QUESTION
Question 1
Mac Stevenson has patented a low-cost organic battery for storing electricity using an organic mineral, which can be mined in Australia. He wants to register a company that will mine the organic mineral and manufacture and market the batteries. The marketing studies conducted by Marc Stevenson indicatethat the batteries will be in demand by the solar industry. The venture will require capital of $1.5 million. Mac Stevenson has savings of $350,000 and the bank has agreed to lend him $250,000 when the business is successfully set up. Mac Stevenson expects the registered company to raise the remaining capital by issuing shares.
Mac Stevenson’s five year plan shows that in the first two years the company will only need $600,000 to purchase the equipment and set up the mining of the organic mineral. At this stage Mac Stevenson plans to invest his savings of $350,000 and issue shares to raise capital of $250,000. In the next three years Mac Stevenson will need a further $900,000 to manufacture and market the batteries. By the end of five years, Mac Stevenson expects the company to have a turnover of $6 million and employ between 40 to 60 staff members.
Mac Stevenson wants to keep the company’s affairs private and confidential as is reasonably possible and expects to remain the managing director of the company. He also wants the company to have a constitution with the following clause:
- The company’s business to be restricted to the mining of the organic mineral and the manufacture and sale of organic batteries.
Mac Stevenson has asked that you investigate the following legal matters under the Corporations Act 2001 (Cth) and case law before setting up the company and its constitution.
- The type and class of company that will best suit Mac Stevenson’s needs.
- Whether Mac Stevenson can expand the business to install solar panels together with the batteries.
Required
Prepare a report for Mac Stevenson showing the outcome of your investigation.
[18 marks]
Question 2
Tony has a carpentry sole trader business. Last year he decided to form a proprietary company Handyman Pty Ltd to take over the business. Tony sold his business to the Handyman Pty Ltd at an inflated price and lent the company $250,000, secured on the company’s property. Tony is the sole director and shareholder of Handyman Pty Ltd.
Whilst working late one night, Tony injured himself and is now unable to work as a carpenter. Since Tony is the sole employee, Handyman Pty Ltd has been unable to pay all its creditors and is forced into winding up.
The unsecured creditors’ claim that they should be repaid before Tony as the business was sold at an inflated price. Tony states that the company is a separate legal entity and as such separate from him.
Required
With reference to section 124 of the Corporations Act 2001 (Cth) and case law discuss whether the unsecured creditors can pierce the corporate veil.
[8 marks]
Overall presentation and accurate grammar. [4 marks]
Total 30 marks
Note:There are multiple issues in the above questions. You must read the questions and requirements very carefully to ensure relevance and completeness of your answers.
SOLUTION
Answer 1
Area of law
Types and classes of companies
Principles of law:
Types, advantages and disadvantages of companies as well as description of replaceable rule.
A company is a separate legal entity from its directors and shareholders and is governed by Corporations Act 2001. Companies are regulated by Australian Securities and Investment Commission. A Company can govern itself internally with the help of the company constitution or if it is not available then with the help of replaceable rules of the Corporations Act 2001.
There are mainly two types of companies, proprietary and public.
- Proprietary Company (Section 45A (1)): A proprietary company can be either limited by shares (shareholders are not liable for the debt of company) or it can be unlimited with share capital (liability of the shareholders is not limited).
Proprietary companies are restricted to have more than 50 shareholders and cannot get themselves involved in fund raising as fundraising requires disclosure of certain company documents to investors.
A proprietary company is further divided into small and large proprietary companies and this distinction is basically because of operating revenue, number of employees and assets. In case of a large proprietary company the auditor of the company is required to file financial statements of the company with the Australian Securities and Investment Commission. Small proprietary companies have to prepare their financial statements if these are instructed by the Australian Securities and Investment Commission to do so.
Advantages of proprietary company
Limited Liability for the company’s debts: shareholders have limited liability towards the debts of the company if it is a proprietary company limited with shares.
Ease in transferring ownership by sale of shares: Ownership transfer is not at all a complicated process in these types of businesses as it can be done just be selling of the shares.
Favourable tax rates: there are special tax rates for proprietary companies and it helps in retaining the profit and in expansion of the company.
Disadvantages of proprietary company
High cost to establish and maintain: the official registration papers of the proprietary company are required to be filed with Australian Securities and Investment Commission and certain registration and paperwork fee is required to be paid. Financial statements also need to be reported to Australian Securities and Investment Commission leading to further costs an appointing an auditor and filing fee etc.
Compliance with Australian Securities and Investment Commission rules: Propriety companies have to comply with the rules and regulations as laid by Australian Securities and Investment Commission and any failure to comply with these can lead to various fines and penalties.
Complicated Deregistration Process: Before a proprietary company can be dissolved it has to fulfil all the requirements as laid by the Australian Securities and Investment Commission like no outstanding liabilities, lawsuits, fees or any fine. Complying with these requirements is a lengthy and complicated process. `
- Public Companies are listed with the Australian Stock Exchange and have the ability to raise funds from the investors by complying with certain disclosure requirements. There need to be at least one shareholder but no limit on the maximum number of shareholders. It is required to have 3 directors’ 2 of which need to be resident of Australia.
Public companies are further of several types:
Company limited by shares: It is defined in section 9 of the Corporations Act 2001 and the liability of its shareholders is limited to the unpaid amount which is of shares held by them.
Company limited by Guarantee: It is defined in section 9 of the Corporations Act 2001 and liability of its members is limited to the amount that the shareholders have undertaken or guaranteed to contribute towards the property of the company in case of the company is dissolved.
