Analysis Of Transactions And Legal Issues For Incredible Gifts Pty Ltd And Chip-Eze Pty Ltd

Pre-Registration Contracts and Section 131 of the Corporation Act 2001

1.Introduction: Alteration of constitution, Power of minority to restrain alteration, Contract with Company in its independent capacity.

Ryder and Kody graduated and then decided to initiate a business which deals in selling of unique, hand-made crafts and other gifts online. They want to start a company with the name Incredible Gifts Pty Ltd. On 2^nd May 2018, Kody and Ryder went for the registration of the name Incredible Gifts Pty Ltd, but it was already registered. So they registered the name Astounding Gifts Pty Ltd.

Now, there are series of transactions that take place which require analysis.

To advice Melanie as what recourse she has for the non-payment of her monthly payments for the remainder of her 12 month contract?

In Australia, it is the Corporation Act 2001 that governs the incorporation and the working of a company. When a company is made then in order to achieve its object there are several contractual relationships that can be established by a company. Such contracts are binding in nature as it is made by the company in its individual capacity (Salomon v A Salomon and Co Ltd (1897). (Harris, Hargovan, & Adams 2011)

But, many a times, the officers (promoters) establish contracts on company behalf before its registration and are called pre incorporation/ registration contracts. In common law, Kener v Baxter (1866), the pre registration contracts are void. (Easson & Soberman 1992)

But, Section 131 of the Corporation Act 2001, provides that if pre registration contract is approved/ratified upon its incorporation, then, such contracts are enforceable (Aztech Science Pty Ltd v Atlanta Aerospace (Woy Woy) Pty Limited (2004)

In Commonwealth Bank of Australia vs. Australian Solar Information Pty Ltd (1987), section 131 has the applicability upon contract which is made prior the incorporation. If a contract was made when the company was registered and later altered its name, then, section 131 is not applicable. (Hossain 2013)

Thus those contracts which are binding on the company either because the company has established it on its own behalf or whether the same is ratified by the company, such contracts are binding in nature. Thus, as per Airloom Holdings Pty Ltd v Thales Australia Ltd (2011) if there is breach of any contractaul obligtaion then the agreived party can sue the comoany for breach and claim damages.

Now, as per the facts, that a contract was made by Ryder with Melanie for a monthly payment of $5,000 on 26 April 2018. But, the contract was made by Ryder on behalf of Incredible Gifts Pty Ltd, which was not registered when the contract was made.

Alteration to the Company Constitution and Expropriation of Shares

As per Aztech Science Pty Ltd v Atlanta Aerospace (Woy Woy) Pty Limited, the contract should not be enforceable as it is a pre regitertaion contract.

Later a comoany was registered in the name of Astounding Gifts Pty Ltd. Astounding ratify the contract in its meeting on 12^th May 2018. Thus, the pre registration contract was made with Ryder but the contract was ratified by Astounding. So, by applying section 131 and Commonwealth Bank of Australia vs. Australian Solar Information Pty Ltd, the contract is valid as even though it is made when the comaony was not registered but was ratified by a comoany after its regitsrtaion. Only the name of the comoany was changed and nothing else. So. Melaine has full right to sue the comoany when the comppany has stopped paying the contract price of $5,000 (Airloom Holdings Pty Ltd v Thales Australia Ltd (2011).

Now, Kody and Ryder were the two directors (holding 45% shares each). A contract was also made with Salman (holding 10% of the shares) to act as the company’s accountant.

A first director meeting was held on 12^th May 2018. On 10^th July 2018, Ryder and Kody found that Salman has confirmed the accounting position with Incredible Gifts Pty Ltd (competitor) and is trying to encourage Melanie to provide her hand-made gifts to Incredible Gifts instead. A members meeting was called and a resolution was passes to alter the constitution according to which the directors have now power to buy back shareholdings of less than 12% at their discretion.

So, the issue that arise is

To make Salman understand the process of alteration of the company constitution.

A comoany can govern its self either by the constuitition or by the replaceable rules or by both. There are various rules and provisins that are made part of the constitution with which all comoany officers must comply with. However, at times, the shareholders may find a need to bring varations in the provisons of the constitution. (Legal Vision 2018)

The basic process that must be folowed in order to bring alternation in the constitution is nentioned under section 136 (2) of the Act. Section 136 (2) submits that a constitution can be repealed or modifies by the shareholders by passing special resolution on such behlaf. The resolution must be passed by 75% of the votes. These amendments has the power to bind the minoirty shareholders even if the minority shareholders are agianst the specail resolution. (Australia 2011)

Breach of Directorial Duties under Section 181 of the Corporation Act 2001

Thus,

It is submitted that Kody and Ryder are both permitted to alter the constitution by giving 75% of the votes in the meeting. Salman holds 10% of the votes and even if votes againt the resolution still Kody and Ryder together makes 90% of the shareholdings (which is in excess of 75%) and thus are capable to pass the resolution. The alteration is perfectly valid and Salman has to abide by the same.

