BTF2220

Word count: 2132 words

Question 1 Part (a)

The first issue is whether the directors of Orchards Downs Pty Ltd are obliged to comply with the replaceable rules adopted by the company. It is established that a company’s internal management may be governed by replaceable rules contained in the Corporations Act or by a constitution or a combination of both. Section 135(3) states that failure to comply with applicable replaceable rules is not of itself a contravention of the Corporations Act. Therefore, the provisions in the Corporations Act concerning criminal liability, civil liability and statutory injunctions cannot be applied to breaches of replaceable rules. Consequently, persons affected by a contravention of a replaceable rule cannot apply for a statutory injunction under s 1324 as this section only applies if the Corporations Act is contravened. However, an injunction may be sought after based on the statutory contract established by s 140: Smolarek v Liwsyzc.1 The key purpose of s 140 is to allow parties to the statutory contracts to enforce compliance with a company’s constitution (if any) and any replaceable rules that apply. The s 140(1) (a) states that a company constitution (if any) and any applicable replaceable rules have effect as a contract between the company and each member. The s 140(1)(a) clearly has a contractual effect on the company. A member is able to force the company to comply with the provisions of its constitution and any applicable replaceable. However not all provisions in a company’s constitution have contractual effect. Hickman v Kent or Romney Marsh Sheep-Breeders’ Assoc2 establishes that members may enforce only those provisions that confer rights on members in their capacity as members. In the case of Orchards Down Pty Ltd, the directors had appointed Betty as a director without holding a general meeting. Orchard Downs Pty Ltd adopted the replaceable rule in s 201G which states that a company may appoint a person as a director by resolution passed 1 2

Smolarek v Liwsyzc. [2006] WASCA 50. Hickman v Kent or Romney Marsh Sheep-Breeders’ Assoc[1915] 1 Ch 881

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in general meeting. Also, the company constitution does not contain anything that allows for the appointment of a director by the board. It is apparent that the rights of the members have been violated and their capacity as members have been effected as they were not given the chance to vote in a general meeting for the appointment of Betty as a director. The case of Pender v Lushington 3states that members have the right to enforce provisions in a constitution that give them the right to have their votes counted at a general meeting. Section 1322(2) reinforces this right of members to enforce the constitution. It enables the court to invalidate a procedural irregularity that causes substantial injustice. Given that a resolution had to be passed, a majority vote of the shareholders had to be in favour of the appointment of Betty for the resolution to be passed. In the case of Orchards Downs Pty Ltd who only have three shareholders : Norm, Sean and Anne, at least 2 out of the 3 had to vote in favour for that resolution to be passed. Given that s 140(1)(a) has been breached, an injunction or declaration is the appropriate remedy. The second issue is whether the shareholders can force the company to comply with clause 2.1 which states that Orchards Downs Pty Ltd will only use suppliers of recyclable goods for the packaging of its products. In this case, shareholders cannot force the company to comply with clause 2.1 using s 140(1)(a) because the breach of clause 2.1 does not affect their capacity as shareholders. Initially, the Doctrine of Ultra Vires stated that contracts or transactions were void and had no legal effect if a company engaged in businesses and activities that was not within the scope of one its objects. However, the doctrine of ultra vires has been abolished by the combined effect of ss 124 and 125. S 125(1) states that if a company’s constitution contains an express restriction or prohibition on the exercise of any of its powers, the exercise of such a power is not invalid merely because it is contrary to such an express restriction or prohibitions.4

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Pender v Lushington [1877] 6 Ch D 70

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Philip Lipton, Abe Herzberg and Michelle Welsh, Understanding Company Law (Thomson Reuters, 16th ed,2012)

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If a company has an objects clause, s 125(2) states that an act is not invalid merely because it is contrary to or beyond any of its objects. Furthermore, if a company’s constitution contains an express restriction or prohibition on the exercise of any of its powers, the exercise of such power is not invalid merely because it is contrary to such an express restriction or prohibitions s 125(1).5 Therefore, Orchards Downs Pty Ltd, the shareholders cannot force the company to comply with the clause 2.1 and the 12 month contract with Packaging Kings Pty Ltd to purchase packaging is valid. Shareholders can seek to remove and replace the directors by way of resolution as the company has adopted replaceable rule in s203c that states that a proprietary company may by resolution remove a director from office may by resolution appoint another person as a director instead. Besides that, shareholders can opt to sell their shares and no longer have a holding in Orchards Downs Pty Ltd.

