Supreme Court of New South Wales Decision in Raulfs v Fishy Bite Pty Ltd - Essay Example

Case Analysis, Corporations Act provisions Name of Student Student No: Date: Name of Supervisor: Part A. SUPREME COURT OF NEW SOUTH WALES’ DECISION IN RAULFS V FISHY BITE PTY LTD [2011] NSWSC 105 1) a. The party applying to the court was one Deborah Raulfs who brought suit via her solicitors McLaughlin & Riordan. b. The plaintiff alleges that she paid the sum of 400,000 to the second defendant, Mr Ajaka in payment of a partnership for Fishy Bite Pty Ltd which was subsequently not purchased by him. 2) a. The first defendant is Fishy Bite Pty Ltd. b. The second defendant is Louie Ajaka c. The defendants state that the partnership deed did not reflect an agreement between Ms. Raulfs and Mr Ajaka and therefore they were free to do as they wished with monies paid to Fishy Bite. d. These parties alleged that while they acknowledge that 400000 was paid by the plaintiff, they dispute the additional 230000 she claims to have paid, and while they acknowledge that they were in talks to purchase Seasalt, they claim to have informed the plaintiff that the talks ended in May 2006. 3) a. The court decided that the second defendant is liable for the $400000 to the receiver of the partnership. b. the defendant’s actions were said to be governed by failure of consideration. 4) a. The court decided that the sum of $400,000 was paid as capital contribution by the plaintiff and should be paid back. b. This finding was arrived at because it was decided by the court that the $400000 paid was a capital contribution to the new partnership yet it was not used for this purpose. This resulted in a trust similar to that seen in Barclays Bank Ltd v. Quistclose Investments Ltd (1970) AC 567 in which the judgement stated that when monies given for a specific purpose are not used for that purpose, they are liable to repayment. The judge also asserted that there was a constructive trust case equal to that found in Muschinski v. Dodds (1985) HCA 78; (1985) 160 CLR and/or the premise that total failure of consideration occurred which means Mrs Raulfs was owed her $400000. 5) a. The court decreed that should the partnership deed be rectified to reflect the agreement between Mrs Raulfs and Mr Ajaka, then Fishy Bite is free to do whatever it likes with the assets of the business including the $400000. The defendants were in support of this premise and stated that in that case the money should be paid back to the partnership and not Mrs Raulfs. The defendants concede that if the Partnership Deed is not rectified then Fishy Bite was in breach of fiduciary duty when Mr Ajaka transferred the money to the SunCorp account. The relevance of Quistclose trust in this case is limited but the plaintiff submits that since the money was not used for the purpose for which it was given, then the first defendant needs to refund it to her. The problem with this is that the payment to Fishy Bite was a partnership payment that Mrs Raulfs was in agreement to pay. Thus the money ‘was paid and received with the intention that it should become absolute property of the trust as is seen in Twinsectra per Lord Millett at (91). Once Fishy Bite received the money, it became a partnership asset and was wrongfully used by Mr Ajaka. However, should Fishy Bite refund the money to Mrs Raulfs, she would owe the partnership $400000. Part B. CORPORATIONS ACT 2001 1) a. Chapter 5A part 1 of the Corporations Act 2001 details the steps to be taken to deregister a company. b. The statutory effects of deregistration on a company are primarily that it ceases to exist. Furthermore, all properties held in trust by the company immediately before deregistration is vested in the commonwealth. This applies even when that property was vested with a liquidator before deregistration. This provision is applicable even to properties outside the jurisdiction. Other company property not held in the company’s trust is vested in ASIC. If the company property is vested in a liquidator apart from that property on trust, then upon deregistration this property vests in ASIC. This applies to property outside the jurisdiction as well. 2) a. s. 180(1) provides that the powers and duties entrusted to a director or other officer of a corporation must be carried out with the amount of care and due diligence expected of a reasonable person were they in that position and occupied that office with the same responsibilities as the director or other officer. This subsection pertains to civil penalty provision. b. Section 180(2) of the Corporations Act known as the statutory Business Judgement Rule was introduced by the CLERP Act of 1999 (Cth) for the purposes of clarity and confirmation of the position of general law in which it is stated that bona fide business decision rarely lend themselves to review1. The rationale behind it was to encourage entrepreneurial commercial enterprise and minimise inhibition of directors while simultaneously increasing assurance in their liability2. This rule is supposed to act as a defence against liability for directors who may be faced with the prospect of such through decisions to take action or not in the operational activities of a corporation3. Section 180 (2) provides that should a corporation director meet all the requirements of due diligence and care as stated in section 180(1) when carrying out a business judgement then if that judgement was undertaken; in good faith and with the appropriate aims; while making an reasonably and appropriately informed decision; and with no personal interest of a material nature; with reasonable faith that the resolution was in the best interests of the corporation Then the business judgement rule has been adhered to, although it only protects the director from liability from section 180(1). 