COMPANY LAW TOPIC 2

THE CONSTITUTION OF
COMPANIES Chp 3 p 79
100, Chp 4 p 105 -124
When applying for registration
the promoters must first select
the kind of company they wish to
create- Sec 117, Corporations Act
 There are different kinds of
companies, groups and trusts
Have a brief general knowledge of the basic
differences but this is basic introductory
knowledge only. It will be assumed that you
have a basic understanding of these
differences as foundation knowledge in
tests and exams but it is knowledge that
will NOT be directly tested or examined.
BUT the information in Slides 13-22 could
be examined in detail in the mid semester
Test.
 Kinds of Companies Public &
Private
Section 9 Corporations Act 2001 provides for the definitions of companies.
and makes the DISTINCTION between PUBLIC Co. and a PRIVATE Co. (Pty
Ltd.)
Sec.9 a Public Co is a company other than a Proprietary Co.
The Act requires all companies to be registered with ASIC and keep a registered
business office. S 142 and:
A PUBLIC Co. is listed on the Stock exchange (ASX) ( a licensed public market)
where shares are issued for sale to the public.- A Private is not listed on the ASX.
- It must comply with ASX listing rules s 793 C ( regular disclosures) Private
does Not
- It must hold an Annual General Meeting ( AGM) and publish an Annual Report for
members with a statement of audited Financial Accounts s 301 including details of
the remuneration of its directors. S 292- 323D copies sent to ASIC. - Private No
- It must appoint a Company Secretary as administrator s 204A (2)- Private No
- It must have a minimum of 3 directors. - Private only needs 1 director and 1
member.
- Sec 203 D, E requires an ordinary resolution of members for the removal of any
directors, they cannot be removed by other directors.- Private No
 Kinds of Public Companies
Limited by shares is the most common kind of company
with approx 99% of all companies in Australia being limited
by shares where the liability of a shareholder is limited to the
unpaid value of their shares, see Sec 254, and Sec 515
516. They are all required to have Ltd after their name as
a warning to creditors see Sec 148(2).
Unlimited where no limit is placed on the liability of
shareholders once assets are sold, somewhat similar to a
partnership. It is not suitable for a trading company but is
useful for professional corporations such as Law Partnership
firms and Accounting Partnership firms that have professional
restrictions but want the advantages and features of
incorporation without limited liability by shares. There are
only approx. 600 of these in Australia.
 Kinds of Public Companies
continued:
Limited by Guarantee eg. Not for Profit
Corporations such as scientific
organisations, and charitable trusts: where
the company has no share capital equity but
raises its funds through donations, grants,
membership subscriptions and fund-raising
events. It is not suitable for a trading company
and there are about 9,000 of such companies in
Australia. The Constitution and Rules of the
company will prescribe the amount of the
guarantee that members have to make in the
event winding up or of a shortfall in funds.
 Kinds of Public Companies
continued:
A No Liability Company has the sole purpose in its
business of mining and has share capital which
members can pay in instalments but there is no liability
and shares can be forfeited, Sec 112(2),(3) and
254M(2), 254Q.
As a warning to creditors the company must put
the letters NL after its name, Sec 148(4) and Sec
156. There are approx. 1,000 of these type of
companies in Australia.
whereas
Private (Proprietary Pty Ltd) Cos make up the
majority of companies and are mostly limited by shares.
 Private ( Proprietary) Pty Ltd.
Differences between Large and Small
They do not have to hold Annual Meetings nor prepare Annual
Reports and Audits( unless the members request otherwise s 293 ),
and resolutions can be passed by the signing of circulating
documents ( s 249A) but they must still prepare profit and loss
statements. They must not engage in public fundraising see
section 113(3). Some Public Cos could use Pty Cos as subsidiaries
to avoid disclosure and audit requirements so a distinction has been
made between Large and Small Proprietary Companies.
Definition of small: must have any two of the following criteria :-
less than 50 employees s 113(1), operating revenue less than 25
million or assets less than 12.5 million. or
Single member company has 1 member/ 1 director and can
follow special modified rules. Part 1.5 of the Corporations Act
contains guidance for single member companies.
