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Lecture 8A Directors Duties (revision) and Shareholder Remedies

Revision

Insolvent trading/ Civil penalty provisions


o Elements to establish liability under s 588G(1)
1. A person is a director of a company
includes de-facto directors and shadow directors
does not include officers
2. At the time when the company incurs a debt
contingent liabilities (like guarantees) sufficient to constitute
a debt: Hawkins v Bank of China
deemed debts (s 588G(1A))
3. The company is insolvent at that time, or becomes insolvent by
incurring that debt
Solvent if the person is able to pay all the persons debts as
and when they become due and payable (Section 95A(1))
4. At that time, there are reasonable grounds for suspectin that
the company is insolvent, or would so become insolvent (MFS v
Miller)
o (Inadequate) defences to insolvent trading
reliance on management in circumstances where a director failed
to monitor the companys financial affairs is no defence (CBA v
Friedrich)
directors are expected to take an active part in the managing or
monitoring the management of the company. Blindly delegating
this power and responabiility would not satisfy this duty
o Defences to insolvent trading: s 588H
(2): reasonable grounds to expect (and did expect) that the
company was solvent
(3): reasonable reliance on the information form a reasonable
person who was responsible for providing the information to the
director: McLellans Case
(4): Justifiable non-participation: DCT v Clark
(5) and (6): reasonable steps to prevent the incurring of a debt
o Dont forget s 588V and X: Liability for insolvent trading by holding
companies
o Remedies for breach of general law duties
Duty of care, skill and diligence: equitable compensation; damages
Duty of loyalty: injunctive relief, declaratory relief, rescission,
account of profits, constructive trust
o Civil penalty provisions
Standing
ASIC can apply for a range of orders: s1317J(1)
Company can apply for a compensation order: s1317J(2)
ASIC
Declaration of Contravention: s1317E
Disqualification order: s206C (Need DoC)
Pecuniary Penalty order: s1317G (Need DoC)
Compensation Order: s1317H
o Release from liability
Shareholder ratification
GM must be full informed before resolution is passed
otherwise resolution ineffective: Winthrop v Winns

Arguable case that GM cant cure a statutory breach: Forge


v ASIC
Board ratification
Usually ineffective unless authorised by constitution or
replaceable rules. But see QLD Mines v Hudson.
The court
s1317S: where the director has acted honestly, and, having
regard to all the circumstances ought to be excused:
McLellans Case
The Constitution
Exemption prohibited, but attenuation ok: Whitehouse v
Carlton
Indemnification for some breaches prohibited: s199A(2)

-----------------------------------------------------------------------------------------Problem question Topic VI: Mandalay (26:10)

Intro
o What kind of company are we dealing with? Mandelay is a public
company
o What is its internal governance structure (i.e. does it have a constitution
or not)? No written constitution therefore it is governed by the
replaceable rules (s 135)
All management power is vested in the board of directors (s 198A).
This includes the power to:
Delegate its powers to a managing director (s 198C)
o Managing director
Mandelay is under Maxs directional control
Post-Daniels v Andersen there is little distinction between
executive directors and NEDs the only thing that differentiates is
the skills they have
Duty #1: Duty of care, skill and diligence
o Rebecca is a member (19% shareholder)
o She wants to know whether any of the directors are in breach of duty
under both general law and statutory law
o Max
He has a higher degree of responsibility
What is the duty that has been breached?
Intro line: Max facilitated the purchase of these properties
without adequate due diligence. He may have breached his
duty of care under general law and the statutory equivalent
under section 180.
General law
Max, as an executive director of Mandelay, he will have an
executive service contract, implied that he will act in care,
skill and diligence in the performance of his duties
Equity: court of negligence (PBS v Wheeler; Daniels v
Andersen)
Principle: test at general law for due care, skill and
diligence
o At general law, a director needs to exercise the care,
skill and diligence that a reasonable person would

