of their personal assets to satisfy the debts of the company: See the definition in ss 9, and 112(1). Such a company may, but need not, have a share capital. An unlimited company can redeem its own shares and because of this, some mutual fund companies have operated through this medium.
3. No liability company: s 112(2) A company can only be registered as a no liability company when its sole objects are for mining purposes as defined in s 9. See s 112(2) and the definition of mining company in s 9. The essential feature of such a company is that any unpaid amount of shares is not a debt enforceable by the company and therefore the shareholder has no liability to pay calls: s 254M(2) However, where a call is unpaid the shares must be forfeited: s 254Q.
A shareholder has no liability for calls or contributions but is not entitled to participate in a surplus on winding up on any non-forfeited share where a call is in arrears until the amount owing has been fully paid: s 254P(2).
Restrictions are placed on the timing of calls: s 254P.
Shares with unpaid calls are automatically forfeited and must be offered for sale by public auction within six weeks from the date on which the call is payable: s 254Q; but the directors are entitled to fix a reserve price not exceeding amount of calls due and unpaid: s 254Q(7).
Proceeds of sale of forfeited shares is applied in payment of:
Any person whose shares have been forfeited may redeem the shares up to the day before date of sale by paying the amounts due with respect to such shares, including a proportion of the expenses of forfeiture: s 254R.
shares – the obligation of the shareholder is limited to the nominal value of the shares held, and the shareholder cannot be called upon to contribute more than this amount in satisfaction of the company’s debts: s 516;
a.
guarantee – a member undertakes to contribute a stated amount to the property of the company if it is wound up; and
b.
shares and guarantee – previously a company could use both of the above methods in combination under s 518. This possibility was removed in CLRA though companies previously registered as companies limited by shares and guarantee continue to exist as such under s 1378.
c.
expenses of sale;a. expenses incurred with respect to forfeiture;b. calls due and unpaid; andc. any balance paid to the member whose shares sold if he/she delivers to the company the share certificate for those shares: s 254Q(11).
d.
LAW00004 Company Law
Topic 3 The creation of a company: Types of companies, promotion, formation and the company’s Constitution | 39
4. Companies, recognised companies, corporations, bodies The existence of separate State companies’ acts and administrations created difficulties for companies when they wished to expand their operations into another State or Territory. A scheme between four States, New South Wales, Queensland, Victoria and Western Australia (the Interstate Corporate Affairs Commission Scheme) operated for a number of years in the 1970s. This eventually grew into the National Co-operative Scheme of the 1980s described in Topic 2.
The Interstate Corporate Affairs Commission scheme created the concept of a ‘recognised company’, making the carrying on of business by companies formed in one participating State easier in the new state when they crossed state boundaries. If a recognised company or recognised foreign company wished to carry on business in another State or Territory it needed to have a principal office within that State or Territory and to have its name reserved or registered.
The present Act draws on some of the principles established in the Interstate Corporate Affairs Commission Scheme.
Companies incorporated under the Corporations Act are automatically entitled to carry on business in any Australian jurisdiction without any need to register in that jurisdiction.
Corporation is defined in s 57A as an all embracing term covering bodies corporate, companies, recognised companies, and certain unincorporated bodies. Body is defined as meaning a body corporate or an unincorporated body, for example, it includes a society or an association. Generally the term company means a company registered under the Corporations Act, though see s 9 for its expanded definition.
5. ‘Registrable Australian bodies’ and foreign corporations
Textbook 10th ed, p 85
In each State and Territory a number of bodies corporate are created under statutes other than the Act or the previous Companies Code of that State or Territory. A co-operative is an example. In addition there are unincorporated bodies that may sue or be sued, or may hold property in the name of its secretary or of an officer. Together these are referred to in the Act as ‘registrable Australian bodies’. Section 601CA requires such bodies to be registered prior to carrying on business outside their home State.
In order for these corporations to obtain the benefit of not having to maintain a principal office in each State, s 601CB of the Corporations Act requires an application to be lodged in respect of each State and Territory. These multiple applications can be lodged in a single application, provided that the application refers to the application as being made under the Corporations Act.
Section 601CD requires foreign companies to register ‘under this division or a corresponding law’ prior to commencing business. Accordingly foreign companies are also obliged to register in only one jurisdiction.
It should be noted, however, that instead of receiving an ‘Australian Company Number’, both foreign corporations and ‘registrable Australian bodies’ are allocated an ‘Australian Registered Body Number’. The requirements for using the number and the procedure for obtaining them are found in Part 5B.3.
Textbook
LAW00004 Company Law
Topic 3 The creation of a company: Types of companies, promotion, formation and the company’s Constitution | 40
6. Proprietary and public companies
Public company
A public company is defined as being any company other than a proprietary company: s 9.
Proprietary company
Under s 113(1) a proprietary company must have no more than 50 non-employee shareholders. A proprietary company must not engage in any activity that would require the lodgement of a prospectus, for example by inviting the public to subscribe for shares in or debentures of the company, or deposit money with the company.
Proprietary companies must use that term, or its abbreviation ‘Pty’ in the company name, so it is possible to tell the type of company from the name: ss 148, 149.
Hence A Pty Ltd is a proprietary company and Z Ltd is a public company.
A proprietary company enjoys a number of advantages over a public company some of which are:
Small proprietary company
Provision is made in the Act for a small proprietary company: see the definition in s 45A(2) which concentrates on the value of assets, turnover and the number of employees.
A small proprietary company enjoys these advantages:
Small companies limited by guarantee
Provision is made in the Act for a small company limited by guarantee: see the definition in s 45B. A small company limited by guarantee enjoys these advantages:
minimum number of directors is 1: s 201A (three for a public company);
directors may be made removable by other directors if power to do so is given in the Constitution. Note that s 203E only applies to public companies;
there is no necessity for each director to be appointed by a separate resolution: s 201E;
there is no statutory right of shareholders to remove a director: s 203D (though such a right could be included in the company’s Constitution). Note that s 203C is a replaceable rule;
certain exemptions apply in relation to the takeover provisions for companies with less than 50 members;
strict rules relating to the independence and qualifications of a liquidator do not apply in a members voluntary winding up: ss 532(4), 532(1), 532(2);
auditing requirements are reduced: see generally s 327; and
the rules on voting where there is a personal interest under 2D.1 are not as strict: see ss 194 and 195.
Under s 292(2) such companies are generally protected from the need for public financial reporting though 5% of shareholders can request financial reports and directors reports: s 293; and the ASIC may direct compliance under the financial reporting provisions: s 294.
Under s 292(3) such companies are generally protected from the need for public financial reporting unless required to do so under s 294A (5 per cent of members) or s 294B (directed by ASIC).
LAW00004 Company Law
Topic 3 The creation of a company: Types of companies, promotion, formation and the company’s Constitution | 41
3.2 Promotion and promoters
Textbook 10th ed, p 221–226 and 230–232
A considerable amount of work is needed before a company can reach the stage of incorporation. Originally the Companies Acts did not set out any provisions for action taken before actual incorporation, except with respect to the issue of a prospectus. Consequently, it was left to the general law to provide rules governing promotion of companies. This has now changed.
The person forming a company (the promoter) owes a high level of duty to the company and will become personally liable to the company if this duty is breached.
Definition of a promoter A promoter may be described as a person who undertakes the formation of a company, and who takes the necessary steps to carry out that purpose. In deciding whether a particular person is acting in the capacity of promoter the facts of the particular circumstances must be considered. The identity of a promoter may range from the sole proprietor who decides to form a company and sell his business to that company to the professional promoter who specialises in company formation.
A promoter is not defined in s 9 of the Corporations Act. It is necessary therefore to refer to the common law:
The fiduciary duties of a promoter A promoter stands in a fiduciary relationship towards the company: he/she must not make any profit out of the promotion without disclosing it to the company. To be effective such disclosure must be made to an entirely independent board of directors or to the existing and potential members as a whole. Having made such disclosure – which must be explicit and not partial or incomplete – there is nothing to prevent a promoter from selling his/her property to the company.
The High Court of Australia decision in Tracy v Mandalay Pty Ltd [1953] HCA 9; (1953) 88 CLR 215 (see Textbook 10th ed, pp 222 and 224) examines the nature of the disclosure required.
Activity 3.1
Do you agree with the following statements? Give reasons for your answer. A no liability company may be registered for any purpose.a. Unpaid calls on shares in a no liability company are a debt for which the company may sue.b. Only companies incorporated outside Australia are required to comply with the formalities prescribed for a foreign company.
c.
1.
What are the main advantages of a small proprietary company? Are there any disadvantages associated with a proprietary company?
2.
Textbook
Reading
LAW00004 Company Law
Topic 3 The creation of a company: Types of companies, promotion, formation and the company’s Constitution | 42
Summary
Some matters settled by promoters:
3.3 Pre-registration contracts Many of the legal problems associated with company promotion arise from the fact that until registration of the company there is no legal entity with whom the promoter, or another party, can enter into legally enforceable agreements. Under the common law a company could not ratify an agreement after it had been incorporated. The Corporations Act changes this.
Sections 131–133 very carefully, and Textbook 10th ed, pp 226–230
The major provisions of s 131 are summarised below:
Note also s 122 allows the company to pay the expenses incurred before registration out of the company’s assets.
preparation and printing of the company Constitution and prospectus; arrangement with underwriters to underwrite the issue of shares, the publication of the prospectus, the type of shares to be offered – preference or ordinary, and the selling of the shares generally;
the preparation of preliminary agreements covering the transfer of any property to the company;
proposed directors, auditors, solicitors, banks and secretaries;
proposed experts, consulting accountants, valuers, engineers, surveyors and geologists, from whom reports are required;
recouping the costs of incorporation and other preliminary expenses from the company.
Textbook
The Act alters the common law position in relation to ratification of contracts. It allows a company once it comes into existence on registration to ratify a pre-registration contract ‘within the time agreed to by the parties to the contract’ or ‘within a reasonable time’: s 131(1).
1.
If ratification is made then the company will be bound by the contract: s 131(1).2. Under s 131(2) other parties to the pre-registration contract are granted a right of damages against the person who purported to enter into a contract on behalf of a company before it is registered if:
‘within the time agreed to by the parties to the contract’ or ‘within a reasonable time’.
the company is not registered; ora. the company does not ratify the contract;b.
3.
The court is given various discretions where a company is formed but does not ratify the contract, including the power to order the company to pay damages that a person who signed the contract on behalf of the company (such as a promoter) may have to pay; orders for the transfer of property; and the payment of amounts to a party to the contract: 131(3).
4.
Note the possibility of a release of liability in s 132. This enables the promoter in some circumstances to avoid liability.
5.
LAW00004 Company Law
Topic 3 The creation of a company: Types of companies, promotion, formation and the company’s Constitution | 43
3.4 Formation of companies
Summary
A company can only exist by the deliberate act of some person to create it at law: usually by registration under a statute such as the Corporations Act. You need to understand the process by which a company is created.
Textbook 10th ed, pp 83–96
The basis for the formation of a company is set out in Pt 2A.2 of the Act. It is important to note:
Activity 3.2
Are there any deficiencies in the way Part 2B.3 purports to overcome the difficulties in the common law regarding pre-registration contracts? Does the Act enable payment to the promoter for services?
1.
You have been approached to aid in the formation of a company. From your reading of cases and the Act what particular problems do you face:
in seeking remuneration for your valued services?a. in assisting the yet to be formed company to take advantage of lucrative contracts which need to be signed before the company is incorporated?
b.
2.
Textbook
the contents of the application to register a company are listed in s 117(2);
once an application is lodged under s 117 ASIC may register the company and issue a certificate of registration: s 118;
the s 118 Certificate of Registration is conclusive evidence that all registration requirements have been met and that the company is duly registered as a company: s 1274(7A);
public and proprietary companies now only require at least 1 member: s 114;
various types of company are permitted under s 112;
the restriction (discussed in Topic 1) on numbers forming a partnership without incorporation: s 115;
only public companies which are to have a Constitution on registration are required to lodge a copy of the company’s Constitution with the application for registration: s 117(3);
a company comes into existence on the beginning of the day on which it is registered: s 119;
members, directors and the company secretary who have consented to being named in the application to register the company become so on registration: s 120;
a company is not required to have a common seal though it may: s 123.
LAW00004 Company Law
Topic 3 The creation of a company: Types of companies, promotion, formation and the company’s Constitution | 44
3.5 Australian company number and company name
Textbook 10th ed, p 89
The Corporations Law introduced a concept whereby each corporation was required to have an Australian Company Number (ACN). A numbering system was necessary because the new central national registration system had to deal with companies from separate States that had the same name.
Companies with the same name at the time the Corporations Law commenced were not required to change the name. Now companies seeking registration have to ensure that the preferred name is available. It will not be allowed if it is identical to a name that is reserved or registered: s 147. The Corporations Regulations 2001, most importantly sch 6 to the Regulations control the procedure for reservation and registration of a name: see 2B.6.01–03.
The ACN can be registered as the name of the company: s 148.
The name of the company must appear on all public documents and cheques: s 153, along with the ACN, subject to certain exceptions.
In certain circumstances a company limited by guarantee may be allowed to dispense with the requirement under s 149 to use Limited or Ltd in the name: s 150.
Names can be changed under s 157 by special resolution and the lodging of an application with the ASIC. In certain circumstances the ASIC can direct the changing of a name: s 158.
Textbook
LAW00004 Company Law
Topic 3 The creation of a company: Types of companies, promotion, formation and the company’s Constitution | 45
3.6 The company’s Constitution Note: Whenever a question in this unit requires reference to a company Constitution, and no information is given with respect to the Constitution it will be assumed that the replaceable rules in s 141 govern the situation.
The company’s Constitution is fundamental to all aspects of corporate existence. In this part we examine its legal effect, what it must contain and how to alter it.
Textbook 10th ed, pp 119–131, 134–135
The situation prior to CLRA Previously companies were required to have two constituting documents, the memorandum of association and the articles of association. The requirement for constituting documents with those names was changed by the CLRA, nevertheless for some years to come, most companies will still have a memorandum and articles of association so it is important to understand these documents. These will contain the company’s Constitution under s 134 until such time as they are repealed.
Activity 3.3
Julie Smith, a sole trader operating a large industrial concern in New South Wales, seeks your advice on the conversion of her business to a public company limited by shares. She wishes to know:
what documents need to be prepared;a. what documents need to be registered and what particular time;b. when the company will be entitled to commence business;c. the procedure to obtain a name for the company;d. the number of members and directors the company will need to have. Smith controls a family company, Smith Pty Ltd which she wishes to make a director of the company be formed. Can she do this?
e.
whether the company will need to hold any meetings before or within six months of commencement of business.
f.
1.
Julie Anne wishes to register a new company, and wishes to use one of the following names:
Will she be allowed?
Commonwealth Crown Tyres Pty Ltd;
Prince Chuck Tyres Pty Ltd;
RSL Tyres Pty Ltd;
Chartered Tyres Pty Ltd;
The Tyred University Pty Ltd;
The Tyre Bank Pty Ltd.
2.
Textbook
LAW00004 Company Law
Topic 3 The creation of a company: Types of companies, promotion, formation and the company’s Constitution | 46
Previously the memorandum had to contain clauses covering:
The law did not list all the matters which had to be included in the articles, but did make reference to the need for particular clauses in various situations – for example, an alteration of capital had to be authorised in the memorandum or articles. The articles contained the basic rules of the company.
A company limited by shares, and a no liability company, did not need to lodge articles, in which case they were controlled by Table A and Table B respectively (previously found in sch 1 to the Corporations Law). If articles were lodged, Table A or Table B applied to the extent they were not specifically excluded.
The situation after CLRA For companies registered after the commencement of Pt 2B.4 or those that repeal their memorandum and articles the company Constitution’s consist of:
The Constitution can be adopted on registration by agreement in writing of each person specified in the application for registration, or afterwards by the company passing a special resolution: s 136(1).
The Constitution can displace or modify a replaceable rule: 135(2). In this sense replaceable rules are very much like many of the provisions in the Partnership Act such as those under s 24 of the Partnership Act.
Some rules are replaceable for proprietary companies but mandatory for public companies, for example s 249X.
The contract in the company’s Constitution
Textbook 10th ed, pp 128–129 and p 134. The company’s Constitution (including applicable replaceable rules) is contractually binding on the company and each member: Hickman v Kent [1914–15] All ER Rep 900. This rule is now found in s 140(1).
In Hickman v Kent the article provided that disputes between the company and its members were to be referred to arbitration. Hickman ignored the article and commenced court proceedings alleging his rights as a member were affected by certain conduct of the company.
Held: the company which had sought a stay of proceedings was successful because H was bound by the contract contained in the articles to refer his dispute to arbitration.
Hickman v Kent also held:
name of company;
objects of company;
capital of the company – the total amount and the way in which it is to be divided;
liability of members of the company; and
details of subscribers.
the replaceable rules listed in s 141 (less any which the company choses to exclude); plus
its Constitution, if it has one.
Textbook
an article cannot constitute a contract between the company and a third person;
LAW00004 Company Law
Topic 3 The creation of a company: Types of companies, promotion, formation and the company’s Constitution | 47
Other case examples of the rule in Hickman v Kent are:
Altering the Constitution
Textbook 10th ed, pp 129–131 and 430–432
Provision is made in the Act for alteration of the Constitution by special resolution: s 136(2).
The company is required to lodge a copy of any resolution altering the Constitution with ASIC within 14 days: s 136(5), and alteration generally takes effect from the date of passing: s 137(1).
The power to alter the Constitution could allow despotic rule of a company by those who are able to command the requisite majority to have the special resolution passed. As we shall see this necessitates certain protections such as those found in s 140(2) and the decision in Gambotto v WCP [1995] HCA 12; (1995) 182 CLR 432; (1995) 13 ACLC 342.
Section 140(2) prevents the company increasing the liability of a member by modifying the Constitution in certain ways after the person became a member, unless the member agrees. Prohibitions include:
The statutory power to amend the Constitution must be exercised for a proper purpose and not oppressively. The leading case in this area is the High Court decision in Gambotto v WCP [1995] HCA 12; (1995) 182 CLR 432.
no right merely purported to be given by an article to a person whether a member or not, in a capacity other than that of member (for example, as solicitors or accountants) can be enforced against the company.
Eley v Positive Life (1876) 1 Ex D 20
The articles were drawn up so as to provide that Eley should be the solicitor of a company. He sued for breach of contract when he was not employed.
Held: As he was not a party to the contract he had no such right of action.
Rayfield v Hands [1958] 2 All ER 194
An article provided: ‘every member who intends to transfer shares shall inform the directors who will take the said shares equally between them at fair value’.
This article was enforced by a shareholder against the directors who were required by the articles to have a share qualification.
Because of this requirement, the article bound the directors as members.
Textbook
requiring the member to acquire more shares;
pay additional money to the company; and
increasing restrictions on transferability of shares except in certain cases, such as conversion of a company from public to proprietary.
LAW00004 Company Law
Topic 3 The creation of a company: Types of companies, promotion, formation and the company’s Constitution | 48
You should note carefully Gambotto Textbook 10th ed, pp 428–432
Textbook 10th ed on page 420, mentions the case Peter’s American Delicacy Co Ltd v Heath [1939] HCA 2; (1939) 61 CLR 457 which was an earlier High Court decision before Gambotto. In Peter’s American Delicacy v Heath the company’s articles provided that if profits were distributed in the form of shares, that would be done in the proportion of shares held. The company altered its articles to provide that the distribution would be in accordance with the amount paid up on the shares. Naturally holders of partly paid shares objected and challenged the alteration.
Held: Alteration was valid.
Note Dixon J’s views in this case: ‘If a resolution is regularly passed with the single aim of advancing the interests of a company considered as a corporate whole it must fall within the scope of the statutory power to alter the articles and could never be considered as mala fides.’ And also:
Thus a company’s Constitution could be altered to expropriate the shares of a shareholder, but if this was done because he/she were troublesome or disliked, that would be bad faith.
If this were done because he/she was a competitor, then it might be allowable under the test.
Latham CJ made these points in Peter’s Case:
The court will not attempt to investigate the thoughts and motives of each shareholder. The fact that some members may suffer a detriment in consequence of the alteration of an article does not necessarily make the alteration void. If the alteration is passed fraudulently or oppressively or is so extravagant that no reasonable person would believe it is for the benefit of the company it will be invalidated.
The leading case on statutory oppression under ss 232–234 is Wayde v NSW Rugby League Ltd [1985] HCA 68; (1994) 180 CLR 459. We will return to this case and the subject of oppression in Topic 4.
For students wanting to know more; See Heydon v NRMA Ltd [2000] NSWCA 374, http://www.austlii.edu.au/au/cases/nsw/NSWCA/2000/374.html.
Textbook
No one supposes that in voting each shareholder is to assume an inhuman altruism and consider only the intangible notion of the benefit of the vague abstraction of the company as an institution.
an alteration must not be such that no reasonable person could have reached it; nor can the voting power be exercised fraudulently or oppressively; and
onus is on the party complaining.
LAW00004 Company Law
Topic 3 The creation of a company: Types of companies, promotion, formation and the company’s Constitution | 49
The directors seek advice on obtaining the required $400 000. Advise them on what they can do, and, briefly, the procedure necessary to do it.
This is the end of Topic 3.
Activity 3.4
Research and summarise the decisions in Gambotto’s Case. Does the ‘bona fide for the benefit of the company as a whole’ test still have any operation?
1.
What are the essential differences and similarities between the previous concepts of memorandum and articles and the present notions of replaceable rules and the company Constitution?
2.
A Ltd, a public company limited by shares, has an authorised capital of$500 000 divided into ordinary shares of $1 all of which are issued. The directors have decided that the company requires another $400 000 capital to provide funds for business expansion. Relevant clauses in the Constitution state:
the company may by ordinary resolution increase its authorised capital;a. where a new issue of shares is being made they shall first be offered to existing shareholders in proportion to shares which they presently hold, and if any shareholder; does not accept his entitlement thereunder his share may be offered, without restriction, to any other shareholder;
b.
no new issue of shares will be offered to the public unless the company, by special resolution, has authorised an issue to the public; and
c.
the directors have the power to borrow money by the issue of debentures, and in so doing may create a floating charge over all assets of the company, but the amount so borrowed shall not exceed $300 000.
d.
3.
LAW00004 Company Law
Topic 3 The creation of a company: Types of companies, promotion, formation and the company’s Constitution | 50
Topic 4
The capacity of the company and its agents and the rights of its members
Objectives To successfully complete this topic you will need to be able to:
4.1 Introduction Unlike a natural person, a company as a legal person takes its powers from an act of parliament. The company itself must act through agents.
In this topic we will analyse the legal capacity of a company: the power of the company to make valid contracts. We will also examine the power of a company’s officers or agents to make contracts on the company’s behalf. Thus we are about to examine the capacity of a company, and the capacity of its agents. You must not confuse these two matters.
We will also examine rights of membership including the register of members, the means of becoming a member and the important and interesting issues relating to the rights of minority shareholders.
4.2 Capacity of a company
Textbook 10th ed, pp 131–135 and 140–141
You must also carefully work through ss 123–127
distinguish between the legal capacity of a corporation and the capacity of its agents;
demonstrate familiarity with the ultra vires doctrine, the law relating to corporate powers and restrictions, and the powers and restrictions of corporate agents;
be aware of the information contained in the register of members and its importance;
describe the means of becoming a member of a company;
discuss and apply the statutory and common law remedies available to minority shareholders; and
describe and discuss any proposals to reform this area of law.
Textbook
51
4.2.1 Introduction to the ultra vires doctrine You must be able to distinguish between the power of a company to act and the powers of its officers as agents. Companies were originally established by specific statute or royal charter. A doctrine developed whereby the company could not act outside the powers/objects given in the statute which created it. Thus if the corporation was enacted to engage in trade with China it would not have been able to engage in trade with France unless this power was specifically given or was incidental to its trade with China.
The ultra vires doctrine made some sense in the context of single statute companies but was inappropriate for modern corporations formed under a general statute such as the Corporations Act, particularly when the doctrine’s effects were considered. One such effect was that a contract entered into which was outside the powers/objects of the company was likely to be invalid. This created consequential difficulties for the other, usually innocent party who might be faced with a void contract.
Another doctrine, the doctrine of constructive notice, deemed the third party to be aware of the contents of public documents such as the memorandum which contained the objects clauses.
The constructive notice doctrine had meant that persons dealing with a company were deemed to be aware of publicly registered corporate documents. This worked hand in hand with the ultra vires doctrine and against the interests of the other party. The doctrine of constructive notice has now been abolished: s 130(1). There is an exception in relation to registrable charges: s 130(2).
The rule in Turquand’s Case (The Royal British Bank v Turquand [1856] EngR 470) had slightly mitigated the harshness of this rule: third parties were entitled to assume that internal procedures had been carried out. This is known as the indoor management rule, examples of its operation were that a third party could assume:
The ultra vires and the constructive notice doctrines were finally abolished in Australia from 1984, though officers who allowed the company to act outside the powers contained in its memorandum were held to have contravened the Act. This was changed in 1998 so that conduct contrary to the objects or powers of a company is no longer a contravention of the Act, though management and the company may still face action under:
Note also that:
The combination of these two matters has further de-emphasised the importance of the ultra vires doctrine.
a quorum was present at a meeting;
a meeting was properly called; and
votes properly counted.
the provisions relating to directors duties: see Chapter 2D;
members rights and remedies: see chapter 2F, especially oppression in ss 232–234; and
the just and equitable ground for winding up: s 461(1)(k).
a company has the legal capacity of both an individual and a body corporate; and
a company is no longer bound to have objects: s 125.
LAW00004 Company Law
Topic 4 The capacity of the company and its agents and the rights of its members | 52
4.2.2 Summary and brief history of the ultra vires doctrine in Australia
In Australia prior to 1961
In Australia after 1961 Uniform Companies Acts
The Companies Code 1981
1983–84 amendments to the Code
1986 amendments to the Code
Rewording of the provisions in CLRA in 1998
Possible invalidity of contracts if a company acted outside the powers given to it in its memorandum, that is, it acted ultra vires: Ashbury Railway Carriage v Riche [1874–80] All ER 2219 Lawyers’ response to the harsh effects of this possible invalidity:
many broad object clauses giving company power to perform an often ridiculous and unlikely range of activities;
the development of ‘smart’ clauses such as the ‘Bell House’ clause:
To carry on any other trade or business whatsoever which can, in the opinion of the directors be carried on by the company in connection with or ancillary to any of the above business or the general business of the company.
the development of ‘independent objects clauses’ which as a matter of legal construction required each clause to be interpreted independently of any other clauses.
This legislation modified significantly the effect of the ultra vires doctrine in Australia: A contract entered into which was ultra vires the company was not invalid.
Initially, the Code simply repeated the 1961 provisions.
These attempted (though it was thought by many unsuccessfully) to abolish the ultra vires doctrine.
A further attempt to abolish the ultra vires doctrine and was retrospective to date of commencement of 1983–84 amendments.
These amendments ensured that a company had the legal capacity of a natural person.
A company can still have restrictions in its constitution. These will operate internally, but will not make third party contracts inoperative.
Same basic policy but wording simplified.
Conduct contrary to the objects or powers of a company is no longer a contravention of the Act, but could give rise to liability under other sections such as Chapter 2D, ss 232–234 or s 461(1)(k).
Sections 124 and 125 now govern the situation.
LAW00004 Company Law
Topic 4 The capacity of the company and its agents and the rights of its members | 53
Peter enters into a contract with Jones Pty Ltd whereby Peter would assist it to obtain a building lease. He fails to assist. Jones Pty Ltd sues him for breach of contract. He argues that the alleged ‘contract’ is void as being ultra vires the company.
The plaintiff company’s constitution contains the following powers:
The concluding paragraph reads: ‘The intention is that the objects specified in any paragraph … shall … be in no way limited or restricted by reference to or inference from the terms of any paragraph’.
Advise the parties. Would it make any difference if Peter had read the company’s constitution prior to entering the contract?
4.3 Capacity of the agents of a company
4.3.1 Overview The 1983–84 amendments to the Companies Code also introduced provisions relating to the powers of company officers and agents. In practice, this is far more important than the ultra vires doctrine. A company acts through its agents. If agents do not have the power they profess, they may be personally liable. On the other hand, third parties could have difficulty enforcing contracts against the company if a person who purported to act as agent of the company did not have legal power to do so.
