BLO1105 Business Law: A Case Study of Sinking Ship Ltd

Insolvency

1. Claude, Jackie and Allison are directors of Sinking Ship Ltd (“Sinking Ship”). Sinking Ship manufactures high end yachts and is listed on the ASX. Sinking Ship’s bank is Bad Bank Ltd (“Bad Bank”).  Sinking Ship has borrowed $10,000,000 from Bad Bank on an unsecured basis which it is required to pay back in full on July 1, 2016.

After the loss of the large contract, Bad Bank told Sinking Ship that it would no longer extend credit to the company. Likewise, many of Sinking Ship’s suppliers became nervous and placed the company on a strict COD basis.   The directors started to get numerous calls from creditors wanting to know when the company would be paying them back. The directors started to pay the more aggressive creditors while putting off others.  Soon cheques started to bounce.

The stock market became very wary of Sinking Ship’s financial status and the share price dropped precipitously.  In order to arrest the drop in the share price, on May 1, 2016, the directors decided to pay a dividend to shareholders. The dividend was actually paid on May 4, 2016.  After paying the dividend, it became apparent the company had very little cash left to continue paying creditors.

Knowing that the company was doomed, on May 10, 2016, Claude transferred the last $50,000 in the company’s bank account to Bad Bank because he felt sorry for Bad Bank and thought it deserved something back.  He also transferred a Mercedes motor vehicle which was owned by Sinking Ship into his name on the basis that he thought the company owed him something for all his hard work in running the company.

On August 20, 2016, the directors had no alternative but to place Sinking Ship into voluntary administration and it was subsequently placed into liquidation. The liquidator now desires to commence an action against the directors for breaches of section 588G.  Further, she desires to recover the Mercedes motor vehicle and the $50,000 under Part 5.7B Div 2 of the Corporations Act. She is also curious as to whether the directors had the right to pay the dividend. 

2. Queensland Rail Constructions Ltd “RCL” purchases $2 million worth of wood for the Brisbane-Sydney rail line project from Queensland Timber Ltd (“QTL”).  After installing tracks between Brisbane and Robina, RCL is unhappy to observe that the wood components have warped dramatically, such that RCL will have to re-lay the entire length of track.  As a result, RCL refuses to pay QTL for the wood.  In due course, QTL sends RCL a letter stating that RCL owes it “$2 million, plus compound interest at 8% per year”.  (The letter was addressed to “Rail Contracting Pty Ltd”.)  RCL is of the view that the entire lot of wood is defective, and if anything, QTL should have to pay RCL for the massive expense that RCL is going to incur (way more than $2 million) in re-laying the damaged track.  Advise RCL in relation the demand it has received and the alleged quality of the wood they it may relate to subsequent winding up proceedings

3. Regal (Burleigh) Ltd (“Regal) owned and operated a cinema in Burleigh Heads on the Gold Coast. Gulliver, Fred and Barney were the only directors of Regal.  Gulliver was appointed the managing director due to his extensive knowledge of operating cinemas. Both Fred and Barney are nonexecutive directors. Regal has a number of unrelated shareholders.

Over the last few years, Regal’s financial position has steadily deteriorated. While Gulliver was aware of this, he did not pass any financial information onto the other directors.  Indeed, he repeatedly told them that the company was performing wonderfully. While Fred and Barney were given the company’s financial reports, they never looked at them closely as they assumed that the auditors or Gulliver would alert them to any problems.

By January 2017, things had started to get dire for Regal as attendance at its cinema dropped precipitously due to a competitor opening a new cinema nearby. Regal’s cash reserves were running low and Gulliver was post-dating cheques in order to avoid running out of money. In a few instances, cheques were presented when Regal had insufficient funds and they bounced.  On January 20, 2017, the manager of Regal’s bank – Bad Bank Ltd - called Gulliver and said that he would be forced to suspend the company’s overdraft facilities unless the company improved its financial position.

At a board meeting on February 1, 2017, Gulliver informed the board that he had a revolutionary idea for Regal. He proposed that Regal enter into leases for two more cinemas that were located in Burleigh Heads. He suggested that by undertaking this transaction, revenue would increase and it would even make the company a potential takeover target.  Fred and Barney were intrigued and told Gulliver to do whatever he had to do to get the transaction done.

After the meeting, Gulliver approached a commercial leasing agent who informed Gulliver he had two cinemas available for lease. The agent said the cinemas were in wonderful condition and would be just what Regal needed. Gulliver inspected the cinemas with his friend George who is an accredited residential building inspector. Gulliver thought the cinemas were acceptable and George said he couldn’t see any structural problems with the cinemas.

