Analysis of Corporation Law - Case Study Example

Corporation Law Name Course Lecture Date Step 1: Samantha loaned the company she owned $50,000. The loan to the company had the following characteristics: It was not beneficial to the company as it was made to cover an inflated purchase of the business. It required the company to repay Samantha, the sole Director and shareholder of the company the loan amount. These features of a transaction characterize a director related transaction (Latimer 2012, 85). In the scenario the company is being folded up and there is a question of whether the loan by Samantha to the company takes precedent over the debts owed by other unsecured creditors. In Australian corporation law, liquidators are mandated to investigate transactions that may unfairly interfere with the right of unsecured creditors to claim debts from a company under liquidation (Latimer 2012, 79). Under the definition in Section 588FDA subsection 1 of the Corporation Act 2001 the following transactions are considered unreasonable director-related transactions if: The company made a payment. There is transfer, disposition or conveyance of the company’s property. Company issues securities including share options. Company incurs an obligation to issue securities, make payment, transfer, dispose or convey property. In Section 588FDA subSection 3 of the Corporation Act 2001 the payment or issue will be or is made to: A company director. An associate of a company director. On behalf of the persons mentioned above. Step 2: The purpose of distinguishing Director-related transactions in Company law comes about because of the need to protect unsecured creditors during liquidation of a company. Directors may have entered into transactions in the company whose only aim is to frustrate creditor’s effort to recover their debt. Thus a liquidator has to investigate if all the transactions entered by the company with director related entities are reasonable (Latimer 2012, 84). For a transaction to be considered unreasonable a number of conditions have to be fulfilled, under the Corporation Act Section 588FDA sets out unreasonable transactions as those that are entered to without regard to: The benefit to be accrued by the company in entering the transaction. The possible detriment to the company if it enters into the transaction. One of the most important factors in determining which transactions can be set aside during liquidation is the timing of the transaction. In the Corporation Act Section 588FDA (6A), an unreasonable director related transaction is voidable only if it took place four years prior to commencement of liquidation proceedings. In unreasonable director related transactions only the amount of undervalue in the transaction can be recovered (Latimer 2012, 92). This is set out in the Corporation Act Section 588FF. Step 3: The actions of Samantha in selling the business to her limited company can be said to constitute unreasonable director related transaction. The transaction entered by Samantha requires the company to make payment to her and thus is covered by Corporation Act paragraph 588FDA 1 (a) (ii) that categorizes transactions. Secondly, the payments are to be made to Samantha herself the sole director and shareholder of the company therefore fulfilling the requirement for Corporation Act paragraph (b) (ii) which requires that the recipient of a payment, issue or disposition be director of the company under liquidation. Thirdly, the transaction to buy a business at an inflated value is of no benefit to the company. In contrast, paragraph (C) requires that reasonable transaction be of net benefit to the company. Similarly, in Woodgate v Fawcett [2008] NSWSC 868 the court ruled that transactions that were detrimental to the company were to be considered unreasonable. Ziade Investments Pty Ltd v Welcome Homes Real Estate Pty Ltd [2006] NSWSC 457 transactions that have no commercial justification and benefit to the company involving the directors parents were considered unreasonable director related transactions. Finally, the transaction had taken place within 4 years to the commencement of winding up the company and therefore satisfies Corporation Act Section 588FDA (6A) which only considers transaction unreasonable director related transactions if they took place within a period of 4 years prior to commencement of liquidation process (Latimer 2012, 105). In this case, Samantha had inflated the cost of her business by $50,000, the same amount of money she loaned the company to complete the purchase. Therefore, the liquidator can apply for the setting aside of Samantha’s debt $50,000 as it would have the effect of making the transaction reasonable. The Corporation Act Section 588FF provides that only the amount of undervalue can be recovered in unreasonable director related transactions. Step 4: The debate over whether shareholders or director loans to their own company should be considered before those of outside creditors is hotly contested in legal circles. In this case, Samantha will not be able to recover her $50,000 loan to her company as she has clearly engaged in unreasonable director related transaction when lending the money to the company. The company would not have needed the loan if she had not inflated the value of her business. In effect, the application of