Section 126(1) of the Act now provides:
Textbook 10th ed, pp 187–205
You must also carefully work through ss 128–130
Note the assumptions in s 129. Section 129 is a reworded version of previous s 164, though s 128(4) is different to s 164(4). Previously, s 164(4) imputed knowledge where a person ‘ought to know’ the assumptions were incorrect, this has been replaced by a test of suspicion that the assumption was incorrect.
Section 129 does not define the powers and duties customarily exercised or performed by a managing director or director.
Activity 4.1
to carry on business as importers, exporters, buyers and sellers of, and dealers in, merchandise of all descriptions; and
to obtain the grant of, purchase, or otherwise acquire any concessions, contracts, rights, patents, privileges, monopolies, undertakings or business or any right or option in relation thereto.
A company’s power to make, vary, ratify or discharge a contract may be exercised by an individual acting within the company’s express or implied authority and on behalf of the company. The power may be exercised with or without using a common seal.
Textbook
LAW00004 Company Law
Topic 4 The capacity of the company and its agents and the rights of its members | 54
According to Austin and Ramsay, Ford, Austin and Ramsay’s Principles of Company Law (16th ed), (Ford) these implied powers would include:
Re governing directors see Ford 7.295.
Managing Director: Power to do all such acts as are necessary to manage the business of the company in the ordinary way, including the power to borrow money, guarantee loans, give security and employ, but no power to sell the business.
— [Ford 7.275–7.280 and 13.070]
Individual directors: Their powers are limited: there is no implied power to bind the company under typical company’s articles, they must get powers as an agent by express appointment. Directors generally act as part of the board.
— [Ford 13.080]
LAW00004 Company Law
Topic 4 The capacity of the company and its agents and the rights of its members | 55
4.4 The rights and remedies of members In this part we turn to an investigation of the rights of members of a company. There are two themes:
Textbook 10th ed, Chapter 9, pp 235–255
Activity 4.2
John Smith Builders Pty Ltd has been wound up and the liquidator is investigating a claim by XY Co Ltd for materials supplied to the sum of $15 000. These materials had been used by John Smith Builders Pty Ltd in the construction of a Research Centre at the University. Mr Smith had taken on the Research Centre project because it was particularly profitable to ‘his’ company over which he exercised total control as governing director and majority shareholder.
The memorandum of John Smith Builders Pty Ltd contains the following objects clauses:
At no time had the officers of XY Co Ltd inspected the constitution of John Smith Builders Pty Ltd and they were not aware that the materials were to be used on the Research Centre project.
the company shall have power to carry on the business of builders of project homes;
the company shall have power to carry on such business as the governing directors shall think profitable.
Is there any ground on which the liquidators could refuse payment of the claim? What arguments could be raised by XY Co Ltd in support of its contention that the claim be paid?
a.
Would your answer differ if the officers of XY Co Ltd were aware that materials supplied would be used exclusively on the Research Centre project?
b.
1.
Assume the facts as in question 1. Could the liquidator in view, of the Act, legally refuse payment of the monthly accounts in the following separate circumstances?
How would your answer in (b) differ if:
Mr Smith is the person who made the order and the company’s constitution specified that the shareholders’ approval should be signified by ordinary resolution to contracts in excess of $10 000 and the unpaid account related to an order which exceeded $10 000? What if XY Co Ltd knew Mr Smith did not have shareholders’ approval?
a.
Mary Smith (John’s spouse), a shareholder in John Smith Builders Pty Ltd, is the person who ordered the materials supplied:
b.
Mr Smith had authorised Mary to make orders of a similar nature for the Research Centre project on previous occasions and those accounts had been paid?
Mr Smith had authorised Mary to make the orders in respect of the unpaid accounts?
Mary was the Company Secretary?
2.
procedural rules relating to membership; and
the rights of members
Textbook
LAW00004 Company Law
Topic 4 The capacity of the company and its agents and the rights of its members | 56
4.5 The means of becoming a member of a company Section 231 lists three methods of becoming a member:
4.5.1 The register of members Every company must keep a register of members: s 169. In the absence of evidence to the contrary, a register kept under Chapter 2C, including the register of members, is proof of the matters shown in the register: s 176.
The importance of the register of members is that it is evidence of membership of a company and, unless the person is within s 231(a) or (c), a person who agrees to become a member but whose name is not entered on the register is not a member even though that person may be beneficially entitled to the shares.
From the viewpoint of the company, the entry of a name on the register of members determines the time at which such person became a member, and the removal of a name from the register is necessary before such person ceases to be a member. The importance of the register of members in determining membership of the company is recognised by s 175 which makes provision for application to the court for an order for correction.
The main features relative to a register of members are:
being a member on registration;1. agreeing to becoming a member of the company after registration and that person’s name being entered in the register of members; this could occur by:
application and allotment – this is the way in which membership results from a contract with the company. The application is the offer and acceptance is made by allotment, which is communicated to the offeror by a letter of allotment. Membership of the company does not occur until the allottee’s name is entered in the register of members;
transfer of shares – where a shareholder sells shares in a company to another person, the buyer of the shares does not become a member of the company until his/her name is entered in the register of members and the seller does not cease to be a member until his/her name is removed from the register. This may cause problems where the directors of the company have the power, under the company’s constitution, to restrict the transfer of shares. The legal position is that the company only recognises as a member the person whose name is on the register. However, under principles of general law the seller of such shares is considered to be trustee of the shares for the buyer. This means that the seller, while his/her name remains on the register, is the legal owner, but the buyer is the beneficial owner. If a dividend is declared after the same, but before change of the register, the company would pay it to the seller, but he/she would receive it as trustee for the buyer who would be entitled to such dividend. This matter is considered in more detail in Topic 6;
transmission of shares – this is a transfer of shares effected by operation of law – for example, upon death (s 1072A), bankruptcy (s 1072B), or incapacity (s 1072D). The trustee in such cases is entitled to have his/her name entered on the register as the legal owner of the shares, but, again, these are held for the benefit of the persons entitled to such benefits. A trustee, in such case, does not become a member until his/her name is entered on the register – he/she need not cause this to be done. He/she can leave the shares registered – that is, in the name of the estate and transfer them directly to the beneficiary;
2.
becoming a member as a result of a company limited by guarantee converting to one limited by shares under s 167.
3.
every company must keep a register with the particulars in s 169 entered therein;
LAW00004 Company Law
Topic 4 The capacity of the company and its agents and the rights of its members | 57
4.6 Members’ statutory rights
Textbook 10th ed, Chapter 14, pp 423–465
4.6.1 Investigation by the ASIC and investigation of company records Section 247A allows a member to obtain a court order enabling inspection of company records by the applicant or another person, such as an auditor or legal practitioner.
Significant power is given to the ASIC by Part 3 of the Australian Securities and Investments Commission Act 2001 to investigate corporate conduct.
Textbook 10th ed, pp 433–434
Note Figure 14.2: Members’ legal rights and remedies, in Textbook 10th ed, p 464.
4.6.2 Variation of shareholders rights
Textbook 10th ed, pp 510, 526–529, 531–539
The Act in ss 246B–246F seeks to protect the rights of classes of shareholders against the unrestrained voting power of the majority, who may otherwise have been able to remove special rights given to specific classes of shareholders by alteration of the company’s constitution at a general meeting. The thrust of these sections is to require a special meeting of the class prior to any resolution at a general meeting. These provisions were found in ss 197–199 prior to the CLRA amendments.
The rights granted under the sections depend upon whether the company’s constitution make provision for the variation or cancellation of rights. If pro-vision is made, the variation of rights must be achieved in accordance with that provision: s 246B(1). Where there is no constitution, or no provision exists in the
the register must be open to inspection, without charge to a member and certain other categories or on payment of a fee by a non member: s 173(1). Any person (member or non member) may request, and be supplied with, a copy of the register or part thereof on payment of the appropriate fee: s 173(3);
the trustee, executor or administrator of the estate of a deceased person may obtain registration as such; in such case he/she assumes the same liability, but no more, as the deceased shareholder would have had: s 1072E(8). Except as provided in ss 1072E and 216B no notice of any trust shall be entered on the register: s 1072E(10);
section 172 deals with the location of the register of members and other registers required under the law.
Textbook
Textbook
Textbook
LAW00004 Company Law
Topic 4 The capacity of the company and its agents and the rights of its members | 58
company’s constitution, the procedure to be followed is prescribed by s 246B(2). A special resolution of the company is needed in favour of the variation and either a special resolution of the class of members or written consent of members with at least 75 per cent of votes in the class.
The new provisions widen the statutory meaning of ‘variation of rights’. For example protection is now offered to minority shareholders within a class of shares. Thus, where it is proposed to vary the rights of only some members of a class, such members will be treated as a separate class: s 246C(1). This will prevent members representing at least 75 per cent of a class from being able to vary rights of the remaining members without their consent.
Similarly if, in certain circumstances (basically where there has been no prior agreement to do so) a company with one class of shares issues new shares with rights different to the existing shares, this will be taken as a variation of rights under s 246C(5), as will a new issue of preference shares under s 246C(6).
The Act provides a right of application to the court to have the variation set aside unless the vote to vary was unanimous: s 246D. Within one month of the variation, cancellation or modification of the company’s constitution having been made, holders of not less than 10 per cent of the votes in the class affected can apply to have it set aside. The court may make such an order if it is satisfied that the variation, cancellation or modification would unfairly prejudice the applicants: s 246D(5).
This section works closely with the new requirement in s 246B(3) for a company to give notice of a variation or cancellation to any affected class member within 7 days of the variation. This will assist members to exercise their rights to apply to the court under s 246D.
Unless a variation receives unanimous consent under s 246E it will have not have effect until one month after it is made, but if there is an application to the court, the variation will not take place until that is dealt with: s 246D(3)
The Act provides certain other protections to members: Section 246F requires companies to notify the ASIC of any division or conversion of shares into classes. Public companies also have to lodge certain documents and resolutions dealing with the attachment, variation or cancellation of rights attached to shares: s 246F(3). Section 246G allows members to obtain copies of documents or resolutions referred to in s 246F(3).
Read carefully ss 246B–246G, and the case Gambotto v WCP Ltd considered in Topic 3; Textbook 10th ed, pp 427–432 & pp 510, 526–529, 531–539. Note that the judgment of Mason CJ, Brennan, Deane and Dawson JJ suggests that appropriation of shares might be available if the alteration secures the company from detriment, such as removing a shareholder who is competing with the company or one who is causing the company to breach ownership restrictions such as foreign ownership of a television station. However a majority could not appropriate ‘merely in order to secure for themselves the benefit of a corporate structure that can derive some new commercial advantage by virtue of the appropriation’.
The appropriation must be for a proper purpose, and fair in the circumstances, both in process and terms.
4.6.3 Correction of the register of members and refusal to register a transfer of shares without just cause These matters will be further considered in Topic 6. The relevant sections are ss 1071F and 175.
Reading
LAW00004 Company Law
Topic 4 The capacity of the company and its agents and the rights of its members | 59
4.7 Remedies available to minority shareholders A matter which will forever create difficulties in company law is the extent to which the voting power of the majority can be used to interfere with the rights, especially ownership rights, of the minority.
Can majority shareholders use voting power to expropriate the shares of the minority, or to refuse to declare a dividend, or to allow a minority shareholder to leave the company? We address these issues now and, to the extent that they relate to the exercise of directors’ powers, these matters are also considered in Topic 5.
4.7.1 The general law: Fraud on the minority We saw in Topic 3 that majority shareholders do not have unlimited power as to how they exercise their voting power. For example, Gambotto tells us that a majority could not expropriate the shares of the minority to secure for themselves the benefit of a corporate structure that can derive some new commercial advantage by virtue of the appropriation. The appropriation must be for a proper purpose, and fair in the circumstances, both in process and terms. Furthermore, the statutory power to amend the constitution must be exercised for a proper purpose and not oppressively.
Failure to do this may amount to a fraud on the minority: Gambotto v WCP Ltd (in Topic 3).
Note carefully that this does not relate to fraud in the criminal or tortious sense, though conduct amounting to a fraud on the minority could be criminal coincidentally. The classic example of a fraud on the minority is where the majority uses its voting power to expropriate the property of the company.
On the other hand, we would normally expect that the will of the majority should prevail and that the company itself should be the proper plaintiff in any legal action to enforce its rights. But what should be done where, for example, the directors also control majority voting power and obviously will not have the company proceed against themselves for breach of fiduciary duty or the law itself?
The law has to balance the conflicting principles discussed above. The next reading addresses these issues.
Read carefully Textbook 10th ed, pp 427–432 and p 435 noting especially fraud on the minority and the rule in Foss v Harbottle, (Foss v Harbottle [1843] EngR 478) the common law concept of a derivative action (but noting its replacement, see s 236–242 and s 236(3)) and s 1324 of the law.
4.7.2 Statutory remedies – oppression: ss 232–234
ss 232–234 and
Textbook 10th ed, pp 442–448
Textbook
Textbook
LAW00004 Company Law
Topic 4 The capacity of the company and its agents and the rights of its members | 60
Oppression The term ‘oppression’ was summarised by Olssen J in Popovic v Tanasijevic (No 5) [2000] SASC 87 [503] 1, (a case referring to s 61 Associations Incorporation Act 1985 (SA)), which is similar (although not identical) terms to ss 232–234). Olsson J said:
Oppression: ss 232–234 – Summary These sections go further than the common law.
Legislative history: Sections 232–234 are a slightly reworked version of s 246AA which previously was s 260. Section 260 was derived from s 320 of the Companies Code which in turn came from s 186 of Uniform Companies Act.
A resolution challenged under ss 232–234 might conceivably meet the test at common law of being adopted in good faith for a purpose within power, yet not meet the tests in ss 232–234.
This would be so if, according to ordinary standards of reasonableness and fair dealing, it unfairly imposed a disadvantage, disability or burden on a member. Cases which discuss this are considered below.
There is no need to point to:
Proof of oppression or unfairness must be shown; mere discrimination or prejudice is insufficient.
Textbook 10th ed, p 445 mentions the major High Court of Australia decision on oppression: Wayde v New South Wales Rugby League (“Western Suburbs case”) [1985] HCA 68; (1994) 180 CLR 459.
Wayde v NSW Rugby League Ltd [1985] HCA 68 was discussed by Besanko J in Millar v Houghton Table Tennis Sports Club Inc [2003] SASC 1 as a case where the board of directors of the League decided to reduce the number of teams in a competition it conducted. The Club (Wests) which was to be excluded, challenged the Board’s decision. The League had an article which gave the board of directors the power to determine the teams which took part in the competition. In the HCA ‘Brennan J wrote a separate judgment agreeing with the joint judgment of Mason ACJ, Wilson, Deane and Dawson JJ. Brennan J agreed with the observation of Richardson J in [Thomas v H W Thomas Ltd [1984] 1NZLR 686] that it is not necessary for a complainant under s 320 [Companies (NSW) Code, an earlier example of statutory oppression)] to prove any actual irregularity, invasion of his legal rights, or a lack of probity or want of good faith towards him.’
Note that in Wayde’s Case oppression was not proven. The decision taken to exclude Western Suburbs from the league was not such that no reasonable board could have taken it.
According to its normal meaning the word ‘oppression’ connotes the exercise of authority or power in a burdensome or unjust manner.
… As appears from authorities … the concept is not susceptible of precise, all embracing definition. At best, decided cases are illustrative of conclusions in specific fact situations … However, it may at least be said that the [focus is] on the effect of particular transactions sought to be impugned or management procedures adopted by those who are in de facto or de jure control. What is in contemplation is a notion of unfairness, according to ordinary standards of reasonableness and fair dealing.
Conduct complained of must be unjustly detrimental to either individual members specifically or, alternatively, members as a whole. It is not necessary to prove lack of bona fides, but conduct beyond power or in breach of statutory, legal or financial duty may well amount to oppression. …
any actual irregularity;
invasion of legal rights; or
lack of probity or good faith on the part of the controllers.
LAW00004 Company Law
Topic 4 The capacity of the company and its agents and the rights of its members | 61
In an earlier House of Lords decision, oppression was proven. This was in Scottish Co-operative Wholesale Society v Meyer [1958] 3 All ER 66.
A subsidiary company of Scottish was formed by Scottish and Meyer to exploit licences to manufacture rayon cloth. The respondent Meyer originally had the licence and the expertise. He had 3900 shares and Scottish had 4000.
The need for a licence was revoked and Scottish had little use for the subsidiary or for Meyer. It also refused to buy Meyer’s shares. He successfully brought an oppression petition, Scottish being forced to buy his shares.
The House of Lords thought that oppression amounted to a lack of probity or fair dealing in the affairs of a company to the prejudice of some portion of its shareholders.
It did not matter that the conduct complained of could also hurt the majority.
The conduct complained of under the section can be passive, for example by neglect of interests, or concealment of knowledge.
4.7.3 Statutory remedy – statutory derivative action
ss 236–242
Textbook 10th ed, pp 435–442
There now is a statutory derivative action; ss 236–242. They are contained in the Act in Pt 2F.1A Proceedings on behalf of a company by members and others.
Statutory derivative Action was discussed in Denis Cassegrain v Gerard Cassegrain & Co Pty Ltd [2008] NSWSC 976 by Sackville AJ at [7] as follows:
The main sections in Pt 2G.1A are:
Palmer J in Swansson v RA Pratt Properties Pty Ltd [2002] NSWSC 583 notes that:
Textbook
Prior to the Corporate Law Economic Reform Program Act 1999 (Cth) (CLERP), the entitlement of a minority shareholder to bring a so-called derivative action in the name of or on behalf of a company was governed by the rule in Foss v Harbottle, [1] and by the exceptions to that rule. [2] CLERP introduced Pt 2F.1A into the Corporations Law, now the Corporations Act.[3]
Section 236 – Bringing proceedings on behalf of a company; Section 237 Applying for and granting leave; and Section 241 General powers of the Court.
Pt 2F.1A is, by its terms, intended to keep a careful balance between facilitating the bringing of derivative actions, where the earlier rule in Foss v Harbottle and its exceptions were seen to create undue difficulty, and protecting a company from too ready and unwarranted interference in its internal management.[4]
LAW00004 Company Law
Topic 4 The capacity of the company and its agents and the rights of its members | 62
Sackville AJ in Denis Cassegrain v Gerard Cassegrain [2008] continued at 8 as follows:
It is important to note that s 236(3) provides that the statutory derivative action provisions displaces the rule and exceptions in Foss v Harbottle.
Section 237 specifies five criteria that must be satisfied for the court to grant leave. If any one criteria is not satisfied the Court must not grant leave.[5]
Section 241 gives the court broad discretionary powers to make any orders, and give any directions that it considers appropriate.
You are required to understand ss 236, 237 and 241.
A more in depth discussion can be found at Swansson v RA Pratt Properties Pty Ltd [2002] NSWSC 583.
4.7.4 Statutory remedy – injunction
Section 1324
Textbook 10th ed, pp 448–450
Section 1324 provides the Court with broad discretionary powers to grant an injunction.
An injunction is an order of the Court generally directing a person to refrain from doing or continuing an act or from omitting to do an act.
Where a person has engaged or proposes to engage in a contravention of the Corporations Act the Court may, on the application of ASIC or a person whose interest have been affected, grant an injunction on such terms as it thinks appropriate.
Section 1324 empowers a court to order a final or interim injunction and includes power for the Court or order that a person pay damages.
4.7.5 Statutory remedy – winding up by the court (Part 5.4A – other grounds) A dramatic remedy available to members is to have the company wound up.
Part 2F.1A provides for a member of a company and certain other persons to bring a derivative action in the name of a company (s 236(1)), but requires the person bringing the proceedings to obtain the prior leave of the Court (s 236(1)(b)). The right of a person under the general law to bring proceedings on behalf of a company has been abolished (s 236(3)).
Textbook
A petition may be presented to the court for a winding up order by any one or more of the parties set out in s 462.
1.
The circumstances in which the court may order a winding up are detailed in s 461. The cases below discuss these circumstances.
2.
LAW00004 Company Law
Topic 4 The capacity of the company and its agents and the rights of its members | 63
Textbook 10th ed, pp 451–454
In the reading note the important decisions, Ebrahimi v Westbourne Galleries Ltd [1973] AC 360 and Re Tivoli Freeholds [1972] VicRp 51, which outline the principles relevant to the court in making a determination as to whether a winding up should be ordered.
Read also Act ss 461–464 noting especially ss 461(1)(e), (f), (g) and (k)
4.7.5 Statutory remedy – procedural irregularity
Section 1322 and
Textbook 10th ed, pp 450–451
Generally, a proceeding required by the Corporations Act 2001 (Cth) is not invalid merely because of a procedural irregularity. However the Court has power to order that a proceeding is invalid if it is of the opinion that the irregularity has caused a substantial injustice which cannot be remedied by any other order; s 1322(2).
Textbook
Textbook
LAW00004 Company Law
Topic 4 The capacity of the company and its agents and the rights of its members | 64
Activity 4.3
James and Justin are the directors of a company. They are also its majority shareholders. The share capital of the Company is as to one quarter, preference shares and as to three quarters, ordinary shares. The preference shares have two votes attached to each share. The ordinary shares have one vote attached to each share. James and Justin between them hold all the preference shares. Johannes holds about half of the ordinary shares. The remainder of the ordinary shares are held by various shareholders other than James and Justin.
Johannes begins to buy up the remaining ordinary shares with the aim of becoming the controlling shareholder.
James and Justin become aware that Johannes had been a director of a ‘one man’ company which had become insolvent and eventually wound up two years ago. This venture had caused thousands of investors to lose small fortunes.
Subsequently James and Justin say that they have formed the following opinions about Johannes:
Later, alarmed at Johannes’ increasing voting strength with the consequent possibility of Johannes taking control of the company, the board of directors (James and Justin) resolve to issue to the present holders of preference shares one new preference share for each preference share already held by them.
Incensed and outraged, Johannes protests that the failure of his former ‘one person’ company was attributable to a credit squeeze which had been the downfall of numerous other companies in addition to his own, and moreover that the alleged opinions of the directors are erroneous and insupportable.
Contemporaneously with this, the directors on reasonable and justifiable grounds, decide that the company is in urgent need of additional capital. This need is also a factor in this decision to issue the new shares.
Johannes seeks a declaration from the court that the resolution of the board of directors is null and void. Discuss.
he lacks sound experience in management;
he is unreliable and erratic; and
his ability to make sound judgments is blinded by rapacious ambition.
1.
The directors of Ripitout Mining NL decide to sell a mine owned by the company to Lovingit Pty Ltd at a price which is substantially less than the real value of the mine. The majority of the shares in Ripitout Mining NL are owned by Lovingit Pty Ltd and the companies have common directors.
Tina is a minority shareholder in Ripitout Mining NL and wants to know what steps she can take to protect her interest. Advise.
2.
LAW00004 Company Law
Topic 4 The capacity of the company and its agents and the rights of its members | 65
Conclusion to Topic 4 In the next topic we will discuss the law relating to corporate management. We have concluded our analysis of the capacity of the company and its agents. We have also examined the rights of its members. Topic 5 is related to both of these matters. A director may have acted improperly by exercising powers he/she does not have, or by allowing the company to so act. Directors may have taken certain improper steps which have destroyed the rights of minority shareholders. This will have civil or criminal consequences. However, there is a much wider range of activities of individual directors, the Board and senior management which is subject to control at common law and under statute. Topic 5 will investigate this conduct.
1. [1843] EngR 478; (1843) 2 Hare 461; 67 ER 189. 2. see Scarel Pty Ltd v City Loan & Credit Corporation Ltd (No. 2) (1988) 17 FCR 344 at 347–350 per
Gummow J. 3. see Swansson v RA Pratt Properties Pty Ltd [2002] NSWSC 583; (2002) 42 ACSR 313 at 317
[19]–[20] per Palmer J. 4. Swansson v RA Pratt Properties Pty Ltd [2002] NSWSC 583 per Palmer J at para 22 5. Goozee v Graphic World Holdings Pty Ltd [2002] NSWSC 640; (2002) 42 ACSR 534 at [27] per
Barrett J cited in Denis Cassegrain v Gerard Cassegrain & Co Pty Ltd [2008] NSWSC 976 per Sackville AJ at 69.
LAW00004 Company Law
Topic 4 The capacity of the company and its agents and the rights of its members | 66
Topic 5
Management
In any company it is very important to examine the rights, powers and duties of those in control including its directors and senior employees. This topic will also cover certain procedural rules relating to management and company meetings.
Objectives To successfully complete your study of this topic you will need to:
Textbook 10th ed, Chapter 6, pp 147–180
5.1 The company secretary – appointment, role and responsibilities
Textbook 10th ed, p 164
Note also s 188 and the sections referred to in s 188(1)
There is a requirement that a public company has one or more secretaries, one of whom ordinarily resides in Australia: s 204A(2).
A proprietary company is not required to have a secretary: s 204A(1).
A secretary must be an individual at least 18 years of age who is not disqualified from managing a company: s 204B.
be aware of the provisions of the Act relating to appointment and dismissal of directors;
be able to describe the role and responsibilities of the company secretary;
have considered in detail the role and responsibilities of company directors, executive officers and officers of corporations;
be aware of the provisions of the Act relating to the registered office;
be familiar with the provisions relating to the types of meetings, the calling of meetings, rights to demand a poll, the appointment of proxies, minutes and quorums; and
describe and discuss any proposals to reform this area of law.
Reading
Textbook
67
A secretary faces particular liability under ss 142, 145 and 205B, furthermore, the term ‘secretary’ is included in the definition of officer in s 9 and often will be an employee. Secretaries are specifically named in s 182(1) but why this has been done, given the s 9 definition, is not clear.
5.2 Definitions, appointment, removal and disqualification of directors
5.2.1 Role and definition of a director
As to the role of the Board of Directors and the division of power between the Board and the general meeting see Textbook 10th ed, pp 153–154 and 161–162.
You are required to understand the definition of a director.
The term ‘director’ is defined in s 9 (the ‘dictionary’ section of the Corporations Act as follows:
On appointment and removal of directors read Textbook 10th ed, pp 162–165 168–170 and the sections referred to below.
Textbook
‘director’ of a company or other body means:
Subparagraph (b)(ii) does not apply merely because the directors act on advice given by the person in the proper performance of functions attaching to the person’s professional capacity, or the person’s business relationship with the directors or the company or body.
Note: Paragraph (b) – Contrary intention – Examples of provisions for which a person referred to in paragraph (b) would not be included in the term ‘director’ are:
a person who:
regardless of the name that is given to their position; and
is appointed to the position of a director; ori. is appointed to the position of an alternate director and is acting in that capacity;ii.
a.
unless the contrary intention appears, a person who is not validly appointed as a director if: they act in the position of a director; ori. the directors of the company or body are accustomed to act in accordance with the person’s instructions or wishes.
ii.
b.
s 249C (power to call meetings of a company’s members)
sub-s 251A(3) (signing minutes of meetings)
s 205B (notice to ASIC of change of address).
Textbook
LAW00004 Company Law
Topic 5 Management | 68
5.2.2 Appointment of directors In your reading you should have noted the following in regard to the appointment of directors:
5.2.3 Removal of directors Section 203D allows the removal of a director of a public company before his/her term of office expires. Note the following summary.
Summary
Only a person 18 years or older who has not been disqualified from managing corporations under Pt 2D.6 may act as a director: s 201B. A proposed director must consent to act as a director: s 120.
1.
Every public company must have at least three directors, two of whom must ordinarily reside in Australia. A proprietary company must have at least 1 director, and at least one director must ordinarily reside in Australia: s 201A.
The numbers of directors so specified are minimum requirements, and a company, by its Constitution, may provide for a greater number of directors. A company cannot be a director of another company.
In relation to the appointment of directors, see also replaceable rules 201F, 201G, 201H, 201J and 201K.
2.
The procedure for the appointment of directors is normally set out in the Constitution, which may also provide the method of retiring directors in rotation, even though typically under the Constitution, such retiring directors may offer themselves for re-election. The Constitution may also require a share qualification.
Previously where there was a share qualification required by the Constitution it had to be obtained within two months or such shorter period as fixed by the Constitution, or the director would have been required to vacate his/her office: s 223 (since repealed). Now, a director, failing to obtain his/ her qualification, will face whatever penalty is provided in the Constitution for not obtaining the qualification, most likely loss of office. There is no statutory requirement that a director be a member of a company.
