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MLC203 Corporations Law | Decide to Incorporate the Business

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Questions:

XYZ Ltd, a technology company, was incorporated three years ago. In the last year, the board of directors resolved, on the advice of the CEO, to venture into investment advisory services. The board of directors has also resolved to appoint Mr. Lee as a director because of his experience in investment advisory services.

Question 1

  1. BlueRock Ltd, a large investment fund, which has invested substantially in the company is unhappy with the board’s decision to start investment advisory services. What options does BlueRock Ltd have?
  2. What procedure would you advise XYZ Ltd. to follow to ensure that he is appointed as its director?

Question 2

  1. What recourse does Linda have and against whom?
  2. Are the replaceable rules suitable for AYNPL?

  3. What is Max’s position at AYNPL?

Answers:

Question 1

Issue 1

Whether Linda can initiate legal actions against AYNPL, or not?

Rule

The Corporation Act 2001 (Cth) is the act governing the provisions pertaining to the formation of any company in Australia. The formation of a company marks its birth in a legal manner. In other words, the company comes into existence, as per section 119 of the Corporations Act, 2001, on the date of its registration. Once a company is formed, it becomes a separate legal entity, and carries on its operations, like entering into contractual obligations.

However, even before a company can be formed, there is a need for entering into certain obligations or agreements, on behalf of the company. These obligations are entered into by the promoters of the company. The reason behind the contracts being entered into by the promoters is that before the company is formed it has no legal capacity for entering into contractual obligations. This means that it cannot appoint any individual to act on its behalf as its agent.

Section 131 of this act provides that when a contract is entered into before the registration of a company, the same becomes applicable on the company, if it is made for the benefit of the company, and the same has been ratified by the company upon its registration, within the period specified in the contract or within a reasonable period of time, after entering into the contract. Ratification can be made in two modes, the express or implied. In express ratification, the contract is acknowledged through conduct or unequivocal words by the company. Under the implied ratification, the company acts in a manner, and this depicts that there is an intention to be contractually bound.

In case the company is not registered, or in case the company does get registered but fails to ratify the contract within a reasonable or agreed period of time, then as per section 131(2), the individual who entered into the contract on behalf of the company, is liable to pay damages to the other party for the pre-registration contract. And the amount payable is the amount which would have been payable if the company had ratified the contract, but failed in performing the same. When a case is brought against such individual representing the company, for recovery of damages, the court has the authority under section 131(3) to order for the following: paying a part of, or all of the damages; transferring the company of the company, which was received as a result of this contract; or paying specified amount to the other party.

Application

In the given case study, one of such pre-contractual agreements was entered into by John and Taylor, on behalf of AYNPL. Since, the company was not legally present at the time the contract was drawn the contract was entered into by the promoters of the company. However, as was required under section 131 of the Corporations Act, 2001, John and Taylor failed to get the contract ratified by AYNPL. This ratification would have enabled Linda to initiate legal actions against AYNPL in case of a breach. As the same was not done, section 131 makes the promoters of the company, which is John and Taylor in this case, personally liable for the breach of contract, due to failure of getting the contract ratified. Due to these reasons, Linda can initiate legal actions against John and Taylor, instead of AYNPL for recovery of damages. And the amount of damages would be decided upon by the court, as per section 131(3).

Conclusion 

To conclude, Linda cannot initiate legal actions against AYNPL. However, she can sue John and Taylor for recovery of damages, due to failure in ratification of the contract.

Issue 2

Whether the replaceable rules are suitable for AYNPL, or not?

Rule

Section 135 provides that the internal management of the companies registered under Corporation Act 2001, is governed by constitution or the replaceable rules, or both of these. Part 2B.4 of this act deals with the provisions regarding the internal management of the company. The provisions regarding replaceable rules are provided in section 141. When the members of the company decide that they do not want to be ruled by the replaceable rules, they can opt for constitution. And the provisions regarding the same are covered under section 136.

The replaceable rules were introduced in 1998 and are applicable on the companies, until they are modified or displaced. These rules are not applicable to the proprietary companies, where the sole individual is both its only director and the only shareholder. These rules are aptly suited for such companies, which are not listed, and have more than two members. The replaceable rules govern the areas like dealing with company’s shares and dividends, director’s and member’s meetings, officeholders’ appointment, and inspection of company’s books.

