LAW504 Corporations Law | Liability of Steve

WA Gold Exploration Ltd was registered as a company by ASIC on 10 July, with Steve as 90% shareholder. He and the other shareholders met on 11 July, to elect a board of five directors. Steve himself was not elected to the board, because although he had originally discovered the opportunity, he had no experience in mining operations, and so did not want to be a director. On 14 July, the board signed a contract with for a fleet of five ore trucks from Volvo Trucks (Australia) Ltd, costing a total of $ 500 000, to be delivered on 30 September. The board also established a sub-committee to determine the company’s technical needs, and on 25 July the board accepted the committee’s recommendation that the company buy a drill from United Mining Machinery Ltd for $ 100 000. The board also contacted Thor Mining Machinery Ltd and told it that it would not be taking delivery of the drill.

Unfortunately, in mid-September it became clear that the gold deposit was not as large as hoped, and the board ceased trading on the basis that the company had only $ 400 000 in assets and had accumulated $ 2 million in liabilities. The company is therefore unable to pay for the trucks.

Steve, who has personal assets of $ 1 million, has now been sued for breach of contract by both Thor Mining Machinery Ltd and Volvo Trucks (Australia) Ltd. Assume you are his legal advisor. Prepare advice for him citing full legal authority, as to what his legal position is.

2.Simon, George, Sara and Mary were all employed by different IT companies. However, they felt that they could do better if they went into business themselves. They pooled their available cash and drew up a partnership agreement, which stated that each partner had authority to enter into transactions on behalf of their firm, which they called Computer Solutions. The firm operates in Sydney and provides a service of storing data for customers. The agreement states that partners have authority to enter into contracts of up to $ 10 000, but that any contract for more than that must be approved unanimously by all partners.

George, Sara and Mary approach you for legal advice in relation to two transactions entered into by George, who had acted without referring back to the partners. One was for a 50TB hard-drive, bought by Simon on behalf of Computer Solutions, from Sunstar Computer Hardware Ltd, costing $ 15 000.

The other was for a second-hand ute, costing $ 9 000, which Simon ordered for the firm from You Beaut Ute Ltd, on the basis that the partnership should branch into the freight business – an idea that the other partners had previously rejected.

Answers:

1.Issue

Whether Steve is personally liable towards discharging the debts of the company since he formed the contract on the behalf of the company?

Law

The Corporations Act 2001 (Cth) is the key legislation which monitors and governs the operations of a company. The provisions given under this act are necessary to comply by the corporations which have established their business in Australia. In Salomon v Salomon & Co Ltd (1897) AC 22 case, the court established one of the key attributes of an enterprise which is that it is considered as a separate personality in the eyes of the law (CSU LAW504 Modules, 2018, Topic 14). In this case, the unsecured creditors filed a suit against the majority shareholder of the enterprise in order to recover their debts. The court rejected the claim based on establishing the separate entity of the enterprise in which the liability of members is limited. The concept of incorporation of a company is given under section 119 of the act which provides that the corporation become a separate legal entity upon registration. The contracts formed by a company after its incorporation are created under its own name and the members of the company cannot be held liable for fulfilling the contractual terms of such contracts. However, the promoters of a company have to form many contracts before the company is registered. These are referred as pre incorporation contracts, and provisions regarding these contracts are given under section 131 of the act. According to section 131 (1), the contract which is formed by the promoters of a company on behalf of the enterprise has the power to bind the company under the contractual terms of the agreement (CSU LAW504 Modules, 2018, Topic 14).

Moreover, the enterprise has the right to rectify the contract which is formed before its incorporation within an appropriate time as per the terms of the contract. The liability which is raised under these contracts is limited to the company since the benefit of the company is enjoyed by the enterprise. However, section 131 (2) of the act imposes the penalty on the promoters who form the pre incorporation contract on behalf of the enterprise. The section provides that the person will be liable who formed a contract on behalf of the company if the company failed to register. Furthermore, the law provides that if the organisation failed to rectify the terms of the contract within the appropriate time, then the party has the right to hold the promoters liable for the contract. Thus, this section imposes the liability on the person who signs the contract on behalf of the company in case the company is not able to discharge its contractual liabilities. Furthermore, section 131 (3) of the act provides that the court has the option to provide a judgement after analysing the fact of the case which is formed under section 131 (2) of the act. The court can order the company to pay partly, or full payment of the liability rose under the pre incorporation contract (CSU LAW504 Modules, 2018, Topic 14). The court also has the option to order the company to transfer the property which it received under the pre incorporation contract. The court can also order the party who formed the pre incorporation contract to pay back the debts of the contract.

Application

Steve formed a contract with Thor Mining Machinery Ltd in order to purchase a drill for the company which is not yet registered, thus, the agreement formed between the parties was a pre incorporation contract. Based on such contract, WA Gold Exploration Company has the right to receive the benefit of the company or rejected it within the appropriate time. The contract comes under the provisions given under section 131 of the act. After the registration of the enterprise, the board members of failed to rectify the contractual terms which are included in the pre incorporation contract formed between the parties. The organisation rejected the delivery of the drill based on which it rejected the benefits raised under the contract. Thor has the right to held Steve liable under section 131 (2) of the act and demand compensation from him for the breach of the contract by WA. On the other hand, the contract formed with Volvo Trucks (Australia) Ltd regarding the purchase of five trunks was made by the company itself. Since the contract was formed after the registration of the company, the corporation has gained its separate personality in the eyes of the law based on which the shareholders of the company has limited liability as established by the court in Salomon & Salomon & Co Ltd case. Thus, Volvo did not have the right to hold Steve liable for the debts of the company based on the fact that he is the majority shareholder of the company. Volvo can set off its debts based on the amount collected after the liquidation of the company.

