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W2 Workbook (Workshop 2)
Company Law (2106AFE)
Griffith University
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2106AFE Company Law Workshop 2 No . Workshop Objective Key Law Further Reading Know it? 1 Explain the separate legal entity principle and CA: Salomon v Salomon Co limited liability with reference to relevant case Lee v Air Farming Macaura v law Northern Assurance Co 2 Identify holding and subsidiary companies in a 46, 47, Bluebird Investments Pty Ltd Ors corporate group v Graf 3 Understand the separate legal entity concept Walker v as it applies to corporate groups 4 Identify and apply the circumstances in which a Gilford Motor Co v Creasey v Court will lift the corporate veil, being an Breachwood Motors Re CSR Ltd exception to the separate legal entity concept v Young 5 Describe the characteristics of passive and active promoters Tracy v Mandalay Pty 6 Explain the common law and statutory duties of promoters 711, Erlanger v New Sombrero Phosphate Gluckstein v 7 Explain the remedies available for breach of duties and when rescission is not available Case law as above for remedies at common law Note: Cases denoted are provided in the textbook. Otherwise they are summarized in this workbook. 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............................................................................................. Lecture diagrams: Re Dar 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........................................................................................................... Workshop exercises: to be completed in class......................................................... Workshop exercise: for you to do before class......................................................... 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 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 share capital? A company 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 a holding company (s48(2)). Example: Corporate Group (shareholding) Company A Company B Company C Company D 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 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 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 debts. The Courts and the CA lift the corporate veil in limited circumstances. For example: Fraud: Re Dar 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 employees in the course of employment (remember Business Law?) 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 activities: CSR Ltd v Young (we discussed agency in the context of partnerships in Business Law) The lecture this week will refer to three key cases: Creasey v Breachwood Motors Ltd, Re Dar and CSR Ltd v Young 5 Lecture diagrams: Re Dar and Creasey v Breechwood Motors Pty Ltd Dar (D) sells license Company assets directors and Glyde (G) purchases license Quarry license holder Creasey Welwyn Ltd assets Welsh Slate Quarries Ltd promoters Dar and Glyde Breachwood Motors 7 sues transfers assets 8 which is outside their professional capacity. For example, an accountant sets up their own company, or a lawyer, whilst working on a company registration, receives shares or is appointed a director of the company on registration. A passive promoter is a person who takes no active part in the registration of a company, leaving it to active promoters. However their passive involvement must include two things: 1. Knowledge of the active plans for and 2. An understanding that they will share in any gains from the plan. For example, shareholders of one company that sells property under a preregistration contract to a new company may be considered passive promoters, as was the case in Tracy v Mandalay Pty Ltd below. Passive promoter: a person who knows the active plans for incorporation and understands that they will gain from incorporation Case example: Tracy v Mandalay Pty Ltd (1953) 88 CLR 215 Facts: One company (RSC) purchased land in Sydney for the purpose of the land to Mandalay Pty Ltd (Mandalay). Mandalay was to construct an apartment building on the land. The active promoters of Mandalay had encouraged persons to purchase shares in RSC with a view to making a profit once the land had been sold to Mandalay. The purchase of the land was funded persons purchasing apartments the and these purchasers became shareholders of Mandalay. Due to changes in building laws, the apartments were never constructed. Mandalay took action against the active promoters of Mandalay and the shareholders of RSC to recover the monies paid the purchasers (now shareholders of Mandalay). Decision: The persons who purchased shares in RSC were passive promoters. Although they took no active part in the formation of Mandalay, they knew of the active plans to incorporate and then sell the land to Mandalay, and understood (as evidenced their discussions with the active promoters) that they would make a profit from the plan. Duties of a promoter Promoters owe fiduciary duties to the company under common law and in limited circumstances, statutory duties. The two typical situations which raise the issue of duties are set out in Figure 1 below. These situations will be referred to in the case law and sections which follow. Figure 1 10 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 contract to the company they are promoting. The promoter can abuse their position 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 best interests. To regulate the conflicts, the law imposes a duty on promoters: 1. To disclose their interests in any contract to an independent board of 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 pounds. They then formed a company and sold the island to the company for 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 Erlanger. The directors ratified the contract and the 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. 11 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)). Note that the disclosure in the prospectus is made to future shareholders of the company. This may satisfy the fiduciary duties of disclosure in the event that the board of directors is not independent. Promoters responsible for preparing the prospectus must also ensure there are no misleading or deceptive statements or omissions in the prospectus, which includes information about their remuneration and interests (s 728). Remedies for breach of duties A breach of fiduciary duties entitles the company to claim remedies against the promoter. In particular circumstances, the external controller of a failed company or ASIC can take action on behalf of the company. If the promoters are on the board of directors of the company, it is unlikely that legal action will be taken against them. In these circumstances, the shareholders may wish to remove the directors and appoint independent directors, or alternatively, commence a statutory derivative or oppression action (discussed later in the semester). Common Law The main remedy for breach of duties is rescission. With rescission, the Court takes the position that the contract, the subject of the breach the promoter, never existed. This enables the Court to restore the parties to their position. For example, the effect of rescission in Figure 1, Scenario A is that the company returns the property to the promoter and the promoter returns the consideration that it received to the company. However, rescission will be unavailable in four main situations: 1. There is undue delay in the decision to rescind following discovery of the breach. The Court considers that delay represents acceptance of the 2. The company affirms the