Legal Regulation of Business Structures

This article discusses the legal regulation of business structures, including company constitutions and expropriation of shares. It explores the Gambotto case and the two-part test for determining the validity of alterations to a company constitution. It also covers the duties of directors under the Corporations Act 2001 and provides a case study on Re Smith and Fawcett Ltd. Students can access more study material on Desklib's online library.

LEGAL REGULATION OF BUSINESS STRUCTURES
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Question 1
Introduction: changing a company constitution
The constitution of a company is a legal document that is drafted either before or after
the registration process is through. The constitution is a legal framework, among the roles of
the constitution, the documents delegates’ duties to the company directors and other officers
meant for the operational purposes and the internal management of the institution. The
constitution of a business 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. 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 constitution1. In the case Salman vs. Astounding Gifts Pty.
Ltd, the case subjects itself to the provisions of the Corporations Act 2001 (CTH) with
specific regards to the expropriation of shares.
Expropriation of shares
The high court of Australia turned the tide of corporate power in favor of the minority
shareholders. The victory in the Gambotto case was termed significant as the court initiated a
mechanism of stringent rules aimed at measuring the validity of the alterations of the
company constitution. The case ruling represented an interfering method which traditional
law courts had been hesitant to embrace in the corporate environment. However, it is
important to note that the court has limited powers in regards to the best interests of the
1 Corporations Act 2001 (CTH)

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company; Latham CJ stated that, “it is not for the court to impose upon a company the ideas
of the court as to what is for the benefit of the company…2” The same was applied in the
English court of Appeal in the case Shuttleworth v Cox Bros Ltd (1927) 2KB 9, here the court
refused to impose its views as to whether an amendment to the company constitution was
aimed to benefit the company3.
For years, there have being considerable tension amidst the majority and the minority
shareholders due to the general exercise of the significant power controlled by the majority.
Normally, the minority shareholders are placed on a situation of a weaker position as
compared to the majority. The main issue of concern is the decisions made at general
meetings where in most cases the minority shareholder are coerced to accept the decisions
made to favor the majority shareholders especially where related to the amendment of the
company’s constitution. Over the years, through the legal system restrictions to the majority
shareholders have been effected. The canon of fraud on the minority shareholders was
employed to access whether fraud against the minority had taken place; it was the
prerequisite measure of the majority to act bonafide in the best interest of the business and
not themselves.
Gambotto v WCP Ltd (1995) 182 CLR 432
99.7% of the shares of WCP ltd were controlled by Industrial Equity. Gambotto was a
minority shareholder in WCP Ltd. Industrial Equity intended to change the ownership
structure of WCP by making it a wholly owned subsidiary in order to attain savings through
taxes and administrative costs. IEL proposed to purchase 50590 shares from Mr. Gambotto
and Ms Eliana Sandri who were the minority shareholders. The notice of meeting also
contained information regarding the financial assessment of shares owned by WCP Ltd
prepared by the accounting department. The offer price to purchase the shares was valued at a
2 Peters' American Delicacy Co Ltd v Heath (1939) 61 CLR 457 at 481
3 Shuttleworth v Cox Bros Ltd (1927) 2KB 9

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premium. The minority shareholders filed a legal suit arguing that the amendments were
invalid, as they were not done in good faith4.
The court held that the constitutional amendment was invalid rejecting Allen’s test of
bona fide and in the interest of the firm as a suitable test for evaluating modifications in the
constitution. 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 value. Expropriation is only allowable because
minority has 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 safeguard the
interests of the firm5.
Amending the company constitution
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 case where the adoption of the constitution comes after the
registration process, a special resolution of the adoption is passed6. Section 136 (2) of the
Corporations Act states where the constitution has a provision governing modifications, the
amendments must foremost comply with the required provisions prior to making any
changes. Such additional requirements can be negotiated by the minority as a means to offer
4 Gambotto v WCP Ltd (1995) 182 CLR 432
5 Ibid.
6 (Commonwealth of Australia), 2012a. Volume 1