3.
Public companies: special provisions: A single resolution may not be used, in a public company, for the appointment of two or more persons as directors, unless there is first a unanimous vote agreeing thereto. In other words, each appointment is made by a separate resolution. This does not apply where the election is conducted by poll: s 201E.
4.
The acts of a director, manager or secretary are valid notwithstanding any defect that may afterwards be discovered in his/her appointment or qualification: s 201M.
5.
The power to remove given by s 203D overrides any provision in the company’s Constitution or any agreement with the company. However, where the removal is in contravention of an agreement the removed director may have a claim for damages for breach of contract. Note s 200B(1) and s 200F(a) (ii).
1.
Where the director to be removed represents a class of shareholders or debenture holders, the removal will not take effect until a replacement director is appointed: s 203D(1).
2.
Where the vacancy resulting from the removal of a director is not filled at the same meeting, the vacancy may be filled as a casual vacancy. In such a case, the director appointed will normally hold office only to the next Annual General Meeting. A director appointed at the removal meeting would normally holds office for the remainder of the term of the director whom he/she replaces: s 203D(7).
3.
LAW00004 Company Law
Topic 5 Management | 69
5.2.4 Disqualification of directors
Textbook 10th ed, pp 170–173 and the sections referred to below.
Section 206A prohibits the following persons from taking part in the management of the company, as broadly defined in s 206A, except with leave of the court under s 206G:
As well as the above statutory disqualifications, the company’s Constitution may provide for circumstances in which the office of a director will become vacant. In this case the provisions of the company’s Constitution will supplement the Act.
5.3 Directors’ duties – duty of care, skill and diligence
Textbook 10th ed, Chapter 11, pp 291–364
The procedure for removal of a director of a public company must be strictly followed:
The effect of the above procedure is that a director of a public company may only be removed by resolution of the company in general meeting. The board of directors of a public company has no power, irrespective of any provision in the company’s Constitution, to remove a director from office: s 203E.
Removal of directors in a proprietary company will be in accordance with the company’s Constitution: see replaceable rule s 203C.
an ordinary resolution is required of which 21 days notice is given: s 249H(3). Notice cannot be reduced under s 249H(1), this allows the director time to exercise his/her rights. Because it is an ordinary resolution, only a simple majority is required to pass the resolution;
notice of intention to move the resolution has to be given two months before the meeting s 203D(2);
a copy of the resolution shall forthwith be sent to the director concerned: s 203D(3);
the director has a right to make written representation which should be sent by the company to every member: s 203D(4);
the director is entitled to speak on the resolution at the meeting: s 203D(4).
4.
Textbook
an undischarged bankrupt: s 206B(3);
a person convicted of certain offences under s 206B;
a person against whom the ASIC has obtained a disqualification order from the Court under s 206C, 206D or 206E; and
a person whom the ASIC has disqualified from managing corporations following liquidators’ reports under s 533(1).
Textbook
LAW00004 Company Law
Topic 5 Management | 70
5.3.1 Directors’ general law duties – care and diligence
Textbook 10th ed, pp 292–293, 299–300, and especially 312–336 and note Figure 11.3 (p 336)
The reading above may have convinced you that life can be very tough for a director. Surprisingly, the law has not developed duties of care and diligence to parallel the rigorous nature of the fiduciary principle. Thus, while a director must be scrupulously honest, he/she does not have to have skill levels of the highest order:
Note that the above propositions were established in Re City Equitable Fire Insurance [1925] Ch 407.
In your reading take note of the expected standard of care and skill and diligence requirements.
5.3.2 Directors’ statutory law duties – care and diligence
Chapter 2D of the Act, esp ss 179–180 and 185
You should understand that ss 179–180 have very wide application and expand on the City Equitable principles discussed above. Carefully read these sections and analyse what must be proven, and the remedies provided in Pt 9.4B of the Act for contravention of the civil penalty provisions.
Note well:
Section 180 use the term ‘director or other officer’. (Refer to the terms ‘Director’ and ‘officer’ as defined in the ‘dictionary’ in s 9.)
Textbook
Skill: the degree of skill required varies with the qualification of the director and the business of the company. The general attitude of the common law to the skill required of a director is that he/she should act with such care as is reasonable to be expected from a director, having regard to his/her knowledge and experience. He/she is not expected to exercise a skill which he/she does not have, but if the director is an expert in a certain area he/she is expected to use his/her knowledge for the benefit of the company.
Diligence: the degree of diligence required depends on the circumstances, but there is a necessity to exercise care and discretion. In many cases the position of a director has been likened to that of a trustee, and consequently he/she should have a knowledge of those facts which are necessary for carrying out the business of the company. However, a director, unless he/she is also an executive of the company, is not required to give continuous attention to the affairs of the company. He/she will satisfy the requirements of his/her office if he/she attends board meetings, and committee meetings of those committees of which he/she is a member.
Reading
s 180 is civil;
the business judgment rule in s 180(2); and
the sections do not limit the common law: s 185, but note s 185(b) re s 180.
LAW00004 Company Law
Topic 5 Management | 71
Section 180 – Directors’ statutory duties – care and diligence & the business judgment rule
Textbook 10th ed, pp 345–352
As noted above, an officer has a duty to act with the degree of care and diligence described in s 180(1), in accordance with business judgment as defined in s 180(2).
You are required to read and understand the statutory duties imposed on company directors by virtue of s 180.
5.4 Directors’ general law duties – good faith and proper purpose and conflict of interest
Textbook 10th ed, Chapter 12 pp 367–385 and ss 181, 184, 185 and 187
Textbook 10th ed, Chapter 13 pp 387–420 and ss 182, 183, 184 and 185
Directors owe duties of good faith and loyalty because they are in a ‘fiduciary relationship’ with their company.
A fiduciary relationship is the relationship between a person in a position of trust, (the fiduciary), and the person for whose benefit the fiduciary acts (the principal).
Directors of a company are in a fiduciary relationship with the company; Mills v Mills [1938] HCA 4; (1938) 60 CLR 150 (Dixon J).
There are numerous decisions in which the extent of the duty of a director has been considered by the courts. The starting point is that a director is a fiduciary.
Fiduciary responsibility: he/she has a duty to act in good faith in the interests of the company in all circumstances, and consequently must be careful that his/her personal interests do not conflict with his/ her duty as a director.
There are a number of fundamental obligations which follow from the fact that a director is a fiduciary:
In your reading of the cases that follow you should pay particular attention to these applications of the fiduciary principle. Note also that while shades of dishonesty may be apparent in some cases, such as Cook v Deeks [1916] UKPC 10; this is not fundamental to establishing a breach of fiduciary duty. For example in Regal (Hastings) Ltd v Gulliver [1942] UKHL 1 the directors appeared to be acting in the best interests of the
Textbook
Textbook
the obligation to act bona fide in the interests of the company;
the obligation to use powers for their proper purpose; and
the obligation to avoid conflicts of duty.
LAW00004 Company Law
Topic 5 Management | 72
company as they saw it. A similar comment could be made of Whitehouse v Carlton [1987] HCA 11 and Howard Smith Limited v Ampol Petroleum Ltd [1974] UKPC 3. Yet in all these cases the directors were found to have breached their duties. You must ascertain why that was the case.
On the obligation to act bona fide in the interests of the company: Textbook 10th ed, pp 380–382
On the obligation to use powers for their proper purpose: Textbook 10th ed, pp 376–380
Howard Smith Limited v Ampol Petroleum Ltd [1974] UKPC 3; (1974) AC 821
In Howard Smith v Ampol Petroleum Ampol and an associated company Bulkships wanted to takeover Millers. Howard Smith also was keen to get control of Millers. The directors of Millers issued shares to Howard Smith and in effect encouraged Howard Smith to make a rival takeover offer. Millers needed additional capital at the time, and had received advice that it should borrow rather than issue more shares.
Held: Directors had exceeded their powers in making the share issue and had breached their duty of good faith towards the company. The use of the fiduciary power for the purpose of altering voting power was invalid. The court looked to the prime motive behind the share issue and found it was not to raise funds, but to defeat a takeover. The share issue was therefore invalid. See the discussion in this case between the primary and subsidiary motives behind directors’ actions.
The Privy Council also noted that self-interest is not the only example of improper motive.
This provided the additional £3000 required. The board of the subsidiary and Regal (Hastings) Ltd agreed to this method of raising finance. Later the sale of the cinemas went ahead but by sale of the shares in the two companies. Thus a profit of 2 pounds per share was made by the above parties.
The purchaser of the companies sought to recover this profit.
Held: The four directors had made the profit in breach of their fiduciary obligations and were liable for an account of profits. The solicitor was not liable. The chairman was not liable because he did not profit personally.
Furs sued seeking a declaration that Tomkies held the shares as trustee for it and for payment of $8000 to it. These remedies were granted.
Textbook
On the Obligation to Avoid Conflict of Interests. Ciro & Symes, pp 270–274
Regal (Hastings) Ltd v Gulliver Regal (Hastings) Ltd owned a cinema. It wished to acquire two others in the same town and then sell the lot as a going concern. It formed a subsidiary to acquire the cinemas. The subsidiary required £5000 but could only raise £2000. Thus:
Four directors of Regal (Hastings) Ltd took 500 shares. Regal (Hastings) Ltd’s Solicitor took 500 shares. Persons nominated by chairman of Regal (Hastings) Ltd took 500 shares.
Another relevant case (not in the Textbook) is Furs Ltd v Tomkies [1936] HCA 3; (1936) 54 CLR 583. Tomkies, the managing director of Furs Ltd, while negotiating the sale of its tanning business, also negotiated for himself a job as manager of the buyer’s business. He knew the secret processes and was obliged to disclose these to the buyer as part of his new employment. This would have rendered the processes valueless to Furs. Tomkies’ contract entitled him to receive shares in the buyer, $8000, and an annual salary. He did not disclose the making of these benefits.
LAW00004 Company Law
Topic 5 Management | 73
Rationale: No director shall obtain for himself/herself a profit by means of a transaction in which he/she is concerned on behalf of the company unless all material facts are disclosed to the shareholders.
Undisclosed profits belong in equity to the company. It does not matter that the company could not have made the profits itself.
Summary of a director’s fiduciary obligations A director has an obligation to act in good faith, honestly for the benefit of the company as a whole. More specifically he/she must:
5.5 Directors’ statutory law duties – good faith and proper purpose and conflict of interest
Textbook 10th ed, pp 381–382
You should understand that ss 181–185 have very wide application and expand on the fiduciary principles discussed above. Carefully read these sections and analyse what must be proven, and the remedies provided in Pt 9.4B of the Act for contravention of the civil penalty provisions.
Note well:
Like s 180, ss 181–183 use the term ‘director or other officer’ which expands the application of the statutory law further than that of the general law (refresh your memory and refer to the terms ‘Director’ and ‘officer’ as defined in the ‘dictionary’ in s 9).
Section 181 describes the fiduciary obligation to act in good faith in the best interests of the corporation for proper purposes, and gives it statutory force.
Section 182 prevents the improper use of position.
Section 183 prevents the improper use of information.
Sections 180–183 are civil penalty provisions and give rise to various forms of liability, described later under the heading ‘Civil Penalty Compensation Orders’.
use powers for proper purposes;
avoid actual and potential conflicts of duty;
not make gains from office without full and complete disclosure;
not make improper use of property or confidential information of company without full and complete disclosure; and
not compete with the company without full and complete disclosure.
Textbook
some sections are only civil: ss 181–183;
s 184 is criminal; and
the sections do not limit the common law: s 185.
LAW00004 Company Law
Topic 5 Management | 74
Section 184 traverses the ground covered in ss 181–183 but, unlike those sections, s 184 is a criminal section, note the mens rea, reckless or intentionally dishonest.
You are required to read and understand the statutory duties imposed on company directors by virtue of ss 181–185.
5.6 Executive officers: Role and responsibilities
Textbook 10th ed, pp 338
The Act includes provisions which apply to those below the level of directors in corporations. In many instances these people have duties and obligations which are indistinguishable from those of directors. Many of these employees do not realise the potentially onerous position they are in under the law and at common law.
5.7 Directors’ statutory obligations Section 187 seeks to clarify the question, ‘to whom is the duty owed?’ for directors of wholly owned subsidiaries.
Section 189 allows reliance on others in the circumstances described in the section.
Section 190 and 198D let a director delegate powers and in certain circumstances avoid liability for actions of the delegate. See s 190(2).
In addition to the duties discussed above, there are a large number of statutory duties imposed on directors by the Corporations Act, sometimes by specific provision that a certain act must be done by a director, and more generally under a provision relating to officers (which of course, includes directors). These are considered in relation to the specific area with which they are concerned.
Disclosure of interests in contracts – public and proprietary companies
Textbook 10th ed, pp 402–407
A director of a company who has a material personal interest in a matter that relates to the affairs of a company must give the other directors notice of the interest: s 191(1).
Section 192 allows for the giving of a standing notice.
Section 193 ensures that the company’s Constitution and the general law continue to apply. This will be important where either provides for higher standards.
Section 194 is a replaceable rule and only applies to proprietary companies. In certain circumstances a director may vote on matters despite having an interest.
Textbook
Textbook
LAW00004 Company Law
Topic 5 Management | 75
Section 195 prohibits directors of public companies with material personal interests from being present or voting except in the very limited circumstances described.
As to the effect of non disclosure see s 195(1).
Related party transactions
Textbook 10th ed, pp 407–408
Chapter 2E of the law, and note the facts in ASIC v Adler (Textbook 10th ed, pp 408–409)
ASIC v Adler & 4 Ors [2002] NSWSC 268
The law relating to loans to directors has now grown into a complete chapter in the Law. Chapter 2E aims to prevent public companies from entering into uncommercial transactions with related parties.
The general rule is stated in s 208 which requires:
Sections 210–216 list various exceptions. Examine these carefully.
Disclosures A director of a listed company has an obligation to make certain disclosures to the stock exchange. These include securities in which a director has a relevant interest and certain contracts relating to shares, debentures and interests: see s 205G.
Payment for loss of office In general, a director is not entitled to payment for loss of office unless particulars of such payment have been disclosed to, and approved by, a general meeting of the company: ss 200B, 200E.
Contracting out of liability Generally a company cannot exempt an officer or auditor out of any liability to the company incurred as an officer or auditor: s 199A(1). But certain indemnities and insurances are allowed. Carefully examine the exceptions.
Insider trading
Textbook 10th ed, pp 659, 662–666
Textbook
member approval (the mechanics of this are strict see ss 217–227);
of any financial benefits (defined in s 229); and
to related parties (defined in s 228).
Textbook
LAW00004 Company Law
Topic 5 Management | 76
A person suffering loss as a result of dealing in securities of the corporation, where the director (or officer) used confidential information to his/her own advantage in such dealings may have an action against that person. This is known as insider trading. The relevant provisions are ss 1042B to 1043O of the Act, but see especially s 1043A.
Corporations Act, ss 1042B–1043O
Duty to have regard to the interests of creditors There is a duty owed by directors to have regard to the interests of creditors when the company is insolvent or where there is a real risk of insolvency: Kinsela v Russell Kinsela Pty Ltd (in liq.) (1986) 10 ACLR 395.
Textbook 10th ed, pp 373–374
The decision in Grove v Flavel (1986) 43 SASR 410 is mentioned in Textbook 10th ed, p 374. This case is important in establishing the proposition that shareholders cannot ratify a transaction whereby the interests of creditors are at risk. It is described below:
While the developments in the common law create an obligation on the directors to have regard to the interests of creditors it would seem the law has not yet reached the stage where a creditor can sue the director for breach of that duty. The general proposition at common law is that a director owes his/her duties to the company and not to the shareholders or outside parties.
The important recent developments in this area are incurring under statute law. Section 588G gives a liquidator, in certain circumstances, a right of action against a director and certain other officers. We will consider this critical section and the insolvency cases shortly.
Reading
Textbook
Grove, the director of BGC, obtained information by virtue of his position as director that the company was in financial difficulty. Grove was an unsecured creditor of BGC. BGC repaid these amounts as part of a series of transactions thereby reducing the risk of all ‘internal’ creditors including himself. Such creditors became creditors of a secure member of the group rather than creditors of BGC. Grove was prosecuted for a criminal offence under s 124 of the Uniform Companies Act (an early forerunner to s 182, but note that s 182 is no longer criminal. The criminal offence is now contained in s 184 which was substantially reworded by the CLERP Act.) It was argued that he made improper use of information acquired as an officer. Held: He was in breach of the section. Rationale: A director of a company who acquires information which leads him/her to believe the company faces a real and not remote risk of liquidation who then acts to protect him/herself from that risk to the possible detriment of its creditors is acting improperly as a director.
LAW00004 Company Law
Topic 5 Management | 77
5.8 Directors’ statutory duties – insolvent trading
Textbook 10th ed, pp 352–354, 356–358
Read s 588G and s 588H
Directors have a statutory duty to prevent insolvent trading by the company: s 588G. This provision is contained in Pt 5.7B which commenced on 23 June 1993. A director is liable if:
Note the meaning of the terms ‘solvency’ and ‘insolvency’: s 95A.
Regarding the law on insolvency see Tru Floor Service Pty Ltd v Jenkins (No 2) [2006] FCA 632 per Sunberg J at 43–48, http://www.austlii.edu.au/au/cases/cth/federal_ct/2006/632.html.
The director will be liable to compensate the company for any loss (see below).
Compensation to the company On an application for a civil penalty order the court may order the director to pay compensation to the company: ss 588J.
A liquidator may recover from a director compensation for any loss suffered by a creditor where the director has breached s 588G. This section applies whether or not the director has had a civil penalty order made against him/her or has been convicted of an offence: s 588M.
Action by creditor A creditor may, only with the written consent of the liquidator, bring proceedings against the director under s 588M: ss 588R, 588S. A creditor may take action to obtain compensation without the liquidator’s consent with the leave of the court: s 588T. Certain events may prevent the creditor from taking action: s 588U.
Defences In proceedings for a contravention of s 588G, a director may rely on the defences contained in s 588H:
Textbook
at the time the company incurs a debt;
the company is insolvent (or becomes so);
at that time there are reasonable grounds for suspecting that the company is insolvent (or would become so);
the director fails to prevent the company incurring the debt; and
the director is aware that there are grounds for so suspecting or a reasonable person in such circumstances would be so aware.
the general defence is that the director had reasonable grounds to expect and did expect that the company was solvent;
specifically, this defence could be available where the director expected on the basis of information given to him/her that the company was solvent. The information must be given by a competent and reliable person who was responsible for providing information about whether the company was solvent;
LAW00004 Company Law
Topic 5 Management | 78
Note that amounts recovered under ss 588J, 588K, 588M and 588W are not available for payment to certain creditors: s 588Y.
5.9 Civil penalties and compensation orders
Textbook 10th ed, pp 308–310; Table 11.3 (p 310) and pp 397–398
The Act contains a range of sections, breach of which is civil rather than criminal, which give rise to the payment to the Commonwealth of large pecuniary penalties, up to $200 000. The civil standard of proof applies.
Section 1317E lists the sections to which the civil penalty regime applies; note in particular ss 180–183, 209, and 588G.
Obviously s 184 is not included because that section is criminal.
Breach of these sections may also give rise to a claim for compensation by a corporation damaged by the conduct: s 1317J, and see also s 1317H, but note the defence in s 1317S.
These sections do not remove rights that the corporation may have to claim compensation or an account of profits or some other remedy for a breach of a director’s or other officer’s duties under the general law.
5.10 Criminal penalties
Textbook 10th ed, pp 399–402
5.11 Ratification and exculpation of breaches of duty
Textbook 10th ed, pp 410–415
It is generally possible to ratify a breach of director’s duty by resolution at a general meeting of company members unless this would amount to a fraud on the minority: Furs Ltd v Tomkies (above).
the director was ill, or for some other good reason, and did not take part in management;
the director took reasonable steps to prevent the debt being incurred.
Textbook
Textbook
Textbook
LAW00004 Company Law
Topic 5 Management | 79
Ratification may even be possible for an improper exercise of power not yet performed: Winthrop Investments Ltd v Winns Ltd [1975] 2 NSWLR 666.
For ratification to be valid there must be full disclosure and the interests of creditors must not be at risk: Kinsela v Russell Kinsela Pty Ltd (in liq) (1986) 4 NSWLR 722
Note that the common law will be subject to Pt 2D.2, see especially s 199A.
Consider also the possibility of s 1318 relief, where the officer has acted honestly. But this section only applies to civil proceedings for negligence, default, breach of trust or breach of duty.
Summary: Remedies for breach of duty We have discussed a number of areas of law above. The following provides a non-exhaustive statement of the remedies that various parties may have at common law or under the statute:
Company
Remedies under common law and equity:
Civil remedies are provided under the Act, such as s 1317J.
In Winthrop Investments Ltd v Winns Ltd the directors of the offeree company (Winns), with the object of defeating a takeover, entered into negotiations re a merger with a third company involving the purchase of retail stores and the issue of shares to partly cover that investment. A meeting of the shareholders of Winns approved this. The NSW Court of Appeal accepted that the general meeting could, if given sufficient information (proper and full disclosure), ratify actions taken by the directors of a company, notwithstanding that the directors were in breach of their duty to the company. If, however, the ratification amounted to a fraud on the minority, it would be invalid. It would be a fraud on the minority if the majority in voting were not acting for the benefit of the company as a whole. Two judges also thought that prospective ratification could be obtained. Held: On the facts, insufficient disclosure was made and therefore the ratification was bad.
An insolvent company, in a state of imminent collapse entered into a transaction which had and was intended to have the effect of placing its assets beyond the reach of its creditors. This was done by the granting of a lease in commercially questionable terms over its premises to two of its directors. The liquidator challenged the lease. Held: The lease was entered into by the directors (with full approval of its shareholders) in breach of their duty to the company in that it directly prejudiced the creditors of the company. The lease was therefore voidable by the liquidator. Significance: The judgment limits the power of the shareholders to ratify transactions. They cannot ratify a breach where the interests of creditors are ‘at risk’.
Once it is accepted … that the directors’ duty to a company as a whole extends in an insolvency context to not prejudicing the interests of creditors … the shareholders do not have the power or authority to absolve the directors from breach. (per Street CJ)
compensation;
account of profits;
rescission of contracts;
declaration of trust.
LAW00004 Company Law
Topic 5 Management | 80
Members (see also Topic 4)
They have few remedies at common law because of the rule in Foss v Harbottle, but note the exceptions including fraud on the minority.
Members remedies under statute include:
Creditors
Major remedy is to petition for winding up and rely on the liquidator to proceed, but there are some limited remedies under s 588G via s 588R.
ss 232–234 oppression;
s 461 winding up;
s 1324 injunction;
the statutory derivative action in ss 236–242.
LAW00004 Company Law
Topic 5 Management | 81
Activity 5.1
A, B, C, D, and E are directors of Y Ltd, a public company limited by shares. E continually disagrees with the other directors. The number of directors under the Constitution is six, and the board of directors appoints F to fill the casual vacancy. The Annual General Meeting is due to be held within the next three months. A and B are due to retire at this time but are eligible for re-election. The other directors would like to replace E as a director. On these facts advise D generally as to the action that must, or may, be taken at the Annual General Meeting.
1.
Z is a director of B Ltd, a public company, and on 1 April, gave notice in writing to the secretary that he holds 51 per cent of the issued capital of C Pty Ltd. On 30 April the board of directors of B Ltd discussed buying a parcel of land from C Pty Ltd and at that meeting the secretary did not bring to the attention of the board the notice received from Z. Z was also present at that board meeting, and because no decision was made regarding the land did not disclose his interest in C Pty Ltd. On 15 April Z had purchased additional shares in C Pty Ltd so that he now holds 60 per cent of the issued capital. Z thinks that a decision on the purchase of the land will be made at the next board meeting. Z consults you on his position. Advise him.
2.
M Ltd is a public company with an issued capital of 100 000 ordinary shares of $1 called to 60 cents. On 1 July the directors pass a resolution calling up a further 20 cents per share payable on 31 July. P is a shareholder in M Ltd holding 20 000 ordinary shares. On 25 July he consults you, and informs you that X and Y, two of the directors of M Ltd who voted on the resolution with respect to the call have not satisfied the share qualification requirement of their appointment. P seeks your advice on his liability for payment of the call. Advise him.
3.
LAW00004 Company Law
Topic 5 Management | 82
Cash Ltd is a public company incorporated under the Corporations Act. It uses all relevant replaceable rules in the Act.
At a general meeting of the company, a member alleges that the company’s security arrangements are so lax that any employee could easily steal large sums of money from the company. The director of the company who is in charge of security denies the allegation. The member moves a resolution requiring the Board of Directors to re-allocate the functions and responsibilities of each of the directors so as to ensure that a director, other than the present one, is in charge of the company’s security arrangements. This resolution is passed by a simple majority.
The Chairman of the Board states that he intends ignoring the resolution. He says that he and his fellow directors know what is best for the company and they will allocate the managerial functions of the company as they see fit.
At a meeting of the Board held the next day the resolution is discussed. All the directors know that there is a great deal of substance to the allegations behind the resolution, but they agree that a united stand is important.
However, as ‘a sop to the stirrers’ amongst the members of the company, it is decided to present them with a symbolic sacrifice. Accordingly, the Chairman of the Board moves at a directors’ meeting that the director who is in charge of the company’s security arrangements be dismissed. This motion is passed.
Discuss the legal principles applicable to each of the events which have occurred.a. Does the dismissed director have any remedies against:
If so, what are those remedies?
the directors of Cash Ltd; and
Cash Ltd?
b.
The member who had moved the resolution in the general meeting petitions the court under ss 232–234 claiming that the affairs of the company are being conducted in an oppressive manner. In the petition she asks the Court, pursuant to its powers under ss 232–234 to direct the Board of Directors to implement the resolution of the Company in general meeting. Will her petition be granted?
c.
4.
LAW00004 Company Law
Topic 5 Management | 83
5.12 The registered office The major provisions of the Act in relation to the registered office are:
Trans National Holdings Pty. Ltd. is a Sydney-based company owning 15 hotels throughout Australia. Harrison and Whitelaw, the two directors of the company, respectively own 30 per cent and 25 per cent of the issued shares. The remaining shares are owned by a variety of companies and persons one of whom is Sam who owns about 10 per cent. Sam, a retired accountant, had invested his superannuation money in the company and relies on his dividend as the principal source of his income. For the past two years the company has not declared any dividend. This had occurred after the majority, in company general meetings, had defeated resolutions aimed at forcing the declaration of a dividend. Sam, who has been privately investigating the company, discovers that three years ago the company entered into an agreement with Harrison and Whitelaw whereby they were each to be paid each year, in addition to their salaries, a sum of money described as ‘directors’ incentive payments’, which sum was stated to be 20 per cent of the gross profits. Harrison and Whitelaw sell most of their shares to Northern Minerals NL which has allowed them to remain as the directors of Trans National Holdings Pty. Ltd. One week later the Board of Trans National Holdings Pty. Ltd. announces that it has sold the company’s 15 hotels and has invested the proceeds in exploration for diamonds.
What proceedings can Sam take against Trans National Holdings Pty. Ltd or any other party having regard to the case and statute law?
5.
Black and Small are directors of Company X and whilst visiting the company’s secretary’s office saw a typewritten report which, amongst other things, forecast an increase in the value of the company’s assets. Black knew that the statements were false and misleading but Small believed them to be true. They both agreed that they would use the document to promote interest in the company and to encourage prospective purchasers of a new issue of shares in the company which were about to be placed on the market. The document did in fact then become a part of the company’s prospectus. Black did not reveal that he knew the report to be false and misleading. Jones is a friend of Black and Small. Both Black and Small encouraged Jones to buy shares in the company by outlining the details of the report when showing Jones the prospectus. Jones then decided to purchase the shares in the company because of the encouragement of Black and Small. Small then discovered that the statements were false and misleading but decided to take no action whatever. Jones purchased the shares. Instead of increasing in value the new issue of shares dropped well below par.
Discuss the relevant principles of law and appropriate authorities to determine what action(s), if any, could be taken against Black and Small and the remedies, if any, which are available.
6.
What obligations are imposed on directors of insolvent companies? Describe the test of insolvency used in the relevant sections.
