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LST5CCL Company and Commercial Law | Business Management

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Questions:

Mary, Fred and Chris agree to start a cafe in Melbourne. In order to save money, they decide to keep it simple and just write down some rules of their agreement on a serviette. They write that they agree to put equal money into the business and to share the profits equally, and that everyone will be involved in the management of the cafe. They start their business, which becomes very popular with the local residents.

1a) Under what type of business structure are Mary, Fred and Chris running the cafe? Give reasons for your answer; in particular support your answer by citing relevant cases and statutes.

Mary, Fred and Chris also buy lots of items for their café, including a brand new Italian coffee machine that costs several thousand dollars. Unfortunately the coffee machine was not worth the money. In fact, the coffee machine produced such hot coffee that one of the customers received second-degree burns on her lips, while she only wanted to enjoy a short black. Chris had served the coffee without checking the temperature regulator on the coffee machine. The regulator is usually set to a medium heat temperature but apparently the thermometer was broken so that the water was, in fact, boiling hot. The customer is so upset that she threatens to sue the café. The customer received second-degree burns that were very painful and which had to be treated medically. Furthermore the customer could not work for a week.

1b) Who would be liable for the damages suffered by the customer? Please make sure that you only assess the legal risks under tort of negligence and support your answer by citing relevant cases.

Based on this experience, Mary, Fred and Chris want to manage their risks much better, in particular limit their liability. They are also in need of some cash and want to raise it by selling shares to families and friends.

2a) What type of business should Mary, Fred and Chris operate now? Again, support your answer by citing relevant cases and statutes.

Unfortunately, the trouble for the business does not end there. Chris, Mary and Fred changed business form and are now all directors of the business.

Chris is upset for being blamed for the incident with the customer and wants to make it up to Mary and Chris. He finds out that the neighbouring shop is available for sale for $120,000 – a prize that he considers a bargain. Chris decides to take out a loan for $150,000 in order to buy the shop and have some spare money for renovation.

The constitution/ replaceable rules of the business state that a director has power to manage the ordinary affairs of the company, however any contract for goods and services (including a loan) exceeding$100,000 must be signed by a director and another person authorised by the board for that purpose.Chris did not discuss this with any of his colleagues before signing the contract.

2b) Is the business bound by the loan contract under the Corporations Act 2001 (Cth)?

2c) Has Chris breached any duties as director under the Corporations Act 2001 (Cth) by taking up the loan?


Answers:

Answer 1A

All business which fall under the category of partnership are governed by the partnership Act 1963 (the Act) in Australia. Whether or not a partnership exist is determined through a fixed criterion. Firstly it has to be proved by the business that a valid contract has taken place between its partners in order to fall under the definition of partnership. A partnership is not as same as a joint venture. A partnership requires continuous performance of business whereas in case of a joint venture the transactions are single or isolated. A business when only engages in transactions on a periodic business when are subjected to long intervals cannot be held as a partnership as rued by the case of Smith v Anderson (1880) 15 Ch D 247. The elements which are required to constitute a partnership are provided through Section 6 of the PA.  As soon as the continuous business procedure is initiated a business may be regarded as a partnership provided all essentials of a partnership are met as provided by the case Khan v Miah (2000) 1 WLR 2123. 

A few things have to be common in relation to the partners when it comes to a partnership business. There must be mutuality between the partners with respect to interest, agency, obligation of business and rights. The firm as a whole along with the representation of all partner is ensured when a partner carries out a business activity for the firm.  A business cannot be called a partnership if any of the partner cannot represent each other and carry out transactions with respect to the business as ruled in the case of Degiorgio v Dunn (2004) NSWSC 767. Section 6(1) of the PA provide provisions relating to joint ownership with respect to a partnership.

