Legal Regulation of Business Structures

This article discusses the legal regulations of business structures, including the alteration of a company constitution and the duties of directors. It includes a case study on the alteration of a company constitution and the transfer of assets to a new company. The article also covers breach of contract and the duty of good faith.

LEGAL REGULATION OF BUSINESS STRUCTURES
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Question 1
Brief summary
Having come up with an idea to start a subscription business that provides with highly
entertaining podcasts an interviews, Sammy and Huw approach Gracey for exclusive supply
of a weekly podcast to their new company. They sign an agreement on the 20th April 2018
stipulating that for the exclusive rights, Gracey is to be paid a fee of $4000 per month for a
period of one year.
They initially intended to name the company Gosh Pty Ltd. however, when they went
to register the company on 1st May 2018 the name was already in use. In its place the two
opted to use Oh My Pty Ltd as the name of the company with Huw and Sammy as the listed
directors. The newly formed company employs Amaya as the company accountant. The
shareholding is 45% each for the directors and 10% for Amaya.
On 1st July 2018, both Sammy and Huw realize that Amaya has agreed on a contract
appointing her as the accountant for a competing firm Gosh Pty Ltd. Moreover, Amaya is
soliciting Gracey to abandon Oh My Pty Ltd. but instead provide the exclusive weekly
podcasts to her new employer instead.
In an emergency member’s meeting, both Sammy and Huw agree to alter the
company constitution allowing directors to buy back shareholdings from shareholders with
less than 11% at their discretion.
Altering a company constitution
The constitution of a company covers the powers, rights, and duties of the firm, the
executives, the board, and those of the different shareholders. It is a pact between the firm
and its members, company and its secretary, the organization and each director, and amongst
the company members. According to the Corporations Act 2001 sect 136, a company is
allowed to implement a constitution before or after the company is registered. When
embraced prior to the registration process, all members must in form of writing agree to the
terms set forward by the constitution. In a care where the adoption of the constitution comes
after the registration process, a special resolution of the adoption is passed1.
As per the corporations act, the company is allowed to alter or revoke its constitution
by adopting a special resolution which needs a minimum of 28 days’ notice for public
companies and 21 day notice for other types of company. For the resolution to be formalized
and adopted as part of the company constitution, it must be supported by a minimum of 75%
of the shareholders. The amendment to the company constitution is binding. However,
1 Corporations Act 2001 sect 136

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according to section 136 (2) of the Corporations Act, the amendment must first comply with
certain specified additional requirement to make it effective. For instance, the additional
requirement may include the amendment requiring the approval of a specific individual, or
the resolution to amend be voted for unanimously by its shareholders. In case the constitution
has specified requirements, the specific requirements must first be fulfilled prior to the
amendment takes effect2.
Such additional requirements can be negotiated by the minority as a means to offer
some form of protection from resolutions made by the majority shareholders bearing
extensive financial consequences. As such, these requirements make it difficult for majority
shareholders to amend the constitution. Nevertheless, a company cannot limit its statutory
powers to change its constitution and the constitution cannot have a statute that bars the
company from making any changes to the constitution, as such, restrictions or provisions
would be void. The Corporations Acts and the common law however shields the company’s
shareholders from the variations or annulment of class rights, various amendments to
provisions of a firm’s constitution that have the impact of expropriating the shares of the
minority or rights ascribing to those shares; and revisions to precise provisions of the firms
constitution3.
The supremacy of majority shareholders to amend the constitution for expropriating
the shares of a minority shareholder or valuable rights bestowed upon those shares is limited
following the decision of the High Court of Australia in Gambotto v WCP Ltd (1995) 182
CLR 432. The court held that for such an amendment conferring upon the majority
shareholders powers to expropriate powers of the shareholders must first satisfy the
following; it is for an appropriate purpose and not meant to oppress the minority
shareholders. The court further held that the process require complete disclosure of key
information, an autonomous assessment of the value of the shares by an expert, and
imbursement of the shareholding at market value4.
Based on the ruling of the Gambotto case, expropriation is only allowable on the
grounds that minority’s continued shareholding would be injurious to the firm. Other grounds
include where the minority shareholder is in direct competition with the firm, and by the act
of expropriation the company would be in a position conform with the principles governing
the principal business is involved in, or where the expropriation would be to protect the
2 Corporations Act 2001 sect 136
3 Corporations Act 2001 sect 136
4 Gambotto v WCP Ltd (1995) 182 CLR 432