7.
a company is required to have a registered office in Australia: s 142(1);
the address of the registered office must be lodged with the application to register the company: s 117(2) (g);
this office must be open to the public during prescribed hours: ss 145;
the importance of the registered office is that service of notices and documents may be effected by delivery or posting to the registered office of a company: s 142(1);
the name of the company must be displayed at every place of business that is open to the public: s 144(1);
LAW00004 Company Law
Topic 5 Management | 84
5.13 Meetings and proceedings
Read Chapter 2G.1–2G.3 of the Act
Then read Textbook 10th ed, Chapter 10, pp 257–284
The overall control of a company is exercised by the members of the company in general meeting but the business of the company is normally managed by the directors: s 198A. To a large extent the rules governing the conduct of meetings is provided by the company’s Constitution, and where these do not conflict with the provisions of the Act they will be followed.
The scheme of the Act, with respect to meetings, is to lay down certain meetings which must be held by a company, and to provide certain rights to members with reference to company meetings. These provisions may not be overridden by the Constitution, unless they are in the form of replaceable rules.
This particular chapter of the Act has a significant number of replaceable rules, a number of which have been borrowed from the old Table A articles.
Provisions of the law on meetings
a public company must prominently display the words ‘Registered Office’ at its registered office: s 144(2).
Reading
Types of company meetings:
The former requirement for a statutory meeting for a public company was repealed by CLRA.
annual general meeting;
general meeting.
1.
Resolutions. Provision is made for the following resolutions: special resolution: this requires at least 75 per cent of the votes cast by members entitled to vote. See s 9 for definition;
ordinary resolution: this requires a simple majority of the votes cast by members entitled to vote.
2.
LAW00004 Company Law
Topic 5 Management | 85
Notice: 21 days notice of a meeting of company members is required under s 249H, unless:
Written notice must be given to members and directors individually: s 249J.
The contents of the notice are described in s 249L. Under s 249L(3) the notice must be worded in a clear, concise and effective manner.
Provision is made for an ordinary resolution of which special notice is given. This type of resolution is used for the removal of a director of a public company or an auditor: ss 249H(3) and (4). The effect of the special notice is that notice cannot be reduced in time under s 249H(1). This allows the director or auditor sought to be removed to exercise his/her rights: s 203D (directors of public companies); s 329 (auditors). A simple majority is required to pass the resolution.
Every member of the company, having a right to attend, must receive notice of the meeting. However, the accidental failure to give notice to any member will not automatically invalidate the meeting. The position is that a meeting is assumed to be valid, so that any person wishing to challenge the validity of a meeting on the ground of non receipt of notice would have to take action to obtain a court order declaring the meeting invalid and the onus of proof would be on the member taking such action. The notice of the annual general meeting is typically incorporated in the annual report, which is usually sent to members earlier than the time for notice specified in the Act.
a longer period is specified in the company’s Constitution; the procedure allowing shorter notice described in s 249H(2) is followed; or
the company is an Australian incorporated listed public company, where 28 days notice is required: s 249HA.
3.
Proprietary companies are not required by the Act to hold an AGM, though their Constitution may impose this obligation.
A public company, unless it has only 1 member, must hold an annual general meeting at least once in every calendar year and within five months after the end of its financial year: s 250N(2).
The company can apply to the ASIC to extend this time: s 250P(1).
The business of the AGM, covered by s 250R, provides an opportunity for members to obtain a report on the activities of the company for the previous financial year. The financial accounts and reports of directors are presented, and general housekeeping matters such as the remuneration of directors and election of directors to comply with retirement requirements are attended to. Auditors are appointed and dividends declared. Section 250S allows questions a reasonable opportunity to ask questions and make comments about management, and s 250T allows questioning of auditors.
Under s 250R a listed company must submit the directors’ remuneration report (see s 300A) to a non binding vote. See also s 250SA. The company’s auditor is now required to attend the AGM: s 250RA. See also s 250T.
4.
The power to call meetings of a company is given to the directors by replaceable rule s 249C, and for listed companies by s 249CA.
5.
LAW00004 Company Law
Topic 5 Management | 86
Requisition of meeting by members under s 249D: The directors are required to convene a meeting if so requisitioned by the specified numbers in s 249D(1). This is the method by which the members of a company can force the holding of a meeting even if the directors refuse to call a meeting. The requisition must state the general purpose of the meeting. If the directors fail to convene a meeting on presentation of the requisition, the requisitionists themselves may call the meeting under s 249E. The company’s Constitution cannot prevent the calling of this meeting.
In addition to the ss 249D and 249E rights, members can also call a general meeting under s 249F, but this time it is at their expense.
The Court can also order a meeting if it is impracticable to call the meeting in any other way: s 249G.
6.
Proprietary companies with more than one member can avoid the need for a meeting if all the members entitled to vote on a resolution sign a document supporting the resolution: s 249A(2). This does not apply to a resolution removing an auditor: s 249A(1). Companies (public or proprietary) with only one member can pass a resolution simply by recording it and signing the record.
7.
Right to demand a poll: s 250K. The importance of a poll in company meetings is that a vote by a poll is determined on the voting rights of shares held (these rights are usually specified in the Constitution), and may result in a different decision from the other type of voting used in company meetings, namely a show of hands. In a show of hands vote, each member has one vote only, irrespective of the number of shares held: s 250E.
Consequently, provisions in the Constitution will be overridden by the Act if they have the effect of excluding the right to demand a poll, other than on the question of election of a chairman or adjournment of the meeting.
Under 250L(1) a poll can be demanded by:
These are maximum requirements, and the company’s Constitution may provide for a lesser requirement: s 250L(3).
A proxy is entitled to demand, or join in demanding a poll: s 249Y(1)(c).
at least five members;
members with at least 5 per cent of the votes that may be cast on the resolution; or
the chair.
8.
Proxies: Section 249X is a mandatory rule for public companies and a replaceable rule for proprietary companies. Thus there is an entitlement for a member of a public company to appoint a proxy to attend and vote for him/her. The proxy can be a body corporate: s 249X(1A). The Constitution of a proprietary company may entitle proxies to be appointed and this will be the case where the proprietary company does not exclude s 249X and the replaceable rules apply to that company.
A proxy has a right to speak at a meeting, and to participate in demanding a poll and to vote to the extent allowed by the appointment: s 249Y.
9.
Minutes of meetings: s 251A. Minute books of all meetings (general, directors etc) must be kept by a company. Minutes of meetings of members of the company are open to inspection free of charge by members of the company: s 251B.
10.
Quorum: see replaceable rule s 249T which sets two as the quorum for meetings of members.11. On irregularities note the very important s 1322.12.
LAW00004 Company Law
Topic 5 Management | 87
Activity 5.2
A Ltd is a public company limited by shares. An extraordinary meeting of the company is called for 2.00 pm on 20 September 2017 for the purpose of considering a special resolution. The notice of meeting, correct in form, was posted by the secretary on 1 September 2017, to all registered shareholders. The special resolution is put to the meeting and the chairman declares it carried on a show of hands. Jones, Smith, Brown, who are each shareholders in A Ltd, and present at the meeting, are not happy with the passing of the resolution. Assume you are Jones. Discuss ways in which you may upset the resolution, enlisting the support of Smith and Brown where necessary.
1.
B Ltd is a public company limited by shares. You are a shareholder in the company and are disturbed at some actions recently taken by the directors with respect to the running of the company business. You ask the directors to call an extraordinary general meeting of the company to discuss certain specified matters. They refuse to do so. What can you now do, if anything?
2.
Ripemoff Ltd held its first meeting on 1 June 2017 and was incorporated in 2015. It issues its first prospectus on 1 March 2015. At the meeting on 1 June 2017 (for which notice was mailed on 14 May) the following events occurred. You are required to comment on any irregularities or problems disclosed by these facts or facts below:
Forty members of the 700 members of Ripemoff Ltd attended this meeting. A motion to change the company’s Constitution by reducing the number of directors from five to two was carried. ASIC was not notified of this change to the Constitution.
a.
A resolution to accept a dividend recommended by the directors was carried. The Chairman refused to accept a demand for a poll on this resolution made by five shareholders. Her reason for so doing was that the Constitution provided that the number of members required to demand a poll was six.
b.
A resolution was passed changing the Constitution to delete the right of members to demand a poll, unless such members held more than ten shares.
Discuss.
c.
3.
LAW00004 Company Law
Topic 5 Management | 88
Conclusion to Topic 5 We have now completed our examination of the general duties of directors and other officers at common law and statute and our overview of the law relating to meetings.
Mickey and his friend, Minnie, each own 10 000 ordinary shares in a public company, Greater Chocolate Manufacturing Co. Ltd (‘Greater Chocolate’). The company is incorporated and adopted a constitution. One article in the constitution providing that proxy forms must be witnessed by a J.P. Greater Chocolate held its first Annual General Meeting on 1 January 2015 when Pete was elected a Director. Pete subsequently became the Chairman of Directors.
The second Annual General Meeting was held on 1 April 2016. Mickey and Minnie and about 20 shareholders attended the meeting. Pete assumed the role of Chairman of the Meeting. He announced that the company accounts had not been prepared and that the meeting would have to be adjourned. He said he called the meeting in order to comply with the Act and he said that the company was not now liable to prosecution. He added that he would apply to the ASIC for an extension of time in which to hold the meeting, as an extra guarantee that the company would not be prosecuted, and assured the shareholders that the extension would be granted automatically. The shareholders voted to adjourn the meeting.
On 1 June 2016 Pete issued notices to the shareholders that an Extraordinary General Meeting would be held on 8 June 2016. The office assistant dropped Mickey’s notice in the street on his way to the post office, and that notice was never posted. Minnie received her notice, and Mickey, when he read it and realised he had a prior engagement and could not attend the meeting, completed a proxy form appointing Minnie his proxy. Mickey overlooked a note on the form indicating that it must be witnessed by a JP and failed to have a JP sign the form. Minnie and 15 other shareholders attended the meeting on 8 June. Pete’s friend moved the following resolution: ‘That the Company’s Memorandum is hereby amended to include the power to engage in oil exploration.’
The resolution was seconded and put to the vote. When Minnie asked how she could exercise her proxy Pete said she could not, on the show of hands. Minnie then demanded a poll. Pete inspected her proxy and declared it invalid, because it had not been witnessed by a JP.
A shareholder then moved the following resolution:
‘That before the Company commenced oil exploration activities a committee be appointed to investigate the prospects.’
That motion was seconded and it was seen on a show of hands that all shareholders present were in favour of the motion. Pete then said that a poll should be taken. After the poll Pete refused to declare the vote and suggested the meeting be adjourned temporarily. Weeks drifted by but the meeting was not recalled.
Specify each of the instances, if any, where the provisions of the Act have not been complied with.
a.
Can Mickey challenge the validity of the resolution giving the company power to engage in mineral exploration?
b.
Can Mickey, as a shareholder, call a meeting and can he remove Pete from his office of Director?c.
4.
LAW00004 Company Law
Topic 5 Management | 89
From time to time we will return to provisions relating to management. For example we will find that directors can be liable to third parties for misstatements in a prospectus and that directors must exercise their discretion to approve a transfer of shares properly. Later, we will examine their obligations in the takeover and insolvency contexts.
LAW00004 Company Law
Topic 5 Management | 90
Topic 6
Financing the corporation
Objectives To successfully complete this topic you will need to be able to:
6.1 Introduction Fundamental to the development of the modern industrial economy has been the existence of a separate legal entity, the company with limited liability, vested with the power to invite the public to invest funds with it. In Australia the privilege of inviting the public to invest with it is reserved to public companies who may seek funds from the public either in the form of equity through the sale of shares, or ‘interests’ or as debt via a debenture issue.
In this topic we will consider the methods used by company management to raise funds. A company wishing to raise funds can do so by two main avenues. The first is to providing investors with equity in the company which is done through the issue and sale of shares. The second avenue is by borrowing funds which may be done through the issue of debentures.
Proprietary companies have limited liability but must rely on private sources of funds.
The public company’s power to invite the public to invest in it carries with it significant protective regimes. In this topic we will examine the protective nature of the prospectus provisions in the Act. Before considering prospectuses we need to understand the law relating to shares, debentures and interests.
The capital maintenance doctrine is closely related to limited liability and corporate finance. Creditors have a right to rely on the capital remaining undiminished by expenditure, outside the limits provided in the Act, or by return of capital to the shareholders. We will consider this doctrine in the final part of this topic.
describe the provisions of the Act relating to shares including nature, types, transfer, transmission, surrender, forfeiture, extinction, mortgage, issue and restrictions on allotment;
be familiar with the law relating to debentures and registration of security interests;
distinguish between shares, debentures and interests;
list the information which must be contained in a prospectus and describe the rules relating to the issue of a prospectus;
describe and apply the statutory and common law remedies and protective measures available where there has been a misstatement in a prospectus;
describe the statutory and common law rules relating to the capital maintenance doctrine;
have considered the rules relating to accounts and audit; and
describe and discuss any areas in need of further law reform.
91
6.2 Equity finance
6.2.1 Shares
Textbook 10th ed, Chapter 16, pp 499–511
The nature of a share A share is personal property: s 1070A. A share also exists separately from its holder and can consequently be sold, bequeathed, gifted, etc. A shareholder usually holds a share certificate which acts only as prima facie evidence of the title of the member to the shares: s 1070(C)2. It is the registration of the member’s holding in the register of members which confers upon a shareholder the status of shareholder.
Consider the distinction between shares and stock: Shares cannot be dealt with in fractions of their face value but stock can be split up into as many parts as desired. Under Australian law a company does not have the power to issue bearer shares or issue stock or convert shares into stock: s 254F.
The need for authorised share capital was repealed by CLRA, along with it rules relating to increasing or decreasing authorised share capital and the concept of shares having a par value.
Shares as ‘equity’ in a company should be distinguished from ‘debentures’ which represent borrowings by a company. A debenture is simply a certificate acknowledging that the company owes money to the debenture holder. ‘Shares’ and ‘debentures’ together with ‘interests’ and certain other matters make up the definition of ‘securities’ in s 92.
6.2.2 Types of shares
Textbook 10th ed, Chapter 17, pp 517–532
Deferred or founder’s shares Deferred or founder’s shares are referred to as management shares. The rights of the holder to receive a dividend are deferred until other shareholders receive a dividend at a specific rate. Founders often take these shares to illustrate their faith in the company.
Ordinary shares Ordinary shareholders are entitled to a dividend before deferred shareholders but after preference shareholders. They have full voting rights and usually in a public company exercise a greater control of the company.
Textbook
Textbook
LAW00004 Company Law
Topic 6 Financing the corporation | 92
Preference shares Section 254A(2) requires the rights of shareholders of various classes of preference shares to be set out in the Constitution or approved by special resolution. The law does not define the preferences that are available except in relation to redeemable preference shares. Below we consider examples of preference shares, however it should be emphasised that ultimately the rights of preference shareholders turn on the construction of the clauses in the Constitution which establish the preference and on certain common law presumptions which will apply in the absence of a clear statement to the contrary.
Various types of typical preference shares confer different preferences:
Governor’s shares Generally these are issued in a proprietary company whose members are of the one family or business group. Such shares usually have special voting rights attached enabling the shareholders to control the company. Governor’s shares should be distinguished from classes of shares where for example the company splits its ordinary shares into A, B or C class with different rights to voting, dividend, or participation in capital on a winding up.
Employee’s or worker’s shares Such shares will usually confer limited rights on employees and in practice companies have been reluctant to concede too much especially in relation to voting.
Cumulative preference shares
Such shares entitle the shareholders to a dividend at a fixed rate throughout the entire life of the company. Preference shares are assumed to be cumulative unless there is a provision contrary to this in the terms of the issue.
Non-cumulative preference shares
Shareholders are only entitled to a dividend when declared.
Participating preference shares
Entitles the shareholders to participate in dividends over and above the stated preference rate.
Redeemable preference shares: s 254A(3) and Pt 2H.2
A company may issue preference shares which may be redeemed by the company at a later date. This does not represent a reduction of capital because the redemption may be made only if the shares are fully paid up and out of profits or the proceeds of new issue of shares made for the purpose of the redemption: s 254K.
The buy back provisions may also be used: s 254J(2).
Previously if shares were redeemed otherwise than out of the proceeds of a fresh issue, an amount equal to the nominal value of the shares redeemed had to be transferred from undistributed profits into a capital redemption reserve. This was not distributable to shareholders and had to be treated as if it were part of the paid-up capital of the company. CLRA abolished this requirement.
LAW00004 Company Law
Topic 6 Financing the corporation | 93
6.2.3 Transfer of shares
Textbook 10th ed, pp 248–252
In your reading consider the matters emphasised below.
A share is capable of being transferred. If shares are listed on the stock exchange, there must be no restriction on transfer. Proprietary companies normally restrict transfer of shares thus they cannot be listed on the stock exchange.
Any restriction on transfer must be observed before transfer – for example, director’s consent might be required.
If the directors refuse consent they are required by the law to send to the prospective transferee a notice of refusal within two months of the lodgement of the transfer of shares for registration: s 1071E. Shareholders are entitled to an exercise of the director’s discretion fairly and with due regard to the shareholders right to transfer shares.
Note that the director’s discretionary power:
A director cannot frustrate a transfer of shares by wilfully refusing to attend meetings.
The Constitution may be so framed that it would be very difficult to challenge a refusal. The Constitution can provide that no reason need be given for refusal. This would make it difficult to establish the power was not exercised in good faith because the burden of proof is on the transferee to establish that the power was not exercised in good faith: Australian Metropolitan Life Assurance v Ure.
If the directors are empowered to grant refusals only on certain grounds, then these grounds must be stated when refusing the right to transfer shares. Note the possibility of challenge provided in s 175 and in s 1071F. This latter section gives the court power to order a transfer or transmission of shares when it is satisfied that the directors have refused to register without just cause: Monardo v Complete Hardware (1990) 2 ACSR 605.
Method of transfer
Textbook 10th ed, pp 248–250
Read and consider s 1071F, Pt 7.11
Part 7.11 Div 3 contains provisions designed to facilitate and simplify transfers of shares and other securities on the stock exchange. It simplifies forms of transfers when a broker is involved, and in certain circumstances avoids the need for the transferee to sign the transfer.
Textbook
must be exercised;
in good faith (legitimately); for
the purpose for which it was conferred: Australian Metropolitan Life Assurance Company Ltd v Ure [1923] HCA 29; (1923) 33 CLR 199.
Reading
LAW00004 Company Law
Topic 6 Financing the corporation | 94
Respective duties of purchaser and seller on a transfer of shares Generally on a transfer it is:
Summary of points to consider with respect to transfer of shares
A company shall not register a transfer of shares unless a proper instrument of transfer has been delivered to the company: s 1071B. However provision is also made in s 1071B for the transmission of shares by operation of law – for example, personal representative of a decreased shareholder. The Act does not define a proper instrument of transfer, but it would appear to require a written document, signed by both parties, except in a transmission, and containing details of shares transferred.
the seller’s duty: to exercise a valid transfer;
hand the certificate of transfer and share certificates to the purchaser; and
do all that is necessary on his/her part to enable the purchaser to be registered.
the purchaser’s duty: to pay the consideration; and
if the purchaser is slow on obtaining registration of transfer, he/she may be liable on an implied promise to indemnify the vendor while he/she is still the holder against calls on the shares.
It is left to the company’s Constitution to determine the manner in which a share may be transferred. This will balance the interest of the shareholder in having an unrestricted right of transfer against the interests of the company in controlling membership. Whilst proprietary companies are no longer required to restrict transfer of shares most proprietary company’s constitutions contain such a restriction. On the other hand one of the requirements for shares obtaining listing on a stock exchange is that there be no restriction on transferability. However, it is also possible for an unlisted public company to include restrictions on transfer of shares in its Constitution.
The provisions relating to each share having a distinguishing number are modified by s 1070B. The purpose is to establish the entitlement of a shareholder. If this can be done in the circumstances described, then distinguishing numbers are not required.
A certificate under s 1070C(1) specifying details of the shares held by any member of a company is prima facie evidence of the title of the member to the shares: s 1070C(2). Note that the certificate is evidence of title only, and where the certificate is a forgery or where the certificate is obtained by improper means the holding of the certificate does not confer good title. However a company is estopped, as against a person altering his/her position to his/her detriment on the faith of representations in a certificate from denying that the facts are as therein stated. Consequently a claim for damages may arise against a company under such circumstances.
Where a share certificate is lost or destroyed the company is required, upon payment of a fee to issue a duplicate certificate provided that it also receives:
In addition the company may require the applicant:
a statement in writing that the certificate has been lost or destroyed and proper searches have been made;
a written undertaking that the original certificate, if found, will be returned to the company: s 1070D(5).
to advertise the loss or destruction of the certificate; and/or
to indemnify the company against loss on production of original certificate: s 1070D(6).
LAW00004 Company Law
Topic 6 Financing the corporation | 95
Normally the transferee lodges the transfer with the company for registration of the transfer, but where the transferee fails to do this provision is made in s 1071D for the transferor to request the company in writing to register the transfer. There may be situations where it is important for the vendor of shares to ensure that his name is removed from the register of members – for example, where the shares transferred are not fully paid up. For the implications of not having a name removed from the register of members see the material on membership of a company.
Where under a power given in the Constitution a company refuses to register a transfer the transferee must be given notice of such refusal within two months of transfer being lodged: s 1071E.
Provision is made for certification of transfers in s 1071H. This works in the following way. Suppose A is the holder of 100 shares and he sells 60 shares to B, and either sells the other 40 to C or retains them himself. Since A cannot hand a certificate to B or to C for the shares transferred he forwards the certificate with executed transfers to the company who then mark the transfers with ‘certificate lodged’ or ‘script in office’. The company retains the certificate and eventually forwards a new certificate to B and either C or A as appropriate. A company is required to issue a new certificate within a month of transfer being lodged, or to issue an original certificate within two months of allotment: s 1071(H).
LAW00004 Company Law
Topic 6 Financing the corporation | 96
Activity 6.1
Harbour Views Ltd is a home unit company which owns a large building containing seventy home units in Kings Cross. The issued capital of the company is divided into ten ‘A’ class shares, and sixty ‘B’ class shares. The ‘A’ class shares carry the right to the exclusive use of the ten garages in the building, but both ‘A’ and ‘B’ class shares carry equal voting rights at general meetings. The holders of the ‘B’ class shares wish to demolish the garage and provide common parking space for all shareholders. This scheme is opposed by the ‘A class shareholders. An extraordinary general meeting has been called and has passed a special resolution, altering the Constitution so that the scheme to demolish the garages and provide common parking space for all shareholders may be put into effect.
What is the position of the ‘A’ class shareholders if there is no provision in the Constitution for variation of class rights?
1.
A, the owner of 1000 $1 fully paid up shares in the Acme Purchasing Company Ltd, sells them to B at the current market value of $2.75. A signs the necessary transfer form but does not surrender the share certificate, and the company transfers the 1000 shares into B’s name upon receipt of a sworn affidavit by A that he has lost the share certificate. Subsequently, A sells the same shares to C for $1.50 per share and hands to C the original share certificate and a signed transfer form in blank. C pays A for the shares and seeks to have the shares registered in his name, but the company refuses to do so on the grounds that the shares have already been transferred to B. At the date of the refusal to register, the shares are worth $4.75 each. Clause 21 of the Constitution is as follows:
21. The instrument of transfer must be left for registration at the registered office of the company together with such fee not exceeding 25c as the directors from time to time may require accompanied by the certificate of shares to which it relates and such other evidence as the directors may reasonably require to show the right of the transferor to make the transfer, and thereupon the company shall subject to the powers vested in the directors by these regulations register the transferee as a shareholder and retain the instrument of transfer.
Advise C of his rights, if any, against the Acme Purchasing Company Ltd.
2.
LAW00004 Company Law
Topic 6 Financing the corporation | 97
Transmission of shares This is a change in ownership of shares by death or bankruptcy. See ss 1071B, 1072C, 1072D, 1072E and the replaceable rules in ss 1072A and 1072B.
The person to whom shares vest immediately on the death of a member will be determined according to the law of testate or intestate succession of the particular state or territory in which he/she was domiciled at his/ her death. The directors of a company generally have the same right to decline or suspend registration of shares by way of transmission as they had in the case of transfer of the share by that member before his/her death or bankruptcy. Note that s 1071F applies also to transmissions.
6.2.4 Surrender of shares When the Constitution permits, the directors of a company may accept a surrender of shares. This power will not allow them to accept a surrender for valuable consideration paid by the company out of its own assets as this would amount to the company purchasing its own shares. A limited company cannot purchase its own shares, except in accordance with the share buyback provisions in Chapter 2J, since this would amount to a reduction in paid-up capital and a breach of ss 256B and 259A.
A surrender of shares whether fully paid or not, which means a reduction of capital, requires the court’s approval.
A surrender of fully paid shares in return for other shares of the same nominal amount is not a reduction of capital.
Forfeiture of shares If shares are partly paid the shareholder is liable to pay calls on the shares in accordance with the terms of issue, unless the company is a no liability company: s 254M.
X, Y and Z were the sole directors of Austral Ltd, a public company. A and B were each registered holders of a large part of the company’s shareholding. Over a period of about five years, A and B had continually brought frivolous and vexatious lawsuits against the company, against the directors, and against each other. The company, as a result, was hindered in its everyday management, and the price of its shares was declining. Clause 50 of the Constitution of the company stipulated: ‘whensoever a shareholder shall be desirous of selling his shares or any part thereof, he shall first offer the same to the directors for the time being at the company, who may take the shares at a fair price’.
A and B contracted to sell some of their shares to outsiders, retaining others. They also advertised their intention to sell all of their shares as soon as possible.
The Constitution was altered, largely at the instigation of X, Y and Z, to give power to the directors for the time being of the company to compulsorily acquire the shares of any member at a fair price.
Discuss, citing authority where appropriate, whether:
X, Y and Z may, after the Constitution was altered, compulsorily acquire any of the shares of A and B; and
a.
X, Y and Z have any rights against A and B concerning the shares which they contracted to sell.b.
3.
LAW00004 Company Law
Topic 6 Financing the corporation | 98
The terms of issue may provide that shares can be forfeited for non payment of calls, and the company may cancel forfeited shares: s 258D.
The company’s Constitution or the terms of issue should give the directors power to make calls and to sell such shares. Directors can only exercise the power for the benefit of the company and not solely for the benefit of individual shareholders.
Under the terms of issue it is likely that after forfeiture the shareholder will still be liable for unpaid calls and interest on this unpaid call. Liability will not cease until such payment is made in full. Note also the rules relating to contributories in a winding up, especially ss 515 and 516.
Extinction of shares When a company is wound-up, the legal existence of a share disappears.
Mortgage of shares It is legally possible to mortgage shares.
6.2.5 Restrictions on allotment Section 254B allows a company to determine the terms of issue and the rights and restrictions attached to shares.
Part 2J.2, restricts a company from being a member of a company, which is its holding company or taking security over shares in itself or in a company that controls it: ss 259B, C and D.
Section 254E allows the court to validate an issue or allotment of shares that otherwise would have been invalid.
An allotment of shares cannot be made if this would breach the rules relating to prospectuses. The circumstances when a prospectus is required covered later in this topic.
Issue of shares A company may not issue a share warrant: s 254F. A share warrant entitles the bearer to the shares represented by it, and transfer may be effected by delivery of the warrant. The effect of such a warrant is to create bearer shares which is against the policy of the Act for establishing membership of a company – that is, entry of a shareholder’s name on the register of members.
Commission may be paid to a person in respect of that person or another person agreeing to take up shares in the company: s 258C.
6.3 Debt finance of loan capital
Textbook 10th ed, Chapter 20, pp 587–606
Textbook
LAW00004 Company Law
Topic 6 Financing the corporation | 99
6.3.1 Debentures and debt capital
Textbook 10th ed, pp 590–595 then you should consider the following matters
See the definition of ‘debenture’ in s 9 and note the exceptions listed in (a)–(f).
Not all debentures will be secured by a security interest over the assets of the borrowing company or its subsidiaries. From a legal point of view the defining character of a debenture is the concept of indebtedness, not whether a security exists.
In brief, a debenture is an acknowledgment by a borrowing company of its indebtedness to the debenture holder.
But note carefully s 283BH provides an important table which lists the precise ways in which the terms ‘debenture’ ‘mortgage debenture’ and ‘unsecured note’ may be used by a borrowing company. Read this table which is designed to protect lenders.
Quite frequently a debenture gives a security interest over the assets of the company, so that the debenture holder has security to that extent for the payment of the debt.