3) a. Section 124 of the Corporations Act confers upon companies the same legislative power as an individual such as the capacity to form an agreement. A corporation is a product of law whose legal existence is detached from the personnel who make it up. This corporation however, is able to utilise the legal capacity of a person and can therefore indulge in contractual agreements. Not everyone is able to enter into a contract according to Australian law, therefore this section is important because it gives the corporation the ability to do this, an ability it otherwise would not have. 4) a. The section entitled ‘Remuneration of Directors’ is in Chapter 2 Part D Section 3 Division 2. b. this section applies to all companies except public companies whose provisions for remuneration of directors is in section 2E. 5) a. Section 302 of the Corporations Act requires submission of a half-year financial report and directors’ report. This includes preparation of the financial report, followed by auditing and review according to Division 3 and obtaining of an auditor’s report. Finally, the financial report, directors’ report and the auditors’ report on the financial report is to be lodged with the ASIC. This is mandatory unless the entity is not a disclosing entity at the time the requirement is due. b. The financial report for the half year contains financial statements for the half-year, the notes on these financial statements and the directors’ declaration about the statements and notes. The financial statements for the half year are those related to the disclosing entity required by the accounting standards unless the accounting standards require the disclosing entity to prepare financial statements that are related to the consolidated entity. The notes to the financial statement contain disclosures that are a regulation requirement, notes as required by accounting standards and other information that would be pertinent to provide a true and fair view according to section 305. The directors’ declaration states whether in the opinion of directors the disclosing entity is capable of discharging its debts as they become due and payable and also whether the financial statement and notes comply with the Act in particular, section 304 and 305. The declaration is made in accordance with a resolution of the directors upon a specific date and signed by a director. 6) section 201J of the Corporations Act states that the directors of a company can appoint one or more of their number to serve as managing director of the company for a stated time under terms, including remuneration as the directors see fit. This is a replaceable rule under section 135. This rule applies to every newly formed company in Australia which does not have a specific constitution except those companies who have the same person as sole director and shareholder. These rules are used to govern the internal management of a company in the absence of the company’s own constitution. DIRECTORS MUST UNEQUIVOCALLY ACT IN THE BEST INTERESTS OF THE COMPANY Introduction One feature of corporate law that is significant is the role and duties of directors in management of their firms. It is said in law that the director is obligated to act in the bona fide best interests of the company which he runs4. The traditional approach to this concept is that the director conducts his affairs in the best interests of company shareholders, both current and in the future. A lot of literature demonstrates this position in that the contemporary conceptualisation of the corporation contains the assumption of shareholders that the firm will be run in their best interest5. This viewpoint is known as the shareholder primacy principle/paradigm, shareholder value principle or the shareholder wealth maximisation norm6. It embodies the principle that the shareholder should take priority in whatever interests a company is engaged in ahead of any other interested parties who may claim some obligation from the company. This principle obliges the company to primarily optimise market value by maximising efficiency in allocation, production, and dynamism of resources7. This view is widely held in Australia among other jurisdictions8. One result of the recent economic crisis has been continuous discussion on the standards of corporate governance and how it is regulated and the effect of this upon the economy. There are those who feel that more regulation of corporate directors is desirable while others are of the opinion that they are already over-regulated. This discussion has been focused upon the way, in which remuneration for executive and board members is structured, as well as related issues such as structure of corporate boards, but the wider issue lies with how appropriate are the liability levels faced by directors and company officers. To find the most appropriate level from which directors will be found liable is a huge issue with stakeholders including business lobbyists, politicians, and law reform and law enforcement agencies9. The main issue has been the intricate overlapping nature of state and federal laws which confer personal responsibility on company directors and managers for a wide range of legal