Law

  • Category:
    Law
  • Document type:
    Math Problem
  • Level:
    Undergraduate
  • Page:
    5
  • Words:
    3702

I13nsert Surname

Lecturer

Question 1

  1. What kind of a business are Frida and Denise running?

Freda and Denise can be said to be operating their cafe business as a partnership. According to Spadaccini, a partnership is a business structure where two or more people start a commercial venture with the objective of making profits1. The Partnership Acts in a various Australian states and territories define partnerships as business relationships for “carrying on a business” whose objective is to make and share profits2. Denise and Freda have been engaged in the cafe business for the past five years and they share profits. Thus, their business is partnership as defined by the Partnership Act. A partnership would exist between the two the following salient features are found after examination of their business relationship3:

  1. The venture must be commercial in character;

  2. Two or more people must carry it on in common;

As seen in Smith v Anderson (1880) 15 Ch D, a business is venture where repetitive acts are carried out with the objective of making a profit4. In this case, Denise and Freda are engaged in a cafe business which carries out the repetitive act of providing meals to the public with the intent of making a profit. The business also needs to be carried out in common for it to qualify to be a partnership. Denise and Freda have been running the cafe together for 5 years. This limb of the test for partnership can also be satisfied if Denise and Freda act as principals or proprietors of the business5. Finally, Denise and Freda’s cafe business objective is to make and share profits as established in Cummings v Lewis (FCA, No 668/ 89, 2 August 1991, unreported)6.

II. Preferable Business Structure

A partnership is not the best business structure for a business that is exposed to liability like the Cafe operated by Freda and Denise. A partnership exposes the partners to unlimited liability as the law does not make a distinction between a partnership business, and its owners7. The lack of limited liability protection means that the personal assets of both Denise and Freda can be attached to cater for the debts and liabilities of the company. For example, the liability for falls in the cafe may result in the attachment of the personal property of both partners.

Unfortunately, the partnership business form also has another major flaw. Under, Section 12 (1) of the Partnership Act 1892 (NSW), a partner can be liable for the liabilities and losses that result from the actions of other partners acting on behalf of the firm8. As seen in Walker v European Electronics Pty Ltd (in liq) (1990) 23 NSWLR 19, Partners can be held liable for other partners decisions that attract liability to the partnership although there were not aware of such decisions or actions. In addition, Section 115 of the Corporation Act (cth) limits the number of member who can join Denise and Freda in the partnership is limited to only 2010. This limitation negatively affects the ability of the business to raise additional capital.

In contrast, a company limited by shares is a more advantageous business structure for the Denise and Freda cafe business. Under this business structure, the liability of the two partners will be limited to their capital contribution to the company11. This means that if the company fails to clear its debt obligation or attract other type of liabilities, the personal asset of the shareholders cannot be attached. This limited liability flows from the fact that a company is a legal entity which is considered separate from its shareholders. In this case, Freda and Denise can start a proprietary company where they both own equal shares. The main advantage is that the two partners will be less exposed for liability in both contract and tort. For example, the personal assets of both Freda and Denise cannot be attached to cover for liabilities that arise from falls in the cafe. The number of people who can own a Limited company is higher than is a partnership as up to 50 people can contribute towards the formation of a partnership12.

In conclusion, it would be better for Fred and Denise to convert their partnership into a proprietary company. By incorporating, the two will reduce their exposure for the liability and debts of the business. The partnership is already in trouble because of possible liability that arises from fall inside the cafe. In addition, the partnership business form will significantly expand the pool of investors who can make capital contribution to the business to a maximum of 50 people. In contrast only 20 investors can come together to form business that operates as a partnership.

Question 2

Are the executive and non executive directors of TBC Company in breach of their duty of care and diligence under section 180 of the Corporation Act (cth)?

