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Study Guide - Week 2 - Lecture notes 2
Company Law (2106AFE)
Griffith University
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BSL305 Company LawPreview text
Study Guide – Week 2 Company Formation: separate legal entity concept and exceptions; corporate groups; promoters No . Seminar Objective Key Law 1 Explain the separate legal entity principle and CA: 124; 516; Salomon v Salomon & Co Ltd*; [3]-[3] limited liability with reference to relevant case law Lee v Lee’s Air Farming Ltd*; Macaura v Northern Assurance Co Ltd* 2 Identify holding and subsidiary companies in a 46, 47, 50; Bluebird Investments Pty Ltd & Ors v corporate group Graf N/A 3 Understand the separate legal entity concept as Walker v Wimborne* it applies to corporate groups [3]-[3] 4 Identify and apply the circumstances in which a Gilford Motor Co v Horne*; Creasey v Court will lift the corporate veil, being an Breachwood Motors Ltd; Re Darby*; CSR Ltd v exception to the separate legal entity concept Young [3]-[3] 5 Describe the characteristics of passive and active Tracy v Mandalay Pty Ltd* promoters [4]-[4] 6 Explain the common law and statutory duties of promoters 711, 728; Erlanger v New Sombrero Phosphate Co*; Gluckstein v Barnes* [4]-[4] 7 Explain the remedies available for breach of promoters’ duties and when rescission is not available 729; Case law as above for remedies at common law [4] Further Reading Harris, Corporations Law Note: Cases denoted by * are provided in the textbook. Otherwise they are summarized in this Study Guide. Know it? (Y/ N) Answers to revision questions: (d), (c), (b), (e) 1 Contents Separate Legal Entity Concept.................................................................................... Video: What is the Separate Legal Entity concept?................................................. Corporate Groups........................................................................................................ The separate legal entity concept and corporate groups............................................ Lifting the Corporate Veil............................................................................................. Video diagrams: Re Darby and Creasey v Breechwood Motors Pty Ltd................. Promoters.................................................................................................................... Duties of a promoter.................................................................................................... Fiduciary Duties........................................................................................................ Statutory Duties...................................................................................................... Remedies for breach of duties................................................................................... Common Law......................................................................................................... Statute.................................................................................................................... Criminal Law........................................................................................................... A guide to answering a hypothetical.......................................................................... Revision hypothetical question and answer.............................................................. Revision Questions.................................................................................................... 2 B is to vote at the meeting, and the number of votes B has is more than 50% of the total votes that can be cast at the meeting, then shareholder B is a holding company (Bluebird Investments Pty Ltd & Ors v Graf & Ors) When does a company “hold” share capital? A company “holds” shares if it is a registered shareholder. If a company is merely holding the shares in a fiduciary capacity, such as a trustee, then the shares are not treated as being held by a holding company (s48(2)). Example: Corporate Group (shareholding) Company A 75% Company B 55% Company C 60% Company D 80% Company E Company A would be the holding company and Company B, C, D and E would be subsidiaries in this corporate group. Company E is also a subsidiary of Company D Case example: Bluebird Investments Pty Ltd & Ors v Graf & Ors1 Facts: Bluebird Investments Pty Ltd (BI) had a minority shareholding in Graf Holdings Pty Ltd (GH). One issue before the Court was whether BI was in a position to control more than half of the votes able to be cast at a general meeting of GH despite being a minority shareholder. Held: Control in terms of voting rights is different to control over the composition of a company’s board. Holding unrestricted proxies represent votes that one entity can control the casting of. However any restrictions on how the entity can vote, for example an agreement with the shareholder to vote in a particular way, would not constitute control. In this case there was no evidence to support the argument that BI was in a position to control more than half the voting shares of GH. 1 Part of case headnote in CCH Australian Company Law Cases online database available from the CCH Company, Corporate and Securities Law library, 2014 4 The separate legal entity concept and corporate groups The separate legal entity concept also applies to corporate groups. Each company in