But, what of Salman does not want to abide by the same.

So, the next issue that arise is

Whether Salman can prevent the inclusion of the clause allowing the directors to expropriate her shares?

It is submitted that there are few amendements in the Constitution that does not bind the shareholders. Such amendmenst are establihed under section 246B of the Act. The amendment includs:

Cancellation or variation of class rights;
When changes are brought to the provisions of the constitution which might hamper the expropriating the shares of minority shareholders or rights attaching to those shares;

Changes to few provisions of the constitution.

In the leading case of Gambotto v WCP Ltd (1995) it was held that if alterations are made to the constitution by the majority shareholders in order to expropriating the shares of a minority shareholder or valuable rights attaching to those shares then such alterations are not permitted. The court held that expropriation is only valid provided the same is made for the proper purpose of the company or that it is not oppressive to the minority shareholders. (Cassidy 2006)

The court held that expropriate can take place only when all material facts are revealed, the valuation of the shares are done by an expert and the market value of the shares must be paid. also, if the court finds that:

Presence of minority shareholders is detrimental to the company;
Minority is competing;

To protect company interest, then, expropriate is permissible, then expropriate is permissible.

It is submitted that the alteration was made because it was found that Salman has confirmed the accounting position with Incredible Gifts Pty Ltd (competitor) and is trying to encourage Melanie to provide her hand-made gifts to Incredible Gifts instead. Thus the acts of Salman are detrimental to the company and Salman is competing, so the alteration is permissible and Salman is not permitted to challenge the alterations.

2.Introduction: Breach of directorial duties

Chip-Eze Pty Ltd is a company having four directors Michaela, Jordon and Marianne (each owning 25% of the shares each). The rest 25% shares are owned by outside investors (Ayub, Saeed, Donte, Neeve and Faizah).

The company was dealing with two businesses, that is,

The manufacture of potato crisps and other snack foods. However, the business was making loss.

The manufacture of frozen potato chips and other foods – which was reasonably profitable.

Financial difficulties are faced by the company. Payments are due to the creditors and the suppliers of the snack food.

On 1^st August 2018, a board meeting was called wherein Michaela proposes a resolution to incorporate a separate company, Freeze Me Pty Ltd and to transfer the profitable frozen foods business to this company. The resolution is unanimously passed. On the 10th of August 2018, Freeze Me Pty Ltd is incorporated, the assets related to the frozen food business are transferred and all the customers and suppliers are updated with the new details.

Upon application by creditors who had not been paid, the court orders that a liquidator be appointed and Chip-Eze Pty Ltd be wound up in insolvency. Archibald is then appointed as liquidator

Based on the facts the main issue that arose is to further advice to Archibald of whether the directors of Chip-Eze Pty Ltd have breached s181 of the Corporations Act 2001 (Cth) or their equivalent equitable duties and what penalties or remedies might be applicable.

In Salomon v A Salomon and Co Ltd (1897 it was held that once a comoany is incorporated then it a distinct and artificial legal person. The directors, officers and shareholders are distinct and the acts of the comoany are its own (Lee v Lee’s Air Farming Ltd (1960). (Latimer 2011)

Every comoany is govern by its officers and the director is the most important officer of the comoany. As per section 198A, the comoany directors are responsible for the daily activities of the comoany. Section 9 of the Act establihes the position of a duirector. Though the directors have immense power, but there are few responsibilties that must also be cater by the comoany director.

One of the most promising duty that must be honred by a director is under section 181 of the Act.

Section 181 of the Act deals with the duty of good faith.

Section 1181 (1) of the Act submits that every officer and director must carry out their functions in the company’s best interest and for its proper purpose. Whether the duty of good faith is comply with or not is an objective tests Charterbridge Corporation Ltd v Lloyds Bank Ltd (1969). It is not what the directors think but what the court thinks that determine the presence of duty of good faith. In Whitehouse v Carlton Hotel Pty Ltd (1987) it was held that the failure of objectivity will make a director liable under section 181 of the Act. (Ford, Austin and Ramsay 2000)

When it is found that the directors are giving preference to their own interest in comparison with the interest of the company then there is breach of section 181 and is held in Walker v Wimborne (1976). Whether the duty is comply with or not must be access by looking at the position of a normal prudent man and id is held in Farrow Finance Company Ltd (in liq) v Farrow Properties Pty Ltd (1997).