Directors of companies in Australia are under obligation to act with care and diligence in respect to the financial reports of the company. If the directors omits or adds information that makes the financial statements misleading, the director is liable for material misstatement. A director will not avoid this liability even if they had delegated the duty of preparing financial statements to third parties. The law requires that the directors be well informed about the matters of the company. Failure to ensure that financial statements represent a “true and fair” view of the company financial position and performance leads to a breach of the duty of care and diligence as set out in Section 297 of the Corporation Act13. Thus, both executive and non-executive directors are judged to in breach of section 180 (1) of the Corporation Act, if they fail to check financial statements make sure that they are not misleading14.

Application

Section 297 of the Corporation Act requires companies to present financial results that represent a “true and fair” view of the performance and the position of the company15. This duty means that directors have the responsibility to ensure the financial reports comply with reporting obligations. The accounts must also comply with the accounting standards and regulations16. The law also requires the director to make a report that confirms that the information contained in the financial report is accurate. These requirements establish enough internal control to ensure that financial statements should not contain any misleading information or make any material omissions.

In this case, Stephen, Brendan and David as the executive directors of TBC limited are in breach of their duty of care and diligence. The three directors failed to ensure the financial statements of TBC Ltd represented a true and fair view of the company positions. Stephen is liable for breach of his director’s duties because he prepared the financial statements of the company negligently. Stephen cannot escape blame as he was the person in charge of preparing the financial statements of TBC.

In contrast, David and Brendan may seek to avoid liability by claiming that Stephen was responsible for the preparation and presentation of the company’s financial statements. However, AWA v. Daniels (1992) 7 ACSR 759 asserted that directors have a duty to make enquiries, and stay informed about the affairs of the company and all aspects of the company’s business17. Therefore, David can be held to be in breach of his duty of care and diligence as he failed to make enquiries about the reported profit in the account. David knew or ought to have known that the company was making a loss as they had entered into several money losing ventures in recent years. Similarly, Brendan is in breach of his director’s duty under section 180. Brendan as the CEO of the company has responsibility both to the public and shareholders to ensure that the financial reports of the company are accurate. However, he never read the financial statements before they were approved. Thus he did not even the chance to notice or ask for rectification of the errors made by Stephen. Similarly, Jane may also be found liable of breach of his duty of care and diligence. As set out in AWA Ltd v Daniels, Jane as a non-executive director is required to regularly review the financial statements of the company18. She should also be familiar with the company’s business activities. However, Jane does not attend TBC board meetings, and is absence at the time the misleading financial statement is presented and approved.

The cases for breach of section 180 for the four directors of TBC would result in them being found liable as seen in several precedents. In Australian Securities and Investments Commission v Hellicar [2012] HCA 17, the High Court of Australia held that the directors were in breach of their duty under section 18019. The court asserted that the directors faulted by allowing a press release that claimed the company had set aside money to fully fund an asbestos disease liability settlement20. The press release failed to mention that the fund had a shortfall of $1 billion and therefore it misled the public.

Similarly, in ASIC v Healey & Ors [2011] FCA 717 (James Hardie decision), the directors were found liable for a breach of section 180 as they had adopted and approved a financial statement that understated the Centro Properties group current liabilities position21. In addition, the Centro group sought to hide more than US$1.75 billion in short term liability guarantee to an affiliate company. The ASIC submission implicated the CFO and the directors of the group as they were responsible for the adoption and the approval of the understated current liability figures. The court agreed with ASIC and held the Centro group directors liable for material misstatement in their financial statement22. The financial statements approved by the TBC Company were similarly misleading although the errors in the statement arose from negligence. The whole board of the company should be held accountable for the misleading information that showed a profit while the company was making a loss in reality. In the earlier case of AWA vs Daniels, both the non-executive and executive directors were found liable for contributory negligence for engaging the company in a loss making foreign currency venture. Jane as a non-executive director would also be held to the same standard of duty of care and diligence as the non-executive directors found liable in the above cases.