Making profit must be the main purpose for which business activities must be carried out. When the purpose and intention of the firm is not to make profit than it will not be considered as a partnership under the common law and statutory provisions in Australia.  It is not compulsory that a business must make profit in order to be called a partnership as a business having loss can also be called a partnership here the intention of the business to make profit is primary. The mere inductive sharing of profit or being the owner of property in a business or having a share in the gross return cannot make a person a partner. In the case of Canny Gabriel Castle Jackson Advertising v Volume Sales (Finance) Pty Ltd (1974) the above discussed concept had been used.  Section 6(3) and 6(2) of the PA provide rules and regulations in relation to sharing gross returns on profit and losses,

All members of the firm must have control over the management of the business. They must be able to take a decision in relation to profit, functioning of business buying of assets and future transactions. The intention of the party is also necessary to determine whether a partnership exist or not. In the case of United Dominions Corp v Brian (1985) HCA 49 the judges used the above discussed concept. Section 28 of the PA provides provisions in relation to the right of a partner with respect to management.

The given scenario provides that the three friends want to open a café. In that café they agree to work together having equality towards the rights in profits and decision making with respect to the management.  They have formed an agreement which has not been registered but is still written. As there is an agreement the initial step in relation to partnership has been fulfilled. As there is intention of making profit and they have equal right in the management it can be said that the friends are operating under a partnership business. The business makes them liable for the actions of each other. The business does not have a separate identity from them and will come to an end if any of them leaves.

Answer 1B

This part of the paper will analyze whether the customer is entitled to compensation for the injury suffered by her and if yes who is liable to pay her the compensation.

According to the rules of partnership all the partners are responsible for the actions of each other when they operate in the name of the firm. Thus in case it can be provided that the customer is entitled to compensation for the actions of Chris than not only Chris but also the other two partners Fred and Marry would be Liable to pay compensation.

Law operates to provide remedy to a person who has been subjected to a detriment because of the actions of another. The law of torts are a set of principles dealing with civil wrongs committed in the society. The purpose of tort law is to make the aggrieved party entitled to compensation for the losses incurred by them. Negligence is an act when person is reckless towards his duties and responsibilities.  The best example of the tort of negligence can be cited through the landmark case of Donoghue v Stevenson 1932 AC 522. In this case the court set a standard for determining what actions and circumstances may lead to the tort of negligence. The court provided the neighbor principle through its decision in the case. The court provided that it is the duty of a neighbor to love another. The neighbor has to ensure that his actions do not bring detriment to the other. The question is this case was that who is a neighbor. The court described who is a neighbor through addressing the facts of the case. In this case the plaintiff visited a café along with his fried to have a drink. The drink was provided to them in a bottle which was opaque. When the drink had been consumed by the plaintiff it was noticed by him that the bottle contained a snail. Following the sight the plaintiff become ill. It was provided by the court that if a person can be harmed by the actions of anther than he is his neighbor in relation to negligence. The case is also famous for providing the three essentials of negligence which are Duty of care, violation of the duty and harm caused because of the violation.

The concept of negligence is Australia is same as that of England subjected to a few exceptions. The civil liabilities Acts deal with situations related to torts in Australia. Most of the states have their own civil liabilities Act. The acts have similar provisions in relation to negligence. The acts sets a standard in relation to the care which must be observed by a person when they have a duty of care towards another. The risk must not be insignificant and a reasonable person would have taken precautions in same situation.  The probability of the harm, seriousness, burden of precautions and utility of the activity is taken into account in order to determine reasonability of a person.

The duty of care has to be firstly analyzed to find out that the defendant is liable or not. The best way of analyzing the existence of the duty is through the application of the Caparo test. The test had been used and provided by the case of Caparo Industries pIc v Dickman [1990] 2 AC 605. The test uses the concept of reasonability to find of the duty. If a person could foresee that the other can be damaged form his actions than a duty of care must be present.  The harm must be foreseeable for example a driver should foresee reasonably that if he drives rashly he can harm other vehicles and pedestrians. Thus in this case as the customer has went to the café for a coffee it was the duty of Chris to take care of her safety. Applying the Caparo test it can be said that Chris could have reasonably foreseen that if he does not take precautions with respect to the safety of the customer she could face injuries. As the injury caused to customer could be foreseen by a reasonable person it can be said that there is a duty of care which exist between Chris and the customer.