the group is separate from the other companies. The case examples in your textbook include Industrial Equity Ltd v Blackburn and Walker v Wimborne which provide two key lessons: First, if one company in the group is insolvent, the creditors can only claim from insolvent company, not the other companies in the group. Second, a director of a company only owes duties to that individual company, not the entire group. For example, company A purchases goods from Company B at a substantial undervalue. Company A director only owes duties to Company A, not to company B to ensure that it didn’t get ripped off. Lifting the Corporate Veil Video: What is the corporate veil and when will it be lifted? The corporate veil is a term used to illustrate the separation of the company from its shareholders and directors. A court will not generally look behind the veil to determine why a company was formed or the liability of a party. For example, the corporate veil ensures that shareholders are not personally liable to creditors for the company’s debts. The Courts and the CA lift the corporate veil in limited circumstances. For example: Fraud: Re Darby Avoidance of legal obligations: Gilford Motor Co Ltd v Horne and Creasey v Breachwood Motors Ltd Vicarious liability of companies for the negligent acts or omissions by employees in the course of employment (remember Business Law?) Directors’ liability for insolvent trading: s 588G CA. Directors are liable to pay compensation if they fail to prevent a company from incurring a debt where there are reasonable grounds for suspecting that it is insolvent (i. the company cannot pay their debts when they fall due) In cases involving a holding and subsidiary company: the holding company carries on business as agent for the subsidiary company, such that it controls the subsidiary’s activities: CSR Ltd v Young (we discussed agency in the context of partnerships in Business Law) The video in your materials this week refers to three key cases: Creasey v Breachwood Motors Ltd, Re Darby and CSR Ltd v Young 5 sues transfers assets 7 Promoters Promoters are associated with the formation of a company. The common law is the source for defining the term “promoter”. It recognises persons who are actively and passively associated with the company’s formation. For example a promoter includes: … Not only the persons who take an active part in the formation of a company and the raising of the necessary share capital to enable it to carry on business … (but also) … persons who leave it to others to get up the company upon the understanding that they also will profit from the operation may become promoters. (Tracy v Mandalay (1953) 88 CLR 215 at 242) What are the types of promoter? As the name suggests, an active promoter takes active steps in forming the company. An example of an active promoter previously addressed in the Week 1 Study Guide is Mr Salomon, the sole trader of a boot manufacturing business who set up a company and sold his business to the company (Salomon v Salomon & Co Ltd [1897] AC 22). Active promoter: a person who takes active steps in forming the company The steps taken by the active promoter may include: Finding the initial shareholders and directors of the company; Capital raising and completing associated documents (e. prospectus for public companies); Drafting the company’s constitution (if any); Entering pre-registration contracts on behalf of the proposed company (e. employment, supply and for credit); Completing the Form 201 Application for Registration as an Australian company and associated documents (e. consents, member register, resolutions); Payment of fees; and Appointing professionals to undertake these activities. Source (Form 201): asic.gov/asic/asic.nsf/asic+formsdisplayW? readform&code=201 The professionals referred to above may include lawyers and accountants. For example, the promoter instructs an accountant to prepare the Application for Registration and constitution, whereas a lawyer may be instructed to prepare supply contracts or the prospectus. However, this does not make the professional a promoter. The professional will be a promoter if they act or stand to gain in a way 8 Scenario A: Sets up Promoter (owns property) Sells property to Company X Scenario B: Sets up Promoter (owns property) Sells property to Company X (promoter is sole shareholder and sole director) Fiduciary Duties Promoters owe fiduciary duties to the company. These special duties require the promoter to act in good faith and avoid situations in which their personal interests and duties to the company do conflict or may conflict. An example of a direct conflict of interest is Scenario A. The promoter owns property and then sells the property under a pre-registration contract to the company they are promoting. The promoter can abuse their position by selling the property at an inflated price. The law recognises that conflicts are inevitable and that preventing the promoter from entering such activities in all circumstances may not be in the company’s best interests. To regulate the promoter’s conflicts, the law imposes a duty on promoters: 1. To disclose their interests in any pre-incorporation contract to an independent board of directors; and 2. To disclose all profits made because of their position as promoter to an independent board of directors (Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218). Case Example: Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218 