Corporate Law Economic Reform Of Program – Explanation And Case Studies

Binding Contract Under Director’s Authority

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The contract that has been entered into by Bob on behalf of the company with Computer Supplies Pty Ltd for $8,000 for the delivery of ten computers is a binding contract. The general rule which is laid down in the Corporations Act 2001 (Cth) is that, except otherwise contracted between the parties, where a company has more than one directors, any contract with such company can be executed only if the contract has been signed by at least two directors of the company[1]. Further it has also been held by the courts in various cases that where there are more than one directors in a company, a director of such company who is acting individually is not authorized to bind the company by virtue of his position[2]. A director cannot bind the company by his acts on behalf of the company unless he is expressly given the authority by the board to do so. But in the instant case the constitution of the company lays down that a contract of an amount more than $10,000, which has received approval of the board by a resolution passed and has been executed by at least two directors, will be binding on the company. Here, the contract which was entered into by Bob on behalf of the company with Computer Supplies Pty Ltd for delivery of ten computers was a contract for $8,000, an amount which is less than $10,000 as was required by the constitution of the company. The constitution of the company does not makes any provision regarding the contracts of amount smaller than $10,000, therefore, it is presumed that the directors had authority to act on behalf of the company for cases otherwise.

Further the Corporations Act also lays down that if a third party enters into a contract with the company where there are more than one directors, the former has right to make an assumption that the latter has been authorized to act on behalf of the company and that all the requirements of the constitution and the law has been complied with[3]. Also the third party has the right to make an assumption that the director who is representing the company is duly appointed and authorized by the members of the company to make such appearance on behalf of the company[4]. In the instant case also the company is registered with the ASIC and therefore the Computer Supplies Pty Ltd has right to make an assumption that Bob was duly authorized to enter into contracts on behalf of the company.

Invalid Contract Due to Non-Compliance of Constitution

As per the observations made above it can be concluded that for the contract that was entered into by Bob on behalf of the company was a valid contract as under Section 129 he is presumed to be authorized by the company to enter into contracts with third parties and therefore, the Sunshine Scooter Art Pty Ltd is bound by the contract and the directors are advised to make payment of $8,000 on behalf of the company to the Computer Supplies Pty Ltd for the supply of ten computers made by the latter to the former.

The contract that has been entered into by Bob on behalf of the company with Plastica Pty Ltd for $50,000 is not a binding contract. The reason that can be given for the conclusion is that firstly, according to the law that has been laid down in the Corporations Act 2001 (Cth) except in cases where a contrary contract has been entered into by the parties, a company which has more directors than one and any contract has been entered into on behalf of such company, such contract can be enforced only if it has been signed by at least two directors of such company[5]. Further as per the rules laid down by different courts if there are more than one director in a company and a director is acting independently, he has no authority to bind the company by virtue of his position[6]. A director can bind the company by his acts only if he has been given an express authority by the board to do so. Also according to the constitution of the company in the instant case a contract of an amount more than $10,000 will be executable and binding on the company only if such contract has received approval of the board by a resolution passed for the purpose and has been signed by at least two directors of the company. Here, the contract which was entered into by Bob on behalf of the company with Plastica Pty Ltd for an amount of $50,000 was not made in accordance with the requirement of the constitution of the company as no resolution was signed by the directors to enter into any such contract and neither did Bob was given any implied or express authority for making contracts on behalf of the company. Further, it should be noted that Bob represented himself as the ‘sole director’ of the company, which he was not. Section 129 of the said Act entitles a third party who is entering into a contract with the company to make an assumption with regard to the authority of a director of the said company only in case where the contract has been signed according to the provision as laid down in section 127. Here, in the instant case the contract has not been entered into by Bob accordingly.

Distinction Between Holding and Subsidiary Company

Therefore, on the basis of the observations made above it is concluded that the contract that was entered into by Bob on behalf of the company with Plastica Pty Ltd was not a valid contract as Bob made a misrepresentation that he was the sole director of the company and also the contract was not made in compliance with the constitution of the company. The contract with the Plastica Pty Ltd was not binding on the company and therefore neither the company, Sunshine Scooter Art Pty Ltd nor its other two directors, Jana and Adrian can be made personally liable for the act of Bob as his act was not authorized, either expressly or impliedly, and therefore he will be personally liable for his act.

Superdry Holdings Ltd is the holding company of Superdry Manufacturing Ltd and Superdry Retail Stores Ltd. The board of directors of the Holdings, viz., Francis, Jack and Alice hold shares in the company in ratio of 5:3:2. The Holding holds 70% shares in the Manufacturing while 30% shares in the Stores. These three companies are considered to be group of companies by the directors. According to law a company is considered to be a subsidiary of another where the holding company holds at least 50% shares of the subsidiary company[7]. Here in this case, Holdings has 70% shares of Manufacturing while only 30% shares of the Stores, therefore, Manufacturing is a subsidiary of the Holdings but Stores cannot be said to be the subsidiary of the Holdings as the latter holds less than 50% shares in the former. The Stores is not related to the Holdings and the Manufacturing as the former is not a subsidiary of the latter companies although Manufacturing is related to the Holdings[8].

