BLO5540 | Company Law | The Duties of Directors Corporations Act 2001
1. Food Works Ltd is in the groceries retailing business. It has a board of three directors, Dion and Larry (both executive directors) and Peter (the non-executive director). Only Dion and Larry are shareholders in the company (holding 10% of the shares each) while the remaining shares are held by Raldi Pty Ltd (which holds 80%). Vance, a former founder of the company has stepped down from his previous role as Chief Executive Officer and has taken on the role of ‘Consultant’ and is now a sounding board for the other director (due to his extensive experience in the industry).
In December of 2017, while on a work trip in Europe sourcing business opportunities for Food Works Ltd, Dion met Randy, the CEO of Organica Ltd, a company specialising in the production of organically made food products. Upon further meetings with Randy, Dion discovered that the sales of organic food products in Australia was a very lucrative business opportunity. Dion decided against informing the Board of Food Works Ltd as he believed that some of the Board members would not be interested in sourcing organic food products from Europe due to higher sourcing costs. Dion had a separate health foods business, Lifestyle Today Ltd, in which he presided as single director and single shareholder and entered into a contract with Organica Ltd to source various organic products. Profits at Lifestyle Today Pty Ltd soared due to greater awareness of healthy eating amongst the younger generation while Food Works Ltd was struggling to stay competitive.
While attending a conference, Peter met Randy and has since discovered that Dion had failed to disclose about the organic food products supply contract to the Board of Food Works Ltd. Peter informs Larry and Vance about this issue who had no knowledge and were surprised to hear about this.
At a recent board meeting, the Board has become aware that Raldi Pty Ltd had launched a takeover bid. Vance has recommended to the Board that they should issue further shares to Dion and Larry. The result of this, is that the shareholding of Raldi Pty Ltd would be diluted, hence blocking the takeover. There was no urgent need at the time for Food Works Ltd to raise capital.
Further, at the same board meeting, Vance recommended that in a desperate attempt to improve profitability of its existing brands, Food Works Ltd should spend an additional $100,000 on media advertising and marketing. Due to his extensive industry experience, Dion and Larry concurred with this strategy. Peter, however, reviewed the cash flow statement and after discussions with Rita, the accountant highlighted to the others that the company was already having some cash flow problems (being on the brink of insolvency) and that investing in further advertising and marketing was not a good idea. Dion, Larry and Vance who are very optimistic, argue for the advertising to continue as in their view the company was not yet ‘insolvent’. A resolution is passed that the company should continue its aggressive advertising and marketing efforts for another year. After a few months, the company’s capital has run dry.
Questions:
(a)Advise whether any of the persons mentioned above have breached the directors’ duties regime in the Corporations Act 2001(Cth). Please refer to relevant case law authorities in support of your discussion.
(b)Advise if any defences are available to any of the above persons in the circumstances.
(c)Advise what penalties (under the Corporations Act 2001 (Cth)) and common law remedies are available if a breach of directors’ duties is found.
2. Carpets Galore Pty Ltd, is a family-owned importer and retailer of luxury carpets. There are four directors (all siblings): Caitlin, Ben, Sarah and David. Ben and David, hold 80% of the shares between them with Caitlin and Sarah each holding 10% of the shares.
Over the past couple of months, Caitlin and Sarah have found the other directors to not be receptive to their views on any major decisions. Caitlin and Sarah want the family business to diversify into sales of designer rugs as well but the others resisted the idea of diversification as it was not part of the business plan and it diverted resources away from the carpet business. Caitlin and Sarah have since learnt that Ben and David have held some board meetings which they did not inform them of, where important business decisions were made.
These decisions at the aforementioned meetings included the following:
- The approval of pay rises for Ben and David (but not for Caitlin and Sarah)
- Despite the company’s increased profits, the decision not to declare a dividend yet again (the company having not declared dividends in the prior 2 years despite being profitable).
- The ratification of the sale of four of the retail outlets belonging to Carpets Galore Pty Ltd to Household Mania Pty Ltd, a company at which Ben is founder and director at. No independent valuations of the retail outlets had been obtained and the sale price was considerably less than the market price.