Facts: A group of people known as a syndicate purchased an island believed to have mineral deposits for 55,000 pounds. They then formed a company and sold the island to the company for 110,000 pounds (this reflects Scenario A in Figure 4 above). Erlanger, the leader of the syndicate, nominated the directors of the company. A number of these directors were effectively controlled by Erlanger. The directors ratified the contract and the company’s shareholders were disadvantaged as a result. Decision: The syndicate, as promoters, failed to disclose their interests and profit in the island sale contract to an independent board of directors. The Court ordered that the contract be rescinded, which meant that the purchase price was returned to the company and the island was returned to the syndicate. 10 The reference to “independent board of directors” confirms that the promoter owes fiduciary duties before and after registration of the company and that the promoter cannot have a direct or indirect influence on the board at the time the disclosures are made. For example in Scenario A (Figure 1), suppose that the board of Company X included the promoter who voted, in their capacity of director, in favour of approving the pre-registration contract. In this situation, the board would not be independent. The independent board is designed to remove any bias or influence of the promoter on decision-making following registration of the company. In the event that the board is not independent, the promoter may fulfil their fiduciary duties by disclosing the interest to existing or potential shareholders. This is provided the initial shareholders are not simply the ‘cronies’ of the promoters (Aequitas v AEFC [2001] NSWSC 14). Such disclosure could be made in the company’s constitution, a prospectus or to shareholders individually or at a general meeting. However, it would appear that promoters are not subject to these fiduciary duties if they are the sole shareholder / sole director of a proprietary company (Figure 3, Scenario B). In this scenario: The two organs of the company are not independent; The promoter, in their capacity as shareholder, may suffer loss should there be a breach of any fiduciary duties; and The promoter, in their capacity as director, still owes fiduciary and statutory duties to the company which protects future shareholders’ and creditors’ interests. Statutory Duties Companies that raise capital by offering securities to investors must prepare and then lodge a prospectus with ASIC (s 709). Remember that the requirement to raise funds by way of a prospectus only applies to public companies (refer s 113(3)). A person who prepares (other than in a professional capacity), or instructs professionals to prepare the prospectus, is a promoter. The prospectus must include the following information about the promoter: 1. The nature and extent of any interests that the promoter holds, or has previously held in the last 2 years, in: the formation or promotion of the company; any property acquired or to be acquired by the company; and the offer of securities (s 711(2)); and 2. The amount paid or to be paid for the promoters services in connection with the formation or promotion of the company or the offer of securities must also be included in the prospectus (s711(3)(b)). 11 Another remedy referred to in the case law is equitable compensation. Equitable compensation represents the losses that would not have been incurred by the company but for the promoter’s breach of duty (Aequitas v AEFC [2001] NSWSC 14 at [433]; per Austin J). Equitable compensation: an amount representing the loss that would not have been incurred by the company but for the promoter’s breach of duty. The Court can order rescission and equitable compensation provided that the loss suffered is as a consequence of rescinding the contract (Aequitas v AEFC [2001] NSWSC 14). In other words, the company will be compensated for any loss that enables the company to be restored to its pre-contract position. For example in Tracy v Mandalay Pty Ltd (1953) 88 CLR 215, the company was able to recover taxes, council rates and other losses in connection with the contract. Statute An eligible applicant, which includes a liquidator, ASIC or an administrator, can take action against a promoter for fraud, negligence or breach of a fiduciary duty owed to the company under s 598. The Court can order the promoter to: pay money; transfer property to the company; or pay for loss or damage. For example, if a promoter sells property to a company at an inflated price without disclosing the profit the promoter made on sale, and this leads to the company’s insolvency, a liquidator or administrator may take action on behalf of the company. The liquidator may also be able to recover money or property from the promoter if the transaction which gave rise to the breach of fiduciary or statutory duty is voidable under Part 5 (covered later in the semester). A promoter of a public company is also liable to pay damages under s 729(1) if they are involved in a misleading or deceptive statement or omission of material required in the prospectus in breach of s 728. Criminal Law Promoters may also face criminal sanctions. A promoter commits an offence if they breach s 728 in a way which is materially adverse from the point of view of an investor (s 728(3)). The maximum penalty is a $340,000 fine and/or 5 years imprisonment (Schedule 3). The actions of promoters can also attract criminal penalties outside Company Law, as demonstrated in the case of Burnard v R, R v Burnard [2009] NSWCCA 5. The case arose from the collapse of the Westpoint group of companies (Westpoint). Westpoint raises a number of legal issues including the power of ASIC under s 50 of the ASIC Act 2001 (Cth) to take action on behalf of company participants (Study Guide Week 1). 