On March 1, 2017, the board had a further meeting and Gulliver updated the board regarding the leases.  Gulliver told the board that Regal needed $2 million to place signage on the new cinemas.  Gulliver said he had reached an agreement with Bad Bank whereby it would loan the company $1 million and suggested Fred and Barney each contribute $500,000 in return for shares in Regal.  Fred and Barney agreed.

On March 5, 2017, the leases were signed, Fred and Barney transferred $1 million to the company and a credit agreement was entered into with Bad Bank for $1 million.  The new signage was completed on March 10, 201X and Gulliver arranged a grand opening scheduled for March 15, 2017.

On March 13, 2017, Gulliver received a letter from the Gold Coast City Council saying that Regal was not permitted to open the two new cinemas as they did not have adequate fire exits and the fire sprinkler system needed to be replaced. After some preliminary investigations, Gulliver discovered that it would cost over $5 million to install additional fire exits and upgrade the sprinkler system.

Knowing that the company was doomed, Gulliver transferred its last $50,000 in the company’s bank account to Bad Bank because he felt sorry for Bad Bank and thought it deserved something back.  He also transferred a Mercedes motor vehicle which was owned by Regal into his name on the basis that he thought the company owed him something for all his hard work in connection with leasing the two new cinemas.

On April 20, 2017, the directors had no alternative but to place Regal into voluntary administration and it was subsequently placed into liquidation. The liquidator now desires to commence an action against the directors (1) alleging the directors breached their duty of care, skill and diligence; and (2) for insolvent trading.  Further, she desires to recover the Mercedes motor vehicle and the $50,000 under Part 5.7B Div 2 of the Corporations Act.

Accounts and audit

1. Explain what is meant by ‘auditor independence’, why this is an important concept and how legislation attempts to achieve auditor independence.

2. Discuss auditor liability with reference to conduct that could lead to liability; potential defences against liability; as well as the parties that could hold company auditors liable.

3. Shazaam Pty Ltd is a business which hires out entertainers and party equipment for parties and events. Although the business started modestly, Shazaam’s business has grown significantly over the last year or so, to the extent that the company now employs 62 employees.  The value of Shazaam’s assets also increased significantly over this period, due to a rapid rise in property value in the areas in which Shazaam has bought property to use as party venues. Shazaam’s assets are now worth at least $14million dollars. 

Shazaam’s two directors, Jack and Jill, are very pleased with how the business has grown.  Jack also acts as a part-time accountant for Shazaam. In spite of the rapid growth of their business over the last three years, Jack, although not having any formal training in accounting, is confident that he has picked-up enough bookkeeping skills over the years to be able to cope. He doesn’t have much faith in computerised accounting software, preferring to do all the accounting calculations and book entries by hand using an abacus. Jack prefers to keep his working papers and documents, needed to explain his methods by which the company’s financial statements are made up, in a convenient short-hand that he invented himself. Jack keeps Shazaam’s invoices, receipts and working papers locked in the rear trunk of his car.

Shazaam also imports party aids and novelty goods from overseas, for sale in Australia. Jack and Jill, both feeling more confident about their own ability as entertainers rather than importers, do not fully understand import regulations, or the currency conversions involved in these transactions. They rely heavily on Mona, a recent International Studies graduate who claims to be an expert in this area, to take care of this side of the business. In reality, Mona knows nothing about importing goods from other countries, or currency conversion. Due to her ineptitude, she causes big financial losses for Shazaam. Given Jack’s unique accounting approach, the losses caused by Mona aren’t immediately apparent. Neither Jack, nor Jill directly supervises Mona.

Meanwhile, Peter, Shazaam’s auditor, has become curious about the state of Shazaam’s financial affairs. Peter is a junior partner in the auditing firm, Smith & Jones, which provides high fee-generating taxation and consulting services, as well as audit services to Shazaam. After a meeting with Jack, where Jack refuses to provide the books of the company as requested by Peter, Peter recommends to Smith & Jones that things are looking a bit ‘funny’ at Shazaam and that they should consider what the most appropriate approach would be under the circumstances. Senior partners at Smith & Jones (one of whom is married to Jack’s sister) warn Peter not to be ‘fussy’ with the audit so as not to upset their client. Peter, careful to avoid any conflict with the senior partners, decides not do to anything further about Shazaam

A couple of months later, Jack realises that Mona’s incompetence has cost them millions of dollars. Jack cannot explain how the loss occurred, as his car and its contents, including all Shazaam’s papers locked in the rear trunk, were stolen and burnt beyond recognition. Jack and Jill blame the loss on the company’s auditors.