Differences of opinion have become rather acute such that the relationship between Caitlin and Sarah and the other two brothers is now quite acrimonious. Key decisions about management of the business are difficult to achieve.
Advise Caitlin and Sarah whether any member remedies are available under the Corporations Act 2001(Cth). Please refer to relevant case authorities in support of your discussion.
Answer:
1.a. Issue
The relevant issues in this case study are if any of the persons mentioned have breached the duties of directors with reference to Corporations Act 2001 (Cth).
Law
Part 2 D.1 states the duties of the directors of the company. Section 180 of Corporations Act 2001 states that it is the responsibility of the directors of the company to discharge their duties and exercise their powers prudently and carefully. The duty of the directors is to make judgments for a proper purpose and in good faith. They should not be involved personally with the subject matter of the judgment. Their judgment should be in the best interest of the company.
Additionally, section 181 states that it is the civil obligation of the directors discharge their duties and to execute their powers in good faith and in the best interest of the company. They should discharge their duties for an appropriate purpose. Section 182 states that the directors are prohibited to use their position for gaining an advantage for themselves and for some related party which could be detrimental for the company. Section 183 states that they are restricted from using any information which is obtained by them as a consequence of their position with the company for personal interests. They cannot misuse the information thereby causing harm to the company. In AWA Ltd v Daniels t/as Deloitte Haskins and Sells, it was held that it is an equal duty of care for executive and
non-executive directors . They should be conversant with the commercial affairs of the company.
Thus under the Common Law, the directors are responsible for owing a duty of care to the company. It has been reinstated by section 180(1) of the Corporations Act (Cth). The Business Judgment Rule states that while deciding whether a director has breached any of his duties, the courts apply the business judgment rule made by the directors. It is applicable with regards to the adoption of the statutory duty of prudence and care by the directors. It applies to the duty of diligence and care of the directors as mentioned in Section 180(1). In ASIC v Rich - One. Tel, it was decided that the non-executive directors failed to act with due care and diligence and it also deals with business judgment rule.
The Statutory business judgment states that if the directors and other officers of the company, making the judgment, are taken to meet the requirements of section 180(1) if they make the judgment for a proper purpose and in good faith. They are not personally interested in the content of the judgment. They should have the conviction that the judgment is in the favor of the company and inform them about the subject matter to the extent it is proper . In Jubilee Mines NL v Rile , the findings were that consistent disclosure should be not equliased with misleading or deceiving conduct . The principles of ‘when in doubt disclose’ should be reflected and the company should not misguide the market with incomplete information.
Application
In the given case, Dion has failed to inform the members of the Board of Food Works Ltd. in which he is an executive director, about the sourcing of organic business from Europe and transacting it in Australia which would be a lucrative business. The reason was his belief that some of the members would not be interested due to the high sourcing cost. But at the same time, he managed to transact with Organica Limited for his own venture Lifestyle Today Pty Ltd. due to which he gained a lot of profit from his own company while Food Works Ltd. was struggling to survive.
It is purely a matter of contravention of section 180 to section 182 of the Corporations Act 2001 (Cth). Section 180 of the Corporations Act 2001 states that the directors are responsible for the duty of care. Here, Dion and Larry have failed to observe the duty of care because he was not interested in informing the board members about the prospects of new business.
Furthermore, he had not disclosed his interest in Lifestyle Today Ltd. and his contract with Organica Ltd.
Both Dion and Larry did not consider the advice given by Peter, the non-executive director which was about the crisis of capital faced by the company. All this attracts the contradiction of Section 180-183 of the Corporations Act 2001.
Conclusion
Hence to conclude, it can be said that there is a breach of the duties of directors as stated in section 180-183 of Corporations Act 2001.
1.b. Issue
If there are any defenses available to the directors who have breached their duties.
Law
Section 1318 of the Corporations Act 2001(Cth) provides some safeguards for the directors of the company against the results of a breach of duty in some circumstances. In Edwards v Attorney General (NSW), it was held that court must equalize the balance between allowing the entrepreneur of the directors and liable to the directors for their mistakes. In relation to this, Section 180(2) of the Corporations Act 2001 states that directors and officials making the business judgment should meet the requirements of the statutory duty to exercise with due diligence and care. However, it is not necessary that the business judgment requires the exercise of discretion and acquittal of the decision of the directors. Section 1318 presumes that director’s liability depends upon the case. It also provides partial flexibility. In Scott v Williams the director was partially successful as per section 1318.