Prior to the Personal Property Securities Act 2009 (hereinafter called PPSA) a security was created by a charge, peculiar to companies, called a ‘floating charge’.
A floating charge did not attach to specific property, and did not prevent a company from dealing with the assets of the company, subject to a floating charge, in the ordinary course of business. In this respect it differed from the normal type of security charge which follows the property charged – for example, a mortgage over land and buildings will prevent those land and buildings being dealt with other than as subject to the mortgage.
A floating charge became a fixed charge (the floating charge was then said to crystallise) when there was a breach of the trust deed or the terms of issue of the debentures.
Typical breaches include:
When this happened the person holding the floating charge (in a debenture issue, the trustee for debenture holders) took steps to enforce rights, for example, by the appointment of a receiver to represent the interests of the debenture holders.
The law regulating security interests has changed. The PPSA introduced a new process for the creation and registration of security interests over personal property (including debentures). More will be said on the PPSA under the heading ‘6.4 Registration of Charges’. Importantly the terminology has changed and the terms fixed and floating charges are not used in the PPSA.
Textbook
non-payment of interest by the due date;
the debentures are not redeemed on the due date;
the company ceases to be a going concern;
the company goes into liquidation; and
a receiver is appointed by another creditor, often a bank holding a fixed security, such as a mortgage over land.
LAW00004 Company Law
Topic 6 Financing the corporation | 100
It is important to understand that debenture holders are creditors of the company and are not shareholders or members of the company. Consequently, the rights of debenture holders under the Act are very different from the rights of shareholders.
With respect to debentures note the following:
A register of debenture holders must be kept by the company containing names and addresses of debenture holders and amount of debentures held: s 171. The information in such register is available to anyone to inspect: s 173. On registers more generally see Chapter 2C of the Act.
1.
A trust deed containing the information listed in s 283AB is required for a debenture issue which needs disclosure to investors under Chapter 6D: s 283AA(1)(a). Chapter 6D is covered later in this topic.
2.
In the circumstances described in s 283AA a trustee for debenture holders must be appointed by provision being made in the debentures or in a trust deed relating to those debentures. The trustee is able to act on behalf of all the debenture holders and protect their interest much more effectively than the individual debenture holders could. Provision is made for the trustee to call a meeting of all debenture holders: s 283EB. See Pt 2L.5 generally on meetings, noting (a) that in certain circumstances they have to be called by the borrower; and (b) that power is given to the court to order their holding.
3.
Appointment and retirement of trustees. Only certain types of corporations are eligible for appointment as trustees: s 283AC. Because of the importance of the functions of the trustee the Act ensures that the office of trustee shall never be vacant: a trustee may not retire from the position until another qualified corporation has been appointed: s 283AD.
4.
Certain matters must be included in the debentures or the trust deed: s 283AB.5. Duties and powers of trustees, see s 283DA. The trustee for debenture holders is under a duty to:
exercise reasonable diligence to ascertain: (i) whether the property of the borrowing corporation and its guaranteeing subsidiaries will cover the eventual discharge of the debenture; (ii) whether the borrower has breached the deed or the terms of issue of the debentures: s 283DA(a)(b).
a.
Meet the other obligations described in s 283DA(c)–(i). When a company breaches a covenant of the trust deed, a trustee can usually enforce the debenture under powers given in the trust deed. These may include:
A trustee may apply to a Court at any time for directions relating to its duties as trustee: s 283HA.
appointment of a receiver or manager;
presenting a petition for winding up;
selling the assets if the trust deed gives a power of sale;
taking legal action against the company for arrears of interest and principal.
b.
6.
A trustee cannot contract out of its liability for breach of trust resulting from failure to exercise the required care and diligence: s 283DB.
7.
An obligation is placed upon the borrowing corporation to supply, at regular intervals, a report relating to its activities. This report must be submitted to the trustee in writing. Section 283BF describes the information which must be included in the report.
8.
A company may redeem debentures by purchasing them from the public during the life of the debenture. It is also possible to reissue such debentures unless the Constitution prevents this or unless the company has indicated that the debentures shall be cancelled.
9.
Section 283F provides for the recovery of loss or damage suffered as a result of contravention of the section. Criminal offences are described in s 283BI.
10.
The Court’s powers in relation to debentures are described in ss 283HA and s 283HB. The powers of the ASIC are contained in ss 283GA and 283GB.
11.
LAW00004 Company Law
Topic 6 Financing the corporation | 101
6.4 Registration of security interests (formerly known as ‘charges’)
Note the introduction of the Personal Property Securities Act 2009 (hereinafter called PPSA);
Textbook 10th ed, pp 595–606
The purpose of the legislation relating to registration of security interests is that persons intending to deal with a company should be able to discover whether a company has encumbered its property by searching a public register.
The Personal Property Securities (Corporations and Other Amendments) Act 2010 (Cth) was enacted to amend the Corporations Act 2001 (Cth) to align it with the PPSA. This alignment included changes in terminology and closed the ASIC Register of Company Charges. Charges registered on the ASIC Register were migrated to the PPS Register. The PPS register became operative on 30 January 2012.
Importantly the reform repealed Chapter 2K of the Corporations Act (which established the ASIC Register). Chapter 2K Corporations Act has been replaced with Chapter 5 of the PPSA. There are transitional provisions in place but for the purpose of this unit it is important to understand the creation and registration of security interests. These amendments are intended not to interfere with existing rights of parties under the Corporations Act. [1]
Note also s 266 Corporations Act has been replaced with s 588FL which has the same purpose as s 266. Section 588FL(2) applies where a security interest has been registered in Australia and provides that a security interest will vest in the grantor where they have not been perfected by registration within six months of the winding up of the company, an administrator being appointed or a deed of company arrangement being executed. [2]
The PPSA reform introduced new terminology [3] which should be understood. The information on the PPSR homepage provides the following:
Textbook
LAW00004 Company Law
Topic 6 Financing the corporation | 102
Table of PPS related terms and their current equivalent Term Equivalent
Secured party The person who holds a security interest in collateral. Financier, mortgagee, chargee, lender, retention of title supplier, lessor etc
Grantor A person (or their transferee or successor) who owns or has an interest in the property to which a security interest has attached. The borrower, mortgagor,
Collateral Personal property to which a security interest is attached
Security agreement
An agreement in writing that creates a security interest; financing agreement, mortgage, debenture charge etc
Security interest
An interest in personal property created by a transaction that in substance secures the payment or performance of an obligation, without regard to the form of the transaction.
Attachment Attachment is a term related to the creation of enforceable rights. A security interest must have ‘attached’ to collateral (for example the company’s property) in order for the security interest to be enforceable against the grantor
Perfection A security interest is perfected once it is attached to collateral and the secured party provides public notice of its security interest. This is done by registration on the PPSR; (in some instances perfection can be made by possession, control or temporary perfection). Perfection confers priority over competing perfected or unperfected security interests in the collateral
Circulating assets
Assets that could be used or transferred in the ordinary course of the grantor’s business, even if they are subject to a security interest, including currency, negotiable instruments, inventory and certain accounts (except where the secured party has possession or control)
The process under the PPSA for creating and protecting security interests in personal property is summarised as follows:
The usual method of perfecting the security interest is by the secured party registering it on the personal property securities register. The secured party registers a financing statement (not the security instrument or the security agreement) with respect to the security interest. Importantly registration provides perfection (of the security interest) and confers priority over competing security interests in the collateral (property).
You might find the terminology, as set out in the table above, helpful to understanding the process under the PPSA.
The grantor (company) and secured party (financier) make a ‘security agreement’ (for example a debenture deed) to create a ‘security interest’ in personal property (collateral). The security agreement (between the grantor and the secured party) sets out the extent of the grantor’s ability to deal with the property without the secured party’s consent. The security interest is said to attach to the grantor’s property (collateral). Although the term ‘floating charge is not used in the PPSA the parties can agree to create a security interest over the grantor’s ‘circulating assets and ‘all the grantor’s present and future assets’.
LAW00004 Company Law
Topic 6 Financing the corporation | 103
6.5 Interests other than shares or debentures: Managed investment schemes
Overview It is possible to have managed investment opportunities other than through shares or debentures. The most understandable type is the unit trust including:
Unit trusts are not the only way in which managed investments can arise.
Other forms include:
The typical unit trust is one where shares or other securities listed on a stock exchange are purchased by the unit trust manager and vested in a trust, and units or sub-units representing fractions of the beneficial ownership of such shares or securities are sold by the manager to investors. The manager is normally a company and it is remunerated by an initial charge plus periodic charges on the income of the trust.
Activity 6.2
P Ltd, a public company limited by shares, intends to make a $100 000 debenture issue. They approach Honest Trustee Co Ltd to act as trustee for the debenture holders. The Honest Trustee Co acts for a number of P Ltd’s shareholders and a check of the Register of Members reveals that Honest Trustee Co is registered as the holder of shares in P Ltd, but in all cases these are held as executor of deceased estates. P Ltd seeks your advice on the appointment of Honest Trustee Co. Advise them.
1.
E Ltd a public company, obtains additional funds by:
As secretary of E Ltd, what action would you take with respect to these newly created security interest?
issuing debentures for $100 000 secured by a security interest over assets of the company except land and buildings
a.
obtains a fixed loan of $50 000 against a mortgage on land and buildings.b.
2.
Is the area of law relating to security interests satisfactory and clear? Identify any difficulties in the provisions relating to registration of security interests.
3.
M Ltd has issued debentures for $100 000 secured by a security interest over ‘all its present and future’ ‘circulating assets’ as specified in the security agreement and has appointed Reliable Trustee Co Ltd as trustee for debenture holders. M Ltd is unable to pay interest due on the debentures at 30 June 2014, and appears to be getting into financial difficulties. Reliable Trustee Co seeks your advice on what action they should take. Advise them.
4.
cash management trusts;
equity trusts; and
property trusts.
time sharing schemes;
the sale of interests in forestry or various other primary production schemes; and
certain types of interests in film production.
LAW00004 Company Law
Topic 6 Financing the corporation | 104
Investors become beneficial owners of a defined portion of the whole of the trust’s securities. The holder of a unit may thus dispose of his/her holding at a price corresponding to the market value of those securities.
Such managed investment schemes are covered in Chapter 5C of the Act. We will not consider these provisions in this unit.
6.6 Corporate fundraising in public companies
Textbook 10th ed, Chapter 21, pp 611–637 then you should consider the following matters.
Generally read Chapter 6D of the Corporations Act, and carefully work through the sections described below and CLERP made a number of significant changes to the law relating to fundraising and rewrote and renumbered all sections.
Introduction For many years there have been stringent rules designed to protect the investing public from the activities of unscrupulous companies and their directors. Indeed control over the advertising of securities by companies is probably the very earliest example of consumer protection legislation. Such laws existed long before modern consumer laws which protect us from harmful products or misleading advertising, and this reflected the fundamental need in the capitalist model for well informed and controlled securities markets. Accordingly, the advertising of securities has been tightly controlled. Models vary across different countries, but typically the document inviting people to invest in the company, commonly called a prospectus, has to be lodged with a registering authority prior to distribution to investors and is required to contain certain prescribed information. This is backed up by laws imposing liability for misleading or deceptive conduct in relation to the issue of securities.
Naturally there are risks with such models, registration may imply that the registering authority has gone through the document in great detail, and, in registering, is attesting to the value of the securities offered by the company. Furthermore the sheer weight and size of the document may deter the public from even reading the document. All of this has meant significant cost to the company issuing the prospectus, often money completely wasted because the document had achieved such a level of legal and accounting detail that investors were unable to discern the wood for the trees.
In the last 20 years of the 20th century the corporate regulators in Australia wrestled with the issues described above. The outcome in now contained in Chapter 6D of the Act. We will discover that there is minimal checking by the ASIC and the right, in certain circumstances, to issue quite brief fundraising documents which can refer to where more detail can be found.
6.7 Current Australian policy on prospectuses The modern policy is explained in the extract below from the Explanatory Memorandum (EM) which accompanied the CLERP Bill 1999 through Parliament. Note the Bill was passed and enacted to amend the Corporations Law and the ASIC Act; Corporate Law Economic Reform Program Act 1999 (Cth).
The EM can be viewed at:
Textbook
LAW00004 Company Law
Topic 6 Financing the corporation | 105
http://parlinfoweb.aph.gov.au/piweb/view_document.aspx?ID=311&TABLE=OLDEMS
(Section number references are to the previous law on prospectuses, references to proposed sections are to sections now contained in the Act.)
Improving disclosure
General disclosure requirement
8.2 The primary function of prospectus disclosure is to address the imbalance of information between issuers of securities and potential investors. Given the important role of disclosure in the market, the Bill makes a number of changes to improve the current disclosure requirements.
8.3 The Bill will substantially retain the general prospectus content rule in current sub-s 1022(1). Retaining the current flexible disclosure requirement will allow the length of a prospectus to vary depending on the investors’ needs.
8.4 The general content rule requires a prospectus to contain all information that investors and their professional advisers would both reasonably require, and reasonably expect to find in the prospectus, to make an informed investment decision (proposed section 710).
8.5 The requirement that a prospectus contain all information that investors and their professional advisers ‘expect to find’ has in practice expanded the disclosure test. For example, in practice issuers have had regard to other prospectuses and included certain types of information merely because it has been included historically or is contained in other prospectuses. This is not the intention of the provision. The words ‘expect to find’ are intended to limit, and not expand, the disclosure test.
LAW00004 Company Law
Topic 6 Financing the corporation | 106
With this policy in mind CLERP introduced the following changes to the previous prospectus provisions, which were summarised in clause 4.4 of the Explanatory Memorandum:
Let us now turn to the legal mechanisms designed to this.
Coverage Part 6D.1 describes the coverage of the fundraising rules. For our purposes the provisions apply to public companies: note the exclusion of proprietary companies from the right to raise funds under chapter 6D. This is contained in s 113(3) which prohibits such companies from engaging in activities which would require disclosure under Chapter 6D, though they can seek funds from employees or existing shareholders.
For the definition of a proprietary company, see s 45A.
When disclosure to investors is needed Section 704 and 705 summarise this for you, so carefully study the table provided in s 705, noting the different types of disclosure document needed and examining the sections listed. See also s 708.
4.4 The key features of the new regulatory arrangements proposed by the Bill are: Small business fundraising will be facilitated by:
allowing issuers to raise up to $2 million each year from up to 20 persons without issuing a prospectus or other disclosure document;
allowing issuers to raise up to $5 million under an offer information statement rather than a full prospectus. The statement will be required to disclose material information known to the issuer but it will not be necessary for the issuer to undertake the due diligence investigations required for prospectuses; and
extending the class of ‘sophisticated investors’ from whom an issuer can raise capital without issuing a prospectus or other disclosure document.
Facilitating shorter prospectuses by reducing the volume of material provided to retail investors and providing retail investors with the information which will assist them, without unnecessary detail. Information which may be of interest primarily to professional analysts and advisers can be mentioned in the prospectus and made available on request. In addition, ASIC will be empowered to allow the use of short profile statements in suitable industries. The full prospectus will be available on request.
Rationalising liability provisions by removing the overlapping application of the Australian Securities and Investments Commission Act and corresponding provisions in the Fair Trading Acts of the States and Territories. In addition, changes proposed to the fundraising liability regime and associated defences will provide both issuers and investors with greater certainty about their rights and obligations under the Law. A uniform defence will be available to all persons acting with reasonable care. Professional advisers and experts will only be liable to investors for statements attributed to them with their consent. The rule reversing the onus of proof for forward-looking statements will be removed.
Reforming advertising restrictions to enable information to be provided to the market about a proposed offer. Advertising of securities which are already traded on the Australian Stock Exchange (ASX) will be liberalised. Advertising of securities which are not already traded on the ASX will be restricted to basic information until a disclosure document has been issued.
Electronic commerce will be facilitated by enabling fundraisers to issue disclosure documents in electronic form and distribute them via any medium, including the Internet.
Prospectus registration will be replaced with a 7 day ‘free look’ period during which ASIC, market participants, financial journalists and others will be able to examine a prospectus before fundraising is permitted.
Removing governmental immunity from the fundraising provisions of Federal government business enterprises and encouraging the States and Territories to follow suit.
LAW00004 Company Law
Topic 6 Financing the corporation | 107
6.7.1 Types of disclosure documents The Explanatory Memorandum described the different types of disclosure documents, described in the Table in s 705 and defined in s 709, as follows:
Shorter prospectuses
Profile statement
6.7.2 Disclosure requirements Section 710 provides the general test relating to the content of a prospectus: it must contain all the information that investors and their professional advisers would reasonably require to make an informed assessment of the matters described in the table contained in s 710.
Section 711 lists specific disclosures that must be made in a prospectus.
Section 712 lists specific disclosures that must be made in a short form prospectus.
4.5 Prospectus length and complexity is a particular concern for retail investors, who may not be experienced in reading and comprehending technical information. The Bill will facilitate the presentation of prospectuses to retail investors in a manner best suited to their needs, while still making available a more technical analysis to investors, professional analysts and advisers who wish to seek further information.
4.6 This is achieved by changing current section 1024F to facilitate the use of short form prospectuses. The Bill will allow a prospectus to identify documents which are lodged with ASIC and thereby incorporate the information in the document into the prospectus (proposed sub-s 712(1)). The prospectus does not need to summarise each material fact in the incorporated document. However, where the issuer considers that the information may be of interest to retail investors, the prospectus must include sufficient information for investors to determine whether they need to obtain a copy of the document or part of the document to be incorporated by reference.
4.7 Where the issuer considers the information is primarily of interest to professional advisers, the prospectus must state this and describe the contents of the disclosure document (proposed sub-s 712(2)). A document incorporated in this way is treated as being included in the prospectus (proposed subs 712(3)). This will ensure that the incorporated document is subject to the content and liability rules under the new provisions.
8.9 The Bill will allow a prospectus to refer to any document lodged with ASIC, including documents that are not required to be lodged (proposed sub-s 712(4)).
8.10 The Bill will provide for capital raising through the use of a profile statement (proposed subsections 709(2) and (3)). A prospectus will still need to be prepared and lodged with ASIC.
8.11 ASIC is empowered to authorise the use of profile statements for offers of securities in suitable industries (proposed subsections 709(2) and (3)). Industry specific profile statements will give investors the ability to make comparisons between similar products. The profile statement must:
identify the body and the nature of the securities
state the nature of the risks involved
detail all amounts payable in respect of the securities
include any other information required by the regulations or ASIC, and
state that the profile statement has been lodged with ASIC and that the investor is entitled to a copy of the prospectus (proposed sub-s 714(1)).
8.12 As a primary source of information for retail investors, the profile statement attracts liability for any failure to adequately address matters required to be disclosed in it (proposed section 728). However, to ensure that issuers continue to provide full disclosure in the associated prospectus, issuers will be liable to investors in relation to the prospectus regardless of whether an investor actually received a copy of the prospectus (proposed sub- s 729(2)). The defence provisions will be applicable to profile statements. A person will not be liable for a misstatement in or an omission from a profile statement if they can prove that they did not know that the statement was misleading or deceptive or that there was a material omission from the statement in relation to that matter (proposed section 732, see also proposed section 733)
LAW00004 Company Law
Topic 6 Financing the corporation | 108
Section 713 lists specific disclosures that must be made where there is a prospectus for securities which are continuously quoted on a stock exchange.
Section 714 describes the contents of a profile statement and s 715 lists the contents of an offer information statement.
Section 715A requires disclosure documents to be worded and presented in a clear, concise and effective manner.
6.7.3 Procedure for offering securities Note the table in s 717 which summarises what a person wishing to make an offer of securities must do. The consents listed in the table in s 720 will have to be obtained.
Section 717 and s 727 provide a new mechanism for lodging prospectuses. The prospectus can be distributed immediately it is lodged, but if the securities are not already listed on the stock exchange, the company cannot accept applications for a further seven days: s 727(3). This gives the market an opportunity to examine the document before a contract (for example by an allotment of shares following an application) is made under it. ASIC is not required to prevent the document, though the market or financial press could draw deficiencies to its attention allowing the ASIC or another party time to seek an injunction, a remedy under Part 6D.3, or if there has been a misstatement or omission in the document under s 728, the issuing of a stop order by the ASIC under s 739.
Section 724 provides remedies for investors affected by a failure by a company to comply with clauses in a disclosure document which contain:
What remedies are available to the investor in such circumstances? See s 724(2).
This section also assists investors in the event that it becomes known that a statement in the disclosure document is misleading or deceptive or that statutory information has been omitted, or that new information which is materially adverse to the investor has become known after the lodging of the disclosure document.
Advertising of securities The new provisions in s 734 are explained in the Explanatory Memorandum to CLERP.
Listed securities
a requirement that a certain number of securities must be sold before issue or transfer of any securities; or
a statement that stock exchange listing will be obtained for the securities.
8.15 The Bill will significantly liberalise the current advertising restrictions for issues of securities which are already listed on the ASX. Prior to the issue of a disclosure document, advertising for these securities will be permitted if the advertisement states that a disclosure document will be made available and that an application form in, or accompanying, the disclosure document must be completed in order to acquire the securities (proposed paragraph 734(5)(a)).
8.16 The current law generally allows advertising only after the prospectus is lodged provided the advertisement states that a prospectus has been lodged and contains certain details about the prospectus (current section 1025). Relaxing the advertising restrictions for quoted securities will not compromise investor protection as information regarding the issuer and the nature of the securities is publicly available (through the continuous disclosure regime) and provides a basis upon which investors may assess the merits of acquiring the securities.
LAW00004 Company Law
Topic 6 Financing the corporation | 109
Unlisted securities
Image advertising
Pathfinder documents
6.7.4 Legal liability under the disclosure document provisions The provisions providing remedies to investors are contained in part 6D.3 of the Act. Note in particular:
8.17 In relation to issues of securities which are not listed on the ASX, the draft provisions will limit advertising prior to the issue of the disclosure document to the following:
a statement identifying the offer or and the securities
a statement that a disclosure document will be made available when the securities are offered
a statement that persons wanting to acquire the securities will have to complete an application form in, or accompanying, the disclosure document, or
a statement of how to receive a copy of the disclosure document (proposed paragraph 734(5) (b)). This last statement is optional.
8.18 These rules are designed to minimise the potential for persons seeking to raise funds to generate expectations among potential investors about the desirability of a proposed offer before all relevant information reaches the market and investors are able to make an informed investment decision.
8.19 For postdisclosure document advertising, the Bill will allow a streamlined statement to be made that informs potential investors that offers will be accompanied by a disclosure document and that the application form will need to be completed (proposed sub-s 734(6)).
8.20 As at present, the advertising restrictions will not apply to notices lodged with a securities exchange, reports on the body’s general meeting, news reports and reports by persons who have no interest in the offer (proposed sub-s 734(7)). Such notices and reports should not be tainted by promotional material intended to induce persons to purchase the securities.
8.21 The restrictions on advertising are designed to encourage investors to rely on a disclosure document, rather than the contents of an advertisement, and to ensure that the disclosure document is the principal information document. The prohibitions against misleading and deceptive conduct and the market offence provisions in Part 7.11 of the Law will continue to apply to securities advertising and will provide additional investor protection.
8.22 There is often uncertainty under current paragraph 1026(2)(c)) as to whether a particular image advertising campaign breaches the restrictions on pre-prospectus advertising or is permissible advertising of the body’s general business in the ordinary course of trade. In practice image advertising can be very influential on investors, extolling the virtues of a body without referring to a pending public offer. The Bill will clarify the Law in order to ensure that a body is not inhibited from promoting its products or services in the course of trade and to provide protection to investors. The Bill specifies criteria which should be taken into account in deciding whether image advertising exists (proposed sub-s 734(3)).
8.24 To assist an issuer to set a realistic price and finalise the contents of a disclosure document, the Bill will allow draft or ‘pathfinder’ documents to be circulated for comment to ‘sophisticated’ and ‘professional’ investors (proposed sub-s 734(9)). Pathfinder documents serve a useful purpose without causing any detriment to investors, as such, pathfinder documents will be exempt from the advertising restrictions in the Bill.
the prohibitions contained in sections 726 and 727;
the provisions in s 728 covering misleading or deceptive statements and omissions;
the right to recover loss or damage in s 729 and the Table contained in that section describing who is liable;
the obligation to inform contained in s 730; and
the defences in ss 731, 732, 733.
LAW00004 Company Law
Topic 6 Financing the corporation | 110
Re s 729 see Cadence Asset Management Pty Ltd v Concept Sports Limited [2005] FCAFC 265, http://www.austlii.edu.au/au/cases/cth/FCAFC/2005/265.html
There has been significant reorganising of the previous provisions into the form you now see them in. The reasons why this was done and a general description of the effect of the changes appears in the extract from the CLERP Explanatory Memorandum which follows.
Prohibitions
Persons liable
8.24 Division 1 of Part 6D.3 will bring together the provisions on prohibited conduct. 8.25 The Bill will remove the current overlap between the general prohibition on misleading and deceptive conduct
and the prohibition on misstatements in or omissions from a prospectus (current sections 995 and 996). The current overlap is unsatisfactory as it is unclear whether the current defences available for an action under section 996 are also available for an action under section 995 where the misleading or deceptive conduct is constituted by the issue of a defective prospectus.
8.26 Actions for damages or injunctions for misleading or deceptive conduct in connection with a disclosure document will no longer be available under section 995 (proposed Schedule 3, Part 1, item 59). Instead, Division 1 of Part 6D.3 will provide a self-contained liability regime for misstatements and omissions from disclosure documents.
8.27 Similarly, the misleading and deceptive conduct provisions in the Australian Securities and Investments Commission Act will no longer apply to securities dealings (proposed Schedule 4, Part 1, items 1, 2 and 3). This will ensure that there is no overlap between the Corporations Law and the Australian Securities and Investments Commission Act in relation to securities dealings. One of the main effects of this change would be to provide a self-contained liability regime in the Law for dealings in securities.
8.28 Consistent with this approach, the misleading and deceptive conduct provisions in the State and Territory Fair Trading Acts will no longer apply to securities dealings (proposed Schedule 3, Part 1, items 24 and 61). Again, this will ensure a self-contained liability regime in the Law for dealings in securities.
8.29 It will no longer be necessary in civil actions under the Law to establish that the misleading or deceptive statement, omission or new matter was material (proposed sub-s 728(1)). However, in place of a materiality element, recovery of damages will depend on establishing that loss has been suffered as a result of the misleading or deceptive statement, omission or new matter (proposed subs 729(1)). An injunction will remain a discretionary remedy available under current sections 1324 and 1325. It will only be an offence to offer securities under a disclosure document containing a misleading or deceptive statement, omitting required material or without a significant new matter if it is materially adverse from an investor’s point of view (proposed subs 728(3)).
8.30 The Bill will clarify the people who could be held liable for the disclosure document and the extent of their liability (proposed sub-s 729(1)).
8.31 The issuer of a disclosure document, the directors and proposed directors and underwriters will be liable in relation to the disclosure document as a whole. Other persons will only be liable for statements in the disclosure document that they have made or which are based on their statements. A person will need to have consented to being named in the disclosure document in relation to a statement, or as a proposed director, before any liability may arise.
8.32 Other persons involved in a contravention of the fundraising provisions could also be liable to compensate for any loss suffered (proposed sub-s 729(1), item 6).
8.33 Since the liability provisions and the offence provisions operate independently, it will not matter whether or not the person against whom compensation is being sought has been convicted for an offence in respect of the contravention.
8.34 A person who may be liable on a disclosure document must inform the person offering the securities in writing as soon as practicable after they become aware of a material misleading or deceptive statement, omission or new circumstance (proposed section 730).
8.35 The Bill will retain the current prohibitions on offering securities without a current disclosure document or in a body that does not exist (proposed sections 726 and 727).
LAW00004 Company Law
Topic 6 Financing the corporation | 111
Defences 8.36 The Law currently contains a complex set of defences for people who are liable in connection with a prospectus.
These defences have been criticised as lacking coherence and a clear underlying policy. Furthermore, substantially similar concepts are expressed in different ways.
8.37 The Bill will make it easier for a person to determine whether defences are available by providing a uniform defence to all persons who are potentially liable in relation to disclosure documents. For disclosure under a prospectus, a person will not be liable if they made such inquiries as were reasonable and they believed on reasonable grounds that the prospectus did not contain any materially misleading or deceptive statements or omit any material matter (proposed section 731).