infringements10. So the issue remains as to what extent the company directors should be held liable for the infringements of the law during their tenure and this is under review with a view to extending the defences available to directors and officers or introduction of new general defences. Thus two pertinent issues may come into conflict; protecting the best interests of the stakeholders in the company by ensuring that directors conduct themselves in a manner that is in their best interests, yet giving them enough room to run the company in a way that is commensurate with their best judgement. This essay will attempt to define the best interest of the company and how directors should conduct themselves in the carrying out of their duties. It will also attempt to find out if there are situations as laid out in law where the two are mutually exclusive. Discussion Those who subscribe to the theory of contracts in business are mainly proponents for a law and economics approach to law. This approach emphasises the contractual obligations that exist between parties involved in the running of an enterprise and as a result believe in the principle of inviolability of the contract. Many contractarians as they are known,11 are of the opinion that the firm is no more than a series of intricate, confidential, and consensual relationships based on the contract12 whether expressly stated or implied and they are made of manifold interconnections that are embodied by company associates13. This approach to legislation to do with the objective of companies is pertinent to Australia especially due to the inquiry carried out by the Australian Parliamentary Joint Committee on Corporations and Financial Services and the resulting report14 as well as the Australia Corporations and Markets Advisory Committee report15 on the same subject. The enlightened shareholder value approach as embodied by the shareholder primacy paradigm is featured in both reports16. This issue, which both reports recognise is one which has gained prominence in Australian jurisprudence due to such happenstances as the as the James Hardie Group undergoing restructuring in order to prevent injured parties from holding them liable for the consequences of exposure to Asbestos which the company has been using and producing for over seventy years in Australia17. One aspect of restructuring was relocating its assets to an offshore location thus ensuring that affected Australians could not receive compensation for their injuries. The argument as to whether the interests of shareholders should be foremost in the minds of directors has been ongoing for many years in different jurisdictions. The United Kingdom and Australia are merely prominent examples of whether directors could be allowed to factor in the interests of non-shareholders as they manage the company. According to the law, directors are under no obligation to run their firms in such a way as will produce immediate interim benefits such as quick profits18. They instead do state that the durable health of the company must be a priority19 and what it comes down to is the director’s business judgement20. Case law does exist which gives latitude to directors on company management which, while keeping shareholders in mind, also allows for substantial discretion on the director’s part as to what aspects need to be factored in when evaluating what is in the company’s best interest21. On the other hand, those in favour of shareholder value as a principle guide to the company’s best interest argue that according to the agency theory22 directors act as shareholders’ agents because the latter do not have the time or ability to run the company. This therefore makes the shareholders best placed to direct and regulate directors as they carry on with their business23. The argument goes on to aver that without the shareholder value principle the directors would ‘shirk’ their duties leading to agency costs. These costs are said to result when managers do not take appropriate action leading to monitoring and disciplinary action and their attendant costs. When there exists a duty to shareholders, these costs are decreased and the shareholders are protected. This implies that shareholder value increases accountability of directors in the conduction of business. Furthermore, the principle of shareholder value is based on efficiency because they are incentivised to optimise profits which would result in economic efficiency. The company is run more efficiently if the director’s focus is on maximisation of shareholder assets due to the awareness of cost efficiency employed in meeting this objective24. Connected to this argument is the premise that if the directors’ loyalties are divided, it will become unfeasible for them to satisfy all the conflicting interests that they represent, resulting in either an impasse or poor decision-making25. This principle is said to be a bit more definite and simpler to carry out as compared to the stakeholder theory26 which demands that stakeholder interests must be foremost in directors’ minds. Shareholder value gives room for the courts to examine the conduct of directors in a rational manner according to its proponents. In any case, these proponents argue that other parties have recourse via the contracts that they hold with the firm should anything happen and this course is not available to shareholders. This makes them vulnerable27 because they have no contractual protection and are therefore vulnerable to the director’s doings