1. Have Jack and Jill breached any of their account-keeping duties?
2. Are Jack and Jill liable for losses caused by Mona?
3. What responsibility do Peter and Smith & Jones have as Shazaam’s auditor?

Financing a company via equity or debt

1. Distinguish between equity and debt in corporate finance.

2. What is a company share?

3. Who determines whether new shares are to be issued by a company? What needs to be considered?

4. What is a debenture?

5. Summarise the default priority rules for security interests under the Personal Property Securities Act 2009 (Cth).

6. Explain the distinction between a circulating and non-circulating security interest.

7. Give six examples of categories of information which are generally found in a company prospectus prepared in accordance with Ch 6D of the Corporations Act 2001 (Cth).

Questions:

1. Alex and Paco recently purchased a block of land in Surfers Paradise for $1 million. They want to develop the land by building an apartment block and selling the apartments at a profit.  Unfortunately, Alex and Paco don’t have the money to proceed with the development.

Alex and Paco come up with a plan to develop the land whereby they will register a company called Bug Ltd.  Alex, Paco and their friend Goofy will be the directors of Bug Ltd.  They plan to get investors to buy shares in Bug Ltd for $2.0 million.  

With the proceeds of the share issuance, they will have Bug Ltd buy the land from them for $1.5 million. With the remaining $500,000, they plan to build the apartment building.  

If Alex and Paco proceed with their plan and register Bug Ltd, would they be required to comply with the disclosure requirements in Ch 6D of the Corporations Act (Cth) 2001 in connection with the fundraising they propose?

2. Larry started a clothing business several years ago called Larry’s Leisure Suits.  The business is owned by a company called LLS Ltd. The business is successful and Larry wants to expand.  As he needs additional capital, he wants to raise $5 million by issuing shares. One option being considered by Larry is to offer the shares to a number of institutional investors. An alternative is to float the business, that is, offer the shares to the public and apply for listing on the ASX. Larry approaches you for advice on the following matters:

• What are the implications under Ch6D of the Corporations Act of the two fundraising options being considered?

• If a decision is made to carry out a float, what type of disclosure document will be required and what type of information must it contain?

• Can Larry advertise the fact he is raising funds?

Members’ remedies

1. Richie, Fonzie and Ralph form a company called Big Als Pty Ltd to own and operate a fast food franchise business. Each of the founders own 10 shares.  The directors of Big Als Pty Ltd are Richie, Joanie and Chachi.

Analyse the following:

• Richie has used money from the company’s bank account to purchase a new car for himself. Joanie has just discovered this and wants to bring an action under section 232.  Can she?
• Assume Joanie and Chachi are the nominee directors of Fonzie and Ralph, respectively. Richie has a fight with Fonzie and Ralph.  At a shareholders meeting they pass a resolution voting him off the board.  Can Richie assert a cause of action under section 232?  What remedy would he be seeking?
• Ralph has learned that the directors negotiated for the purchase of some land for a new restaurant.  Apparently the price negotiated was so good, that the directors formed a new company and purchased the land themselves.  Ralph has complained, but the directors just ignore him.  He wants the company to sue the directors to get land and/or profit they made on the transaction. Advise Ralph on whether he could peruse a derivative claim against the directors.
• Fonzie is concerned that the directors are overstating the profits in the company’s financial accounts in order to meet their full bonus criteria.  Fonzie wants a forensic accountant to review the company’s books and records.  How should Fonzie proceed?
• Fonzie has also discovered that the directors want to enter into a transaction to purchase a number of service stations from a company owned by Joanie at above market prices.  Fonzie wants to stop this transaction from proceeding.  What should he do?

2. Kestrel Pty Ltd (Kestrel) is a small family company which operates a business breeding kestrels, eagles, falcons and other large birds of prey. Kim, Kourtney and Khloe are all siblings and the only directors of Kestrel and each owns 25 ordinary shares. When the siblings first started the company, they thought it would be wonderful for them all to be involved in an enterprise where they worked together and had control over their destiny.

Clause 15 of the constitution of Kestrel provides that Kim, Kourtney and Khloe shall be a director of Kestrel at all times. Late last year Kim had a massive fight with the rest of the family and now Kourtney and Khloe won’t speak to her and don’t want her to have anything to do with the company.

At a recent board meeting, Kourtney and Khloe passed the following resolution (Kim voted against the resolution):

Kestrel Pty Ltd (ACN 123 456 789)

Written resolution

Share Issue

Resolved that:

As Kestrel Pty Ltd requires additional capital to purchase more inventory, Kestrel Pty Ltd shall issue 25 ordinary shares to Kourtney and 25 ordinary shares to Khloe in consideration of $5,000.00 for each share.