8.38 The defence provisions are modified to take account of the reduced disclosure requirements for profile statements and OISs (in particular, there is no requirement for the issuer of an OIS to undertake reasonable inquiries). A person will not be liable if they prove that they did not know that the statement made was misleading or deceptive or that there was a material omission from the statement (proposed section 732).
8.39 Because all aspects of a disclosure document will not necessarily be within the expertise of all persons who may be potentially liable, a person who places reasonable reliance on information provided by someone else will also have a defence to any liability that arises from statements or omissions in relation to that information (proposed sub-s 733(1)). The Bill will extend this defence to all persons who may be liable, rather than its current application to the auditor’s report.
8.40 However, a person will not be able to rely on information provided by an employee or agent or, if the person is a body, its directors (proposed sub-s 733(1)). This will prevent someone relying on what is effectively their own information. Although the body will not be able to rely on information supplied by its employees for the purpose of establishing a subs 733(1) defence, it will be able to carry out due diligence through its officers and employees for the purpose of establishing a defence under proposed section 731.
8.41 The proposed limitation will not preclude a director of a fundraising body relying on information supplied by the fundraising body’s employees as those persons are not employees of the director. A person will be able to rely on someone who performs a particular advisory or professional function provided they are not an agent for some other reason (proposed sub-s 733(2)).
8.42 A defence will also be available to persons who are liable as a result of being named in the disclosure document if they publicly withdraw their consent to being named (proposed sub-s 733(3)). This defence is extended to underwriters.
8.43 As under the current law, there will not be a defence to an action for an injunction. A court will be able to restrain the circulation of a disclosure document that has a misleading or deceptive statement or omits required information even if due diligence has been taken in its preparation (current sections 1324 and 1325).
LAW00004 Company Law
Topic 6 Financing the corporation | 112
Activity 6.3
H Ltd has issued a prospectus, one of the terms thereof being that the company has recently obtained a large contract, and the additional capital will be used for carrying out such contract. In fact, at the date of issue of the prospectus the company was negotiating for the contract, but subsequently did not obtain it. On the basis of the prospectus Y applied for, and was allotted, 5,000 ordinary shares of $1 each payable in full on application. Y has now discovered that the stated contract is not held by H Ltd. Advise Y on her rights with respect to the shares.
1.
a. Outline the procedure involved in inviting the public to subscribe for an issue of shares. b. Under what circumstances is it not necessary to prepare a prospectus?
2.
An investigation into the affairs of Ripemoff Ltd has revealed the following information. You have been requested to give advice as specified below. In 2017 Ripemoff Ltd issued a prospectus. One statement in this prospectus was that Ripemoff Ltd had purchased eight blocks of land upon which it intended to build a new factory. In fact, only three blocks had been purchased and the new factory could not be commenced. As a result share prices of Ripemoff Ltd have plunged on the stock market.
Advise:
How will damages be assessed, if recoverable?
as to any possible breaches of the law by either the company or directors. What defences could be raised?
a.
shareholders as to possible actions that can be brought against: the directors;i. the company.ii.
b.
3.
LAW00004 Company Law
Topic 6 Financing the corporation | 113
6.8 The capital maintenance doctrine
Textbook 10th ed, pp 546–569 and then consider the following matters
A and B are in the process of forming a company to be known as Warra Minerals N.L. A prospectus is published by A and B, part of which recited that an agreement had been signed in the proposed company’s name for the purchase of certain land which guaranteed that the company would in the future own the land. In addition, contained in the prospectus, was a statement by X, a newly qualified geologist, that certain ore had been found on the land to be purchased which would be most likely to be very profitable to the company. A and B agreed to publish his/her opinion despite the fact that other tests had been made previously on the land by other companies who showed little interest in the land. The company was then formed. C bought shares after perusing the prospectus.
X was a rogue and had made the statement that the ore would be valuable in order to profit on share trading. In fact the ore was worthless. However, A and B believed that the ore was valuable, having been convinced by X that this was the case.
After this issue of the prospectus but before the allotment of the shares, X admitted to B that the ore was worthless and that he had lied, whereupon B put a notice up outside the company’s office stating that he was withdrawing his backing for the prospectus.
Later, when the shares were allotted, C became suspicious of the bona fides of the company and sold some of his shares to D.
Outline the remedies, if any, available to C and D against A, B, X and the company. C and D wish also to bring action against all of these by way of prosecution under the Act.
4.
A Ltd upon incorporation issues a prospectus on 1 January, inviting the public to subscribe for an issue of 400 000 shares of $1 each, payable 25 cents on application, balance on allotment. Among statements in the prospectus are:
On the basis of the above information advise on the following situations:
A Ltd will apply for listing of the shares on the Sydney Stock Exchange.a. The minimum subscription required is $350 000.b.
X applies for 5000 shares on 31 January. Allotment is made to him on 20 February. On 5 March X learns that the company has not made application to have the shares listed on the Sydney Stock Exchange. Advise X.
i.
Y applies for 10 000 shares by letter received by A Ltd on 25 January. The letter contains a single sheet of paper requesting 10 000 shares and enclosing a cheque for $10 000. Advise A Ltd on the allotment of shares to Y.
ii.
By 10 February, applications have been received for 450 000 shares (excluding the application by Y above), on which application money is paid, and on 20 February A Ltd allots 400 000 shares. Advise A Ltd on the legality of the allotment.
iii.
5.
Textbook
LAW00004 Company Law
Topic 6 Financing the corporation | 114
The capital maintenance doctrine provides that creditors have a right to rely on the capital remaining undiminished by expenditure outside the limits provided in the law, or by return of capital to the shareholders. This is founded in the decision in Trevor v Whitworth (1887) 12 A.C. 409, but these days is largely based on statutory principles. We consider these statutory principles below.
Trevor v Whitworth The company’s articles provided that a company (J Schofield and Son Ltd) could purchase its own shares. Whitworth’s executors sold his shares back to the company.
The company went into liquidation prior to the payment of the second instalment and the executors sought the payment from the liquidator.
The purchase was held to be invalid, despite the company’s articles, because creditors have a right to rely on the capital remaining undiminished by expenditure outside the limits provided in the Act, or by return of capital to the shareholders.
Other comments from the case are:
The principles in Trevor v Whitworth are contained in the Act.
Read the following sections carefully:
Reduction of capital In Re Tantalex Ltd (1987) 5 ACLC 266 Mr Justice Young of the Supreme Court of NSW noted that a company reducing its share capital should:
Holding/subsidiary companies A company cannot be a member of its holding company.
For example:
forfeiture of shares is outside the rule because the Act recognises it;
a surrender of shares is also outside the rule because it does not involve a payment of money. If it did then it would be caught.
Reading
Sections 256A–256E Sections 259A, B, C and D Sections 260A–D; ss 257A–257J
make full and fair disclosure to members;
notify the tax commissioner;
notify general public by advertisement; and
convene a meeting of the company.
Holding Ltd owns 60% of the shares in Subsidiary Ltd.
Subsidiary Ltd may not own shares in Holding Ltd.
LAW00004 Company Law
Topic 6 Financing the corporation | 115
Note:
Sections 260A – D Companies financing dealings in own shares and Part 2J.1 Div 2 Share buybacks These provisions allow the possibility of a corporation purchasing its shares at a price which increases the net asset backing per share, to the benefit of remaining shareholders.
The prohibition on a company financing dealings in its own shares is found in ss 260A–D of the Corporations Act. These sections prohibit a corporation from dealing in its own shares either by acquiring them itself, providing financial assistance (in any form) to do so, or by lending money on the security of those shares.
Under s 257A a company can buy back its shares if the buyback does not materially prejudice the company’s abilities to pay its creditors and the procedures in the Division are followed. The procedures are described in ss 257B–H.
6.9 Dividends The circumstances under which a dividend may be declared is provided for in s 254T. Previously the Act forbad the payment of dividends except out of profits of the company.
Textbook 10th ed, pp 577–583
CLRA has changed the common law rules relating to when a debt is incurred: see 254V and below.
A director has a duty to ensure that payment of dividends does not cause a breach of the insolvent trading provisions: see s 588G. The provision that dividends may only be paid out of profits is, of course, an extension of the basic principle that the capital of a company should be preserved from avoidable erosion. However, the Act makes no attempt to define profit, and the only guidance on the matter is found in judicial decisions.
Section 254V amends the common law by providing that a company does not incur a debt merely by fixing the amount or time for payment of a dividend, and further providing that the debt arises only when the time fixed for payment arrives. The decision to pay may be revoked any time before then.
Moreover, there is always the possibility that the Constitution may lay down restrictions on the payment of dividends, and in such case the company’s Constitution must be followed, see also the replaceable rule in s 254U.
the time periods in s 259D; and
the definition of control in s 259E.
Textbook
LAW00004 Company Law
Topic 6 Financing the corporation | 116
6.10 Financial reports and audit
Textbook 10th ed, Chapter 15, pp 467–494 and the sections below, and note the right of inspection by the directors (s 290), auditors (s 310) and the limitations on the members rights to inspect documents in s 247A (court order needed).
Introduction The Corporations Act provides rules with regard to the accounts and audit of such accounts in order that investors and creditors (and potential investors and creditors) are provided with the information necessary to inform them of the financial position of a company whilst, at the same time, attempting to prevent any information that would be of vital interest to the company’s competitors, from being gratuitously provided to them.
Activity 6.4
On 25 June, the directors of Law Ltd recommended that a final dividend of $1 a share should be paid by the company. At the annual general meeting held on 10 July, the shareholders accepted the recommendation of the directors in regard to the final dividend. On 30 July, the company’s accountants revalued the assets of the company and advised the directors that there were no profits to meet the dividend.
Should the dividend be paid?a. Can dividends be declared from a ‘profit’ arising from a revaluation of some assets of a company? Comment on any relevant case or statute law.
b.
1.
a. What aspects of public policy underlie the capital maintenance doctrine? b. For whose protection have these provisions been inserted into the Act? c. To what extent does the doctrine still stand?
2.
a. In what circumstances will a company be allowed to purchase its own shares? b. Should companies be permitted to do this? c. Do these provisions provide sufficient protection?
3.
Big Ltd holds 20% of the shares in Large Pty Ltd and the directors of Big are eager to increase the company’s shareholding. The directors of Large are quite happy to see Big’s shareholding increase as they perceive Big to be able to provide technical expertise and marketing contacts. The directors of Large decide to recommend a higher than usual dividend in the hope that Big will use the cash to purchase more shares in Large.
Discuss.
4.
Textbook
LAW00004 Company Law
Topic 6 Financing the corporation | 117
Financial records The Act requires that companies keep ‘financial records’ (as defined in s 286) to correctly record and explain any transactions of the company. Such written records are required:
Annual financial reports and directors reports The companies that have to prepare annual financial reports are listed in s 292. All large proprietary companies and public companies are caught. Note the circumstances when a small proprietary company has to report as listed in ss 292(2), 293 and 294.
The contents of the Annual Financial Report are described in s 295. For listed companies note ss 295A and 299A.
The obligation to comply with accounting standards is provided in s 296.
The financial statements must give a true and fair view of the financial position and performance of the company and of any consolidated entity: s 297.
Directors are responsible for the provision of an annual directors report: s 298, containing the information listed in ss 299–300A.
An audit must be performed under s 301, but note the exemption in s 301(2) for small proprietary companies.
Under s 314 companies must report to members, and comply with the deadlines imposed under s 315. Companies which are obliged to hold an annual general meeting must lay before that meeting the financial, directors and auditors reports: s 317. Reports also have to be lodged with ASIC under s 319.
Since August 1991 the Act has required that companies which control other ‘entities’ must issue consolidated accounts: See ss 323, 323A, 323B and 323C.
ASX listing rules Companies which are listed on the Australian Securities Exchange are also required to comply with the accounts provisions of the Australian Securities Exchange listing rules which are recognised by s 793C of the Act.
Annual returns or lodgement with ASIC
Generally read Chapter 2N of the Act.
to correctly record and explain its transactions and financial position and performance;
to enable true and fair financial statements to be prepared and audited; and
to be retained for seven years: ss 286(2).
Reading
LAW00004 Company Law
Topic 6 Financing the corporation | 118
Accounting standards
For an overview of changes introduced by CLERP see CLERP EM at Chapter 4, Summary of key amendments proposed by the Bill Accounting standards, para 4.2 reproduced below. (See also Chapter 9.) The relevant provisions are contained in Part 12 of the Australian Securities and Investment Commission Act 2001 (Cth). Detailed knowledge of these provisions is not required. See also Reading 6.1.
Reading
LAW00004 Company Law
Topic 6 Financing the corporation | 119
Accounting standards
Audit ASIC, in Practice Note 34, indicates that it expects auditors to be vigilant in detecting and reporting contraventions of the Act. Accordingly it opines that the auditor’s duty to report arises where, on a balance of probabilities, the auditor is led to believe that a contravention has taken place. Such a breach could be if the company, issues shares at a discount, fails to keep correct records and that there are obvious breaches of the duties of the directors.
4.2 The key features of the new regulatory arrangements proposed by the Bill are: Establishing the Financial Reporting Council as an advisory body with responsibility for the broad oversight of the Australian accounting standard setting process and for giving the Minister reports and advice on that process.
Members of the FRC would be appointed by the Minister on the basis of nominations made by peak professional, business and government organisations having an interest in the standard setting process.
Specific functions of the FRC would include: appointing the members of the standard setter (the Chairman of the standard setter would be appointed by the Minister)
approving and monitoring the standard setter’s priorities, business plan, budget and staffing arrangements
monitoring the development of international accounting standards and furthering the harmonisation of Australian standards with international standards, and
promoting a greater role for international accounting standards in the Australian accounting standard setting process.
Reconstituting the standard setter, the Australian Accounting Standards Board (AASB) as a body corporate, thus enabling it to employ staff and acquire property in its own right.
Functions of the AASB would include making accounting standards for the purposes of national scheme laws, formulating accounting standards for entities not established under national scheme laws and participating in the formulation of international accounting standards.
The AASB’s powers include engaging the staff and consultants needed to undertake its technical research and providing administrative support.
Facilitating interpretation of accounting standards by setting out the objectives of the accounting standard setting provisions in the legislation and providing that accounting standards are to be interpreted in accordance with those objectives. In addition, each accounting standard would have to be interpreted in accordance with any ‘statement of purpose’ provision in the standard, so long as that statement was not inconsistent with the objectives of the standard setting provisions.
A body, based on the existing Urgent Issues Group (UIG), would be established by either the FRC or the AASB to provide guidance on urgent financial reporting issues.
Requiring a cost/benefit analysis of the impact of a proposed accounting standard to be prepared by the AASB before:
making or formulating an Australian accounting standard
providing comments on an exposure draft of an international accounting standard, or
proposing a standard for adoption as an international accounting standard.
Funding – it is anticipated that funding of the new standard setting arrangements, which will be overseen by the FRC, will be provided by the Government, the Australian Society of Certified Practising Accountants and The Institute of Chartered Accountants in Australia (jointly) and preparers/users in the public and private sectors in broadly equal proportions.
International harmonisation – the Minister would have the power to give the AASB a direction about the role of international accounting standards in the Australian accounting standard setting system but, before giving such a direction, would be required to consider a report from the FRC about the desirability of giving the direction.
LAW00004 Company Law
Topic 6 Financing the corporation | 120
Audit – under the common law Almost a hundred years ago the courts indicated the duties and responsibilities of an auditor under common law when, in 1896 Lord Lopes said of the auditor ‘He is a watchdog, but not a bloodhound’ (Re Kingston Cotton Mill Co. (No. 2) [1896] 2 Ch. 279). This metaphor has been the topic of comment by Rogers C.J. in the Commercial Division when in the matter of AWA Ltd v Daniels (No. 2) (1992) 10 ACLC 1643 he added to the phrase: ‘Whether auditors are watchdogs, or bloodhounds, or any other form of canine, they cannot allow themselves to be utterly toothless’ (at p 1652).
The Institute of Chartered Accountants in Australia has, more recently, described an audit as being:
Considerable case material is available with regard to the duties of auditors. See the Kingston Cotton Mill Case (supra) and the more recent Australian cases Pacific Acceptance Corp. Ltd v Forsyth (1970) 92 W.N. (NSW) 29 and AWA Ltd v Daniels (supra).
With the development of tortious liability from the significant case of Hedley Byrne & Co Ltd v Heller & Partners Ltd [1964] AC 465 there has been a great deal of discussion with reference to the auditor’s role vis-a- vis third parties. The cases are very difficult to reconcile. The leading case from England is Caparo Industries plc v Dickman & Ors (1990) 8 ACLC 3011: [1990] 1 All ER 569 In Australia the case of Lowe Lippman Figdor & Frank v A.G.C. (Advances Ltd (1992) 10 ACLC 1168 appeared to agree with the English views although the reasoning was different. This is demonstrated in the Supreme Court of NSW decision in Columbia Coffee & Tea Pty Ltd v Churchill (1992) 10 ACLC 1659.
In the former case, the Supreme Court of Victoria considered the situation where a finance company advanced monies to the audited company based on a statutory report of the auditors in which the audited accounts relied on stock sheets which, to the auditor’s knowledge were false. The court found that, to be liable, the plaintiff in the case would have to have been induced by the auditors to act on the accounts. The latter case was one in which the auditors had substantially understated the liability of the company to its creditors. The NSW Supreme Court found that because the audit manual acknowledged responsibility to any interested parties who relied on the reports, the auditors owed a duty of care to the plaintiff in the matter.
The leading Australian authority is now the High Court decision in Esanda Finance v Peat Marwick (1997) 188 CLR 241. Esanda Finance followed the decision in Lowe Lippman and held that it is not sufficient to show that a financier or creditor might rely on the audited accounts, there is need for more to show proximity, such as evidence that the auditors had (i) been approached to give information of a particular kind which would be relied on by a particular person or class or persons or (ii) performed the audit so as to induce persons to rely on the audit.
It should be noted that in New Zealand the Court of Appeal has ruled that an auditor is liable to persons whose use of the auditor’s statement is just foreseeable (see Scott Group Ltd v McFarlane & Ors (1978) 1 NZLR 553).
the independent examination of financial information of any entity, whether profit oriented or not, and irrespective of its size, or legal form, when such an examination is conducted with a view to expressing an opinion thereon … The auditor’s opinion helps establish the credibility of the financial information. The user, however, should not assume that the auditor’s opinion is an assurance as to the future viability of the entity nor an opinion as to the efficiency or effectiveness with which management has conducted the affairs of the entity.
While the auditor is responsible for forming and expressing an opinion on the financial information, the responsibility for its preparation is that of the management of the entity. Management’s responsibilities include the maintenance of adequate accounting policies, and the safeguarding of the assets of the entity. The audit of the financial information does not relieve management of its responsibilities.
— (Statement of Auditing Standards AUS 1, 1993 #4, 8 & 9)
LAW00004 Company Law
Topic 6 Financing the corporation | 121
Audit – under the Corporations Act The aim of an audit is to carry out an investigation into the affairs of a company and thereafter to make a report which, in terms of the Act, demands that the auditor be responsible for reporting on the financial statements to be laid before the members of the company at the AGM. The auditor must also report to the members on the financial records under s 308 and as to whether they give a true and fair view and are in accordance with relevant accounting standards. If this is not the case then particulars must be given of the financial implications of the non compliance: s 308(2).
The audit must be conducted in accordance with auditing standards: s–307A. On auditor independence see s 307C. On appointment and removal see Part 2M.4.
The auditors are also under a duty to give their opinion on the manner in which the accounting records have been kept and in the case of any defect to report accordingly. Access to necessary information is required and any deficiency must be the subject of comment.
A further statutory duty arises under s 311 to inform the ASIC in relation to contraventions of the Act.
Apart from the Corporations Act and liabilities under common law auditors should be aware of the implications of the Competition and Consumer Act 2010 (Cth), Schedule 2 s 18, The Australian Consumer Law with reference to misleading and deceptive conduct and the wide range of remedies that are available from the application of the statute. Audit companies may now be used: Part 9.2A Corporations Act 2001 (Cth).
LAW00004 Company Law
Topic 6 Financing the corporation | 122
Activity 6.5
Charles Stevens and Co were auditors to the General Technology Co Ltd, a company involved in the import and export of electronic components, and they have provided unqualified audit statements in their reports to the company over the previous four years despite a discovery when carrying out the audit investigation that there were gaps in the internal management controls within the company which related to the organisation’s dealings in relation to foreign exchange. The company’s chief accounting officer had been informed of the auditors’ concern with reference to what appeared to be gross inefficiency on the part of the clerical staff involved with these dealings but, no action was been taken by the Board of Directors in any attempt to remedy the discovered irregularities.
As a result of their audit manager’s concern one of the senior partners of the audit firm forwarded a letter to the CEO which indicated a general misgiving in the company’s internal checks and procedures and some recommendations in order to remedy the situation, however the letter contained no reference to the foreign exchange operations of the company nor did it indicate any urgency in the situation.
Several months later it was discovered that the senior finance officer appointed to manage the foreign exchange currency transactions had caused the company to lose several million dollars due to his mishandling of the transactions and the lack of supervision by the accounting manager and that he had attempted to cover the losses by obtaining unauthorised foreign currency from a number of banks who, incorrectly, assumed that he did have the required authority to obtain such loans.
On discovery of the losses which had been incurred by the company, the board of directors commenced an action against the auditors for failing in their contractual obligations to the company. The auditors denied the allegations made against them and counterclaimed that it was the company’ management that was at fault through not informing the board of directors that no action had been taken by the company’s CEO on the receipt of their letter suggesting improvements required to be made to the company’s own internal controls and lines of procedure.
Should the auditors be held responsible for the company’s losses? Discuss the probability of success in both the claim and counterclaim based on the facts as provided.
1.
Consider the CLERP (Audit Reform and Corporate Disclosure) Bill 2003, described in Reading 6.1. How did this amend the law relating to director’s remuneration, accounts and audit?
2.
1. Explanatory Memorandum to the Personal Property Securities (Corporations And Other Amendments) Bill 2011 (Cth).
2. ibid. 3. See fact sheets at http://www.ppsr.gov.au/Pages/ppsr.aspx See also the glossary of the Explanatory
Memorandum, Personal Property Securities Bill 2009 (Cth) circulated by the authority of the Attorney-General, the Honourable Robert McClelland MP http://www.comlaw.gov.au/Details/ C2009B00154/Explanatory%20Memorandum/Text (accessed 17 April 2012).
LAW00004 Company Law
Topic 6 Financing the corporation | 123
Topic 7
Takeovers
Objectives To successfully complete your study of this topic you will need to:
7.1 Introduction The conduct of takeovers in Australia is regulated by Chapter 6 of the Corporations Act. This legislation is quite complex and represents the gradual, and in more recent time, rapid introduction of regulatory controls in the area.
The early companies acts did not contain any specific provisions on takeovers. The 1961 Uniform Companies Acts introduced the Part A/Part B takeover offer/announcement provisions which now appear in a more sophisticated form in s 616 of the Corporations Act. Modern takeover law dates back to the 1980s when an earlier version of the model now used was first introduced.
In this topic we will also examine the laws relating to substantial shareholdings and share ownership tracing which are directly linked to takeover law.
Textbook 10th ed, Chapter 23, pp 687–715
7.2 Takeovers
Influence of the companies codes The present provisions are similar to the complicated scheme introduced in 1980 in the Companies (Acquisition of Shares) Codes. The general philosophy behind the scheme introduced in 1980 was to ensure:
develop an understanding of the law relating to takeovers, substantial shareholdings and share ownership tracing; and
be able to describe the statutory mechanisms provided in the Corporations Act to regulate takeovers, substantial shareholdings and share ownership tracing.
Textbook
a sufficient, competitive, informed market;
equal access to information;
equal opportunity to deal in the market;
equal opportunity to participate in benefits accruing to members under the bid;
that the premium paid by an bidder for control of a company is shared by all members;
124
The 1980 provisions were incorporated into the Corporations Law. They underwent a major rewrite in 2000 with the introduction of the CLERP amendments which changed all section numbers and the content of a number of provisions. A summary of these changes is included below. A statement of purposes of the current takeover law is found in s 602.
The regulatory regime works as follows:
Note also the reform introduced by the Corporations Amendment (Takeovers) Bill 2007. The Bill was enacted and made amendments to the takeover provision of the Corporations Act 2001 (Cth). The amendments include amendments to the Corporations Act 2001 that relate to the Takeovers Panel. The explanatory memorandum to the Corporations Amendment (Takeovers) Bill 2007 explains the amendments and can be viewed at: http://parlinfoweb.aph.gov.au/piweb/Repository/Legis/oldEms/Linked/27040705.pdf
that all members of the target company had sufficient information to assess the merits of the offer;
that the directors of the target company were not able to frustrate a bid prior to its members having an adequate opportunity to evaluate it; and
that actual or potential market manipulation would be promptly detected.
once a person has obtained 20 per cent of the voting rights in a company that person may not acquire further voting rights, for example, by the purchase of more shares, unless the person follows one of the mechanisms provided in the Act in ss 611–615;
the most common exceptions, on market or off market bids, are described in more detail in s 616;
bids have to follow a strict procedure and contain certain information, which is contained in a ‘bidders statement’;
the bid will generate a response from the target company known under the Act as the ‘target’s statement’;
further provisions exist to protect investors and in certain circumstances allow recovery of loss or damage.
LAW00004 Company Law
Topic 7 Takeovers | 125
For an overview of changes introduced by CLERP see the Explanatory Memorandum Chapter 4, Chapter 4, Summary of key amendments proposed by the Bill Takeovers at paragraph 4.2 which is reproduced below (see also Chapter 7).
In addition, provisions in the Bill will have the effect of removing the overlapping application of s 52 of the Trade Practices Act [now 18 Misleading or deceptive conduct, Competition and Consumer Act 2010 (Cth), Schedule 2 The Australian Consumer Law] to takeover activity, and removing governmental immunity of federal government business enterprises from the takeover provisions.
7.3 Prohibition on acquisitions of more than 20 per cent The key to the operation of the takeovers provisions is s 606 which prohibits the acquisition of over 20 per cent of the voting shares in a company, except via one of the avenues listed in the table in s 611.
In addition, the section prohibits a person who holds between 20 per cent and 90 per cent from acquiring further voting shares, except as provided by the Act.
Reading
4.2 The key features of the new regulatory arrangements proposed by the Bill are to: Promote a more competitive market for corporate control by:
allowing a bidder to exceed the statutory threshold of 20 per cent of total voting rights to gain control of a target provided that the announcement of a full takeover bid – the mandatory bid – immediately follows the acquisition that takes the bidder through the threshold. The bid price must be the same as, or higher than, the best price paid by the bidder for shares in the target in the previous 4 months.
modifying the compulsory acquisition rules to: allow all types of securities (not just shares) to be compulsorily acquired
allow compulsory acquisitions to take place at any time (not just following a takeover bid)
facilitate the acquisition of the outstanding securities in a class by any person who already holds 90 per cent of the class, and
make it easier for majority shareholders to obtain the benefits of 100 per cent ownership by providing for the acquisition of all the securities, in all classes, of a target, where overwhelming ownership of the target by the majority shareholder can be demonstrated.
Improve resolution of takeover disputes by reforming the Corporations and Securities Panel (Panel) so that it, rather than the courts or the Administrative Appeals Tribunal (AAT), is the primary forum for resolving takeover matters. This will be achieved by:
opening up access to the Panel to any interested party (rather than being limited to ASIC as at present)
except on the application of ASIC or another public authority of the Commonwealth or a State, ensuring that the courts will not grant injunctions during the bid period, and
having the Panel, rather than the AAT, deal with appeals against ASIC
exemption and modification decisions relating to takeovers.
Extend the takeover provisions to listed managed investment schemes, so that members of these schemes will have the same rights to share in a control premium as shareholders, while responsible entities of these schemes will face the same competitive pressure to perform as company directors.
Streamline the rules for off-market and market bids, including bringing together disclosure requirements into a bidder’s statement (replacing the current Part A and Part C statements) and a target’s statement (replacing the current Part B and Part D statements). These statements will facilitate better disclosure by replacing the checklist of content rules with a general disclosure requirement for all information material to a shareholder’s decision whether or not to accept an offer.
Rationalise liability provisions by ensuring that the liability regime for the contents of takeover disclosure documents is generally consistent with that applying to the proposed new fundraising rules.
