Question:
Carborundum Pty Ltd (Carborundum) is a company that was incorporated in July 2014. The main business of the company is the manufacture of drilling machinery for the mining industry. The company has issued 50,000 $ 1 shares as follows: Alan, Ben, Colin and Eric Sanders have 4,000 shares each; Donald Thump, a wealthy industrialist, has 12,000 shares; and the remaining 22,000 issued shares are owned by a company called Inventions Pty Ltd (“Inventions”). The directors and shareholders of Inventions are Hilary and Bill Winton. The Carborundum shares held by Alan, Ben and Colin are fully paid up, whilst the rest of the issued Carborundum shares are paid up only to the extent of one cent per share.
Hilary is the managing director of Carborundum and she is also its chief engineer. The other directors are Ben and Colin. Colin is the Chairman of the Board. Alan is the Company Secretary for Carborundum.
Carborundum’s Constitution states, inter alia:
“Clause 3. The sole objects of the company shall be to manufacture of drilling machinery.
Clause 4. Hilary Winton shall be director for life.
Clause 5 The company agrees to employ Hilary Winton as its chief engineer. To amend this clause, there must be 80% approval at a General Meeting. ”
Part A Advice to Hilary (12 marks)
Hilary seeks advice on the following matters:
- Explain the potential liability of all of the named parties in the event that Carborundum is wound up with unpaid debts. (3 marks)
- How secure is her position as Managing Director of Carborundum? In particular, discuss what would be the procedure the Company would have to take to remove her as a managing director. (2 marks)
- Only in this part, assume that Hilary convinces Colin to issue 50,000 $1 shares in Carborundum to Inventions with the requirement that only 1 cent needs to be paid initially. This was decided at a Board Meeting where neither Ben nor Alan was present. Discuss the consequences of this action. (4 marks)
- Can Carborundum remove Hilary as its chief engineer? If so, explain how this may be done. If not, explain why not. (3 marks)
Part B Advice to Donald (5 marks)
Donald has heard that Inventions is considering convening a general meeting, with a view to having the following changes made to Carborundum’s constitution:
- Deletion of Clause 3 from Carborundum’s Constitution (1 mark);
- The name of the company to be changed to Winton Ltd (2 marks); ; and
- Insertion of a clause that allows Inventions Pty Ltd to compulsorily acquire the shares of any member for 10 cents per share. (2 marks)
Donald is strongly opposed to all the proposed changes and seeks your advice on what steps must be taken to effect the changes and how Donald may be able to oppose them. Donald is concerned that the changes may mean that the company will no longer manufacture drilling machinery and instead carry on some other business. He is also concerned that the name change will bring publicity to the “Winton” name at the expense of the Carborundum brand. Lastly, he is concerned that he is the target of the proposed compulsory acquisition power that is proposed to be granted to Inventions.
Part C Advice to Colin (2 marks)
Hilary has decided to incorporate a new company to enter into the mining industry. She believes that Carborundum has enough expertise in mining through its exposure to that industry. The new company called Mineral Investments NL (“Mineral”), was incorporated on 2 July 2017 and the only share is owned by Carborundum. The 3 directors are Hilary, Ben and Colin and Alan is the company secretary. On 3 June 2017 Hilary entered into a contract to buy office furniture on “behalf of Mineral Ltd” from Hardly Normal, a furniture store. The furniture is to be delivered in September. However Ben and Colin object to the purchase as Mineral will be operating from Carborundum’s present offices and so should not have any need for separate offices or furniture.
Colin wants to know whether the contract is binding on Minerals Investments NL.
Part D Advice to Eric (3 marks)
Eric has a farm that he claims has silver deposits. The land was valued at 1 million dollars in June 2017. He incorporates a company called Silver Pty Ltd (“Silver”) on 2 July 2017. He is the sole director and shareholder of this company. On 5 July, he approaches Mineral to purchase the land for 2 million dollars. The purchase price is to be proivided by Mineral purchasing 2 million $1 shares of Silver. In August, a detailed report by an independent geologist established conclusively geologist that there is no silver in the land. Eric is now being sued by Mineral. Discuss what are the chances of Eric being able to defend himself.