exercise if they were in the same position and have


the same skills
o Given that he is a managing director, he may be held
to a higher standard than the other directors
Application to the facts
o He doesnt reveal the methodology of the $30m
valuation
o He didnt give the board any financial data
o By failing to reveal proper methodology and give
financial documents to the rest of the board
members, which is something a reasonable director
would have done, he breached his duty of care, skill
and diligence (a reasonable director would not have
done that)
Statute
s 180(1) mirrors the general law (ASIC v Adler; daniels v
Anderson)
Because there has been a breach of the general law, there
has been a breach of the statutory law
Defences to breach
s 180(2) business judgment rule
Max may argue that his failure to provide
methodology/financial reports was a business judgment
within the meaning of s 180(3)
Business judgment includes decision regarding business
decisions planning, budgeting and forecasting but he
bears the burden of proving all 4 elements of ASIC v Rich
(very high bar)
o Good faith
o Proper purpose
o No material personal interest: has a 30% interest in
the counter-party
o Director informs themselves of the subject-matter of
judgment: we dont have any evidence to suggest
that he knows the methodology where the $30m
came from.
He cannot rely on the business judgment rule (s 180(3))
Danny and Harley (no proper enquiry)
They voted on this property transaction
Reliance and delegation
D & H relied on Maxs advice
Need to consider the permissible bounds of reliance and delegation
under general law and statute
General law
o History: Re City Equitable (Roma J) (High distinction
stuff)
o Post Daniels v Andersen: the monitoring role is raised
cannot delegate some director duties
Everybody with a financial capability needs to
do their own due diligence
o Should they have turned their own mind to this
transaction or should they have relied on Max?

It is a $30m property transaction: it is pretty


unreasonable to rely on someone else for a
transaction of this size
Potentially conflicted Max raised he had a
personal stake in it; didnt provide the details.
This is another reason that they shouldnt have
relied on Max
Pre-emptive strike by Caroline before she left
the meeting: she said that $30m valuation
seems a little bit too high
All of the above 3 factors combined
should have led the directors to have
turned their mind to it
Danny: financial transactions are a nondelegable duty. You cannot avoid responsibility
(Daniels v Anderson)
Everybody else, made a decision based on a 20
minute presentation
o Breach of General law duty
Statute
o Only a couple of provisions we need to know
198A: holiday can delegate
198D: you can delegate, but the risk remains
with you
Risk is going to shift if you, as a director,
believed at all times on reasonable grounds
that your delegee would perform your duties
with the instructions youve given to them
and that after making proper enquiry, if the
circumstances indicated the need to make an
enquiry
o Can they delegate to Max? Sure, yes but if they
dont make an enquiry about the subject matter, then
theyre just as culpable
No proper enquiry
Defences
o Business judgment rule? No no proper enquiry

Caroline
What kind of company are we dealing with? It is a public company
so consistent with her obligations under s 195, Caroline plead her
conflict and left the meeting. If we see something like that we
need to look at PBS v Wheeler
Case: Mr Hamilton, who was the most experienced member
of the board, his decision making was so integral to the
transaction that he cannot call conflict and leave the
meeting. Can we distinguish the case from this case?
o (1) position of Caroline [she is a garden variety
director, not managing director] and
o (2) she did express some concern about the valuation
assigned to the company before the meeting [it would
be interesting to question the impact of that under s
195 should she have said nothing?]
Doesnt seem like she has a conflict of interest
Duty #2: s 181: Share allotment is there an issue of new shares to
finance the transaction
o

Paddington transaction entered into concurrently with a takeover offer


part of the consideration for that property transaction was an allotment of
shares
o General law
Duty to act in good faith for the benefit of the company as a whole
for a proper purpose Smith v Fawcett: the duty to act in good
faith under common law is a subjective test
However, subsequent case read this with an objective of the proper
purpose test (Howard Smith v Ampol; Hogg v Cramphorn)
2 limb test to determine whether director was acting for
proper purposes
o What is the power? Power to issue/allot shares
o How was the power used? Max will likely argue that
the share allotment was necessary to finance the
transaction of purchasing the properties
But is this a true reason? Need to look at the
entire circumstances of the case
Other purposes
Stymie Rebeccas takeover attempt
2 tests to prove dual-purposes
o Whitehouse v Carlton but-for
test: but-for Rebeccas takeover
offer, would this share allotment
have taken place? On its face
defeating a takeover is an
improper purpose: Howard Smith,
Hogg v Cramphorn. But there are
contours to this
Darvall: not improper
because directors were
getting a better deal for
their shareholders
Tech (Canadian mining
case): directors should have
discretion and if they think
it will cause substantial
damage to their company
they can issue shares.
Can we distinguish Tech and
Darvall?
No facts to suggest Darvall
case in this case
Pre-existing negotiations
were taking place in Tech
the company already
decided that they wanted to
go into a deal. There is no
side negotiations in this
case
Maxs self-interest
It is likely that a profit will come to that company (McGurley
v McCann???)
o Statute reflects general law
Duty 3: Conflicts (s182)
o