13 COMPANY LAW IN THE MEDIA – WESTPOINT Westpoint was a group of development companies that raised mezzanine, or middle layer, finance to fund property developments. The mezzanine finance was raised through high interest, but unsecured, promissory notes (written IOUs). Burnard promoted the promissory notes for the development companies. He organised and attended promotional seminars of potential investors. During those seminars, Burnard introduced himself to investors as a “director of Kebbel Investment Bank” when in fact no such entity existed. This reference gave investors the impression that their funds were relatively secure as they had bank protection. Westpoint entered into a series of high risk developments which failed. The group collapsed with debts of approximately $600 million. Much of the investors’ unsecured funds were lost in the Westpoint collapse. Burnard was found guilty on nine criminal charges under section 178BB of the Crimes Act 1900 (NSW) (now repealed) of making or publishing a statement knowing it to be false in a material particular with intent to obtain a financial advantage for another person. Burnard received a 12 month suspended prison sentence and a $50,000 fine. This original decision was upheld on appeal (Burnard v R, R v Burnard [2009] NSWCCA 5). 14 What do I need to do? Your answer in a hypothetical should involve three sections – Issue, Application of Law and Conclusion. Many students are very brief when it comes to the Application of Law part of their answer. Application is the most important part of your answer (and the section which carries the most marks) as it requires strong analytical skills and written expression. When addressing the Application part, my tip is to continually ask yourself “why am I writing this?” Questioning yourself forces you to justify what you are writing and it is this justification that forms part of your Application. For example: o A student writes this sentence - Craig breached his fiduciary duties to the Company – why? o By not acting in good faith as required by section 180 Corporations Act – why? o As a director, he purchased shares in the Company using insider knowledge o What insider knowledge? – Craig accessed Board documents about a proposed merger. So the answer will now read: Craig breached his fiduciary duties to the company by not acting in good faith as required by section 180 Corporations Act. As a director, he purchased shares in the company using insider knowledge, being the Board documents about the proposed merger. If you are having trouble starting your application, my tips are as follows: o In the first sentence summarise the relevant law and place the names of the parties into the law; o Then add the word “because” in the first sentence. By using “because”, it forces you to justify what you have said in the first part of the sentence. o For example, on the issue of whether A is the holding company of B, you could write “A is the holding company of B, the subsidiary, because A controls the composition of B’s Board”. Your next sentence 16 will explain why A controls B’s Board. See how the Application is a process of justifying what you are saying? When you complete the Application section of your answer, ask yourself: o Have I applied all the relevant law in my answer? For example, one section of the Corporations Act may contain more than one key word or phrase that you need to interpret and apply. o Have I justified what I have stated in the Application using the law and relevant facts of the question to answer the issue? o Would a reader be convinced that what I have stated in the Application is correct? You should be writing full sentences in the Application of Law. See how much I wrote for the Application of Law to the practice hypothetical question in the next section of this Study Guide on lifting the corporate veil. Remember the Application of Law: o IS using the law that you identify and the facts relevant to the law you identify to answer the issue. o IS NOT copying large chunks of law from your notes / my notes / your textbook / your legislation o IS NOT simply repeating the law o IS the argument which supports the law. Revision hypothetical question and answer Karl was employed by GR Services Pty Ltd (“GRS”). Gold River Ltd (“GR”) holds 55 of 100 $2 shares in GRS. GRS owns and operates a gold mine at Mataranka, Northern Territory. Gold River supplies all of GRS’ mining equipment. GRS pays GR for each piece of equipment an amount equal to Cost of Goods Sold + 5%. Scientists recently discovered that GRS’s mining activities have contaminated the water supply. A number of former employees, including Karl, have contracted cancer because they drank the contaminated water. The GRS shareholders call a general meeting for the sole purpose of addressing GRS’s potential liability to its current and 17 19
Study Guide - Week 2 - Lecture notes 2
Course: Company Law (2106AFE)
University: Griffith University
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