Signed: Kourtney (Chairperson)

JANUARY 1, 2016

An extraordinary general meeting was held in February where a special resolution was passed removing Clause 15 of the constitution.  Thereafter, a second resolution was passed at the meeting removing Kim as a director.  

After removing Kim from the board, Kourtney and Khloe attended a board meeting suspending dividends indefinitely and increasing their directors’ salary. After the February meeting, Kourtney and Khloe realized that they could sell bird droppings to farmers to use as fertilizer and make a lot of money. Kourtney and Khloe registered a new company called BirdFert Pty Ltd (“BirdFert”) in which they are the only shareholders and directors.  BirdFert collects the droppings from Kestrel at no price (utilizing Kestrel’s employees) and sells the droppings to famers at a massive profit.  

Kim wants to know if (i) it was legitimate for Kourtney and Khloe to award the new shares to themselves; (ii) she can commence a cause of action in Kestrel’s name against Kourtney and Khloe to recover the profit they made from selling the bird droppings; (iii) she has any claims she can commence in HER name for the actions that Kourtney and Khloe have undertaken, and the remedies to which she might be entitled.

Directors’ and officers’ duties

1. Stationary Pty Ltd is a company that sells high end stationary products.  Unfortunately, sales have dropped recently.  The company hires Rick Pen, a New York-based consultant, to advise it on how to increase sales.  Stationary Pty Ltd also names Rick to its board as a non-executive director. Rick does not make it to Australia very often and although the company arranges a dial-in number so that Rick can participate by teleconference, Rick forgets to call in to most of the company’s board meetings, which take place in the middle of the night, New York time.

Rick is not that concerned, though as he says, “I’m only a marketing person.  I don’t know how to run companies.  Anyway, the other directors and outside advisers will tell me whatever I need to know.”

In the meantime, Stationary Pty Ltd issues its year-end financial statements.  Neither Robert, a non-executive director who is an accountant by trade, nor the outside accountants or auditors realize that the financial statements neglected to disclose that Stationary Pty Ltd had just borrowed $50 million from Bad Bank.  The error made Stationary Pty Ltd’s financial situation look significantly healthier than it in fact was.  

Discuss the potential liability of Stationary Pty Ltd’s directors under section 180 of the Corporations Act, including any defences they may have.

2. Webster is a director of Papadapolis Ltd. Papadapolis Ltd sells toy dolls called “Cute Kids”.   The dolls are not selling well and the company is running low on working capital. To remedy the situation, Webster obtains an unsecured loan in the amount of $1 million.   Webster thinks that the company will be able to pay the loan back because it is nearing the end of the year and his projections suggest he will sell lots of dolls around Christmas.

Unfortunately, things don’t go as expected and Webster doesn’t sell as many dolls as anticipated.  It is now January – a slow period for selling dolls.  Webster is aware of section 588G of the Corporations Act and doesn’t want to violate it. Accordingly, he hires Shoddy & Dodgy accountants too prepare a solvency report. The report shows that Papadapolis Ltd has net assets and, based on projections, can pay its debts when the fall due. Based on the report, Webster has the company enter into a contract to purchase $10 million of material for the manufacture of the dolls:

• It transpires that Shoddy & Dodgy’s report was incorrect and Papadapolis Ltd is placed into liquidation. Does Webster have any liability under s 588G?
• What about if Webster was ill when the contract was entered into and it was his fellow directors that decided to move forward with the contract?
• What about if Webster didn’t get the Shoddy & Dodgy report but thought that the company was performing well?
• Would it make any difference if Webster’s fellow directors were eager to enter into the contract but Webster was against it?  How would have you advised Webster?

3. Regal (Burleigh) Ltd (“Regal) owned and operated a cinema in Burleigh Heads on the Gold Coast. Gulliver, Fred and Barney were the only directors of Regal.  Gulliver was appointed the managing director due to his extensive knowledge of operating cinemas. Both Fred and Barney are non-executive directors. Regal has a number of unrelated shareholders.

Over the last few years, Regal’s financial position has steadily deteriorated. While Gulliver was aware of this, he did not pass any financial information onto the other directors.  Indeed, he repeatedly told them that the company was performing wonderfully. While Fred and Barney were given the company’s financial reports, they never looked at them closely as they assumed that the auditors or Gulliver would alert them to any problems.

By January 2014, things had started to get dire for Regal as attendance at its cinema dropped precipitously due to a competitor opening a new cinema nearby. Regal’s cash reserves were running low and Gulliver was post-dating cheques in order to avoid running out of money. In a few instances, cheques were presented when Regal had insufficient funds and they bounced.  On January 20, 2014, the manager of Regal’s bank – Bad Bank Ltd - called Gulliver and said that he would be forced to suspend the company’s overdraft facilities unless the company improved its financial position.