Application

In the given case study, John and Taylor are the only directors and the only shareholders of AYNPL. But, these are two different people, which make them as two directors and two shareholders of the company. Hence, the replaceable rules can be rightly adopted in this case. Moreover, the company is unlisted and has two directors and shareholders, which makes it a small company. These factors make the replaceable rules as the best suited on for AYNPL, and its directors and shareholders.

Conclusion 

To conclude, replaceable rules are best suited for AYNPL in the present circumstances.

Issue 3

Whether Max has any position in AYNPL, or not?

Rule

The directors of the company have the obligation of acting on behalf of the company and carrying on its operations. Section 198A (1) of the Corporation Act provides that the business of a company has to be managed according to the directions given by the company’s directors. Subsection (2) of this act provides that the directors can exercise any and all such powers relating to the company, unless the particular power is required to be exercised in the general meeting due to this act or due to the constitution of the company.

The directors are considered as officers of the company and participate in the decision making of the company, which impacts the business of the company as a whole, or its substantial part. The directors of the company include such individuals who have been appointed in the company as a director, irrespective of the name given to their position. It also includes such individuals, who are not explicitly appointed as the directors of the company, but acts in the same position. Any such individual, upon whose directions, wishes or instructions the directors of the company are accustomed to act.

A de facto director is an individual, who has been appointed in the position of a director; however, he is not described as being a director. And even without the valid appointment as a director of the company, the individual acts in the position of director. There is another category of directors, which is that of shadow director. A shadow director is an individual who has not been appointed validly as the director or the company, but upon whose instructions, the directors of the company have a habit of acting, depending upon the wishes or instructions of such individual. Such a shadow director is subjected to the usual duties of the directors.

Application

In the given case study, Max was John’s brother, and he had experience as a business man. Due to these reasons, John and Taylor too the decisions on the basis of advice given by Max. On his advice only, the company AYNPL engaged Focus Pty Ltd for providing the software consulting and online marketing services. This makes him the shadow director of the company, as John and Taylor, the directors of AYNPL, acted on the directions of Max. Hence, Max is subjected to the usual duties, by being a shadow director in the company.

Conclusion 

To conclude, Max does have a position in AYNPL, as being a shadow director of the company for the reasons of John and Taylor, acting on the directions of Max.

Question 2

Issue 1

Whether BlueRock Ltd, which is a large investment fund, and also a substantial investor in XYZ Ltd., has any options against the decision taken by the board of XYZ Ltd. for initiation of the investment advisory services undertaken by the company, or not?

Rule

The members of a company have the decision making power pertaining to the adoption, repeal and modification of a constitution. They also have the power for vetoing the capital reduction and even some of the relation party transactions. They have certain important powers like the removal of directors and the appointment of auditors. However, some of the powers are explicitly reserved for the board of directors.

Broadly, there are three types of decisions which have to be made by the companies, and these are constitutional, capital and enterprise decisions. The first one, i.e., the constitutional decisions relates to the internal arrangements of the company, which includes the decision regarding the adoption of constitution. The second one is the capital decisions, which relate to the composition, sources and amount of the capital of the company. These capital decisions are also known as the funding decisions. The last category is the enterprise decisions which deals with the decisions related to the operations or the business of the company.

As has been mentioned in the preceding section, the business of the company is managed by the directors of the company. The members of the company have the right of voting in the matters of the company; though, the same have been provided for the limited matters only. These matters have been particularly reserved to the members through the established principles of company law or the internal governance rules. The members of the company, who are not in agreement with the management decisions taken by the board of the company, can refuse to vote for the reappointment of the directors or for removing the directors.

However, the members of the company do not have the power of overriding the management decisions made by the board, unless the same relate to the oppression or mismanagement. In one of the UK cases of Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame [1906] 2 Ch 34, the general power of management was conferred upon the board of directors through the internal governance rules. The same was subjected to the qualification of the powers passed through a special resolution passed by the members. McDiarmid was the owner of 1202 shares out of the 2700 shares. McDiarmid arranged for the sale of the assets of the company, and subsequently undertaking of another company. For these purposes, a meeting of the shareholders was held, so that a resolution could be passed for instructing the board of directors, to enter into sale agreement.

