Sources Of Company Law In Australia Law Company Business Partnership Essay

Published Date: 02 Nov 2017

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Corporations Law

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LWZ315 – Corporations Law 

Introduction

Sources of company law in Australia

Come from three main areas: – the common law – statute law and under the Corporations Act 2001 (Commonwealth) – a company’s constitution.

Directors’ duties, responsibilities and obligations

Australian company director’s duties are to act in the company best interests, and promote good governance including putting their company’s interests in front of their own. They have a duty to function in good faith for the interests of the whole of the company, and must not act for any improper purpose. They have duties of diligence, care, avoidance, conflicts of interest, not use their position for any improper purpose or trade while insolvent.

Director’s common law duties

Directors must act with honesty or good faith and comply with the test in Whitehouse v Carlton Hotel Pty Ltd [1] . Directors have a duty to subjectively give proper consideration for their company’s interest Walker v Wimborne [2] A director must have reasonably believed that his transactions are for the companies benefit and the shareholders as a collective group. Charterbridge Corporation Ltd v Lloyds Bank Ltd [3] Directors powers mustn’t be used for an improper purpose especially if they obtained an advantage personally Mills v Mills [4] or by defeating the existing shareholders by making a new majority Comptroller of Stamps v Howard-Smith [5] but raising of capital could be a proper purpose Comptroller of Stamps v Howard-Smith [6] or for taking an advantage of an opportunity of a genuine favourable commercial decision Pine Vale Investments Ltd v East Ltd & East Ltd & Anor [7] But when benefitting the company, a director may be indirectly promote their own interest Mills v Mills [8] Directors have a duty of knowing their actual financial affairs including its solvency, these decisions must be independent and informed, they can’t claim ignorance of company affairs Statewide Tobacco Services Ltd v Morley [9] Directors must place themselves in a position where there decisions are in the company’s best interest ANZ Executors & Trustee Co Ltd v Qintex Australia Ltd. [10] 

Statutory duties

Corporations Act chapter 2D states the duties of diligence, care, improper use of information and position, good faith and criminal offences. Other provisions are insolvent trading, financial benefits to related parties, disclosure of material personal interests, reliance on delegates, financial reporting, and the company constitution and replaceable rules. Sections 180 – 184 sets out the rules of duty of care, diligence and the business judgment. A director or an officer of a corporation must discharge their duties and exercise their powers of a standard of a reasonable person, with an objective standard of care, which is of a consistency of an equivalent fiduciary duty, with subjective elements of an officer when assessing if a duty has been breached AWA Ltd v Daniels. [11] 

When insolvent a director must not continue to trade, if the director was dishonest when incurring the debt or continues to trade when insolvent they commit a criminal offence. [12] The director has a duty to protect the shareholders welfare in the company Woodgate v Davis [13] A director must ensure they act at "arm’s length" when they are involved in any financial benefit that may impact on themselves (s210) [14] When a director has a material personal interest relating to their company affairs they must notify the other directors of their company of that interest. [15] 

Company constitutions

A Company’s internal management rules provide information on the director’s duties by stating their obligations in their company’s constitution. The company’s management is controlled by the provisions in the Corporations Law that can apply to their company if they decide to have a constitution instead of "replaceable rules" or they can combine them both. A company may decide to have their own constitution or the replacement rules or a combination of both. [16] 

The replaceable rules and constitution have the effect of having a contract between each director and secretary and the company, where each agrees to adhere and observe the constitution and rules. [17] 

Board Positions

The board

The directors operate as a board and the board may if their articles permit, they will delegate their powers to a sub-committee or to an individual director.

Non-executive directors

These directors are, usually directors who have no executive powers that are approved by the board. Even though they do not have executive powers, they have voting power at board meetings and usually have the same similar duties as executive directors.

Executive directors

Executive directors are usually employees with powers granted to them by the board or under a service contracts.

Managing directors or sometimes they are called a chief executive officer. They are given

more extensive powers by the company's memorandum of articles or by a special board resolution. [18] 

Penalties

Criminal Penalties

The maximum penalty is a fine of $200,000 or five years imprisonment, or both (Schedule 3 of the Corporations Act). Section 206B of the Corporations Act provides for automatic disqualification from managing a corporation for criminal convictions.