Part E Advice to Alan (8 marks)
Alan found out that Ben has entered into the drilling machinery business. He has set up a company called Bendrill Pty Ltd (“Bendrill”) to sell drilling machinery to Carborundum’s existing customers. Alan has been told that Ben approached two of Carborundum’s customers and offered them Bendrill’s products, which are 30% cheaper than Carborundum products. Upon checking in ASIC’s database, Alan finds that Bendrill made a profit of $500,000 in the previous financial year.
Based on the above, Alan wants to know the likelihood of ASIC and/or Mineral successfully pursuing criminal and/or civil remedies against Ben and/or Bendrill.
Answer:
(i)
The key issue in this case is regarding the parties who can be made liable for the unpaid debts of the company, in case of possible winding up of the company.
The companies have been given a separate legal entity status, due to which, for their liabilities, the shareholders of the company cannot be made liable. However, the shareholders of a company can be made liable in certain cases. When the company is limited by shares, the members are not required to pay anything other than the outstanding amount, i.e., the unpaid amount of shares, for the debts of the company. Further, the outstanding sum regarding the shares is deemed as the debt of the company[1]. Based on this section, Eric Sanders, Donald Trump and Inventions Pty Ltd would be liable for the unpaid capital on their respective shareholdings, i.e., for the remaining 0.99 dollar per share.
The liability for the obligations is also upon such individuals, who have been named in the shareholder agreement and the constitution of the company[2]. The directors of the company can also be held liable for the debts of the company, when it can be established that there is a breach of duties held by the directors, pursuant to different sections of the Corporations Act, 2001[3]. So, a director can be held liable in case the directors incurred debts when the company was insolvent pursuant to section 588H of this act[4]. However, such situation is not present here, so, these two clauses would not be applicable here.
Hence, in this case, Eric Sanders, Donald Trump and Inventions Pty Ltd can be made liable for the unpaid debts of the company, in case the company is to be wound up.
(ii)
The key issue in this case revolves around the possibility of removing Hilary as the managing director of the company.
When a person is made a director in the company, the process of removing the director has to be given careful consideration. When the company is incorporated under a constitution, the rules for company’s governance are covered under this constitution. Constitution is basically a contract which takes place between the shareholders who regulate the company’s management, along with the responsibilities and roles of the officers and directors of the company. In order to remove a director, there is a need to pass a resolution in the general meeting of the company. A proper notice has to be given for the general meeting, clearly stating that one of the agenda is to remove the director at the meeting. There is a need to obtain 50% of people in control, along with 1 share of company, who have voting rights, to pass the resolution for the removal of the director[5]. So, for removing Hilary, there is a need to convene a general meeting and get a resolution passed by people having 50% of power plus one share.
Hence, by following the procedure laid down here, Hilary can be removed from being the managing director of the company.
(iii)
The key issue in this case revolves around the breach of director duties on part of Hilary by asking Collin to issue shares to a company, in which she is a director.
The directors owe certain duties under the common law and under the statutory law, which have to be strictly followed. Under the common law, the directors have the duty to avoid a conflict of interest[6]. And accordingly, they have to make full disclosure in such cases where they have a material interest in the transaction being undertaken. When such is not done, the transaction can be made voidable at the choice of the company and the board of directors can decide if they want to initiate legal proceedings for making the transaction void[7]. Aberdeen Railway Co v Blaikie Bros[8] provided that the directors should not put themselves in a situation where there is a conflict of their interest with that of company. Based on Phipps v Boardman[9], such situation will arise when there is a real possibility of conflict.
Under the Corporations Act, the directors have the duty to work in the best interest of the company and take the decisions which show care and diligence and this duty is covered under section 180[10]. Section 181 imposes a duty of good faith on the directors[11] and section 182 imposes a restriction on making an improper use of the position in the company[12].
In this case, Hilary misused her position and persuaded Colin to issue shares to Inventions, where she was a director and shareholder. This was not in the best interest of the company, as this would put Hilary in a controlling position in the company. This was a conflicting position which had to be avoided based on Aberdeen and gave rise to a real possibility of conflict based on Phipps due to controlling position of Hilary after this share transfer. Hence, Hilary breached her director duties covered under common law and the statutory law.
To conclude, by asking Collin to issue shares to a company, Hilary contravened her director duties.
(iv)
The key issue in this case revolves around the possibility of removing Hilary from Carborundum’s chief engineer position.