After the existence of the duty is affirmed by the court the court determines that the duty has been violated by the person owing it or not. Unless it has been proved that the duty is violated the person cannot be held responsible. For instance if a driver is driven cautiously within the speed limits than he is not liable for the harm caused to a person to whom the duty of care is owed. The objective test is the best way to analyze the violation of the duty has taken place or not. The test has been used and provided through the case Vaughan v Menlove (1837) 3 Bing N.C. 467. According to the test the actions of the wrongdoer is compared and analyzed with a reasonable person. What a reasonable person would do given the risk of harm and significance of harm in the same situation is verified. The actions of the defendant are analyzed based on the actions of the reasonable person. If it is found that the person has not taken the similar precautions than it is said that the person has violated the duty of care. Thus the test provided by the Vaughan case can be used to find out the breach of the existing duty in this scenario. Firstly the risk or probability of the harm is to be taken into account according to which it was really probable that if a high temperature coffee is served than it would led to harm to the customer. Than the significance of the harm has to be considered according to which the high temperature coffee would have caused significant harm to the customer reasonably. Lastly it was not very difficult to observe the required precautions to prevent the accident as it could have been prevented through a normal temperature test. Thus the duty has been breached by Chris.

It has been clear through the above discussed rules that only an existence of the duty or its breach cannot make a person liable for negligence. It also has to be shown that the actual harm caused was the effect of the breach. One of the best methods for analyzing the situation is the application of the test provided through the case of Barnett v Chelsea & Kensington Hospital [1969] 1 QB 428 known as the “but for” test. In this case the doctor was negligent by not treating his patient and asking him to go home. The doctor evidently had a duty of care which had been breached. The patient was suffering from arsenic poisoning and died. The court ruled in this case that the doctor was not liable for paying damages as the patient would have suffered injury irrespective of the treatment. Thus in case the breach does not cause the harm or in simple words the harm would have not occurred if the reach did not take place only then the person doing the violation is liable. In the provided case it is evident that the customer would not have faced any injury if the temperature of the coffee was checked thus Chris is liable for negligence.

The court intends to replenish the injury caused to the person due to the actions of another. However the injury caused to the person is only entitled to get compensated by the wrongdoer. In the case of British Transport Commission v Gourley [1956] AC 185 the court held that a person can only claim for what he has lost. The remoteness of damages is also taken into account by the court as per the principles of The Wagon Mound no 1 [1961] AC 388 according to which reasonably foreseeable losses are entitled to be compensated. Thus the customer has to be paid a compensation for the expenses of treatment, the injury and the loss for unemployment for two weeks.

Answer 2A

A public limited company has a separate legal identity from that of the owners of the company. In the event an owner of the company expires, the company continues to carry out its operations as a public limited company enjoys the significant feature of perpetual succession. Since the company is a separate legal entity any legal action may be brought against the company as well as the company may also initiate any legal action against any person in its own name. Further, a corporation enjoys the right to purchase or sell any property in its own name as is done by any human person (Cole 2016). This concept of separate legal entity or SLP was introduced in the case of Salomon v Salomon [1897] AC 22 where the house of Lord held that once a company is duly incorporated, it shall be deemed as a an independent person with its rights liabilities appropriate to itself. Moreover, those who participated in the incorporation of the company shall have no right to determine such rights and liabilities. Furthermore, the case established the fact that the liability of the company shall be imposed upon the owners of the company only if the fundamental purpose of the incorporation of the company was fraudulent in nature.

The companies are entitled to contract with their employers, outsiders and directors as was established in the case of Lee v Lee’s Air Farming Ltd (1961), AC 12. It was held in this landmark case that the company is competent to employ one of its members under a contract of service and such member may include the principal shareholder of the company. In the event the directors suffers any loss during the course of employment, the company shall be come entitled to compensate the directors for suffering such loss.

In Gilford’s Motors v Horne (1933) Ch 935 and Green v Bestobel Industries Pty Ltd [1982] WAR 1, it was held that where a company is used as an instrument of fraud, under such circumstances the court shall treat the company and the shareholders as one. The court further held that where two companies have a number of common directors, it would imply to the court that although these companies have same ailms and objectives but one may use a different resources or distinct client base that would make them two separate companies.