Consequences of breach of duty

The consequences of breaching section 180 of the Corporation depend on the context of the breach and the position of the person making the breach23. Consequences of breach include24:

  • a declaration of contravention as set out in section 1317E

  • Termination of the director’s contract of employment;

  • and/or civil penalty orders such as a ban from management and a pecuniary penalty as set out in section 206C and 1317G respectively.

According to Fred Robins, the directors found liable for breach of the duty of diligence are not protected by the limited liability afforded companies25. The breach attracts civil penalties such as fines, disqualification from company management, compensation orders, and even criminal sanctions. In the ASIC v Healey & Ors case at the NSW Supreme Court, all the directors were banned from managing Australian Companies for up to 15 years26. In addition, they were fined between $30,000 and $350, 000.

Conclusion

Directors are under obligation to present accurate financial statements that represent a true and fair view of the company’s position and performance. It is their responsibility to ensure that the information contained in financial statement is not misleading or deceptive to investors or the public. This duty extends to both executive and non-executive directors as they must ensure that they have perused financial statements, and satisfied their conscience that they do not contain any material misstatements or omission. Directors must remember that preparing and/or approving misleading financial statements is considered a breach of the director’s duty under section 180. This contravention attracts serious penalties including disqualification from management and heavy fines.

Question 3

What is the members remedy available to Ric?

The Corporation Act allows a member of a company to bring action against the company for oppressive conduct either by the company as a whole or by its directors27. Under section 232, a member has the right to sue the company; if the company’s affairs are run in a way that is oppressive, prejudicial or discriminatory against the member28. Under section 234, a member who is either oppressed or not has the right to bring action to remedy the breach of his member’s rights29.

Application

As seen in Wayde v New South Wales Rugby League Limited (1985) 180 CLR 459, courts use an objective test to make a finding for oppressive conduct and violation of member rights30. Court will examine the degree of oppressiveness or unfairness and decide whether to remedy the breach. However, Justice Brennan in the above case asserted that companies and their directors have a duty to make decisions that are fair to their members.

In the scenario, many of the decisions made by Rachel and Tanya are unfair and oppressive to Ric. According to Wayde v New South Wales Rugby League Limited (1985), oppressive conduct is apparent where the member(s) is unfairly excluded from company management or unfairly restricted from sharing in the dividends of the company. In this case, Ric is unfairly oppressed as he is unfairly removed from the management board of the company. As seen in John J Starr (Real Estate) Ply Limited v Robert R Andrew & Ors 6 ACSR 63 oppression of member (s) is either as single act or a series of oppressive and unfair acts against the member31.

As set out in Wayde v NSW Rugby League Ltd, a member’s dissatisfaction with the management of the company cannot be considered oppressive conduct32. Thus, courts cannot make a finding for oppressive conduct on the basis that Rachel and Tanya have awarded themselves huge salary increases and onuses. The complaint concerning the planned lease expensive cars for their use of the two executives is also a management matter. The failure to award dividends during the current year and past years cannot also serve as basis for oppressive conduct. Companies are under no legal obligation to pay dividends even in years where profits increase significantly.

If the court finds Tanya and Rachel liable for oppressive conduct under section 232 they may make orders that remedy the oppression33. Section 233 of the Corporation Act gives courts the right to make the orders as remedies for oppressive conduct34. Some of the remedies include orders for the winding up of the company, order to regulate management, or order to coerce Tanya and Rachel to reinstate Ric in the board of directors.

Question 1

Section 180 (2) or the Australian “business judgment rule” is a provision designed to limit liabilities related to business decisions that may caused detriment to the company35. The rule recognizes that business decisions are risky and may not always be correct. The aim of the rule is to protect directors from liability where they make decision in good faith, without personal interest, and in the best interest of the corporation36. The courts prefer not to interfere with business decision as this may constrain the ability of directors to take risk. Section 180, is a well intended rule which aims to encourage entrepreneurship in company management. However, some section of the legal and communities criticizes the rule as it allows management to escape liability for bad managerial decisions37. On the other hand, other critics argue that the rule doesn’t give adequate coverage to promote managerial entrepreneurship in companies. The latter argument is the basis for this short essay.

