Eiffel Towers Ltd, a listed company, was a builder and property developer specialising in projects in Brisbane’s central business district. It has five directors. Giscard is the managing director and Henri is the chief financial officer. They are the only

Reading

Text, Chapter 6, Chapter 8

Objectives

On successful completion of this module, you should be able to:

· describe the obligations of company promoters

· recognise where a pre-registration contract exists and describe the consequences of breach of a pre-registration contract in a given factual scenario.

· understand and recognise the nature and purpose of the Constitution (or Replaceable

· Rules) of a company, including its sources; determine the contents of the Constitution (or Replaceable Rules) of a company in a given factual scenario (and how it may be altered and enforced);

· know and solve problems relating to company constitutions in given factual scenarios.

6.1 Introduction

Before a company can be registered, it needs someone, known as ‘promoter’, to assist in its formation. After a company is incorporated by satisfying the rules setting out in s117, it needs rules to govern internal management and operation. Companies have considerable flexibility in deciding such rules. Typically, company’s internal governance rules deal with matters such as the powers of directors, rights of members/shareholders, and meetings of directors and members/shareholders. A company’s internal management may be governed by a constitution, or by replaceable rules contained in the Corporations Act 2001 (Cth), or by a combination of both: s134. This module discusses these internal governance rules. It is very important for you to understand the contractual effect of these rules.

6.2 Promoters

A company is an artificial being and thus does not exist until it is incorporated. The date of incorporation then is, effectively, its ‘birthday’. Someone (or multiple people) – usually known as promoters - must cause a company to become incorporated, by registering that company at ASIC and doing other matters in preparation for incorporation. Read your text book and find out what matters do promoters normally prepare.

6.2.1 Why is it important to recognise a promoter?

The term ‘promoter’ is more a business term than a legal one, although it does have a precise legal meaning defined by the common law. The legal definition is important because a

person who is a ‘promoter’ under that legal definition will owe duties to the eventual company and/or its members. If any of those duties are breached, that person can have significant liability as a result.

6.2.2 How is this relevant to me?

This is personally relevant for you because if you are involved in setting up a company, or advising someone who is setting up a company, you need to be able to know when you owe promoters’ duties (and when you do not), as well as what those duties are – else you could face significant personal legal liability for breach of those duties.

6.2.3 Where do I find the definition of a promoter?

As the Corporations Act primarily deals with ‘companies’ and ‘corporations’ (that is, after they exist), ‘promoter’ is not defined in the Corporations Act and indeed, does not appear in the Corporations Act except in relation to disclosure documents (used by companies to raise capital). Thus the legal principles relating to promoters are primarily found in the common law, not in the Corporations Act. In Twycross v Grant (1877) 2 CPD 469 at 541, a promoter was defined as:

a person who undertakes to form a company with reference to a given project, and to set it going … takes the necessary steps to accomplish that purpose.

Other cases have clarified that a person can still be a promoter (and thus owe the duties of a promoter) even if they are not actively involved in incorporating that company. For example, in some circumstances (see below), a person who benefits from the formation of a company can be a promoter.

Still other cases have clarified that not everyone involved in the incorporation of a company will be classified as a ‘promoter’ under the legal definition. For example, professional advisers like solicitors, accountants and brokers, when acting solely in their professional capacity and not benefiting from the incorporation other than by the fees they charge for professional services, can escape classification as ‘promoters’ and thus will not owe promoters’ duties to the eventual company and its members (although some professional advisers such as accountants and lawyers will still owe duties to the individual client requesting and paying for those professional services). However, if the adviser ‘steps over the line’ and becomes personally involved in (and benefits from) the formation of the company, then the adviser can be classified as a promoter (and thus owe promoters’ duties, and become liable for breach of those duties) after all.

Case study exercise 6.1

Tracy v Mandalay Pty Ltd (1952) 88 CLR 215

1. Can a company be a promoter of another company?

2. In this case, who were the ‘active promoters’ and what activities did they do?

3. In this case, who were the ‘passive promoters’ and what activities did they do?

4. What factors did the court consider when deciding whether each person was a promoter?

6.2.4 Source of Promoters’ Duties

As discussed above, the Corporations Act does not regulate promoters (although a promoter can become liable for a misleading or deceptive prospectus under the prospectus provisions in Chapter 6D of the Corporations Act). Instead, the duties of promoters are imposed by the common law (specifically, the principles originating in courts of equity) because a promoter

is considered to be a ‘fiduciary’ – that is, a person in a position of power able to exercise that power to the disadvantage of others and thus owing special duties to not abuse that power. These duties are known as ‘fiduciary duties’ and are not only imposed on promoters, but also on trustees of a trust, on directors of a company, and even certain advisers owe these duties

to their clients. We will consider these fiduciary duties (as imposed on company directors)

in greater detail in Module 7.