 Corporate Groups
Due to the Salomon Principle every company is a
separate entity where creditors only have rights
against the debtor company and directors only owe
duties to their own company.
In modern times corporate groups are commonplace
with 89% of listed public companies in Australia having
links to other companies. On average there are approx
28 companies in each group. A group will consist of a
parent ( holding)company with controlling interests in
several subsidiary companies. Efficiencies and market
advantages arise from different aspects of business
activities being divided amongst the group.
Controlled entities sec 50AA
There is a danger because of the effect of the
Salomon Principle that companies may use
corporate groups to avoid transparency and
move assets around the group to avoid
creditors and taxes.
To overcome avoidance of obligations, the
AASB Accounting Standard 127 requires an
entity that is a parent company of a group to
prepare consolidated financial statements
which include information on its investments
in its subsidiaries.
 Company Audits
All companies must keep financial records to allow
true and fair financial statements to be prepared.
Public companies and large proprietary companies are
required to prepare annual audited financial accounts
s 292, s 301.
Small proprietary companies do not have audited
accounts unless they are asked to do so by ASIC or 5%
of their shareholders.
Since CLERP 9, the HIH Royal Commission and the
Audit Reform and Disclosure Act 2004 there have been
new rules of disclosure and a strengthening of the
requirements for the independence of auditors.
The Legal Concept of a Trust
The development of Equity Law in the 16th Cent. saw the
creation of the Law of Trusts for charitable institutions and now
the use of the concept of a trust has become expanded into
modern business and corporations.
A trustee is appointed to hold and manage property on behalf
of beneficiaries. A trustee is in a position of trust and can be
liable for shortfalls in the Trust funds.
A trust is not a separate legal entity but exists according to a
formal agreement called a Trust Deed. A trust can continue for
the life of a person plus 21 years or alternatively in some states
for 80 years. There are no limits on the number of beneficiaries.
Beneficiaries pay individual income tax on earnings from their
trust property.
The law of trusts is state law.
 Kinds of Trusts
Fixed Unit Trusts where the trust pays a fixed rate of
dividend is used as a form of investment.
Discretionary Family Trusts where the trustee has a
discretionary power to vary the amount of income for
beneficiaries according to their needs and
circumstances are used by wealthy business people to
disperse their income amongst the beneficiaries thereby
dividing and minimizing the amount of tax that has to
be paid. eg.- The mining magnate Lang Hancock Family
Trust managed by his daughter Gina Reinhart who is the
wealthiest person in Australia, has recently seen
arguments between the beneficiaries and the trustee,
as also in the Solomon Lew Family Trust.
 Trustee Companies and Joint
Ventures
Because a company is a separate legal entity it
can act as a trustee of a managed fund.
Companies are used because of their limited
liability, tax benefits and perpetual succession.
Some companies have government approval to
act as executors and trustees for deceased
estates.
Joint Ventures are where individuals / companies
enter into a business arrangement by contract to
work together on a single project. The venture
comes to an end once the project is completed.
 Company Constitutions and
Replaceable Rules
Before 1998 a company had to submit a written Constitution when
applying for registration. It included a Memorandum of Association and
Objects Clause and Articles of Association.
After 1998 in Australia, in order to achieve greater uniformity and
improvements in standards of governance, default internal governance
rules were set out in the Corporations Act by s 134.
These rules are called replaceable rules and are set out in a table in s
141 in the Act and p. Of the Text. They make the requirement for a
Constitution for new companies obsolete. Some are mandatory and
some only apply to Public Companies ( s 249X for proxy votes) and
some only apply to Pty Companies ( s 203C for removal of directors) but
most rules however can be replaced thereby allowing a company to
develop its own constitution out of the default rules, s 135.
The rules deal with the appointment, powers and removal of directors,
meetings, classes of shares, payment of dividends, the transfer of
shares and rights of members.