At a board meeting on February 1, 2014, Gulliver informed the board that he had a revolutionary idea for Regal. He proposed that Regal enter into leases for two more cinemas that were located in Burleigh Heads. He suggested that by undertaking this transaction, revenue would increase and it would even make the company a potential takeover target.  Fred and Barney were intrigued and told Gulliver to do whatever he had to do to get the transaction done.

After the meeting, Gulliver approached a commercial leasing agent who informed Gulliver he had two cinemas available for lease. The agent said the cinemas were in wonderful condition and would be just what Regal needed. Gulliver inspected the cinemas with his friend George who is an accredited residential building inspector. Gulliver thought the cinemas were acceptable and George said he couldn’t see any structural problems with the cinemas.

On March 1, 2014, the board had a further meeting and Gulliver updated the board regarding the leases.  Gulliver told the board that Regal needed $2 million to place signage on the new cinemas.  Gulliver said he had reached an agreement with Bad Bank whereby it would loan the company $1 million and suggested Fred and Barney each contribute $500,000 in return for shares in Regal.  Fred and Barney agreed.

On March 5, 2014, the leases were signed, Fred and Barney transferred $1 million to the company and a credit agreement was entered into with Bad Bank for $1 million.  The new signage was completed on March 10, 2014 and Gulliver arranged a grand opening scheduled for March 15, 2014.

On March 13, 2014, Gulliver received a letter from the Gold Coast City Council saying that Regal was not permitted to open the two new cinemas as they did not have adequate fire exits and the fire sprinkler system needed to be replaced. After some preliminary investigations, Gulliver discovered that it would cost over $5 million to install additional fire exits and upgrade the sprinkler system.

On April 20, 2014, the directors had no alternative but to place Regal into voluntary administration and it was subsequently placed into liquidation. The liquidator now desires to commence an action against the directors (1) alleging the directors breached their duty of care, skill and diligence; and (2) for insolvent trading. Advise. 

Companies, outsiders and corporate liability

1. Wayne, Erin, Alan and Kirk are all ex-police officers and have decided to start a private security business.  Due to tax and ownership issues and the obvious benefits associated with having limited liability, their lawyer recommends that they should register a company for the business.  They agree and instruct their lawyer to register a company to be called WEAK Security Pty Ltd. It is agreed that Wayne, Erin, Alan and Kirk will each be allotted 100 ordinary shares in WEAK Security Pty Ltd.

After the company is registered, they decide to employ Rodger as a receptionist in the office. Rodger is given strict instructions that he is not to enter into contracts on behalf of the company.

Walter is a used car salesman and a good friend of Rodger.  Rodger tells Walter about his new position at WEAK Security Pty Ltd and mentions that he has been instructed not to enter into any contracts on the company’s behalf. Walter tells Rodger that he has been trying to sell a truck and it would be perfect for the security business.  Walter shows Rodger the truck and lets him drive it.  Rodger agrees that the truck would be a great addition to the security business and thinks the price Walter is offering is very reasonable.  Rodger agrees to buy the truck on behalf of WEAK Security Pty Ltd.

Can Walter rely on any of the assumptions in section 129 in order to enforce the contract against WEAK Security Pty Ltd?

2. Volcano Pty Ltd (Volcano) operates three surfing stores in Queensland.  On 8 August 2008, Joel was appointed to the position of managing director of Volcano for a period of two years.  A return was lodged with ASIC indicating his appointment as a director on that date.   Joel was not formally reappointed after 8 August 2010, but he has continued to act as managing director.  The terms of Joel’s appointment, which were set out in a contract between him and Volcano and were also in Volcano’s constitution, included a restriction to the effect that he was not to commit the company to borrowing transactions in excess of $20,000.  Any such transaction was to remain subject to the approval of the Board of Directors.

On 20 March 2009 Joel, purportedly acting on behalf of Volcano, signed a loan contract with Fanning Bank, pursuant to which the Bank agreed to lend the company $30,000 in order to establish a website for motorbike enthusiasts. The transaction was not referred to the Board.

The Bank was not aware of either:

• the contents of Joel's contract, or
• the company’s constitution.

The Board has since discovered the loan contract and has stopped all repayments on the loan.  The Bank has called in the loan and is suing Volcano for the principal together with all outstanding interest.

What do you think the outcome of this case will be?

Would the outcome of this case be different if:

• the loan was for the refurbishment of two of Volcano’s surfing stores,
• the Bank had a copy of the company’s constitution, or
• the bank was aware the board had not passed a resolution approving the transaction.