In many jurisdictions, the business judgment rule works very well as strong protection to directors who make poor business decisions. The rule frees directors to advantage of risky and frequently successful business opportunities that would otherwise be missed38. Directors are more confident as they are not afraid of prosecution for negligence arising from unsuccessful business decisions. Thus, the rule protects directors from prosecution when ventures fail to produce returns or make losses. Directors can only be prosecuted only in cases where they are guilty of misappropriation corporate funds or fraud. Unfortunately, the rule also frees directors from liability even where their decisions are careless and lack diligence. This weakness of the business judgment is arises from the fact that the business judgment rule is based on a subjective test of the reasonableness of a business decision.

In contrast, Australia’s statutory construction of the rule is based on a more objective test. Section 180, subsection 2 (a) states that the management have to rationally believe that the decision was in the best interest of the corporation. The ASIC in Australian Securities and Investments Commission v Rich (2009) 75 ACSR 1; 236 FLR 1 contended that section 180(2) intended to create a reasonableness standard that directors’ conduct and decisions can be tested against39. The ASIC argued that a director can either hold reasonable or unreasonable belief about the chances of success of a business venture. The ASIC further submitted that the use of the world rational in subsection 2(a) was meant to create a more objective test for the reasonableness of decisions. Such an interpretation would see the protection from liability afforded directors by the rule watered down significantly. However, Justice Austin in ASIC vs Rich 75 ACSR 1; 235 FLR 1 asserted that the more appropriate test for whether a decision is in the best interest of the corporation is the subjective reasonableness test40. Justice Atkin asserted that the drafter did not mean to set an objective test on whether a director’s decision was reasonable. Justice Atkins decision is welcome as it stops ASIC’s attempts at watering down the business judgment rule. The interpretation will allow business management to continue taking advantage of business opportunities that include significant risk taking. However, the wording of the section 180(2) in the Australian Corporation Act need to be reviewed to ensure the Australian business judgment rule creates the safe harbor for directors intended by its drafters.

Bibliography

  1. Articles/Books/Reports

Clark, Eugene, and Ram Vemuri. «Conducting business in Australia: Prospects and strategies for international managers.» Global Business and Organizational Excellence 27, no. 5 (2008): 49-64.

Fletcher, Keith Lloyd, The Law of Partnership in Australia & New Zealand (LBC information services, 2000)

Golding, Greg. «Tightening the screws on directors: Care, delegation and reliance.» UNSWLJ 35 (2012): 266.

Howson, Nicholas, When’Good’Corporate Governance Makes’ Bad'(Financial) Firms: The Global Crisis and the Limits of Private Law,’ (2009) 108 Michigan Law Review, First Impressions 108 44.

Lindgren, K.E. and Vermeesch, R.B, Vermeesch and Lindgren’s Business Law of Australia, (LexisNexis Butterworths, 2011)

Robins, Fred. «Corporate governance after Sarbanes-Oxley: an Australian perspective.» Corporate Governance: The international journal of business in society 6, no. 1 (2006): 34-48.

Spadaccini, M. Business Structures: Forming a Corporation, LLC, Partnership, Or Sole Proprietorship. ((2007, Irvine, CA : Entrepreneur Press)

ASIC v Healey & Ors [2011] FCA 717

ASIC vs Rich 75 ACSR 1; 235 FLR 1

Australian Securities and Investments Commission v Hellicar [2012] HCA 17

Australian Securities and Investments Commission v Rich (2009) 75 ACSR 1; 236 FLR 1

AWA v. Daniels (1992) 7 ACSR 759

Cummings v Lewis (FCA, No 668/ 89, 2 August 1991, unreported)

Golding, Greg. «Tightening the screws on directors: Care, delegation and reliance.» UNSWLJ 35 (2012): 266.