No Liability Company: it is that company that can engage itself only in the mining activities. It needs to have share capital and the constitution should state the objective of the company as mining. It has a share capital and cannot have contractual rights to recover calls made on its shares from a not paying shareholder.
Unlimited Company: in this type of companies shareholders have unlimited liability as stated by Section 9 of the Corporations Act 2001 but still it is a separate legal entity with advantages of incorporation.
Advantages of Public Companies
These companies have the ability to raise funds from the investors by sale of its securities. It is therefore not very burdensome to establish a public company and the profit on shares is gained in the form of dividends and or capital gains.
Disadvantages of Public Companies
These companies have to comply with a lot of disclosure requirements keeping a lot of information in public domain and are under constant pressure to meet sales and profit figures.
A lot of money is also spent in hiring accountants and other people to do a lot of paperwork to comply with all the government regulations.
Replaceable Rules
These are those rules which are framed for the governance of internal management and administration of the company. Prior to this memorandum defined the nature of the Company and Articles of its Association were enough to govern the company. An object clause is now no more mandatory in Australia except when the company is a no liability mining company. After July 1998 it is now not compulsory for a company to chalk out its own constitution. Section 134 of the Corporations Act 2001 states that constitution of a company can consist of replaceable rules, or its own constitution or it can be a mix of both.
Replaceable rules applies to all companies that are registered after the July 1998, unless the company has opted for its own constitution. Those companies which were registered before July 1998 can adopt replaceable rules by repealing their old constitution. Some replaceable rules are mandatory for public companies and some apply only to proprietary companies. These are not applicable on proprietary company with just one shareholder. A table of all replaceable rules is provided under section 141 of the Corporations Act 2001.
Apply the law to the facts:
Mac Stevenson wants to register a company that is basically into mining of an organic material so it is advisable for him to invest in a no liability company which is a company that can engage itself only in the mining activities. It needs to have share capital and the constitution should state the objective of the company as mining. It has a share capital and cannot have contractual rights to recover calls made on its shares from a not paying shareholder. The constitution of mining companies has to state that the main objective of the company is mining only for which Mac Stevenson is ready but I doubt if ‘the manufacture and sale of organic batteries’ can be a part of the objective clause of such mining companies. It is a risky venture so there are no liabilities and if losses are incurred this business can be left without incurring any liabilities. Purchase of shares in such companies is not a binding contract and shareholder can forfeit both the paid and unpaid shares. If a company is advantageous than it can be converted to limited liability company so that Mac Stevenson can keep his company matters as confidential and private which is possible in case of a limited liability proprietary company.
Conclusion:
It can be concluded that Mac Stevenson can go for a No Liability Company which engages itself in the mining activities only and later when it turn advantageous he can convert it into a limited liability proprietary company.
Answer 2
Area of law:
Piercing of corporate veil.
Principles of law:
Section 124 of the Corporations Act 2001 provides companies with a number of powers and these companies are limited in their liabilities. In the case of Salomon v Salomon 1897 AC 22 (Solomon) it was affirmed by the House of Lords that once a company is incorporated it is considered as a new legal entity separate from its members or shareholders. In this case Aron Salomon decided to sell his business to a company that was formed by him himself in return for fully paid up shares to himself and to his wife and son and thus secured debentures of the company. The company became indebted and was to be liquidated; Aron Solomon’s claim was paid off in priority to other creditors as he proved that he is not required to indemnify the company for its debts as company is a separate legal entity.
The facts of the Lee v Lee’s Air Farming Ltd. (1961) AC 12 are that Mr Lee held 2999 to 3000 shares of a company that was formed by him through Christchurch accountants. He was the only director of the company and was also employed by the company as chief pilot as the business of the company was to spread fertilizers in the farms from air. His plane crashed and he died Mrs Lee claimed that under Worker’s Compensation Act 1922 her husband is a worker of the company and she is entitled to all the benefits to which a worker’s wife would have been if he would have died while working in the company. The Privy Council held that as a company is separate from its director s hence a director can enter into a contract with a company.
At the same time it has also been realized that sometimes piercing of this corporate veil becomes necessary to deny shareholders the protection that is provided to them by Limited Liability Company. It is a judicially imposed exception to the rule of a company being a separate legal entity. In these matters separateness of the company from its shareholders is denied and shareholders becomes responsible for all the acts of the company as if these were his own acts and becomes liable for all the debts of the company.
Apply the law to the facts:
Creditors should be paid first keeping in mind the piercing of corporate veil principle as Handyman Pty Ltd was basically the sole trading company of Tony and he was the one who was acting behind the veil so the veil can be pierced and creditors can be paid first. Tony was also employed by the company though he was a director of the company but was also working for it as an employee so he needs to be compensated as a worker would have been
Conclusion:
It can be concluded that creditors should be paid on priority.
List of Cases Referred:
- Lee v Lee’s Air Farming Ltd. (1961) AC 12
- Salomon v Salomon 1897 AC 22 (the Solomon case)
List of Other Sources:
- Baxt, R; Black, A; Hanrahan, P Securities and Finacial Service Law (2003) 6th Ed.
- Corporation Act 2001 (Cth) –Austll II
- Cassidy, J. 2006, Concise Corporations Law, (5th ed) Federation Press, Sydney
- Harris, J; Hargovan, A; Adams,M Australian Corporate Law 3rd Edition
- Hyland,M and Nehme, M Quick Reference Card Corporations Law: Directors Duties
KH47
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