Part (b) Shareholder approval is required to alter a constitution or displace a replaceable rule. The s 135(2) provides that a company may modify any one or more of the replaceable rules that applies to it by adopting a constitution. The s 136(2) provides that a special resolution is needed to modify or repeal a constitution or a provision of a constitution. Section 9 defines ‘special resolution’ as a resolution passed by at least 75% of the votes cast by members entitled to vote on the resolution.6 In addition, s 249L (1) (c) requires notice of the meeting at which a special resolution is proposed to set out an intention to propose the special resolution and state the resolution.

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Lipton, Herzberg and Welsh, above n 4. Lipton, Herzberg and Welsh, above n 4.

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The issue here is whether Nick can prevent the new clause being inserted even though the other shareholders passed a special resolution to that effect. The case of Gambotto v WCP Ltd7

established that an expropriation of shares would be for a proper purpose if it prevented the company from suffering significant detriment or harm. Therefore, the expropriation of shares from Kevin will only be possible if it can be proven that it would prevent Teen Music Pty Ltd from suffering any detriment or harm. The case of Gambotto v WCP Ltd also required the expropriation of shares to be fair. Fairness in this context involves two elements. The first element is that the process of expropriation must be fair. This requires majority to disclose all relevant information leading up the alteration and it requires shares to be valued by an independent expert8. The second element is regarding the price paid. If the share price is less than market price, it is said to be unfair. However, the current market price is not necessarily the sole criterion for fairness. Acquiring Nick’s shares for the price they were originally issued for would only be fair if it had undergone a fair process and the price should have taken into account a variety of factors, including assets, market value, dividends, and the nature of the corporation and its likely future.9

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Gambotto v WCP ltd [1995] 182 CLR 432

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Lipton, Herzberg and Welsh, above n 4. Lipton, Herzberg and Welsh, above n 4.

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Question 2 Part (a) The first issue here is whether Movie-Mania Pty Ltd can avoid paying for the debts owed to creditors if the directors incorporate a new company by transferring all of the assets of Movie-Mania Pty Ltd to a new company and continue to trade under the new company. In Salomon v Salomon & Co Ltd10, it is established that a company is a separate legal entity. This case established that as long as the necessary formalities of incorporation were satisfied, a new entity comes into existence that is separate and distinct from its directors and shareholders. The recognition that a company is separate legal entity distinct from its shareholders if often referred to as the ‘veil of incorporation’. This is because once a company is formed, the courts usually do not look behind the ‘veil’ to enquire why the company was formed and who really controls it. However, in relation to the situation with Movie-Mania Pty Ltd, the courts may lift the corporate veil if a company has been used as a sham or to avoid legal obligation. The new company was incorporated for the purposes of avoiding legal obligation to creditors. The case of Creasey v Breachwood Motors 11 established that the corporate veil could be lifted where a company was used to avoid legal obligation. Therefore the new company will be liable to the unpaid creditors.

