Share Allocation and Director Duties

This assignment delves into a legal case concerning the allocation of shares by a director to his son, potentially undermining the voting power of the director's wife. The analysis focuses on the directors' fiduciary duties, specifically the prohibition against using their powers for improper purposes or personal gain. The court's decision, which overturned the initial share allocation, is examined in detail, referencing relevant legal precedents and principles.

Running head: DIRECTORS DUTIES
Directors Duties
Name of the Student
Name of the University
Author note

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Table of Contents
Introduction......................................................................................................................................2
Case Facts........................................................................................................................................2
Duties breach by the directors.........................................................................................................3
Decision of the court........................................................................................................................3
Conclusion.......................................................................................................................................5
References........................................................................................................................................7

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Introduction
One of the most popular restraints which is imposed on the directors of the company in
relation to discharging their duties is the duty to act in good faith and proper purpose of the
company (Knepper et al. 2016). The duty exists both in common law as well as in the provisions
of the Corporation Act 2001 (Cth) through section 181. People who have been serving as the
directors of an organization for a long time tend to forget that the company is a separate legal
entity. The company however cannot function on its own and therefore require the help of the
directors (Farrar 2016.). The directors have to therefore comply with legal provisions while
discharging their duties in relation to the company (Keay 2014).
Case Facts
The case of Whitehouse v Carlton Hotel Pty Ltd [1987] 162 CLR 285 had to address the
question in relation to the duty of directors to act bona fide. In this case it had been ruled by the
court that a subjective test of “good faith and honesty” have to be applied in order to determine
whether the directors had complied with the duty of good faith or not. Whether good faith is
present or absent is determined based on the circumstances which are present in the case (this is
why the court cannot pin precise rules in relation to it). There are no fixed set of uniform rules
which can be applied to determine whether the element of good faith was present in the actions
of the directors or not. Depending upon the circumstances, a transaction which is carried out by
the directors in relation to the company will be considered to be in bad faith if it is outside the
purpose of the company. In case a director of the company willingly and knowingly agrees to go
against the law, t is most likely to be deemed as not done with the observation of good faith.
In this case the governing director of the company was Charles Whitehouse. He owned
class A shares which had voting rights, his wife owned class B shares which had partial voting
rights and his children held class C shares which had no voting rights. He got divorced with his
wife who aligned with his daughter and he aligned with his son. He was concerned about the
fact that on his death the control of the company would likely be taken by his wife and daughter
and thus to prevent such a thing from happening he issued class B shares to his son. However he

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had fallout with his son and claimed that the transfer of shares was not valid as it has been done
in bad faith. The court has to determine whether the transfer of share was valid or not
Duties breach by the directors
In the given situation the director has apparently violated the duty to act in good faith in
relation to the company. The duty is provided and imposed on the directors of the company
through the provisions of common law. In addition currently the CA through its section 181 also
provides that the director’s whole discharging their duties towards the company has to act in
good faith and for a proper purpose. The actions of the directors have to be in the best interest of
the company. In case the provisions are not complied with by the directors they are liable to be
prosecuted under the civil penalty provisions under section 1317E. This is because the director
has acted in bad faith by making a share transfer in relation to the company which was not
lawful.
Decision of the court
The judges in relation to this case were Mason , Wilson , Brennan , Deane and Dawson
JJ. They have to decide whether it was a valid exercise of power by Carlton to transfer the shares
to his son under the discriminatory power provided to him under Article 127 of the Article of
association. According to the article among other things Mr. Whitehouse had to be the
Permanent Governing Director of the organization and all powers of the board of directors
should be vested in him alone. It was held by the court in this case that a decision which is made
in bad faith and towards an improper purpose is a voidable, however not against a third party
who does not have any knowledge or notice in relation to the situation which lead to breach of
duty. They are given protection through the indoor management rule. If the third party is able to
establish that they had entered into the transaction in good faith and did know about the breach
of duty the transaction will be regarded as valid. It was ruled that the existence of an in
permissible purpose will not merely make the transaction of the fiduciary power to allot shares
invalid.
In addition it had been provided by the court that the test which had been provided in the
case of Mills v Mills will not be applicable in this case as it will only follow in case the