3. Assume a section in a piece of OH&S legislation provides:

“A person shall not knowingly leave exposed live electrical wire on any construction site. Any person breaching this provision will incur a penalty of $1000.”

The legislation defines the term “Person” to include a company.

Duke Ltd is a multinational construction company and is in the process of building a new building on the Burliegh University campus. Daisy is an apprentice electrician employed by Duke Ltd. On a Friday afternoon she was wiring some power points on the building site when her friend, Bo, called her and asked her to meet him at the pub for a beer.  Daisy really wanted to go, so she dropped her tools and went to the pub.  She knew she had some live wires hanging out of the wall, but she thought no one else was on the construction site and she would go back first thing the next morning and complete the job.

Has Duke Ltd breached the legislation? In real life, how do you think the legislation would be drafted differently?

What if someone was injured as a result of the wires?  Would Duke Ltd be liable?

Promoters and pre-registration contracts

1. Darcy, Jack and Angie decide to form a company called Cute Farms Pty Ltd (“Cute Farms”).  They intend for Cute Farms to own a small farm with cows, horses and other animals.  Cute Farms will charge children to enter the farm where they will be able to pat and play with the animals, have horseback rides, milk the cows etc.

Prior to registering the company, Angie is having lunch with her friend Alex who mentions she owns a horse called Bingo that she wants to sell. Angie tells Alex all about Cute Farms and offers to purchase the horse on behalf of Cute Farms for $1000. Alex agrees to the price and a contract is formed between Alex and “Cute Farms Pty Ltd”.

Angie subsequently registers Cute Farms Pty Ltd with ASIC.  The directors of Cute Farms are Darcy, Jack and Angie. Angie holds 80% of the shares issued by Cute Farms.

When Alex delivers Bingo to Cute Farms, Darcy and Jack say they will not accept delivery because they don’t want any horses on the farm because they will scare the other animals. Alex is furious and says that they have to take Bingo and pay her because she has a contract of sale with the company. Is Alex correct? If not, does Alex have any recourse?  

2. Marcia and Greg decide to form a company call Brady Ltd for the purpose of undertaking a business selling used Rolex watches. Marcia and Greg arrange for a number of their friends to invest in the company.  In addition, Marcia and Greg agree that they will each sell their personal Rolex watch collection to the company for $100,000 and $250,000, respectively. They had previously purchased the watches for $15,000 and 200,000, respectively.

Prior to forming the company, Marcia meets her friend Cindy who says that she needs money and wants to pawn her diamond Rolex watch. Marcia said that she would be happy to buy the watch in the name of the company.  They agree to a contract whereby the yet-to-be-formed Brady Ltd will purchase the watch for $1,000,000.00.

Shortly after her discussion with Cindy, the company is formed.  The directors of the company are Marcia, Greg and their friends Peter, Mike and Carol. At the first board meeting, Marcia and Greg recuse themselves and Peter, Mike and Carol agree that the company should purchase both Marcia’s and Greg’s collection of Rolex watches for $100,000 and $250,000, respectively.  

• If Brady Ltd proceeds to purchase the watches from Marcia and Greg, would they bear any liability as promoters?  
• Can Brady Ltd enforce the contract with Cindy for the purchase of her diamond Rolex watch?

3. Jack and Jill jointly recently purchased a block of land in Surfers Paradise for $2 million.  They want to build a high-rise on the land but don’t have any money.  They decide to form a company called Hill Pty Ltd. They seek out several people who invest in Hill Pty Ltd.  Jack and Jill then form Hill Pty Ltd, the investors transfer $20,000,000 to Hill Pty Ltd, Hill Pty Ltd purchases the real property for $4,800,000 (the price agreed by Jack and Jill) and construction commences.

The building is completed and all the units are sold at a massive profit. At that point, one of the investors discovers, for the first time, that the real property was purchased from Jack and Jill.  He doesn’t think it was fair that Jack and Jill made money selling the real property to the company.  Can anyone recover the profit from Jack and Jill?

4. Edmund and Baldrick are in the business of selling antiques. They operate as a partnership.  Edmund and Baldrick decide to form a company called Blackadder Antiques Pty Ltd and once formed will transfer the business from the partnership to the new company.

Edmund contacts his solicitor, Melchett, and instructs him to register the new company. Melchett says “it will be done this afternoon.” Immediately after the call, Melchett feels dizzy.  He consults a doctor who says he has a rare medical condition and cannot work for the next two weeks. Melchett goes home to bed and fails to register the company.