Also as per the facts of this case Stores, which has a chain of its retail stores, sells the products of the Manufacturing at reduced rates and in a recent past has also started selling products of other brands which have more demand than the Manufacturing’s products. According to these facts, it can be concluded that the Stores is a separate entity from Holdings and Manufacturing as when Stores started selling products of other brands, the latter did not stop them from doing so. This conduct of the latter shows that they do not have a substantial control over the day-to-day business of the Stores. Further it has also been held by court that a parent company and a subsidiary company of the former are distinct legal entities. Therefore, they are not bound by each other’s legal obligations[9]. From this observation of the court, it can be suggested that the decision made in the meeting of the Board of Directors of Stores, where the Stores is required to provide guarantee to the Finance Bank of the debts of Holdings and Manufacturing, is not bound to give such guarantee as has been held above that a company is not bound by the legal obligations of the other even if it is a subsidiary company of the other.

Parent-Subsidiary Companies Not Bound by Legal Obligations of Each Other

In the instant case, the directors of the Holdings are personally liable for the debts accruing to the Financial Bank. They cannot make Stores bound by their legal obligation as Stores is a separate legal entity distinct from the Holdings and the Manufacturing.

Further, the decision made by the Directors in the Board meeting is in contravention of the director’s duty under law[10]. The directors of a company are under a legal obligation not to take advantage of their position or cause disadvantage to the company[11]. Also the Business Judgment Rule which is intended to evade needless limitations on appropriate business activities has also been laid down in the Corporations Act 2001. According to the rule a director should make a proper business judgment which requires care and diligence on his part while making such judgment. A judgment is said to be made carefully and diligently when it is made with bona fide intention for an appropriate purpose and should not have a substantial interest in the issue of the judgment. Further the judgment shall also be made in the interest of the company[12]. The basic objective of the rule is to prevent the directors of the company from exercising their powers arbitrarily and not to shield them from their liability. It has been held by court that the duty that has been imposed under section 182 is not made to ensure obedience to the requirements of the provisions of the law rather to avoid the directors from taking advantage of their authority for their personal interest[13].  

The directors cannot delegate their responsibilities to other members of the company[14]. The directors of Holdings cannot escape from their liability towards the company and the Financial Bank by making the Stores the guarantor for the overdraft facility to the Financial Bank. They are bound by the obligations by the virtue of their position. The directors have no right to give away their obligations their subsidiary company which is not even their subsidiary company.

It may be observed that the directors have acted in contravention of their general duties under section 182 of the Corporation Act which invites the civil penalty under section 1317E. The court upon being satisfied that the director has acted in contravention of the civil penalty provision, it will declare that such contravention has taken place. Upon declaration the Australian Securities and Investments Commission will be entitled to get an order for pecuniary penalty under section 1317G or an order for disqualification under section 206C.

Therefore it is advised to Karen, the non- executive director of Stores that the three directors of the Holdings for failing to carry out their general duties and thereby contravening the provisions of Corporations Act. The directors want to avoid their personal liability as against the Financial Bank by making the Stores guarantor for their overdue debts and the overdraft facilities. The Stores is not a part of the Holdings or the Manufacturing rather it does not even form part of the group of the company as given under section 50 of the Corporations Act 2001. The Store has a separate legal entity as distinguished from the Holding and the Manufacturing and therefore it cannot be bound by the decisions of the Holdings.

The duties of the directors as discussed here above are their equitable duties whereby they have duties of loyalty and to act carefully and diligently while acting on behalf of the company. Under these duties the directors are required not to act arbitrarily while exercising their discretion. The contravention of these duties on the part of the directors will invite penalty to be imposed on such directors.

Reference List:

ASIC v Maxwell (2006) NSWSC 1052.

Australian Insitute of Company Directors, General Duties of Directors, (2013) <https://aicd.companydirectors.com.au/resources/all-sectors/roles-duties-and-responsibilities/general-duties-of-directors>.

Brick & Pipe Industries Ltd v Occidental Life Nominees Pty Ltd (1992) 10 ACLC 253.

Chandler v Cape Plc (2012) EWCA Civ 525.

Corporations Act 2001 (Cth).

Corporate Law Economic Reform Program, Director’s Duties and Corporate Governance: Facilitating innovation and protecting investors, (1997) Commonwealth of Australia <https://archive.treasury.gov.au/documents/283/PDF/full.pdf>.

Northside Developments v Registrar General (1990) HCA 32.

Queensland Government, Corporations Act 2001 (Cth) (the Corporations Act), (2016) Department of the Premier and Cabinet. From https://www.premiers.qld.gov.au/publications/categories/policies-and-codes/handbooks/welcome-aboard/member-duties/corp-act-2001-c.aspx>.