6.3 Pre-registration contracts

As discussed above, a company is an artificial being and thus does not exist until it is incorporated and a company is now incorporated by means of registration at ASIC.

The company’s legal capacity (eg to enter contracts) only arises once the company exists, and so before incorporation, the ‘company’ lacks both existence and legal capacity. Thus, where a ‘company’ (in quotes because, technically, it doesn’t exist and thus cannot actually be a company) attempts to enter into a contract before the company is registered, there is no valid contract because one of the essential elements of a valid contract is missing at the time of the ‘contract’ – namely, the legal capacity of one of the parties. This could cause major problems for the other party – particularly if they were unaware of the legal capacity problems.

Although such transactions are not actually binding contracts, we nonetheless classify such transactions as ‘pre-registration contracts’ (or sometimes ‘pre-incorporation contracts’ is used as a synonym) because they occur before a company is registered, and thus there are special legal principles that apply to them.

Historically, the courts would never recognise such pre-registration contracts, even if the company subsequently became registered and after registration wished to adopt and become bound to the pre-registration contract (a process known as ‘ratification’). Nowadays, section 131 of the Corporations Act allows for ratification of pre-registration contracts, and section 133 provides that section 131 replaces the common law position.

Reading activity 6.2

1. What are the reasons that the common law does not recognize the pre-registration contracts?

2. Read sections 131-133 of the Corporations Act and summarise under what circumstances the company will be held liable for pre-registration contracts.

3. Read sections 131-133 of the Corporations Act and summarise under what circumstances promoters will be held liable for pre-registration contracts.

6.4 Company’s constitution

A company Constitution is the document or documents that govern the internal operations of the company. (Do not confuse this with the Australian Constitution, which regulates the relationship between the Commonwealth and the various States of Australia).

Until 30 June 1998, these documents were known as the Memorandum of Association and the Articles of Association. Together, these documents were known as the company’s

‘internal rules’.

The Memorandum of Association (a one or two page document) was the company’s formal charter document and it defined the range and nature of its activities with the world in general. It also had the power to limit the company’s legal capacity. The Articles of Association was a much longer document, which contained the formal rules which regulated the internal operations (eg meetings) of the company.

The law changed as at 1 July 1998. A company incorporated on or after 1 July 1998 will not have a Memorandum of Association and Articles of Association, but instead will have a company Constitution. The information previously in a Memorandum of Association is now in the application for registration lodged at ASIC, and the Constitution contains the internal rules that were previously in the Articles of Association.

Companies that existed before 1 July 1998 could have since changed their internal rules to a formal Constitution, but even if no change has been made, the Articles and Memorandum of Association are now deemed to be the Company’s Constitution.

6.5 The replaceable rules

Many companies have a personalised Constitution drafted by the company’s lawyers (or perhaps by lawyers hired by the promoters). All listed companies will have a personalised Constitution, because this is a requirement of the listing rules (that the company have a constitution consistent with the listing rules).

However, not all companies – whether incorporated before or after 1 July 1998 – had or have a personalised set of internal rules. Instead of drafting their own personalised internal rules, companies could (and can) rely on a set of ‘default’ rules that are set out in the legislation. Nowadays, these ‘default’ rules are known as ‘Replaceable Rules’ and are scattered throughout the Corporations Act. There is also an index of them in section 141. (Previously, the ‘default’ rules in the previous legislation were known as ‘Table A articles’. You will not be examined on Table A articles).

If a company is registered after 1 July 1998 without a constitution, the replaceable rules will operate as the constitution of that company – section 135(1). Since 1 July 1998, a company that already has or has had its own personalised constitution (or Memorandum and Articles of Association) is or has been also free to decide to ‘repeal’ 7 that constitution – leaving a vacuum which is then filled by the replaceable rules.

The Replaceable Rules are so-named because each such ‘replaceable rule’ is able to be replaced by a provision in a Company Constitution. In general, most companies with a personalised Constitution include a provision in that Constitution stating that ‘all replaceable rules are excluded and replaced by the Constitution’ – thus ensuring that no replaceable rule will apply to that company. This is permitted by section 136(1). The Constitution can also exclude some replaceable rules and not others, or to not exclude any at all and thus operate in conjunction with the replaceable rules.

Exercise 6.1 – Test your understanding

Read sections 203C and 203D of the Corporations Act and answer the following questions. If you are not yet familiar with the terms ‘ordinary resolution’ (also known as a ‘company resolution’ or ‘resolution’) and ‘special resolution’, see

the definition of these terms in section 9. (Basically, a resolution is passed if

50% of the votes on that resolution approve of the resolution; a special resolution is passed if 75% or more of the votes on that resolution approve of it. To know which type of resolution is required in a particular case, you must consider the requirements of the Corporations Act and the company constitution).

1. Smith Pty Ltd was incorporated in 2000 with two shareholders and no company constitution (and has not adopted a constitution since then). How can the company appoint a director?