in many ways especially as it is difficult to oversee the work of directors28. Corporate law in Australia is written in such a way as to promote responsible running of businesses by company directors. This is because they are liable in various common law and statutory obligations that pertain to different aspects of a company’s business. They are obligated to act with honesty, have good faith and to the utmost of their capability in the best interests of the company. Furthermore, they are also obligated to check insolvent trading by their company. This is because Australian law hold directors to be criminally and civilly liable if they allow their company to trade while bankrupt. The results of bankruptcy concern many stakeholders including creditors, company personnel, tax authorities, shareholders, and consumers. The law on insolvency is designed to take all these various interests into account so that all who are dealing with companies in financial distress are protected. This law is a stimulant to economic activity because it is a source of restriction to directors who might be tempted to take irresponsible risks29. The last few years has witnessed a succession of corporate failures such as HIH, Onetel and Enron30. This is not a novelty but seems to occur in cycles. Ten years ago, Australians were shocked by the collapse of Quintex group and the Pyramid Building Society. The similarity between that period and this was the prominence of corporate governance as a popular concept. This issue with corporate governance affects the corporate remuneration as well. This remuneration has sky rocketed in the last decade and this has invited comment of even the former Prime Minister, John Howard who termed the ‘golden parachute’ amounts which are said to reach $30 million as outrageous. The general public has long expressed concerns about the amount and increase of executive remuneration as compared to the average wage rate. These concerns have been magnified by the global crisis which was attributed to uncontrolled greed in corporate finance; the loss in value of shares that has affected many as well as rising unemployment; the resolution by Pacific Brands to decamp offshore while in receipt of taxpayer funds after appointment of a new CEO31. Some participants claim that these pay amounts are a symptom of systemic failure while others are of the view that the system works and these unaccountable pay amounts are an anomaly. However, should the reservations of the general public become widespread; it will result in lack of trust for corporate governance which has wide reaching ramifications. The opposite is also true because if remuneration is poorly designed then the director(s) will take irresponsible risks and focus on short term profits leading to crosscurrents that will affect the wider economy32. When HIH collapsed there was a massive loss of capital by shareholders through mismanagement by directors. A royal commission was established by the Australian government to find out what happened and they undertook implementation of each recommendation arrived at in the report33 which led to amendments of the Corporations Act. Whether or not these amendments will stop the mismanagement of firms is the question. Directors are legally bound to act in good faith and with the right purpose34. Furthermore, both statutory and common law impose a duty of care on directors to reconcile any conflict of interest resulting from extraneous forces with the best interests of the firm at heart. The premise that whatever reforms have been instituted are likely to fail are as a result of precedent which shows that whenever a prominent corporate entity collapses, there is legislation instituted that leads to added demands upon directors in terms of accountability. However, this does not stop further collapses from occurring. Corporate governance does not suffer from a dearth of duties for directors or reporting requirement or that shareholders propose too few solutions. The fact is that directors are quite ingenious when it comes to avoiding lawful traps or in many cases, will simply ignore the law due to the lure of money. The premise that prevention is better than cure is true for law as well as health. It is essential to take apart the corporate framework which dis-incentivises the director from making practical and accountable financial decisions. It is possible that no quantity of regulation will enable directors to have integrity and diligence and certainly it is not possible to have a corporate checklist to guard against personal indiscretion. The problem with the regulation as it now stands in the Corporations Act may well be that there is a distinction between ownership and corporate control. The basic reason why company directors make poor financial choices is that it is not their own money they are spending. In the context of corporate governance, this is known as ‘agency costs’35. Conclusion When the ownership of a corporation is separated from its corporate control a situation results which is detrimental to good governance. This is because the information that is available to the owner as to the everyday running of the corporation is minimised. Furthermore, when ownership is spread out widely, the interest in affairs of the company of each owner is diluted. This also leads to a breakdown in coordination because of the larger number of votes necessary to alter any management paradigm, aggravating the difficulty of the problem. This situation results in