As had been explained in part (ii) of this discussion, the constitution is a contract, which has to be strictly adhered. So, the terms which are provided in the constitution, become a rule for the company[13]. In this case, the constitution through Clause 5 clearly provides that to change the position of Hilary as being a chief engineer, there is a need to obtain 80% approval at the general meeting. So, the notice of the general meeting has to provide that this is an agenda of the meeting. And by obtaining an 80% approval at the meeting, Hilary can be removed from the position of chief engineer.
Hence, Hilary can be removed from the position as Clause 5 of the constitution of the company clearly provides so, by obtaining 80% approval at the general meeting.
Part B
The key issue in this case revolves around the possible steps which can be taken by Donald against the changes which Inventions seek to make in the constitution of Carborundum.
Under the Corporations Act, the constitution of a company can be modified or repealed by passing a special resolution, whereby 75% of the votes put in by the shareholders are needed to pass the resolution. When the people who are opposing such changes in the constitution are in minority, the provisions regarding the minority shareholding come into play[14]. As per section 232 of the Corporations Act, an order can be made by the court pursuant to section 233 in such cases where the conduct of the affairs of the company; or the proposed or actual omission or act on behalf of the company or by the company or; the proposed resolution or the resolution of the members or a class of members of the company is either against the interest of the members in entirety, or is oppressive/ unfairly discriminates or is prejudicial against the members[15].
Upon establishing the prejudicial conduct, the court can make an order[16] to amend or repeal the constitution of the company; regulate the conduct of the affairs of the company for future; for the company to discontinue, defend, prosecute or institute thee specified proceedings; restrain a person from doing a particular act, and the like[17].
In the given case study, for Inventions to amend the constitution, there is a need to obtain 75% of the votes put in by the shareholders. Donald has 12,000 shares out of 50,000 shares, which makes him the owner of 24% of the shares. So, if he has to move against the possible passing of the resolution at the board meeting, he needs to make a claim under section 232 of the Corporations Act. For each of the points he would have to provide the reasons to the court, which have been given in the case study. After showing that the company brand would be impacted, where the company can be placed under compulsory acquisition and where the business of the company would change, he can show that the decision is neither in his favor nor in the favor of the company. So, he can ask the court to pass the order pursuant to section 233 of this act. By doing so, the court would order the company to not delete Clause 3 from the constitution of the company. The court can also disallow the name of the company to be changed and also passing the order to stop the clause to allow the shares be compulsorily acquired by the Inventions. The court can also pass order to regulate the affairs of the company, stop this resolution from being placed in the general meeting and restrain Inventions from asking the shareholders to pass this resolution.
Hence, by opting for the minority shareholder provisions, Donald can stop Inventions from making changes to the constitution.
Part C
The key issue in this case revolves around the contract being bounding upon the new company.
As has been stated earlier, the company has the status of a separate legal entity, due to which the company can enter into the contract[18]. This status was granted through the case of Salomon & Co Ltd[19], where the plaintiff was personally held liable for the debts undertaken by him on behalf of the company. The company is run by different people but continues to have a separate status from the ones running it. In this case, upon being incorporated from July 02nd, 2017, the company obtained its separate legal entity status. And for conducting the affairs on behalf of the company, there is a need for specific permission from the Board of company. This permission was never obtained by Hilary and so, the contract which she entered into, would not be binding due to separate legal entity status of Mineral.
To conclude, the contract is not binding on Mineral.
Part D
The key issue in this case revolves around liability of Eric for the misrepresentation and the ability of defending himself for the case initiated by Silver.
When a false statement is made, just to induce the other party into entering in some contract, a misrepresentation is made. In such cases, the aggrieved party has the option of voiding the contract at their option[20]. It is crucial that the statement which has been made is a statement of fact. In Bisset v Wilkinson[21], the statement made by the defendant was a statement of opinion and not of fact, so the plaintiff was not able to make a successful case of misrepresentation. However, where the person making the statement is in the position of knowing the truth behind the statement, a case of misrepresentation would stand, as was seen in Smith v Land & House Property Corp[22], where the court held that the statement made for the tenant being most desirable was a statement of fact.
In this case, Eric made a claim regarding the silver deposits on his farm and led to the contract been entered for the sale of land at the purchase price fixed between him and Silver. As the companies have separate legal entity status, they can enter into contract with their directors. Eric can claim a defense on the basis of Bisset v Wilkinson that this was a statement of opinion. However, the position of Eric was such that he had to know that silver deposit was not present on his form based on Smith v Land & House Property Corp. And the false statement would mean that Eric indulged in misrepresentation, which would make him liable for damages to Silver.