Civil penalties

The Australian Securities and Investment Commission (ASIC) is the national body responsible for company registration and securities regulation in Australia. Under the Corporations Act, ASIC can ask the court for a: civil penalties declaration of contravention, pecuniary penalty order, compensation order. The court may order a pecuniary penalty of up to $200,000 Disqualification from managing corporations Section 206C of the Corporations Act gives the court power to prohibit a director from managing a corporation for breaking a civil penalty provision. The courts have the power to grant officers (which include directors) relief from civil liability if the person has acted honestly and ought to fairly be excused.

Changes to Statutory and Common Law

Changes to both statutory and common law duties have occurred in relation to directors governance, this has been in response to the changing business environment which has occurred over the last 30 years with the strengthening of the Australian economy, which has largely been fuelled by corporate growth. But despite this growing corporate environment there has been some spectacular failures ranging from the massive corporate excesses of the 80’s to the collapse of such business heavyweights such as HIH [19] and One.Tel [20] , this has resulted in a much need toughening of the rules of corporate governance in relation to company directors through both statute and common law.

A recent corporate collapse which has caught the attention of both the media and ASIC is that of LM Investments. [21] LM Investments a company that claims to have three billion dollars’ worth of assets under management has recently been placed into voluntary administration.

The company seems to have lost investors funds many of whom were retired or the soon to be retired, while at the same time the director of the company paid himself millions in fees. [22] The current situation seems to highlight the strong possibility of breaches under both statute and the common law.

In 1925 a test was laid down in the case of Re City Equitable Fire Insurance Co Ltd. [23] The test was based upon an officers skill, knowledge and experience, as with the afore mentioned changes to the environment in which corporations operate have changed dramatically since 1925 and in response to these changes the federal government introduced The Corporations Law Reform Act 1992 (Cth). The act sort to bring about a more objective approach to corporate governance, until the introduction of the act, the duties expected of directors under common law were the low by any standard. [24] 

In the same time frame as the introduction of Corporations Law Reform Act [25] was the AWA case [26] which also introduced a far more objective and stringent test under common law than the subjective test that was given by Romer J in Re City Equitable Fire Insurance Co Ltd. [27] .

It was at this time that the common law principles were incorporated into legislation under s180 (1). [28] 

Section 180(1)

A director or other officer of a corporation must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would exercise if they:

(a) were a director or officer of a corporation in the corporation’s circumstances; and

(b) occupied the office held by, and had the same responsibilities within the corporation as, the director or officer.

In the situation which is being faced by the director of LM Investments the court may ask if a reasonable person in the place of the director would have exercised the same care and diligence as the director of LM Investments, on the initial look into the company a court may find it very hard to support any defence that the director acted with the correct degree of care needed to fulfil his corporate duties. [29] 

In Vrisakis v Australian Securities Commission, Ipp J compared the tests for assessing breach of the common law and the statutory provision and found that the two are different in nature. This is due to the common law of negligence is centred on the duty to avoid causing harm by engaging in conduct that unreasonably creates a risk of harm. However, Ipp J stated:

The statutory duty of care and diligence involves an assessment of harm, whether the company director acted in a manner that no reasonable director would have acted, in light of the extent of the risk of harm to the company that the conduct created. This risk must be balanced against the potential benefit that the company could have received through the conduct. [30] 

One of the main arguments given in defence of directors is that without a degree of risk taking by company directors that a company will become stagnant and will not be dynamic, however this argument seems to be rendered ineffective in the face of the duty of care owed by company directors towards their investors and those who they have dealings with. [31] 

Negligence

ASIC v Vines , [32] makes a clear link between the statutory duty of care under the Corporations Act [33] and the developments within the common law tort of negligence.

Austin J relied upon the famous High Court negligence case of Wyong Shire Council v Shirt to help determine what a reasonable person would do. Consideration of the degree of the risk and the probability of loss occurring are examined, also taken into account would be any possible challenges that the defendant may have, these factors are important in determining what a reasonable director would do in the given circumstances. [34] The negligent behaviour may lie in the fact that obvious harm was suffered by the investors with the significant loss of investor funds, it may also be important to the courts to know at what time the director gained knowledge that the company was about to become unable to fulfil its corporate and financial obligations. [35] 

It is likely that a breach of a fiduciary duty has taken place; of note is the lack of ability of the managers to successfully manage the funds which would seem to be a breach of a duty of care. [36] Yet at the same time the director would reward himself with millions of dollars in fees as the company was losing investors funds and the company was on the brink of voluntary administration. [37] 

The directors of the company may also have the possibility of facing charges for negligence under the common and statute law for their poor handling of the business. It is highly probable that if the case should go to court that the director may face liability on the grounds previously discussed. With the size of the corporate environment in Australia only seems to get larger and more complex it would suggest that if current trends continue the laws in regards to company directors will only get more stringent in nature as time continues.