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interests of the firm. Expropriation is illegal where its aim is for the majority to secure
themselves increased benefits of a new corporate structure or from an economic undertaking5.
Plaintiff’s advice
Based on the rules governing the alteration of the constitution of a company, Amaya
had no legal redress in the court of law as the changes satisfied all the quotas of alteration.
Base on the facts of the case, Oh My Pty Ltd constitution did not have any requirement that
had to be met before any alteration of the constitution commenced. Furthermore, by her
position as an accountant in a competing firm and by soliciting Gracey to offer the exclusive
rights to her new employer allowed Sammy and Huw to expropriate her shares. Her
association with Gosh Pty Ltd. as an accountant was a direct conflict of interests for the two
competing firms. Her continued shareholding would therefore be detrimental to Oh My Pty.
Ltd and by removing her; they would be advancing the interests of the company. Her first
action in her capacity as the accountant at Gosh Pty Ltd was to solicit Gracey to join Gosh
Pty ltd. a company in direct competition with Oh My. The company constitution did not grant
her the powers to prevent the inclusion of the new clause in the constitution limiting a
company’s statutory powers to amend its constitution and the constitution cannot have a
clause forbidding the constitution from amended; as such restrictions or provisions would be
invalid.
Gracey
In as far as, Gracey is concerned; she has not bleached the contract yet. The burden of
proof lay with Oh My Pty, as they were the ones who stopped her monthly payments and the
ones who had to proof to the court that she had bleached their contract yet. Their contract
signed between the two parties gave Sammy and Huw exclusive rights to her weekly podcasts
for which she would receive $4,000 monthly for a period of one year. By the mere fact that
Amaya was encouraging her to offer her podcast to Gosh instead of her former employer did
not equate to her actually providing her podcast to Gosh. There was nothing wrong with her
talking to Amaya. The bleach of contract would come into play only if she went against the
stipulation of the contract by giving her podcast to Gosh despite the existence of the
exclusive rights with Oh My Pty.
Gracey can sue for damages as a party found to be in breach of contract is liable for
losses incurred due to the breach. The purpose of a breach is to place the afflicted body or
person in equal position they would have being if the breach had not occurred and the
contract was properly fulfilled. In the case Commonwealth of Australia v Amann Aviation Pty
5 Corporations Act 2001 sect 136

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Ltd (1991) 174 CLR 64 it was held that the afflicted parties should be placed in equal
position to what it would have been provided that the contractual obligations were fulfilled6.
However, the plaintiff must prove that they suffered a loss and the actual amount of the loss
or damage so that they could recover the compensations. Therefore, the quantity of damages
that is being demanded ought to be clear and must be quantified. In the case Airloom
Holdings Pty Ltd v Thales Australia Ltd [2011] NSWSC 1513 it emerged that the burden is on
the party requesting indemnities to comprehend from the onset that the quantity of damages
they are seeking and what concurrent material required to support the assertion7.
Question 2
Duties of the directors
The duties of a director are mainly concerned with the governance of the relationship
between the directors and the company where they offer their services as the directors. The
duties of the directors are owed to the firm as a whole. In their capacity as the directors,
directors often find themselves in a fiduciary positions vis-à-vis the company’s creditors
especially during financial situations. Moreover, there are situations though limited where the
directors have valid duties, which they owe to specific or individual shareholders. The vital
principle governing the directors’ tasks is that the directors must conform to the corporations
Act 2001 (Cth). Section 181 of the Corporations Act executes a civil requirement on directors
and other officials in an organization to implement their powers and discharge their duties in
good faith, in the best interests of the corporation and for a proper purpose8. Failure to
execute one’s duty as a director, the director is open for civil or criminal or a hybrid of the
two offences9.
The burden of proof lies with Lily Mae who must convince the court that in splitting
the company the directors did not act in good faith. She must prove that the directors
exercised their powers to benefit themselves, confer upon a third party or a class of
shareholders additional benefits, or to damage the firm itself. If she can prove this then the
duty of the directors will have being breached attracting civil actions against the directors.
The duty of good faith is based on the intention, the belief, and the motive of the directors
and whether any decision made was made based on the interest of the company as the
principal consideration10.
6 Commonwealth of Australia v Amann Aviation Pty Ltd (1991) 174 CLR 64
7 Airloom Holdings Pty Ltd v Thales Australia Ltd [2011] NSWSC 1513
8 Section 181 of the Corporations Act
9 Tomasic, R., Bottomley, S., McQueen, R., 2002. Corporations Law in Australia. Federation Press.
10 Australian Securities & Investments Commission, 2018. Directors’ liabilities when things go wrong. Directors
Liabilities Things Go Wrong. URL https://asic.gov.au/for-business/your-business/tools-and-resources-for-