Conclusion

After analysis of the above facts, it can be concluded that the liability of Steve is present in the pre incorporation contract formed with Thor. The company can hold him liable for breach of the contract by WA. However, in the case of Volvo, the company has become a separate legal entity; thus, its members have limited liabilities based on which Steve cannot be held personally liable to set off its debts.

2.Issue

Whether the liability of other partners can be raised under the contract which is formed by Simon on behalf of the partnership firm after violating the terms of the contract? Whether a legal action can be taken by other partners against Simon?

Law

The partnership is a common business structure in Australia since it is easier to form and partners did not have to comply with relatively complex regulations. The provisions which govern this business structure are given under the Partnership Act 1892 (NSW). The partnership business did not have a separate entity in the eyes of the law based on which the partners have unlimited liability in the business. Section 1 (1) defines the partnership business as a relationship which is formed between two or more parties. This relationship is formed for a particular purpose that is to run the operations of the business in common, and the purpose of the business is to make profits for the partners. Section 5 provides that while acting in the business, the partners act as the agent for each other (CSU LAW504 Modules, 2018, Topic 13). The business decisions taken by a partner which are not outside the scope of the business have the authority to bind other partners liable under the terms. However, this provision is limited to the actions of the partners which are within the definition of the ordinary course of business.

When a partner acts outside his authority to form a contractual relationship, then other partners are not bound under such terms because they are not constructed under the ordinary course of business. The actions must be covered under the business operating in “usual way” because activities outside the scope of business as usual did not bind the parties into a legal relationship as given under section 5 (2) of the act. However, the actions which are outside the ordinary course of business can bind the other partners into the contractual terms under section 7 of the act. The law provides that those actions which are taken by a partner under the expressed authority given by other partners can still bind other partners even if the activities did not come under the definition of the business as usual. Section 8 of the act also provides key provisions based on which partners can be held personally liable towards third parties based on the action of a single partner (CSU LAW504 Modules, 2018, Topic 13). This section provides that in case an internal agreement is formed between partners to limit their authority regarding taking the business decisions without prior approval of the partners, then other partners will not be held personally liable in case the third party was aware regarding such agreement.

In Mercantile Credit v Garrod (1962) 3 All ER 1103 case, an agreement between partners limits their authority to purchase and sell cars in the garage business. One partner breached his agreement by selling a car to the third party; the court provided that since the third party was not aware of the agreement between partners, they are liable towards the party. Section 9 (1) of the act provides that if a person releases a partner from the contractual obligations, then all other partners are released from the obligation as well. Section 10 of the act provides provisions regarding tortious actions of a partner which are taken by him during the ordinary course of the business. In Polkinghorne v Holland & Whitington (1934) 51 CLR 143 case fraud was committed by a partner by investing the money of the client into a sham company which was established by the partner as well. It was held by the court that all other partners are personally liable under such tortious act as well (CSU LAW504 Modules, 2018, Topic 13).

Application

A 50TB hard drive was purchased by Simon for managing the operations of the business. This comes under the definition of the business as usual for the partnership. However, while entering into the contract, Sunstar Computer Hardware was not aware of the fact that an internal agreement has constituted between all partners in which they have decided that the prior approval of all partners is necessary while they are investing more than $10,000. As per the provisions given under section 8 of the act and the judgement of Mercantile Credit v Garrod case, all partners are liable toward Sunstar. On the other hand, the decision of purchasing a second hand Ute was outside the scope of the business of an IT partnership. No expressed authority was given by other partners to Simon to purchase a Ute for the business. Thus, this action did not come under the definition of the business as usual for ‘Computer Solutions’. Thus, the liability of purchasing a second hand Ute is limited to Simon, and You Beaut Ute Ltd cannot hold other partners liable for the contract formed by Simon. Since Simon breached the internal agreement formed between the partners, they can file a suit to recover the compensation from Simon for the loss suffered by them.

Conclusion

After analysis of the above facts, it can be concluded that the decision taking by Simon while forming the contract with Sunstar was insider the scope of the business and Sunstar did not have the knowledge about the internal agreement, thus, all partners are liable. In case of the second contract, the actions of Simon were outside the scope of the business, thus, other partners are not liable towards You Beaut Ute Ltd. A legal suit can be filed against Simon for breaching the terms of the internal agreement.

References

Corporations Act 2001 (Cth)

CSU LAW504 Modules, 2018

Mercantile Credit Ltd v Garrod (1962) 3 All ER 1103

Partnership Act 1892 NSW

Polkinghorne v Holland & Whitington (1934) 51 CLR 143

Salomon v Salomon & Co Ltd (1897) AC 22