this rule means, the prospects of the company’s unsecured creditors to be compensated is increased. Question 2 Step 1: Australian Company law offers protection to people dealing contractually with companies; in that one does not need to concern himself with the internal management of the company while transacting business with the company. From the facts, the legal issue that is in contention is whether Windy Willow Winery Pty Ltd is bound by the contract made by Ian and Anne to purchase equipment from Vinotec Limited. In the Corporation Act Section 124, a company has the power and authority to enter into contracts. However, the law recognizes that a company is a fictitious person and needs people to act on its behalf. In the Corporation Act Section 126, the capacity and legal power of a company in contract making is vested in individuals representing the company (Latimer 2012, 128). According to replaceable rule 2 or Section 198A of the Corporation Act 2001, directors have the right to direct the company and while acting on behalf of the company all the company’s legal capacity is conferred on them. According to replaceable rule 4 or Section 198C of the Corporation Act, directors of a company may confer their legal capacity on the managing director. However, Corporation Act Section 129(1) which allows a person dealing with a company to assume all the company internal affairs are in order including compliance with the replaceable rule or the constitution. Step 2: These rules clearly give the directors of a company the power to deal and contract with the outside world on behalf of the company. However, in some instances the company may refuse to honour a transaction on the argument that the person who entered the transaction on their behalf did not have the capacity to bind the company to the contract. In such, a situation a creditor of the company may result to the assumptions in Corporation Act Section 129(1) or what is known as the indoor management rule in common law (Latimer 2012, 128). Step 3: When Ian and Anne Frost as directors of Windy Willow Winery Pty Ltd decided to purchase the Wine presses and other winery equipment they were acting on behalf of the company. According to the Corporation Act replaceable rule 2 which the company follows a company is run according to the direction of its directors. Directors also have the mandate to exercise all the powers of the company under Corporation Act Section 198C including the capacity to contract. Despite this, the company may argue that its constitution limits the powers of the two directors and prevents them from entering into contracts above $40,000. In view of replaceable rule 2, in the Corporation Act allows companies to limit the powers of directors to act on behalf of the company and therefore this is a valid argument for the company to exit the contract entered on its behalf by Ian and Anne. However, if the company is allowed to make this argument Vinotec Ltd may lose the equipment supplied to Windy Willow Winery Pty Ltd or make losses incurred in supplying the same. Due to this problem Vinotec ltd is allowed to rely on the assumptions in the Corporation Act Section 129 that Ian and Anne as directors of the company were adhering to the company constitution and replacable rules in purchasing the equipment on behalf of the company. Similarly, the Royal British Bank v Turquand (1856) 119 ER 886 helped establish the principle of the indoor management rule. In Northside Development Pty Ltd v Register-General (1990) people dealing with a company are allowed to make assumptions that its internal management is in order1. However, Vinotec’s reliance on the assumptions in the Corporation Act Section 129 is limited by conditions set in Corporation Act Section 1282. In this Corporation Act Section, if Vinotec had actual knowledge or implied knowledge that Ian and Ann did not have the legal capacity to enter into transaction above $40,000 on behalf of Windy Willow Winery Pty Ltd, then they cannot rely on the assumption in Corporation Act Section 129. Step 4: It can be concluded that Windy Willow Winery Pty Ltd has a binding contract with Vinotec for the purchase of the Wine Presses and other winery equipment. It is clear that both Ian and Anne had the legal capacity to enter into contract on behalf of Willow. Although, they contravened the company constitution by entering into a contract with Vinotec of $50,000 well above the limit of $40,000 this would not have been apparent to Vinotec. In this case, Vinotec is able to rely on the indoor management rule or the assumptions in Corporation Act Section 129 to maintain that he has a legally binding contract with Windy Willow Winery Pty Ltd despite the fact it contravenes the companies constitution. Therefore, Vinotec is able to rely on statutory protection for creditors who may be fleeced by companies that enter into transactions and later deny that the person who acted on their behalf lacks the legal capacity to bind them to the contract. Bibliography Corporation Act 2001, cth Latimer, Paul. 2012. Australian business law. Sydney: CCH Australia Limited. Northside Development Pty Ltd v Register-General (1990) Royal British Bank v Turquand, (1856) 119 ER 886 Woodgate v Fawcett [2008, NSWSC 868 Ziade Investments Pty Ltd v Welcome Homes Real Estate Pty Ltd [2006] NSWSC 457 Read More