Hence, Eric would not be able to defend himself owing to the misrepresentation undertaken by him and Silver would be able to get the sale contract rescinded or claim damages for the misrepresentation of Eric.
Part E
The key issue in this case revolves around the civil and criminal remedies which can be imposed on Alan by the ASIC or Carborundum.
As has been stated earlier, the directors of the company have certain duties, under common and statutory law. One of the duties under the common law relates to the duty of not abusing the corporate opportunities. The court stated in Chan v Zacharia[23] that the directors had to avoid such situations where their personal interests conflict with the interests of the company. And it is not relevant if the company would have exploited such situation or not, as was seen in Regal (Hastings) Ltd v Gulliver[24].
Section 180, 181, 182, and 183 puts a civil obligation on directors and relate to the duty of care and diligence[25], the duty of good faith[26], the duty to not use their position[27] in an improper manner and the duty to not use the information[28] of the company in an improper manner. Any use of information of the company which is used personally by the director to gain a benefit for them, which causes detriment to the company, would breach the director duty covered under section 183[29]. In R v Byrnes[30], section 182 was said to have been breached as it caused damage to the company owing to the misuse of position as the company director.
When these sections are contravened, the civil penalties covered under section 1317E become applicable on the directors. Under this section, the court gets the power to make a declaration of contravention[31]. And once this is done, ASIC gets the power to apply for a pecuniary penalty[32] order pursuant to section 1317G of the act or can apply for the disqualification order[33], pursuant to section 206C of this act. Section 184 leads to the attraction of criminal liabilities for the directors when they do something intentionally dishonest or recklessly and also fail to use their powers and fulfill their duties in a manner which is in the best interest of the company and for the proper purpose[34].
In this case study, by setting up the Bendrill, Ben breached his director duties which he owed by being a director of Carborundum, on the basis of R v Byrnes. Ben was under an obligation to avoid conflict of interest position on the basis of Chan v Zacharia, but he ignored to do so, and used the material confidential information of the company and got the clients of Carborundum taken to his new company Bendrill. This breached the duties placed on him under the statutory and common law. And based on the remaining three cases quoted above, he would be held liable for breaching his director duties. Where the breach of section 180, 181, 182, and 183 would give rise to civil liability, breach of section 184 would attract criminal liability. And as he made a profit by misusing the information of Carborundum, he would be held liable.
Due to these reasons, Alan can make an application to the ASIC to initiate both civil and criminal proceedings against Ben as he breached the director duties by being a director of Carborundum. This would allow the ASIC to initiate legal proceedings against Alan. However, a case cannot be made against the newly formed company Bendrill. This is again due to the case of a company being a separate legal entity and for the acts of the director, a company cannot be made liable, till the time the need for lifting the corporate veil is established. Had the new company being solely run by Ben and was being used just as a front of Ben, only then the corporate veil could have been lifted in this case. However, as no such information is given, the new company cannot be made liable.
To conclude, there are high chances of a case being made against Ben by ASIC on application of Alan and by Carborundum.