Sec 141 examples of Replaceable Rules
See Table set out in Text p. 106 - 107
Appointment of Directors sec 201
Remuneration of Directors sec 202
Removal of Directors in a Pty Co. Sec 203
Directors may allow a member to inspect the Co
books sec 247D
The calling of meetings sec 248 & 249
Pre-emption rights for existing members sec 245D
Dividend rights sec 254W (2)
Directors discretion to refuse a transfer of shares
sec 1072
 Replaceable Rules and Constitutions
create a binding contract on members
In statute law sec 140 of the
Corporations Act:
A companys constitution and
replaceable rules that apply to the
company have the effect as a
contract:
(a) between the company and each
member
(b) between the company and each
director
 Cases law precedents for
sec 140 -
A company can take legal action against a member to comply with
company rules and a member has the right to take action to
enforce company rules:
Hickman v Kent [1915] 1 Ch 881- Hickman commenced a court
action complaining of irregularities in the conduct of the affairs of
the company. The company took a counter court action to stop
Hickman from proceeding by referring to an arbitration clause in
the company rules that required all disputes about internal
management of the company should be settled by arbitration not
by court action. The Court Held: that Hickmans court action could
not proceed because as a member he was bound by his contractual
relationship with the company and therefore must follow the rules
and submit his complaints to arbitration. (Text p.101)
The ratio of this case is: members have a contractual obligation to
follow the company rules and the company can enforce the rules.
 Cases continued
In Ely v Positive Government Security Life Assurance Co
(1875) 1 Ex D 20 Ely a solicitor and founding member of a
company was asked by the other members to draft the
Constitution for the company in return for an allotment of
shares. He included a provision in the Constitution that
made him the company solicitor for life. The other members
were not happy with this provision and they dismissed him.
Ely brought court action for breach of contract. The court
held: that Ely had no rights to protect, because the rules
only confer a contractual right on members when that right
relates to capacity as a member. Elys employment as
solicitor should have been set out in a separate
employment contract, it had nothing to do with the rights of
members of the company.
 Cases continued
In Re Carratti Holding Co Pty Ltd [1975] 1 ACLR 87,
the Company Constitution gave the majority
shareholders a pre-emptive right to make a
compulsory acquisition of a minority shareholders
shares. The court held: that because the acquisition
provision was in the Constitution then according to
precedent it would binding on all members as a
general rule, but in this case the circumstances
gave rise to the exception of another principle in
corporations law that oppressive and unfair
conduct against a member could be invalid.
( see Corporations Act sec 232) Later Lecture Topic
 Cases continued
In Forbes v NSW Trotting Club [1997] 2 NSWLR
515, the company that controlled racetracks made
a resolution to exclude Forbes, an undesirable
gambler, from its racetracks. Forbes took the
company to court on the basis that the resolution
did not comply with the rules in Constitution.
The court held: that Forbes had no right to
challenge the conduct of the company because he
was not actually a member of the company. Only
members can uphold their rights according to the
rules in a Constitution.
 Cases continued
In Shuttleworth v Cox Brothers [1927] 2 KB 9, five founding
members of a company agreed to specify in its Articles of
Association six circumstances in which a director would no
longer be able to continue. Shuttleworth failed to make
proper disclosure of financial dealings to the other directors
on several occasions, so this kind of failure was added as a
seventh circumstance. They then determined that
Shuttleworth was disqualified and expelled. A challenge by
Shuttleworth resulted in a court action. The court held:
The action by the other members/directors was valid. The
rules in a Constitution may provide for the appointment of a
director for life but can also be altered at any time subject to
the company using its statutory powers to alter the
constitution.
 Alteration of the Constitution and
Replaceable Rules
A Special resolution must be passed to alter the Rules in the Constitution. Sec 9
defines a Special resolution as one which is passed by at least 75% of the votes
of members entitled to cast a vote.
Sec 249H(1) requires at least 21 days notice of the intention to call a meeting to
propose a special resolution.
Sec 249L (1) (c) requires the notice to set out the details of the special resolution
Sec 135(2) provides that a Co may displace or modify any one or more of the
replaceable rules by adopting a Constitution.
Sec136(1) (b) provides that a Co can adopt a Constitution if it passes a special
resolution to do so.