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Drink It Up Pty ltd is involved in two businesses one which bottles and markets
springs water and the other involved in the production and marketing of organic fruit juices.
The water section is profitable whereas the one involved in organic juices has a being facing
financial challenges in settling its financial obligations. The directors of Drink It Up Pty
unanimously vote for the registration of a new company H20 Pty Ltd where they will transfer
the profitable unit (water production and marketing). This is done on the 7th of July 2018, and
all the assets related to the spring water are transferred to and all its customers and suppliers
are informed of the changes11.
S181 of the Corporations Act 2001
As a director, when discharging their duties they must do so in good faith and in the
best interest of the firm. They must discharge their duties whilst avoiding conflict of interests
and must manage any conflict that may arise. While acting in good faith they must do so
honestly in such manner that is inspired by the firm’s best interest, as would be evaluated by
an able officer in the director’s position12. Their actions must be in fulfilment for proper
purposes translating to not being involved in actions that any reasonable person would
perceive as a contradiction to the purposes or the activities of the enterprise. Moreover
section 180 (1) of the Corporations Act state that a director must execute their powers whilst
showing a certain degree of care and diligence that any practical individual would exercise if
they were directors or were in similar position holding similar obligations as those of an
officer functioning as a director13.
The power to manage a company is granted to the directors by the company. In the
case, Re Smith and Fawcett Ltd. [1942] Ch 304 Lord Greene MR held that, “The principles
to be applied in cases where the articles of a company confer a discretion on directors … are,
for the present purposes, free from doubt. They must exercise their discretion bona fide in
what they consider - not what a court may consider - is in the interests of the company, and
not for any collateral purpose14.” Based on this, the duties of a director are subjective and are
dependent upon the director executing their discretionary powers bona fide in what they and
not the court would consider as acting in the best interest of the company15.
business-names-and-companies/asic-guide-for-small-business-directors/directors-liabilities-when-things-go-
wrong/ (accessed 9.12.18).
11 Corporations Act 2001 sect 136
12 Australian Metropolitan Life Assurance Co Ltd v Ure (1923) 33 CLR 199 per Isaacs J at 217
13 Queensland Goverment, 2018. 7.3 Corporations Act 2001 (Cth) (the Corporations Act). URL
https://www.premiers.qld.gov.au/publications/categories/policies-and-codes/handbooks/welcome-aboard/
member-duties/corp-act-2001-c.aspx (accessed 9.12.18).
14 Re Smith and Fawcett Ltd. [1942] Ch 304