o
o

o
o
o

How can we get out of our conflicts at general law? A director cannot
place himself in a position where duties/interests conflict however, they
may do so if they have given full and fair disclosure to the general
meeting and the general meeting approves that conflict by ordinary
resolution (Winnthrop v Winn???)
Boardman v Fipps: Would a reasonable man looking at the circumstances
of the case see a real sensible possibility of conflict?
Has Max put himself in a position where interest and duty conflict?
Even if its not, Transvile Land the no-conflict limb: the validity of
a transaction cannot depend on the extent of the interest any
interest would invalidate a transaction (i.e. a strict approach)
Has there been full disclosure to the general meeting? No
Where do we come out with Max? Is he conflicted, given that no
exception can apply, at general law? Arguably yes.
Statute: Conflict disclosure (s 191)
What do we have to remember? s 191 (mandatory rule regardless
of public/private company)
Must disclose the nature and extent of interest has Max done
this? No.
Has Caroline satisfactorily disclosed her interest? Yes
s 195: if you are a director in a public company if you have a
material personal interest, you cannot attend/vote on the
transaction in the absence of a board resolution after all these
steps have taken place
Even though the board in this case have agreed to allow
him, there is no formal board resolution as required
Secret profits of Max
Regal Hastings: Need to show, that the act/transaction related to
the affairs of the company, came to the director in the course of
them managing that company, and the utilisation of their special
knowledge by virtue of them being a director ultimately resulted
in profit
Did the opportunity come to Max in his position as director
courtesy of some special information that was only available to
him?
Profit only came to him in his capacity as director
Mandelay board had considered Phillips street property and
rejected it therefore he was free to pursue it
Max will try and say that the company rejected it
He might try Regal Hastings style that the company
couldnt pursue it, didnt have enough cash
The opportunity came to him in his capacity as director they
talked about it he had special knowledge of that then he
entered into a side deal through his company
Statutory equivalent: s 182 and 183 apply to employees as
well (former directors, former employees, former officers etc)

True false questions: Topic VI Directors Duties


(A) Equitable Limitations on the Voting power of Majorities
Shareholder Remedies

Background

The Rule in Foss v Harbottle: where a wrong is done to the company the
company is the plaintiff (proper plaintiff rule)
Exceptions
o Ultra vires or illegal acts
o Absence of authorisation by a special majority of the company in GM
o Fraud in the minority
o Breaches of members personal rights
o Where justice so requires
Fraud on the minority
o the powers of the majority must be exercised bona fide for the benefit of
the company: Allen v Gold Reefs of West Africa
Main type of resolutions where fraud on the minority has been applied
o Misappropriation of corporate property and rights
Misappropriation of an opportunity that the company had been
actively pursuing = actual misappropriation amounting to fraud on
the minority: Cook v Deeks
C.f. when directors receive an incidental profit, rather than
stealing per se: Regal Hastings v Gulliver
In Cook v Deeks, there was breach of no conflict and breach of
proper purposes rule by directors impossible for directors to
argue they were acting for the benefit of the company according to
the formulation of fraud on the minority in Allen v Gold Reefs
o Release of directors duties
Traditionally, depended on the quality of the directors acts
complained of
Breaches where general meeting ratification or waiver would
seemingly be permitted include
Incidental profit: Regal Hastings v Gulliver
Failure to disclose an interest in a contract with the
company: North-West Transportation Co Ltd v Beatty
Duty to act in good faith and for proper purposes: Hogg v
Cramphorne
Winthrop Investments v Winns
Facts
o The Winns board engaged in defensive conduct in
response to an unwelcome takeover bid, by making a
diluting share issue to Burns Philp
o The Winns shareholders approved the directors
conduct
o The agreed assumption was that the directors didnt
enter into the transaction bona fide in the best
interests of the company, but rather to frustrate the
takeover
o Therefore it was assumed that this was a mala fide
(i.e. bad faith) breach i.e. intentionally not for proper
purposes
Issue: could the shareholders in GM validate such a breach?
Finding
o Exercise of power by the directors is voidable, but
not void possible for GM to relieve the breach of
duty, by waiving the breach
o Waiver can occur prospectively or retrospectively
o Purpose of the resolution must be clearly stated and
the nature of the directors breach clearly
o

disclosed by the directors seeking absolution (i.e.