2. Smith Ltd was incorporated in 2000 with two shareholders and no company constitution (and has not adopted a constitution since then). How can the company appoint a director?

3. Smith Pty Ltd was incorporated in 2000 with two shareholders and with a company constitution that provides for appointment of directors by special resolution. How can the company appoint a director?

4. Smith Ltd was incorporated in 2000 with two shareholders and with a company constitution that provides for appointment of directors by special resolution. How can the company appoint a director?

6.6 Adopting a constitution

Although this section specifically refers to ‘adopting a constitution’ and not the replaceable rules, the section 136(1)(b) requirement for a special resolution would also apply to a company wishing to adopt the replaceable rules.

Reading activity 6.3

1. When a new company is formed today, what are its choices for internal rules?

2. How may a company adopt a constitution today?

3. Must a company give members a copy of its constitution?

4. Must a company give ASIC a copy of its constitution?

6.7 Contents of Constitution

Reading activity 6.4

1. Does the Corporations Act specify what a company must include in its constitution? If there are any exceptions to the general rule, describe them also.

2. How do courts interpret constitutions?

3. What is an ‘objects clause’? Must a company today have one in its constitution? If a company does have an objects clause in its constitution today, what is the effect of the clause?

Reading activity 6.5

1. What is an ‘objects clause’? Must a company today have one in its constitution? If a company does have an objects clause in its constitution today, what is the effect of the clause?

2. What was the historical effect of an objects clause in a company constitution? What effect, if any, does an objects clause have today?

3. What is the meaning of the phrase ‘ultra vires’?

4. What was the purpose of the ultra vires doctrine? Who did it protect and how? Did it achieve this purpose?

6.8 Effect of the Constitution and Replaceable Rules

Under section 140, the constitution (or replaceable rules) has effect as a contract:

● between the company and each member;

● between the company and each director and company secretary; and

● between each member and each other member.

Reading activity 6.6

1. Can a company enforce a provision of the constitution against a member?

2. Can a member enforce a provision of the constitution? What limitations apply to the general rule?

3. What types of rights affect members in their membership capacity? Give at least three examples from cases.

4. Can a person who is not a member of the company, enforce the company constitution? What is the relevant case authority for this principle?

5. What remedies are available for breach of constitution?

6.9 Altering or repealing the constitution

6.9.1 Basic Procedure

The basic procedure to alter or repeal the company constitution is a special resolution of the company – section 136(2).

A copy of any special resolution which adopts, modifies or repeals a company constitution must be lodged with ASIC within 14 days – section 136(5).

A modification of a company’s constitution takes effect from the date of the special resolution or such later date as is specified in the resolution: section 137 (1).

Section 136(3) & (4) – additional requirements imposed by entrenching provisions in the constitution.

6.9.2 Limits on the power to alter the constitution

– Section 140(2): prohibits imposing further liability on members unless they agree in writing.

– Sections 232-234: prohibits alterations where it is to be oppressive, unfairly prejudicial or unfairly discriminatory against a member or members, or operate against the interest of the company as a whole.

· Alteration must be effected bona fide in the interest of the company as a whole: Allen v Gold Reefs of West Africa Ltd [1900] 1 Ch 656; Gambotto v WCP Ltd (1995) 13 ACLC 342

Reading activity 6.7

1. How does a company amend its constitution? What requirements are there?

2. Can the directors amend the company’s constitution without shareholder approval?

3. What limits are there on the ability to amend the constitution? Name at least three.

4. Case study: Bailey v NSW Medical Defence Union Ltd (1995) 184 CLR 399; Peters American Delicacy Co v Heath (1939) 61 CLR 457

Module 6 tutorial questions

1. You are consulted by Mason, a surveyor, who, on 1 February, carried out a survey of land on the instructions of one Adams. At the time that instructions were given, Adams informed Mason that he was the Managing Director of a new company, Land Developers Pty Ltd, which was in the process of developing a subdivision of land. Mason’s fee for the survey was $3500 and he rendered his account to Adams, C/- Land Developers Pty Ltd.

Investigations subsequently revealed that when Mason carried out the work the company was not incorporated but did become incorporated in March. Mason has approached the company for payment, but it has refused, saying the fee is too high and it is not certain whether it will proceed with the subdivision due to the economic recession. The company has a paid-up capital of $2. Later enquiries reveal that the company has not proceeded with the subdivision, except that it sold off one block of land.

Advise Mason as to his legal rights to recover his fee.

2. Susan is a member in Negative Ltd. The company's constitution had a clause that stated that Susan was a solicitor of the company and she cannot be removed, unless she commits gross negligence. Susan worked for the company as a solicitor for a number of years. However, the directors decided to stop employing her even though they were satisfied with her work.

Advise Susan on whether she can prevent the company from terminating her services (your answer needs to be based on company law).