LAW00004 Company Law
Topic 7 Takeovers | 126
A person who holds 90 per cent or more can force the compulsory sale of the balance without the need to follow one of the s 611 exceptions.
I want you to consider the definition and importance of the following definitions which give meaning to the expression ‘relevant interest’ used in s 606:
This term uses the words ‘power’ or ‘control’ which are also defined:
You will soon see that these definitions extend the operation of s 608 to catch obvious avoidance techniques, such as the use of a company controlled by the bidder to make the bid where the bidder itself is prohibited from doing so because it is already over the 20 per cent threshold. This attempted use of the separate legal entity does not work under takeover law.
Similarly, the bidder might have sought to make its bid through some agreement it had with a friend or associate: Section 608(8) forces the inclusion of such agreements in the calculation of control and hence the calculation of ‘relevant interest’.
7.4 Exceptions to section 606 Section 606 does not prohibit takeovers per se, rather it is part of a broad scheme designed to regulate the means by which takeovers can proceed.
There are a number of exceptions to s 606 which are summarised in s 611. Note in particular:
The first two exceptions are the most relevant in practical terms. In both cases a person proposing or announcing a bid must make their offer within two months: s 631.
The steps that follow are described in ss 633 and 634 depending on whether the offer is made for listed securities through the stock exchange, known as an on market bid, or an off market bid which can be made for both listed and unlisted securities.
Reading
relevant interest: – s 608(1).
power or control: – ss 608(2), (4), (5), (6);
relevant interests held through a body corporate: – s 608(3);
control pursuant to an agreement: – s 608(8).
takeover announcements on the stock exchange, pursuant to an on market bid (covered later);
takeover offers under an off market bid (covered later);
creeping takeovers: under this section a person entitled to 19 per cent or more of voting shares may acquire no more than 3 per cent every six months;
acquisitions under a will;
acquisitions pursuant to a prospectus or an underwriting agreement;
acquisitions that result from an acquisition of voting shares in a listed company; and
acquisition of companies where the company has resolved previously to approve the acquisition and the bidder did not vote on the resolution.
LAW00004 Company Law
Topic 7 Takeovers | 127
7.5 Off market bids If an off market bid is made under s 616, the bidder and the target company must follow the detailed steps described in ss 632 and 633.
7.6 On market bids If an on market bid is made under s 616, the bidder and the target company must follow the detailed steps described in ss 634 and 635.
Now work through the steps in ss 632, 633 and ss 634, 635, noting:
What is in the target’s response? See s 638.
Is there a procedure for updating these documents? See ss 643–647. Note the effect of ss 617–629.
These sections define the terms and types of offers that can be made. When can a partial offer be made? See ss 617, 618.
Can offers be made in cash and securities? See s 621. How long must a bidder leave an offer open? See s 624.
Under what circumstances can a bidder make conditional offers? See s 625, and ss 626–629. Can a bidder vary an offer? Under what circumstances? See Part 6.6.
Can a bidder withdraw an offer? Is any consent required? See Part 6.7.
What if a bidder sell shares during the period when it is bidding for them? See s 654A. Can reports from experts be used? See 648A.
7.7 Other relevant sections regarding takeovers Note these important provisions in the Act relevant to takeovers:
Activity 7.1
the role played by each party; and
the documents that have to be lodged with the ASIC, and sent to various parties. What information must be contained in a bidder’s statement? See s 636.
Chapter 6A allows compulsory acquisitions where a bidder acquires 90 per cent of the voting shares in a company.
1.
Chapter 6B deals with liability for misleading or deceptive statements in, or omissions from, takeover documentation.
2.
Part 6.10 vests significant powers in the Australian Securities and Investment Commission and the Takeovers Panel, the latter body having power to declare certain acquisitions unacceptable. Wide powers are also given to the Court in Part 6.10.
3.
Note the relevance of Topic 5 to takeover law especially in relation to defensive measures adopted by directors, see especially Howard Smith v Ampol Petroleum Cassidy 10.320.
4.
LAW00004 Company Law
Topic 7 Takeovers | 128
7.8 Substantial shareholdings
Textbook 10th ed, pp 247–248
Chapter 6C of the Act
The provisions relating to substantial shareholdings are covered in Chapter 6C. This Chapter is aimed at disclosure by major shareholders of the extent of their holdings in a public listed company. It is based on the belief that the company, shareholders and the public should know of any member of the company, who in terms of voting power, is able to exert an influence on the company.
For this reason the test applied to determine who is a substantial shareholder is 5 per cent of the voting power, and it applies to all persons, whether Australian residents or not, with respect to companies listed on Australian Stock Exchanges: s 671B.
Activity 7.2
The Board of Directors of Mills Ltd is fearful of a takeover offer. The value of the shares on the stock market is $500 000 and the company’s principal asset is one acre of land in the centre of Lismore which is valued at $1 million, and the company has reserves of cash because although substantial profits have been made in the past 5 years, no dividends have been paid. The Board therefore resolves to pay a dividend of $250 000 to existing shareholders and issue 100 000 voting shares to a trust fund for the benefit of employees. Both decisions are put before the general meeting of shareholders who are told the following:
We have declared a dividend because we have cash in excess of our needs, and a share issue in favour of employees is vital if Mills Ltd is to maintain good industrial relations.
The general meeting ratifies the two resolutions. Three days after the general meeting, Smith acquires a 19 per cent share holding.
What legal action can Smith take?
1.
A Ltd has received notice of a takeover bid from B Ltd and the required statement. A meeting of the directors of A Ltd has been called to discuss the offer. As a secretary of A Ltd, itemise the matters you want to have considered at this board meeting.
2.
3a A Ltd has made a takeover offer for all the issued shares of B Ltd, such offer to be accepted by 31 July. The terms of the offer were one share in A Ltd plus 50 cents cash or $1.50 cash for each B Ltd share. By 31 July, A Ltd has received acceptances from 95 per cent of B Ltd shareholders.
Advise A Ltd on any procedure available by which they may acquire the remaining 5 per cent.
3b Jenny, one of the shareholders of the remaining 5 per cent (in a) above) consults you as to her rights.
On the basis of your answer to (a), advise her.
What are the legal consequences of a misrepresentation in a bidder’s statement?4.
Reading
LAW00004 Company Law
Topic 7 Takeovers | 129
The test of a substantial shareholder relates to a person who has an interest in 5 per cent of the voting rights of the company: s 671B. In order to make a decision on this it is necessary to refer to the definition of ‘substantial holding’ and ‘associate’ in s 9 and the definition of ‘relevant interest’ in s 608.
A person is required to:
Provision is made for notification of change in interests where there has been more than 1 per cent movement as defined in 671B(2), and for notice of ceasing to be a substantial shareholder: s 671B(1).
Note the civil remedy provided in s 671C for loss or damage suffered because a person contravenes 671B.
The substantial shareholding provisions work closely with the provisions allowing listed companies to trace the beneficial ownership of their shares covered below. Contrast beneficial ownership to mere legal ownership, for example, a trustee who may appear on the register of members as the owner of the shares but is in fact holding the share for some other undisclosed person’s beneficial or real ownership.
The tracing laws are aimed at forcing total disclosure of members, and their associates’ holdings whether or not the shares are registered in the name of the beneficial owner.
Knowledge of beneficial holdings may be critical for a company about to launch a takeover bid. It is also very useful for a target company to monitor potential bidders in a takeover.
Prior to the introduction of this amendment it was possible for a person to obtain a substantial shareholding by use of trusts in a company without the fact being discoverable from an inspection of the register of members.
7.9 Share ownership tracing
The provisions on share ownership tracing are described in Part 6C.2 of the Corporations Act.
A listed company may direct a member to give full details of their relevant interests in shares under s 672A. ASIC may make a similar direction.
Furthermore a corporation or a member may request the Commission to conduct a beneficial share ownership trace, though if the Commission is of the opinion that the request is unreasonable, it may refuse to comply with the request: s 672A(2). Even if the request is assented to, the results of the share trace need not be forwarded to the requesting party: see s 672C.
The information that must be given by a member following a direction under s 672A is contained in s 672B. Note the civil remedy provided in s 672F for loss or damage suffered because a person contravenes s 672B.
give written notice to the company within two days of becoming a substantial shareholder: s 671B(6); and
must advise full particulars of the voting shares in which he/she has an interest: s 671B(3).
Reading
LAW00004 Company Law
Topic 7 Takeovers | 130
7.10 Securities regulation The provisions on securities regulation will not be specifically examinable except to the extent covered elsewhere in this subject; for example, insider trading is examinable and was covered in Topic 5. If you are working in the area you should be aware of:
Conclusion In this topic we have examined takeover law in some detail. You should now appreciate how complicated our Australian regulatory regime is in this area. You should also have identified the relevance of other topics, in particular Topic 4 where we examined the rights of minority shareholders, and Topic 5 on management. Cases such as Howard Smith v Ampol Petroleum (1974) AC 821 are very relevant to the conduct of target company directors and should be re-read in the context of this topic.
Activity 7.3
What is meant by beneficial share ownership?1. What policies underlie, and who benefits from:
the requirement of substantial shareholding notices?a. beneficial share ownership tracing?b.
2.
Why are there restraints on the free exercise of beneficial share ownership tracing?3.
the role and regulation of the stock exchanges and the importance of the listing rules;
the controls on and the licensing of dealers and investment advisors;
the prohibited practices of: short selling;
share hawking;
false, misleading and deceptive conduct;
market manipulation and rigging;
fraudulently inducing persons to deal in securities; and
insider trading.
LAW00004 Company Law
Topic 7 Takeovers | 131
Topic 8
Corporate insolvency
We now turn to insolvency law, and whilst there is no direct link between Topic 7 and Topic 8 in terms of the law, there is no doubt that unrestrained takeover activity can be a contributing cause to a company or group of companies becoming insolvent.
Objectives To successfully complete Topic 8 you will need to be able to:
8.1 Introduction This final topic is critical. Much of modern company law has arisen out of an insolvency law context. Insolvency litigation is close to 50 per cent of all litigation involving companies. This area of law is therefore of vital importance academically and in accounting, legal and banking practice.
We will consider five topics: schemes of arrangement, receivership, voluntary administration, deeds of company arrangements and winding up.
It is worth noting that a good summary of the legal principles relating to the roles of a liquidator (appointed by the court and by private appointment), administrator and receiver are provided by S A Forgie, Deputy President, in Lofthouse and Australian Securities and Investments Commission [2004] AATA 327, at para 10–63.
http://www.austlii.edu.au/au/cases/cth/aat/2004/327.html
Some useful internet links are:
describe the law relating to insolvent trading and have considered the implications of this for business;
discuss and apply the common law and statutory provisions relating to schemes of arrangement, receivership, voluntary administration, deeds of company arrangement and winding up;
compare various avenues open to a company and to its creditors where the company is in financial difficulty, including receivership, arrangements and reconstructions, voluntary administration and winding up;
analyse the impact of corporate insolvency on the management of a company and discuss the circumstances when management may be liable for the corporation’s debts;
describe the precise role, powers, duties and potential liability of receivers, scheme managers, and liquidators; and
describe and discuss any areas in need of law reform.
Austlii – http://www.austlii.edu.au
ASIC – http://www.asic.gov.au
Australian Restructuring Insolvency & Turnaround Association (IRITA) – http://www.arita.com.au
132
Textbook 10th ed, Chapter 24, pp 723–755
8.2 Corporate insolvency law reform The Australian Law Reform Commission conducted an inquiry into insolvency law and in 1988 delivered what is known as the ‘Harmer Report’; Australian Law Reform Commission (ALRC) Report No 45, General Insolvency inquiry, 1988 and can be viewed at: http://www.austlii.edu.au/cgi>-bin/sinodisp/au/other/ lawreform/ALRC/1988/45.html.
The Harmer report has had a major influence in developing current insolvency law in Australia.
Corporate insolvency law reform took centre stage in 2007. After a number of public enquiries into the corporate insolvency framework, including the 1997 Review of the Regulation of Corporate Insolvency Practitioners; the 1998 Corporations and Markets Advisory Committee (CAMAC) Report Corporate Voluntary Administration; the 2000 CAMAC Report Corporate Groups; the 2004 CAMAC Report Rehabilitation of Large and Complex Enterprises; the 2004 Parliamentary Joint Committee on Corporations and Financial Services (PJC) Report Corporate Insolvency Laws: A Stocktake and the 2004 Report of the James Hardie Special Commission of Inquiry, the Australian Parliament finally passed a package of corporate law reforms on 9 August 2007. The reforms were contained in the Corporations Amendment (Insolvency) Act 2007; Corporations Amendment Regulations 2007 and the Australian Securities and Investments Commission Amendment Regulations 2007 which all came into effect on 31 December 2007.
The explanatory memorandum to the Corporations Amendment (Insolvency) Bill 2007 can be viewed at: http://parlinfoweb.aph.gov.au/piweb/Repository/Legis/oldEms/Linked/13110706.pdf.
The most recent insolvency law reform is the amendments made by the Insolvency Law Reform Act 2016 (ILRA). The ILRA, among other things, makes changes to the procedural provisions in Chapter 5 of the Corporations Act. The changes will come into effect on 1 March and 1 September 2017. The reform is aimed at improving efficiency and public confidence in the insolvency profession.
Key changes include:
Textbook
Disciplinary procedures for liquidators have been removed from the Companies Auditors and Liquidators Disciplinary Board (CALDB) to a new committee comprising of members from ASIC, the Australian Restructuring Insolvency Turnaround Association (ARITA) and a Ministerial appointee. The new committee will be responsible for discipline, registration and deregulation of liquidators.
CALDB has been renamed the Companies Auditors Disciplinary Board (CADB).
There is no longer a distinction between official and registered liquidators with the latter being the sole category.
Significant changes to remuneration of insolvency practitioners, including the introduction of a statutory default remuneration (max. $5,000)
An increase of powers to creditors, including powers to give directions to external to give directions to external administrators and powers to provide them with information and documents.
Increased powers to ASIC including powers to monitor, to issue written directions and to suspend or cancel a liquidator’s registration.
LAW00004 Company Law
Topic 8 Corporate insolvency | 133
An important aspect of the reform is the movement of procedural provisions from Chapter 5 Corporations Act to the new Schedule 2; the Insolvency Practice Schedule (Corporations); see s 600K. The objects of Schedule to are set out in in 1–1 and aim to regulate external administrators of companies and to ensure registered liquidators have appropriate level of expertise; behave ethically; and maintain sufficient insurance.
8.3 The law on insolvency The law of insolvency, and in particular how the courts interpret s 95A of the Corporations Act is well set out in the judgment of Sunberg J in Tru Floor Service Pty Ltd v Jenkins (No 2) [2006] FCA 632 at 43–48, http:// www.austlii.edu.au/au/cases/cth/federal_ct/2006/632.html
8.3.1 Insolvent trading The Corporations Act 2001 imposes liability on directors of a company where they allow the company to incur debts when the company is either insolvent or the debt will render the company insolvent. Section 588G Corporations Act outlines the director’s duty to prevent insolvent trading by the company and should be revisited and understood.
The Act contains detailed provisions relating to insolvent trading. Note the material in Topic 5 on insolvent trading.
8.4 Schemes of arrangement – Part 5.1 Corporations Act
8.4.1 Introduction The Act provides two procedures which may be used in an attempt to save a company which is facing insolvency. These are the procedures in ss 411–415, dealing with schemes of arrangement and Pt 5.3A Voluntary Administration.
Schemes of arrangement
Textbook 10th ed, pp 748–749
Schemes of arrangement are dealt with in ss 411–415. When implemented these provisions allow shareholders and creditors to adapt to a new or deteriorating financial position. In brief, the law provides for court ordered meetings between the different classes of shareholders and creditors with a view to putting the affairs of a company under the control of a scheme manager. Generally such shareholders and creditors may be asked to give up rights in lieu of new rights which may become available, for example creditors may exchange debt for equity. The schemes are sanctioned, ordered and approved by the court. The court order binds all parties, including dissenting minorities. Schemes require two applications to the court. This involves delay and adds to the expense of introducing a scheme. For these reasons schemes have not been as common as would be the case if the procedure was simpler and the costs reduced.
Textbook
LAW00004 Company Law
Topic 8 Corporate insolvency | 134
In your reading please note the particular attention to the different types of schemes of compromise or arrangement, the procedure for implementation of a scheme of arrangement including the operation of s 411, and the factors relevant for court approval of a scheme.
Different types of schemes under s 411 Note that the Act does not prescribe the form or nature of the scheme. This is probably the greatest advantage of the procedure because it allows flexibility of design. Nevertheless, it is possible to describe the typical features of certain types of schemes:
Creditors’ schemes
Moratorium This involves deferment of payment of debts. The affairs of the company are run by a scheme administrator and a committee. The scheme administrator generally has broad powers, including those of the directors and can usually sell assets. The directors have the remaining powers delegated to them by the administrator.
Compromise In a compromise the creditors agree to receive less than 100 per cent of the amount claimed. It is also possible that shares might be received in lieu of full payment. The company is then released from outstanding debts.
Elements of moratorium/compromise It is possible that a particular scheme could contain a combination of both moratorium and compromise schemes.
Members’ schemes
Reconstruction This involves more than one company. For example, shares in company A might be cancelled and its assets transferred to company B with new shares (partly or fully paid up) being issued in company B. Thereby a similar business may be operated by the same general group.
It may also involve the variation of rights of shareholders within the company.
Example: Members who have fully paid shares could be made liable to pay more by issuing partly paid shares to them in a new company which takes over the assets of the old company.
It should be emphasised that such a reconstruction could also be useful in a non insolvency context. The procedures in s 411 are not limited to companies facing insolvency.
Reading
LAW00004 Company Law
Topic 8 Corporate insolvency | 135
Merger or amalgamation Assets in several companies could be transferred to a new company which issues shares to members of the old companies. Those redundant companies are then wound up.
The procedure for implementing a scheme under s 411 The arrangement is between three parties:
The initial application to the court is made by the company, a member, a creditor, or the liquidator. This is an application to the court for an order to hold meetings s 411(1), and an order to restrain other proceedings if necessary under s 411(16). Such an application would usually be made following discussions between a company, its creditors, and legal and financial advisors as to the viability of a rescue through these procedures. If the court accepts the application it will order certain meetings to be held:
Under s 412 an explanatory statement is required for the members and creditors attending these meetings.
Following the meetings the applicants have to come back to the court for an order implementing the scheme. Before the court gives its final approval, it is necessary at each meeting to get a majority in number representing three-quarters in value of the creditors present and voting in person or by proxy: see s 411(4). Aggregation is allowed in the circumstances described in s 411(5).
Once implemented a scheme:
Factors relevant for court approval Note that the court will not automatically approve a scheme even if all the requisite approvals are obtained at the various meetings:
the company;
its members; and
its creditors.
members meetings – these must be separate if there are different classes of members;
creditors meetings – these must be separate if there are different classes of creditors. Thus secured and unsecured creditors would vote in different classes.
binds dissenters;
may be terminated if the parties resolve.
The scheme must not be contrary to general law nor be used to circumvent the law.
How have majorities acted towards minorities?
Is the scheme reasonable? Is the scheme speculative? Is there a conflict of interests amongst creditors? For example, are there members or directors who are
also creditors, or have preferential payments been made to creditors prior to the scheme commencing?
Re the meeting(s): Was ‘the meeting honestly procured and conducted’?
Was it ‘founded on honesty of purpose’?
Was all ‘reasonable information before the meeting to enable it to arrive at a real conclusion’ [City of Melbourne Bank (1897) 3 ALR 220].
LAW00004 Company Law
Topic 8 Corporate insolvency | 136
8.5 Receivership and controllers – Part 5.2 Corporations Act
Textbook 10th ed, pp 743–748
In Topic 6 you were introduced to the law relating to debentures. You will recall that one remedy for breach of a covenant in a trust deed is that the trustee for debenture holders can enforce the debenture under powers given in a trust deed. The typical remedy is the appointment of a receiver to receive, secure and control the assets secured by the security interest. Generally this will have devastating effects on the company. The appointment of a receiver in such circumstances is known as a private appointment.
It is also possible to apply to the Supreme Court to have a receiver appointed. This may, but need not, relate to insolvency or otherwise. Where this occurs it is known as a court appointment.
Appointment
In your reading I want you to pay particular attention to the distinction between a receiver and a receiver and manager, provisions relating to all appointments of a receiver, the appointment of a receiver by the court, private appointments, and appointment by the court under s 1323 of the Act.
Note the issues relating to appointment, covered in the reading, including the following.
The distinction between a receiver and a receiver and manager A receiver is a person who receives rents or other income, paying ascertained outgoings, but who does not manage the property subject to receivership.
A receiver and manager is appointed with authority to carry on the trade or business as a going concern. The appointment of a receiver/manager replaces the powers of the directors. Note that s 420 may have reduced the importance of this distinction.
The term ‘controller’ in relation to property of a corporation is defined in s 9 to mean a receiver, a receiver and manager of that property, or anyone else who has control of that property for the purpose of enforcing a security interest.
In the materials that follow I will simply refer to the appointment of a receiver and will assume that such a person has the additional powers of a manager.
Provisions relating to all appointments of a receiver A receiver can be either privately appointed or appointed by the court.
To be qualified for appointment as a receiver a person must be a registered liquidator, and certain classes of persons are disqualified under s 418.
Textbook
Reading
LAW00004 Company Law
Topic 8 Corporate insolvency | 137
The appointment of a receiver or termination of such appointment must be notified to the ASIC (s 427) and the fact that a receiver has been appointed must be shown on all documents of the company after the date of appointment, for example XYZ Ltd (Receiver Appointed): s 428.
The court has power, upon application being made to it, to fix the remuneration of receivers and managers: s 425. Section 419 makes the receiver personally liable in the circumstances discussed therein.
Private appointments Although the court may appoint a receiver or receiver and manager, it is usual for debentures issued by a company, secured by a security interest, to contain a provision that, upon a breach of the terms occurring, the trustee for debenture holders has power to appoint a receiver or receiver and manager who may enter into possession of the assets subject to the security interest and carry out the realisation of such assets. The instrument appointing a receiver is of paramount importance. It details the circumstances when a receiver may be appointed, for example:
The appointment of a receiver by the court Note that the court has an inherent power to appoint a receiver. Generally application to the court is made by a debenture holder or mortgagee. There are examples of appointments being made in other circumstances, for example when management disputes meant that directors were not discharging their duties. The major ground on which a court will appoint a receiver is when the security is in jeopardy. Other grounds include the non-payment of interest or of principal.
A receiver may be appointed by the court even when the debenture or trust deed allows for a private appointment. If, for example, the trust deed did not vest sufficient power in the receiver, application could be made for a court appointment. It would be safer to apply to the court when there is some doubt as to the validity of a power to appoint contained in a trust deed or debenture. If a private appointment was made which for some reason was invalid, the receiver could be liable to the company for damages suffered. Despite this possibility most receiver appointments are made pursuant to a power contained in a trust deed. Note the power in s 418A to declare an appointment valid.
Section 1323 Note the broad powers given in s 1323 to appoint a receiver in the circumstances listed in that section. See also s 233(1)(h) in cases of oppression.
The effect of the appointment of a receiver
In your reading, I would like you to pay particular attention to the specific effects of the appointment of a receiver on directors and management, corporate personality, employees and on contracts, and the rules relating to priority of debts in a receivership.
on an application to wind up the company;
on failure to maintain/insure property;
on reduction of capital;
where the company is operating at a loss; and
where the company has ceased trading.
Reading
LAW00004 Company Law
Topic 8 Corporate insolvency | 138
The private appointment of a receiver does not completely replace management, but it does limit the directors’ abilities to manage. A receiver could get a court order prohibiting the directors from acting if the function was within the power of the receiver.
The internal structure continues to exist notwithstanding that the directors no longer have authority to exercise their ordinary business-management functions.
A valid receivership and management will ordinarily supersede, but not destroy, the company’s own organs. The effect ‘bears a direct, inverse relationship to the validity and scope of the receivership and management’: per Street J in Hawkesbury Development Corporation Ltd v Landmark Finance Pty Ltd (1970) 92 WN(NSW) 199.
Directors may still be liable under the Act, for example they must still lodge the accounts of the company.
A receiver appointed by the court is a court official and an officer of the company under s 9. Thus rights against such receivers are limited. There may be a close liaison with the court on decision making. Court- appointed receivers generally do not have extensive management powers but note that s 420 applies, unless it is excluded by court order. The duration of the appointment may be more limited than in a private appointment. There is a very extensive and excluding effect on existing management during the period of appointment, but this will depend on the court order.
Potential liability
Pay particular attention to ss 9 (where it defines controller), 180–184, 419, 420, 420A, 420B, 420C, 421, 423, 1318 and 1321.
Note that where a receiver acts as an agent, for example where he/she has been privately appointed, the receiver will be personally liable if he/she:
Other statutory provisions relating to receivers There are a number of other matters of importance. Please note:
Reading
exceeds the authority contained in the appointment instrument;
does not contract as agent; and
has been improperly appointed (for the tort of trespass).
A receiver and manager appointed under powers given in any instrument, for example under a debenture trust deed, may apply to the court for directions in performance of his/her duties: s 424.
A receiver or manager must notify the company and the company is then required, within 14 days or longer period as allowed by the court, to submit to the receiver a statement of affairs (s 429). The matters which must be shown in such statement of affairs are detailed in s 430.
A receiver or manager is required to lodge accounts with the Commission. The Commission may have the accounts audited. For presentation of information therein see s 432.
Liquidation does not in itself terminate a receivership. A receiver may be appointed even though the company is in the course of being wound up.
Section 433 provides rules as to priority in relation to debts out of property subject to a circulating security interest.
LAW00004 Company Law
Topic 8 Corporate insolvency | 139
8.6 Voluntary administration – Part 5.3A Corporations Act
Textbook 10th ed, pp 727–733.
Introduction A new scheme for the voluntary administration of a company came into effect on 23 June 1993. This scheme replaces the official management provisions of the Act. Under those provisions an official manager was appointed to carry on the business of the company with a view to bringing the company to a position where it would be able to pay its debts. It was a procedure rarely used in practice; it was cumbersome and lacked the flexibility of a s 411 scheme.
The Pt 5.3A procedure results from the ‘Harmer Report’; Australian Law Reform Commission’s General Insolvency Inquiry (1988) ALRC 45.
The Commission was critical of schemes of arrangement and official management and recommended a new procedure designed to be speedy, efficient and flexible.
In your reading please pay particular attention to the matters raised below.
Overview Part 5.3A will allow a company that is experiencing financial problems to appoint a person, called an administrator, who will assume control of the company’s affairs. The administrator will investigate the company’s affairs and will then submit a report to the creditors. The company will have time in which to prepare a plan for discussion with its creditors with a view to executing a deed of company arrangement.
Note s 420 on the powers and duties of receivers and s 420C on the power to carry on the corporation’s business during a winding up.
Note also s 420A on the duty of care in exercising power of sale. See [2015] VSCA 68 Florgale Uniforms [2004] VSC 65 per Dodds-Streeton J, http://www.austlii.edu.au/au/cases/ vic/VSC/2004/65.html
For the legal principles relevant to s 420A(1) see Boz One Pty Ltd v McLellan [2015] VSCA 68 (Whelan, Santamaria and Kyrou JJA) [153] to [177].
Activity 8.1
Describe the effects of the appointment of a receiver on a corporation, and analyse whether these effects vary, depending on the nature of the appointment.
1.
Discuss the role of a receiver and list particular areas of concern faced by a receiver in discharging his or her obligations.
2.
Obviously there is a need to have rules relating to priority of debts in a winding up, but why is there a need to have provisions relating to priority of debts in a receivership?
3.
Textbook
Reading
LAW00004 Company Law
Topic 8 Corporate insolvency | 140
The administrator when investigating the company’s business must form an opinion about matters affecting the company’s creditors. He/she must supply a statement to the creditors setting out his/her opinion about those matters. The creditors may resolve at a creditors’ meeting to:
Object of Part 5.3A The object of this part of the Act is stated in s 435A:
Commencement of administration The administration begins when the administrator is appointed: s 435C. A company may make an appointment by resolution of the board where in the opinion of the directors the company is insolvent or is likely to become insolvent: s 436A. An appointment may also be made by a liquidator or certain secured persons: ss 436B and 436C.