The next day, Edmund enters into a contract on behalf of Blackadder Antiques Pty Ltd with Percy for the purchase of some very expensive antiques. The purchase price had to be paid by October 30.

Melchett returns to work on October 20 and immediately registers the company but mistakenly calls it Whiteadder Antiques Pty Ltd.

• What steps must Edmund and Baldrick do to ensure the contract is binding on and enforceable by Whiteadder Antiques Pty Ltd?
• Assume the company is never registered. What remedies does Percy have and against whom?
• Assume Whiteadder Antiques Pty Ltd is registered. The company’s constitution provides that both directors have to consent to ratifying a pre-incorporation contract.  Baldrick fails to agree to ratify the contract.  What are Percy and Edmund’s rights?

Company constitution

1. What is (a) a memorandum of association; and (b) articles of association? Why are they still relevant?

2. What are replaceable rules? When is it appropriate for a company to use the replaceable rules?

3. What is a constitution? Why would a company use a constitution instead of the replaceable rules?

4. Who is bound by the replaceable rules and constitution?

5. How does a company change its rules?

Questions:

1. Nightclub Pty Ltd is a company which owns a number of night clubs on the Gold Coast. It has a constitution which provides, inter alia:

“No person shall be excluded from attending events at venues owned by Nightclub Pty Ltd unless the directors pass a resolution excluding any such person.”

Jack was drunk and causing mischief at one of Nightclub Pty Ltd’s venues when a manager (who was not a director) said to Jack that he was excluded from the venue and could not return.  Can Jack enforce the constitution and argue that the exclusion is not enforceable as it was not supported by a directors’ resolution.

2. Kelly and Jordy are directors of ASP Pty Ltd and jointly own 70% of the shares. Taj holds the remaining 30% of the shares. The constitution provides that Taj will hold the position of the company’s “Senior Product Tester” for the period 1 January 2015 to 1 January 2020.  There is no separate written employment agreement. Kelly and Jordy want to remove Taj from the position of “Senior Product Tester”.  Advise Kelly and Jordy.

3. The shareholders of Croc Pty Ltd (‘”Croc”) are Dundee (10 shares), Mick (10 shares), Gus (10 shares) and Sue (10 shares).  The directors are Dundee and Mick.  Upon registration, Croc adopted a constitution that replaces all the replaceable rules.

Clause 10 of the constitution provides:

10. The maximum number of directors shall be three (3).

Clause 11 of the constitution provides:

11. Directors can remove other directors from office by majority vote except Mick can only be removed by members’ resolution approved by 95% of the members voting.

Part A: Sue is dissatisfied with the way Dundee and Mick are running the company.  She wants to alter clause 11 of the constitution to say that there can be four directors. Can she do this? If so, how?

Part B: Can she amend the constitution to remove clause 11?  If this occurred, could Dundee enforce clause 11 pursuant to section 140 of the Corporations Act?

Part C: Dundee and Mick are annoyed about Sue’s plans regarding the constitution and want to remove her as a shareholder.  Could they potentially alter the constitution so as to allow the company to compulsory acquire her shares at a stated price?

Part D: Gus is concerned that Sue might sell her shares to a competitor. If the competitor owned the shares, Gus is concerned this may adversely impact Croc’s business.  Gus proposes altering the constitution to provide that shareholders cannot sell their shares to anyone in competition with the company.  Would such an alteration be enforceable?

4. Kitty, Butch, Leroy and Kenny each on one share in K9 Grooming Pty Ltd. As the name suggests, the company owns a dog grooming business. Kenny is an accountant and is the company’s CFO. Indeed, the company’s constitution provides that Kenny will be paid $50,000 per annum and cannot be removed from the position as CFO until 2030. The constitution also has an objects clause that says the company’s “sole object is the business of grooming dogs.”

How can Kitty, Butch and Leroy remove Kenny from the position of CFO? Can the company engage in a business other than dog grooming?

5. How can a company adopt a constitution?

Companies and incorporation

6. For the past several years, Bobby Byron has been working on a new design for the manufacture of surfboards. While Bobby believes that the sale of his inventive surfboard will make a lot of money, considerable additional research and development is needed to perfect the design. Indeed, the first few prototype surfboards that were manufactured snapped and one had fins that were too sharp and injured the person using it. Bobby believes that if the design is successful, many thousands of people will want to invest in his company. Advise Bobby about the most suitable type of company for his surfboard design project.

7. What type of company would be best suited for the following organisations:  

1. A charity raising funds for cancer research.
2. A major domestic soccer federation.
3. Three friends who wish to start a fashion business.
4. A group of 75 people who have agreed to pool money and invest in the stock market. 
5. A mining company that wants to invest in a speculative gold mining venture with its own funds and funds raised from the public.
6. A start-up telecommunications company that needs $1billion for its infrastructure and intends to raise the funds from the public.

