Enforceability of Contracts and Directors' Duties in Business Associations

This article discusses the enforceability of contracts and directors' duties in business associations, covering relevant sections of the Corporations Act 2001. It includes case studies and legal analysis.

LAW OF BUSINESS ASSOCIATION
Student Name
[Pick the date]

Question 1
Part (a)
The main issue is to tender advice to Raj and Alana with regards to whether the contract enacted
between Seedy Vineyards and Organic Wines Pty Ltd (OW) is an enforceable contract or not
taking into cognisance the following aspects.
 When agent Priya has entered into legal relationship with Seedy Vineyards irrespective of the
fact that she is exceeding the level of authority.
 Breach incurred of the objects clauses of OW’s constitution
Company holds a separate legal title from the owners as highlighted in s. 124(1). Company has
various agents who form legal relationships with the third party in the name of company. These
agents receive authority from the company to form legal contractual relations. These agents are
not liable for the contractual liabilities which they have formed on behalf of the company with
third party. When agents are forming contract in the name of company with the third party while
they are not having sufficient authority, then the relevant provisions applicable are highlighted in
s. 129, Corporations Act 20011. In accordance with this section, the third party has the legal right
to assume that the agent who works for the company holds requisite authority and hence enacts
the contract in good faith. The rights of the third party will be safeguarded under indoor
management rule as they have entered in good faith and do not have any clue regarding the lack
of authority of agents. As a result, the contractual liabilities raise from the enactment of the
contract by agent will be enforceable on the company and company has to discharge all the
contractual liabilities. Further, Royal British Bank v Turquand2 is the evidence of above
highlighted understanding3.
The exception of s. 129 is highlighted in s. 128, where the third party have reasonable suspicion
about the lack of authority on the part of agent4. It means when the third party has any hint,
1 Austlii, Corporations Act 2001- Sec 129 http://www5.austlii.edu.au/au/legis/cth/num_act/ca2001172/s129.html
2 Royal British Bank v Turquand (1856) 6 E&B 327 case
3 Jason, Harris, Corporations Law, (LexisNexis Study Guide, 2nd ed., 2014)
4 Austlii, Corporations Act 2001- Sec 128 http://www5.austlii.edu.au/au/legis/cth/num_act/ca2001172/s128.html
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knowledge or suspicion about the lack of authority of the agent and still has enacted a contract
with the agent then, the contract would not be enforceable on company5.
The relevant provision with respect to the objects clause is s. 125 (2) that indicates that breach of
only the object clauses by the agent would not limit the activity of the company thereby not
making it illegal. In other words, 125 (2) provides wide scope for the course action of company
while making legal relations with third parties even through there is breach of object clauses
which is mentioned in company’s constitution6.
In present case, Priya has been appointed as the managing director of Organic Wines Pty Ltd
(OW) and has the authority to work on behalf of OW and to form contracts with third parties.
Priya has entered into a contractual relationship with Seedy Vineyards. However, it has been
found that she does not hold required authority which is evident from the two factors which are
listed below.
 Priya has been appointed as the managing director of Organic Wines Pty Ltd (OW) for a
tenure period of 2 years which ended in February 2018 and therefore, it is essential to
reappoint her on the position of managing director so that she can again work for OW.
However, she has not been reappointed for the position and therefore, as per the constitution
of the company she does not have authority to work as managing director of company after
February 2018. However, she has enacted a contract with Seedy Vineyards In June 2018
which is invalid.
 It is clearly stated in the constitution of company that she cannot form contracts for any
transaction higher than $100,000 but she has formed a contract with Seedy Vineyards for
$500,000 which is in violation with the company constitution.
Therefore, the conclusion can be drawn that Priya has formed the contract with Seedy Vineyards
while holding lack of authority from OW. Further, it is essential to note that Seedy Vineyards
does not have any hint or suspicion about the lack of authority of Priya as she was working for
OW for more than 2 years and hence, Seedy Vineyards has entered into contract in good faith.
Thus, indoor management rule will be enforceable here as per s. 129, Corporation Act 20017.
5 Julie, Cassidy, Corporations Law Text and Essential Cases, (Federation Press, 4th ed., 2013)
6 Austlii, Corporations Act 2001- Sec 125 http://www5.austlii.edu.au/au/legis/cth/num_act/ca2001172/s125.html
7 Ibid. 2.
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Therefore, the company OW will be held accountable for the contract enacted on the part of
Priya. Also, it is apparent that objects clause of constitution of company has specified that only
organic grapes should be used for wine. However, Priya has formed contract for purchasing
inorganic grapes from Seedy Vineyards which indicates the breach of objects clause. Here, s.
125(2) will be applicable and breach of objects clause will not limit the authority of agent and
therefore, the contract will be enforceable on OW irrespective of the breach of object.
Part (b)
The main issue is to find whether the clause in the company constitution regarding Ted
appointing himself as solicitor of would be legally enforceable or not. Further, breach of this
clause would also be examined and available remedy would be provided.
As per s. 140 Corporation Act 2001, provisions stated in company’s constitution forms an
imperative aspect to run the company smoothly8. The contractual associations among various
members and directors and with the company are defined by the various clauses of the
constitution. It is essential that members & relevant agents of the company must conduct as per
the clauses of constitution. Further, as per Part 2F, when a member suffers loss of position
because of the conduct of the member or when a member fires another member without any
reason or reason rather than specified in clause of constitution, then he/she can approach the