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Directors have a duty to act in good faith what they envisage as functioning in the best
interests of the firm. If their intentions are genuine and they justly believe that, what they are
doing truthful for the company, directors are safeguarded from accusation that they would
have done something differently. From the inference above, the directors of Drink It Up Pty
did not breach s181 of the Corporations Act 2001 or any other duty16. Voting unanimously to
split the business in two separating the profitable spring water business from that of juice was
in the best interest of the company. That way the liabilities of the loss making department
would not tamper with those of the profit making unit that way the business unit dealing with
the water was a going concern having being saved from winding up. As a director, one must
take relevant steps to help reduce losses to the creditors in case the business became
bankrupt17.
Dhruv
Based on the fact that Dhruv was an investor and a shareholder of Drink It Up, he
ought to have performed due diligence on the financial position of the company before
seeking additional shareholding. He was the one who approached Kristofer with an offer to
purchase an additional shareholding, which was accepted, Kristofer reduced his shareholding
by 5%. Although Krostfer was privvy of the information regarding the financial position of
the company, Dhruv being a shareholder had access to such information as well but still
proceeded with the acquisition. The purchase did not affect the structure of the company and
its impact was insignificant, in his capacity as a director, he was allowed to dispose his shares
provided that the sale is disclosed to other directors. The burden of proof in this lies with
Dhruv who must show to the court that Kristofer acted mali fide and his actions contradicted
those of the directors. Shares of a company that has being liquidated are worthless. Dhruv has
no legal redress against Kristofer18.
Bibliography
Airloom Holdings Pty Ltd v Thales Australia Ltd [2011] NSWSC 1513
Australian Metropolitan Life Assurance Co Ltd v Ure (1923) 33 CLR 199 per Isaacs J at 217
15 Treasury, 2018. Corporations Act 2001. Federal Registration Legislation. URL
https://www.legislation.gov.au/Details/C2017C00129/Html/Volume_1,
http://www.legislation.gov.au/Details/C2017C00129 (accessed 9.12.18)
16 Commonwealth Consolidated Acts, 2018. CORPORATIONS ACT 2001 - SECT 181 Good faith--civil obligations.
URL http://classic.austlii.edu.au/au/legis/cth/consol_act/ca2001172/s181.html (accessed 9.12.18).
17 Parliament of Australia, C., 2018. Chapter Four - Directors’ duties [WWW Document]. URL
https://www.aph.gov.au/Parliamentary_Business/Committees/Joint/Corporations_and_Financial_Services/
Completed_inquiries/2004-07/corporate_responsibility/report/c04 (accessed 9.12.18).
18 Hindle v John Cotton Ltd (1919) 56 Sc LR 625

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Australian Securities & Investments Commission, 2018. Directors’ liabilities when things go
wrong. Directors Liabilities Things Go Wrong. URL https://asic.gov.au/for-business/your-
business/tools-and-resources-for-business-names-and-companies/asic-guide-for-small-
business-directors/directors-liabilities-when-things-go-wrong/ (accessed 9.12.18).
Commonwealth Consolidated Acts, 2018. CORPORATIONS ACT 2001 - SECT 181 Good
faith--civil obligations. URL
http://classic.austlii.edu.au/au/legis/cth/consol_act/ca2001172/s181.html (accessed 9.12.18).
Commonwealth of Australia v Amann Aviation Pty Ltd (1991) 174 CLR 64
Corporations Act 2001 sect 136
Corporations Act 2001 sect 181
Gambotto v WCP Ltd (1995) 182 CLR 432
Hindle v John Cotton Ltd (1919) 56 Sc LR 625
Parliament of Australia, C., 2018. Chapter Four - Directors’ duties. URL
https://www.aph.gov.au/Parliamentary_Business/Committees/Joint/Corporations_and_Financ
ial_Services/Completed_inquiries/2004-07/corporate_responsibility/report/c04 (accessed
9.12.18).
Queensland Goverment, 2018. 7.3 Corporations Act 2001 (Cth) (the Corporations Act). URL
https://www.premiers.qld.gov.au/publications/categories/policies-and-codes/handbooks/
welcome-aboard/member-duties/corp-act-2001-c.aspx (accessed 9.12.18).
Re Smith and Fawcett Ltd. [1942] Ch 304
Tomasic, R., Bottomley, S., McQueen, R., 2002. Corporations Law in Australia. Federation
Press.
Treasury, 2018. Corporations Act 2001. Federal Registration Legislation. URL
https://www.legislation.gov.au/Details/C2017C00129/Html/Volume_1,
http://www.legislation.gov.au/Details/C2017C00129 (accessed 9.12.18).