The liability of the members of the company is restricted to the amount of shares held by the shareholders of the company. However, such liabilities may extend to the amount of shares that is held by the owners of the company. Unless the corporate veil of the company is lifted, the owners of the company cannot be held personally liable for the debts accrued to the company (Macey and Mitts 2014). It is upon the discretion of a public company whether it would publish its shares in the stock exchange. In order to raise its capital, a public company may invite public to invest in the company. In Macaura v Northern Assurance Co Ltd (1925) AC 619, the directors requested to lift the corporate veil so that they are enable to claim the insurance amount that accrues to the property of the company (Cohen 2014). The court held that since the company owns the property, the directors are not entitled to claim for insurance on such property, as they are separate entities.

In the present scenario, where the café carried on in the form of a partnership firm, making its owners liable for the debts of the company, the most appropriate form of business would be a company limited by shares. Every partner shall hold his or her own part of the shares and shall be liable to the extent of the amount of shares held by each of them. Moreover, since the partners are interested to raise capital in order to expand the café, therefore, it would be appropriate if the partnership firm is changed in to a public limited company owing to the power of a public company to invite public to invest in the company to raise its capital.

Answer 2B

In Australia, the Australian Securities and Investment Commission has enacted the Corporation Act 2001 (Cth) to govern the company related laws in the country. Under section 135 of the Corporations act, a company must have a constitution and it must include replaceable rules, if any, applicable to such company. Section 140 of the Act stipulates that such replaceable rules or the Constitution shall have a binding effect upon the company and its members. The binding effect shall extend to the directors and other members of the company. The replaceable rules are applicable to companies that have been incorporated or registered after 1 July 1998 and all the members of the company are under statutory obligation to abide by the rules of the company. However, the replaceable rules are subject to modification or removal as per the Constitution of the company.

The directors of the company are statutorily obligate to exercise their duties and discharge their respective functions as stipulated under the Corporations Act 2001. The directors must perform their functions and must exhibit reasonable standard of care and diligence while dealing with the affairs of the company in accordance with section 198 A of the Act (Ryan 2015). The directors must exercise the powers conferred upon them by the Constitution of the company and the directors are required to act in the best interest of the company. The directors must ensure that the powers conferred upon them such as the power to issue shares and debentures, lending of money etc are carried out diligently and honestly without conducting any fraudulent intention causing detriment to the company.

Section 140 (3) of the Corporations Act 2001 stipulates that in the event the directors fail to act in accordance with the replaceable rules, it shall not amount to any infringement of stipulated provisions and neither the director/directors infringing such provision shall be entitled to any civil or any criminal liabilities under the Corporations Act, 2001. The statute further provides that the replaceable rules have similar effects, as contracts and the binding nature of the replaceable rules are also similar to that of the contracts (Brush and Van Staden 2016).

In the given scenario, Chris has already caused losses or damages to his partners owing to his negligent conduct and is therefore, ready to make up for the loss so caused to his partners. Chris is already a director as per section 9 of the Corporations Act and wishes to purchase a shop in the neighbourhood. Chris believed that available price for the shop would be reasonable and beneficial for the company and therefore he took a loan from the company in good faith, without acknowledging the other partners of the company about the loan. He took a loan of $1500000 whereas as per the replaceable rules of the company a director was only allowed to take a loan amount of $1000000. In case a director takes a loan more than the stipulated amount, it is mandatory to obtain the signatures of the other persons authorised by the board of the company. Therefore, since Chris did not inform the other directors it is apparent that he has committed a breach of the replaceable rules of the company.

As mentioned above that the replaceable rules are similar to contracts therefore, in case of infringement, it would amount to a breach of the rights of party for which the aggrieved may either claim compensation for the damage caused or rescind the contract. A contract is rescinded when the condition of contract is infringed and damages can be claimed if a warranty is breached. In this case, Chris may be held liable for violating a warranty and may become entitled to pay compensation to the company.

However, as per section 135 of the Act, breach of replaceable rules does not amount to infringement and does not call for any penalties. Further, section 198 A allows a director to take loan money therefore, Chris’s conduct is legal under the Act and hence, it is established that the loan contract binds the business under the Act.