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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.
Application of the expropriation of shares
The high court in the Gambotto case established a two-part test as a measure to
determine whether the alterations of the company constitution allowing expropriation of
shares are valid. The validity of the tests is based on whether it was done for a proper purpose
and that the aim of the amendment was not to oppress them minority shareholders. The
proposed clause by Kody and Ryder is a provision allowing the majority shareholders to
forcefully acquire shares from minority shareholders not controlling more than 12%. Salman
has just accepted an accounting position with a competing firm and is already encouraging
Melanie to provide her hand-made gifts to the competitor, hence the clause was meant to
protect the interests of Astounding Gifts Pty Ltd. Based on the ruling in Gambotto case, the
court held that expropriation was only applicable where;
1. Proper purpose: proper purpose was meant to prevent the company from suffering
significant detriment or harm. The court gave two examples for establishing proper
purpose; the minority shareholders are competing with the company or the
expropriation is necessary to ensure that the company continues to comply with the
law governing the company key business. As such, expropriation was justified in the
case where the actions of shareholder were seen as competing with the company7.
Salman controls 10% of the shares in Astounding Gifts Pty Ltd and by accepting the
accounting position in a company that was in direct competition with Astounding Ltd
and further pursuing Melanie to provide his new employer with the same services she
provided his former employer would be detrimental to his previous employer,
Astounding Gifts Pry Ltd.
7 Gambotto v WCP Ltd (1995) 182 CLR 432

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2. Fairness: fairness based on the Gambotto case ruling involved the majority
shareholders revealing all the significant information pertaining the amendment of the
constitution8. Furthermore, the share price of the share should either be at market
value or at a premium. Seeking the court intervention to stop an oppressive conduct,
the plaintiff must prove that the amendment was unfairly prejudicial. In the case
Wayde v NSW Rugby League Ltd (1985) 180 CLR 459 to determine fairness is an
objective test, the plaintiff must prove that the director’s actions were not justified9.
The directors decision to expropriate the shares was justified based on Salman’s’
actions.
Since there were no additional requirements that were to be met before amendments
of the constitution were made, both Kody and Ryder controlled 90% of the shares meaning
that they met the required threshold of 75% to pass resolution to amend the company
constitution, meant that the amendments were binding. Moreover, Salman actions were in the
best interest of his new employer and in this case formed the basis of a conflict of interest.
Kody and Ryder being the majority shareholders had the right to expropriate his shares as his
actions contravened those of an officer of a registered company.
Therefore, Salman has no legal redress in a court of law for the expropriation of
Salman’s’ shares was in the best interest of Astounding Gifts Pty Ltd and was meant to
further protect their principal business.
Question 1B
Astounding Gifts Pty Ltd. can argue that the contract between the company and
Melanie is non-existent because it was entered before the registration of the name Astounding
Gifts. When entering the contract, the company was meant to be registered as Incredible Gifts
Pty Ltd. The court can be called in to determine the validity of the contract. For a period,
8 Ibid
9 Wayde v NSW Rugby League Ltd (1985) 180 CLR 459

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Astounding Gifts Pty has being remitting $5,000 for the exclusive rights, which in essence
ratifies the pre-registration contract. In this case, this can be an implied contract effected
when payment is made for the purchase of the goods as determined in the case Aztech
Science Pty Ltd v Atlanta Aerospace (Woy Woy) Pty Ltd10.
Proving whether a party to the contract has indeed breached the contract can prove to
be difficult mainly because of the initial wording of the contract. Under normal circumstances
it is the party’s’ to the contract who agree on the terms of the contract. Australian common
law recognizes four types of breaches that include; material breach, minor breach,
anticipatory breach, and actual breach11. Where there is a breach of a contract, the afflicted
parties can claim remedies including damages that will place them in the same position if the
terms of the contract were fulfilled. This was an anticipatory breach, Astounding Gifts
refused to continue paying Melanie for the remaining term as per the contract. In exchange
for her unique handmade gifts, she was to be paid $5,000 monthly for a period of twelve
months. In the case Robinson v Harman (1848) 1 Ex Rep 850, the court ruled that,
“The rule of the common law is that where a party sustains loss by reason of a breach of
contract, he is, so far as money can do it to be placed in the same situation, with respect to
damages, as if the contract had been performed12.” Melanie can seek remedy in terms of
damages from Astounding Gifts Pty Ltd. for she had not failed to fulfil terms of the contract
by talking to Salman offering her an opportunity to sell her products to Gifts Pty Ltd unless it
was explicitly stated that she was forbidden from engaging with competitors. The amount of
damages will be based on the ruling in the case Commonwealth of Australia v Amann
Aviation Pty Ltd (1991) 174 CLR 64 the court ruled that the afflicted parties should be placed
in a similar situation to what it would have been if the contractual obligations were fulfilled13.
10 Aztech Science Pty Ltd v Atlanta Aerospace (Woy Woy) Pty Ltd
11 Kevans, S., 1996. Oppression of Majority Shareholders by a Minority? Gambotto v WCP Ltd. Sydney Law
Review , 18(110), pp. 110-119.
12 Robinson v Harman (1848) 1 Ex Rep 850
13 Commonwealth of Australia v Amann Aviation Pty Ltd (1991) 174 CLR 64