With 1502 votes, this resolution was passed with a simple majority. This resolution was resisted by the directors, as they were of the view that the sale of assets of the company was not in its best interest. When the matter was taken to the court, the court gave the ruling in favor of the directors and they further stated that the management decision had to be vested with the board of directors only as per the internal governance rules. The court also stated that the members of the company could not substitute their judgment for that of the one taken by the directors, through the use of an ordinary resolution.

A similar ruling was given in the case of John Shaw & Sons (Salford) Ltd v Shaw [1935] 2 KB 113. It was held in this case that when the powers of managing the company are vested with the directors, then the same can only be exercised by the directors. The only manner, in which control can be exercised over the powers vested to the members through the internal governance rules, is by altering the rules or through the refusal of re-election of the directors, the actions of who is disapproved by the members. The powers which are vested in the directors through the rules cannot be usurped by the members, in the same manner in which the directors is prohibited from usurping the powers, which is vested to the general body of the shareholders through the rules.

Even though the members do not have the authority of instructing the board regarding the management decisions, as has been highlighted through the two cases, they can apply for a meeting or get the resolution included in the agenda of a meeting. In case of Australian Centre for Corporate Responsibility (ACCR) v. Commonwealth Bank of Australia (CBA) [2015] FCA 785, three alternative resolutions were provided by the ACCR to the board of directors, for getting them included in the agenda for the meeting. However, the inclusion of the first two resolutions was refused by CBA and the third one was included in the agenda.

This third resolution proposed a special resolution which required the constitution of the CBA to be amended in a manner so as to include the requirement of the annual report of CBA to disclose the details regarding the greenhouse gas emissions, which it had the responsibility of financing. The opinion of the board regarding the notion that the resolution should not be passed in the meeting was also included in the agenda by the CBA. And this decision of CBA was upheld by its board of directors.

Application

In the given case study, BlueRock Ltd us a large investment fund, who has invested in XYZ Ltd in a substantial manner. But this investor is not happy with the decision taken by the board of directors of XYZ Ltd regarding initiation of the investment advisory services. Being the members of the company, BlueRock Ltd does have certain powers, but it does not have the power to usurp the decisions made by the board of XYZ Ltd. As was seen in the case of Automatic Self-Cleansing Filter Syndicate Co Ltd v Cuninghame, even a substantial member cannot interfere with the decisions of the board. And so, BlueRock Ltd cannot go against the decision taken by the board.

Though, BlueRock Ltd does have an option which relates to making an application for adding the agenda regarding not taking initiating these investment advisory services. Upon the discretion of the board, the same agenda may be added in the agenda. Moreover, the same may be added, but with an opinion to the board regarding the non-passing of this resolution, as was seen in the case of Australian Centre for Corporate Responsibility (ACCR) v. Commonwealth Bank of Australia (CBA).

Conclusion 

To conclude, BlueRock does have an option in this case, and that pertains to making of an application to XYZ Ltd to get their viewpoint included as an agenda item for the meeting, which would then be decided upon in the ensuing meeting.

Issue 2

What is the procedure for appointing Mr. Lee as a director in XYZ Ltd.?

Rule

The role of the board in the appointment of a new director relates only to the presentation of a suitable candidate in front of the shareholders for the election of such individual as the director of the company. An individual can be appointed as the director of the company by passing a resolution in the general meeting and this provision is provided in section 201G of this act. Under this section, the director is appointed by the members through an ordinary resolution. The board of directors also has the power of appointing the directors, but the same is subjected to the approval of the members pursuant to section 201H, in the general meeting.

In order to ensure that the individual is appointed as the directors by the members at the general meeting, the board should demonstrate to the satisfaction of the members that the individual elected as possible candidate for being a director has the requisite knowledge and skills, and would help in the growth of the company. So, the candidate has to possess the following to ensure his successful appointment as the director: knowledge regarding accounts and finance; risk management and business development; industry experience; and a mix of required skills and expertise, which could act as a justification for his appointment.

Application

Hence, the board of XYZ Ltd can appoint Mr. Lee as the director of the company, but he would have to be appointed through a resolution of members, passed at the general meeting. The board should show to the board that Mr. Lee posses the experience and knowledge in investment advisory services, which would prove beneficial for the company, as the company is venturing into these services.

Conclusion 

To conclude, the above stated conditions and procedure should be adopted for appointment of Mr. Lee as the director or XYZ Ltd.

This problem has been solved.


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