Sec 136(2) provides that a Co can modify or repeal a Constitution by passing a
special resolution to do so.
Sec 136(5) A public Co that adopts, modifies or repeals its Constitution by special
resolution must lodge a copy of the change with ASIC within 14 days.
Sec 137 (a) provides that unless otherwise specified a special resolution that
adopts, modifies or repeals a Constitution takes effect on the date that the
resolution is passed.
Restrictions on the power to alter a Constitution ie oppression, class rights.
Restrictions on company changes to
their rules/ Constitution
See Text p. (116 119) any changes should be fair:-
Some restrictions due to fairness arise from statute law:
oppression remedy sec 232 provides that a member
can oppose a special resolution where the change is
contrary to the interests of the members as a whole, and
that is oppressive, unfairly prejudicial or discriminatory to
members.
variation of share class rights. The rights of different
classes of shareholders are usually set out in the
Constitution and these rights can only be varied or
cancelled through the use of a special resolution which is
approved by 75% of members and shareholders of the
affected class sec 246 B.
 Common law limits on the power to
alter Constitutions
The courts have become increasingly involved in imposing restrictions on companies that alter
their constitutions. Recent decisions have become complex in their attempt to find a balance in
regard to the rights of the majority vs the individual member, in the context of what is a proper
purpose for the company as a whole and what is fair for the individual and minority.
The leading precedent is found in the English case Allen v Gold Reefs West Africa [1900] 1 Ch
which established a two part restriction on the majority with the following tests- (1) the change
must be bona fide, and (2) must be for the benefit of the company as a whole.
Unfortunately the record of the courts in the application of Allens case has been confused and
inconsistent, with varying interpretations of the meaning of the phrase, for the benefit of the
company as a whole. For example in 1927 in the case of Shuttleworth v Cox, the Court upheld the
way in which the directors exercised their power, relying on the directors as the main shareholders
as having the best knowledge of whether the amendment was for the benefit of the company. This
approach was affirmed in later cases.
In Peters American Delicacy Co Ltd v Heath (1939) 61 CLR 457, Latham C.J. Held that company
as a whole means an entity separate from its shareholders.
But Dixon J. In the same case held that it means a corporate entity consisting of all shareholders.
Then Evershed L.J. In Greenlaugh v Arderne Cinemas Ltd [1951] 1 Ch 286, held that it just means
all the shareholders.
Recently in Gambotto v WCP Ltd (1995) 13 ACLC 342 the High Court of Australia held that where
the majority had a conflict of interest or held an advantage when dealing with minority shares
then the price must be fair, all financial information should be disclosed and the shares must be
independently valued.
 Sample Test/Exam
Questions
Explain the principles of law that were applied
and established by the Courts in each of the
following cases: Hickman v Kent, Elys case,
Re Carratti and Forbes v NSW Trotting Club.
(20 marks) or
Outline the relevant statutory provisions that
have been derived from Hickman v Kent, Elys
case, Re Carratti and Forbes case, and discuss
how these provisions apply and the
importance of the principles of law that they
uphold.
 Sample Test/Exam
Questions
Three friends form a Pty Ltd
company and one of them is a
solicitor who offers to draft a
Constitution for the company rules.
He puts a rule in the constitution that
he should be employed by the
company for life as the company
solicitor. Discuss with reference to
the relevant case law whether this
clause is binding or not.
 Sample Test/Exam
Questions
There is a dispute between the majority
shareholders in a company and the minority
shareholders over share rights. The minority
feel that they have been treated very unfairly
and want to make an application to have the
matter heard in a court but the majority point
to the fact that there is a company rule that
all disputes must go to arbitration. With
reference to the relevant law advise the
minority as to their rights. (20 marks)
Topic 2 Key Points of Focus
There are different kinds of companies, groups
and trusts. Introductory knowledge only.
Constitutions with Objects Clause,
Memorandum of Association and Articles of
Association are not required since 1998.
Sec 135, 140 and 141 Replaceable Rules
what are they and what is the nature of the
contract that they create? Explain the 5 case
examples of this contract and how it applies.
How can the Replaceable Rules be changed?