the classic shareholder being less involved in management leading to apathy, disenfranchisement, and poor corporate performance36. It follows that even if the rights and privileges of shareholders were overhauled, it would not eliminate the main problem which is the separation of corporate control and ownership. In order to increase accountability, it is necessary that the directors have as much to lose as any other shareholder. In that way, they will always act in the best interest of the firm. References Allen, W., Jacobs, J. and Strine, L. “The Great Takeover Debate : A Mediation on Bridging the Conceptual Divide” (2002) 69 U Chi L Rev 1067 at 1075 Bainbridge, S. “In Defense of the Shareholder Wealth Maximization Norm : A Reply to Professor Green” (1993) 50 Washington and Lee Law Review 1423; M. Roe, “The Shareholder Wealth Maximization Norm and Industrial Organization” (2001) U Pa L Rev 2063 Bainbridge, S. “Director Primacy : The Means and Ends of Corporate Governance” (2003) 97 Northwestern University Law Review 547 at 549, 552, 565. The Company Law Review Banks, Gary.Fitzgerald, Robert. and Fels.Allan. Executive Remuneration in Australia. Productivity Commission Inquiry Report(2009) Cheffins, Daniel ‘Current Trends in Corporate Governance: Going from London to Milan Via Toronto’ (1999) 10 Duke Journal of Comparative and International Law 5, 15. Commonwealth of Australia (2010). Insolvent trading: A safe harbour for reorganisation attempts outside of external administration. Commonwealth Copyright Administration. Attorney-General’s Department Company Law Review, Modern Company Law for a Competitive Economy : “The Strategic Framework” 1999, London, DTI, at paras 5.1.12ff. Corporate Law Economic Reform Program Bill 1998 (Cth) (CLERP) Explanatory Memorandum Corporations Act 2001 (Cth) s 180 (duty of due care and diligence) and 181 (duty to act in good faith and for a proper purpose). Corporations and Markets Advisory Committee, Personal Liability for Corporate Fault (September 2006), available on www.camac.gov.au Corporations and Markets Advisory Committee, The Social Responsibility of Corporations, (2006) at 111 Dunn, E. ‘James Hardie: No Soul to be Damned and No Body to be Kicked’ (2005) 27 Sydney Law Review 339. Easterbrook Frank, H. and Fischel, Daniel R. “The Corporate Contract” (1989) 89 Colum L Rev 1416, 1426. Eugene Fama & Michael Jensen, ‘Separation of Ownership and Control’ (1983) 26 Journal of Law and Economics 301. Fama, Eugene. “Agency Problems and the Theory of the Firm” (1990) 99 Journal of Political Economics 288 at 290 Farrer Jonathan and Ramsay, Ian 'Director Share Ownership and Corporate Performance- Evidence from Australia' (1998) 6 Corporate Governance: An International Review 233, 233. Final Report of the HIH Royal Commission (‘HIH Report’), available on-line at . Fisch, Jill. ‘Measuring Efficiency in Corporate Law: The Role of Shareholder Primacy’ (December 2005) Fordham Law Legal Studies Research Paper No 105 http://papers.ssrn.com/sol3/papers.cfm?abstract_id=878391 Grove v Flavel 11 ACLR 161 (Full Court of the Supreme Court of South Australia) (1986) Harlowe’s Nominees Pty Ltd v Woodside (Lakes Entrance) Oil NL (1968) 121 CLR 483 at [493] (Barwick CJ, McTiernan & Kitto JJ) Henry Bosch, ‘The Changing Face of Corporate Governance’ (2002) 25 University of New South Wales Law Journal 270. Jensen, Michael & Meckling, William .‘Theory of the Firm: Managerial Behaviour, Agency Costs, and Ownership Structure’ (1976) 3 Journal of Financial Economics 305; Eugene Fama, Eugene. ‘Agency Problems and the Theory of the Firm’ (1980) 99 Journal of Political Economy 288 Klausner, Michael. “Corporations, Corporate Law and Networks of Contracts” (1995) 81 Virginia Law Review 757, 759. Lonrho Ltd v Shell Petroleum Co Ltd [1980] 1 WLR 627 (HL). Matheson, John & Olson, Brent. ‘Corporate Law and the Longterm Shareholder Model of Corporate Governance’ (1992) 76 Minnesota Law Review 1313 at 1328. Mayer, C. “Corporate Governance, Competition and Performance” (1997) 24 Journal of Law and Society 152 at 155. Mitchell, R. O’Donnell, A and Ramsay,I. “Shareholder Value and Employee Interests : Intersections Between Corporate Governance, Corporate Law and Labour Law” a research report for the Centre for Corporate Law and Securities Regulation and the Centre for Employment and Labour Relations Law, 2005. Parliamentary Joint Committee on Corporations and Financial Services, Commonwealth of Australia, Corporate Responsibility: Managing Risk and Creating Value (2006) People’s Department Stores Inc v Wise [2004] SCC 68, 244 DLR (4th) 564 at [42] (Major, Deschamps JJ) Provident International Corporation v International Leasing Corp Ltd [1969] 1 NSWR 424 at 440 (Helsham J); Paramount Communications Inc v Time Inc 571 A. 2d 1140 (Del, 1989) Review of Sanctions in Corporate Law, available on: http://www.treasury.gov.au/contentitem.asp?NavId=013&ContentID=1182 Roach, L. “The Paradox of the Traditional Justifications for Exclusive Shareholder Governance Protection: Expanding the Pluralist Approach” (2001) 22 Co Law 9 at 9. Teck Corporation Ltd v Millar (1973) 33 DLR (3d) 288 (BCSC) The Committee on Corporate Law, ‘Other Constituency Statutes: Potential for Confusion’ (1990) 45 The Business Lawyer 2253 at 2269. Van der Weide, Mark E ‘Against Fiduciary Duties to Corporate Stakeholders’ (1996) 21 Delaware Journal of Corporate Law 27 at 56-57 Zingales, Luigi ‘Corporate Governance’ in The New Palgrave Dictionary of Economics and the Law (1998) at 501. Read More