Answer 2C

A public limited companies have directors as it cannot operate on its own. The directors have the responsibility of working on behalf of the company in return of remuneration. The directors are the employees of the company. They have been provided with the duty of safeguarding the company. The proper functioning of thee day to day business of the company is to be ensured by the directors. The directors have maximum control over the affairs of the company and in order to ensure its proper functioning law has imposed certain duties which must be complied by the directors.

In Australian the Corporation Act 2001 provides statutory duties which have to be strictly observed by the directors while discharging their functions. If he duties provided by the CA are not complied by the directors they are liable for civil and criminal penalties. Civil penalties are subjected to the provisions of section 1317E of the CA.

The statutory duties of the directors are mentioned in Section 180-184 of the CA. The duties have been affirmed and used in various cases in Australia such as AISC v Rich 2003 and AISC v Healey 2011.

According to the first duty as provided by Section 180 of the CA a director while discharging its duties must observe care, skill and diligence towards the affairs of the company. The duties must be discharged according to the best knowledge of the directors. No compromise shall be done by the directors while making decisions in relation to the operations of the company.

Section 181 of the CA provides the duty which makes the directors work with good faith and towards the best possible interest of the company. The purpose of the decisions taken by the directors must be to ensure that the company is benefited. The non-compliance of this section provides for civil penalties. Best interest should be for the company and its shareholders and creditors.

Section 182 of the legislation provides that the position which has been provided to the directors by the company must not be misused. The misuse must not be done to achieve a personal interest or the interest of another at the cost of benefits for the company. In the same way the directors are not allowed to use the information which have been provided to them by the company for personal use or for any their party which would not be in the best interest of the company according to section 183. Thus the sections 180-183 have not been violated by Chris in relation to the loan.

Section 184 provides for criminal penalties for being reckless and intentionally breaching section 180-183 of the CA. this section has thus not been breached by Chris as the above three provisions have not been violated.

However the business judgment rule provides that the courts do not interfere with the decision of the management unless the decision taken are absurd and against the interest of the shareholders and creditors. The directors have better knowledge about the interest of the company. In the modern market they have to take risky and innovative decisions for the best interest of the company which might sometimes result in losses. Thus keeping this in mid the courts abstain themselves from interfering with the management as long as the decision is taken in good faith. In the situation the decision taken by Chris has been in Good faith which has also resulted to be profitable for the company. The decision was not taken to bring detriment to the company or gain personal benefit. Thus it can be rightly concluded that this was a purely business decision and has not breached any provisions of the Corporations Act 2001.

References

Barnett v Chelsea & Kensington Hospital [1969] 1 QB 428

British Transport Commission v Gourley [1956] AC 185

Canny Gabriel Castle Jackson Advertising v Volume Sales (Finance) Pty Ltd (1974)

Caparo Industries pIc v Dickman [1990] 2 AC 605

Corporation Act 2001 (Cth)

Degiorgio v Dunn (2004) NSWSC 767

Donoghue v Stevenson 1932 AC 582

Gerner-Beuerle, C., Paech, P. and Schuster, E.P., 2013. Study on directors’ duties and liability.

Gilford’s Motors v Horne (1933) Ch 935

Green v Bestobel Industries Pty Ltd [1962] WAR 1

Hill, J.G., 2013. Evolving Directors’ Duties in the Common Law World.

Keay, A., 2014. The public enforcement of directors' duties: a normative inquiry. Common Law World Review, 43(2), pp.89-119.

Keay, A.R., 2014. Directors' duties.

Khan v Miah (2000) 1 WLR 2123,

Knepper, W.E., Bailey, D.A., Bowman, K.B., Eblin, R.L. and Lane, R.S., 2016. Duty of Loyalty (Vol. 1). Liability of Corporate Officers and Directors.

Lee v Lee’s Air Farming Ltd (1961) AC 12

Macaura v Northern Assurance Co Ltd (1925) AC 619

Partnership Act 1963

Salomon v Salomon [1897] AC 22

Smith v Anderson (1880) 15 Ch D 247

Stokes v House With No Steps [2016] QSC 79

The Wagon Mound no 1 [1961] AC 388

United Dominions Corp v Brian (1985) HCA 49

Vaughan v Menlove (1837) 3 Bing N.C. 467

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