One of the most popular restraints which is imposed on the directors of the company in relation to discharging their duties is the duty to act in good faith and proper purpose of the company (Knepper et al. 2016). The duty exists both in common law as well as in the provisions of the Corporation Act 2001 (Cth) through section 181. People who have been serving as the directors of an organization for a long time tend to forget that the company is a separate legal entity. The company however cannot function on its own and therefore require the help of the directors (Farrar 2016.). The directors have to therefore comply with legal provisions while discharging their duties in relation to the company (Keay 2014).
The case of Whitehouse v Carlton Hotel Pty Ltd [1987] 162 CLR 285 had to address the question in relation to the duty of directors to act bona fide. In this case it had been ruled by the court that a subjective test of “good faith and honesty” have to be applied in order to determine whether the directors had complied with the duty of good faith or not. Whether good faith is present or absent is determined based on the circumstances which are present in the case (this is why the court cannot pin precise rules in relation to it). There are no fixed set of uniform rules which can be applied to determine whether the element of good faith was present in the actions of the directors or not. Depending upon the circumstances, a transaction which is carried out by the directors in relation to the company will be considered to be in bad faith if it is outside the purpose of the company. In case a director of the company willingly and knowingly agrees to go against the law, t is most likely to be deemed as not done with the observation of good faith.
In this case the governing director of the company was Charles Whitehouse. He owned class A shares which had voting rights, his wife owned class B shares which had partial voting rights and his children held class C shares which had no voting rights. He got divorced with his wife who aligned with his daughter and he aligned with his son. He was concerned about the fact that on his death the control of the company would likely be taken by his wife and daughter and thus to prevent such a thing from happening he issued class B shares to his son. However he had fallout with his son and claimed that the transfer of shares was not valid as it has been done in bad faith. The court has to determine whether the transfer of share was valid or not
In the given situation the director has apparently violated the duty to act in good faith in relation to the company. The duty is provided and imposed on the directors of the company through the provisions of common law. In addition currently the CA through its section 181 also provides that the director’s whole discharging their duties towards the company has to act in good faith and for a proper purpose. The actions of the directors have to be in the best interest of the company. In case the provisions are not complied with by the directors they are liable to be prosecuted under the civil penalty provisions under section 1317E. This is because the director has acted in bad faith by making a share transfer in relation to the company which was not lawful.
The judges in relation to this case were Mason , Wilson , Brennan , Deane and Dawson JJ. They have to decide whether it was a valid exercise of power by Carlton to transfer the shares to his son under the discriminatory power provided to him under Article 127 of the Article of association. According to the article among other things Mr. Whitehouse had to be the Permanent Governing Director of the organization and all powers of the board of directors should be vested in him alone. It was held by the court in this case that a decision which is made in bad faith and towards an improper purpose is a voidable, however not against a third party who does not have any knowledge or notice in relation to the situation which lead to breach of duty. They are given protection through the indoor management rule. If the third party is able to establish that they had entered into the transaction in good faith and did know about the breach of duty the transaction will be regarded as valid. It was ruled that the existence of an in permissible purpose will not merely make the transaction of the fiduciary power to allot shares invalid.
In addition it had been provided by the court that the test which had been provided in the case of Mills v Mills will not be applicable in this case as it will only follow in case the impermissible purposes are considered as dominant (“the substantial object,” “the moving cause”).
It is provided by the case that preferably whether the nature of the impermissible purpose is causative “but for” it existence, in case no exercise of power would have been exercised but not a concluded view as the case is not related to competing impermissible or permissible purpose.
In this case the appeal made by the sons against the decision of the full court that the allocation of shares to them was invalid was dismissed by the court with cost. The decision of the court had been supported by the case of Fraser v. Whalley (1864) 2 H. &M. 10, at pp 30-31 where it has been stated that the directors are not allowed to use a fiduciary power in relation to allocating shares for defeating the voting power of a shareholder through the creation of a new majority. The decision was also supported by the case of Ashburton Oil N.L v. Alpha Minerals N.L. (1971) 123 CLR 614, at p 640 for the same reason.