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impermissible purposes are considered as dominant (“the substantial object,” “the moving
cause”).
It is provided by the case that preferably whether the nature of the impermissible purpose
is causative “but for” it existence, in case no exercise of power would have been exercised but
not a concluded view as the case is not related to competing impermissible or permissible
purpose.
In this case the appeal made by the sons against the decision of the full court that the
allocation of shares to them was invalid was dismissed by the court with cost. The decision of
the court had been supported by the case of Fraser v. Whalley (1864) 2 H. &M. 10, at pp 30-31
where it has been stated that the directors are not allowed to use a fiduciary power in relation to
allocating shares for defeating the voting power of a shareholder through the creation of a new
majority. The decision was also supported by the case of Ashburton Oil N.L v. Alpha Minerals
N.L. (1971) 123 CLR 614, at p 640 for the same reason.
In the case of Automatic Self-Cleansing Filter Syndicate Co. Ltd. v. Cuninghame (1906)
2 Ch 34 it had been stated by the court that as the shareholders of the company do not have the
power to control the decision of the directors, it would not be constitutional for the directors to
use their power in relation to the company for the creation of a new majority and destroying the
power of existing shareholders to vote. If this is done it would interfere with the element of the
constitution which is set against the power.
In the case of Piercy v. S. Mills and Company (1920) 1 Ch 77, at pp 84-85 it had been
provided by the court that in case of a purported allotment of shares for an impermissible
purpose the directors may have a belief that they are doing so in the best interest of the company.
However this belief is not adequate to overcome the invalidity of share allotment.
In the case of Grant v. John Grant &Sons Pty. Ltd. (1950) 82 CLR 1 it had been ruled
that in some statements of vitiating effects of a purpose of decreasing voting power off existing
shareholders a qualification of effecting the allotment is invalid in case it is solely, merely or
purely done for that purpose.

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However Wilson J dissented from the decision of the majority and stated that he would
allow the appeal based on the same reason as provided by the trial court. He stated that a share
allocation would be valid even case it has been done for an improper purpose and in bad faith
where the third party does not have knowledge about the situation.
Conclusion
From the above discussion it can be concluded that the director of a company who has the
power to take decision in relation to the company in the same way as the board of directors also
have the duty to act in good faith and proper purpose of the company as it is a separate legal
entity. In this case it was held by the trail court that a share allocation is valid even in case it is
done in bad faith where the third party was not aware about such facts. However the court of
appeal and the high court overturned the decision provided by the trail court and invalidated the
share allocation done in bad faith and for an improper purpose. It is provided by the case that
preferably whether the nature of the impermissible purpose is causative “but for” it existence, in
case no exercise of power would have been exercised but not a concluded view as the case is not
related to competing impermissible or permissible purpose. The appeal which was made by the
two sons was dismissed by the court with cost. The decision which was reached by the court was
a result of a 3:2 majority. The cases which had been cited by the court in this case had been very
well applied in relation to addressing the issue which had brought before the court in this case.
For instance In the case of Automatic Self-Cleansing Filter Syndicate Co. Ltd. v. Cuninghame
(1906) 2 Ch 34 it the court ruled that as the shareholders of the company do not have the power
to control the decision of the directors, it would not be constitutional for the directors to use their
power in relation to the company for the creation of a new majority and destroying the power of
existing shareholders to vote. If this is done it would interfere with the element of the
constitution which is set against the power. In this case also there was a same situation where the
director had tried to indulge in an activity where he wanted to the create a new majority by
providing additional shares to his son and destroying the power of existing shareholders which
was his wife to vote in matters related to the company. On another instance in the case of Fraser
v. Whalley (1864) 2 H. &M. 10, at pp 30-31 it had been ruled by the judges that the directors are
not allowed to use a fiduciary power in relation to allocating shares for defeating the voting
power of a shareholder through the creation of a new majority. Thus in the given situation the act

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of the directors was clearly invalid and the application of any defense in the given situation
would not be in the ends of justice.

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References
Ashburton Oil N.L v. Alpha Minerals N.L. (1971) 123 CLR 614, at p 640
Automatic Self-Cleansing Filter Syndicate Co. Ltd. v. Cuninghame (1906) 2 Ch 34
Corporation Act 2001 (Cth)
Farrar, J., 2016. Book Review: Directors' duties: Principles and application.
Fraser v. Whalley (1864) 2 H. &M. 10, at pp 30-31
Grant v. John Grant &Sons Pty. Ltd. (1950) 82 CLR 1
Keay, A.R., 2014. Directors' Duties. Jordans.
Knepper, W.E., Bailey, D.A., Bowman, K.B., Eblin, R.L. and Lane, R.S., 2016. Duty of
Loyalty (Vol. 1). Liability of Corporate Officers and Directors.
Mills v Mills 1938) 60 CLR 150, [1938] HCA 4.
Piercy v. S. Mills and Company (1920) 1 Ch 77, at pp 84-85
Whitehouse v Carlton Hotel Pty Ltd [1987] 162 CLR 285