similar stringent standards in relation to notices and
circulars)
o Impact on minority
This is very broad if you can identify a breach,
seems like at the GM shareholders can waive
anything
What is the impact on minority shareholders?
Less and less opportunities for them to bring
action against the company
No grounds to bring an action
o What happens where the Directors whose actions are
challenged themselves control the General Meeting?
If majority shareholders had the same improper
purpose as the directors that would amount to
fraud on the minority such that the breach
could not be cured: Residues Treatment and
Trading Co v Southern Resources
Alteration of articles (constitution)
A classic area for challenges under the doctrine of fraud on the
minority, since it was an obvious area of shareholder power to
pass resolutions
Traditionally, the test for fraud on the minority as set out in Allen
v Gold Reefs of West Africa
Peters American Delicacy v Heath
Facts
o Constitution contained 2 inconsistent modes of
making issues of bonus shares
Computed on amount of capital paid up on the
shares (Art 108); and
Computed on the number of shares held (Art
120)
o Constitution was altered to delete article 120, so that
thereafter the shares could only be distributed on the
basis of the amount paid-up on the shares
o The partly-paid shareholders challenged the
resolution
o The fact that an alteration prejudices or
diminishes some of the right of the shareholders is
not in itself a ground for attacking the validity of
the alteration
o A resolution to alter the articles that is made bona
fide for the benefit of the company as a whole and,
not exercised fraudulently and for the purposes of
oppressing the minority, will be valid
o Shareholders need not always have only the benefit of
the company in view, particularly when the question
which arises relates to the relative rights of different
classes of shareholders
Key principles
o Company cannot deprive itself of the power to alter
its articles
o Shareholders are able to vote for their own personal
advantage

If actions prejudice rights not automatically mean


fraud on the minority
Greenhalgh v Arderene Cinemas
Facts
o Mr Greenhalgh was a minority shareholder in
Arderene Cinemas and wished to prevent majority
shareholders, Mr Mallard, selling control
o Constitution contained a pre-emption clause, which
prohibited the sale of any members shares to an
outsider, so long as another member was prepared to
purchase them
o Company changed its articles, allowing existing
shareholders to offer any shares to person/members
outside the company, provided it was approved by
ordinary resolution
o Mr Mallard, the majority shareholders, wished to
transfer his shares for 6 shillings each to Mr Sol
Sheckman in return or $5000 and his resignation from
the board
Issue: was this resolution passed in fraud on the minority?
Finding
o Lord Evershed MR (which whom Asquith and Jenkins
LLJ concurred) held that the $5000 payment was not a
fraud on the minority
o None of the majority voters were voting for a private
gain
o The alteration of the articles was perfectly legitimate,
because it was done properly
Key principles
o Test for fraud on the minority is whether, in the
honest opinion of the shareholders, the alteration to
the article was passed bona fide for the benefit of the
company as a whole
o The company as a whole doesnt meant the
company as a commercial entity, but the shareholders
as a general body
o Look at the resolution and whether it is liable to
discriminate between majority and minority
AFT v Clyde Industries (not much detail required all we need is
the finding)
Facts
o The case involved a resolution directed at members
who held shares as a trustee under unit trusts
o The resolution stated that henceforth, such
sharheolders vould not vote unless they had received
the direction of the majority of unit holders
Expropriation of members shares
Gambotto v WCP
Facts
o Majority shareholders in WCP were wholly-owned
subsidiaries of Industrial Equity Limited and held
99.7% of the issued capital (compulsorily acquisition
was not possible under the Corporations Law)
o A notice of general meeting included a proposed
amendment to the articles, the effect of which was
o