In the case of Automatic Self-Cleansing Filter Syndicate Co. Ltd. v. Cuninghame (1906) 2 Ch 34 it had been stated by the court that as the shareholders of the company do not have the power to control the decision of the directors, it would not be constitutional for the directors to use their power in relation to the company for the creation of a new majority and destroying the power of existing shareholders to vote. If this is done it would interfere with the element of the constitution which is set against the power.
In the case of Piercy v. S. Mills and Company (1920) 1 Ch 77, at pp 84-85 it had been provided by the court that in case of a purported allotment of shares for an impermissible purpose the directors may have a belief that they are doing so in the best interest of the company. However this belief is not adequate to overcome the invalidity of share allotment.
In the case of Grant v. John Grant &Sons Pty. Ltd. (1950) 82 CLR 1 it had been ruled that in some statements of vitiating effects of a purpose of decreasing voting power off existing shareholders a qualification of effecting the allotment is invalid in case it is solely, merely or purely done for that purpose.
However Wilson J dissented from the decision of the majority and stated that he would allow the appeal based on the same reason as provided by the trial court. He stated that a share allocation would be valid even case it has been done for an improper purpose and in bad faith where the third party does not have knowledge about the situation.
Conclusion
From the above discussion it can be concluded that the director of a company who has the power to take decision in relation to the company in the same way as the board of directors also have the duty to act in good faith and proper purpose of the company as it is a separate legal entity. In this case it was held by the trail court that a share allocation is valid even in case it is done in bad faith where the third party was not aware about such facts. However the court of appeal and the high court overturned the decision provided by the trail court and invalidated the share allocation done in bad faith and for an improper purpose. It is provided by the case that preferably whether the nature of the impermissible purpose is causative “but for” it existence, in case no exercise of power would have been exercised but not a concluded view as the case is not related to competing impermissible or permissible purpose. The appeal which was made by the two sons was dismissed by the court with cost. The decision which was reached by the court was a result of a 3:2 majority. The cases which had been cited by the court in this case had been very well applied in relation to addressing the issue which had brought before the court in this case. For instance In the case of Automatic Self-Cleansing Filter Syndicate Co. Ltd. v. Cuninghame (1906) 2 Ch 34 it the court ruled that as the shareholders of the company do not have the power to control the decision of the directors, it would not be constitutional for the directors to use their power in relation to the company for the creation of a new majority and destroying the power of existing shareholders to vote. If this is done it would interfere with the element of the constitution which is set against the power. In this case also there was a same situation where the director had tried to indulge in an activity where he wanted to the create a new majority by providing additional shares to his son and destroying the power of existing shareholders which was his wife to vote in matters related to the company. On another instance in the case of Fraser v. Whalley (1864) 2 H. &M. 10, at pp 30-31 it had been ruled by the judges that the directors are not allowed to use a fiduciary power in relation to allocating shares for defeating the voting power of a shareholder through the creation of a new majority. Thus in the given situation the act of the directors was clearly invalid and the application of any defense in the given situation would not be in the ends of justice.
References
Ashburton Oil N.L v. Alpha Minerals N.L. (1971) 123 CLR 614, at p 640
Automatic Self-Cleansing Filter Syndicate Co. Ltd. v. Cuninghame (1906) 2 Ch 34
Corporation Act 2001 (Cth)
Farrar, J., 2016. Book Review: Directors’ duties: Principles and application.
Fraser v. Whalley (1864) 2 H. &M. 10, at pp 30-31
Grant v. John Grant &Sons Pty. Ltd. (1950) 82 CLR 1
Keay, A.R., 2014. Directors’ Duties. Jordans.
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.
Mills v Mills 1938) 60 CLR 150, [1938] HCA 4.
Piercy v. S. Mills and Company (1920) 1 Ch 77, at pp 84-85
Whitehouse v Carlton Hotel Pty Ltd [1987] 162 CLR 285
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