Application
The directors can be safeguarded under section 1318 which states that it is not necessary that the business judgment considers the exercise of discretion and acquittal of decision of the directors. It also presumes that the liability of Dion and Larry would be provided partial flexibility as per the decision of the court.
Conclusion
As per section 1318 of the Corporations Act, the directors Dion and Larry have been given partial flexibility as per the decision of the court.
1. c.Issue
The type of penalties (under the Corporations Act 2001 (Cth) and common law remedies which are available if a breach of directors’ duties is found
Law
All the provisions of the Corporations Act 2001 lead to civil penalties in case of breach of duties by the directors as per section 1317 E of the Act. It can impose a fine of up to $200000 as per section 1317G of the Act and disqualify the director from regulating the management of the company as per section 206C as per the provisions of the Act. Section 588G(1) of the Act enforces a duty on the directors to prevent the company from trading while it is insolvent or becomes insolvent due to the execution of that transaction. Furthermore, the directors had reasonable grounds of suspecting this.
In addition to the application of civil penalty orders, the Court has been granted the power as per section 588J of the Act to pass orders relating to the disqualification of the person from managing the corporates and requiring him to pay a compensation which is equal to the loss or damage suffered by the company.
Application
Dion would be liable to penalized for an amount of $200000 under section 1317 E and 1317G of the act along him disqualifying him to regulate the management of the company as per section 206 C of the act. Furthermore , at the board meeting it was recommended by Vance that in order to improve profitability the company should invest $100000 on its promotional activities but in reality, it was found by Peter, the non-executive director of the company that company was already facing a cash crunch. He even informed it to the non-executive directors of the company but they were too optimistic regarding its solvency. But later on, it was found that it had been insolvent.
This is a contravention of Section 183 which restricts the directors from utilizing any information obtained by them as a result of their position with the company for personal interests. They cannot misuse the information thereby causing harm to the company. It also attracts the contravention of section 588G(1) which enforces a duty on the directors to prevent the company from trading while it is insolvent or becomes insolvent due to the execution of that transaction. They have reasonable grounds of suspecting this. As a result, the directors are liable for under section 588J for their disqualification from managing the affairs of the corporates and they would have to pay a compensation which is equal to the loss or damage suffered by the company.
Conclusion
As per section 1317 E and 1317G of the Corporations Act 2001, Dion would be penalized for $200000 and he would be disqualified from regulating the management as per section 206C of the act. Dion, Larry and Vance would be liable under section 588J as they ignored the advice given by Peter the non-executive director and it resulted into the monetary crisis confronted by the company.
So they would be disqualified from managing the affairs of the company and they would have to pay the compensation which is equal to the loss suffered by the company.
2. Issue
The issue pertains to the availability of remedies to the members as per Corporations Act 2001(Cth) in cases of :
Law
Part 2F.1 of the Corporations Act 2001 evaluates the development of the statutory remedy to restrict the oppression of the minority group of members of the company. It comprises section 232-235.
Under section 233 of the act, the action must be associated with the affairs of the company as per section 232(1) of the act. Section 53 illustrates that the affairs of the company must not be limited to the internal management and proceedings of the company. The control, establishment, business, transactions and trading and ownership in the shares of the company are also involved in the affairs of the company. Lastly, the members are also concerned with the ascertainment of the person having a financial interest in the success or failure of the company or control the policy of the company. As per section 234 of the act , if the application is related to the act or omission against the member other than a capacity as a member or another member as their capacity as a member, then they can apply for the same.
The examples of oppressive and unfair conduct include:
- The issuance of shares with an intention of dominating and diluting the voting rights of the minority.
- It also includes the non-payments of dividends to shareholders and excess payments to directors when the verdicts are not justified as per the situation of the company and excluding the directors for representing the shareholders from the management of the company.
- The application of the funds of the company for the beneficial interests of some of the shareholders.
- Refusal to call the meetings of the company to avoid the minority shareholders from participating in the affairs of the company . In Mopeke Pty Ltd v Airport Fine Foods Pty Ltd it was held that exclusion from the management is an example regarding the unfair or oppressive conduct of the company.