It is submitted that Chip-Eze Pty Ltd and its directors, Michaela, Jordon and Marianne, have violated section 181 of the Act.

It is found that the company was facing financial difficulties and payments were due to creditors. But, instead of paying the creditors, the company on 1^st August 2018, decided to incorporate Freeze Me Pty Ltd and to transfer the profitable frozen foods business to this company. The main aim of doing the same was to cheat on the director so that there payment could not be made through Chip-Eze Pty Ltd. so, the acts are not carried out in good faith.

Also,

As per section 191 -195, the directors must disclose all the material personal interest to the company. If there is conflict of interest then the company interest must proceed. But, by establishing the new company, the directors have given preference to their own interest. So, there is clear violation of section 191-195.

So, the acts of the directors are in breach of section 181 and section 191-195. Thus, the directors can be imposed with civil penalty under section 1317E of the Act. He can be imposed pecuniary penalty (upto $200,000), compensation, disqualification of director under section 206C of the Act.

If the breach is reckless then criminal penalties scan be imposed with includes jail of 5 years or fine up to $200,000 or both.

Now,

On the 6th of August, Jordon had been approached by Faizah who had asked if she could purchase additional shares in Chip-Eze Pty Ltd. Jordon agreed to sell her an additional 5% of the shares himself, and they completed the transaction on the 8th of August.

It is now important to understand whether Faizah has an action against Jordon for breach of directors’ duties for selling her the shares in Chip-Eze Pty Ltd just before it was going into liquidation.

As per Section 180 (1), every director must act with all due care and diligence in order to act in the company best interest and proper purpose and is held in Statewide Tobacco Services Ltd v Morley (1990). The actions of the director are analyzed as what a normal prudent man will do in similar situations and is held in AWA Ltd v Daniels (1992).

However, at times the director can protect him by availing the defense under section 180 (2) of the act which is popularly known as business judgment rule. The rule submits that of the director can prove that his action are taken in the best interests of the company or that his reasons are correct or that his decision was informed or that expert opinion was taken before the decision is made etc, then the director can protect himself from the liabilities and is held in Daniels v Anderson (1995).

It is submitted that Jordon is aware that they are selling their profitable part of the business to a new company incorporated mainly for the same. Knowing the said fact he still approached Faizah and sold additional shares in Chip-Eze Pty Ltd. the transaction on the 8th of August before the liquidation of the company. Thus, the acts of Jordon are totally carried without due diligence for his own interest and not to the interest of the shareholders of the company.

Also, Jordan has also violated two important duties, that is,

Section 182 of the act submits that the directors of the company must not misuse the information that is acquired by him by posting at the position of a director and is held in R v Byrnes (1995).

Also, as per Section 183 of the act submits that the directors of the company must not misuse his position and is held in R v Byrnes (1995).

The position of Jordan was of a majority directors and he is accustomed with the true financial position of the company. He has all the relevant information and he misused his position and information in order to gain benefit to himself. Thus, section 182 and 183 are breached by Jordon ad he must he held accountable for the same

Reference List

Books/Articles/Journals

Australia, 2011, Australian Corporations & Securities Legislation 2011: Corporations Act 2001, ASIC Act 2001, related regulations, CCH Australia Limited.

Cassidy, J 2006, Concise Corporations Law, Concise Corporations Law, Federation press.

Easson & Soberman 1992, Pre-incorporation Contracts: Common Law Confusion and Statutory Complexity. 17 Queen’s LJ 414.

Harris, J., Hargovan, A., & Adams, M 2011, Australian Corporate Law. Lexis Nexis Butterworths 3rd ed.

Latimer, P 2011, Australian Business Law 2012, CCH Australia Limited.

Case laws

AWA Ltd v Daniels (1992).

Airloom Holdings Pty Ltd v Thales Australia Ltd (2011).

Aztech Science Pty Ltd v Atlanta Aerospace (Woy Woy) Pty Limited (2004).

Charterbridge Corporation Ltd v Lloyds Bank Ltd (1969).

Daniels v Anderson (1995).

Commonwealth Bank of Australia vs. Australian Solar Information Pty Ltd (1987).

Farrow Finance Company Ltd (in liq) v Farrow Properties Pty Ltd (1997)