The second issue is whether the directors of Movie-Mania Pty Ltd breached the duty to act in good faith in the best interests of the company if they follow Tracy’s advice to transfers all of the assets of Movie-Mania Pty Ltd to the new company and continue to trade under the new company.Directors are under a fiduciary duty to act in good faith and in the best interests of the company. Section 181(1)(a), which requires a director or other officer to exercise their powers and discharge their duties in good faith and in the best interests if the corporation, sets out the same requirements as the fiduciary duties. The good faith aspect

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Saloman v Saloman & Co Ltd [1897] AC 22 Creasey v Breachwood Motors Ltd [1992] 10 ACLC 3,052

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of both fiduciary and statutory duties requires directors to genuinely believe that they are acting in the best interest of the company. The case of ASIC v Adler 12 states that the duty is breached if a director acts in a way that no rational director would have considered to be in the best interest of the company. When the company is solvent, the best interests of their company correspond with the best interests of its shareholders as a collective group. However, when a company is facing insolvency or any financial difficulty, the interests of the company belong to its creditors. 13 In this case, Movie-Mania Pty Ltd had financial difficulties and therefore its directors Tracy, Jill, Tim and Bert had to act in the best interests of the unpaid creditors. Therefore, not having acted in the best interest of the creditors, the directors have breached their duty to act in good faith in best interests of the company. Consequences of contravening the s 181(1) can lead to civil penalty for the directors.

Part (b) The issue here is whether Julia, Wayne and Penny have breached the duty to act in good faith in the best interests of the company and for proper purposes by approving the issue of the 100,000 new shares. Directors breach their fiduciary and statutory duties to exercise their powers for a proper purpose if they issue shares to maintain control if the company’s management or majority shareholding, defeat a takeover bid or create or destroy the voting power of majority shareholders. The case of Ngurli Ltd v McCann 14 states that the power must be used in good faith for the purpose for which it was conferred, that is to say, to raise sufficient capital for the benefit of the company as a whole. It must not be used under the cloak of such a purpose for the real purpose of benefiting shareholders of their friends, at the expense of other shareholders so that some shareholders or their friends will wrest control of the company from the other shareholders.15

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ASIC v Adler [2002] NSWSC 171 Lipton, Herzberg and Welsh, above n 4. 14 Ngurli Ltd v McCann [1953] 90 CLR 45 15 Lipton, Herzberg and Welsh, above n 4. 13

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When directors exercise their powers to issue shares, they may be motivated by a number of purposes. That is particularly the case when directors are themselves the shareholders of the company. They must exercise their power in the interests of their company, but in doing so they may also promote their own interests as shareholders to the detriment of other shareholders. In such cases the courts will not intervene unless it is established that their motivating purpose is improper. Whitehouse v Carlton Hotel Pty Ltd16 is states that where there was more than one purpose for share issue, the ‘but for’ test should be applied to work out whether the directors breached their duty and issued the shares for an improper purpose. An allotment of shares will be invalidated if the impermissible purpose is causative in the sense that, but for its presence, no allotment would have been made.17 Julia, Wayne and Penny are directors that also are shareholders of Labour Industries Ltd. Therefore when they exercised their powers to issue shares, they may have been motivated by a number or purposes. Julia was worried that Kevin will persuade a majority of the shareholders to support the resolution removing her as a director. Therefore Julia had an incentive to issue shares to herself to avoid being removed as a director. As for Wayne and Penny, they had incentive to approve this issue of shares as they had been promised to be always elected to the board. However, the issue is it was stated in the minutes that the shares were issued for the purpose of raising capital for the company to allow it to invest in a new business venture. Here, the issue of mix purposes arises. To solve this problem, the ‘but for’ test should be applied. The question to be asked is, but for the motivation to remain in control would the shares still be issued. In this case, if the new shares would still be issued to invest in a new business venture regardless of whether or not there was an incentive for Julia, Wayne and Penny to maintain control then the share issue will be valid. However, if it is found that it was the share issue was primarily motivated by the incentive to remain as a director for Julia and to always be on the board for Wayne and Penny, then the share issue can be invalidated.

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Whitehouse v Carlton Hotel Pty Ltd [1987] 162 CLR 285 Lipton, Herzberg and Welsh, above n 4.

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Bibliography Philip Lipton, Abe Herzberg and Michelle Welsh, Understanding Company Law (Thomson Reuters, 16th ed, 2012)

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