John J Starr (Real Estate) Ply Limited v Robert R Andrew & Ors 6 ACSR 63

Lang v James Morrison & Co Ltd (1911) 13 CLR 1 at 11; 17 ALR 530,

Smith v Anderson (1880) 15 Ch D

The Corporations Act 2001 (Cth), s 115

Walker v European Electronics Pty Ltd (in liq) (1990) 23 NSWLR 1

Wayde v New South Wales Rugby League Limited (1985) 180 CLR 459

Wayde v NSW Rugby League Ltd,

C. Legislation

Partnership Act 1892 (NSW)

The Corporations Act 2001 (Cth), s 115

1
Spadaccini, M. Business Structures: Forming a Corporation, LLC, Partnership, Or Sole Proprietorship. ((2007, Irvine, CA : Entrepreneur Press)

2
Partnership Act 1892 (NSW),

3
Fletcher, Keith Lloyd, The Law of Partnership in Australia & New Zealand (LBC information services, 2000)

4
Smith v Anderson (1880) 15 Ch D

5
Lang v James Morrison & Co Ltd (1911) 13 CLR 1 at 11; 17 ALR 530,

6
Cummings v Lewis (FCA, No 668/ 89, 2 August 1991, unreported)

7
Clark, Eugene, and Ram Vemuri. «Conducting business in Australia: Prospects and strategies for international managers.» Global Business and Organizational Excellence 27, no. 5 (2008): 49-64.

8
Partnership Act 1892 (NSW), s. 1

9
Walker v European Electronics Pty Ltd (in liq) (1990) 23 NSWLR 1

10
The Corporations Act 2001 (Cth), s 115

11
Corporations Act 2001 (Cth), s 516

12
The Corporations Act 2001 s 45 (A) (1)

13
Corporations Act 2001 (Cth), s 297

14
Corporations Act 2001 (Cth), s 180(1)

15
Corporations Act 2001 (Cth), s 516

16
Corporations Act 2001 (Cth), s 296

17 AWA v. Daniels (1992) 7 ACSR 759

18 AWA v. Daniels (1992) 7 ACSR 759

19
Australian Securities and Investments Commission v Hellicar [2012] HCA 17

21
ASIC v Healey & Ors [2011] FCA 717

22
Golding, Greg. «Tightening the screws on directors: Care, delegation and reliance.» UNSWLJ 35 (2012): 266.

25 Robins, Fred. «Corporate governance after Sarbanes-Oxley: an Australian perspective.» Corporate Governance: The international journal of business in society 6, no. 1 (2006): 34-48.

26
ASIC v Healey & Ors [2011] FCA 717

27 Corporations Act 2001 (Cth), s. 232

28 Corporations Act 2001 (Cth), s. 234

29
Lindgren, K.E. and Vermeesch, R.B, Vermeesch and Lindgren’s Business Law of Australia, (LexisNexis Butterworths, 2011)

30
Wayde v New South Wales Rugby League Limited (1985) 180 CLR 459

31
John J Starr (Real Estate) Ply Limited v Robert R Andrew & Ors 6 ACSR 63

32
Wayde v NSW Rugby League Ltd,

33 Corporations Act 2001 (Cth), s. 232

34
Corporation Act 2001 (cth) s 233

35 Corporations Act 2001 (Cth), s. 180

36 See, Lindgren and Vermeesch, above n 29

37 Howson, Nicholas, When’Good’Corporate Governance Makes’ Bad'(Financial) Firms: The Global Crisis and the Limits of Private Law,’ (2009) 108 Michigan Law Review, First Impressions 108 44.

39
Australian Securities and Investments Commission v Rich (2009) 75 ACSR 1; 236 FLR 1

40
ASIC vs Rich 75 ACSR 1; 235 FLR 1