8. Blondie Pty Ltd was registered with Matt and Aaron as its directors. Blondie Pty Ltd has issued 5 shares with the following persons owing one each: Matt, Aaron, Jason (Matt’s son), Janice (Aaron’s daughter) and Marilyn (Aaron’s friend).  Blondie Pty Ltd operated a business which manufactured and sold widgets.

After the company was formed, the following happened.  

Would the shareholders and/or directors be personally liable to the landlord, NAB Bank, Janice, or Acme Computers Pty Ltd?  Explain.

1. Blondie Pty Ltd entered into a lease for new premises where the business was to be headquartered.
2. Blondie Pty Ltd borrowed $100,000 from NAB Bank on an unsecured basis. Matt personally guaranteed the repayment of the loan.
3. Blondie Pty Ltd purchased a block of land from Janice for $500,000 to build a new warehouse.  Blondie Pty Ltd gave Janice a mortgage over the land equal to the $500,000 purchase price.
4. Blondie Pty Ltd purchased several computers from Acme Computers Pty Ltd. One third of the purchase price was paid on delivery and the balance payable in equal monthly instalments.

Business organisations

1. Jenna, Koda and Lula decide to start a business baking expensive wedding cakes. Jenna and Koda will each invest $10,000 in the business. While they don’t want to participate in the day-to-day running of the business they still want to have an active role in management.   Lula has no money to invest, but she has years of experience baking cakes.

Lula’s son, Asa, also wants to invest $50,000 in the business.  He wants to have a steady income from his investment.  While he does not want to be involved in the management of the company, he still wants to have some ability to direct how his $50,000 investment is spent.

What legal structure would you advise for their project: a partnership, an incorporated association, a company (if a company, provide details on the type of company) or some other structure?  Why would you recommend this structure – provide details?

2. Jacob and Marley are avid tennis players and decided to form a club called the Burleigh Breakers Tennis Club. Jacob becomes the president and Marley the secretary.  Malcolm, Jason and Alex and ten other people join the club as members. Each member pays a membership fee of $100.

The club organizes a tournament and all the members are invited to participate.  At the tournament, the club supplies sports drinks to the players.  Unfortunately the drinks contain a contaminate and many players fall ill. It turns out that in order to save money, the club had purchased the drinks at a discount as they been recalled due to bacteria been found in some bottles.

Can the ill players bring an action in negligence against the club? If not, what remedy do they have?  What would you have recommended Jacob and Marley to do differently when forming the club?

3. John is a foreign exchange trader working for a large bank. John and twenty five of his fellow workmates decide to leave the bank and start their own foreign exchange trading firm.  They decide to operate as a partnership.  Do you think this is a good structure for the business?

4. Darryl and Julia are both passionate chess players. They meet for the first time at a recent chess tournament. After a short discussion about their love of chess, they decide they should open a chess store together selling exotic chess products to other likeminded chess fanatics. Unfortunately, neither Darryl nor Julia has any money.  Julia’s friend, Otis, told Julia he had saved some money and was looking to invest it in a business.  Julia and Darryl approach Otis and pitch their chess store idea.  Otis is completely blown away by the pair's enthusiasm for the idea and agrees to invest $100,000.  The three agree that Otis will not receive any interest on his investment, but will get 50% of the net profits generated by the business.

Darryl is given the responsibility of finding a suitable location for the business.  He finds a store in Burleigh Heads and promptly enters into a lease.  As Julia is out of town on business, Darryl signs the lease in his name.  Darryl engages a firm of architects to prepare designs for the store.

When Julia returns, she is told about the new premises. She takes her good friend Glenda to check out the new premises.  When they enter the store, Glenda trips over a broom that was left lying on the floor and severely injures her leg.

Julia is horrified by the new premises.  She doesn’t like the location, it is too dark and it is too expensive.  She tells Darryl that the whole chess store idea just won’t work and she has no interest in perusing the venture any further.

Who is liable for the lease obligations, the architects’ fees and Glenda’s injuries?

5. Leroy is considering starting a catering business. Leroy has three children (aged 3, 16 and 21) and is married to Melanie. 

The proposed business will cater to high end corporate clients and wealthy individuals. In order to have the ability to cater events for these clients, Leroy needs approximately $4 million of capital.   Leroy intends to invest the $2 million into the enterprise from his own funds and get the balance from third party sources.  

Leroy wants to have his wife and children involved in the business as well. Advise Leroy.