honourable court and take legal action to get the position back9.
Ted is a member who has 5% stake in the company. It is noteworthy that Ted has drafted the
constitution of OW and also, has inserted a clause about the solicitor that he himself would work
as solicitor for OW and would only be fired when he has engaged in some misconduct. It is
apparent that Priya wanted to appoint her boyfriend Carl for solicitor position and therefore, fired
Ted without any reason. Therefore, the interest of Ted will be safeguarded under s.140,
Corporation Act 2001 and thus, the members of OW along with Priya cannot harm the interest of
any of the member including Ted by breaching the clause of constitution of company. If Priya
8 Ibid. 5.
9 Austlii, Corporations Act 2001- Part 2Fhttp://www5.austlii.edu.au/au/legis/cth/num_act/ca2001172/part2F.html
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does fire Ted from the position, then Ted has right to approach the honourable court and take
legal order to get the solicitor position back as per Part 2F (1).
Question 2
Part (a)
Both common law and statutory duties are applicable on directors of any company as they
possess significant power and have rights to take imperative decision for the company10. As per
s. 181 Corporation Act 2001, the directors must take decision in good faith of company and use
their power for the profit of stakeholders and company. Breach of duties of director is explained
in s. 181 and the directors may suffer civil penalties as discussed in s. 1317 E Corporations Act
200111. It includes the scenario in which the director may work for own- interest and restrict the
registration of transfer of shares of transferee, when the remedy will be available to the transferee
as given in s. 10F (1). According to this section, the transferee who could not register transfer of
shares may go to court and take legal remedy and order for the respective directors to not restrict
the register transfer of shares under s. 1071 F(2)12.
It can be seen that Miles, Karim are directors and also, shareholder of Seedy Vineyards Pty Ltd
with shareholding of 45% each. Further, the remaining 10% of shareholding has been acquired
by Olive. Company’s current position was not good enough and hence, company was not paying
dividends to their shareholder. As a result of this, Olive wanted to liquidate her shareholding.
Karim and Miles (both the directors) wanted to buy the 10% shares of Olive but could not buy as
they were not having requisite funds. Meanwhile, Olive agreed to liquidate the shares to Priya.
After the directors got to know that Olive is selling shares to Priya, they then restricted the
registration of transfer of shares of Olive so that they could buy the shares later on and get
significant gains as they have enacted the contract with OW that might provide significant
returns. It is apparent that Miles and Karim have breached directors’ duties by restricting the
10 Austlii, Corporations Act 2001- Sec 181 http://www5.austlii.edu.au/au/legis/cth/num_act/ca2001172/s181.html
11 Austlii, Corporations Act 2001- Sec 1071F
http://www5.austlii.edu.au/au/legis/cth/num_act/ca2001172/s1071F.html
12 Austlii, Corporations Act 2001- Sec 1072 http://www5.austlii.edu.au/au/legis/cth/num_act/ca2001172/s1072.html
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registration of transfer of shares for Olive under s. 181. Hence, Olive can obtain courts notice
under s. 1071 F(1) and get the permission to sell her shares to Priya13.
Part (b)
The key issue is to determine if the statutory directors’ duties have been breached by Miles
getting in to a share purchase with shareholder Olive for 5% stake purchase without
disseminating the information in regards to the contract for supply of grapes from OW.
One of the duties bestowed on directors is highlighted in s. 191 Corporation Act 2001 as per
which any material conflict of interest need to be disclosed by directors to the board so that the
objectivity of the business decision making is not adversely impacted. However, the disclosure
does not need to be made to the shareholders regarding conflict of interest14. Also, in accordance
with s. 183 Corporations Act 2001, it is essential that the information that directors derive owing
to their position must not be utilised for deriving personal gains or benefiting any associated
entity. Any violation of this duty would bring s.1317E into play and result in civil penalty on the
defaulting director(s)15.
In accordance with the information provided, it is apparent that director Miles has given
agreement to purchase 5% stake in the company from shareholder Olive. A key reason which
could have prompted the purchase of shares from Olive at this junction was the $ 500,000
contract to be signed with OW owing to the positive impact on valuation of the company.
However, disclosure regarding the same was not made to Olive. Even if there is any material
conflict of interest for Miles, it is noteworthy that the decision to buy shares is to be taken by
Miles in her personal capacity and not by the company. Thus, s. 191 disclosures to other
directors are also not required. However, owing to the private information about the contract
with OW by buying shares from Olive, Miles is trying to derive significant amount of self-
advantage which is not permissible by s. 183. Disclosing the information about the contract with
OW would imply that Olive would demand a higher price but it would be a fair price and will
not lead to a windfall gain for Miles. The windfall gain is visible since the company after
contract signing would pay dividend that is five times higher than in any of the previous three
13 Austlii, Corporations Act 2001- Sec 1071F
http://www5.austlii.edu.au/au/legis/cth/num_act/ca2001172/s1071F.html
14 Austlii, Corporations Act 2001- Sec 191 http://www5.austlii.edu.au/au/legis/cth/num_act/ca2001172/s191.html
15 Austlii, Corporations Act 2001- Sec 183 http://www5.austlii.edu.au/au/legis/cth/num_act/ca2001172/s183.html
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years. Therefore, going ahead with the share purchase by Miles without disclosure of all the
relevant details to Olive would violate the directors’ duty levied under s.183.
Hence, it can be concluded that Miles has breached the duty of director as per s. 183 since
private information is being used for deriving material gains for self and hence disclosure to
Olive should be made before making a share purchase agreement for 5% stake.
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