Remedies:

Remedies generally could be divided in into two forms: A) Common law remedies and B) Statutory remedies (Reference 1 [38] ).

Common law remedies

The common law duty of care, skill and diligence provides a remedy for the company to sue for damages considering that it can prove that the director’s negligence caused it to suffer loss.

The breach of the fiduciary duties could give rise to equitable compensation, an account of profit, an injunction, a constructive trust or a rescission.

Statutory remedies

A breach of ss 180–183 and 588G requires the court to issue a declaration of contravention under s 1317E.The issuing of a declaration is noteworthy because it allows ASIC to apply for a pecuniary penalty order under s 1317G, and to apply to the court for an order that the director be disqualified from managing corporations under s 206C. The court may also order that: a) the director pay damages to the company: s 1317H. b) An injunction be imposed restraining the future breach of duty: s 1324. c) A receiver is appointed over the property of the company: s 1323.

There is also a civil penalty provision. Part 9.4B (Civil consequences of contravening civil penalty provisions, ss 1317DA - 1317S provide a more flexible punishment which is not as severe as imposing criminal law punishment on directors who fail to meet community standards of conduct. Seeking this type of civil penalties offer a major benefit of operation because using civil court procedures has a lesser civil burden of proof, based on the balance of probabilities rather than the criminal procedures with a judge and jury [39] . However, it is worth noted that all the provisions of the Corporations Act 2001 are consider criminal offence, unless the specific provision in question states otherwise: s 1311. An example of such an exception concerns the statutory duty of care and diligence which is not subject to criminal penalties: s 184.

Statutory defences

There are three main defences that a director may invoke in respect of an alleged breach of duty under s 180(1) or the common law equivalent. These are:

delegation of responsibility to others;

reliance upon others; and

business judgment rule.

Delegating responsibility to others (Reference 1)

Under statute, s 198D provides that directors may delegate powers and functions to a subcommittee of the board of directors; see also Romer J ruling in Re City Equitable Fire Insurance Co Ltd [40] ; AWA Ltd v Daniels [41] per Rogers CJ. However, directors are responsible for the actions of the persons to whom they delegate their powers and functions: s 190.

Section 190(2) states that a director is not responsible for the decisions which have been delegated under s 190 if:

the director believed on reasonable grounds that at all times the delegate would exercise the power in conformity with the duties imposed upon directors of the company by both the Corporations Act and the corporate constitution; and

the director believed on reasonable grounds and in good faith and after making proper inquiries (if the circumstances indicated the need for an inquiry) that the delegate was competent and reliable.

Furthermore in cases like Sheahan v Verco [42] it is mentioned that directors have a positive obligation to monitor the company’s performance and to ensure that management are held accountable. There is a difference between delegating tasks to subordinates, especially in large and complex corporations, and ignoring the role of director by totally relying upon management without independent supervision.

Reliance on others (Reference 1)

Section 189 states that directors can reasonably rely on information or advice provided by others only if:

the reliance is made in good faith; and

the director only relied on the information or advice after making an independent assessment of the information or advice in the context of the director’s position and the company’s operational complexity.

It can be seen from Sheahan v Verco, above, that the directors in breach of their duties could not comply with s 189 because they failed to make any independent assessment of how the managing director was managing the company.

Business judgment rule (Reference 1)

When Parliament introduced the refined statutory duty of care and diligence in s 180(1), they also introduced a statutory business judgment rule as a director’s defence against decisions resulting in commercial failure and causing harm or loss to the company: s 180(2).

The statutory business judgment rule in s 180(2) is narrow in its application; see also ASIC v Adler [43] ; ASIC v Rich [44] . It can only be relied upon as a defence relating to the reasonable care and diligence under s 180(1) or the equivalent under the common law. This is a defence for all officers who are to be taken as complying with the duties in s 180(1) and their common law equivalents if all the following conditions are satisfied:

the business judgment was made in good faith for a proper purpose;

the officer does not have a material personal interest in the events;

they inform themselves about the subject matter; and

they rationally believe that the judgment is in the best interests of the corporation.