Bibliography
A. Articles/ Books/ Reports
Anderson H, Directors’ Personal Liability for Corporate Fault: A Comparative Analysis (Kluwer Law International, 2008)
Andrews N, Contract Law (Cambridge University Press, 2nd ed, 2015)
Baxt R, Duties and Responsibilities of Directors and Officers (AICD, 18th ed, 2005)
Cassidy J, Concise Corporations Law (The Federation Press, 5th ed, 2006)
Parthalan OR, Separate Legal Entity (Vadpress, 2012)
B. Cases
Aberdeen Railway Co v Blaikie Bros (1854) 1 Macq 461 at 471
ASIC v Adler and 4 Ors
ASIC v Stephen William Vizard [2005] FCA 1037
Bisset v Wilkinson [1927] AC 177
Chan v Zacharia (1984) 154 CLR 178
Phipps v Boardman [1967] 2 AC 46 at 124
R v Byrnes (1995) 130 ALR 529
Regal (Hastings) Ltd v Gulliver [1967] 2 AC 134
Salomon & Co Ltd [1897] AC 22
Smith v Land & House Property Corp (1884) 28 Ch D 7
C. Legislations
Corporations Act, 2001 (Cth)
D. Others
Legal Vision, How to amend a company constitution (16 September 2013) <https://legalvision.com.au/how-to-amend-a-company-constitution/>
Legal Vision, What are the Rights and Liabilities of a Shareholder in a Company? (18 March 2015) <https://legalvision.com.au/rights-liabilities-shareholder-company/>
Moore D, and McLachlan T, UK: Unpaid Share Capital In The Context Of Tax-Avoidance Schemes: Shareholder Liability In Corporate Insolvencies (26 January 2015) <http://www.mondaq.com/uk/x/368922/Insolvency+Bankruptcy/Unpaid+Share+Capital+In+The+Context+Of+TaxAvoidance+Schemes+Shareholder+Liability+In+Corporate+Insolvencies>
PwC, A guide to directors’ duties and responsibilities for non-listed public companies and proprietary companies in Australia (2008) <http://etraining.communitydoor.org.au/pluginfile.php/608/course/section/95/GuideDirectors_Apr08.pdf>
Streten Masons Lawyers, What is the process for removing a director of a company? (20 September 2015) <https://smslaw.com.au/what-is-the-process-for-removing-a-director-of-a-company/>
Victorian Law Reform Commission, 3. The oppression remedy in the Corporations Act (20 July 2017) <http://www.lawreform.vic.gov.au/content/3-oppression-remedy-corporations-act>
[1] Daniel Moore and Tom McLachlan, UK: Unpaid Share Capital In The Context Of Tax-Avoidance Schemes: Shareholder Liability In Corporate Insolvencies (26 January 2015) <http://www.mondaq.com/uk/x/368922/Insolvency+Bankruptcy/Unpaid+Share+Capital+In+The+Context+Of+TaxAvoidance+Schemes+Shareholder+Liability+In+Corporate+Insolvencies>
[2] Legal Vision, What are the Rights and Liabilities of a Shareholder in a Company? (18 March 2015) <https://legalvision.com.au/rights-liabilities-shareholder-company/>
[3] Corporations Act, 2001 (Cth)
[4] Corporations Act 2001, s588H
[5] Streten Masons Lawyers, What is the process for removing a director of a company? (20 September 2015) <https://smslaw.com.au/what-is-the-process-for-removing-a-director-of-a-company/>
[6] Helen Anderson, Directors’ Personal Liability for Corporate Fault: A Comparative Analysis (Kluwer Law International, 2008)
[7] PwC, A guide to directors’ duties and responsibilities for non-listed public companies and proprietary companies in Australia (2008) <http://etraining.communitydoor.org.au/pluginfile.php/608/course/section/95/GuideDirectors_Apr08.pdf>
[8] (1854) 1 Macq 461 at 471
[9] [1967] 2 AC 46 at 124
[10] Corporations Act 2001, s 180
[11] Corporations Act 2001, s 181
[12] Corporations Act 2001, s 182
[13] Julie Cassidy, Concise Corporations Law (The Federation Press, 5th ed, 2006)
[14] Legal Vision, How to amend a company constitution (16 September 2013) <https://legalvision.com.au/how-to-amend-a-company-constitution/>
[15] Corporations Act 2001, s 232
[16] Corporations Act 2001, s 233
[17] Victorian Law Reform Commission, 3. The oppression remedy in the Corporations Act (20 July 2017) <http://www.lawreform.vic.gov.au/content/3-oppression-remedy-corporations-act>
[18] Ozzy Ronny Parthalan, Separate Legal Entity (Vadpress, 2012)
[19] [1897] AC 22
[20] Neil Andrews, Contract Law (Cambridge University Press, 2nd ed, 2015)
[21] [1927] AC 177
[22] (1884) 28 Ch D 7
[23] (1984) 154 CLR 178
[24] [1967] 2 AC 134
[25] Corporations Act 2001, s 180
[26] Corporations Act 2001, s 181
[27] Corporations Act 2001, s 182
[28] Corporations Act 2001, s 183
[29] Robert Baxt, Duties and Responsibilities of Directors and Officers (AICD, 18th ed, 2005)
[30] (1995) 130 ALR 529
[31] Corporations Act 2001, s 1317E
[32] Corporations Act 2001, s 1317G
[33] Corporations Act 2001, s 206C
[34] Corporations Act 2001, s 184