The administration will usually end when a deed of company arrangement (DOCA) is executed, or the creditors resolve it should end or the company is wound up: s 435C(2). If a DOCA is executed, the administrator (or someone else appointed in his/her place) will administer the deed: s 444A(2).
The administrator The administrator must be a registered liquidator and must consent in writing: s 448B, see also s 448A. He/ she will be disqualified from acting if certain connections with the company exist: s 448C. The administrator must lodge notice of appointment with ASIC and publish the notice in certain newspapers: s 450A. Other notices must be given as outlined in the section.
Declarations by administrator – indemnities and relevant relationships As soon as practicable after being appointed, an administrator must make:
Failure to make the declarations is an offence; see s 1311(1).
Section 436DA sets out the declarative requirements for administrators appointed under ss 436A, 436B or 436C; and s 449CA sets out the requirements for administrators appointed under s 449C(1).
execute a deed of company arrangement (DOCA); or
end the administration; or
resolve that the company be wound up.
to provide for the business, property and affairs of an insolvent company to be administered in a way that maximises the chances of the company, or as much as possible of its business, continuing in existence; or
if that is not possible, that results in a better return for the creditors and members than would result from an immediate winding up of the company.
a declaration of relevant relationships; and
a declaration or indemnities.
LAW00004 Company Law
Topic 8 Corporate insolvency | 141
Role of administrator The administrator’s role is to control the business, property and affairs of the company and carry on the company’s business: s 437A. He/she is the company’s agent: s 437B. An administrator may take action against a person for fraud, negligence, breach of duty in relation to the company: s 598.
Directors must assist the administrator: s 438B.
The administrator may remove a director from office or appoint a director: s 442A. Only the administrator is allowed to deal with the company’s property.
A transaction is void unless:
There are exceptions relating to certain exempt payments. If an officer of the company enters a void transaction, the officer is guilty of an offence: s 437D.
The administrator is liable for certain debts incurred but is entitled to be indemnified by the company: ss 443A–443F. He/she has further powers outlined in ss 442A–442F. The administrator may seek directions from the court: s 447D.
The appointment cannot be revoked. The court may remove an administrator from office on the application of the Commission or of a creditor: ss 449A and 449B.
Protection of company’s property One of the purposes of voluntary administration is to provide the company with a moratorium, during which certain creditors cannot enforce their rights against the company’s property unless the administrator consents or with the approval of the court: ss 440B–440D. There are, however, certain exceptions and in these circumstances the creditor may enforce rights: ss 441A–441K.
Guarantees of company liabilities given by the director or relatives are not enforceable against the directors or relatives except with leave of the court: s 440J.
This moratorium on claims against the company permits the administrator to control and use that property for the benefit of the company.
Administrator investigates the company’s affairs The administrator is under a duty to investigate the company’s business, property, affairs and financial circumstances. He/she must form an opinion about whether it would be in the interests of the creditors:
The investigation must begin as soon as practicable after the appointment.
If the administrator discovers:
entered into by the administrator; or
the administrator consented to it in writing before the transaction; or
entered into by court order.
for the company to execute a deed of company arrangement; or
for the administration to end; or
for the company to be wound up: s 438A.
that a past or present officer or member of the company may have committed an offence; or
LAW00004 Company Law
Topic 8 Corporate insolvency | 142
Meetings of creditors There are two meetings of creditors under the Administration process.
The first meeting of creditors must be convened by the administrator and must be held within eight business days after the administration begins. The purpose of this meeting is to enable the creditors to decide whether to appoint a committee of creditors. The function of this committee is to consult with the administrator on matters relating to the administration. The creditors may also resolve to remove the administrator from office and appoint another person as a replacement. This could occur where the creditors for some reason have no confidence in the company’s appointed person: s 436E.
Meeting of creditors to decide company’s future The second creditors meeting is the more important one; see ss 439A and 439C. It will decide the future of the company. This meeting must be held within five business days before or five business days after the end of the ‘convening period’. This is defined as:
The court may extend the convening period (s 439A (6)) but only if in the best interests of creditors: s 439A(7).
The purpose of this meeting is to enable the creditors to make a decision on the future of the company. Written notice of the meeting must be given to each creditor and must be accompanied by:
If a DOCA is proposed, there must be a statement setting out the details: s 439A.
The creditors at the meeting may resolve to adopt one of the above alternatives: s 439C.
8.7 Deed of company arrangement (DOCA) – Part 5.3A Corporations Act
Textbook 10th ed, pp 733–735
that a person who has taken part in the formation or management of the company may be liable to account for money or property, or may have been guilty of some breach of duty – for example, negligence, breach of trust;
the administrator must lodge a report with the Commission: s 438D.
if in December or less than 25 business days before Good Friday, 25 business days from appointment; or
otherwise 20 business days from appointment.
a copy of a report by the administrator about the company’s affairs; and
a statement setting out the administrators opinion about whether it would be in the creditors interests for the company to:
execute a deed of company arrangement (DOCA); or1. for the administration to end; or2. for the company to be wound up; and3. reasons for those opinions.4.
Textbook
LAW00004 Company Law
Topic 8 Corporate insolvency | 143
The process of entering into a deed of company arrangement (DOCA) is explained in the extract below from the Explanatory Memorandum to the Corporations Amendment (Insolvency) Bill 2007 (Cth), circulated by the authority of the Parliamentary Secretary to the Treasurer, the Hon Chris Pearce, MP) 3.17–3.21:
The expectation is that creditors will resolve at the meeting that the company execute a deed of company arrangement. The administrator of the company is to be the administrator of the deed (unless at the creditors’ meeting they have resolved to appoint someone else to be the administrator of the deed). The company’s affairs will continue to be administered by an administrator under the terms of the deed. The contents of the deed will reflect the needs and wishes of the creditors and the company. Certain matters must be specified in the deed: ss 444A and 444B.
Effect of deed The deed when executed binds all parties: the company, the creditors and also the administrator: ss 444B–444G. All creditors, secured and unsecured are bound. However, a secured creditor is bound only if the creditor voted in favour of the deed. The court may limit the rights of secured creditors and owners or lessors of property: ss 444D–H.
The deed may be varied: s 445A.
Termination of deed The deed terminates in the circumstances set out in ss 445C–445H. The creditors may terminate the deed and resolve that the company be wound up: ss 445E and 445F.
It does not require court approval and therefore may be brought into operation very simply and quickly; also, it is very flexible and less expensive than other schemes.
These advantages should ensure its popularity.
3.17 The primary purpose of the voluntary administration procedure, set out in Part 5.3A of the Corporations Act 2001 (Corporations Act), is to provide a flexible and relatively inexpensive procedure that enables a company to suspend the payment of its debts, so that it can attempt a compromise or arrangement with its creditors aimed at saving the company or the business or, if that is not possible, maximising the return to creditors. If successful, the compromise or arrangement will be set out in a deed of company arrangement (DOCA), which binds the company and the creditors. If these attempts fail, the legislation facilitates the transition to winding up.
3.18 If the creditors decide to enter into a DOCA, the Corporations Act sets out what the deed must contain, although the requirements are flexible. The DOCA details the adjustment of the rights and obligations of creditors in relation to the company.
3.19 If a DOCA is recommended, the administrator must provide a statement setting out details of the deed. The DOCA must include some essential matters (such as the property to be available to pay creditors’ claims, the duration of any moratorium period for which the deed provides, the extent to which the company is to be released from its debts, conditions for the deed to operate, the circumstances for termination of the deed, and the order of payment of creditors’ claims).
3.20 In addition, the deed may include prescribed provisions (set out in Schedule 8A of the Corporations Regulations). One of the provisions is clause 4 of Schedule 8A, which provides that the administrator must apply the property of the company in the order of priority specified for a liquidation. It is not mandatory to include these provisions in every deed. The deed may make other provision including altering the priority that would apply in a liquidation. In practice, most deeds will apply the property of the company in the order specified for a winding up.
3.21 To address the possibility that some creditors may be unfairly treated by the meeting of creditors, or outmanoeuvred at the meeting, the law allows creditors who consider a particular deed oppressive or unfairly prejudicial or discriminatory to initiate proceedings in the Supreme Courts or in the Federal Court to have the deed overturned.
LAW00004 Company Law
Topic 8 Corporate insolvency | 144
Note that the court also has discretion to order termination of the deed under s 445D Corporations Act. See Mondello Farms Pty Ltd v Annatom Pty Ltd (Subject to Deed of Company Arrangement) & Ors [2007] SASC 296, http://www.austlii.edu.au/au/cases/sa/SASC/2007/296.html.
Transition to creditors’ voluntary winding up If the creditors resolve that the company be wound up, the company is taken to have passed a special resolution under s 491 that the company be wound up voluntarily. Of course, no special resolutions under s 491 would actually have been passed: Section 446A equates the resolution to wind up the company passed under s 439C (and also under certain other sections) with such a special resolution under s 491. Refer also to ss 445E and 445F.
What are the essential differences between schemes of arrangement and voluntary administration? When would one procedure be used instead of the other?
8.8 Liquidation – Winding up Part 5.4–6 Corporations Act
Textbook 10th ed, pp 735–743
Introduction Winding up is the process by which the life of a company is brought to an end and its assets are shared amongst those who have a legal entitlement to them, including its creditors and shareholders. When winding up is complete the company is dissolved. At that time it ceases to exist as a legal entity.
A company may be wound up:
8.8.1 Voluntary winding up There are two forms of voluntary winding up. The first is members’ voluntary winding up and the second is creditors’ voluntary winding up.
A members’ voluntary winding up requires a declaration of solvency by the company’s directors and a special resolution by the company’s members.
A creditors’ voluntary winding up may arise where there is a special resolution of the company’s members but no declaration of solvency by the directors; or where there is a special resolution by the members and declaration by the directors but the liquidator discovers the company is insolvent; or as an outcome of the Pt 5.3A administrations.
Activity 8.2
Textbook
voluntarily by special resolution under s 491 (but subject to s 459A); and
as a compulsory by the court under s 459A or under s 462.
LAW00004 Company Law
Topic 8 Corporate insolvency | 145
In your reading you should have noted these major points:
A members’ voluntary winding up may only take place when the directors are able to provide a declaration that the company will be able to pay its debts in full within 12 months. A members’ voluntary winding up requires a special resolution passed by the company.
If the directors call a meeting for the winding up of the company and cannot make the declaration of solvency required under s 494, but the company resolves to voluntarily wind up, the winding up will proceed as a creditors’ voluntary winding up. If the directors make the necessary declaration and the company resolves to voluntarily wind up, but the liquidator is then, or at some future time, of the opinion that the company cannot pay its debts in full within the period stated in the declaration, the winding up will proceed as a creditors voluntary winding up. In a creditors voluntary winding up, the creditors have the right to appoint the liquidator: ss 496 and 499.
If company resolves to wind up at a time when the company is insolvent, the winding up will proceed as a creditors’ voluntary winding up.
In relation to creditors meetings, note ss 497(1) and 496(5), 499(1), 499(3) and 506(1).
Such a winding up could also become a compulsory winding up if the creditors do not accept it.
A members’ voluntary winding up may become a creditors’ voluntary winding up if, in the opinion of the liquidator, debts cannot be paid: s 496.
8.8.2 Compulsory winding up – by court order A court winding up results from an order of the court upon a petition being presented to, and accepted by, the court.
There are two forms of court-ordered winding up: a court-ordered winding up in insolvency under Pt 5.4 Corporations Act and a court-ordered winding up on other grounds under Pt 5.4A Corporations Act.
Court-ordered winding up in insolvency under Part 5.4 In your reading you should have paid particular attention to these matters:
there is a requirement for a special resolution of the company under s 491 to commence the voluntary winding up proceedings;
a liquidator is appointed under s 495 for a members’ voluntary winding up and under s 496 in a creditors’ voluntary winding up;
there is a need for a declaration of solvency under s 494;
creditors do not have the right at law to force a company to voluntarily wind up. Carefully distinguish between a creditor’s voluntary winding up and a compulsory winding up initiated by a creditor.
the most common winding up ground and the most relevant to our present discussion is inability to pay debts. Note in particular the effect of ss 459A, 459C and 459E and the rights in ss 459G–459N. Note especially the deemed insolvency and statutory demand process;
compulsory winding up commencement: see s 513A;
when a winding up order has been made (or a provisional liquidator appointed) no action or proceedings shall be commenced or proceeded with against the company, except by leave of the court, which may impose terms thereon: s 471B.
LAW00004 Company Law
Topic 8 Corporate insolvency | 146
Court-ordered winding up on other grounds under Part 5.4A Note that companies can be forced to wind up on grounds other than those relating to the company’s insolvency: s 461. In your reading you should have paid particular attention to these matters:
One example is where there is evidence of oppression. This area of the law was considered in Topic 4.
Liquidators appointed by the court
Effect of winding up (voluntary and compulsory)
Effects on creditors
Note that s 468 dates back to the commencement of the winding up, and the important effects of s 468(4) and s 500(2).
Effects on company
a petition may be presented to the court for a winding up order by any one or more of the parties set out in s 462;
the grounds upon which the court may order a winding up are detailed in ss 461 and 464. You must analyse these sections carefully.
On a court order for winding up, the court may appoint a registered liquidator, and, before the making of such order, may appoint a provisional official liquidator: s 472.
Note the possibility of delay between the application and the order to wind up. If the assets are in jeopardy the court will usually appoint a provisional liquidator: s 472(2).
His/her primary purpose will be preservation of the status quo. Note the effect of 471B, which creates a stay of proceedings.
The provisional liquidator will have directors’ powers divested upon him/her, but his/her actions will be carefully monitored by all parties and thus the court. He/she will only have power to carry on the business of the company when it is necessary for the beneficial winding up of the company and the requisite permission is obtained under s 477.
A statement of affairs must be submitted to the liquidator within 14 days of the winding up order, and the liquidator is required to file a copy thereof with the Commission and the court: s 475.
A liquidator is given extensive powers under the Act to carry out his/her duties. Some of these require the authority of the court or the committee of inspection, and some are given to the liquidator personally. Note especially ss 474, 477, 478 and 480.
Commencement date: see s 513A and s 513B.
Stay of proceedings: s 471B.
Void dispositions: s 468.
‘In liquidation’ in name: s 541.
Property still belongs to company but the company has limited power to deal with it: s 468.
Directors lose their powers but their office is not abolished (common law, not in Act).
The liquidator controls assets: s 474.
Shares cannot be transferred: s 468(1).
LAW00004 Company Law
Topic 8 Corporate insolvency | 147
Effects on employees In a compulsory winding up, publication of the winding up order operates as a summary dismissal, however, a liquidator can waive this. If dismissed, employees can lodge a proof of debt in the winding up, relating to damages for breach of contract.
8.9 Liquidators
Appointment See ss 532, 1282 and 1283. Note the requirement that there be consent in writing to act: s 532(9).
Declarations by liquidators – relevant relationships and indemnities. Liquidators appointed in relation to a creditor’s voluntary winding up, within 10 business days of the meeting of the company which resolved for voluntary winding up, must, in accordance with s 506A, make:
Failure to make the declarations is an offence; see s 1311(1).
Termination of a liquidator’s appointment
Powers and duties of liquidator
General functions of the liquidator
See ss 474, 475, 477, 478, 480, and 533.
a declaration of relevant relationships; and
a declaration or indemnities.
By death.
By insolvency.
By resignation.
By removal: see s 473.
By release.
On application.
The liquidator assumes the powers of the board of directors. Note in particular: s 477 (for voluntary winding up see s 506); and
s 488 further powers.
The liquidator is a fiduciary.
The liquidator may be caught under various sections, for example, those in Chapter 2D (ss 180 to 184).
The liquidator has obligations of proper administration: s 537.
There is an obligation to collect, preserve, realise and distribute assets.
Take possession of assets.
Realise assets.
Determine what debts are owed.
Rank priorities and distribute dividends accordingly.
Apply for deregistration of company.
LAW00004 Company Law
Topic 8 Corporate insolvency | 148
There is no obligation to carry on the business, with a view to profit.
The nature of the liquidator’s duties Re Contract Corporation (Gooch’s Case) (1872) 7 Ch App 207 per James LJ:
The decisions in CCA v Harvey [1980] VR 669 and Maelor Jones Investments (Noarlunga) Pty Ltd v Heywood Smith (1989) 7 ACLC 1232 consider in detail the nature of the duty.
It is certainly worth noting that the judgment in Australian Securities & Investments Commission v Edge [2007] VSC 170 http://www.austlii.edu.au/au/cases/vic/VICSC/2007/170.html considered, inter alia, the duties of liquidator including the improper delegation of duties; failure to maintain proper books; failure to prepare and lodge prescribed documents, including s 533(1)(c) reports; failure to advertise, convene and hold meetings, including final meetings; the unauthorised destruction of companies’ books and records; undue prolongation of liquidations; drawing remuneration without approval or adequate supporting documentation; exaggerated claims of work done; failure faithfully to perform duties as liquidator; and the removal and unfitness to remain liquidator. In addition the judgment (from para 39 on) provides a good summary of the relevant legal principles relating to the liquidator’s role, duties and powers.
8.10 Recovery of assets You should note that there are a number of provisions available to the liquidator to assist in the recovery of assets of the company:
Preferences: post 23 June 1993: Recovery of property or compensation: Part 5.7B The present provisions relating to the recovery of property or compensation commenced to operate on 23 June 1993. You are not required to study the law on preferences prior to 23 June 1993.
Note the presumptions that may be made in recovery proceedings: s 588E.
Part 5.7B sets out a comprehensive basis for the review of prior transactions of a company without reference to the Bankruptcy Act.
In truth it is of the utmost importance that the liquidator should as an officer of the court maintain an even and impartial hand between all the individuals whose interests are involved in the winding up… It is his duty to the whole body of shareholders and to the whole body of creditors and to the court to make himself thoroughly acquainted with the affairs of the company; and to suppress nothing, and to conceal nothing, which has come to his knowledge in the course of his investigation, which is material to ascertain the exact truth in every case before the court.
the provisions relating to contributories: rules for the liability of present and past members to contribute to the assets for the payment of liabilities of the company and adjustment of the rights of contributories among themselves are set out in Pt 5.6 Div 2. The primary liability is with present members, but it is possible for a person who has been a member within twelve months of the commencement of winding up to be called upon to contribute. No member, or ex-member, can be required to contribute more than he/she originally contracted to do in a limited liability company, but note that special provisions operate for a company that has converted from an unlimited company;
invalid circulating security interest under s 588FJ;
disclaimer of onerous property under s 568;
statutory and common law actions in the name of the company for breach of fiduciary duty or statutory actions for breach of Chapter 2D of the Act. See Topic 5;
the preference provisions, which are further considered below.
LAW00004 Company Law
Topic 8 Corporate insolvency | 149
We are concerned mainly with Div 2 of Pt 5.7B: note the meaning of the terms ‘Solvency’ and ‘Insolvency’: s 95A.
The liquidator under s 588FF may apply to the court for an order for recovery where a transaction is voidable because of s 588FE. That latter section relies on the meaning given to certain terms in ss 588FA–588FDA.
Those terms are:
In winding up, the above transactions may be voidable (see s 588FE) if the transaction was entered into at or after the commencement of this part (23 June 1993) and:
Defences Certain defences are available against the liquidator under s 588FG. You should read this section carefully noting its division into two parts:
Where there is an insolvent transaction and it is voidable under s 588FE and has had the effect of discharging a liability (for example, a guarantee) of a related entity (defined s 9; for example, a director), the liquidator may recover from the related entity as a debt due to the company amount equal to the amount of such discharged liability: s 588FH.
Circulating security interest (see s 51C)
In certain circumstances a circulating security interest created during the 6 months ending on the relation- back day (defined s 9) or after that day but on or before the day winding up began is void against the liquidator; s 588FJ.
unfair preference given to a creditor: s 588FA (they would receive more than if they had to prove in a winding-up);
1.
uncommercial transactions (having regard to any benefit and detriment to the company): s 588FB;2. the transactions in 1 and 2 are insolvent transactions if the company is insolvent at the time of entering the transaction (or becomes insolvent): s 588FC;
3.
unfair loan to the company (having regard to interest on the loan and any charges and other matters): s 588FD;
4.
voidable transactions: s 588FE;5. unreasonable payments to directors: s 588 FDA.6.
6 months – If an insolvent transaction was entered into during the 6 months ending on the relation-back day (defined in s 9) or after that day but on or before the day winding up began. Example: company pays a particular creditor knowing the company is in financial difficulty.
2 years – If it is an insolvent transaction and also an uncommercial transaction and was entered into during the 2 years ending on the relation-back day. Example: assets sold at a price significantly below value.
4 years – If it is an insolvent transaction and a related entity (defined s 9; for example, a director) is a party to it and was entered into during the 4 years ending on the relation-back day.
10 years – If it is an insolvent transaction and was entered into for the purpose of defeating or delaying, or interfering with the rights of creditor/s on a winding up and was entered during the 10 years ending on the relation-back day. Example: extortionate interest rates.
Anytime – If it is an unfair loan to the company made at any time before the day when the winding up began.
a person not a party to a transaction; and1. a person who was a party to the transaction.2.
LAW00004 Company Law
Topic 8 Corporate insolvency | 150
8.11 Proving and distributing the assets of the company A major task of a liquidator is to identify claims against the company in liquidation and distribute the assets of the company accordingly.
Proofs of debt A creditor’s claim against a company in liquidation is known as a proof of debt. A liquidator has a duty to consider proof of debts lodged by creditors of the company. The rules relating to proofs of debt originally come from ss 82, 86, 90 of the Bankruptcy Act. They are now contained in Pt 5.6 Division 6.
Distributing the assets of the company When the liquidator has determined the amounts owing to the company and owed by the company he/ she will be in a position to distribute the balance, which is known as a ‘dividend’. Where the assets are not sufficient to meet liabilities the distribution must be made in accordance with the list of priorities laid down in the law and at common law.
The relevant provisions are contained in ss 555–564 especially s 556(1) which lists the priority of payment of certain unsecured debts. This priority must be strictly observed by the liquidator. Note that s 556 deals with unsecured debts. Consequently, secured debts will rank ahead of the matters in s 556.
8.12 Deregistration and reinstatement The final task of the liquidator is to have the company deregistered and its name removed from the register.
The law relating to deregistration and reinstatement of companies is contained in Chapter 5A of the Act.
In your reading of Chapter 5A note:
Reading
Reading
voluntary deregistration;
ASIC deregistration;
effect of deregistration;
power of ASIC;
third party rights against insured deregistered companies; and
reinstatement.
LAW00004 Company Law
Topic 8 Corporate insolvency | 151
Activity 8.3
How does the liquidator ascertain priority for payment of debts?1. List the essential differences between voluntary administration, voluntary winding up and a winding up by the court.
2.
Describe the law relating to preferences.3.
LAW00004 Company Law
Topic 8 Corporate insolvency | 152
PH Ltd is a company that is having considerable trouble. Profits over the last few years have been non-existent and this financial year a loss of $500 000 has been made. A search of the company’s accounts, trust deed and other documentation reveals the following information:
(i) Liabilities: $
Bank loan (secured by a mortgage over land and buildings) 2 000 000
Debentures 1 500 000
(9% p.a. maturing 1/1/XX) (secured by a circulating security interest over assets of the company excluding land and buildings)
Trade creditors 2 500 000
(ii) The only assets of PH Ltd of significance are:
Land and buildings 3 000 000
Investments in other companies 400 000
Inventories 800 000
Plant and equipment (non-fixtures) 100 000
Trade debtors 100 000
(iii) There are no outstanding calls on shares. (iv) A trust deed exists providing for appointment of a receiver ‘upon the company not paying
interest on due date’. Interest is now due on the debentures. (v) A dividend of 50 cents per share has been declared for the current financial year, but has not
yet been paid. This, if paid, will require $50 000. Discuss possible legal alternatives and remedies raised by these facts available to:
Are there any additional facts you believe are necessary to adequately advise these parties?
the company;i. ii creditors (secured and unsecured);ii. iii the company and creditors jointly; andiii. shareholders.iv.
a.
Of the alternatives listed in (a) which do you believe would be the most likely? Give your reasons. How will the alternative you have selected resolve any conflicting claims arising within or between the groups discussed in (a)?
b.
4.
LAW00004 Company Law
Topic 8 Corporate insolvency | 153
Conclusion We have completed our study of company law. No doubt you have found this at times rather technical, though I trust not unnecessarily so. Insolvency law is a technical area and this obviously emanates from the various rights and claims that have to be met and adjusted.
You may have by now realised that it is far easier to set a company up than it is to dissolve it. You may also be questioning the whole nature of the separate legal entity and limited liability, particularly in the context of s 588G and insolvency law generally.
LAW00004 Company Law
Topic 8 Corporate insolvency | 154
- LAW00004 Company Law Study Guide
- Contents
- Unit overview
- About the writer
- About the lecturer
- Topic 1 Partnership
- 1.1 Various business structures
- 1.2 Partnership
- Partnership Acts
- Topic 2 The Australian Constitution and corporate law and the administration of corporate law
- Changes to company law
- 2.1 Introduction
- 2.2 The operation of the previous legislation
- 2.3 The Australian Securities and Investments Commission (ASIC)
- 2.4 Separate legal entity and limited liability
- 2.5 The difficulty of dealing with corporate groups: A statutory exception to the separate entity doctrine
- 2.6 Corporate liability
- Topic 3 The creation of a company: Types of companies, promotion, formation and the company’s Constitution
- 3.1 Types of companies
- 3.2 Promotion and promoters
- 3.3 Pre-registration contracts
- 3.4 Formation of companies
- 3.5 Australian company number and company name
- 3.6 The company’s Constitution
- Topic 4 The capacity of the company and its agents and the rights of its members
- 4.1 Introduction
- 4.2 Capacity of a company
- 4.3 Capacity of the agents of a company
- 4.4 The rights and remedies of members
- 4.5 The means of becoming a member of a company
- 4.6 Members’ statutory rights
- 4.7 Remedies available to minority shareholders
- Conclusion to Topic 4
- Topic 5 Management
- 5.1 The company secretary – appointment, role and responsibilities
- 5.2 Definitions, appointment, removal and disqualification of directors
- 5.3 Directors’ duties – duty of care, skill and diligence
- 5.4 Directors’ general law duties – good faith and proper purpose and conflict of interest
- 5.5 Directors’ statutory law duties – good faith and proper purpose and conflict of interest
- 5.6 Executive officers: Role and responsibilities
- 5.7 Directors’ statutory obligations
- 5.8 Directors’ statutory duties – insolvent trading
- 5.9 Civil penalties and compensation orders
- 5.10 Criminal penalties
- 5.11 Ratification and exculpation of breaches of duty
- Summary: Remedies for breach of duty
- 5.12 The registered office
- 5.13 Meetings and proceedings
- Conclusion to Topic 5
- Topic 6 Financing the corporation
- 6.1 Introduction
- 6.2 Equity finance
- 6.3 Debt finance of loan capital
- 6.4 Registration of security interests (formerly known as ‘charges’)
- 6.5 Interests other than shares or debentures: Managed investment schemes
- 6.6 Corporate fundraising in public companies
- 6.7 Current Australian policy on prospectuses
- 6.8 The capital maintenance doctrine
- 6.9 Dividends
- 6.10 Financial reports and audit
- Topic 7 Takeovers
- 7.1 Introduction
- 7.2 Takeovers
- 7.3 Prohibition on acquisitions of more than 20 per cent
- 7.4 Exceptions to section 606
- 7.5 Off market bids
- 7.6 On market bids
- 7.7 Other relevant sections regarding takeovers
- 7.8 Substantial shareholdings
- 7.9 Share ownership tracing
- 7.10 Securities regulation
- Conclusion
- Topic 8 Corporate insolvency
- 8.1 Introduction
- 8.2 Corporate insolvency law reform
- 8.3 The law on insolvency
- 8.4 Schemes of arrangement – Part 5.1 Corporations Act
- 8.5 Receivership and controllers – Part 5.2 Corporations Act
- 8.6 Voluntary administration – Part 5.3A Corporations Act
- 8.7 Deed of company arrangement (DOCA) – Part 5.3A Corporations Act
- 8.8 Liquidation – Winding up Part 5.4–6 Corporations Act
- 8.9 Liquidators
- 8.10 Recovery of assets
- 8.11 Proving and distributing the assets of the company
- 8.12 Deregistration and reinstatement
- Conclusion