contract after becoming aware of the breach the 3. The company cannot be restored to its position. This may occur where significant changes are made to the property as otherwise a rescission order may be to the 4. An innocent third party acquires an interest in the property. For example in Scenario A (Figure 1), if all or part of the property was sold to a third party, the Court cannot generally ask a third party to return the property to the promoter 13 as the promoter and third party were not the parties to the original preregistration contract. Rescission: A Court order that has the effect of restoring the parties to their precontract position Another remedy referred to in the case law is equitable compensation. Equitable compensation represents the losses that would not have been incurred the company but for the breach of duty (Aequitas v AEFC NSWSC 14 at per Austin J). Equitable compensation: an amount representing the loss that would not have been incurred the company but for the 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 NSWSC 14). In other words, the company will be compensated for any loss that enables the company to be restored to its 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. Note that an account of profits is unavailable as a remedy if the company elects not to rescind the contract (refer further textbook and Gluckstein v Barnes for a limited exception to this rule). 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 transfer property to the 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 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. 14 Workshop exercises: to be completed in class Exercise 1 (Workshop objective 2) Logan Butchers Pty Ltd is the registered shareholder of of the shares in Raw Hide Pty Ltd. The other of the shares are spread amongst 3 shareholders, Steven, Desmond and Gerald. Steven and Desmond each own of the shares in Raw Hide. Logan Butchers is the proxy holder for shares. The proxy can be revoked written notice from Gerald to Logan Butchers. Logan Butchers has agreed in writing to vote according to wishes in relation to the proxy. Raw constitution provides that it must have 5 directors, and that Logan Butchers has the power to remove 3 of the directors. Is Logan Butchers the holding company of Raw Hide? Exercise 2 (Workshop Objectives Jill was the owner of a small island located on the Gold Coast. Jill had development approval for the construction of a luxury apartment complex. Jill appointed Gina and John to set up the company Leisure Properties Pty Ltd to find shareholders and enter into all relevant arrangements for its registration and operations. Gina and John (on behalf of the company yet to be registered) entered a contract on 11 May with Jill to purchase the land for million. Jill had purchased the land on 2 February for a price of million. Jill, Gina and John became directors. Immediately after incorporation on 8 July, the Board of LPT held a meeting during which Jill disclosed her profit of to the directors and the contract to purchase the land was ratified all directors. Gina and John receive legal advice on 12th July that there is a breach of duty. Advise LPT as to whether Jill: 1. Was a promoter of 2. Breached any statutory or common law duties owed to and 3. The remedies (if any) LPT has against Jill. HINT: Draw a Diagram it provides you and the reader with a better understanding of the facts 16 Workshop exercise: for you to do before class Anita and her business partner Bertha had successfully run their florist shop in partnership for the last ten years. The partnership makes a large profit and Anita and Bertha pay a large amount of income tax on their respective shares of partnership profit. After their accountant tells them that they are paying a higher average tax rate than the company tax rate they decide to form a private company limited shares to acquire the florist shop. After registering the new company in accordance with the Corporations Act, Anita and Bertha sell the florist shop to Flowers R Us Pty Ltd for Flowers R Us Pty Ltd paid for the florist shop providing the following consideration: Anita: fully paid shares and Cash Bertha: shares paid to 50c on each share and mortgage debenture secured over the florist shop. Flowers R Us Pty Ltd borrowed from Best Bank to pay the cash amount to Anita. Anita is appointed managing director of Flowers R Us Pty Ltd at a salary of per annum. Initially the company is successful, however after a long drought and unseasonal weather the company begins to lose orders from their regular customers. Best Bank notifies Flowers R Us Pty Ltd that they have failed to make two progress payments due on their loan. The financial records indicate that the business may be in financial difficulty once their suppliers begin demanding payment for flowers supplied. An extraordinary shareholders meeting is called where the members decide that the company should go into voluntary liquidation and be wound up. Cameron has been supplying flowers to the florist shop since Anita and Bertha first commenced business and continues to do so after Flowers R Us Pty Ltd is registered and acquires the florist shop. Cameron is owed Flowers R Us Pty Ltd. When Cameron hears that the florist shop is struggling financially he speaks to Anita who tells him that the company has been placed into voluntary liquidation and that as Cameron is an unsecured creditor, he might not recover the amount of his debt from Flowers R Us Pty Ltd. 1. Advise Cameron and Best Bank as to whether they can recover any of the monies owed to them from Anita or Bertha. 2. Advise Anita and Bertha if the Liquidator of Flowers R Us Pty Ltd can require either of them to make a contribution towards paying the debts. 3. Advise Bertha whether she has a right to recover moneys owing under the debentures issued the company to her. Note: You only need to apply the law when answering each question 17 What do I need to do? Your answer in a hypothetical should involve three sections Issue, Law and Application and Conclusion. Many students are very brief when it comes to the Application 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 am I writing 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 not acting in good faith as required 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 not acting in good faith as required 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 o Then add the word in the first sentence. using 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 is the holding company of B, the subsidiary, because A controls the composition of Your next sentence 19 will explain why A controls 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 Law and 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 Law and Application is correct? You should be writing full sentences in the Law and Application. See how much I wrote for the Law and Application to the practice hypothetical question in the next section of this workbook on lifting the corporate veil. Remember the Law and Application: 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 GR Services Pty Ltd Gold River Ltd holds 55 of 100 shares in GRS. GRS owns and operates a gold mine at Mataranka, Northern Territory. Gold River supplies all of mining equipment. GRS pays GR for each piece of equipment an amount equal to Cost of Goods Sold Scientists recently discovered that 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 potential liability to its current and 20
W2 Workbook (Workshop 2)
Course: Company Law (2106AFE)
University: Griffith University
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