In RBC Investor Services Australia Nominees Pty Ltd v Brickworks Ltd it was held that when the directors act in the best interest of the company, the court would not intervene.
As per section 233 of the Corporations Act, 2001 suggests that it is the discretion of the court to grant solutions for the purpose of discharging the minority shareholders from the impact of oppression. It includes an order to purchase the share of the minority at a price which is evaluated by the court. The company can also purchase the shares of the minority. A receiver and manager should be appointed and a person can order to perform a particular act such as unwinding the raising of the capital. The last resort is to wind up the company or it can be prohibited to perform a certain act.
The director shareholders who are involved in oppressive misconduct can be ordered to buy the shares of a minority without any control over their prices.
In Foss v Harbottle , the court stated the two rules of proper plaintiff rule and internal management rule.
Application
It has been mentioned in the case study that Caitlin and Sarah, the minority directors has been excluded from the approval of pay rises for Ben and David. They have also decided to not to pay the dividends even though the company is in a profitable condition. The dividends have not been declared for two years. The four retail outlets of the company have been decided to sell to a company in which Ben is a director with no independent valuations been done.
It attracts the provisions of Section 232 of the Corporations Act 2001 which states that oppression pertains to the absence of fair dealings and righteousness. The minority shareholders are being treated in a harsh, wrongful and burdensome way. In order to safeguard the interests of the minority shareholders, the court grants some remedies as per section 233 of the act.
It states that the organization may be wound up or the constitution might be revoked or modified. The shares of the minority shareholders may be purchased by other members. In Profinance Trust SA v Gladstone it was held that the shares in a going concern would be valued at the date on which it is ordered by the court to acquire the shares.
Conclusion
Hence to conclude it can be said that the rights of the minority shareholders are to be protected by the court by providing the remedies as per section 233 of the Corporations Act 2001.
Bibliography
William Roberts Lawyers , Directors' Duties(2018) < https://www.williamroberts.com.au/News-and-Resources/News/Articles/Directors--Duties>
AWA Ltd v Daniels t/as Deloitte Haskins and Sells (1992) 7 ACSR 759
Barnes Lisa,’ The Albatross Around The Neck Of Company Directors: Journey Through Case Law, Legislation And Corporate governance’(2013) 12(1) Journal Of Law And Financial Management ,3.
ASIC v Rich (2009) 44ACSR 341; 21 ACLC 450
Jubliee Mines NL v Rile (2009) 253 ALR 673; 69 ACSR 659
Wai Yee Wan ,’Directors’ defense of reliance on professional advisers under Anglo-Australian law’ (2015 ) 44(1) Common Law World Review, 71, 93.
Edwards v Attorney General (NSW) (2011) NSWSC 478
Scott v Williams(2002) 224 LSJS 393
Louise Gullifer and Jennifer Payne , Corporate Finance Law: Principles and Policy(Bloomsbury Publishing,2015) 100.
Stephen Bottomley , The Constitutional Corporation Rethinking Corporate Governance(Routledge,2016) 100.
Legal Services Commission, General Duties of Directors - Corporations Act 2001 (Cth)(2018) < https://www.lawhandbook.sa.gov.au/ch05s04s02.php>
O’Brien Palmer , Directors Duties(2014)< https://obp.com.au/director-duties/>
Shanthy Rachagan and Aiman Nariman Mohd Sulaiman ,’Controlling Shareholders: Issues and Challenges for Shareholders’ Empowerment in Directors’ Remuneration in Corporate Malaysia’(2015) 9 (1) Asian Journal of Comparative Law 267.
Mopeke Pty Ltd v Airport Fine Foods Pty Ltd (2007) NSWSC 153
RBC Investor Services Australia Nominees Pty Ltd v Brickworks Ltd (2017) FCA 756
Foss v Harbottle (1843) 2 Hare 461.
Fitzpatrick Jeffrey Frederick, Symes Christopher F., Veljanovski Angelo and Parker David, Business and Corporations Law (LexisNexis Butterworths, 3rd ed., 2016)
Profinance Trust SA v Gladstone (2002) 1 BCLC 141
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