o
o

to enable any member who was entitled for the


purposes of the Corporations Law to 90% or more of
the issued shares to compulsorily acquire the
remaining issued shares
In May 1992, the meeting took place and the
resolution was approved
The appellants contended that the purported
amendment was invalid as
The amendment was oppressive and thus
beyond the scope and purpose of the power of
alteration of the articles conferred by s 176 of
the Corporations Law (now s136(2) of the
Corporations Act); and
The amendment imposed restrictions on the
right to transfer shares within the meaning
of s180(3) of the Corporations Law (now
s140(2) of the Corporations Act)
Finding
It was a fraud on the minority
2-limb test: The power to amend the
constitution to expropriate the shares of
the minority can be taken only if
Onus is on the majority (shifting from
minority)
Limb 1: It is exercisable for a proper
purpose; and
o Application to facts: it is only right
the exceptional circumstances
should be required to justify an
amendment to the articles
authorizing the compulsory
expropriation by the majority of
the minoritys interests in a
company
Limb 2: Its exercise will not operate
oppressively in relation to minority
shareholders
o Procedural fairness
Full and complete disclosure
of all material information
leading to the alteration
(mandatory); and
An independent experts
valuation of the shares to
be expropriated (optional or
presumptive)
** centres upon quality and
extent of information
provided to shareholders
o Substantive fairness
Largely concered with the
price at which the shares
are expropriated (i.e. an
economic view of fairness)

Market price is relevant


insofar as expropriation
below market price is prima
facie unfair. However,
market price is not
determinative
A variety of other factors
must be considered when
assessing fairness including
assets of the company,
market value, dividends, the
nature of the company, and
its likely future
an expropriation may be justified where it
is reasonably apprehended that the continued
shareholding of the minority is
detrimental to the company, its undertaking
or the conduct of its affairs resulting in
detriment to the interests of the existing
shareholders generally and expropriation is a
reasonable means of eliminating or mitigatin
that detriment
McHugh J (same conclusion favour of minority
but on different basis)
fair price: questionable as to whether
the market price represented a fair price.
He stated judges cannot delegate to the
market the duties of courts to fix a fair
price for shares.
fair dealing involves how the
expropriation was structured, initiated,
negotiated, and disclosed
o Key views
Majority proper purpose
To avoid detriment (e.g. competition
Goal of majority sharheolders to reduce
the companys taxation liability did not
satisfy this test of validity
McHugh proper purpose
Did not restrict proper purpose to
avoidance of detriment
It was also a proper purpose to pursue
significant goal
Expropriation for a legitimate business
object was OK provided fair to
expropriated party
This test would permit a company to
pursue a tax advantage
Post-Gambotto Principles what really matters
Test 1: Constitutional amendment not involving
expropriation
o Prima facie valid unless ultra vires, beyond any
purpose contemplated by the companys articles or
oppressive
o Onus: on minority to establish fraud on the minority

Test 2: Constitutional amendment involving expropriation


o Prima facie invalid unless
Proper purpose
Fairness
o Onus: on majority

Shareholder suits

Background
o Minority shareholders had issues in bringing proceedings at general law
due to
proper plaintiff limb in Foss v Harbottle
derivative suit exception to the rule in Foss v Harbottle:
Fraud on the minority
Wrongdoers in control
Statutory injunction (s 1324)
o Historically, restrictions on standing could be by-passed under s 1324
which permits, inter alia:
Any person whose interests have been, are or would be affected by
conduct contravening the Act to apply for injunctive relief and
damages
o In the 1990s a number of cases interpreted s1324 narrowly, to prevent it
undermining the rule in Foss v Harbottle
o Led to introduction of the statutory derivative suit in Part 2F.1A which
replaces the common law rules regarding standing
Statutory derivative suit: Part 24.1A (ss 236-242)
o s 239: ratification of directors breach of duty by GM not an absolute bar,
but one of serveral considerations, including extent to which
shareholders were properly informed and voted for a proper
purpose
o s 236(3): abolishes the right at general law to bring an action or
intervene on behalf of the company
o Standing: Who can apply to the court for leave to bring a derivative
action?
A member of the company (or a related body corp)
A former member of the company (or rbc)
A person entitled to be registered as a member of the company (or
rbc)
An officer or former officer of the company
o When must the court permit a derivative action to proceed?
It is probable that the company will not commence the action
The applicant is acting in good faith
The action is in the best interests of the company
There is a serious question to be tried
The applicant gave the company 14 days notice of the intention to
apply for leave to bring the action OR it is appropriate for the court
to grant leave anyway
o What if the members ratify the impugned conduct? (s 239)
Will not necessarily prevent the bringing of a statutory derivative
action, however the court may take the ratification into account
Must be Well-informed
Acting for proper purposes when they voted to ratify the
conduct
o What costs orders can the court make? (s 242)

any orders it considers appropriate about the costs any of the


parties to a statutory derivative suit