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Question 2
Corporations Act 2001
The framework governing the duties of the director is that, as a director one must
conform to the Corporations Act 200114. Section 181 of the Corporations Act executes a civic
requirement on directors plus relevant 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 purpose15. The failure of a director to execute their duties, the director is open for civil
or criminal or a hybrid of the two offences16. When discharging their duties, directors and
other officials recognized by the Corporations Act must do so in good faith, their action must
be in the best interest of the company, and be done for proper purposes17.
Re Smith and Fawcett Ltd. [1942] Ch 304
As per Article 10, the directors were at liberty to refuse to register shares. When Mr.
Fawcett, a director of the company, died; the remaining director, Mr. Smith refused to
register and transfer the shares of the dead director to his executioner. Mr. Smith opted to sell
some of the shares whereas the remaining shares were transferred to the executors of the will.
Lord Greene ruled in favour of Mr. Smith stating that his actions were appropriate and within
his mandate as a remaining director. The actions of the director were free from the court
intervention, director must exercise their powers on their discretion based on what they and
not the court decides as the best interest of the company18.
Application in the case law
Determining what is in the best interest of the company is at the director’s discretion
and not a court mandate. Based on the expectations of the directors as stated in the
Corporations act (2001), they must act in good faith, best interest of the company and for
14 Section 181 of the Corporations Act
15 Ibid
16 Tomasic, R., Bottomley, S., McQueen, R., 2002. Corporations Law in Australia. Federation Press.
17 Corporations Act 2001 (CTH)
18 Ibid

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proper purposes; 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. The directors of Chip Eze Pty Ltd. satisfied the three legal
mandates set out in the Corporations Act by incorporating a new company Freeze Me Pty Ltd
to cater for the profitable frozen foods business19. By doing so, they protected the interests of
all stakeholders in Chip Eze Ltd. shielding them from the consequences meant for the
unprofitable manufacture of potato crisps and other snack foods. The shareholders were
shielded from loss after the winding up of Chip Eze Pty Ltd. As a director, one must take
relevant steps to help reduce losses to the creditors in case the business became bankrupt20.
Question 2B
Faizah
The case of Faizah is unique, she is an existing shareholder to Chip-Eze Pty Ltd and
in the meeting to split Chip Eze into two, the resolution was voted for unanimously. She was
aware of the financial status of Chip-Eze and was aware of the factors that led to the removal
of the more profitable unit to be registered as an independent company from Chi Eze. She
still went ahead to approach Jordon to sell her additional 5% of his shareholding. Jordan had
the right to sell some or all his shares to whoever he chose, but by the fact that he was a
director he was further required to reveal the sale to other directors. When trading with
shares, directors are supposed to seek authorization from the company secretary as a measure
to ensure that the one intending to purchase or sell their shares does not have any information
that is not known by the public21. The agency of a director gives rise to the status fiduciary. In
regards to fiduciary, there are two areas of concern which include the particular relationship
19 Harris, Jason R & Hargovan, Anil, 1962-, (author.) & Adams, Michael A. (Michael Andrew), (author.) 2018,
Australian corporate law, 6th edition, LexisNexis Butterworths, Chatswood, N.S.W
20 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).
21 Ibid.

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out of which the duty arise and the content and proper performance of the duty. However, the
fiduciary duty is owed to the company and the company alone, which means that, the
directors do not owe any duty to the individual members.
In Coleman v. Myers 22one of the key issues was the non-disclosure of material
information. In the case the court held that the directors duty are owed to the company does
not stop them from having fiduciary duties to the shareholders provided there is an agency
relationship or a very specific relationship giving rise to fiduciary duties. I would argue that
for anyone intending to make any purchase additional shares in a company where one is
already a shareholder means that one has already performed due diligence on the financial
position of the company.
Faizah decision to purchase additional shares in what remained to be a poorly
performing company instead of additional shares in the newly formed company can be
argued as a decision made out of ignorance. Based on the position held by Faizah, he was
aware of the prevailing situation. Despite Jordan owing a fiduciary duty towards Faizah,
Faizah was ignorant of the prevailing situation since the information to split the company was
agreed by the directors meaning there was a circular to show the progress and procedures to
safeguard the profitable unit. Hence, Jordan cannot be blamed for selling her shares of a
company that was headed for liquidation hence she had no legal redress against Jordan23.
22 Coleman v. Myers
23 Harris, Jason R & Hargovan, Anil, 1962-, (author.) & Adams, Michael A. (Michael Andrew), (author.) 2018,
Australian corporate law, 6th edition, LexisNexis Butterworths, Chatswood, N.S.W

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Adams, M. & Nehme, &. M., 2015. Business Organisations Law Guidebook. Second ed.
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Corporations Act 2001 sect 181
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